Not Just Squeezing the Balloon: A Comprehensive Set of State Strategies for Addressing Health Care Cost  

Focus Area:
Sustainable Health Care Costs
Topic:
Health Care Cost Growth Target Data Analysis Peterson-Milbank Program for Sustainable Health Care Costs State Policy Capacity

Abstract 

Health care is increasingly unaffordable in the United States. While comprehensive, affordable health coverage for middle- and low-income people is essential, the underlying problem is that US health care itself is too expensive.* High and rising health care costs harm families, employers, and state budgets. This brief expands on our New England Journal of Medicine  Perspective, “Addressing Health Care Cost Growth – Why and How States Should Lead,” which posits that states are best positioned to address what we refer to as “the balloon problem” — when policymakers or others push back on rising costs in one way, entities whose revenues are threatened find the dollars elsewhere. We argue that states must adopt four complementary approaches to health care reform that can both improve care and lower costs: (1) establish state agencies to track, analyze and report on all components of health care spending, establish statewide spending growth targets, and work to achieve them; (2) address the twin challenges of rural hospital sustainability and profit-driven expansion of many larger hospitals by shifting from paying hospitals based on fee-for-service methods to prospectively set global budgets; (3) provide a strong foundation of primary care and promote integrated, coordinated care by adopting population-based payment models for physician services, such as those used by accountable care organizations (ACOs); and (4) use rate-setting authority to regulate hospital, physician, ACO, and insurance rates where needed due to lack of competition. To be successful at reining in spending growth and improving health system performance, all four approaches should be implemented together and applied to all payers and all providers (the intent underlying the Centers for Medicare and Medicaid Services’ States Advancing All-Payer Health Equity Approaches and Development [AHEAD] total cost of care model). Because powerful interests will oppose this work, those who care about the future of health care will need to organize and lead the change.  

Introduction 

Rising health care costs threaten everyone and sectors of the health system itself such as safety net and rural hospitals and primary care practices. As we argue in our New England Journal of Medicine  Perspective, “Addressing Health Care Cost Growth – Why and How States Should Lead,” the prospects for near-term major federal reforms are low, but states have a tremendous opportunity to turn the tide and address the underlying causes of persistent health care cost growth. We ask state leaders to think systemically and act thoughtfully to build a system that can continuously learn how best to slow spending growth while improving health care. But first: a brief review of the harms caused by our current health system.  

The problem: health care in the United States is increasingly unaffordable 

The US health care system is seriously underperforming. A recent Commonwealth Fund report comparing the health system performance in 10 countries describes the US system as failing.1 Since 1980, US life expectancy has fallen relative to our peer nations and health care costs have risen dramatically (See Figure 1). US life expectancy lags peer nations by about 5 years; within the US, life expectancy differs by more than 15 years across counties and within many cities.2,3 The US spends twice as much on health care as its peers and about 50% more than the next most expensive country. Most of that excess spending is avoidable waste due to high administrative costs, the high prices caused by monopoly power, and avoidable low-value care.4 These high costs have made health care increasingly unaffordable. 

Figure 1: Health Care Spending Higher in US Than Other Nations While US Life Expectancy Lags 

The affordability crisis affects almost every household, especially lower-income ones. As health care costs rise, individuals pay more — both directly (lower wages, higher premiums, higher deductibles and copays) or indirectly – higher taxes. A recent report5 found that among US adults 74% were worried about being able to afford health care; 47% said it was hard for them now; 24% said difficulty paying for care in the past year; 25% said they had skipped or delayed care because of costs; 28% said they had difficulty paying for their prescriptions.5 Insurance does not solve this: 48% of insured adults worry about being able to afford their premiums. These burdens fall most heavily on the poor.5  

The indirect harms of high health care costs affect everyone. Investor Warren Buffet has referred to health care as “the tapeworm of American economic competitiveness.” Rising health care spending can lower overall economic growth and reduce the competitiveness of American businesses by raising costs and diverting resources from productivity-enhancing investments. Increasing government spending on health care contributes to higher taxes, more borrowing, or reduced spending on other goods and services (or all of these), thereby leaving less for individual or government spending on things that can more effectively assure “life, liberty and the pursuit of happiness.” 

