Two kinds of risk are being calculated, priced, allocated, managed, and in many cases bought and sold in the healthcare finance system. One is credit risk which is simply the risk of default on a financial obligation. Credit risk is a characteristic of all the participants in the healthcare system, including all the consumers, all providers, and all of the intermediaries.  The other kind of risk is health risk, which is a characteristic of all consumers, but not providers or intermediaries.  The techniques which have evolved to calculate these two kinds of risk are quite different, although they are both probabilistically based.

The degree of integrity and accountability with which each type of risk are calculated influences the efficiency and effectiveness of pricing, allocation, management and the sales and trading of these risks in such markets as reinsurance and the capital markets.

Credit Risk

The techniques for measuring the credit risk of individuals and providers have been developing slowly over a long period of time in the US.  For individuals, the credit bureaus and lending institutions have been the principle third party evaluators of credit risk, with credit bureau produced FICO scores becoming the almost universal measure of each individual’s historical willingness and ability to pay; and verified personal income (e.g. as evidenced by pay stubs, most recent income tax returns, etc.) becoming an almost universal means of judging current and probable future willingness and ability to pay.  After a substantial amount of investigative journalism, litigation, legislation and regulation, the credit bureaus have become more transparent leading to much better accountability, and they have become somewhat more responsive to appeals, e.g. in cases where inaccurate information needs to be changed, leading to better data integrity and more accountability. The computing and telecommunications revolutions have mechanized the processes used by credit bureaus and many lenders, with less and less reliance on personal knowledge of the borrower and judgments based on that knowledge from the credit risk calculation process.

As “relationship banking” with individual borrowers has been undermined, so too has accountability between most of the “sellers” and “buyers” of individuals’ credit risk.  By contrast, the community banking and credit union sectors have maintained a dedication to old-fashioned relationship banking while using the standard mechanized systems to help speed and standardize their decision-making. This insistence on using both the older techniques of relationship banking and the newer mechanized techniques of the credit bureaus appears to have produced good results, particularly dealing with low and moderate income borrowers. The fact that mortgage default rates have remained low for the community bankers, despite the fact that the borrowers often have sub-prime or Alt-A credit quality provides one clear metric for this difference.

The techniques for measuring credit risks of providers have also been developing slowly over a long period of time in the US as the techniques for evaluating various credit risk have evolved first within lending institutions and then within credit rating agencies.  The process has become more and more objective as accounting standards have been developed and as the rigor of third-party auditing has risen, leading to increasing integrity. As rating agencies in particular have codified and published their standards, and as stock and bond markets have demanded more and more initial and continuing disclosure of the financial performance of providers, the process has become increasingly transparent, leading to greater accountability.  One consistent weak spot in this generally healthy picture has been the continuing difficulty which lenders, rating agencies, and others have encountered in the detection of fraud.

Health Risk

The health risk calculation, allocation, management and trading processes are far more complex.  The process includes the interaction of doctor and patient, with the doctor building up a base of knowledge which produces what we might call the patient’s informal health risk profile, while other actors such as life insurers, disability insurers and health insurers use a fairly narrow range of “objective” indicators (e.g. EKG results, weight and body mass measurement, addictions to tobacco and alcohol, history of medical insurance claims, etc.) to create a more formal risk profile which eventually categorizes individuals into a few low, medium, or higher risk categories.  Life, disability and health insurers use the formal medical risk profiles to price their assumption of medical risk in somewhat different ways. For example, life insurers are most interested in the medical risk indicators most associated with longevity, e.g. addictions, EKG results, etc. and use these to price their product which is essentially a bet with the insured about how long he or she will live. Disability insurers are interested in many of the same indicators but use them a little differently in pricing their product which is essentially a bet with the insured over how much time they will have to take off from work due to a disabling chronic illness. Health insurers which are likely to have relatively short relationships with the insured can be expected to put more emphasis on the indicators of risk of an event or long-term illness are likely to take place in the short term while health insurers which are likely to have relatively long relationships with the insured can be expected to put more emphasis on the indicators of the risk of an event or long-term illness which may take place at any point over a much longer stretch of time. The very recent introduction of DNA analysis, seeking genetic markers of potential health risk factors is likely to further complicate the health risk analysis process.

The processes of medical risk calculation, allocation, management, and trading lack much of the transparency of the analogous processes for handling credit risk, for a variety of reasons including concerns over patient privacy, the very complexity of the system compounded by its high degree of fragmentation, and the higher degree of uncertainty about how best to treat both episodic and chronic illnesses.  The system is also less responsive than the credit risk system, for many of the same basic reasons. The result is at least the perception of a lack of integrity and accountability by health consumers and many providers.  Is there much outright fraud further undermining the accurate calculation of health risk? We know there is some, from the periodic scandals in the Medicaid and Medicare programs. Since many of these cases boil down to gaming the system either by performing un-necessary procedures, or inflating the expense and pricing of medical procedures, they do further undermine both the integrity and accountability of the systems for calculating, allocating, managing and trading in health risk.

As with credit risk, many elements of health risk can be influenced by the individual, e.g. through withdrawal from addiction, eating less but more nutritious food, getting more exercise, controlling stress, complying more rigidly to prescribed drug regimes, etc. However, as with most forms of human capital investment, the results are less certain and may be less clear to the individual, the provider and all other actors in the system for far longer than with hard capital investment, where the results tend to be far more immediate and clear.  Finding ways to signal more clearly to the individual health consumer how he and she is being held accountable, e.g. rewarded with lower premiums, for good health behavior or punished with higher premiums for bad health behavior is an important challenge for all those trying to bring greater integrity and accountability to the healthcare finance system.

• What are our assumptions about the core purpose and effectiveness of health insurance?
• How can credit terms such as interest rates and tenors be improved for health care consumers and providers?
• How does current research measure the impact of shorter term policies and what benefits policies with long terms (15 years) have?
• What are the default rates on extended payments for Healthcare costs? For SBA loans? For at risk students?
• What are the compliance/default rates for people who borrow using secured and unsecured debt to pay medical bills?

Many components are at least loosely associated with this leverage point because credit and health risk calculations are central to all health finance system transaction. Those components most directly associated with the leverage point include:

• Consumer Credit Rating
• Medical Credit Scores
• Credit Cards and Debit Cards
• Lines of Credit
• Credit Terms
• Bond Rating Systems
• Wellness Plans
• Insurance Contract Tenor
• Fraternal and Mutual Societies
• Self-insurance Groups