nherent inequities in the design of alternative payment models (APMs) are standing in the way of their widespread adoption; it will be important to address these inequities to ensure the future success of value-based payment.


APMs are a critical element of the Affordable Care Act (ACA), often not recognized as the lynchpin for the law’s ability to achieve its primary objective: to reduce the cost of the nation’s health care while also improving the quality of care. By reducing care costs, APMs hold the promise of helping to drive down insurance premiums, thereby improving the affordability of coverage. Yet achieving this promise has remained elusive as healthcare organizations have been slow to adopt APMs. Here, we offer a provider’s perspective on some of the reasons why.

Public Criticism of the ACA

Much of the public criticism of the ACA has focused on the issues of broader regulation for healthcare insurers, margin compression for providers, and continuously rising insurance premiums for consumers. Quick to cast blame on each other, advocates for consumers, employers, insurance companies, and providers have contributed to a collective narrative in which the ACA’s shortcomings in certain markets are attributed to the combination of adverse risk selection from the newly insured due to weak enforcement of mandates, a lack of meaningful competition among insurers, and the inability of providers to restrain costs.

Although these perspectives have some validity, more attention should be focused on understanding the prevailing economic relationships among insurers, providers, and consumers and properly aligning these stakeholders’ various interests in a framework that is equitable to all parties. To date, this larger purpose of the ACA has remained poorly articulated, with the result that each stakeholder group has focused most of its attention on specific aspects of the law without fully appreciating or understanding how these aspects constitute pieces of a larger puzzle that must come together if the law is to achieve its intended outcomes. Redesigning APMs to support this aim will be a critical next step.

The ACA: Purpose and Design

Simply put, the ACA was designed to create access to health care by making health insurance more affordable for consumers through two major platforms. The first consists of insurance regulations focused on stimulating increased competition in the sector through new market-entrant stabilizers referred to collectively as the 3Rs (i.e., risk corridors, risk adjustment, and reinsurance). The second platform consists of APMs designed as vehicles for provider payment reform whose purpose is to finance the transformation of care delivery while compressing the underlying cost of health care.

The federal government has been the catalyst for these APMs, and commercial insurance companies have followed with a similar framework. Unfortunately, certain providers and insurers have met economic challenges in fully adopting these models. These challenges stem from an inherent misalignment between the design of APMs and the basic structure of the integrated delivery systems (IDSs) that are expected to adopt them. The purpose here is to consider the steps that can overcome these challenges.

The APM Framework

Under ideal performance, about 85 percent of an insurance premium dollar is paid to healthcare providers for delivering healthcare services. The ACA attempts to address the rising cost of healthcare delivery by introducing APMs that shift the way providers are paid from the traditional FFS payment model to a value-based model, which uses quality and cost performance metrics to align providers and give them incentives to improve quality while also reducing costs. The Centers for Medicare & Medicaid Services (CMS) is leading this effort by offering providers a range of APMs that present various degrees of risk and reward. Commercial health plans and local state governments have in turn adopted CMS’s APM framework to initiate payment reform in their segments of the industry. This basic framework of APMs, is illustrated in the exhibit below.

Advanced Payment Model (APM) Framework
Advanced Payment Model Framework

Since the inception of the idea of value-based payment in health care, payment reform has been described in the literature predominantly as a journey from volume (FFS) to value. The framework, developed by the Health Care Payment Learning & Action Network, outlines the stages in this journey to population-based payment or capitation models. Notably, many of the payment models represented in the framework remain fundamentally based on traditional FFS payment, wrapped under the overarching value-focused concept.

Nonetheless, the larger purpose of the value-focused evolution represented by this framework is to contain volume and resulting FFS payment growth by requiring providers to adhere to performance and quality measures, with an underlying focus on reducing unnecessary utilization of care.

