A New Type of Hospital Insurance

Abstract

This paper discusses a new type of hospital insurance called Variable Cost Insurance (VCI). The basic idea is to have each household choose its hospital(s), and then to make its insurance premium depend upon the costliness of the hospital chosen. The advantages of such a method in terms of improved efficiency and equity are pointed out. Extensions of the idea to physician services and comprehensive care are also discussed. This proposal is compared with other commonly proposed remedies for rising hospital costs such as planning, cost targets, and capitation. An experiment is proposed whereby VCI could be tested to determine its administrative feasibility and the gains which might accrue from its adoption. It has become a cliche that medical care prices, especially hospital prices, are rising. Present hospital insurance arrangements are an important cause of this situation. Typically the purchaser of an insurance policy can go to any hospital without changing his total bill very much (although his choice may change the bill paid by insurance by a great deal). In such a situation the consumer and his physician have no incentive to seek out the most economical hospital; rather each physician and consumer has the incentive to demand the very best. In other words, Joseph P. Newhouse, Ph.D., is Research Associate for The Rand Corporation. Vincent Taylor, Ph.D., is a Consultant for The Rand Corporation. He was formerly Associate Director of the National Health Manpower Commission and prior to that was Program Manager for Health Research for The Rand Corporation. This paper was submitted in February, 1971. This research was supported by a contract between the Office of the Secretary of the Department of Health, Education, and Welfare, and Professor Lester B. Lave. Any views expressed in this paper are those of the authors. They should not be interpreted as reflecting the views of the Department of Health, Education, and Welfare or The Rand Corporation. The authors wish to acknowledge helpful comments from Judy and Lester Lave and Richard Zeckhauser on an earlier draft. since the costs of hospitalization are shared among all subscribers to an insurance plan, any given individual incurs little financial penalty by demanding the very best. Hospitals' attempts to meet these demands contribute importantly to rising prices. Moreover, since price is not very important to patients, cost-saving measures receive relatively low priority in management decisions, further exaggerating the effects of rising labor and material prices on hospital costs. The remedy most commonly heard for coping with rapidly rising hospital costs is hospital planning. In practice, however, it is not clear what planning implies. Often its advocates focus upon the duplication of equipment among hospitals, and assume that planning can end gross duplication. Perhaps it can, although even that may not be true. And ending gross duplication would, in all likelihood, do little to stop the rise in hospital costs. A more specific proposal, put forth by the National Commission on Health Manpower is to adopt incentive payment plans for hospitals.' This proposal has also been 'National Commission on Health Manpower, Report; Washington: GPO, 1967.