In this arrangement, decision makers receive a fixed payment for attaining a target or undertaking an action. Such incentives are simple to describe and administer and are widely used in various policy areas. For example, unrestricted cash payments to low-income families for choices that increase human capital and break the cycle of poverty are being tested in several sites. Such incentives are known as conditional cash transfer programs.

A privately funded New York City program called Opportunity NYC offers cash payments to parents if they document particular actions designed to increase the school attendance of their children, improve their children's academic achievement, and increase their preventive health visits (eg, documented prenatal care for mothers and health care for young children) (3). The payments are substantial and together can raise family income by an estimated 25% to 30% (approximately $4,000 to $6,000 annually). Nonprofit partners pay, for example, $25 for attending parent-teacher conferences, $100 for a preventive health screening, and $150 per month for maintaining full-time employment. A similar program, Mexico's Oportunidades, has demonstrated increases in the educational and health outcomes of its participants, including significant increases in school attendance, achievement, and preventive health visits (8).

An advantage of such a plan is that it induces initial action that otherwise may not have been undertaken. However, such a flat payment does not reward continuity of effort after the goal has been achieved. Another disadvantage is that decision makers (in this case, parents) may be paid for choices they would have made anyway. Such payments are "windfalls" to the decision maker and lead to unproductive increases in costs to the payer.

A variation of the flat-payment arrangement is a schedule that increases payments as documented behavior moves toward the goal. For example, states operate child support enforcement programs with a mix of federal and state funds. The federal government matches every $1 a state spends on child support enforcement with $2 of federal funds. The federal government also offers graduated incentive payments to states as they achieve better performance on specified indicators (eg, the percentage of cases with paternity established or with on-time payments). Most analyses conclude that these incentive arrangements have been effective in increasing total child support collection nationally (9). The advantage of such graduated plans is that they maintain and increase the incentive for sustained efforts toward attainment of the objective.

Penalizing behaviors that do not meet goals is a common form of financial incentive, especially for environmental targets. The primary example is the "effluent charges" policy that has long been advocated by economists. In 1 variant of this proposal, a target level of emissions (eg, carbon dioxide) would be specified for organizations that discharge the gas. If they do not meet this target, they would be required to pay a fee for each unit of discharge beyond the target level.

Penalty arrangements also might be appropriate for some health care targets. For example, a meaningful target might be that 80% of a primary care physician's patients have blood pressure lower than 140/90 mm Hg. A penalty of $200 could be imposed for every percentage point that a provider's patient base falls short of the target. If only 75% of the patient base has normal blood pressure after a predetermined length of time, the penalty would be $1,000. This negative incentive could also be graduated in accordance with the extent to which behavior falls below expectations. Although some adjustment for risk is essential in such an arrangement, the difficulties of specifying an appropriate adjustment must be recognized.

Imposing penalties for inadequate attainment is like imposing a fine; it signals poor performance. Such a signal could lead to provider resentment, discouragement, erosion of loyalty, and opposition to other incentives. From the organization's point of view, imposing penalties avoids a monetary payment, whereas offering incentives does not. Finally, such penalty arrangements could encourage providers to discourage or reject high-risk patients, who would then have to seek alternative care arrangements, potentially resulting in no care or inferior care.

Incentive payment systems may be structured to allow the decision maker discretion over the bundle of procedures and processes chosen to attain an objective. Such a bundled incentive focuses the incentive payment only on the overall health outcomes at issue, rather than each of the actions or behaviors that lead to them.

Bundled payment arrangements are common in the private sector, and are often known as fixed-price contracts. For example, a municipality may contract with a private construction company to resurface a road but stipulate only the required characteristics of the resurfaced road, allowing the construction company wide discretion in choosing the best production process to accomplish the resurfacing.

In health care, prospective payment systems provide a single comprehensive payment for an episode of care, on the basis of the diagnosis. In the context of Medicare reimbursement for hospital stays, each patient is classified into a diagnosis-related group (DRG) and the hospital is paid a flat rate for the DRG (after adjusting for outliers or early release), regardless of the actual services provided. The motivation for this financial incentive system is to establish a base payment for providing a typical set of services, thereby eliminating the incentive for providers to charge more for profitable — though unproductive and discretionary — follow-up services or secondary diagnoses. The system lowers costs by reducing lengths of stay, reducing intensity of care, or improving efficiency of hospital operations. However, these incentives may cause providers to manipulate the demand for services, for example, by disaggregating hospital stays into multiple admissions or, in the provision of primary care services, attempting to attract healthy patients.

Moreover, this sort of incentive arrangement can lead to "risk shifting"; for example, by paying a group-specific fixed amount, the payer shifts the risk of variable treatment costs to the health care provider. This shift may encourage excessively restrictive (and thereby inefficient) care than a DRG typically warrants or the movement of patients into an inappropriate DRG.

Nonfinancial inducements to enhanced performance are common. In the private sector, a typical scheme might provide additional paid vacation days to high-performing workers or public recognition such as employee of the month. In the education sector, schools might try to attract teachers and improve their performance by streamlining hiring practices, offering comprehensive mentoring, reducing class sizes, and providing strong administrative support. In selected settings, these incentives can be effective (10).

Nonfinancial incentives may also work in the health care sector. Although people are often constrained in their health care choices, information on the cost and quality of providers could result in a reallocation of demand and revenue toward providers with the best results. If such information were mandated and widely used, hospitals and providers might be pressured to improve their performance in the dimensions indicated (11). Comparative effectiveness research has been proposed to evaluate the benefits, risks, and costs of treatment options. To affect medical treatment and reduce health care costs, the results of comparative effectiveness analyses would have to be not only persuasive but also used in ways that change the behavior of providers and patients (12,13).

Designing good incentive programs is difficult. By focusing rewards on choices that promote health outcomes, quality improvements, and efficiency gains, health care organizations and their patients appear to have much to gain. However, some incentives may foster undesirable competition, may become subjective or political, or may be poorly aligned with the collegial norms of the organization. Evidence for the benefits of incentive programs has been slow to emerge, partly because reliable assessment of incentive arrangements requires detailed research about how behaviors have changed because of the incentives. Nevertheless, the potential for such programs seems large; comparative effectiveness research should be considered for both financial and nonfinancial incentives. Additional research is necessary to support the effective design of incentive programs and to assess them comprehensively.