David E. M. Sappington

We examine how to procure health care services at minimum cost while preventing suppliers from refusing to care for high‐cost patients. A single risk‐adjusted prospective payment is optimal only when it is particularly costly for the supplier to discover likely treatment costs. Cost sharing is optimal when these screening costs are somewhat smaller. When screening costs are sufficiently small, screening is optimally accommodated and subjective risk adjusting is implemented. Under subjective risk adjusting, the supplier classifies patients according to his personal assessment of likely treatment costs, and payments are structured accordingly. Optimal procurement policies are contrasted with prevailing industry policies.