Adverse Selection Chapter 4

2 Definition Adverse Selection Adverse Selection Purchasers know more about their likely use services and use this knowledge to select a health plan that is designed for people with lower expected claims experience. Purchasers know more about their likely use services and use this knowledge to select a health plan that is designed for people with lower expected claims experience.

3 HMO Performance Compared to indemnity insurance, HMOs had: oAdmission rates:26 – 37% lower oLength of stay: 1 – 20% lower oHospital days:18 – 29% lower oOffice visits:Higher or equal oExpensive services:Used less Source: Miller & Luft (1994)

4 HMO Effect vs. Favorable Selection How to keep people out of hospitals How to keep people out of hospitals _________________ _________________ How to attract people who do not use hospitals __________________

5 Question Can a firm that has always offered a conventional insurance plan save money by adding an HMO option? Can a firm that has always offered a conventional insurance plan save money by adding an HMO option? HMO Effect HMO Effect Favorable Selection Favorable Selection “Shadow-Pricing” “Shadow-Pricing”

6 HMO Effect Likelihood of Any Use (%) One or More Admissions (%) HMO Assigned 877 HMO Control 916 Free FFS 8511 Source: data from RAND Health Insurance Experiment (Manning et al. 1987)

7 Favorable Selection Total Expense Institutional Expense Professional Expense FFS $ $ $ HMO $ $ $ Difference $ 23.14* $ 18.22* $ 5.00* Source: data from Jackson-Beeck & Kleinman (1983) * Statistically significant at the 99% confidence level.

8 Total Medicare Expenditures of HMO Enrollees Relative to Traditional Medicare Enrollees Six months prior to enrollment 63% Six months after disenrollment 160% Source: data from PPRC (1996)

9 Effects of HMO Enrollment on Traditional Medicare Expenditures Revisited If Medicare HMOs attract lower utilizers, then when a larger share of Medicare enrollees are enrolled in traditional Medicare, the average claims expenditure should be lower, other things equal. If Medicare HMOs attract lower utilizers, then when a larger share of Medicare enrollees are enrolled in traditional Medicare, the average claims expenditure should be lower, other things equal. Analysis of 1990–1994 non-rural Medicare county-level claims data Analysis of 1990–1994 non-rural Medicare county-level claims data Each 1 percent larger traditional share associated with: Each 1 percent larger traditional share associated with: $1,033 lower average total claims $1,033 lower average total claims $1,028 lower average Part A claims $1,028 lower average Part A claims $ 18 lower average Part B claims (not statistically significant) $ 18 lower average Part B claims (not statistically significant) Implies that Medicare HMO enrollees were 30 to 40 percent less costly Implies that Medicare HMO enrollees were 30 to 40 percent less costly Source: Batata (2004)

10 Does Favorable Selection Persist? If yes—keep existing subscribers happy If yes—keep existing subscribers happy If no—encourage turnover If no—encourage turnover

11 Persistence of Medicare Expenditures among Elderly Beneficiaries Medicare beneficiaries 1987–1995 Medicare beneficiaries 1987–1995 Includes Part A and Part B expenditures Includes Part A and Part B expenditures Cohorts defined by expenditures in 1989 and 1993 Cohorts defined by expenditures in 1989 and 1993 Analysis conducted with and without decedents Analysis conducted with and without decedents Source: Garber, McCurdy, and McClellan (1999)

12 Figure 4-1 Persistence of Expenditures for Surviving Medicare Beneficiaries $41,921 Source: data from Garber, McCurdy, and McClellan (1999)

13 Shadow-Pricing Historically some firms have observed that when they began offering both traditional and HMO insurance offerings, their total insurance expense increased rather than decreasing or remaining unchanged. Historically some firms have observed that when they began offering both traditional and HMO insurance offerings, their total insurance expense increased rather than decreasing or remaining unchanged. An HMO effect suggests lower total premiums as the managed care plan “does something” to keep people out of hospitals. An HMO effect suggests lower total premiums as the managed care plan “does something” to keep people out of hospitals. A favorable selection effect suggests no change in premiums. The lower utilizing employees are disproportionately in the HMO and the higher utilizing employees are in the traditional plan. A favorable selection effect suggests no change in premiums. The lower utilizing employees are disproportionately in the HMO and the higher utilizing employees are in the traditional plan. “Shadow-pricing” has been suggested as the explanation. The HMO is said to price its services “just a shadow below” the premium changed by the traditional insurer even though its utilization experience is lower due to either an HMO effect or favorable selection. “Shadow-pricing” has been suggested as the explanation. The HMO is said to price its services “just a shadow below” the premium changed by the traditional insurer even though its utilization experience is lower due to either an HMO effect or favorable selection.

14 Discussion Questions Suppose that the difference in utilization between conventional insurance and managed care is attributable to favorable selection. If so, would a state Medicaid program save any money if it required all of its recipients to join a Medicaid managed care plan? Suppose that the difference in utilization between conventional insurance and managed care is attributable to favorable selection. If so, would a state Medicaid program save any money if it required all of its recipients to join a Medicaid managed care plan?

15 Discussion Questions A common experience of employers that began offering multiple health plans instead of a single plan was that their total health insurance costs increased. How could this occur? A common experience of employers that began offering multiple health plans instead of a single plan was that their total health insurance costs increased. How could this occur?

16 Discussion Questions If insurers of dental services understand that high utilizers are disproportionately likely to join their plan, what actions would you expect them to take to deal with this condition when they design their insurance plan? If insurers of dental services understand that high utilizers are disproportionately likely to join their plan, what actions would you expect them to take to deal with this condition when they design their insurance plan?