Why can’t we control health care costs? The balloon problem 

The balloon problem. The easiest responses to the health care affordability crisis are to subsidize its purchase — usually with public funds — or to shift costs to somebody else, most often from employers to employees. Addressing rising health care spending directly is often like squeezing a balloon: as policy makers try to constrain spending in one area, those whose incomes are threatened simply seek additional revenue and profits elsewhere in health care. This dynamic, pervasive across all health care systems in the world, was the focus of a seminal 1990 article by economist Robert Evans.6 He summarized the problem as follows:  

“Control of health care costs is often portrayed as a struggle between external, “natural” forces pushing costs up and individuals, groups, and societies trying to resist the inevitable. This picture is false. Control includes strenuous efforts by some to raise costs, and by others to resist those increases, and/or to transfer costs to someone else.”  

Figure 2 highlights the depth of the challenge. Price constraints by public payers are not sufficient, for example, as providers may then increase prices for private plans and those plans may shift costs to individuals in the form of increased copays and deductibles. Innovative payment models — whether bundled payments or population-based payments that are negotiated between one payer and one provider — leave that provider free to increase the volume of profitable services delivered to other payers’ patients. Adding fuel to this fire is the increasing financialization of the US health care sector,7 which has enabled the greed of some8 to harm the well-being of those working on the frontlines of health care and, most importantly, their patients and the public.  

Figure 2. Cost Shifting in US Health Care 

Source: Fisher E. Reforming health care: the single system solution. NEJM Catalyst Innovations in Care Delivery. 2020;1(5).

Addressing the balloon problem: build state capacity to manage the total cost of care 

Why states? For now, they are best positioned to do so. The federal government can play an important role to the extent that it supports efforts to improve health system performance and is willing to help address the many sources of market failure revealed in the figure. But there are aspects of health policy (insurance regulation, tax policy, public health) where states play the central role, and the drivers of health care spending growth and inefficiency may vary by state. Without joint state and federal effort, the balloon problem cannot be solved.  

What states can do: leadership to drive system-wide improvement and a clear vision of the path. States are in the best position to lead the effort to improve the performance of their health systems. They can and have legislated to establish much of the legal authority required to collect and analyze needed data and to identify the sources of waste and the opportunities to improve system performance. The table below, from our New England Journal of Medicine Perspective, provides an overview of approaches. Many of these have been suggested by others and additional details on most can be found in recent reports.9-11 What we hope to add to the policy discussions is the necessity of a comprehensive approach. We believe that these reforms will be most successful if implemented not only as a package but also with full participation by all payers and providers. We recognize that this is no easy task, but with clarity about the goal and evidence from other states and models, this necessary change is possible. 

Table 1. State Policies That Could Collectively Slow Cost Growth and Improve Health and Care 

PolicyJustification
Comprehensive oversight and spending-growth targets: Each state should establish and adequately fund a state agency to track system-wide cost and quality performance, set spending-growth targets, identify drivers of cost growth and opportunities for improvement, and implement or recommend needed reforms.System-wide oversight, sound data, and understanding of state-specific drivers of cost growth provide the foundation for effective policy. Having the statutory authority to achieve spending-growth targets makes agencies’ actions more likely to withstand legal threats from groups and organizations that resist reform.
Hospital global budgets: States should work with Medicare to establish all-payer hospital global budgets that ensure both adequate local and regional access to needed facilities and services and their financial viability, gradually shifting resources to primary care and population health improvement, as possible.All-payer hospital global budgets shift incentives by rewarding health improvements, reductions in avoidable utilization, and increased efficiency rather than volume growth for high-margin services. Implemented properly, they can strengthen safety-net and rural facilities while reducing duplication in overserved markets.
All-payer accountable care organizations: All payers should be required to adopt aligned global payment models for physician-led organizations that can deliver comprehensive, coordinated primary and specialty care with accountability for quality and the total cost of care.Still the predominant payment model, fee-for-service payment rewards overuse, focuses accountability on each provider, and results in fragmented care. Providers receiving global payments for all their patients have powerful incentives to improve care and the necessary freedom to innovate.
Limit pricing power by means of effective regulation: States should adopt policies to preserve competition wherever possible. Where it is not possible, they should establish regulatory bodies authorized to review cost structures and effectively regulate prices as needed.
Consolidation and barriers to entry have led to decreased competition, lower quality of care, and monopoly pricing, especially for hospital services and prescription drugs. In such cases, regulation is essential for improving affordability and access to care.
Source: Fisher et al. Addressing Health Care Cost Growth — Why and How States Should Lead. N Engl J Med 2024;391:1271-1273. DOI: 10.1056/NEJMp2409365

