Just What the Market Ordered

Malpractice lawsuits play an important role in a functioning health care market. As in most markets, sellers who provide quality products are rewarded with high demand, while lower-quality sellers see less demand. Lawsuits can help separate the wheat from the chaff, allowing patients to signal when a doctor provides bad services.

But the research so far seems to suggest that market effects from lawsuits are minimal. Sensing that they were not seeing the full picture, David Dranove, a professor of management and strategy at the Kellogg School of Management, Yasutora Watanabe, an assistant professor of management and strategy at the Kellogg School, and Subramaniam Ramanarayanan, an assistant professor at UCLA, developed a more nuanced model of patient demand. They found that the market actually does punish negligent doctors in a way that other studies had glossed over: by taking away their most profitable patients.

Lawsuits, Recalls, and the Market

In other industries, lawsuits and product recalls have caused dramatic decreases in demand. In 1982, Tylenol sales plummeted after tampering caused seven deaths in the Chicago area, and more recently, Toyota’s market share fell in the United States after faulty acceleration forced vehicle recalls. But in medicine, Dranove says, the picture is more complicated. Some studies have shown that lawsuits do not shake the health care industry the way they do others. “After a provider has been sued, they don’t tend to lose any patients,” Dranove says. Perhaps, he thought, patients do not take lawsuits seriously or maybe do not even hear about them. Medical malpractice lawsuits are also notoriously inefficient. “For every dollar that goes to a harmed person, another dollar goes to experts and lawyers,” Dranove notes. The problem of demand is compounded by the existence of different types of insurance. For instance, patients insured by a preferred provider organization (PPO) have more personal choice in what doctors they see, but someone insured by a health maintenance organization (HMO) must choose a doctor in a specific network.

These insurance types also pay different service fees to doctors, so the researchers translated the issue of insurance type into a determinant of doctor quality. Physicians have to limit the number of patients they see, but high-quality doctors can see more patients insured by PPOs, which tend to pay much higher rates. “Obviously a physician cannot work that much, so they are limited,” Watanabe explains. “Higher-quality ones can select those [patients] who will pay more.” Lower-quality physicians are less in demand for PPO patients, so they need to fill their caseload with more patients insured by programs like Medicare. Public programs and HMOs both pay less to doctors than PPOs do. Dranove, Watanabe, and Ramanarayanan defined doctor quality by a ratio of PPO patients to other patients. In their data, high-quality doctors had about 40 percent of their caseload as PPO patients, while low-quality doctors had only 2.5 percent.

Theory Meets Reality

Armed with a model that took these different demand structures into account, the researchers turned to real data. They examined data on malpractice claims in Florida from 1994 to 2003, focusing on obstetricians, which they took as doctors who performed at least 50 deliveries annually on average. Obstetrics seemed a good choice for several reasons: patients tend to see one physician regularly for a long time, malpractice lawsuits are relatively common, and people often use referrals from friends or other doctors to choose an obstetrician. Florida is a particularly litigious state, and information on malpractice lawsuits is easily accessible. “This info is posted online,” Watanabe adds. “You can just go to the state of Florida website and check each doctor’s history of litigation.”’

The researchers’ model predicted that after a lawsuit, high-quality physicians would see both a reduction in their privately insured patients and an increase in Medicaid patients. To everyone’s delight, the model proved uncommonly accurate. “The data was matching so well with what we had expected,” Watanabe says. The real data also showed that low-quality physicians see a drop in their Medicaid patients and a slight increase in PPO patients, but a decrease in the total number of patients. After a lawsuit, high-quality physicians do not lose many patients overall, but they will lose two PPO patients on average per quarter and gain an average of 1 HMO and 1.5 Medicaid patients. A low-quality physician will lose an average of 2.2 HMO and 2.9 Medicaid patients per quarter, and gain an average of 1.65 PPO patients.

For both high-quality and low-quality physicians, this shifting demand translated into losses in income. Using estimates for service fees from the different insurance types, the researchers calculated that a high-quality physician with an annual income of $400,000 might see his or her income drop to $394,600. A low-quality physician with an annual income of $320,000 might see his or her annual income go to $305,000 after the lawsuit. A physician loses only one to two days of time preparing lawyers for the actual lawsuit, so the drop in income is a much more important deterrent.

The study is the first to examine demand effects in such a systematic way, and it shows one powerful way that the market keeps doctors on track. Dranove already has ideas for future studies about word-of-mouth effects. “We’d love to have data that identify bad patient outcomes independent of the presence of a lawsuit,” he says. After all, not everyone sues after being a victim of negligence. This could help researchers find out whether lawsuits are the primary reason that doctors lose patients, or whether cautionary tales from patients’ own doctors are enough.

Of the current study, Dranove said he was especially excited that an economic model he had used to teach in class worked so well in real life. “I’m always surprised when economic theory works,” he said. “I’m like a little kid when it comes to these things.”

Related reading on Kellogg Insight

Tort Reform No Miracle Cure: Limiting liability has limited impact on healthcare costs

Does Malpractice Liability Keep the Doctor Away? The impact of tort reform damage caps

To Settle or Not to Settle: Negotiations and attorney interests in medical malpractice cases