Preparing for a value-based health care environment is daunting at a time when fee-for-service payments still predominate. But boards can take steps now to help hospitals thrive today and in the future.

Hospital boards and C-suite executives have a major strategic decision to make in the near future: Should they go at-risk?

Risk-based payment structures take on various forms. Some provide opportunities to share in savings when care is provided at a lower than expected cost (“upside risk”); others also demand financial penalties when costs exceed a benchmark (“downside risk”).

While many boards may believe they have already assumed risk through existing value-based payments, accountable care organizations or bundled payment scenarios, they may not realize that the majority of these agreements lack downside risk. As payers move beyond gain-sharing arrangements, providers also will need to enter into downside risk agreements.

The clearest signal for change came with recent announcements by the Centers for Medicare & Medicaid Services and leading payers and providers that set ambitious goals for increasing value-based payments. Despite indications that value-based reimbursements are what the future holds, many delivery organizations are hesitating.

One reason is concern that if they start too early and without some defined arrangement with a payer, they will forgo revenue in today’s fee-for-service model without any offset through gain-sharing or other structures.

In truth, preparing for risk can help boards to optimize their revenue in the current payment model. Start by optimizing fee-for-service today, then build out infrastructure you’ll need in the future. But first, it’s important to understand what risk looks like in the context of the current health care marketplace.

ACO Programs

CMS launched the Pioneer ACO program with 32 member organizations in January 2012, and the Medicare Shared Savings Program ACO model soon after. While the MSSP has grown in participation, the Pioneer program saw a significant decline in the first two years. Both programs were intended to facilitate improved care coordination, leading to better outcomes at lower costs, but they differ in how providers assume financial risk.

The increase in MSSP participation is largely due to the opportunity to take on upside-only risk. In contrast, the Pioneer group faced downside risk from Day 1. The biggest problem cited by Pioneer dropouts wasn’t with coordinating care, but rather how CMS measured their improvements and linked them to penalties and rewards. The Pioneer model requires organizations to reduce spending based on national benchmarks, which effectively penalized providers who already were operating more efficiently than their peers in other regions of the country.

Pioneer participants also have expressed serious concerns about program design, including its administrative complexity; the tepid financial incentives relative to penalties; and their inability to manage beneficiaries’ outcomes and costs when they aren’t permanently assigned to the ACO or limited to ACO providers. New rules for both CMS ACO programs are now in place, but we expect the underlying issues to create continued problems.

Bundled Payment

Another risk-bearing arrangement is bundled payment. Bundled payment programs were proposed as a way to encourage improvements in health care quality while reducing variability and costs. The model has been labeled a critical element in payment reform, aligning activities, costs and outcomes.

Bundled payment may cover an acute clinical episode or a chronic condition (e.g., heart failure), including disease management costs, over a specified time frame. If the negotiated costs associated with the clinical episode or time frame are less than the contracted bundled payment amount, the providers keep the difference, as long as they meet quality criteria. Alternatively, if costs exceed payment, providers absorb the loss. Bundled payment programs continue to expand through public and commercial payers, and a broader adoption of bundled payment and associated risk may be on the horizon.

Understanding Cost Structure

Facing a future of risk-based payment requires that providers understand and measure not only quality, but also variation in clinical practice and associated cost at the provider level. It’s been long recognized that the physician’s pen is the most expensive piece of medical equipment in the hospital. With it, medications, diagnostics, imaging studies and procedures of all types can be unleashed from the medical-surgical armamentarium. In most health care delivery organizations, however, the ability to analyze underlying production cost by case type and physician is limited by several factors.

In the past, health care financial data have been a “black box.” Administrators and providers alike often are unable to see what it really costs to provide a given service in terms of labor, infrastructure and materials, because most financial systems were designed with one primary purpose — to facilitate billing, not to analyze the underlying cost components of the charges.

Even when the data can be pulled from the system, the capability to analyze data is lacking, because the need to do so has never been a priority.

If functionality and capability weren’t obstacles enough, the methodology typically used to arrive at underlying production costs is fuzzier than “fuzzy math.” The current method of arriving at underlying costs by case type or even service typically relies on a method of cost-to-charge ratio.

Based in part on list prices from hospital chargemasters that reflect what the market will bear, costs based on this method are wildly distorted, bearing at best only a passing resemblance to facts on the ground.

