Lately it seems as though a day doesn't go by that we don't hear about a new federal investigation, settlement or conviction stemming from inappropriate hospital billing practices.
It is no wonder then that many state governments have introduced new initiatives and Web sites directed at making hospital prices transparent to consumers.
This month when the House of Representatives reconvenes, one of the major pieces of legislation expected to pass is a bill requiring states to adopt price disclosure rules. Such disclosures could likely include the requirement for hospitals to provide patients with estimates prior to or at the point of service, and to publish chargemaster prices and/or the average rates billed for certain elective medical or surgical procedures.
Moreover, the bill, which was introduced last year, has the backing of the American Hospital Association. And this follows the executive order signed by President Bush last August, requiring four federal agencies to compile and publish information that will make quality and pricing information more readily available to the public.
How Did Prices Become So Irrational?
In the seventies and early eighties, most hospital financial managers were content with their hospitals being reimbursed for the actual cost of treating Medicare and Medicaid patients as determined by a Medicare cost filing. This was no problem, because a large proportion of their patient population was made up of indemnity or commercial payors.
With spiraling healthcare costs resulting from advances in medical technology and high rates of inflation, cost reimbursement by the Medicare & Medicaid program was actually a blessing in disguise. For the non-federal population, prices reflected in chargemasters were the prices that were actually paid. Since those prices were based on cost-plus – a provision taking into account overhead and a reasonable profit margin, combined with cost reimbursement from federal payors – hospitals, in most instances, were made financially whole.
But times quickly changed. Just as hospital financial managers were unable to predict the effects of new technology, medical advances and inflation, the government found it difficult to balance the Social Security fund from which Medicare payments were drawn. So, the federal government trashed the cost reimbursement system.
The solution? The government implemented the DRG system for inpatients and, eventually, the APC system for outpatients. These systems provided the federal government with an opportunity to more accurately predict its own expenses for healthcare by paying hospitals on prospectively set rates.
The financial risk was now fully placed on the hospital to survive within those rates. Many financial managers would agree that those rates, when initially established, seemed fair and reasonable. As the years passed, however, adjustments for inflation, new technology and advances in medical care did not keep pace with their actual experience.
Further stressors on the healthcare system came with the advent of managed care and payors being able to successfully negotiate their own prospectively set rates. This practice that began during the mid to late 80’S and continues through this day placed further financial burden on hospitals.
Enter the concept of cross-subsidization. Although certainly not unique to hospitals, cross-subsidization strategies are used today in many kinds of businesses in determining the retail price for their products or services. Businesses, for example, may offer certain loss leaders and to keep their business financially whole, they will subsidize those losses by establishing higher prices on other products or services. Furthermore, most businesses make up (or cross subsidize) the losses for customers who don't pay by increasing their prices high enough to cover the resultant bad debt expense.
As some hospitals began to experience less-than-cost reimbursement as a result of inadequately established prospective payment rates by the federal government and managed care organizations, they, like other businesses, deployed cross-subsidization techniques in their pricing strategies. This technique is sometimes referred to as chargemaster optimization.
Unfortunately, after years of deploying such techniques, most hospital chargemasters reflect irrational prices and most hospitals cannot accurately provide a patient with an estimated bill at point-of-service.
The Remedy: A Rational Pricing Strategy
The most defensible price would clearly be a price that is based on the hospitals direct unit cost for the item as adjusted for overhead and a reasonable profit margin. Prior to the use of prospectively set rates by the federal government and managed care organizations, it is likely that most hospital prices were closely related to their cost. The following charts simplistically illustrate how, over time, a hospital's chargemaster pricing – once based on cost – could have become irrational.
Example:
Exhibit 1 illustrates a hypothetical abstract of four line item prices from a hospital chargemaster for the laboratory back in the early 1980's. These line items were similarly priced and were based on the cost of the procedure.
Exhibit 1
Exhibit 2 illustrates how many hospitals and/or their consulting firms analyzed the chargemaster along with usage data and payor contract information to calculate a "Charge Payor Contribution Factor."
This charge payor contribution factor represents the weighted average percent of total gross charges for the line item that is being paid on a percent of charges. Once the factor is determined, prices such as the CBC and URINALYSIS tests that have a higher than average contribution factor could be increased by 20 percent, while those with a lower than average contribution factor such as the POTASSIUM and MAGNESIUM test could be decreased by an equal percentage resulting in no overall change in gross charges for the department, yet increasing net revenue by 8.4 percent.
It is clear from this illustration how hospitals have been able to cross subsidize shortfalls resulting from inadequate federal government or managed care reimbursement. It is also clear that prices, which were initially established based on cost, can become irrational from a consumer standpoint. It is important to re-emphasize that this concept of cross subsidization is not unique to the hospital industry. Consumers often experience the effects of cross subsidization in airline prices when a flight from the East Coast to the West Coast can sometimes cost less than a flight from New York to Pittsburgh.
Hospitals nationwide typically would engage a consulting firm once every three or four years to perform this form of analysis and price restructuring using current data.
Exhibit 2
Not only does it become difficult to defend prices in relation to reasonable cost after cross-subsidization techniques are deployed, but as Exhibit 3 illustrates, prices may become difficult to defend in relation to competitor or peer group hospitals.
Exhibit 3
Many hospitals would increase prices "across-the-board" (ATB) in the years following the cross-subsidization price restructuring. Exhibit 4 illustrates the impact of a one-year ATB increase of 5 percent in the Laboratory.
Exhibit 4
Increasing prices across-the-board, as seen in Exhibit 5, can exacerbate an already brewing problem regarding the reasonableness of prices in relation to peers and cost. You can also see on this chart that even including the five percent increase, the prior reduction in prices for the POTASSIUM and MAGNESIUM tests has caused the prices to fall below the fee schedule amount, thereby reducing net revenue unintentionally to levels below those contractually agreed upon by the payors.
Exhibit 5
Hospital financial managers continue to have a fiduciary responsibility to ensure optimum net revenue for their facility. However, in this era of consumer driven healthcare and increased governmental scrutiny at the state and federal levels and among consumer groups, more sophisticated pricing techniques must be deployed.
What Rational Pricing Options Are Available to Healthcare Financial Managers?
There are several available strategies for transparent pricing. Managers could consider implementing fully cost based prices as the most defensible price. Or, it may be more realistic to implement a market-based approach or a hybrid thereof. It is also feasible to deploy the traditional cross-subsidization technique as a first step in the price restructuring process from which these preliminary prices would be compared to Peer Group and Fee Schedule thresholds before final prices are determined.
Exhibit 6 illustrates how deploying a more rational pricing strategy to already optimized prices can realign prices in a way that keeps prices above approved fee schedules and below peer group standards or thresholds while maintaining or protecting net revenue levels.
Exhibit 6
Finally, before deploying your hospital's rational pricing strategy there are a few more strategies to consider in addition to cross-subsidization analysis (optimization) and comparisons to market norms and fee schedules. Other techniques you should consider include the following:
Remember that change is inevitable: payor contracts change, market data is updated throughout the year, HCPCS coding changes, items are deleted and added to your chargemaster each year, unit costs change, and actual volumes may differ from that what was used in your implemented pricing structure.
Therefore, unlike the past, in today's ever changing environment it is important to leverage technology to monitor and modify a new pricing structure periodically.
