DISC 7 AND 8 HMGT 420

CHAPTER

37

2HEALTHCARE INSURANCE AND REIMBURSEMENT METHODOLOGIES

Learning Objectives After studying this chapter, readers will be able to

• Explain the overall concept of insurance, including adverse selection and moral hazard.

• Briefly describe the third-party payer system. • Explain the different types of general payment methods. • Describe the incentives created by the different payment

methods and their impact on provider risk. • Describe the purpose and organization of managed care plans. • Explain the impact of healthcare reform on insurance and

reimbursement methodologies. • Explain the importance and types of medical coding.

Introduction

Compared with other services, the provision of healthcare services is unique. First, often only a few providers of a particular service exist in a given area. Next, it is often difficult to judge the quality and cost of competing services, although new tools aim to facilitate service comparison.1 Then, the decision about which services to purchase is usually not made by the consumer but by a physician or some other clinician. Also, full payment to the provider is not normally made by the user of the services but by a healthcare insurer. Finally, for most individuals, health insurance from third-party payers is paid for or subsidized by employers or government agencies, so many patients are partially insulated from the costs of healthcare.

This highly unusual marketplace for healthcare services has a profound effect on the supply of, and demand for, such services. In this chapter, we discuss the concept of insurance, the major providers of healthcare insurance, and the methods used by insurers to pay for health services.

C o p y r i g h t 2 0 2 1 . A U P H A / H A P B o o k .

A l l r i g h t s r e s e r v e d . M a y n o t b e r e p r o d u c e d i n a n y f o r m w i t h o u t p e r m i s s i o n f r o m t h e p u b l i s h e r , e x c e p t f a i r u s e s p e r m i t t e d u n d e r U . S . o r a p p l i c a b l e c o p y r i g h t l a w .

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G apenski ’s Healthcare F inance38

Insurance Concepts

Healthcare services are supported by an insurance system composed of a wide variety of organizations and payers. Because insurance is the cornerstone of the healthcare system, a general understanding of insurance will help you better comprehend the marketplace for healthcare services.

A Simple Illustration To better understand insurance concepts, consider a simple example. Assume that no health insurance exists and you face only two possible medical out- comes in the coming year:

Outcome Probability Cost Stay healthy 0.99 $ 0 Get sick 0.01 20,000

Furthermore, assume that everyone else faces the same medical out- comes at the same odds and with the same associated costs. What is your expected healthcare cost—E(Cost)—for the coming year? To find the answer, we multiply the cost of each outcome by its probability of occurrence and then sum the products:

E(Cost) = (Probability of outcome 1 × Cost of outcome 1) + (Probability of outcome 2 × Cost of outcome 2) = (0.99 × $0) + (0.01 × $20,000) = $0 + $200 = $200.

Now, assume that you, and everyone else, make $20,000 a year. With this salary, you can easily afford the $200 “expected” healthcare cost. The problem is, however, that no one’s actual bill will be $200. If you stay healthy, your bill will be zero, but if you are unlucky and get sick, your bill will be $20,000. This cost may force you, as well as other people who get sick, into personal bankruptcy.

Next, suppose that an insurance policy that pays all of your healthcare costs for the coming year is available for $250. Would you purchase the policy, even though it costs $50 more than your expected healthcare costs? Most people would. In general, individuals are risk averse, so they would be willing to pay a $50 premium over their expected costs to eliminate the risk of financial ruin. In effect, policyholders are passing to the insurer the costs associated with the risk of getting sick.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 39

Would an insurer be willing to offer the policy for $250? If an insurance company sold a million policies, its expected total policy pay- out would be 1 million times the expected payout for each policy, or 1 million × $200 = $200 million. If there were no uncertainty about the $20,000 estimated medical cost per claim, the insurer could forecast its total claims precisely. It would collect 1 million × $250 = $250 million in health insurance premiums; pay out roughly $200 million in claims; and hence have about $50 million to cover administrative costs, create a reserve in case realized claims are greater than predicted by its actuaries, and make a profit.

Basic Characteristics of Insurance This simple example of health insurance illustrates why individuals would seek health insurance and why insurance companies would be formed to pro- vide such insurance. Needless to say, the concept of insurance is much more complicated in the real world. Insurance is typically defined as having four distinct characteristics:

1. Pooling of losses. The pooling, or sharing, of losses is the basis of insurance. Pooling means that losses are spread over a large group of individuals, so that each individual realizes the average loss of the pool (plus administrative expenses) rather than the actual loss incurred. In addition, pooling involves the grouping of a large number of homogeneous exposure units—people or things having the same risk characteristics—so that the law of large numbers applies. (In statistics, the law of large numbers states that as the size of the sample increases, the sample mean gets closer and closer to the population mean.) Thus, pooling implies (1) the sharing of losses by the entire group and (2) the prediction of future losses with some accuracy.

2. Payment only for random losses. A random loss is one that is unforeseen and unexpected and occurs as a result of chance. Insurance is based on the premise that payments are made only for losses that are random. We discuss the moral hazard problem, which concerns losses that are not random, in a later section of this chapter.

3. Risk transfer. An insurance plan almost always involves risk transfer. The sole exception to the element of risk transfer is self-insurance, which is the assumption of a risk by a business (or an individual) itself rather than by an insurance company. (Self-insurance is discussed in a later section.) Risk transfer is the transfer of a risk from an insured to an insurer, which typically is in a better financial position to bear the risk than the insured because of the law of large numbers.

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G apenski ’s Healthcare F inance40

4. Indemnification. The final characteristic of insurance is indemnification for losses—that is, reimbursement to the insured if a loss occurs. In the context of health insurance, indemnification takes place when the insurer pays the insured, or the provider, in whole or in part for the expenses related to the insured’s illness or injury.

Adverse Selection One of the major problems facing healthcare insurers is adverse selection. Adverse selection occurs because individuals and businesses that are more likely to have claims are more inclined to purchase insurance than those that are less likely to have claims. For example, an individual without insurance who needs a costly surgical procedure will likely seek health insurance if it is affordable to do so, whereas an individual who does not need surgery is much less likely to purchase insurance. Similarly, consider the likelihood of a 20-year-old to seek health insurance versus the likelihood of a 60-year-old to do so. The older individual, with much greater health risk due to age, is more likely to seek insurance.

If this tendency toward adverse selection goes unchecked, a dispro- portionate number of sick people, or those who are most likely to become sick, will seek health insurance, and the insurer will experience higher than expected claims. This increase in claims will trigger a premium increase, which will only worsen the problem, because the healthier members of the plan will seek insurance from other firms at a lower cost or may totally forgo insurance. The adverse selection problem exists because of asymmetric infor- mation, which occurs when individual buyers of health insurance know more about their health status than do insurers.

The best strategy for healthcare insurers to combat adverse selection is to create a large, well-diversified pool of subscribers. If the pool is sufficiently large and diversified, the costs of adverse selection can be absorbed by the large number of enrollees. Many current health policies, such as health insur- ance exchanges, attempt to limit adverse selection by creating or requiring these large, diversified risk pools.

Moral Hazard Insurance is based on the premise that payments are made only for random losses, and from this premise stems the problem of moral hazard. An exam- ple of moral hazard in a casualty insurance setting is the owner who delib- erately sets a failing business on fire to collect the insurance. Moral hazard is also present in health insurance, but it typically takes a less dramatic form; few people are willing to voluntarily sustain injury or illness for the purpose of collecting health insurance proceeds. However, undoubtedly there are people who purposely use healthcare services that are not medically required. For

adverse selection The problem faced by insurance companies because individuals who are more likely to have claims are also more likely to purchase insurance.

moral hazard The problem faced by insurance companies because individuals are more likely to use unneeded health services when they are not paying the full cost of those services.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 41

example, some people might visit a physician or a walk-in clinic for the social value of human companionship rather than to address a medical necessity. Also, some hospital discharges might be delayed for the convenience of the patient rather than for medical purposes.

Finally, when insurance covers the full cost or most of the cost of healthcare services, individuals often are quick to agree to an expensive magnetic resonance imaging (MRI) scan or other high-cost procedure that may not be necessary. If the same test required total out-of-pocket payment, individu- als would think twice before agreeing to such an expensive procedure unless they clearly understood the medical necessity involved. All in all, when somebody else is paying the costs, patients consume more healthcare services.

Even more insidious is the poten- tial impact of insurance on individual behavior. Individuals may be more likely to forgo preventive actions and embrace unhealthy behaviors when the costs of not taking those actions will be borne by insurers. For example, individuals may be less motivated to stop smoking if the monetary costs associated with smoking- related illnesses are carried by the insurer.

