Richa Upadhyay, Stanford University
Introduction and Summary
One in four Americans report that they or a family member struggles to afford healthcare. The American healthcare industry is facing a critical need to control costs and incentivize high-quality care. Empty hospitals and shorter stays should be seen as a sign of efficient healthcare provision and improved population health rather than a revenue red flag. States must align financial and public health incentives through global budgeting, a form of value-based care, to tie hospital payments to health outcomes.
Global budgeting is a hospital payment system in which hospitals receive a predetermined annual payment that is adjusted for inflation, population, and other factors. Additionally, unused funds go toward physicians’ compensation, which gives providers an incentive to reduce unnecessary care. Viewed holistically, global budgets cut hospital costs and improve health outcomes by investing more in population and preventative health.
This piece details the current landscape of healthcare payment systems, notably the US’ historical reliance on fee-for-service payment systems and fragmented care. It will first describe global budgets, their benefits and limitations, and the process for determining annual budgets. Next, it will analyze case studies of global budgeting systems in Maryland, Pennsylvania, and California, as well as in the private sector at Kaiser Permanente, before discussing considerations for states and hospitals adopting global budgeting.
The Current Fee-For-Service System
Currently, the majority of hospitals and providers in the US are paid via fee-for-service (FFS), which “rewards quantity over quality, especially for high-cost, high-margin services.” In practice, this means physicians and hospitals are retrospectively paid based on the number of provided services, treatments, and days spent in the hospital without regard for health outcomes or quality of treatment.
In FFS systems, physicians have the incentive to maximize the number of services—especially high-cost services—they provide. This process can ultimately lead to patients receiving duplicative or unnecessary services. This is especially dire for government-funded healthcare programs, where it is a violation of the False Claims Act for physicians to bill for unnecessary services and supplies. And because physicians simultaneously recommend and provide those services, they have a direct incentive to maximize their compensation. This inevitably leads to a domino effect of inflated costs since insurers are required to pay providers for these unnecessary services, leading to higher premiums and cost-sharing for consumers.
Hospital consolidation and fee-for-service models result in the misalignment of financial incentives, driving up healthcare costs. As hospitals and health systems continue to gain market power and negotiating leverage, there is an urgent need to regulate these rising costs while improving health outcomes.
FFS systems are particularly unfavorable for safety net hospitals that serve a disproportionate share of Medicaid and Medicare beneficiaries because the government negotiates lower rates for services compared to private insurers. Those hospitals reap less revenue per service, pushing them to overcompensate by providing a greater volume of services. In fact, a study based on the commercially-insured US population between 2010 and 2015 showed that Medicare beneficiaries experienced 2 to 3 times more episodes of care with unnecessary services per year compared to commercially-insured patients.
Similarly, fee-for-service systems are unfit for rural hospitals. Since rural hospitals tend to have unpredictable revenue streams and larger percentages of Medicare and Medicaid patients, they are at a higher risk of shutting down. These factors make FFS systems challenging to manage financially.
Global Budgeting Overview
Global budgeting is a promising method for implementing value-based care. Under global budgeting, hospitals receive a predetermined annual payment regardless of “the number of inpatient admissions, emergency department visits, and other volume measures,” while considering inflation and population changes. Any surplus at the end of the year stays with the hospital and contributes to physicians’ compensation. This creates a financial incentive for physicians to reduce hospital costs and thereby the number of unnecessary services.
Simply put, compared to FFS systems, global budgets shift the “financial risk from payers to providers.” This reduces the FFS incentive to inflate the number of patient visits, pushing providers to further invest in preventive services that help keep people out of the hospital.
Especially important for rural hospitals and hospitals with large Medicare and Medicaid populations, global budgets streamline administrative costs and generate predictable revenues. Budgets make it easier to allocate costs, analyze demand shifts for certain services, and control annual expenditures. Moreover, global budgets are comparatively more flexible and efficient for distributing resources because they essentially represent “one-line budget[s].” Likewise, global budgets limit the use of “inflated claims” for treatments, thereby increasing accountability among providers and hospitals. Global budgets also encourage hospitals to invest in population and preventative health since physicians earn more with fewer patients in the hospital.
