Structuring Incentives within Accountable Care Organizations by

Accountable Care Organizations (ACOs) are a new model for integrated health care delivery created by the Patient Protection and Affordable Care Act. They allow a group of hospitals and providers to jointly contract with the Center for Medicare and Medicaid Services to provide care to a population of Medicare enrollees in an environment that rewards cost-efficiency through shared savings so long as the ACO achieves certain quality thresholds. To improve the precision of performance measures, ACOs are required to have at least 5,000 enrollees. Pooling the patient panels of many physicians to achieve this scale causes a free-riding problem. Working with a model of ACO incentives, we establish that the negative effect of free-riding swamps the positive effect of increased precision. We then calibrate the model using proprietary performance measures from a very large insurer and find that free-riding within ACOs is so severe that the pay-for-performance plans will likely not be self-financing; that is, the savings they produce will not be sufficient to pay for the requisite performance bonuses. It follows that to achieve their goals ACOs will have to find ways to augment under-powered pay-for-performance incentives with motivational strategies that complement pay-for-performance. We observe that some of these motivational strategies can only be implemented in conventional integrated organizations, while others may prove workable in hybrid organizational forms. This has implications for the efficacy of ACOs as a policy for promoting integrated care delivery.