Incentive Contracts for Public Health Care Provision under Adverse Selection and Moral Hazard

The author will in this paper analyse the issue of payment reforms for a public health care system, where public hospitals offer treatment. Any health care system should provide treatment so as to maximise expected social welfare. The implementation of this outcome, through the way private og public health care providers or hospitals are compensated for the cost of providing services, has been a policy issue in a number of countries. Many payment reforms are now based on a (high-powered) DRG-price system, so as to induce cost consciousness. The hospitals are privately informed about the diseases of each patient and offer treatment with a stochastic outcome, while cost control cannot be verified. Ex post outcome and realised cost of treatment can be verified, with cost depending on treatment intensity, cost-reducing effort and the type of disease. With a disease-contingent transfer, the hospital is able to capture a rent, which has a social cost due to tax distortions and because rent has no direct weight in the welfare function. When type of treatment can be verified, treatment should be less intensive than under complete information, if marginal cost of treatment is disease-dependent. However, rent extraction is accomplished not only by a less aggressive treatment (which has a negative impact on the likelihood for recovery), but also by offering a cost-reimbursement scheme, without any recovery-contingent bonus. When treatment is unverifiable, induced treatment should again be below the first-best level. This solution is implemented through a combination of a recovery-contingent bonus (declining in severity) and cost sharing (with the fraction of cost being reimbursed by the government being increasing in severity).