Providers should restructure pricing schedules to bring charges into better alignment with the actual cost of services, developing a long-term pricing model that is attractive to both patients and employers
In its 2014 report Price Transparency in Health Care, the HFMA Price Transparency Task Force set out to determine the industry’s consensus on the distinctions among charge, cost, and price, and to recommend a way forward in building “price transparency frameworks for different groups of care purchasers.” a These groups include patients, providers, employers, and referring clinicians. The growing disparity between hospital charges and what patients end up paying is eroding consumer confidence while at the same time challenging finance leaders to cope.
In recent years, and especially since the report’s release, many hospitals have expressed a desire to dramatically reduce their charges—some by as much as 70 to 80 percent. Some have an interest in reducing charges for targeted patient services (e.g., outpatient imaging, surgery, and therapy), while others are attracted by the idea of lowering charges across the entire hospital. Although many hospital finance leaders would like to be able to implement such a policy, they have a fiduciary responsibility to ensure it would not negatively affect net patient revenue.
There are, of course, many good reasons for hospitals to want to lower charges. Hospitals now realize that a dramatic reduction in charges may be necessary to remain competitive, especially with respect to freestanding outpatient services. Hospitals also have been accused of being complicit in driving up the cost of health care by setting unreasonably high charges.
Further, in its recently issued 2019 final rule for the inpatient prospective payment system (PPS) the Centers for Medicare & Medicaid Services (CMS) discusses its continuing effort to improve the transparency of hospital charges. CMS requires, effective Jan. 1, 2019, that hospitals make available a list of their current standard charge via the internet in a machine-readable format. Although the final rule leaves unanswered many questions and is not necessarily directly affected by a hospital’s overall charge level, CMS’s increasing focus on hospital charges underscores the need for hospitals to look for ways to reduce their patient charges.
Anyone who works in the healthcare industry knows this is a complicated issue with many contributing factors. However, a hospital that voluntarily reduces its charges dramatically would be considered to be part of the solution rather than part of the problem.
Historical Perspective: Factors Driving the Need for Change
Hospital charges and the hospital charge description master (CDM), along with their roles in healthcare financing, have evolved significantly over the past several decades.
In the pre-Medicare era, insurance and patient payments for healthcare services were based primarily on charges. During that time, most physician and other outpatient services were a fee-for-service cash business. Insurance coverage focused primarily on inpatient care and catastrophic coverage, with payment rates also based primarily on charges.
Upon the inception of Medicare, hospital payment for the 65+ age cohort involved interim Medicare payments based on a percentage of charges, but with a year-end settlement based on reimbursable costs determined by the Medicare Cost Report. Charges were used in the Medicare Cost Report as a component of cost-to-charge ratios to determine total reimbursable costs and ultimately Medicare’s share of those reimbursable costs.
After the 1983 implementation of the Medicare PPS, fixed DRG inpatient payments initially—and, later, fixed outpatient PPS payment rates—became the dominant payment mechanisms, and the gradual movement away from cost-based payment was initiated. However, charges continue to be used in developing cost-to-charge ratios and remain a significant factor in determining inpatient DRG outlier payments.
In theory, when Medicare payment was cost-based, hospitals generally received the full cost of delivering patient care. Although Medicare PPS payment rates initially were determined based on those full costs, over the three decades since, the inflation update factors have not kept pace with medical cost inflation.
Medicare high utilization rates—along with cost increases due to the proliferation of expensive technology, information systems, and clinician shortages—have long produced Medicare budget constraints that have continually required adjustments. As a result, limiting hospital and physician Medicare payment rates has been the political fix of choice.
The Medicare Payment Advisory Committee (MedPAC) recently reported that, in 2015, hospitals nationally incurred Medicare margins averaging –7.1 percent. b MedPAC also estimated 2015 combined losses from Medicare and Medicaid payers to be almost $58 billion.
Conversely, MedPAC reported that 2015 total hospital all-payer margins averaged 6.8 percent, the highest in 30 years. This level means the commercial sector was contributing about 14 percentage points to hospital margins in 2015 through payment rates that significantly exceeded governmental rates.
The Medicare PPS also has had a major impact in influencing Medicaid plans and commercial payers to adopt similar fixed payment methodologies. Large commercial payers and managed care plans now almost exclusively use DRG, per diem, outpatient fixed payment, or capitation payment methodologies (although many of these agreements continue to include outlier or stop-loss provisions as well as provisions regarding the lesser of charge or agreed-upon fixed payment). Consequently, the use of charges or a percentage-of-charges as a basis for setting payment amounts has been left to patients who are uninsured, out of network, or enrolled in small payer plans.
