Research Brief

Can Contracts Optimize Both Health Care and Clinician Pay?

Accountable care organizations can levy penalties against specialists for poor patient outcomes

The struggle to create a superb health care system within the parameters of American capitalism has frustrated experts and shortened political careers. So far, there’s no well-loved business model for providing good, low-cost patient care that also generates great profits for insurers, doctors, hospitals, clinics and the vast number of other vested parties. It’s difficult to please everyone at once in this business.

Insurers, including Medicare, have experimented with many contract designs in hopes of aligning all those interests. With names like capitation, bundled payments, cost sharing, readmission penalty and shared savings, these agreements between the payers of health care and the professionals who determine treatments offer practitioners financial incentives to keep their patients healthy and to do so cheaply.

Yet best practices and optimal profits in one part of this immense service chain often leave another link worse off. For example, a physician practice that provides preventive care might collect a bonus from an insurer trying to keep a lid on costs. But if the incentive discourages referrals for advanced care when needed, patients suffer. And good preventive care by definition cuts business for specialists.

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Similarly, the specialist physician who hires professionals to coordinate and oversee follow-up care significantly improves her patient outcomes and keeps costs predictable for insurers and patients. But her own profits are lower for these efforts.

Where’s the win-win for keeping the patient healthy? A reimbursement contract that simultaneously encourages high-quality treatment, optimizes profits for all types of caregivers, and cuts costs for insurers might be the rare idea in this business that the entire chain could embrace.

A recently released working paper by University of California Riverside’s Elodie Adida and UCLA Anderson’s Fernanda Bravo offers a new type of contract as something close to the goal. A coordinating contract that includes a penalty assessed to specialist physicians for poor patient outcomes can generate near optimal profits for the specialists and the physician-led accountable care organizations that refer to them, according to the research.

The contract that Adida and Bravo devised also leads to better patient outcomes on certain procedures than fee-for-service contracts that are standard to the industry, the findings suggest. The results indicate that it can better meet the needs of patients and providers simultaneously than a variety of reimbursement contracts insurers are testing as alternatives.

The findings support conventional wisdom that practicing medicine solely for financial gain rarely results in the healthiest patients. But they suggest that it can get very close.

Mutually Beneficial Referrals

Most contract experiments to improve health care focus on agreements between insurers, such as Medicare, and independent care providers that actually make the treatment decisions. Adida and Bravo tackled the issue by analyzing the more modern scenario in which both sides of the contract are directly responsible for the medical decisions that affect patient health.

The study focuses on physician-led accountable care organizations (ACOs), a subset of an increasingly popular business model for health management. Explicitly encouraged in the Affordable Care Act, ACOs now provide health care for about 23 million Americans, the researchers note.

ACOs are groups of caregivers, such as hospitals, clinics and physicians, that collect predetermined revenue to pay for all health care needed for a population of patients. Their profits are higher when the actual cost of patient care is less than their revenues, lower or into losses when the cost of care exceeds the target. Payments to outside contractors, such as specialist physicians that ACOs are required to hire when they cannot provide the care in-network, greatly affect ACO earnings.

Physician-led ACOs, which account for about 37 percent of all ACOs, are distinct for their direct involvement in the preventive care that heavily influences overall medical costs. The financial incentive for a physician-led ACO to provide great primary care is very clear. Their profits are higher when the patients are healthier and don’t require the ACO to pay specialists or hospitals for advanced care. By contrast, healthier patients reduce some costs for hospital-led ACOs but also limit their hospital revenues. And many hospital-led ACOs contract with primary care organizations rather than provide those services in-house.

The physician-led ACO structure creates an awkwardly dependent arrangement between the organization and the specialists they hire. The amount of business the specialist gets is greatly affected by the ACO’s initial patient care, since great primary care will lower the need for specialists. And the final bill to the referring ACO is partly determined by the results of the specialist treatment. The costs of any complications or failed specialist treatment come out of the ACO’s profits.

The researchers looked at the profits that specialists and physician-led ACOs could earn under various contract designs. They also looked at whether patients would receive defined best practices treatments under each contract when physicians were motivated by profits alone.

Their study indicates that it’s possible to financially induce the ideal level of medical effort by both caregivers — appropriate primary care through a physician-led ACO and thorough specialty care — with a coordinating contract that includes a penalty to the specialist for poor patient outcomes. The key, according to the results, is setting the right price for the specialist services, with the right penalty — which is a percentage of the price — as a fine.

The paper offers working formulas for this sweet spot.

