Are Factor Substitutions in HMO Industry Operations Cost Saving?

Abstract

Past research on the potentials for cost‐saving scale and scope economies in multiproduct HMO operations in the United States are incomplete in their economics of the underlying technology structure. This article exploits the translog cost model estimates of all past studies of HMO production to infer the extent to which pairwise factor substitutions (e.g., administrative services vs. medical care resources, e.g., hospital days, physician services) suggest potential for cost savings in groups and independent practice associations. Given the industry's nonhomothetic production over a 20‐year period, the conceptually valid Morishima elasticity measure at constant output reveals limited cost‐saving potentials from factor interchange and input demands. These opportunities differ for groups and IPAs across Medicare and non‐Medicare products. My findings add a timely and significant dimension to understanding potential cost savings in HMO operations. Policy suggestions and cost implications are rationalized in light of the declining Medicare HMO enrollment and recent changes in factor input prices.