H_11_05W_ Cost containment

H_11_05W_ Cost containment - HEALTH ECONOMICS Handout 11...

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HEALTH ECONOMICS Handout 11 Cost Control Mechanisms Traditional FFS insurance was based on the following principles of “guild free choice” which led to the above problems. 1) Free choice of physician by patient. 2) No interference by insurer in what treatment physician prescribes. 3) No interference by insurer in the price of treatment. 4) Fee-for-service payment. Insurance provides a great benefit because it reduces risk. Yet insurance leads to several “problems.” 1) Moral hazard/welfare loss 2) Induced demand 3) Less consumer search (which leads to higher prices). This “problem” is a “macro” problem in that 1 person will not benefit if they search but others do not. Insurance arrangements can be understood in the context of how they address these issues. The cost control mechanisms typically involve movement away from the principles of “guild free choice” and/or movement away from full insurance (i.e. cost sharing). Cost Sharing: A digression on the optimal level of coinsurance (assuming coinsurance is the only available method to limit welfare loss). Graph 1 $ 0 1-C The vertical axis is the premium. The horizontal axis is (1 - % consumer pays). (More cost sharing is a move to the left on the horizontal axis). A zero profit policy would have the premium (r) such that: r = (1 + L) (1-C)*expected loss: L = loading factor; C = co-pay rate 1
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If there were no moral hazard (and the load does not depend on the co-pay rate) this would be a straight line. When the insurer share rises, insurer costs rise for two reasons. 1) They pay a greater percent of the loss 2) The loss is higher because of moral hazard Hence with moral hazard, the premium rises faster than the portion of the loss paid by the insurer. Consumers have preferences for premiums and coinsurance rates. Holding the premium constant, individuals would like greater coverage holding the co-pay rate constant individuals would like lower premiums. These preferences can be depicted as indifference surfaces curved around the lower right (because premiums are “bads,” not “goods”). The optimal coinsurance rate/premium combination that still offers the insurer zero profits can be found by where an indifference surface is tangent to the zero profit curve. Graph 2 1-C 0 $ If there is no moral hazard and the tangency will be at the full insurance point (actually the indifference curve might be steeper than the zero profit line at this point). If there is moral hazard, the curves will cross at the full insurance point and individuals will substitute away from full insurance in exchange for a lower premium. This will move them to a higher indifference curve. --Cost sharing summary:
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This note was uploaded on 04/09/2008 for the course HMP 661 taught by Professor Michaelchernew during the Winter '06 term at University of Michigan.

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H_11_05W_ Cost containment - HEALTH ECONOMICS Handout 11...

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