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Annals of Surgery:
doi: 10.1097/SLA.0000000000000677
Surgical Perspectives

Aligning Private Sector Incentives With Health Care Quality: Need for Quality-Adjusted Hospital Bond Ratings

Chang, David C. PhD, MPH, MBA

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From the Director of Outcomes Research, Department of Surgery, University of California San Diego, San Diego, CA.

Reprints: David C. Chang, PhD, MPH, MBA, Department of Surgery, University of California San Diego, 9500 Gilman Dr, La Jolla, CA 92093. E-mail:

Disclosure: The author declares no conflicts of interest.

Ever since the publication of the Institute of Medicine report, Crossing the Quality Chasm, there has been growing political will in the United states to improve the quality of health care.1 This political will has spurred policy changes aimed at quality improvement, such as, the recent reduction in reimbursements to hospitals with higher-than-expected readmission rates.2 These quality improvement efforts have primarily been led by public sector insurers, such as the Centers for Medicare and Medicaid Services. Given the culture and political atmosphere in the United States, if we hope to truly transform our health care system, we need to increase the involvement of the private sector in promoting health care quality. In contrast to European countries that have a more socialist culture, successful efforts to drive social change in the United States are more reliant on engagement of the private sector.

To some extent, private insurance companies have tried to participate in the quality movement, by linking their contracting process with quality and outcomes data. However, as evidenced by the endless battles between insurance companies and health care organizations, this approach is limited in scope, because the potential profits of the 2 parties are inversely correlated: every dollar that an insurer withholds is a dollar more in profit for them, but a dollar less for a health care organization. We must find a new way to align the profit motives of the private sector with health care quality. This is not easy; the goal of aligning profit motives with a public good has been a holy grail but has had a few examples of success (one notable example is “micro lending”3).

A potential new approach to achieving alignment of goals emerges if we move the focus away from the daily revenue streams of a health care organization and examine its process for long-term organizational financing: the startup and expansion of its capital base. We will find unique leverage in that the private sector is the source of the capital base for most health care organizations in our country. In fact, other than a few publicly owned hospitals (mostly Veterans Affairs hospitals, a few military hospitals, and a few county hospitals in some of the larger counties), almost all health care organizations raise startup and expansion capital from the private sector. This opens up a unique opportunity to engage the private sector, by engaging capital markets.

This is an opportunity because health care organizations in the United States frequently access the capital markets via bond issuance, that is, to borrow money. In the last decade, the issuance of new health care financing bonds ranged from $20 to $60 billion each year,4 and these bonds, like many home mortgages, are decades-long in duration. Because most health care organizations are not-for-profit, they cannot raise equity financing, or sell ownership shares through stock offerings. Therefore, if we want to engage the capital markets, we need to connect the concept of health care quality to the debt financing process.

One way to do so would be to integrate quality into the bond rating process. If we can make the argument that quality is ultimately linked to financial performance, then we can demand more favorable bond ratings for higher quality hospitals. This will translate into lower debt interest payments for them, potentially saving millions of dollars over the life of the bonds. In a way, this bond interest discount is analogous to auto insurance discounts for good drivers.

This argument makes sound financial sense for bond investors for several reasons. One is profitability. Quality measures serve as surrogates for organizational culture and organizational morale. And so, an organization that ranks highly on quality measures could enjoy both higher revenues (through better patient satisfaction, higher patient volumes, etc) and, more importantly, lower expenses (through lower staff turnover due to higher morale, more cohesive teams, better internal communications, less waste, fewer errors, lower malpractice risk, etc). Granted, there has been debate on whether quality could actually increase hospital market share, volume, and revenue, given the observation that patients often do not rely on quality data in their selection of health care providers.5 Nevertheless, it should be noted that profitability is not solely a function of revenue, but a function of both revenue and expenses. It should thus be noted that hospital quality could additionally affect the expense side of the profitability equation, even if its impact on revenue is yet to be determined. This philosophy would also have the added benefit of alleviating the current emphasis in hospital financing that is focused mostly on the revenue side of the profitability equation, and consequently on market share and volume.

Second is default risk. Most health care organizations are perceived to have a public mission, and thus they enjoy some degree of implicit backing from the local community. When a hospital runs into financial difficulties, it is not difficult to find a politician who will vote to back it with public dollars. Poor quality will erode this community support, making debt defaults more likely. Therefore, in contrast to insurance companies, bond investors’ profit motives are actually on the same side as health care organizations: bond investors profit only when a health care organization profits. Just like “micro lending,” this “macro lending” approach aligns financial incentives with a public good.

And there is a market for this investment for our partners in the financial industry. Given the growing interests in so-called “social impact investing,” financial leaders can also simply choose to consider outcomes and quality data as a form of marketing for these debt instruments, even before the empirical evidence base is complete, if they want to sell these products to socially conscious investors.6 It should be noted that this proposal is different from some of the “social impact bonds” currently in the marketplace, which often requires government backing and asks the investors to risk their principal to help reimburse the organizations if the stated objectives are not achieved. In contrast, this proposal does not require government backing, and it would focus on engaging the bond rating agencies to try to affect the bond interest rates, in essence only asking the bond investors to accept lower interest rates in exchange for better health care quality, instead of asking the investors to risk losing their principal if objectives are not met. It can be argued that this is, simply, the right thing to do.

Today, bond ratings are purely based on financial assessments, primarily generated by volume projections. However, it is not far-fetched, logically and morally, to argue that bond ratings for health care organizations should also incorporate health care outcomes and quality data. The fact that it currently plays no role is a missed opportunity, for both health care and financial industry leaders.

It is time we engage Wall Street in the health care quality movement.

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1. National Research Council. Crossing the Quality Chasm: A New Health System for the 21st Century. Washington, DC: The National Academies Press; 2001.

2. Centers for Medicare & Medicaid Services. Readmission Reduction Program. Web site. Available at: Published August 2, 2013. Accessed January 1, 2013.

3. Khandker SR. Microfinance and poverty: evidence using panel data from Bangladesh world bank. Econ Rev. 2005;19:263–286.

4. Huang G, Cohen N, Eappen R. 2012 not-for-profit hospital bond volume and yield projections. Wells Fargo Municipal Securities Research. Available at: Published January 9, 2012. Accessed November 4, 2013.

5. Jha AK, Epstein AM. The predictive accuracy of the New York State coronary artery bypass surgery report-card system. Health Aff (Millwood). 2006;25:844–855.

6. Palandjian T, Hughes J. The social impact bond market: three scenarios for the future. Stanford Social Innovation Review. Available at: Published December 19, 2013. Accessed February 3, 2014.

© 2014 by Lippincott Williams & Wilkins.


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