A study published in the April 2017 issue of Health Affairs examines both California and national hospital charges from 2002 through 2014 and concludes that “high list prices causally increased payments from the uninsured.” c This scenario continues to be problematic and may be a greater issue going forward if the ranks of the uninsured begin to rise again. It also has influenced state legislation, such as the California Hospital Fair Pricing Act and rate regulation in both Maryland and West Virginia.
TheHealth Affairs study also concludes that “list prices varied predominantly across hospitals and within markets, were well predicted by observable hospital characteristics, and were positively related to prices actually paid by patients and their insurers.” It appears, therefore, that although most commercial payers now use fixed payment methods, the negotiated rates have been influenced by the hospitals’ charges.
In theory, hospitals and insurers also may have employed unique price negotiation strategies that, over time, have resulted in wide variations in charges and fixed negotiated rates for specific services. One consistent trend, however, has been hospitals’ reliance on revenue from ancillary services—particularly outpatient services, which tend to have a more favorable payer mix. This trend has led the insurer Anthem to institute a policy, over hospitals’ objections, that precludes coverage for most advanced imaging performed in hospitals on an outpatient basis. d
These pricing strategies were acceptable in an era of low-deductible/coinsurance health plans, when patients were shielded from high out-of-pocket payments. However, with the advent of much higher deductible and maximum out-of-pocket plans, hospitals and insurers that lack a strategy to redesign their pricing structures now run the risk of losing considerable market share. In effect, with the high deductible/co-insurance plans currently offered, outpatient services are now to a large extent uninsured and sensitive to price.
Hospitals and insurers have worked within a fee-for-service “system” that really hasn’t changed much in more than 30 years. Given the new realities of the healthcare insurance market, they both should have a mutual incentive to find common ground and develop the next generation pricing methodology.
Kevin Brennan, the current Chair of HFMA’s Board of Directors, has characterized this matter as “one of the most intractable issues facing healthcare financial leaders today.” Brennan also notes that redesigning the pricing model will not be easy, but it can be accomplished. “I think it is doable if we can identify and reduce the cross subsidies within the current system,” Brennan says. “The key will be to identify those services that have been historically underpriced and are currently being subsidized by other profitable services. To eliminate the cross subsidies in the system, the market will need to acknowledge that pricing will need to increase for those types of services.”
The hope is that a new methodology could be developed that would provide the runway to a “soft landing” for the existing players in the healthcare market. Otherwise, market disruptors will have ample opportunity to take advantage of an outdated healthcare fee-for-service system.
Reducing Charges in a Financially Responsible Way
Such a strategy can be successfully implemented, but it requires the support of the highest levels of the hospital—that is, from senior management and the board of trustees—and their counterparts at the insurance companies, as well as coordination with governmental payers.
The next generation charge/pricing redesign process should present a value proposition to both hospitals and insurers that includes the following:
- A long-term pricing model that is attractive to both patients and employers
- Reduced hospital reliance on ancillary service and procedural profit margins
- Affordable outpatient services for patients
- Better alignment between prices and the cost of services
If properly designed and implemented, the new pricing approach would reduce future bad debts and provide better balance and diversification in service line margins. Preliminarily, this process should include the following steps.
Conduct an inventory of insurance plan codes. Each insurance plan code should be reviewed to identify those patient classifications and insurance contracts for which payments are affected by charges. Some will be straightforward (e.g., percentage of charge contracts), but others will be more complicated (e.g., outlier payments, stop-loss payments, and lesser of payment or charge provisions).
Build a database of historical patient utilization. This database—consisting of CDM line-item historical utilization and detail on inpatient and outpatient claim-level historical utilization—can be used to model potential changes. Although using historical utilization is probably the best way to estimate the potential future impact of changes in charges, it is important to remember that this is an estimate and that future patient utilization will not mirror historical utilization.
Review current relationships between charges and associated standard costs. This review should encompass both inpatient and outpatient services based on the rollup of charges by service type.
Model potential changes in payments. Potential payment changes should be modeled through a series of “what-if” analyses that consider, for example, the estimated impact on payments from each payer if the hospital were to reduce its charges by X percent or Y percent. The purpose of such modeling is to enable the hospital to focus its efforts and continually assess the feasibility of its strategy.
