An Evidence-Based Incentive System for Medicare's End-Stage Renal Disease Program

Recent legislations directed Medicare to revamp its decades-old system for reimbursing dialysis treatments, with focus on the risk adjustment of payments and on the transition toward a pay-for-compliance system. To design an optimal payment system that incorporates these features, we develop an empirical method to estimate the structural parameters of the principal–agent model underlying Medicare's dialysis payment system. We use the model and parameter estimates to answer the following questions: Can a pay-for-compliance system based only on the intermediate performance measures currently identified by Medicare achieve first-best? How should patient outcomes be risk adjusted, and what welfare gains can be achieved by doing so? Our main findings are as follows: (1) the current set of intermediate measures identified by Medicare are not comprehensive enough for use alone in a pay-for-compliance system; (2) paying for risk-adjusted downstream outcomes instead of raw downstream outcomes can lengthen the hospital-free life of admitted patients by two weeks per patient per year without increasing Medicare expenditures.

This paper was accepted by Christian Terwiesch, operations management.