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A Modest Proposal On Payment Reform

July 24th, 2009

Editor’s Note: In the post below, Uwe Reinhardt proposes to move from the present, price-discriminatory system of private-sector pricing of health services toward an all-payer system that could serve as a transition to an eventual system based on bundled payments per episode of illness for acute care, or capitation for chronic care.

In a response to Reinhardt’s post, Paul Ginsburg suggests that an all-payer system could apply pressure on providers to contain costs in a “far less radical” manner than the public plan proposed by many advocates of health reform. Ginsburg discusses the success of Maryland’s all-payer system. For a thorough discussion of the Maryland’s regulatory scheme and its results, look for the article by Robert Murray, chair of the Maryland Health Services Cost Review Commission, in the Sept/Oct issue of Health Affairs, to be released Sept. 9.

In my capacity as chair of Gov. Jon Corzine’s New Jersey Commission on Rationalizing Health Care Resources, I had asked two major private health insurers what they actually paid different hospitals for a number of fairly standard medical procedures. The tables reproduced at the bottom of this blog posting exhibit their responses.

These remarkable data should raise two questions in the minds of health reformers. First, what is actually meant by “a level playing field” between the proposed public health plan and private health plans, when there are much larger variations of payment levels within the private sector than there are between the public health programs (Medicare and Medicaid) and the private sector?

Second, should a reformed U.S. health system go forward with this bizarre set of private-sector prices — prices that do not seem to be rooted in relative costs or any other factor besides pure bargaining power among different insurers?

In this commentary I propose a way of simplifying the pricing of health care in the private sector in a way that should (1) substantially reduce the administrative cost of health insurance and (2) also be much more transparent and understandable to all parties in health care, especially in a competitive environment.

The Proposal

Basically, my proposal is to move our health system to a common relative value platform, for at least physicians and hospitals, to be used as a platform for charging all patients. For starters, one could use the diagnosis-related groups (DRGs) and resource-based relative value scale (RBRVS) now used by Medicare as the first-stage relative value scales, which could be refined over time on the basis of either cost or imputed value.

If price competition among providers were desired, one would allow each individual provider to set their own monetary conversion factor for their relative value scale and compete on that simple, one-dimensional price indicator. Employers, insurers, and patients all would be able to understand this price indicator. It would replace the 20,000 or so itemized “charges” (list prices) now in each hospital’s charge master, and the 9,000 or so prices in the physicians’ fee schedule.

One could also, however, have these conversion factors negotiated between associations of providers and associations of insurers with a region (e.g. a state) and make them binding on all providers and insurers in the region, as is now done in some European countries — notably Germany — which operate all-payer systems within regions.

Thus, to do away with the unwieldy and unseemly price discrimination now prevalent in American health care, a physician or a hospital would charge all insurance carriers or patients the same price for identical procedures. The system would work best if there were not a large number of uninsured people and if the public insurance programs — Medicare, Medicaid, and the Children’s Health Insurance Program, or CHIP — were part of the arrangement.


Former Centers for Medicare and Medicaid Services (CMS) administrator Tom Scully described Medicare as a “dumb price fixer.” Perhaps so. One would be hard put, however, to defend the current bizarre private-sector price system that produces data such as those shown in the tables as any less dumb. Dumber might be the more appropriate word.

In their Redefining Health Care (2006), Michael E. Porter and Elizabeth Olmsted Teisberg have remarked on this issue:

Within the private sector, patients enrolled in large health plans are perversely subsidized by members of smaller groups, the uninsured and out-of-network patients. . . . This administrative complexity of dealing with multiple prices adds costs with no benefit. The dysfunctional competition that has been created by price discrimination far outweighs any short-term advantages individual system participants gain from it, even for those participants who currently enjoy the biggest discounts. The lesson is simple: skewed incentives motivate activities that push costs higher. All these incentives and distortions reinforce zero-sum competition and work against value creation (p.66).

The “zero-sum” competition among payers referred to by the authors is a massive and endless game of cost shifting among private payers. It is an expensive game, because every insurer must negotiate these price-discriminatory prices with every provider every year. That administrative expense, which, as Porter and Teisberg note, is unlikely to yield social benefits, could be avoided with a move to the system I propose here — one, incidentally, I had proposed as early as 1993.

