1
Introduction

Health care quality in the United States falls short of its potential. Patients do not always receive the care that is best suited to their needs, and increased spending for health services does not always result in higher-quality care or better patient outcomes (IOM, 2000; Fisher et al., 2004). In some cases, the care provided can in fact be harmful; services that are not necessary, safe, or timely can put the lives and well-being of patients at risk. As a result, not only the quality but also the overall value of health care services has become questionable. In two seminal reports—To Err Is Human: Building a Safer Health System and Crossing the Quality Chasm: A New Health System for the 21st Century—the Institute of Medicine (IOM) recognized these disquieting realities and called for a restructuring of the health care system (IOM, 2000, 2001).

The Quality Chasm report identified ten rules for redesigning health care processes to improve performance (see Box 1-1). The report also recommended the alignment of public and private payment methods to build incentives for quality enhancement. In response to the Quality Chasm report, numerous reform efforts were undertaken with the goal of improving the quality of care. These efforts yielded modest gains in some areas, but have not resulted in the fundamental improvements Americans deserve. In the 5 years since the report was published, the quality of health care has remained poorer than it should be (Leape and Berwick, 2005). Transformational changes throughout the health care system are essential to close the quality gap, and these needed changes include the restructuring of payment methods.



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Rewarding Provider Performance: Aligning Incentives in Medicare 1 Introduction Health care quality in the United States falls short of its potential. Patients do not always receive the care that is best suited to their needs, and increased spending for health services does not always result in higher-quality care or better patient outcomes (IOM, 2000; Fisher et al., 2004). In some cases, the care provided can in fact be harmful; services that are not necessary, safe, or timely can put the lives and well-being of patients at risk. As a result, not only the quality but also the overall value of health care services has become questionable. In two seminal reports—To Err Is Human: Building a Safer Health System and Crossing the Quality Chasm: A New Health System for the 21st Century—the Institute of Medicine (IOM) recognized these disquieting realities and called for a restructuring of the health care system (IOM, 2000, 2001). The Quality Chasm report identified ten rules for redesigning health care processes to improve performance (see Box 1-1). The report also recommended the alignment of public and private payment methods to build incentives for quality enhancement. In response to the Quality Chasm report, numerous reform efforts were undertaken with the goal of improving the quality of care. These efforts yielded modest gains in some areas, but have not resulted in the fundamental improvements Americans deserve. In the 5 years since the report was published, the quality of health care has remained poorer than it should be (Leape and Berwick, 2005). Transformational changes throughout the health care system are essential to close the quality gap, and these needed changes include the restructuring of payment methods.

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Rewarding Provider Performance: Aligning Incentives in Medicare BOX 1-1 Ten Rules for Redesigning Health Care Processes Care based on continuous healing relationships. Patients should receive care whenever they need it and in many forms, not just face-to-face visits. This rule implies that the health care system should be responsive at all times (24 hours a day, every day) and that access to care should be provided over the Internet, by telephone, and by other means in addition to face-to-face visits. Customization based on patient needs and values. The system of care should be designed to meet the most common types of needs, but have the capability to respond to individual patient choices and preferences. The patient as the source of control. Patients should be given the necessary information and the opportunity to exercise the degree of control they choose over health care decisions that affect them. The health system should be able to accommodate differences in patient preferences and encourage shared decision making. Shared knowledge and the free flow of information. Patients should have unfettered access to their own medical information and to clinical knowledge. Clinicians and patients should communicate effectively and share information. Evidence-based decision making. Patients should receive care based on the best available scientific knowledge. Care should not vary illogically from clinician to clinician or from place to place. Safety as a system property. Patients should be safe from injury caused by the care system. Reducing risk and ensuring safety require greater attention to systems that help prevent and mitigate errors. The need for transparency. The health care system should make information available to patients and their families that allows them to make informed decisions when selecting a health plan, hospital, or clinical practice, or choosing among alternative treatments. This should include information describing the system’s performance on safety, evidence-based practice, and patient satisfaction. Anticipation of needs. The health system should anticipate patient needs, rather than simply reacting to events. Continuous decrease in waste. The health system should not waste resources or patient time. Cooperation among clinicians. Clinicians and institutions should actively collaborate and communicate to ensure an appropriate exchange of information and coordination of care. SOURCE: IOM, 2001:8–9.

