In the healthcare reform debate, coverage expansion-particularly the concept of a public sponsored plan-grabs most of the headlines. However, coverage expansion in any form is not sustainable without controlling costs.

As the country's largest healthcare budget line item, hospitals can expect Congress to look for considerable savings opportunities within the industry. Instead of advocating across-the-board rate cuts that negatively impact all providers, both Congress and the Medicare Payment Advisory Commission (MedPAC) have expressed interest in approaches that reward facilities providing high-quality, low-cost care while penalizing those that don't.

This overall approach to payment reform presents a unique opportunity for hospitals. Those that can increase the value of the care they provide by simultaneously reducing cost and improving quality stand to improve both market share and margin from what they could have received under the current "system." Providers looking to improve their "value" proposition need first to understand each of the payment reform approaches and then begin making selected improvements in both physician relationships and cost structure.

Payment Reform Approaches

Three reforms-reducing readmission rates, bundling payment for episodes of care, and establishing accountable care organizations (ACOs)-have attracted considerable attention from MedPAC, the president, and Congress. Although the details of how each will work are far from finalized, an April 28, 2009, description of policy options issued by the Senate Finance Committee offers the most concrete discussion to date of how these reforms might work if enacted into law.a

Readmission rates. A recent report in the New England Journal of Medicine estimates that 20 percent of Medicare patients were rehospitalized within 30 days of discharge costing the program $17.4 billion annually.b Although lack of physician follow-up was noted in 50 percent of readmitted cases, it appears that the financial burden for reducing unnecessary readmissions will fall squarely on hospitals.

In its June 2008 report, MedPAC recommended that hospitals and physicians confidentially receive readmission data for a period of two years.c After this "coordination improvement" period, the data would then be made public. In conjunction with this time line, MedPAC also recommends reducing payments to hospitals with relatively high 30-day readmission rates for select conditions.

The Senate Finance Committee's approach is similar. The April policy options paper proposes to reduce payments to hospitals with high readmission rates within 30 days of discharge, starting in federal fiscal year (FFY) 2013. The plan calls for a 20 percent withhold on selected Medicare severity-adjusted diagnosis-related group (MS-DRGs) for facilities with readmission rates above the 75th percentile based on prior years data. Despite the short implementation time line, few best practices have been documented in the area of reducing readmissions.

In April, CMS launched its Care Transitions Pilot in 14 communities across the country.d The goal is to identify ways to improve coordination across the care continuum, promoting well-executed discharges from the hospital to home or a non-acute level of care. What's interesting about this pilot is that although it involves hospitals, the Centers for Medicare & Medicaid Services (CMS) is exploring community-level approaches for preventing readmissions.

Payment bundling. The Senate Finance Committee's policy options paper also outlines a method to bundle payments for Medicare Part A and B services into a global payment for 30-day episodes of care to control cost, which would also assist in reducing readmissions. The payment amount would be calculated as the MS-DRGs amount plus average historical cost of postacute care for patients in that MS-DRG. This new "base rate" would then be adjusted downward for anticipated efficiencies that result for greater coordination of care.

If passed into law as set forth in the paper, bundling would begin for the MS-DRGs accounting for 20 percent of Medicare spending in FFY16, with the next 30 percent going online in FFY17 and the final 50 percent in FFY18. This measure, combined with reducing readmissions, is projected to save $26 billion over the next 10 years. To date, few providers, outside of those with managed care global capitation contracts, have experience coordinating care and managing population health on this scale. However, CMS is working to remedy this deficiency with a demonstration project.

CMS's Acute Care Episode Demonstration project went live at one of the five selected hospitals in May. Although it does not use a full 30-day episode of care, the project is exploring the challenges of a global payment for all services related to a hospitalization for certain cardiovascular and orthopedic DRGs.

The demonstration involves a hospital and at least one physician group. Participating facilities analyzed historical data to submit global bids discounted off of the combined inpatient and physician fee schedule for each MS-DRG. At a meeting of MedPAC on April 9, it was disclosed that the five selected hospitals offered discounts ranging from 1 percent to 6 percent. Considerable cost savings is expected as coordination improves and physicians implement best practices clinical pathways to reduce variation of care.

