Liability law, Defensive medicine and Healthcare quality

This paper develops a liability model that incorporates both patient heterogeneity and demand for healthcare services. After choosing the quality level of care, healthcare providers use diagnostic information to decide whether to treat patients based on their individual risk profiles. This information determines both the expected treatment costs and the potential compensation in case of a medical accident. We show that under strict liability, a fixed prospective payment can discourage providers from treating most high-risk patients — a phenomenon known as negative defensive medicine — and can lead to under-investment in care quality for those who are treated. Under a negligence rule, high-risk patients may also be denied care, but to a lesser extent. However, the negligence rule may incentivize providers to over-invest in care quality. This inefficiency can be partially mitigated by adjusting the prospective payment level, allowing the negligence rule to better align providers’ incentives with the socially efficient level of care.