AMCPEdu 2008 Poster

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The Pricing of Medical Options

Damon Douglas
University of Maryland School of Pharmacy

Introduction Simple Medical Option Simple Medical Option Chain Conclusion


Chronic disease progression traverses through a series • Cost and risk of chronic disease progression stages
of events that accrue greater and greater costs (Fig. 1). may be managed through the local trade of options
contracts within a network of providers.

• Option pricing may be achieved through a binomial


Figure 1. Disease Progression Model. Starting from risk model of cashflows hedging extremes in projected
factors a patient may be diagnosed with a disease leading to medical utilization.
symptom presentation. Their disease state may lead to further
exasperation requiring hospitalization. This may lead to
subsequent disability requiring further long-term care and • Institutions yielding greater health outcomes may
eventually death. anonymously accrue greater cashflow for their
organization and participating organizations in the
Third party medical insurance providers engage in option network.
benefit design in order to manage these costs. This
study addresses whether the cost and risk of these Future Work
individual events may be managed through the local Figure 6. Medical Option Chain. Local indemnity relationship • Derivation of option pricing using real healthcare
between a primary care provider (PCP), hospital and long
trade of options contracts within a network of costs and outcomes.
term care (LTC) facility. LTC indemnifies hospital for patient
providers as illustrated (Fig. 2). Figure 3. Simple model of local indemnity relationship
disability for which a hospital pays a premium. The hospital
between a hospital and a long term care (LTC) facility. LTC
indemnifies a hospital for patient disability for which a
indemnifies the PCP for disease exasperation requiring • Standards and guidelines for the development of
hospitalization in return for a premium. The LTC option
hospital provides a premium. The LTC option contract
contract guarantees the hospital for admission ($700). The medical options in daily medical practice.
guarantees the hospital a price for admission ($700). Therein
hospital option contract guarantees the PCP a price for
is the projected cashflow from the indemnity at two extremes
of utilization, 50 and 0, respectively. (Note: costs are made up
admission ($35). Therein is the projected cashflow from the • Assessment on the use of medical options and their
indemnities at each of the two extremes of utilization for the
Figure 2. Risk Management Chain Between Providers. A for illustrative purposes only.)
hospital and LTC respectively. (Note: costs are made up for impact on health outcomes and organizational
chain of local benefit provision within a self-organizing
provider network. Solid arrows indicate the provision of
illustration purposes only). financial performance.
insurance coverage. Open arrows indicate the flow of
premium payment.

Methods References
• Cox, J.C., Ross, S.A., Rubinstein, M.
Simple Medical Option Figure 4. Price solution of Medical Option Chain. Option price (φ)
Option Pricing: A Simplified Approach.
• Binomial outcome model of cashflows based on from the hospital to the PCP depends on hedging of the worst case
scenario of maximum utilization of its own service cost (Admission = Journal of Financial Economics.
extremes in projected utilization. 100) and subsequent LTC admission (Admission = 50) at a 10% rate 1979;7(3):229-263.
Figure 4. Option Price (φ) solution depends on hedging of a of return (r). RH-Hospital Revenue, CH-Hospital Cost, EL-LTC Option
• Markov model involving two states, hospitalized and worst case scenario of maximum utilization (Admission = 50) Exercise Cost.
at a 10% rate of return (r). RH-Hospital Revenue, CH-Hospital • Douglas DA. Using Option-Based
disabled, respectively (10,000 iterations). Cost. Contracts To Improve Health Outcomes.
Managed Care. 2008;17(4):50-52.
• Modeling of cashflow outcome for the Long-Term
Care (LTC) facility from differing hospital disability
end-outcomes. Acknowledgements
Simple Medical Option Chain Special thanks to Yu-Jung (Jenny) Wei for her listening,
• Binomial outcome model of cashflows based on Figure 5. Simulation of cashflows.
Markov model simulation
encouragement, criticism and feedback. Thanks to the
extremes in projected utilization for both the hospital (iterations=10,000) whereby two University of Maryland School of Pharmacy and
and LTC facility. hospital disability end-outcomes are Student Government Association for funds to print this
compared (30% vs. 15% LTC
admissions). As expected the better
poster and the travel expense subsidy. Finally, thanks to
• Markov model involving three states, outpatient, performing hospital (15% LTC friends of AMCP and the Maryland Student Chapter
hospitalized, and disabled, respectively. admission) results in higher with special acknowledgement to Tim Sawyers, Kim
cashflow for both the hospital and
the LTC facility.
Vernachio, Chip Robison, Beth Holland, Darlene
• Modeling of cashflow outcomes for both the hospital Mednick, and Robert Navarro for their encouragement
and LTC due to differing hospital disability end- and support.
outcomes.

Figure 5. Simulation of cashflows. Result of markov model


simulation (iterations=10,000) whereby two hospital disability
end-outcomes are compared (40% vs. 20% LTC admission).
As expected, the better performing hospital contracted by the
LTC results in higher cashflow for the LTC facility.

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