Behavioral economics and countervailing incentives in value-based payment

Countervailing incentives in value-based payment

By Daniel R. Arnold
Healthcare, May 17, 2016


Payment reform has been at the forefront of the movement toward higher-value care in the U.S. health care system. A common belief is that volume-based incentives embedded in fee-for-service need to be replaced with value-based payments. While this belief is well-intended, value-based payment also contains perverse incentives. In particular, behavioral economists have identified several features of individual decision making that reverse some of the typical recommendations for inducing desirable behavior through financial incentives. This paper discusses the countervailing incentives associated with four behavioral economic concepts: loss aversion, relative social ranking, inertia or status quo bias, and extrinsic vs. intrinsic motivation.

From the Introduction

The Department of Health and Human Services (HHS) intends to have 85% of Medicare fee-for-service (FFS) payments tied to quality or value by 2016 and 90% by 2018. In addition, HHS is moving away from FFS in favor of alternative payment models, such as accountable care organizations and bundled-payment arrangements. HHS's goal is to have 30% of Medicare payments tied to quality or value through alternative payment models by the end of 2016 and 50% by the end of 2018. The U.S. health care system's transition to value-based payment is underway.

Loss aversion

While upfront payment has the potential to leverage physician's loss aversion and nudge them toward providing higher-value care, it is also important to recognize the implications loss aversion has for current design features of value-based payment. One example is wage variation. Wage variation under value-based payment is likely to be greater than wage variation under FFS, particularly if value-based payment is tied to patient outcomes that are highly variable. Loss aversion implies that employees respond poorly to variable wages – relatively low wage years are more painful than relatively high wage years are pleasurable. There is some evidence that physicians may respond to low wage years by boosting their incomes in subsequent years, either through increasing prices or shortening patient appointments. Thus, as long as there is some level of productivity-based compensation, certain value-based payment arrangements could increase the likelihood of unappealing income boosting activities that stem from perceived low wage years.

Relative social ranking

There are, however, drawbacks to comparing physicians to their peers. After New York and Pennsylvania began releasing coronary artery bypass graft (CABG) report cards, both states saw surgeons turn away sick patients in an effort to avoid poor outcomes and lower publicly reported ratings. In Pennsylvania, 63% of cardiac surgeons admitted to being reluctant to operate on high-risk patients. In New York, 67% of cardiac surgeons refused to treat at least one patient in the preceding year that was perceived to be high risk.

Another concern is the power of rankings: individuals often attribute more meaning to rankings than is warranted. For instance, Isaac and Schindler have identified a “top 10″ effect–people categorize performance by round numbers (i.e. you are either inside or outside the top ten). This makes moving from rank 11 to rank 10 more important than moving from rank 10 to rank 9, even if the absolute change in performance is the same. Furthermore, the importance of rankings can lead individuals to sabotage others in order to improve their relative ranks. Finally, rankings become particularly problematic when all participants perform well, there is random variation in outcomes, or performance is difficult to measure — all of which can be true for physicians. Outside of health care, team-based, rather than individual, incentives have been shown to reduce these undesirable behaviors.

Inertia or status quo bias

But what happens when the default choice is not clear? Is it still better to give physicians a default option, or instead rely on physicians to actively decide which treatment option is best. A recent study introduced the notion of a “default pull” effect: defaults shape what a decision maker prefers by making him consider whether he prefers the default. This pull can have a substantial effect on choice, even when the default itself is not chosen. It may be better to allow physicians to have their undistorted preferences in situations where there is no obvious best course of treatment.

Another downside of imposed defaults is that they reduce physician autonomy. Ariely and Lanier vividly describe that physicians without autonomy “may feel like Charlie Chaplin's character in Modern Times, pulled through the gears and cogs of a machine in a factory, and as a consequence they often feel defeated when attempting to put their hearts and souls into their profession.” But in the opposite direction, some argue that nudges are too weak. For example, calorie labeling has done little to reduce people's calorie intake, which has led some to argue that some public health policies need to be more aggressive – shoves rather than nudges.

The effect of explicit incentives on intrinsic motivation

Himmelstein et al. highlight two important assumptions of pay-for-performance that are rarely made explicit: (1) variation in performance is caused by variation in motivation, and (2) financial incentives will add to total motivation, not undermine it. Incentive pay is unlikely to improve variation in poor performance that is not due to motivation, such as mistakes from fatigue that come from overworked physicians. Assuming a lack of motivation as the problem, pay-for-performance then assumes financial incentives can increase motivation. Financial incentives clearly affect behavior. For instance, shifting physicians from fixed salaries to FFS has been shown to increase the amount of clinical work performed and improve billing practices.

But there is mounting evidence that extrinsic rewards can undermine intrinsic motivation. Of the numerous findings that relate to the crowd-out of intrinsic motivation, two seem particularly relevant to physicians: (1) negative effects of monetary rewards are strongest for complex cognitive tasks and (2) motivational crowd-out spreads to work that is not directly incentivized. With respect to complex cognitive tasks, even very large financial incentives undermine performance. For example, rural villagers in India offered half their annual money income experienced worsened performance on complex memory and puzzle-solving tasks. The spread of motivational crowd-out to work not directly incentivized has been observed in England. In 2004, the U.K. government introduced a pay-for-performance scheme with 136 indicators for family practices. By 2007, improvement for incentivized measures had plateaued, and quality deteriorated for two measures that were not incentivized.


Insights from behavioral economics can be used to create value-based payment policies that promote high-value care. Upfront bonuses, physician rankings, and better default options can all help promote high-value care. But it is important to follow the implications of these behavioral motivators through to all areas of physician decision-making and performance. In doing so, unintended consequences may be revealed along the way.



By Don McCanne, M.D.

As the government moves away from payment based on volume and forward to payment based on value, it is important to have a thorough understanding of behavioral economics, and the application needs to be done right. The excerpts selected from the article above describe the problem of countervailing incentives in value-based payments.

There will always be a certain volume of care and payment must take that volume into consideration, but that care should be of value. Through approaches such as comparative effectiveness, cost effectiveness, and outcomes research we can determine to a great extent what care is beneficial and affordable, that is, what care is of value.

Through the application of behavioral economics we can motivate health care professionals to strive for higher value care, but we have to get it right. Dedicated, altruistic health professionals are much more likely to set the compass in the right direction than are business school academics and government bureaucrats. But the strategists do need a good foundation in behavioral economics.