Q. 1. Mr. Gold referred to a national study of copayment levels. The important results of this study are provided in Exhibit 3.

a. Calculate the price elasticity of demand for physician visits at each copayment level using the arc method. What does the data tell you about the price elasticity of demand for physician visits?

How does this information help Mr. Green in making his decision?

b. Using the six months of data provided in the Excel data file, simulate the profitability of the physician services department if copayments are increased to $20 per visit. Repeat your analysis using a copayment of $25 per visit.

Calculate the Arc Price:

What is the Arc Equation?

Is demand for physician services elastic or inelastic? Explain.

Note: a change in the deductible has two effects: Reduces the number of visits per employee, Reduces the cost per visit by $5: Estimates the new level of visits for each.

\fGOODLIFE ZONE Goodlife Zone (Goodlife) is a managed care company that provides and finances health care services for employees of Sparks Interactive, Inc. Approximately 5,000 employees at Sparks Interactive, Inc. (Sparks) are currently enrolled in Goodlife's health insurance plan. The number of enrollees has increased over the past year as Sparks continued to expand its workforce, and more and more Sparks employees have elected to receive this benefit. Sparks currently pays Goodlife the full cost of health insurance for its employees. This insurance provides comprehensive coverage for inpatient and outpatient hospital care, surgical services, physician office visits, and other services (e.g., x-rays). The only cost to employees is a $15 copayment for each physician's office visit. Brad Green is the Director of Strategic Planning and Forecasting at Goodlife Zone. His key function is to direct the overall development and analysis of all strategic financial planning initiatives relating to Goodlife's managed care programs. His staff is involved in many activities, including preparing periodic reports of the costs incurred under the Sparks account. Every time a Sparks employee uses health care services, information about the type of service and the relevant costs are recorded in a database. Mr. Green recently directed his staff to perform a financial analysis of the current utilization and costs incurred under the Sparks account. Bad News Clara Davis personally delivered her summary of utilization on the Sparks account to Mr. Green (See Exhibit 1). The data, he noted, indicated a sharp increase in the number of physician office visits over the past month. He remarked, \"The Sparks employees' use of outpatient physician services has been going up for the past six months. What's going on?" He asked Ms. Davis to provide him with the enrollment numbers to see if the increase in the utilization of physician services was primarily due to the change in the number of employees enrolled in the health plan. \"No problem," she replied. "'I have already put the last six months' weekly statistics into a spreadsheet." Mr. Green was concerned about Goodlife's profitability. Last year, Goodlife negotiated with Sparks to charge a xed premium of $260 per employee per month. The total premium revenue is allocated as follows: 55% to hospital and surgical services, 30% to physician visits, and 15% for other services, administration, and profit. These allocations are used to establish budgets in the different departments at Goodlife. The Sparks contract would expire next month, at which time Goodlife would need to renegotiate the terms of its contract with Sparks. Mr. Green feared that Goodlife would have to request a sharp rate increase to remain profitable. Goodlife's monthly cost of administering the health plan was fixed, but the increases in the use of health care services were eroding Goodlife's profits. He suspected that other health plans were planning to increase premiums by 5-10 percent, which was reasonable given the recent statistics on national health expenditures. A report from 2004, the most recent he could find, indicated that total national health expenditures rose 7.9 percent from 2003 to 2004 -- over three times the rate of inflation. Mr. Green called in the rest of his staff to assist him in devising a strategy for renegotiating the Sparks account. \"If possible, Iwould like to figure out how we can continue providing this service for the rate we established last year. I'm afraid if we attempt to increase the per member premium, Sparks will contract with another health insurer. What other options do we have?\" Manny Ramirez, who works in Membership Marketing, reported that he recently conducted a survey of cost control mechanisms used by other health plans. His analysis revealed that Goodlife's competitors are increasing their use of these mechanisms, which include copayments, waiting periods, preauthorization requirements, and exclusions on certain health care services. \"One of the problems, in my opinion, is that the Sparks employees have nearly full coverage for all their health care services," remarked Ramirez. \"The Sparks employees should pay some part of their health care services out-of-pocket, so that they share an incentive to stay healthy. Goodlife only charges a $15 copayment, but many other health insurance plans require that enrollees pay $20 25 for each physician's office visit. A higher copayment will help us reduce the use of physician services.\" He showed them the results from a national study that showed a signicant relationship between the amount of a copayment and the number of visits to a physician (See Exhibit 3), and recommended that Mr. Green consider implementing a larger copayment for each physician visit when the contract with Sparks is renegotiated. Francesca Carol, who works in Provider Relations, disagreed. \"I don"t think a higher copayment is going to reduce the level of physician visits. The demand for health care services is a derived demand because it depends on the demand for good health. People don't necessarily want to visit their physician, but they often have to in order to stay healthy. If we want to cut our costs, we will have to figure out how to pay the health care providers less.\" Goodlife currently pays for health care services on a fee-for-service basis. Most of the area hospitals and physicians \"participate\" in Goodlife's health insurance plan. When Sparks employees obtain health care services from participating healthcare providers, the providers are reimbursed for their costs directly by Goodlife. Several factors have increased health care costs over time, including the growing availability of medical technology, such as magnetic resonance imaging (MRI), and increased medical malpractice litigation. Ms. Carol suggested that Mr. Green consider negotiating with physicians to lower the costs of the services provided. \"I've heard that some managed care plans have cut deals with physicians to lower their charges by 1025 percent,\" she said. \"Physicians have accepted these deals because if they don't, they could be cut out of the health insurance plan and they could lose all their patients." Mr. Ramirez conceded that this might be possible but expressed his concern that if participating physicians accepted a lower amount per visit, they might reduce the quality of care they provide to Goodlife's members. Mr. Green dismissed his staff. Eager to resolve this issue, he phoned your consulting company for assistance. Goodlife's executives would need a full report of the current situation and evaluation of his staffs suggestions to either (a) increase the copayment, or (b) implement a reduction in charges for physician office visits. Category of Service July 2006 August 2006 Hospital Services- Inpatient $205,839 $216,209 Hospital Services - Outpatient $185,919 $183,898 Surgical Services $103,806 $105,043 Physician Office Visits $339,317 $393, 113 Administrative Expenses $91,711 $93,364 TOTAL $926,592 $991, 627 Number of members, July 31, 2006: 4129 Number of members, August 31, 2006: 4137 Exhibit 2 Data file has been provided on the course website. Exhibit 3 Sample Means for Annual Use of Health Care Services Copayment Physician Visits Level Per Capita $10 6.3 $15 6.0 $20 5.7 $25 5.4 $30 5.1 $35 4.8 Source: "Demand for Health Care Services at Different Copayment Levels: Results Based on a National Study of Health Insurance Enrollees"