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How are providers (hospitals, clinics, managers, physicians, nurses, etc.) paid?


Once funds have been raised in the health system and pooled within a pooling agent, the organizations that pool those funds - governments, social and private insurance plans and community financing schemes – have to decide how to purchase health care.  Payment schemes play a critical role in determining health system performance in so far as they influence the supply and demand of health care. On the supply side, payment influences how providers enter the market and how services will be produced; and on the demand side, patients often decide what to purchase and how much to consume, based on the amount they have to pay.

Purchasing is the transfer of pooled funds to providers.  Purchasers are insurers or agents who act on behalf of the Government. Under strategic forms of purchasing, purchasers take proactive decisions about which health care services should be purchased from providers, at what quantity and price, how and from whom (Figueras et al. 2005). To affect provider behavior, a purchaser will need adequate information to assess provider performance and use results in purchasing and contract enforcement; as well as to monitor utilization of care and implications for health financing.  Limited autonomy and flexibility to respond to the financial incentives under mechanisms like capitation and activity-based payments can seriously hamper efforts to change provider behaviors. (Langenbrunner, et al. 2005).

Incentives & Risk – Decisions on who to pay, for what and how much will create specific risks and incentives which in turn, will affect the type and amount of services offered.  Payment Systems play a particularly important role in the health sector, due to the peculiar interplay of demand and supply.  Market outcomes in health are largely determined by the incentives, as well as the cultural influences and professional ethics on


Bullet  Purchasing

Bullet   Incentives & Risk 

Bullet   Payment Methods 

Bullet   Line-Item Budgets 

Bullet   Fee-for-Service (FFS) 

Bullet   Capitation

Bullet   Salary 

Bullet   Salary Plus Bonus 

Bullet   Case-based

Bullet   Per Diem 

Bullet   Per Admission 

Bullet   Global Budget 

Bullet   Additional Reading 

the basis of which providers act. Payment and reimbursement criteria, in turn, are critical to determining those incentives, and that is why different payment systems can lead to diverse outcomes, in terms of utilization of care, quality and cost of services offered within the health sector, and total health care expenditures.  In this section, we list the principal payment systems for providers and introduce some of the incentives associated with each of them.  Table 1 provides an overview of the various payment methods and the related incentives.

 Table 1: Overview on Payment Methods and Related Incentives

Health facility

Payment method

Financial incentive set to provider

Primary health care

Input-based line item budget 

Increase input factors (bed, staff, etc) and use full budget


Increase number of services per patient

Capitation adjusted by age and gender

Treat patient within budget, or in worst case, provide sub-standard care and exclude high-risk patients; Refer patients to specialist and hospitals

Capitation – Fee-for-service mix

Treat within budget and increase number of fee-based services


Lowers physician’s productivity and level of responsiveness; no financial incentives to improve the quality of care and patient satisfaction or increase the number of services

Pay for Performance 

Increase number of services that lead to improved performance indicator

Hospital payment

Input-based line item budget 

Increase number of staff, bed, etc.; reduce number of admissions; keep occupancy rate low but prolong patients’ average lengths of stay, refer high-risk/intensity patients to other hospitals

Hospital day 

Increase number of admissions and prolong patients’ average length of stay (ALOS)

Per Admission 

Incentivizes hospitals to reduce the length of stay and the amount of care given to each patient. 


Increase number of admissions, shorten ALOS, risk-select less severe patient case-mix

Global budget 

Provide care within a budget ceiling

Source: Schneider, Pia. Provider payment reforms: Lessons from Europe and America for South Eastern Europe. HNP Discussion Paper. The World Bank, 2007.

Probably more than in any other market, when demanding health services individuals are often largely uncertain about the appropriateness of the service they are receiving.  Any health service is an experience good, a good whose appropriateness and quality can be ascertained only ex-post. Even ex-post, the appropriateness of any individual health service is difficult to assess precisely because the patient often receives a multidimensional service (diagnosis, advice, treatment), and because the final outcome, ‘good health’ or `health improvement`, which is what people really demand, depends on factors other than the kind of care received, the output produced.  The lack of information and the particular psychological condition of patients produce crucial consequences for the interaction between demand and supply. It is the doctor, and not the patient, who generally chooses the amount and the type of services that the latter receives.  

