Alternative Payment Models in Healthcare

U.S. healthcare spend reached $4.5 trillion in 2022—making it account for a staggering 17.3% of the country’s gross domestic product (GDP), the Centers for Medicare and Medicaid Services (CMS) reports. And this number is rising rapidly: CMS predicts annual healthcare spending will outpace average GDP growth, increasing by 5.4% each year between now and 2031.

Why are employers and Americans alike shelling out so much for medical procedures and services? Inflation isn’t the only thing to blame—more complex and chronic conditions and the coinciding treatment costs are driving up overall costs, along with inefficiencies driven by the traditional fee-for-service healthcare model.

The good news: Alternative payment models (APMs) can help combat this issue by improving patient experiences while simultaneously decreasing costs for those receiving care.

We’ll get into how, but first, let’s talk about why fee-for-service healthcare isn’t working.

What is fee-for-service, and why is it a problem?

Fee-for-service (FFS) is a payment model in healthcare where a patient and/or their health insurance company is billed for each service provided, be it a scan, test, prescription, office visit, hospital stay, or surgery, “with no adjustments allowed for the quality and/or value of care provided,” as CMS puts it. With this, healthcare providers are incentivized to focus on quantity rather than quality in treatment—after all, more procedures equals more money.

Of course, sometimes it’s necessary for a physician to take several different steps to achieve a positive outcome. However, many times doctors motivated by FFS ignore other options—such as waiting it out or taking a more conservative approach—in favor of volume of services, to the potential detriment of their patients. Take back pain: Surgery is one option, and certainly a pricey one, but many people would benefit much more from alternatives, such as physical therapy or cognitive behavioral strategies.

A 2023 medical trends survey conducted by Willis Towers Watson found that overutilization of care is a key cost driver for three out of four insurers. Other researchers estimate that the U.S. wastes up to $101 billion a year in overtreatment.

Doctors, too, agree that clinical waste is a problem.

In a 2017 survey, around 71% of participating doctors believed that those in their field were more likely to perform unnecessary procedures when they profit from them, and the majority of respondents also said de-emphasizing FFS compensation would reduce healthcare costs.

What are alternative payment models?

Alternative payment models are a component of value-based care; these types of payment models are driven by the quality of services provided, rather than quantity. In other words, practitioners are incentivized and paid to help patients in the best and most efficient way possible and to partner with other physicians when advantageous.

Beyond the obvious perk of better outcomes for patients—someone with back pain, for example, avoids an expensive, cumbersome, and possibly painful or debilitating surgery—alternative payment models can also reduce health disparities for marginalized communities by holding healthcare providers accountable for prioritizing individual patient outcomes over profit. Most importantly, they can decrease unnecessary and wasteful spending.

Where and when did alternative payment models originate?

You can thank CMS for alternative payment models in healthcare. In 2005, while under the George W. Bush administration, CMS launched the Medicare Physician Group Practice Demonstration Project, which then became the Medicare Shared Savings Program (MSSP), permanently authorized by the Affordable Care Act in 2012.

To participate in the MSSP, healthcare providers must join or create an Accountable Care Organization (ACO) to collaborate with other healthcare providers to ultimately deliver high-quality, coordinated service while managing associated costs. When participants succeed in both these areas, they’re eligible to share savings, also called performance payments.

While alternative payment models have mostly existed in the Medicare and Medicaid space since the MSSP was founded, in recent years they’ve begun making their way into commercial health insurance. (More on that below.)

What are the types of alternative payment models?

Alternative payment models come in several shapes and sizes, most of which utilize FFS in combination with other methods:

• Pay-for-performance (P4P): Fee-for-service is the foundation of this alternative payment model, but providers can be penalized for low-quality performance and receive bonuses for high-quality performance.
• Shared savings: Shared savings utilize FFS in the sense that services are itemized. However, if the healthcare provider keeps medical costs below expectations and meets standards for quality of care, they’re able to retain some or all of the savings—determined via a “shared savings ratio.” Alternatively, if they increase costs, they may owe back those losses.
• Shared risk: Shared risk uses a “liability ratio” to determine how much a provider owes based on how much they go above expected medical costs pre-determined by the payer, along with the quality of their treatment. This can be all or a portion of the difference.
• Two-sided risk sharing: In two-sided risk sharing, providers must agree to share in any savings and cost overruns with the payer, which factors in quality of care as well. Some research has found that this method can have the greatest impact when compared to others.
• Capitation or population-based payment: With capitation or population-based payment, FFS is not used, but rather payments are fixed for each patient over a specific time period, and paid in advance to the provider. This can take the form of a “partial capitation,” where you pay for a set of services, or a “full or global capitation,” where you pay for all services rendered. The provider is then responsible for all or most losses above the amount, and retains all or most of the savings below the amount, with adjustments for quality of care.

What strategies incorporate alternative payment models?

The following value based care strategies utilize APMs:

• Accountable Care Organizations (ACOs): As mentioned above, ACOs, consisting of groups of doctors, hospitals, and other clinicians, hold themselves accountable for costs and quality of care over a specific time period, either receiving shared savings when they reduce expenditures or covering shared risk when they increase spending.
• Bundled Payments: Bundled payments put all costs—from diagnosis to recovery—under one fee, simplifying the process but putting providers at risk to bear the losses if costs exceed the set price, or if quality is below the set standard.
• Primary Care Medical Homes (PCMHs): With Primary Care Medical Homes, primary care providers are monetarily incentivized to take a team-based approach with other providers, with each one incurring losses or savings depending on the quality of their care and low or high costs.

Where are alternative payment models in the commercial sector?

Luckily for both patients and employers, over the past several years the commercial sector has started to follow CMS’s lead in prioritizing and promoting value-based care—and in turn, changing how healthcare is paid for and delivered for the better.

In Michigan and North Carolina, for example, Blue Cross Blue Shield initiated programs to tie payments to quality of care in hospitals and primary care practices. This is great news, considering commercial insurance spending is growing faster than individual spending for Medicare and Medicaid.

That said, private companies are still lagging behind in the adoption of alternative payment models: A 2023 analysis from the Health Care Payment Learning and Action Network found that 34.6% of commercial sector payments were alternative payment models or advanced APMs, compared to 40.2% in Medicaid, 48.9% in traditional Medicare, and 57.2% in Medicare Advantage. The appeal and legacy of FFS, complex nature of and risks associated with alternative payment models, and lack of reliable decision-making tools and infrastructure continue to hold many providers back.

In 2022, 70% of workers had access to employee-sponsored healthcare programs, and 66% of those workers participated in the benefit, according to the U.S. Bureau of Labor Statistics. With tens of millions of Americans relying on the commercial sector for screenings and treatment, pushing for value based care is all the more important. And if we want to reduce overall healthcare spend, we need businesses on board with alternative payment models. When quality is at the forefront of patient care, ultimately, everyone wins.

The information contained on this page is for informational purposes only. No material is intended to be a substitute for professional medical advice, diagnosis, or treatment.