Theory and Practice in the Design of Physician Payment Incentives

TLDR

Combining principal‑agent theory with marketplace innovations reveals how physician payment methods have evolved, highlighting the flaws of fee‑for‑service and capitation. Payment innovations that blend fee‑for‑service, capitation, and case rates can preserve advantages while attenuating disadvantages. These innovations include capitation with fee‑for‑service carve‑outs, department budgets with individual fee‑for‑service or contact capitation, case rates for defined illness episodes, and are embedded in contexts featuring non‑price mechanisms such as screening, monitoring, employment, and ownership. The analysis has implications for health services research and public policy regarding physician payment incentives.

Abstract

Combining the economic literature on principal‐agent relationships with examples of marketplace innovations allows analysis of the evolution of methods for paying physicians. Agency theory and the economic principles of performance‐based compensation are applied in the context of imperfect information, risk aversion, multiple interrelated tasks, and team production efficiencies. Fee‐for‐service and capitation are flawed methods of motivating physicians to achieve specific goals. Payment innovations that blend elements of fee‐for‐service, capitation, and case rates can preserve the advantages and attenuate the disadvantages of each. These innovations include capitation with fee‐for‐service carve‐outs, department budgets with individual fee‐for‐service or “contact” capitation, and case rates for defined episodes of illness. The context within which payment incentives are embedded, includes such nonprice mechanisms as screening and monitoring and such organizational relationships as employment and ownership. The analysis has implications for health services research and public policy with respect to physician payment incentives.