The primary tool that insurers have to combat the moral hazard problem is coinsurance, which requires insured indi- viduals to pay a certain percentage of eligi- ble medical expenses—say, 20 percent—in excess of the deductible (the amount that individuals pay before their insurance plan starts to pay). Insurers also use copayments, which are similar to coinsurance but are expressed as a dollar amount: $20 per pri- mary care visit, for example. To illustrate coinsurance, assume that Juan Pérez, who has employer-provided medical insurance that pays 80 percent of eligible expenses after the $100 deductible is satisfied, incurs $10,000 in medical expenses during

For Your Consideration Who Should Pay for Health Services— Users or Insurers?

One of the most confounding questions that arises when discussing healthcare services is who should bear the responsibility for payment. Should the patient be responsible, or should some third party, such as the government or an insurance company, foot the bill?

Many people argue that when individuals bear the cost of their own healthcare, they will be responsible consumers and only pay for necessary services. In addition, they will choose providers on the basis of cost and quality and hence create incentives for providers to offer better yet less expensive services. It is estimated that this action alone would reduce total healthcare costs in the United States by 20 to 30 percent, or even more.

Other people argue that individuals can- not make rational decisions regarding their own healthcare because they do not sufficiently understand the nature of illness and injury. Fur- thermore, there is insufficient information about provider quality and costs available to guide individuals to good decisions. Finally, individuals would skimp on routine preventive healthcare ser- vices to save money, which would create health- care problems down the road and ultimately lead to higher future costs.

What do you think? Should individuals be held more responsible for their own costs of healthcare services? What about the arguments stated here? Is there some way of balancing the need for more consumerism in healthcare service purchases with the need to protect individuals against the very high costs of many services? Can you think of a current example?

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G apenski ’s Healthcare F inance42

the year. The insurer will pay 0.80 × ($10,000 − $100) = 0.80 × $9,900 = $7,920, so Juan’s responsibility is $10,000 − $7,920 = $2,080. The pur- poses of coinsurance and copayments are to reduce premiums (monthly fees for purchasing the insurance plan) to employers and to prevent overutiliza- tion of healthcare services. Because insured individuals pay part of the cost, premiums can be reduced. Additionally, by being forced to pay some of the costs, insured individuals will presumably seek fewer and more cost-effective treatments and embrace a healthier lifestyle.

1. Briefly explain the following characteristics of insurance: a. Pooling of losses b. Payment only for random losses c. Risk transfer d. Indemnification

2. What is adverse selection, and how do insurers deal with the problem?

3. What is the moral hazard problem, and how do insurers mitigate it?

SELF-TEST QUESTIONS

Third-Party Payers

Up to this point in the chapter, we have focused on basic insurance concepts. A large proportion of the health services sector receives its revenues not directly from the users of their services—the patients—but from insurers, which are known collectively as third-party payers. Because an organiza- tion’s revenues are critical to its financial viability, this section briefly exam- ines the sources of most revenues in the health services sector. In the next section, the reimbursement methodologies employed by third-party payers are reviewed in more detail.

Health insurance originated in Europe in the early 1800s, when mutual benefit societies formed to reduce the financial burden associated with illness or injury. Since then, the concept of health insurance has changed dramatically. Today, health insurers fall into two broad categories: private insurers and public programs.

Private Insurers In the United States, the concept of public, or government-provided, health insurance is relatively new, while private health insurance has been in existence since the early 1900s. In this section, the major private insurers are discussed: Blue Cross Blue Shield (www.bcbs.com), commercial insurers, and self-insurers.

third-party payer A generic term for any outside party, typically an insurance company or a government program, that pays for part or all of a patient’s healthcare services.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 43

Blue Cross Blue Shield Blue Cross Blue Shield organizations trace their roots to the Great Depres- sion, when both hospitals and physicians were concerned about their patients’ ability to pay healthcare bills. One example is Florida Blue (www. floridablue.com) (formerly Blue Cross and Blue Shield of Florida), which offers healthcare insurance to individuals and families, Medicare beneficiaries, and business groups that reside in Florida.

Blue Cross originated as a number of separate insurance programs offered by individual hospitals. At that time, many patients were unable to pay their hospital bills, but most people, except the poorest, could afford to purchase some type of hospitalization insurance. Thus, the programs were initially designed to benefit hospitals as well as patients. The programs were all similar in structure: Hospitals agreed to provide a certain amount of ser- vices to program members who made periodic payments of fixed amounts to the hospitals, whether services were used or not. In a short time, these pro- grams expanded from single-hospital programs to community-wide, multi- hospital plans called hospital service plans. The Blue Cross name was officially adopted by most of these plans in 1939.

Blue Shield plans developed in a manner similar to Blue Cross plans, except that the providers were physicians instead of hospitals. Today, there are 36 Blue Cross Blue Shield organizations (referred to as “the Blues”). Some offer only one of the two plans, but most offer both plans. The Blues are organized as independent corporations, including some for-profit entities, but all belong to a single national association that sets standards that must be met to use the Blue Cross Blue Shield name. Collectively, the Blues provide healthcare coverage for more than 106 million individuals in all 50 states, the District of Columbia, and Puerto Rico.2

Commercial Insurers Commercial health insurance is issued by life insurance companies, casu- alty insurance companies, and companies that were formed exclusively to offer healthcare insurance. Examples of commercial insurers include Aetna, Humana, and UnitedHealth Group. All commercial insurance companies are taxable (for-profit) entities. Commercial insurers entered the health insur- ance market following World War II. At that time, the United Auto Workers negotiated the first contract with employers in which fringe benefits were a major part of the contract. Also following the war, the Internal Revenue Service ruled that employer-provided health insurance was not taxable, giving employers an incentive to offer this tax-free benefit. Like those covered under Blue Cross Blue Shield, the majority of individuals with commercial health insurance are covered under group policies negotiated by employee groups, professional and other associations, and labor unions.

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G apenski ’s Healthcare F inance44

Self-Insurers The third major form of private insurance is self-insurance. Although it might seem as if all individuals who do not have some form of health insurance are self-insurers, this is not the case. Self-insurers make a conscious decision to bear the risks associated with healthcare costs and then set aside (or have available) funds to pay future costs as they occur. Individuals, except the very wealthy, are not good candidates for self-insurance because they face too much uncertainty concerning healthcare expenses. On the other hand, large groups, especially employers, are good candidates for self-insurance. Today, most large groups are self-insured. For example, employees of the State of Florida are covered by health insurance whose costs are paid directly by the state. Florida Blue is paid a fee to administer the plan, but the state bears all the risks associated with cost and utilization uncertainty.

Public Insurers Government is a major insurer as well as a direct provider of healthcare services. For example, the US federal government provides healthcare ser- vices directly to qualifying individuals through the medical facilities of the US Department of Veterans Affairs; the US Department of Defense and its TRICARE program (health insurance for uniformed service members and their families); and the Public Health Service, part of the US Department of Health and Human Services (HHS). In addition, government either provides or mandates a variety of insurance programs, such as workers’ compensation. In this section, however, the focus is on the two major government insurance programs: Medicare and Medicaid.

Medicare Medicare was established by Congress in 1965 primarily to provide medical benefits to individuals aged 65 or older. About 44 million people have Medi- care coverage, which pays for about 21 percent of all US healthcare services.

Over the decades, Medicare has evolved to include four major cover- ages: Part A, which provides hospital and some skilled nursing facility cover- age; (2) Part B, which covers physician services, ambulatory surgical services, outpatient services, and other miscellaneous services; (3) Part C, which is managed care coverage offered by private insurance companies and can be selected in lieu of Parts A and B; and (4) Part D, which covers prescription drugs. In addition, Medicare covers healthcare costs associated with selected disabilities and illnesses, such as kidney failure, regardless of age.

Part A coverage is free to all individuals who are eligible for Social Security benefits. Individuals who are not eligible for Social Security ben- efits can obtain Part A medical benefits by paying monthly premiums. Part

Medicare A federal government health insurance program that primarily provides benefits to individuals aged 65 or older.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 45

B is optional for all individuals who have Part A coverage, and it requires a monthly premium from enrollees that varies with income level. About one- third of Medicare enrollees elect to participate in Part C, also called Medicare Advantage Plans, rather than Parts A and B. Part D offers prescription drug coverage through plans offered by private companies. Each Part D plan offers somewhat different coverage, so the cost of Part D coverage varies widely.

