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 det ermine standards of care and the corresponding premiums to cover costs. Rev enues are allocated among HMO providers by gatekeepers who are often subjec t to strict utilization controls. The authors' model identifies various unc ompensated health and pecuniary externalities that may result from patient disenrollments, thereby affecting treatment costs. As a result of these ext ernalities, HMOs may provide less than socially efficient levels of care, a nd they may also enroll less than socially efficient numbers of members. Th e model also predicts that HMOs may promote socially cost-inefficient treat ment options for conditions in which multiple options are available.