Hal Andrews
Gunter Wessels

Many hospitals face the prospect of losing millions of dollars of Medicare revenue if they fail to perform above the 75th percentile among all U.S. hospitals based on performance measures proposed for value-based purchasing.

At a Glance

  • Beginning federal fiscal year (FFY) 2013, value-based purchasing (VBP) would implement a withholding of 2 percent of Medicare reimbursement, which would then increase gradually to 5 percent in FFY16.
  • A hospital's percentile ranking in a VBP performance measurement system would determine the amount of payment, if any, it would receive from these withheld funds.
  • To receive incentive payments, hospitals will need to raise their performance on the measures.

If Congress's proposals for what has been termed value-based purchasing(VBP) are enacted, as is expected, the ramifications for healthcare providers will be profound. VBP not only will bring about a fundamental change in how hospitals are reimbursed under Medicare, but also will very likely influence commercial payment methods as well. History suggests that whatever new initiatives are adopted for Medicare will also be incorporated by commercial insurers across all of their products.

Even so, VBP also represents an important opportunity for healthcare providers. It not only gives them a way to show their dedication to providing the best possible care for their communities but also offers them an incentive to step up their efforts toward achieving another mission-related goal: that of continuous improvement.

VBP is just one of numerous healthcare reform initiatives that Congress has recently proposed,  and Senate and House leaders have promised votes on these measures by the end of the summer. The House tri-committee bill has numerous provisions for modifying Medicare Advantage plans, including proposals for VBP, episode-based payments, and comparative effectiveness.a

A common thread through these proposals is cost savings; every Senate or House committee that is drafting healthcare reform legislation has either included or signaled intent to include cost saving measures. Therefore, regardless of the form healthcare legislation takes in 2009, providers are almost certainly faced with payment cuts that could exceed those contained in the Balanced Budget Refinement Act of 1997.

Moreover, in addition to changes that directly affect providers, health insurance coverage reform will likely modify cost sharing and payment rates to encourage the use of services that promote health and value. For example, under the House tri-committee bill discussion draft dated June 19, 2009, the Secretary of the Department of Health and Human Services (HHS) is instructed to "provide affordable, quality health care for all Americans and reduce the growth in healthcare spending." VBP is widely seen as one of the best means to achieve these ends. Indeed, of all of the cost reduction and payment reforms being discussed, it is the only one that does not face significant opposition.

VBP at a Glance

Under existing proposals, if enacted, the majority of hospitals will forfeit some Medicare reimbursement under VBP. On Oct. 1, 2012, beginning federal fiscal year (FFY) 2013, VBP would phase in payment adjustments by implementing a withholding of 2 percent of Medicare reimbursement (excluding payment for indirect medical education, disproportionate share hospitals, and outliers). Under the April 2009 Senate Finance Committee's proposal, the percentage of the withholding would then increase by 1 percent per year to 5 percent in FFY16.b

Hospitals with performance above the 75th percentile in a performance measurement system that includes both quality and patient satisfaction measures will receive all risk-pool dollars, plus a small bonus-probably about 3 percent of the dollars at risk. It is anticipated that the bonus monies would come from the funds withheld from and not eventually returned to lower percentile hospitals. Hospitals below the 26th percentile would not see any risk-pool dollars returned. Hospitals between the 26th and 75th percentile would receive risk-pool dollars prorated on a linear basis.

The following model demonstrates the expected impact of the Senate Finance Committee's VBP proposal on specific hospitals. Consider, for example, that Hospital X has a quality performance score of 68.24 and a patient satisfaction score of 72.35 (out of a possible score of 100 in each case), for a total performance score of 69.06 out of 100 (where the quality score = 80 percent, and patient satisfaction = 20 percent). This score places this hospital in the 50th percentile nationally.

Assume Hospital X will receive risk-eligible Medicare revenue of $30 million per year. Based on the identified percentages of risk pool funds refunded for hospitals in different percentiles, Hospital X would have $4.2 million in Medicare payments withheld over the four-year period of FFY13 through FFY16 (beginning in October 2012), and would be refunded half of those payments. Thus, Hospital X's financial loss would be $2.1 million over the five years beginning in October 2012 (see exhibit 1) .

