There’s a collision brewing between Indiana and Washington over health care: whether our system will be a top-down affair of central planning, or whether it will leave any room for bottom-up arrangements that rely on dispersed, individual decision-making and resource-allocation by self-correcting consumer choice. The relevance to pending national decisions is obvious. Here’s how it began.

In 2006, at the instigation of a new governor, Indiana added a consumer-driven health plan (CDHP) to the benefit options offered to its 35,000 state employees. That first year, 4 percent of state workers chose it. This year, 94 percent did.

Then in 2008, the state again used a consumer-driven model to create an affordable health plan for low-income Hoosiers not eligible for Medicaid. To date, this Healthy Indiana Plan (HIP) has served over 98,000 people. Of users surveyed, 94 percent said they were satisfied with the program, and 99 percent would reenroll, according to the governor’s office.

The idea behind consumer-driven health plans is that people are careful shoppers when paying for services piecemeal but tend to overuse what seems to be free—think of an open buffet. Making every consumer of health care cost-conscious will spread market discipline throughout the system, the thinking goes, and contain prices more successfully than commands from on high. Indiana is now the largest test laboratory in America for this concept as applied to health care. And the results are encouraging. Not only are the customers satisfied, but overuse of emergency rooms and specialists has declined, use of generic drugs has risen, the state’s cost for insuring its workers has been reduced, and—most remarkable—the participants have accumulated in their personal Health Savings Accounts combined reserves of nearly $60 million. That’s $60 million worth of health security for the future.

The tax-free Health Savings Accounts (HSAs) for out-of-pocket expenses are just one feature of Indiana’s CDHP for state workers, along with high-deductible insurance and 100 percent coverage of preventive care. The state deposits money in each worker’s HSA every pay period, and employees can make contributions as well. Employees receive a simple statement every month showing deposits, expenditures, and balances.

It’s the HSA that users seem to appreciate most, judging by interviews with a dozen state workers approached at random in the main state office building here the other morning. “Actually, I love it,” said one fortyish paralegal who’s been in her state job almost a year. “Saving those pre-tax dollars benefits me—I’m a single mom.” A middle-aged administrator noted, “You’re saving as you go, so you have the resources when you need them.” Two others emphasized, “You decide how much you put in,” and, “The state gives you money.”

Still, some employees have tried a CDHP and preferred to return to traditional health insurance. Not many, though—under 3 percent.

State budget hawks are delighted at the savings. An independent analysis by the consulting firm Mercer in 2010 concluded that the CDHPs reduced costs to the state by 10.7 percent per year, for projected savings of $17 to $23 million in 2010. That’s in addition to the $7 to $8 million employees themselves were projected to save.

The users’ savings come from cost-conscious decision-making. “Employees and dependents have historically been .  .  . shielded from the actual costs of health care services,” noted Mercer. CDHP “participants are exposed to the full cost of health care services and forced to decide if the care is appropriate.” Providers, for their part, like receiving immediate payment, without the rigmarole of third-party reimbursement.

The common objection to market-based schemes is fear that people paying out of pocket won’t go to the doctor. Mercer found “no evidence that participants in the CDHPs are avoiding care”—no reporting of health difficulties resulting from deferred care, no flood of complaints, no exposés in the press, barely a trickle of participants returning to traditional insurance. At present, CDHP participants are getting preventive care at rates higher than those in the traditional plan, according to the governor’s office.

While the savings alone are eye-catching, especially with control of health care costs by fiat continuing to fail nationally, it is the intangible value of consumer-driven care that is primary for the mastermind of Indiana’s reforms, Governor Mitch Daniels. Nearing the end of his second four-year term in office, Daniels is emphatic that this is the approach to health care “consistent with human dignity.”

“Some people sincerely believe that others just aren’t up to making their own decisions—they’re foolish or they’re victims or they’re not bright enough; for whatever reason, they can’t sort out the complexities of life. But in a free society, people must be trusted with their own decisions,” he says, adding, “We’ll always help people who are down.”

As the driving force behind the introduction of consumer-driven health care in the state, Daniels paid close attention to the system’s design. He made sure that the HSA is the employee’s personal property and goes with him when he leaves his state job. Any unused money in the account at the end of each year rolls over and may earn compound interest. In healthy years, employees’ accounts grow, building reserves for less healthy times that may come. After the worker retires, the account can be used to pay Medicare premiums and deductibles and other health bills. And as long as it remains dedicated to health care, any balance left in the HSA upon the death of the participant passes tax free to a beneficiary named at the time of enrollment.

There’s minimal paperwork. Participants must keep receipts in case they’re audited by the IRS. Otherwise it’s an honor system.

In response to concerns that participants might face hefty health bills early in the year, the state deposits half its HSA contribution in January and the rest in equal increments every pay period. By now the state offers two CDHPs with different premiums, deductibles, and maximum personal cost. The most that participants can contribute tax-free ($3,100 for individuals, $6,250 for families) is laid down by the IRS, not by Indiana.