The APMs are designed utilizing patient attribution methodologies, specifically targeting primary care physicians (e.g., general internists, pediatricians, family medicine practitioners, and geriatricians). These physician providers, in most cases, continue to receive FFS payment for professional services rendered, but are now required to adhere to quality and cost targets for the members that are attributed to them. The quality metrics offer incentives for preventive screenings, improved appointment access, and an enhanced patient experience. Moreover, cost targets encompass the total cost of care for a member, including a primary care provider’s professional payment; payments made to hospitals, facilities, and specialty providers; and pharmacy costs. Under ideal conditions, the total cost of care constitutes the 85 percent of a health plan’s premium dollar, as noted previously.

To date, the adoption and success of APMs has varied nationwide. Although there have been successes, APMs generally have demonstrated various degrees of performance effectiveness in reducing the underlying cost of healthcare delivery and, by extension, in driving reductions in insurance premiums paid by individuals and employers. Part of this variation can be attributed to provider types and the flaw in the “one-size-fits-all” implementation of APMs.

Misalignment Between APM Design and an IDS’s Cost Structure

As the industry has learned more about APMs, different provider types clearly have gained very different perspectives on these models. In simple terms, the category 3 APMs (shared savings/risk) are viewed as physician incentive plans designed to drive down hospital utilization or revenue. For a stand-alone physician organization without any strong ties to a hospital system, these APMs offer enough of an incentive to reduce hospital-related medical costs without jeopardizing the organization’s current revenue/cash flow.

Unlike physician organizations and insurers, IDSs carry a high degree of fixed cost, and much of their existing FFS revenue, which has been used to support these fixed costs, is threatened under these models.

Example of the Funds Flow in a Typical Shared Savings Program
Example of the funds flow in a typical shared savings program

To illustrate this challenge, the exhibit above provides a funds-flow diagram of the premium dollar, detailing the inverse economic relationship and cost structure differences between an insurer and IDS using hypothetical numbers. Simply put, the insurer’s cost is the IDS’s revenue.

An insurer’s cost structure also is highly variable, with about 85 percent of expenses linked to the count of claims paid to providers. For an IDS, about 74 percent of expenses are attributed to fixed costs that typically do not fluctuate based on claim count. Therefore, when an IDS faces reductions in utilization, the IDS is left with a lower contribution margin toward fixed costs.

The funds-flow diagram shows that, despite receiving half of the savings generated by the provider, the IDS experiences a reduction in net profit amounting to $12.50 per member per month (PMPM)—that is, from a net profit of $8.50 PMPM to a net deficit of $4.00 PMPM. Conversely, assuming the portion of the insurer’s savings is not returned to the consumer in the form of rebates or premium discounts, the insurer’s profit more than doubles from $20 PMPM to $45 PMPM. Such unintended consequences of the payment model pose a significant financial risk for an IDS and significant upside gain for an insurer.

To benefit from the structure of this APM, the IDS must either reduce fixed cost or backfill lost volume. Both options are difficult to execute without the alignment and integration between the insurer and IDS. Reducing fixed cost is a slow, labor-intensive process that exposes an IDS to the financial risk of fluctuating inpatient volume. Alternatively, reducing leakage or gaining market share of inpatient volume is a heavy lift without insurer-provider collaboration coupled with benefit designs tailored to drive utilization to high-performing providers.

A Possible Solution for IDSs

Insurers and IDSs do share several common goals, including delivering high-quality, cost-effective care with a goal of creating an outstanding customer experience that differentiates the organization from its competitors, thereby building brand loyalty. Both insurers and providers also are committed to making the necessary investments to transform care delivery and payment, and they both possess the right elements for success. However, current shared savings arrangements do not take into account four important considerations.

First, to realize shared savings at the net-profit level, a provider must not only eliminate the variable cost associated with the foregone services but also substantially reduce overall fixed cost. Recall, that a significant portion of an IDS’s costs are fixed and difficult to eliminate in the short term.

Second, the current operating margin structures of insurers and providers differ significantly, with operating margins typically in the range of 1 to 3 percent for providers compared with higher margin percentages for commercial health plans. Razor-thin margins place a financial constraint on a provider’s ability to finance the restructuring or repurposing of fixed assets.

Third, the operational changes required to generate savings or reduce an insurer’s medical cost through delivering more cost-effective care are disproportionately reliant on the provider’s capabilities and resources.

