The impact of medical insurance payment systems on patient choice, provider behavior, and out-of-pocket rate: Fee-for-service versus diagnosis-related groups

The medical insurance payment system (MIPS) is a key mechanism to ensure the public's access to medical services. In a game-theoretic model, we examine the impact of two MIPSs, fee-for-service (FFS) and diagnosis-related groups (DRG), on patient choices, provider behavior, and out-of-pocket rate. We find that neither FFS nor DRG can dominate the other in all three aspects: social welfare, provider profit, and total patient surplus. In particular, under DRG, the out-of-pocket rate for patients is lower, and the total patient surplus is higher than that under FFS. However, patients with lower illness severity tend to not participate in DRG, while FFS can make all patients participate in the program. Furthermore, when the marginal cost of medical services is high, the profit of the provider and social welfare under DRG is higher than those under FFS, otherwise lower. After interviewing hospital leaders, we further investigate two extended (pilot) payment systems: DRG with two price groups, and the hybrid model incorporating both FFS and DRG. We find that both models contribute to improving provider behavior, making more patients choose the provider, but are still not perfect payment systems due to lower provider profit or social welfare. Our findings offer important insights for policymakers regarding implementing medical insurance reform in practice.