Reimbursement schemes for hospitals, malpractice liability, and intrinsic motivation

We develop a simple multi-task principal-agent model to analyze the interplay between optimal reimbursement schemes for hospitals and liability rules (basic model). We then extend our model and assume that the hospital is intrinsically motivated to exert positive effort for quality and cost reduction. This effort, however, is biased towards quality. Moreover, the intrinsic motivation may be crowded out by monetary incentives. In such a setting, we find that a pure prospective payment system (PPS) that has become widespread in recent years can only be optimal in the unlikely case where malpractice liability holds hospitals fully responsible for expected harm. For other cases, we confirm the prejudice that PPS may lead to inefficiently low quality. Then, the traditional fee-for-service (FFS) system is superior if the intrinsic motivation is high and relatively little biased towards quality, whereas mixed systems should be chosen otherwise. Our model sheds light on why countries like the USA with a tough liability system haven been less reluctant to switch from FFS to PPS than Germany, for instance.