Bundled Payments As An Alternative

In the current debate on health reform, payment reform has come to mean “evidence-based case reimbursement,”  a term used by the think tank PROMETHEUS Payment Inc., which is now experimenting with this approach. A more popular term is simply “bundled payments.”
Bundled payments are a great idea. One would hope that, ultimately, most standard, acute episodes of care will be paid for on that basis, along with capitation for chronically ill Americans and some fee-for-service payment for nonstandard cases.

However, rummaging around the Web site of PROMETHEUS Payment Inc. should convince anyone that a wholesale move of the American health care system from the current fee-for-service system to one of bundled payments and capitation will be a long and hard-fought campaign. Not only does it raise a whole host of technical problems of how to calculate the proper bundled payments without incorporating in them an incentive to underserve patients, but it also would trigger vast redistributions of economic and professional power among the providers of health care.

The Advantage Of An Intermediary Step

The scheme proposed here should be thought of as a transition toward bundled payments, but one whose components are in place now. Nothing new needs to be invented. It could be fairly quickly initiated — certainly much, much sooner than a full-fledged system of bundling.

Of course, moving from the current system to the alternative proposed here should be phased in over, say, 4 to 5 years, just as was done with the DRGs in the 1980s and the Medicare physician fee schedule in the 1990s. Once the system is in place, it could be the platform for moving towards bundled payments.  Most hospital episodes would already be bundled substantially though the DRG system. From there it would be relatively easier to incorporate convalescent care or, say, the mainly hospital-based services of radiologists, anesthesiologists, and pathologists. There is no reason to think that the DRG system would stand in the way of further bundling, once the mechanics and politics of it had been worked out. Nor would the scheme proposed here stand in the way of bundling payments for those services that could now be bundled or to apply that method in settings hospitable to it. 

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9 Responses to “A Modest Proposal On Payment Reform”

  1. dhyamamoto Says:

    This proposal is consistent with a recent blog posting I had on the healthcareblog.

    That posting was an excerpt from an essay written for the Society of Actuaries but includes an all payer system that is constructed a little differently and I think could gain greater acceptance in the market than a forced government schedule. Of course, as with anything, it could be viewed as the nose under the tent toward government price control but it doesn’t have to be.

  2. Kenneth Sperling Says:

    As support for Dr. Reinhardt’s concept, I submit the following link to a brief editorial paper about an all-payer system and the positive impact it would have on the current debate. I concur it is a transition step to a more clinically sound reimbursement model, as even a massive health care system needs to crawl before walking.

    Ken Sperling
    Hewitt Associates

  3. Brad Kirkman-Liff Says:

    The idea of bundled budgets has been used in the Netherlands for over a decade to pay hospitals and their affiliated specialists. The competing private health insurers select one insurer to negotiate a global bundled budget with the hospital and the specialists. The insurers then convert this global bundled budget into uniform per admission (for inpatient care) and per service (for ambulatory care) rates. The hospital and the specialists simultaneously negotiate an agreement as to how they will split the budget, with various incentives for quality improvement and improved efficiency. It allows specialists to choose between fee-for-service payment or salaries- depending on the local hospital culture – while promoting hospital-specialist collaboration and establishing an overall budget across all payers.

    It is said among lab scientists that “One month of laboratory work can save four hours of research in the library.” When it comes to health policy, it sometimes seem that we Americans prefer to spend five years doing policy research than spending two weeks looking into the details of how the Europeans operate their systems.

  4. DavidHansen Says:

    An objection that Professor Reinhardt’s proposal faces is that implementing it will drive many providers to drop lines of medical services for which they have high costs. This, however, represents a cleansing process needed in any economic sector, and it should be embraced. In fact it represents the key long term gain, as finally then price mechanisms would work toward driving patients from less efficient providers to the more efficient. This point is discussed in my blog article,

    Another gain of instituting a price control system would be lowering one key source of scale advantage for health plans: the costs of negotiating favorable contracts with providers across a broad network. Thus, the proposed price system would make it easier for small health plans, such as innovative plans put together by primary care physicians or community-based cooperatives, to get established. Competition among health plans would increase.

