Part IV: Business Practices—A major, modifiable driver of healthcare costs. Entry 21 - 2009

In the previous blog, we covered three out of the four drivers of healthcare costs:
1) Basic costs & bad luck;
2) Demographics and labor market; and
3) Health status.

We learned that #1 and #2 account for a portion of healthcare costs that are non-modifiable, and that health status is a less influential driver than one might expect.

We move to the final driver of healthcare costs, which is both modifiable and significant, but unfortunately too often overlooked: business practices. What do we mean? Business practices are the entire set of employee policies and practices captured in everyone’s workplace environment and employment contract—such as how compensation works, how health benefits are structured, how time off is allotted, how employees are trained and managed, etc. In combination, these practices have amazing influence over employee behavior. (This topic has been touched in previous blogs and will not be surprising to regular readers.) However, the magnitude of business practices’ influence on employee behavior catches most people off-guard.

The bottom line: business practices can have three times the impact on cost as health status. First, some history. If business practices matter so much, why haven’t we heard about them before?

• Actually, you probably have, just not in one place. Most of these effects are well-documented.


• Actuaries have decades of evidence showing the impact of deductibles and copayments; however, it is usually seen as differences in cost-sharing arrangements rather than behavioral incentives (1, 2).


• Management and compensation journals highlight many ways that rewards impact worker performance and withdrawal (3, 4).


• Risk management professionals understand that worker satisfaction influences the rate of accident and injury (5).


• Disability carriers clearly understand the relationship between insurance policy design and the rate of claim submission (6).


• Experts in talent development know what sorts of advancement opportunities help an organization keep its top workers.


• Health economists have documented the use-it-or-lose it phenomenon of both sick leave and annual deductibles (7, 8).

So, the evidence is everywhere, but each piece of it typically remains stuck in separate fields. And because this information is so seldom captured and integrated from so many different sources, the impact of independent cost drivers has been nearly impossible to measure, until now.

Economics tell us that incentives matter.
Simply put, if we align business practices such that employees can earn more rewards for being more productive, and get extra value by avoiding absences, both are more likely to happen, no matter what the health status of the group. On the contrary, if employees perceive little reward for higher productivity and have to take absence days in order to avoid ‘losing’ them, workers are more likely to be absent, REGARDLESS of their overall health status.

Thus, when we examine the full array of business practices, a combination of aligned compensation, benefits design, training, and management practices can influence healthcare and disability costs by as much as 30% or 40% compared to misaligned business practices. (Remember, improving health status (Part III) by 10% only produces a 10% cost improvement opportunity.)

A typical example is shown in this figure (click to enlarge) where medical and absence costs are separated along the lines of the categories discussed above. This is a hypothetical “organization” with typical business practices we commonly see in large corporations. As expected, there is a significant cost component attributed to Basic Costs and Workforce Demographics (Parts I & II). Also notice that there is potential to reduce costs through a 10% health status improvement (Part III). But of critical importance, our models indicate that the vast majority of their modifiable costs (which account for 39% overall) are attributable to their business practices (28%).

While the effect of business practices may seem large (in some cases up to 40%), recall that we are talking about a combination of many different business practices. In the RAND health insurance experiment, the effect of a larger deductible by itself was a 40% difference in medical costs (1). Here we are talking about policies and incentives governing healthcare coverage, paid time-off, compensation, disability, training, and other things. Given the cumulative influence of all these incentives combined, we should not be surprised that their sum is dramatic.

Which business practices matter most?
The truth is they act in combination because they are interrelated in fundamental ways. The easy answer is that we need to align them all. But which one is MOST important for a given organization depends on what they are already doing right. Compensation design influences benefits use, absences policies influence medical costs, training practices influence turnover, and so on. In other words: cost drivers that are sometimes considered to be unmodifiable (in the sense that they are immutable) are really influenced by the modus operandi (management practices) of the business and therefore are really modifiable.

In separate blogs, we have explained that business practices have measurable impact in several areas, such as:

• PTO plans and buy-back plans (versus strict sick leave) improve attendance.


• Variable pay plans improve retention, absence and benefits use.


• High deductibles combined with fully-funded HSA plans reduce costs and improve health protection.


• Our new models confirm that aligned business practices are predictive not only of benefits cost, but also productivity and turnover. And, from all indications, better aligned business practices also enhance employee engagement and health program participation.

All aspects of human capital management are connected. How you reward, train and manage people has a stronger effect on business performance than you may think. This is no longer simply a health benefits issue, but a critical discovery that points to affordable solutions that have a demonstrable effect on business performance. Further, if a company’s sole strategy for controlling medical and disability costs is focused on health improvement or value-based purchasing strategies, the largest part of the cost-savings opportunity will be missed.

Why this matters: Employers invest billions of dollars in health improvement and health management to try to control costs. Yet many employers overlook an even larger opportunity to reduce benefit costs by aligning incentives with their business practices in ways that do not require additional investments. Ignoring such obvious opportunities leaves huge potential for business performance unrealized.
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References
1. Newhouse JP. Free for All? Lessons from the RAND Health Insurance Experiment. Cambridge, MA.: Harvard University Press, 1993.

2. Manning WG, Newhouse JP, Duan N, Keeler EB, Leibowitz A. Health insurance and the demand for medical care: evidence from a randomized experiment. Am Econ Rev 1987;77:251-77.

3. Lazear, EP. Performance Pay and Productivity. American Economic Review 2000;90(5):1346-61.

4. Trevor CO, Gerhart B, Boudreau JW: Voluntary turnover and job performance: curvilinearity and the moderating influences of salary growth and promotions. J Appl Psychol 1997;82:44-61.

5. Butler RJ, Johnson WG, Côté P. It pays to be nice: employer-worker relationships and the management of back pain claims. Journal of Occupational & Environmental Medicine 2007;49(2):214-25.

6. Health as Human Capital Foundation. Money matters in decisions about disability. September 27, 2005. Accessed October 11, 2009.

7. Keeler, EB, Rolph, JE. The demand for episodes of treatment in the health insurance experiment. Health Econ 1988;7(4): 337-67.

8. Ehrenberg RG, Ehrenberg RA, Rees DI, Ehrenberg EL. School district leave policies, teacher absenteeism, and student achievement. J Human Resources 1991;26(1):72-105.