How Do the 3 Healthcare Payment Models Work?

There are a few different ways that healthcare payments are made in the U.S. Public and private health insurers play a particularly important role in reimbursing providers based on how services are delivered. With the ongoing national push to improve healthcare, many reform programs have paved the way for new healthcare payment models that incentivize quality, rather than quantity.

These new models now exist alongside older ones, so it can be a bit confusing to keep track of how payments in healthcare actually work. To help you understand this landscape, we’ll break down the core types of payment models and describe the pros and cons of each one.

The 3 Core Types of Payment Models in Healthcare

While various federal programs and incentives affect reimbursement rates for providers, there are generally three core healthcare payment models that can be used either alone or in combination. We’ll outline how each of these models work:

1. Fee-For-Service (FFS)
2. Capitation
3. Episode-Based

1. Fee-For-Service (FFS) Model

Fee-for-service is one of the oldest and most traditional payment models in healthcare. Under this model, providers are reimbursed a flat fee for each type of service they provide. This means that patients get billed for every single medical test or procedure they receive when they visit a health facility.

Pros

• Providers have more autonomy over which services to provide and bill for.
• Patients have more flexibility in the providers they can see and their treatment options.
• Billing for individual services can lead to higher revenue for facilities.

Cons

• Providers are rewarded for service quantity, regardless of the patient’s outcome.
• Providers may be incentivized to deliver services that aren’t medically necessary.
• Patients under a FFS model can face rapidly increasing medical costs.
• There is less incentive to refer patients and coordinate care with other providers.

2. Capitation Model

Capitation is one of the alternative payment models in healthcare created to move providers away from traditional fee-for-service. Under this model, a fixed amount of money for each patient is paid to providers in advance, for a set time period (typically, one month).

A certain percentage of these payments is also withheld until the end of the fiscal year. This amount is paid back to the provider if the health insurer makes enough profit, or withheld to cover deficit costs.

Unlike the FFS model, providers that sign a capitation agreement are required to provide a specific list of services, which is usually decided by the health plan. It’s also common for providers to receive payments to cover the cost of referrals.

Pros

• Providers are incentivized to limit unnecessary services, which helps control costs.
• The costs for patients, providers, and insurers are more predictable.
• Capitation simplifies administrative billing, since services aren’t reimbursed individually.

Cons

• Patients and providers are more restricted in the services they can receive/provide.
• Providers may be incentivized to take on healthier and less time-consuming patients.
• Providers may end up trying to save on service costs to the point of compromising care.

3. Episode-Based Model

Under the episode-based healthcare payment model, a bundled fee is provided to facilities up-front for an entire “episode” of care. An episode is more specifically defined as a specific diagnosis and the services needed to treat that diagnosis over a period of time.

For example, if a patient receives cardiac bypass surgery, a health plan would not pay separate fees to the primary provider, anesthesiologist, and surgeon. They would instead provide a single payment to cover all the estimated costs of treating the patient’s condition.

Pros

• Providers are incentivized to coordinate care delivery with other health professionals.
• It fosters more accountability to effectively and efficiently treat an “episode.”
• Reimbursements are often tied to patient outcomes, which can help improve quality.

Cons

• Defining the boundaries of an episode can sometimes be unclear and complicated.
• To avoid exceeding payments, providers may choose to only see healthier patients.
• The predicted costs of care may not be accurate due to unforeseen medical events.

Other Types of Payment Systems

You may have heard of other healthcare payment systems that aren’t classified as “core” models. This is because these systems can’t exist alone, and they typically work alongside one of three primary healthcare payment models discussed above. These “supplementary” systems include:

• Pay for Performance: Pay for performance in healthcare is an incentive-based program used to improve the quality of services provided. Certain health payers, particularly Medicare and Medicaid, apply this by reducing or increasing fee-for-service payments to providers based on a set of quality measures.

• Shared Savings: Some health plans implement a shared savings program, which compares annual care costs to a facility’s historical performance. Providers either receive a bonus or pay a penalty at the end of the year, depending on whether they meet cost targets calculated by a health plan.

• Retainer-Based Payment: Retainer practices refer to when providers charge a “membership” type monthly fee to cover a range of services that may not fall under traditional health plans. To collect this fee, the patient is charged directly.

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