The why, what, where, and how of value-based contracts


  • Defines VBCs and their role in health care, namely cost control
  • Identifies other areas where VBCs are in use, including the development of new pharmaceuticals and medical devices
  • Describes how VBCs will affect the way surgeons and other providers and payors define value-based care

A value-based contract (VBC) is a written contractual arrangement between parties in which the payment for health care goods and services is tied to predetermined, mutually agreed upon terms that are based on clinical circumstances, patient outcomes, and other specified measures of the appropriateness and effectiveness of the services rendered.1 In other words, rather than payment being solely dependent on the amount of services rendered, it is instead influenced or determined by value of care delivered to a population or specified group of patients.

Most VBCs are based on the following three premises:2

  • Reducing cost by eliminating inappropriate and unnecessary use of services
  • Sharing of the savings captured through lowered costs of care
  • Increasing volume through gains in market share resulting from enhanced value to customers

Examples of VBCs are as follows:2

  • Hospital and/or physician pay-for-performance contracts
  • Hospital and/or physician shared savings contracts
  • Bundled pricing models
  • Capitation or global budget contracts
  • Private-label health plans with a private payor

Why are VBCs important in health care?

In short, the answer is cost control—the “bending of the cost curve” for health care. According to the Centers for Medicare & Medicaid Services (CMS), 2019 saw health care spending in the U.S. grow by 4.6 percent, reaching a total of $3.8 trillion. That spending equates to more than $11,000 per person or 17.7 percent of the nation’s gross domestic product (GDP).3 However, we all have heard these or similar figures quoted on numerous occasions. To better understand what is meant, and what is at stake for our nation, a historical economic perspective may be illustrative.

In 1940, Americans spent almost 30 percent of their household income on food and very little on health care. Fifty years later, in 1990, the portion of household income spent on food had fallen by 50 percent. However, the rising costs and spending on health care filled the gap, with the decline in spending for food almost exactly offset by the increased spending for health care.4

It is common for household spending to fluctuate over time relative to amounts spent on different sectors of the economy. Furthermore, growth in varied sectors of the economy is generally viewed as a positive sign of a vibrant economy. The takeaway point is that household spending across different economic sectors fluctuates over time. For example, consider the amount of household income spent on information and communications technology in 2021 compared with 1990, much less the amount spent on such innovations in 1940. Americans typically embrace these fluctuations in household spending as progress and consider them to be a positive attribute of a productive national economy subservient to individual consumer choices in the marketplace.5

But, to be sure, health care is different than other sectors of our economy, and the reason health care is different is that, for the most part, consumers do not pay the entire price for the health care services they consume with their own money. For example, in 2017, national spending on health care was $3.5 trillion. Of that, 75 percent was covered by insurers.6 Thus, insurance creates a “moral hazard” by hiding the true economic cost of health care and enables consumers to acquire health care goods and services for a fraction of what it actually costs to produce them.7 In addition, consumers are cognizant that they are paying, at least in part, for health care coverage and want to “get their money’s worth.” The end result is the creation of economic waste.

Stated differently, by slashing consumers’ out-of-pocket prices, health insurance fuels the provision of health care goods and services at higher-than-optimal levels in terms of quantity. In addition, because clinical standards have evolved over time, improvements in quality have been incorporated that serve to further distort how much is paid for individual services.4

Without significant change, federal expenditures on health care are projected to increase from today’s level of 28 percent to 40 percent by 2047.8 This spike in spending would necessitate significant increases in the nation’s ongoing repetitive cycle of public borrowing to levels that would be likely to predict a national fiscal crisis. In part because of the necessary, but nonetheless extraordinary, borrowing necessitated by the coronavirus 2019 (COVID-19) pandemic, federal debt held by the public stood at 100 percent of the U.S. GDP at the end of fiscal year 2020. By the end of 2021, the national debt is projected to reach 102 percent of GDP, and then dip slightly for a few years before rising further. By 2031, debt is projected to equal 107 percent of GDP, the highest in the nation’s history.8

Thus, finding ways to make significant changes to the way in which we finance the provision of health care for the nation’s population to slow this rapid growth has been the subject of significant effort by “policy wonks” and policymakers for decades.9 For the reasons outlined previously, the effort has been and remains profoundly necessary. However, multiple previous attempts unfortunately have failed. No doubt part of the reason for their failure has been the lack of proper incentives. As examples, consider bluntly applied cost control efforts that ignore quality or only place a cursory emphasis on quality, such as the early health maintenance organizations (HMOs) and Medicare’s sustainable growth rate. In large part, these efforts failed because they either created incentives to limit care (even advisable or necessary care in some cases), or they simply reduced the price paid for services without regard to quality. These efforts only incentivized physicians and other providers of health care services to increase the volume of goods and services provided to maintain revenue.

