Physician Incentives and Treatment Choice

I analyze the impact of physician competition for patients on treatment selection and an insurer's ability to induce its preferences through a supply-side payment mechanism. Informed patients choose the physician whose treatment practice best fits their preferences, aligning physician incentives with patient preferences. An insurer's ability to counter these incentives is not monotonic in how informed patients are, however. When demand is either perfectly inelastic to treatment practices because patients are completely uninformed or a sufficient proportion of the market is informed relative to the number of physicians in the market, then an insurer can induce its preferences through supply-side payment rules. Otherwise, more intensive policy levers such as utilization review must be employed. Programs that increase patient information can therefore improve the efficiency despite generating stronger incentive to treat according to patient preferences. I also explore how noisy signals of illness type and diagnostic testing further complicate the insurer's problem.