For more than three and a half decades health care expenditures in the United States have grown at a much higher rate than those in other wealthy nations. Although this trend has moderated in recent years, most observers believe that expenditures, which by international standards are already high, will continue to rise. These increases will put more pressure on employers, employees, states, and the federal government, particularly on the public programs on which millions rely for their health insurance.

Evidence clearly shows that for the most part high prices historically have been the primary driver of this growth; moreover, it is evident the U.S. pays more than comparable nations for the same health care procedures, services, drugs and devices. In order to control expenditures, we must get a handle on price. As we summarize here and explore more fully in a separate Issue Brief, we believe that to gain control over price, policymakers should seriously consider rate regulation. Such an approach is traditionally used in the United States for essential goods like water and electricity and can be adapted to regulate the prices of health care goods and services.

Current Price Control Strategies Aren’t Working

Total health care expenditures in the United States are a product of public and private health insurance, as well as out-of-pocket spending. Price control strategies tend to be limited to specific types of insurance and fall into two basic categories. In public programs, principally Medicare, we have used systems of administered pricing like the Diagnosis-Related Group (DRG)-based hospital inpatient prospective payment system and the Resource-based relative value scale (RBRVS)-based physician payment system. However, these mechanisms have had limited impact on public spending, which continues to be driven by other factors such as enrollment, intensity of care, and volume.

Medicare payments are siloed by site of care, provider type, and distinct service type. When financial constraint is imposed on one silo, such as Medicare Part A, providers are able to shift care to a different, more lucrative silo, such as Medicare Part B, simply by shifting the location of care. Providers are also skillful at gaming payment systems, taking advantage of fuzziness among categories of services—such as the overlap among the DRGs—in order to increase the amount of payment they receive. Finally, to a great extent, direct and targeted controls over pricing have proven incapable of controlling either the volume or intensity of services, each of which increases expenditures. Moreover, while administered pricing can control discrete payments by one insurer relative to other payers, expenditures overall continue to rise. Constraint over prices paid by public insurers is a pyrrhic victory: overall expenditures remain relatively unconstrained.

The second principal strategy for controlling expenditures has been the use of market forces to drive down the price and cost of care. This strategy has faced a number of obstacles. Some health care goods and services, such as eyeglasses, are relatively simple; for normal vision correction, consumers can shop for deals and products are readily comparable. However, most health care is extremely complex, with multiple dimensions necessitating an extremely large number of choices. As a result, research shows that only a relatively small fraction of total expenditures are “shoppable” by ordinary consumers. Moreover, evidence shows that even relatively sophisticated consumers respond perversely to incentives to shop, failing to make price-driven choices or to differentiate between services that have value and those that do not. Therefore, consumers need the aid of experts—sophisticated purchasers—to act as agents for them.

Insurers possibly can act as agents for consumers but the evidence shows that consumers aren’t very good at choosing among insurers, and typically, whether at work or in the individual market, their choices among plans are relatively limited. Even relatively sophisticated consumers get overloaded by information and fail to understand basic features of health insurance such as coinsurance, deductibles and networks, particularly in health insurance markets in which state or federal regulators allow major product variation. Consumers need experts to choose insurers to act for them.

Employers have been the leading candidates to fulfill this role. However, over the past two decades, the proportion of the working-age population covered by employer-sponsored health plans has shrunk, now covering only about 60 percent of the non-elderly population. Moreover, only large employers and employer coalitions have the incentives and capacity—technical skill and market power—to act as agents for their employees and to control expenditures, and even large employers find themselves small fish in far larger markets driven by factors beyond their control, such as the underlying expense of medical care. Furthermore, to the extent that large employers might exercise some leverage over price and quality, most employees do not work for large, powerful employers.

Finally, and most importantly, payment in the United States is fractured across a horde of health insurance plans — more than one million health plans sponsored by private employers, thousands of plans sponsored by public employers, thousands of Marketplace plans, 51 state Medicaid programs offering scores of managed care plans, dozens of separate CHIP plans, and Medicare. The result is that within large geographic regions, no payer has the power or the incentive to control overall expenditures. This fractured approach to payment stands in stark contrast with those of other wealthy democracies, which pool risk through government sponsorship, government-regulated social organizations or both and which utilize other tools such as control over market entry of new technologies and negotiations with provider associations, to temper the underlying cost of health care. The result is that payment is coordinated, consolidating purchasing power to control price and expenditures. This collective purchasing power, coupled with numerous institutional means such as collective bargaining to elicit cooperation and to resolve conflict when cooperation fails, enable other countries to pay far less than we do.

