Sticking Points: Common-agency Problems and Contracting in the U.s. Healthcare System

Brigham Frandsen (Brigham Young University)
Michael Powell (Northwestern University)
James B. Rebitzer (Boston University)

Abstract: It is commonplace to argue that persistent inefficiency in the healthcare system is due to the presence of health insurance. In this paper, we consider another source of inefficiency: the failure of health insurers and other payers to write efficient cost-sharing contracts with providers. The absence of such contracts is widely believed to inhibit investments in integrated care and so to contribute to inefficient organizational fragmentation. Important public policy initiatives, such as Medicare’s Accountable Care Organizations (ACOs), aim to induce efficient contracting between insurers and providers, but the underlying market failure justifying intervention has not been well articulated or analyzed. This paper argues that common-agency problems may impede efficient contracting between insurers and providers. We find that common agency can lead to a coordination failure when incentive contracts aim to elicit organizational innovations involving lumpy investments or fixed costs. This coordination failure leads to an inefficient equilibrium in which contracts offer no incentives at all. Although these results apply to many common-agency problems, they have specific implications for healthcare policy. Interventions such as Medicare’s ACOs ameliorate the common-agency market failure in two ways: but subsidizing investments by agents and by jumpstarting more efficient contracting by private payers. Subsidies crowd out private incentives either partially or fully. Jumpstarting can do better, but only if the market is stuck in an inefficient equilibrium and only if the contracts ACOs offer are sufficiently high-powered and aggressive. Weak ACO contracts are likely to have no effect at all.