There is evidence in California of a broad decline in health care costs to employment groups adopting managed care and managed competition--premium reductions up to 10 percent. National comparisons and utilization data generally confirm the beginning of lower costs. Large California medical groups and health systems have responded to pressure by finding ways to reduce costs and improve quality. While examples are encouraging, there is room for improvement. Two levels of competition have emerged and continue to evolve: carrier competition and delivery system competition. Each model has strengths and limitations, but the existing mix is driving down costs.

Studies of hospital demand and choice of hospital have used straight line distance from a patient's home to hospitals as a measure of geographic access, but there is the potential for bias if straight line distance does not accurately reflect travel time. Travel times for unimpeded travel between major intersections in upstate New York were compared with distances between these points. The correlation between distance and travel time was 0.987 for all observations and 0.826 for distances less than 15 miles. These very high correlations indicate that straight line distance is a reasonable proxy for travel time in most hospital demand or choice models, especially those with large numbers of hospitals. The authors' outlier analyses show some exceptions, however, so this relationship may not hold for studies focusing on specific hospitals, very small numbers of hospitals, or studies in dense urban areas with high congestion and reliance on surface streets.

Increasing levels of HMO activity may influence health expenditures in other sectors of the market. Medicare provides FFS coverage to the majority of its beneficiaries and may thus provide a way of examining these so-called spillover effects. This paper examines 1986-1990 Medicare FFS expenditures at the county- and MSA- levels, coupled with county- and MSA-level measures of HMO market share. Fixed-effects and IV estimates of the relationship between market share and expenditures are presented. All of the models imply that FFS expenditures are concave in market share and that expenditures are decreasing in market share for market shares above about 18%. Many of the estimates suggest that expenditures become decreasing in market share at much lower levels (between 0% and 10%). Fixed-effects estimates imply that increases in market share from 20 to 30 percent would be associated with expenditure reductions of 3.4% -6.6% in Part A expenditures and 2.5% - 5.6% in Part B expenditures. IV estimates imply larger responses. The results are consistent with the hypothesis that managed care can affect non-managed-care expenditures.

In today's competitive health care markets, market forces are motivating large innovations in cost reduction and customer service improvement. Government programs, on the other hand, are often associated with waste, complexity, rigidity, and coercion. Thus, there are important advantages to be gained by leaving resource allocation to the private market. But market forces in health care if left unchecked can produce undesirable results. Therefore, collective action at some level is often needed to correct these problems. In some cases, there is no alternative to government intervention; in others, with appropriate rules and incentives, collective action in the private sector may produce the desired results.

Market forces will not produce universal coverage, because some people cannot reasonably afford coverage, and others are motivated to take a free ride (by the cost of coverage, the availability of the safety net, and the easy access to coverage if there is guaranteed issue without exclusion of coverage for preexisting conditions or waiting periods), Thus, to produce universal coverage, the market needs to be supported by a system of incentives, subsidies, or possibly compulsion (mandates or taxes).

Rapid Response Project prepared for the Management Decision Research Center, Department of Veterans Affairs