An Incentive Mechanism for Using Risk Adjuster to Reimburse Health Care Providers

Health care providers are almost always universally reimbursed by third party purchasers. As a result, health care purchasers are faced with risk selection challenges. In response, risk adjustment methods are introduced in the reimbursement for services. However, health care providers under this arrangement have incentives to manipulate the risk elements in an attempt to obtain larger payments from the purchasers i.e. the realisation of risk adjuster then becomes sensitive to the providers?upcoding behaviour. Whilst there is usually an outside auditor (e.g from the o¢ ce of inspector general of the department of health and human services in the United States) who randomly monitors providers?beahviour and imposes penalty in the event that dishonesty is detected, monitoring such behaviour is highly costly. In this paper, we propose a reward scheme to combat such moral hazard problems. We analyse two types of incentive schemes where treatment intensity is contractible in one and not in the other. We show that under both incentive schemes, the honest provider receives the same reward and obtains higher expected utility in comparison to the full information case. Further, with contractible treatment intensity, the contract resembles the full information one.