Chapter 6
Organizing and Financing
Mental Health Services

Overview of the Current Service System

The Costs of Mental Illness

Financing and Managing Mental Health Care

Toward Parity in Coverage of Mental Health Care


Appendix 6-A: Quality and Consumers’ Rights


The Costs of Mental Illness

As many of the preceding chapters have indicated, mental disorders impose an enormous emotional and financial burden on ill individuals and their families. They are also costly for our Nation in reduced or lost productivity (indirect costs) and in medical resources used for care, treatment, and rehabilitation (direct costs).

Indirect Costs

Figure 6-3. Global burden of disease* –DALYs** = worldwide –1990

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The indirect costs of all mental illness imposed a nearly $79 billion loss on the U.S. economy in 1990 (the most recent year for which estimates are available) (Rice & Miller, 1996). Most of that amount ($63 billion) reflects morbidity costs—the loss of productivity in usual activities because of illness. But indirect costs also include almost $12 billion in mortality costs (lost productivity due to premature death), and almost $4 billion in productivity losses for incarcerated individuals and for the time of individuals providing family care. For schizophrenia alone, the total indirect cost was almost $15 billion in 1990. These indirect cost estimates are conservative because they do not capture some measure of the pain, suffering, disruption, and reduced productivity that are not reflected in earnings.

The fact that morbidity costs comprise about 80 percent of the indirect costs of all mental illness indicates an important characteristic of mental disorders: Mortality is relatively low, onset is often at a younger age, and most of the indirect costs are derived from lost or reduced productivity at the workplace, school, and home (Rupp et al., 1998).

The Global Burden of Disease, a recent publication of the World Bank and the World Health Organization, reported on a study of the indirect costs of mental disorders associated with years lived with a disability, with and without years of life lost due to premature death. Disability Adjusted Life Years (DALYs) are now being used as a common metric for describing the burden of disability and premature death resulting from the full range of mental and physical disorders throughout the world (Figure 6-3). A striking finding from the study has been that mental disorders account for more than 15 percent of the burden of disease in established market economies; unipolar major depression, bipolar disorder, schizophrenia, and obsessive-compulsive disorder are identified as among the top 10 leading causes of disability worldwide (Murray & Lopez, 1996).

Direct Costs

Figure 6-4. 1996 National health accounts, $943 billion total – $99 billion* mental, addictive, and dementia disorders

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Mental health expenditures for treatment and rehabilitation are an important part of overall health care spending but differ in important ways from other types of health care spending. Many mental health services are provided by separate specialty providers—such as psychiatrists, psychologists, social workers, and nurses in office practice—or by facilities such as hospitals, multiservice mental health organizations, or residential treatment centers for children. Insurance coverage of mental health services is typically less generous than that for general health, and government plays a larger role in financing mental health services compared to overall health care.

In 1996, the United States spent more than $99 billion for the direct treatment of mental disorders, as well as substance abuse, and Alzheimer’s disease and other dementias (Figure 6-4).

More than two-thirds of this amount ($69 billion or more than 7 percent of total health spending) was for mental health services. Spending for direct treatment of substance abuse was almost $13 billion (more than 1 percent of total health spending), and that for Alzheimer’s disease and other dementias was almost $18 billion (almost 2 percent of total health spending) (Figure 6-4).3

Despite the historical precedent for linking all these disorder groups together for diagnostic and cost accounting purposes, they are handled differently by payers and providers. A majority of private health insurance plans have a benefit that combines coverage of mental illness and substance abuse. However, most of the treatment services for mental illness and for substance abuse are separate (and use different types of providers), as are virtually all of the public funds for these services. This separation causes problems for treating the substantial proportion of individuals with comorbid mental illness and substance abuse disorders, who benefit from treating both disorders together (Drake et al., 1998).

Alzheimer’s disease and other dementias historically have been considered as both mental and somatic disorders. However, recent efforts to destigmatize dementias and improve care have removed some insurance coverage limitations. Once mostly the province of the public sector, Alzheimer’s disease now enjoys more comprehensive coverage, and care is better integrated into the private health care system. Inequities in coverage are diminishing (U.S. Department of Health and Human Services Task Force on Alzheimer’s Disease, 1984; Goldman et al., 1985).

As indicated, coverage differs for treatment of substance abuse and Alzheimer’s disease. With respect to financing policy, both conditions are outside the scope of this report (although some services aspects of Alzheimer’s disease are discussed in Chapter 5); thus, they will not be included in the spending estimates that follow.

Mental Health Spending

Of the $69 billion spent in 1996 for diagnosis and treatment of mental illness (see Figure 6-5), more than 70 percent was for the services of specialty providers, with most of the remainder for general medical services providers.4 The distribution for all types of providers is shown in the figure.

