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Prior to beginning work on this discussion, review required readings (see attached)There are four specific reimbursement methods in our health care system. For this discussion, you will write your initial post on the topic of Fee-for service. Address the following in your initial post:Explain why your method of reimbursement is the best method for the U.S. health care system.Identify how this reimbursement model has evolved.Determine how this reimbursement model has positively influenced cost, quality, and access of care.Reimbursement MethodFee-for-service
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MEDICINE AND PUBLIC ISSUES
Annals of Internal Medicine
The 8 Basic Payment Methods in Health Care
Kevin Quinn, MA
Eight basic payment methods are applicable across all types of
health care. Each method is defined by the unit of payment (per
time period, beneficiary, recipient, episode, day, service, dollar
of cost, or dollar of charges). These methods are more specific
than common terms, such as capitation, fee for service, global
payment, and cost reimbursement. They also correspond to the
division of financial risk between payer and provider, with each
method reflecting a risk factor within the health care spending
identity. Financial risk gradually shifts from being primarily on
providers when payment is per time period to being primarily on
payers when payment is per dollar of charges. Method 4 (per
episode) marks the line between epidemiologic and treatment
risk. The 8 methods are typically combined to balance risk and
thus balance incentives between payers and providers. This taxonomy makes it easier to understand trends in payment reform—
especially the shifting division of financial risk and the movement
toward value-based purchasing—and types of payment reform,
such as bundling, accountable care organizations, medical
homes, and cost sharing. The taxonomy also enables prediction
of conflicts between payers and providers. For each unit of payment, providers are rewarded for increasing units while decreasing their own cost per unit. No payment method is neutral on
quality because each encourages and discourages the provision
of care overall and in particular situations. Many professional
norms and business practices have been established to mitigate
undesirable incentives. Health care differs from many other industries in that the unit of payment remains variable and
unsettled.
I
THE 8 BASIC PAYMENT METHODS
propose that 8 basic payment methods apply to all
types of health care and all payers. I describe their
development, implications for provider and payer behavior, and mathematical relationship within the health
care spending identity. The goal is to help clarify debates on payment reform and value purchasing. Although the examples reflect U.S. experience, the principles are relevant to payment reforms elsewhere (1).
To be sure, money does not drive many decisions
of physicians and other health care providers. For centuries, medicine has espoused the value that “The physician’s first and primary duty is to the patient” (2). Every
health care professional has witnessed patients receiving excellent care regardless of financial incentives.
Yet payment methods clearly affect whether, how,
and how much care is provided. Examples include hospital length of stay (3), diagnostic imaging in physician
offices (4), home health care visits (5), coordination
among physicians and hospitals (6), the volume and
mix of services under fee-for-service medicine (7), and
much more. Financial incentives seem particularly potent in situations of clinical ambiguity, such as diagnostic tests, follow-up visits, and some procedures (8). Effects of financial incentives often become more evident
over time, such as decisions to open and close
business lines (9) and medical students’ choice of
specialty (7).
Health care—rarely pleasurable, often uncomfortable, and occasionally dangerous—is not purchased for
its own sake but rather as a path toward health. As an
economic good, however, health is ephemeral (10).
Moreover, most purchasing decisions are made not by
consumers, but by payers acting on their behalf. Practically speaking, we cannot buy health but we can buy
health care. Many recent initiatives aim to close this
gap and achieve more health for the health care dollar
(1, 11).
300 © 2015 American College of Physicians
Ann Intern Med. 2015;163:300-306. doi:10.7326/M14-2784 www.annals.org
For author affiliation, see end of text.
This article was published online first at www.annals.org on 11 August 2015.
Payment methods are distinct from payment levels.
Although payment methods certainly affect growth in
spending over time, there are many alternatives for
paying providers for any given level of spending.
(Methods and levels are typically negotiated between
providers and commercial payers and are set unilaterally by government payers.) These alternatives can be
understood as combinations of the 8 basic methods
described in Table 1. The essential difference among
methods is the unit of payment, which divides financial
risk between payer and provider. The methods are presented in order from top to bottom, with financial risk
increasing for payers and decreasing for providers. Although the 8 methods form a continuum, method 4
(per episode) marks the line between epidemiologic
risk (prevalence of medical conditions) and performance risk (treatment of medical conditions).
This taxonomy may increase clarity in clinical and
policy discussions in which participants often use similar terms to mean different things. Here, for example,
“fee for service” means method 6 (per service). The
common use of “fee for service” as the counterpoint to
capitation is imprecise because it comprises methods 4
through 8. The taxonomy also avoids confusing terms,
such as “global” and “bundled” (Table 2).
