Payment Mechanisms and The Composition of Physician Practices: Balancing Cost-Containment, Access, and Quality of Care

HEALTH ECONOMICS
Health Econ. 24: 895–906 (2015)

Published online 2 July 2014 in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/hec.3069
PAYMENT MECHANISMS AND THE COMPOSITION OF PHYSICIAN

PRACTICES: BALANCING COST-CONTAINMENT, ACCESS, AND
QUALITY OF CARE
VICTORIA BARHAM and OLGA MILLIKEN

Department of Economics, Faculty of Social Sciences, University of Ottawa, Ottawa, Ontario, Canada
SUMMARY
We take explicit account of the way in which the supply of physicians and patients in the economy affects the design
of physician remuneration schemes, highlighting the three-way trade-off between quality of care, access, and cost. Both
physicians and patients are heterogeneous. Physicians choose both the number of patients and the quality of care to provide
to their patients. When determining physician payment rates, the principal must ensure access to care for all patients.
When physicians can adjust the number of patients seen, there is no incentive to over-treat. In contrast, altruistic physicians
always quality stint: they prefer to add an additional patient, rather than to increase the quality of service provided. A
mixed payment mechanism does not increase the quality of service provided with respect to capitation. Offering a menu of
compensation schemes may constitute a cost-effective strategy for inducing physicians to choose a given overall caseload
but may also generate difficulties with access to care for frail patients. Copyright © 2014 John Wiley & Sons, Ltd.
Received 11 June 2013; Revised 28 March 2014; Accepted 6 May 2014
KEY WORDS: fee-for-service; menu; access to primary care; mixed payment mechanism
1. INTRODUCTION
One of the looming issues for health policy makers is the anticipated increase in demand for health care services
associated with population aging, which will go hand-in-hand with a wave of physician retirements. Simoens
and Hurst (2006) reported that there are already shortages of primary care physicians in Canada, UK, and rural
Australia. The impact of these shortages can be seen in the difficulty that patients have in obtaining timely
access to a doctor. For example, in 2013, only 41.1% of Canadians reported being able to see a doctor on the
same or next day when they were sick (Health Council of Canada, 2014, p. 22). Cowling et al. (2013) provided
evidence that a 20% increase in visits to Emergency Departments in England since 2007 is driven by increasing
wait times for consultations with general practitioners (GPs). And in Sweden, difficulties in accessing primary
care physicians are seen as the factor behind an unusually high level of reliance on specialist care and hospital
outpatient clinics for first-contact care (Masseria et al., 2009). As physician shortages become more acute,
policy makers must increasingly be concerned by the way the physician payment scheme affects access to
health care services, as well as the incentives to provide appropriate treatment.
There are rich and sophisticated theoretical and empirical literatures, which examine physician responses to
the incentives embedded in alternative payment systems (see McGuire, 2000, and Léger, 2008, for overviews).
The underlying workhorse of this literature has been the principal-agent model, in which the physician is viewed

Correspondence to: 38 Ramsgate Private, Ottawa, Ontario, K1V8M4, Canada. E-mail: omilliken@gmail.com
Copyright © 2014 John Wiley & Sons, Ltd.

