for-service plans continue to be the most common form of reimbursement (Gapenski, 2003).
Financial Incentives and Risk
Each of the reimbursement methods provides dif-ferent financial incentives to providers of health-care services. In cost-based reimbursement, for example, providers are paid more if their costs are higher; therefore, no incentive exists to contain costs. In charge-based reimbursement, on the other hand, providers have an incentive to increase their prices because that results in higher payments.
Generally, in a competitive marketplace, consumers will only be willing to pay so much for a service, but because most payments for health-care services come from third parties, providers have limited abil-ity to pass on higher charges. As third-party payers transition to a discount charge-based methodology, providers have an incentive to manage costs to maintain the same level of profit. Additional costs are no longer able to be recouped through increas-ing charges for services, as only a portion of the charges will be reimbursed.
In all of the prospective payment methods, regardless of the unit of payment (procedure, diag-nosis), an incentive exists to reduce costs because the payment is fixed. The overall incentive under the PPS is to work more effectively by managing costs and increasing the utilization of the most prof-itable services. Under global pricing, for example, one payment is made for an entire episode of services, so a strong incentive exists for the physi-cians and hospitals to work together to offer the most effective treatment. Finally, under capitation, the key to profitability is to increase efficiency and decrease utilization. In a capitation setting, pro-viders have the incentive to practice preventive medicine rather than just treating the illness so they can limit unnecessary utilization of services.
Health-care providers also face several financial risks created by the reimbursement methods in place. The risks create some uncertainty regarding the profitability of the organization. First, providers now bear the risk that costs will exceed revenues.
Due to reimbursement for services being somewhat fixed under current payment methods, providers can no longer increase revenues to offset additional costs. Revenues can be increased, but the reim-bursement will be the same, regardless of the charge. A key difference among the reimbursement
methods is the ability of the provider to influence the profit of each service by setting the prices above the costs. In the PPS, risk is increased due to the payment being fixed regardless of the charge to the patient. The PPS payment is based on the resource utilization necessary for the average patient, and because some patients need more intensive treat-ments than others, the health-care provider is at greater risk to manage costs to maintain profitabil-ity. It is important to realize that the recent trends in reimbursement represent a shift in risk from the insurers to the providers. By implementing a fixed payment for services regardless of patient charges, the providers are now responsible for managing costs to ensure a profit is made on services.
organizations developed across the country as inde-pendent not-for-profit corporations. Today, the var-ious Blue Cross/Blue Shield plans continue to operate as independent organizations and are members of a single national association that sets standards. In 1986 Congress eliminated their tax-exemption status because the organizations were offering commercial insurance. As a result, several plans have converted to for-profit status; due to the complexities involved in converting from for-profit to for-for-profit status, others maintain their not-for-profit status (Gapenski, 2003). Because all Blue Cross/Blue Shield corporations operate indepen-dently, reimbursement methods vary by state. Just as with Medicare, the trend has been toward a prospective payment methodology. Many private insurers have adopted Medicare’s diagnosis-related group (DRG) system and developed their own payment rates based on specific diagnoses.
Several types of organizations, most often for-profit insurance companies, offer commercial health insurance. Traditionally, commercial insurers have reimbursed providers for health-care services on the basis of billed charges. As health-care costs continue to grow, and as these organizations have begun charging higher insurance premiums, a trend has started toward more cost-effective
reimburse-ment methods. As for-profits, these organizations have an incentive to maximize their owners’ profits.
Another form of private insurance is where com-panies set aside funds to pay for future health costs of their own employees rather than using an outside organization to provide their health insurance. This form of insurance is referred to as self-insurance and is very popular among organizations with a large number of employees. The next section of the chapter focuses on the two major government insurance programs, Medicare and Medicaid.
Medicare
The Medicare and Medicaid programs were estab-lished through the Social Security Act in the mid-1960s. These programs were administered by the Department of Health, Education, and Welfare (HEW). “In 1977, the Health Care Financing Administration (HCFA) was created under HEW to effectively coordinate Medicare and Medicaid. In 1980, HEW was divided into the Department of Education and the Department of Health and Human Services. In 2001, HCFA was renamed the Centers for Medicare & Medicaid Services (CMS)”
(Medicare Information Resource, 2005).
CMS is the federal agency that administers the Medicare program. Currently, Medicare provides coverage to approximately 40 million Americans.
Medicare is the national health insurance program for:
■ People age 65 years or older
■ Some people younger than age 65, with quali-fying disabilities that have been recognized by the Social Security Administration
■ People with end-stage renal disease, which is permanent kidney failure requiring dialysis or a kidney transplant
Medicare coverage is separated into two plans:
■ Part A coverage provides hospital and some skilled nursing home coverage.
■ Part B coverage provides outpatient, physician, ambulatory surgical, and several miscella-neous services.
