Final answer:
Proto-HMOs were formed as an alternative method of organizing healthcare, providing reimbursement based on the number of patients handled. This addresses adverse selection, reducing the risk for the insurance company.
Step-by-step explanation:
Proto-HMOs were formed as an alternative method of organizing health care. In a fee-for-service system, medical care providers are reimbursed based on the cost of services they provide. However, HMOs operate on a different model, where reimbursement is based on the number of patients they handle. This incentivizes providers to allocate resources between patients who require varying levels of care.
HMOs were formed to address the issue of adverse selection in insurance markets. Adverse selection occurs when insurance buyers have more information about the risks they face compared to the insurance company. High-risk parties may be more likely to embrace insurance, while low-risk parties may avoid it due to cost concerns. By shifting to an HMO model, the insurance company reduces the risk of adverse selection.