Spending by the Public and Private Sectors

Funding for the mental health service system comes from both public and private sources Table 6-3 and Figure 6-6 (percent distribution) and Table 6-4 (dollar distribution and per capita mental health costs)]. In 1996, approximately 53 percent ($37 billion) of the funding for mental health treatment came from public payers. Of the 47 percent ($32 billion) of expenditures from private sources, more than half ($18 billion) were from private insurance. Most of the remainder was out-of-pocket payments. These out-of-pocket payments include copayments from individuals with private insurance, copayments and prescription costs not covered by Medicare or Medigap (i.e., supplementary) insurance, and payment for direct treatment from the uninsured or insured who choose not to use their insurance coverage for mental health care.

Figure 6-5. 1996 National health accounts, $69 billion total mental health expenditures by provider type

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Figure 6-6. Mental health expenditures by payer – 1996 (total = $69 billion)

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Table 6-3. Distribution of 1996 U.S. population and mental disorder direct costs by insurance status

Insurance Status
Direct Costs
Private 63%* 47%
Medicare 13%** 14%
Medicaid 12%** 19%
State/Local 16% 18%
Other Federal
Total 100% 100%
* About 70 percent of the population has some private insurance—reflecting the fact that 7 percent of the population has both Medicare and Medigap or other dual private insurance coverage. Although 61 percent of the population has employment-based private insurance, this percentage also includes some military insurance coverage. ** Since 2 percent of the population has both Medicare and Medicaid insurance coverage, adding this duplicated count to each insurance category results in the first column addingto a duplicated total of 104 percent. *** Although some state/local/and other Federal government support goes to those who are underinsured in the private and public insured groups, these funds are primarily allocated to the uninsured population. Source:

Mark et al., 1998 (Revised)

Trends in Spending

Between 1986 and 1996, mental health expenditures grew at an average annual growth rate of more than 7 percent (Table 6-5). Because of changes in population, reimbursement policies, and legislative and regulatory requirements during this decade, the share of mental health funding from public sources grew from 49 percent to 53 percent. Overall, the rate of growth in the public sector was slightly more than 8 percent per year (Medicare and Medicaid, both about 9 percent; state/local government, nearly 8 percent).

Table 6-4. Population, spending, and per capita mental health costs by insurance status (1996)

Insurance Status
Number (millions)
Spending ($ billions)
Per Capita ($ per year)
Private 167.5 32.3 193
Insurance Payment 18.4
Out-of-Pocket Payment 11.7
Other Private 2.2
Medicare 30.6 9.8 320
Medicaid 27.0 13.0 481
Other and Uninsured 41.7 13.9 333
SPMI* 5.1 12.4 2,431
Other 36.6 1.5 41
Total 266.8 69.0 259
* Severe and persistent mental illness

Source: Mark et al., 1998, and calculations by D. Regier, personal communication, 1999

In the private sector, out-of-pocket costs increased only 3 percent, which, together with the private insurance increases of almost 9 percent, resulted in a net private cost increase of little more than 6 percent—significantly lower than the increase found in the public sector.

Table 6-5. Mental health expenditures in relation to national health expenditures, by source of payer, annual growth rate (1986–1996)

Average Annual Growth Rate (1986–1996)
Mental Health Care
All Health Care
Out-of-Pocket Payment 3% 5%
Private Insurance 9% 9%
Other Private 7% 7%
Total Private 6% 7%
Medicare 9% 10%
Medicaid 9% 13%
Other Federal Government 4% 6%
State/Local Government 8% 10%
Total Public 8% 10%
Total Expenditures 7% 8%
Source: Mark et al., 1998 (Revised)

Among the fastest-rising expenses for mental health services were outpatient prescription drugs, which account for about 9 percent of total mental health direct costs (Figure 6-5). Although these medications are prescribed in both specialty and general medical sectors, they are increasingly being covered under general medical rather than mental health private insurance benefits.

The higher than average growth rate (almost 10 percent) of spending for prescription drugs reflects, in part, the increasing availability and application of medications of demonstrable efficacy in treating mental disorders. Estimates from the National Ambulatory Medical Care Survey show that the number of visits during which such medication was prescribed increased from almost 33 million in 1985 to almost 46 million in 1994. Only one-third of psychotropic medications are now prescribed by psychiatrists, with two-thirds prescribed by primary care physicians and other medical specialists (Pincus et al., 1998). Although Medicaid covers 21 percent of drug costs (and state/local/other Federal government covers 4 percent), Medicare does not cover prescription drugs. Although many older adults have supplemental insurance that does cover prescription drugs, the failure to cover any prescription drugs under Medicare is a barrier to effective treatment among the elderly who cannot afford supplemental insurance.

