Provider Payment

Provider Payment Methods and Financial Risk in Health Care

Provider payment is the set of rules by which a purchaser of health care, such as a national health service, a social health insurer or a health plan, turns the care that doctors, hospitals and other providers deliver into money owed to them. In billing terms, the payment methodology fixes the unit that is paid for (a budget line, a period of employment, an item of service, a bed-day, a case, an episode or an enrolled person) and the rate attached to it. Each method rewards different behaviour and leaves a different share of cost risk with the provider, so the same service can be expanded, rationed, shortened or avoided depending on how it is paid.

Three questions that classify any payment method

The World Bank manual edited by Langenbrunner, Cashin and O'Dougherty sorts methods by whether the rate is set before or after services are delivered, whether money is paid before or after, and whether payment follows inputs (staff, drugs, running costs) or outputs (services, bed-days, cases, enrolled people). It is the combination of the three that shapes the incentives. A case-based hospital system sets its rate in advance but pays after the case is treated, while capitation sets and pays in advance.

Jegers and colleagues add two dimensions. One is whether providers can influence their income through activity (variable or fixed systems), and the other is whether payment follows their own costs after the event (retrospective) or is set in advance without reference to them (prospective). The WHO guide by Mathauer and Dkhimi states that the unit of payment and the payment rate define how much expenditure risk the provider bears.

The main payment methods and the incentives each creates

A WHO technical brief on strategic purchasing names the six most common methods and states that there is no gold standard. The table draws on that brief and the World Bank manual it adapts, with salary from the WHO guide and Jegers, pay for performance from a Cochrane review by Mathes and colleagues, and bundled payment from a review by Agarwal and colleagues.

Quantity rises wherever an extra unit earns extra money, and the European Observatory study of diagnosis-related groups edited by Busse and colleagues sets the over-provision of fee-for-service against the under-provision of global budgets, with case payment between them. Cost per unit falls wherever a fixed rate is paid per unit of output. Quality can move either way, and the same study lists optimised care pathways alongside inappropriately early discharge and withholding necessary services (skimping) as responses to case payment. Selection arises because a fixed price overpays for cheap patients and underpays for costly ones, rewarding cream skimming and dumping costly patients on other providers. Because the price depends on the group, case payment also rewards up-coding cases into better-paid groups. For capitation, the World Bank manual names risk adjustment for predictable differences in need, such as age and sex, as the counter to selecting healthier enrolees.

Who bears the cost risk

The World Bank manual states that when rates are set retrospectively and reflect the provider's costs, the purchaser bears all the risk, and that fixing rates in advance for a bundle of services shifts some of it to the provider. Under capitation the provider is liable for costs above the per capita amount and can usually keep a surplus. Under a soft global budget the purchaser pays for overruns; under a hard budget the provider does. Case payment splits the risk, with the provider carrying cost per case above the rate and the purchaser carrying the number and mix of cases unless volumes are capped.

Ellis and McGuire describe supply-side cost sharing, which changes the incentives of providers to supply services, as the counterpart of demand-side cost sharing, in which patients pay more through copayments or deductibles. A simple mixed rule of this kind pays part of a prospective rate and part of actual cost.

$$R = (1-\lambda)\,\hat{p} + \lambda\, c$$

where $R$ is the payment for a case, $\hat{p}$ is the prospective rate for the case's group, $c$ is the provider's actual cost and $\lambda$ is the share of actual cost reimbursed, between 0 and 1. The provider's margin is $R - c = (1-\lambda)(\hat{p} - c)$, so the provider keeps a share $(1-\lambda)$ of any saving and bears the same share of any overrun; $\lambda = 1$ is cost reimbursement and $\lambda = 0$ pure case payment. In their 1986 model, Ellis and McGuire showed that cost-based reimbursement leads to too many services and that, if physicians undervalue patient benefits relative to hospital profits, prospective payment can lead to too few; a mixed system was superior under a variety of circumstances and reduced providers' risk.

Worked example of one shorter hospital stay under four payment rules

This example is illustrative. A surgical case costs a hospital GBP 2,000 for theatre and procedure plus GBP 400 per bed-day, and a new pathway cuts the stay from six days to four with the same outcome.

1. Cost before and after. Beforehand the case costs 2,000 + 6 × 400 = 4,400. Afterwards it costs 2,000 + 4 × 400 = 3,600, a saving of 4,400 − 3,600 = 800 per case.
2. Cost reimbursement. Payment equals cost, so the purchaser pays 800 less and the hospital's margin stays at zero.
3. Per diem at GBP 750 a day. Before the change, payment is 6 × 750 = 4,500, a margin of 100. Afterwards it is 4 × 750 = 3,000, a margin of 3,000 − 3,600 = −600. The purchaser pays 1,500 less and the hospital is 700 worse off.
4. Case payment at GBP 4,400. Payment is unchanged, so the margin rises from 0 to 4,400 − 3,600 = 800 and the purchaser pays the same.
5. Mixed payment, 30% of cost reimbursed. The case rate part is 0.7 × 4,400 = 3,080 and the cost part 0.3 × 3,600 = 1,080, so payment is 3,080 + 1,080 = 4,160, a margin of 4,160 − 3,600 = 560 and a purchaser saving of 4,400 − 4,160 = 240.

The same saving lands in different places. Under per diem the hospital loses by adopting the pathway, in line with the incentive to lengthen stays that the World Bank manual describes. Under case payment the hospital keeps the whole saving, and the purchaser gains only when rates are recalculated from new cost data. The mixed rule splits the saving 560 to 240, the ratio of $(1-\lambda)$ to $\lambda$.