Four Key Pillars for Reform 

A. An agency to provide comprehensive information, oversight and leadership on health care spending and quality 

The goal: effective limits on spending growth. Economists have long argued that the United States should follow the lead of many other countries by establishing firm limits on health care spending growth.12 A growing number of states have created more or less independent agencies charged with tracking the total cost of health care, setting spending growth targets, and taking steps needed to slow spending growth.  Some also include targets to increase the share of spending devoted to primary care and a focus on improving the quality of care. Spending targets are established using a multi-stakeholder process intended to align health care spending growth with economic and/or income growth. State performance against the target is reported annually, and spending data is analyzed to identify drivers of avoidable spending growth and policy approaches to addressing them. Eight states currently have health care cost growth targets13 and a playbook for implementing targets is available from the Milbank Memorial Fund.14 The growing consensus on the importance of all-payer, all-provider spending targets underlies their inclusion as a key component of the Centers for Medicare and Medicaid’s (CMS) States Advancing All-Payer Health Equity Approaches and Development (AHEAD) total cost of care model.  

The foundation for progress: a state agency with the charge and resources needed. To meaningfully slow spending growth and improve care, state agencies need authority, independence, adequate resources to provide evidence and insights, as well as tools to address the major drivers of spending growth identified. Attaining cost growth targets will be an iterative and ongoing process that requires focused and persistent data-driven leadership.   

The Massachusetts Health Policy Commission (HPC) was the first such agency and is a leading example of what is possible. The HPC is an independent agency governed by an 11-member board, with an annual budget of over $12 million. It is supported by its sister agency, The Center for Health Information and Analysis, which had a 2024 budget of over $30 million. The HPC oversees the spending growth target, and conducts extensive analyses of the drivers of spending growth, as shown in one of their recent reports.15 The commission has many tools at its disposal, including the authority to impose financial penalties on provider organizations that fail to meet spending growth targets and sufficient funding to develop policies and work with the legislature to implement additional reforms.  

B. Hospital global budgets 

Why hospital global budgets? Hospitals represent the largest single component of US health care spending (30.4%).16 They provide the technologies and facilities needed for the effective and timely diagnosis and treatment of emergencies and many diseases. Some of their services must be geographically accessible to all. At the same time, a large share of health care spending is due to avoidable hospital care and associated physician services,17 the high administrative costs associated with hospitals, and the excessive prices that many hospitals are able to charge due to monopoly power in their local, regional, or national markets. 

It is well documented that the current system of paying hospitals a fee for each service provided (FFS) exacerbates the current challenges of runaway spending growth and inequitable access to care. Under the still pervasive FFS paradigm, many rural hospitals struggle to provide access to essential services. Other hospitals, particularly in population-dense areas with higher-paying patients, are incentivized to maximize the volume of care delivered, particularly for high-margin services. (There are few billboards advertising a health system’s vaccination services.) 

Hospital global budgets offer an opportunity to realign hospitals’ goals for institutional stability with community goals of affordable access to high-quality services. By setting upper limits on the total cost of hospital care (both volume and price), they can support reallocation of resources to improve population health and overall health system performance. Hospital global budgets can also complement ACO payment models and increase competition among hospitals.18,19 State interest is growing and global budgets are also a component of the AHEAD model.19 

The current evidence: Maryland’s hospital global budgets. Maryland is the only state that has implemented all-payer global budgets for all of its hospitals under a long-standing federal waiver with Medicare that has been renegotiated several times.1  Maryland’s Health Services Cost Review Commission (HSCRS) sets annual target budgets for each hospital based on approved unit prices and projected volumes for inpatient and outpatient services and a target spending annual growth rate of 3.58%. If hospitals reduce their utilization rates (achieving savings), the HSCRS adjusts the prices paid to the hospital upward and the hospitals are allowed to retain those savings. There is an additional smaller financial incentive to improve the quality of care. Hospitals are also offered grants to invest in population health programs and there is a complementary program focused on improving primary care. The most recent evaluation found that the program reduced Medicare spending by 2.1%, hospital admissions by 16%, and emergency room visits by 6%.20 Based on recent reviews of hospital global budget programs20-22 and our understanding of the balloon problem, we suggest that legislators and advocates strive to include the elements listed in the sidebar above when pursuing global budgets. The next section discusses the importance of a parallel program for physician services. 

C. All Payer ACOs – or similar approaches to population-based payment for patient care 

Addressing the problems of inadequate primary care and care fragmentation: integrated, accountable care. FFS remains the dominant physician payment model. According to the most recent American Medical Association (AMA) survey,23 86% of physicians work in practices that receive at least some fee-for-service payments and 69% of physician revenue is derived from fee-for-service. Just as for hospitals, fee-for-service rewards increasing volume and specialist-provided care, while offering little or no support for care-coordination. ACOs were proposed24 and eventually implemented25 under the Affordable Care Act (ACA) to redesign payment to reward integrated, coordinated primary and specialty care that improved health and reduced costs. Payment is based on the number of patients cared for by the practice (adjusted for severity) and the quality and outcomes of the care provided. Examples include capitated payments and hybrid models that combine a per-member per month payment and some elements of fee-for-service. The essential element is that providers in ACO models are rewarded for improving health and reducing avoidable utilization.  

