Topic 9: Health Care Funding

Funding and RemunerationFunding and Remuneration concerns the way that

money is allocated to organizations and providers in exchange for health care services

Funding:allocating money to organizations

Remuneration:allocating money to individuals

Payment: a term applying to both “funding” and

“remuneration”

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Importance of Health Care FundingFunding influences system performance because the

chosen funding methods create financial incentives regardingwho provides serviceswhat services are providedthe quality of the services providedwhere services are providedto whom services are provided

Designing funding schemes that encourage efficiency in the production and distribution of health care services has consequently been a central concern of health economics and health policy.

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Important Policy Trade-OffsIn FINANCING we trade off between:

Insuring against risksVERSUSAvoiding moral hazard

In FUNDING and REMUNERATION we trade off:Productive efficiencyVERSUSAvoiding strategic selection

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Insurance benefits people by reducing risk but creates problems of moral hazard

In this topic we will discuss how payment schemes that encourage efficiency also create chances for health care providers to act strategically (which may ultimately result in sub-optimal HC treatment)

Principal-Agent FrameworkMost of the design of funding schemes in health economics

relies on a more general framework of economic problems called “Principal-Agent” models

The principal-agent framework describes a situation in which an individual (the principal) would like to accomplish some task or goal but must contract with another individual (the agent) to do the work required

This is common in the everyday workplace: A firm seeks to maximize profits, yet must hire employees without knowing for certain their abilities or the level of effort expended

For health care funding, the principal is usually a public/private insurer and the agent is a provider (hospital or physician). The funder wants a provider to efficiently meet the health care needs of beneficiaries. 5

Payment/Funding Scheme

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Describes the “who, what, when, where and how” of a funding or remuneration policy

For analytic purposes, we distinguish three parts:Participants: Who pays whom to care for whom?

This includes parties to the exchange/transfer of funds (ex. government, insurers, providers, health care organizations, beneficiaries/patients etc.)

Services and activities: What is being paid for? Can range from a narrow subset of services (ex. only drugs) to

a broader basket including primary care and non-care activities such as risk-bearing

Payment/Funding Mechanism: How is it paid for? Refers to the methods by which funds are transferred between

participants in a funding scheme

Common Scheme ExamplesThe funding scheme indicates who has financial incentive to

do what in the health care systemFunding primary care through a system where a physician

receives a payment each time they provide a reimbursable service (called fee-for-service payment) encourages the provision of care listed in the fee schedule and discourages the provision of care not explicitly defined in the fee schedule

The incentives change if this scheme were replaced by a capitated system in which the provider receives a fixed sum of money each period per patient enrolled in the practice (regardless of if or how much they seek care), with the responsibility to meet all defined health care needs of the enrollees . There is now an incentive to minimize the provision of unnecessary services and to increase the provision of preventive services that will reduce future need for care 7

Financial Intermediaries are…Organizations that collect money and pay for health

care services on behalf of beneficiariesEx. Governments (Federal, provincial ministries etc.)Ex. Insurance CompanyEx. Charitable Organization

Note: Intermediaries are not always present. For instance when purchasing health care goods/services that are not covered by private/public insurance, ex. crutches, chiropractor services, etc. (or for most other out-of-pocket medical expenses).

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Beneficiaries are…Individuals who receive the health care services paid

for under a payment schemeEx. patients covered by a health planEx. patients of a health centre or clinicEx. cash paying patientsEx. residents of a province

The key is that each payment scheme must properly specify who the potential beneficiaries are

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Providers are…Whomever it is that can (or must) provide care in

exchange for paymentEx. Individual professions (physicians etc.)Ex. Groups of professionals (organizations, companies,

hospitals etc.)They may range in sizeThey may be private or public, for-profit or not-for-

profit (we will discuss these alternative in the next topic focusing on health care suppliers)

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Funding Flow Diagram

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U.S. or Canadianuninsured health services

U.S. health servicesthrough private insurerwith co-payments

Canadian health servicesthrough federal andprovincial governments

(Private Insurer)

(Federal gov’t)

(Provincial gov’t)

Funding/Payment MechanismsWhat is paid for, and how?The “what” in this definition may include health care

procedures, products, administrative services, risk-bearing responsibilities, etc.

