I will offer my proposal for Medicare indemnities. I will ascertain how much risk would be involved with indemnities, and how this risk could be reduced to a manageable level. After discussing how the occurrence of a costly event would be verified, I will explore the question of whether the indemnity should be restricted to medical care.
The Primary Argument for Indemnity Insurance. I propose that Medicare scrap the RBRVS physician payment system and replace it with "Medicare indemnities" that would pay patients a fixed amount of money depending on the diagnosis of a particular medical condition. Patients would be able to use the indemnity to purchase medical care from any provider under any terms and conditions the patients and providers find mutually satisfactory. Under some conditions, discussed below, they might be allowed to cash in part of the indemnity, as well.
The primary reason I believe indemnities would be superior to the current Medicare fee schedule is that they would reward patients who seek less costly care. With an indemnity policy, the cost of medical care is paid out-of-pocket, compared with the coinsurance policy, where the patient pays only a fraction of the cost out-ofpocket. Thus, the last dollar of medical care spent under the indemnity policy is worth one dollar to consumers, whereas the last dollar of medical spending under the coinsurance policy is worth only a fraction of a dollar. Having received an indemnity payment, an individual would consume the same amount of medical care as he would when paying with his own money. As a consequence, he would have an incentive to use the right amount of medical care and to shop for the best prices and types of care offered by alternative providers.
Both policies start from the same consumer budget, shown by the heavy black line. For a small premium relative to the medical expense, the traditional policy reduces the consumer's out-of-pocket price of medical care (along the less steeply sloped dashed line), leading to an increase in consumption of medical care. In contrast, the indemnity policy for the same premium transfers income to the consumer but does not change the relative price of medical care, as shown by the second dashed line, which is parallel to the budget line. As a result, the consumer uses less medical care than with the traditional policy and reaches a higher level of utility. This is shown by the fact that the indemnity equilibrium point touches a higher indifference curve than does the equilibrium point for the traditional policy.
Many issues would need to be addressed in order to design a practical Medicare indemnity. The first of these is the question of how to set the indemnity in relation to the expected costs of treatment. Gianfrancesco recommended a process of "trial and error," where the insurer attempts to set the indemnity equal to the modal expenditure associated with that category of service under traditional insurance. Patients who seek care from providers who charge less than the modal payment could keep the difference.
When we add other payers to the market, however - for example, patients under age sixty-five with private insurance - the situation becomes more complicated. In some cases, the indemnity payment might be more than enough to pay the physician's total bill, while in others it would be less than the modal expenditure, and patients would be balance-billed for the difference. Which case is relevant depends on the same conditions that determine the extent of balance billing under the current Medicare fee schedule. When physicians have "low capacity," and demand from other payers is added to the model, the market price for the modal treatment may exceed the indemnity payment, and Medicare patients would be balancebilled. In contrast, when physicians' capacity is high, patients would be able to cash in the unused portion of the indemnity. Because providers' marginal costs and market demand conditions vary among geographic markets, the indemnity payments should be adjusted for these variations.
Medicare currently relies on three Geographic Practice Cost Indexes (GPCIs) to adjust the fee-schedule prices for local variation in the cost of physicians' work, practice expense, and professional liability insurance. However, there are only eighty-nine GPCI local market areas for the entire United States. This is well below the number of local markets that would be defined by patients' willingness to travel to obtain physicians' services. If Medicare moved to an indemnity payment system, it would be necessary to explore new market definitions that correspond more closely to geographic markets for physician services. They also discussed demand factors, such as illness burden and per-capita income, that influence Medicare spending in local markets. Efficient pricing requires that adjustments be made for these factors, as well as for differences in physicians' practice costs across markets.
A problem closely related to geographic adjustment is how to adjust the indemnity for changes in medical technology. It should be noted that all third-party payers, including competitive private insurers, face the same problem. One possible response is for Medicare to observe the adjustments that private payers make to their physician fees. With all of these adjustments, wouldn't Medicare indemnities wind up looking like the RBRVS system with its thousands of codes, which for all practical purposes has been captured by the regulated industry? I suggest that the process of setting Medicare indemnities could be simpler than that of determining the relative fees under RBRVS. This hunch follows from the different purposes of the two systems: Whereas the RBRVS claims to replicate physicians' actual costs, the indemnity system is designed to pay some portion of what the doctor charges. To set the indemnities, Congress would have to decide how much, on average, of the doctors' charges patients should be expected to pay. This decision would be less complicated than setting prices that are supposed to measure the costs of thousands of different services.
I also suggest that a considerable percentage of all Part B spending for physicians' services could be captured by a relatively small number of indemnities. This shows the top fifty principal diagnoses for Medicare-allowed charges by physicians and suppliers in 2002. The top fifty diagnoses accounted for 54 percent of the USD 81 billion of Medicare-allowed charges by physicians and suppliers in 2002. In comparison, the top fifty "HCPCS" codes, representing the types of services performed, accounted for 47 percent of allowed charges. Thus, the types of illness represented in the Medicare population appear to be somewhat more concentrated than the types of services provided. This should make it easier to focus on setting the indemnity payments - in contrast to the difficulty of trying to determine the cost of each service provided.
Another way of looking at this issue is to examine the causes of death of Medicare beneficiaries (although this information is somewhat dated). Analyzing a six-year file of Medicare use and cost data linked to death certificates, Riley and Lubitz (1989) found that almost 70 percent of the 1.27 million Medicare beneficiaries over age sixty-five who died in 1979 died from three major causes: heart disease (40.9 percent), cancer (18.0 percent), and stroke (10.5 percent). During the year prior to death, these beneficiaries spent 3.38, 6.62, and 3.68 times as much, respectively, as the average aged Medicare enrollee. Therefore, from this perspective as well, health-care spending in the Medicare population is concentrated on a fairly small number of diseases. Of course, there can be wide variation in the cost of an illness depending on severity or disease stage, so these data are not meant to be definitive.
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