To entice physicians to improve coordination of care and reduce practice variation, Stark laws and other regulatory impediments to gainsharing have been relaxed. Participating hospitals can use limited gainsharing (up to 25 percent of the fee-for-service payment) to reward clinicians who measurably improve the quality or efficiency of care.

ACOs. Although the cost savings potential of ACOs has not been estimated, both MedPAC and Congress believe there is ample opportunity. As outlined in the policy options paper, ACOs-if passed-would start in 2012. Under this model, CMS would allow groups of providers that meet quality standards to share in any cost savings they generate for the program

Neither MedPAC nor the policy options paper has clearly defined the model, but it will likely involve a combination of a hospital or hospitals, primary care physicians, and possibly, specialists. In the policy options paper, to qualify, organizations would need to agree to the following:

  • Participate for at least two years
  • Develop a formal legal structure to receive and distribute incentive payments
  • Include primary care providers serving at least 5,000 beneficiaries
  • Provide CMS with a list of primary care and specialist physicians participating
  • Have contracts in place with a core group of specialists
  • Develop a management structure that allows for joint decision making
  • Establish processes to promote evidenced-based medicine, report on quality and cost measures, and coordinate care

During questioning at a recent MedPAC meeting, it was suggested that it would be beneficial for an ACO to comprise multiple hospitals where possible. Physicians, who would have incentives to improve quality and reduce overall cost, would steer their patients to facilities that provide the highest-value services. In this model, hospitals viewed as "high-value" providers would operate at capacity. Those perceived as not providing high value would ultimately struggle financially due to underutilization.

Steps You Can Take Immediately

Hospitals should prepare for these changes now by improving relationships with physicians, reducing cost, and analyzing readmission rates.

Physician relationships. Facilities can improve relationships with physicians and engage them in quality-control efforts in two ways. First, until regulations are relaxed permitting true gainsharing, facilities should pursue modified agreements. A few facilities-St. Joseph Mercy Health System in Michigan being one example-have programs that reinvest a percentage of cost savings achieved with physician assistance into equipment and education for the service area.

Second, hospital administration needs to involve more physicians in decisions made by finance and management committees. This brings a broader perspective into decisions and builds the trust required for greater collaboration in the future.

Cost reduction. Although probably every facility has embarked on a major cost-cutting effort recently, hospitals need to take a more sustained approach. First, hospitals need to provide their clinical staffs with some basic financial education so they can participate in these sustained efforts. Adventist HealthCare in Maryland, for example, has developed an interactive workshop that has achieved this goal.e Once clinicians and physicians are educated and on board, hospitals should explore implementing six-sigma methodology to reduce unnecessary variation in supply usage and staff scheduling.

Readmission rates. Within their facilities, providers should analyze their unplanned readmission rates. Although this effort will not account for all readmissions, it will begin to frame the problem. Using this information, hospitals can perform a root-cause analysis and identify where care coordination breaks down. This information can be used to facilitate process improvement conversations with referring physicians and primary care providers.

Hesitation Is Not an Option

The final incarnation of the reforms discussed above is far from certain, but it is safe to assume that they, or something that achieves a similar goal, will be passed into law. Given that each proposal will require providers to radically restructure the way they interact with other providers and control costs, facilities will be best served by preparing now. Those that wait risk their facility's financial health through reduced payments and lower volumes.


Chad Mulvany is a technical manager in HFMA's Washington, D.C., office, and a member of HFMA's Virginia Chapter.



a. Senate Finance Committee, Transforming the Health Care Delivery System: Proposals to Improve Patient Care and Reduce Health Care Costs, April 28, 2009 (
b. Jencks, S.F., Williams, M.V., and Coleman, E.A., "Rehospitalizations Among Patients in the Medicare Fee-for-Service Program," NEJM, April 2, 2009.
c. MedPAC, Report to Congress: Reforming the Delivery System, June 2008.
d. Read a press release on the pilot program.
e. Uhles, N., Weimer-Elder, B., and Lee, J.G., "Simulation Game Provides Financial Management Training," hfm, January 2009.

Publication Date: Wednesday, July 01, 2009

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