The U.S. Secretary of Health and Human Services,
Sylvia Burwell, recently crystallized Medicare payment
reform efforts by stating that within 3 years, 90% of
Medicare payments will be tied to quality or value, with
50% of those total payments tied to quality or value
through alternative payment models (11). (The percentages exclude managed care, which accounted for
about one quarter of the $583 billion in Medicare payments in 2013 [23].) Alternative payment models include accountable care organizations, medical homes,
bundled payment arrangements, payment per episode
MEDICINE AND PUBLIC ISSUES
8 Basic Payment Methods in Health Care
Table 1. The 8 Basic Payment Methods in Health Care*
Unit of Payment
Common Term
Examples (Common Classification
Systems)
Comment
1. Per time period
Budget and salary
Typically but not necessarily per year
2. Per beneficiary
Capitation
3. Per recipient†
Contact capitation
Salaried physicians and government
hospitals
Managed care organizations (ACG, CDPS,
CMS-HCC, CRG, and DxCG)
Physician specialist services
4. Per episode
Case rates, payment per stay,
and bundled payments
5. Per day
Per diem and per visit
6. Per service
Fee-for-service
7. Per dollar of
cost
8. Per dollar of
charges
Cost reimbursement
Percentage of charges
Hospital inpatient (DRG), physician surgeries
(RBRVS), home health care (HHRG), and
multiple providers (ECR, ETG, MEG, and
PFE)
Nursing facilities (RUG), hospital outpatient
(EAPG), and ambulatory surgical centers
(APC)‡
Physician services (RBRVS), hospital
outpatient (APC)‡, dentists, medical
equipment and supplies, and drugs
Critical access hospitals, government-owned
providers, and nursing facilities
Any provider type
More commonly used to pay health plans than
to pay individual providers
Not common; an example is a cardiologist
accepting financial risk for treatment of
cardiac patients
Defined here as related clinical services across
multiple days
An outpatient visit may be defined as all
services on 1 day
Separate payments are often made for
multiple services per day
Payers typically pay a percentage of cost as
allowed by the payer
Based on charges as billed by the provider
ACG = adjusted clinical group; APC = ambulatory payment classification; CDPS = chronic illness and disability payment system; CMS-HCC =
Centers for Medicare & Medicaid Services– hierarchical condition category; CRG = clinical risk group; DRG = diagnosis-related group; EAPG =
enhanced ambulatory patient group; ECR = evidence-informed case rate; ETG = episode treatment group; HHRG = home health resource group;
MEG = medical episode group; PFE = patient-focused episode; RBRVS = resource-based relative value scale; RUG = resource utilization group.
* Shown in decreasing order of financial risk borne by the provider or, alternatively, in increasing order of financial risk borne by the payer. The units
of payment correspond to financial risk factors within the health care spending identity, as shown in Table 3.
† A beneficiary is eligible for care, whereas a recipient has received ≥1 service.
‡ In practice, the incentives of the Medicare APC-based method align most closely with payment per day for ambulatory surgical centers and with
payment per service for hospital outpatient care.
(method 4), and capitation (method 2). The descriptions found in Table 2 place examples of current payment reforms within the framework of the 8 basic
methods.
The 8 basic methods are comprehensive and mutually exclusive because each method uniquely corresponds to a risk factor within the health care spending
identity (Table 3). Like other accounting identities, this
identity illuminates the relationship between the whole
and its parts. Using inpatient care as an example, total
hospital charges depend on several factors, including
the number of inpatient episodes, average length of
stay, and hospitals’ markup of charges over cost. In parallel, the 8 basic payment methods include method 4
(per episode), method 5 (per day), and method 8 (per
dollar of charges).
DIVIDING FINANCIAL RISK
Table 3 shows why payers seek payment reform.
For example, when payment is calculated as a percentage of charges— even a low percentage—the payer absorbs the effect of any increase in any of the risk factors
in Table 3. Payers try to buffer themselves from provider decisions about charges and cost, but payers also
mistrust many provider decisions about the volume of
care. They point to an Institute of Medicine panel that
estimated that 14% of U.S. health care spending (or
$340 billion in 2009) reflected unnecessary or inefficiently delivered services (28). In recent years, payers
also have asserted a role in improving the quality and
value of care and cite evidence of systemic deficiencies
www.annals.org
and unflattering comparisons with other nations
(29 –31).
