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This article uses a principal agent framework to examine the role that monitoring costs faced by an insurer have on health care utilization. We compare hospital lengths of stay for fee-for-service and capitated patients in low and high monitoring cost situations. Monitoring costs associated with a particular procedure are assumed to be high when there is large variation across patients in hospital lengths of stay. The empirical results indicate that differences in utilization between fee-for-service and capitated patients increase as monitoring costs increase. However, we do not find that fee-for-service reimbursement is used less in the difficult to monitor situations. (JEL I1)
ABBREVIATIONS
FFS: Fee for Service
HMO: Health Maintenance Organization
LOS: Length of Stay
MEPS: Medical Expenditure Panel Survey
I. INTRODUCTION
The way in which the health care industry is organized has undergone significant changes over the past 20 years, making it a particularly interesting arena for industrial organization analysis. There are currently two primary types of health insurance plans: traditional indemnity insurance (fee-for-service) and managed care organizations. Under fee-for-service (FFS), the provider is paid for each procedure or service dispensed to a patient. Managed care is more complex-health maintenance plans (or health maintenance organizations, HMOs) take many forms and health care providers are reimbursed in different ways. Of particular importance for this study is capitation. This form of reimbursement is one where the plan pays a fixed amount of income to the physician to care for a patient over a certain period of time. Physicians do not get additional payments, even if the cost of the patient's care is more than what was expected. Essentially, this fixed fee payment per patient transfers the financial risk of treatment from the insurer to the physician and is almost a textbook example of how to implement an incentive-compatible contract to contain excessive use of services. Principal agency theory, however, suggests that transferring the financial risk of treatment from the insurer to the physician can be costly if physicians are risk averse (Eeckhoudt et al. 1985). For example, levels of risk aversion vary across medical specialties and this has implications for medical malpractice (Danzon 1983). Also, incentive-compatible contracts may result in the physician not being a good agent for the consumer, leading to an underprovision...