Alternative payment models require a second look

When the Affordable Care Act (ACA) was enacted in 2010, alternative payment models (APMs) were touted as promising tools for reining in costs. After a decade of modest results, the Biden administration should consider adjusting their design.

The premise of APMs is that the financial incentives embedded in reimbursement policies drive how care is delivered to patients. Fee-for-service (FFS) payment is said to reward volume rather than value because providers get paid more when performing more services and ordering more tests. APMs try to counter these incentives by focusing bonuses on population-based measures of spending and health status, or by combining discrete payments into bundles covering the full cost of entire episodes of care.



The most prominent APM is the Accountable Care Organization (ACO) initiative in Medicare. ACOs bring together hospitals, physician groups, and others into affiliations that encourage team-based care for patients and attention to total costs. Most ACOs get paid on a fee-for-service basis but earn more by keeping their combined costs below spending benchmarks. The Centers for Medicare and Medicaid Services (CMS) has created numerous versions of ACOs for providers to choose from based on their circumstances and ambitions.

In addition to ACOs, providers can participate in episode-specific APMs. A bundled payment is sent to one of the participating facilities or practitioner groups involved in a care delivery episode, which then works with the others to divide up the single payment into reimbursement amounts for all the various services needed to successfully address the patient’s needs.

Evaluations of these efforts confirm that incentives matter. Most of the tested APMs have reduced overall costs while retaining acceptable levels of quality. Predictably, providers alter their behavior to maximize their revenue, and with APMs that means reducing measured costs just enough to satisfy the requirements for incentive payments. The overall savings to Medicare has been disappointing, however, as the bonuses paid to encourage participation have offset most of the cost reductions from more efficient care.

Analysts have pointed to several causes for APMs falling short of previous expectations:

  • Too Many Models. The ACA encouraged CMS to test numerous APMs all at once, which increased the odds that one or more would deliver impressive results. A complication has been models working at cross-purposes with each other. Hospital systems can join ACOs and sponsor bundled payment tests too. The savings from one can reduce the opportunity for efficiency improvement under the other. In other words, there are multiple initiatives now being tested in the field, many of which are chasing the same limited pot of cost reductions.
  • Risk Aversion. Facilities and practitioners have expressed reservations about APMs that include penalties for missing benchmarks. They prefer incentives and have pushed CMS to extend the timelines of upside-only options. But paying out rewards to high performers while getting no offsetting receipts from low performers leads to upward pressure on overall spending.
  • Voluntary Experiments. Compulsory APMs are controversial, which is why CMS has moved toward voluntary participation by providers, but allowing providers to opt out compounds the problem of risk aversion. Only facilities and practitioners who expect to gain financially are joining the APMs, which means the results are skewed toward higher costs.
  • Complexity in Determining Benchmarks. CMS’ methodology for setting spending targets is necessarily complex, and relies on payment methodologies that were long ago severed from market realities. The result is widespread second-guessing by providers. Most of them believe the targets unfairly penalize efficiency gains from previous years. Distrust of this benchmark-setting process has further discouraged risk-taking.
  • Disinterested Patients. Medicare beneficiaries do not usually sign up to get their care through an ACO. Instead, they are assigned to ACOs based on their use of physician services. As such, they have little incentive to cooperate with ACO-driven managed care protocols because they do not share in any savings from the cost reductions.

The Biden administration cannot be expected to fix these problems quickly, or all at once. The APM tests are on-going, and thus will have to be modified incrementally over the coming years.

A priority should be encouraging more active engagement by the APM participants and Medicare beneficiaries. One option would be to set payment benchmarks based on provider bids rather than current FFS regulations. Facilities and physician practices could set their own prices but would be required to charge the beneficiaries for amounts above the average bids. This design would encourage aggressive cost-cutting. The government could then reward beneficiaries who select low-cost providers by sharing some of the savings with them.

APMs are a major opportunity for the Biden administration. The cost-cutting potential is still there, but needs to be unlocked. The key is to ensure providers and beneficiaries both win financially when they opt for high value instead of high cost.

James C. Capretta is a columnist for State of Reform and is a resident fellow at the American Enterprise Institute.