Physician Payment Contracts in the Presence of Moral Hazard and Adverse Selection: The Theory and Its Application in Ontario

We develop a stylized principal–agent model with moral hazard and adverse selection to provide a unified framework for understanding some of the most salient features of the recent physician payment reform in Ontario and its impact on physician behavior. These features include the following: (i) physicians can choose a payment contract from a menu that includes an enhanced fee‐for‐service contract and a blended capitation contract; (ii) the capitation rate is higher, and the cost‐reimbursement rate is lower in the blended capitation contract; (iii) physicians sort selectively into the contracts based on their preferences; and (iv) physicians in the blended capitation model provide fewer services than physicians in the enhanced fee‐for‐service model. Copyright © 2015 John Wiley & Sons, Ltd.