A Theory of Prepayment, Managed Care, Deductibles and Copayments

1. A Theory of Prepayment, Managed Care, Deductibles and Copayments Allen C. Goodman, Wayne State U. Maia Platt, U. of Detroit – Mercy Seminar University of South Florida March 30, 2012

2. Managed Care • Managed Care has largely taken over the non-Medicare market for health care provision, and is making in-roads into Medicare. • Fee-for-service is essentially moribund in the US. See following chart.

3. Managed Care Plans

4. Theory of MCOs? • There’s been no theory. • What characterizes MCOs? • Is the Veterans’ Administration an MCO? (Probably is).

5. Theory of MC? • Kaiser Permanente • Vertically integrated • Very little choice • “Managed Care heavy” • PPOs, POS, etc. • Less heavy handed • More choice • “Managed Care light”

6. Theory of MC? • Utilization Review • Prospective • Concurrent • Retrospective • Everyone does it now

7. Selective Contracting • Morrisey argues that the ability to exclude some (higher cost, noncompliant) providers allows MCOs to reduce costs. • Providers give up potentially higher payments per activity for the promise of more clients. • Contracts are extraordinarily complicated. I can give personal examples.

8. A “Health Services” Perspective • We had this diagram in FGS-2  FGS-4.

9. Shortell et al How good are the information systems? How well do they communicate with each other Some point to the VA as a prime example of one that works!.

10. Stylized Facts • Economists love stylized facts! • Most Americans get their health care risk pooling through the workplace (btw, PPACA won’t change that). • Health insurance (HI) is largely (entirely?) paid for by the worker in the form of reduced wages. • In many ways at least some portion of HI can be considered as “prepayment” for services.

11. More Stylized Facts • Although coinsurance rates are negatively correlated with use, • Deductibles are as often positively correlated as negatively correlated. • Consumers most often have access to a few, discrete opportunities. How do they choose among them?

12. Who Pays – Mkt Analysis

13. Who Pays – Firm Level High loading costs may force firms to hire fewer workers, or (with minimum wage) not offer insurance

14. Some Notation • Household chooses among options in its health insurance package. The health insurance will essentially pre-pay for well-care, and some expected illness. • The household also may need additional insurable care with probability w. How do they choose among MCO plans? • At WSU we have 2 HMOs, 2 PPOs, and 1 FFS plan.

15. Some Notation Suppose there are three plans n, where n = i, j, k, with w = probability of needing insurable care Ei , Ej, Ek = expenditures necessary if care is needed. bi ,bj, bk= coinsurance rate faced by household Ri,Rj, Rk = deductible faced by household Si, Sj,Sk = out of plan expenditures Without loss of generality

16. Proposition 1 • Proposition 1: Criterion for choosing among MCOs – “less than or equal.” • Unless a MCO matches household’s preferences (point A) for prepaid care exactly, with number of visits vA, the household will pick one that provides less care. • A household can purchase additional health care out-of-plan, but cannot sell surplus care. • With the current individual’s preferences, then, plans i and k dominate plan j. The insured may or may not choose to purchase additional care out of pocket. For purposes of this exposition, we will assume that Sn = 0, so that the insured uses care level

17. MCOi, MCOk MCOj Plan Annual Cost Out of Plan, or Deductible (coinsurance rate = 1) A Other Goods Pure Risk Premium Visits

18. Proposition 2 • Consumers sort themselves into MCOs based on expected need for insurable care, and on the characteristics of the MCOs as defined by coinsurance rate and deductible. • For empirical work, across large numbers of MCOs, higher deductibles may very well be related to higher levels of utilization or expenditures rather than lower levels. • In contrast, higher coinsurance rates, holding deductibles constant, will always, in this model, lead to more utilization and expenditures.

19. MCOi, MCOk provide same basic care. MCOi – higher deductible and lower coinsurance rate MCOk – lower deductible, lower coinsurance rate. MCOi, MCOk MCOj Plan Annual Cost Out of Plan, or Deductible (coinsurance rate = 1) Rk A Other Goods B biwEi(bi)Ri bkwEk(bk)Rk Visits

20. Proposition 3 • There may be heterogeneous preferences within individual MCOs. • Suppose that there are only 2 MCOs available, MCOi and MCOj, and there are two households as noted in Figure 3. In these circumstances, both households will prefer MCOi to MCOj. As drawn, however: • a low deductible and a high coinsurance rate will be preferred by Household 1, • while a higher deductible and a lower coinsurance rate will be preferred by Household 2.

21. Proposition 3 – cont. • At the lower deductible Rk and higher coinsurance rate bk, Household 1, if faced with an insurable event will purchase visits, while Household 2 would purchase visits. • By inspection, we can see that with a higher deductible Ri and a lower coinsurance rate bi Household 1 will be worse off, whereas Household 2 will purchase visits and be better off.

22. U1 U1 A1 and A2represent ideal amounts of prepaid care MCOi, MCOk U2 U2 U2 Plan Annual Cost A1 A2 Other Goods Visits

23. Observations • There’s a lot of public finance in this model. • It suggests yet another reason why MCOs may “under-provide” services – i.e. consumers don’t want to pay for something they might not use. • Suggests ways to model the willingness to pay for insurance, and the structures of copayments and deductibles.

24. Other Issues • Given the taste and income distributions what is the optimal number of MCOs? • Merging of MCOs? • Disintegration of one MCO into 2 or more?

25. Other issues • Does not model the production from MCOs. In other work, Goodman and Stano (2000) argue that there will be a bias toward MCOs that : • are too small; • offer too little service; • offer service that is too “low tech.”

26. Questions or Comments?

28. This assumes NO “pure” insurance against risk. If we want to show pure insurance, we have a parallel downward shift and everything else follows as before.