forward to future years. Thus workers, in their medical and health care deci-
sions, should begin acting as if they are spending their own money, at least up
to the amount of the deductible.^9
An alternative approach targets physician incentives. The traditional fee-for-
service approach simply reimburses doctors for the cost of treatment and gives
neither the patient nor the doctor an incentive to consider costs. When ordering
outside tests, doctors are often unaware of the cost of the tests. Even worse, in
some practice areas, doctors have a financial incentive to prescribe costly treat-
ments, even if less costly treatments would be more effective. Moreover, under the
current legal regime, the threat of malpractice suits encourages doctors to prac-
tice defensive medicine—to overprescribe costly tests and treatments.
In contrast to a fee-for-service approach, fixedpayments for treatments, sepa-
rated into diagnosis-related groups, provide strong cost incentives. For instance,
a hospital that receives a fixed payment for a surgical appendectomy has a strong
incentive to keep down costs. If its cost exceeds the fixed payment, it bears the loss;
if its cost is below the fixed payment, it garners the profit. An increasingly popu-
lar payment scheme, the capitationapproach, takes incentives to the limit. Under
capitation, an HMO pays a group of doctors one fixed annual payment per
patient. The fee per patient is set at the estimated cost of caring for each enrollee.
At the end of the year, if total costs come in below total fees, the doctors pocket
the profit. Conversely, if costs outpace fees, the doctors absorb the loss.590 Chapter 14 Asymmetric Information and Organizational Design(^9) However, whether such incentive plans will always lead consumers to wiser health decisions is an
open question. A 2004 Rand Corporation study found that worker co-payments reduced the use
of prescription drugs but increased visits to emergency rooms, raising the concern that patients,
made to pay for a significant share of their health costs, were not buying the medicines they
needed, leading to more expensive treatment in the future. Other research has found that many
older women were foregoing mammograms to detect breast cancer, in spite of government guide-
lines recommending regular mammograms. See V. Fuhrmans, “Higher Co-Pays May Take Toll on
Health,” The Wall Street Journal, May 19, 2004, p. D1; and David Armstrong, “Co-Payments Shown
to Curb Number of Mammograms,” The Wall Street Journal, January 24, 2008, p. D6. For a discus-
sion of the Whole Foods program, see R. Lieber, “New Way to Curb Medical Costs: Make Employees
Feel the Sting,” The Wall Street Journal Online, June 23, 2004, p. A1.
CHECK
STATION 2
The capitation approach gives full decision-making control to physicians. One result
might be a greater focus on preventive care. Explain why. Might adverse selection (exer-
cised by the physician group) and moral hazard (also exercised by the physician group)
be a problem? What risks do doctors face under capitation? On the patients’ side, might
there be a risk of compromised health care quality? Explain.
The U.S. financial crisis of 2007 and 2008 was marked by a “perfect storm” of
asymmetric information, moral hazard, and misaligned incentives. Although
this synopsis can hardly do justice to all the factors at play, we can highlight
some basic points. Financial institutions mediate between borrowers and
lenders in order to efficiently allocate capital, spread risks, and lubricate eco-
nomic activity. How might this process go wrong and unravel?
The Financial
Meltdown
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