HMOs and Health Externalities: A Local Public Good Perspective

This article introduces a Health Maintenance Organization (HMO) model that characterizes HMO decisions on enrollment, utilization levels, and quality. Facing global budgets dependent on revenue raising capacity, HMOs must determine standards of care and the corresponding premiums to cover costs. Revenues are allocated among HMO providers by gatekeepers who are often subject to strict utilization controls. Our model identifies various uncompensated health and pecuniary externalities that may result from patient disenrollments, thereby affecting treatment costs. As a result of these externalities HMOs may provide less than socially efficient levels of care; and they may also enroll less than socially efficient numbers of members. The model also predicts that HMOs may promote socially cost inefficient treatment options for conditions where multiple options are available.