How Bundled Payments Will Redefine Value in Healthcare: A Primer for Investors

March 2016

By William Bithoney, M.D., FAAP, Paul Gallese, PT, MBA, The BDO Center for Healthcare Excellence & Innovation

The healthcare market’s shift to value-based reimbursements is well underway, with the Centers for Medicare and Medicaid Services (CMS) steering the ship. CMS has been aggressively rolling out initiatives to support its goal of tying 85 percent of traditional Medicare payments to quality or value by the end of 2016. As further evidence of the payment shift, the Department of Health and Human Services announced on March 3, 2016, that 30 percent of all Medicare payments were being delivered to providers through “alternative payment methods,” exceeding the stated goal of achieving that threshold by the end of 2016. These payments totaled $117 billion of the $380 billion projected fee-for-service payments in 2016.

One of the most understated game changers is set to roll out in April this year: CMS’ first mandatory bundled payment program. The program mandates that care is considered, delivered and measured as an “episode,” not as a fragmented array of services. The “episode” approach, including a range of services in a single “bundle,” is a major shift in how care is managed and reimbursed, impacting, most significantly, decisions about where and when patient care is delivered.
While the first mandatory bundled payment initiative is fairly narrowly focused, it will have a significant impact throughout the post-acute provider space, changing business models and the competitive landscape. With additional mandatory bundled payment programs expected to follow, it’s critical for investors to understand how bundled payments are changing care delivery and the broader financial impact.

An Overview of Bundled Payments

The movement toward bundled payments has been around for a while, beginning with the inpatient prospective payment system in 1983, leading to the Bundled Payment for Care Improvement program (BCPI), which in October 2015 reported more than 1,600 voluntary participants. However, this year marks the first time that CMS is making bundles mandatory via its Comprehensive Care Joint Replacement Model (CJR), which holds hospitals responsible for all the costs, processes and outcomes for Medicare patients’ hip and knee replacement surgeries within 90 days of the initial hospitalization. Hip and knee replacements are the most common inpatient surgeries for Medicare beneficiaries, and recovery and rehabilitation can be lengthy; therefore, the CJR model is a critical test of whether bundles will succeed as a method to control costs and increase quality of care. The five-year program starts April 1, 2016, affecting 800 hospitals in 67 metropolitan statistical areas (MSAs).

CMS will calculate and establish a bundled payment price specific to each provider. The provider’s price becomes increasingly tied to regional performance each year until, after five years, the bundle price is the regional price. The quality of treatment and aggregate spending performance over the course of the 90-day period will dictate whether the hospital owes money or will receive additional payment from Medicare. The bundled payment model provides a real incentive for hospitals, physicians and post-acute care providers to collaborate on the best clinical process and most cost-effective resources for patients after hospital discharge.

To further stress the importance of quality in the equation, Medicare will tie payments to quality reporting under the CJR model. In an additional acknowledgement to quality, CMS announced that it is waiving the three-day stay requirement for Skilled Nursing Facility (SNF) placement, as long as the patient is discharged to a SNF with a Medicare Star Rating of 3 or higher.   

The Ripple Effect

This singular reimbursement change forces hospitals to re-think their entire approach to caring for hip- and knee-replacement patients. For the first time, hospitals have both the responsibility and incentive to help manage what happens to patients outside the hospital walls. Realizing clinical and financial success under this new payment and incentive model will require a more coordinated effort between hospitals and post-acute care providers, involving sharing data and analytics and developing gain sharing agreements and compliance systems to ensure the model’s guidelines are met.