This chart, taken from the Open Enrollment packet for 2012, shows the costs to Indiana state employees of the two consumer-driven health plans and the traditional Preferred Provider Organization. Preventive care is covered in full under all three plans. As state workers steadily migrated out of traditional insurance over the last seven years, one of the traditional health plans previously offered went out of business, and a second CDHP was created.

In addition to the obvious basics like paying doctors, hospitals, pharmacies, and labs, HSA funds can be used for dozens of “allowable expenses,” from substance-abuse treatment to guide dogs, accommodating without fuss the various needs and preferences of individuals and families. Each plan comes in a tobacco-free variant. If the employee signs a pledge not to use tobacco during the year and to undergo random nicotine testing, the state contributes more to his HSA: The tobacco-free bonus is slated to go up next year from $25 to $35 per paycheck. And if you’re caught cheating? You lose your job.

Even as he prepares to leave office at the end of this year, Daniels is working to refine the system. Soon, a wide range of user-friendly information, including prices charged by different health care providers, is to be posted online. The idea is to make comparison shopping easier, as citizens become more used to controlling their health dollars.

It was Daniels, too, who persuaded Democrats in the legislature and bureaucrats in Washington to let him use a consumer-driven design for the Healthy Indiana Plan. Because it is funded not only from an increase in the cigarette tax but also with money reallocated from the state’s Medicaid account, HIP required a waiver from the federal Department of Health and Human Services. Like the state employees’ plan, HIP combines high-deductible insurance (a choice of three plans) with first-dollar coverage of preventive care and a state-funded HSA, to which participants (if financially able) must contribute. In HIP, the state’s contribution to the HSA rolls over only if routine preventive care is completed each year.

Whatever the success of Indiana’s market-based reforms, their future is fraught with uncertainty. What Governor Daniels calls “the big hairy foot of Obamacare” is poised to crush them.

Or maybe not. It’s impossible to get answers out of Washington these days, say those working on compliance with the Affordable Care Act. Federal bureaucrats are choking on thousands of pages of new regulations that interpret the thousands of pages of the law itself.

In 2011, Indiana legislators of both parties voted to adapt the Healthy Indiana Program as the vehicle for the expansion of Medicaid envisaged by Obamacare. But the state’s request for a three-year renewal of its waiver for HIP was denied; a one-year waiver was granted.

One reason HIP may be viewed askance in Washington is that it is—quite deliberately—not an entitlement, but rather a means-tested, state-subsidized health plan available on a first-come, first-served basis until the allocated money is used up. The governor, who has balanced his budget for eight straight years and led Indiana into the elite of states with AAA credit ratings, insisted on not saddling the state with commitments he wasn’t sure it could keep. He’d watched nearby Tennessee enact the open-ended “TennCare” entitlement, then, drowning in costs, have to scale it back under a Democratic governor.

At the moment, then, whether Indiana will expand its Medicaid program, and whether HIP will survive for long in any form, remains in doubt, confirms Seema Verma, a health care consultant to the governor. Surely, though, the consumer-driven health plans for state employees will be left alone?

Not so fast, says Daniels. Obama-care has already forced expensive changes in CDHP coverage. Inclusion of dependents up to age 26 on their parents’ insurance, a newly required “summary of benefits explanation,” and free coverage of contraception together added roughly $2.5 million to the cost of the state program this year. It was not good enough, apparently, for Hoosiers to pay for birth control from their HSAs.

Regulatory burdens and “poison pills” can clog even the best of programs, but what might actually kill Indiana’s CDHPs, says the governor, is something called the “medical loss ratio”: the requirement under Obama-care that at least 80 percent of premiums be spent on health care delivery and quality improvement as opposed to overhead. Washington ought to allow money spent from Health Savings Accounts to count toward the 80 percent, but so far it hasn’t. Indiana’s popular, effective consumer-driven plans are thus in jeopardy.

It’s an epic clash: faith in experts and compulsory, abstract rules made far away versus respect for the choices of ordinary citizens and their locally elected representatives.

As part of his farewell to government, Mitch Daniels wrote a book last year distilling what he has learned working in business, working in Washington for two Republican administrations, and serving his home state. It’s called Keeping the Republic: Saving America by Trusting Americans, and the chapter on health care ends with a cri de coeur:

Obama­care must be undone and replaced not merely as a matter of sound health policy, not merely because it promises to damage a staggering national economy, not merely because it will hasten the bankruptcy of the American government. Obama­care must be undone for the even more fundamental reason that, in its essence, it demeans and diminishes the rights of the free people Americans were intended to be.

This is not grandiosity. The health care conundrum is quite properly seen in the context of the larger struggle over what sort of people we are and what policies are congruent with human nature. We really are facing that kind of a choice.

Claudia Anderson is managing editor of The Weekly Standard. William Anderson, a retired physician, teaches at Harvard University.

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