Richard Wichmann
Reatha Clark

Hospital pricing is a science, not an art.


At a Glance 

  • A more sophisticated approach to establishing hospital pricing strategies should include: 
  • Reevaluating billing policies and processes to establish payment plans and protocols for collection 
  • Establishing a predictable and accurate pricing schedule for all services based on variables such as market, cost, and fee schedules 
  • Leveraging IT to guide decision making 
  • Informing hospital boards of the basis for pricing strategies  

Pricing strategies are as complex and varied as the hospitals that employ them. The science of developing a pricing strategy lies in determining how to meet a series of competing objectives: balancing budgets while remaining competitive, complying with regulatory standards, providing community benefit, and withstanding legal scrutiny.   

Scrutiny of hospital pricing is at an all-time high. Cracks in the healthcare financing system have been exposed by escalating costs, a growing number of underinsured and uninsured patients, and the rise of empowered consumers insisting on price transparency and accountability in an era of consumer-directed health care.  

The call for price transparency in health care rings loud throughout the industry, but price transparency without meaningful quality comparisons exposes market-based pricing discrepancies that could invite further criticism. More than ever, hospital financial managers need to take a more sophisticated approach to establishing their pricing strategies and integrating payer contract information with market analysis and actual costs to ensure that their prices are set at defensible yet sustainable levels.

Consumerism Is the Driving Force

Although recent investigations into improper pricing practices are what really got the ball rolling, the driving force of greater price transparency in health care ultimately may be consumerism, as companies provide employees with financial incentives to assume a greater role in managing their care.

All hospitals are under fire for pricing practices, but the bull's eye is really on tax-exempt hospitals. Much of the bad press has focused on the uninsured being charged high prices for services while managed care plans, Medicaid, and Medicare receive deep discounts. Critics claim that tax-exempt hospitals bear the responsibility to care for the underserved in exchange for their tax-exempt status. State and federal officials, the media, and interest groups are all now asking about the value of that exemption: What is society getting in return for the tax exemption? 

Pressure is building from federal and state governments as well as attorneys for consumers who have filed lawsuits against hospitals. Pricing has been at the heart of many of these lawsuits. In 2005, legislation was introduced in at least 15 states on the following topics:

  • Prices charged to self-pay patients with, in some cases, the requirement that prices be capped
  • The requirement that hospitals have policies and procedures to determine a patient's ability to pay
  • Mandated posting of signs or other communication about charity care policies
  • Discounts for services to certain qualified self-pay patients
  • Debt collections from self-pay patients
  • Reporting requirements on the number of uninsured/underinsured treated

Some states have passed legislation dictating the prices to be charged to the uninsured. In Minnesota, for example, prices for the uninsured must be equal to the rate paid by commercial insurers that generated the most revenue in the prior year. In other jurisdictions, hospitals are charging uninsured patients the average price negotiated by the three largest managed care plans.

The Demand for Accountability

Although specific prices for hospital services are rarely set by law, there are stiff penalties for fraud and abuse in pricing. For example, investigations into the abuse of the outlier supplemental payment system sparked a wave of legal actions against hospitals that were accused of overcharging for certain services and procedures to boost revenues. These cases also exposed issues with diagnosis-related group upcoding, in which incorrect DRG codes were being selected by some hospitals to obtain higher payment, from both government and private payers.

Flaws in the outlier payment formula can hurt both taxpayers and other hospitals because less funding will be available for them. This is one reason why House Ways and Means committee chairman Rep. Bill Thomas, R-Calif., has urged Michael Leavitt, secretary of health and human services, to issue a final rule regarding the limits Medicare would recognize as reasonable on reported charges. He wrote:

In 2003, the OIG proposed yet another rule that would have established a reasonable benchmark for determining excessive levels of charges relative to the rates paid by the private sector. Three years later, this rule has not been finalized. Recently, President Bush proposed to control healthcare costs and to better inform consumers through transparent pricing. This is difficult to accomplish, however, because hospital charges have become so grossly inflated above their private market rates so as to be almost meaningless.

Absent a market-based benchmark, a broad transparent pricing initiative that includes hospitals will fail before it starts. Such a result would be disappointing to healthcare consumers, lawmakers, and the American public. I urge that this regulation be finalized as quickly as possible.

Currently, there is widespread bipartisan support in Congress to force providers to make their prices known to consumers and to post their charges for major procedures. The Medicare program has announced it will begin publishing hospital prices based on information collected from hospital claim data and will also begin sharing what Medicare pays for those services. 

Earlier this year, Senate Finance Committee chair Charles Grassley, R-La., sent the American Hospital Association a detailed letter requesting information on how the Association would support legislative activity related to hospital charges and charity care. And Allan Hubbard, director of President Bush's National Economic Council, called the lack of price transparency by hospitals "absolutely indefensible." He has warned hospital executives that, if hospitals do not voluntarily adopt price transparency, such transparency will be imposed on them by Congress. 

