Countries seeking to move away from a purely fee‐for‐service (FFS) system

may consider a hybrid approach whereby only some procedures are paid by

FFS while others are paid prospectively. Yet little evidence exists whether such

a hybrid payment system contains overall costs without adverse influences on

health outcomes. In 2003, Japan experienced a reform from FFS to a hybrid

payment system in which only some inpatient procedures were paid prospectively.

We exploit this reform to test how such a hybrid system affects

overall costs and health outcomes. Briefly, we find that healthcare providers

responded opportunistically to the reform, moving some procedures out of the

bundled inpatient setting to FFS services, leading to no reduction in cost.

There was some evidence of a moderate deterioration in health outcomes, in

terms of a decline in the probability of symptoms being cured at discharge. In

sum, our results suggest that in some cases, a hybrid payment system can be

non‐superior to either FFS or a prospective payment system.