Cover: Option Pricing

Option Pricing

A Flexible Tool to Disseminate Shared Saving Contracts

Published in: The American Journal of Managed Care, v. 19, no. 8, Aug. 2013, p. e285-e292, Appendix p. 1-7

Posted on Aug 1, 2013

by Mark W. Friedberg, Anthony M. Buendia, Katharine Lauderdale, Peter S. Hussey

OBJECTIVES: Due to volatility in healthcare costs, shared savings contracts can create systematic financial losses for payers, especially when contracting with smaller providers. To improve the business case for shared savings, we calculated the prices of financial options that payers can "sell" to providers to offset these losses. STUDY DESIGN AND METHODS: Using 2009 to 2010 member-level total cost of care data from a large commercial health plan, we calculated option prices by applying a bootstrap simulation procedure. We repeated these simulations for providers of sizes ranging from 500 to 60,000 patients and for shared savings contracts with and without key design features (minimum savings thresholds, bonus caps, cost outlier truncation, and downside risk) and under assumptions of zero, 1%, and 2% real cost reductions due to the shared savings contracts. RESULTS: Assuming no real cost reduction and a 50% shared savings rate, per patient option prices ranged from $225 (3.1% of overall costs) for 500-patient providers to $23 (0.3%) for 60,000-patient providers. Introducing minimum savings thresholds, bonus caps, cost outlier truncation, and downside risk reduced these option prices. Option prices were highly sensitive to the magnitude of real cost reductions. If shared savings contracts cause 2% reductions in total costs, option prices fall to zero for all but the smallest providers. CONCLUSIONS: Calculating the prices of financial options that protect payers and providers from downside risk can inject flexibility into shared savings contracts, extend such contracts to smaller providers, and clarify the tradeoffs between different contract designs, potentially speeding the dissemination of shared savings.

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