Paying for Health Gains Using Patient Reported Outcome Measures

ABSTRACT Payments to healthcare providers are often based on the number of patients with a particular diagnosis or treatment with well known limitations. Payment based on health outcomes, a form of pay‐for‐performance, has long been advocated as a possible solution. We use a contract theory approach and illustrate how it can inform practical implementation of pay‐for‐performance schemes that reward health outcomes. The pricing rule suggests that the bonus should be set to reflect the difference between the provider's marginal cost of a health improvement before the policy intervention and the provider's marginal cost evaluated at the target health set by the purchaser. We provide estimates of the optimal bonus for hip and knee replacement under a range of assumptions about provider cost functions and the value of health improvements.