Integrating Pay-for-Performance into Health Care Payment Systems

Health care payers have implemented pay-for-performance contracts without explicit characterization of the underlying quality problem or an understanding of the interaction between pay-for-performance and existing payment mechanisms. In this paper, ine cient quality of health care services stems from di culty consumers have in observing some aspects of quality. Traditional health care payment systems result in under-provision of those attributes that are poorly observed by consumers, but not those that are well-observed. Within a model of provider competition on two dimensions of quality, I show that the e cient pay-for-performance contract corrects the market failure within the existing payment system, and rewards those dimensions of quality that are under-supplied in the existing system. These will be dimensions that are poorly observed, not necessarily those that are most important for improving patient health. Policymakers often worry about multitasking problems arising from pay-forperformance. I argue that physician allocation of e ort to various tasks is ine cient without pay-for-performance, and the optimal design of the pay-for-performance contract can mitigate multitasking.