In the provider space, alternative payment models are increasingly common. These models aim to pay more money when providers improve quality and lower total cost and pay providers less when quality is suboptimal or total cost rise. Because there is significant uncertainty in quality of care and variability across providers, value-based purchasing is sensible in many cases. In fact, in 2019 60.9% of all provider health care payments were made through some sort of value-based arrangement.
Should value-based or outcome-based payment be adopted for pharmaceuticals? At first glance, the answer is no. While quality of care varies across providers, the impact of a pill on health outcomes is the same across pills. While there may be some heterogeneity in the impact across patients, the actual average value of the drug is much more homogenous. Secondly, the average treatment effect of drugs are much more well known that for provider services. The reason is that pharmaceuticals are required to conduct clinical trials–typically randomized controlled trials–in order to be approved. Thus, drug “quality” is well known. Thus, can we can conclude the outcomes-based contracting for drugs is a waste of time?
According to a paper by Hlávka et al (2021), the answer is ‘it depends’. Under perfect market conditions, outcomes-based contracting is not needed. Even if a drug’s real-world effectiveness varies by type of patient, health plans and manufacturers can still contract based on the average treatment affect and the consumer surplus it generates. Pricing under this approach is efficient in the absence of market failures. However, the paper notes that there are a number of market failures that could justify the use of outcomes based contracts:
- Uncertainty over the patient distribution. In some cases, the value individuals place on health benefits is not uniform. For instance, for socioeconomically disadvantaged patients. “…health outcomes might negatively covary with consumer surplus, and tying prices to health outcomes may be a poor substitute for ‘consumer-surplus-based’ pricing. An example might be intensive treatments for diabetes, which tend to disproportionately benefit the poor…Thus, [value-based pricing]…works best when consumers place reasonably uniform values on health improvement, so that variation in consumer surplus is well captured by observable variation in health outcomes.”
- Asymmetric beliefs. One key question is how well will a drug work in the real world. In some cases clinical trials may not provide the answer. In some clinical trials, individuals with a number of comorbidities are excluded from the trial in order to better power a causal effect; in the real-world, however, patients with multiple chronic conditions may also take the medication. Further, clinical trials may be short and long-term outcomes may need to be extrapolated. In cases where payers and drug manufacturers disagree on the likely health outcomes, then outcome-based contracts can be a useful tool to bridge this divide.
- Payer agency imperfection. While the Hlávka paper assumes payers are perfect agents for patients, this may not be the case. For instance, commercial payers in the US may not want to pay for expensive treatments with long-term benefits. The reason is that most of the costs would accrue to the commercial payers but many of the benefits would be captured by Medicare. Even in single payer systems is may not always be the case that single-payer decision making perfectly internalizes the values of consumer. For instance, the single payer may care about measuring health system value (i.e., limiting to health outcomes and cost) but may ignore other aspects of the social welfare function (e.g., impact on productivity, impact on caregivers).
- Provider agency imperfection. In some cases, physicians may not be perfect agents for patients. As the article write: ” Providers may care about patient health or well-being, but they also care about their own profits, which could be at odds with patient utility. There may be overuse of profitable therapies or underuse of therapies with limited financial returns, such as preventive therapies.”
- Patient behavior and treatment adherence. In clinical trials, patients are generally adherent to the medication; in the real-world, however, that may not be the case. Thus, outcomes-based contracting conditional on adherence could be a way to reach first-best outcomes.
In summary, in theory, outcomes based contracts are not needed when there is a perfect market. In practice, many market failures do occur and there may be a place for outcomes based contracts. Note, however, that outcomes-based contracts are not costless to enact and there are significant transaction cost (e.g., contracting, data collection) to implementing these payment mechanisms.