Optimal price-setting in pay for performance schemes in health care

The increased availability of process measures implies that the quality of health care is in some areas de facto verifiable. Optimal price-setting for verifiable dimensions of quality is well-described in the theoretical literature on incentive design. We seek to narrow the large gap that remains between actual price-setting behaviour in pay for performance schemes and the incentive design literature. We present a stylised model for hospital price setting for process measures of quality and show that optimal hospital prices should reflect the marginal benefit of the expected health gains, the weight given to patients' benefit relative to profits, and the opportunity cost of public funds. Based on published estimates, we derive the optimal prices for three measures of quality that have been incentivised in the English National Health Service since April 2010 (treatment in an acute stroke unit, rapid brain imaging, and thrombolysis with alteplase). We then compare the optimal prices with the actual prices offered to hospitals in England under the Best Practice Tariffs scheme for emergency stroke care.