A blended system for the future

The complex challenges facing the NHS after the pandemic reinforce the need for a combination of payment approaches moving forward. No single approach is likely to be sufficient. For example, block contracts may reduce perverse incentives for providers to compete with each other for patients, but would do little to incentivise bearing down on the elective care backlog. While the scale of the backlog of care after the pandemic points to a need to incentivise additional activity, a move back to PbR alone for hospitals would not help the NHS meet its wider objectives. Activity-based payments do not provide a framework to fund reserves of capacity, which are necessary if the health system is to be more resilient to health shocks, such as another pandemic in the future. Nor do they address the poor coordination of care which may have a less visible impact than long waiting times but which is increasingly important given the number of people, particularly older people, who are living with multiple long-term health problems.

Figure 4 sets out the broad framework for a three-part blended payment system.

Figure 4: Framework for the hospital, community and mental health payment system

Source: Authors’ representation of possible tariff system, drawing on NHSE and wider evidence base.

This three-part tariff framework has major advantages. However, there are some important underpinning design questions that need to be thought through if the new payment system is to support (and preferably stimulate) desirable service changes and outcomes without unintended negative consequences.

Moving towards a more system-based rather than individual provider organisation based approach to running the NHS, with a focus on population health gain, remains the longer-term direction of travel. But over the next few years the NHS is once again having to respond to a significant backlog of patients waiting for planned care and a need to increase hospital capacity. To address this challenge a larger share of provider funding will need to be channelled through the variable activity payment until the backlog can be cleared. The advantage of a blended payment is that as priorities shift over time so the balance of funding between the three elements can change. This provides a more adaptive system than traditional PbR or block.

Moreover, the public finances context means that the Treasury will be looking for the NHS to achieve high levels of annual productivity growth and ensuring the NHS does not move into deficit. While there is considerable agreement about the broad direction of travel for the payment system, the detailed design work for the new system will involve difficult choices and tensions, not least prioritising reduction of the elective care backlog in the short to medium term.

We now set out some of the issues that need to be considered in the detailed design work over the coming months.

Component one: A provider-specific fixed payment

The role of fixed payment

A core component of the blended payment system is a fixed payment, unique to the individual provider (hospital, mental health or community trust). The advantage of this approach is that it allows commissioners to set a payment that acknowledges the current financial reality of a provider and persistent variations in the cost of care, which may reflect the legacy of capital investments through the private finance initiatives (PFI) or lack of access to necessary capital to make services fit for purpose. It has been advocated for emergency care for a number of years and was endorsed by the NHS for 2019/20

A key strength of this approach is that it allows local decision making about complex issues, such as balancing how far people have to travel to their health care facilities, which might require units that are smaller than optimal in terms of cost with efficiency.

Supporting the efficient delivery of services

It will be important to disentangle avoidable and unavoidable differences in costs between providers, so that organisations are not funded in perpetuity for inefficient care. If an ICS has a provider who is in deficit and has high costs, the ICS will need to set the fixed component based on a realistic assessment of the pace at which costs can be reduced and inefficiency tackled. But it is important that costs are no higher than absolutely necessary, and for no longer than necessary (ie providers need to be technically efficient). Conversely, a provider who can see how to reduce costs may wonder what benefit they would derive from doing so if the result is simply a lower fixed payment from the commissioner that could be used elsewhere.

To support these judgements, ICSs will need very good comparative data on costs and activity to develop efficiency benchmarks for services and whole hospitals, mental health and community providers. Comprehensive comparative data will be essential, and ICSs will also need support to interpret and use these data. A shift away from the national rules-based approach of PbR will be much more demanding for ICSs and the national role will be to support and develop ICSs.

As well as ensuring services are technically efficient, payments will need to reflect where best public value can be achieved (‘allocative efficiency’). A fixed payment to hospitals could result in resources remaining in suboptimal settings (such as too much care remaining in hospitals rather than moving into home and community settings). The fixed payment element needs to be set at a level that reflects appropriate models of care.

Improving allocative efficiency may mean doing less of something that is not as cost effective in order to provide financial headroom for something more cost effective. Research has shown significant differences in the cost effectiveness of spending at the margin in different disease areas (programme budget categories). There is also evidence that within a given disease area there is scope for improved allocative efficiency. The programme identifies unwarranted variation in patterns of care and pathways across the NHS, and promotes tools for commissioners to shift towards more cost effective patterns of care.

Fixed payments will need to adjust over time if activity is moved into different care settings. However, local discretion over the timing of this will help with the management of ‘stranded costs’ that arise as pathways are changed. Stranded costs are those that cannot be reduced in the short to medium term despite activity having moved – these have historically proved an obstacle to service transformation.

