Are Incentives Everything? Payment Mechanisms For Health Care Providers in Developing Countries
Are Incentives Everything? Payment Mechanisms For Health Care Providers in Developing Countries
Are Incentives Everything? Payment Mechanisms For Health Care Providers in Developing Countries
WPS2624
Varun Gauri
Public Disclosure Authorized
The findings, interpretations, and conclusions expressed in this paper are entirely those of
the author and do not necessarily represent the views of the World Bank, its Executive
Directors, or the countries they represent. Policy Research Working Papers describe
research in progress by the author and are published to elicit comments and to further
debate.
Summary: This paper assesses the extent to which provider payment mechanisms can help
developing countries address their leading health care problems. It first identifies four key
problems in the health care systems in developing countries: 1) public facilities, which provide
the bulk of secondary and tertiary health care services in most countries, offer services of poor
quality; 2) providers cannot be enticed to rural and urban marginal areas, leaving large segments
of the population without adequate access to health care; 3) the composition of health services
offered and consumed is sub-optimal; and 4) coordination in the delivery of care, including
referrals, second opinions, and teamwork, is inadequate. The paper examines each problem in
turn and assesses the extent to which changes in provider payments might address it.
1. Introduction
Health care delivery systems involve a variety of actors, including physicians, nurses,
hospitals, pharmacists, and payers, many of whom interact with each other and with
patients in decentralized settings that are difficult to observe. Most, especially physicians,
can influence the kinds, quantities, and quality of health care goods and services
delivered and consumed. Physicians’ routine practices for making appointments,
diagnosing illness conditions, recommending and administering treatments, offering
counseling and health information, charging for services and materials, and referring
patients to their colleagues greatly affect utilization, efficiency, and quality. That is why
so many health care reforms, and still more arguments in favor of other reforms, focus on
the incentives believed to condition those routine practices, and particularly on the
mechanisms for paying providers.
1
others interested in improving the health systems of developing countries must act in the
interim with imperfect knowledge. For that reason, this paper is written in the spirit of an
essay. It is an effort to glean practical knowledge, from the partial theoretical and
empirical findings that are available, on whether and how to use payment mechanisms in
health care reform in developing countries. The paper first identifies four leading
problems in the health care systems in developing countries. The succeeding sections
reflect on each of the problems in turn, and assess the extent to which changes in provider
payment mechanisms can address it.
Poor countries with larger and more concentrated populations, such as Pakistan
and Kenya, exhibit a second pattern of health care provision. This pattern resembles the
first with one exception: in these countries semi-trained private providers dominate the
supply of health care in most rural and marginal urban areas. These private providers
utilize a mix of Western and indigenous medical concepts, make money purchasing and
reselling drugs from local chemists, often engage in agricultural or other activities part-
time, and have limited contact with the formal, public health care system. Patients are
2
usually uninsured and pay these providers out-of-pocket, resulting in substantial
household outlays. For example, about three-quarters of health expenditures in India
come directly from households. (Chakraborty 1998)
Middle- income countries such as Chile, Mexico, Thailand, and South Africa, have
a distinct, third pattern of health care provision. Risk-pooling, often financed with formal
sector payroll taxes, is far more common. A government- managed social security
organization usually collects taxes and pays physicians and hospitals, which are either
public or contracted private providers. Most of these countries also have general revenue-
financed hospitals and clinics for informal sector workers, and growing or already
substantial private insurance markets for the relatively well-off in the larger cities.
These patterns are heuristic devices only, and many countries’ systems are
hybrids, with different patterns predominating in distinct geographic areas. Nevertheless,
the typology helps to illuminate the main challenges facing the health systems of
developing countries and to make clear what is hoped for from reforms that implement
new incentive structures. Four key institutional problems facing the health systems of
developing countries emerge from the preceding account: 1) public facilities, which
provide the bulk of secondary and tertiary health care services in most countries, offer
services of poor quality; 2) the composition of health services offered and consumed is
sub-optimal; 3) providers cannot be enticed to rural and urban marginal areas, leaving
large segments of the population without adequate access to health care; and 4) the
referral system and coordination in the delivery of care is inadequate. The next sections
analyze the extent to which getting the incentives right might help address each of these
problems.
3
comes from classical agency theory, which holds that time-based payments for services
(salaries or budgets) do not charge agents (in this case hospitals) for on-the-job leisure.
(Harding and Preker 2000) As a result, the managers of public and not- for-profit
organizations do not personally lose income when they hold a Friday afternoon office
party, misplace a patient’s file, or otherwise slack off.
