Incentive Design for Diagnostic Effort and Testing

Diagnostic errors are prevalent and can result in severe patient harm. Identifying a correct diagnosis often necessitates significant diagnostic effort. Nonetheless, most physician payment schemes are procedure-based and do not account for diagnostic effort or accuracy, due to observability issues. In this paper, we develop a parsimonious model to examine the impact of a physician payment scheme on physicians’ decisions to (1) exert diagnostic effort and (2) conduct a confirmatory test. A high effort level yields an informative (although imperfect) signal of the patient’s true state; the test is confirmatory in that it is necessary (although not sufficient) for a positive diagnosis. Our model uses a two-step diagnostic process to capture the interaction between a physician’s diagnostic effort and testing decisions. We show that under a fee-for-service payment scheme, the physician may view the diagnostic effort and the confirmatory test as either complementary or substitutive, depending on the additional revenue from testing. We also reveal non-monotone properties such that a more patient-centered physician may not exert more effort or provide a more accurate diagnosis. In addition, either a flat or differentiated payment scheme may be optimal. We also show that an alternative payment scheme, under which the revenue from the confirmatory test is contingent on its result, can induce the social optimum under certain conditions