05/17/2013 11:19 am ET | Updated Jul 17, 2013

Reforming Flawed Incentive Models in Healthcare Systems

Co-written by Peter Bozzo, Yale Law School

It's no secret that the U.S. healthcare system has a cost-control problem. Unless you tuned out the most recent presidential campaign, you probably know that Medicare stands at the center of debates over rising medical costs: current estimates indicate that the program's hospital insurance component will run out of funds by 2024. Medicare's governing body, the Center for Medicare and Medicaid Service (CMS), has made strides to cut healthcare spending by establishing accountable care organizations (ACOs). ACOs are groups of medical practitioners who coordinate treatment options for their patients. Under the program, physicians are financially rewarded for improving patient outcomes and reducing costs. As a result, the program aims to reduce needless expenditures on repetitive procedures while improving patient quality of care.

Successful implementation of the ACO program is currently hindered by several factors. First of all, significant upfront cost required to establish an ACO is a significant barriers to entry. For example, federally-mandated regulations could require physician groups to implement a slew of expensive measures, including reporting mandates and administrative procedures, as well as new electronic health record systems, which may require high start-up costs. For physicians serving rural or underprivileged communities and lack sufficient funding, high financial barriers to entry is a troubling consideration. As a result, requiring high-risk, high cost start-up investments may discourage ACO formation among these physicians.

Another key challenge facing ACOs arises from uneven distribution of financial incentives across states. Physicians within ACOs are encouraged to control per patient spending, where savings are calculated by subtracting incurred costs from a benchmarked national standard. This baseline is updated based on projected growth of national Medicare spending. Ideally, accounting for national growth levels will encourage high-spending, high-growth providers to lower costs. However, providers from states that spend more on average are will likely have fewer incentives to form ACOs, since they will be unlikely to attain the same amount of savings as a provider from a lower spending state. Thus, policymakers should consider calculating benchmarks based on regional rather than national growth levels. With a regional baseline, providers from districts with high spending and growth will be compared with providers facing similar market conditions. Consequently, they will be more likely to achieve enough cuts to qualify for shared savings, encouraging ACO formation.

In addition, the current cost savings formula may create perverse incentives for physicians. Assume that providers spend $100 million yearly treating a group of patients; after forming an ACO, these providers reduce spending to $80 million annually. During the next year, the HHS Secretary will likely revise the benchmark downward to $80 million, and since healthcare providers will already have implemented many of the most logical cost reductions, additional cuts may be unfeasible. Providers will be increasingly likely to exceed benchmark spending, meaning that they may not find it economically sensible to maintain their membership in an ACO. As a result, the Secretary should consider gradual benchmark reductions. For example, instead of reducing the benchmark to $80 million after one year, the Secretary might "phase in" the new requirements by setting a $90 million threshold in Year 1 and not lowering the benchmark to $80 million until Year 2. These modifications may increase long-term incentives for providers to maintain their membership in ACOs.

The ACO program is a first step toward controlling Medicare costs without sacrificing quality-of-care. Yet the program's success depends on healthcare providers' willingness to form ACOs, and the current incentive structure may not provide sufficient rewards to ensure that providers establish these networks. Fortunately, many of the potential critiques can be addressed by effective implementation of the Affordable Care Act. CMS has already created programs to subsidize poorly-capitalized groups; baseline levels can be revised to project downward gradually; and policymakers can modify the legislation to rely on regional--rather than national--baselines. Each of these actions would promote ACO formation, potentially resulting in greater cost reduction. ACOs represent an initial step toward ameliorating America's Medicare cost-control program, but further progress will come only with the implementation of several crucial reforms.

Peter Bozzo is a first-year law student at Yale Law School. He graduated from Harvard College in 2012 with a degree in Government and a minor in History. His senior honors thesis comparatively analyzed special education policies in the United States and the United Kingdom. At Harvard, Peter served on the editorial board of The Crimson, chaired the Community Action Committee at the Institute of Politics, wrote articles for the Harvard Political Review, and mentored special-needs students. He grew up in Freehold, New Jersey.

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