Because very few services are wasteful always and
everywhere, providers presumably are the best judges
of “right care, right time, right way,” so long as they
have the appropriate incentives (32). Thus, Medicare
shifted risk toward providers in 11 of 13 payment reforms since 1983 (Table 4). These reforms have had
broad influence because many payers emulate Medicare (33, 34).
Changes in basic payment methods can have
sweeping effects— both good and bad. In 1983, Medicare inpatient payment jumped 3 steps from paying
according to hospital costs (method 7 [per dollar of
cost]) to paying for diagnosis-related groups (DRGs)
(method 4 [per episode]). Payment by DRG led to decreased hospital costs, shorter lengths of stay, reduced
growth in Medicare payment, and even increases in
hospital margins (the surplus of revenue over costs) as
hospitals became more efficient. This payment change
also accelerated the growth in outpatient and postacute care services, possibly increasing fragmentation
of care (34). In 1992, Medicare moved physician payment from method 8 (per dollar of charges) to method
6 (per service). The change insulated Medicare from
charge inflation but did not protect it from growth in
service volume—both actual and as reported on claim
forms (35). In an 8-year period, Medicare spending per
beneficiary for physician services grew more than twice
as fast as spending for other services and was driven
entirely by growth in volume (36). And in 2000, MediAnnals of Internal Medicine • Vol. 163 No. 4 • 18 August 2015 301
MEDICINE AND PUBLIC ISSUES
8 Basic Payment Methods in Health Care
Table 2. Current Examples of Major Payment Reforms in the United States
ACOs
Although models differ, ACOs generally comprise physicians and hospitals that continue to be paid fee-for-service (method 6) for physician care and by
episode (method 4) for inpatient stays. What is new is that ACOs and payers share savings when total spending falls below benchmarks (12). The effect
is similar to capitation (method 2) in damping incentives for providers to generate more volume. Further, ACOs often must adhere to specific quality
and performance standards.
Medical homes
Medical homes also take many forms, but they, too, are typically paid using previous payment methods. On the basis of performance, they become
eligible for payment adjustments (13). As with ACOs, some medical homes may be paid using capitation or episode payment.
Payment adjustments
These increasingly common initiatives also do not change the basic payment method. Current examples include penalties or bonuses for readmission
rates, adoption of electronic health records, and reporting quality measures (14). Further, MACRA, a new law signed in April 2015, consolidates
physician payment adjustments within a new Merit-Based Incentive Payment System, with details to be specified later (15).*
Bundling
In practice, “bundling” means broadening the unit of payment in 1 of 3 senses: including different provider types (e.g., by requiring ACOs to include
hospitals and physicians); lengthening the time period (e.g., by redefining an inpatient episode to include postacute care and readmissions) (16); or
aggregating services, such as Medicare’s efforts to move its outpatient hospital payment method from a fee schedule (method 6) toward a visit-based
approach (method 5) (17).
Global” payment
Can be a synonym for a fixed budget (method 1) (18), capitation (method 2) (19), or payment per episode (method 4) (20). Because of ambiguity, the term
is best avoided.
Patient cost sharing
Payment methods are used to set the amount “allowed” as total payment to a provider. Payers and patients typically pay a portion of the allowed amount.
Without changing the basic payment method, some payers have restructured patient cost-sharing to incentivize cost-conscious choices (21).
Increased transparency
Leading examples include Medicare’s publication of provider-specific charges and payments for hospital and physician care (22). Although these
initiatives do not involve payment methods per se, the data are published using the units of payment described in Table 1.
ACO = accountable care organization; MACRA = Medicare Access and Children’s Health Insurance Program Reauthorization Act.
* MACRA also encourages movement to alternative payment models.
care’s shift of home health care payment from method
7 (per dollar of cost) to method 4 (per episode) led to
17% fewer visits per episode but similar patient outcomes, which suggests improved efficiency (5).
If the payer can shift risk to the provider, why stop?
Why pay nursing facilities per day when hospitals are
paid per episode? Or why is capitation rarely used to
pay individual physicians? The single biggest reason—
indeed, arguably the single most important statistic in
health policy—is that 5% of persons account for 50% of
spending (37). If the provider bears too much financial
risk, the provider has an overwhelming incentive to
avoid costly patients. This essential tension between efficiency and access is mitigated by classification sys-
Table 3. The Health Care Spending Identity*, Using U.S. Hospital Inpatient Charges as an Example
Risk Factor
2002
2012
Factor Decomposition
Change, %
1. Time period
2. Beneficiaries per time period†
3. Proportion of eligible population that receives care‡
4. Episodes per recipient§
5. Days of care per episode
6. Services per day of care
7. Cost per service
8. Markup of charges over cost
Total charges
1
287 625 193
7.5%
1.69
4.6 d
NA
$1491
2.50
$626 926 866 973
1
313 914 040
7.2%
1.61
4.5 d
NA
$2299
3.54
$1 337 939 745 325
1.00
1.09
0.96
0.95
0.98
NA
1.54
1.42
2.13
0
9
−4
−5
−2
NA
54
42
113
NA = not available.
