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Controlling Health Care Costs


Roger I. Schreck

, MD, Merck Manual

Last full review/revision Mar 2020| Content last modified Mar 2020

Health care costs can be controlled or decreased only by using strategies that decrease the following:

  • How much people use health care services
  • How much providers are reimbursed for services
  • How much the overhead of running a health care business is (overhead excludes the costs of providing health care)

(See also Overview of Health Care Financing.)

Some ways of achieving these goals compromise quality of care while others may improve care. It can be difficult to predict the effects of major changes in the health care system. Often the effects are unknown until after changes are made. Ideally, cost reductions should not compromise quality of care.

  • Traditionally, insurance companies have limited access to health care as a way to control costs (a strategy that is decreasing because of requirements of the Affordable Care Act).
  • Unnecessary health care is easier to define than to eliminate and even to recognize.
  • Whether strategies to improve health can reduce overall health care costs is unknown.
  • Many strategies used to decrease health care costs also have significant disadvantages.
  • Reducing overhead costs for insurance companies and health care providers and reforming malpractice laws may help reduce health care costs.

Some strategies have negative effects because they make obtaining needed or preventive care harder. Then disorders may progress, reducing the likelihood that treatment will be effective and leading to disability or even death. Other strategies may improve care.

Evaluating different strategies is difficult, partly because accurately measuring what effect strategies have on the people treated is difficult. Such measurement is expensive and must involve the evaluation of many people, who must be monitored for a long time. As a result, most measures used to assess health care quality reflect how care was delivered rather than how it affected the health of the people treated over the long term. How well care was delivered may not correlate well with how well care helps health over the long term.

Decreasing the Use of Health Care Services

Strategies for decreasing the use of health care service include

  • Limiting access to care, which may prevent unnecessary care but may make getting necessary care more expensive, difficult, or impossible
  • Limiting need for care, by improving health and preventing disease

Limiting access to health care

Traditionally, limiting access has been the strategy used to limit health care costs.

Insurance companies previously limited access to care by refusing to cover people likely to need care (such as those with a preexisting disorder) and by stopping coverage of people who use many health care services. In the United States, the Affordable Care Act has prohibited these practices.

The government may make qualifying for medical assistance programs more difficult.

Insurance companies may increase the amount people have to pay themselves. For example, payors may

  • Limit the type and number of visits that are reimbursed (for example, for mental health care or physical therapy)
  • Increase deductibles and co-payments
  • Decrease the amount that they will pay for specific procedures

Thus, people have financial incentive to limit their use of health care.

These strategies probably negatively affect health because many people will avoid necessary as well as unnecessary care. For example, prior to the Affordable Care Act, many people who needed a flu (influenza) shot did not get it, and women may have avoided screening tests, such as a Papanicolaou (Pap) test or mammography. However, coverage of these and other preventive practices is required in Affordable Care Act health plans.

Some insurance companies have complex procedures for getting care. They may require approval for tests, referrals, and procedures. They may limit which doctors people can use. Enrollment procedures and regulations may be complex. Such administrative red tape may slightly decrease the use of health care.

Limiting access to health care can cause problems. For example, people who are denied access to health care insurance may become seriously ill (which is more likely when routine care is lacking). Such people are often treated in a hospital when a disorder is advanced. They often cannot pay for this care. The care is then paid for by the people who pay into the health care system and may be more expensive than if routine care had been provided all along.

Eliminating unnecessary care

Unnecessary care is easy to define (care that does not improve health), but it is often difficult to recognize and even more difficult to eliminate. To help recognize unnecessary care, researchers need to do studies that compare the effectiveness and cost-effectiveness of tests, drugs, and other treatments. Other factors that affect health may also be studied. These factors include exercise, physical therapy, and different providers, systems, settings of care, and reimbursement systems.

Using guidelines for evaluation and treatment, provided by various organizations, can help health care providers use the best approach to a disorder and thus avoid unnecessary tests and treatment. However, guidelines are available for only a limited number of disorders and are not always clear or helpful. Also, guidelines from different organizations may differ.

