support rewards of sufficient magnitude to motivate various types of providers? If there is one large pool, what is to be done with those who, because of inadequate performance measures, cannot initially qualify for rewards? While many of these matters are discussed in Chapters 4 and 5, which focus on the distribution of funds and implementation issues, respectively, these questions must be considered when basic decisions on the initial funding source(s) for the rewards are made since all subsequent program decisions will hinge on those choices.


The resources needed to support a pay-for-performance program can be obtained from existing funds, from generated savings, or from direct investment (new money). Existing funds are monies that are already part of the payment system. This model reduces payments to all or selected types of providers for redistribution to those exhibiting higher quality in examined areas. The reward pool that is divided among those providers who reach specified quality goals may be created by reducing planned fee schedule increases (referred to as “shaving the update”), by withholding a portion of the base payment, or by enacting an explicit set of Medicare program cuts. The generated-savings model creates a reward pool from the money saved as a result of the adoption of cost-reducing reforms and efficiencies associated with the effort to improve quality. The direct-investment model adds new money from either Medicare’s Hospital Insurance trust fund or general revenues and distributes it as bonuses over and above a scheduled payment. Variations on each of these funding sources are discussed in more detail later in this chapter. Although these models represent three distinct approaches to funding, mixed approaches are also possible.

The decision as to the source of funding is important for several reasons. Most important, there will be concern over whether the program is budget neutral—that is, whether it will add to government spending. In an era of high and escalating budget deficits, lawmakers are likely to object to spending more on a program that is already very costly, with expenditures growing rapidly. Provider groups, on the other hand, will want new funds to be used, arguing that payment rates are already too low and that redistributing a portion of these inadequate amounts will leave some with insufficient resources to do their jobs well and respond to new demands. In addition, some types of providers who are adversely affected by the funding mechanism selected will initially not have the opportunity to receive performance rewards. For example, performance measures are insufficiently developed for some specialties and provider types to allow for participation in a pay-for-performance program. This disconnect will cause understandable dissension. Overall, defining the mechanism for the creation of an initial

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