Optimal Ins (Theory)

Physicians’ contracts, treatment decisions and diagnosis accuracy

What is the optimal way to pay physicians? If there were a singular variable ‘health’ that could be easily measured, patients could pay physicians for each unit of health they receive. Of course, this is not how the physician-patient relationship operates in the real world. Physicians are paid either a base rate per person per month or receive a fixed fee for each service provided. In physician contracts with health plans, the physician effort level to gather information (diagnosis) is non-contractible and pay based on the patient’s health condition (physicians’ private information) is also non-contractible. In a setting with so much uncertainty, what is the optimal physician contract?

This is the question which Izabela Jelovac attempts to answer in her 2004 paper in Health Economics. In her model, patients who visit the doctor can have two types of illnesses, one mild and one severe. The doctor chooses an effort level ε, in order to diagnose the illness. The more effort the doctor puts forth, the more likely they will diagnose the disease correctly. In the next stage of the game, the doctor chooses whether to treat the patient with an expensive treatment which will cure the severe disease and or the inexpensive treatment which will cure the serious disease. Prescribing the expensive treatment when the patient has the mild disease causes a health loss. If the patient recovers, then the game ends, but if the patient does not recover then the patient returns to the physician and receives the alternative treatment.

So what does the physician do? Typically, we would guess that the doctor will prescribe the adequate treatment strategy of providing the expensive treatment for the severe disease and the inexpensive treatment for the mild disease. However, “…if a single visit is less profitable to the physician than two visits, the physician is better off providing the most inadequate treatment than the most adequate one in order to increase the likelihood of a second visit.” This is like a car mechanic who damages people’s cars when they come in for an oil change in order to earn more money during the second visit from fixing the problem which they caused in the first.

The author also found that a strategy of always prescribing the inexpensive (or expensive) treatment during the first visit can be optimal as well. For instance, if diagnosing the serious illness is very costly (numerous expensive tests and many physician labor hours are incurred) and if the serious illness isn’t too severe, then giving all patients the inexpensive treatment during the first visit may be optimal.

The authors go through some dense math, but end up concluding that some supply-side cost sharing by the physician is optimal since it induces the physician to provide the most adequate treatment. With the cost sharing, having the patient return for a second visit is never profit maximizing.

This paper does have a few problems. A key assumption in this model is that “the need for a second treatment is necessarily the physician’s fault.” In reality, this need not be the case. Also, the authors do not take into account issues of the physician’s reputation. If 100% of a physician’s patients had 2 visits, patients may decide to leave this physician and sign up with a doctor who choses the “adequate treatment” strategy.

Hillman (Ann Intern Med 1990) writes that “whereas most physicians will act in the patient’s best interest when the medical decision is clear-cut, the effect of financial incentives may be most important in cases where the correct decision is not obvious.”