Much of the empirical research on adverse selection in healthcare was done in the 1980s, as employers began to offer HMOs and other managed care plans. The issue arose because of substantial differences in the utilization experience of those enrolled in HMOs and those in conventional health insurance plans. Robert Miller and Hal Luft [1994] reviewed much of the literature on the differences in utilization, and Box 4-2 presents a summary of their findings. Essentially, Miller and Luft found that people enrolled in an HMO use considerably less hospital care. The question is why.
One explanation is that HMOs do something to keep people out of hospitals. This is the so-called "HMO effect." It might be the result of a number of strategies.
For example, HMOs could substitute ambulatory services for inpatient services at a much more aggressive rate than do conventional insurers. HMOs could employ effective utilization management techniques that are designed to limit hospital use to only those most likely to benefit for it. HMOs may only affiliate with physicians who are very conservative in their use of hospital services and/or they may provide financial incentives to physicians that lead the physicians to admit fewer patients. HMOs may provide preventive services that identify harmful conditions at an early stage and reduce hospitalizations.
Alternatively, HMOs may do nothing at all to lower the hospital utilization experience of its members. Instead, they may attract members who are low utilizers to begin with ["favorable selection"]. They could accomplish this in many ways. HMOs could target their enrollment efforts at younger and/or healthier groups by, for example, marketing to schoolteachers rather than construction workers on the theory that schoolteachers, on average, are less likely to take risks in their daily lives.
HMOs might contract with physician groups and hospitals that are located in suburbs populated by young, upwardly mobile professionals, believing that such proximity will disproportionately attract the residents. HMOs could offer excellent maternity and well baby care in the hopes of attracting otherwise healthy young families into their plans. Similarly, they could offer abundant preventive services, expecting that those who value such services prefer to keep themselves healthy and out of the hospital.
HMOs might offer a tie-in sale with their health insurance plan for example, enroll in the HMO and receive a substantial discount at a local gym. Indeed, recently, some HMOs have begun giving "health credits" to members who undertake healthy activities. While these could be efforts to keep people out of the hospital, they could also be efforts to attract people with healthy lifestyles. Perhaps those who are less prone to exercise will see these offers as wastes and not join the plan. HMOs may choose their panel of providers such that there are an abundance of primary care physicians but very few specialists. The theory may be that an individual with chronic health problems probably has an ongoing relationship with a specialist, and if that specialist is not in the HMO''s panel of providers, the consumer is less likely to join.
Alternatively, HMOs may do none of these things. It may simply be that the philosophy of "health maintenance" attracts people who do not like to interact with the healthcare system. If so, even though HMOs may reach out to all members of the community, they may still attract a favorable draw of the population.
Obviously, HMOs could seek to attract low utilizers and also to limit their use of hospitals once they join the plan. To an employer considering offering an HMO in addition to a conventional plan, however, it is critical to appreciate which effect dominates.
If the difference in utilization is largely attributable to the HMO effect, then the plan can do something that will lower healthcare costs for the employer and employees. There are potential savings to be had. On the other hand, if the difference in utilization is largely attributable to favorable selection, then there are no savings.
The best the employer could hope for is writing two checks, one to the traditional plan and one to the HMO.2 Moreover, the employer may conceivably be even worse off as a result of adding the HMO to the employee benefits. Consider an employer that has long offered a conventional health insurance plan. It now adds an HMO that achieves its lower utilization by means of favorable selection and attracts a disproportionate share of the employer''s healthy workers.
As Feldman and Dowd [1982] noted, it is not at all obvious that the lower claims experience will be passed on to the employer and employees in the form of lower premiums. The HMO may try to set the premium just a shadow below the competitively priced conventional plan''s premium. If so, the employer and employees will effectively pay a higher premium for the healthy employees than they were when only the conventional plan was offered.
To make matters worse, the conventional plan may find that its claims experience now has increased and the plan will have to raise its premiums! Thus, in the face of both favorable selection and "shadow-pricing," the employer finds that its efforts to reduce health insurance costs resulted in higher costs. A solution to the shadow-pricing problem, as we will discuss in later articles, is competition in the HMO segment of the market.
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