Better coordination of services among health care providers (see Continuity of Care) may make evaluation and treatment more efficient. For example, better communication and use of electronic medical records can eliminate unnecessary duplication of tests.

About one third of overall health care costs occur in the last year of life, when expensive treatments may be used to try to prolong life. Often, these treatments greatly increase discomfort and dependence and may prolong life for only a short time (see Treatment Options at the End of Life). Care that focuses on relieving symptoms (palliative and hospice care), rather than prolonging life, is often more useful during this time. People can request this type of care in documents called advance directives. Requesting palliative and hospice care may help decrease use of expensive, often technology-intensive care.

Improving health

Increasing use of relatively inexpensive services that help prevent disease may decrease the later need for expensive treatments. For example, screening for, diagnosing, and treating high blood pressure and high cholesterol may help people avoid having a heart attack or a stroke. Thus, these people would not need treatments such as angioplasty to clear blocked arteries. Screening for breast and colon cancer may find cancer at an early stage and help people avoid costly treatments for late-stage cancer (as well as increase their chance of surviving).

The Affordable Care Act requires insurance companies to cover certain defined preventive services without sharing the cost with patients.

Strategies to increase preventive care include

  • Increasing the number of primary care doctors, who can often provide appropriate screening measures and help prevent complications, which often require expensive treatments
  • Eliminating co-payments for preventive services
  • Providing free preventive services, particularly for needy people
  • Financially rewarding health care providers for following preventive care guidelines (called pay-for-performance measures)

Decreasing Reimbursement for Care Used

Even when insurance companies and the government provide health care, they can limit how much it costs in several ways.

Lower fees

Insurance companies and the government may negotiate lower fees with hospitals and other institutions and with health care providers, or they may simply dictate such fees. In the United States, Medicare and Medicaid determine what they will pay for each service (reimbursement rates). These rates tend to influence those used by other plans. As a result, providers may be paid less for a service and thus charge less than if they were left on their own.

Increased use of primary care

Primary care usually costs less than specialty care.

One way to increase the use of primary care is to increase the number of primary care doctors. Several measures have been suggested:

  • Insurance companies could increase their reimbursement rates for primary care, encouraging medical students to choose primary care practice.
  • The government could provide more funding for primary care training (and less for specialty programs).
  • Primary care could be made more attractive for medical students by other means, although how this measure could be implemented is unclear.

Another suggestion is the patient-centered medical home. In this model, primary care doctors coordinate and integrate all medical care, including specialty and interdisciplinary care, in all settings (including the home, hospitals, and long-term care facilities). This model may decrease the use of unnecessary specialty care, duplicative care, and care that may be inappropriate for the person's health goals. For example, the person may want symptom relief rather than aggressive treatments to prolong life.

Prospective payment systems

In these systems, health care providers are paid a fixed amount regardless of how much care they provide. How this amount is determined varies. How much providers are paid is sometimes based on the person's diagnosis. In some systems, providers are paid a fixed annual amount to provide health care for a person regardless of the services that person uses (called capitated systems).

Prospective payment systems reward less expensive care and usually use fewer services than fee-for-service systems, in which providers are paid more when they use more services. However, prospective payment means that providers have no financial motivation to care for people with complex health problems, such as those who have several disorders or who are seriously ill. Thus, theoretically, necessary care may not be provided. Also, quality of care may decrease. Quality control systems (such as use of an organization that regularly reviews the care provided) are often also put into place to maintain quality of care.

Accountable Care Organizations

Accountable Care Organizations (ACOs) are groups of health care providers who agree to provide coordinated high-quality care to the Medicare patients assigned to them. The ACO is reimbursed based on measures of health care quality and reductions in the cost of care rather than on the volume of services it provides. When the ACO succeeds in providing high-quality care while reducing costs, some of those savings are shared with the ACO by Medicare.

