In this debate there are two issues - how care is purchased and how much is paid for that service. There are two conventional approaches to purchasing medical services. Insurers can pay the service providers a specific amount for each discrete service (fee-per-service model) or make bundled payment for all of the care a patient needs over the course of a defined clinical episode.
The former is the prevailing purchase model across countries and has its set of inefficiencies. The biggest problem with this approach is that it becomes difficult to manage the incentive of doctors and hospitals to prescribe more diagnostics and treatments than is required. Insurers manage this problem by increasing the effectiveness of their pre-authorization and/or with conditions like prohibiting payments for certain basic tests. In contrast, the later approach effectively addresses this incentive problem. However, it fails with implementation problems.
Regarding the pricing of these services, different insurers can either individually negotiate with the service providers and arrive at their different price schedules or they could collectively bargain and fix standardized prices for all insurers. The US health insurance market is a classic example of such price differentiated market and its inefficiencies are well documented. Government-run health insurance systems undertake collective bargaining and fix standardized prices for each service.
Uwe Reinhardt summarizes the merits and demerits of both approaches and advocates the All-payer model,
"In developed nations that rely on multiple, competing health insurers — for example, Switzerland and Germany — the prices for health care services and products are subject to uniform price schedules that are either set by government or negotiated on a regional basis between associations of health insurers and associations of providers of health care. In the United States, some states — notably Maryland — have used such all-payer systems for hospitals only. Elsewhere in the United States, prices are negotiated between individual payers and providers. This situation has resulted in an opaque system in which payers with market power force weaker payers to cover disproportionate shares of providers’ fixed costs—a phenomenon sometimes termed cost shifting—or providers simply succeed in charging higher prices when they can. In this article I propose that this price-discriminatory system be replaced over time by an all-payer system as a means to better control costs and ensure equitable payment."
In particular, Prof Reinhardt points to the successful example of Maryland, which has historically deviated from other states in the US and has had an all-payer model of health services pricing. Maryland’s rate-setting system is widely believed to be one of the most enduring and successful cost containment programs in the United States. In his excellent paper, Prof Reinhardt finds evidence of price differentiation efficiencies at many levels. Private insurers pay much more for all services than public insurers, who use their larger bargaining power to lower prices.
For the same service, the variations in service fee are large in case of hospitals as against other treatment centers. There is an obvious high premium extracted by certain hospitals. The variations in payments across hospitals for the same service can be substantial.
The effectiveness of India's health insurance market will depend on it being able to get both the health service purchase and pricing model right. It is fortunate that being a nascent health insurance market, governments are not constrained by any legacy models. Since governments will be able to provide adequate health insurance to only a small proportion of the population, it is important that private health insurers too are able to keep their costs low and sell policies at affordable prices. Public policy should play a catalytic role in facilitating this.
The purchase model is more complex and not easily amenable to policy fixes. However, governments should encourage private insurers to adopt a purchase model that bundles services and makes payment for treatment of the medical condition. It is possible for governments to get health service providers as far away from the fee-per-service model of charging insurers. While it may be easier for large specialty hospitals to accept this, this model may end up excluding smaller diagnostic centers and clinics. Encouragingly, India's nascent health insurance model is, for various reasons, moving more towards the bundled purchase model than the fee-per-service model.
In case of pricing though, there is a more direct role for governments in assisting insurers arrive at standardized prices for services in all hospitals within a particular area. The model of all-payer price fixing, as is done in many continental European countries, would reduce the administrative and other transaction costs, and help keep insurance premiums at affordable levels.
In some ways, there is a free lunch here. Governments, both state and center, have an increasing leverage over private health service providers due to various newly announced state and central health insurance schemes. This strength should be used to bargain out standardized rates for services by participating hospitals within a geographical area. The private insurers could differentiate by offering variants of the basic service with top up prices.
Unfortunately, failure in this front is already evident in public health insurance. As I have blogged earlier, one of the critical failings with the Aarogyasri program was its inefficient price-fixing model. Other state governments, eager to embrace the wild populism inherent in Aarogyasri, may end up making the same mistakes.
Update 1 (3/3/2012)
Two excellent posts by Uwe Reinhardt on payment and pricing health insurance. The first dwells on the relative merits of the three purchasing models - fee for service, medical condition-based bundled payments, and capitation fee model. The second examines the three price determination models between the insurers and the insured and insurers and health care providers (doctors, clinics, hospitals etc) - free market negotiations, price-setting in quasi-markets (all payer system where the associations of health insurers within a region would negotiate with corresponding associations of hospitals, doctors etc uniform fee schedules that then would apply to all payers and providers in that region), and administrative price fixing by the government.
See also this paper by Prof Reinhardt on pricing in US hospital services.