Hospitals need accurate cost information to make informed business decisions. Activity-based cost accounting, a useful technique used by most businesses, can assist health care providers in cost management. In ABC, it is essential to identify relationships between an activity and the resources needed to complete it. Using ABC methodology, a cost is assigned to the resources required by the activity. Once a provider knows how much it costs to provide a specific service, more informed care decisions can be made.

Health care systems, regardless of whether they are protecting margins under volume-based, fee-for-service models or preparing for value-based, at-risk contracts, need to understand and manage their costs. As patients continue to shoulder more of the cost of their own care because of high deductibles, they increasingly will shop for care based on cost and quality data.

Better understanding of cost structure also helps organizations compete in a fiscally constrained market. Improving the bottom line is always a good thing to do regardless of the payment model.

Variation and Accountability

Variation in the way health care is delivered in the United States has been a point of focus for providers and other stakeholders for many years. In cost and quality of clinical practice, there is significant variation among regions, hospitals in a region, physicians in a hospital, and even physicians in the same practice. Decades of research have shown that more care and higher cost do not necessarily translate to better outcomes; in fact, the opposite is often true. This variation in cost of care is an enormous opportunity to reduce overall care cost.

Managing variation cannot be addressed by implementing new information technology platforms and software suites. Many organizations may think they have it covered with new electronic health record and data warehouse investments, but they are just scratching the surface. Getting to the cause of practice variation (and associated cost and quality issues) requires re-evaluating assumptions of how health care is delivered. To start, managing variation requires relevant, high-quality data delivered to physicians from a credible source (a peer or colleague). Quality reporting data delivered from the hospital quality assurance team is generally not specific enough to the patient or practice to allow for meaningful physician-level conversations.

To target better management of clinical cost and quality, organizations need to implement evidence-based care paths. Clinical care paths, also known as clinical pathways or care maps, are designed based on the best available clinical evidence and are focused on improving clinical outcomes, resource management and reducing the cost of care.

Care paths are the basis for analysis of best practice patterns, cost and outcomes. Care paths are also the foundation for moving to bundled payment and population health management. Being able to manage cost and quality not only helps to prepare for the future of risk-based contracting, it also facilitates margin improvement in fee-for-service models.

Analytics and Capabilities

Boards will play a critical role in driving health care systems to build the analytic, process and capability needs to: (1) ask the right questions, (2) collect the right data, (3) analyze the data and (4) make the right clinical and financial decisions. Providers are establishing clinical and financial dashboards to understand practice and physician-level performance focused on patient outcomes and total costs. Initial drivers of data analytics have been the penalties providers face if they miss targets for readmission rates, patient satisfaction and other performance measures.

Bundled payments also will require predictive analytics that can identify at-risk patients, enabling proactive management of their health conditions outside the hospital to prevent more costly care. For providers, preventive interventions enabled by predictive analytics can deliver profits under new payment models, which are moving toward various forms of capitation.

Data and analytics won’t move the cost and quality dial if the right questions aren’t being asked and the answers aren’t being used to effect change. Clinical and financial data must be integrated to demonstrate the connection between physician practices and costs, and physicians must be aligned with organizational goals. If cost and quality data are siloed and not actively integrated into practice, uncoordinated and fragmented care will persist. Boards and C-suite leaders need to benchmark providers internally as well as nationally, create structured opportunities to share best practices, and establish clear accountability for results.

Path Forward for Boards

Hospitals and health systems in the United States are facing unprecedented pressure for change. Multiple intersecting dynamics will drive the transformation of health care delivery and financing from volume- to value-based payments over the next three to seven years.

In the current regulatory and economic environment, hospital boards must lead the way in focusing executive efforts on performance initiatives essential in the short term that also will remain critical for long-term success. By ensuring success today, boards are establishing the foundation for success tomorrow. 

Copyright © 2015 Numerof & Associates. All rights reserved.

Michael N. Abrams, M.A. ( is the managing partner, Rita E. Numerof, Ph.D. ( is the president, and Christen Buseman, Ph.D., M.P.H. ( is a research analyst at Numerof & Associates Inc., St. Louis.


Fortunately, there are steps hospitals and boards can take to improve performance now, even in a fee-for-service environment, while preparing to assume risk in value-based payment models. These steps focus on understanding underlying cost structures; managing variation in cost and quality; and delivering predictable, transparent outcomes.

Questions that all boards need to ask as they contemplate an at-risk model include:

• Do we understand our cost structure today?

• Are we providing care through evidence-based care paths?

• Do we understand our clinical outcomes?

• How do we tackle provider accountability?

• What data and analytic capabilities are needed to support accountability and risk-based payment?