Study: Option Pricing Optimal in Cost-Effective, Collaborative Care

When providers and insurers collaborate on providing efficient care in settings like accountable care organizations (ACOs) and patient-centered medical homes, it presents them with an ability to share savings. However, when a patient’s care exceeds projected cost expectations, current models of shared-saving contracts can disproportionately affect insurers. Findings published this month in The American Journal of Managed Care suggest that a more cost-effective solution may be possible through option pricing. This “call options” tool may resolve many payers’ concerns about entering shared saving contracts with providers.

Costs of care for a given patient are often unpredictable, varying annually depending on any amount of given factors. This random variation can make predicting a patient’s expected costs difficult, and can drastically influence the savings or losses experienced in a shared saving environment. AJMC study authors, Mark W. Friedberg, MD, MPP, Anthony M. Buendia, BA, Katharine E. Lauderdale, BA, and Peter S. Hussey, PhD, found that this volatility affects payers most as they often risk significant financial losses.

“A substantial proportion of shared savings bonuses may be paid due to chance alone (‘paying for volatility’), even if providers do nothing to contain costs,” the authors wrote. “While random variation also can produce cost overruns, the resulting penalties will not counterbalance random rewards when shared savings contracts are asymmetric.”

Insurers remain hesitant to enter shared saving contracts unless they are positive there will be efficient cost-containment efforts made by the provider. Widespread adoption of shared savings contracts will only be made possible in addressing their concerns. In implementation of option pricing, providers and payers can bridge the gap that lies between providers, who want protection against downside risk, and payers, who seek a more favorable business proposition. When payers sell “call options” as a condition of a shared savings contract, the “options can be priced to counterbalance exactly payers’ expected losses due to random variation in healthcare costs, under any shared savings arrangement, with providers large and small.” Having options will lead to a more customized shared savings contract agreement between a provider and insurer.

Option pricing is calculated based on the cost data of a network’s own patients, their own techniques of estimating benchmark costs, and their particular estimates of projected savings. After calculating option prices, payers can present a provider with a selection of potential shared saving contracts, including the option that a fee be tied to other terms like minimum savings rates, bonus caps, and risk factors.

“With healthcare costs threatening to devour other parts of the national economy, efforts to contain these costs are increasingly important,” wrote the authors. “An urgent response may require all hands on deck, including government and private payers as well as providers of all sizes.”

Shared savings contracts show promise to offer more flexible, innovative ways of encouraging cost savings in healthcare, but they must be more broadly adapted.

Press release available here.

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Option Pricing: A Flexible Tool to Disseminate Shared Savings Contracts [AJMC]

Option Pricing: A Flexible Tool to Disseminate Shared Savings Contracts - See more at: http://www.ajmc.com/publications/issue/2013/2013-1-vol19-n8/Option-Pricing-A-Flexible-Tool-to-Disseminate-Shared-Savings-Contracts#sthash.9xbwURUK.dpuf