Reflecting security of supply

COVID-19 has demonstrated the importance of ‘security of supply’. In part this is about having sufficient capacity and flexibility within that capacity, which includes people, equipment (eg ventilators and scanners) and buildings. The payment system needs to reward the provision of that security of supply.

Security of supply is not only important in national or global emergencies, such as COVID-19. With the NHS regularly running at 90–95% capacity, there is too little margin to deal with any unexpected uptick in demand: a severe winter flu season, a significant heatwave or other events that may be more common than pandemics. All these risk stretching the NHS nationally or locally beyond its ability to effectively handle a crisis without jeopardising the health of those who need vital but non-crisis-related treatment.

The payment system needs to cover the cost of capacity that appears underutilised but is beneficial in terms of the system’s resilience to external events (or unexpected variations in annual demand). The fixed provider specific payment will therefore need to cover planned NHS activity and an assessment of the unavoidable cost differences. But this also needs to reflect the system need for additional capacity, which will provide greater resilience to demand shocks from severe winters or new infections such as COVID-19.

Such payment structures need to balance the risk of failure due to insufficient standby capacity with the cost of building resilience. Working out how much extra capacity is optimal requires an analysis of risks. This is not a new concept: payments for security of supply are common in other vital services, such as electricity and water supply. Part of the ‘fixed payments’ received by these providers ensure there is sufficient capacity to meet unanticipated peaks in demand. Providers of these services are paid not just to supply current demand but to hold sufficient capacity for unexpected surges. In theory, unit prices such as PbR tariffs can be used to reward holding excess capacity: providers who hold excess capacity gain more revenue during the unexpected peaks. In practice, experience in other sectors suggests this revenue is too uncertain to lead to meaningful investment and that fixed payments are more effective.

Historically, in the health sector such ‘excess’ capacity has been viewed as wasted taxpayer money (beds empty, diagnostic equipment not used, staff trained for activities not carried out). A fundamental reassessment of this view is now essential given the NHS will be at capacity in the coming years and needs to build the resilience to deal with inevitable surges in demand, as well as the possibility of future shocks. Payments for security of supply should be incorporated into the fixed payment received by NHS institutions.

Scope of the fixed payment

A key question for the fixed payment element is whether this model is exclusively for NHS providers or whether ICSs should also use the same three-part tariff approach when contracting with non-NHS providers. If we need more health care capacity in the future for NHS funded care either to tackle waiting list backlogs and/ or to provide greater resilience for health shocks, that capacity could all be provided in NHS owned hospitals or some of it in the charitable and independent sector.

The NHS drew on capacity from the charitable and independent sector in its response to COVID-19 and before the pandemic could use the ‘any qualified provider’ process to procure additional capacity (where, for example, waiting lists had grown too long). The government’s white paper proposals aim to streamline this process, potentially still allowing the NHS to access wider capacity but without the need to use competitive processes by default. How far the payments for capacity and care provided by charitable and independent sector providers should match the system for NHS providers will be an important issue to work through. The NHS could continue to use the fixed tariff to pay private providers but the downside of this is that it does not deliver secure supply in the locations where it is needed.

Component two: Activity payments

Why continue with some activity payments?

To help reduce elective care waiting times, which were a significant problem in 2003/04, the PbR tariff was introduced. The first decade after the tariff’s introduction did see a rapid expansion in elective care and waiting times fell. But the tariff was part of a package of reforms, funding and support that increased capacity and improved the management of patients on the waiting list.

Even before COVID-19 the NHS was struggling to meet the 18-week waiting times standard and the NHS Long Term Plan funding settlement included resources to improve access and reduce waiting times. The pandemic has resulted in a major backlog in care. Modelling work projects that without a significant increase in activity, waiting times and the number of people on the waiting list will increase substantially. From January to August 2020, 4.7 million fewer patients were referred for elective care (compared with 2019). If three-quarters of these ’missing patients’ are referred for treatment in the coming months, the waiting list could grow to 9.7 million by 2023/24 compared with 4.4 million on the list before the pandemic in February 2020. 

By the end of May 2021, nearly one-third (32.6%) of patients on the waiting list had waited more than 18 weeks. Meeting the 18-week standard by 2023/24 would require an annual average 11% increase in the number of elective procedures being performed each year by the NHS, needing some 4,000 extra consultants and 17,000 extra nurses a year. The Health Foundation estimates that it is more realistic to achieve the waiting time standard and eliminate the backlog of long waits over a 6-year period, ending in 2026/27. Achieving this would still require a significant increase in elective activity, but also additional funding of around £900m a year. In the 2020 Spending Review the NHS was allocated £1bn to begin to address the backlog of care but it will take many years of funding and additional capacity to get back to the standard of 92% of patients being treated within 18 weeks.

