Phase-type aging modeling for health dependent costs

In the present paper we develop recursive algorithms to evaluate the distribution of the net present value (abbreviated as “NPV”) of a health care contract. The duration of the program is a random variable representing the lifetime of an individual. We suggest a discrete time phase-type approach to model individual health care costs. In this approach, annual health care costs depend naturally on the health state of the individual. We also derive the distribution of the NPV assuming that annual health care costs are iid random variables. We demonstrate analytically that, under special parametrization, the model with iid costs gives a similar expectation of the NPV to the one of the model with health dependent costs. We propose techniques to evaluate the impact of health related events and demonstrate it on numerical examples. Based on Canadian government data on health expenditures, we study the impact on the NPV of the health cost structure by age.