After several consecutive years of double-digit premium increases, employer-sponsored health insurance is again coming under intense scrutiny in the United States. But a remedy might be emerging in the form of consumer-driven health plans. This new type of insurance combines a high-deductible policy¹ with a tax-exempt health savings account (HSA) and gives consumers more responsibility for managing their spending on health care.² Early results suggest that these plans could slow the rise in costs by lowering demand and prompt hospitals and other medical professionals to improve the quality of care.

Efforts to reform the US health care system aren't new of course—rising costs have sparked major reforms in each of the past several decades (Exhibit 1). Although none succeeded in controlling cost increases for more than a few years, they have cumulatively reshuffled the competitive positions of payers (mainly insurance companies) and providers (doctors, hospitals, clinical laboratories, and drug companies). The United States might now be on the cusp of another big change as high absolute levels of health spending and continuing annual premium increases make health benefits less and less affordable for employers and employees alike.

For the first time since the introduction of employer-funded health premiums during the Second World War, the government is authorizing health insurance plans that are consistent with efficient markets. These plans at least partially end the third-party-payer system and force people to make economic trade-offs between consuming more health care and other goods and services. With the ability to accumulate unspent funds and invest them tax free, consumers have a strong incentive to avoid unnecessary care and to become more cost conscious when they do seek treatment. Medical providers, in turn, will be increasingly pressured to improve the quality of care and service they offer to consumers while maintaining competitive prices.

The success of the plans in restraining the cost of medical care will depend partly on how they address the problem of the growing number of people suffering from chronic diseases—people who, according to some critics, would bear an increased financial burden under HSAs. Besides introducing some form of individual economic accountability, the plans will therefore have to tackle the underlying controllable causes of conditions such as cancer, diabetes, heart disease, hypertension, and obesity and to offer rigorous disease-management support for patients. Otherwise HSAs, whose underlying principles are essential to transforming the delivery and financing of US health care, may not have enough political support to become a long-term solution to the problem of rising medical prices.

The pace at which consumer-driven health plans will be adopted is far from certain. According to one survey, the employers of 40 percent of the commercially insured population are "somewhat likely" or "very likely" to offer HSA plans by 2006.³ Although no one knows how many subscribers will actually sign up, some research indicates that as many as 25 percent of all commercially insured people will enroll in consumer-driven health plans by 2009. Many of the nation's largest payers are already exceeding their enrollment expectations in these types of plans for January 2005. Regardless of how fast they are adopted, we believe that acceptance by even 15 to 20 percent of the insured population will prompt fundamental changes in the businesses of payers and providers.

While payers seem to have responded more quickly, neither group has explicitly realized how drastic the effect on its business systems will probably be. Payers will need not only to develop innovative products but also to build skills in asset management, individual underwriting, and the integration of payments from a number of sources. In addition, they will have to help consumers understand the provider options, the prices, and the quality of the services available. To acquire these skills, many payers could pursue partnerships with third parties such as financial-services firms. Providers, for their part, will have to learn how to compete on the basis of value in a more transparent marketplace requiring a greater focus on clinical quality, service, responsiveness, and productivity. New health care intermediaries will likely emerge to rate the quality and service levels of care, to advise consumers on their choice of treatments and providers, and to manage their health savings vehicles. In short, the basis for competition and the competitive landscape could change substantially.

The rise of the consumer

US health care premiums have continued to escalate as a result of three basic problems: third-party payers that insulate consumers from the financial implications of their health care choices, a lack of transparency in the quality of care and in the prices providers charge, and a reimbursement system that rewards activity over outcomes.⁴

In addition, there was a backlash during the 1990s against so-called managed care, which had been intended to give insurance companies more control over what services they would reimburse. The result of such criticisms was a series of government-mandated stipulations on matters such as the minimum length of stays in hospitals and guaranteed access to care. These developments hindered the payers' ability to hold down medical costs and reduced the employers' willingness to control or limit the consumption of health services directly.

