Why Do Some Firms Spend So Much on Medical Care? Accounting for Variation

We are engaged in a long-term project to analyze the determinants of health care cost differences across firms. An important first step is to summarize the nature of expenditure differences across plans. The goal of this article is to develop methods for identifying and quantifying those factors that account for the wide differences in health care expenditures observed across plans.We consider eight plans that vary in average expenditure for individuals filing claims, from a low of $1,645 to a high of $2,484. We present a statistically consistent method for decomposing the cost differences across plans into component parts based on demographic characteristics of plan participants, the mix of diagnoses for which participants are treated, and the cost of treatment for particular diagnoses. The goal is to quantify the contribution of each of these components to the difference between average cost and the cost in a given firm. The demographic mix of plan enrollees accounts for wide differnces in cost ($649). Perhaps the most noticeable feature of the results is that, after adjusting for demographic mix, the difference in expenditures accounted for by the treatment costs given diagnosis ($807) is almost as wide as the unadjusted range in expenditures ($838). Differences in cost due to the different illnesses that are treated, after adjusting for demographic mix, also accounts for large differences in cost ($626). These components of cost do not move together; for example, demographic mix may decrease expenditure under a particular plan while the diagnosis mix may increase costs.Our hope is that understanding the reasons for cost differences across plans will direct more focused attention to controlling costs. Indeed, this work is intended as an important first step toward that goal.