Reimbursement under Ambiguity and Unknown Physician Altruism

Ambiguity-averse physicians tend to overtreat under diagnostic ambiguity and to undertreat under therapeutic ambiguity. This paper analyzes the optimal cost-sharing mechanism between the payer and the physician when diagnostic and therapeutic ambiguity are jointly present. We derive the first-best cost share when the physician’s altruism is common knowledge. This share lies above the ambiguity-neutral benchmark when diagnostic ambiguity dominates therapeutic ambiguity, and below it when therapeutic ambiguity dominates. When physician altruism is privately known, the payer screens physicians through a menu of contracts, moving the cost share toward zero relative to the full-information benchmark. Under sufficiently strong diagnostic ambiguity, the second-best cost share may nevertheless remain above its ambiguity-neutral level.