The Theory of Healthcare P4P

The challenge for healthcare regulators, such as U.S. federal government’s Centers for Medicare and Medicaid Services (CMS), is to create efficient contracts, payment methodologies and incentive systems that reward improved health outcomes. Agency theory provides theoretical support for assessment of such contracts. The theory was developed separately in the early 1970s by Stephen A. Ross for economics and Barry M. Mitnick for political science and extended by Kathleen M. Eisenhardt to organizational research in the late 1980s.

 Agency theory pertains to difficult contracting or regulatory conditions where the goals between principal and agent are incongruent (Eisenhardt, 1989), the outcomes are uncertain (Ross, 1973), the agent is self-interested and risk-averse (Eisenhardt, 1989), and the principal maintains a formal oversight relationship to the agent (Mitnick, 1982).  These theoretical attributes, manifested in a negative sense as the “agency problem,” and the conditions needed to control them, such as incentives, are at the heart of this healthcare pay-for-performance contracts.

Recent healthcare research predominantly applies the theory to physicians or hospitals as agents (Cangialose, Cary, Hoffman, & Ballard, 1997; Schneider & Mathios, 2006). For care management organizations (CMOs), such as HMOs and the like, Jacob Glazer and Thomas G. McGuire (2002) argued that capitation payment made to CMOs can be manipulated “to induce the profit maximizing plan (the agent) to provide the efficient quality (the regulator’s goal).”

A regulator contracts with CMOs to obtain for improved health outcomes for members, and the CMO is expected to perform services at an agreed upon rate. But how does the regulator know that the CMOs are performing as required?

Under agency theory, an efficient contract should minimize “the principal’s monitoring and enforcement activities” (Mitnick, 1973). High cost to the regulator when conducting audits, collecting information on performance, and devising regulations and communicating performance programs is a major problem in regulatory oversight. Since it is expensive for regulators to oversee the implementation of the required programs, incentive programs can be used to try to control the behaviors of CMOs (Maio, Goldfarb, C. Carter, & Nash, 2003). A typical incentive system retrospectively pay CMOs through bonuses, fines or tiered differential payments based on population-based performance. There is little formal research on the results of these P4P schemes for CMOs.

Do CMOs affect healthcare quality independent of direct healthcare providers, such as hospitals and doctors? The preliminary answer is yes. Researchers found that increased quality of care (QOC) indicators, such as medication adherence, cancer screening, and diabetes care management, were associated with CMOs independent from the direct care given by provider groups.

An example of a successfully implemented Medicaid MCO incentive program is the New York State Quality Assurance Reporting Requirement (QARR) and Quality Incentive (QI) programs.  According to the report, evidence of QI program effectiveness includes improvement in quality of care process measure scores, the exit of poorly performing plans from the Medicaid managed care program, and improved performance scores (e.g., immunizations, well-child visits, and diabetes control) compared to Medicaid fee-for-service.

However, according to Rosenthal et al. (2005), the evidence is mixed on provider-focused P4P in terms of creating relative improvements, and the impact on their long-term effects. Rosenthal et al. (2006) argue that the small size of the bonuses account for the small effect sizes in P4P studies. Also, unintended consequences schemes may dampen the enthusiasm for P4P. For example, one study showed that the proportion of African-Americans patients treated by a hospital was inversely associated with performance for certain process-related performance measures.

Agency theory supports the use of incentive-based contracts in difficult agent-principal relations in political science, economics, and organizational research. However, the jury is still out on the effectiveness of P4P in healthcare. Certainly, the relationship of principal and agent is complicated and the oversight to ensure contract compliance is extensive. Yet, there are many extenuating issues that make the application of agency theory to healthcare P4P complicated. More investigation into the application agency theory in healthcare incentive-based contracts is required.