Managed Care and Physician Incentives: The Effects of Competition on the Cost and Quality of Care

We analyze the effect that competition between HMOs has on the cost and quality of medical services. Our key result is that increasing competition enhances consumer utility while also moderating the impact of managed care on quality and costs. Indeed, we find that heightened competition between HMOs can cause an overall increase in care quality and costs. This result derives from an important, but overlooked, feature of the managed care market place. Plans differentiate themselves by the size and depth of their provider network. The resulting competition to attract physicians exerts a moderating effect on the incentive contracts HMOs write with providers.