Martin J. D'Cruz
Terri L. Welter

Healthcare financial leaders can implement some cost-saving and cost-shifting initiatives to enhance their organizations' margins in 2008

At a Glance

Healthcare financial leaders should focus on initiatives that will help them increase their organization's margins in 2008, such as:

  • Payment policing and standardization of contract requirements
  • Contract performance modeling
  • Shift in volume and cost risk to hospitals
  • Consumer-directed health plans, price transparency, and pay for performance
  • Health plan consolidation
  • Value-driven health care

The healthcare industry is at a crossroads. Healthcare spending is growing three times faster than wages and is expected to double from current levels to exceed $4 trillion by 2016, according to a February 2007 Health Affairs article. As a result, there is tremendous pressure on key industry stakeholders to mitigate this cost growth. This cost pressure means that hospitals need to extract additional efficiencies out of their operations and spend more time on revenue strategies. Yet hospitals have a significant opportunity to enhance margins by focusing on managed care performance, a critical focus in 2008.

Hospitals will need to work with stakeholders toward achieving more controlled growth in medical spending. These stakeholders, including government, employers, payers, and providers, are forging ahead with several models to contain the growth of healthcare costs and ensure quality of care. Price transparency, consumer-directed health plans (CDHPs), pay-for-performance (P4P) programs, health savings accounts, and the payment incentives of the Centers for Medicare and Medicaid Services (CMS) are all moving health care in that direction. Regardless of which model reigns, in the future, a greater emphasis will be placed on the value of healthcare services with the demand for transparency of service price.

These cost-saving and cost-shifting initiatives require hospital financial and clinical leaders to spend more time in 2008 on the following to maintain their margins:

  • Health plan payment accuracy and administrative rules that lead to denials, uncollected revenue, and increased costs
  • Contract performance modeling
  • The shift in volume and cost risk to providers to facilitate health plan cost predictability
  • The shift of financial liability to patients via creative payer and employer initiatives, such as CDHPs and high-deductible benefit designs
  • Health plan consolidation and its implications for hospital and physician payment
  • Value-driven health care

Payment Policing and Standardization of Contract Requirements

Auditing payments will continue to be one of the most important jobs for hospitals in 2008. It is particularly important that unique managed care contracts be modeled and understood by all departments, including finance, revenue cycle, and case management. When contracts are complicated by payment nuances such as carve-outs, underpayments tend to be more prevalent.

In addition, payer administrative requirements have a material effect on revenue. Therefore, it is important to audit denials and underpayments related to the hospital's or the payer's failure to meet the contract's administrative requirements. It is also important for negotiators to understand the variability and inefficiency of requirements across payers to move toward standardization and lessen the cost burden of administering contracts. The fundamental premise is to keep the contract manageable to mitigate administrative costs and enhance revenue collections.

As an example, variable medical management policies continue to affect the bottom lines of hospitals. Hospitals typically use the InterQual guidelines for defining medical necessity as dictated by Medicare, but many payers use an alternate publicly available (or proprietary) case management system. This has created a major disconnect between payers and hospitals, as hospital case managers struggle to understand and ultimately comply with the care management requirements of their portfolio of health plans.

A recent survey shows that 8 percent to 14 percent of revenues go uncollected. The number is much higher for hospitals that lack an effective audit function. Hospitals need to be vigilant and have the ability to appeal and put the mechanisms in place to close this gap.

Action plan
  • Assess the magnitude of the underpayment and denial problem to determine the percentage of commercial business that goes uncollected and the reasons for underperformance (including internal and external reasons).
  • Form a denial/underpayment management team with assigned responsibilities and regular performance reporting to the CFO.
  • Create a monitoring tool or dashboard report.
  • Routinely appeal all denials to preserve appellate rights.
  • Expand resources to address underpayments stemming from the nuances of the Medicare Advantage preferred provider organization (PPO) and Medicaid managed care.
  • Define performance improvement standards and deadlines for health plans.
  • Make sure that the medical management policies of the health plans are consistent with the provider's processes and policies.
  • Collaborate with the medical director and case management on medical management policies.
  • Trend the shift of health maintenance organization, point-of-service, and PPO products. If the provider has separate rate structures for each of the products, monitor the shift to lower payment products. Is there a rationale for the plan to do it? Can the health plan provide documentation of benefit plans that have changed?
  • Assess the impact that variability of contract terms and requirements has on revenue and costs.
  • As a result of this assessment, identify standard contract terms and administrative rules to prioritize and obtain in contract negotiations.

