Health Care Reimbursement Models

By Chris Yang | Last Updated: April 12, 2021

Image by: Brett Dashevsky

What are health care reimbursement models?

We all know healthcare costs a lot. But how does cash flow from patient to provider? The complex healthcare reimbursement structures in the U.S. evolved to curb rising medical costs and shift financial risk from patients to providers.


Key Takeaways

  • Health care reimbursement structures were created to curb the rising prices of medical care.

  • Physicians were originally reimbursed through fee-for-service transactions.

  • Modern reimbursement models compensate physicians based on the number of patients they see and the “value” they contribute (i.e. a patient’s health outcomes).


The Basics 

In a typical day, a provider may encounter 4-5 distinct types of reimbursement. Treating two patients who require the same services will likely involve two wildly different modes of payment, ranging from direct out-of-pocket transactions to fixed monthly premiums.

Healthcare reimbursement involves many different players, but most models include three main parties:

  1. the patient/payer

  2. the insurer

  3. the provider

Patients typically pay a monthly fee to insurers, who reimburse providers based on the services rendered to patients enrolled in their plans.

Grasping the concept of unit of payment is crucial to understanding the healthcare reimbursement process. In a nutshell, units of payment can be placed on a scale of simple to complex. The simplest units of payment assign one fee per service rendered while the most complex assign one fee per multiple services rendered, with many variations in between.


Fee-for-service models implement the simplest unit of payment by paying providers for each service delivered. The more services a provider issues, the more they get paid. In this arrangement, patients or payers take on the financial risk associated with unpredictable medical costs. These models reward providers who see many patients because they’ll be reimbursed based on the number of services rendered, regardless of health outcome.

Historically, FFS structures incentivized physicians to provide more services than needed and contributed to a rapid rise in health care costs in the U.S. Though most providers still operate under FFS models, they’re slowly being replaced by more equitable models that emphasize quality over quantity.

Per diem (hospitals only)

In this model, insurers pay providers a flat fee for all services administered to a patient per diem (day). In this arrangement, financial risk is shifted from the patient to both the insurer and the provider. The insurer must pay for each additional day the patient is in the hospital. Similarly, the provider will rack up costs by providing more services per day to the patient but will not receive additional payments to cover these costs. 

Per episode of illness (aka “DRG” or diagnosis-related group)

The DRG model takes the per diem model one step further. In DRG structures, providers receive a single sum for each episode of illness a patient experiences, regardless of how many times the patient visits the hospital or how many services they receive. For example, a hospital that oversees a hip replacement surgery will receive a single payout regardless of how many days the patient stays for recovery. DRGs motivate providers to cap the volume of services rendered to limit their financial risk. An increase in the number of services rendered will yield a financial loss for the provider. Unsurprisingly, DRG models can lead to undertreatment.


Capitation models involve fixed monthly payments to providers from each patient who has signed up to receive care. The goal of capitation is to shift financial risk from insurers to providers. Under capitation models, insurers pay a fixed sum to providers, no matter how many services are provided to patients enrolled in their plans.

Capitation has emerged as one of the most popular methods for physician reimbursement because of its ability to control the rising health care costs associated with FFS models and create a stable framework for rational distribution of health care resources. Nowadays, capitation models =  managed care plans and more equitable healthcare.

Value-based reimbursement

Now we’re getting to the good stuff. VBR models reward physicians for providing high-quality care rather than high quantities of care. Typical VBR models involve performance thresholds and cut-offs. For example, in a VBR structure, insurers would no longer pay providers whose patients tend to develop bedsores (ouch) during hospital stays. When thresholds are met, providers receive bonuses. On the flip side, VBR models penalize providers for poor outcomes or medical errors. 

In summary...

The healthcare reimbursement models that exist in the U.S. today were developed to curb rising healthcare prices. Modern reimbursement structures tend to emphasize efficiency, which has made capitation and value-based structures popular. Con: these models can lead to undertreatment. Nowadays, institutions are shifting towards blended reimbursement models that include elements of both FFS and capitation. We’re hopeful these innovations can strike a balance between overtreatment and undertreatment.


Outside the Huddle


Reviewed by Geetika Rao, MPH | Edited by Nidhi Mahagaokar, MPH and Jared Dashevsky, M.Eng. | Fact checked by Julia Radossich, PA-C