View exhibit 1


Under the Senate Finance Committee proposal, the cornerstones of this approach will be the use of existing measures to establish percentile rankings. (The Centers for Medicare & Medicaid Services [CMS], for example, has required hospitals to submit quality measures since 2002.) Specific measures used would include the core measures presented on the Hospital Compare web site developed by HHS (www.hospitalcompare.hhs.gov) and the patient satisfaction measures identified through the CMS-mandated Hospital Consumer Assessment of Healthcare Providers and Systems (HCAHPS) survey (www.hcahpsonline.org).

It is important to understand that, under this approach, hospitals will be evaluated based on a national percentile ranking, and that absolute scores matter less than relative ranking. Thus, regardless of a hospital's overall performance level, if the hospital is in the lowest quartile, it loses all at-risk funds. Open to speculation is whether the Senate Finance Committee proposal's focus on national performance is preferred because of its simplicity or is designed to send a signal about quality on a national level. In any event, it should be clear to hospital CFOs that a hospital's performance rankings under such a system would require constant attention.

As usual, Congress will provide a transitional period between the date legislation is approved and the date it is effective. Given the magnitude of proposed change, hospital leaders will need to act expeditiously to prepare for all pending reforms, but especially in anticipation of VBP. Hospital financial leaders should keep themselves apprised of the evolving form of these proposals. There is still time to adapt and change hospital care delivery processes to avoid potentially negative implications of these imminent reimbursement changes.

VBP Methodology

As noted previously, VBP measures include quality measures, such as those found at the Hospital Compare web site (and possibly to include patient safety indexes and/or 30-day mortalities), and patient satisfaction measures (from HCAHPS). The formula used to set a hospital's overall performance score-and ultimately, its national percentile ranking-is complex and not yet definite in all its details; it computes an "attainment" score and an "improvement" score for each core measure Indicator. The higher of the two scores for each indicator are combined to give an overall performance score falling somewhere from 0 to 100. When hospitals' overall performance scores are distributed nationally from lowest to highest, each hospital is assigned to a percentile in the distribution.

This ranking system does not apply to hospitals that do not have a minimum number of patients with conditions related to the quality measures or to which a certain number of quality measures are simply not applicable. For example, the proposal does not cover critical access hospitals (CAHs), though it contemplates the possible creation of three-year demonstration projects to test VBP models tailored toward CAHs and small hospitals that otherwise would not qualify to participate.

The Challenges of VBP

VBP presents a significant challenge to providers not only to achieve a high percentile ranking, but also to sustain that ranking. Small changes in a hospital's performance on some measures can have a disproportionately large negative impact on a facility's national ranking because performance variance in a number of core measures is relatively small-there are not large differences among facilities in acute myocardial infarction 30-day post-discharge mortality, for example.

Because of diminishing returns, maintaining a specific level of performance in these areas is more important than achieving incremental improvement. Nonetheless, hospitals should expect CMS will replace "topped-out" measures over time with new measures that better demonstrate variance among hospitals.

On the other hand, a facility can raise its percentile ranking significantly by improving its performance on measures for which there tends to be large variance among hospitals (e.g., pneumonia vaccination). There also can be a big difference between a hospital's performance on core measures performance and the hospital's HCAHPS scores. For this reason, to receive greatest incentive payment rewards, hospitals generally should focus not only on improving performance on high-variance core measures, but also on improving patient satisfaction to raise HCAHPS scores.

A facility's performance with respect to VBP also has implications for operating income, as a lower percentile ranking will reduce revenue despite expenses remaining the same. Because performance on core measures is not directly linked to cost of care, hospital financial managers should continue to look for ways to drive down cost and utilization to sustain the economic viability of their organizations. Both internal and external benchmarking will be required to verify positive business performance outcomes.

There are strategic approaches that can help both to reduce costs and to improve performance on VBP. Cost economies of scale achieved through mergers, consolidation, and integration can aid a hospital in affording and maintaining higher levels of specialized equipment, physicians, and staff. In addition, facilities with moderate utilization in an emerging service-line may do well to accelerate growth, or if the service line is declining, they might consider divesting, because lower scores in these areas will affect the national ranking under VBP.

Raising VBP Performance Depends on Reducing Process Variance

It is normal for a hospital to experience a level of variance in its clinical, operational, and financial performance over time. However, hospitals should strive to reduce such variance as much as possible in order to maintain a high level of performance under VBP, and the best way to do so is to reduce variance in care processes.

