Addressing incentive distortions in health insurance

Health care abounds with information asymmetry and incentive distortions, and consequent market failures. The objective of any efficient health insurance system is to align incentives in a manner that health service providers deliver and patients demand the right amount of care, and insurers do not turn away any deserving patient. All the different models of health insurance in use across the world seek to achieve this objective.

Health insurance providers base their payments to health service providers either on the basis of fee-per-service or a single lump sum for the full treatment regime. The former aligns the incentives of health service providers towards over-treatment - they get more money for more procedures. The latter shared-savings programs, while attempting to be cost-effective, may incentivize providers to provide less care overall and channel patients towards the cheapest treatments.

Insurers have sought to address such incentive distortions with rigorous screenings and patient-side measures like co-payments and deductibles. The latter consumer-driven schemes seek to encourage patients into searching for the most cost-effective option by forcing the patient to share part of the treatment cost burden. Though there have been apprehensions that such cost-sharing would force patients to skimp on their treatment options, they have not been borne out conclusively. In fact, the Rand Health Insurance Experiment, the most comprehensive study of its kind, found that when insurers increased cost-sharing, though individuals reduced their care consumption by about 30 percent, the vast majority suffered no ill effects.

Now an interesting paper by Lorens Helmchen proposes a new cash-for-care arrangement, where "when faced with two treatments of roughly equal efficacy but dramatically different cost, the insurer would pay patients a cash fee if they chose the less expensive option". Though a form of shared savings plan, such plans differ in that unlike conventional shared savings plans which share savings exclusively with health care providers, cash for care shares savings with patients. In simple terms, cash for care gives patients a bonus to ration their own care.

Such cash for care schemes would be especially effective in end-of-life care (it accounts for a quarter of Medicare spending in the US), especially relating to cancer treatment. Treatments for the same class of cancer can range in cost from as little as $1,300 a month to more than $7,000. In such cases, the choices of the patient would be a reflection of the value attached by the patient to his/her own life.

However, from the perspective of the insurers, I am not sure whether it will be effective for end-of-life care patients. Unless it forces them to face extreme pain and other difficulties, any such patient is most likely to choose a treatment option that increases the chances of living longer. This objective is most often fulfilled by the expensive option. In any case, the success of such models can be evaluated only when actually implemented, since it would also depend on whether it causes any dramatic drop in health care outcomes for those chosing the cheaper alternative over the more expensive one.