The “how” relates to financial terms of the contract. It includes timing of payments, fees per unit of services, limits on total payment, duration of contract, etc.

A relatively small set of funding mechanisms dominate in health care, but no one single mechanism is used for the whole of a health care system

Details of each type of payment mechanism will be given in the following slides…

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Prospective vs. Retrospective PaymentsProspective Payments: Terms of payment

determined before service deliveryHigher degree of prospective payment means more

financial risk born by the provider not the funderWill minimize cost of components paid for on a

prospective basisRetrospective Payments: Terms of payment

determined after service deliveryHigher degree of retrospective payment means more

financial risk born by the funderWill maximize volume of services paid for on a

retrospective basis13

Very important since the provider might not be able to handle the risk and may try to avoid this risk

Payment by “Fee-for-Service” (FFS)The provider or organization is given a fixed amount of money

for each unit of a service that they provideFees are only given for specified services (different fees for

different services)The fee per service is pre-determined (in a “fee schedule”)Total payment depends on the number of services renderedIt is for funding or remunerationMostly a retrospective payment system

It creates an incentive for providers to produce each service rendered in the least-cost way (since the difference between the fee and their costs determines their income/profit)

Paying Fee-For-Service biases providers toward inefficient over-provision of reimbursable services and under-provision of services not listed in the fee schedule 14

Historically dominated funding for physician services in Canada, France, Australia, Germany and other countries although its role is diminishing

Payment by CapitationThe organization/provider receives a fixed sum of money per period

for each individual (enrolled) under its careFee is for all “covered services” required by persons under care in

the periodThe fee per person per period is pre-determinedTotal payment depends on the number of persons on the “roster”

(enrolled with the provider/organization) regardless of their utilization or number of visits/services needed

It is for funding or remunerationMostly prospective payment

The capitation payment is usually risk-adjusted to reflect the differing needs of individuals (age and sex risk classes are common factors)

It creates incentive to under-provide care (called “skimping”) and to engage in risk selection to attract relatively low-risk, healthy individuals within each risk class 15

Dominates for primary care in the U.K. and is growing in Canada

Payment by Case/DiagnosisThe provider or organization receives a fixed sum of money

each time they treat a case of a particular diagnosis (ex. treat a case of appendicitis)Payment is for all services required to treat diagnosisThe fee for each case is pre-determinedTotal payment depends on the number of cases treatedIt is for funding or remunerationCombines prospective and retrospective payment terms

It gives incentive to produce services in the least-cost manner and to provide only necessary services

It also creates incentive to under-treat patients, to select only the less severe cases within a diagnostic category, and to strategically classify diagnoses so as to maximize payments 16

Primarily used for funding U.S. hospital care, where a case is defined as a hospital admission and the payment varies according to the diagnosis of the individual admitted

More on Case/Diagnosis: DRGs/ACGs/ADGsIn order to fund providers based on the thousands of diagnosis

of each case admitted, individual diagnoses are put into groups with other diagnosis which tend to cost the same to treatDiagnosis-related groups (DRGs) are a patient

classification scheme based on demographic and diagnostic characteristics used in Case/Diagnosis based funding schemes (based on past doctor/hospital records of patient)

Researchers at Johns Hopkins have developed a DRG system that most believe best captures the costs of patients with complex case-mixes (multiple co-morbidities)Adjusted Clinic Groups (ACGs) (93 mutually exclusive

groups) Aggregated Diagnosis Groups (ADGs) (32 independent

ACG building blocks) 17

More on ACGs and ADGsACGs: Adjusted Clinical Groups ACGs assign a person to unique morbidity category based on

patterns of disease and expected resource requirements. A person falls into one of 93 mutually-exclusive ACG health status categories based on a combination of ADGs, age, and gender

ADGs: Aggregated Diagnosis GroupsACGs are based on building blocks called ADGs. Each ADG

is a grouping of diagnosis codes that are similar in terms of severity and likelihood of persistence of the health condition over time. All ICD-9 diagnosis codes assigned by doctors/hospitals are assigned to one of 32 ADGs. A person may have multiple ADGs.

