For many medical conditions, the variance of cost will exceed the amount of risk that patients can manage on their own. Partial indemnities may be appropriate for these conditions, but pure indemnities are not. In such cases, how should risk be managed? As a starting point, I recommend that Medicare undertake as part of its demonstration an up-to-date analysis of the cost of treating common medical conditions, as well as the amount of risk that patients are willing to bear. Measures of patients' willingness to bear risk should be contingent on their income and wealth.
Several designs could be used to construct partial indemnities. These include charging coinsurance on expenses above the indemnity and requiring a deductible above the indemnity before a major medical policy kicks in. Pure indemnities could be used for "relatively straightforward" conditions. It might be advisable to test each of these designs in a demonstration.
Now, suppose that the mean expense for a given condition is USD 10,000. If each eligible person were given an indemnity of this size, we could use the formulas above to calculate how many people would experience costs greater than the indemnity and how much they would have to pay out of pocket. For example, if the indemnity were set at the mean expense, then 37 percent of the eligible population would have costs that exceed the mean, and, on average, they would have to pay USD 10,000 out of pocket. In other words, they would be exposed to a significant amount of risk. This information could be used to design a mixed indemnity policy with a deductible. Using this example again, suppose there were a USD 1,000 deductible after eligible expenses exceeded the indemnity. Of the eligible population, 37 percent would have to pay something out of pocket, and 33 percent would exceed the deductible. For simplicity, assume that all 37 percent with positive out-of-pocket expenses would exceed the deductible (although this is actually an overstatement of their risk). The mean out-of-pocket expense in the whole population would therefore be USD 370, and the variance of outof- pocket expense would be USD 233,100. The point of the demonstration would be to test whether this cost is worth it in the sense that the value to beneficiaries of self-directing the first USD 10,000 of their expenses would be greater than USD 98–USD 128.
Enrollees in the RAND Health Insurance Experiment were guaranteed that participation would make them no worse off than refusing to participate. This was accomplished by participation incentive payments equal to the maximum loss they risked by changing from their existing coverage to the experimental plan to which they were assigned. In a demonstration of Medicare indemnities, a similar set of hold-harmless payments would maximize beneficiaries' incentives to participate and might even become part of a functioning indemnity program.
Unlike enrollees in the RAND Health Insurance Experiment, however, participants in the Medicare indemnity demonstration could not be held "absolutely harmless" against risk. To see why this is the case, imagine the worst thing that could happen to a participant. Even if the indemnity were risk-adjusted, the worst outcome would be to have expenses that far exceed the indemnity. In order to hold patients absolutely harmless against this risk, Medicare would have to pay 100 percent of the maximum possible expense. This would make it impossible to design a demonstration of indemnities because they would have to be set at the highest level of expense. In addition, a demonstration of this type would be prohibitively expensive. Despite this difference from the HIE, participants in a demonstration of indemnities could be held "relatively harmless" by being offered a deal that should be acceptable to all of them a priori: The maximum deductible in the Medicare indemnity policy, less a risk premium calculated for each service, would never exceed the beneficiary's out-of-pocket cost for an equal amount of covered services in the traditional Medicare program. For example, in 2008, a beneficiary in traditional Medicare with USD 10,000 of covered services would pay a deductible of USD 135 and 20 percent coinsurance on the remainder, or USD 2,108 in all. He or she could be guaranteed that the deductible in the Medicare indemnity policy would never exceed USD 2,108, less a risk premium of approximately USD 100. This clearly is a "good deal" because it does not include any risk premium for traditional Medicare, nor does it consider the possibility that the beneficiary's coinsurance payments could greatly exceed USD 2,108 in traditional Medicare. In addition to encouraging participation, a useful side effect of these hold-harmless payments is the opportunity they would provide to measure the degree of risk aversion among Medicare beneficiaries.
The question of whether the indemnity should be restricted is probably the most intensely ethical one to ask about indemnities. A continuum of possible answers to this question ranges from no restrictions at all to restricting the indemnity to being spent on medical care (that is, making it into a medical- care voucher). Intermediate positions would carve out certain services from the indemnity and require that these be covered by traditional Medicare. For example, patients with terminal cancer might be required to have hospice benefits.
Unrestricted indemnities would be unenforceable because society wouldn't have the stomach to refuse medical care after the fact, even if the patient had signed a voluntary, informed contract to forgo medical care. However, if policymakers can agree on a set of minimum benefits that cost less than the indemnity, on average, and if patients want to cash in the rest, then I see no reason to prevent them from doing so. Even if a demonstration accomplished nothing else, it would provide an opportunity to have an open and frank discussion about how much medical care society wishes to compel individuals to use.
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1. Indemnities are not used in Medical Insurance for a number of reasons
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