Cost incentives for doctors: A double-edged sword

•First paper to model patient-doctor communication.•When a doctor takes costs of treatment into account communication suffers.•Not taking cost into account can be welfare maximizing (even cost minimizing).•Taking costs fully into account is never welfare maximizing.

If doctors take the costs of treatment into account when prescribing medication, their objectives differ from their patients' objectives because the patients are insured. This misalignment of interests hampers communication between patient and doctor. Giving cost incentives to doctors increases welfare if (i) the doctor's examination technology is sufficiently good or (ii) (marginal) costs of treatment are high enough. If the planner can costlessly choose the extent to which doctors take costs into account, he will opt for less than 100%. Optimal health care systems should implement different degrees of cost incentives depending on type of disease and/or doctor.