Wednesday, November 5, 2008

Insurance 101 for the Medical Home

Over at e-CareManagement Blog, my colleague Vince Kuraitis examines the Medical Home, likening it to a new family moving into the neighborhood. He describes how the long-term residents are left to ponder the new arrival of this upstart provider-family. The employer-family really likes them while the insurer-family next door is duplicitous. Hospital-family and the specialist physician-family down the street are suspicious, while the disease management family is jealous. Only one thing is clear: the neighborhood is in for BIG changes.

While the Disease Management Care Blog likes metaphor (and all the useful links), it’s not sure it quite captures the dynamic. So it came up with something different. There is the world of insurance (where avoided cost is the name of the game) and then the world of retail (where revenue is the name of the game). Health care is dominated by insurance. So with that introduction, and inspired by Maggie Mahr's lengthy blog posts, the DMCB invites readers to tie on your oxygen tanks and dive dive dive.......

Imagine a large Arena with a very rough and tumble field of play. The only persons allowed on that field are buyers and sellers of an obscure but quantifiable notion called “risk.” The bartering of these packages of ‘risk’ involves individuals or coalitions agreeing to accept the cost of ‘fixing’ a possible bad event. Examples include a boat sinking, a house fire, a car accident, the occurrence of a dreaded cancer.

Players on the field know that the greater the likelihood of a bad event, the greater their risk of having to pay for it. In addition, the greater the cost of a bad event (replacing the boat, building a new house, fixing the car or curing the cancer), the more they should charge for taking that risk.

Cost and risk are only two dimensions of this game.

How could this ‘play’ out? Suppose a hospital stay costs $10,000. Suppose the risk of that happening is 1%. Player A could agree to ‘take’ or contract for that risk for 1% of $10,000 or $100. Better yet, add a dollar to make it worth it. Player B wins because the threatening cost of the inpatient stay is neutralized at a cost of only $101. Player A wins because there is a 99% chance he’ll pocket the $101. Player B may have wasted $101 over a small 1% chance. Player A exposes himself to a small possibility of a $10,000 catastrophe. There is also nothing to keep players from forming buying and selling coalitions. It’s a classic market that sells ‘risk’ like potatoes or lawnmowers and it is in equilibrium.

This is an oversimplification but still instructive. The DMCB has read that this Arena is one of the greatest intellectual achievements of mankind. Understanding and deploying the laws of probability in insurance markets has enabled each of us to manage the occasional catastrophe by economically transferring that risk elsewhere. When it works well, persons can be assured of getting to work within a few days of totaling a car. When it doesn’t work well, we have Katrina. Healthcare is arguably somewhere - on average - in between. There are many Katrina-like victims on one end and many persons with bad illness that are successfully getting to work.

Does the Arena apply in the world of health care? Employers or individuals possess the ‘risk’ of cancer, heart attacks and car accidents and they want to get if off their hands. They enter the Arena and offer to pay others to take on that risk. Those others are called health insurers.

Here are the Rules of the Arena:

1. To make a profit, players really need to understand the likelihood of bad events and the cost of fixing them. To do that, smart players hire a very special species of individual called “actuary.” They don’t even think of setting foot in the arena without one on their side.

2. Actuaries believe that it’s better to set prices based on prevailing market reality, rather than spending a lot of effort to change reality. Their reality doesn't link quality and cost. For example, if the prevailing price of a hospitalization is $10,000 and the risk is 1%, it’s better to set the price at $100, rather than ask for the hospital to charge $9000 or work with your subscribers to reduce the risk to 1%, especially by lowering the A1c. (Astute readers will argue that browbeating hospitals and all other providers of services into lower fees is a widely used approach and the DMCB doesn’t disagree. However, providers - with some exceptions - have shown a remarkable ability to push back against the player-insurers’ monopsonies. Maybe that deserves a separate post. The DMCB invites a reader to submit one).

3. If you are in the business of accepting risk, to further increase your likelihood of profit, you want to take on small amounts of risk (plus that extra dollar) spread over many many contracts. The reason for this is because it enables your actuary to more accurately set the price of your risk transfers. This is known as the Law of Large Numbers.

4. If something bad happens, you better pay up or the Keepers of the Arena will throw you in jail. There are 50 of them, one for each State. The Keepers will also, from time to time, look at how well you are playing. They will hire their own actuaries to assess if you’ve taken on too much risk or have too little money on hand to pay up if something bad happens. That is their Job 1. As an aside, they also want to make sure that the ‘little guy’ can transfer the risk at an actuarially sound price. That is called fiduciary duty and the whole process is called regulation (Single players have a tougher time in the Arena, which is why individual insurance costs are so high. However, that is largely not a failure of regulation, but the result of it).

5. Last but not least, the money being moved back and forth in the arena must be visible not only to the players but the Spectators. This tempts the Spectators to enter the arena and become Players.

Long explanation, but now consider the Medical Home. Using the Arena metaphor above, the DMCB believes the Medical Home family wants to stop being Spectators and enter the Arena and play. They see all that money and they are offering the other players in the Arena one - or a mix of - two deals:

a) For a ‘case management fee,’ they will mitigate the health insurer’s risk. There is no real risk transfer.

b) They will take on the risk. But seeking the best of all possible worlds, they want ‘upside’ risk. If the $10,000 goes unspent, they want a piece of the $100. If the $10,000 is spent, they don’t want to pay any of it. They remember the bad days of capitation when they had to withhold care to manage downside risk.

Absent legislative fiat, it will be interesting to see how the others in the Arena will react. The actuaries don’t understand the cost or the risk yet. They also wonder if the Medical Home is the exception to the general rule on changing reality.

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