How Hospital Payment Models Shape High-Value Care Decisions

Authored by: Shriya Mehta

Art by: Vanessa Chen Hsieh

Introduction 

The debate over American Healthcare payment centers heavily on outcomes. Our system cares about whether patients get better or if  costs fall. But different payment models don’t just alter revenue streams; they entirely reshape administrative priorities, organizational infrastructure, and where institutional energy flows. Does a transition toward value-based care actually advance care, or does it only exchange one form of bureaucratic complexity for another?

The Fee-For-Service Administrative Apparatus

Under fee-for-service (FFS), the institutional logic is volume. Every doctor’s visit, diagnostic screening, or blood draw is seen by hospitals as potential revenue. Revenue cycle management teams comb through clinical notes looking for undercoded diagnoses. The reimbursement model insurance companies use to pay hospitals follow the Medicare's Inpatient Prospective Payment System using Medicare Severity Diagnosis-Related Groups (MS-DRGs) [1]. MS-DRGs are roughly 760 categories that assign a fixed payment based on a patient’s diagnosis, procedures performed, and presence of complications or comorbidities [1].  ICD-10 codes classify the diagnosis, CPT codes describe the procedure,  the DRG uses both inputs to place the hospital stay into a payment category [2]. MS-DRGs that indicate major complications or comorbidities are reimbursed at higher rates [2,3]. This means a hospital would earn more for a pneumonia case coded with sepsis than one coded without it. This is the reason why Clinical Documentation Improvement specialists exist; they need to make sure that every secondary diagnosis, complication, and comorbidity is entered in the record before coding. The result of these payment methods is a bureaucratic ecosystem built around quantity, not outcomes. 

The FFS is fueling U.S. spending. Administrative costs account for roughly approximately 20-30% of total U.S. healthcare spending [4]. A cross-national Health Affairs analysis found that processing a single inpatient surgical bill costs $215 in the United States–compared to only $6 in Canada [5]. 

The Value-Based Shift: Accountable Care Organizations

An ACO is a group of coordinated providers–hospitals and physicians–that agrees to be accountable for the quality, cost, and overall care of a defined patient population [6]. Think of it as Medicare saying: “We’ll tell you the budget upfront, and then you figure out how to make it work.” The CMS sets a spending benchmark for each ACO based on the average Medicare spending during the preceding three-year baseline [6,7]. If the ACO comes in under budget and meets quality standards, it keeps anywhere from 40-75% (based on the 2024 performance year) of the savings[8]. If the ACO exceeds the budget under a downside risk contract, the ACO owes money back. 

That structure demands administrative infrastructures FFS never required. ACOs must identify attributed patients, monitor total cost of care across all providers, and flag high-risk patients before they deteriorate. Essentially, they’re trying to prevent the expensive moments before they happen. This model incentivizes physicians to carefully provide care because preventable hospitalizations become financial losses and not a revenue event. In performance year 2024, 476 MSSP ACOS generated $2.4 billion in net Medicare savings, the program’s highest ever [9]. Physician-led ACOs generated nearly double the per-capita savings of hospital-led ones, a gap that shows how difficult it is to reduce inpatient volume when your fixed costs depend on keeping beds filled[9]. 

The Value-Based Shift: Bundled Payments

Under traditional Medicare, separate payments go to every provider involved in a single episode of care: hospital, surgeons, anesthesiologist, post-acute facility–with no shared accountability for total cost or coordination across these providers [2,9]. Bundled payments change this by combining those separate bills into a single target price covering the full episode, typically 90 days post-discharge. If participants deliver care below the target price, they keep the difference; if costs exceed it, they repay CMS the overage [10]. Hospitals and physicians have entirely different financial incentives under FFS. However, with bundled payments, both hospitals and physicians share risk over the same episode. So a surgeon who discharged a patient to an unnecessarily expensive nursing facility driver costs above the bundle ceiling, which means the hospital and physicians groups both lose money. CMS’s BPCI Advanced program has reported reduced spending across several episode types, though bonus payments have at times yielded net losses for Medicare overall [12].

