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

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.

Managed Care Plans

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

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

Theory of MC? Utilization Review –Prospective –Concurrent –Retrospective –Everyone does it now

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.

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

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!. Shortell et al

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.

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?

Who Pays – Mkt Analysis

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

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.

Some Notation Suppose there are three plans n, where n = i, j, k, with w = probability of needing insurable care E i, E j, E k = expenditures necessary if care is needed. b i,b j, b k = coinsurance rate faced by household R i,R j, R k = deductible faced by household S i, S j, S k = out of plan expenditures Without loss of generality

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 v A, 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 S n = 0, so that the insured uses care level

Plan Annual Cost Visits Other Goods MCO i, MCO k MCO j Out of Plan, or Deductible (coinsurance rate = 1) Pure Risk Premium A

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.

Plan Annual Cost Visits Other Goods MCO i, MCO k MCO j Out of Plan, or Deductible (coinsurance rate = 1) RkRk b k wE k (b k )R k A B b i wE i (b i )R i MCO i, MCO k provide same basic care. MCO i – higher deductible and lower coinsurance rate MCO k – lower deductible, lower coinsurance rate.

Proposition 3 There may be heterogeneous preferences within individual MCOs. Suppose that there are only 2 MCOs available, MCO i and MCO j, and there are two households as noted in Figure 3. In these circumstances, both households will prefer MCO i to MCO j. 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.

Proposition 3 – cont. At the lower deductible R k and higher coinsurance rate b k, 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 R i and a lower coinsurance rate b i Household 1 will be worse off, whereas Household 2 will purchase visits and be better off.

Plan Annual Cost Visits Other Goods MCO i, MCO k A2A2 U1U1 U2U2 A1A1 A 1 and A 2 represent ideal amounts of prepaid care U1U1 U2U2 U  2

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.

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?

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.”

Questions or Comments?

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.