In reviewing the various payment methods, it is first important to distinguish between payment systems for individual providers and those for provider facilities (such as hospitals, clinics or health centers). Some payment systems are the same for both institution facilities and individual providers, and, in general, the criteria for paying the latter are very much influenced by those for the former. Yet, this is not necessarily always the case. For example, in several countries of Western Europe physicians employed in hospitals and other facilities continued to receive salaries even after the reimbursement criteria for their provider facility had been radically changed, from an input towards an output-based Payment Systems.

Line-item budgets –Unit of payment is an expense category for an organization - for example, salary, supplies, transportation, drugs.   Once the amount budgeted is approved by the funding agency, the provider has little discretion to switch funds across budget categories, which can often lead to technical inefficiency.  In the mid-1980s prior to hospital payment reform in Western Europe, most public hospitals were paid a fixed line-item budget based on inputs such as the number of staff and hospital beds (Docteur et al. 2003). Hospitals in many countries are still predominantly paid an annual line-item budget by the national health insurance fund to cover operating costs.  Line-item budgets based on input factors such as bed and staffing norms, set incentives to hospitals to employ more of the input factors (i.e. staff) based on which the budget is defined and operate within the allocated budget.  Rigid budget formulation and inflexibility limit the reallocation of funds across line-items to better respond to changes in utilization or population needs. To improve activity management, European countries moved from input-based payments first to fee-for-service and more recently to bundled case-based payment systems such as diagnosis-related groups (DRGs).

Fee for Service (FFS) – Payment based on individual visits or clinical activities (injections, lab tests, x-rays, etc). This payment method tends to promote excessive use of services and can increase costs, although it can increase productivity and output when service providers are underperforming. Financial Risk under FFS is borne by the payer (patient or insurer).  In a fee-for-service payment system the revenue facilities (and individual doctors) receive depends on the quantity and of the services they provide. Thus, those OECD countries, such as the US and Europe, where  FFS was more widespread, over time experienced a more pronounced growth in health expenditure, in absolute terms as well as a proportion of GDP.  One stream in the US health economics literature has also underlined that, when reimbursement to providers is activity-and-cost-based (as in a fee-for-service system), there is no incentive to focus on technological progress that could lead to less costly treatments. Providers can gain by making use of ever more costly treatments and equipment, and even by inducing demand and supplying services above the level that would be clinically justified. (See Wagstaff et al 2009 for case study on China).   FFS is still one of the most widely used methods for paying private-sector hospitals and providers in developing countries and is used selectively in many OECD countries for priority services such as vaccinations. In the 1990s, with the adoption of social health insurance systems, several ECA countries, including Czech Republic, Croatia, Slovakia, and Ukraine, moved from input-based payment to reimbursement by fee-for-service.  FFS quickly led to increased activity levels and put financial pressures on purchasers, causing them to put ceilings on the total amount, or negotiate volume contracts within a capped budget, or prospective global budgets with activity caps(Langenbrunner, et al. 2005).

Capitation – Payment on a per-person basis, for a defined package of services during a fixed period of time – usually a month or year. Commonly, a per-person fixed rate is paid to a general practitioner based on the number of individuals enrolled in that practice for the time period regardless of whether they use services and the type of service rendered. Capitation is generally used to pay outpatient providers including GPs and less often specialists.  Capitation shifts the financial risks to providers, as they are responsible for any costs above the capitation rate and are able to keep any unused funds. The risks vary by the specific terms of the contract and organizational arrangements. Incentives under capitation tend towards risk selection, enrolling only healthy patients (unless the capitation payments are adjusted to adequately reflect the relative expected cost of treating different categories of individuals), under-providing services and tests, limiting drugs (if drugs fall under the capitation), referring sick patients on to specialists (if it is the primary care doctor who is subject to capitation), but it also provides stronger incentives than FFS to become more efficient, control costs.  To prevent negative effects including under-provision of care and exclusion of high risk patients, capitation often comprises some sort of case-mix adjustment and output-based incentives such as FFS payment for delivering specific services. 

