The Business of Healthcare: The Role of Physician Integration in Bundled Payments

Problem definition: Under the prevailing fee-for-service (FFS) payments, hospitals receive a fixed payment, whereas physicians receive separate fees for each treatment or procedure performed for a given diagnosis. Under FFS, incentives of hospitals and physicians are misaligned, leading to large inefficiencies. Bundled payments (BP), an alternative to FFS unifying payments to the hospital and physicians, are expected to encourage care coordination and reduce ever increasing healthcare costs. However, as hospitals differ in their relationships with physicians in influencing care (level of physician integration), the expected effects of bundling in hospital systems with a varying level of physician integration remains unclear. Academic/practical relevance: There is a lack of both academic and practical understanding of hospitals’ and physicians’ bundling incentives. Our study builds on and expands the recent operations management literature on alternative payment models. Methodology: We formulate game-theoretic models to study (1) the impact of the level of integration between the hospital and physicians in the uptake of BP and (2) the consequences of bundling with respect to overall care quality and costs/savings across the spectrum of integration levels. Results: We find that (1) hospitals with low to moderate levels of physician integration have more incentives to bundle as compared with hospitals with high physician integration; (2) to engage physicians, hospitals need to financially incentivize them, a mechanism that was not available in traditional FFS-based payment models; (3) when feasible, BP is expected to reduce care intensity, and this reduction in care intensity is expected to result in quality improvement and cost savings in hospital systems with low to moderate level of physician integration; (4) however, when bundling happens in hospital systems with a relatively higher level of physician integration, BP may lead to underprovisioning of care and ultimately quality reduction; (5) in an environment where hospitals are also held accountable for quality, the incentives for bundling will be higher for involved parties, yet quality vulnerabilities due to bundling can be exacerbated. Managerial implications: Our findings have important managerial implications for policy makers, payers such as the Center for Medicare and Medicaid Services, and hospitals: (1) policy makers and payers should be aware of and account for potential negative effects of current BP design on a subset of hospital systems, including a possible quality reduction; (2) in deciding whether to enroll in BP, hospitals should consider their level of physician integration and possible implications for quality. Based on our findings, we expect that a widespread use of BP may trigger further market concentration via hospital mergers or service-line closures. Supplemental Material: The online appendices are available at https://doi.org/10.1287/msom.2023.1187 .