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Rewarding Provider Performance: Aligning Incentives in Medicare STUDY CHARGE AND SCOPE A unique opportunity to examine the contribution of and experience with pay-for-performance strategies was provided by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (Public Law 108-173, Section 238). In this legislation, the U.S. Congress asked the IOM to conduct a study that would identify and prioritize options for aligning performance with payment in the Medicare program under Title XVIII of the Social Security Act (42 U.S.C. 1395 et seq.). The congressional mandate identified three topics for the IOM study to address: The performance measure set to be used and how that measure set should be updated. The payment policy that should be used to reward performance. The key implementation issues involved, such as data and information technology requirements. In response to this mandate, the IOM charged the Committee on Redesigning Health Insurance Performance Measures, Payment, and Performance Improvement Programs to explore the implementation of rewards for provider performance in Medicare. In carrying out its charge, the committee considered the role of payment strategies within a broader set of interdependent performance improvement efforts that include performance measures, public reports, use of innovative technologies, technical assistance, provider and consumer education, provider certification processes, and new organizational structures; these efforts may all be tied to financial incentives. Taken together, these performance improvement strategies have the potential to transform the quality of health care services and the settings in which they are delivered so that greater attention is focused on what truly matters—better health and outcomes. The committee has authored three reports, known collectively as the Pathways to Quality Health Care series, which explore how selected tools for improving health care quality and performance can be used to achieve better health and better value. The first report in the Pathways series—Performance Measurement: Accelerating Improvement (IOM, 2006b)—reviewed leading health care performance measures and examined their utility in supporting quality improvement, public information, and pay-for-performance policies. The committee recommended a starter set of performance measures to stimulate data collection, reporting, and, ultimately, payment that is directed toward fostering quality improvement. This study also provided a roadmap for defining and developing measures that could capture other dimensions of quality essential to assessing the overall performance of individual provid-

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Rewarding Provider Performance: Aligning Incentives in Medicare ers, as well as complex organizational settings. The dimensions largely missing from currently available measures include longitudinal, population-based measures that foster shared accountability of providers. Measures emerging in these areas could yield a deeper understanding of the ways in which certain processes and relationships are linked to better health outcomes; patient experiences of care; and more efficient use of financial, human, and organizational resources. Recognizing performance measures as essential building blocks for an improved health care system, this study also recommended the formation of a new governmental entity, the National Quality Coordination Board, to offer leadership in and help standardize and coordinate performance measurement efforts. Introducing new data collection, reporting, and payment systems throughout the health care system will require intensive collaboration, technical assistance, and information technologies that can contribute to quality improvement. Many of these issues were addressed in the second Pathways report, Medicare’s Quality Improvement Organization Program: Maximizing Potential (IOM, 2006a). For example, providers need to learn more about how to improve clinical and preventive care by sharing best practices and lessons learned in the adoption of new technologies, procedures, and behavioral interventions. Technical assistance for quality improvement will become increasingly important throughout Medicare as pressure to contain health care costs grows, and providers place more emphasis on quality improvement with the expansion of pay-for-performance programs. The Quality Improvement Organization program, administered by Medicare through a series of state-based contracts, constitutes an important national resource in building the necessary infrastructure for this technical assistance. The program’s goals and mission need to be redefined, however, so its efforts can focus on giving all providers the technical assistance they need to build their capacity for performance measurement and quality improvement. In this third report in the Pathways series, the IOM committee builds on its earlier analyses of performance measures and quality improvement. The report specifically addresses the creation of incentives designed to reward health care providers for improvements in care, as well as for their efforts that increase the value of health care services. This payment approach is part of a long-term strategy for better aligning the health care system with a vision of quality. The principal focus of this study is on the Medicare program, as requested, but many of the insights offered in this report are relevant as well to other aspects of the public and private health care sectors. THE DESIRE TO IMPROVE PERFORMANCE Americans make large investments in health care every year. In 2004, aggregate spending on health care reached $1.9 trillion, equating to 16 per-