The model’s main limitation is scope. Evidence on bundled payment performance is heavily weighted toward hospitals, in which physician group participation remains understudied and increasingly at risk of being excluded from mandatory future models [12].  

Bundled Payments vs. ACOs

The two models attack the same problem from different angles. An ACO is accountable for the total cost of care for an entire patient population [5]. Its incentive is to reduce unnecessary utilization altogether (fewer hospitalizations and ED visits). However, a bundled payment doesn’t try to reduce whether a procedure happens; it restructures who is financially responsible when it does. Under bundled payments, providers receive a fixed payment for a single episode of care. This means their financial success depends on delivering that episode efficiently. ACOs require population-wide infrastructure across all patients and all providers, while bundled payments require episode-tracking systems for specific, high-cost procedures. 

Conclusion

Payment model transitions are organizational transformations. The shift from FFS to value-based reimbursement reallocates administrative priorities in ways that can advance high-value care. The CMS data on ACO performance is genuinely encouraging. But the evidence also makes clear that administrative investment in quality reporting and population health infrastructures is not self-executing as it requires clinical integration to generate clinical value. 

References: 

1. CMS. (2025). Medicare Payment Systems - MLN6922507 March 2021. Www.cms.gov. https://www.cms.gov/Outreach-and-Education/Medicare-Learning-Network-MLN/MLNProducts/html/medicare-payment-systems.html

2. Inserro, A. (2018, March 14). Healthcare Spending Driven by Price, Not Utilization: JAMA Study. AJMC. https://www.ajmc.com/view/healthcare-spending-driven-by-price-not-utilization-ijamai-study-

3. Centers for Medicare & Medicaid Services Data. (n.d.). Data.cms.gov. https://data.cms.gov/medicare-shared-savings-program/performance-year-financial-and-quality-results

4. Turner, A., Miller, G., & Lowry, E. (2023, October 4). High U.S. Health Care Spending: Where Is It All Going? The Commonwealth Fund. https://www.commonwealthfund.org/publications/issue-briefs/2023/oct/high-us-health-care-spending-where-is-it-all-going

5. Billing And Insurance–Related Administrative Costs: A Cross-National Analysis. (2022). Health Affairs, 41(8). https://doi.org/10.1377/hlthaff.2022.00241

6. Tseng, P., Kaplan, R. S., Richman, B. D., Shah, M. A., & Schulman, K. A. (2018). Administrative Costs Associated With Physician Billing and Insurance-Related Activities at an Academic Health Care System. JAMA, 319(7), 691. https://doi.org/10.1001/jama.2017.19148

7. JAMA study dismisses administrative waste. (n.d.). PNHP. https://pnhp.org/news/jama-study-dismisses-administrative-waste/

8. Sahni, N. R., Istvan, B., Thornhill, H. B., Joynt-Maddox, K. E., Cutler, D., & Emanuel, E. J. (2025). Availability of consistent, reliable, and actionable public data on US hospital administrative expenses. Health Affairs Scholar, 3(5). https://doi.org/10.1093/haschl/qxaf069

9. Medicare Shared Savings Program Accountable Care Organizations Performance Year 2024 Financial and Quality Results. (2025). https://www.cms.gov/files/document/fact-sheet-ssp-py24-financial-quality-results.pdf

10. Chernew, M., & Mintz, H. (2021). Administrative expenses in the US health care system: Why so high? JAMA, 326(17), 1679–1680. https://doi.org/10.1001/jama.2021.17318

11. Gee, E., & Spiro, T. (2019, April 8). Excess Administrative Costs Burden the U.S. Health Care System. Center for American Progress. https://www.americanprogress.org/article/excess-administrative-costs-burden-u-s-health-care-system/