This year's landmark health reform legislation includes a five-year pilot project for bundling payments for episodes of care to hospitals, physicians, nursing homes, rehabilitation facilities and other Medicare providers. Beginning in 2013, the voluntary program will put participating hospitals at risk for the cost and quality of care delivered outside their walls. A similar one-year Medicaid demonstration begins in 2012.

Ordinarily this kind of demonstration project might be interesting, but not critical, to the broader hospital field. But this one is different. If independent reviews, to be conducted after two and three years, show that the Medicare program lowers costs or improves outcomes at the same cost, the Department of Health & Human Services may extend and expand the program without additional congressional action.

In other words, episode-based bundled payments potentially could become Medicare policy as early as 2016. Private insurers and large corporations also are looking to bundled payments to reduce costs and improve care effectiveness. The Massachusetts Blues have implemented a bundling contract program covering all insured services, and some large companies are contracting with integrated providers for high-cost services such as heart surgery as well as ongoing care for chronic conditions on a flat-fee basis.

Results from several demonstration projects suggest that bundled payments, particularly when linked to evidence-based quality metrics, can improve outcomes and lower costs by creating financial incentives to coordinate care from all providers involved in an episode of care. For example, Geisinger Health System's bundled payment for coronary artery bypass grafts (CABG) reduced hospital costs by 5 percent, post-acute care costs by 50 percent and 30-day readmission rates by 44 percent. Medicare's Heart Bypass Demonstration reduced costs an estimated 10 percent overall.

Indeed, a 2009 model developed by the Rand Corp. concluded that bundled payments have the greatest potential to reduce costs and increase quality of 12 system reform options examined. The other options included establishing medical homes, expanding value-based purchasing that reimburses providers for achieving specified quality goals and reducing resources devoted to end-of-life care. This evidence makes bundled payments an attractive option for both public and private payers.

However, bundled payments also create significant strategic challenges for providers. Because they require providers across the continuum of care to collectively manage care and costs, and divvy up a lump-sum payment, success requires a high level of clinical, operational and financial integration. Making the required operational and structural changes is not easy.

Many systems that have successfully implemented bundled payment programs have been able to because they already incorporated physician groups and other provider entities. Even so, these integrated systems generally have had to make significant investments to develop protocols, beef up clinical and operating management, and add information technology and other support infrastructure. Some non-integrated systems have found the costs of creating these structures exceeded the benefits. Others have found it impossible, or nearly so, to muster the management resources or gain the cooperation of other providers to attempt it at all.

These difficulties are reflected in participation rates in early demonstration projects. For example, of the 734 hospitals that expressed interest in Medicare's Heart Bypass Center Demonstration, 209, or 29 percent, submitted pre-applications. Within a year of the introduction of Blue Cross Blue Shield of Massachusetts' Alternative Quality Contract about 20 percent of providers signed up.

Many technical questions also must be answered before episode-based bundled payments can be widely implemented. These include determining appropriate time frames for episodes and developing methods for monitoring performance and sharing payments among providers.

Nonetheless, should Medicare broadly adopt a bundled payment program, hospitals will likely face intense financial pressure to participate. Even if participation is voluntary, fee-for-service rates will likely move toward lower bundled payment costs. Likewise, private payers may limit payments to bundled cost levels, or even exclude providers unable to manage bundled payments.

Active board leadership and participation will be needed to make the delivery system changes required to successfully manage bundled payments. Significant capital resources may be required to fund IT and management infrastructure development. Integrating with physician groups and other providers may require bringing representatives onto the system board or service line governing boards to help enlist cooperation in developing protocols and integrating operations and finances. Board action to establish organizational goals, and reporting mechanisms to the board level to ensure goals are met, will also help ensure the organization commits to collaboration—particularly if partner providers are represented.

In this article we explore the details of bundled payments, the results achieved by some existing models, questions that must be addressed to broadly adopt bundled payments, and some implications for boards preparing for their impact.

Medicare's Bundled Payment Pilot

The Medicare bundled payment pilot program will test 10 conditions to be selected by the secretary of Health & Human Services. They will include a mix of acute and chronic, and medical and surgical conditions. Pilots may involve hospitals, including long-term care hospitals and inpatient rehabilitation facilities, physician groups, and skilled nursing facilities and home health agencies for an episode of care that begins three days prior to a hospitalization and spans up to 30 days post-discharge. However, longer periods may be designated for the condition.

The Medicare pilot program also will monitor clinical, functional, patient perception and financial outcomes. Monitoring outcomes is seen as a crucial way to counterbalance financial incentives to under-treat patients. Linking bundled payments to quality metrics also has been shown to improve outcomes. The program may be expanded and extended if independent reviews show it reduces costs without affecting quality or improves quality and reduces costs.

