A theory of incentives for providers: Payment systems, quality of services, and consumer information in health care markets

This dissertation explores the optimum structure of payment systems for providers in health care markets as is represented by the mix of prospective and cost-based payments. Based on the theory of incentive contracts, I characterize reimbursement systems in terms of financial risks and incentives for providers, and investigate the effect of different methods of paying providers on the quality of services they supply. I then develop theoretical models to examine the determinants of the optimum compensation arrangements for providers, and to explain the equilibrium existence of a variety of payment systems in health care markets. It is shown in my thesis that the optimum structure of payment systems and its distribution across markets for managed care plans, in which various financial incentive systems for providers are used, depend on two factors. One is consumers' concern for the quality of medical services under different physician compensation arrangements. Consumer preference is critical because the willingness to pay for the quality of health services differs, and consumers who understand the effect of financial incentive systems on provider behavior view the payment system as a signal of service quality. Accordingly, the buyer chooses the payment system that provides the optimum combination of quality and cost. The second factor is providers' ability and willingness to accept compensation arrangements that impose some degree of financial risks. Physicians' ability to bear financial risks hinges on patient heterogeneity in terms of cost of treatment in the market. Physicians' willingness to accept incentive systems depends on personal factors such as the degree of risk aversion. Therefore, both consumer preference and provider characteristics should be taken into account in structuring optimum payment systems for health care services.