Administration of the Medicare program falls under the HHS, which creates the specific rules of the program on the basis of enabling legislation. Medicare is administered by an agency within the HHS called the Centers for Medicare & Medicaid Services (CMS). CMS has ten regional offices that oversee the Medicare program and ensure that regulations are followed.3 Medicare payments to providers are not made directly by CMS but by con- tractors for 12 Medicare Administrative Contractor (MAC) jurisdictions.

Many private insurers also offer coverage called Medicare supplement insurance, or Medigap. Such insurance is designed to help pay some of the healthcare costs that traditional Medicare does not cover, such as copayments, coinsurance, and deductibles. In addition, some Medigap policies offer cov- erage for services that Medicare does not include, for example, medical care when traveling outside the United States. When an individual buys Medigap coverage, Medicare will first pay its share of the Medicare-approved amount for covered costs, and then the Medigap policy pays its share.

Medicaid Medicaid began in 1966 as a modest program to be jointly funded and operated by the states and the federal government. The goal was to provide a medical safety net for low-income mothers and children and for elderly, blind, and disabled individuals who receive benefits from the Supplemental Security Income (SSI) program. Congress mandated that Medicaid cover hospital and physician care, but states were encouraged to expand the basic package of benefits, either by increasing the range of benefits or by extending the program to cover more people. A mandatory nursing home benefit was added in 1972.

Over the years, Medicaid has provided access to healthcare services for many low-income individuals who otherwise would have no insurance cover- age. Furthermore, Medicaid has become an important source of revenue for healthcare providers, especially for nursing homes and other providers that treat large numbers of indigent patients.

It is important to note that both Medicare and Medicaid expenditures have been growing at an alarming rate, which has forced both federal and state policymakers to search for more effective ways to improve the programs’ access, quality, and cost.

Medicaid A federal and state government health insurance program that provides benefits to low-income individuals.

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G apenski ’s Healthcare F inance46

1. What are the different types of private insurers? 2. Briefly, what are the origins and purpose of Medicare? 3. What is Medicaid, and how is it administered?

SELF-TEST QUESTIONS

Managed Care Plans Managed care plans combine the provision of healthcare services and the insurance function into a single entity. Traditional plans are created by insur- ers that either directly own a provider network or create one through con- tractual arrangements with independent providers.

One type of managed care plan is the health maintenance organiza- tion (HMO). HMOs are based on the premise that the traditional insurer– provider relationship creates incentives that reward providers for treating patients’ illnesses while offering little incentive for providing prevention and rehabilitation services. This is often referred to as volume over value. By com- bining the financing and delivery of comprehensive healthcare services into a single system, HMOs theoretically have as strong an incentive to prevent illnesses as to treat them. However, from a patient perspective, HMOs have several drawbacks, including a limited network of providers and the assign- ment of a primary care physician (often called a gatekeeper) who acts as the initial contact and authorizes all services received from the HMO.

Another type of managed care plan, the preferred provider organiza- tion (PPO), evolved during the early 1980s. PPOs are a hybrid of HMOs and traditional health insurance plans that use many of the cost-saving strategies developed by HMOs. PPOs do not mandate that beneficiaries use specific providers, although financial incentives (i.e., patients pay less for going to more efficient providers) encourage members to use providers that are part of the provider panel—those providers that have contracts (usually at discounted prices) with the PPO. Furthermore, PPOs do not require beneficiaries to use preselected gatekeeper physicians.

In an effort to achieve the potential cost savings of managed care plans, most insurance companies now apply managed care strategies to their conventional plans. Such plans, which are called managed fee-for-service plans, use preadmission certification (review of patient need before a hospital admission), utilization review (examination of services provided to a patient), and second surgical opinions (another physician validates recommended treatment) to control inappropriate utilization.

Although the distinctions between managed care and conven- tional plans were once quite apparent, considerable overlap now exists in the strategies and incentives employed. Thus, the term managed care

managed care plan A combined effort by an insurer and a group of providers that aims both to increase quality of care and to decrease costs.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 47

now describes a continuum of plans, which can vary significantly in their approaches to providing combined insurance and healthcare services. The common feature in managed care plans is that the insurer has a mechanism by which it controls, or at least influences, patients’ utilization of health- care services.

1. What is meant by the term managed care? 2. What are the different types of managed care plans?

SELF-TEST QUESTIONS

Healthcare Reform and Insurance

The Affordable Care Act (ACA) introduced a number of provisions to expand insurance coverage and improve insurance affordability and access. Here we outline some of the act’s provisions that focus on healthcare insurance.

Insurance Standards A number of new insurance standards were specified in the ACA. In terms of coverage, these include the following:

• Children and dependents are permitted to remain on their parents’ insurance plans until their twenty-sixth birthday.

• Insurance companies are prohibited from dropping policyholders if they become sick and from denying coverage to individuals due to preexisting conditions.

• Individuals have a right to appeal and request that the insurer review denial of payment.

In terms of costs, the standards include the following:

• Insurers are required to charge the same premium rate to all applicants of the same age and geographic location, regardless of preexisting conditions or sex (this is called community rating).

• Insurers are required to spend at least 80 percent of premium dollars on health costs and claims instead of on administrative costs and profits. If the insurer violates this standard, it must issue rebates to policyholders (this is called the medical loss ratio).

• Lifetime limits on most benefits are prohibited for all new health insurance plans.

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G apenski ’s Healthcare F inance48

In terms of care, the standards include the following:

• All plans must now include essential benefits, such as ambulatory patient services, emergency services, hospitalization, maternity and newborn care, mental health and substance use disorder services, prescription drugs, laboratory services, preventive and wellness services, chronic disease management, and pediatric services, including oral and vision care.

• Preventive services, such as childhood immunizations, adult vaccinations, and basic medical screenings, must be available to patients free of charge.

• Individuals are permitted to choose a primary care doctor outside the plan’s network.

• Individuals can seek emergency care at a hospital outside the health plan’s network.

It is important to note that individuals who seek primary or hospital care out-of-network will likely pay more.

Individual Mandate The individual mandate of the ACA went into effect in January 2014. This mandate required that all eligible individuals (i.e., US citizens and legal residents) who were not covered by an employer-sponsored health plan, Medicaid, or Medicare have a health insurance policy or face a tax penalty. In 2017, passage of the Tax Cuts and Jobs Act repealed the individual mandate (effective January 1, 2019). The Congressional Budget Office estimated that repeal of the individual health insurance mandate would increase the number of uninsured people by 4 million in 2019 and 13 million in 2027.4

Medicaid Expansion One of the key provisions of the ACA was the expansion of Medicaid to all citizens and legal residents between the ages of 19 and 64 who have household incomes below 138 percent of the federal poverty level. Medicaid expansion primarily benefits childless adults who previously did not qualify for Medicaid regardless of their income level as well as low-income parents who previously did not qualify even if their children did qualify. As a result, if every state expanded Medicaid, it is estimated that an additional 16 million people would receive coverage.

Originally, under the ACA, Medicaid expansion was mandatory for all states; states that did not comply were to be penalized by the federal gov- ernment. However, in 2012, the US Supreme Court ruled that states could opt out of the Medicaid expansion, leaving the decision to participate in the

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 49

hands of the state’s leaders. The court further ruled that the federal govern- ment could not penalize states through denial of federal funding if they did not expand Medicaid. Despite these rulings, 37 states and the District of Columbia had expanded Medicaid eligibility as of 2019.5

Health Insurance Exchanges Health insurance exchanges (HIEs) are online marketplaces where people can research and review their options and purchase health insurance. People who are unable to receive health insurance through their employer, the unem- ployed, or the self-employed can purchase coverage through an exchange. Therefore, HIEs are an important part of ensuring that healthcare access is available to all Americans and legal immigrants. As of 2018, roughly 12 million people used HIEs to buy healthcare insurance coverage.6 To ensure price transparency, all participating insurance companies are required to post on HIEs the rates for their health insurance plans. This mandate permits individuals and businesses shopping for insurance to compare all plans and rates side by side and select plans that are affordable and meet their needs.

There are different types of HIEs. Public exchanges are created by state or federal governments and are open to both individuals seeking per- sonal insurance and small-group employers seeking insurance for their work- ers. All plans listed on an HIE are required to offer core benefits—called essential health benefits—such as preventive and wellness services, prescription drugs, and hospital stays. Private exchanges, on the other hand, are created by private-sector firms, such as health insurance companies.