896 V. BARHAM AND O. MILLIKEN
as making a treatment decision about a single representative patient (e.g., Ellis and McGuire, 1986, 1990, 1993;
Ma and McGuire, 1997; McGuire, 2000; Eggleston, 2005; Jack, 2005; Choné and Ma, 2011)1 . Alternatively,
the physician is interpreted as having a ‘per patient’ utility function (Ellis, 1998; Eggleston, 2000; Allard
et al., 2009). Whereas this approach is useful for investigating the ways in which differences in the information
structure, in physician preferences, or in patient characteristics result in differences in the quality and quantity
of care provided to patients, it is less well suited to highlighting the extent to which physicians respond to
different payment schemes by adjusting the number of patients treated, as distinct from the services, which
are provided.
Practice size is endogenously determined in the literature on competition for patients (Allard et al., 2009;
Ma and McGuire, 1997), which considers an environment in which patients are relatively scarce, and argues
that physicians have an incentive to provide increased quality of care or effort so as to retain their patients
when they have the option of turning to an alternative provider; whereas these papers seem to describe well the
client-oriented practices of primary care physicians in countries with a surfeit of physicians, the analysis is less
compelling when applied to countries with physician shortages, where finding a new primary care provider is
difficult. The literature on cream-skimming and dumping (Ellis and McGuire, 1986; Ellis, 1998; Newhouse,
1998; Barros, 2003) analyzes the incentives imbedded in different remuneration schemes to limit access to
care for those patients who are costly to treat. This literature focuses on characterizing the consequences of
providers selecting patients; in contrast, it does not discuss how to design physician remuneration schemes to
provide access to health care to the entire population.
This is the first paper in the physician remuneration literature that takes a population-based approach: physi-
cians choose both the number of patients to treat of a given type and the quality of care that they provide to
their patients, and their utility depends on their total caseload. Moreover, when selecting a payment scheme,
the principal seeks to ensure that all patients can obtain health care services. Physicians differ with respect to
their degree of altruism, and patients differ with respect to the benefits they derive from health care services.
Our model highlights the three-way trade-off between quality of care, access, and cost. The model is very much
inspired by the Canadian experience, where there are long-standing shortages of primary care physicians, and
a variety of different payment mechanisms are offered to physicians.
We show that when physicians are able to determine the number and type of patients to treat, as well
as the quality of care provided, their predicted responses to the incentives imbedded in different payment
schemes differ in important ways from what has become standard wisdom. Specifically, when physicians
are paid on a fee-for-service basis, there is no incentive to over-treat patients2 : instead, physicians adjust the
number of patients in their practice. This result is consistent with the mixed empirical evidence concern-
ing the tendency of physicians to over-treat when paid on a fee-for-service basis (Léger, 2008). Studies by
Carlsen and Grytten (1998), Grytten and Sorensen (2001), Grytten et al. (2001), Madden et al. (2005), and
Grytten et al. (2008) found no evidence of supplier-induced demand under a fee-for-service regime in coun-
tries with publicly funded health care systems. Additionally, and regardless of the payment scheme, we show
that the quality of care provided to frail patients by altruistic physicians is always less than the optimal level.
Moreover, under a capitated (prospective) payment structure, we find that the quality of care provided to frail
patients by altruistic physicians decreases as the capitation fee increases, although the number of patients
treated increases. In sharp contrast with Ellis and McGuire (1986), Chalkley and Malcomson (1998), McGuire
(2000), and Léger (2008), switching to a mixed payment scheme does not reduce quality stinting as com-
pared with a capitated payment scheme with the same per patient fee but merely increases the number of
patients treated.3
1
An exception is Chalkley and Malcomson (1998), who allow hospitals to adjust both the number of patients and the quality of care
provided.
2
It has long been argued that fee-for-service (which pays for each unit of service provided) may encourage physicians to induce demand
for unnecessary services (Evans, 1974; Pauly, 1980; McGuire and Pauly, 1991; McGuire, 2000).
3
These authors suggest that it is desirable to create a mixed payment mechanism that is a mixture of prospective and retrospective schemes
in order to mitigate problems associated with each pure system.
Copyright © 2014 John Wiley & Sons, Ltd. Health Econ. 24: 895–906 (2015)
DOI: 10.1002/hec
PAYMENT MECHANISMS AND COMPOSITION OF PHYSICIAN PRACTICES 897
More recently, the literature on physician remuneration has investigated the consequences of heterogeneity
among patients and among primary care providers. While patients differ in the degree of their health care needs,
physicians appear to differ with respect to their reasons for, and approach to, practicing medicine: some are
motivated principally by financial gain, whereas others attach greater value to the complexity of the caseload
or to the neediness of the patients they treat. Godager and Weisen (2011) conducted a laboratory experiment to
study physician altruism and found significant heterogeneity among providers.
The heterogeneity of the physician population makes it natural to propose a menu of physician compensa-
tion schemes. Whereas the existing theoretical literature has suggested that more altruistic physicians should
generally be paid under a prospective payment scheme (Ellis and McGuire, 1990; Chalkley and Malcomson,
1998; Eggleston, 2005; Jack, 2005), we find that it is altruistic physicians, who treat primarily frail patients,
who should be paid on a fee-for-service basis, whereas nonaltruistic physicians, who treat healthy patients,
