Chad Mulvany

Over the past 18 months, as the recession has weighed on the economy and credit markets, American businesses, investors, and consumers have reduced their appetite for risk. Hospitals have rightly joined the pack, reducing exposure to financing risk and decreasing capital expenditures. However, payment reform will force providers to again embrace a type of operational risk that many have avoided since their experience with capitation in the 1990s.

Those experiences of the 1990s are well documented. Many healthcare providers engaged in capitated contracts and acquired physician practices as well as other hospitals to expand their catchment area. However, for most providers, the amount of revenue at risk through these contracts wasn't sufficient to drive the necessary cost reductions and implement systems to adequately manage population health. When providers realized they were losing money on their capitated contracts, they quickly exited them for the safety of traditional fee-for-service payment or used market clout to renegotiate contracts based on other methods, such as per diems.

However, this time may be different for two reasons. First, several of the payment reforms currently under consideration for Medicare and Medicaid shift risk from payers to providers, as shown in Exhibit 1. And exponential cost growth has caused insurance companies-at the behest of employers-to contemplate the same strategies as Congress is for Medicare. Adoption of these reforms by both the public and private sector will put a significant amount of revenue at risk, giving providers an incentive to adopt systems necessary to manage costs and outcomes.

Exhibit 1


Second, although the reform mechanisms considered do transfer risk to providers, the type and amount shifted is far more manageable than what providers bore under capitated contracts.Payers are experimenting with a broad array of payment methodologies that transfer some risk. For providers to succeed in this evolving environment, they need to understand the various types of risk inherent in proposed reforms and understand how to manage them.

Seeds of Change Are Being Sown

Although payment reforms requiring providers to bear risk may seem at this point to be purely academic exercises, the reality is that all of them are either in market or being tested via a demonstration project. Exhibit 2 provides examples of four prominent reform initiatives and how they are being implemented today by both Medicare and commercial payers.

Exhibit 2


To successfully address the risks transferred to hospitals by payment reform, providers need to disaggregate those risks into their individual components and identify ways to mitigate them.

Types of Risk

Under a reformed payment system, hospitals will encounter the three types of risk: quality risk, efficiency risk, and population health risk.

Quality risk. This type of risk is the probability that errors, poor care processes, or poor outcomes will negatively impact the amount providers receive for a service rendered. As more payers publish quality metrics and attempt to steer patients to high-scoring providers, quality risk will affect not only payment at the case level, but also overall patient volumes. Lower performing hospitals face the prospect of seeing their financial performance decline exponentially as they begin to see fewer patients while also receiving less per case. 

Reimbursement mechanisms that expose hospitals to limited quality risk are already in market for both Medicare and commercial payers. And quality risk is only going to increase for hospitals. Existing pay-for-performance programs are expected to evolve from reporting process-based measures of care to evaluating clinical outcomes. The first stage in this evolution occurred over the summer as the U.S. Department of Health and Human Services (HHS) started making mortality and readmission rates public for Medicare patients at its web site. With this move, HHS laid the groundwork for the implementation of value-based purchasing, which is prominently featured in early drafts of both the House and Senate healthcare reform bills.

Efficiency risk. Efficiency risk is based on how cost-effectively a hospital can provide high-quality care. Providers bear efficiency risk when they receive a fixed payment for a given unit of service or time (e.g., diagnosis-related group or per diem payments). Hospitals are more comfortable with this type of risk than with the other two types because they have dealt with it for the longest time.

In a reformed payment system, providers will encounter greater efficiency risk as payment methodologies move to bundled payments spanning longer time frames or to accountable care organizations (ACOs) that emphasize strict cost controls in conjunction with high-quality care.

Population health risk. Also known as insurance risk, this type of risk is encountered when providers accept a fixed per capita payment in exchange for providing care to a defined population of patients for a set period of time. It is the most challenging type of risk for providers to address. It requires tight cost controls, collaboration across provider types, and the ability to accurately estimate the incidence and severity of illness within a population in order to negotiate pricing. Although providers have had varying degrees of success in dealing with the first two risk types, few have shown that they can manage population health risk.

Capitated service arrangements are the most common examples of population health risk. However, reform mechanisms such as payment bundling and nonpayment for avoidable readmissions will transfer elements of this risk to hospitals.

Preparing for Payment Reforms

Experience with capitated contracts in the 1990s shows that providers must have strong risk management capabilities to succeed in a reformed payment system. Health systems that profited from capitated contracts had several factors in common: They developed accurate microcosting data, made extensive use of standard clinical care processes, and empowered staff to make decisions based on data. The combination of the three factors allowed successful hospitals to accurately price and manage the risk they accepted. 

Developing accurate micro-costing data. Having access to such data allows providers to cost each subcomponent that constitutes an episode of care, which is essential not only for negotiating sustainable payment rates, but also for controlling costs. Establishing credible cost benchmarks lays the groundwork for continuous quality improvement, identifies costly variations in clinical care protocols, and helps facilitate discussions with physicians about high-cost preference items.

Standardizing clinical care processes. This factor can be brought into play by leveraging disease registries and encouraging physician peer review to promote a culture focused on reducing costly clinical variation and improving quality. Dedicated clinical care coordinators armed with utilization management tools also can reduce readmissions and improve outcomes by ensuring that patients adhere to their treatment regimes and receive the right care at the appropriate time.

Empowering staff. An empowered staff is necessary to realize the benefits of accurate cost data and standardized care processes. If caregivers (including physicians) are to use the data provided to them to eliminate wasteful variations in clinical care processes, they will need some basic training to understand hospital finances and the impacts of their everyday decisions on profitability. Hospital leaders will also need to create an environment in which people feel comfortable using the tools and data. They can do so by demonstrating the desired behaviors in their daily actions, providing incentives to staff at all levels of the organization, and holding staff accountable for results.

Not If, but or When
Whether Congress will enact sweeping payment reform this year is anyone's guess. One thing is certain, however. Healthcare cost inflation at the rates seen recently is unsustainable. It will bankrupt the Medicare Trust Fund by 2017 and force many small to midsized businesses to drop coverage for their employees. Many of the reforms that will eventually be enacted to slow cost growth are certain to transfer some degree of risk to providers. And building the infrastructure to manage these types of risk is not an overnight process. As is suggested in HFMA's recent payment reform whitepaper, Healthcare Payment Reform: A Call to Action, providers need to start building these capabilities now.

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

Publication Date: Sunday, November 01, 2009

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