Finally, as was noted at the beginning of the chapter, different payment methods are designed to meet different objectives, but none automatically has quality improvement as an objective. Such an objective must therefore be explicitly designed into any payment method.


There is a growing body of evidence that quality improvement can translate into dollar savings (Classen et al., 1997; Clemmer et al., 1999; Conrad et al., 1996; Jarlier and Charvet-Protat, 2000). Poor quality is costly in several ways. First, quality-related problems can result in waste, such as when a step in the care process fails so that treatment must be repeated (e.g., the CT scan has to be redone), or extra resources are required to fix the failed process (e.g., treat an avoidable complication). Second, quality-related problems can lead to inefficiencies, as when two processes can produce the same outcome, but the more costly alternative is selected. An additional issue is that some processes may produce superior outcomes but utilize more resources, therefore resulting in cost increases. There is no advantage to this kind of quality improvement. In an environment that evaluates costs but not results, Anderson and Daigh (1991) suggest that quality waste accounts for 25–40 percent of all hospital costs.

Despite the evidence that poor quality costs money, however, health care organizations and professionals have not adopted quality-based process management to compete in today’s marketplace. In fact, there are cases in which significant financial losses have resulted in the elimination of quality projects rather than the intensification of such efforts (Shulkin, 2000). Indeed, a variety of barriers embodied in current payment methods prevent health care organizations from pursuing quality improvement. The following subsections describe examples of four such payment barriers: perverse payment methods, adverse risk selection, annual contracting arrangements, and up-front investments required by provider groups.

Perverse Payment Mechanisms

Two examples of how payment mechanisms can inhibit quality improvement were provided at the IOM workshop held on April 24, 2000, by Dr. Brent James of the Intermountain Health System, Salt Lake City, Utah:


Much of the discussion in this section draws on a paper prepared by Brent James, M.D. presented at an IOM-sponsored workshop on the relationship between payment and quality improvement held on April 24, 2000.

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