Major Healthcare Reimbursement Models

Why This Matters

Healthcare reimbursement models are the financial engine driving every clinical decision, hospital strategy, and patient outcome in the U.S. healthcare system. You're being tested on your ability to understand how payment structures create incentives—and how those incentives can either improve care quality or inadvertently encourage overtreatment, undertreatment, or fragmented services. These models represent the fundamental tension between volume versus value, risk-sharing versus fee-based payment, and individual provider accountability versus coordinated care.

Don't just memorize the names and definitions of these models. Know what behavioral incentive each model creates, which stakeholder bears the financial risk, and how models can be combined or evolved to address healthcare's biggest challenges: rising costs, inconsistent quality, and fragmented care. When you see an exam question about reimbursement, ask yourself: Who gets paid, for what, and what does that motivate them to do?

---

Volume-Based Models: Payment Per Service

These traditional models pay providers based on the quantity of services delivered. The more you do, the more you earn—which creates strong incentives for high utilization but weaker incentives for efficiency or outcomes.

Fee-for-Service (FFS)

• Pays providers for each individual service rendered—every office visit, test, and procedure generates separate reimbursement based on a predetermined fee schedule
• Incentivizes volume over value, potentially leading to overutilization of services since provider revenue increases with each additional service
• Gives patients maximum choice in selecting providers and services, but offers no built-in mechanism to coordinate care or control costs

Resource-Based Relative Value Scale (RBRVS)

• Determines physician payment rates based on resources required—calculates reimbursement using relative value units (RVUs) that account for physician work, practice expense, and malpractice costs
• Used by Medicare and most private insurers to create standardized, consistent payment structures across different medical services and specialties
• Adjusts for geographic variation through a Geographic Practice Cost Index (GPCI), recognizing that practice costs differ by location

---

Episode-Based Models: Payment Per Case or Condition

These models shift from paying per service to paying per clinical episode. Providers receive a fixed amount for treating a defined condition, creating incentives to deliver care efficiently within that payment.

Diagnosis-Related Groups (DRGs)

• Classifies hospital inpatient cases into payment categories—each DRG represents a group of clinically similar patients expected to require similar hospital resources
• Provides fixed payment per admission regardless of actual services delivered, incentivizing hospitals to reduce length of stay and eliminate unnecessary tests
• Adjusts for case complexity through factors like patient severity, comorbidities, and geographic wage indices to account for legitimately higher-cost cases

Prospective Payment System (PPS)

• Establishes payment rates in advance based on patient classification rather than actual costs incurred—providers know what they'll be paid before delivering care
• Serves as the payment mechanism for DRGs in Medicare inpatient services, though PPS methodology extends to other settings like skilled nursing and home health
• Transfers financial risk to providers who must manage care delivery within predetermined payment amounts or absorb losses

Bundled Payments

• Single payment covers all services for a treatment episode—includes hospital, physician, post-acute care, and other services related to a specific condition over a defined time period
• Encourages provider collaboration since all participants share the same payment pool and benefit from coordinated, efficient care delivery
• Extends episode logic beyond hospital walls to include 30, 60, or 90-day post-discharge periods, addressing the full care continuum

---

Population-Based Models: Payment Per Patient

These models pay providers a fixed amount to care for a defined population over time. Revenue is predetermined regardless of service volume, shifting financial risk to providers and creating strong incentives for prevention and efficiency.

Capitation

• Fixed payment per member per month (PMPM)—providers receive the same amount whether a patient visits once or twenty times during the payment period
• Transfers financial risk to providers who must manage all patient care needs within the capitated amount, creating incentives for preventive care and efficient resource use
• Can lead to underutilization if poorly designed, since providers financially benefit when patients don't seek services—quality metrics are essential safeguards

Accountable Care Organizations (ACOs)

• Provider networks sharing accountability for population health—groups of hospitals, physicians, and other providers coordinate care for a defined patient population
• Shared savings model rewards providers with a portion of cost savings achieved below benchmark spending while meeting quality thresholds
• Emphasizes preventive care and chronic disease management since reducing expensive acute episodes generates savings that providers share

Patient-Centered Medical Homes (PCMHs)

• Team-based primary care model organizing comprehensive, coordinated care around patient needs rather than individual provider visits
• Enhanced care management payments supplement traditional reimbursement to support care coordination, extended access, and population health activities
• Focuses on relationship continuity with emphasis on a primary care provider team managing whole-person care, including behavioral health and social needs

---

Quality-Based Models: Payment Tied to Performance

These models link reimbursement to measurable quality outcomes rather than volume or episodes alone. Providers earn more by demonstrating better results, aligning financial incentives with patient health goals.

Pay-for-Performance (P4P)

• Financial bonuses or penalties based on performance metrics—providers receive additional payment for meeting targets or face reductions for falling short
• Measures include clinical quality, patient experience, and efficiency—examples include vaccination rates, diabetes control, hospital readmission rates, and patient satisfaction scores
• Aims to align provider incentives with patient outcomes by making quality financially meaningful rather than optional

Value-Based Purchasing (VBP)

• Medicare program adjusting hospital payments based on quality performance—redistributes a percentage of base DRG payments based on achievement and improvement on standardized measures
• Comprehensive quality domains include clinical outcomes, patient experience (HCAHPS), safety, and efficiency metrics
• Creates competitive pressure since hospitals are measured against national benchmarks and their own historical performance—funds are redistributed from lower to higher performers

---

Quick Reference Table

---

Self-Check Questions

1. Which two reimbursement models both use fixed episode-based payments but differ in scope—one covering only inpatient stays and the other spanning multiple providers and post-acute care?

2. A hospital administrator wants to reduce length of stay without sacrificing quality. Which reimbursement model creates the strongest financial incentive for this goal, and why?

3. Compare and contrast capitation and fee-for-service: What opposite behavioral incentives do they create, and what quality risks does each model introduce?

4. If an FRQ asks you to recommend a reimbursement model that promotes care coordination across a health system while maintaining quality accountability, which model would you choose and what evidence would you cite?

5. How does Value-Based Purchasing differ from general Pay-for-Performance in its funding mechanism, and why does this create competitive pressure among hospitals?