Contract Performance Modeling

Analysis of contract performance has become paramount. Prospective performance modeling is critical to the eventual success or failure of each contract negotiation. Retrospective performance modeling clarifies the profitability of each contract after the agreement is signed. Managed care profitability analyses should be reconciled closely with the hospital's financial statements as a reference. A benchmark that may be used is the cost-to-charge ratio of the most recent Medicare cost report. Analysis should also be devoted to identifying the top 25 inpatient diagnosis-related groups (DRGs) and the most frequent 50 outpatient procedures by winners and losers. These should be analyzed for all major commercial payers (and minor payers as appropriate) on a quarterly basis and year to date.

Trending of patient type by inpatient, outpatient, observation, emergency, and outpatient surgery is imperative. Trending employer groups by national, midsize, and small group can also be a valuable resource for understanding payment trends and would prove useful if the hospital ever decides to pursue direct contracting. These data can also be used if an agreement must be terminated.

Hospital executives should analyze clinical, financial, and market data available on a timely basis and use the data for negotiation, strategic analysis, and programmatic planning.

Action plan
  • Create a contract modeling tool specific to each negotiation that enables the organization to project performance under multiple volume, price, and payment methodology scenarios.
  • Obtain all contract adjudication rules from the plan (e.g., bundling logic, multiple procedure rules, etc.) to ensure that the financial projections account for claims payment rules.
  • Use the modeling tool as a key means for deciding whether individual contract terms are acceptable.
  • Develop sensitivity analyses to examine the financial/clinical impact of price and volume changes for key margin-driving services such as outpatient surgery and imaging services.
  • Incorporate denial analyses in the model to track actual versus expected payment.
  • Monitor contract financial performance by health plan and product routinely to understand profitability and to identify and address payment problems.

Shift in Volume and Cost Risk to Hospitals

Tremendous pressure is being placed on hospitals to accept more volume and cost risk. The primary objective of payers is to rein in costs, create cost predictability to price premiums, and publish prices for common procedures, thereby forcing hospitals to accept lower payments.

Shift in volume risk. Most payers are planning to shift to the Medicare-Severity DRGs (MS-DRGs) for 2008 and to more fixed pricing methodology in the outpatient setting. Historical data should be analyzed for the implementation of the new DRGs. The FY08 final rule will replace the current 538 DRGs with 745 new severity-adjusted groups.

The goal of the new MS-DRGs is to make payment better reflect a patient's condition and to reduce incentives to "cherry pick" healthier patients whose care may result in higher margins under the current DRG system. The new MS-DRG system revises the list of complications and comorbidities (CCs) and expands them to include major CCs (MCCs), conditions that require twice the resources of a typical CC.

Complicated claims adjudication and rising technology costs are leading health plans down the path of overhauling their traditional outpatient payment methodologies to achieve more predictable cost outcomes. Plans are being aggressive with outpatient payment changes, which is causing hospitals financial and administrative pain as they are forced to move to case category payment.

Unique payment methodologies can be risky to negotiate if hospitals do not have the modeling capabilities and payment expertise to fully analyze the impact to the bottom line. The complexity of these arrangements can leave management feeling that they negotiated good rates only to experience a declining revenue base several months later.

To illustrate, one carrier's outpatient payment methodology contains per-case payment for emergency, false labor, rule-out myocardial infarction, observation, and urgent care; per-visit payment for more than 30 outpatient diagnostic and therapeutic service categories; per-case payment for outpatient surgery based on health plan unique surgery groupings; and inclusion of all pharmaceuticals, implants, and other supplies in the per-visit and per-case categories.

A major component of modeling the financial impact lies in analyzing the payer's payment ranking system, which will, for example, group all services in connection with an emergency visit into one case rate. If a patient visits the emergency department (ED) and has a diagnostic test, the emergency case rate is the only payment due. Understanding the payment needed on a per-case basis to cover the various ED service scenarios is critical to predicting the impact and negotiating favorable rates. A single error in the financial modeling can lead to catastrophic revenue shifts.

