A Guide to Healthcare Payment Models: How They Work

As healthcare policy continues to update and shift, there is increasing innovation in the technologies and treatments provided to patients. Accordingly, alternative payment models have also evolved.

Why should your facility be concerned about diversifying its healthcare payment models?

Different models can affect the care provided, a facility's financial management, and the patient experience. This means that healthcare facilities need to adapt their payment models as well in order to stay competitive in the marketplace.

Primary payment models for healthcare providers

What are some of the primary payment models for healthcare facilities?

Some of the most common models include fee-for-service, episode-based, and value-based healthcare arrangements. Other alternative payment methods include capitation, bundled payments, and shared savings models.

Here, we detail different payment models that exist and their advantages and disadvantages.

1. Fee-for-service

In the fee-for-service (FFS) model, healthcare providers are reimbursed for each service they provide.

As an analogy, we can think of going to a mechanic for car repairs and paying for each part and service provided. Likewise, every service provided to the patient is charged, be it consultations, procedures, tests, and so on.

Generally, these services already have a predetermined cost, which may vary due to various factors.

Pros

The advantages of the FFS model are as follows:

The patient can choose among several providers for the same service.
It is easy to keep track of costs for the facility, making it easy to reimburse.

Cons

Unfortunately, the drawbacks of the FFS model can impact patients in the following ways:

Over-utilization of services, such as unnecessary tests or procedures, may occur.
The focus may shift to quantity instead of quality of service provided.
Costs may increase for patients.

2. Capitation

Capitation is a model in which a provider is paid a predetermined, fixed amount—monthly or annually—for a patient’s care. This method is often used by health maintenance organizations (HMOs).

In this scenario, the physician is responsible for managing the patient’s care cost-effectively because they only receive a fixed amount.

Pros

This model has the following benefits:

Providers are encouraged to avoid unnecessary services.
Capitation offers monetary incentives for improved quality of care.
This model tends to have better patient outcomes.
It reduces operating costs such as bookkeeping or accounting.
Healthcare facilities focus more on preventive health.

Cons

Although it has many benefits, the disadvantages include the following:

A patient may require additional and costly services that the facility must cover, even if it represents a financial loss.
To mitigate financial losses, it is possible that the provider under-treats a patient.

3. Episode-based payment

Episode-based payment, also called bundled payments, is a model that makes a bundled payment to address the patient’s needs for a specific “episode of care” (or illness). The payment is intended to cover all services necessary to treat the episode.

This type of payment model typically implements “retrospective reconciliation.” This means that if the provider spends less on the treatment, the provider keeps the balance of the bundled payment, and if more money is spent, the provider must cover the cost.

Pros

With the episode-based model, some advantages include the following:

Unnecessary services are often reduced.
It is a cost-effective model.
This model gives the provider greater flexibility for a patient’s treatment.

Cons

Some of the key disadvantages of this model are as follows:

Calculations for bundled payments are complex.
When there are more costs involved in a procedure, it puts the healthcare provider at financial risk.

4. Value-based care

Value-based healthcare (VBHC) is a model that seeks to improve patient outcomes while managing costs. For example, in a clinic, physicians can coordinate so that patients can do all the necessary tests in one day so they don't have to keep coming back.

In particular, this model invests more money and thought into prevention programs. An example of this is PHASE 2024 (Prevent Heart Attacks and Strokes Everyday), in which providers seek to promote specific lifestyle changes to prevent heart attacks.

Overall, this model emphasizes integrated care and seeks the collaboration of an entire team to improve a patient's overall health.

Pros

The benefits of a value-based healthcare payment model include the following:

This model aims to improve the quality of care and patient outcomes.
It seeks a reasonable cost for both patients and facilities.
VBHC promotes better coordination between healthcare providers and multidisciplinary teams.
Healthcare prevention is prioritized.

Cons

Despite its benefits, this model has some drawbacks to overcome, such as the following:

Adoption can be challenging for healthcare providers.
There may be different interpretations of the model, creating inconsistencies among providers.

5. Pay for performance

Pay-for-performance (P4P) is a model that offers economic incentives to providers. For this purpose, this model has predetermined quality targets. A wide range of providers can participate in P4P programs.

Pros

The pay-for-performance model has attractive advantages, including the following:

When P4P goals are met, the quality of care improves, and healthcare costs are reduced.
There are financial rewards for improving the quality of care.

Cons

Like all models, there are disadvantages as well, such as:

Measuring the quality of a procedure is challenging, so many physicians choose not to participate in this model.
It can narrow the clinical focus, diminishing the quality of other aspects of care.
Providers receive financial penalties when they don’t meet benchmarks.

6. Shared savings

Shared savings programs aim to reduce healthcare costs by sharing a percentage of the savings with healthcare facilities when they meet financial and quality targets.

For example, Medicare estimates that it will spend a fixed amount on its patients. If the facility provides quality care that is also cost-efficient, Medicare saves money. This excess amount is distributed between the facility and Medicare.

Generally, the focus is on improving patient care and reducing costs for everyone.

Pros

The advantages of a shared savings model include:

It encourages providers to improve health outcomes and reduce unnecessary costs.
It encourages facilities to invest in better services.
It improves healthcare revenue cycles.

Cons

The drawbacks of this payment model include the following:

Healthcare providers and facilities may have to pay for losses if they do not achieve their objectives.
Calculations for shared savings and losses are complicated.

7. Accountable care organizations

The Accountable Care Organization (ACO) model incentivizes a network of doctors, hospitals, and healthcare providers to collaborate and coordinate care for a specific population group. Targets include cost and quality of care, as well as patient experience.

Typically, providers in an ACO also employ other payment models, such as FFS payments and Medicare reimbursements, with the ACO model creating opportunities for bonuses when targets are met.

Pros

Some of the main benefits of ACOs are as follows:

ACOs help improve patient outcomes.
Patients receive better care coordination and clinician collaboration within ACOs.
Providers have monetary incentives to provide quality and cost-effective care.

Cons

A key disadvantage of this payment model is:

To be part of an ACO model, the provider must be willing to take on the risk of healthcare costs if targets are not met.

8. Retainer-based payment

This model is also known as concierge medicine, direct care, or boutique medicine. In this model, patients pay an annual “retainer” fee, which they may also pay directly to the physician.

As the term “concierge” suggests, patients using this model receive personalized services. Their physicians typically provide longer appointments, in-depth questioning and assessments, and focus on primary care.

Pros

Patients appreciate the advantages of this payment model, such as the following:

Personalized services and attention are provided for patients.
This model may include 24-hour access.
Appointments last longer and occur on the same day patients request them.

Cons

No model is without drawbacks. The following are some associated with this model:

Many have ethical concerns with this model due to its limited accessibility.
Usually, the patient must pay out of pocket any extra costs above the retainer.

The bottom line: There is no single “ideal” payment model

Healthcare finance is complex. There is no single payment model that is perfect for a specific facility.

A facility can operate within multiple payment models simultaneously. Operating within a mix of services, contracts, arrangements, and payers allows you to diversify and adapt to changing conditions.

Your facility can determine the payment models that work best for your situation by taking into account the needs of your patients, prioritizing quality patient care, and offsetting disadvantages while enhancing advantages.

Explore our articles and find more helpful resources for your facility.

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Understanding healthcare payment models for facilities