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More on managed care. Demand for MCOs. Patients and/or employers may wish lower cost alternative. BUT, they might not like to have their options limited. In the past, if patients already have strong relationships with current providers, they might be unwilling to seek MCO alternative.

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Demand for mcos
Demand for MCOs

  • Patients and/or employers may wish lower cost alternative.

  • BUT, they might not like to have their options limited.

  • In the past, if patients already have strong relationships with current providers, they might be unwilling to seek MCO alternative.


  • Proposition: Criterion for choosing among MCOs – “less than or equal.”

  • Unless a MCO matches household’s preferences (point A) for prepaid care exactly, with number of visits vA, the household will pick one that provides less care.

    • A household can purchase additional health care out-of-plan, but it cannot sell surplus care.

    • With the current individual’s preferences, then, plans i and k dominate plan j. The insured may or may not choose to purchase additional care out of pocket. For purposes of this exposition, we will assume that the insured uses care level

More on managed care

Proposition 1 – Less than or equal



Initial Income




Out of Plan, or

Deductible (coinsurance rate = 1)




Pure Risk Premium


Supply of mcos
Supply of MCOs

May offer considerable cost advantages:

  • Reduce quantity and intensity of care.

  • Substitute lower cost care for higher cost care.

  • Provide economies of scale in the purchase and use of inputs.

  • Quicker to develop effective utilization review.

  • Adopt new technology more efficiently.

  • Encourage use of cost-effective preventive care.

  • Provide administrative economies.

Are mco costs lower
Are MCO costs lower?

  • Without question, they have lower hospitalization costs.

  • Following “bottom lines”

    • Inpatient services account for a higher percentage of total expenditures than do outpatient services.

    • MCO plans use fewer services that are expensive, and/or have less costly alternatives.

    • MCOs provided more comprehensive coverage than did indemnity plans.

  • All of these imply that MCOs provide care at lower costs than do indemnity (FFS) plans.

Quality of care
Quality of Care?

  • What is quality?

    • Structure = quality and appropriateness of inputs and their organization.

    • Process = quality of the performance of the delivery of care.

    • Outcome = ultimate impact on health.

  • In a nutshell, it’s hard to conclude that MCOs are either better or worse.

  • This is important, because many people would assume that they are worse.


  • Some of the financial and quality of care problems associated with patient disenrollments are well known.

  • Patients and providers face the difficulties of maintaining continuity of care and complete medical records.

  • MCOs face added financial burdens resulting from higher patient recruiting costs, disruption of cash flows, and upward pressure on premiums for continuing members if lower risks are more likely to disenroll.


  • Why emphasize preventive care for a patient who is not likely remain a member, when that care provides the greatest return in the form of averted future treatment costs?

  • Potential loss of patients may influence treatment decisions of FFS providers as well as MCOs, but capitation method of payment to MCOs renders the disenrollment problem particularly important.

  • FFS providers are paid for each unit of care. Aside from uncollectibles, they are not at risk of losing money on services provided currently or in the future.

Managed care in contrast
Managed Care, in contrast …

In contrast, by integrating insurance with the provision of health care, the MCO receives a fixed payment per enrollee to cover costs in the current period, and over time, for those who remain enrolled.

Thus, unlike FFS care, where payment in every period is very likely to cover costs, the MCO must consider the timing of expenditures and the financial losses of overspending on patients who may disenroll.

One way for an MCO to “self-insure” against long term losses attributable to disenrollment is to economize on care for those currently enrolled.

This would mean:

Enrolling fewer patients.

Providing less care.


xi= services level

ki = # of members


Ci = the MCO’s total annual cost to provide expected level xi of health services to its ki enrolled members.

Total cost Ci is related positively to xi, positively to number of person-years of membership ki, and negatively to “health” y of those who happen to be members at the time.

With ki as an argument in the cost function we can have either increasing and/or decreasing returns to scale for both ki and xi.

The health externality
The Health Externality

This is easily shown. Without the externality, MCO1 optimizes at point A, giving level x1mkt.

C1x + k1 (C1y+ C2y)



The optimal level of x1 at point B is x1opt, as noted by the downward shift in the right hand side by the factor k1 (C1y+ C2y), which is unambiguously negative.

This indicates an inefficiently small level of MCO care x, and by implication a substitution of non-MCO and/or non-health care inputs (such as the patient’s own time) for the MCO care.


k1 P1x

k1 (C1y+ C2y)



Inputs (services) x1

Disenrollment and treatment choice
Disenrollment and Treatment Choice

  • What about alternative treatment methods.

  • Consider the longer term consequences that potential disenrollment can have on MCO treatment practices.

  • In the presence of expected disenrollment, MCOs will tend to use “low-tech” treatments with smaller up-front costs, even when the present discounted value (PDV) of the costs equals the PDV for “high-tech” treatments.

Disenrollment and treatment choice1
Disenrollment and Treatment Choice

We can write a two-period model where an MCO provides either

high tech treatment M the first period; no treatment the second period.

low tech treatment m in each period.

r is the rate of interest and g is the disenrollment rate.

It turns out that the MCO will provide high tech treatment if:

M < m[1 + (1-g)/(1+r)],

and low-tech if:

M > m[1 + (1-g)/(1+r)].

Thus the higher the disenrollment rate g, the more important is the disenrollment effect. If g = 0, the MCO faces the standard investment criterion, comparing first period costs with discounted future costs. Its decision here will be economically efficient.

Disenrollment and treatment choice2
Disenrollment and Treatment Choice

  • With the likelihood that increased competition through increased choice will raise g, managed competition and other competitive strategies must be more carefully examined.

  • If g, m [1 + (1-g)/(1+r)] , and continuing care m becomes the more financially viable option even if the PDVs are equal, and even if treatment M is more economically efficient in producing health.

  • In effect, MCOs self-insure against future disenrollment by reducing current costs through (low cost) continuing care rather than high-tech treatment.

Competitive effects
Competitive Effects


  • What effects might occur?

  • In principle, it would lead to more competition, flatter demand curves.






  • Shift demand curve to the left.

  • Shift the MR curve to the left.

  • Increase the demand elasticity at any price because there are now more competitors.