Prioritize and approach payers. Senior management should initially approach payers, as well as board of trustee members, to obtain buy-in on the strategy, both in concept and regarding its potential value for all stakeholders (the insurer, the hospital, the public) were it to be pursued cooperatively.
Continue to conduct negotiations and perform modeling. These actions should be ongoing, to track and assess the estimated impact of various negotiating proposals.
Monitor actual payments. After the contract with revised payment mechanisms is implemented, actual impact of the revised payment mechanism should be monitored, including the comparison of actual payments to anticipated payments using actual patient utilization.
Negotiate a potential year-end settlement. Because transitioning from a payment methodology that is affected by charges to a fully fixed-payment mechanism poses inherent challenges, assumptions about factors such as volume and intensity will be required. Therefore, negotiating a year-end settlement during the initial period(s) of the contract may be advisable to ensure that neither party is unintentionally hurt or advantaged.
Implementation of a next-generation pricing strategy should parallel an information systems installation. It should be designed and piloted in a test environment, running parallel with the existing system for a certain period.
A Practical Methodology-Related Matter
In addition to the forgoing points, a crucial issue remains as to how a hospital can identify the actual revised CDM charges. A hospital’s approach to revising charges in its CDM with the goal of drastically reducing them depends, to a large extent, on the methodology the hospital had used to identify its current CDM charges. If a hospital’s existing CDM charge methodology is thoughtful and meets some of the value proposition described here, then it is reasonable to expect that the hospital will be able to dramatically reduce its overall charge level by implementing an across-the-board percentage reduction.
Generally, a CDM charge methodology can be defined as meeting the value proposition when it is structured with a systematic methodology that identifies each individual CDM line item based on a formula that considers a series of supportable benchmarks, including cost, market, and payment schedules. However, because these benchmarks tend to be inaccurate and are subject to significant variations, it is best for a hospital to use multiple benchmark sources as a means to “smooth over” individual benchmark anomalies.
If a hospital has established this type of charge methodology throughout its CDM, then it reasonable to expect that it could reduce its current CDM charges by an identified percentage applied across the board without disrupting the logic of the current methodology. However, if the hospital has not yet implemented a CDM charge methodology that meets this value proposition, now would be an opportune time to do so.
Many hospitals started to use more value-based methodologies for identifying CDM line item charges in response to heightened scrutiny on hospital CDM charges, which began to rise in the past decade. Previously, most hospitals would have not been able to articulate their CDM charge methodology, and they likely would have focused more on the anticipated impact each CDM line item charge change would have on the realization of net patient revenue. Although this approach made practical financial sense, it created CDM line item charges that had little or no relationship to the cost of delivering the service.
In short, the test of whether a hospital can reasonably make a simple across-the-board reduction to dramatically reduce its overall charge level is whether, for each charge identified under its current methodology, the hospital always will have a ready and simple answer to the question, “How was this specific CDM line item charge identified?” If the answers to this question are not so simple, a hospital has yet to develop a rational and defensible CDM charge methodology, and it should undertake a process to do so.
A Prospect for Forward-Thinking Leaders
The most challenging aspect of this strategy will be convincing all parties to cooperate. To ease the transition for all parties, each side should focus on “win-win” methodologies that clearly benefit all stakeholders, including healthcare providers, insurers, and their respective patients/members.
We acknowledge that provider-insurer negotiations have not historically been handled in this way. However, with the advent of new low-cost health plans and recent relaxed rules regarding association health plans, the benefits that would accrue to all participants are too critical to ignore. Hospital leaders who are willing to tackle this problem stand to be perceived as forward thinking.
Moreover, if properly implemented, a redesigned CDM and related pricing methodology likely would provide a long-term strategic benefit rather than reduced revenue to those participating. What other business strategy in today’s health care market can result in win-win benefits to all?
a. HFMA Health Transparency Task Force, Price Transparency in Health Care , 2014.
b. Dickson, V., “ Slumping Medicare Margins Put Hospitals on Precarious Cliff,” Modern Healthcare, Nov. 25, 2017.
c. Batty, M., and Ippolito, B., “Mystery of the Chargemaster: Examining the Role of Hospital List Prices in What Patients Actually Pay,” Health Affairs, April 2017.
d. Bannow, T., “ Hospitals Cry Foul and Sue Anthem over New Policies,”Modern Healthcare, April 21, 2018.