The search for at least a partial answer to these problems is becoming ever more urgent because average annual health insurance premiums have more than doubled over the past ten years, to more than $10,000 for a family of four enrolled in a preferred-provider organization (PPO).⁵ As a result, many employers, particularly small ones, no longer offer their workers any coverage at all. Employees, meanwhile, pay an average of 28 percent of their family premiums, or $280 a month, for PPO coverage. That expense has prompted many workers to opt out of employer-sponsored plans and to go uninsured or buy coverage on the open market for catastrophic events only. Employed men and women have accounted for most of the growth in the number of uninsured people since 1999. Indeed, of the uninsured, nearly two-thirds (almost 30 million people) are employed workers earning more than $25,000 a year; half of those earn more than $50,000.

The new HSAs differ significantly from previous health savings instruments in one respect: the ability to accumulate unspent funds on a tax-preferred basis. Instead of the "use it or lose it" provisions of earlier plans, an HSA allows consumers to keep unused money by rolling over the balance from year to year; they can also move an account from one employer to another. In addition, they can invest HSA funds in a wider array of investment instruments and shelter the capital gains from taxes. After a certain age, they can spend the accumulated funds on items other than health care. A majority of commercially insured US households today spend less on health services than the annual $1,500 to $2,000 deductible that would be part of an HSA, meaning that these households would pay for most or all of their health expenses directly out-of-pocket or from their HSAs. (Beyond the deductible, the insurance company pays for health services, though it might charge consumers a 20 percent coinsurance fee up to an out-of-pocket maximum for the year.)

Thanks to these features, healthy consumers who avoided buying insurance because of its cost may now enter the system, and many consumers will have a strong incentive to become more discriminating in the way they choose health care. They will avoid what they perceive to be unnecessary services and become more cost conscious when they do seek treatment—choosing cheaper generic drugs rather than branded ones, avoiding expensive facilities such as emergency rooms, and showing more discipline about visiting doctors in the payer's medical network. Payers and providers must prepare for these changes and move swiftly to devise appropriate strategies.

Payers: Responding to new competitive threats

Payers that regard the challenge now facing them as merely the need to develop and market this year's insurance product will be found wanting if consumer-driven health plans gain in popularity. In reality, the payers will have to deal with the changing influence of various players in the value chain as well as a potential reordering of the current winners and losers. Success will involve making strategic choices, developing new operational skills, or forging new alliances and partnerships to gain needed capabilities.

Initially, payers will have to decide whether to play a shaping role—driving the pace and extent of the migration to consumer-driven health plans—or to be fast-followers if the plans take off. To decide which role to play, the payers must assess their tolerance for risk, their desire to lead and innovate, the inherent capabilities of their organizations, and other pending challenges, such as a need to improve current performance substantially. For the national payers in particular, a shaping role may turn out to be the way they have been seeking to improve their position against strong regional players, such as the Blue Cross and Blue Shield Association organizations, whose high local market share has assured them a greater influence with the providers over pricing. Although first movers incur more risk if consumers don't adopt the new plans, creating direct consumer relationships does hold the potential of higher returns. Moreover, if it turns out that consumers don't want to switch HSA accounts frequently—and they don't do so for bank accounts and 401(k) assets—leadership could provide powerful benefits.

Other payers, such as the Blues, may be tempted by a wait-and-see strategy, but that could be dangerous. Their traditional strengths have derived from lower unit prices paid to local providers, but this advantage may not be enough to offset the dramatic fall in consumption by newly accountable consumers. After three to four years of what employers often considered exorbitant premium increases, many will value a new way to manage costs.

Whether leader or follower, payers must choose their form of competitive differentiation. One company might decide to compete on the basis of technology, offering seamless integration between claims, payments, and asset management. Another could offer advanced information tools that provide data on treatment options and the quality of providers and thus help consumers to get the best care and to reduce unnecessary spending. Some payers might be able to compete, as they do today, largely on the strength of lower-cost networks of providers. But this position is less likely in the future, since the key buying factors of many employers and consumers will be total medical costs (depending on unit costs, the mix of services, and volume) and total value (depending on the quality of the consumer experience, medical outcomes, and prices). In the brokerage industry, the large national firms beat out regional participants by building better technology and consumer brands—an approach that might succeed among health care payers as well.