Action plan
  • Perform an assessment to understand your hospital's preferred payment methodologies for both inpatient and outpatient services.
  • Prepare a financial analysis by payer to determine the impact on payment resulting from the change to MS-DRGs.
  • Assess the volume trends affecting your hospital and the market that are specifically related to patient steerage for diagnostics and high-margin services.
  • Access competitive market information and track the trends in other markets.

Shift in Cost Risk

Payers are shifting cost risk to hospitals with limits on hospital chargemaster increases, raising dollar threshold stop-loss, and implementing new payment methodologies for high-cost drugs and new technologies:

  • Chargemaster limitations. Health plans are limiting their risk for increased costs tied to charge increases by negotiating language that puts a cap on payments by using the medical consumer price index or some other methodology. Chargemaster limitations should be based on the cost of healthcare and premium increases.
  • Increasing the stop-loss threshold.Health plans continue to shift catastrophic case risk to hospitals under the DRG payment methodology. The threshold should be based on reviewing inpatient cases to determine the level of stop-loss. It is important that analysis be completed before negotiations to identify cases that reached the stop-loss threshold. The hospital should determine the threshold based on the types of services offered. Consideration should also be given to establishing an outpatient stop-loss provision if the hospital is paid on a fixed-fee methodology.
  • Payment for high-cost pharmacy and implants. Payers continue to blend payment for high-cost pharmacy and implants into case payments on both inpatient and outpatient services. Including these in the case rate leads to easier claims adjudication but increases the financial burden on the hospital. An alternate approach would be to negotiate a percentage of charge payment, which can be easily monitored.
  • Payment for new technologies. Payers are reluctant to pay for new technologies. It is imperative that hospital finance and managed care leaders know in advance whether new procedures will be reimbursed. Some hospitals have a research committee that includes managed care representatives. If payment is not made by the plan, the hospital should demand payment to cover the cost by the manufacturer.
Action plan
  • During negotiations, weigh the benefits and risks of accepting additional cost risk.
  • Understand your costs specific to drugs, implants, and new technologies.
  • Seek protections in the contract for supply cost increases.
  • Get involved with the research committee pursuant to direction from the CFO.

CDHP, Price Transparency, and P4P

The challenges posed by CDHPs, price transparency, and P4P programs are enormous, and these market factors will become more interconnected in 2008. As a result, hospitals will need to implement strategies and initiatives to address these factors, particularly with regard to consumer choice and direct patient collections.

CDHP. To be simple and comprehensible for the consumer, CDHP assumes price transparency. This new paradigm for the delivery of health care allows the consumer to have better economic incentives to shop for services. The incentives make consumers more judicious with the resources by seeking information on medical conditions based on price and quality. As outpatient business becomes more competitive in a retail setting, hospitals should renegotiate inpatient services with payers to improve financial performance. The goal is to strive to be revenue-neutral. This goal depends on the dynamics of the local market and the ability to leverage with payers.

P4P. For price transparency to be of value to consumers, P4P has to be an integral component. Payment will be linked at least in part to adherence to safety and quality measures. This initiative should be driven by local hospital collaboration with employers, physicians, and health plans. Standard metrics should be used so that the practices of hospitals and physicians in the community are consistent with the program. Use of standard metrics will establish the benchmarks for the local community rather than have large payers dictating how performance should be measured with their program.

Action plan
  • Establish an interdisciplinary team across departments and major revenue cycle functions, including managed care, revenue cycle, chargemaster, marketing, and clinical and ancillary services. The team's activities would include addressing education, improving up-front collections, monitoring credit card programs, and establishing overarching goals for the revenue cycle staff.
  • Develop scripts for use by hospital and medical staff.
  • Identify through the local chamber of commerce key employers most likely to offer CDHP as an option for 2008.
  • Track the requests for price quotes at both the hospital and in physician offices.
  • Verify data about your hospital that payers publish.
  • Collaborate with and provide education to medical staff members and physician office managers.
  • Facilitate the ability to collect up front for CDHP products by amending the agreement.
  • Contact the payers to receive information on new products offered in the market for 2008.
  • Identify the top 50 inpatient and outpatient procedures. Also, identify the top 20 services at the physician office level.

