Health care providers are almost always universally reimbursed by third party purchasers. As a result, health care purchasers are faced with risk selection challenges. In response, risk adjustment methods are introduced in the reimbursement for providers' services. However, health care providers under this arrangement have incentives to manipulate the risk element in an attempt to obtain larger payments from the purchasers i.e. the realisation of risk adjuster becomes sensitive to the providers' upcoding behaviour. In such a scenario, we analyse two types of incentive schemes: one where the treatment intensity, along with the payment schedule, is contractible, and the other in which it is not. We show that both schemes have strong incentive effects and induce honest behaviour by providing positive rents (rewards) to the honest provider compared to the full information case although the channels via which such incentive effects work are quite different. With the non-contractible treatment intensity, the payment schedule is distorted in favour of the provider who treats patients with worse medical conditions. With contractible treatment intensity, however, the intensity level is reduced compared to the first best one although such a contract resembles the one under full-information with a modified ex-post utility function. Our analysis has strong policy implications for health care markets pervaded by upcoding issues.
Keywords: Upcoding, Asymmetric Information, Health Contracts, Risk Adjuster, Treatment Intensity
JEL Classification: I11, D82