The document discusses how incentives drive human behavior using examples from the whaling industry in the 1800s and recent changes in the US healthcare system. It describes how whaling ship owners originally struggled to find crews for dangerous voyages until they offered crews a percentage of profits, incentivizing them to join. Similarly, the document outlines studies showing physicians and patients respond to financial incentives, altering behaviors like visit numbers or service utilization. The healthcare system is shifting payment models to better align incentives between payers, providers and patients to encourage high-value care.

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 Current Concepts | Health Care Management Series
In 1852, the ship Essex left the port of New Bedford, MA, on a voyage to capture a whale.
In the previous decades, the whaling industry had seen a tremendous increase in the
number of these types of voyages. These journeys were often seen as risky but many
sailors were willing to sail across the waters in the hunt for a whale. Often these journeys
would last for months to years with an unpredictable outcome. The question ultimately
is why would any member of the crew sign up for a journey where there was a 20% chance
of not returning?
Inthepastfewdecades,therehasbeenaconsiderableamountofworkinunderstanding
humanbehaviorasitrelatestoincentives. Inanattempttotransitiontowardavalue-based
health care system, the Centers for Medicare and Medicaid Services (CMS) is revising the
fundamental Medicare payment formula from the sustainable growth rate (SGR) toward
the Merit Based Incentive Payment System and Alternative Payment Models. Alongside
thischangeisadiscussionregardinghowmuchriskaprovidershouldtake. Balancingthe
risk/reward ratio for completing a job or a task is a challenge in any industry. Ultimately
we know that incentives drive behavior—the question is, of course, what type of behavior
do we want to incentivize?
From Whales to Health Care
In the early 1800s, the whaling industry exploded as the demand increased. Whale oil
was a valuable commodity as it was used to fuel lamps in England and other nations.
Industries were created around the materials gained from whales. Ships were constantly
leaving the ports of New Bedford in search of whales.
Unfortunately, this was a dangerous mission. Initially, ship owners were unable to
enlist crew members to take the journey. Soon ship owners realized that allowing them
to keep a percentage of the revenue from the whales would incentivize them to enroll
in the dangerous journey. Every member of the crew from the captain on down to the
lowest sailor benefited from attractive sales. Changing the incentive structure made it
easier to find individuals who were willing to take the risky journey. Ultimately, allowing
the sailors to have an equity stake in the rewards changed the behavior among them and
created alignment between the crew and the ship owners.
Do Physicians Respond to Incentives?
Research is limited on understanding what types of incentives result in changes in physi-
cian behavior. The ultimate incentive in medicine is improving the health of patients. But
as Sister Irene Kraus (the founding chief executive of the Daughters of Charity National
Health System) stated, “No Margin, No Mission.” Achieving that mission requires physi-
cians to deliver care in a financially responsible and disciplined manner.
Physicians, like other professionals, respond to incentives. In a study conducted in a
pediatric continuity clinic, pediatric residents were separated into two groups based on
financial incentives.1 One group was paid for every patient visit they conducted (ie, fee-
Understanding Incentives
Alok Sharan, MD, MHCDS
WESTMED Spine Center
Yonkers, NY

