Signs everywhere signal with increasing frequency that our health care system is moving steadily closer to linking payment to designated quality outcomes. There are numerous variants of this phenomenon, but one, colloquially termed "pay for performance," is drawing paramount interest. Pay for performance describes a payment relationship where providers (including physicians) that satisfy externally imposed quality metrics are either (i) selected by payors over non-qualifying providers as eligible to enter payor contracts, or (ii) paid additional amounts over and above what is paid to non-qualifying providers.

JCAHO has recognized this trend and has published what it views as key (albeit somewhat abstract) principles which payors can use to structure their pay-for-performance programs. Medicare, too, is on board, with negative reimbursement adjustments (effective for fiscal year 2005) under the 2003 Medicare reform legislation for hospitals which do not report certain quality measurements, a development which many believe precedes the future linkage between increased Medicare reimbursement and designated quality outcomes. MedPAC also recently recommended that Congress adopt an incentive payment policy — one that includes physicians and home health agencies as well as hospitals, making it all the more likely that Congress will revisit this issue during the current session. In fact, the pay-for-performance issue was taken up at a February 10, 2005, hearing held by the House Ways and Means Health Subcommittee.

Perhaps the most active participants in this debate are private employers who have come to realize that in exchange for the large amounts they spend on health care for their employees, the health outcomes ought to be better. The Leapfrog Group, a coalition of some 160 companies which provide health care benefits to their employees nationwide, has explicitly linked financial incentives to quality, and has recommended that payments to providers "vary .based on comparative value." Leapfrog also has compiled on its website a compendium of some 87 incentive programs operating in discrete markets across the country.

At the local level, the Minneapolis experience is telling. There, a coalition of private and government employers, in conjunction with the state's Medicaid program, have crafted a unique direct contracting model. The payor coalition plans to collect quality and patient satisfaction data from Minnesota providers. Employers will contract individually, but will use the quality data in their contracting decisions and payment rate negotiations.

How can hospitals prepare themselves for this coming trend? First and foremost, medical staff leadership and active cooperation is critical. When increased reimbursement (or, in some cases, even the ability to contract with a payor at all) is tied to the achievement of quality measures, it is clear that care delivery protocols and clinical pathways within the hospital will be required or, for those hospitals which now utilize them, refined. These protocols will require significant physician input to develop or modify, as well as subsequent physician compliance with the actual protocol. The AMA strongly urges that physicians become involved in this process, noting that, "[d]octors have to make sure they are part of developing these initiatives or it will be rammed down their throats."

From a legal perspective, the development piece of the puzzle is easy to solve. It is quite feasible to contract with selected physician leaders — either individually or in one or more groups — to help the hospital develop the metrics and pathways which will help achieve the quality goals imposed by the payor. These agreements can usually be crafted to comply with all applicable regulatory restrictions.

Harder to solve, however, is the question of how to incent medical staff physicians to adhere to these new protocols (where clinically appropriate for their patients). Depending on the reimbursement difference between hitting the payor's benchmark or not, significant dollars could be at stake, and physician buy-in will be critical.

To the extent steps are required beyond peer-driven voluntary compliance, at least two external compliance options exist. The first would be to incorporate adherence to the protocols (in medically appropriate cases) into the medical staff credentialing criteria. Simply put, physicians with an unacceptable score would not be recredentialled. Given that such provisions need to be approved by the medical staff, such amendments to the bylaws, like any form of "economic credentialing," may be fiercely opposed by the staff. Thus, tying recredentialing decisions to pathway adherence will be politically challenging.

The second and easier option would be to create an incentive fund (the dollars for which would come, in part, from the payors' quality add-on payments) to be shared with eligible physicians whose clinical performance is responsible for the increased reimbursement. Structuring such a contractual arrangement must comply with Stark, antikickback, civil money penalty, and, for Section 501(c)(3) hospitals, exemption constraints which limit the sharing of net revenues with physicians. To the extent bond-financed space is involved, the contract also will need to comply with the term and termination provisions of Rev. Proc. 97-13.

One possible approach would be to amalgamate participating physicians into a legal entity and structure a contract with that group. Eligible Stark exceptions could include "professional services" and "indirect compensation" — the latter is especially appropriate in the case where the payment mechanism contemplates a fixed amount or fixed percentage compensation formula. Antikickback concerns should be minimal, as the requisite referral intent is absent. Indeed, in an analogous case challenging a federal demonstration gainsharing program, the court rejected the argument that the existence of the challenged program at one hospital would be an improper incentive to refer to that facility. See Robert Wood Johnson University Hospital, Inc. v. Thompson, Civ. No. 04-142 (D.N.J. Apr. 15, 2004). Civil money penalty (or gainsharing) concerns can be minimized also, given that the focus of the program will be on the improvement of clinical outcomes — not the reduction of services provided to patients. Finally, in order to ensure compliance with the inurement, private benefit, and intermediate sanctions provisions applicable to exempt hospitals, it will be critical to justify that the payment to the physician group is consistent with fair market value. This will require an outside expert to opine that the payment is reasonable, given the hospital's achievement of the quality measures justifying the extra payment.

Implementing an appropriate strategy to allow a hospital to participate fully in pay-for-performance programs is challenging and will require significant lead time. It is not too early to consider planning now.