Market forces will likely exert the greatest pressure toward making healthcare prices transparent. The rise of empowered consumers means that individuals are playing a greater role in their own care, and they want the same information on the value of medical services that they would be able to expect for any consumer product. This means providers' charges will increasingly be made public. Hospitals and physicians will need to rationalize their rates, and administrators can expect an increase of pricing inquiries and consumer requests for discounts. They will be asked to supply explanation and consumer education on the differences among charges, prices, and costs, as well as to develop a position on what data will or will not be released. 

Providers fear that one impact of consumerism will be a reduction of revenue due to the tiering of systems based on a combination of quality and financial data. In addition, as the patient responsibility portion of claims increases, nonpayment or delayed payment will likely increase dramatically because, historically, the self-pay portion of patient accounts has been the most difficult amount for providers to collect. New high-deductible health plans can dramatically increase patient outlays, and without an effective plan for managing these higher self-pay amounts, bad debt write-offs could increase. 

Time to Reevaluate Your Billing Policies

Now is a good time for hospitals to reevaluate their billing policies and processes to reduce the risk of uncollectible accounts, establish payment plans and protocols for collecting on patient accounts, and clearly define and consistently apply policies. Establishing a predictable and accurate pricing schedule for all services will ensure consistency and reduce uncertainty and confusion among consumers.

The ultimate goal of hospitals, of course, is to get paid for the care they render, and many hospitals are finding success in the use of prompt-pay discounts. Patients are motivated to pay when they are billed at discounted rates. Prompt-pay discounts may be applied for payments received at the time of service or a certain number of days after the service. 

Examining Your Pricing Strategy

The industry is responding to the push for transparency in a variety of ways, including taking a hard look at pricing strategies. Some of the major pricing practices in the industry today that were developed in response to consumer demands are rate rationalization, integrated systems pricing tiers, fixed payment arrangements, and aggressive rate reduction strategies.

Although every hospital has a pricing strategy, some are more sophisticated than others. If a hospital's pricing strategy is driven solely by the desire to meet a budget, without a more deliberate, fact-based assessment of costs, contracts, and market conditions, that hospital will continue to be vulnerable to attack.

A sound pricing strategy needs to incorporate a range of complicating factors, including the impact on the brand, payer contracting, compliance, competition, the cost of education and research, and the implications of consumerism. For example, consumerism is beginning to drive providers to reduce costs, change utilization, negotiate new contracts and rates, focus on quality reporting, and create new competition, such as express care clinics. Healthcare providers executing pricing initiatives need to consider these external influences to fully understand the healthcare pricing environment.

Internally, financial managers need a way to analyze their existing charge structure to ensure that it is optimal, that it can be defended, and that net patient revenues and third-party payments are being fully realized.

Organizations should develop dynamic pricing migration strategies that are customized based on the market and the organization's competitive position and that incorporate three critical factors: costs, comparative market data, and payment. The process should begin by analyzing hospital charge data at the department and procedural level to determine each procedure's contribution to charge-based, cost-based, and fixed revenues. Once this analysis has been completed, the goals and parameters for desired gross or net revenues changes should be defined.

"The $250 Band-Aid" and Other Chargemaster Considerations

As the average ratio of hospital charges to payments received has widened over the years, some hospitals have been able to squeeze additional revenue from payers who pay more of the full cost of their services, as well as from certain services, by increasing charges. The chargemaster, however, is primarily relevant for individuals who are insured but pay a portion of the hospital bill directly, payers without a contract, uninsured or self-paying patients, and/or contracts based on discounted charges. Some have speculated that the vast majority of items on the chargemaster have no identifiable basis, certainly not actual costs, and that changes to the chargemaster have evolved over time to hurt the uninsured.

As public scrutiny increases, hospitals must be able to defend their chargemaster adjustments, particularly if line items are inconsistent or if markups are too high compared with those of other providers in the same market. Charges should be linked to cost and market conditions, and changes should be made with sensitivity to the end user, the circumstances of the illness, and public perception.

Through careful modeling, prices and markups on the chargemaster can be set so that there is a clear rationale that makes sense to all stakeholders. At a minimum, hospitals should ensure that charges are within a reasonable range of market benchmarks that they are comfortable with and can be easily explainable to their constituents. Hospital systems with multiple facilities within the same market also should have the ability to closely monitor, if not synchronize, their chargemaster programs. They need to ensure that prices at an affiliated community hospital, for example, do not exceed those of another facility.

In the end, hospitals actually can achieve significant improvements in net revenue by strategically and judiciously adjusting items in their chargemaster programs. By evaluating both market value and competitive pricing landscape issues, hospitals can identify acceptable price ranges based on specific rules, including market and cost overlay variables and fee schedules. Within these parameters, charges can be raised for procedures that contribute the most to net revenue and reduced for those procedures that contribute the least, until the hospital's predetermined financial goal is attained.

