OBJECTIVES: Pay-for-performance is gaining popularity and acceptance as an approach to improve quality and efficiency of healthcare in the U.S.. However, little evidence regarding the economic feasibility of this approach is currently available in the literature. Our objective was to examine the cost savings of a quality-based physician incentive program implemented in a PPO setting. METHODS: Administrative claims data for 2003-2005 were obtained from a voluntary physician incentive program implemented by a large non-profit health plan in Hawaii and used to calculate all costs and probabilities included in the decision tree. Health plan members were categorized into two groups: those who visited only physicians who participated in the program and those who visited only non-participating physicians during the study period. Rates of recommended care for two evidence-based quality of care indicators – glycosylated hemoglobin testing and lipid panel testing for members with diabetes – were compared between the two groups to determine program effectiveness. Program costs included administrative costs, the cost of quality of care evaluation, and physician reimbursement. Quality indicators that included several procedures were assigned a weighted average cost. One year events included severe diabetic complications. RESULTS: Average program cost per enrollee was $21; the average cost of receiving the two tests was $18; and the cost of developing relevant complications was $6470. With the incentive program, the health plan saved approximately $18 per adult diabetic considering just the two indicators (i.e., total program costs were distributed across just the two indicators for the purposes of this analysis), which translated to two year savings ranging from $2.5 to $6.7 million. CONCLUSION: Physician reimbursement models built upon evidence-based quality of care metrics may result in direct cost savings to the health plan within a relatively short follow-up time, in addition to positively affecting delivery of high quality, recommended care.