Fourth, total savings potential is greater in the initial years of a shared savings program than in later years, leading to diminishing returns from generating savings year over year. As providers progress through the APM framework, the promise of a high percentage of a smaller savings pie can cause them to lose their motivation. Figuratively speaking, IDSs wear pants that have Part A and Part B pockets, and under current APM distribution models, there are not enough economic stimuli to allow for aprimary focus on incentives for one pocket at the expense of the other.

IDS Shared Savings/Risk Distribution Model

As a potential solution, a shared savings (or risk) distribution model could be adopted that addresses some of the inequities in existing shared savings programs and creates an alignment among insurers, providers, and consumers, which is required for long-term care delivery transformation. The exhibit below illustrates this solution, providing an overview of its glide path for long-term transformation.

Overview of a Shared Savings Distribution Model Glide Path for Transforming Care Over the Long-Term
Overview of a Shared Savings Distribution Model Glide Path for Transforming Care Over the Long-Term

The guiding principle behind the model is to provide financial stability to the IDS during the transformative years of operational and care delivery change. The greater portion distributed up front to the provider helps to backfill the loss contribution margin and provides the investment to build out new functionality for a provider. As the model matures, the savings are redirected back to the healthcare consumer in the form of discounted premiums or rebates to employers and individuals. Under this model, the shared savings are distributed in three tiers, shown in red, orange, and brown in the exhibit.

Tier 1 (red). During the transition years or at the medical-loss-ratio (MLR) milestones, the provider captures 50 percent of the generated savings to:
  • Contribute to the fixed cost associated with foregone services that cannot be eliminated in the short term
  • Begin to establish regulatory reserve requirements that will better enable the provider to enter into risk-bearing arrangements
  • Serve as long-term continuous support of infrastructure cost-of-care management

Tier 2 (orange).This portion, which progressively declines over the transition years, is directed to support the provider’s start-up cost in building its care management organization (CMO) as these functions shift from the insurer to the provider. A provider-based CMO should be able to deliver care management services that are superior to those delivered by an insurer-based organization, given the inherent relationship between provider (physician) and patient. Shifting this function also benefits the insurer by directly reducing its operating cost.

Tier 3 (brown).The remaining portion of the savings is directed to the consumer in the form of discounted premiums or rebates to employers and individuals. This portion grows over time as the distribution in Tier 2 declines. Providers and insurers then can apply the realized savings in marketing efforts targeting brokers, employers, and employees that detail the benefits of maintaining a preferred relationship with a provider, thereby ultimately promoting healthcare consumerism and a competitive provider marketplace and establishing a means to attract volume other than the use of narrow networks.

A Time of Transformation

The greatest challenges posed by value-focused healthcare reform do not lie ahead in the future: We are in the midst of them today as we contend with the transformative years of operating in a paradox of FFS and a value-based world. We can take heart in the assurance that the difficulties will fade away as the reform effort reaches its final state. Yet the transformation will take both time and a level of partnership unseen in health care.

Although the idea of distributing a larger portion of the initial savings to a provider is simple and disruptive compared with current APM distribution designs, such an approach does offer a viable means to bridge the financing challenges posed by APMs. Insurers and providers should adopt a long-term perspective on payment transformation that should be customized to align with the pace of care transformation. There is enough common ground to form innovative solutions to the challenges of all parties. All it takes is an engaged and committed conversation.

Although changes to the ACA are likely, there is bipartisan consensus to support further adoption of APMs as a means to reduce the cost of care delivery. There may be some relief on the mandatory requirements of some APMs by CMS that may have a trickle-down effect on slowing adoption in the commercial sector, but it is likely that commercial insurers will only be prompted to counter these forces and work more closely with their local provider networks in developing equitable and transformative payment models.


Luis Rivera, MBA, 
is CFO, Physician Organization, Allegheny Health Network, Pittsburgh. At the time of writing this article, he was assistant vice president, value-based contracting, Northwell Health, 
Great Neck, N.Y.

Publication Date: Friday, December 01, 2017