Bg life after cash money

I

Introduction

IT IS WELL KNOWN that some parties to a contract who have an information advantage over the other parties may engage in post-contractual opportunistic behavior. This behavior is commonly known as moral hazard. In health-care insurance, moral hazard is usually associated with increased use of medical services after insurance (Pauly, 1968). Because the insurer usually cannot tell whether a treatment is motivated by actual need, or by lower marginal cost of services to the insured, there is room for the insured and the service provider to use more services than would be used without insurance. This information advantage on the part of the insured and the service provider thus determines the extent of moral hazard. The greater the information advantage is, the higher the cost of containing opportunistic behavior, and the greater the extent of moral hazard.

When moral hazard cannot be costlessly eliminated, the interest of the insurer is adversely affected if he cannot cover easily his loss from the insured's overuse by increasing the premium. It is as if some property right of the insurer have been converted into de facto property right of the insured. The extent of this de facto right is defined by the level of successful moral hazard. In other words, the gap between the ideal interest of the insurer under perfectly enforced property right (i.e., without moral hazard) and his effective interest under imperfectly enforced property right (i.e., with moral hazard) represents competitively capturable resources (Fung, 1991).

The higher the cost of containing moral hazard, the larger this pool of competitively capturable resources becomes. But these resources are likely to be lower in value than their equivalent market values to the insured because they must be captured in kind and not in cash. Therefore, the insured may be induced to give up his de facto property right in exchange for part of the competitively capturable resources, if such an exchange offers him greater utility. In turn, the insurer can keep the rest of the competitively capturable resources. This exchange, a benefit conversion, if successful, can make the insured better off and lower insurance premium for a given coverage.

Deductibles and copayments are incentives designed to contain this de facto property right of the insured. Their effectiveness in curtailing moral hazard, however, is limited to minor illnesses (Zweifel, 1988). For major illnesses of a terminal and/or chronic nature, treatment levels typically extend beyond the reach of deductibles and coinsurance. Here, comparable incentives to contain the insured's de facto property right do not exist. Not surprisingly, aggressive treatments of major illnesses have contributed significantly to health-care cost explosion.

This paper will look at a two-pronged incentive scheme that may curtail over-treatment and the spiralling of health-care costs in major illnesses. This scheme is based on a recognition of the insured's de facto property right to competitively capturable resources and the offer of a package of benefits that is more valuable, in some cases, to the insured than a futile resort to more medical treatment.

II

Budget Constraints of the Insured in Major Illnesses

WITHOUT INSURANCE, moral hazard is absent because the limit to medical services is determined by the individual's income and the market price of medical services. This income-price budget constraint is represented by AA|prime~ in Figure 1. This individual's (say John's) income can be spent on up to |M.sub.2~ units of medical services and nothing else, or up to OA units of other goods and services (other goods for short) and no medical services, or any other consumption bundles of medical services and other goods along the budget constraint AA|prime~. The slope of the constraint reflects the price of medical services in terms of the amount of other goods that must be given up in exchange.

With health insurance, the budget constraint is transformed in different ways depending on the type of insurance. The transformation for a typical Blue Cross and Blue Shield plan is as follows: First, the vertical intercept of the constraint is lowered by the premium, say AB. Second, a deductible (say |BG.sub.1~) must be paid by the insured. Because John must pay the market price for his medical services until the total out-of-pocket medical expenses exceed |BG.sub.1~, BB|prime~ has the same slope as AA|prime~. Third, John must pay for a portion of the market price for any additional medical services beyond |M.sub.0~ and up to |M.sub.1~. Since the copayment is less than 100% of the market price, B|prime~B|double prime~ is flatter than BB|prime~. Fourth, when the total out-of-pocket expenses for the year exceed |BG.sub.0~, full coverage takes over. The budget constraint becomes horizontal representing zero copayment and zero private marginal cost of additional medical services. For major illnesses, the level of medical services required will typically exceeds |M.sub.2~. In other words, the insured's demand for additional treatment in major illnesses is unlikely to be restrained by private cost consideration in any given year. In the next calendar year, however, the deductible and copayment will start over again.

For those who have no private insurance and very little cash income or countable assets (Gordon, 1990), Medicaid is the safety-net public insurance. It does not require any deductibles or copayments. For the qualified, the budget constraint is a horizontal line with a very small vertical intercept. As in B|double prime~B|triple prime~, there is zero private marginal cost for additional treatment. Because major illnesses tend to be the most financially burdensome, most Medicaid resources are tied up with treating major illnesses. The most typical major illness funded by Medicaid is long-term care, which neither private health care insurance nor Medicare covers. Again, demand for additional treatment in major illnesses is unrestrained by private cost consideration.

The budget constraint for Medicare Part A beneficiaries is more complicated (Medicare Supplement Insurance in New York State, 1987). For hospital costs, there is full coverage up to a maximum number of days after a deductible per benefit period. These maximum full-coverage days are usually long enough to take care of major illnesses. For in-patient skilled nursing-care costs, there is also full coverage for a maximum number of days per benefit period (not shown in Figure 1).

Full coverage invites moral hazard from two sources. First, the insured has no incentives to conserve medical services because his private marginal costs are zero. Second, the service provider has no incentive to control access as payment for their services is based on retrospective costs.

To contain moral hazard, (the tendency to over use something since it is covered by insurance) the insurer has placed many constraints on full coverage. These may be (a) prospective pricing, (b) exclusion of certain treatments, and/or (c) caps on total claims.

Prospective pricing contains moral hazard on the part of the service provider by limiting payment to the provider to reasonable charges. Sometimes, it can be so effective that the service provider does not accept the patient. This happens most often under Medicaid. For Medicare in-patient care, prospective pricing is constrained by means of Diagnosis Related Groups (DRGs).

Some treatments are excluded because they are still experimental in nature. That is, their mean result may be less than satisfactory and/or the variance around the mean result may be too large. This rationale for exclusion simply encourages medical research to overcome technological barriers towards full acceptance of a given treatment. This control has not been successful at all because an upper limit to the cost per quality unit of life year has never been imposed by any insurer. Unless such a limit exists, there is no defensible basis for excluding a perfected treatment simply because it is too expensive, or for denying a treatment that merely succeeds in transforming a terminal illness into a chronic illness with a large lifetime medical bill (Weisbrod, 1991).

A cap on total claims can be imposed on a lifetime basis or per-benefit-period basis. For Medicare Part A hospital costs, there is both a lifetime cap and a per-benefit-period cap. For Blue Cross and Blue Shield plans, there is only a lifetime cap. A cap on total claims will entail moral hazard from both the insured and the service provider.

The much touted cost control scheme practiced by HMO's (Health Maintenance Organizations) is nothing but a combination of prospective pricing and rationed full coverage. Most of its cost saving comes from completely eliminating moral hazard from the service provider.