When given a choice, most people are risk averse; they will choose an option with 100 percent certainty over an option involving an uncertain but likely more valuable outcome. This principle of risk aversion is illustrated in a study in which subjects were given a choice between a one-week vacation that was certain or a three-week vacation they had a 50 percent chance of winning. The vast majority of subjects chose the one-week vacation (Kahneman and Tversky, 1979). Even though the 50 percent chance of a three-week vacation might be considered a more rational choice, most people will choose the sure thing because they perceive it to be a better choice than the possibility of getting nothing at all.
With regard to P4P program design, the principle of risk aversion suggests that decreasing the risk or uncertainty in the likelihood of receiving a financial incentive is likely to lead to a greater behavioral response to the incentive. Some P4P payment structures use relative thresholds, such as paying those in the top quartile of performance, as the basis for determining who “wins.” This type of payout scheme creates greater uncertainty for hospitals than do payment schemes that use absolute thresholds (i.e., a fixed target) for determining who receives an incentive payment. The reason for the greater uncertainty with relative thresholds is that the level of performance necessary to earn the incentive is unknown until after the fact, when hospitals can be sorted by rank order of performance. In contrast, absolute thresholds known in advance and thus provide greater certainty to the individual or institution trying to hit the target. Because of the uncertainty they create, relative thresholds may reduce the behavioral response to an incentive more than an approach using an absolute threshold will. Similarly, a shared saving program, such as is being used in the CMS Physician Group Practice (PGP) demonstration, might lead to a reduced behavioral response, in this instance because the providers in the PGP face uncertainty about whether there will be cost savings to fund incentive payments. In contrast, the most certain incentive would be an adjustment to the fee schedule. For example, for every admission for myocardial infarction, a hospital would receive an extra $100, on top of its DRG payment, if the patient received all applicable processes of care. In such an incentive system, the hospital would know that if its physicians provide these processes, it would definitely obtain the additional payment.