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ECONOMIC INCENTIVES AND CLINICAL DECISIONS
Rhema Vaithianathan
A thesis submitted
in partial fulfilment of the requirements for the degree of Doctor of Philosophy.
The University of Auckland
1999
Acknowledgements
I would like to thank Dr John Small, for his helpful and enthusiastic supervi- sion.
I am grateful to the many people whose helpful insights and comments on ear- lier drafts have greatly improved the quality of this thesis, particularly Dr Toni Ashton, Dr John Boyce, Nicola Bush, Dr Paul Calcott, Doug James, Professor Stephen King, Dr William Rainger and Dr Alan Rogers. I am also grateful to participants at the 1997 PhD Conference in Economics and Business, Perth, Aus- tralia; the 1998 NZAE Conference, Wellington; the LEANZ seminar series; and the Economics Department Graduate Workshop, University of Auckland.
Funding from the Health Research Council is gratefully acknowledged.
The good humour and support of my office-mates, Chris and Doug, made the process of writing this thesis seem far less arduous than it could have been - for which I am thankful.
I would like to thank my parents and my sister for their encouragement and support throughout my years at University.
Finally, I would like to thank my husband, Matthew Ryan, whose wisdom and love have supported me through the course of writing this thesis. He also provided me with detailed comments on earlier drafts of this thesis.
Abstract
In the face of escalating health care expenditure, OECD countries are turn- ing to a variet>y of cost,-containment, strategies. This thesis analyses three such mechanisms.
In Part I. I consider the use of coinsurance t o limit the demand for health care. Because coinsurance reduces the elasticity of demand with respect t o the price of health care, consumers facing low coinsurance rates may be charged a higher price by doctors. Such discriminatory pricing enables t,he doctor to extract surplus created in the insurance market, and therefore reduces the effectiveness of coinsurance. I show that in equilibrium, some consumers remain uninsured. I also show how this problem is solved if the doctor and insurer enter intlo managed care style arrangements. Such arrangements improve insurer and doctor profitability, and restore complet,e insurance market coverage.
In Part 11, I consider the design of fundholding schemes which encourage doc- tors t o restrict expensive treatment to severely ill patients. I show that such schemes may be undermined by a patient-doctor side contract. In the face of such patient-doctor collusion, the fundholding scheme may be made collusion- proof by increasing its "power". I show that the optimal collusion-proof scheme may pay the doctor more than his reservation wage. An alternative solution to patient-doctor collusion is to use a partial fundholding scheme that requires some additional co-payment from the patient.
Part 111 analyses New Zealand's internal market reforms. Introduced in 1993, the reforms involved the separation of funding and provision of health care, and
were intended t o simulate a competitive market. environment, thereby improving the incentives of government. owned health care providers t o be efficient. On the supply side, I look at the internal restructuring of hospitals into private-sector clones. I argue that this commercialisation failed to take account of informational issues within the hospital. On the demand-side, I examine the suitability of internal markets for elicit,ing optimal innovation from the hospital sector. Again, I find that a standard argument. namely that increased competition leads to innovation, is questionable in the context of the internal market.
Contents
Introduction
I Insurance and Managed Care
1 Health insurance and price discrimination 26
. . .
1.1 Introduction 26
. . .
1.2 Related theoretical literature 31
. . .
1.3 Doctor price &scrimination 32
. . .
1.4 A diagrammatic illustration 35
. . .
1.5 The model 39
. . .
1.6 Equilibrium in the insurance market 44
. . .
1.7 Conclusion 54
2 Integration of insurance and provision 57
. . .
2.1 Introduction 57
. . .
3.2 Common ownership 63
. . .
2.3 Preferred provider organisations 67
. . .
2.4 Discussion 69
I1 Common Agency and Doctor Reimbursement 73
3 Moral hazard and fundholding 75
. . .
3.1 Introduction 75
. . .
3.2 The model 81
. . .
3.3 The singleprincipal optimal scheme 84
. . .
3.4 The second-best scheme 90
. . .
3.5 Conclusion 96
4 Patient-doctor collusion 99
. . .
4.1 Introduction 99
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4.2 Related literature 101
. . .
4.3 The model 104
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4.4 Sidepayment robust schemes 107
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4.5 Discussion 117
5 Allowing side-payments 121
. . .
5.1 Side-payment
.
supplemented scheme 121. . .
5.2 Conclusion 128
111 Internal Market Reform in New Zealand
6 Introduction t o the hospital sector 132
. . .
6.1 Background 132
. . .
6.1.1 Administration of the public health expenditure 134
. . .
6.2 The funding of hospital services 135
. . .
6.2.1 Regional Health Authorities 137
. . .
6.2.2 Accident Compensation Corporation 142. . . 6.2.3 Other sources of hospital revenue 143
. . .
6.3 Crown Health Enterprises 144
7 Supply-side reform: corporatisation of hospitals 148
. . .
7.1 Introduction 148
. . . .
7.1.1 Changes t o the internal organisation of the hospital 149 7.1.2 Principal-Agent theory and the reformed hospital structure 152
. . .
7.1.3 The failure of the reforms 156
. . .
7.1.4 The dismantling of the hospital structures 158
. . .
7.2 The "two firm" view of the hospital 159. . .
7.3 Contracting between managers and doctors 162. . .
7.3.1 Optimal contra. cts 163
. . .
7.3.2 Incomplet. e contracts 168
. . .
7.3.3 Real and formal authority 170
. . .
7.4 Elective surgery and the private sector 176
. . .
7.5 Policy Implications 179
. . .
7.6 Conclusion 180
8 Demand-side reform: Competition amongst hospitals 182
. . .
8.1 Introduction 182
. . .
8.1.1 The dynamic gains hypothesis 184
. . .
8.1.2 Competition in the internal markets 186. . .
8.1.3 Innovation and competition 189
. . .
8.2 Procurement Auctions 191
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8.3 Yardstick Competition 198
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8.3.1 The FElA and PPS 201
. . .
8.4 RHA-CHI3 contracts in practice 205
. . .
8.4.1 Negotiating prices 205
8.5 Competition and ownership . . . . . .
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211 8.6 Conclusion ..
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. . 213Conclusion
Bibliography
Appendix
List of Figures
. . .
1.1 Demand for health care with and without coinsurance 36
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1.2 Price discrimination 37
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1.3 Price discrimination for small c 38
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1.4 Insurer's iso-profit curve 48
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1.5 Profitable insurance contracts 52
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2.1 Market share of US employer-sponsored insurance plans 59
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2.2 US employer-sponsored insurance plan prices 60
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3.1 The single principal optimal scheme 88
. . .
3.2 Schemes whch implement (tl. t l ) 91
. . .
4.1 Timing of events 105
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4.2 Doctor-patient subgame: SPRS 109
. . .
4.3 Side-payment robust schemes 111
. . . 4.4 SPRS which exceeds doctor's reservation utility 112
. . .
4.5 SPRS which are not optimal 115
. . .
5.1 Doctor-patient subgame: SPSS 122
. . .
5.2 Patient side-payments 123
. . .
5.3 Sidepayment supplemented schemes 125
. . .
6.1 Funding sources of health care 133
. . .
6.2 Hospital funding 136
. . .
6.3 Accountability in the health sector 139
List of Tables
3.1 Cost-effectiveness of ACE Inhibitors (Source: Bonita and Beagle-
. . .
hole (1998)) 78
. . .
6.1 Health expenditure by categories 134
. . .
6.2 Funding by W A 138
6.3 Contracted and actual volumes delivered by CHEs (1996197) . . . 146
