• Health Insurance tends to lead to an overconsumption of healthcare by the insured because the insured person only considers out-of-pocket expenses and not the “full” cost at point of purchase.
– i.e., purchases of healthcare beyond the point where marginal benefit equals marginal cost
• Can also have overprovision of healthcare services because of SID and SAV.
• Response to overconsumption or overprovision: set up a system where physician practice must be managed in order to address high healthcare costs and the overprovision of services.

• MCO = managed care organization
• HMO = health managed organization
• FFS = fee-for-service
• PPO = preferred provider organization
• POS = point of service

Managed Care Organizations Defined
• Analysts speak of an organized delivery system as a network of organizations (for example, hospitals, physicians, clinics, and hospices) that provides or arranges to provide a coordinated continuum (from well care to emergency surgery) of services to a defined population.

• This system is held clinically and fiscally accountable for the outcomes and the health status of the population served. It is tied together by its clinical (treatment) and fiscal (financial) accountability for the defined population.
– This means that there could be financial penalties on physicians that have higher volumes of services
• Often the organized delivery system is defined by its association with an insurance product.

• Can contain costs and perhaps improve the quality of care by using three mechanisms:
– Selective contracting: payer negotiate prices with selected physicians and hospitals
– Steering: send enrollees to providers in the network
– Utilization Review: review appropriateness of provider practices, in a few different ways
• We’ll discuss the first two in a little more detail later, but first we’ll consider utilization review

• Examines the appropriateness of medical care for necessity and appropriateness before, during and after medical care:
– Prospective (before care): e.g., require mandatory second opinions and pre-admission certification to determine whether surgery and length of hospital stay that are appropriate
– Concurrent (during care): occurs during hospitalization and determines the appropriateness of treatment relative to diagnosis and discharge planning

– Retrospective (after treatment): reviews treatment after discharge to determine whether treatment was necessary and appropriate and whether they were actually provided; can also be used to determine practice patterns which identify providers and facilities that are providing treatment in a cost-effective manner and those that are not.

• Differences between managed care and fee-forservice arrangements have to be measured along several dimensions, which would include: health of people receiving treatment; price of care; and, quality of care.
• Common characteristics of managed care are that most (if not all) care for a patient is provided in a network and resources are centralized in the network (via utilization review).

Overview
• Managed care features a health care delivery structure involving the integration of insurers, payment mechanisms, and a host of providers, including physicians and hospitals.
• There are three different types of managed care organizations that we will consider.

• Provide relatively comprehensive health care, entail few out-of-pocket expenses, but generally require that all care be delivered through the plan’s network and that the primary care physician authorize any services provided.

• Provides two distinct tiers of coverage. When subscribers use the PPO’s preferred provider network, the required cost sharing with deductibles or coinsurance is lower than when they use nonnetwork providers. Although a network is formed, PPOs have no physician gatekeepers.

• Are a hybrid of HMOs and PPOs. Like PPOs,
POS plans offer two tiers of insurance benefits. Coverage is greater (out-of-pocket costs are lower) when members use network providers and less generous (out-of-pocket costs are higher) when they use nonnetwork providers. Like HMOs, however, POS plans assign each member a physician gatekeeper, who must authorize in-network care in order for the care to be covered on in-network terms.

• Most HMO and POS plans pay their network physicians on a capitation basis.
• Under capitation, the plan pays the physician’s practice a fixed fee, generally an actuarial permember-per-month (PMPM) dollar amount, in return for the treatments provided to members of the insurance plan.

• PPO contracts with physicians rarely involve capitation. Instead, they specify the discounted fees for various services that the plan will pay in exchange for the privilege of being in that plan’s network.
• Utilization review procedures are commonly covered in managed care contracts, whether they are HMO, PPO, or POS plans.

• HMO and PPO plans contract with only a subset of the providers (physicians and hospitals) in the areas that they serve. This key feature of the managed care sector allows plans to promote price competition among hospitals that might otherwise lose plan business.

• The probability and characteristics of contracts between individual managed care organizations and hospitals appear to depend on three sets of factors:
Plan characteristics, including whether it was a PPO or an HMO (and possibly what type of HMO), plan size, whether the plan serves several localities, and how old the plan is.
Hospital characteristics, including size, ownership (including for-profit versus nonprofit status), location (city versus suburb), teaching status, and cost structure (reflecting prices).
Market characteristics, generally measured at the metropolitan area level, including the penetration and rate of growth of managed care plans.

• Zwanziger and Meirowitz (1998) examine the determinants of plan contracts with hospitals in a study that looks at the three categories. For HMOs and PPOs in 13 large, metropolitan statistical areas (MSAs), they report:
Managed care plans prefer to contract with nonprofit hospitals, preferring even public hospitals to for-profit ones.
Plans will more likely contract with large hospitals compared with medium-sized hospitals, and with medium-sized hospitals compared with small ones.
Hospital cost factors (which reflect hospital prices) do not significantly affect contracts.

• There are a few economic different aspects of managed care that we will consider. This will be from the perspective of the
U.S. health care system, but some contrasts to Canada will also appear (and be discussed later in the course).
• There are two potential benefits of managed care:
– Reducing price discrimination
– Reducing prices

• If you have perfect competition (suppose
MC=AC, so supply curve is horizontal) then health care providers are price takers.
– This is a very appropriate description of how the health care markets work in Canada.
• However, in the U.S. not all physicians are price takers. In fact, some (or many) can viewed as having some sort of monopoly power, they can charge different prices to different consumers, which is referred to as price discrimination

• To price discriminate you need two basic conditions to hold
– You need to be able to distinguish between different consumers and hence their demand curves
– You need to be able to prevent the resale of goods from one type of consumer to another type of consumer

• For example, socioeconomic status is known to tell you a lot about the demand for health care services
– Persons with higher socioeconomic status tend to have more inelastic demand for health care services
• If a physician has monopoly power and is able to distinguish between different segments of the market and there is no resale between markets can treat markets separately:

• In the market with the more inelastic demand the price is higher than in the market with the more elastic demand curve; so the more inelastic demand is the higher the price for medical services
• In the limit, if the physician could distinguish between all the different demand curves there would be perfect price discrimination, so every consumer pays a different price.

• Price discrimination means that the physician will extract more of the consumer surplus than if the physician did not price discriminate.
• Perfect price discrimination means that the physician will extract all the consumer surplus.

• For a consumer, managed care can reduce the price paid for services, i.e, the MC of services will be lower
• It can also reduce the demand for care by reducing the potential for SID as well as SAV

• Changed incentives in managed care should constrain utilization/provision of services and the prices for services.
– Incentives mean the healthcare provider shares risks with the insurer and so reduces the volume of services they can provide

Projected 5-Year Age-Weighted Population
Growth Rate by Region, 2006 to 2011
25%
% Projected
Age-Weighted
Population
Growth
0%
32

Hospital and Homecare Expenditures by LHIN
6%
-12%
33