Consolidation of Health Plans

Managed care has become the typical hospital's core base of business. It is particularly important for hospitals to optimize payment from commercial payers, as Medicare and Medicaid payments remain relatively fixed. In addition to having a robust revenue cycle department, hospitals should demonstrate value to their stakeholders in terms of cost and quality. When health plans merge, they tout that the result will be better service to members, greater efficiency in operations, and better premium pricing. Hospitals are finding, however, that these benefits are either at the expense of hospital payments or are not realized at all. Transaction costs for hospitals are huge and growing, and contract variability requires incredible investment in business office staff to comply with arcane and inconsistent contracts.

Meanwhile, payers are using their market power to squeeze payment and create bureaucratic hassles for hospitals, physicians, and others. At the same time, payers have continually raised premiums for consumers while typically offering no increase in benefits or services.

Action plan
  • Contemplate market strength of the health plans in the hospital's portfolio of contracts to understand competitive dynamics of the marketplace and to inform the decisions for the negotiations.
  • Review contract terms to determine whether the controlling plan has the right to access a different rate structure upon acquisition. If it does, the contract will have to be renegotiated on a "win-win" basis.
  • Trend historical financial and clinical information related to plan volumes, charges, length of stay, and outpatient services.
  • Evaluate opportunities to develop standard contracts across all health plans.

Value-Driven Health Care

Value-driven health care employs the concept of standardized methods for measuring quality and pricing; it puts healthcare information into the hands of consumers, thereby empowering and motivating them to make informed decisions. Informed consumers are able to seek the best available care, which stimulates the entire healthcare system toward improved quality and enhanced efficiency.

The federal government's initiative in this regard is to ensure that programs build on collaborative efforts to promote the four cornerstones for healthcare improvement (as outlined below). These cornerstones represent specific actions taken by the federal government; providers will need to be aligned with these initiatives.

Utilize health IT. This action has the potential to create greater efficiency in healthcare delivery. Progress has been made to develop standards that enable health information systems to communicate and exchange data and securely protect patient privacy.

Measure and publish quality information. To make informed decisions about their providers and their treatment options, consumers will need quality-of-care information. Quality measurement should be based on measures that are developed through consensus-based processes involving all stakeholders, such as the processes used by the Ambulatory care Quality Alliance (AQA), a multistakeholder group focused on physician quality measurement, and the Hospital Quality Alliance.

Measure and publish price information. To make rational decisions about providers, consumers will demand treatment options. Price information strategies are being developed to measure the overall cost of services for common episodes of care and the treatment of common chronic diseases.

Create positive incentives for high-quality, efficient health care. Stakeholders should participate in arrangements that reward both those who offer and those who purchase high-quality, competitively priced health care. Such arrangements may include implementation of P4P programs of payment for providers or the offering of consumer-driven products, such as account-based plans for enrollees in employer-sponsored health benefit plans.

Driving Change

Taking control of the hospital's revenue stream and lessening the administrative burden of operating contracts is a critical and necessary balance to protecting the hospital's margin and maintaining the long-term financial viability of the organization.

Hospitals are feeling significant pressure from commercial and government payers to contain healthcare costs. At the same time, today's hospital financial leaders are facing the most complex revenue cycle environment ever. The challenges that lie ahead are enormous with the consolidation of health plans, evolving CDHPs, demand for price transparency, P4P, and demand for value-driven health care.

Today's hospital leaders need to stay the course on payment initiatives that are working, such as payment compliance auditing, and focus their attention on taking incremental steps toward revamping the overall payment system. To drive this change, our leaders will need to take an honest look at the financial implications of the current payment system and move toward an improved model of efficiency.

Martin J. D'Cruz, FHFMA, is vice president, managed care services, St. Vincent Health, Indianapolis, and a member of HFMA's First Illinois Chapter (

Terri L. Welter is a senior manager, ECG Management Consultants, Inc., Arlington, Va., and a member of HFMA's Virginia Chapter (

Publication Date: Tuesday, January 01, 2008

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