In addition to establishing HIEs, the ACA aimed to make insurance more affordable by offering subsidies to individuals below 400 percent of the federal poverty level that purchase insurance on the HIEs. There are two types of subsidies: (1) premium tax credits that offset the amount of monthly premiums that an individual pays, and (2) cost-sharing subsidies that mini- mize the amount of out-of-pocket costs an individual pays. There are several challenges associated with HIEs. First, the federal exchange, along with many state exchanges, had a difficult launch as a result of technological challenges. This led to distrust of the system and initially lower enrollment than pro- jected. Second, while coverage on the HIEs is largely affordable for individu- als that receive subsidies, it is unaffordable for many individuals with incomes above 400 percent of the federal poverty level who do not receive subsidies.

High-Deductible Health Plans Many consumers who choose coverage are opting for high-deductible health plans (HDHPs). HDHPs are growing in popularity because they are among the least expensive options on the insurance exchanges. In fact, the rate of enrollment in HDHPs has more than doubled since 2009. These plans have

health insurance exchange (HIE) An online marketplace created primarily by the states or the federal government that insurers use to post plan details and consumers use to purchase health insurance.

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G apenski ’s Healthcare F inance50

low premiums and high deductibles. Some are linked with health savings accounts or health reimbursement arrangements, under which enrollees can use tax-advantaged accounts to pay for medical expenses. HDHPs aim to provide individuals with control over their healthcare expenditures. Individu- als enrolled in an HDHP are required to meet minimum deductibles before the plan starts to cover healthcare expenses.

1. Briefly describe the impact of the ACA on health insurance. 2. What is a health insurance exchange (HIE)? 3. What is a high-deductible health plan (HDHP)?

SELF-TEST QUESTIONS

General Reimbursement Methodologies

Regardless of the payer for a particular healthcare service, a limited number of payment methodologies are used to reimburse providers. Payment meth- odologies fall into two broad classifications: fee-for-service and capitation. Under fee-for-service payment, of which many variations exist, the greater the amount of services provided, the higher the amount of reimbursement. Under capitation, a fixed payment is made to providers for each covered life, or enrollee, independent of the amount of services provided. In this section, we discuss the mechanics, incentives created, and risk implications of alterna- tive reimbursement methodologies.

Fee-for-Service Methods The three primary fee-for-service methods of reimbursement are cost based, charge based, and prospective payment.

Cost-Based Reimbursement Under cost-based reimbursement, the payer agrees to reimburse the pro- vider for the costs incurred in providing services to the insured population. Reimbursement is limited to allowable costs, usually defined as those costs directly related to the provision of healthcare services. Nevertheless, for all practical purposes, cost-based reimbursement guarantees that a provider’s costs will be covered by payments from the payer. Typically, the payer makes periodic interim payments to the provider, and a final reconciliation is made after the contract period expires and all costs have been processed through the provider’s managerial (cost) accounting system.

During its early years (1966–1982), Medicare reimbursed hospitals on the basis of costs incurred. Now, most hospitals are reimbursed by Medicare,

fee-for-service A reimbursement methodology that provides payment each time a service is provided.

capitation A reimbursement methodology that is based on the number of covered lives (or enrollees) as opposed to the amount of services provided.

cost-based reimbursement A fee-for-service reimbursement method based on the costs incurred in providing services.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 51

and by other payers, using a per diagnosis prospective payment system (this topic is addressed in more detail later in this chapter). However, critical access hospitals, which are small rural hospitals that provide services to remote popu- lations that do not have easy access to other hospitals, are still reimbursed on a cost basis by Medicare.

Charge-Based Reimbursement When payers pay billed charges, or simply charges, they pay according to a rate schedule, called a chargemaster, established by the provider. To a certain extent, this reimbursement system places payers at the mercy of providers in regard to the cost of healthcare services, especially in markets where compe- tition is limited. In the early days of health insurance, all payers reimbursed providers on the basis of billed charges. Few insurers still reimburse providers according to billed charges; the trend for payers is toward other, less gener- ous reimbursement methods (e.g., discounted charges).

Most payers that historically reimbursed providers on the basis of billed charges now pay by negotiated, or discounted, charges. This is especially true for insurers that have established managed care plans. Additionally, many conven- tional insurers have bargaining power because of the large number of patients that they bring to a provider, so they can negotiate discounts from billed charges. Such discounts generally range from 20 to 50 percent, or even more, of billed charges. The effect of these discounts is to create a system similar to hotel or airline pricing, where there are listed rates (e.g., chargemaster prices for providers, and rack rates or full fares for hotels and airlines) that few people pay.

Prospective Payment Under a prospective payment system, the rates paid by payers are established by the payer before the services are provided. Furthermore, payments are not directly related to either costs or chargemaster rates. Here are some common units of payment used in prospective payment systems:

• Per procedure. Under per procedure reimbursement, a separate payment is made for each procedure performed on a patient. Because of the high administrative costs associated with this method when it is applied to complex diagnoses, per procedure reimbursement is more commonly used in outpatient than in inpatient settings.

• Per diagnosis. Under the per diagnosis reimbursement method, the provider is paid a rate that depends on the patient’s diagnosis. Diagnoses that require higher resource utilization, and hence are more costly to treat, have higher reimbursement rates. Medicare pioneered this basis of payment in its diagnosis-related group (DRG) system, which it first used for hospital inpatient reimbursement in 1983.

chargemaster A list of all items and services provided by a health services organization containing their gross (list) prices.

prospective payment A fee-for-service reimbursement method in which the payment amount is established beforehand by the third-party payer and, in theory, is not directly related to costs or charges.

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G apenski ’s Healthcare F inance52

• Per day (per diem). If reimbursement is based on a per diem payment, the provider is paid a fixed amount for each day that service is provided, regardless of the nature of the service. Note that per diem rates, which are applicable only to inpatient settings, can be stratified. For example, a hospital may be paid one rate for a medical/surgical day, a higher rate for a critical care unit day, and yet a different rate for an obstetrics day. Stratified per diems recognize that providers incur widely different daily costs for providing different types of care. Per diem rates may also vary by the day of a patient’s stay, recognizing that early days of care may be more expensive than those later in a patient’s stay.

• Bundled. Under bundled payment, payers make a single prospective payment that covers all services delivered in a single episode, whether the services are rendered by a single provider or by multiple providers. For example, a bundled payment may be made for all obstetric services associated with a pregnancy provided by a single physician, including all prenatal and postnatal visits as well as the delivery. For another example, a bundled payment may be made for all physician and hospital services associated with a joint replacement operation. Bundled payments incent hospitals and providers to provide the most

efficient and effective care at the lowest cost. Finally, note that, at the extreme, a bundled payment may cover an entire population. In this situation, the payment becomes a global payment, which, in effect, is a capitation payment (described in the next section of this chapter).

Capitation Up to this point, the prospective pay- ment methods presented have been fee- for-service methods—that is, providers are reimbursed on the basis of the amount of services provided. The service may be defined as a visit, a diagnosis, a hospital day, an episode, or in some other man- ner, but the key feature is that the more services that are performed, the greater the reimbursement amount. Capitation, although it is a form of prospective pay- ment, is an entirely different approach to reimbursement and hence deserves to be

per diem payment A fee-for-service reimbursement method that pays a set amount for each inpatient day.

bundled (global) payment The fee-for-service payment of a single amount for the complete set of services required to treat a single episode.

For Your Consideration Creating the Proper Provider Incentives

An article in the Wall Street Journal on February 18, 2015, described the case of a patient who was discharged from a Kindred Healthcare long-term care hospital after 23 days of treatment for com- plications from a previous knee surgery. Accord- ing to family members, the timing of his release did not appear to be related to any improvement in his medical condition. However, it did result in the hospital receiving a higher reimbursement for his stay.

According to billing documents, Kindred collected $35,887.79 from Medicare for his treat- ment—the maximum amount it could earn for treating patients with his condition. Under Medi- care’s reimbursement rules, if the patient had left the hospital one day earlier, Kindred would have received a per diem rate that would have resulted in a total payment of roughly $20,000. If

(continued)

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 53

treated separately. Under capitated reim- bursement, the provider is paid a fixed amount per covered life per period (usu- ally a month) regardless of the amount of services provided. For example, a pri- mary care physician might be paid $15 per member per month for handling 100 members of an HMO plan.

Capitation payment, which is used primarily by managed care plans, dramati- cally changes the financial environment of healthcare providers. It has implica- tions for financial accounting, managerial accounting, and financial management. Discussion of how capitation, as opposed to fee-for-service reimbursement, affects healthcare finance is provided throughout this book.