Denial of claims

In the United States, unlike in most of the developed world, insurance companies (including Medicare) routinely deny many claims for services people have received. The denial rate averages between 5 and 10%. Some of the claims are paid after appeal, but appealing a claim is quite expensive and requires much time and effort for everyone involved.


Competition among health care providers for patients and among insurance companies for customers is thought to encourage a reduction in charges. For example, to attract patients, providers may charge less than their competitors for a similar service. However, people usually do not know the provider's charges in advance, and if they know, they often cannot act on this knowledge, partly because their insurance plans often limit them to certain providers and because they are limited in their ability to judge quality of care. Also, because the cost of medical care is subsidized for most people (for example, through employer-paid health insurance and tax deductions), they are less motivated to price shop than they are for most other purchases. Thus, competition is more effective in reducing costs and maintaining quality when it is among large organizations such as insurance companies, which compete for contracts from corporations or the government, or among hospitals, which compete for contracts from insurance companies.

Competition also contributes to health care costs (mainly administrative). Dealing with the many different rules for claim submission, evaluation, and many other services (such as referrals and coding) required by different insurance companies takes more time—for health care providers, their clerical staff, or both.

Decreased drug costs

Using generic drugs or, when appropriate, more cost-effective brand-name drugs can help decrease drug costs. Ways to decrease drug costs include

  • Teaching health care providers about how to use drugs in a cost-effective way
  • Limiting how much drugs are advertized and marketed to people and providers
  • Establishing rules for how hospitals and other institutions use drugs (thus limiting unnecessary use of expensive drugs)
  • Allowing the government to negotiate lower drug prices for people covered by government insurance
  • Allowing drugs to be imported from other countries for purchase in the United States

Negative effects on medical research

The efforts to reduce health care costs may affect medical research. The money that doctors and institutions earn from private practice allows them to participate in medical research. Similarly, the income from drug sales helps pay for research for new drugs by pharmaceutical companies. If this income decreases, less medical research may be done.

Decreasing Overhead

Overhead refers to the continuing expenses of running a business. In health care, it refers to the money that is paid into the health care system that does not pay for health care per se. It includes administrative costs, malpractice insurance, and profits for for-profit hospitals and insurance companies.

Decreasing overhead for insurance companies (including the government)

For government health care plans in developed countries (including the United States) and private health plans outside the United States, overhead costs usually represent 3 to 5% of total costs. Thus, 95% or more of all health care funds are used for health care.

However, in the United States, overhead costs for private insurance companies were about 20 to more than 30% of total costs, until the Affordable Care Act limited the amount that private insurance can spend on administrative costs by requiring at least 80% of premiums to be spent on medical care. Most of those administrative costs are generated by marketing and underwriting, processes that do not improve medical care. Also, the existence of numerous private insurance plans in the same geographic area typically increases health care providers’ costs by making processing (for example, claim submission or coding) complicated and time-consuming.

In addition to the Affordable Care Act minimizing overhead costs, the following may help limit such costs:

  • For health care providers, using standardized electronic health records
  • Obtaining insurance through government plans or possibly not-for-profit plans, which have lower overhead than for-profit plans

Competition among insurance companies is thought to encourage increased administrative efficiency, but it also motivates them to pay out less by denying claims and coverage (which adds to the need for a large administrative staff).

Decreasing overhead for health care providers

Any strategy that enables providers to reduce their administrative staff can help reduce their overhead. Having to deal with many different insurance companies, each with different rules for billing and claims, requires a large administrative staff. Thus, the following measures can help reduce overhead for providers:

  • Making the payment amounts and rules the same for all insurance companies
  • Requiring insurance companies to pay all bills submitted by health care providers
  • Making the cost of the same service the same throughout the country

These measures are used in some health care systems (such as in Germany and Japan),

Although malpractice costs are a small fraction of overall costs, malpractice costs for certain doctors can consume a considerable part of their annual income. Reforms that limit the number of suits and settlements should eventually lower premiums and benefit these doctors. Such reforms may also reduce the use of unnecessary, defensive medicine.

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