Process variance on a daily basis appears to indicate a wide disparity in outcomes and cost for any given hospital. For example, publicly available data on one hospital (referred to here as ABC Hospital) for FFY08 in the Medicare Provider Analysis and Review (MedPAR) database suggest that a patient hospitalized for a stroke has up to three times the risk of mortality based on day of discharge, as is depicted in the exhibit 2 . MedPAR data on the same hospital also suggest that average length of stay (LOS) can vary substantially based on day of admission and route of admission, whether direct or through the emergency department (ED), as is shown in the exhibit 3 .

View exhibit 2


View exhibit 3


Looking at such broad averages and using simple statistics to manage performance are the first steps in identifying opportunities to reduce process variance. But it should be kept in mind there are inherent limitations in such data. For example, these averages make no distinction between male and female patients, and they therefore overlook factors that can influence results based on differences in gender.

Sources of Process Variance

In general, process variance can occur at the departmental or enterprise level in a hospital or health system.

Reducing departmental process variance. Hospital leaders should encourage the use of techniques such as process mapping and Six-Sigma to improve the operations of key departments, such as the ED, admissions, and laboratory. These approaches can help a hospital reduce departmental inefficiency, labor redundancy, and errors. Projects in the ED, in particular, can have a strong positive effect on the overall profit and loss of the enterprise. For example, reducing the number of delayed admissions can improve the throughput for the entire facility.

Reducing enterprise process variance. Eliminating process variance throughout the enterprise is more difficult. The care pathways that specific patients embark upon when admitted intersect with numerous departmental processes, each with its own variance. Therefore, the overall LOS, profitability, efficiency, and outcome profile of a stroke admission retains substantial variance.

To illustrate the effects of enterprise process variance, exhibit 4 shows a report analyzing Medicare severity-adjusted diagnosis-related groups (MS-DRGs) for ABC Hospital based on MedPAR data and data from CMS's Healthcare Cost Report Information Systems (HCRIS) data files. The exhibit shows the calculated profit and loss per case by LOS for the composite MS-DRG 291/292/293, Congestive Heart Failure. These numbers demonstrate the somewhat obvious point that longer LOS equates to lower profit. However, the distribution of patients across this exhibit points out the first hint of enterprise process variance. Why is it that almost one half of patients in this MS-DRG stay longer than five days, and almost one in five stays longer than
10 days? Within the same DRG one would expect 1/20 (1 in 20) to stay longer than 10 days; less than 5 percent of cases are expected to be

View exhibit 4


Such differences are most likely due to enterprise process variance that results when multiple departments are allowed to retain idiosyncratic processes that cause bottlenecks and process interruptions.

Patient Satisfaction

Patient satisfaction is difficult to manage and is not significantly correlated with outcomes. A recent study that included 2,172 hospitals (those reporting HCAHPS scores historically) showed a low correlation (0.103) between core measures and HCAHPS scores. Hence, simply delivering high-quality care does not guarantee patient satisfaction. The prospect of payment based in part on HCAHPS scores will challenge hospitals to manage the patient experience more closely. To do so, hospitals will need to improve employees' orientation to patient service.

How could hospital managers respond? Hospital managers can manage the impact of VBP by seeking ways to improve the employees' experience at work-a goal that could be partially achieved by shoring up service lines by focusing on the creation of structured, repeatable processes. Indeed, the value proposition of a service-line strategy is just that: Well-developed service lines have specific, well-developed care delivery processes. Therefore, hospitals that focus on strengthening their service lines are likely to enjoy not only competitive advantage, but also improved employee morale and higher HCAHPS scores.

What Can Hospital Financial Leaders Do?

To reduce process variance, hospital senior financial leaders should use effective analytical tools and automation technology, promote the adoption of effective diagnostic technologies and modalities, and foster the education initiatives that will be required for success.

Tools and technology. Using calibrated analytical tools, such as dashboards and benchmarks that illuminate enterprise variance, hospital financial leaders can focus on problem areas where there is wide process variance and a clear affect on clinical outcomes. Clinical resource management tools are also useful for such an effort.

To determine the potential impact of VBP on their facilities, financial leaders also need to construct models, collect benchmarking data, and run simulations. First, financial leaders should conduct a sensitivity analysis to understand which areas will produce the greatest increase in revenue. Second, CFOs should understand how changes in the relative weights of different benchmark factors (e.g., weighting quality at 50 percent instead of 80 percent) will affect performance. Finally, managers should model quality performance with and without "topped out" measures. These efforts will facilitate the monitoring of progress.

Leveraging technology and infrastructure that automates processes pays dividends beyond the initial FTE-driven ROI. Automated processes, employing both medical and information technologies, include algorithms for patient treatment and highly structured care pathways. Effective management of information, both electric and paper, is as critical as workflow and workload management.