1. Briefly explain the following payment methods: a. Cost based b. Charge based and discounted charges c. Per procedure d. Per diagnosis e. Per diem f. Bundled g. Capitation

2. What is the major difference between fee-for-service reimbursement and capitation?

SELF-TEST QUESTIONS

Provider Incentives Under Alternative Reimbursement Methodologies

Providers, like individuals and businesses, react to the incentives created by the financial environment. It is interesting to examine the incentives that alternative reimbursement methods have on provider behavior. Under cost-based reimbursement, providers are given a “blank check” to acquire facilities and equipment and incur operating costs. If payers reimburse pro- viders for all costs, the incentive is to incur costs. Facilities will be lavish and conveniently located, and staff will be available to ensure that patients are

he had stayed longer than 23 days, the hospital likely would not have received any additional reimbursement other than the $35,887.79 single payment for an “extended” stay.

What do you think? What incentives are created for providers under the reimbursement method used by Medicare for long-term (as opposed to acute care) hospitals? Can you think of a payment system that would encourage long- term care hospitals to discharge patients at the appropriate time?

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G apenski ’s Healthcare F inance54

given “deluxe” treatment. Furthermore, services that may not be medically required will be provided because more services lead to higher costs and hence lead to higher revenues.

Under charge-based reimbursement, providers have incentives to set high charge rates, which lead to high revenues. However, in competitive markets, there will be a constraint on how high providers can go. But, to the extent that insurers, rather than patients, are footing the bill, there is often

considerable leeway in setting charges. Because charge-based payment is a fee-for- service type of reimbursement in which more services result in higher revenue, a strong incentive exists to provide the highest possible amount of services. In essence, providers can increase utilization, and hence revenues, by churning—that is, by creating more visits, ordering more tests, extending inpatient stays, and so on. Charge-based reimbursement creates incentives for providers to contain costs because (1) the spread between charges and costs represents profits, and the more the better, and (2) lower costs can lead to lower charges, which can increase volume. Still, the incentive to contain costs is weak because charges can be increased more easily than costs can be reduced. Note, however, that discounted charge reim- bursement places additional pressure on profitability and hence increases the incen- tive for providers to lower costs.

Under prospective payment reim- bursement, provider incentives are altered. First, under per procedure reimburse- ment, the profitability of individual proce- dures varies depending on the relationship between the actual costs incurred and the payment for that procedure. Providers, usually physicians, have an incentive to perform procedures that have the highest profit potential. Furthermore, the more procedures, the better, because each pro- cedure typically generates additional profit.

For Your Consideration Value-Based Purchasing

Value-based purchasing is based on the concept that buyers of healthcare services should hold providers accountable for quality of care as well as costs. In April 2011, the HHS launched the Hospital Value-Based Purchasing Program, which marked the beginning of a historic change in how Medicare pays healthcare providers. The shift from volume to value is widespread. Currently, 2,800 hospitals across the country are being paid for inpatient acute care services based on care cost and quality, not just the quantity of the ser- vices provided.7

“Changing the way we pay hospitals will improve the quality of care for seniors and save money for all of us,” said former HHS Secretary Kathleen Sebelius. “Under this initiative, Medicare will reward hospitals that provide high- quality care and keep their patients healthy. It’s an impor- tant part of our work to improve the health of our nation and drive down costs. As hospitals work to improve quality, all patients—not just Medicare patients—will benefit.” The measures to deter- mine quality focus on how closely hospitals fol- low best clinical practices and how well hospitals enhance patients’ care experiences. The better a hospital does on its quality measures, the greater the reward it receives from Medicare.

What do you think? Should providers be reimbursed based on quality of care? How should “quality” be measured? Should the additional reimbursement to high-quality providers be obtained by reductions in reimbursement to low- quality providers?

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 55

The incentives under per diagnosis reimbursement are similar. Provid- ers, usually hospitals, will seek patients with diagnoses that have the greatest profit potential and discourage (or even discontinue) those services that have the least potential. Furthermore, to the extent that providers have some flexibility in selecting procedures (or assigning diagnoses) to patients, an incentive exists to upcode procedures (or diagnoses) to ones that provide the greatest reimbursement.

In all prospective payment methods, providers have an incentive to reduce costs because the amount of reimbursement is fixed and independent of the costs actually incurred. For example, when hospitals are paid under per diagnosis reimbursement, they have an incentive to reduce length of stay and hence costs. Note, however, that when per diem reimbursement is used, hospitals have an incentive to increase length of stay. Because the early days of a hospitalization typically are more costly than the later days, the later days are more profitable. However, as mentioned previously, hospitals have an incentive to reduce costs during each day of a patient stay.

Under bundled pricing, providers do not have the opportunity to be reimbursed for a series of separate services, which is called unbundling. For example, a physician’s treatment of a fracture could be bundled, and hence billed as one episode, or it could be unbundled, with separate bills submit- ted for making the diagnosis, taking X-rays, setting the fracture, removing the cast, and so on. The rationale for unbundling is usually to provide more detailed records of treatments rendered, but often the result is higher total charges for the parts than would be charged for the entire package of services. Also, bundled pricing, when applied to multiple providers for a single episode of care, forces involved providers (e.g., physicians and a hospital) to jointly offer the most cost-effective treatment. Such a joint view of cost containment may be more effective than each provider separately attempting to minimize its treatment costs because lowering costs in one phase of treatment could increase costs in another.

Finally, capitation reimbursement changes the playing field by com- pletely reversing the actions that providers must take to ensure financial success. Under all fee-for-service methods, the key to provider success is to work harder, increase utilization, and hence increase profits; under capita- tion, the key to profitability is to work smarter and decrease utilization. As with prospective payment, capitated providers have an incentive to reduce costs, but now they also have an incentive to reduce utilization. Thus, only those procedures that are truly medically necessary should be performed, and treatment should take place in the lowest-cost setting that can provide the appropriate quality of care. Furthermore, providers have an incentive to promote health, rather than just treat illness and injury, because a healthier population consumes fewer healthcare services.

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G apenski ’s Healthcare F inance56

1. What provider incentives are created under fee-for-service reimbursement? Under capitation?

SELF-TEST QUESTION

Medical Coding: The Foundation of Fee-for-Service Reimbursement

Medical coding, or medical classification, is the process of transforming descriptions of medical diagnoses and procedures into code numbers that can be universally recognized and interpreted. The diagnoses and procedures are usually taken from a variety of sources within the medical record, such as doctor’s notes, laboratory results, and radiological tests. In practice, the basis for most fee-for-service reimbursement is the patient’s diagnosis (in the case of inpatient settings) or the procedures performed on the patient (in the case of outpatient settings). Thus, a brief background on clinical coding will enhance your understanding of the reimbursement process.

Diagnosis Codes The International Classification of Diseases (most commonly known by the abbreviation ICD) is the standard for designating diseases plus a wide variety of signs, symptoms, and external causes of injury. Published by the World Health Organization (WHO), ICD codes are used internationally to record many types of health events, including hospital inpatient stays and causes of death. (ICD codes were first used in 1893 to report death statis- tics.) The WHO periodically revises the diagnostic codes in ICD, which is now in its eleventh version (ICD-11).8

The United States has used ICD-10-CM since October 1, 2015. This national variant of ICD-10 was provided by CMS and the National Center for Health Statistics, and the use of ICD-10-CM codes is now mandated for all inpatient medical reporting. There are over 70,000 ICD-10-CM procedure codes and over 69,000 diagnosis codes, compared with about 3,800 proce- dure codes and roughly 14,000 diagnosis codes found in the ICD-9-CM.

The ICD-10 codes are three to seven characters long. The first three characters refer to the category; the next three characters refer to etiology, anatomic site, severity, or other clinical detail; and the seventh character refers to extension. For example, code S52 describes a fracture of the fore- arm, while S52.521A describes a torus fracture of the lower end of the right radius, initial encounter for closed fracture.

In practice, the application of ICD codes to diagnoses is complicated and technical. Hospital coders have to understand the coding system and the medical terminology and abbreviations used by clinicians. Because of this

medical coding The process of transforming medical diagnoses and procedures into universally recognized numerical codes.

International Classification of Diseases (ICD) codes Numerical codes for designating diseases plus a variety of signs, symptoms, and external causes of injury.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 57

complexity, and because proper coding can mean higher reimbursement from third-party payers, ICD coders require a great deal of training and experience to be most effective.

