Working Papers

Adjusting Capitation Rates for Risk: An Equivalent Martingale Pricing Approach
Robert T. Maurer

Abstract: While the use of capitated reimbursement encourages efficiency in the production of health care services, it also creates incentives for health plans to select favorable risks. Incentives to select risks exist when a plan's compensation depends on the financial performance of a risk pool and the plan has an ability, through marketing strategies or other means, to alter the probability distribution of the expected payoff by selectively enrolling favorable risks or by discriminating against unfavorable risks.

Risk selection is an information asymmetry problem in which the health plan exploits its differential ability, relative to the plan sponsor, to predict risk. From the sponsor's perspective, the problem becomes one of eliminating predictable sources of priced risk from the pricing scheme, in order to make the health plan's expected return from the arrangement a random variable. Generally speaking, the normative approach uses risk proxies to detect predictable risk and then groups risks into homogeneous risk categories with risk-adjusted capitation rates. To make this approach work, the sponsor must find observable risk proxies that are also good risk predictors. However, there is some doubt whether observable risk proxies can capture all of the predictable economically-priced risk.

This paper uses financial engineering techniques to formulate a conceptually different approach to the problem that makes the capitation rate a 'fair game' over time. The paper makes three contributions. First, in contrast to the normative static approach, the paper uses an intertemporal framework to capture the evolving nature of the problem over time. Second, since the basic idea underlying risk adjustment is the use of conditioning information, the paper uses a probability measure space framework to emphasize the role of conditioning information in pricing risk. And third, the paper uses the financial theory of martingale pricing processes to derive a risk-adjusted retrospective price as a function of the prospective price conditioned on information revealed by the health plan's actions about changes in the distribution of risk in the population. The paper also shows how this model leads to a straightforward, easily implemented pricing scheme.

Graduate Program in Health Care Administration
Texas Woman's University
E-mail: rmaurer@twu.edu
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Supporting Patient-Centered Care in Medical Groups With Information Technology
Thomas R. Prince

Thomas R. Prince, PhD, CPA, is Professor of Health Industry Management and Professor of Accounting Information and Management at the Kellogg Graduate School of Management, Northwestern University, Evanston, Illinois.

Abstract: Corporate purchasers of healthcare benefits for employees and their dependents are beginning to demand the use of information technology in healthcare for purposes of improving quality. Level of investment in information technology is directly related to net income for hospitals. The proper choice of investments in information technology is associated with financial stability and supporting patient-centered care in medical groups. Empirical studies of healthcare services in outpatient facilities and clinics indicate the opportunity for significant improvements in quality by focusing a very small set of treatment protocols.

Key words: computer-based medical record, Internet, information technology, financial viability, investment decisions, patient-centered care

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