It is anticipated that changes that emphasize the provision of high-value health care goods and services can contribute in a meaningful way to modifying the U.S. health care system. An example of such a change is the VBC.

It is anticipated that changes that emphasize the provision of high-value health care goods and services can contribute in a meaningful way to modifying the U.S. health care system. An example of such a change is the VBC, which is already in use in certain sectors of the health care economy.

What is a VBC?

Expanding on the definition stated previously, a VBC can be any payment arrangement between buyers and sellers of health care services that has the following characteristics:

  • Identifies a set of outcomes, mutually recognized by payors and providers, that reflect the clinical or economic benefits expected from health care goods or services in therapy for a specific condition in a specific population.
  • Defines the measurement of specific clinical outcomes in real-world populations to include the specification of reference data sources, protocols, and processes used and the outcome thresholds that represent “good” and “poor” outcomes.
  • Specifies a formula that determines the net price to be reimbursed for goods and services rendered. The payment of the net price is contingent upon the achievement of specified measured outcomes. The mechanism of implementation also is specified, usually as a rebate. The contract terms also delineate auditing and adjudication processes acceptable to both parties.10

A key element of some VBCs is the treatment protocol. Health benefits vary across patients, just as the marginal utility of consumer products vary between consumers. Treatment protocols allocate treatments to patients based on the expected health benefit to be achieved. In economic terms, treatment protocols serve as the equivalent to a market “demand curve” for the population covered by the buyer of the health care services. In other payment models, the agreements establish target prices and quality metrics, including outcomes, but leave the specifics as to how those goals are achieved to those providing the care.

Once a contract price is negotiated, the buyer of the health services (whether private insurance payor or government payor) incentivizes patients and physicians to allocate care to those individuals for whom it is expected to be most beneficial and cost-effective. Ideally, the expected benefits per dollar spent across covered patients and all health care goods and services should be equal across covered patients.

The development and implementation of treatment protocols to this level of detail requires vastly more coordination across payors and providers than is typical in our current health care system. In addition, once the requisite level of coordination is achieved, the implementation of such treatment protocols also requires an immense repository of verified data and evidence on the clinical outcomes, as well as the capability to analyze and interpret these data to foster improvement and greater efficiency.

Many of the health care goods and services subject to a VBC are subject to an evidence-based treatment protocol that documents a relationship between the impact on patient outcomes and certain patient characteristics. With protocols in place, payors, as the buyer of the specified goods and services, incentivize patients and their physicians to provide treatment according to the protocol.11

As an alternative to forced adherence to a specific pathway, the provision of financial incentives for clinicians to achieve better outcomes and efficiency based on their expertise and specific clinical information may be substituted. Such a mechanism would account for the fact that not all systems have identical resources and capabilities. Thus, though systems might achieve the same outcome via a different care pathway, the key is to determine how much variation is warranted and how much is unwarranted and can be eliminated. With proper patient-centered incentives, greater clinical coordination, access to meaningful clinical quality information, and accurate cost analysis it should be possible to begin to determine what services are being provided that add little or no benefit to the patient outcome and eliminate them. Where appropriate, services can be substituted that have a greater impact on outcomes and patient goals of care.12

Where are VBCs already in use?

VBCs are not just for physicians and hospitals. Many early value-based contracting efforts took the form of arrangements between the developers of new drugs and medical devices and the large purchasers of those products, such as HMOs, health insurers, and government programs.11 Such value-based agreements are directed at promoting greater access to effective but costly products by linking coverage of, or payment for, the product to specified outcomes. Recent reports indicate that there are 88 VBCs involving the pharmaceutical industry, but detailed terms of only 23 have been publicly disclosed.13 In the pharmaceutical industry, many VBCs are found in the areas of hematology and oncology, where innovative drugs can be costly but also potentially lifesaving.14 In those circumstances, VBCs serve to mitigate some of the inherent risk related to the uncertainty of a drug’s efficacy in real-world situations as opposed to U.S. Food and Drug Administration (FDA) clinical trials.