should be paid on a capitated basis. Our results are largely consistent with the experimental results of
Hennig-Schmidt et al. (2011), who found that healthy patients are best served by physicians paid by capita-
tion, whereas less healthy patients do better when physicians are paid under fee-for-service. In most countries,
physicians are in fact paid under a variety of payment schemes (Gosden et al., 2011; Fujisawa and Lafortune,
2008). In Canada, physicians have been offered a menu of options for many years, to take account of the dif-
ferent sorts of challenges faced by physicians practicing in academic, urban, or rural settings or with practices
that target vulnerable populations.
Offering physicians a menu of payment scheme allows us to highlight the trade-off between quality of care,
access, and cost. On the one hand, it is shown that a menu can be designed, which induces physicians to choose
the same overall caseload as when they are paid under a single payment mechanism but obtains these services
at lower cost. This is consistent with a number of theoretical papers (Jack, 2005; Makris and Siciliani, 2013;
Delfgaauw and Dur, 2008), as well as the empirical findings of Fortin et al. (2010) who simulated a shift from a
menu to a mandatory single mixed payment mechanism for specialists in Quebec, Canada, and showed that this
would result in an increase in health care costs. On the other hand, when physicians are switched from a single
payment scheme to a menu, this leads to changes in the composition of their practices, and in the quality of the
care provided to their patients, which in turn potentially generates problems of access to care. When all patients
must have access to health care services, a menu may not be superior to a single payment scheme. In a nutshell,
the menu outperforms the optimal single payment scheme when the improvement in the quality of care to frail
patients, and in the nonmonetary benefits to altruistic physicians, outweighs the additional costs of providing
this care. The conclusion that a menu is not always superior to a single payment scheme is consistent with some
recent theoretical results (Choné and Ma, 2011; Allard et al., 2010; and Liu and Ma, 2013); however, these
papers do not take into account the way in which a menu of compensation schemes influences the composition
and size of physicians’ practices.
The outline of this paper is as follows. We, first, introduce our model, and then study physician behavior
under different payment schemes (fee-for-service, capitation, and the mixed payment mechanism). Subse-
quently, we consider the impact of offering a menu of payment arrangements. Section 4 concludes.
2. THE MODEL
We consider an economy consisting of two populations: primary health care providers (further, GPs) and
patients. A GP is either altruistic .j D 1/ or nonaltruistic .j D 2/. Patients are also of two types, frail and
healthy. The total number of frail (healthy) patients in the population is denoted by F .H / respectively, whereas
the number of frail (healthy) patients in an individual physician’s practice is denoted by f .h/, respectively.
Frail patients benefit more from primary health care services than do healthy patients.
A health care services purchaser (e.g., the government, or health insurance company, further addressed as
Principal) contracts with GPs for the provision of health care services to patients. Both patients and GPs know
their own type, but their types are not observed by the principal. Physicians can observe the patient’s type;
patients can observe the length of consultation offered and are aware of the appropriate service standard for
DOI: 10.1002/hec
individuals of their own type. As in Choné and Ma (2011) and Makris and Siciliani (2013), the quantity of
services provided is observable.
In this paper, we are principally interested in how the design of physician remuneration schemes influences
the number of patients in a given physician’s practice and the quality of care provided to each patient. In
contrast, we are less interested in telling a story focused on deriving the optimal level of service provided
to each type of patient. Instead, we denote a targeted level of service that the principal would like to see
provided to frail and healthy patients and denote these service standards as q f and q h , respectively, where
q f > q h . 4 We assume that patients derive no benefit from receiving services exceeding these standards. For
the purposes of this analysis, we assume that the number of frail patients is large relative to the number of
altruistic physicians: in a world of full information, altruistic physicians would serve only frail patients, whereas
nonaltruistic physicians would serve a mix of frail and healthy patients (or might serve only healthy patients).
Whereas the utility of nonaltruistic GPs depends only on net income, altruistic GPs derive warm glow
benefits from the level of service provided to frail patients; they do not derive any warm glow from seeing
healthy patients. We express the GP’s payoff as
Vj D Ij C.qfj fj C qhj hj / C fj Aj .qfj /; (1)
where Ij is the GP’s income, C./ measures the total cost to the physician of providing primary care services,
qfj is the level of service provided to frail patients, fj the number of frail patients, qhj the level of care provided
to healthy patients, and hj the number of healthy patients. We assume that the cost function is convex, that is,
C 0 > 0; C 00 > 0: As it depends only on the total case load, we are implicitly assuming that there are no costs
associated with getting to know new patients.5 Moreover, we assume that the altruism function is bell-shaped :
A01 jqi <q f > 0; A01 jqi >q f < 0; A01 jqi Dq f D 0; A00 .0/ > 0, and 9 qO < q f such that A00 .q/ > 0 when q < q;
O and
00 f 6
A .q/ < 0 when qO < q < q . Note that for nonaltruistic physicians, A2 .q/ D 0 for all q. The restriction that
warm-glow benefits are maximized when frail patients receive the optimal amount of care means that altruistic
GPs do not have incentives to overprovide services to frail patients in order to obtain additional nonpecuniary
benefits for themselves and is therefore consistent with formulations of the altruism function that takes the
patient’s welfare as its argument.
3. PHYSICIAN BEHAVIOR UNDER ALTERNATIVE PAYMENT MECHANISMS