Procedure Codes While ICD codes are used to specify diseases and conditions, Current Pro- cedural Terminology (CPT) codes are used to specify medical procedures (treatments). CPT codes were developed and are copyrighted by the Ameri- can Medical Association. The purpose of CPT is to create a uniform language (set of descriptive terms and codes) that accurately describes medical, surgi- cal, and diagnostic procedures. CPT and its corresponding codes are revised periodically to reflect current trends in clinical treatments. To increase stan- dardization and the use of electronic health records, federal law requires that physicians and other clinical providers, including laboratory and diagnostic services, use CPT for the coding and transfer of healthcare information. (The same law also requires that ICD codes be used for hospital inpatient services.)

To illustrate CPT codes, there are ten codes for physician office vis- its. Five of the codes apply to new patients, while the other five apply to established patients (repeat visits). The differences among the five codes in each category are based on the complexity of the visit, as indicated by three components: (1) extent of patient history review, (2) extent of examination, and (3) difficulty of medical decision-making. For repeat patients, the least complex (typically shortest) office visit is coded 99211, while the most com- plex (typically longest) is coded 99215.

Because Medicare, Medicaid, and other insurers require additional information from providers beyond that contained in CPT codes, CMS devel- oped an enhanced code set, the Healthcare Common Procedure Coding System (HCPCS) (commonly pronounced “hick picks”). The system expands the set of CPT codes to include nonphysician services (e.g., ambulance trans- portation) and durable medical equipment (e.g., prosthetic devices).

Although CPT and HCPCS codes are not as complex as the ICD codes, coders still must have a high level of training and experience to use them correctly. As in ICD coding, correct CPT coding ensures correct reimbursement. Coding is so important that many businesses offer services, such as books, software, education, and consulting, to hospitals and medical practices to improve coding efficiency.

1. Briefly describe the coding system used in hospitals (ICD codes) and medical practices (CPT codes).

2. What is the link between coding and reimbursement?

SELF-TEST QUESTIONS

Current Procedural Terminology (CPT) codes Codes applied to medical, surgical, and diagnostic procedures.

Healthcare Common Procedure Coding System (HCPCS) A medical coding system that expands the CPT codes to include nonphysician services and durable medical equipment.

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G apenski ’s Healthcare F inance58

Specific Reimbursement Methods

There are many specific reimbursement methods in use today. Typically, the meth- ods differ from one insurer to another. In addition, insurers use different methods for different types of providers and services, such as hospitals versus physicians or even hospital inpatients versus outpatients. In this section, we discuss the specific meth- ods used by Medicare to reimburse hos- pitals for inpatient services and physicians for all services. Medicare reimbursement methods for other types of providers and other services are described in the Payment Basics series developed and maintained by the Medicare Payment Advisory Com- mission (MedPAC), available at http:// medpac.gov/-documents-/payment-basics.

Hospital Inpatient Services Medicare’s inpatient prospective pay- ment system (IPPS) is a prospective payment methodology based on an inpa- tient’s diagnosis at discharge. It starts with two national base payment rates (operat- ing and capital expenses), which are then adjusted to account for two factors that affect the costs of providing care: (1) the patient’s condition and treatment and (2) market conditions in the facility’s geo- graphic location (see exhibit 2.1).

Discharges are assigned to one of 754 Medicare severity diagnosis- related groups (MS–DRGs), which designate the diagnoses of patients with similar clinical problems, who therefore are expected to consume similar amounts of hospital resources. Each MS–DRG has a relative weight that reflects the expected cost of inpatients in that group. The payment rates for MS–DRGs in each local market are determined by adjusting the base pay- ment rates to reflect the local input price level and then multiplying them by the relative weight for each MS–DRG. The operating and capital payment rates are increased for facilities that operate an approved resident training

inpatient prospective payment system (IPPS) The method, based on diagnosis, that Medicare uses to reimburse providers for inpatient services.

Healthcare in Practice Using RVUs for Physician Compensation

Traditionally, there have been a number of ways of estimating physician productivity when tying com- pensation to performance. For many years, produc- tivity was measured by volume-based metrics such as number of patients seen or amount of revenue billed. Today, however, physician productivity mea- sures and compensation models are rapidly moving toward models based on relative value units (RVUs).

Work RVUs, which are one of three compo- nents of RVUs, measure the relative level of time, skill, training, and intensity required of a physi- cian to provide a given service. They are a good proxy for the training required and volume of work expended by a physician in treating patients. A routine well-patient visit, for example, would be assigned a lower RVU than an invasive surgical procedure. Given this relative scale, a physi- cian seeing two or three complex or high-acuity patients per day could accumulate more RVUs than a physician seeing ten or more low-acuity patients per day. Thus, the nature of the work, rather than number of patients or billings, is being measured and hence used for compensation levels.

According to the Medical Group Manage- ment Association, well over half of all physicians are compensated, at least in part, on the basis of productivity as measured by work RVUs. Usually, work RVUs are combined with other productivity and quality measures in determining productivity and compensation, but there is little doubt that work RVUs have the dominant role.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 59

program or that treat a disproportionate share of low-income patients. Rates are reduced for transfer cases, and outlier payments are added for cases that are extraordinarily costly to protect providers from large financial losses due to unusually expensive cases. Both operating and capital payment rates are updated annually.

The IPPS rates are intended to cover the costs that reasonably efficient providers would incur in providing high-quality care. If the hospital is able to provide the services for less than the fixed reimbursement amount, it can keep the difference. Conversely, if a Medicare patient’s treatment costs are

+

+ + =

×

Adjusted for geographic factors

Adjusted for case mix

Adjustment for transfers

Policy adjustments for hospitals that qualify

If case is extraordinarily

costly

Wage index > 1.0

Wage index ≤ 1.0

Indirect medical

education payment

Disproportionate share payment

Full LOS

Short LOS and discharged

to other acute IPPS hospital or post-acute

care*

Operating base

payment rate

Adjusted base

payment rate

Per case payment

rate

Payment

High- cost

outlier (payment

+ outlier

payment)

Per diem

payment rate

Hospital wage index

Adjusted base

payment rate

MS–DRG

Patient characteristics

68.3% adjusted for area wages

62% adjusted for area wages

Principal diagnosis Procedure Complications and comorbidities

Non-labor related portion

Base rate adjusted

for geographic

factors

MS–DRG weight

EXHIBIT 2.1 Medicare Hospital Acute Inpatient Services Payment System

Note: MS–DRG (Medicare severity diagnosis-related group), LOS (length of stay), IPPS (inpatient prospective payment system). Capital payments are determined by a similar system. In addition to the inpatient operating and inpatient capital payments per discharge, hospitals may receive additional payments, such as those related to direct graduate medical education, uncompensat- ed care, and bad debts. Additional payments are also made for certain rural hospitals. Hospitals may receive penalties or additional payments based on their performance on quality standards.

* Transfer policy for cases discharged to post–acute care settings applies for cases in 278 selected MS–DRGs.

Source: Reprinted from MedPAC, “Hospital Acute Inpatient Services Payment System,” revised October 2019, http://medpac.gov/docs/default-source/payment-basics/medpac_payment_ basics_19_hospital_final_v2_sec.pdf.

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G apenski ’s Healthcare F inance60

more than the reimbursement amount but do not meet the definition of an outlier, the hospital must bear the loss.

Physician Services Medicare pays for physician services using a resource-based relative value scale (RBRVS). Under the RBRVS system, payments for services are determined by the resource costs needed to provide them as measured by weights called relative value units (RVUs). RVUs consist of three components: (1) a work RVU, which includes the skill level and training required along with the intensity and time required for the service; (2) a practice expense RVU, which includes equipment and supplies costs as well as office support costs, including labor; and (3) a malpractice expense RVU, which accounts for the relative risk and cost of potential malpractice claims. To illustrate, the (total) RVU is 0.52 for a minimal office visit, 1.32 for an average office visit, and 3.06 for a comprehensive office visit. Furthermore, the average office visit RVU is composed of a work RVU of 0.67, a practice expense RVU of 0.62, and a malpractice expense RVU of 0.03.

The RVU values then are adjusted to reflect variations in local input prices, and the total is multiplied by a standard dollar value—called the con- version factor—to arrive at the payment amount. Medicare’s payment rates may also be adjusted to reflect provider characteristics, geographic designa- tions, and other factors. The provider is paid the final amount, less any ben- eficiary coinsurance (see exhibit 2.2).

