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Pondering the Psychology of Incentives in Bundled-Payment Contracts

July 27, 2018
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Healthcare policy researchers, in an op-ed piece in the Health Affairs Blog, ponder the differences between prospectively and retrospectively based bundled payment incentives

A fascinating analysis of the trade-offs involved in different forms of incentivization appeared late this spring in the Health Affairs Blog, concerning prospective and retrospective financial incentives. Could the difference between the two make a real difference in how the payers and purchasers of healthcare stimulate the best behavioral outcomes from the providers of healthcare? The question is a very complex and nuanced one, and ultimately, the blog’s authors reach no firm conclusions either way. But pondering the different elements and possibilities is certainly a worthwhile exercise.

Under the headline, “When Designing Bundled Payments, Don’t Ignore the Lessons of Behavioral Economics,” Jeroen Struijs, Arthur Hayen, and Koen van der Swaluw, begin their analysis by stating that “In health care, all bundled payment models shift financial and clinical accountability to a single provider-led entity that then is responsible for a budget and the quality of care delivered for any given episode. The entity receiving the bundled payment earns a higher margin if a patient has fewer expenditures but also bears the financial risk of (re)admissions and complications. This payment model therefore produces an incentive for providers to coordinate care across settings and not to stint on needed care. When implementing bundled payment models, payers and providers can choose two main strategies regarding the payment flow, namely a prospective payment (which is made before services are rendered) or a retrospective payment (which is made after all services are rendered).”

Continuing on, they write, “Currently, there is ongoing debate about which payment strategy to follow. In a June 2017 Health Affairs Blog post, François de Brantes and Suzanne F. Delbanco stated that the difference between retrospective and prospective payments is not significant in practice. Paraphrasing their line of reasoning, the difference between the two is believed to vanish as retrospective payments are often based on upfront, negotiated benchmarks as well. The authors continue by saying that people’s “aversion to losses” would make a case for including downside risk to retrospective bundled payments, as a way of mimicking the incentives that follow from prospective bundled payments.”

But, these authors beg to differ on that point. “The universal lessons of behavioral economics have taught us otherwise, namely that people’s aversion to losses is precisely the reason why an upfront, negotiated benchmark is not the same as a prospective payment,” they write. “What is more, assuming downside risk in a retrospective payment arrangement will lead to different physician behaviors than when these physicians would assume full financial accountability for managing a prospective bundled payment. Understanding the difference in reference points under different payment strategies and their expected consequences for provider behavior is crucial in this discussion. As we will show, behavioral economics can be a useful paradigm for thinking about the behavioral implications of different payment strategies.”

For evidence to support their contentions, the authors dip into “prospect theory,” noting that prospect theory is “a descriptive model of decision making, which acknowledges, in contrast to conventional economics, that people respond to changes in wealth, instead of expected final assets. These changes are evaluated in relation to a neutral reference point (the status quo). Therefore, the same level of wealth can feel like poverty to a previously rich person and feel like riches to a previously poor person. In prospect theory, the status quo serves as the zero point of the value scale. Outcomes that are better than the status quo are perceived as gains. Worse than the reference point, they are losses.”

So how might prospect theory apply with regard to stimulating the “correct” behaviors and actions among providers, in bundled payment systems? Here’s an experiment with implications for healthcare payment. “Losses are more painful than forgone gains, and whether something feels like a loss or a gain depends on our point of reference,” the authors write. “As a consequence, people systematically assign higher value to things they own than to things they can acquire: the endowment effect. The primary effect of endowment is not the increased appeal of money in our pockets but merely the pain of giving it up. The endowment effect and accompanied loss aversion have been leveraged by behavioral economists to bolster the impact of incentives. For example, in one experiment, Mitesh S. Patel and colleagues paid a group of employees $1.40 each day they achieved the goal of walking 7,000 steps. Another group of employees was instead allocated upfront the maximum attainable monthly amount ($42) as a prospective payment; the researchers then took back $1.40 each day that the goal was not achieved. While the incentive was identical in economic terms, only participants in the loss-incentive group outperformed the control group and also had a 10 percent higher chance of achieving their daily step goal than participants in the gain-incentive group.”

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