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Current Concepts | Health Care Management Series 
for-service) in their clinic. Another group was given a fixed
monthly salary regardless of the number of patient visits they
conducted, ie, capitation. The dollar amount was set to be
proportional to their salary at a rate comparable to what they
would receive if they were in private practice. This study was
conducted over one year and no one in the clinic administra-
tion was informed of the payment structure for each resident,
so as not to bias the schedule. Thus the pediatric residents
wereabletosettheiroverallvolume. Overalltheresidentswho
were in a fee-for-service arrangement had a greater number
of clinic visits per patient than the capitated group.
This study is often cited as an example of a financial incen-
tive affecting physician behavior. Unfortunately, very few of
these studies have attempted to correlate the incentive to
patient outcome, which is clearly the most critical metric to
measure.
How Do Patients Respond to Financial Incentives?
The largest study ever conducted to understand the role of
financial incentives on patients’ behavior was conducted by
the Rand Corporation from 1974-1982.2 The RAND Health
Insurance Experiment used funding from the Department
of Health and Human Services to establish a health care in-
surance company. As part of this experiment, patients were
assigned to one of four groups where they either had no cost
sharing, or coinsurance rates of 25%, 50% or 95%. The maxi-
mum annual payment for any patient was $1000.
This study was conducted to answer the question: “Does
free medical care lead to better health than insurance plans
that require the patient to shoulder part of the cost?” Overall,
the study demonstrated that patients who do not have to pay
any coinsurance are more likely to have higher utilization
ratesforbothoutpatientandinpatientservices. Unfortunately
this study also demonstrated that cost sharing reduced “ap-
propriate or needed” medical care as well as “inappropriate
or unnecessary” medical care.
It is clear that benefit design plays a large role in health
care service utilization. The RAND experiment continues to
becitedasthedefinitivestudyinunderstandinghowfinancial
incentives affect patient behavior in regards to utilization of
services. Unfortunately the study was not able to clearly de-
terminehowinsurancebenefitdesignaffectsoveralloutcome.
New Types of Incentive Programs
n Reference Pricing (Patients Bearing Risk)
It is clear that incentives drive behavior. Ultimately the
questioniswhichbehaviorneedstobeincentivized. TheCalp-
ers program is the employee retirement fund for California
state employees. In an attempt to control their health care
costs, Calpers instituted a reference-pricing program.
Withintheprogram,administratorssawthegreatvariation
in prices that were being paid for various procedures.3 For a
joint replacement, costs varied from $12,000 – $75,000. Their
data appeared to show no difference in outcome from the
high and low cost sites.
As a means to control costs and incentivize the use of
high value providers, Calpers set a reference price for a joint
replacement. Ifpatientschoseahigherpricedfacilityfortheir
joint replacement, they were responsible for the remaining
balance. Similarly, if they chose a hospital that charged less
than the reference price, the patient would bear no financial
costfortheprocedure. Theprogramwassimilartomanyofthe
prescription drug benefit plans where insurance companies
will often pay full price for a generic drug but not full price
for other brands.
Soonafterinstitutingthereferencepricingprogram,Calp-
ers saw a significant decrease in patients utilizing high cost
hospitals for a joint replacement. The program was able to
save $2.8 million for joint replacement surgery in the first two
years of the program. In addition, the program saw a migra-
tion of patients toward high volume centers where there was
an overall increase in the quality of care.
n Warranty Program (Physicians Bearing Risk)
GeisingerMedicalCenterrecentlyimplementedawarranty
program for spine surgery.4 Called the ProvenExperience
program,Geisingerguaranteesarefundofthepatient’sco-pay
if they are not satisfied with their spine surgery. This program
is modeled after the ProvenCare Cardiac program whereby, if
a complication occurs within 90 days after a CABG, Geisinger
does not charge the patient for the cost of the complication.
Conclusion
Health care as an industry is currently undergoing massive
changes as it transitions to a value-based payment system.
Some fundamental questions need to be asked during this
transition. Forspinecareproviders,thefundamentalquestion
is: “What should payers be paying for (in the context of spine
care)?” In Sweden, multiple provider groups came together
to develop the OrthoChoice bundled payment program that
links financial reimbursement to an agreed upon functional
metric. Choosing to link a functional metric with the incen-
tive program achieves alignment between the patient and
provider. Spine care providers will have to determine what
type of incentive program will achieve a meaningful align-
ment between the patient and provider. More importantly,
providers will have to ask how much risk they are willing to
bear for this incentive. The whaling industry understood the
importance of sharing a portion of sales with every member
ofthecrewtoachievealignmentandproductivity—andmore
importantly—to overcome the risk of the journey.
The move to the Merit Based Incentive Payment System is
an attempt to bring alignment between the incentives of pay-
ers,providers,and,ofcourse,thepatients. TheMIPSprogram
canbeseenaseitheranaturalevolutionorasanexperimentin
thehealthcaretransformationjourney. Regardlessofgovern-
mentintentions,thereisnoquestionthatprovidergroupshave
to begin closely scrutinizing their current incentive schemes
to ensure alignment with a value-based delivery system.

3. 30 SpineLine | july · august 2016 www.spineline-digital.org
 Current Concepts | Health Care Management Series
References
1. HicksonGB,AltemeierWA,PerrinJM. Physicianreimbursement
by salary or fee-for-service: effect on physician practice behavior
in a randomized prospective study. Pediatrics. 1987;80(3).
2. Brook RH, Ware JE, Rogers WH, et al. The effect of coinsurance
on the health of adults. Results from the RAND Health Insurance
Experiment. Report R-3055-HHS. Santa Monica, CA: RAND
Corporation; 1984.
Disclosure Key
Direct or indirect remuneration: royalties, stock ownership, private
investments, consulting, speaking and/or teaching arrangements, trips/travel.
Positionheldina company: boardofdirectors,scientificadvisoryboard,other
office. Support from sponsors: endowments, research–investigator salary,
research–staff and/or materials, grants, fellowship support. Other
Degree of support:
Level A. $100 to $1000 Level F. $100,001 to $500,000
Level B. $1,001 to $10,000 Level G. $500,001 to $1M
Level C. $10,001 to $25,000 Level H. $1,000,001 to $2.5M
Level D. $25,001 to $50,000 Level I. greater than $2.5M
Level E. $50,001 to $100,000
3. Boynton A, Robinson JC. Appropriate use of reference pricing
can increase value. Health Affairs Blog. July 7, 2015. Available at:
http://healthaffairs.org/blog/2015/07/07/appropriate-use-of-
reference-pricing-can-increase-value/
4. Sternberg S. Unsatisfied with your surgery? Get (some of) your
moneyback.USNews&WorldReport.Nove11,2015.Availableat:
http://www.usnews.com/news/articles/2015/11/11/unsatisfied-
with-your-surgery-get-your-money-back
Author Disclosure
ADSharan:Consulting:ParadigmSpine(B);Other:JaypeeBrothers(A).