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“Pay for performance” is currently one of the hottest concepts in managed care contracting. As the name suggests, the term refers to plans that reward health care providers with financial incentives for controlling costs and improving quality. PricewaterhouseCoopers has reported that as many as one-third of commercial health plans have implemented some form of pay-for-performance methodology in their provider contracts. National coalitions such as Bridges to Excellence have implemented bonus programs in a number of markets. Medicare also has weighed in with several initiatives, including the Hospital Quality Initiative and the Physician Group Practice Demonstration, which is scheduled to become operational in 10 pilot programs in April 2005. And earlier this month, Mark McClellan, administrator of the Centers for Medicare and Medicaid Services, reportedly stressed how he wants Medicare to adopt pay for performance soon. Even the Federal Trade Commission and the Department of Justice have endorsed pay for performance. They note in their 2004 report “Improving Health Care: A Dose of Competition” that pay-for-performance programs will be an important strategy for improving the quality and efficiency of health care delivery in the United States. Pay-for-performance programs frequently are being introduced as a reaction to managed care arrangements that put providers fully at risk for the cost of health care services for their patients, but they also have been implemented in markets where there are few managed-care organizations. As these pay-for-performance programs are created, health plans and providers will face numerous program design and implementation issues. These issues must be resolved to the benefit of both parties if these programs are going to take hold and produce the desired improvements in quality and efficiency. However, very few comprehensive pay-for-performance programs have yet been established. Many of the commercial programs that have been implemented are limited to a few quality-based performance goals. Medicare has yet to develop detailed quality and efficiency metrics, procedures for making incentive payments, or progress reporting systems for the physician demonstration pilots. In short, while general discussions exist, there is a shortage of specific guidance of how to resolve the necessary issues in a pay-for-performance program. THE RIGHT TARGETS We recently have completed the negotiation of comprehensive pay-for-performance-based contracts with three different health plans on behalf of a large network that includes academic and community hospitals and physicians. Affecting more than 500,000 covered lives, these contracts contain a relatively consistent set of both efficiency and quality improvement measures. They also have substantial financial incentives for achieving each of the performance targets. Based on this experience, we believe that health plans and providers should take into account several key considerations as they negotiate these programs. The performance measures and targets and the measurement process must be chosen carefully. While health plans and providers may have a common interest in achieving improvement, they may have differing views on the types of performance measures to be selected. Providers may favor quality improvement measures, such as the Health Plan Employer Data and Information Set measures for diabetes or asthma care, since these standards are widely accepted and because setting targets for these metrics is not dependent on the always tricky task of analyzing the historical and projected trends in an organization’s performance. Health plans may be more interested in efficiency measures � such as reductions in inpatient admissions or the use of high-cost radiology tests � that provide more immediate financial returns. Both providers and health plans also should consider infrastructure goals, such as the development of electronic health record systems, that can improve both quality and efficiency. Some provider organizations are attempting to use pay for performance as a means of clinically and/or financially integrating the providers in a joint venture that can undertake collective fee negotiation. In this case, they should include meaningful efficiency-based measures in view of the FTC’s emphasis on efficiency improvement in evaluating physician joint ventures under the antitrust laws. Providers should also be mindful that health plans may use the pay-for-performance measures for differentiating providers in the tiered networks that are being introduced in new “consumer-directed” health insurance products. Using metrics that are not carefully defined and measured could result in a provider’s being placed erroneously in a “lower” quality tier. TOO MANY TARGETS Care must be taken, however, to avoid the inclusion of too many performance measures. This can dilute both the value of the pay-for-performance financial incentives and the amount of provider time and effort available for implementing improvements. The problems associated with a multiplicity of performance metrics may be magnified in markets with multiple payers, including Medicare. In markets with either a single significant health plan or single large provider network, the payer or provider may have the opportunity to establish a consistent pay-for-performance program design across the market. But in markets with multiple payers and providers, the tendency toward a multiplicity of potentially inconsistent