If anything, the situation has gotten worse in recent years because markets in the health care sector are now concentrated. Most urban areas of the country are now dominated by a handful of hospital systems or even just one, and these systems are integrating with other provider sectors, such as hospitals’ purchase of physician practices. Additionally, almost all insurance markets across different types of products—group plans, individual policies, Medicare Advantage plans, and Medicaid plans and services—are sold in concentrated markets; and the evidence of the effect on those who ultimately pay—employees and taxpayers—is not good. Consolidation among providers increases prices paid by insurers and these prices result in higher premiums. Consolidation among insurers also results in higher premiums.

In short, we just end up paying more. One can reasonably conclude that our decades-long experiment with using markets to control spending has failed. It is time to consider seriously the mechanism used by other nations to control expenditures: rate setting.

State Rate Setting

State rate setting in the United States, when properly designed and implemented, has a strong track record, particularly in Maryland. Rate setting works because it consolidates the demand-side, thereby enabling the assertion of collective bargaining power and control of expenditures. Properly designed, rate setting can control health care prices and the volume and intensity of services. It also promises large administrative savings in that rates are transparent and standardized, in contrast to the current situation, which involves myriad conflicting, complex rules negotiated over a vast, fragmented payer-provider landscape.

Rate setting traditionally has been applied to public utilities, which sell standardized products for mass consumption, like water and electricity, and possess natural monopolies. By contrast, health care rate setting necessarily involves extremely heterogeneous goods and services that raise complex, important, and difficult quality issues. As a result, rate setting must pertain to some unit of payment that averages across types of services and patients, such as Medicare’s inpatient DRG-based system, which bundles an array of services into a single consolidated unit of payment, the DRG. However, setting payment units like DRGs allow providers to shift services to more lucrative settings not subject to fixed rates, and to increase either or both the volume and intensity of care. To prevent such behavior, global units of payment, encompassing broad ranges of activities or providers, are preferable. Maryland has recently shifted its hospital rate setting system to global budgets, as has Vermont’s all-payer Accountable Care Organization (ACO) system model. Massachusetts too has moved toward use of a global, fiscal constraint. Ideally, all types of services would be bundled within the global unit of payment; Vermont’s payment of ACOs represents movement toward this ideal and is designed to achieve other important aims such as coordination across the continuum of care.

There are other features that, although not essential, would make a rate-setting system more effective. For example, rates must be updated periodically, and to make the system truly prospective, this updating process must not allow all “excesses,” such as cost overruns, to be bundled into future rates but should instead include only those factors over which providers lack control, such as the costs of inputs. The system must include all payers because if some payers are allowed to opt out, the system cannot control overall expenditures. Additionally, as is true of Maryland’s system, waiver of Medicare’s normal payment rules, permissible under federal law, can act as an important constraint to fend off the demands of providers and local interests. Ideally, this type of system would not allow, or would tightly regulate, discounts to certain payers to avoid any appearance of favoritism, a factor behind the relative political stability of Maryland’s system, deemed fair and thereby legitimate to all stakeholders. The system must also be simple and transparent, again important to maintain the system’s legitimacy. Finally, stakeholders like insurers and providers must buy into the system without capturing it.

Properly designed rate setting has been successful in controlling expenditures in the United States and elsewhere. The recent demise of the Medicare Part B oncology experiment might suggest a political unwillingness to pursue ambitious plans to control prices, but given the trajectory of expenditures and its implications for national priorities, it is essential that the nation keep trying to get a handle on its health care expenditures. Although new enactment of rate setting is currently limited to three very blue states, this is not a blue state or red state issue but a major social crisis as health care expenditures crowd out other vital governmental investments in economic growth and infrastructure. Hopefully the Trump administration will encourage other states to move in this direction.

What we have been doing is not working. Rate setting should be high on the policy and political agenda.