By Stein, Alex
Regulation , Vol. 29, No. 4
Medical care organizations (MCOS), such as health maintenance organizations and preferred provider organizations, have become popular in recent decades because of their ability to lower consumers' healthcare costs while increasing providers' throughput. These organizations function as healthcare intermediaries or, in a technical language, as platforms in the two-sided market for medical care, with the two sides being healthcare providers looking for patients and patients looking for healthcare providers. This function currently has negative implications for the quality of medical care, but it can be utilized to improve that quality.
This article explains how to do it. It begins with describing various factors--both legal and economic--that affect the quality of medical care under the MCO framework. This discussion singles out a serious economic anomaly that the law of medical malpractice aggravates instead of rectifying. This anomaly is the virtual absence of incentives on the part of MCOs and their doctors to compete with each other over the quality of medical care. The article offers a semi-regulatory law reform proposal that would unlock that competition.
MCOS are not just health insurers, as many take them to be. They are also, albeit less conspicuously, healthcare intermediaries. An individual pays the MCO in advance for medical care that he may require in the future. The MCO provides medical care to the individual when the need arises. This is how it functions as a health insurer.
The MCO provides this care by paying affiliated doctors and other healthcare providers who deliver care to the MCO's insureds. The doctors' affiliation to this plan is contractual. They contract with the MCO to set the prices it will pay them for the delivery of medical care to the MCO's insureds. The MCO pays the doctors by using the money collected from the insureds (either directly or, as typically is the case, through the insureds' employers). This is how the MCO intermediates between doctors and patients--a characteristic identifying it as a platform in a two-sided market. It is here where my account of MCOs' economically perverse incentives begins.
PLATFORM ECONOMY To understand these incentives, consider the simplest example of a platform in a two-sided market: a videogame console such as Sony's PlayStation or Microsoft's Xbox. These platforms effectuate transactions between the sellers of videogames (such as Bungle or EA Sports) and gamers. In this example, buyers and sellers cannot transact without the platform (no matter what transaction costs they are willing to expend). To play FIFA-07, a soccer enthusiast cannot just purchase the program from EA Sports; he needs Sony's or Microsoft's console to run the program. Without the platforms, game-programmers would not have buyers. A platform developer thus needs to design a platform that attracts many gamers and thereby induces game-programmers to develop games that port to its platform.
In other two-sided market scenarios, buyers and sellers theoretically are able to transact with each other, but their transaction costs are too high to make it happen. A seller, for example, may be willing to sell its product for, say, $100 to an individual buyer. The buyer, however, would not buy the product because $100 is too expensive. He would only be willing to pay, say, $70 for the product--a price the seller would gladly accept as well if she had at least 1,000 buyers rather than just a few. In the 1,000-buyers scenario, the seller might even be happy to sell the product to each buyer for $60. There may be 1,000 or more potential buyers for the product, but they are dispersed and consolidating them would be too expensive.
A cost-efficient platform, however, may still effectuate the product's sales. To be cost-efficient, a platform needs to make a profit by collecting a fee from both buyers and sellers. For example, it may charge a $10 access fee to each buyer in exchange for its undertaking to the buyer to sell her the product for $60. …