Next, payers must decide on their role in the value chain. They can opt to be full-service providers, integrators (entering into partnerships with other institutions to create offerings), or components suppliers to others. The choice will depend on the current market share and influence of the payer, its technological capabilities, its credibility with potential partners, and the strength of its balance sheet. Most large commercial payers will likely become integrators, assembling the skills they need through partnerships or outsourcing arrangements. That approach would allow these companies to control the customer relationship and the provider network and help them develop superior skills in both areas.

Finally, payers must decide whether to treat HSAs as a separate set of products, distinct from the core operating platform, or to transform the platform. They should base the answer on their view of how rapidly and extensively consumers are likely to adopt the new plans. Either way, certain operational capabilities will be required. An HSA plan must specify funding and asset-management options: will employees make a defined monthly contribution or contribute whenever they wish, for instance, and will employers match their contributions? The plan must also specify investment options for HSA balances. Underwriting too will be more challenging: payers won't have reliable histories of medical claims for several years or data accurate enough to predict which people would be most likely to choose a consumer-driven health plan or how their behavior might be altered after they did.

Consumer-driven plans will also force payers to develop more sophisticated administrative capabilities than they now possess. For one thing, they will have to report HSA balances to employees on demand and, preferably, in real time, much as ATMs enable bank customers to see account balances. And they will need to introduce more sophisticated payment mechanisms that draw the correct amounts from four different sources of funding (primary and secondary insurance, HSAs, and the employee's pocket). Debit cards that draw directly on HSAs are already beginning to emerge. In addition, payers might need to create controls, preferably at the point of sale, to ensure that subscribers spend tax-deductible funds on approved medical expenses (even though, legally, that responsibility rests with the individual and the Internal Revenue Service).

To develop these capabilities, payers are pursuing partnerships with companies, from outside the industry, that already have them (Exhibit 2). "Infomediaries"—businesses that can advise consumers about their complicated treatment and provider options—would be one type of potential partner. In other industries (such as automotive, financial services, and personal computers), independent agents have emerged to give consumers information about the technical performance, reliability, customer satisfaction levels, and, of course, prices of products and services. These agents are now starting to emerge in health care. Partnerships with such independent advisers might help payers to overcome the consumers' current lack of trust in them.

Financial-services providers could also be suitable partners, bringing investment expertise, customer-reporting capabilities, and advisory skills. As many as 20 financial institutions are set to market HSAs, in much the same way they do individual retirement accounts, 401(k)s, and 529 plans for educational expenses.⁶ Although these companies will threaten the payers' traditional customer relationships, they could become valuable partners.

So too could third-party payment integrators. The ability to manage a number of streams of payments during a single episode of care by seamlessly drawing them from the sources and delivering them to health care providers will be essential to success. Some providers assert that they would accept a sizable—say, 10 percent—cut in their reimbursement levels in exchange for rapid, accurate, dependable, and easily administered third-party payments.

Payers will need to make these strategic choices and start developing the necessary operational skills relatively quickly. Several relationships already emerging among payers, asset managers, and banks will prevent latecomers from locking up the best partnerships. In addition, once employers make "shelf space" for consumer-driven health plans and people begin to adopt them (even if slowly), there will probably be some reluctance to change payers, because of the high cost of switching. (The problems might include learning how to compare the providers' quality, service, and prices on a payer's Web site or linking a debit card to an HSA.) Such factors will create barriers to entry for late movers.