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Rewarding Provider Performance: Aligning Incentives in Medicare cent of gross domestic product (GDP) and $6,280 per capita (Smith et al., 2006). These figures represent a sevenfold increase over health care expenditures in 1980, and this rapid rate of growth is expected to continue: by 2014, health spending is projected to grow to 18.7 percent of GDP (Heffler et al., 2005). Several studies of rising health care expenditures have demonstrated that some of these costs are associated with important medical advances, improved health outcomes, and increased value over time (Cutler and Miller, 2005; Murphy and Topel, 2005). For example, both investments in technology and pharmaceutical advances have yielded important gains in longevity. Angioplasty, a treatment for acute myocardial infarction, has been found to yield long-term benefits, such as higher survival rates and better outcomes relative to other, less expensive treatments, such as streptokinase (Zijlstra et al., 1999). Another area in which additional costs are incurred but are associated with important medical advances is prevention of specific cancers through screenings for particular populations, such as Pap smears for cervical cancer, mammography for breast cancer, and use of fecal occult blood testing for colorectal cancer (USPSTF, 2006). Certain treatments, such as hemodialysis, which cost Medicare $14.8 billion in 2003 for approximately 400,000 enrollees (USRDS, 2006), have also been shown to prolong life. The growth in expenditures and per capita health care spending in the United States far exceeds that in other developed countries. In spite of this spending, the United States still ranks in the bottom quartile of industrialized countries for life expectancy and infant mortality (Hussey et al., 2004). Within the United States, the level of Medicare spending per capita varies twofold from one geographic region to another, and varies even more during the last 6 months of life, without evidence of more effective care or better outcomes in the high-spending areas (Wennberg et al., 2002). Although the health status of Americans generally has improved over time, in some important areas it has not improved significantly or has even deteriorated. For example, obesity has increased dramatically in the population aged 20–74 since the 1980s (NCHS, 2005). During the period 1999–2002, 31 percent of adults were obese, and another 34 percent were overweight. Obesity is a major risk factor for many diseases, including diabetes, which increased in the population aged 20 and older from 8.4 percent in 1988– 1994 to 9.4 percent in 1999–2002 (NCHS, 2005). For the population over age 60, the diabetes rate increased from 18.9 to 20.9 percent between the same time frames. The United States lags behind many other countries (where per capita spending levels are lower) in such areas as longevity, heart disease, and diabetes (Schoen et al., 2004; Banks et al., 2006). Statistics such as these have led some analysts to suggest that the current incentive structure creates excessive waste and inefficiency (Skinner et al., 2006) by encouraging complex, expensive, and profitable services that are not

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Rewarding Provider Performance: Aligning Incentives in Medicare necessary to achieve high-quality outcomes, while at the same time discouraging primary care and other services that could yield significant gains (Ginsburg and Grossman, 2005). The desire to improve performance, encourage patient-centered practices, and deliver high-quality care across provider settings more efficiently has engaged interest in designing payment incentives that might help achieve these goals. Recognizing that much of the increase in health care spending will shift from the private sector and Medicaid to Medicare with the initiation of the Medicare prescription drug benefit (Heffler et al., 2005) and the aging of the baby boomer generation, policy makers and researchers have raised concern about the value received for Medicare dollars. Many policy makers are now seeking to reframe these expenses as public investments that should be designed to leverage higher levels of quality and performance for all Americans (Davis et al., 2005; Davis and Collins, 2006). CLINICAL QUALITY, PATIENT-CENTEREDNESS, AND EFFICIENCY Ultimately, pay for performance is one of several mutually reinforcing reform strategies that collectively could move the health care system toward providing better-quality care and improved outcomes. The Quality Chasm report identified six fundamental aims associated with health care quality: safety, effectiveness, patient-centeredness, timeliness, efficiency, and equity (IOM, 2001). A broad range of activities is now under way to develop evidence-based measurable standards and outcomes for each of these aims. Many physician specialty societies, trade organizations, and public and private purchasers are developing new performance measures that can provide valuable benchmarks for assessing the quality of care for particular diseases and conditions in various provider settings. As noted above, such performance measures are essential building blocks for any quality improvement effort, including pay for performance. In addition, patients and their caregivers are becoming more active in managing their care, and are increasingly seeking providers who are sensitive to their needs and preferences, especially in such areas as patient– provider communication, patient experiences with provider services, and attention to care transitions across care settings. New measures have recently emerged that capture these important dimensions of the patient’s experience, and such patient-centered measures are becoming more important in consumer evaluations and professional certification of the performance of hospitals, physicians, long-term care facilities, other institutional health care providers, and health plans. Faced with rapidly growing health insurance premiums and out-of-pocket costs, patients and payers also need measures of efficiency to help

