health: An illustration

Figure 5.1 Key factors of performance-based financing that influence population health: An illustration

and monitoring. All told, the new mix of services and service effectiveness produced under PBF may result in a higher or lower level of population health, depending on at least six factors: health-increasing substitution, health-decreasing substitution, provider surplus extraction, net externalities, monitoring costs, and risk premium costs. The degree to which these six factors are modified by PBF will determine the impact of the program on the effective coverage of health services. Figure 5.1 depicts these six factors in a highly stylized manner to demonstrate their potential impact on population health. This figure relates population health as a function of the share of a provider’s revenue (or a health worker’s wage) that is based on PBF. The y-axis measures a broad summary measure of effective health coverage, as targeted by the health system reform.

In figure 5.1, the net effect of the six factors potentially influenced by PBF is aggregated in the curve labeled “Total,” with point A marking the PBF incentive level that is expected to maximize effective coverage. As the share of health provider revenue based on PBF increases, overall health increases, levels off, and then begins to decrease as the negative impact of

Better health 1. Health-increasing substitution

4. Net externalities

Total 3. Provider surplus extraction

A

Worse health 2. Health-decreasing substitution 5. Monitoring costs

6. Risk premium costs

0%

Increasing share Share of provider revenue based on pay for performance Source: Friedman and Scheffler 2016.

the risk premium cost begins to dominate. This stylistic figure decomposes, in a qualitative sense, PBF’s impact on population health into the channels through which the program operates. The relative contribution and shape of each line are largely based on theoretical constructs and will certainly vary across programs and contexts; additional work will be needed for a fuller understanding of these relationships.

Most PBF programs use the additional funds introduced by the program to pay for health worker and facility bonuses, as well as increased health system monitoring. The same funds could have been spent in alternative ways. For example, the funds could have been used to increase base compensation rates, hire additional staff, accredit private providers, or build new facilities. To isolate the impact of the incentives from the overall funding increase, the health impact on the vertical axis in figure 5.1 is in reference to an unobserved counterfactual condition, that is, if those new funds were being used to increase base reimbursement under more standard supply-side approaches.

In figure 5.1, the horizontal axis is the share of provider revenue that is based on PBF, because the fraction of incentivized payment in total payment is a key PBF design issue. The share that will maximize population health depends on health system characteristics, such as the payment model, administrative controls, and the potential to increase efficiency, as well as other features of the contract, such as the monitoring level, decisionmaking authority, job design, and asset ownership. In most of the countries studied here, the performance payments were capped between 20 and 40 percent of worker base pay.

Factor 1: Health-increasing substitution Health-increasing substitution occurs when more efficient services and inputs replace less efficient ones. For example, as more antenatal health screens become available, less costly delivery services will be needed if health problems are identified earlier and well managed. In figure 5.1, health-increasing substitution is assumed to begin gradually as a function of incentive size, as the incentive must exceed the marginal cost of the incentivized action for it to affect behavior. Once these thresholds are exceeded, the slope increases. While a fairly linear relation is assumed here, the actual relation may be nonlinear depending on the provider’s cost function for effort to provide different services. Health-increasing substitution can also include actions that are not directly incentivized but are

perhaps complementary to actions that are incentivized. Bauhoff and Kandpal (2021) provide a theoretical model and some empirical evidence of such an example.

Factor 2: Health-decreasing substitution Health-decreasing substitution occurs when less efficient services and inputs replace more efficient ones, which can arise when an agent performs multiple tasks (Holmstrom and Milgrom 1991). In colloquial terms, incentivized tasks may “crowd-out” unincentivized ones. It is impractical to include explicit incentives for each possible task a health worker can undertake, in part because many tasks are unobserved or difficult to measure. Therefore, the health worker can substitute effort from unobserved and nonrewarded tasks (for example, counseling), which may be relatively more efficient for health production, toward the rewarded subtasks (for example, record keeping). For example, in the United Kingdom’s Quality and Outcomes Framework, some providers report that the record keeping necessary under the PBF program has reduced available time to listen to patients’ concerns (Maisey et al. 2008). In figure 5.1, health-decreasing substitution is assumed to mirror health-increasing substitution as the incentive for change must be greater than the cost of the incentivized action. If the PBF measures are well designed, then the magnitude of health-decreasing substitution will be less than the magnitude of health-increasing substitution, and there will be a net positive impact on health related to overall substitution effects. Few studies have looked at PBF impacts on unincentivized health activities, but those that have found little evidence of negative coverage impacts (Kandpal 2016; Diaconu et al. 2020).

