Medicaid has become an urgent agenda item for state policymakers as they seek to control expenditures while improving outcomes. To achieve these goals, the care-delivery system needs to be less focused on expensive in-patient and acute care and much more focused on out-patient preventive care and coordination.

For example, in Wadesboro, N.C., a 52-bed hospital built in the 1950s is being replaced by a smaller, modern facility with a 24-hour emergency department, fewer in-patient beds and a new emphasis on primary and preventive care. Rather than investing in a facility that was no longer what the community needed, Carolinas HealthCare System and local leaders designed a different model for Anson County, delivering leaner and better-suited care.

Such success stories, however, require payment reform to become ubiquitous. Current incentives stimulate volume and do not reward high-quality care or efficient care delivery. Fee-for-service is still the dominant payment model for providers under Medicaid, even in states where managed-care organizations have become common. With fee-for-service, better outcomes, such as reducing avoidable readmissions or emergency-room visits, often mean less revenue for providers. This is obviously a problem: What hospital CEO could afford to lose a vital revenue stream, even if that meant delivering suboptimal care?

But states do not have to look far for payment models that reward lower costs and produce higher-quality care. One solution is a smart mix of fixed payments tied to the number of people in the served population ("capitation") for innovative primary-care models such as the patient-centered medical home. That can be combined with bundled payments for episodes of more specialized care in order to stimulate competition and the realization of better health outcomes. In such an environment, it becomes profitable for providers to prevent such cases as chronic obstructive pulmonary disease admissions, diabetic amputations and relapses of behavioral problems such as depression or substance abuse), and to reduce avoidable emergency-room visits and nursing home admissions.

Many payers and states are experimenting with such innovative payment models, but to realize real change in providers' behavior and structurally improve the value of care delivered, payment reform will have to move beyond experimentation.

For this to happen, obtaining information on the costs and outcomes of the care delivered by providers is an essential first step. Based on already available data, states can create so-called "value heat-maps" that show the total cost of care for various subpopulations within Medicaid (including the "duals," those who receive benefits under both Medicaid and Medicare) and the outcomes of that care. Such maps can help identify where good outcomes go hand in hand with lower costs (and vice versa), and are key in monitoring progress over time.

Subsequently, states should consider rolling out payment reform for providers either by contracting with managed-care organizations to do so or through a Medicaid waiver that allows the state to rewrite the payment rules. Moving toward paying for value rather than volume can be achieved gradually by building upon the current payment infrastructure. Medicare's Bundled Payments for Care Improvement initiative, for example, mostly remains based on fee-for-service.

A payment-model shift away from rewarding volume to rewarding upstream care that focuses on proactive lifestyle interventions, disease prevention and increased value of care will be jarring for many providers, and some in-patient facilities may not survive it. Financial investment will be required to help transform these facilities into centers that are more community-focused or to help them close beds while increasing outreach to outpatients.

As payers, states have clout, especially when they align payment reforms for Medicaid with the regulations for qualified health plans under state health-benefit exchanges and the health plans they purchase for their employees. This will stimulate commercial payers to follow suit, especially when states also realize alignment with the payment reforms that are taking place within Medicare.

Ultimately, payment reform also will imply changing incentives for health-care consumers. Adequate incentives can nudge consumers to choose high-value providers and make lifestyle changes that lead to better health. Incentives can reward desirable behavior, such as visiting primary-care doctors and following up as needed. Undesirable behavior, such going to the ER for non-urgent care, can be discouraged through the use of co-pays.

States are facing important questions about the future of their Medicaid programs. Tools are available and the time has come to make changes that can transform the system for the better.