An Evaluation of Prospective Payment Plans for Hospitals

The rapid increase in health care costs in recent years may be attributed to a number of factors, for example, increases in the costs of inputs and the creation of new and more expensive technology. However, another possible reason for the cost increases is the lack of incentives for hospital managers to control costs and to promote efficient operation of facilities. This lack of incentive has been attributed to the "cost-reimbursement" method of payment for services by third party payers. As a result, a number of "prospective-payment" schemes have been suggested to encourage hospitals to become more cost conscious. In essence, prospective-payment plans shift some part of the risk for health are costs to those who may be in a better position to control those costs. The behavior of hospital management when making a decision under risky conditions may not yield the types of outcomes desired by the third-party payers. This paper is addressed to this point. In essence, the problem amounts to finding a performance-evaluation system, that is, a payment plan that will encourage the hospital administrator to choose desired actions under conditions of uncertainty. In such a setting, the concept of risk sharing between the parties is introduced.