Blended and mixed payment systems

Pure methods are rare. The WHO guide states that in nearly all countries several payment methods co-exist as a mixed provider payment system, for instance when a finance ministry pays salaries while an insurer pays for services. The WHO brief presents deliberate blending as a way to keep the useful incentives of each method, citing a small fee-for-service payment for immunisation inside primary care capitation to counter under-provision.

The Busse study reports that almost all countries using case payment also give hospitals revenue that does not vary with activity, such as teaching and research funds, with a lower price per case than in a pure system. Marginal pricing pays activity above an agreed target at a fraction of the full price; a fraction of zero removes the incentive to add activity.

What the evidence shows

The evidence is thinner than the theory. A Cochrane review by Gosden and colleagues found only four eligible studies. In these, fee-for-service produced more visits and diagnostic and curative services but fewer hospital referrals than capitation, and more visits and greater continuity than salary, though patients were less satisfied with access. The authors judged the generalisability unknown.

For case payment, the World Bank manual reports that evidence worldwide links it with shorter stays, and that admissions rose significantly in Hungary, Russia and other countries after its introduction. The Busse study calls findings on hospital efficiency mixed and relates them to different starting points. Moving from cost reimbursement to case payment weakens the activity incentive, while moving from global budgets strengthens it.

The Cochrane review of hospital pay for performance by Mathes and colleagues covered 27 studies of six programmes and found effects on patient outcomes that were at most small, with very low certainty. Scott and colleagues found insufficient evidence for or against financial incentives for quality in primary care. Agarwal and colleagues reviewed 20 studies of three bundled payment programmes of the Centers for Medicare & Medicaid Services and found that bundled payment maintained or improved quality while lowering costs for lower extremity joint replacement, but not for other conditions or procedures.

Payment rules in economic evaluation and budget impact

A payment is not the cost of care. The World Bank manual notes that case and per diem rates are meant to reflect the average cost of a unit of output in an average hospital, so an efficient hospital makes a surplus on some cases and a loss on others.

The payment method also decides where savings appear. A treatment that shortens stays saves the payer money at once under per diem but, under case payment, shows a payer saving in a budget impact analysis only once tariffs, which are built from case weights, fall. Models of service use should allow for provider responses to payment, such as supplier-induced demand and selection.

Common misreadings of provider payment

Several confusions recur in policy writing and modelling. Most treat a payment label as the whole incentive.

1. Prospective does not mean paid in advance. Case rates are fixed before treatment but paid after it.
2. Provider payment is one part of financing. It sits within health system financing, and the WHO brief lists it as one of five purchasing decisions, with coverage, benefit packages, contracting and quality.
3. Supply-side and demand-side levers differ. Ellis and McGuire note that the price paid to providers can be set separately from the price insured patients pay. Demand-side cost sharing is the usual response to patient moral hazard.
4. No method is neutral. The WHO guide names over-provision and under-provision as the main incentives created, and notes that professional ethics, supervision and training also shape behaviour, so payment is one lever on the agency relationship between purchaser and provider.

Sources

• Agarwal R, Liao JM, Gupta A, Navathe AS. The impact of bundled payment on health care spending, utilization, and quality: a systematic review. Health Affairs. 2020;39(1):50-57. https://doi.org/10.1377/hlthaff.2019.00784
• Busse R, Geissler A, Quentin W, Wiley M, eds. Diagnosis-Related Groups in Europe: Moving Towards Transparency, Efficiency and Quality in Hospitals. Maidenhead: Open University Press; 2011. Chapters 2, 6 and 7. https://eurohealthobservatory.who.int/publications/m/diagnosis-related-groups-in-europe
• Ellis RP, McGuire TG. Provider behavior under prospective reimbursement: cost sharing and supply. Journal of Health Economics. 1986;5(2):129-151. https://doi.org/10.1016/0167-6296(86)90002-0
• Ellis RP, McGuire TG. Supply-side and demand-side cost sharing in health care. Journal of Economic Perspectives. 1993;7(4):135-151. https://doi.org/10.1257/jep.7.4.135
• Gosden T, Forland F, Kristiansen IS, Sutton M, Leese B, Giuffrida A, Sergison M, Pedersen L. Capitation, salary, fee-for-service and mixed systems of payment: effects on the behaviour of primary care physicians. Cochrane Database of Systematic Reviews. 2000;(3):CD002215. https://doi.org/10.1002/14651858.CD002215
• Jegers M, Kesteloot K, De Graeve D, Gilles W. A typology for provider payment systems in health care. Health Policy. 2002;60(3):255-273. https://doi.org/10.1016/S0168-8510(01)00216-0
• Langenbrunner JC, Cashin C, O'Dougherty S, eds. Designing and Implementing Health Care Provider Payment Systems: How-To Manuals. Washington, DC: World Bank; 2009. https://doi.org/10.1596/978-0-8213-7815-1
• Mathauer I, Dkhimi F. Analytical Guide to Assess a Mixed Provider Payment System. Health Financing Guidance No. 5. Geneva: World Health Organization; 2019. https://iris.who.int/handle/10665/311020
• Mathes T, Pieper D, Morche J, Polus S, Jaschinski T, Eikermann M. Pay for performance for hospitals. Cochrane Database of Systematic Reviews. 2019;7:CD011156. https://doi.org/10.1002/14651858.CD011156.pub2
• Scott A, Sivey P, Ait Ouakrim D, Willenberg L, Naccarella L, Furler J, Young D. The effect of financial incentives on the quality of health care provided by primary care physicians. Cochrane Database of Systematic Reviews. 2011;(9):CD008451. https://doi.org/10.1002/14651858.CD008451.pub2
• World Health Organization Regional Office for South-East Asia. Provider Payment Methods and Strategic Purchasing for UHC. UHC Technical Brief. New Delhi: WHO; 2017. https://iris.who.int/handle/10665/258894