Mental Health Compared With Total Health

Mental health spending figures acquire more meaning when they are compared with those for all health care. Annually, the Health Care Financing Administration produces estimates of this spending. These estimates include nearly all of the expenditures presented for mental health services. However, some specialty providers who work in social service industries are excluded from the national health care spending estimates. Accordingly, mental health estimates require adjustment to allow direct comparison with these national figures, reducing the total from $69 billion cited earlier to $66 billion (Table 6-6).

Table 6-6. Mental health expenditures in relation to national health expenditures, by source of payer, 1996

Expenditures in Billions (1996)
Mental Health Care
All Health Care
Client Out-of-Pocket $11 $171 6%
Private Insurance $17 $292 6%
Other Private $2 $32 5%
Total Private $30 $495 6%
Medicare $10 $198 5%
Medicaid $13 $140 9%
Other Federal Government $1 $41 3%
State/Local Government $12 $69 18%
Total Public $36 $447 8%
Total Expenditures $66 $943 7%
Source: Mark et al., 1998 (Revised)

Estimated total health care expenditures were $943 billion in 1996. Of this amount, 7 percent was for mental health services. Table 6-6 describes expenditures on mental health services as a percentage of national health spending by source of payment. The significance of mental health spending for various payers varies from a low of only 3 percent of “other” Federal government spending to a high of 18 percent of health care expenditures by state and local governments.

Between 1986 and 1996, spending for mental health treatment grew more slowly than health care spending in general, increasing by more than 7 percent annually, compared with health care’s overall rate of more than 8 percent (see Table 6-5). This difference may stem from the greater reliance of mental health services on managed care cost-containment methods during this period. Increased efficiency could account for a slower rate of growth in mental health care expenditures. Slowing of the growth rate in the public sector may also be due to other Federal and state government policies, such as limitations in states’ ability to use certain Medicaid funds to support state mental hospitals and states’ greater emphasis on community-based outpatient care as opposed to inpatient care. Finally, it may also reflect the greater contribution of institutional care, particularly in nursing homes, to total health care figures. Changes in these components affect overall growth rates more in general health care than in mental health care.

For most provider categories, the rise in mental health spending was not much different than spending growth rates for personal health care, with the exception of home health (higher) and nursing home (lower) expenditures. For various types of payers, spending growth in mental health care has been about the same or less than that in general health care. Mental health spending in Medicare, Medicaid, and other Federal programs has grown more slowly than overall program spending. For private sources, the growth rate of mental health out-of-pocket expenditures has been below that of total out-of-pocket spending (see Table 6-5).

During the past two decades there have been important shifts in what parties have final responsibility for paying for mental health care. The role of direct state funding of mental health care has been reduced, whereas Medicaid funding of mental health care has grown in relative importance. This is in part due to substantial funding offered to the states by the Federal government. One consequence of this shift is that Medicaid program design has become very influential in shaping the delivery of mental health care. State mental health authorities, however, continue to be an important force in making public mental health services policy, working together with state Medicaid programs. Considerable administrative responsibility for mental health services has devolved to local mental health authorities in recent years (Shore & Cohen, 1994).

Private insurance coverage has played a somewhat more limited role in mental health financing in the past decade. Various cost containment efforts have been pursued aggressively in the private sector through the introduction of managed care. There is also some emerging evidence on the imposition of new benefit limits on coverage for mental health services (HayGroup, 1998). At the same time private insurance coverage for prescription drugs has expanded dramatically over the past 15 years. In this area, insurance coverage for mental health treatments is on par with coverage for other illnesses. Accompanying this pattern of private insurance coverage are the availability of innovative new prescription drugs aimed at treating major mental illnesses and a shift in mental health spending in private insurance toward pharmaceutical agents.

In summary, spending for mental health care has declined as a percentage of overall health spending over the past decade. Further, public payers have increased their share of total mental health spending. Some of the decline in resources for mental health relative to total health care may be due to reductions in inappropriate and wasteful hospitalizations and other improvements in efficiency. However, it also may reflect increasing reliance on other (non-mental health) public human services and increased barriers to service access.

3 Between the early 1980s and 1990s—prior to the dominance of managed care—about 5.8 percent of U.S. adults used some type of specialty mental health outpatient services in any year. This rate now can be used as one reference point for assessing subsequent changes in access to mental health services, although there is no evidence on the appropriateness of this care.

4 Researchers and administrators often report access in terms of treated prevalence or penetration rates. These rates reflect the proportion of individuals in a given population (e.g., members of a particular managed behavioral health care plan) that use specialty mental health and/or substance abuse services in 1 year.

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