ECONOMIC INCENTIVES AND CONTRACTS: THE USE OF PSYCHOTROPIC MEDICATIONS

I. INTRODUCTION "The past decade has seen an outpouring of new drugs introduced for the treatment of mental disorders. New medications for treatment of depression and schizophrenia are among the achievements stoked by research advances in both neuroscience and molecular biology" (U.S. Department of Health and Human Services, 1999, p. 68). Innovation in prescription pharmaceuticals has been dramatic during the past two decades. The impact of new psychotropic medications for the treatment of mental disorders has been particularly profound. In 1977, 5.2% of the U.S. population received treatment for a mental disorder, and among those people, about 63% of the treatments received involved the use of prescription drugs. By 1996, 7.7% of the U.S. population received treatment for a mental disorder and 77% of those people were treated with prescription drugs. In fact, nearly the entire growth in the rate of treatment of mental disorders is attributable to expansion in cases treated with prescription drugs (Frank and Glied, 2006a). At the same time these psychotropic medication innovations were being introduced, dramatic changes were occurring in the institutions that ration mental health services. Managed care arrangements became widespread, and specialized managed care organizations emerged, known as managed behavioral health care organizations (MBHOs), focusing on treatment of mental disorders. Mental health was increasingly "carved out" of general health plans. That is, the insurance risk for mental health care was separated from general health care and managed under specialized contracts by MBHOs. While the emergence of MBHO carve-outs is a development specific to the behavioral health care sector, it has much greater implications in the broader overall study of contracts and market incentives. (1) Most importantly, studies have shown that this new form of contracting appears to be successful in circumventing two long-standing issues in health care markets--moral hazard and adverse selection (Frank et al., 1996; Ma and McGuire, 1998). Furthermore, two features of carve-outs are particularly significant for understanding the utilization of new technologies. First, MBHO carve-outs apply specialized expertise and economies of scale in contracting to managing care of mental disorders. Second, the carve-out contracts all separate prescription drug financial risks from other mental health care financial risks. The effect of this latter phenomenon is to take the costs of one important set of inputs--psychotropic drugs--"off budget" for the organization that has been delegated responsibility for managing care for those suffering from mental illness. Thus, MBHOs have strong economic incentives to shift treatment strategies to those that favor use of prescription drugs over other nondrug inputs (e.g., psychotherapy, inpatient care, and other psychosocial interventions). (2) An implication is that the study of carve-outs may shed light on the role of demand-side factors, specifically the role of prices in the substitution between old and new technologies. Our analysis of the substitution between old and new medications within Medicaid population builds on Griliches' (1957/1997) seminal study on hybrid corn. Griliches identified three main determinants that affect the adoption and utilization of new technology: supply-side factors (such as the determinants of potential profitability of entry), demand-side factors (such as the long-run equilibrium profitability differential from users adopting the innovation), and the rate of reaching market saturation (such as the spread of information concerning new products). Given the stochastic and long drug approval process and our relatively short study period of 10 yr from 1991 through 2000, we do not examine the research and development (R & D) origins of this innovation but instead treat U.S. Food and Drug Administration (FDA) approvals as exogenous or predetermined. …