We start by studying physicians’ response to different payment mechanisms and characterize the optimal
contract for each alternative mechanism when all patients must have access to care. Under each scenario,
the GP chooses both the number of patients to treat of each type and the quality of treatment to provide.
The notion that health care providers can be selective about the types of patients they treat is a key feature
of the literature on cream-skimming and dumping (Ellis and McGuire, 1986; Ellis, 1998; Newhouse, 1998;
Barros, 2003) but also appears to be consistent with empirical evidence. Glazier et al. (2012) found that in
4
There are different stories that may be told regarding the determination of q f and q h . One may take the view that these targeted standards
of service reflect consensus medical opinion: primary care physicians often refer to clinical practice guidelines, which indicate—quite
precisely—the care that should be provided to patients with given sets of symptoms. Alternatively, they may be thought of as the levels
of service that would be chosen at the equilibrium of a political economy model or as the levels of service that would be identifed at the
solution to the optimal contracting problem in a full information world.
5
A cost function C.f C h; qf f C qh h/ would capture the notion that physicians may care both about the number of patients treated
and about their total case load. Ceteris paribus, as compared with the specification treated here, this cost function will induce doctors to
choose smaller practices and to choose a higher quality. This more general specification does not, however, eliminate the incentive for
altruistic doctors to undertreat frail patients nor significantly modify the flavor of our results.
6
The requirement that the altruism function be bell-shaped ensures that the introduction of altruism does not absurdly distort physician
behavior. If the altruism function is strictly concave, there is an incentive to severely undertreat patients (but to treat many patients); if it
is strictly convex, then altruistic physicians benefit from over-treating their frail patients. Our results do not change if we allow altruistic
physicians to derive nonmonetary benefits from treating healthy patients: as long as physicians are mandated to provide at least the optimal
level of care for healthy patients, altruistic physicians still strictly prefer to care for frail patients.
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Ontario, Canada, there are significant differences in the practice profiles of primary care physicians who
are paid under different remuneration schemes and that physicians paid under prospective payment schemes
typically have healthier patients than do physicians paid under fee-for-service. Also, Olah et al. (2013),
studying access to primary care physicians in Toronto, found that providers actively select patients, discrimi-
nating against people with low socioeconomic status7 . Evidence of patient selection is not confined to Canada:
Matsaganis and Glennerster (1994) argued that an introduction of a fund-holding scheme for GPs in UK makes
cream-skimming of healthy patients technically feasible and financially lucrative—thus difficult to resist—and
also cite evidence of cream-skinning under capitation in Health Maintenance Organizations in the USA and in
the Netherlands.
3.1. Capitation
A capitation contract consists of a uniform fee per patient. The type-j GP must choose both the number of
patients to roster of each type and the quality of care for each patient:
Maxfj ;hj ;qfj ;qhj Vj D R.fj C hj / C.qfj fj C qhj hj / C fj Aj .qfj / (2)
subject to qfj q h ; qhj q h
where the constraints reflect the contractual requirement to provide at least a minimum quantity of service, R
is the per patient capitation fee, and fj C hj is the patient roster consisting of fj frail and hj healthy patients.
The solution to this problem satisfies the following system of first-order conditions:
qfj W C 0 C A0j C fj D 0 (3)
qhj W C 0 C hj 0 (4)