1. Briefly describe the method used by Medicare to reimburse providers for inpatient services.

2. Explain the method used by Medicare to reimburse providers for physician services.

SELF-TEST QUESTIONS

Healthcare Reform and Reimbursement Methods

In addition to improving healthcare delivery through focusing on access and quality, the ACA has significantly changed the way providers are reimbursed. The key reforms include an increased focus on quality and efficiency and a move from a fee-for-service model to a prospective payment model, which may include bundled payments or capitation. These new payment methods aim to shift from reimbursement based on the amount of services provided (volume) to reimbursement based on value and better outcomes. Despite efforts to repeal and replace the ACA, most experts predict that the shift toward value-based payment will continue.

relative value unit (RVU) A measure of the amount of resources consumed to provide a particular service. When applied to physicians, a measure of the amount of work, practice expenses, and liability costs associated with a particular service.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 61

The new payment methods are specifically designed to accomplish the following:

• Encourage providers to deliver care in a high-quality, cost-efficient manner

• Support coordination of care among multiple providers • Adopt evidence-based care standards and protocols that result in the

best outcomes for patients • Provide accountability and transparency • Discourage overtreatment and medically unnecessary procedures • Eliminate or reduce the occurrence of adverse events • Discourage cost shifting

+ +× × × ×

=

Complexity of service

and expenses

Geographic factors

Provider type Geographic Quality Payment Program

Payment

Adjusted for:

Conversion factor

Payment modifier

Adjusted fee schedule

payment rate

Adjusted fee schedule

payment rate

Total RVUs from fee schedule

Policy adjustments (multiplicative)

Work RVU

PE RVU

PLI RVU

PLI GPCI

PE GPCI

Work GPCI

(decreases)

Non-physician billing

independently

Non- participating

HPSA bonus

Clinicians who participate in

advanced alternative

payment models

Clinicians in the Merit-based

Incentive Payment System

(MIPS)

(increases) (increases) (increases, decreases, or no change)

EXHIBIT 2.2 Medicare Physician Services Payment System

Note: RVU (relative value unit), GPCI (geographic practice cost index), PE (practice expense), PLI (professional liability insurance), HPSA (health professional shortage area). This fig- ure depicts Medicare program payments only. The fee schedule lists separate PE RVUs for facility and nonfacility settings. Fee schedule payments are often reduced when specified nonphysician practitioners bill Medicare independently, but not when services are provided “incident to” a physician’s services and billed under a physician’s billing number. Clinicians who participate in advanced alternative payment models receive an incentive payment of 5 percent of their professional services payments. Clinicians in MIPS (the Merit-based Incentive Payment System) receive a positive or negative payment adjustment (or no change) based on their performance in four areas: quality, resource use, advancing care information, and clinical practice improvement.

Source: Reprinted from MedPAC, “Physician and Other Health Professional Payment System,” revised October 2019, http://medpac.gov/docs/default-source/payment-basics/medpac _payment _basics_19_physician_final_sec.pdf.

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G apenski ’s Healthcare F inance62

The sections that follow describe a few of the important implications for provider payments.

Value-Based Purchasing Value-based purchasing (VBP) is a Medicare initiative that rewards acute care hospitals with incentive payments for efficiently providing high-quality care to Medicare beneficiaries. This should lead to lower costs and better clin- ical outcomes for all hospitalized patients. The amounts of these payments are based on outcome measures such as mortality, healthcare-associated infections, patient safety and experience, process of care, and efficiency and cost reduction. Hospitals may be rewarded for their performance compared with all other hospitals, or for how well they improved their own perfor- mance compared with performance during a baseline period. Medicare also uses value-based payment programs for end-stage renal disease, skilled nurs- ing facilities, and home health.

Quality-Based Clinician Compensation In addition to VBP for hospitals, Medicare factors quality into payments for physicians and most other clinicians. Quality-based compensation is part of Medicare’s effort to shift medicine away from the volume-based focus, where clinicians are paid for each service regardless of quality. Clinicians can earn additional compensation based on the quality of care they provide to their patients. Bonuses and penalties are calculated on the basis of performance on quality measures, which vary by specialty. As with VBP programs for hospitals, quality-based clinician reimbursement programs can be paired with shared savings programs, discussed next.

Shared Savings Programs Shared savings is an approach to reducing healthcare costs and a mechanism for encouraging the creation of accountable care organizations (ACOs). Under shared savings, if a provider reduces total healthcare spending for its patients below the level that the payer expected, the provider is then rewarded with a portion of the savings. The benefits are twofold: (1) The payer spends less than it would otherwise, and (2) the provider gets more revenue than it expected. The savings can arise from the more efficient, cost- effective use of hospital or outpatient services that enhance quality, reduce costs over time, and improve outcomes. It can be applied to hospital episodes of care, including physician services, or to physician office care.

Bundled Payment Models Bundled payment models are a form of fee-for-service reimbursement in which a single sum covers all healthcare services related to a specific

value-based purchasing (VBP) An approach to provider reimbursement that rewards quality and efficiency of care rather than quantity of care.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 63

procedure. The objective of bundled payments is to promote more efficient use of resources and reward providers for improving the coordination, qual- ity, and efficiency of care. If the cost of services is less than the bundled payment, the physicians and other providers retain the difference. But if the costs exceed the bundled payment, physicians and other providers are not compensated for the difference.

In some circumstances, an ACO may receive the bundled payment and subsequently divide the payment among participating physicians and providers. In other situations, the payer may pay participating physicians and providers independently, but it may adjust each payment according to negoti- ated predefined rules to ensure that the total payments to all the providers do not exceed the total bundled payment amount. This type of reimbursement is called virtual bundling. For providers, the challenges of bundled payments include determining who owns the episode of care and apportioning the pay- ment among the providers.

Readmissions Reduction Program The Hospital Readmissions Reduction Program is a Medicare initiative that financially penalizes hospitals if they experience excessive readmission rates compared with expected levels of readmission. The penalties are based on a 30-day readmission measure for conditions such as heart attack, heart failure, and pneumonia.

Hospital-Acquired Conditions Reduction Program The Hospital-Acquired Conditions Reduction Program is a Medicare initia- tive to encourage hospitals to improve patient safety. Under the program, hospitals in the worst-performing quartile for hospital-acquired conditions such as bed sores, infections, complications from extended use of catheters, and injuries caused by falls are penalized 1 percent of inpatient payments for all discharges.

1. Briefly describe the impact of healthcare reform on payments to providers.

SELF-TEST QUESTION

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G apenski ’s Healthcare F inance64

Key Concepts This chapter covers important background material related to health- care insurance and provider reimbursement. The key concepts of this chapter are as follows:

• Health insurance is widely used in the United States because individuals are risk averse and insurance firms can take advantage of the law of large numbers.

• Insurance is based on four key characteristics: (1) pooling of losses, (2) payment for random losses, (3) risk transfer, and (4) indemnification.

• Adverse selection occurs when individuals most likely to have claims purchase insurance while those least likely to have claims do not.

• Moral hazard occurs when an insured individual purposely sustains a loss, as opposed to a random loss. In a health insurance setting, moral hazard is more subtle, producing such behaviors as seeking more services than needed and engaging in unhealthy behavior because the costs of the potential consequences are borne by the insurer.

• Most provider revenue is not obtained directly from patients but from healthcare insurers, known collectively as third-party payers.

• Third-party payers are classified as private insurers (Blue Cross Blue Shield, commercial, and self-insurers) and public insurers (Medicare and Medicaid).

• Managed care plans, such as health maintenance organizations (HMOs), strive to combine the insurance function and the provision of healthcare services.

• Third-party payers use many different payment methods that fall into two broad classifications: fee-for-service and capitation. Each payment method creates a unique set of incentives and risk for providers.

• When payers pay billed charges, they pay according to a schedule of rates established by the provider called a chargemaster.

• Negotiated charges, which are discounted from billed charges, are used by insurers with sufficient market power to demand price reductions.

• Under a cost-based reimbursement system, payers agree to pay providers certain allowable costs incurred when providing services to the payers’ enrollees.

(continued)

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 65

Because the managers of health services organizations must make financial decisions within the constraints imposed by the economic environ- ment, the insurance and reimbursement concepts discussed in this chapter will be used throughout the remainder of the book.

• In a prospective payment system, the rates paid by payers are determined in advance and are not tied directly to reimbursable costs or billed charges. Typically, prospective payments are made on the basis of the following service definitions: (1) per procedure, (2) per diagnosis, (3) per diem (per day), or (4) bundled pricing.

• Capitation is a flat periodic payment to a physician or another healthcare provider; it is the sole reimbursement for providing services to a defined population. Capitation payments are generally expressed as some dollar amount per member per month, where the word member typically refers to an enrollee in some managed care plan.