4
The literature on the tradeoff between risk and efficiency for hospitals is directly
relevant for several pattern three countries, such as the Mexico and Argentina, where the
rate of increase in medical prices is an emerging priority. But pattern one and two
developing country markets do not have wid espread third-party payment, do not have
private hospitals in large numbers, and most have weak information systems for reporting
treatment quantities and marginal costs. Cost-containment is achieved simply in those
contexts – by shrinking the public sector health budget. But budgetary caps are ham-
fisted instruments that force facilities to ration care arbitrarily, creating confusion,
distrust, patient dumping, and steadily eroding the credibility of government incentives
for providers. Explicit rationing would create less arbitrary distribution rules, and limiting
government financing to packages of basic, cost-effective services has been proposed
(World Bank 1993), but most governments resist official rationing on political and
normative grounds. Another solution to the moral hazard problem that does not rely on
supply-side cost-sharing is to encourage the creation of medical savings accounts, as
Singapore and Hong Kong have done, and to charge patients the full price of health care;
but medical savings accounts need to be combined with insurance for more expensive
and catastrophic care for hospital services that, in pattern one and two countries, are not
feasible in the short- to medium- term. By far the most common means to limit consumer
demand are informal payments, whether proscribed, tolerated, or officially sanctioned as
user fees. These are widespread in all three patterns of health care systems, but especially
in patterns one and two.
Empirical studies on the risk-efficiency tradeoff have found that supply-side cost-
sharing seems to be associated with shorter average length-of-stay in hospitals. There is
as yet no conclusive evidence on whether supply-side cost sharing is forcing cuts in
medically necessary care or are otherwise damaging the quality of care provided; but the
concern that they might fuels research in the area. One study have found evidence that
decreases in reimbursement associated with prospective payment in the United States
were associated with inpatient hospital mortality rates, but not with mortality in the year
after discharge. (Cutler 1995)
The possibility that providers are skimping on care-giving leads to the recognition
that the classical agency model is not the full story. There is more going on than the
transfer of risk to providers. When agents perform multiple tasks, basing rewards on just
one or two of them can distort agents’ incentives, leading to perverse outcomes.
Hospitals, among the most complex organizations in the modern world, obviously
perform multiple tasks, including patient intake, emergency care, thousands of different
5
medical procedures, patient education, billing and payment, training residents and interns,
case conferences and grand rounds, epidemiological surveillance, charity, procuring new
equipment, stocking pharmaceuticals, disposing biohazards, building construction, and
fundraising. Basing hospital contracts on a few indicators, even fundamental ones such as
patient intake, bed days provided, or risk-adjusted diagnosis at entry, might compromise
other objectives, such as the quality of care delivered.
That suggests some of the problems that limit the applicability of these models.
When retrospective reimbursements are set below marginal cost (there is supply-side cost
sharing), physicians have no incentive to exert effort above the minimal level. Corner
solutions result unless physicians value their patients’ well-being (“beneficence”) or
unless patients set their demand levels after observing physician effort. In the former
case, the existence of provider beneficence increases health care utilization at any given
level of supply- or demand- side cost sharing. So some writers have noted that payers can
“exploit ‘ethical’ behavior” to extract greater physician effort, by increasing copayments
(Ma and McGuire 1997) or lowering physician reimbursement rates, which also saves
6
(presumably distortionary) tax revenues. (Ma 1994) But this understanding of
“beneficence” as an exogenous characteristic of providers is simplistic. In reality,
physicians will become less beneficent once they observe payers extracting effort from
them. This is an example of the way in which the use of extrinsic incentives might crowd
out intrinsic incentives (Kreps 1998), and how economic organization can change agents’
objectives. (Bowles 1998). There is evidence that intrinsic incentives motivate the
behavior of social workers (Heckman 1997), and they are undoubtedly critical for
physicians and hospitals as well. (Newhouse 1970) Designing incentives systems that
support, rather than detract from provider beneficence, is a real concern that, though
difficult to document, deserves careful consideration when new payment systems are
being considered.
7
summarizing the overall value of a hospital is complex (a problem that is perhaps on par
with the difficulty of ranking the performance of national health systems), so contracts
with hospitals cannot easily utilize quality measures or other global performance
indicators to condition payments.