fj W R qfj C 0 C Aj .qfj / C fj qfj q h D 0 (5)

hj W R qhj C 0 C hj qhj q h 0 (6)

fj fj qfj q h D 0; hj hj qhj q h D 0; fj 0; hj 0; (7)
where fj .hj / denotes the shadow price of the constraint on the minimum level of care for patient of type
f .h/, respectively, delivered by a physician of type j . Denote by qfjCAP ; qhjCAP ; fjCAP ; hCAP CAP
j ; fj the solution to
the aforementioned system of first-order conditions. Equations (3) and (4) together imply that a nonaltruistic
GP provides qfCAP 2
D q h to both frail and healthy patients, whereas the altruistic GP provides qh1 CAP
D q h to
CAP
healthy patients and qf 1 > q h to frail patients, implying that f 1 D 0. Notice, altruistic GPs underprovide
care to frail patients, that is, qf < q f .
Conditions (3)–(6) indicate that nonaltruistic GPs are indifferent between treating frail and healthy patients.
It is straightforward to verify that the roster size is increasing in R, which implies that nonaltruistic physicians
adjust their roster size, but not the quality of care, when the capitation fee is varied.
Turning to altruistic physicians, it is clear that they strictly prefer to treat frail patients. Consequently,
hCAP
1 D 0. Also, when the altruistic physician serves only frail patients dqfCAP 1
=dR < 0: as R increases,
the altruistic physician reduces the quality provided to frail patients but increases the total number of patients
7
The Canada Health Act forbids co-payments, and so, there is no difference in the remuneration paid to physicians when they treat patients
of different socioeconomic status.
DOI: 10.1002/hec
served. For high enough R, the altruistic physician’s practice will be constituted only of frail patients, all receiv-
ing q h . This result illustrates the usefulness of framing the physician’s decision problem in terms of both the
number of patients and the quality of service provided to each patient: were the physician simply choosing total
caseload, it would be predicted that an increase in R would result in more services. Here, in contrast, it is clear
that the quality of care actually decreases, although the size of the practice and the total caseload increases with
the capitation fee. The following proposition summarizes these findings.
Proposition 1
Under capitation, nonaltruistic GPs provide the minimum level of service to both healthy and frail patients.
Altruistic GPs prefer to serve only frail patients and typically provide a higher level of service than the man-
dated minimum level of care. The number of patients treated by both types of physicians is increasing in the
capitation fee. The quality of care provided by altruistic physicians is decreasing in R. For high enough R,
altruistic physicians provide frail patients with the same quality of care as does nonaltruistic GPs.
When designing the optimal capitation scheme, the principal has to trade off the social costs and benefits
of providing the services, while ensuring that all patients have access to health care. Under capitation, the
principal’s problem can be expressed as

MaxR W D N1 f1CAP .R/ q f qfCAP
1 .R/ C N2 f2CAP .R/ q f q h C H .q h q h /
(8)
CAP
CAP CAP

N1 f1 .R/ C N2 f2 .R/ C h2 .R/ R;
subject to N2 hCAP
2 .R/ H;
N1 f1CAP .R/ C N2 f2CAP .R/ F;
where is a concave function, which attains its maximum at zero, when the level of services provided is equal
to the desired level8 . As f1CAP ; f2CAP and hCAP
2 are all increasing in R, whereas the quality of service provided
to frail patients by altruistic doctors is decreasing in R, it follows that the solution to this problem is to choose
the R for which the supply of consultations is exactly equal to the population size. Observe, at the minimum R
for which the total supply of roster spaces is equal to the total population, there is no reason to expect that all
frail patients will have access to altruistic physicians. 9
3.2. Fee-for-service
Once again, the physician under fee-for-service decides simultaneously on the length of the consultation and
the number of patients in the practice. The decision problem of a type-j GP is
Maxqfj ;qhj ;fj ;hj Vj D p.qfj fj C qhj hj / C.qfj fj C qhj hj / C fj Aj .qfj / (9)
subject to qhj q f ; qfj q f
8
In this paper, we do not impose a zero-profit constraint with respect to physician income. If the optimal capitation scheme requires that
nonaltruistic physicians provide health care services, then it is automatic that the zero-profit constraint is satisfied for these physicians.
With respect to altruistic physicians—and unlike hospitals or charitable organizations—what is critical to the risk of bankruptcy is the
overhead costs incurred in the exercise of their professional activities. In survey data for family physicians practicing in the province of
Ontario, Canada, the mean net income of family physicians in 2009–2010 was $207,600; the highest reported proportion of gross revenue
spent on overhead costs was 68%, indicating that net income was positive for all physicians in the sample (Petch et al., 2012).
9
The solution to the principal’s problem raises similar issues to that of the ‘integer problem’ in club theory: f1CAP ; f2CAP , and hCAP 2 may
not be integer values, and therefore, patients may be ‘part-time’ patients of more than one doctor. By extension, and to abstract from the
issue of potential competition between frail patients for access to altruistic providers, it can be assumed that all frail patients are part-time
patients of an altruistic physician and get the rest of their care from nonaltruistic providers.
DOI: 10.1002/hec
where p is a fee per unit of service, and the constraint reflects the fact that the principal will refuse to pay for
any services beyond the level that is optimal for frail patients10 . The first-order conditions are
qfj W p C 0 C A0 fj D 0; (10)
qhj W p C 0 hj 0; (11)
fj W .p C 0 /qfj C Aj D 0; (12)
hj W .p C 0 /qhj 0: (13)

