Modeling and detecting potentially ruinous streaks in health expenditures

The mean of a distribution of medical expenditures in an insured population can be affected significantly by the occurrence of a few high cost cases. This fact leads some organizations that hold the primary risk for the population (e.g., health plans or self-insured employers) to seek reinsurance arrangements that spread the risk of high cost cases across a broader pool. Recently, the private reinsurance market has experienced some difficulties, attributable to information asymmetries between primary risk holders and reinsurers. The disproportionate effect of a few high cost cases also has generated interest in the development of "risk-adjustment" systems that attempt to reduce the difference in health plans' unreimbursed costs either to endogenous management decisions or random chance. We discuss these issues in light of a well-known statistical result regarding the probability of "streaks" in random data. We illustrate problems that can arise and suggest methods to distinguish random streaks from systematic trends.