One multifacility health system, for example, recently implemented a charge structure that incorporated both external market data and internal health system specific cost constraints. Using a rate analyst tool, the hospital summarized available market prices; quantified and controlled contributions at procedure, department, and hospitalwide levels; and used both hospital procedure cost data and market data when recommending new charges. By adjusting prices in this manner, the health system not only moved toward a more rationalized price structure, but also increased incremental net revenue on an annualized basis by about $7 million.

Managing Managed Care Contracts

As hospitals adjust their chargemasters, it is important that they work with managed care payers to make sure they are meeting their contractual obligations and the hospital is held harmless for adjusting charges that are deemed to be too high. Managed care contract terms are important to pricing policies and should be flexible to accommodate these types of adjustments. In some instances, payment rates may need to be renegotiated in a way that guarantees a specific amount of increase year to year, regardless of the changes in prices. 

Hospitals with managed care contracts that base payment on a percentage of charges could face a corresponding decrease in payment when chargemaster line items are decreased. Some have argued that if charges are lowered because they were too high, the hospital should in turn receive less in payment. This argument is complicated by a larger philosophical discussion about whose responsibility it is to provide care to the growing uninsured population. If charges are reduced to cover an increase in charity care, neither the payer nor provider should benefit from change. Rather, the benefit should accrue to the community.

Communicating the Science of Hospital Pricing

Hospitals will face increased risk of exposure to negative publicity, regulatory scrutiny, and legal ramifications as hospital pricing becomes public-but there are steps providers can take to minimize their exposure.

Now is the time for providers to take the necessary steps to rationalize their pricing, leverage IT to guide their decision making, document their processes, and inform their boards of the basis for their pricing strategies. Most important, providers need to consider all of their stakeholders and payers-not only Medicare, but also the growing number of underinsured Americans who are most vulnerable to pricing discrepancies. A more sophisticated approach to establishing pricing strategies, with attention to market analysis and actual costs, is essential to setting prices at levels that can be defended as well as sustained.


Richard Wichmann is managing director, PricewaterhouseCoopers, Boston, and a member of HFMA's Massachusetts Chapter (richard.wichmann@us.pwc.com).

Reatha Clark is a partner, PricewaterhouseCoopers, Atlanta, and a member of HFMA's Georgia Chapter (reatha.clark@us.pwc.com).


Differentiating Among Prices, Charges, and Costs

Understanding how hospital prices differ from hospital charges and costs may be among the most difficult and controversial issues in the debate over hospital pricing.

Costs are a hospital's actual expenses to provide a service, in consideration of all resources required. In comparison, charges-a standard healthcare finance measure used for analytical and statistical purposes-are what insurers, the government, and individuals must pay for the healthcare services they receive. Decades ago, charges were used to set prices, but charges are essentially meaningless to today's patients unless they are among the uninsured, who pay the full cost of their treatment.

Federal regulation requires hospitals to charge every patient or payer the same; however, regulations also allow prices to differ for various payers based on a number of factors, including contract rates and discounts afforded to insurance companies and large payers.

An analogy to hospital pricing is the hotel "rack rate," a rate that is rarely paid in actuality because of discounts achieved through sales, tour packages, club memberships, and the like.

Hospitals eventually supported creation of hospitalization insurance under a structure in which each plan had its own territory. Other private insurers eventually joined the fray, and the federal government, through Medicare and Medicaid, did as well. Prices were determined through government regulations and competitive negotiations between hospitals and commercial insurers- a piecemeal approach that improved hospital payments but led to pricing discrepancies among institutions across the country and even within markets.

The system had other curious ramifications. Unlike virtually every other commercial enterprise, patients became insulated from the true cost of their care.

As the beneficiaries, not the payers, of care, many patients became largely indifferent to price. In this environment, there was little incentive to make prices transparent or even equitable.

Today, hospital pricing is driven by a complex mix of differing payment schemes, contracting arrangements, and market forces, the result of regulations and competitive negotiations with payers over time. The perception of different prices for different patients for the same care, however, is a recipe for disaster in a litigious society.

Although price transparency theoretically would allow anyone, including the average consumer, to understand charges for healthcare services and make comparisons across institutions, in practice this is difficult because price varies widely between hospitals and geographic areas for the same procedure, making effective yet broad-based comparisons difficult to develop.

Weaving a Tangled Web: The History of Health Insurance

Before private health insurance was developed in the 1930s, hospitals and physicians were paid a fee for service. Their charges were based on what a patient could afford, and often, services were provided for free.

The first private health insurance plan, a prepaid hospital care plan developed for Dallas teachers by the Baylor University Hospital, was a prototype for Blue Cross, Blue Shield, and similar insurance programs. The availability of private health insurance expanded during World War II, when wage and price controls led companies to offer health insurance to attract workers. The birth of the employer-sponsored healthcare system proved to be a boon to hospitals and physicians by improving their payment.

Publication Date: Sunday, October 01, 2006

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