Check on Health Care Costs

David Pacchioli
March 01, 1994

As health care costs continue to rise, providing medical benefits becomes an increasing burden on employers. One particularly nettlesome problem is accidental overpayment of insurance claims. Yet as more claims are filed, and more companies cede the administration of benefits to third parties, this kind of wasteful error increases. Jack Martin and Terry Harrison hope to reverse this trend—with the help of a computerized auditor.

Most companies these days handle insurance on a "self-funded" or "cost-plus" basis, says Harrison, an associate professor of management science at Penn State: They hire an outside administrator to handle claims, then pay that company the cost of claims plus a fee for its service. This works out cheaper, in most cases, than purchasing a health care policy or handling claims in-house. But cost-plus arrangements have a fundamental flaw.

"An administrator is generally paid either a flat fee or a percentage of the money doled out in claims," explains Martin, assistant professor of marketing at Penn State Behrend. "Either way, there's no incentive to help keep costs down." "If you're spending someone else's money," adds Harrison, "you're not as careful as if you're spending your own."

Errors crop up, and if they aren't caught, it's the employer that pays. But checking out each and every claim is simply not feasible. For a large firm, the number of line items can run well into the hundreds of thousands, even millions—each one standing for pages of documentation.

Conventional practice, says Martin, is to "pick off high-value claims." An auditor will scrutinize certain categories, like emergency-room visits, where often a less-expensive visit to the family physician would have sufficed. Cosmetic procedures are another target. "No plan pays for these," Martin says. "The problem arises where you leave it up to the administrator to decide what is cosmetic and what isn't."

This method of recovery can work reasonably well, as far as it goes, but it leaves a lot of errors uncovered.

In 1991 Martin, then Harrison's doctoral student, came up with another alternative. With Harrison's help, he built an expert system for screening claims. By interviewing human experts in accounting, medical practice, and claims procedures, and encoding the pertinent knowledge into a computer program, he developed a tool that would divide claims into three categories: those with no errors, those with obvious errors, and those where the existence of an error is uncertain.

Then, since even after this winnowing the number of questionable claims might be too many to analyze by hand, he developed a mathematical model that would narrow the field still further by balancing two key variables: the likelihood of recovery against the amount likely to be recovered. "This way you maximize the amount of recovery you can expect for a given amount of resources applied," Harrison explains.

Martin and Harrison have tested the system using claims data provided by ARASERVE, a division of ARA Services, one of the largest privately-owned corporations in the United States. The potential recoveries the system detected, they calculate, would have saved the corporation two to three percent of its total health care expenditures for a two-year period.

"That doesn't sound like a lot," Martin says, "but when you get into the amounts of money a company like this pays out, it is a lot."

The real cost-cutting potential for such a system, however, is not in recovering on past claims. "If you took your outputs from this and presented them to your administrator, used them to prevent similar mistakes from happening in the future," Martin says, "you could save much more."

Jack L. Martin, Ph.D., is assistant professor of management at Penn State Erie, The Behrend College, Station Road, Erie, PA 16563; 814-898-6428. Terry P. Harrison, Ph.D., is associate professor of management science in the Smeal College of Business Administration, 336 Beam Business Administration Building, University Park, PA 16802; 814-863-3357.

Last Updated March 01, 1994