Providers: A spotlight on value

Equally daunting challenges face the providers. If even 20 percent of consumers become more discriminating about their health care spending by choosing an HSA plan, the basis for competitive advantage will shift from scale to delivering high-quality care at a reasonable price. Over the past decade, some providers have focused on growing in scale and on building high local market share in hopes of extracting higher payments from payers. In the future, they will need to show that the prices they charge consumers reflect value. Niche players—such as independent ambulatory surgery centers, diagnostic-imaging centers, and commercial laboratories—that can demonstrate comparable quality at competitive prices will become even more attractive.

Early results suggest that most of the cost savings come from consumers who forgo treatments they deem unnecessary and switch to lower-cost providers. Branded pharmaceuticals have already been hit by current insurance plans that give consumers incentives to choose generic drugs. The next victims of change could be high-cost hospitals that over the past three to four years have used strong local market share to obtain double-digit increases from commercial insurers but don't offer consumers truly distinctive services.

Competition among providers will increase as the geographic limits defining health care markets recede. Today, some people drive to airports more than 100 miles away to save $350 by taking cross-country flights from low-cost carriers. These people will probably travel comparable distances to save two or three times that amount on medical procedures, particularly planned acute-care ones: a 20 percent coinsurance payment means that consumers who choose facilities that charge $15,000 rather than $20,000 for a service could save $1,000 in out-of-pocket expenses.

Many providers will be tempted to respond to these challenges by slashing prices. The more successful, however, will find other ways to compete. First, providers must create clear value propositions for different customer segments. They will need to understand what different segments will pay for each type of service and how their competitors set prices. Strategies similar to those found today in ophthalmic and plastic surgery are likely to emerge. In these medical specialties, there is an enormous amount of direct-to-consumer advertising and widespread knowledge of price points ("Did you know that Dr. X can do it for $600 an eye?"). Physicians make liberal use of testimonials from patients. Service, ease of scheduling, and aesthetics are often extraordinary as compared with what traditional providers offer. Consumer-financing options are usually available at the point of sale, and top physicians market experience and the quality of outcomes as the central components of their brands. These providers realize that to be successful, they must communicate effectively and compete rigorously on the basis of value. And since many consumers will want to know the coinsurance payment before selecting a medical facility, hospitals will need to review the way they price services and then communicate their prices quickly and reliably.

In a sector where large price differences persist—some providers charge 50 percent or more than competitors in the same community for essentially the same service—consumers will likely demand evidence of better quality and service in, for example, recovery times, waiting times, and technology. Providers, we believe, will focus on specific consumer segments and occupy different positions in the market. Low-cost, no-frills, acceptable-quality care might be found at one end of the spectrum and high-technology, amenity-rich, personalized care at the other.

Second, providers must upgrade their operations, including safety for patients, adherence to evidence-based standards of care, and the measurement of outcomes—all metrics that regulatory agencies, the government, and many employers already follow—to deliver a certain quality of care consistently. We believe that the substantial price differentials in today's market will lead discriminating consumers to seek overall value and, hence, better quality and service.

Finally, providers must upgrade their collection capabilities; for some of them, unpaid consumer bills already amount to 10 percent or more of net revenue. Part of the problem is the uninsured, but much money is lost trying to sort out deductibles and co-payments for insured patients. Consumer-driven health plans will make payments even more complex and add a potential third party—the asset manager overseeing an HSA—to the equation. To succeed, providers will have to create accurate and simple price lists, immediately determine balances due, train frontline employees to solicit payment in a professional and sensitive way, process many daily transactions involving small sums, and deal with delinquent accounts by borrowing best practices from other sectors, such as credit cards and automotive lending. The transformation will require a much greater focus on what happens at the front line of the hospital: maximizing revenues will have less to do with who conducts the negotiations with commercial payers and more to do with who supervises the admissions clerks.

Whatever the take-up of consumer-driven health plans, a fundamental reorientation of the health care business toward the consumer is already under way. Payers will have to make choices that could decide their longer-term role and economic influence in the market. Providers face extraordinary demands on their operating effectiveness as they attempt to compete on the basis of value in a world increasingly focused on price, quality, and service transparency.