05/05/2013 05:14 pm ET Updated Jul 05, 2013

Innovating Healthcare Payment Systems: Moving Beyond the Fee-for-Service Model

In his acclaimed New Yorker article The Cost Conundrum that describes the American health care cost crisis, Atul Gawande recounts the following observation:

"... Patients in higher-spending regions received sixty per cent more care than elsewhere. They got more frequent tests and procedures, more visits with specialists, and more frequent admission to hospitals. Yet they did no better than other patients, whether this was measured in terms of survival, their ability to function, or satisfaction with the care they received. If anything, they seemed to do worse."

This excerpt illustrates how patients who spend more do not necessarily experience better health outcomes -- a key hallmark of our ongoing healthcare crisis. With spending projected to reach $4.8 trillion over the coming decade, experts have denounced America's dominant medical payment model, the fee-for-service (FFS) model, as a prime culprit.

Under the FFS system, doctors are paid based on the number of medical services such as operations, procedures, and tests ordered. As a result, the payment structure encourages physicians to deliver care based on quantity, but does not fiscally incentivize improving patient outcomes. Since doctors profit from each procedure, but are not liable for associated costs or outcomes, patients often receive unnecessary procedures and tests which they and their health insurance providers must pay for. The FFS model as a result, perpetuates healthcare inefficiencies by incentivizing delivery of volume, as opposed to value-based care.

The FFS system not only drives healthcare expenditures, but also threatens the quality of care patients receive. The incentive structure discourages physicians from spending time with each patient because profits are tied to oversight of additional patients. Additionally, since payment does not occur in "bundles," where a fixed sum of money is allocated to cover the necessary set of products and services per disease condition, the "unbundled" nature of financially compensating for individual procedures discourages care coordination and increases provider fragmentation. Indeed, the FFS system may be one of the drivers of the fact that the United States tops all other nations on healthcare spending worldwide, but does not provide "notably superior" care. For example, while the U.S. spent 150-300 percent more on per capita healthcare costs than industrialized nations such as Japan and Norway, death rates for certain diseases such as cervical cancer and asthma were worse than average.

A recent working paper issued by the UnitedHealthGroup's Center for Health Reform & Modernization suggests overspending from FFS payments contributes significantly to the $850 billion in wasteful spending estimated to occur each year. The group announced that up to $600 billion in costs can be cut over the next decade if the FFS system can be reformed. Transformation of America's dominant health care payment model could thus cut costs and alleviate inefficiencies by improving coordination and care delivery.

Hospitals that provide some of the most comprehensive, patient-focused care often employ bundled payment schemes where fixed sums are designated for a given diagnosis or episode of care. Under bundled payment models, multiple specialists coordinate care for a given patient, ensuring provision of comprehensive coverage.

Launched in 2011, the Affordable Care Act's Bundled Payment Initiative proposed bundled payments in place of FFS for treating specific hospital conditions for the purpose of coordinating care and cutting costs. The program saved $42.3 million from heart bypass surgeries alone and lowered hospital mortality. Building on the success of this program, the Centers for Medicare and Medicaid Services (CMS) recently implemented a new, innovative bundled payment initiative that incorporates provider incentives across fiscal and performance metrics for individual episodes of care. With cost and quality targets of the ACA in place, payment reform may alleviate the rising burden of healthcare costs.