* An analytic approach developed by the author to enable time-series and cross-section comparisons of financial totals (e.g., charges and payment)
and utilization (e.g., total services). Each risk factor in the identity corresponds to 1 of the 8 basic payment methods. This table uses the growth in
U.S. hospital charges as an example. For 2002, for example, 1 × 287 625 193 × 0.075 × 1.69 × 4.6 × $1491 × 2.50 = $626 926 866 973 (discrepancy
due to rounding). The algebra of decomposing a percentage change can be used to illuminate the reasons behind the growth in charges from 2002
to 2012. In the factor decomposition, 1.00 × 1.09 × 0.96 × 0.95 × 0.98 × 1.54 × 1.42 = 2.13. The author infers that the main reasons for the 113%
growth in hospital charges were the 54% growth in cost per day from $1491 to $2299 and the 42% increase in hospitals’ average markup of charges
over cost from 2.50 to 3.54. Other changes had much less effect.
† The U.S. resident population (24), consistent with the National Inpatient Sample (25).
‡ The U.S. civilian noninstitutionalized population, which equaled 98.4% of the resident population; 7.5% (26) and 7.2% (27) from the Medical
Expenditure Panel Survey were used as proxies for the resident population.
§ Lines 4 to 8 were calculated using data from the National Inpatient Sample. Total discharges from community hospitals were 36 523 831 in 2002
and 36 484 846 in 2012.
 Data were NA for the average number of services per day. Line 7 therefore refers to average hospital cost per day, which comprises the average
number of services per day × the average cost per service.
302 Annals of Internal Medicine • Vol. 163 No. 4 • 18 August 2015
www.annals.org
MEDICINE AND PUBLIC ISSUES
8 Basic Payment Methods in Health Care
Table 4. Medicare Initiatives to Change Basic Payment Methods
Year
Provider Type
Prior Method
New Method
Classification System
for the New Method
1983
1984
1992
1997
1998
2000
2000
2002
2002
2002
2005
2008
2012
Hospital inpatient
Clinical laboratory
Physician
Critical access hospital
Nursing facility
Hospital outpatient
Home health care
Long-term care hospital
Rehabilitation facility
Ambulance
Psychiatric hospital
Ambulatory surgical center
ACO
7. Per dollar of cost
8. Per dollar of charges
8. Per dollar of charges
4. Per episode
7. Per dollar of cost
7. Per dollar of cost
7. Per dollar of cost
7. Per dollar of cost
7. Per dollar of cost
8. Per dollar of charges‡
7. Per dollar of cost
5. Per day
4. Per episode§
6. Per service
4. Per episode
6. Per service
6. Per service*
7. Per dollar of cost
5. Per day
6. Per service†
4. Per episode
4. Per episode
4. Per episode
6. Per service
5. Per day
5. Per day†
Same as prior method except with savings
incentives most similar to method 2
DRG
CLFS
RBRVS

RUG
APC
HHRG
LTC-DRG
CMG


APC

ACO = accountable care organization; APC = ambulatory payment classification; CLFS = Clinical Laboratory Fee Schedule; CMG = case-mix group;
DRG = diagnosis-related group; HHRG = home health resource group; LTC-DRG = long-term care DRG; RBRVS = resource-based relative value
scale; RUG = resource utilization group.
* Physician surgical services are commonly paid per episode.
† In practice, the incentives of the Medicare APC-based method align more closely with payment per day for ambulatory surgical centers and with
payment per service for hospital outpatient care.
‡ Before 2002, ambulance services were typically but not always paid at a percentage of charges.
§ Hospital inpatient.
 Physician and hospital outpatient.
tems that adjust payments for case mix, so payment is
higher for patients who are likely to be more costly.
Table 1 shows common examples, such as DRGs, resource utilization groups for nursing facility days, and
various systems used in capitation payment.
Risk shifting is limited by the state of the science in
risk adjustment. Classification systems commonly used
in capitation models, for example, still explain less than
20% of …
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