Medicare, the government health program for the elderly (ages 65 and over) and qualified disabled populations, covered nearly 42 million Americans in 2004. Medicare is the nation’s largest single payer for health care services, with total expenditures of $309 billion in 2004, and this amount is estimated to grow rapidly. Although Medicare is federally administered and largely federally financed, its beneficiaries are served almost entirely by private providers. For services provided to the 88 percent (approximately 37 million) of beneficiaries enrolled in the traditional fee-for-service option, Medicare pays providers amounts that are set prospectively on the basis of resource cost and complexity of services delivered. For the remaining 12 percent of beneficiaries who have opted to receive their Medicare services from private plans participating in the Medicare Advantage program, Medicare pays a fixed, risk-adjusted monthly amount per beneficiary to the plans, which in turn pay providers via diverse methods.

The current Medicare fee-for-service payment system is unlikely to promote quality improvement because it tends to reward excessive use of services; high-cost, complex procedures; and lower-quality care. Through bundled and prospective payment arrangements for institutions, Medicare has attempted to create incentives for efficiencies, but significant price and payment distortions persist.

Services that contribute greatly to high-quality care that are labor- or time-intensive and rely less on technical resources, such as patient education in self-management of chronic conditions and care coordination, tend to be undervalued and are not adequately reflected in current payment arrangements. Little emphasis is placed on efficiency (achieving high clinical quality with a given amount of resources). The lack of incentives for comprehensive, coordinated care discourages services targeting early intervention and prevention that can ultimately reduce the use of expensive services, such as avoidable hospitalizations. Providers often miss opportunities for collaboration since the payment system rewards neither team management nor the integration of services across care settings. Medicare’s fee-for-service payments, the relative profitability per service, and most private purchasers’ payment mechanisms create incentives for providers to specialize in fields that are more resource-intensive at the expense of primary care, which has not fared well under the current Medicare reimbursement systems.

Aligning payment incentives with quality improvement goals represents a promising opportunity to encourage higher levels of quality and provide better value for all Americans. However, pay for performance needs to be closely monitored because it could have unintended adverse consequences, such as decreased access to care, increased disparities in care, or impedi-

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