Academic journal article Applied Health Economics and Health Policy

Lessons from Game Theory about Healthcare System Price Inflation: Evidence from a Community-Level Case Study

Academic journal article Applied Health Economics and Health Policy

Lessons from Game Theory about Healthcare System Price Inflation: Evidence from a Community-Level Case Study

Article excerpt

Published online: 11 December 2012

© Springer International Publishing Switzerland 2012


Background Game theory is useful for identifying conditions under which individual stakeholders in a collective action problem interact in ways that are more cooperative and in the best interest of the collective. The literature applying game theory to healthcare markets predicts that when providers set prices for services autonomously and in a noncooperative fashion, the market will be susceptible to ongoing price inflation.

Objectives We compare the traditional fee-for-service pricing framework with an alternative framework involving modified doctor, hospital and insurer pricing and incentive strategies. While the fee-for-service framework generally allows providers to set prices autonomously, the alternative framework constrains providers to interact more cooperatively.

Methods We use community-level provider and insurer data to compare provider and insurer costs and patient wellness under the traditional and modified pricing frameworks. The alternative pricing framework assumes (i) providers agree to manage all outpatient claims; (ii) the insurer agrees to manage all inpatient clams; and (iii) insurance premiums are tied to patients' healthy behaviours.

Results and Conclusions Consistent with game theory predictions, the more cooperative alternative pricing framework benefits all parties by producing substantially lower administrative costs along with higher profit margins for the providers and the insurer. With insurance premiums tied to consumers' risk-reducing behaviours, the cost of insurance likewise decreases for both the consumer and the insurer.

1 Background

Cost containment in the US healthcare system has been a difficult challenge in the past 20 years due to the complexity of the interacting parts [1]. The system has been built around the Adam Smith notion of free markets that is governed by autonomous optimizing behaviours and the laws of supply and demand [2]. This design works well for widgets, but has significant implications when applied to a vertical market consisting of providers and patients/consumers who are linked via the use of health insurance. The pharmaceutical industry is another entity involved in the system but is outside the scope of this study. Under supply and demand economics, these three entities compete for the same dollars to achieve profitability. Insurance companies strive to minimize costs by limiting payments to providers and/or by raising patient (or employer) premiums or implementing copayment systems [3]. In turn, providers set their prices for patient services to maximize their profits; prices are determined by the procedure and diagnosis codes established by the insurance companies, which are prenegotiated between providers and insurers [4]. Patients can, in some cases, lessen their out-of-pocket insurance and healthcare costs by limiting their utilization of provider services and/or by purchasing less insurance [5, 6].

The issue of how to structure healthcare markets to promote both quality and cost effectiveness is highly relevant for policymakers as well as healthcare administrators and providers [7]. Understanding the strategic interdependencies between the insurance industry, providers and patients is critical to cost containment in addition to optimizing patients' health outcomes [8]. Game theory provides a framework to understanding these interdependencies and can shed light on how improvements to the joint healthcare system may be accomplished by altering the 'autonomous behaviours' of individual parties within the system [9]. Game theory assumes that individuals are rational decision makers who are motivated to maximize their utilities [10]. Utility is often contextually defined as, for example, the personal welfares of consumers, or the total revenues or profits of business entities. When combining the decisionmaking processes of two or more parties whose autonomous motivations affect the nature and/or quality of the group outcome, game theory predicts that group outcomes could be suboptimal due to the non-cooperative nature of the parties' independent, yet interdependent, actions. …

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