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Rewarding Provider Performance: Aligning Incentives in Medicare them select providers who deliver high-quality care at lower cost. Currently, for example, incentives are often lacking to deter the provision of services of low clinical value and promote the provision of quality services at a lower cost. If health plan purchasers in the public and private sectors are to offer high-quality, affordable health care services, they must have efficiency measures that can be used to develop better payment and performance measurement systems. Despite the importance of measurement, however, effective measures for all six quality aims have not yet been developed. The committee found it useful to consolidate the six aims into three broad domains when considering what the focus of an initial pay-for-performance strategy should be: Clinical quality, which encompasses effectiveness, safety, timeliness, and equity. Patient-centeredness, an attribute of care that reflects the informed preferences of the patient and the patient’s significant others, as well as timeliness and equity. Efficiency, defined as achieving the highest level of quality for a given level of resources. In assessing pay for performance, the committee explored strategies that could improve performance within each of these three domains, as well as strategies for incorporating these domains into a seamless set of goals for the health care system. The committee recognized the inherent tensions among the three domains. One could strive for high clinical quality and patient-centered care, for example, without being concerned about overall resource use and levels of efficiency. Such an approach could ultimately bankrupt the nation. Conversely, one could emphasize efficiency without accounting adequately for significant variations in clinical quality or patient-centered care. This emphasis could lead to stringent cost containment practices that would compromise the quality of clinical care and patient experiences of care. There is a critical need to achieve an appropriate balance among the three domains that reflects both national values and budgetary constraints. Recognizing that there is room for provider improvement in all three domains, payment strategies should be aimed at achieving higher performance levels in all three and should also stimulate the development of measures to close existing gaps wherever feasible. Therefore, payment strategies should not be designed to reward high clinical quality alone, but should incorporate incentives to ensure that high-quality care is patient-centered and focused on efficiency as well. Similarly, payment strategies should not be aimed at driving down costs at the expense of patient preferences or clinical quality, but should support an integrated

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Rewarding Provider Performance: Aligning Incentives in Medicare and coordinated system of care that emphasizes improving outcomes through efficient use of resources. The introduction of payment incentives designed to reward care that is of high clinical quality, patient-centered, and efficient poses daunting challenges. As noted, promising strategies aimed at achieving objectives in one domain may produce adverse or unintended consequences in other domains. Moreover, key components, relationships, and systemwide reforms necessary to achieve the desired goals may be difficult to implement within the vast and diverse array of private and public provider settings that constitute the nation’s health care system. CURRENT STATE OF PAY-FOR-PERFORMANCE EFFORTS Despite the challenges, many payers, medical groups, and purchasers are currently experimenting with new payment approaches designed to reward higher levels of performance and obtain greater value from health care investments. In the past few years, more than 100 pay-for-performance and incentive programs have been launched in the private sector that offer financial rewards for higher levels of provider performance according to specified measures (Med-Vantage Inc., 2006). Medicare, the nation’s largest single payer for health care services, is also experimenting with pay-for-performance strategies through a series of demonstration programs (see Chapter 2) (CMS, 2005b). While many have invested in the promise of pay for performance, however, results are yet to be identified. The impact of these efforts and their effects on provider behavior and patient health may not be realized for many years. The recent experimentation with pay for performance on the part of private health plans offers an intriguing and attractive potential source of guidance for alternative payment arrangements for traditional Medicare. Experiments such as those implemented within Anthem Blue Cross and Blue Shield and Hawaii’s Blue Cross and Blue Shield plan have been operating since 1999. The Integrated Healthcare Association’s program covers 8 million enrollees (Epstein et al., 2004). (These and other recent pay-for-performance programs are discussed in Chapter 2.) As pioneering efforts, these programs can offer important models and lessons to inform future health care purchasing or investment strategies in the public sector. (See Chapter 2 for a discussion of early experiences with pay for performance and Appendix B for a summary of the literature on such programs.) To date, however, the results of these early efforts have not been systematically examined, nor have specific factors in success that could help guide the development of pay-for-performance programs been identified. In addition, the evidence base to support pay for performance is still emerging. Fewer than 20 empirical studies have assessed the use of payment incentives to