    In the blog article I propose a price ceiling, rather than an all-payer price system. Each of these policy options has their advantages, and one could conceivably do both (i.e., each provider sets one price per service bundle provided and a ceiling determines the maximum price allowed).

    Thanks Professor for highlighting price reforms, the less discussed half of steps needed for controlling medical costs.

  5. henry.dove Says:

    I am a “newbie” to blogging; however, I agree completely with Prof. Reinhardt’s modest proposal.

    CMS’ provider payment systems are well-researched, and I admire their determination to constantly improve them. On the other hand, in most instances, private insurers have adopted a hodgepodge of payment systems that are illogical, confusing to consumers, and expensive for providers and payers to administer. If you don’t believe me, take a look at the inane ways that ambulatory surgery center rates are negotiated! The APCs (ambulatory patient classifications) are not perfect, but they are an enormous improvement over the previous system. Ditto for RBRVS–does anyone remember the horrible system insurers used before 1990?

    The idea of a “single payment” {as opposed to a single payer} system would have the potential to save billions of dollars in administrative costs. In a single payment system, negotiations between providers and insurers would be greatly simplified. Instead of fiddling with payment amounts for various CPT codes or per diem rates, the negotiations would be over a single number: the conversion factor.

    One huge advantage to providers would be that with a standardize payment system, assuming the relative weights accurately reflect the average resources used for a given service, providers would no longer have to be concerned whether payment for a patient’s care is paid on the basis of discounted charges or DRGs. He/she could focus on taking care of the patient in the most efficient way. Similarly, home health agencies wouldn’t worry about whether they are paid on a per-visit or HHRG basis; they would given incentives to treat the patient most efficiently.

    A single payment system would save insurers an enormous amount of time currently devoted to keeping track of various payment methods for different health plans. The administrative backroom costs in physicians’ offices, hospitals, ambulatory surgery centers and SNFs almost certainly would be reduced.

    A single payment system would require continued research, using large datasets, to improve and refine them. CMS would continue to play an important role, but the Standard Analytic Files that currently are available for Medicare patients should include data from insurers.
    Henry G. Dove, Ph.D.
    Casemix Consulting, LLC
    Lecturer, Yale Health Management Program

  6. acavale Says:

    I agree with each of the comments above. Prof. Reinhardt unfortunately addresses the problem from a purely economic angle (as one would expect him to) while minimizing the clinical and logistical aspects. From a practicing solo physician’s perspective, his proposal is very daunting, because it will very likely lead to the demise of the small practice, primarily because of the inability of small practices to have the resources to engage in such intricate rate-setting and collection processes. It is clear to me that economists and the government have absolutely no interest in helping small medical practices thrive in a “new system”.

    The most workable plan would be the one that simplifies the financial transaction required to pay for medical services, as well as provides full transparency. As far as regular office-based medical services are concerned, it is best to promote direct contracting between provider and consumer of services, namely physician and patient, respectively. This allows the consumer to make the choice of how to value care provided by any particular practice. Insurance plans that cover all office-based care (public or private) and allow for various levels of care, with or without deductibles, should be made available, premiums for which should be 100% tax-deductible. Hereby, each individual or family can decide what type of coverage best suits their needs. In addition, insurers/govt. should offer plans to cover medications, hospitalizations, laboratory/imaging services, which individuals/families can purchase either packaged with a basic plan or separately, based on their needs. This is the only way to ensure that consumers have a real choice of plans as well as physicians/hospitals/labs/imaging services, without unnecessary interference in clinical decision-making, that has completely decimated the patient-physician relationship.

    Use of associations, etc as intermediaries will not solve the problem, as this would force physicians and/or hospitals to join associations that may not in their best interests, and would add another layer of bureaucracy to the process.

    To simply say that cost for a particular procedure should be similar at different locations/institutions is like saying that the Ritz Carlton and Motel 6 located in the same state should have the same price for a night’s stay in a room with a queen bed. If only Mr. Reinhardt can extricate himself from his biases against a free market system in the health care universe, he could understand the analogy. Please provide adequate information/education and transparency to the consumer, so he/she can decide how much value he/she places on a particular type of medical care he/she receives.