Good for Me, Not So Much for You

For patients, the best primary care comes from a place that gives great preventive care but readily refers to specialists when needed. The best insurance blesses both expenses. And the best specialist treatment includes crucial follow-up care until recovery is successful.

But each of these efforts costs someone money. And in health care, the party that forks over the extra money isn’t necessarily the one that benefits from the spending.

That unfairness is particularly stark in the fee-for-service model. Although the ACOs in this study are paid in a different way, fee-for-service is still the most common reimbursement plan in U.S. health care. This is the set-up responsible for the billing codes — or CPT® (Current Procedural Terminology), the American Medical Association’s numerical identifiers for each tiny variation in medical problem — that require a niche industry to manage. The insurer pays the primary physician a pre-set amount for each coded interaction.

Under traditional fee-for-service contracts, neither the primary care physician nor the specialist has a financial incentive for keeping patients healthy. The primary care physician earns more money by spending time on treatments, rather than preventive care, even when the chances of treatment success is slim. Insurers, not the primary practice, pay the cost of specialist care when preventive care fails.

Specialist profits under fee-for-service are higher if they avoid unreimbursed follow-up care, such as coordinating post-surgical home help and appointments. When specialist care doesn’t go well, money to treat the complications comes out of insurer profits and patients’ pockets, not specialist fees.

Fee-for-service contracts are widely criticized for incentivizing over-treatment, but the replacement contracts also have drawbacks. Capitation schemes, in which the practice gets a pre-set fee for each patient, reward limited treatment even when the patient needs more. Bundled payments incentivize high-quality care but make unrelated professionals financially liable for each other’s work. Hospital readmission penalties have backfired when hospitals found that the fines were less expensive than upgrading care.

Meanwhile, research concludes that how health care providers are paid has a big impact on how their patients fare. For example, lack of financial incentives for keeping patients healthy was a key contributor to a nearly 20 percent hospital readmission rate for Medicare fee-for-service beneficiaries from 2007 to 2011, according to a study out of Centers for Medicare and Medicaid Services.

Embracing a Penalty

While insurers looked to reduce costs by discouraging ineffective treatments, Adida and Bravo were struck by how much good came out of extra, often unreimbursed efforts by physicians.

Many of the best practices recommended for ensuring good health outcomes are not efforts doctors can readily bill under fee-for-service contracts. At the primary care level, these practices include care known to decrease the need for specialist treatment, such as continuing support for smoking cessation and weight loss. After medical procedures, best practices by the specialist include coordination between primary and specialist physicians to manage medications, schedule follow-up appointments and arrange nursing care if needed.

Adida and Bravo set out to devise a payment system that would encourage both types of physicians to provide these unreimbursed best practices by maximizing their profits. Under its capitation-like reimbursement, a physician-led ACO already has financial reasons to provide excellent preventive care. Staving off poor health and the specialist bills it entails will result in higher profits for the organization. The researchers looked for an existing contract model that could incentivize best practices by the specialist as well.

Their analysis suggests that the common fee-for-service contracts between specialists and the ACOs that refer to them never optimized profits for either, or induced the best medical practices for the patient. Several other common contracts, including capitation, cost-sharing, hospital readmission penalties and shared-savings schemes, also failed to give caregivers and patients the best results.

But a coordinating contract, modified to include a “carefully designed penalty” for failed specialist treatment, can create good results for providers and patients, according to the findings. Even if the treating parties are working solely to maximize their own profits, patients are better off under a coordinating contract with a penalty than under the standard fee-for-service contract, the study indicates.

At first read, this contract looks like nothing a specialist provider could love. The researchers here have reshaped a penalty typically seen only in contracts between insurers and hospitals and aimed it squarely at the specialists.

Unlike Medicare, however, the payers that refer patients to the specialist in this study are making treatment decisions that directly affect how much business the specialist receives. Like any business, the specialist needs a certain level of revenue to cover the costs of maintaining the staff, equipment, facilities and other necessities of providing services when needed. The specialist fee in the coordinating contract is intended to balance the physician-led ACO’s financial benefits of achieving a healthier patient population with the specialist need to maintain income with fewer referrals and higher costs for follow-up care.

That’s a balance likely to get more attention as more organizations act as both health care insurers and primary caregivers. The number of ACOs has been growing since 2010, and they are considered key to cutting the enormous costs in U.S. health care.

The Adida-Bravo study addresses the broad, so far elusive, ultimate goal in this evolving industry — how to make good business good medicine.

Featured Faculty

  • Fernanda Bravo

    Assistant Professor of Decisions, Operations and Technology Management

About the Research

Adida, E., & Bravo F. (2017). Contracts for healthcare referral services. Manuscript submitted for publication.

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