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Rewarding Provider Performance: Aligning Incentives in Medicare improve quality (Petersen et al., 2006). These studies, focused on improving processes and outcomes of care, access to care, and patient experiences of care in a variety of populations and care settings, have yielded mixed results on the effectiveness of pay-for-performance programs (see Chapter 2). Thus the ability of pay for performance to achieve the desired goals will be highly dependent on the presence or absence of several key elements not yet determined. Great uncertainty exists about the specific thresholds and preconditions necessary for pay for performance to succeed. Consequently, it is important for pay for performance to be introduced within learning environments that can identify key lessons from early experience and offer the opportunity for midcourse corrections where necessary. Lessons learned and dissemination of best practices could become critical to the development of successful pay-for-performance programs in the absence of a strong evidence base. As noted above, introducing pay-for-performance strategies within Medicare poses numerous challenges. Unavoidable decisions will have to be made that will reward some providers and penalize others. To achieve higher levels of performance throughout the health care system, strong public- and private-sector partnerships and new governmental arrangements will be necessary. New measures of performance will have to be developed. More important, ongoing monitoring and evaluation will be essential. Independent and objective research focused on early experiences will be required to (1) identify key areas in which new payment strategies can make important differences, (2) explore the necessary resource and implementation costs, and (3) resolve multiple uncertainties and stakeholder disputes that will emerge along the way. OVERVIEW OF THE MEDICARE PROGRAM To understand the nuances of implementing pay for performance in Medicare, it is necessary to understand the basics of the program. Medicare is the government health program for the U.S. elderly population (those over age 65) and those who are eligible because of permanent kidney failure or suffer from a long-term disability. The program, which covered nearly 42 million Americans in 2004—35.4 million elderly and 6.3 million disabled (CMS, 2005a)—is financed through beneficiary premiums and federal general revenues and payroll taxes. Although Medicare is administered by the Centers for Medicare and Medicaid Services (CMS), a federal agency, beneficiaries are served almost entirely through the private-sector health care delivery system (MedPAC, 2005b). Medicare consists of four components: Part A, the Hospital Insurance program, pays on a fee-for-service basis for inpatient hospital care and some home health, skilled nursing facility, and hospice services.

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Rewarding Provider Performance: Aligning Incentives in Medicare Part B covers, also on a fee-for-service basis, outpatient hospital, home health, physician, and other individual health care provider services, as well as such services as clinical laboratory and diagnostic tests, supplies, and durable medical equipment. Part C, or Medicare Advantage (formerly Medicare+Choice), provides capitated payments to private plans that agree to provide Medicare beneficiaries with the services covered by Parts A and B. It offers beneficiaries an expanded choice of delivery systems, including various forms of managed care, such as health maintenance organizations and preferred provider organizations. Part D, first implemented in 2006, provides coverage for therapeutic drugs through private health insurance plans. Medicare expenditures in 2004 amounted to more than $300 billion, 16.5 percent of the total national health expenditures of $1,878 billion (see Table 1-1). In that year, federal health expenditures, excluding federal employees’ health benefits, came to $600 billion, 32.6 percent of total national health expenditures (CMS, 2006). Over the last three decades, Medicare spending has grown at a faster rate than the balance of all national health expenditures (see Table 1-1), although on a per beneficiary basis, expenditures have grown somewhat more slowly than those covered under private insurance (Davis and Collins, 2006). Medicare contracts with private providers for the provision of services to its beneficiaries, for which it pays according to agreed-upon payment rates and methodologies. Unlike private insurers, which often contract TABLE 1-1 Estimated Medicare and National Health Expenditures, 1975–2004 Expenditures 1975 (billions of dollars) 1985 (billions of dollars) 1995 (billions of dollars) 2004 (billions of dollars) Increase 1975–2004 (percent) Medicare 16.3 71.4 182.4 309.0 1,796 National health expenditures 133.6 441.9 1,020.4 1,877.6 1,305 Medicare expenditures as percentage of national health expenditures 12.2 16.2 17.9 16.5 35 SOURCE: CMS, 2006.