Bundled Payment Models

To date, only a handful of bundled payment models have been implemented. Many of these programs are either narrow in scope or have been implemented in highly integrated systems with a broad array of services, such as large hospitals or academic medical centers. Therefore, their design and results are not necessarily applicable on a wide scale and to small, medium-sized, and rural hospitals.

Medicare's Participating Heart Bypass Center Demonstration: From 1991 to 1996, seven hospitals received a single payment covering hospital and physician services for CABG surgery. Hospitals determined how they would share the amount with physicians. Rates were set by bid and updated annually according to the Medicare Prospective Payment System and physician payment schedule. Medicare saved $42.3 million, or about 10 percent of expected costs. Beneficiaries saved about $7.9 million in coinsurance payments. Three of the four initial hospitals in the project reported cost reductions of 2 to 23 percent, mostly due to reductions in intensive care unit use, savings on generic drugs and efficient use of the catheter lab. Mortality rates for CABG patients also dropped at the participating hospitals.

Medicare's Cataract Surgery Alternate Payment Demonstration: From 1993 to 1996, this project tested a negotiated bundled payment for all services routinely provided within an episode of outpatient cataract surgery, including physician and facility fees, intraocular lens costs, and selected pre- and postoperative tests and visits. Negotiated payment rates were 2 to 5 percent lower than the non-demonstration payment rates, saving Medicare about $500,000 on 7,000 patients.

Geisinger Health System's ProvenCare: Begun in 2006, payment is bundled for all non-emergency CABG procedures including the preoperative evaluation, all hospital and professional fees, and management of any complications, including readmissions, occurring within 90 days of the procedure. The price was set at the average cost of inpatient care plus 50 percent of the average cost of post-acute care for the 90-day period. Payment is linked to 40 best practice steps. Initially, 59 percent received all 40 best practice steps, rising to 100 percent after six months. The program is estimated to have reduced all complications by 21 percent and sternal wound infection by 25 percent. Hospital costs fell 5 percent, average length of stay declined 0.5 days and the 30-day readmission rate dropped 44 percent over 18 months. Geisinger has extended the program to include hip replacement, cataract surgery and obesity surgery.

Lanny L. Johnson, M.D., and Ingham Medical Center: In 1987, an orthopedic surgeon partnered with a local hospital to offer a fixed price for knee and shoulder arthroscopic surgery, which included all related physician and hospital charges for surgery and any subsequent service for two years after surgery. Profit margins for the surgeon and the hospital increased, and the payer, an HMO, saved more than $125,000 on 111 cases. The program also reduced avoidable complications and reoperations.

Medicare's Acute Episode Demonstration: Begun in 2009, Medicare pays the five participants a flat fee to cover hospital and physician services for cardiac care (CABG, valves, defibrillators, pacemakers, etc.) and orthopedic care (hip and knee replacement). Participants may reward clinicians and other hospital staff who meet certain quality and efficiency goals.

Prometheus Payment Inc.: With grants from the Commonwealth Fund and the Robert Wood Johnson Foundation, Prometheus is developing a bundled payment system to cover a full episode of care for acute myocardial infarction, hip and knee replacements, CABG, coronary revascularization, bariatric surgery and hernias. Prometheus was implemented in three sites in 2009.

Fairview Health Services: Fairview Health Services in Minnesota is currently working with Target, 3M and other large, self-insured employers to develop flat-fee "care packages" around specific chronic conditions, such as diabetes and asthma. Employers and patients can use online tools to purchase a package that fits their needs.

Blue Cross Blue Shield of Massachusetts Alternative Quality Contract: In 2009, BCBSMA introduced AQC, a global payment system tied to nationally accepted quality measures. The payment rate is set for all services and costs associated with a patient's care, is risk-adjusted for health status, sex and age, and is updated annually for inflation. The AQC is the most comprehensive bundled payment model to date. It covers all conditions, includes all required services across the continuum of care, and rates performance based on detailed process, outcome, and patient experience measures. The contract also includes a 10 percent bonus for meeting certain quality benchmarks. About 20 percent of providers signed up the first year.

Issues with Bundled Payments

Before widespread implementation of bundled payments can be achieved, a number of questions must be addressed. These include:

To which conditions should bundled payment be applied?
Experience suggests that some conditions may be more suitable for bundled payment than others. Medicare's bundled payment demonstrations have included conditions with a defined time frame from diagnosis to recovery, such as CABG and cataract surgery, suggesting that isolated acute care incidents are good candidates.

Bundled payments have also been proposed for longer-term conditions that require a fairly well-defined set of services, such as end-stage renal disease. However, it may be more difficult to apply bundled payments to conditions that are less predictable in the care required, such as congestive heart failure. In general, conditions should have well-defined clinical definitions so it is clear which patients are eligible for bundled payment. Conditions with established clinical guidelines will help with the development of benchmarks and goals for providers. Lessons from the Massachusetts Blues AQC program could be instructive on how bundled payments can be structured for a wide variety of conditions while minimizing administrative burdens.

