Uwe E. Reinhardt: The Options for Payment Reform in U.S. Health Care Uwe E. Reinhardt is an economics professor at Princeton. He has some financial interests in the health care field. Over the years, both experience and empirical research have taught policy makers around the globe that how money enters the health system - and how much enters - has a powerful influence over the shape and modus operandi of health care delivery. It is therefore not surprising that "payment reform" has become the new battle cry in the United States, as the nation seeks better control over the annual increases in health spending per capita. So, what choices do policy makers have in payment reform? It is useful to go back to basics. Any payment system for health care has several dimensions: The "base" upon which prices are defined and paid. The level of the payment per unit of the chosen base. The administrative and economic process by which that price level is determined. The chart below focuses on the first and third of these dimensions. The columns describe the main bases in the menu; the rows describe the methods by which price levels are determined. The second dimension - that is, the "right" level of payment - is highly debated. From society's perspective, economists would define that level as the minimum that must be paid to elicit from the providers of health care the supply of health care goods and services that society wishes to have and is willing to pay for. By far the most prevalent payment base around the world has been and continues to be the piece-rate method base as fee for services, or F.F.S. A major advantage asserted for F.F.S. is that it rewards providers of health care in direct proportion to the number and type of services they render - what is called "productivity." A second advantage is that by its very nature F.F.S. forces the providers of care to describe in detail what services they have delivered to patients. It lays bare what goes on, or at least what is reported to go on, in the provider's practice. A major disadvantage of F.F.S. is the strong financial incentives it creates to prescribe for and deliver to patients more health care than may be clinically warranted by best-practice standards. Furthermore, if the profit margin implicit in the level of a fee for a service and the cost of producing the underlying service varies significantly across services - as in practice it generally does - then these profit margins may distort the mix of services going into medical treatments away from best clinical practice. Finally, the F.F.S. system enables the much-deplored fragmentation of health care suspected of yielding substandard overall quality of medical treatments and excessive costs. Bundled payments per episode of illness, the next payment base in the chart, are thought to mitigate the disadvantages ascribed to F.F.S. The idea here is that expert clinicians use evidence-based, best clinical practices to compose the bundle of distinct goods and services that should go into the treatment of a given medical condition. There should then be one single payment made - the so-called bundled payment - for the entire package of these goods and services. There would, of course, have to be an organization at the receiving end of the payment capable of coordinating the entire treatment and distributing the bundled payment among the various participants in the treatment. The theory driving bundled payments is that, given the payment, the various providers of health care involved in the treatment of a given medical condition - e.g., a hip replacement or a coronary artery bypass graft - will naturally be driven to seek the most cost-effective treatment package. By "cost effective" is meant the total cost incurred to achieve a given clinical outcome from a treatment - for example, a change in life expectancy or in "quality-adjusted life years," known as QALYs (pronounced KWAH-lees). The QALY is a metric based on life expectancy, with each year adjusted by a multiplier ranging from 0, for death, to 1, for perfect health, for the health status experienced in that year (as I discuss in Pages 519-25 of this paper). An added advantage attributed to bundled payments is that they automatically force our health care delivery system to change from its current fragmented organization toward clinically integrated health care, generally thought to yield health care of superior quality (and often lower costs). To health-policy analysts and the policy makers they advise, and many clinicians as well, the concept of bundled payments has enormous intuitive appeal. Not surprisingly, then, bundled payments have become the latest nouvelle vague in this arena. On the way from concept to implementation, however, bundled payments have to run, first, the gantlet of health care providers, not all of whom gain in the switch to bundled payments from F.F.S., and, second, the gantlet of political partisanship. Because bundled payments are so enthusiastically endorsed now and yet face these serious obstacles, I shall return to them in the future. Capitation is the third base upon which payment to providers of care can be made. This concept is particularly suited to nonepisodic, chronic care. Under capitation, an organization - for example, a large, multispecialty medical group or a staff-model health maintenance organization such as Kaiser Permanente in California - willing to coordinate all care an individual may need during an entire year against a prepaid flat capitation receives a payment that is adjusted for the expected, actuarial risk of the patient. Subsequent to receipt of that payment, the paid organization is expected to assume financial risk for the care actually needed by the covered individual. In extraordinary circumstances that could not have been actuarially foreseen, there may have to be ex-post risk-adjustment payment. Annual salaries for health personnel, including physicians, and predetermined budgets for institutions are the final base upon which payment can be made for health care. Budgets for institutions, including nursing homes and hospitals, have been widely used around the world, but less so in the United States. Health personnel other than physicians have traditionally been salaried everywhere. Hospital-based physicians are salaried in many countries and increasingly in the United States, where physicians have switched from self-employment to being employees of hospitals, academic health centers, clinics or large group practices. Salaried physicians almost always receive their payments from an institution (e.g., hospitals or a clinic) that acts as an intermediary between insurance carriers and patients, on the one hand, and physicians on the other. These institutions may be paid by any of the other payment bases in the chart, and frequently by F.F.S. When physicians are in the employ of hospitals, the hospitals have far more control of the costs they incur over the signature of physicians ordering hospital services than hospitals have under the traditional American system, in which self-employed physicians have affiliations with hospitals that they can view as rent-free workshops In that system, the order entry of self-employed physicians attending their hospitalized patients causes the hospital to incur costs over which they have little or no control, while the physicians initiating these costs have typically not been held formally accountable for them. From a managerial perspective, it is an awkward arrangement (see "Hospital Economics 101"). While F.F.S. payment is generally thought to result in overuse and misuse of health care services, bundled payments, capitation, budgets or physician salaries carry with them the risk that clinically desirable services are withheld from patients for financial reasons or simply because exertion is not rewarded. Therefore, these methods must be accompanied by some means to protect patients from these untoward effects through constant monitoring of the care rendered. During the 1990s, for example, California experimented widely with capitation - alas, with mixed results. As the California HealthCare Foundation has noted, capitation methods must be accompanied by constant monitoring of the care rendered, to protect patients from these untoward effects. Actually, the same is true for all payment methods, including F.F.S. Indeed, anyone who thinks for a moment about the problem of paying the providers of health care will quickly come to the disheartening conclusion that there is no ideal method of injecting money into the health care system. Each approach has strengths and weaknesses that must be traded off against one another in settling on a payment option. In my next post, I shall examine the alternative methods of determining the level of payment per unit of whatever base for payment is chosen. Here, too, the choice of method is not obvious. Each method has strengths and weaknesses.