Most people do not pay a monthly Part A pre-mium because they or their spouses are eligible for Social Security, and it comes as a benefit of Social Security. The Part A premium in 2005 for individu-als not eligible for Social Security benefits was $375
Economic Influences 101
Common Types of Managed Care Plans Many private insurers have moved to offering managed care plans. “Managed care plans are designed to control healthcare costs through monitoring, prescribing or proscribing the provision of healthcare to a patient”
(Cleverley, 2003). The two most common plans are health maintenance organizations and preferred provider organizations. There is much variability in how these plans work; however, they both seek to change incentives in several ways:
Limiting subscribers’ choices to a provider within the network of providers.
Relying on the primary care physician to serve as the gatekeeper for referral and approval of services.
Encouraging preventive care services by offering lower co-pays.
Discouraging use of brand name drugs by higher co-pays.
Changing financial incentives for health-care providers to limit the number of services ordered for patients Implementing utilization review processes prior to services being rendered.
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per month. Part B coverage is optional to all indi-viduals who have Part A coverage. In 2005, the monthly premium for Part B was $78.20 (HHS Announces, 2005).
Until 1983 Medicare reimbursed providers for health-care services based on provider costs. In 1983 the federal government implemented a new reim-bursement system for Part A providers called the PPS, discussed earlier. The objective of the PPS was to curb Medicare spending and provide incentives for providers to manage costs. The ultimate goal was to curb growth in health-care spending and to free up funds in the national budget for other services.
Unfortunately, over the years PPS payments have not kept pace with hospital costs. To make matters worse, the Balanced Budget Act (BBA) of 1997 placed significant restrictions on the growth in Medicare spending. The Balanced Budget Relief Act of 1999 restored some of the spending cuts from the BBA, but payment growth is still below the growth in operating costs (Gapenski, 2003).
In the PPS system, providers have an incentive to look for ways to contain costs and maintain prof-itability. From the early 1980s until 2000, outpa-tient services continued to be reimbursed at cost while inpatient services were reimbursed under the PPS, so providers shifted services from inpatient to outpatient. As a result, Medicare spending for out-patient services grew quickly and offset some of the expected savings from the PPS. As a result, in August 2000, Medicare implemented a fixed pay-ment system for outpatient services as well.
Inpatient Prospective Payment System
The foundation of Medicare’s inpatient PPS is the DRG assigned to the patient at discharge from the hospital. The DRG provides a way to classify patients based on their primary diagnosis. The diag-nosis is influenced by which medical diagnostic cat-egory a patient is in. There are approximately 543 DRGs. Each DRG is assigned a relative weight, which represents the average number of resources used in treating the average patient with a certain diagnosis. The average weight of all DRGs is assumed to be 1, so DRGs with a relative weight greater than 1 are more resource-intensive than DRGs with a relative weight of lower than 1. The Medicare case mix index of an institution is a weighted average of all the different diagnoses being treated at a particular organization. For example, a case mix index of 1.5 indicates that a facility’s diag-noses are more complex and resource-intensive than a facility with a case mix index of 0.80. CMS reviews the relative weights of specific DRGs annually and makes adjustments based on changes in resource consumption, treatment patterns, and technology.
The DRG payment assigned by Medicare is based on standardized payment rates for labor and nonlabor costs and the relative weight of the DRG.
The labor portion of the payment must be adjusted for the local area wage index, which attempts to reflect relative labor costs across the United States.
Local wage indices and standardized payment rates are published annually by CMS. Table 7-1 contains an illustration of this calculation for DRG 106 Cardiac Bypass with a PTCA for a hospital in Atlanta, Georgia.
The inpatient PPS works fairly well when patient costs are distributed symmetrically for each DRG, and the payment should be sufficient to cover the costs of an average patient. For example, if within the DRG for pneumonia more patients have a severe rather than a mild case, the charges would be higher for the sicker patients yet the reimburse-ment will be the same regardless. In the event that certain hospitals treat sicker patients who require more resources for certain DRGs, the PPS payment will fall short in covering the costs of care. To pro-vide some cushion for high-cost patients, the PPS provides an additional outlier payment for patients whose costs exceed certain thresholds.
The regular PPS payment covers only operating costs. Because hospitals have to bear the costs of financing assets necessary to provide services, 102 Understanding Organizations
Medigap Plans
A Medigap policy is a health insurance policy sold by private insurance companies that must follow state and federal laws. Many people choose to buy these policies because Medicare does not pay for all their health-care costs. For example, consumers must pay for coinsurance, co-pays, and deductibles, which are called gaps in coverage, and they often choose to buy a Medigap plan to cover these gaps. In addition, Medigap plans often cover benefits that the original plan does not offer, such as emergency health care while traveling. Monthly premiums are paid to the private insurance company for the Medigap coverage. There are 12 standardized plans from which to choose that vary in cost, based on the specific details of each plan, such as deductible and co-pay limits and restrictions on which facilities can be used (Medicare and You, 2006).
