Health Maintenance Organization Effect Versus Favorable Selection

Much of the empirical research on adverse selection in healthcare was done in the 1980s, as employers began to offer HMOs and other managed care plans. The issue arose because of substantial differences in the utilization experience of those enrolled in HMOs and those in conventional insurance plans. Miller and Luft (1994) reviewed much of the literature on the differences in utiliza- tion; see “HMO Performance” for a summary of their findings. Essentially, Miller and Luft found that people enrolled in an HMO use considerably less hospital care. The question is why.

One explanation is that HMOs do something to keep people out of hospitals. This is the so-called HMO effect, which might be the result of a number of strategies. For example, HMOs could substitute ambulatory services for inpatient services at a much more aggressive rate than do con- ventional insurers. HMOs could employ effective utilization management techniques that are designed to limit hospital use to only those most likely to benefit from it. HMOs may only affiliate with physicians who are conserva- tive in their use of hospital services, and/or they may provide financial incen- tives to physicians that lead the physicians to admit fewer patients. HMOs may provide preventive services that identify harmful conditions at an early stage and reduce hospitalizations.

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