This study examines the relationship between the size of Israel's four health funds and average real cost per member over the period 1991–2003. Case-mix adjustment is achieved by using the 1995 national risk adjustment formula. We used two estimation methods, a panel data analysis, and a cross section of time series analysis. The results are quite robust, and indicate that the size of fund that gives the minimum average cost is 2.2– 2.4 million members. The three small funds enjoy economies of scale in their operation, while the biggest health fund, Clalit Health Services (henceforth Clalit) is beyond the minimum point. The results do not change when the fact that Clalit owns hospitals is taken into account. Mergers among the small funds would increase efficiency in production, but would increase market concentration. Splitting the biggest health fund would increase both efficiency and competitiveness. The existence of (dis)economies of scale violates the assumption of constant average costs which is at the basis of the updating of the health budget for population growth and its risk-adjusted allocation among the health funds. Simulation of (i) the surpluses/deficits of the individual health funds and of the market as a whole and (ii) the marginal profit/loss per member in the four health funds under constant and variable average costs over the period 1995–2006 illustrate the importance of acknowledging the variability in average cost in the health funds market.

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