Question

VIP-MD is a health maintenance organization (HMO) located in North Carolina. Unlike the traditional fee-for-service model that determines the payment according to the actual services used or costs incurred, VIP-MD receives a fixed, prepaid amount from subscribers. The per member, per month rate (PMPM) is determined by estimating the health care cost per enrollee within a geographic location. The average health care coverage in North Carolina costs $364 per month, which is the same amount irrespective of the subscriber’s age. Because individuals are demanding quality care at reasonable rates, VIP-MD must contain its costs to remain competitive. A major competitor, National Physicians, entered the North Carolina market early in the current year with a monthly premium of $321. VIP-MD wants to maintain its current market penetration and hopes to increase its enrollees in the current year. The latest data on the number of enrollees and the associated costs follow:

Age	Enrollment in Current Year				Projected Enrollment Next Year				Average Monthly Cost in Current Year
1–4		45,288				48,577			$	11,147,472
5–14		82,056				84,263				10,059,232
15–19		95,473				95,487				8,436,424
20–24		65,846				67,482				9,539,024
25–34		133,096				132,154				26,431,808
35–44		166,476				175,046				38,881,708
45–54		85,096				90,489				22,741,536
55–64		98,824				101,523				28,691,312
65–74		155,888				161,159				49,517,744
75–84		67,495				72,065				33,432,360
85 years and older		23,099				26,449				24,286,075
		1,018,637				1,054,694			$	263,164,695

Required:

1. Calculate the target cost required for VIP-MD to maintain its current market share and profit per enrollee in the current year.

2. Costs in the health care industry applicable to VIP-MD and National Physicians are expected to increase by 8% in the coming year. VIP-MD is planning for the year ahead and is expecting all providers, including VIP-MD and National Physicians, to increase their rates by $25 to $346. Calculate the new target cost assuming again that VIP-MD wants to maintain the same profit per enrollee as in the current year.

(For all requirements, do not round intermediate calculations and round your answers to 2 decimal places.)

Answer 1

	Given Data
			Enrollment in Current year	Projected Enrollment in Next year	Average Monthly Cost in Current year
		Age
		1 to 4	45,288	48,577	$           1,11,47,472
		5 to 14	82,056	84,263	1,00,59,232
		15 to 19	95,473	95,487	84,36,424
		20 to 24	65,846	67,482	95,39,024
		25 to 34	1,33,096	1,32,154	2,64,31,808
		35 to 44	1,66,476	1,75,046	3,88,81,708
		45 to 54	85,096	90,489	2,27,41,536
		55 to 64	98,824	1,01,523	2,86,91,312
		65 to 74	1,55,888	1,61,159	4,95,17,744
		75 to 84	67,495	72,065	3,34,32,360
		85 years and older	23,099	26,449	2,42,86,075
		TOTAL	10,18,637	10,54,694	$26,31,64,695
		Data for analysis (from above and problem requirements):
		Avg monthly insurance cost, NC =		$364
		New competitor's monthly premium offering, NC =		$321
		Expected premium increase		$25
	Answer
	1. The unit cost = $263,164,695 ÷ 1,018,637 =			$258.35
	The current profit per contract issued = $364 - $258.35 =			$105.65
	Therefore, the target cost (TC) to meet the competitive price = $321 - $105.65 =				$215.35

		Enrollment in Current year	Projected Enrollment in Next year	Average Monthly Cost in Current year	Avg Cost in Current year
2.	Age					Avg Cost in Next year (+8%)	Projected Cost in Next year	Age % in Next year	Age % in Next year
	1 to 4	45,288	48,577	$           1,11,47,472	246.15	265.84	$             1,29,13,611	4.4%	4.6%
	5 to 14	82,056	84,263	1,00,59,232	122.59	132.40	1,11,56,171	8.1%	8.0%
	15 to 19	95,473	95,487	84,36,424	88.36	95.43	91,12,674	9.4%	9.1%
	20 to 24	65,846	67,482	95,39,024	144.87	156.46	1,05,58,112	6.5%	6.4%
	25 to 34	1,33,096	1,32,154	2,64,31,808	198.59	214.48	2,83,44,313	13.1%	12.5%
	35 to 44	1,66,476	1,75,046	3,88,81,708	233.56	252.24	4,41,53,959	16.3%	16.6%
	45 to 54	85,096	90,489	2,27,41,536	267.25	288.63	2,61,17,415	8.4%	8.6%
	55 to 64	98,824	1,01,523	2,86,91,312	290.33	313.55	3,18,32,898	9.7%	9.6%
	65 to 74	1,55,888	1,61,159	4,95,17,744	317.65	343.06	5,52,87,440	15.3%	15.3%
	75 to 84	67,495	72,065	3,34,32,360	495.33	534.96	3,85,51,704	6.6%	6.8%
	85 years and older	23,099	26,449	2,42,86,075	1,051.39	1,135.50	3,00,32,893	2.3%	2.5%
	TOTAL	10,18,637	10,54,694	$26,31,64,695			$           29,80,61,189	100.0%	100.0%
				10,18,637			10,54,694
	Average Cost			$                  258.35			$                    282.60
	Current Price			$                  364.00
	Current Profit Per Enrollee (Desired Profit)			$                  105.65	= 364 - 258.35		$                    105.65
	New Market Price			$                  321.00			$                    346.00
	Target Cost			$                  215.35	=321 - 105.65		$                    240.35
	Required Cost Reduction Per Enrollee						$                     42.25	=$282.60 - $240.35

The target cost for Next year is $240.35= $346 - $105.65; this calculation uses the new price and the same profit per enrollee as in Current year.The required reduction in cost per enrollee is $42.25 as shown in the above table. Note that the cost per enrollee is determined by taking the average cost per enrollee for each age group in order to determine total costs of $298,061,189. Note that this number differs from the simple approach of taking Next year enrollment of 1,054,694 × Current year cost of $258.35 × 1.08 = $294,278,610.The reason for the difference is that the sales mix of enrollees has changed from Current year to Next year and in particular, the two oldest age groups, the most expensive groups, have increased slightly in number and percentage.