Social Insurance Design under Uncertainty and Medicare Quantity Regulation

Although commonly perceived as a fee-for-service program that covers all services, by law, Medicare is to cover only medical care that is considered “reasonable and necessary.” With the rapid advancement of healthcare technology in the fifty years since Medicare’s inception, Medicare has witnessed heated debates about its scope of coverage. Since the early 1990s, the “reasonable and necessary” clause is often adjudicated through local coverage determinations (LCDs), which are formal coverage rules created by local Medicare contractors. Using historical data on LCDs, we investigate how Medicare steers the system towards the “reasonable and necessary.” We use the geographic and temporal variation in LCDs to document how coverage policies affect physicians’ treatment decisions and health outcomes of Medicare patients. Medicare context allows us to shed light on three related broader questions about the design of publicly run programs. First, how can the government design social insurance programs under asymmetric information about optimal actions, high monitoring costs, and inability to write complete contracts with agents. Second, can the government use its informational advantage about realized actions to spread the best practices across time and space. Third, what are the costs of transparency in government programs.