Diagnostic capabilities. Because of the payment adjustment for hospital-acquired conditions and the bias of pay-for-performance measures toward the initiation of the right care pathway at the beginning of stay, diagnostic modalities are more important than ever. Hospitals need to develop ways of applying breakthroughs in testing methods and emerging technologies, such as electronic health records, to improve their diagnostic proficiency.

Education. Effective changes in process cannot occur without deliberate, focused educational initiatives that promote the necessary changes in behavior that must accompany the process change. Hospitals with well-developed clinical, managerial, and technical education departments therefore enjoy a strategic advantage in the face of VBP. Simply put, education to modify behavior should be an ongoing part of the organization's culture. Whether or not hospital managers augment in-house capabilities with consultants, success depends upon reinforcement and repetition.

Time to Prepare

Because the VBP proposal will impose a national ranking basis for reimbursement, hospital senior financial leaders should pay attention not only to their organizations' internal performance metrics, but also to how that performance compares with that of other hospitals across the nation. There is still time to plan and implement some process refinements that will avert potential significant reimbursement losses in the near term.

Senior financial leaders also should renew a focus on learning and education of all staff. Because enterprise processes are implicated in reimbursement and cost, all major stakeholders should understand their roles. Focusing on education also can bring additional benefits: Employees tend to respond positively to a work environment that nurtures personal growth goals like learning. Supporting continuing education is, therefore, an important opportunity in preparing for healthcare reform. And the role of the CFO as educator has never been more crucial to the viability of the organization than it is under VBP.

Finally, it bears repeating that, for hospitals, VBP represents an important opportunity by strongly encouraging them to focus on their most essential mission-related goals-i.e., to deliver high-quality healthcare services to their communities and to work with dedication to continuously improve those services-and then rewarding them for excellence in achieving those goals.


a. The authors are aware that a forthcoming study will find little to no cost savings from episode-based payment schemes. In addition, episode-based payments force disharmony among providers who are tasked with coordinating care episodes.

b. See the Senate Finance Committee's Description of Policy Options Transforming the Healthcare System: Proposals to Improve Patient Care and Reduce Health Care Costs, April 29, 2009. The document is available at finance.senate.gov/sitepages/baucus.htm (scroll to April 28, 2009).

Hal Andrews is CEO of Data Advantage, Nashville, Tenn., and a member of HFMA's Tennessee Chapter (handrews@data-advantage.com).

Gunter Wessels, PhD, is a partner at Total Innovations Group, Inc., Tampa, Fla., and a member of HFMA's Arizona Chapter (gunter@figi.net).

Why Is Value-Based Purchasing Likely to Become a Reality?

There are a number of reasons that hospitals can expect value-based
purchasing (VBP) will make it into the signed reform legislation:

  • All of the committees in Congress that are drafting legislation have either included it or signaled an intent to include it as a cost savings measure.
  • VBP can generate significant cost savings, which are much needed to pay for reform.
  • It is not particularly controversial; the only significant objections come from hospital lobbies, which have not been able to produce a persuasive argument as to why hospitals should not be paid based on quality.
  • The infrastructure already exists, so VBP can be ramped up quickly.

Recent Successes in Reducing Enterprise Process Variance: Patient Safety and Adverse Events

Infection control and other "people processes" that involve behavior change by caregivers are being measured and reported publicly already; but now, under value-based purchasing, hospitals will be paid for that performance. These are enterprise processes, and have long been an area of focus for hospital managers.

The present-on-admission rule reduces Medicare reimbursement for a series of hospital-acquired conditions (HACs) that contribute to cost increases and poor outcomes. The threat of reduced reimbursement due to HACs has caused many facilities to make great strides in reducing infection rates-and to enjoy better reimbursement and cost savings as a result.

The same effort could be made to reduce process variance in other areas. Reducing infection rates is challenging because it involves behavior change at the enterprise level. In many instances, small but repetitive behaviors cause infection control problems. To address these problems, many hospitals have instituted admissions processes that leverage diagnostic technology to streamline care pathways. The resulting processes can help ensure patients do not develop complications, thereby improving core measures scores. For example, universal screening for Methicillin-resistant Staphylococcus aureus (MRSA) has a direct effect on infection rates and length of stay. And other diagnostic modalities will continue to aid hospitals as HAC requirements increase.


Publication Date: Saturday, August 01, 2009

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