The Concept of Actuarial Equivalence
The above examples illustrate "actuarial equivalence." On average, a payer can afford to pay for rare and catastrophic care if it pays slightly less for a number of more common, but less expensive services. However, sometimes it is not this simple.
Actuarial equivalence is determined across large populations, but the random occurrence of a rare event can have a great impact on small groups. For example, among a small group of people, one person can suffer catastrophic costs - and those costs can impose a hardship on the entire small group. Actuarial equivalence, and the cross-subsidies that can cover catastrophic costs, require additional mechanisms to operate successfully among small groups of people.
Insurance adjusts for catastrophic risks through pooling and other techniques. For example, an "average" group of 50 covered individuals might expect to pay about $165,000 in health insurance claims in one year. The unlikely event of one organ transplant in that small group could cause the cost to double. By contrast, a group of 5,000 covered individuals might expect to pay $16.5 million in claims in one year. A similar, organ transplant in that larger group would add only 1%. Consequently, insurance programs use pooling /6, stoploss /7 and other techniques /8 to spread the risk of unlikely catastrophic events.
Managing Adverse Selection and Fluctuation
Adverse selection occurs when individuals or groups make benefit selections based on their individual needs. /9 Therefore, healthy people are more likely to go without insurance or chose cheaper insurance, and individuals with particular ailments are more likely to choose plans that provide more generous coverage for their problem and are therefore more expensive to the insurer.
Adverse selection also affects prescription drug benefit design. If a payer offers both Plan A and B, described above, people who need innovative therapies (costing $1,000 or more per month) will tend to choose Plan A because of the $50 copay, and people who want a third tier drug with a cost of $100 will choose Plan B, because the $25 coinsurance (25% of $100) is less than the $50 copay in Plan B. The cross-subsidy that Plan A uses to fund the higher cost therapy will not work well in this example.
Because a concentration of expensive individuals can add a lot of expense to a payer's cost, adverse selection and fluctuation are real concerns in benefit design. However, these issues are not new. Insurers have faced adverse selection and fluctuation since the first employer-based health insurance policy was issued. As a result, pooling, reinsurance, benefit mandates, underwriting and other techniques have been developed to address these challenges, and we are confident that these methods can be successfully used to adapt to the cost of FDA-approved innovative therapies. Actuarial literature offers fuller treatment of these issues /10.
Potential Cost Offsets
This study examines important cost issues for innovative therapies as a whole rather than for specific products. Although we did not examine the potential for innovative therapies to offset the use and cost of other medical products and services, such offsets are a potentially important ameliorating factor. We have been conservative by assuming that no such offset exists.
New and improved medical treatment does not necessarily cost more than traditional treatment, although obviously it can. The current standard of care for certain diseases can be very expensive. Therefore, treatments that replace or modernize the traditional standard of care can reduce a patient's medical costs, even if the new treatments are themselves very expensive. An example is the cost offset of a hypothetical product that would prevent or cure Alzheimer's disease and avoid years of very costly nursing home care. In this example, even if the therapy is expensive, it will be cheaper than years of institutional care.
We believe that potential cost offsets of innovative therapies need to be considered in two ways:
Traditional cost-benefit. Studies of this sort focus on isolated or single-factor decisions, such as comparing the costs and benefits for different treatments for high cholesterol or advanced cancer.
System change cost-benefit. Technologies such as advanced medical treatments can be the agent for dramatic changes in our current, inefficient medical system. For example, use of innovative therapies is often closely monitored according to the principles of evidence-based medicine, which, in turn, can lead to dramatically improved quality and efficiency and reduced costs.
Recommendations for Payers
We suggest that payers consider the following issues in choosing benefit designs:
The compatibility of benefit designs with innovative technologies and needs.
The trade-off between catastrophic benefits and coverage for more routine and low-cost services.
The impact of benefit designs on individuals with serious illness.
Ways to manage the risk of adverse selection and fluctuations.
The cost of traditional treatments and potential cost offsets as innovative therapies replace or supplements other care.
Our work required us to estimate both future innovative therapy costs and future medical costs. This section explains our methodology.
FDA-Approved Innovative Therapies