Global Budgeting Implementation
When exploring historical global budgeting implementation, it is important to consider how the budget will adapt over time. There are three general ways a hospital budget can be set: historical, capitated, and normative.
- Historical: This approach uses the first year’s budget as the base total and is modified for the following years. This method is the most widely used.
- Capitation: This method sets budgets and resources based on the needs of the population served, which is more challenging because of the necessary health assessment analyses.
- Normative: This approach doesn’t consider patterns of cost and need. Instead, it sets unit prices for services and multiplies them by the predicted number of services.
The first budget is most efficiently set with the historical method, in which the budget is based on patterns of past expenditures and is modified annually based on the experiences of the patient population and the extent to which they utilize hospital services. Modifying these budgets annually requires analyzing the reference population, which is the “population most closely tracked for year-over-year budget adjustments.” The reference population can be categorized in various ways, but the simplest method is by analyzing the population living in the hospital area. Pennsylvania, for example, uses geography-based reference populations. Unlike the reference population approach, Canada and some European countries typically set their global budgets based on provider capacity rather than the needs of an entire population, which can make their budgets more stable, predictable, and easier to set.
Modifications to the budget should reflect changes to the reference population and how patients outside the reference population utilize services. For example, if a hospital experiences a growing reference population, then it will receive a larger budget next year.
In order to stay unbiased and maintain a “strong governance structure,” an independent agency should manage global budgets and ensure that the system is fair for both payers and hospitals. In Maryland, this agency is called the Health Service Cost Review Commission (HSCRC)—its members are chosen by the governor and include physicians, patients, and policy experts. Administratively, commission members play an important role in determining which services are included in the global budget.
To prevent hospitals from sending their patients elsewhere with the ill intention of keeping the extra revenue, the budget system must be revisited yearly and analyzed for changes in the market, demographics, and treatment utilization. For example, if the reference population shifts its care to other hospitals, the global budget will be reduced.
The global budget plan should also include determinable quality metrics such as changes in community health outcomes and the number of preventable inpatient admissions. Supplemental pay-for-performance incentive programs based on these quality metrics may further tie global budgets to improved outcomes. For instance, if the reference population shows improvements in health, hospitals may maintain their budget despite reduced utilization.
Case Studies:
Maryland
History of cost containment
Currently, Maryland is the only state to have global budgets implemented statewide. However, it has a long history of cost-containment efforts, beginning with its all-payer rate-setting system in the 1970s. Used to combat price variation, excessive billing, and insurance-related costs, an all-payer rate-setting system does exactly what it suggests: The state government and the independent HSCRC set rates for all payers for the same services at the same site of care provision. Maryland has been successful with this system—private insurers currently pay the lowest rates in the country for healthcare services and were paying some of the lowest rates even before global budgets were implemented.
However, rate-setting systems have limitations. Rate setting does not reward high-quality care because providers and hospitals are still paid via FFS. As such, rate-setting systems should be considered an addition to global budgets to standardize and contain costs while improving quality.
Transition to global budgets
Using the historical approach, global budgets were first established in Maryland in 2014 as a five-year demonstration project with the Centers for Medicare and Medicaid Services (CMS) through a CMS 1115 waiver, which was recently approved to be renewed because of its evident successes. 95% of Maryland’s regulated hospital revenue was able to switch to global budgets within the first year. By the end of the five-year period, all 47 hospitals and 98% of total hospital revenue had transitioned to the budget system, exceeding the original target of reaching 80% by the end of the demonstration timeframe. Moreover, the project realized $1.4 billion in cumulative Medicare savings over five years, surpassing the state’s requirements of at least $330 million with CMS.