hj hj qhj q f D 0; fj fj qfj q f D 0; hj 0; fj 0; (14)
where ij is the shadow price of the aforementioned constraints. We denote by qfj ; qhj ; fj ; hj ; fj ; hj the
solutions to the problem for a physician of type j . As under capitation, nonaltruistic physicians are indifferent
between treating healthy or frail patients: their only significant concern is the overall caseload.11 Because
nonaltruistic physicians do not derive nonmonetary benefits (nor costs) from providing a sub-optimal level
of care to patients, we assume for convenience that they provide q h units to each patient, as long as there is
sufficient demand.12
From (12) and (13), it is clear that altruistic physicians again have a strict preference for frail patients. These
equations imply that
A1 qf 1
A0 qf 1 D ; (15)
qf 1
which, together with Equations (12) and (13), leads to the following proposition:
Proposition 2
Physicians paid under a fee-for-service scheme underserve their frail patients, although altruists provide more
service than they would if they were paid on a capitation basis, that is, qfCAP
1
< qf 1 < q f .13 The level of service
provided to frail patients by altruistic physicians is independent of the fee p. The number of patients—and
therefore the total caseload—is increasing in p.
Contrary to conventional wisdom, an increase in the consultation fee does not lead to higher level of services
to existing patients (or even overprovision). This is driven by the fact that altruists get a higher marginal warm
glow from enrolling a new patient than by increasing services to existing clients.
The principal’s problem of finding an optimal consultation fee (Appendix A in the supporting information)
is similar to that under the capitation regime.
3.3. Mixed payment mechanism

It has been suggested that paying physicians using a mixed mechanism will attenuate the problems with a
pure fee-for-service or pure capitation system. In the succeeding analysis, we follow the approach proposed by
Ellis and McGuire (1986, 1988), later utilized by Eggleston (2005) and Léger (2008), and assume that a mixed
10
To simplify the exposition, we neglect to require that the minimal level of care provided to patients is at least the optimal level for healthy
patients. As will become clear, this is not a particularly restrictive assumption.
11
If, however, there is even an infinitesimal cost associated with managing appointments of different lengths, then nonaltruistic physicians
will choose to supply the same level of care to all patients and will simply adjust the total number of patients seen.
12
If they are unable to find enough patients to generate the total caseload they desire with only q h per patient, we assume that they then
increase, symmetrically, the quality of care provided to all patients.
13
Under capitaton A0 D ACR CAP
CAP > 0, which implies that qf 1 < qf 1 D q,
qf
O where qO is the threshold at which the altruism function changes
1
from convex to concave.
DOI: 10.1002/hec
payment mechanism consists of a capitation payment plus partial reimbursement of costs incurred. Consider a
mixed contract characterized by ; < 1; the portion of costs reimbursed, and RM , a capitation fee per patient.
The decision problem of the type-j GP is

Maxqfj ;qhj ;fj ;hj Vj D RM .fj C hj / .1 /C fj qfj C hj qhj C fj Aj .qhj / (16)
subject to qfj q h ; qhj q h :

The first-order conditions with respect to the frail and healthy patients are
qfj W .1 /C 0 C A0 C fj D 0; (17)
qhj W .1 /C 0 C hj 0; (18)
fj W RM .1 /q1f
M 0
C1 C Aj D 0; (19)
hj W RM .1 /q h C10 0; (20)

ij W fj fj qfj q h D 0I hj hj qfj q h D 0; fj 0; hj 0; (21)
where fj ; hj denote the shadow prices of the constraints in (16). Solutions to (17)–(21) implicitly determine
qfjM ; qhjM ; fjM ; hM M M
j ; fj ; hj :
Proposition 3
For a given RM , the quality of care provided by physicians paid under the mixed mechanism is identical to that
when they are paid under capitation, but practices are larger. The average cost of delivering a given quality of
care to frail patients is higher under the mixed mechanism than under capitation.
Proof: see Appendix B (supporting information).
Whereas it has been suggested (Chalkley and Malcomson, 1998; McGuire, 2000; Eggleston, 2005; and
Léger, 2008) that mixed mechanisms will attenuate quality stinting, our analysis suggests that—holding R
constant—switching to a mixed mechanism merely increases the number of patients seen by a physician but
not the quality of care provided. The result that the average cost of providing a given quality of care is higher
under the mixed mechanism than under capitation is driven by the fact that as increases, more frail patients
have access to this higher quality of care. The difference in the average cost of care can be interpreted as the
cost of providing broader access to higher quality care.
Comparing the optimal mixed mechanism (see Appendix A in the supporting information for the optimiza-
tion problem) with the optimal capitated scheme where both ensure that all patients get at least q h , it is evident
that welfare is (at least weakly) greater, and the optimal reimbursement payment (RM ) is (at least weakly)
lower under the optimal mixed mechanism than under optimal capitated payment system. This implies that frail
patients who are treated by altruistic physicians will receive a higher standard of care when physicians are paid
under the optimal mixed mechanism rather than under optimal capitation.
4. A MENU OF TWO CONTRACTS

