Why the new way of funding public hospitals won’t work

The first of July saw the introduction of one of the most important health care reforms for Australia’s public hospitals: national activity-based funding (ABF). Hospitals will now be paid a fixed price (the national efficient price) for each episode of care, meaning ABF is essentially a fee-for-service payment model.

Treasuries and governments hope ABF will make hospitals more efficient. But key flaws in the design of the scheme may hamper these potential cost savings and result in an ineffective funding system.

Hospital profits

If a service provided at a hospital (such as a hip replacement) costs less than the fixed price paid under ABF, the hospital makes a profit for that service, and has incentives to expand that service. The set of relative prices across all types of operations and procedures will therefore influence a hospital’s incentives to invest in new services. The strongest incentives will be for services that deliver the greatest profits.

If the set of prices reflect costs and not the relative cost-effectiveness of these services, there is potential for a misallocation of resources. After all, the most profitable services don’t necessarily produce the greatest health gains for the population.

At a time when policy should be trying to keep people out of hospitals and provide incentives to sustain smaller hospitals in the longer term, ABF seems clearly out of step. Caps on volumes may help, but this is no difference from the status quo.

Hospital losses

The second problem is that hospitals with costs above the fixed price for each service will make a loss on that service. Hospitals can respond in a number of ways to improve efficiency, reduce waste and cut unnecessary costs, including undertaking more (cheaper) day surgery, changing the staffing mix of services, or reducing lengths of stay.

Of course, some of these measures may compromise quality of care. Reducing length of stay and employing enrolled nurses rather than registered nurses are just two examples of this.

Alternatively, a hospital may decide not to provide the service at all. From the hospitals’ perspective, this could be seen as efficient, but it will mean patients face reduced access. Decisions to disinvest in services will therefore be heavily influenced by costs and not necessarily on cost-effectiveness.

Hospitals could also engage in cream-skimming or patient dumping. In other words, they could transfer more complex patients to other hospitals wanting to increase their patient volume, or to other settings not covered by ABF. The ability for hospitals to cream-skim and dump patients depends on whether the set of prices adequately captures differences in the costs of treating complex cases.

No rewards for improving quality

The third problem with fee-for-service and ABF is it doesn’t reward improvements in quality of care or health outcomes. Neither did the old system, but ABF provides an opportunity to rectify this shortfall.

The [Independent Hospital Pricing Authority](http://www.ihpa.gov.au/internet/ihpa/publishing.nsf/Content/draft-pricing-framework (IHPA) considered schemes in other countries that do not pay hospitals for care where medical errors are made. Some countries also pay extra for services that are delivered according to “best practice” clinical guidelines.

Paying more for services that are cost-effective, and less for services that aren’t, seems to be a very useful purpose of such a funding scheme. But the IHPA has delayed what would be a relatively simple scheme that doesn’t pay for medical errors. Though an opportunity has been missed, it’s clearly an important proposal that requires further development research.

Ensuring quality of care

The new [National Health Performance Authority](http://www.nhpa.gov.au/internet/nhpa/publishing.nsf will play a key role in monitoring public hospitals’ performance. The Authority will produce a report card for each hospital that shows its performance along a range of indicators. Though improvements in these indicators are not linked to funding or ABF, they will provide an important monitoring mechanism for those aspects of performance that can be measured and influenced through ABF.

Setting the efficient price

With payment schemes such as ABF, the devil is in the detail. Though there is much discussion of the role of the fixed national efficient price, in reality its influence will be muted by the remaining power of the states.

The national efficient price each hospital faces will be a combination of the Commonwealth’s share (40%) and the states’ share of the price. States can choose to fund more than their 60% share, and can therefore still “bail out” hospitals facing deficits and influence funding for political reasons. But if hospital managers expect their deficit to be funded by the state, they will have little incentive to reduce costs or services to improve efficiency.

Giving states the discretion to fund deficits may mean the potential for ABF to improve efficiency will be lost. This is a major flaw in the design of the current and relates to the Commonwealth government’s failure to fund 100% of the price of hospital services. The blame game will live on as long as states continue to provide funding.

What happens next?

Since politicians rarely close hospitals, political imperatives are likely to override the imperatives for increased efficiency. And top-down policies to improve population health and reduce costs usually do no more than set the framework for behaviour change.

What really matters for patients’ health outcomes and costs of care are the decisions of health professionals within and outside of hospitals.

How ABF, along with other health reforms, translates into changed behaviours for health professionals and hospital managers will be the key to securing the efficiency gains hoped from activity-based funding. Yet the reform bodies remain silent about how this would occur.

Anthony Scott receives funding from the Austrralian Research Council, National Health and Medical Research Council, Department of Health (Victoria), and Health Workforce Australia.

Jongsay Yong does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.