The FDA’s expedited drug approval process provides for approval with substantial evidence of effectiveness after phase 2 clinical results. This practice encourages pharmaceutical manufacturers to develop drugs for “orphan” indications—for example, drugs used to treat disease conditions that affect fewer than 200,000 persons in the U.S. However, it is claimed that this process comes with the price of higher drug costs. The higher costs are attributed to higher development costs, greater therapeutic complexity, and increased manufacturing expenses. As a result, the pharmaceutical industry has experimented with alternative pricing strategies to make access to these innovative products affordable.14

In addition, pharmaceutical manufacturers have engaged in VBCs with payors to differentiate and distinguish their drug from established competition in their effort to gain preferential status in a payor’s formulary; an example of this scenario is AstraZeneca’s contract with Harvard Pilgrim Health Care for the oral antiplatelet therapy drug, ticagrelor (Brilinta). After being prescribed Brilinta at discharge following hospitalization for acute coronary syndrome, patients were monitored for specific criteria and hospital readmission. Results were compared with patients on other oral antiplatelet medication. Failure to meet the agreed upon outcomes criteria results in lower charges for the drug.15 Similarly, Novartis entered into VBCs with Aetna, Cigna, and Harvard Pilgrim for sacubitril/valsartan (Entresto), tying rebates to the observed frequency of hospitalizations for heart failure.10

However, not all value-based agreements in the pharmaceutical sector require a contract. In some, the measured performance is the stated objective. Nonperformance of the stated benefit results in a reversal of claims, with refunds going either directly to patients themselves or to their payor. Because there is no contract, this type of arrangement can be made available to the entire public. Thus, all patients may benefit, regardless of insurance coverage.14

An example is Bayer’s Vitrakvi Commitment Program that provides a performance commitment to all stakeholders. Vitrakvi (larotrectinib) is an oral tropomyosin receptor kinase (TRK) inhibitor that the FDA approved for the treatment of adult and pediatric patients with solid tumors associated with a neurotrophic TRK (NTRK) gene fusion. Bayer refunds up to the cost of the first 60 days of treatment for patients with NTRK fusion-positive tumors if there is no clinical benefit, defined as static growth, reduction in size, or elimination of the tumor as attested by a physician when specific conditions of the program are met.16

Health insurance companies are entering into VBCs with hospitals and physician groups with the goal of reducing price, controlling use, and improving quality.

Health insurance companies are entering into VBCs with hospitals and physician groups with the goal of reducing price, controlling use, and improving quality. Many of these programs have been focused on primary care and may employ a capitation model, whereby the payor provides a fixed monthly payment based on patient outcomes instead of the standard fee-for-service payment for individual services. A VBC amendment may be added to the initial agreement after achievement of initial quality metrics. The specified metrics included access to care, telehealth access, use of the electronic health record, and care coordination. During the pandemic, some primary care practices came to see such arrangements as a potential way to preserve their ability to maintain viability in the face of the financial impact imposed by the delay in patients seeking nonurgent care.17

How could VBCs be applicable to surgery?

VBCs will affect the way surgeons and other providers and payors define value-based care. VBCs will reward those physicians who provide cost-effective, quality care and who can supply data substantiating that their patients had positive outcomes.


The value equation is defined in a specific theoretical framework with Value as the product of the Quality of care (inclusive of service/patient experience) per unit of Cost.18 This concept was first proposed by faculty of the Harvard Business School, Cambridge, MA, to assist organizations and health care delivery systems in rewarding caregivers for provision of the appropriate and needed care as opposed to rewarding the provision of simply more care. With the additional goal of giving patients an equal voice in determining the value of care they receive, the service/patient experience component was added to the equation.

As outlined and described earlier, VBCs require providers and payors to agree upon a set of terms and metrics that are based on clinical circumstances, patient outcomes, and other specified measures of the appropriateness and effectiveness of the services rendered.1 Thus, the terms negotiated in VBCs will include metrics that encompass both the quality of the care rendered and the price received in remuneration for the provision of that care. The American College of Surgeons (ACS) is pursuing comprehensive, ongoing projects undertaken to assist surgeons in the effort to successfully move toward value-based care.


