Market Structure, Commitment, and Treatment Incentives in Health Care

People are more distrustful of managed care organizations (MCOs) than traditional health plans, a phenomenon that has become known as "managed-care backlash." In a model of the relationship between a patient, insurer, and physician, this paper shows that when the roles of insurer and provider are combined into a single player (as in a staff-model HMO), the equilibrium insurance plan departs from the social optimum, due to the fact that the HMO cannot credibly commit to providing non-least-cost care. In contrast, when the insurer and provider roles are separate, as in fee-for-service insurance, the equilibrium reimbursements for the physician implement the first-best treatment regime at first-best cost. Thus, the relative inability of MCOs to commit to non-least-cost care may account for at least part of managed-care backlash.