Cost Reduction

Hospitals Are Using Cost Reduction to Trim Patient Charges

August 13, 2018 12:24 pm

Within a decade, average charge inflation for U.S. acute-care hospitals fell from 6-8 percent.

I was talking with a group of hospital administrators recently, and we were discussing levels of price and cost inflation in the industry. I remarked that when I started in the industry more than 15 years ago, it was common to see price inflation exceeding 10 percent per year. It’s almost difficult to imagine or remember those times now with significantly lower rates of gross charge inflation.

That discussion prompted a question from the group about how cost changes have influenced or aided the reduction in gross price inflation. The thought was that perhaps a portion of the lower gross charge inflation rates in the industry today could be attributed to the efforts hospitals have made at containing cost growth. As a result of lower utilization of services per patient encounter, overall charge growth could be reduced. This speculation should be explored further.

A Construct to Measure Inflation

Although there are multiple ways to evaluate cost and charge inflation, we decided to consider the average cost and charge for the “products” that acute-care hospitals provide: patient encounters. To measure, we used Medicare claims data and reviewed average claim charges in 2005-06, as well as, 2015-16. Costs were estimated by using department-specific ratios of cost-to-charge (RCC) found on filed Medicare Cost Reports applied to corresponding charge areas on the claims. Finally, these average charges and costs per encounter were adjusted for cost of living using the wage index value and then adjusted for case intensity using case mix index for inpatient and APC weight for outpatient.

The benefit of using this approach is the ability to review inpatient and outpatient areas uniquely and separately for levels of charge and cost inflation. A potential drawback is the exclusion of non-reimbursable expenses from Medicare RCCs and the use of Medicare-only claims. However, these drawbacks are overcome by giving a more consistent reporting of costs as well as a large sample to provide statistical support for conclusions.

Cost Inflation Has Decreased Significantly

What we found was striking. In 2006, the average charge inflation for U.S. acute-care hospitals was just over 9 percent for an inpatient discharge and nearly 12 percent for an outpatient encounter. Fast forward a decade and those figures drop to under 3 percent for inpatient and 4 percent for outpatient. While some of the reduction in charge inflation is undoubtedly the result of lower values for rate-limit language in managed care contracts, we believe that the calls for greater price transparency have also contributed to hospitals making strategic decisions to lower prices and/or the rates of increase.

Interestingly, though, is the corresponding decrease in the levels of cost inflation. The costs associated with producing an inpatient encounter remained flat between 2015 and 2016, where 10 years ago, the increase was nearly 5 percent. Furthermore, outpatient inflation has almost been cut in half during that period—from 5.7 percent to just under 3 percent in the 2016 data.

Hospital Charge and Cost Inflation

Cost Reduction Is Driving Charge Change

However, we wondered if the hospitals that were reducing their charges were also the same ones that were reducing their costs. To evaluate this, we divided the country into quartiles for charge growth over a two-year period from 2014 to 2016. We used a two-year period for this exercise as opposed to the 2015-16 approach to minimize the potential for one-year performance outliers impacting results within the quartiles. This was less of an issue for an overall national charge and cost inflation value. We used the Medicare charge per discharge and Medicare charge per visit metrics, as described earlier, as the basis for our analysis. Several key points emerged:

Significant charge growth disparity exists. The lowest charge-growth hospitals were able to decrease inpatient and outpatient charges year-over-year for two years. This is quite remarkable, given our industry’s historical increase in charges year after year. The fact that 25 percent of U.S. hospitals have reduced charges each year for two consecutive years is a point that could signal a dramatic shift in thinking for many administrators.

While the reduction was more significant for inpatient services, there still was a slight annual decrease for outpatient services as well. Contrast that with the highest charge-growth hospitals that appear to have implemented rate increases that were closer to the industry average 10 years ago. However, at that time, there seemed to me more compression around the mean. Now, we see wide disparity in charge inflation levels.

Linear relationships in charge changes exist for cost changes as well. As median values for charge growth increase for each group, so too do the values for median annual cost growth for both inpatient and outpatient services. This underscores the importance of cost management in controlling charge growth and addresses the central question of whether gross charge inflation rates can be attributed to hospital cost-containment efforts. From the progressions we see in our research, we can tell that charges and costs are absolutely tied together. This point is so evident that it can become a strategy for every revenue cycle administrator in the country.

Chargemaster price reductions are less likely the method to lower charges. For the lowest charge-growth hospitals, it appears that almost all of the percentage change in charge is due to the percentage change in cost. The lowest charge-growth group decreased charges by -3 percent annually and decreased costs by -2.2 percent annually. For outpatient, the group’s cost reduction of -0.7 percent actually surpassed the annual charge reduction of -0.3 percent. This provides significant encouragement for hospitals that would like to reduce charges but find it difficult to do so through chargemaster pricing reductions because of the significant net revenue implications. Interestingly, it appears that the highest charge-growth hospitals are employing higher chargemaster pricing changes, as the changes in charge far surpass the change in cost.

Charge and Cost Growth by Charge Group Quartile

Cost Reductions Are Broad-Based

The final point we were interested in understanding was how these low charge-inflation hospitals were reducing costs to achieve reductions in charges. Are they reducing length-of-stay, decreasing cost per unit, or containing utilization of services? Are there certain areas that seem to be more of a focus for cost reduction than others? We looked at individual patient encounters for the two-year period between 2014 and 2016 and compared the lowest charge growth group to the national average to see where the reductions in cost were greater than what the national average showed.

What we found was that for nearly every MS-DRG, the lowest charge-growth group showed 2016 cost values approximate to or below the 2014 values. Therefore, the reductions appeared to be across all types of patient encounters. In addition, there were a number of areas that seemed to be reduced. There wasn’t, however, a strong connection with length-of-stay reductions. The lowest charge-growth group reduced length of stay from 4.66 days to 4.40 days from 2014 to 2016 which was similar to the national average change from 4.56 days to 4.44 days over the same period.

To illustrate the types of reductions seen, we’ve shown the cost reduction for the highest Medicare volume MS-DRG: 871 – Septicemia or Severe Sepsis Without Mv > 96 Hours with MCC. The cost reduction, in total, for the lowest charge-growth group amount to approximately $1,000 per case over the two-year period (see the exhibit on page 7). The national average, by contrast, remained relatively flat, with a growth in cost of about $150 per case. One interesting note is that these lowest charge-growth hospitals had a cost position in 2014 that was significantly higher than the national average, but is now slightly lower for this MS-DRG.

MS-DRG 871 Example of Cost Reduction


So, it isn’t as if these hospitals have been strong cost performers: They have simply been successful at taking costs out of areas that showed opportunity.

One final note: While many areas were stable or decreased in cost, drugs and supplies appeared to decrease more than most. This certainly ties to the issue of underlying cost as these areas are typically priced off a markup policy that for many is tied to underlying cost. So, a reduction in cost for items would have a direct impact on reduction in charges.

Cost Reduction as Means to Reduce Charges

The data shows that our industry has undergone a major decrease in average annual charge growth. While there appears to be sizable disparity around that average, it’s clear that hospitals at the lowest end of the charge-growth spectrum are using cost reduction to slow the level of charge change.

As our industry continues to move toward greater transparency and sensitivity around pricing, this finding should be of great encouragement to administrators: There is a powerful tool in cost reduction that many hospitals are already taking advantage of. The future of pricing changes could very well be in cost. Over the next 10 years, it will be interesting to see just how true that becomes.

Jamie Cleverley is president, Cleverley & Associates, and a member of HFMA’s Central Ohio Chapter.


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