• Medical coding is the foundation of fee-for-service reimbursement systems. In inpatient settings, International Classification of Diseases (ICD) codes are used to designate diagnoses, while in outpatient settings, Current Procedural Terminology (CPT) codes are used to specify procedures.

• Medicare uses the inpatient prospective payment system (IPPS) for hospital inpatient reimbursement. Under IPPS, the amount of the payment is determined by the patient’s Medicare severity diagnosis-related group (MS–DRG).

• To provide some cushion for the high costs associated with severely ill patients within each diagnosis, IPPS includes a provision for outlier payments.

• Physicians are reimbursed by Medicare using the resource-based relative value scale (RBRVS). Under RBRVS, reimbursement is based on relative value units (RVUs), which consist of three resource components: (1) physician work, (2) practice expenses, and (3) malpractice insurance expenses. The RVU for each service is multiplied by a dollar conversion factor to determine the payment amount.

• Healthcare reform is having a significant impact on health insurance and on the way providers are reimbursed. More people now have access to insurance coverage, and new provider payment methods emphasize value, efficiency, and patient outcomes over volume.

(continued from previous page)

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G apenski ’s Healthcare F inance66

Questions

2.1. Briefly explain the following characteristics of insurance: a. Pooling of losses b. Payment only for random losses c. Risk transfer d. Indemnification

2.2. What is adverse selection, and how do insurers deal with the problem?

2.3. What is the moral hazard problem? 2.4. Briefly describe the major third-party payers. 2.5. a. What are the primary characteristics of managed care plans?

b. Describe different types of managed care plans. 2.6. What is the difference between fee-for-service reimbursement and

capitation? 2.7. Describe the provider incentives under each of the following

reimbursement methods: a. Cost based b. Charge based (including discounted charges) c. Per procedure d. Per diagnosis e. Per diem f. Bundled payment g. Capitation

2.8. What medical coding systems are used to support fee-for-service payment methodologies?

2.9. Briefly describe how Medicare pays for the following: a. Inpatient services b. Physician services

2.10. What are some features of healthcare reform that affect healthcare insurance and reimbursement?

Selected Cases

Three cases in Gapenski’s Cases in Healthcare Finance, sixth edition, are applicable to this chapter: Case 1: New England Healthcare; Case 2: Orlando Family Physicians; and Case 3: Santa Fe Healthcare.

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Chapter 2: Healthcare Insurance and Reimbursement Methodologies 67

Notes

1. See, for example, the Hospital Compare tool of the Centers for Medicare & Medicaid Services (www.medicare.gov/hospitalcompare /search.html) and Medicare.gov’s Procedure Price Lookup (www .medicare .gov/procedure-price-lookup).

2. Blue Cross Blue Shield Association. 2018. “Blue Facts: Healthcare Coverage Designed for Your Community, Accessible Across the Country.” Published May. www.bcbs.com/sites/default/files/file -attachments/page/BCBS.Facts__0.pdf.

3. Centers for Medicare & Medicaid Services. 2018. “CMS Regional Offices.” Modified April 18. www.cms.gov/Medicare/Coding /ICD10/CMS-Regional-Offices.html.

4. Congressional Budget Office. 2017. “Repealing the Individual Health Insurance Mandate: An Updated Estimate.” Published November 8. www.cbo.gov/publication/53300.

5. Medicaid.gov. 2020. “October 2019 Medicaid & CHIP Enrollment Data Highlights.” Accessed January 29. www.medicaid.gov/medicaid /program-information/medicaid-and-chip-enrollment-data/report -highlights/index.html.

6. Kaiser Family Foundation. 2020. “Marketplace Enrollment, 2014– 2019.” Accessed January 29. www.kff.org/health-reform/state -indicator/marketplace-enrollment/?currentTimeframe=0&sortModel =%7B%22colId%22:%22Location%22,%22sort%22:%22asc%22%7D.

7. Centers for Medicare & Medicaid Services. 2020. “The Hospital Value-Based Purchasing (VCP) Program.” Modified January 6. www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment -Instruments/Value-Based-Programs/HVBP/Hospital-Value-Based -Purchasing.html.

8. World Health Organization. 2020. “International Classification of Diseases, 11th Revision.” Accessed January 13. https://icd.who.int /en/.

Resources

For the latest information on events that affect the healthcare sector, see Modern Healthcare, published weekly by Crain Communications Inc.: www.crain.com/ brands/modern-healthcare/.

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Other resources pertaining to this chapter include Beagle, J. T. 2010. “Episode-Based Payment: Bundling for Better Results.” Health-

care Financial Management 64 (2): 36–39. D’Cruz, M. J., and T. L. Welter. 2010. “Is Your Organization Ready for Value-Based

Payments?” Healthcare Financial Management 64 (1): 64–70, 72. . 2008. “Major Trends Affecting Hospital Payment.” Healthcare Financial

Management 62 (1): 52–58, 60. Harris, J., I. Elizondo, and A. Isdaner. 2014. “Medicare Bundled Payment: What Is

It Worth to You?” Healthcare Financial Management 68 (1): 76–82. Kaplan, R. S., and M. E. Porter. 2011. “The Big Idea: How to Solve the Cost Crisis

in Health Care.” Harvard Business Review 89 (9): 46–52, 54, 56–61. Kentros, C., and C. Barbato. 2013. “Using Normalized RVU Reporting to Evaluate

Physician Productivity.” Healthcare Financial Management 67 (8): 98–105. Kim, C., D. Majka, and J. H. Sussman. 2011. “Modeling the Impact of Healthcare

Reform.” Healthcare Financial Management 65 (1): 51–60. Mulvany, C. 2013. “Insurance Market Reform: The Grand Experiment.” Healthcare

Financial Management 67 (4): 82–86, 88. . 2010. “Healthcare Reform: The Good, the Bad, and the Transformational.”

Healthcare Financial Management 64 (6): 52–59. Patton, T. L. 2009. “The IRS’s Version of Community Benefit: A Look at the Rede-

signed Form 990 and New Schedule H.” Healthcare Financial Management 63 (2): 50–54.

Pearce, J. W., and J. M. Harris. 2010. “The Medicare Bundled Payment Pilot Pro- gram: Participation Considerations.” Healthcare Financial Management 64 (9): 52–56, 58, 60.

Ronning, P. L. 2011. “ICD-10: Obligations and Opportunities.” Healthcare Finan- cial Management 65 (8): 48–51.

Saqr, H., O. Mikhail, and J. Langabeer. 2008. “The Financial Impact of the Medicare Prospective Payment System on Long-Term Acute Care Hospitals.” Journal of Health Care Finance 35 (1): 58–69.

Shoemaker, P. 2011. “What Value-Based Purchasing Means to Your Hospital.” Healthcare Financial Management 65 (8): 60–68.

Tyson, P. 2010. “Preparing for the New Landscape of Payment Reform.” Healthcare Financial Management 64 (12): 42–48.

Wilensky, G. R. 2011. “Continuing Uncertainty Dominates the Healthcare Land- scape.” Healthcare Financial Management 65 (3): 34, 36.

Williams, J. 2013. “A New Model for Care: Population Management.” Healthcare Financial Management 67 (3): 68–76.

Woodson, W., and S. Jenkins. 2010. “Payment Reform: How Should Your Organiza- tion Prepare?” Healthcare Financial Management 64 (1): 74–79.

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PART

II FINANCIAL ACCOUNTING

Part I discussed the unique environment that creates the framework for the practice of healthcare finance. In part II, we begin the actual cover- age of healthcare finance by discussing financial accounting, which

involves the measurement and recording of economic events and the prepara- tion of a business’s financial statements. These statements are designed to provide pertinent financial information about an organization to its investors, lenders, and other creditors. Other stakeholders, such as regulators and man- agers, may find the information useful as well.

The coverage of financial accounting extends over several chapters. Chapter 3 begins with an introduction to basic financial accounting concepts and an explanation of how organizations report financial performance, spe- cifically revenues, expenses, and profits. Then, in chapter 4, the discussion is extended to the reporting of financial status, which includes an organization’s assets, liabilities, and equity. In addition, chapter 4 covers the way in which organizations report cash flows. The chapter 4 supplement discusses the recording of transactions, which is the first step in the creation of a business’s financial statements.

Finally, chapter 17 discusses how interested parties use financial state- ment data to assess the financial condition of an organization. Chapter 17 is placed at the end of the book because the nuances of financial statement analysis may be better understood after learning more about the financial workings of a business. Part II and chapter 17, taken together, will provide readers with a basic understanding of how financial statements are created and used to make judgments regarding the operational status and financial condition of health services organizations.

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