That is another way of way saying that granting autonomy to, corporatizing, or
privatizing a public hospital, even in a competitive market with informed consumers,
does not by itself resolve principal-agent problems within the facility. Lab workers,
nurses, doctors, and others often have divergent interests, and the use of high-powered
incentives could intensify conflicts. As two theorists note, “the use of low-powered
8
incentives within the firm, although sometimes lamented as one of the major
disadvantages of internal organization, is also an important vehicle for inspiring
cooperation and coordination.” (Holmstrom and Milgrom 1994, cited in Gibbons 1998).
In addition, doctors have unusual power in comparison to employees in most firms: they
usually enjoy the power, and often the exclusive legal authority, to admit and discharge
patients in hospitals. They, rather than a CEO or senior management, directly control the
key short-term drivers of costs and revenues of their organization; and exposing the
mangers of a hospital or its board to markets forces will not raise the price of on-the-job
leisure for hospital staff if doctor’s practices do not change (and if the information and
assistance that labs and nurses provide doctors do not support changes in treatment
protocols). Private or corporate hospitals can, in turn, make doctors residual claimants on
revenues as well, or hire them with renewable contracts if public sector hiring rules allow
it; but the effects of profit-sharing and other schemes that tie physicians’ income to
corporate performance will be diluted as a function of the size of the hospital. And
whether or not hospitals create such incentive schemes, and how they do it, will vary.
Because of the uncertainties regarding optimal contracts sketched above, the separation
of financing from provision probably will not result in a unique, let alone a first best, set
of incentives within hospitals. There are few if any studies regarding the incentive
schemes adopted by newly corporatized hospitals, but, if evidence from HMOs operating
in competitive markets is a guide, no single pattern is likely to emerge. In the U.S.,
Hillman and others (1992) found that one-third of HMOs in their sample transferred
payments to an intermediate entity (the medical staff of a hospital or a physician group),
not to physicians themselves, and that half of the intermediate entities that were paid by
the HMO on a capitation basis went on to pay primary care physicians on some other
basis, fee-for-service or salary. Why physicians behave they way they do, and what
instruments should be used to motivate them, remains unclear. Existing models of
physician behavior explain less than 10% of inter-physician hours worked (Reinhardt
1999).
9
(Pannarunothai and Mills 1997). A literature on the topic is emerging in the United
States, where longitudinal data sets on patient outcomes are available. (Cutler 2000)
There is evidence that patients admitted to for-profit hospitals incur more total
expenditures in the six months after discharge than patients admitted to government
hospitals, but that survival rates are not significantly different between those ownership
types. (Sloan and others 1999) Between for-profit and non-profit private hospitals, there
is little difference in cost and patient outcome measures. (Sloan 1998) One research
program is focusing on ratios of nurses to patients, arguing that they appear to predict
health outcomes better than the juridical status of providers. (Aiken 2000) A fifth U. S.
study found that for-profit hospitals exhibit higher mortality rates among elderly patients
with heart disease than nonprofit hospitals, and that this difference has grown over the
last decade, but that most of this difference in outcomes is due to the location of for-profit
hospitals. That study’s conclusion sums up the principal findings of the empirical
literature to this point: “[T]he small average difference in mortality between for-profit
and not-for-profit hospitals masks an enormous amount of variation in mortality within
each of these ownership types. Overall, these results suggest that factors other than for-
profit status per se may be the main determinants of quality of care in hospitals.”
(McClellan and Staiger 2000)
The strongest arguments for coporatization emerge not from property rights
theory but from accounts of public sector organization. Public bureaucracies, orderly and
regimented hierarchies in the simple, stylized Weberian conception, are in reality often
divided and politicized. The problem for some public mangers is not that they lack over
their agency discretion, as the stylized account suggests, but that they are responsible to
several principals with differing interests. One theoretical model demonstrates that if a
manger can achieve the goal of one principal only at the expense of the goals of the
others, a situation might result in which the principals find it optimal to reward the
manager on the basis of performance criteria that subvert the goals of the other
principals. (Dixit 1997) This account is plausible for public hospitals, which in
developing countries are answerable to ministries of health, education, finance, as well as
to local governments. The account suggests that mission clarification for public hospitals
could allow principals to set clearer performance benchmarks and user higher power
incentives. The same is true for some discrete tasks in the health sector as a whole, such
as immunization: carving out those tasks from others would allow for the use of higher
power incentives and could enhance performance in specific areas.
10
4. Improving the composition of health care utilization
Patients do not always demand and providers do not always deliver the right kind
of health care. Increasing or decreasing the utilization of specific medical procedures as
technologies evolve is a continual health policy problem, and encouraging greater
utilization of public health and preventive care is a preoccupation of public health
officials in industrial and developing countries alike. Financial incentives play a role in
these efforts.