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Rewarding Provider Performance: Aligning Incentives in Medicare selectively with available providers, Medicare has traditionally allowed all licensed providers to participate in the program who (1) wish to serve Medicare beneficiaries, (2) are willing to accept Medicare’s administratively set rates as payment, and (3) meet minimal predetermined federal standards. Each provider setting has its own requirements for Medicare participation. Essentially all institutional providers must undergo accreditation or certification by CMS or its agents, and many report performance data. For example, hospitals are required to develop and maintain a quality assessment and performance improvement program, meet standards for content and retention of medical records, and fulfill requirements for organization and functioning of medical staff, among many other conditions. Participating physicians must agree to accept Medicare’s payment for covered services as the full charge and not bill the Medicare patient for additional fees above the applicable coinsurance or deductible. While most doctors “accept assignment” as participating physicians, others do not and can bill a limited amount above the Medicare payment. All physicians billing Medicare, nonetheless, agree to specific billing procedures. There are, however, no quality or performance requirements for physicians to participate in Medicare beyond state licensure. Medicare payments have historically been made on the basis of standard formulas or fee schedules that do not reflect different levels of performance (see Appendix A). This payment system was based on the assumption that all licensed providers who met the conditions of participation would provide care of acceptable quality. This payment approach generally persists today, even though it is now recognized that significant variations exist in the quality of care offered by providers and that the average level of care is far from that associated with current best practices. (See Chapter 2 for more discussion of payment systems.) Current Medicare care payment practices can have toxic effects because they do not reflect the relative value of certain services, such as preventive and primary care, and place little or no emphasis on achieving high levels of clinical quality within a given amount of resources. For example, the physician’s fee schedule does not pay providers adequately for cognitive services such as care coordination and patient education, which are essential for patients with chronic conditions. In addition, the data and methodologies that CMS uses to calculate certain payments under the physician’s fee schedule tend to favor relatively new high-technology services (MedPAC, 2006). Costs are frequently driven upward by a system that provides incentives for a high volume of services, but not for efforts to promote the basic principles of higher-quality care. The system also encourages utilization of expensive services that may not be more effective than less costly ones. In fact, the fee-for-service system itself, as well as the payment methodology for various providers, encourages an increase in quantity and intensity of

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Rewarding Provider Performance: Aligning Incentives in Medicare services. Medicare’s hospital outpatient payment system and that for physicians and other health care professionals tend to pay for each additional service, even if the service results from a complication or inadequate initial service. Thus, a provider who makes a mistake and has to repeat a procedure may be paid twice as much as one who performs it correctly the first time. Payment systems that bundle services broadly and comprehensively into a single payment run the risk of having providers avoid patients with extensive needs that are not adequately accounted for in the payment. For example, patients requiring extensive care in a skilled nursing facility can have relatively long waits for placement in such a facility because the base payment does not reflect all their likely needs (MedPAC, 2005a). Medicare’s various prospective payment systems and their incentives are discussed in Appendix A. Just as payment methodologies can have an impact on the quality of health care, there are other aspects of the current health care delivery system that may affect care. For example, consumer-directed health plans are based on the expectation that greater transparency about service costs and quality and a greater responsibility for paying for care, including tiered benefit levels, will motivate consumers to select their health care providers carefully, which in turn will motivate providers to improve their efficiency and clinical performance in order to attract patients. Such health plans are relatively new and their full impact has yet to be measured, but they may have a positive influence on health costs and quality in the future. Another way to overcome the unintended consequences of the current payment system is to create incentives to promote better quality through pay-for-performance strategies. Such strategies reward outcomes and processes associated with improved and/or high-quality care according to selected measures of provider performance. The committee recognizes that such a reward strategy will not necessarily result in lower spending for health care services, but improving quality should make it more likely that patients will receive more effective and efficient care. Although the promise of pay for performance may alter provider behaviors, it alone will not be the silver bullet for achieving high-quality care or curbing health care costs; it will, however, help ensure that what is paid for will be more helpful to patients. The long-term growth in Medicare expenditures is projected to be substantial (see Table 1-2), creating a significant impetus for the development of payment strategies that can provide incentives for efficiency while encouraging high levels of clinical quality and patient-centered care. Because Medicare is such a large payer and because many private payers follow its policy lead, the program exerts a significant influence on the organization and delivery of health care services throughout the United States. Through its coverage and payment decisions, therefore, it could encourage the diffusion of high-quality practices.