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ACG examples: ACG0200 is “one or more acute minor conditions only: age 2-5” while ACG1732 is “pregnant, not delivered, with 2-3 different ADGs, of which one or more is a serious or major condition”

ADG examples: ADG14 is “chronic, stable medical conditions” while ADG22 is “recurrent or persistent, unstable psychosocial conditions”

Payment by Global BudgetThe organization is provided a fixed budget for a

given periodThe budget size is pre-determinedBudget size is the total paymentBudget comes with some pre-specified expectationsIt is for funding onlyMostly prospective payment

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In Canada it has historically been the dominant way to fund hospitals.

Payment by Salary and WageSalary: The provider receives a fixed sum of money for

a given periodWage: The provider receives a fixed sum of money per

hour workedThe salary/wage-rate is pre-determinedThe salary/wage comes with pre-specified expectationsTotal payment is equal to either the salary or wage times

hours workedIt is for remuneration onlySalary is mostly a prospective paymentWage has elements of both prospective (wage element)

and retrospective (hours worked element) payment 20

Common for hospital doctors in the U.K.

Bonus or Incentive PaymentsManaged care organizations in the U.S. often use

bonus payments to encourage lower-cost utilization patterns among affiliated providersphysicians who’s utilization rates fall below a target

receive a bonus paymentMore recently, bonus payments have been advocated

as part of performance-based payment schemes to improve quality of careBonus for providers using effective techniques (ex.

prescribing beta-blockers to post-heart attack victims)Bonuses for providers located in rural locations where

supply is needed (ex. Northern Ontario)21

Sometimes called “Performance-based payments”

Physician Payment BreakdownSource: Kantarevic (2010)

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A Model of Health Care Costs

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Selection vs. EfficiencyFunders face an efficiency-selection trade-off:

A fully retrospective system of payment encourages inefficient over-provision of services but provides little incentive to engage in risk selection and care skimping

A fully prospective system of payment discourages inefficient over-provision but provides incentive for risk selection (cream skimming and dumping [devising polices that discourage bad risks]) and care skimping

In the face of this trade-off, blended funding approaches maybe optimalUnder blended funding a provider’s total funding

comprises a mixture of payment mechanisms, with the goal of optimally balancing the contrasting incentives

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Pro: Avoids selection problems

Pro: Is efficient

Risk AdjustmentIncentives for strategic response by providers stem from

variability in patient-specific costs that are not reflected in prospective payment rates.

To reduce this incentive, efforts are made by the funder to adjust payments (e.g., capitation payments) to reflect the health status of individuals.

Variables used to adjust risk must beobservable by the financial intermediarypredictive of expected health costsnot “gameable” by providers

Some common risk adjustment variables are Age and Sex (these are used in Canada) but Diagnoses (DRGs/ACGs/ADGs) are popular in the U.S. (in some sense DRGs may be “gameable”)

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“Gameable” means that the variable is under the control of the provider. When this happens the provider can strategically manipulate the variable to increase payments received

Questions for Optimal FundingBalance prospective and retrospective payments Ensure that those who bear risks can pool them

effectively (i.e. do not put unfair amounts of risk on individual doctors)

Ensure that the administrative and managerial capacities required to run the payment system effectively are available

Ensure that the payment mechanism matches the context

Minimize the scope for self-interested strategic or manipulative responses by providers

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Self-interested Strategic ResponsesIn addition to over-provision under FFS and risk

selection under capitation there are two other important strategic responses that providers can have:

Strategic up-coding to garner more payment than is appropriate (ex. in FFS, billing an intermediate assessment rather than a minor assessment; in case-based funding, choosing the diagnostic category that will maximize the reimbursement amount)

Strategic referral patterns (ex. when capitation applies to primary care only, a primary care physician can more frequently refer a patient to a specialist, shifting the costs on to separate funding stream)

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Because it is impossible to remove all incentive for strategic responses, development of effective monitoring mechanisms that dissuade providers from responding to those incentives is crucial

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