On the demand side, some payers set relative consumer prices with the objective
of promoting certain kinds of health care. Governments, for instance, frequently subsidize
services with large positive externalities, such as immunization and health information.
Private payers set low co-payments for certain preventive services, such as ante- natal
care, on the basis of a calculation that their utilization lowers expected claims for
hospitalization and other costly procedures. Relative consumer prices are occasionally
used to promote specific treatments or devices (say, condoms instead of sterilization), but
their use is not widespread because cross-price elasticities with other health services and
behaviors (say, abstinence or the female condom) are generally unknown or disputed, and
because a complicated, variable co-payment schedule for all health care services would
lead to controversies regarding actuarial fairness and the equitable treatment of different
medical conditions. Co-payments are rarely negative, but paying people to consume
health care with positive externalities might make sense. One comprehensive literature
review identified 11 “randomized trials with quantitative data concerning the effects of
financial incentives (cash, vouchers, lottery tickets, or gifts) on compliance with
medication, medical advice, or medical appointments,” and found that 10 of the 11
studies showed that some form of financial incentives promoted compliance better than
any alternative. (Giuffrida and Torgerson 1997) It is conceivable that specific financial
incentives could “crowd out” altruistic motivations, such as the willingness to donate
blood (Titmuss 1970). But in Brazil and other countries a program that pays poor families
to send their children to school has met with success; and paying poor families to utilize
health services, particularly those with positive externalities, might under some
conditions be an effective way to change utilization patterns in developing countries.
Supply side approaches are more common than demand side ones. Initiatives to
alter the composition of health care utilization by changing the relative reimbursement
rates to providers for various procedures take as given the notion that health care
providers have significant power to induce patient demand, and also make several other
assumptions regarding health care provision. Lowering the relative supply price of a
11
procedure might not increase its utilization if physicians cannot induce patient demand
(the field is competitive, discretion limited, or patient needs and preferences are strong),
if physicians can make up the lost income from some other source (selling more
pharmaceuticals, gaining referrals from colleagues, increasing referrals to labs or other
facilities from which they receive revenue, substituting into patients covered by a payer
that has not lowered the price of the procedure), if physicians prefer to substitute leisure
for the lost income, or if practicing the procedure sufficiently enhances physicians’
reputations. The long-term effects of changes in relative provider prices, including their
impact on entry and exist into specific specialties, is difficult to study empirically but
warrants historical examination. It might be the case that policy decisions regarding
medical training and licensing have a greater (though belated) impact on patient decisions
and service utilization rates than changes in relative prices. (Arrow 1963)
Changing relative provider prices can occur through reimbursement rates from
third-party payers or in the form of specific “target payments” to public or private
providers. Initiatives in this area have taken a number of forms. In the United States and
Canada, “relative value scales” have increased the fees of “cognitive” services, such as
consultations with primary care physicians, relative to some procedural services, such as
surgery and testing. Target payments for immunization and other services have been
provided in the UK, the Czech Republic, and elsewhere. A blueprint for a health system
reform in Brazil, supported by the World Bank and the Inter-American Development
Bank, explicitly targeted the composition of patient demand by attempting to raise the
supply prices of services deemed cost-effective. (World Bank 1996) In addition, some
initiatives have been proposed to use clinical criteria to bundle certain services, such as
surgery and post-acute care under Medicare (Prospective Payment Assessment
Commission 1997) and deliveries with ante-natal care visits (World Bank 2000).
12
multiple payers. (Hillman and others 1998: AJPH) Studies of the effects of general
changes in relative provider prices have found limited and inconclusive effects (Hurley
and Labelle 1995), and one literature review of target payments found only two studies
using randomized controls (both employing non- linear bonus payments based on
immunization rates). One of these studies found a significant effect of target payment,
and the other did not. (Giuffrida and others 2000) Further experiments in developing
countries are certainly warranted, but results to date suggest that marginal changes in
provider payments have a limited effect on the composition of utilization. It might be
more useful to focus on the composition of health care providers (nurses versus doctors,
generalists versus specialists), which can affect health care consumption over the long
term.
