Risk-Adjusting the Doughnut Hole to Improve Efficiency and Equity

By van Kleef, Richard C.; van de Ven, Wynand P. M. M. et al. | Inquiry, Winter 2011 | Go to article overview

Risk-Adjusting the Doughnut Hole to Improve Efficiency and Equity


van Kleef, Richard C., van de Ven, Wynand P. M. M., van Vliet, Rene C. J. A., Inquiry


An important goal of consumer cost-sharing in health insurance is to increase incentives for cost containment. A relatively new cost-sharing phenomenon is the "doughnut hole": a gap in coverage starting at a predefined level of medical expenses. An important question is where to locate the starting point to achieve the strongest incentives for cost containment. We argue that the answer depends on an individual's health status. Using data from a Dutch insurer, this paper illustrates that using a risk-adjusted starting point results in both stronger incentives for cost containment and more equity than a uniform starting point.

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A major goal of consumer cost-sharing in health insurance is to reduce moral hazard by providing enrollees with incentives for cost containment. A relatively new cost-sharing phenomenon is the so-called "doughnut hole": a gap in coverage that starts at a predefined level of medical expenses. This particular type of insurance design is currently applied in Medicare Part D prescription drug coverage and is potentially interesting for other health plans as well. (1)

A simplified version of this concept is graphically shown in Figure 1, with d referring to the doughnut hole and s referring to the point where the doughnut hole begins. An important question for policymakers is where to locate the starting point to achieve the strongest incentives for cost containment. In this paper, we argue that the answer depends on the individual's health status, implying that we expect a risk-adjusted starting point to result in stronger incentives for cost containment than a uniform starting point.

The article is structured as follows. First, we theoretically consider incentives for cost containment under a doughnut-shaped insurance design. We start from the arguments of Newhouse (1993) and the framework of Van Kleef, Van de Ven, and Van Vliet (2009), who discuss the incentives for cost containment under a first-dollar deductible plan. Secondly, we consider three technical requirements for implementation of a risk-adjusted starting point: availability of data, an adequate (risk adjustment) model for calculating the expected costs, and a measure for determining the starting point given the expected costs. Thirdly, we illustrate intuitively the concept of a risk-adjusted starting point using administrative data from a Dutch insurer. We conclude that risk-adjusting the doughnut hole is not just expected to increase incentives for cost containment, but also to reduce the difference in out-of-pocket expenses between the healthy and the chronically ill. With respect to the latter, a risk-adjusted starting point can be considered more equitable than a uniform starting point. In the last section, we raise some important issues for discussion and further research.

[FIGURE 1 OMITTED]

Doughnut Holes and Incentives for Cost Containment

Compared to full coverage, cost-sharing reduces moral hazard by providing consumers with incentives for cost containment (Keeler and Rolph 1988). In the case of a doughnut hole, the strength of these incentives is expected to vary with the probability of reaching the gap and with the probability of exceeding the gap. For an explanation, we have to distinguish between the market price and the perceived price of medical care. With respect to the perceived price, we mean the price experienced by consumers, given their expected expenses in the contract period (Van Kleef, Van de Ven, and Van Vliet 2009). In the following example, Newhouse (1993) illustrates the relevance of this distinction in the context of a In-st-dollar deductible, which can be seen as a doughnut hole Starting at $0 as applied in consumer-driven health plans in the U.S. (such as health savings accounts) and in mandatory health insurance plans in Switzerland and the Netherlands.

As Newhouse (1993, p.81) explains: "Consider someone with a first-dollar deductible of $1,000 who has to decide whether to visit his doctor for a market price of $40 on the first day of the contract period. …

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