It is natural to imagine that the principal may be interested in exploiting the heterogeneity of the physician
population and offering a menu of compensation schemes. When physician types are observable, a menu is
always preferred to a single payment scheme. In contrast, when the principal cannot observe the agent’s type,
a menu may no longer be desirable: if the cost of inducing the agent to reveal the fact that they are altruistic
exceeds the benefits from doing so, then a single compensation scheme may be optimal.
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Our assessment of the strengths of a menu versus a single compensation scheme highlights the impact of
the alternative payment schemes on the composition of physician practices. Comparisons between schemes are
difficult, because there is a very real sense in which one is always comparing apples and oranges. Our initial
results compare the cost of procuring physician services under a pure payment scheme versus a menu, holding
constant overall caseload, but not the number of patients treated nor the quality of care provided.
Lemma 4
As compared with a pure capitation scheme, a mixed payment scheme can be used by the principal to procure
a given overall level of services from a nonaltruistic physician at less expense.
Given Lemma 4, the question which remains to be addressed is whether it is preferable to pay all physicians
using the mixed mechanism, or whether a menu of fee-for-service and the mixed mechanism will enable the
principal to elicit a given level of health care services at less expense.14
Proposition 5
Holding expenditures constant, a menu of physician payment regimes, under which altruistic physicians are
paid under fee-for-service and nonaltruistic physicians are paid under a mixed mechanism results in a higher
standard of care being provided to frail patients by altruistic physicians but in a reduction in the number of
frail patients having access to higher quality care as compared with outcomes under any mixed mechanism.
As the preceding result makes clear, in assessing the strengths of a menu of payment mechanisms versus
a single payment scheme, the principal faces a complicated trade-off. (See Appendix A in the supporting
information for the principal’s problem for an optimal menu.)
Proposition 6
Paying all physicians using the optimal mixed mechanism (pooling solution) may be socially preferred to the
optimal menu. The menu is preferred when the cost increase associated with providing a higher level of service
to frail patients is small as compared with the increase in social benefit, both to altruistic physicians and
patients, associated with the higher quality of service for frail patients.
Proof
Denote by pQQ the price for which f1 pQQ D f1M .RM ; M /, where f1 pQQ and f1M .RM ; M / are
solutions for a number of frail patients served by an altruist under the fee-for-service and the optimal mixed
mechanism, respectively.15 A sufficient (but not necessary) condition for the menu to be socially preferred to
the optimal mixed mechanism is that

