Third party purchasing of health services: patient choice and agency

Health care provision is almost universally characterised by third party purchasing in which the provider of health services is reimbursed by an agency (public or private insurer), rather than the patient. We show how a purchaser can manage the incentives that patient choice gives rise to by its own choice of monitoring arrangement. Even though patients are ignorant about their exact medical conditions and insulated from the costs of health care, they can help alleviate incentive problems due to asymmetric information through the choices that they make about whether to be treated. We show that if patients are responsive to variations in treatment, it can be worthwhile to base payment on the health outcome achieved rather than upon the treatment delivered. Outcomes-based payments may also be preferable where services are supplied by not-for-profit agencies who are intrinsically concerned with patient welfare.