Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
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A copy of the full analysis can be downloaded by clicking on the link at the bottom of this blog entry.


In Part 1 of this analysis, I described the main issues facing Doctors: (i) decreasing reimbursements, (ii) divergent reimbursements by location, (iii) transition from fee-for-service to pay-for-performance, (iv) increasing costs, and (v) increasing regulations.

In this part of the analysis, Part 2, I describe the main isssues facing Patients and Payers.

In the last part of the analysis, Part 3, I will discuss the tensions (conflicts) between the different sets of players that are engendered by the different incentives each player faces.


In a previous analysis, “Why Are Healthcare Costs So High?” I found that

•  US healthcare expenditures have been increasing over time;

•  There seems to be a shift during the 1980s, in which annual personal expenditures on healthcare started increasing at a faster rate;

•  Healthcare expenditures for treating the top 20 medical conditions account for 75% of expenditures;

•  The increases in spending for the top 20 diseases are due mostly to increases in the number of people being treated for (chronic) diseases, rather than to increases in per-patient costs of treatment;

•  Healthcare expenditures are concentrated, where the Top 5% of Users account for over half of total healthcare expenditures;

•  The Bottom 95% of the population is paying roughly twice as much for healthcare services than they actually use, where the difference is going to subsidize the Top 5% of healthcare users, and the Bottom 70% of the population is paying seven times as much as they use, where the difference is going to subsidize the Top 30% of healthcare users;

•  The high-cost healthcare users are people with multiple, chronic conditions, including coronary artery disease, diabetes, congestive heart failure, and chronic obstructive pulmonary disease;

•  At least seven of the top ten medical conditions that account for the majority of healthcare spending can be at least partially prevented and/or mitigated by factors under the control of individuals, namely, weight control, eating habits, drinking (alcohol) habits, activity levels, and smoking status.

I assume that patients act to maximize their well-being. Patients’ well-being is determined by a variety of factors, some of which are under patients’ control and others of which are not. These factors can generally be divided into four categories (which are overlapping in their respective impacts on well-being), which I call: (i) lifestyle, (ii) environment, (iii) state of mind, and (iv) healthcare costs.

Many patients face a tension when trying to optimize their well-being: while patients enjoy being healthy, many people also enjoy engaging in “unhealthy” lifestyles. I believe that it is this health vs. lifestyle tradeoff lies at the heart of society’s healthcare spending problem.



What I call lifestyle factors are factors that (a) patients control, (b) affect their enjoyment of life, (c) and affect their health. These include

•  Diet: Do patients generally maintain a healthy diet?

•  Exercise: Do patients generally get enough exercise?

•  Alcohol: Do patients drink a lot of alcohol?

•  Smoking Status: Do patients smoke?

•  Risky Behavior: Do patients engage in high-risk activities?

Based upon the findings in my previous analysis (“Why Are Healthcare Costs So High?”) that many more people are being treated over time for chronic conditions that are caused by unhealthy lifestyles, I conclude that people generally are happier when they choose lifestyles that are less healthy.



What I call environmental factors are factors that (a) patients do not control, (b) affect their enjoyment of life, (c) and affect their health. These include

•  Genetic Factors: Are patients predisposed toward bad health?

•  Culture/Neighborhood: Do patients’ cultures or neighborhoods support “healthy” behaviors?

•  Influence Group: Do patients have family or peer groups that influence their attitudes and behavior? Do these groups encourage them to engage in “healthy” behaviors?

Culture and peer groups are factors that are largely outside of peoples’ control and have large impacts behavior and lifestyle. Even if people would like to adopt healthier lifestyles, it will be much more difficult for them to succeed to the extent that those behaviors conflict with their cultures and/or peer attitudes.


State of Mind

The last category of factors that affects patients’ health and well-being, which is (largely) under the patients’ control, is what I call state of mind. This category encompasses

•  Literacy: Does the patient know what constitutes a healthy lifestyle (e.g., does he understanding nutrition basics) and how to adhere to physicians’ recommendations (e.g., is he able to read and understanding proper medication dosing regimens)?

•  Acceptance: Does the patient accept his condition, or is he in a state of denial?

•  Willingness to Participate: Is the patient willing to take responsibility and participate in his own well-being?

Studies have shown that one of the most important factors in contributing to a patient’s positive state of mind is the patient’s relationship with his doctor. The more trust a person has in his doctor, and the better he feels he is able to communicate and be understood by his doctor (i.e, the greater is the patient-doctor concordance), the more likely he is to actively participate in his own care and to adhere to his doctor’s recommendations (see, for example, Leslie R Martin, Summer L Williams, Kelly B Haskard, M Robin DiMatteo, “The Challenge of Patient Adherence”).


Healthcare Costs

People’s well-being is enhanced when they pay as little as possible for their healthcare. People affect the costs they end up paying for their healthcare by choosing

•  Whether or not to buy healthcare insurance,

•  The type of healthcare insurance plan to buy (e.g., high deductibles vs. high premiums), and

•  Their lifestyle and state of mind.


Insurance Companies (Payers)

Healthcare insurance operates by having people who use fewer healthcare services cross-subsidize people who use more healthcare services.  Healthcare insurance costs for low intensity healthcare users will thus be higher when

•  There are more people who are high intensity healthcare users and/or

•  The intensity of use among high intensity healthcare users is greater.

The ACA also increased the amount of cross-subsidization of healthcare services by making wealthier people pay a larger portion of the healthcare costs incurred by poorer people.

Insurance companies seek to maximize profits, which is the difference between (i) insurance premiums collected from customers and (ii) payouts for healthcare services made to customers and providers. Insurance companies choose reimbursement levels they provide to physicians and insurance premiums they charge from patients to maximize these profits.

The insurance companies choose their reimbursements and premium levels at the beginning of the year based on the amount of services they expect patients to consume during the year. If payouts end up being greater than expected, insurance companies will end up generating lower-than-expected profits, and conversely, if payouts end up being less than expected, insurance companies will end up generating higher-than-expected profits. Assuming a relatively competitive system, over time, the higher profit years and lower profit years will generally balance each other out.

Under the ARRA/ACA, however, insurance companies are now constrained in the amount of profits they can generate in any given year. What this means is that if by the end of the year insurance companies end up paying out less for healthcare services than they had anticipated, they are required to refund a portion of the premiums paid by patients.

Under the ARRA/ACA, Payers (insurance companies, Medicare, Medicaid) are also changing the way they reimburse physicians. Specifically, payers are transitioning from a fee-for-service system to a pay-for-performance system. This transition was described above in the section on Physicians.


Go to: Playing the Doctor-Patient-Insurance Company Game, Part 3

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