The current state of ACOs: progress, but not at the needed tipping point. Medicare, Medicaid, and commercial payers have all moved forward to varying degrees to implement ACO payment models: the AMA report found that 45% of physician practices participated in a commercial ACO contract, 38% in a Medicare ACO contract, and 30% belonged to a Medicaid ACO. And there is substantial evidence that ACOs can both improve care and lower costs, especially when led by physicians (as opposed to hospitals) and when they have a high proportion of primary care providers.26 Major barriers to progress include the diversity of organizational forms (each of which may have different requirements), the levels of risk that may be needed to motivate some organizations, and the longstanding problem of achieving all-payer alignment.27 The recent AMA report reinforces this point: only 30% of practice revenue was derived from any type of alternative payment model including both bundled payments and ACOs. Given the evidence that practices must have over 60% of their revenue from population-based payments to be able to implement the team-based care models recommended by the National Academy of Medicine’s report on primary care,28,29 the relatively modest impact of ACOs on costs is not surprising. 

All-payer ACO models would help but will require both federal and state action. We believe that the potential of all-payer ACOs to reduce costs and improve care is strong (if still unproven), especially when combined with hospital global budgets.19 Within a capitated model no longer completely dependent upon billing for each service, ACOs and their physicians would have the flexibility to innovate to improve the health of their patients and much more powerful and aligned incentives to do so.30 Both Medicare and Medicaid have been able to use their waiver authorities to support all-payer ACO models (as in Vermont), but voluntary participation by providers and payers limited the breadth of implementation. Resistance to making participation mandatory remains a challenge to effective implementation.

D. Regulation to preserve markets (where possible) and address pricing power (where needed)  

For commercially insured individuals – it’s the prices (stupid). There is considerable evidence from early studies,31 and states with cost growth target programs, that the fastest growing payer sector is private insurance and that the drivers of those trends are the rising prices of hospital inpatient and outpatient services and prescription drugs. 32 These findings are replicated in recent international analyses.33 For health systems this behavior makes economic and administrative sense: if negotiating leverage exists, raising prices is an easy way to increase profits (and less painful than reducing costs). Medicaid and Medicare establish their payment rates through rule setting, but rates are privately and confidentially negotiated for commercial insurance. Competitive markets work: when faced with competition, physicians, hospitals and insurers keep costs down — and improve quality.34 Many US markets, however, are already too concentrated to support meaningful competition. In 2017, this was true for 90% of hospital markets, 65% of specialist markets, 57% of insurer markets, and 39% of primary care marets.35 Consolidated providers gain negotiating leverage to obtain commercial rates higher than Medicaid or Medicare rates, sometimes by a factor of 3.536; commercial rates are also increasing faster.37The high commercial prices are justified, hospitals maintain, by their own increasing operating costs and public payer underpayments. But evidence does not support this assertion.

Regulations are needed to compensate for this market failure and some states are doing so. Some states have established regulatory policies to address hospitals’ pricing power. In Rhode Island, the Office of the Health Insurance Commissioner documented the contribution of hospital prices to rising commercial insurance premiums, and in 2010, capped the rate of growth of the commercial prices paid to contracted hospitals to Medicare inflation rates.11 The State of Oregon passed legislation in 2017 that prohibits hospitals from charging the state employee plan more than 200% of what Medicare pays for in-network hospital facility services and 185% for out-of-network prices, generating $100 million in savings for the state employee plan in the first 27 months of implementation.39 In Vermont, the Green Mountain Care Board has recently begun to exercise its authority to regulate provider prices, leading an affected health system to try to limit oversight authority from the Board.40 While regulation of prices is essential, it is not sufficient: in a porous system, price constraints can be evaded by increases in volume. And without guard rails such as incentives to improve care, rationing could be the easier path for both providers and payers.

Challenges, what might be done to address them, and the opportunity AHEAD 

In this brief, we have described the capabilities that we believe would enable states to meaningfully slow spending growth while improving quality, based on our review of recent articles and our own knowledge of the states that are leading these efforts. We recognize that these are aspirational goals — and that the political challenges of gaining the level of legislative support required to enact these policies are not to be underestimated. But without a goal, legislators and advocates risk aiming too low when the window of opportunity to achieve reform arises.  