  7. Greg Pierce Says:

    A Public Plan with a Twist: AHIP’s New Drink?

    Doctors don’t like a public plan because it will reduce their fees. They’re right. The same goes for hospitals. A public plan will reduce the fees paid to a lot of healthcare providers. So I understand why doctors and hospitals oppose a public plan, if they’re worried about fees. (The impact on income is less clear: if we succeed in reform, there will be an additional 50 million people calling for appointments and ordering refills.)

    What I don’t get is why America’s Health Insurance Plans (AHIP) is still fighting a public plan. Why not simply support a public plan on the condition that private insurers also have access to the public plan’s payment levels? That would be an “all-payer” system, where each insurance company pays the same amount to a given provider. This does not mean that all providers are paid the same; just that any specific provider is paid the same amount by each health plan. Some hospitals might be paid more than others, and some physicians more than others – reflecting deliberate decisions to compensate some more than others. The only difference between today’s world and an all-payer world is that in an all-payer world, everyone gets to have a seat at the table when healthcare prices are discussed.

    Rates would be set annually, by public-private entities at the state and local level, and would apply to hospitals, physicians, and outpatient services. These Regional Healthcare Pricing Councils (RHPCs) would be governed by a balanced cross-section of purchasers, patients, and providers, and could in theory be integrated into the function of an exchange, cooperative or a public plan. The RHPCs would also be authorized to establish the underlying basis of payment, whether hospital stay, office visit, bundled service, or episode-of-care. The RHPCs would NOT be authorized to sell insurance, provide healthcare services, or engage in any business-related activity.

    This would accomplish a great many good things. First, all-payer rates simplify enormously the billing and collection processes, savings tens of billions of dollars annually as health plans employ fewer claims processors and price negotiators, doctors need fewer billing staff, and hospitals’ accounting offices are downsized.

    Second, all-payer rates enable the rapid implementation, modification, and refinement of payment models that encourage efficiency, quality, and care coordination, consistent with local market conditions. Under the current arrangement, doctors and hospitals face a bewildering array of payment incentives, rewards, and penalties. An all-payer system translates the Tower of Babel faced by providers into a single set of incentives and rates; regional commissions assure that local issues – struggling hospitals, an abundance of a particular specialty, etc. – are reflected in the local payment system.

    Third, we’re spending too much on healthcare, and one reason we spend too much is that a “unit” of U.S. healthcare costs too much. A day in the hospital, a visit to a doctor, and a pill each cost more in the United States than anywhere else in the world. The RHPCs will establish locally-sensitive, transparent and participatory processes to set all-payer rates, and arrive at fair — but not “too fair” — payments for a “unit” of healthcare. Providers could be differentiated using market forces by allowing plans to set differential copayment/coinsurance levels, incenting patients to seek out efficient providers

    Fourth, our current system has failed the basic test of a marketplace: the ability to satisfy consumer demand. Our approach to setting healthcare prices has created huge, intractable, and damaging shortages and unexplainable variation in healthcare spending. We have nowhere near as many primary care physicians, general surgeons, and gerontologists as we need today – much less a decade from now. It’s no accident that these are three of the least-well compensated specialties in American medicine. We have more imaging machines per capita than anywhere in the world by a factor of ten. Our current price-setting approach to setting prices has some hospitals building multi-billion dollar expansions, while others have fewer than 5 days of operating cash on hand. We’re getting irrational results from irrational prices. At this point, any change is preferable to the status quo.

    Finally, our current system has left us with the worst of both worlds. On one side, Medicare manages its budget by squeezing on price, and providers have the well-documented incentive to increase volume. On the other side, private plans often lack price-setting leverage, and try to decrease volume. The provider and the patient are caught in the middle. All-payer takes the issue of price off the table, and enables the comprehensive introduction of new models to pay providers on the basis of a single, consistent payment system that rewards value over volume.

    Private insurance plans continue to oppose a public plan, which is understandable if they are to be relegated to a permanent second place. From a business perspective, the argument against a public plan – even if private plans have access to the public plan rates — is that today, it would set doctor prices; tomorrow insurance premiums. Premium controls turn health plans into regulated utilities, with little incentive for profit and innovation, or so the argument goes.