Factor 3: Provider surplus extraction Provider surplus extraction is the difference between the health worker’s net utility, taking into account effort costs and time not devoted to work, under PBF when compared with the counterfactual condition. Any surplus that the principal extracts from the provider can be used to purchase additional health care services. The degree of surplus extraction will vary both due to the PBF program design as well as across provider types. On the one hand, the realized surplus should be greater from an originally inefficient provider. If the surplus extraction from these workers is large enough, it may cause inefficient providers to leave and thus result in a

sorting of the health workforce over time (Lazear 2000). On the other hand, surplus extraction will be less from an efficient provider. While from the perspective of the social planner, provider surplus extraction is largely a distributional issue, from the payer’s perspective, the extracted surplus is used to improve health through increased provider effort. In figure 5.1, provider surplus extraction is simply depicted as linear with respect to the provider’s share of revenue based on PBF. The actual slope and magnitude of the relation will depend on the degree of preexisting provider surplus.

Factor 4: Net externalities

In addition to the direct impacts of a PBF program on incentivized health services, a PBF program may change the effective coverage of health services if it modifies health system norms and decision-making processes. Any resultant changes in effective health coverage from these modifications can be termed externalities since the changes are not directly targeted by or directly linked to the incentivized health services and related actions. For example, a positive externality may arise if PBF implementation improves general health system decision making through the analysis of data generated by the PBF program. The increased practice of data-driven decision making may have a positive effect on a wide variety of services not directly tied to incentives. Negative externalities can also arise. A PBF program may cause workers to become less team oriented or otherwise demotivated if they feel they must compete for bonuses. In figure 5.1, the net externalities example is assumed to be positive and, further, related to investments in monitoring as increased investment in monitoring systems would hopefully yield these externalities.

Factor 5: Monitoring costs A PBF program will typically incur an initial fixed expenditure to set up a health service and health quality monitoring system and link this system to payments, and then bear ongoing monitoring and verification costs of the payment-related data. These costs reduce the budget available for the production of health care services, thus possibly resulting in worse health. In figure 5.1, the stylized monitoring cost curve includes this setup cost when PBF is introduced. Monitoring costs may continue to increase, as a function of the PBF share in revenue, to dissuade any tendency from providers to game the system and deliberately misreport for a higher payment.

Factor 6: Risk premium costs Most health workers are assumed to be risk-averse with respect to future income uncertainty. As overall uncertainty increases with the share of total compensation due to PBF, especially if the PBF payment is partly a function of factors beyond the worker’s control, such as patient care-seeking decisions, a risk-averse health worker will require a risk premium to continue in the program. This risk premium component reduces the available resources for health care provision, resulting in worse population health. The greater the share of total payment from PBF is, the greater is the uncertainty, and hence the higher is the premium necessary for a worker to participate. As such, in figure 5.1, the risk premium is assumed to increase at an increasing rate of the PBF’s share of a provider’s revenue. This stylization is consistent with providers being almost risk neutral with respect to small amounts of compensation, and growing more risk averse when a larger proportion of income is at stake (Rabin 2000).

Summary of the mechanisms To summarize this conceptual overview of PBF mechanisms, two of the aforementioned channels should positively affect population health: the health-increasing substitution of health care services and inputs as well as provider surplus extraction. Three factors should negatively affect health: decreasing substitution of health care services and inputs, monitoring costs, and risk premium costs. A sixth factor, net externalities, involves possible wider impacts beyond the direct impacts on incentivized indicators, such as those brought on by linking incentive payments to a robust digital data system. Program externalities could positively or negatively affect health depending on the net benefits and costs. When a policy maker considers a PBF program design, how all six of these factors will respond in the specific health setting should be considered for a comprehensive understanding of the potential impact of the program.

The above framework accounts for one commonly stated motivation for PBF programs, namely underutilized capacity in the health system and how such underutilized capacity can be harnessed through the introduction of incentives. If such capacity exists, then gains would be expected from PBF on the margins that are most responsive to “health worker surplus extraction.” However, there are several other possible barriers to effective coverage, in addition to “slackness,” that respond to other types of health interventions. These challenges include (1) demand-side barriers to