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Rewarding Provider Performance: Aligning Incentives in Medicare TABLE 1-2 Estimated and Projected Medicare Spending (billions of dollars)   1975 1985 1995 2005a 2014a Part A 10.6 48.7 114.9 179.9b 317.8 Part B 4.2 22.7 65.2 151.3 261.2 Part D — — — 1.7 169.0 Total 14.8 71.4 180.1 332.9 748.0 aIntermediate estimates. bShifts in funding for some home health care from Part A to Part B are reflected in the relative spending in 2005. SOURCE: Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2005. INITIAL STEPS TO IMPROVE THE U.S. HEALTH CARE SYSTEM As noted earlier, the introduction of pay for performance needs to be examined within a framework of evolving measures and shifting organizational structures and collaborations throughout the health care system. The ability to implement pay for performance is not distributed evenly across all health care settings. Some organizations, such as hospitals and certain specialty practices, have acquired extensive experience with performance measures and quality improvement. Others, most notably individual providers and many primary care settings, are just beginning to experiment systematically with quality improvement measures and strategies. Recognizing that reforms are necessary, leaders in health care and government are considering alternative approaches to implementing a pay-for-performance strategy. One option is to allow quality improvement processes to evolve at a gradual pace, driven by motivated purchasers and providers, and implemented through scattered local experiments with new payment strategies in selected systems of care or geographic regions. This approach can reveal the opportunities and challenges involved in introducing new measures and performance-based care in the treatment of selected health conditions in different care settings. While this approach may generate important insights about the promise and limitations of payment strategies, however, it may be insufficient to achieve the breadth and scope of change necessary to influence provider behavior and practices. It also may fail to identify the key payment incentives and other environmental features necessary to change practices among low performers or poor-quality health care settings if they do not volunteer to participate. A second option is to restructure the Medicare payment system to encourage more rapid transformation and to foster national systemwide

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Rewarding Provider Performance: Aligning Incentives in Medicare change. Such an approach could apply the level of resources necessary to achieve significant changes in practices and collaborative arrangements, which may vary with the severity and complexity of clinical conditions and the performance measures employed. Yet restructuring the payment system in the absence of reliable evidence of positive outcomes associated with new payment incentives poses substantial risks. Certain unknown system requirements may be necessary to ensure that pay-for-performance strategies have their intended effects and do not have unintended adverse consequences. Key features and adjustments must be considered, such as how performance measures will address patients with multiple chronic diseases when accepted measures of high-quality care for one condition may contradict measures of high-quality care for another. If payment strategies are not carefully aligned with desired outcomes, providers may avoid accepting patients whose conditions would jeopardize their performance or withdraw from the Medicare system entirely. Both providers in organizational settings (such as hospitals and skilled nursing facilities) and solo practitioners will need data tools and quality improvement assistance to comply with reporting requirements that will allow them to participate in a pay-for-performance program. In this report, the committee seeks to weigh these two approaches through an evidence-based analysis, keeping in mind that the current payment systems continue to have negative unintended consequences (discussed in Appendix A). The committee proposes a multiphase approach within a learning environment aimed at achieving transformation through a series of structured changes in current payment arrangements. The committee also examines the core features necessary to implement a pay-for-performance strategy while respecting the need for variation and tailored approaches in different health care environments. CONCLUSIONS Changes in the structure of Medicare payments could have a major impact on the quality of care delivered by the entire health care delivery system. As Medicare provides health care benefits to nearly 42 million U.S. citizens at an annual cost of well over $300 billion (2004 expenditures), CMS is in a unique position to lead the American health care industry in providing higher-quality care and greater value for the money spent on that care (IOM, 2002). Medicare’s current payment system is often inconsistent with the goal of promoting higher value. Some in the private sector have moved forward with attempts to reform the current payment system, but these efforts will not realize their maximum benefit without public-sector involvement. Medicare is also working on strategies to add value to the care it provides and is now collaborating with the private sector to accelerate change.