pay-for-performance performance measures will be ever present. It remains to be seen whether Medicare or regional organizations, such as regional health information organizations, can play a role in the standardization of pay-for-performance programs by linking pay-for-performance measures and incentives to the adoption of regionalized electronic health record systems. Setting targets for the performance measures is also a difficult but critical task, usually requiring careful actuarial analysis of prior experience. Such analyses may be difficult, however, in the absence of solid historical data on the applicable patient population. Large provider networks should also consider networkwide targets, as contrasted with the measurement of performance at the individual physician group or hospital level. The former method may be important for demonstrating to the FTC that the network is clinically and financially integrated for antitrust purposes. OVER TIME Finally, the parties must address several issues that affect the measurement of performance over time. First, and perhaps most important, is the patient population being measured. Providers must have a sufficient amount of contact with individual patients in the measured group so that the providers can effectively implement disease management, pharmacy management, and other types of programs that generate quality and efficiency improvements. Similarly, there should be a sufficient number of patients so that the measured experience is statistically accurate and not merely the result of chance. For managed-care plans that require patients to select a primary care physician, both of these criteria are usually satisfied. On the other hand, with preferred provider organization plans and with Medicare’s fee-for-service plan, patients have an opportunity to go to any provider they wish and, therefore, no individual provider may have enough contact with the patient to improve the quality and efficiency of that patient’s care over time. Thus, regionalized programs may be necessary to apply pay for performance to preferred provider or Medicare fee-for-service populations. Performance measurement must take into account any changes in the health status of the measured population. It also must reflect marketwide changes in utilization and pricing where the performance of an individual provider group is being measured against a market-based trend or against the performance of the remainder of the health plan’s provider network. It is also critical to the measurement of performance, as well as the timely implementation of performance improvements, that both health plans and providers have access to timely and accurate data. PAYING OUT The “pay” part of pay for performance is equally important to ensuring success of the program. Health plans and providers may find it difficult to reach consensus on acceptable types and amounts of financial incentives or penalties. Because of the significant infrastructure investment that providers must make to implement disease and utilization management programs and data analysis and reporting tools, providers will seek significant levels of incentive compensation on top of reasonable fee-for-service payments. They will tend to resist a penalty- or withhold-based approach. This will be especially true in markets where competition has tended to retard growth in provider reimbursement, a concern already cited by commentators on the Medicare pay-for-performance initiative. Health plans, on the other hand, tend to prefer to finance pay-for-performance incentives with “new money” from the savings generated by the program’s quality and efficiency improvements, rather than through increased reimbursements plus incentive payments. In either case, the absolute amount of the financial incentives must be significant enough to encourage broad-based provider participation and to motivate providers to alter their behavior. Provider networks should distribute incentive payments or earned withholds in ways that align hospital and physician efforts toward the same quality and efficiency goals. Payment arrangements between hospitals and physicians must be carefully structured, however, to pass muster under applicable fraud and abuse laws. A final, overarching consideration involves the suitability of individual provider organizations to implement comprehensive pay-for-performance programs. A great deal of investment in information systems and personnel is necessary to implement quality and efficiency improvement programs and to track performance. It is necessary to have a statistically significant number of covered lives and align physician and hospital incentives to achieve meaningful improvements. Thus, small or loosely integrated provider organizations may find it difficult to implement pay for performance. Ultimately, pay-for-performance programs and the associated information and medical management infrastructure may be regionalized on a multiplan, multiprovider basis. Until then, perhaps only large provider networks that include hospitals as well as primary care and specialty care physicians will be able to implement comprehensive pay-for-performance programs that have a real effect on quality and efficiency. John R. Higham and Susan W. Berson are partners in the health section of Mintz Levin Cohn Ferris Glovsky and Popeo. Higham is located in the firm’s Boston office; Berson, in the D.C. office. They can be reached at [email protected] and [email protected], respectively.

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