For example in Estonia, the capitation payment system is mixed with other payment systems: payments to PHC providers are based on age-adjusted per capita rate, on fee-for-service for some specified services (such as minor surgeries) and on a fixed allowance for infrastructure and equipment.  This hybrid PS results in diluted efficiency incentives and stronger incentives to increase services paid separately through FFS (Langenbrunner et al, 2009).

Salary– Payment is a salary to the physician or other provider regardless of number of patients seen or the volume or cost of services provided. Under this payment system physicians bear little financial risk and may alter their decision-making to minimize the time and effort spent at work. This method can also lead to low productivity compared to FFS or capitation systems and can often result in lower level of responsiveness by physicians.

In Greece, Finland, Iceland and Mexico, general practitioners (GPs) are Government employees and paid a salary.  Salaries constitute the main component in input-based budgeting; and tend to be determined by seniority and length of service. Salaries are generally negotiated centrally (e.g., between physicians' associations and the government).  Individual salary adjustments include experience and other rewards (Docteur et al. 2003). Salaried staff faces no financial incentives to improve the quality of care and patient satisfaction or increase the number of services. 

Salary Plus Bonus – Paying a salary plus a bonus is an effort to address the lack of productivity incentives in only paying a salary. Bonuses can be paid at any level of the health system and may involve seeing a certain number of patients per day, reaching particular performance targets or patient satisfaction. These pay for performance schemes are becoming more popular in the developing and developed world.  In China, for example, hospital-based physician bonuses are awarded based on the number of patients seen or on the revenue generated for the hospital by the physicians’ medical practice. 

Case-based – Payment linked to type/ severity of cases. This payment system was first introduced in the US Medicare system (1983) and later on adopted in several other countries; it links payment to hospitals to the number and the severity of individual cases treated. Each patient is classified in a specific “diagnostic” group according to his/her principal diagnosis and, correspondingly, a fixed reimbursement is given to the hospital for treating the patient.  This payment system creates incentives to focus on “profitable” patients, to shorten lengths of hospital admission, to provide less care, and admit more patients.  In the late ‘80s and ‘90s, case-based payment systems were adopted in several developing and former socialist economies to pay for inpatient care (for example, Brazil and Hungary). In some cases countries have used the same classification system (DRG-Diagnostic-related grouping) as the US, while others have used alternative classification systems such as the “Nosology-based” system used in several of the Former Soviet Republics. A number of middle income countries (China, Estonia) have sought to experiment with case-based payment system based on simpler classification than the DRGs, due to a lack of data or to reduce administrative costs.

Per diem– Fixed rate paid per day of hospitalization irrespective of the actual services delivered or the costs incurred.  This system gives hospitals incentives to reduce costs, reduce tests/procedures, and keep patients in the hospital longer, which often results in increased average length of stay.  In Japan, for example, where per-diem payments are implemented, the average hospital length of stay is about three times longer than in the US for similar diagnostic services.  This system works better when coupled with a budget cap for hospital services.

Per admission –Fixed amount paid to cover all of the services during a particular hospital stay regardless of the actual services provided. The widely used 'diagnosis-related groups' (DRG) payment method is an example of this approach. This payment method transfers a portion of the financial risk to the provider and incentivizes hospitals to reduce the length of stay and the amount of care given to each patient.  This method provides incentives for the hospital to select patients with less severe illnesses and to admit as many patients as possible whose cost is less than the fee received for each patient.   

Global budget- In response to volume problems under per diem and per case payment systems, global budget payment systems are being developed in many countries.  A global budget at the hospital level is a payment fixed in advance to cover the aggregate expenditures of that hospital over a given period to provide a set of services that have been broadly agreed upon.  A global budget may be based on either inputs or outputs, or a combination of the two (Langenbrunner et al. 2005).  Under this payment system, incentives are created for managers to control expenses while achieving their production targets.  Budgetary caps are widely used for setting volume limits and controlling hospital expenditure, and are often complemented by spending caps on subsectors, including ambulatory care and pharmaceuticals.

Payment Methods for Physicians: Financial Risks and Incentives


Payment Methods for Hospitals: Financial Risks and Incentives


Additional reading on Payment Methods 

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