How to support and incentivise providers to increase elective care will therefore be a key issue once again for the NHS payment system over the rest of this parliament.

How important is the activity payment?

A key decision for policymakers and NHS system leaders will be how much of the overall payment system to devote to incentivising elective activity over the rest of this parliament. Alongside this is the question of how best to work with the charitable and independent sector. In 2004, the NHS introduced independent sector treatment centres (ISTCs) with multi-year contracts to try to increase capacity for tackling long waits. By 2008 as part of improving patient choice, the emphasis had shifted to the any qualified provider (AQP) approach where patients could choose where to have their care from the full range of NHS, licensed independent and voluntary sector providers with the PbR tariff ensuring money followed the patient’s choice. This was associated with a big increase in the number of NHS-funded procedures undertaken in the independent sector.

The white paper reaffirms that patient choice and AQP will remain part of the NHS ‘offer’. The activity payment will need to align with the use of any qualified provider – ensuring fair payment to the new provider but also a level playing field with NHS providers, particularly in the balance between fixed and variable amounts.

The scale of the backlog of unmet need and the duration of the task to reduce it means that ICSs and providers will the NHS need to think very carefully about how to focus activity and capacity to prioritise patients in greatest need and deliver services efficiently. The payment system will then need to be aligned with these goals – channelling resources and focusing incentives on those elements of elective care that are prioritised.

Component three: Quality payments

Historically, the NHS has used the payment system to promote higher quality care through various combinations of best-practice tariffs, CQUIN payments and other targeted quality payments. Evidence suggests that at the right level, incentive payments for quality can be effective, particularly when supported by other measures to improve quality.

It will be important to be clear about the objective for future quality payments. Historically, quality has primarily focused on measures of clinical effectiveness. The vision for population-based health shifts that focus to broader measures of wellbeing. Some of these measures align closely to the work of the NHS (eg obesity treatments, cancer diagnosis) but others extend beyond the NHS, incorporating complex and multi-agency interventions in local communities. This more recent development views the NHS as an anchor institution working in partnership with other public sector and civil society organisations to tackle broader health outcomes, inequalities and population-based metrics.

In the design of a new payment system, previous experience from CQUIN, QoF and best practice tariffs suggest that in designing the new payment system, the ‘quality’ or ‘change’ element needs to be sufficiently large to focus attention on these system goals. Our work with CEOs and senior managers suggests (albeit anecdotally) that they placed less focus on elements of CQUIN as its value fell over the past decade. Busy hospital managers and clinicians will not change established practice for small additional amounts of funding. Providers report that there is often a disconnect between the size of an incentive and the cost of achieving it. The reduction of CQUIN from 2.5% to 1.25% of revenue by 2019 was, in our experience, accompanied by a similar reduction in its role driving change.

In contrast, QoF payments make up a much greater proportion of GP income. This meant that the GPs were more likely to take notice of the quality priorities included in the payment system (for example the proactive management of long-term conditions). And there is evidence that these performance payments to GPs accelerated quality improvements.

Neither of these payments provides a perfect analogy (in part because the threat of withdrawing them was rarely seen as credible). But they contribute to a belief that ‘size matters’.

The corollary of the need for a sufficiently large payment is that there has to be a process of prioritising where to focus in terms of improving quality. In which specific areas can the payment system really drive change if there is a clear signal of sufficient financial reward (and will there be unintended negative or perverse outcomes from providing this focus)? There is ongoing debate as to the extent to which these priorities should be set nationally or locally.

Wider aspects of an effective payment system

Previous Health Foundation research highlighted the key features of an effective payment system (see Figure 3). These encompassed several crosscutting areas that go beyond the design of fixed, activity and quality payments to include: high-quality data; independent oversight and support; national consistency with local flexibility, and evaluation. Here, we consider some of the key features that need to be addressed in the design of the post-pandemic payment system.

High-quality data

Designing a payment system without ensuring sufficiently accurate data are available will greatly reduce its effectiveness. A fixed payment between providers and commissioners will require good data on activity, case mix and the cost profile of the hospital. It may even require better (though not necessarily more) data than PbR about cost. The prices set in PbR are based on the national average cost of an episode of care, a provider specific fixed payment requires a more granular understanding of provider specific cost structures.