In an article published in the October 2020 issue of the Bulletin, the concept of Quality as a program, rather than an erratic assessment of prescribed measures, was described.19 Variable, noncomprehensive types of quality measurement efforts have not proven effective in driving improvement in surgical care. Instead, those efforts have resulted in a fragmented picture of quality that is not holistic, comprehensive, nor reflective of patient goals.

As part of the solution to the present-day quality framework, the ACS asserts that surgical quality should be delivered and assessed based on a full program that effectuates the Donabedian model, including structure, process, and outcomes measures.20 In this way, quality is viewed and appreciated as a whole program whose sum is of greater meaning than the individual component parts. The ACS’ Optimal Resources for Surgical Quality and Safety and the ACS Quality Verification Program provide the definitive standards for establishing the resources and environment needed to deliver optimal care and achieve quality improvement across the entire field of surgery.21 The inclusion of risk-adjusted clinical outcomes measures and patient-reported outcomes measures track patient safety and the achievement of patient goals.

To provide surgeons with the greatest opportunity to succeed in a health care system moving toward contracting for value, a comprehensive, targeted surgical quality improvement program should be implemented to align hospitals and clinicians to incentivize collaboration and shared responsibility. In this way, hospitals will be equipped to support, evaluate, and improve surgical quality of care across all surgical disciplines for all types of procedures. In the future, a demonstrated institutional and administrative commitment to and participation in a robust surgical quality program could be one of the metrics payors want included in the terms specified in VBCs.

Although the programmatic goals of the ACS Quality Verification Program provide the optimal environment for success in the effort to achieve meaningful quality improvement, the institution of the program alone neither accounts for nor ensures a desired outcome. All involved in negotiating terms of a VBC also are necessarily concerned about results. Just as the terms negotiated for pharmaceutical products take into consideration the outcomes of treatment with a specific drug, payors and providers should expect to negotiate terms specific to results achieved because of the care provided. Thus, terms will necessarily include measures of risk-adjusted clinical outcomes. In addition, to adequately account for individual patient experience and perspective, outcomes measures designed specifically to assess the patient role in care decisions and the achievement of patient goals should be incorporated.

Looking forward, perhaps the most significant challenge inherent to VBCs will be the change needed on the part of payors to align their payment programs with providers that participate in effective quality programs, specifically those programs that emphasize meaningful outcome measures, including patient-reported outcomes.


At the outset, it is important to distinguish between “cost” and “price.” In a February 2021 Bulletin article, cost and price were described as two sides of the same coin.12 Price is defined as the amount paid for a good or service. Cost refers to the amount of material and human resources required to deliver a particular good or service. To sustain an economically viable business of any type or size, a reasonable profit margin over and above cost is necessary. That margin is represented by price less cost.

In contract negotiations with payors, surgeons and other providers negotiate a price for specific services delivered to patients. In this context, price represents the sum of what is estimated to be the actual cost accrued in the provision of the care, plus some reasonable profit margin.

Thus, to negotiate price in an economically viable and sustainable fashion, there must be a way to determine cost. Historically, hospitals have used a chargemaster list, but this methodology is labor intensive, variable, and often has little relationship to what payors and patients ultimately pay for care.

The ACS Transforming Health Resources to Improve Value and Efficiency (THRIVE) project employs time-driven, activity-based costing (TDABC) to provide a more reliable and clinically logical estimation of resources used to provide health care services.22 Using the TDABC process maps for each phase of care for a given condition, total cost for a care episode specific to a defined diagnosis can be determined.

The ACS THRIVE project employs TDABC to provide a more reliable and clinically logical estimation of resources used to provide health care services.

Having these types of data will be crucial to providers entering into VBCs with payors because it affords an enhanced level of transparency through better understanding of actual production costs, which provides a more objective basis on which to base the contract price ultimately negotiated for services. Furthermore, detailed information on price and cost, when properly analyzed and presented to clinical teams and decision-makers, can be invaluable in identifying ways to be more efficient. Experts believe transparency will be crucial toward the efforts to slow the growth of health care spending.


In the effort to reduce spending on health care services, the move from an emphasis on volume to an emphasis on value is a core, central objective. Contracts that incentivize value and focus on the results of care are now being applied in some areas of the health care economy. The goal of these VBCs is to control costs while ensuring that quality results of treatment are achieved. ACS efforts focused on the Quality and Cost variables in the value equation are directed toward providing objective data for surgeons and payors to base future VBC negotiations for surgical services.


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