13
the distortionary incentives associated with those payment structures. For instance,
Palmer and Mills (2000) found that part-time district surgeons in South Africa paid on a
fee-for-service basis expend minimal time and effort on their public sector patients. On
the other hand, salaried physicians can easily shirk on the job because of the isolation in
which they work – indeed, the job, if adequately remunerated, might actually attract
individuals looking for low stress positions. The promise of entry into specialist training
or the civil service essentially constitutes a deferred compensation contract with a large
bonus. Younger physicians might be motivated enough by such contracts to avoid
negative reports from their patients or the itinerant supervisors that do visit them. To
work as an incentive, however, entry into the civil service or specialist training should not
be guaranteed but should be contingent on good performance. But young physicians, who
even with explicit guarantees of a deferred bonus are not attracted in larger numbers to
service in outlying areas, probably will not accept the increase in risk associated with
contingent bonuses (what if the government reneges?) unless paid to do so. A salary
increase and a mixed contract, with both high and low-powered incentives, would result.
A problem with relying on younger physicians to staff rural clinics is that the new
workers have little experience and few opportunities for learning. Recruiting older
clinicians will to serve in those areas is difficult both because the deferred bonus payment
would have to be quite high, and because career concerns will be less effective in solving
the monitoring problem.
Problems with referrals and the coordination of health care, while vexing for
health policy makers everywhere, are acute in most developing countries. In most
countries there are too few professional referrals. Patients go directly to emergenc y
rooms and hospital outpatient centers, receive a diagnosis and/or treatment, and return to
their communities with little or no transfer of medical information between the hospital
and their local clinic or health center. In pattern two countries such as India, the private
practitioner working in isolation has an incentive to avoid referring patients and
recommending second opinions –the referring physician might lose a customer if the
patient prefers the colleague. That is a social loss because a physicia n who refers a patient
to a colleague has his work effectively evaluated by the colleague, and the counter-
referral then results in the second colleague being evaluated as well. (Friedson 1989) In
other words, medically indicated professional referrals carry social benefits that the
referring physician cannot internalize: there are positive externalities to professional
referrals. By contrast, lay referrals have a weaker quality control function. Practitioners
14
who rely exclusively on lay referrals, including isolated private providers in developing
countries, are forced to meet patient expectations, dispensing excess pharmaceuticals.
Although professional organizations can encourage referrals, they sometimes prioritize
union interests over quality monitoring, and professional norms that encourage keeping
quiet and not criticizing colleagues can undermine the quality-enhancing potential of
professional referrals.
There exist few studies evaluating explicit incentives for cooperation. Profit-
sharing might promote cooperation, but the incentives tend to be diluted in large
organizations. (Prendergast 1998) One study argues that, theoretically, the use of
promotions or tournaments to reward individuals will be negatively related to helping
behavior, and finds empirical evidence to support the claim. (Drago and Garvey 1998) In
health care, some patterns of payment can affect the frequency of medical referrals.
Weakly monitored physicians on salary exert effort have an incentive to pass off a patient
to a colleague. Withheld payments to physicians, in which payers exclude physicians
from bonuses or withheld payments when their referral rates for laboratory tests or
hospitalizations exceed plan norms, reduce referral rates. Some of the strongest empirical
findings in the provider payment literature document that capitation payments and
fundholding arrangements can reduce hospitalization. In the U.K., the NHS reform that
established general practitioner fundholding has apparently increased the referral power
of general practitioners, though at the expense of a 9-12% increase in transaction costs.
(Le Grand 1999, Klein 1998) One reason many developing countries might chose to pay
for and provide primary health care, even though there are larger market failures in
insurance for catastrophic care, is to use low-powered incentives to establish functioning
referral systems and coordination. There is some evidence, for instance, that private
facilities are less likely to cooperate with public health objectives. In the United States
public hospitals are twice as likely to collaborate, either formally or informally, with
public health departments than not- for-profit hospitals, which in turn are twice as likely
to do so as for-profit hospitals. (Halverson and others 2000) Similarly, there is greater
involvement in preventive activities on the part of public hospitals in Malaysia (Alijunid
and Zwi 1997), though not in Kenya (Berman and others 1995). But low-powered
incentives result in efficiency losses, so some combination of low- and high-powered
incentives, such as those embedded in fundholding, might be able to optimize the balance
between coordination and efficiency. This is speculative at this stage, however, and
further research is needed to determine if and how fundholding arrangements might be
useful in developing countries.
15
7. Conclusion
On the basis of the research conducted to date, this essay recommends that
experiments and pilot projects for improving public sector hospitals should focus on
mission clarity and organizational simplification, programs for improving the
composition of utilization should experiment with payments to consumers and with
medical and nursing training, initiatives for attracting providers to rural areas should use
explicit deferred compensation contracts to improve monitoring, and that developing
mechanisms for increasing medically indicated professional referrals requires more
research.
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