CJR will push hospitals toward a deeper evaluation of potential post-acute care providers, examining a range of factors including clinical processes, length of stay and readmission rates. These analyses will provide insights that will allow hospitals to work with narrower networks of partners to whom the patient’s clinical processes are entrusted. SNFs and Inpatient Rehabilitation Facilities may see profound changes in referral patterns as a result. While CMS’ three-day stay requirement waiver will not be implemented until 2017, hospitals are beginning to see star ratings of SNFs as part of their network evaluation. Under the waiver, 34 percent of the nursing home market (the percentage with Star Ratings of 1 or 2) is automatically eliminated as an option for early discharge based on their rating alone. And that’s just the baseline. Business will plummet for many low-performing SNFs.

SNFs will face new competitive factors as well. Under the CJR model, nursing homes won’t just be competing against other nursing homes for hip- and knee-replacement business; they will also compete with home care agencies and individual ambulatory rehabilitation practices. As hospitals evaluate the best patient care model under these new payment criteria, it’s possible they will completely bypass nursing home care for some patients, opting instead to keep them in the hospital until they are ready for a home health agency or referring patients directly to outpatient rehabilitation services.

Still, why should such a small part of the market be so meaningful in the big picture?

The healthcare market closely tracks CMS trends; where CMS goes, commercial payers are soon to follow. In addition, CJR is a pilot program. As the results start to come in, it’s quite likely that CMS will test mandatory bundled payments in other areas, as well. 

Sink or Swim?

Change invites risk but, in the current healthcare environment, those who refuse to try new approaches are taking the biggest risks.

Hospitals that choose to incur a penalty (and can afford to pay it) instead of expending the time and resources to make the necessary changes that the CJR model requires are making a dangerous gamble. In the short-term, their inaction might yield a better financial outcome for the hospital. However, the regional price for a knee- and hip-replacement will drop as the CJR program progresses. Once those hospitals decide it’s time to catch up, they’ll be chasing a rapidly regressing market cost, potentially losing out on millions in reimbursements.

For nursing homes, change is equally—if not more—critical. Low performers risk not only losing business, but falling entirely out of some hospitals’ networks. As hospitals increasingly use star ratings as a key factor in their decisions about discharging patients, investors must understand and take note of how the system works and how assets in their portfolio may be affected.

Medicare’s Star Rating system is a forced ranking, so a certain percentage of the market must fall under each star level. In other words, there is no status quo; facilities with three stars are at high risk, as they can theoretically be knocked down at any time by a two-star facility moving up the ranks. In this environment, there must be a continuous effort to improve a facility’s star rating. But star ratings don’t necessarily tell the entire story; specific market dynamics will play an important part of a facility’s success. In several major service areas, no three-star or above SNFs exist. Thus, a two-star facility might still be the best available option, after considering other factors such as regional competition and population insights.

Staying on Top

New reimbursement models are re-inventing today’s healthcare system. Questions that are commonplace in many other industries must start being asked of healthcare providers. What value proposition does the organization bring? How does it generate superior outcomes? How can it demonstrate results both financially and clinically?

The BDO Center for Healthcare Excellence & Innovation is of the opinion that mandatory bundled payment initiatives will continue to be forthcoming from both CMS and private insurers. Given this, BDO estimates that bundled payments, accountable care organizations, Medicare Advantage and other value-based purchasing payment initiatives will create $10 trillion in value for those who can adapt, and will result in $4 trillion in losses for those who can’t. Investors on the winning end will have a thorough understanding of how reimbursement changes like bundled payments will impact pricing strategies, budget forecasting, business valuations and the potential for fraud.

For further information on this groundbreaking program and related value-based purchasing models, please visit the BDO Knows Healthcare blog and the CMS website on the CJR.

Dr. William “Bill” Bithoney, FAAP, is a Managing Director and Chief Physician Executive for The BDO Center for Healthcare Excellence & Innovation, where he co-leads clinical strategy. He can be reached at

Paul Gallese, PT, MBA, is a Senior Clinical Fellow for The BDO Center for Healthcare Excellence & Innovation. He can be reached at

Read Next Article, "The Overlooked Element of Value in Pricing Strategy"

Return to BDO Knows Healthcare Newsletter - Spring 2016