One important area of improvement has been the introduction of patient-level information and costing systems (PLICS), mandated in the NHS from 2018. This programme will be critical to implementing a blended payment system, as will ensuring that PLICS data are timely. One challenge under the PbR system was that it was based on reference cost data that had long lags. A blended payment will require good comparative benchmarking data, for example the Getting It Right First Time (GIRFT) programme, which is using these data to examine unwarranted variations and improving efficiency and patient outcomes.

High quality data are important for all aspects of NHS service delivery, so the quality and use of data should be driven independently of the payment system. To work effectively the new ICSs will need access to high-quality data on population health needs, activity, quality and resources. ICSs will need an integrated data strategy and expertise to use and interpret that data. Transparency and accountability are also important. Data needs to be available to support good service delivery but also for public scrutiny. This will require skills and resources within each ICS but also national consistency and support – otherwise benchmarking is impossible and transaction costs may increase if providers have to give different information to each ICS.


For the payment system to succeed it will need to be continually evaluated, providing effective feedback to those involved on how well incentives are working. Unintended consequences or perverse incentives will also need to be identified quickly so the system can evolve and improve.

There needs to be a shared understanding of the expected outcomes, likely impact of changes to the system, and an understanding of how long it might take for these changes to become effective. It may take time for changes to the system to translate into improvements for patients. For instance, a recent study into an integrated care transformation programme shows that despite an initial increase of hospital activity, it took 6 years for the integrated care initiative to deliver a reduction of both A&E attendances and emergency admissions.

It is important the health system and evaluators make the most of data that are routinely collected in the health service, and combine this quantitative evidence with local qualitative insights to understand what is driving the change, and allow for course correction early on.

Independent oversight and national/local balance

Changes to the system will take time to design and will not implemented all at once. Moreover, the precise design will change over time as what works becomes clear. This raises the question of who should be in charge of this shift.

The proposed NHS legislation outlined in the government white paper will overhaul the national governance of the payment system. In the 2012 Act, NHS England had responsibility for the structure of the payment system (eg definition of currencies – what was being paid for) and Monitor (now NHS Improvement) for the level of the individual prices within that system (how much was to be paid). Meanwhile, a process of consultation and approvals for modifications was mandated with the Competition and Markets Authority (CMA) in a backstop regulatory role.

The proposed legislation merges the national bodies, abolishes the CMA role and gives NHS England greater flexibility as it reforms the payment system. The bill will introduce a new NHS payment scheme to replace the NHS tariff. Powers are proposed for NHS England to publish the payments scheme, and to give NHS England a power of direction over commissioners where they fail to comply with rules in the payment scheme. A power is also created for the secretary of state to prescribe, through regulations, some aspects of the proposed NHS payment scheme.

Two distinct issues are important: who makes the initial decisions and what independent oversight exists to act as a check on those decisions?

Who makes the decisions?

A key question for the new payment system is where the balance of decision making will lie. The creation of large ICS collaborative arrangements could provide an opportunity for national policymakers to delegate more tariff-setting powers. The creation of hospital provider collaboratives within ICSs also raises the prospect that the right parties will sit at the same table and share mutual accountability to get the design right (and will allow representatives from other sectors to take part in this important discussion too).

However, the degree of autonomy given to local systems to determine the precise form and size of each of the elements will also be based on how much national variation is acceptable and the advantages and disadvantages of such variation. Elements such as security of supply might best be developed at reasonably large levels of total population. Other elements (eg the balance of activity and fixed payments) might vary depending on how well waiting lists or chronic conditions (such as depression or obesity) are being handled in different parts of the country, unless there is a national programme.

The devolution of payment decisions from national bodies to local commissioners was underway pre-COVID-19, but this next step will require a more structured approach to such devolution.

Independent oversight of decisions

Devolution also raises questions about transparency and accountability. It is particularly important to consider how such a system would work in cases where there are significant financial challenges. The tensions between the financial stability and the sustainability of existing hospitals, quality of care and the need to shift funding to primary, community and mental health settings are hard to resolve and are best served by a transparent system where trade-offs can be considered. The 2012 Act sought to limit price competition due to concerns that quality of care might suffer. This is because quality is harder to observe and if providers and commissioners were under financial pressure they might set prices too low to maintain an appropriate quality of care. The inclusion of quality payments within the blended payment system is designed to ensure that quality remains a key focus but independent oversight of decisions to ensure prices are not being set below the cost of delivering high quality care will be important.

It is not clear where the independent oversight will come from in the new regime envisioned by the white paper and the Health and Care Bill. Parliament can provide some scrutiny but cannot provide the detailed checks-and-balances that institutions such as independent regulators or the CMA play in other parts of the economy. The National Audit Office or others may play that role. It will be important to identify where oversight sits as part of the ongoing reforms.

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