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Question: how much should your surgeon earn?

Healthcare debates taking place in public policy arenas across the world face a common challenge: finding a way to design a system that can provide high quality care at minimum cost. Research by Alex Gershkov and Motty Perry focuses on how “optimal” contracts with providers that achieve this aim by paying good doctors more than bad ones.

Question: how much should your surgeon earn? Answer: how good is your surgeon?

Healthcare policy debates are high on the public agenda in many countries at present, particularly in the United States, where reform is a cornerstone of President Obama’s political agenda.

The central ambition of any healthcare system is to maximise care quality while minimising costs. Our research suggests that one way to achieve this goal is to pay good doctors more than bad ones. We characterise the way that this ought to be done, keeping in mind that doctors’ qualifications as well as the severity of patients’ problems are often known only to the doctors themselves.

Our research suggests that optimal contracts should take account of the differing skills of doctors by offering physicians a choice of two career paths:

  • The first career path, aimed at attracting the most talented doctors into positions requiring the most demanding skills, would offer physicians financial rewards for demonstrating a long history of success with difficult medical cases.
  • The second career path, aimed at channelling worse doctors into more pedestrian medical services, would offer lower pay rates over the course of a career dealing with less challenging and straightforward medical issues.

The research shows that healthcare authorities must design optimal contracts in a way that takes account of doctors’ incentives, and, in particular, acknowledges that doctors themselves know their own skills best, with outside authorities at a decided disadvantage in trying to observe how much effort doctors put into providing care.

Governments and healthcare authorities need to take doctors’ “informational advantage” into account as they consider how to design efficient healthcare systems. In any doctor-patient relationship, the doctor knows more than the patient about critical elements that determine the best course of treatment. For example, the doctor has better information about the medical condition of the patient and the severity of the illness.

The doctor also knows more about the relative merits of the various treatment options. The doctor, more than the patient, knows his or her medical skills and whether they are well suited for a particular type of treatment, such as a surgical procedure. In addition, the amount of effort that doctors exert in carrying out their work is not easily observable to third parties, such as their managers, the government or insurers.

One way to maximise healthcare quality while minimising costs is to pay good doctors more than bad ones

This informational advantage of healthcare providers is a crucial factor that governments or healthcare authorities face in determining the structure of the contracts they offer. A key aim in the design of such contracts is to provide appropriate incentives to the doctors – ones that will induce them to provide the right treatment to the right patient in a cost-effective manner.

Because of this informational advantage, medical services belong to a special category of “credence” goods and services – those that make evaluating their merits difficult or impossible for the consumer. The inherent problem with credence goods and services is the asymmetric information between providers and consumers.

The vast majority of research on credence goods takes what economists call a positive (“what is”) approach, studying the present situation as it exists. Our work is among the minority of research projects on credence goods that adopts a normative (“what ought to be”) approach.

Our mathematical models explore the market prospects for the provision of medical treatment. They are structured to show how governments and healthcare authorities ought to design and organise their systems to maximise the potential for good healthcare while minimising costs.

Our work sheds light on some pressing issues facing the industry. For example, among physicians, there is a widespread belief that the healthcare system is suffering from high costs, inefficient production, and lack of security rather than skewed financial incentives.

But information problems make it difficult for people to choose care appropriately, even when patients have a strong financial interest in doing so – for example, because they must pay for their own medical services or because they face limits on the amount their insurer will pay. Indeed, price and quality comparisons may be impossible for people with emergency medical needs and difficult even for those without emergencies.

The US Institute of Medicine has endorsed the potential of such contracts, as evidenced by its recent call to increase payments to healthcare providers who deliver high quality care.

Not only do surgeons react to financial incentives, but they may over-react in a way that is not in the patient’s best interest by performing tests and procedures that are not needed. Estimates suggest that approximately one-third of common medical tests and procedures are inappropriate or of equivocal value.

For example, one study demonstrates that the number of examinations to detect microscopic cell abnormalities of the cervix increases with the fees that doctors receive for the tests. Another study shows that the frequency of caesarean births compared with normal child deliveries corresponds to the fees paid by various health insurance programmes.

A Swiss study finds that the average person’s probability of receiving one of seven major surgical interventions is one third above that of a physician or a member of a physician’s family. And a study by the Federal Trade Commission documents the tendency of optometrists to prescribe unnecessary treatment.

These findings are exactly what we might expect to find in a naïve market for credence goods. The challenge is to design a system that takes account of agents’ incentives and aligns them in the least costly way with the goals of society as a whole. Our research indicates how, in certain cases, such goals can be achieved. The findings have implications not only for individual contracts but for the way healthcare systems as a whole are organised.

We suggest that healthcare systems ought to establish the two tiers of provider contracts for the long term by offering new doctors a choice of the “good” or “bad” track at the beginning of their careers:

  • Beginning doctors who are confident of their skills will choose to take the most demanding positions, with the promise of large financial gains down the line.
  • Doctors with poorer skills would forfeit receiving substantially higher payoffs later in their careers in exchange for handling more mundane and less-demanding medical matters.

Contracts must be structured over long periods of time to optimise their worth effectively and achieve the twin goals of funnelling doctors into the good or bad categories and of minimising healthcare costs.

Good doctors should be offered contracts with the promise of significant financial gain after many years of work in which these doctors must prove their worth by showing a history of surgical successes. Otherwise, if contracts offer good doctors more money from the beginning of their careers, bad doctors will be tempted to claim to be better than they are.

The option of rejecting riskier patients would not be part of the optimal contract for good doctors who receive higher pay

A recent US controversy over a proposed system of physician report cards illustrates the type of incentive problems that sometimes arise in the industry. These cards would encourage public disclosure of patients’ health outcomes with individual doctors. Supporters argue that the system would give providers powerful incentives to improve quality. Sceptics counter that report cards may encourage providers to “game” the system by avoiding sick patients, seeking healthy patients or both.

The desire to improve the quality of healthcare services by providing incentives is one of the driving forces for broad-based reform. But the contracts must also be fashioned in a way that achieves social goals, for example, ensuring that the sickest patients are not rejected for the sake of preserving a physician’s record of success.

The optimal physician contract could achieve this goal because doctors who opt for the high-skill, high-pay track would do so knowing that they would have no choice but to take the riskiest cases. Rejection of certain patients would not be part of the optimal contract for good doctors.

Many recent healthcare reform proposals seek to reduce expenditures by shifting the delivery of services toward “managed-care” organisations like health maintenance organisations (HMOs). Indeed, evidence suggests that HMOs have lower hospitalisation rates and shorter hospital stays, and also use fewer expensive tests and procedures than traditional healthcare providers.

For example, the New York Times recently reported that for two triple coronary bypass surgeries performed only months apart, George Washington University Hospital received $28,113 from a traditional insurer but only $10,987 from the HMO Kaiser Permanente.

Proponents of HMOs often emphasise their ability to contain costs by implementation of a payment scheme that aligns physicians’ incentives with those of the healthcare plan. But considerable debate remains about the sources of the cost savings generated by HMOs. Our study indicates that optimal contracts for physicians at HMOs are less costly, and one potential source of this efficiency gain for HMOs.

Further details

This article is based on recent research presented in Contracts for Providers of Medical Treatment by Alex Gershkov and Motty Perry, available as Discussion Paper no. 516 of the Center for the Study of Rationality at the Hebrew University of Jerusalem and at:

The authors

Alex Gershkov is a professor in the Department of Economics at the University of Bonn. Motty Perry, a Fellow of the Econometric Society, is a professor in the Department of Economics at the University of Warwick and at the Center for the Study of Rationality at the Hebrew University of Jerusalem.