Cost and Quality Incentives in Health Care: Altruistic Providers

This paper compares the cost and quality incentive effects of cost reimbursement and prospective payment systems in the health industry when providers are altruistic. Providers' behavioral rule is governed by a desire to maximize a weighted sum of profit and consumers' health benefit. When providers exert costly efforts to enhance quality and reduce cost, the first best--a regime in which efforts are contractible--can be implemented by prospective payment. Cost reimbursement does not implement the first-best efforts. Necessary conditions are derived for the implementation of the first best by a combination of prospective and cost reimbursement payments when the provider can refuse services to expensive patients.