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Medicare provides additional dollars to assist in covering capital costs. Currently, the capital pay-ment rate is $416.53, which is multiplied by the DRG relative weight, for each Medicare discharge during the year. So hospitals receive additional reimbursement equal to $416.53 ⫻ DRG weight ⫻ the number of Medicare patients.
Outpatient PPS
On August 1, 2000, CMS implemented an outpa-tient PPS based on ambulatory payment classifica-tions (APCs). Services grouped under each APC are similar clinically and in terms of the resources required. A payment rate is established for each APC, and hospitals may be paid for more than one APC for an encounter. Currently, there are approx-imately 350 APCs that specify surgical and nonsur-gical procedures, visits to clinics and emergency departments, and ancillary services.
The APC payment calculation is based on a stan-dard national payment rate, the national Medicare payment percentage, and the patient’s co-payment amount. The national payment rate is divided into labor and nonlabor components. Labor represents
60% of the payment rate and nonlabor the remain-ing 40%. As in the DRG calculations, the labor component of the payment rate is adjusted for the hospital’s local wage index. The calculation of the payment for an individual APC is fairly straightfor-ward. Complications arise, however, when multiple procedures are performed within the same visit for a patient. The procedure with the highest value is paid at 100% of the APC payment, and additional procedures are paid at 50%. Certain outpatient services are paid based on a fee schedule, such as physical, occupational and speech therapy, ambu-lance services, and diagnostic laboratory services.
In addition to inpatient and outpatient hospital services moving to a PPS of reimbursement, nurs-ing homes and home health agency payment meth-ods have also been revised to shift more risk to the health-care provider by capping payments for services.
Medicaid
Medicaid was created under Title XIX of the Social Security Act in 1965 as an entitlement program
Economic Influences 103
TABLE 7-1 Example of Inpatient PPS Reimbursement*
DRG 106 CORONARY HOSPITAL:
BYPASS WITH PTCA ATLANTA, GA
National unadjusted labor payment Wage index: Atlanta, GA
Wage-adjusted labor payment National nonlabor payment Total adjusted payment for a relative weight of 1
DRG 106 relative weight Total PPS payment for DRG 106
*The current labor payment rate is $2,823.63, which is multiplied by the local wage index for Atlanta, Georgia, of .9960 to calculate the adjusted labor payment rate. This amount is added to the nonlabor payment amount to derive the adjusted hospital rate.
The adjusted hospital rate is an attempt by CMS to account for differences in costs due to geographic location. Finally, the adjusted hospital rate is multiplied by the DRG relative weight to determine the hospital payment for DRG 106. Once the adjusted hospital rate has been determined, it is relatively simple to analyze the payment for any number of DRGs by multiplying the appropriate DRG weight by the adjusted hospital rate to determine the total payment.
$2,823.63
⫻ .9960
⫽ $2,812.34
⫹ 1,730.62
⫽ $4,542.96
⫻ 7.3062
$33,191.74
Practice Proof 7-1
Popularity of new drug-coated stents exceed supply.
Cardiovascular Watch, July 21, 2003, p. 15.
Stents have been used since 1987 in conjunction with angioplasties to help prevent arteries from reclosing from plaque buildup. In the spring of 2003, Cordis Corporation released a new stent that was coated with the drug sirolimus. Research indicates that the drug-coated stents prevent scar tissue from reclogging the artery, which often results in another angioplasty within a year of the first procedure. Demand for the new stents is outpacing supply. At the time of this article, Cordis Corporation had the only drug-coated stent on the market. It is anticipated that Boston Scientific will receive approval from the Federal Drug Administration (FDA) within the next year to offer its own drug-coated stent. In addition, the Cordis stents sell for approximately $2,100 more than the bare metal stents, which is creating financial losses for some hospitals on these procedures.
1. What are the factors driving the demand for the drug-coated stents?
2. What are the possible rationing issues as a result of the shortage? What are possible solutions to this dilemma?
3. Explain the potential reimbursement ramifications from the new stents.
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jointly funded by the federal and state governments to provide medical assistance for qualified individu-als and families with low income and resources.
“Medicaid is the largest source of funding for med-ical and health-related services for America’s poor-est people” (Medicaid: A Brief Summary, 2005).
States have tremendous autonomy in how they structure their Medicaid programs. States decide on:
■ Eligibility criteria
■ Type, amount, duration, and scope of services
■ Payment rates for services
■ Administration
Due to the flexibility each state possesses in structuring its Medicaid programs, considerable variations occur. For example, an individual may be eligible for Medicaid in one state and not be eligible in another state.
The federal government pays a portion of expen-ditures under each state’s Medicaid program. The percentage the federal government pays is updated annually by comparing the state’s average per capita income level with the national income average.
States with higher income levels are reimbursed a smaller percentage. By law, federal payment cannot be lower than 50% or higher than 83% of a state’s Medicaid costs. In 2004, the overall average pay-ment percentage was 60.2%, ranging from 50% in 12 states to a high of 77% in Mississippi (Medicaid:
A Brief Summary, 2005). See Box 7-1 for an example.