Payers, patients, and providers all seek better value for healthcare. This paper joins a conceptual exposition of principal-agent theory with targeted, directly relevant empirical evidence to derive a set of research questions and policy recommendations.

Optimal provider payment incentive design should incorporate cost, clinical quality (process of care), and health outcomes measures. Valid, timely measurement of each of these dimensions is essential.

Providers’ motivation to change

As the Centers for Medicare and Medicaid Services (CMS) continues its journey to value based payments, it must learn how to motivate providers for better outcomes. Value-based care (VBC) models link provider payment to cost, quality, and equity performance. Those involving upside and downside risks, such as bundled payments, may increase provider engagement by providing financial incentives to help overcome loss aversion.

Incentives that reward physician or provider organization ranking relative to prospective, achievable benchmarks are likely to induce more robust provider responses than those based on comparative performance against peers. Likewise, the monetary size of provider losses and rewards should be sized appropriately to avoid crowd-out of intrinsic motivation.

Optimal provider incentives are also shaped by nuances of ownership (for-profit vs. not-for-profit for hospitals) and provider organizational form (e.g., integrated medical group vs. independent practice association [IPA]). Those who incorporate ownership are more incentivized to minimize costs and hold out for competitive prices.

The role of incentives in value-based payments

The right mix of incentives can provide a win-win situation for everyone. It motivates providers to achieve better outcomes and helps payers save money on healthcare costs. However, it is essential to ensure that these incentives are not abused. This is done by setting clear goals and providing appropriate rewards to those who achieve them.

Incentives should reflect the principle of principal-agent theory and the empirical evidence most pertinent to value-based payment design: the more significant the expected impact of a given financial incentive on provider net income and patient net health benefit, the stronger its effect. Incentives must also account for the indirect incentive effects of a provider’s relative gain or loss aversion and the diminishing marginal utility of net income (i.e., the cost of holding out for a higher return).

In addition, outcome measurements are critical in incentivizing providers within value-based payments by assessing and encouraging better healthcare results, ensuring a focus on delivering quality care and improved patient outcomes.

Relative performance incentives that reward providers and organizations based on achieving objective standards offer the most potent incentive power. These rewards tap into the motivational power of loss aversion and can be implemented predictably within fixed-payer budgets.

The role of incentives in ACOs

Under the traditional fee-for-service payment model, physicians are paid for every service they deliver. While this allows healthcare providers to provide many benefits, it often results in suboptimal patient outcomes.

Fortunately, new models of healthcare reimbursement are changing this dynamic. Value-based payments encourage providers to coordinate care with a focus on outcomes. They offer incentives for meeting specific quality benchmarks, such as decreasing hospitalization rates or ER visits.

To maximize their impact, value-based payments must include financial and non-financial incentives. Non-financial incentives can help encourage behavior change, such as giving employees a flexible work schedule or providing a free gym membership.

As the nation continues to shift away from fee-for-service, it’s essential to continue building an incentive framework that promotes participation in value-based programs. This includes aligning incentives across public and private payers, including Medicare, TRICARE, commercial plans sold on the ACA exchanges, Medicaid, and commercial insurers. CMS should also commit to a portfolio approach to alternative payment models (APMs), with specific allotments based on desired high-level goals, such as reducing per-beneficiary costs and improving patient outcomes.

The role of incentives in shared savings

Whether as part of a shared savings program or a gainsharing arrangement, the timing and size of incentives are critical. Incentives must be clear, targeted to specific outcomes, and large enough to entice providers to invest time and resources in piloting new models and transforming their existing practices.

ACOs use financial incentives at the provider level to lower overall care utilization and meet a target price set by payers. At the same time, gainsharing programs focus on lowering the actual cost of hospital admissions rather than decreasing total revenue. ACOs also use non-financial incentives to achieve specific quality metrics, such as reduced readmissions or improved patient experience scores.

Threshold incentive models use pre-specified performance thresholds to determine whether a provider receives shared savings, with rewards for incremental improvement and penalties for poor performance. These models may also include liability for any cost reductions achieved through decreased efficiency or lower quality to discourage the pursuit of artificially low costs.