The Economics Of Paying For Value

Editor’s note: This post is part of a Health Affairs Blog Symposium on Health Law stemming from 4th Annual Health Law Year in P/Review conference hosted by the Petrie-Flom Center for Health Law Policy, Biotechnology, and Bioethics at Harvard Law School. Holly Fernandez Lynch wrote an introductory post in January 2016 and you can access a full list of symposium pieces here or by clicking on the “The Health Law Year in P/Review” tag at the bottom of any symposium post. You can also watch a video of the presentation on which this post is based.

The notion that the American health care system should transition from paying for volume to paying for value has become nearly ubiquitous. There is a broad consensus that health care providers should be paid more if they deliver higher value care (i.e. care that results in substantial health gains per dollar spent).

These beliefs have led to a proliferation of value-based payment programs in both public and private sectors. For example, at the beginning of 2015, Sylvia Burwell announced the federal government’s commitment to tie 90 percent of fee-for-service Medicare payments to quality or value measures by 2018. In January of 2015, a newly formed alliance of health care providers, insurers, and employers called the Health Care Transformation Task Force committed to shifting 75 percent of their business to contracts that provide incentives for quality and efficiency by 2020.

The details of existing value or quality-based payment programs vary enormously and without regard to any conceptual framework. For example, they vary in the size of incentives and the measures used. They also vary in whether quality payments are contingent on financial savings and whether the value-based payment model is budget neutral. Even the term value is inconsistently defined.

The Economics Of Prices

The rhetoric of economics is often used to motivate paying for value. Thus it is useful to explore what economics may say about paying for value. As a broad overview, in economics prices play several roles. They convey information about the costs of production from producers to consumers and they convey information about demand (willingness to pay) from consumers to producers. Moreover, consumers’ willingness to pay for goods and services generally exceeds the costs of production.

The difference between the maximum willingness to pay for a good or service and the cost of production is termed surplus by economists. Prices are the mechanism that divide surplus between producers and consumers. Consumers receive a greater share of the surplus when prices are lower and closer to producers’ costs. Higher value-based payments, which amount to higher prices, allocate more surplus to producers.

While economic concepts are not the sole consideration in designing these programs, examining their design from the perspective of economic theory yields insights that could be useful to payers.

Payments Should Reflect The Incentives Necessary To Induce The Desired Outcomes

The contention that payment should automatically rise with quality is not consistent with standard economic models. In competitive markets, price increases with quality only if there is an additional cost to produce that higher level of quality. This is not always the case — for example, as computers have gotten better, but also become cheaper to produce, prices went down with costs as opposed to up with quality.

Since payment should only rise with quality if higher payment is needed to induce better outcomes, the magnitude of the incentive payment will depend on the cost of producing higher quality. If higher quality leads to lower costs (as some believe), additional payments should not be needed because the producers of better quality can capture the cost savings. And if delivering higher quality costs more, health care purchasers would need to pay more, but only the amount necessary to induce the desired level of quality and certainly not in excess of what that higher quality is worth to consumers (or society).

There are many high-value health care services that we can provide at reasonably low cost (e.g. chronic care medicines, immunizations, cancer screening). There is no economic justification for increasing payments for these services simply because they are high value; doing so would unduly transfer surplus to producers. We should only do so when we believe paying more will induce greater utilization of these services and we are willing to pay more for the associated better outcomes.

In practice, costs and provider responses to incentive payments are often unknown. Therefore payers may have to experiment with higher payment amounts until the desired quality is achieved.

The Scope Of Accountability Matters

Because of the potential for higher quality to reduce spending over time and across health care delivery settings, the payment amounts and the measures selected for a value-based payment program will depend on the scope of provider accountability. At one end of the spectrum, under a fee-for-service (FFS) payment model, providers are accountable only for a specific service delivered at a single point in time. At the other end of the spectrum, under a patient-based payment model such as an accountable care organization (ACO), delivery systems are accountable for all health care services delivered to the patient over an extended period of time (often a year). Episode-based payments and partial capitation fall in between these two scenarios.

Providers who are accountable for a broad range of health care services delivered over an extended period of time may capture more of the cost savings from improving quality and therefore experience a lower net cost of quality improvement. For example, higher quality chronic care management may reduce hospital spending over time. A primary care physician (PCP) paid on a FFS basis would incur additional costs to improve chronic care management but would not capture any cost savings. Quality incentive payments would need to offset those costs. In contrast, an integrated system with a broad scope of accountability (e.g. an ACO) can capture some of these cost savings. As a result, the cost of producing higher quality, netting out downstream savings, will be lower, and so quality incentive payments can be lower.

In contrast to calls for synchronized measures (i.e. the standardization of measures and incentives across different programs and types of providers), economic theory suggests program-specific measures are appropriate. In a FFS environment, quality incentives should be relatively granular because payment is granular. Whereas for an ACO model, broader measures may be developed suited to population health. In addition, incentives for ACOs may need to focus on dimensions of quality that are cost-increasing (i.e. services that are valued by patients but will not reduce costs) as the countervailing incentives from population-based payment will, all else equal, discourage investments in these activities.

Contingency-Based Incentive Programs May Weaken Or Distort Incentives

Often purchasers are concerned about the budgetary impact of pay-for-value programs. If the benchmark is set at the rate of historic spending, any quality payment above that could increase total purchaser outlays. As a result, in some of the population-based payment programs currently in use, there are strings attached to quality incentive payments. For example, in the Medicare ACO program, ACOs share more of the savings if they deliver higher quality. If they have no savings, they receive no quality incentive payments. This ensures that the quality payments do not increase spending relative to the benchmark.

Yet, for organizations unlikely to generate significant savings, there is no financial incentive to invest in quality improvement. For organizations that are likely to achieve savings, the incentive to improve quality depends on the magnitude of the expected savings as well as the cost of producing higher quality. In addition, because payout of the incentive depends on actual cost savings, this incentive design increases uncertainty about the likelihood of earning the quality incentive payment and is therefore likely to reduce effort and investment in improving performance.

All else equal, decoupling quality incentives from incentives for efficiency would likely increase the incentives for quality-improvement activities. Yet such a decoupling would require adjustments to other program parameters (e.g. benchmark rates, shared savings percentages) to meet financial goals. Those changes will have their own incentive effects. As a result, balancing the competing goals of paying for value without paying more overall is complex. More conceptual work, experimentation, and evaluation is needed to identify effective designs.

Paying for quality is an important step in transitioning the incentives in the American health care system away from volume and towards value. Doing it in an efficient manner is important so that we can achieve the quality we desire without over spending.

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