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Rewarding Provider Performance: Aligning Incentives in Medicare Notwithstanding the difficulties involved in overhauling the current payment system and the gaps and uncertainties in the existing evidence base for pay for performance, the committee believes pay for performance could be a viable tool when used in tandem with other performance improvement strategies, such as public reporting and technical assistance, to transform the health care delivery system. The ultimate purpose of a performance-based payment system is to stimulate behavioral and organizational change within the provider community in ways that will foster performance improvement and improve the value of health care services. The committee does not presume that these changes will be easy or that savings will automatically be generated. It also remains cognizant of the unintended consequences that could arise, but believes the consequences of inaction pose a greater threat. The lack of evidence associating pay for performance with improvements in clinical quality, patient-centeredness, efficiency, and, most important, outcomes of care suggests that caution will be necessary as Medicare proceeds. The consequences of aligning incentives to promote higher-quality health care are largely unknown. For instance, providers might avoid treating high-risk, nonadherent, or other types of patients who could jeopardize their performance scores. Payment rewards might encourage a system in which providers would work to improve only on measures for which they were paid, and as a consequence, reduce their quality of care on unrewarded measures instead of trying to improve care on a more global level. From the patient’s perspective, payment incentives could undermine the revered physician–patient relationships, which are based largely on trust. A pay-for-performance program could also increase competition within the health care enterprise and thereby impede knowledge transfer among providers. Recognizing the need for some kind of payment reform and the promise of pay for performance as suggested by early experiments in the private sector, it will be necessary to balance actions taken toward implementation of the approach with due caution. This report therefore emphasizes the need to introduce pay for performance within a comprehensive learning system through a multiphase approach that addresses significant variations in clinical conditions and health care settings, and encompasses an evaluation strategy for deriving insights from the experience gained in early stages of implementation. SCOPE AND ORGANIZATION OF THE REPORT This report sets forth a vision for how pay for performance could be implemented to best help achieve the goals of improving health care quality and patient outcomes. While the report outlines options, designers should

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Rewarding Provider Performance: Aligning Incentives in Medicare not be limited to these options; rather, the report is intended to delineate principles for the development of performance-based rewards. Chapter 2 reviews the promise of pay for performance as assessed in research studies and suggested by initial experiments, while also exploring its potential unintended adverse consequences. Chapter 3 reviews options for funding a pay-for-performance program for Medicare. Chapters 4 and 5, respectively, provide an overview of various reward distribution options and present the committee’s proposed multiphase approach to the implementation of a comprehensive pay-for-performance program. Finally, an aggressive research and evaluation agenda and key features of the kind of learning system the committee believes should be the context for the introduction of pay for performance are detailed in Chapter 6. REFERENCES Banks J, Marmot M, Oldfield Z, Smith JP. 2006. Disease and disadvantage in the United States and in England. Journal of the American Medical Association 295(17):2037–2045. Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds. 2005. 2005 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds. Washington, DC: Medicare Board of Trustees. CMS (Centers for Medicare and Medicaid Services). 2005a. Medicare Information Resource. [Online]. Available: http://www.cms.hhs.gov/medicare/ [accessed December 6, 2005]. CMS. 2005b. Medicare “Pay for Performance (P4P)” Initiatives. [Online]. Available: http://www.cms.hhs.gov/apps/media/press/release.asp?counter=1343 [accessed June 13, 2006]. CMS. 2006. National Health Expenditures by Type of Service and Source of Funds. [Online]. Available: http://www.cms.hhs.gov/NationalHealthExpendData/02_NationalHealthAccountsHistorical.asp#TopofPage [accessed April, 18, 2006]. Cutler D, Miller G. 2005. The role of public health improvements in health advances: The twentieth-century United States. Demography 42(1):1–22. Davis K, Collins S. 2006. Medicare at forty. Health Care Financing Review 2005–2006 27(2):53–62. Davis K, Schoenbaum S, Audet A. 2005. A 2020 vision of patient-centered primary care. Journal of General Internal Medicine 20(10):953–967. Epstein AM, Lee TH, Hamel MB. 2004. Paying physicians for high-quality care. New England Journal of Medicine 350(4):406–410. Fisher ES, Wennberg DE, Stukel TA, Gottlieb DJ. 2004. Variations in the longitudinal efficiency of academic medical centers. Health Affairs VAR19–VAR32. Ginsburg PB, Grossman JM. 2005. When the price isn’t right: How inadvertent payment incentives drive medical care. Health Affairs w5.376. Heffler S, Smith S, Keehan S, Borger C, Clemens MK, Truffer C. 2005. Trends: U.S. health spending projections for 2004–2014. Health Affairs w5.74. Hussey PS, Anderson GF, Osborn R, Feek C, McLaughlin V, Millar J, Epstein A. 2004. How does the quality of care compare in five countries? Health Affairs 3(23):89–99. IOM (Institute of Medicine). 2000. To Err Is Human: Building a Safer Health System. Kohn LT, Corrigan JM, Donaldson MS, eds. Washington, DC: National Academy Press. IOM. 2001. Crossing the Quality Chasm: A New Health System for the 21st Century. Washington, DC: National Academy Press.

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