In addition to the substantial cost benefits, Maryland accrued improvements in health quality and outcomes for its patient population. The demonstration project required Maryland to reduce its readmission rate to the national rate or lower. Before implementing global budgets, Maryland’s readmission rate was 1.22 percentage points above the national rate, and by 2018, the Maryland Medicare FFS Readmission Rate was 0.05 percentage points lower than the national rate. Furthermore, Maryland was able to reduce the number of hospital acquired conditions by 51% and the number of preventable complications by 48%, which was well beyond the 30% requirement.
These positive results motivated the state to push for a more comprehensive approach to improve health quality. Some Maryland hospitals began investing in transportation to healthier grocery stores. Additionally, Lifebridge, a nonprofit healthcare corporation and Sinai Hospital’s parent company, developed a caseworker program for diabetic patients.
Pennsylvania
Although Maryland is the only state that has implemented global budgets for all hospitals, Pennsylvania was the first state to apply global budgets to only rural hospitals, including critical access hospitals and acute care hospitals. Around 46 million people live in rural areas in the US, and rural communities account for almost two-thirds of primary care health professional shortage areas. Rural hospitals experience extra challenges such as fewer patients, a larger demand for uncompensated care, and physician shortages. Keeping hospitals open and running in these areas is extremely important because patients face more financial barriers while having access to fewer care options and medical resources.
In January 2019, Pennsylvania launched an initiative with the goal to transition from volume-based to value-based care. The seven-year demonstration project spanning 2019-2024, with a pre-implementation year from 2017-2018, used $25 million in CMS funding to regulate the model and approve proposed care delivery plans. In their pre-implementation period, Pennsylvania used their funding to gather data and calculate the global budgets based on “historical net revenue for inpatient and outpatient hospital services for each payer.”
In partnership with CMS and the Center for Medicare and Medicaid Innovation, Pennsylvania introduced the Pennsylvania Rural Health Model (PARHM) to protect rural hospitals. Broadly, PARHM affects over 1 million people, which represents 10% of the state’s population, and is partnered with 18 hospitals. The state committed to realizing $35 million in Medicare hospital savings, and according to 2019 data, PARHM has created over 17,000 jobs.
In Pennsylvania, CMS and other commercial payers pay rural hospitals through a global budget to cover the hospitals’ services. For all participating rural hospitals, the state works with CMS to approve the Rural Hospital Transformation Plans that were originally developed during the pre-implementation period. These plans outline how the participating hospitals intend to improve quality and produce Medicare savings. Like Maryland, Pennsylvania developed financial and health targets for the demonstration project. In addition to the Medicare hospital savings requirement, the state required hospitals to constrain the cost growth rate per patient during Performance Years 2 through 5. In terms of fusing financial incentives with health outcomes, the state identified the following three goals: increase access to health services, limit rural health disparities, and improve care and outcomes related to substance use disorder and opioid abuse.
For each participating hospital, the baseline budget for the first year is the larger of the latest fiscal year’s revenue or the average of the past three fiscal years. Global budgets are annually modified for inflation, demographics, and quality. CMS provides the hospitals biweekly, evenly-distributed payments covering the budget for Medicare services.
Other Examples of Global Budgets
Kaiser Permanente
Global budgets have also been implemented by payers rather than by states. For example, Kaiser Permanente (KP) has successfully implemented global budgets without statewide legislation. KP is the largest nonprofit health plan in the US and one of the nation’s leading healthcare providers. Aligning financial incentives is important to the execution of KP’s model since they fuse both healthcare delivery and coverage.
Kaiser physicians are paid through a salary instead of fee-for-service, which reduces the incentive for physicians to overtreat patients. This gives KP an opportunity to promote preventive and integrated care. KP can also reinvest their revenue in electronic health records, population health studies, and telehealth to improve quality of care. KP has taken a unique, small-scale global budgeting approach and has coordinated incentives for all healthcare professionals. However, KP’s model is unique because it is a closed network system. Serving as both a payer and provider, it can more easily align incentives than traditional health plans and hospitals.