There are both technical and political challenges to advancing the reforms that we propose, some of which are listed in the table below, accompanied by our responses.  

Table 2. Concerns That May Be Raised — And Our Responses 

Limitations of our suggested path forward Some responses
Many will be concerned that each of the proposed “pillars” of reform have yet to be proven effective at slowing spending growth or improving care.While each has some evidence of impact, we argue that these reforms are complementary and must be combined to achieve meaningful impact.
Federal policy changes may be required to slow rising prescription drug prices or enable states to enact “all-payer” reforms that include employers.Continued state spending growth analyses should help clarify the drivers of spending growth and strengthen the evidence base for federal reforms. 
Resistance to reform from those whose financial interests are threatened will be well-funded and pervasive:  their lobbyists will show up.Those who care about the future of health care must organize. With public opinion in favor of reform, winning against special interests is possible. 29
Opponents will claim that cost-containment results in rationing and the end of the biomedical innovation that will save future lives. Estimates of the magnitude of waste range from 25% to 50% of US health care spending. 30,31  Redesign is the alternative to rationing.
Even if these proposals are effective, slowing spending growth in a handful of states will not slow federal spending growth or address the budget crisis.If these efforts are successful in some states, others may follow.  Perhaps, as with the Affordable Care Act, even a single state can point the path forward. 

In the face of uncertainty, learning is the best path forward. The most effective way to address these concerns will be to prove through further state-level efforts that a combination of these approaches —and almost certainly others — can have a meaningful impact. We believe that the AHEAD model represents an important opportunity.44 CMS announced in July 2024 that Maryland, Vermont, Connecticut, and Hawaii have been accepted as participants, pending final negotiation on the details of each state’s agreement. The table below summarizes the alignment between our pillars and the AHEAD model. Clearly, AHEAD provides an opportunity for states to advance some or all of the ideas we discuss.  

Table 3. Health System Reform Pillar–AHEAD Alignment 

PillarAHEAD Components to Support
Comprehensive oversight and spending growth targets.The AHEAD model obligates states to live within negotiated state-level health care cost growth rates across all payers and provides funds to build state-level analytic capacity to conduct this work.  It also re-allocates more funds to primary care with a component called Primary Care AHEAD which provides care transformation activities, enhanced payments, learning collaboratives and data and technical assistance to participating practices 
Hospital Global BudgetsThe AHEAD model, drawing on the MD Medicare waiver, requires negotiated Medicare and Medicaid global budgets for inpatient and outpatient care  for participating hospitals.  At least one commercial payer will be required to participate by year two.
Mandatory All-Payer Accountable Care OrganizationsAHEAD does not require this but allows participation in CMMI ACO models and  AHEAD, and provides conceptual guidance for how Hospital Global Budgets and Accountable Care Models would interrelate financially.
Limit pricing power through effective regulation
AHEAD model has no explicit requirement for this.  But, developing hospital global budgets for Medicaid and commercial payers, accountable care oversight, and  meaningful enforcement of spending growth targets will all require states to develop this capacity. 

Conclusion: It Is Up to Us 

Health care costs can only be shifted or subsidized for so long before those paying the bills — the government, employer, or individuals — either run out of money or stint on other, more important expenses. With increasing rates of medical debt and poor population health outcomes, this is already happening in the United States. A comprehensive approach with all-payer, all-provider participation is essential to push back effectively against health care industry efforts to extract additional revenue from the American public.  

Whether at the state or federal level, health policy debates about comprehensive policies are usually dominated by those who prioritize a fundamentally different issue: how to preserve their dominance and maximize future income growth. Health systems, in particular, have become powerful economic and political players at both the state and federal levels. In focusing on their institutional interests (or those of the financial firms or others upon whom they depend for loans or investments), these health care systems — especially those granted non-profit status — are failing to deliver on their obligations to their communities. The financial rules governing their actions must be changed; players in the game should not be setting their own rules. 

We call upon the legislators and public officials who can set a different course, those on the frontlines of health care who came to this work to improve the lives of those we serve, and the advocates and community members who are willing to work for change to set a new path forward. It is up to us.

Funding Acknowledgement

This work was supported in part by a grant from the National Institute of Aging,  R01AG084611

Notes

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Citation:
Fisher ES, Koller CF, Colla CH, Berube A. Not Just Squeezing the Balloon: A Comprehensive Set of State Strategies for Addressing Health Care Cost. The Milbank Memorial Fund. October 2024.



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