    It’s possible but unlikely. It’s far more likely to result in a new burst of innovation, competition, and business opportunity as the insurance sector sheds its old business model of negotiating thousands of complicated contracts and employing tens of thousands of claims processors. Look abroad in the many European states that embrace an all-payer model, and where health insurance companies compete vigorously and reap the rewards of competitive excellence. A regionally-based, all-payer rate setting system would free doctors, hospitals, and yes, AHIP’s members, to re-direct their creativity, capital, and profit-maximizing energy to producing something of real value: a new healthcare system.

  8. agosfield Says:

    As the Chairman of the Board of PROMETHEUS Payment Inc., and a member of the Design Team which has worked since December 2004 to create our model, I am pleased that Professor Reinhardt is following our work, but I think he may be one lap behind. In fact, the creation of a model which could create Evidence-informed Case Rates, severity adjusted in real time, scored for quality performance and allocated across otherwise independent providers was complex, But that work is done. I commend our newsletters on the website at, for stories of the operation of the program on the ground in the real world. The program is now being implemented in four formal pilot sites and other informal tests of the concepts.

    I take issue with a few of his characterizations. The design is not about bundled payments; it is about bundled budgets. It works for integrated settings and completely independent provider contexts. it is about clinical collaboration among them. It expects a cooperative undertaking by willing payors and willing providers, The conceptual breakthrough of identifying monies currently being spent on Potentially Avoidable Complications and giving half of it to providers to change their behavior and prevent some measure of admissions, services, and drugs which might have been unnecessary if care were rendered in accordance with science, can be the basis for sustaining the medical home. On our home page readers will find the three foundational papers which explain the creation of the rates, how they are scored, and how they can be used to pay for the medical home. There is no question that particularly for chronic conditions, the PROMETHEUS Payment model will provide significantly more money to physicians than they are currently paid today. And with that money they are expected to change how they deliver care so as to avoid complications. Even with that change, the system would save half of what is being spent today on those complications. We do not anticiapte ‘vast redistributions’ of power. We do anticipate a less antagonistic, more collaboratively oriented setting in which patients, providers and payors all will do better. Perhaps that might be said to represent a substantial reorientation from business as usual. We certainly hope so.

  9. HaroldDMiller Says:

    Uwe Reinhardt’s post shows the tremendous variation in the amounts a single insurer pays to different providers for the same procedure. But there is an equally serious problem that the tables don’t show – each of the individual providers likely receives very different payments for the same procedure from different payers, and even different payments from the same payer depending on which specific insurance plan the patient is covered by. These widely varying and secret “discounts” force providers to spend considerable resources on contract negotiations and cost-shifting to achieve adequate reimbursement, rather than focusing on finding ways of improving quality and efficiency.

    For payment reform to be successful, setting the right payment amount (i.e., the price) is as important as using the right payment method. Even with better payment methods like episode-of-care payment, if the payment amount is too low, providers will be unable to deliver quality care, and if it is too high, there is no incentive to seek out efficiencies. Different price-setting approaches will likely be needed in different regions and for different providers and services depending on the local market structure. (See “From Volume to Value: Better Ways to Pay for Health Care,” forthcoming in Health Affairs, and “Setting Payment Levels,” available at

    The State of Minnesota is already pursuing something similar to what Professor Reinhardt suggests in order to move away from administered pricing systems and secret discount negotiations for services where competition is possible. In May of 2008, the state passed legislation requiring the development of clear and uniform definitions for “baskets of care” (these are the same concept as what are more commonly called episodes of care) and a transparent pricing structure for them. Through the leadership of the Institute for Clinical Systems Improvement (ICSI), seven baskets of care have been identified (asthma, diabetes, low back pain, obstetric care, preventive care for adults, preventive care for children, and total knee replacement), and the definitions are currently being finalized. Under the legislation, a hospital, physician, or other provider which chooses to offer these baskets of care can set their own price for the services, and all commercial payers and self-insured individuals who choose to use that provider must pay the same price. More information about the initiative is available on the websites for the Minnesota Department of Health ( and ICSI (

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