The Efficiency of Managed Care Patient Protection Laws: Incomplete Contracts, Bounded Rationality, and Market Failure

Abstract

The 1990's have seen an explosion of state legislation mandating the provision of specific health insurance benefits, and the federal government appears poised to enact significant managed care patient protection legislation as well. Although patient protection is popular with voters, economists often decry such legislation as inefficient because it forces consumers to pay for benefits they do not purchase in the free market. In this article, Professor Korobkin argues that managed care regulation can enhance efficiency by requiring the provision of benefits likely to be inefficiently underprovided by the free market.

First, relying on a simple game-theoretic model, the article contends that managed care organizations (MCOs) have an incentive to provide an inefficiently low quality of certain types of benefits because it is difficult for consumers to evaluate their quality prior to contracting, and because consumers who are able to evaluate quality after contracting are the customers that MCOs do not wish to retain. Second, relying on behavioral research on consumer decision making, the article claims that consumers' bounded rationality prevents them from rewarding MCOs in the market for providing a broader range of valued benefits, thus creating another incentive for MCOs to provide inefficiently low quality benefits. The article then compares the ability of regulatory mandates to mitigate the effects of these market imperfections with the promise of market facilitating approaches. Finally, it compares the relative institutional competence of courts, legislatures, and independent commissions to determine which mandates would be efficiency enhancing and which would not.

JEL Classification: I11, I12, I18