Last week, San Diego-based Sharp HealthCare announced its withdrawal from the Pioneer ACO program.  Sharp joins 9 other ACOs that opted out of the program last year, leaving 22 ACOs still participating.

The Pioneer ACO program is an alternative to the Medicare Shared Savings Program (MSSP) for organizations with greater experience operating in ACO-like arrangements.  Unlike MSSP ACOs, Pioneer ACOs are required to share downside risk.  If actual total cost of care for the attributed population exceeds the established baseline, the Pioneer ACO must repay a percentage of that difference back to CMS.  A Pioneer ACO that reduces total cost of care, however, receives a higher percentage of the savings. 

 While the idea behind a shared savings program is relatively straightforward, the execution has proven less so.  In Sharp’s case, it stood to lose millions due to the formula used to calculate the baseline.  Initially, the baseline is calculated based on historical cost of care for the attributed population.  In the first year of its three-year performance period, a Pioneer ACO works to lower total cost of care as compared to those historical numbers. 

During the second and third years, an ACO is not trying to beat its prior year’s performance.  Instead, the ACO’s goal is to lower costs as compared to what would have been expected absent the ACO’s interventions.  That includes accounting for anticipated increases in healthcare costs by adjusting the baseline for inflation. In the Pioneer ACO Program, the baseline is trended forward each year using a hybrid inflationary factor based on national average growth and absolute dollar growth. 

In the San Diego area, however, Medicare spending has increased at a rate significantly above these national averages due to the area’s higher labor costs.  Here’s how it works:  to establish the national Medicare payment rate for a specific inpatient or outpatient hospital service each year, CMS multiplies the assigned relative weight for that service by an annually adjusted conversion factor.  The relative weight is based on the resource requirements for that service, including labor. 

Then, to account for geographic differences in labor costs, CMS adjusts the national payment rate by the local wage index rate.  Thus, the amount Medicare pays a hospital for providing  certain services will be higher in those areas of the country with higher labor costs.  As a result, the total cost of care for beneficiaries residing in these areas is higher. 

Because a Pioneer ACO’s initial baseline was calculated based on historical cost of care for the attributed population, these payment differences were taken into consideration.  However, the annual adjustment to an ACO’s baseline has been based on national averages.  For those Pioneer ACOs in areas where labor costs have increased more than the national average, the adjusted baseline does not accurately reflect the expected cost of care absent the ACO’s interventions.

In the case of Sharp, the San Diego wage index rate increased by 8.2%, meaning that Medicare payments for hospital inpatient and outpatient services in that area increased by more than the national average.  But the ACO’s adjusted baseline assumed those payments only increased at the lower national average.  Stated another way, the fact that Sharp was receiving higher than average fee-for-service payments for its hospital services meant that it could not generate the savings needed to beat the baseline based on national fee-for-service rates, even though it had been successful in reducing readmissions and utilization while improving quality performance.   

Contrary to some of the hyped-up commentary from last week, Sharp’s decision to pull out of the Pioneer ACO Program does not prove the ACO concept is doomed to fail.  Instead, it highlights the need to use local data – not national or even regional averages – to establish spending targets for shared savings programs as well as bundled and capitated payments. 

More broadly, Sharp’s decision reminds us there is no proven path from fee-for-service to value-based purchasing.   Instead, there will be many wrong turns and detours along the way.  Following the plan-do-study-act model, we will need to re-evaluate and recalibrate strategies on an ongoing basis.  But simply throwing up our hands and declaring defeat at each setback will get us nowhere.  Or, worse yet, we will remain in the unsustainable cycle of increasing costs until the wheels come off our healthcare system and, in turn, our economy.

As the Sharp decision demonstrates, new payment models will succeed only if they create incentives for providers to change their behaviors.  If the annual adjustments to Sharp’s baseline had taken into consideration higher Medicare payment rates, for example, the organization likely would have continued its participation in the Pioneer ACO Program as it would have had a realistic opportunity to earn shared savings. 

Despite defections, CMS claims the Pioneer ACO Program has been successful.   As the agency reported last summer, “[c]osts for the more than 669,000 beneficiaries aligned to Pioneer ACOs grew by only 0.3 percent in 2012 whereas costs for similar beneficiaries grew by 0.8 percent in the same period. 13 out of 32 pioneer ACOs produced shared savings with CMS, generating a gross savings of $87.6 million in 2012 and saving nearly $33 million to the Medicare Trust Funds.  Pioneer ACOs earned over $76 million by providing coordinated, quality care.” 

However, CMS cannot rest on reported success; it must address the identified shortcomings – the misaligned incentives –in the Pioneer ACO Program.  Overcoming these growing pains by appreciating and being sensitive to these incentives will drive progress in all value-based payment models.