What providers and services should be included in bundled payments?
Past demonstrations have focused on bundling payments for hospital and physician services mostly associated with surgical care. Bundled payment for medical, chronic or long-term conditions will require including other providers, such as primary care physicians, home health, nursing home, long-term acute care and rehabilitation. Within the hospital there may be an opportunity to link ancillary services such as laboratory work, emergency services, and other diagnostic services to the bundled payment.

Engaging multiple service providers will make it possible to optimize financial and care management. However, linking different types of providers and providers from different organizations will be a challenge. Determining payments to the physician and non-physician components of care within the bundle will also be challenging.

How can provider accountability be determined?
A related consideration is how to attribute provider responsibility for care in an episode. For example, most hip fracture episodes involve four or more care settings, and it may be challenging to determine the extent to which each provider is responsible for the outcomes of an episode. Unfortunately, information on how bundled payment models have enforced accountability for care is scant. Outcomes monitoring and linking payments to quality standards may be a solution. Coupling this with fees based on what individual providers would have received under fee-for-service may encourage providers to control their own costs.

What should be the time frame of a bundled payment?
The time frame determines the types and amount of services in the bundle. Bundle time frames of 30, 60 and 90 days after an acute episode have been proposed, but little evidence exists to support any blanket post-acute time frame. An appropriate post-acute time frame should allow the patient time to fully recover from a condition or procedure. For chronic conditions that may cover a patient's lifespan, six months or a year might be an appropriate bundle time frame.

What capabilities are needed for an organization to collect and administer bundled payments?
Bundled payments create a complex administrative challenge for the entity collecting and dispersing payments. This entity would need the administrative capacity to act as a third-party administrator and also have the professional capacity to determine the continuing care needs of patients. Hospitals, accountable care organizations and medical group practices have been proposed to take the lead. The entity would have to work effectively with hospitals, physicians and other providers. It would need information systems to track and manage care processes. Currently, few organizations have the infrastructure and influence to undertake these tasks.

How should bundled payments be set?
A variety of methods are possible, including historical costs for fee-for-service and rates based on standard-of-care guidelines. Regardless of the method, payers will have to periodically revisit and update payment rates as more data on program outcomes become available. The Massachusetts Blues AQC program was updated annually for inflation, and Medicare's Heart Bypass Center program was updated based on the existing inpatient prospective payment and physician fee schedule rules.

How should bundled payments be risk-adjusted?
Adjusting payment rates for age, sex and health status will be necessary to ensure providers can afford to take on complex cases. Other factors including language issues, availability of social support, socioeconomic status and patient cognitive issues also should be considered because they have a big impact on patients' ability to access post-acute services. Insurers commonly cite 100,000 as the appropriate patient population size to adequately diversify risks. It may be that such thresholds should apply for risk-adjusting bundled payment.

What data are needed to support bundled payments?
Most current studies on bundled payment use episode groupers—software packages that search medical claims and records to identify whether patients meet the criteria of an episode, when the episode began and ended, and the services received. However, for groupers to be effective, data on patient diagnoses and co-morbidities; dates, types, and cost of services; and patient and provider identifiers must be complete and accurate. In current databases there is often limited detail because the systems were designed for fee-for-service payment approaches. Electronic medical records may permit more comprehensive data collection.

Implications for Hospital Boards

Because developing bundled payment capacity is a fundamental strategic issue that potentially involves not only management and infrastructure changes but also governance changes, hospital boards have a central role to play. Some actions to consider include:

Examine how bundled payments fit with hospital strategy and community needs. At the highest level, improving care and lowering costs are consistent with hospital community benefit and financial integrity obligations. Episode-based bundled payment methodologies are also very consistent with hospital service line strategies. Developing them early may result in significant market advantages down the road.

Allocate resources to develop operational capabilities to administer bundled payments. These include implementation of evidence-based protocols and utilization management that extend across provider borders; electronic medical records to gather utilization, outcomes and financial information; and methods for allocating payments to provider partners. This may require significant capital resources. These capacities may be developed for specific services within a service line strategy.

Develop governance and management relationships with physicians to enlist their support for required evidence-based protocols. A growing body of research suggests that physician involvement in system or service line management and governance improves clinical quality and financial performance. Integration of, reciprocal representation on, or formal liaisons among hospital and other provider entity boards as appropriate may be desirable.

Establish organizational goals and mechanisms of accountability, including regular reporting of performance and outcomes to board level. Senior level management and board support is key in generating and sustaining organizational change. Formalizing involvement through regular dashboard reports and board representation on performance improvement oversight committees help establish and reinforce accountability.


In the short term, the Medicare and Medicaid demonstration projects, and bundled payment contracts with private payers, create an opportunity for hospitals to develop the capacity to implement bundled payments. Over the long term, the ability to do so may become an essential core competency.

Source: 2010 Bundled Payment—AHA Research Synthesis Report, American Hospital Association Committee on Research. Available at