Introduction

Contracts, which were introduced into the English NHS in the early 1990s, are the crux of the internal market. As in all markets, the negotiation and implementation of contracts for healthcare allow purchasers and providers to exchange information, and provide a framework for the allocation of financial risk. Financial risk, here defined as uncertainty of outcome, is allocated between purchasers and providers to reconcile their potentially conflicting objectives. Effective risk allocation occurs when risk is allocated to those who can control it, thereby incentivising those with responsibility for the risk to act to mitigate it. The contractual financial levers of pricing and payment structures play a key role in the allocation of financial risk between buyers and sellers. In the NHS, pricing and payment structures can allocate financial risk between those commissioning and providing services in order to incentivise demand management, improve efficiency, and, through the use of risk-sharing arrangements, encourage providers to work collectively.

This chapter examines two studies of NHS contracting conducted by PRUComm which examine how pricing and payment structures in NHS contracts allocate financial risk. As outlined in Chapter 1, institutional economics and socio-legal concepts underlie the study's approach to understanding the use of contracts in the NHS quasi-market. Contracting for health is challenging because of the complexity of health services and concomitant high levels of asymmetric information and uncertainty between providers of care and its purchasers (Arrow, 1963). Opportunism may occur as a result of this ‘information impactedness’ (Williamson, 1975), and one party may take advantage of the other's information deficit. Higher levels of asymmetric information will result in higher costs of negotiating and writing contracts, as well as monitoring, enforcing and renegotiating them. The purchaser can use the mechanisms of the contract, such as pricing and payment structures, to encourage the provider to deliver the outcomes desired by the purchaser, and to try to overcome the problems caused by imperfect information. Relational norms of contracts allow adjustments to be made to the initially agreed terms during the course of the contractual relationship to deal with unforeseen contingencies (Vincent-Jones, 2006).