California’s Global Payment Program
California offers an example of an alternative approach to implementing global budgets and quantifying health outcomes. In 2015, California began its transition to a global budgeting system for its uninsured population with CMS’ approval of an 1115 CalAIM demonstration. California established a Global Payment Program (GPP), which provides global budget payments to participating entities in the public health system for care delivered to uninsured people.
California funded the GPP by combining the state’s existing Disproportionate Share Hospital funding and the renewed Uncompensated Care funding from the waiver. For the first year, there was $1.1 billion in available federal funding from both portions combined. Designated public hospitals can voluntarily join the GPP and commit to reducing costs, providing high-quality care, and emphasizing preventive services. As of 2022, 12 participating hospitals in California’s public healthcare system have opted into the GPP for its uninsured patients.
The Californian GPP sets a budget for the services provided to the uninsured. If entities in the public healthcare system do not meet a service threshold, their payments will be reduced, and the funding may be redistributed to hospitals that exceeded the threshold. Unlike Maryland and Pennsylvania, GPP payments are calculated with a “value-based point methodology” that considers factors that affect uninsured individuals’ utilization of health services. Each service has an associated point value that is initially based on costs and then modified based on other value metrics such as access, prevention, and improvements to health.
Importantly, the GPP prioritizes health equity through a Health Equity Monitoring Metrics Protocol submitted to CMS. The protocol identifies disparities in access and health outcomes by analyzing data on ethnicity, race, language, and disability status.
Limitations and considerations
While global budgets may improve quality and lower costs, interested states and hospitals should consider the limitations. Maryland and Pennsylvania’s global budgeting programs show initial promise and are important models, but more long-term data is needed.
First, the prospect of keeping the surplus at the end of the year could incentivize some hospitals to refer their patients to nearby hospitals to minimize patient volume. Therefore, it is crucial that the independent commission and CMS develop budgets based on patterns of revenue and utilization from years prior to enactment. This ensures that patient volume and referrals do not significantly change from year to year.
Although global budgets disincentivize overtreating patients, there may be an underlying inclination to undertreat patients and limit spending because hospitals receive the same payment regardless of volume and physicians may receive an incentive payment for reducing service provision. Volume and quality standards as well as pay-for-performance policies could help mitigate this issue. Moreover, measuring health outcomes to protect patients from undertreatment is vital. Independent agencies like the HSCRC could help enforce these standards.
While the global budget acts as a predictable buffer for hospital revenues and is beneficial when there are decreases in volume, budgets may not be sufficient with unpredictable increases in volume, such as the steep spike in patients during the COVID-19 pandemic. However, these global budgets should be flexible and should include provisions for unforeseeable circumstances and extreme cases. This way, hospitals will not feel penalized for circumstances out of their control.
For example, Maryland prioritized hospital funding stability over cost savings during the pandemic. More specifically, the HSCRC adopted the following three policies to address temporary changes caused by COVID:
- The Global Budget Guarantee allowed hospitals to increase charges or roll over their expected revenue to the next year if they did not meet their global budget.
- COVID Surge Funding provided additional funding for hospitals that surpassed their expected patient volume.
- COVID Expense Adjustment supported hospitals facing high expenses and reduced margins.
Although these policies might not be relevant for future extreme cases, they provide an example of how global budgets can be used to maintain funding stability.
Conclusion
As healthcare costs continue to rise and disparities in healthcare access and outcomes continue to raise concerns, states and hospitals must explore innovative ways to improve from the status quo. Currently, policymakers struggle to compromise on health policy reform, which further delays action and results. It’s important to remember that lives are at stake and healthcare without proper incentive structures impacts individuals, their families, and communities.
Consequently, states and hospitals aiming to improve quality and reduce costs should consider global budgets. Success stories from Maryland and Pennsylvania suggest that global budgeting can align the incentives of physicians and hospitals with those of patients while yielding significant cost savings. While certain health policy reforms may seem extreme to some, global budgets are a feasible, nonpartisan, and proven strategy to improve the US healthcare system.