**3.2 Step 2: value estimation and economic modeling**

Pricing a value-based contract requires an estimate of the value that will be created by a program, device or other intervention (in addition to estimates of the cost of delivery of the VBC solution). Value estimation requires identification of the patient's current treatment pathway and a projection of an alternative pathway once a VBC solution is implemented. The treatment pathway is a transition or multi-state model that identifies different branches that a patient can follow together with the probability and cost of each different branch. **Figure 4** is an example of a simple multi-state model of a specific condition for which the patient can choose to receive treatment in an urgent care setting or a hospital Emergency Department (ED). Depending on the severity of the condition, a patient in the urgent care setting could be sent home or referred to ED. A patient seeking care in the ED could be tested and sent home or, after referral for further evaluation, either sent home or admitted to hospital.

A detailed claims database will allow the analyst to assess the services, their frequency and the pathway that a typical patient follows. As **Figure 4** shows, we associate transition frequencies with the different states, as well as the cost of treatment

at different stages. A disruptive device or intervention in this model would reduce the frequency of transition to higher-cost pathways. **Figure 4** is a simple pathway; pathways can become extremely complex, in which case some simplification will be necessary. Complexity arises not because of the variety of settings but because the services that the patient receives may be delivered in a different order (for example for some cancer patients, oncology may be delivered first, followed by surgery while for other patients, surgery may be performed first, followed by oncology). Episodes of care that involve physician or auxiliary providers (for example physical therapy) may involve a few treatments over time, to as many as one or two per week.

Once the typical patient pathway is defined and its frequencies and costs have been developed, the analyst can develop an alternative pathway, assuming the provider/ HCM intervention has been applied. The alternative pathway illustrates the disruption to the current standard of practice that the provider intervention generates; this may be estimated from prior studies or simply by clinicians who understand the intervention. The difference between the current and proposed pathways, however, is the source of the estimation of the provider's or HCM's economic value added. The result of this analysis is an economic model which is the basis of the HCM's pricing. The economic model is developed by comparing frequencies and unit costs under the current and proposed pathways.

Understanding pathways is a critically important component of the financial estimation process. Providers/HCMs often spend time and effort on the financial estimation phase and assume that the actual work of caring for patients and driving behavior change will take care of itself, if left to clinicians. Clinicians, however, need to know where and how they can perform interventions, with what patients and what outcome to expect. Operationalizing the model to achieve the projected savings is as important as understanding the opportunity. Pathway analysis can provide valuable input to this process because it provides a basis for breaking savings assumptions into drivers/components. We will return below to considering the implementation of a value-based contract.

## *Value-Based Contracting in Health Care DOI: http://dx.doi.org/10.5772/intechopen.103021*


#### **Table 1.**

*Economic model.*

The Economic Model (**Table 1**) illustrates the estimation of the value created by the sample intervention illustrated in the pathways in **Figure 5**, which moves patients from the Emergency Dept. to Urgent Care, as well as more accurately identifies those patients that may safely be sent home after evaluation.

Combining the predicted savings with the cost of delivery of the program allows the Provider/HCM to price its intervention in a manner that allows an appropriate margin for the HCM while also generating an acceptable ROI for the payer. The economic model also allows the HCM to price its contract: in this example the projected savings after intervention charges is 7.9% of projected costs. For a 50/50 gainsharing contract the HCM could each expect savings of 3.95%. This is a point estimate, however, subject to considerable volatility. Before entering into a contract the parties will want to evaluate the uncertainty around the point estimate, which we discuss next.