QQ f1 pQQ RM f M C M C q M f M ;
pq (22)
1 1 1 1
which can be expressed as

0 M
C q1 f1 q1 C 0 q1M f1M q1M f1M C C 0 q1M f1M q1M f1M C q1M f1M (23)

< A q1 A q1M f1M :
Both the left-hand side and right-hand side of (23) are always positive. The left-hand side measures the
social marginal cost of increasing the quality; the right-hand side measures the social marginal benefit.
14
This next result initially appears to contradict Proposition 2. However, what must be remembered is that the number of patients being
treated, for a given R, is not constant. So, although the cost of delivering a given quality of care to an individual patient is higher with
the mixed mechanism, the physician is willing to treat more patients than is the physician paid under straight capitation.
15
Recall that the quality of care, q1 , provided by an altruist under a fee-for-service contract is independent of price.
DOI: 10.1002/hec
The likelihood of this condition being satisfied comes down to a comparison of the relative curvatures of the
altruism and cost functions: if there are approximately constant marginal costs, the left-hand side of this expres-
sion is more likely to be small, whereas if there is significant curvature to the altruism function, the right-hand
side is more likely to be large.
In other words, a menu is more likely to outperform an optimal mixed mechanism when significant non-
monetary benefits accrue to altruistic physicians from the provision of a higher standard of care to their frail
patients and when there is only a modest increase in the direct costs borne by altruists. The sufficient condition,
earlier, entirely neglects to account for the benefits to patients themselves of the higher standard of service. The
larger are these benefits, the more likely the menu is to be socially optimal.
It is noteworthy that unlike Chalkley and Malcomson (1998), Eggleston (2005), and Jack (2005), we find
that when the menu is optimal, it is altruistic physicians who are paid on a fee-for-service basis in order to
motivate them to provide higher quality care to frail patients. Our results differ because of patient and physician
heterogeneity in our model: when a menu is optimal, it is most cost-effective to pay nonaltruistic physicians to
treat healthy patients under capitation and to use fee-for-service to motivate altruists to treat frail patients with
higher quality care. Because the quality of care provided to frail patients under fee-for-service is independent of
the fee paid, the role of pQ is to determine the proportion of frail patients that are treated by altruistic physicians,
that is, the trade-off between access to high-quality care versus the cost of providing that care.
Our results are echoed by Allard et al. (2010), where the optimality of a menu depends on the distribution
of physician types and on the priorities of the regulator. But they are in contrast to Choné and Ma (2011), who
prefer pooling, because it is too costly to induce physicians and patients to reveal their private information. Liu
and Ma (2013) also prefer a single payment scheme when a physician can commit to treatment plans.
5. CONCLUSIONS
There is a long-standing debate regarding the best way of paying primary care physicians for the delivery of
health care services. This paper highlights the three-way trade-off between quality of care, access to care, and
the overall cost of providing health care services. A crucial feature of the analytic framework is that physi-
cians explicitly choose how many patients to treat of each type, and the quality of care to provided, leading
to predictions that differ sharply from conventional wisdom regarding physician responses to standard pay-
ment schemes. We find that altruistic physicians have an incentive to quality stint when treating frail patients,
regardless of whether they are paid under fee-for-service, capitation, or a mixed mechanism: they are better off
treating additional frail patients—generating additional warm glow—rather than providing better care to their
existing patient base. Nonaltruistic physicians have no incentive to overprovide care to patients: they simply
increase the number of patients to whom they provide health care services.
Offering physicians a menu of payment schemes leads to a higher average quality of service at lower cost
than is obtained when physicians are paid under any one system of remuneration. However, comparing the menu
with a single payment scheme is more complex than a straightforward weighing of overall physician caseloads
versus expenditures. The number of patients, and the quality of care offered to patients by physicians, depends
nontrivially on the compensation scheme. The optimality of offering a menu of compensation schemes depends
critically on whether the marginal social benefit of the increased quality of care provided to frail patients by
altruistic physicians (which includes the increase in the nonpecuniary benefits accruing to these physicians)
outweighs the marginal social cost of providing these patients with better care (and may include a reduction in
the quality of care provided to some frail patients).
In terms of future research, the relationship between the remuneration scheme and continuity of care requires
attention. Intuitively, it seems reasonable to predict that fee-for-service is likely to support greater access to
care, whereas capitation should promote greater continuity of care. Access to care and continuity of care are
both important determinants of the overall quality and effectiveness of family medicine, and it is clearly impor-
tant to better grasp the relationship between the remuneration scheme and these other characteristics of the
DOI: 10.1002/hec
primary care services. Another important extension to this model—and indeed to the literature on physician
remuneration more broadly—should be to examine how the design of the remuneration system affects physi-
cians’ incentives to respond appropriately to stochastic transitions in health status, for example, from healthy
to frail. To the extent that physicians on a fee-for-service contract can be paid directly for providing preven-
tive care (whereas physicians paid on a capitated basis must weigh the costs of providing preventive care in
the short run against the direct benefit to them of reducing the likelihood of one of their patients transitioning
from healthy to frail) and that physicians paid on a fee-for-service basis are less likely to stint on quality than
do physicians paid on a capitated basis; it seems that fee-for-service may be particularly well suited to address
changes in the characteristics of patients in physician practice.
A second issue, which arises from this analysis, is the link between physician supply and optimal physician
remuneration. The population-based approach taken here highlights the fact that the remuneration which must
be offered to physicians in order to ensure that all citizens have access to care is very clearly a function of the
overall number of physicians relative to the patient population. When physicians are relatively scarce, it rapidly
becomes very costly to ensure access to health care services for all citizens. It may in fact be preferable to
resolve the problems of access by enacting policies to increase the supply of physicians rather than by merely
adjusting physician remuneration.
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SUPPORTING INFORMATION
Additional supporting information may be found in the online version of this article at the publisher’s web site.
DOI: 10.1002/hec

Payment Mechanisms and The Composition of Physician Practices: Balancing Cost-Containment, Access, and Quality of Care

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HEALTH ECONOMICS

Health Econ. 24: 895–906 (2015)