Taking Bold Steps with Hospital Pricing & Cost Transparency

March 19, 2014 by Ken Conner, CPA, Shareholder & Healthcare Practice Leader

Executive Summary

Elliott Davis Decosimo is proud to launch a Healthcare White Paper Series with an examination of the emerging trends for hospitals to re-evaluate their charge rates for services and the growing call from many corners of the public for greater price transparency. Though they intersect at certain points in this white paper, charge rates and price transparency are separate issues with their respective sets of concerns. While Elliott Davis Decosimo Healthcare White Paper Series author Ken Conner touches upon price transparency, the major focus of this white paper is to offer a look into a new approach toward facilitating charges and the impact on key stakeholders, including insurance providers and those government agencies working with Medicare and Medicaid.

This white paper asks the key questions and offers cutting-edge answers for hospitals leaders on why and how to engage in the process of restructuring hospital charges. In addition, Mr. Conner examines the impact of charge reductions by hospitals and how hospitals can be positioned for success by making this type of industry-leading change. As the United States moves closer toward becoming a nation of healthcare consumers who are interested in knowing how their out-of-pocket deductibles are being spent, hospitals which can successfully implement more understandable cost structures and provide greater amounts of price transparency will have a competitive advantage.

Headlines on the Horizon: Hospital Lowers Prices!

Latest Trends Moving Closer to Cost Transparency

Imagine you woke up one morning to read the headlines that your biggest hospital competitor had cut its charges by 50 percent and introduced a “Medical Procedure Price Hotline.” Would you choose one of the following options?

A. Ignore it as a marketing ploy.

B. Say, “Who cares! These charges do not mean anything.”

C. Expect to fend off questions from your board and medical staff.

D. Go back to bed.

Such a bold move might be more than a marketing ploy. It might be a real coup. With the ongoing discussion over transparent prices, such a proactive move would clearly draw attention to the hospital and escalate the level of consumerism in the local community.

As evidenced by some recent actual headlines, option “C” from our multiple choice example is becoming the more common response. Without a doubt, the debate over the true cost of medical services and attaining greater pricing transparency has become a significant topic of discussion among an increasing number of hospital administrators and their boards of directors.

This January in Miami, hospital leaders across South Florida were indeed greeted by almost the same price-cutting news described here. Miami Children’s Hospital became one of the first facilities in the nation to announce it would cut the prices listed in its Chargemaster guidelines by 30 percent.

According to numerous media reports, including a feature on National Public Radio, Miami Children’s Hospital made the move in response to a growing stream of inquiries by parents who were trying to get a sense of the cost they would be incurring if they selected the hospital for medical services.

Rather than walk budget-conscience parents through the intricacies of the Chargemaster structure and, for instance, describe how it works with insurance coverage and Medicare, Miami Children’s Hospital facilitated a 30-percent price reduction on its Chargemaster rates. According to a report in Media Health Leaders, Timothy Birkenstock, chief financial officer of the 289-bed hospital, then began the process of renegotiating with health plans, including contracts with Blue Cross, Humana, and UnitedHealth. Miami Children’s negotiated a network rate with a plan that is based in part on a 50-percent discount of the current Chargemaster price. In some instances, the rate renegotiation could result in a lower discount offered by the plan.

Birkenstock noted that the hospital’s focus with these changes is to establish a more transparent pricing system which can achieve two goals:

1. Provide a more accurate pricing model that is easy to understand and more accepted by the public.

2. Achieve an overall pricing structure that is revenue neutral for the hospital.

Who Will Be the Next Hospital Taking Bold Pricing Steps?

As seen in the Miami Children’s Hospital example, the move to transparency should not be dismissed as a meaningless marketing ploy. Not unlike a trip to your favorite grocery store or your retail outlet of choice, the public is beginning to become more of a discerning “hospital consumer.” Hospital administrators must start to understand that the old refrain from the familiar explanation of “those charges don’t mean anything” is no longer acceptable. In fact, a response along those lines could place your hospital at a competitive disadvantage in many markets.

More facts about issues related to traditional hospital pricing structures and Chargemaster modeling are coming to light. In March of 2013, Time Magazine devoted its cover story to “The Bitter Pill: Why Medical Bills Are Killing Us.”

There is a wealth of information available on the issues related to achieving greater transparency in hospital pricing models. Be assured, this is not a passing trend. Pricing transparency is gaining great momentum, and it has the type of strength to bring fundamental change to the hospital industry.

According to the Centers for Medical & Medicaid Services, the cost-to-charge ratios for urban hospitals on a state-by-state basis range from a low of 24 percent to a high of 76 percent — with the majority of states clustered in the mid-30s percent range.

Those statistics could easily prompt the following questions: How many hospital CEOs could defend a 3-to-1 or 4-to-1 mark-up? How many CEOs can actually report with a degree of accuracy their respective cost-to-charge ratio?

Even at a cost-to-charge ratio of 40 percent, the charge is on average 2.5 times the cost of operation. We all recognize that most of the hospital’s payors have some type of fixed-fee schedules based on per diems, diagnosis-related groups (DRGs), current procedural terminology (CPTs) codes or other standard measures. But the charge is a common point of measure for an individual hospital and every hospital has some charge-based payments — whether in the form of a percent-of-charges contract for all charges or for specific high-cost items. Further, the charges impact a variety of calculations, including outlier payments for Medicare or managed-care contracts.

So, what does it really mean if a hospital makes a decision to lower charges a hypothetical 50 percent, with a 50 percent write-off from charge-based payments and if two percent of hospital’s patients are linked to a charge-based payment?

The result of such a seismic change would mean a margin reduction in the bottom line of 1.0 percent, which is more than many hospitals are making. Yet, with that stated, these questions remain: Does a hospital continue to support the current charge structure?  Conversely, in this era of price transparency and increased scrutiny on charges as a result of Medicare outlier problems or uninsured lawsuits, should hospitals being trying to restructure their prices?

A particular hospital’s sensitivity or inclination to reduce charges will be most affected by its historical ability to secure percent-of-charge contracts and the prevalence of less sophisticated payors in the market. In addition, the following trends will continue to erode a hospital’s ability to secure charge-based contracts:

  • Increased consumerism and public awareness.
  • Competitors actions.
  • Market pressures on smaller payors to control cost.
  • Continued consolidation of payors and the consolidation of brokers into more sophisticated sales forces.
  • Improvement in payors analysis and application of fixed payment systems.

The Process of Lowering Charges

The task of lowering charges can be a daunting undertaking when faced with the size of hospital Chargemasters and the lack of good cost accounting at the procedure level. The best approach is one that breaks the line items into common manageable groups.

In trying to find a common factor, hospitals must first look to the nature of the charge item and a common unit of measure. For example, a number of tests are common among patients and between facilities. Tests such as radiology exams or lab tests have various measures of the relative values. The relative values can be used to first set the charge for each line item on a relatively equal basis. From there, charges can be adjusted easily and uniformly.

The next obvious group is supplies and drugs — which are priced using various markup formulas. Within these two categories, the underlying cost is easily determined. The challenge is factoring the cost of dispensing the item into the price. Historically, the markup formulas were designed to recognize that it costs virtually the same to dispense a pill with a price of five cents as it does to dispense a pill costing $2.00. This historical approach to the formula was facilitated by reducing the markup as the item cost would rise. These formulas are often adjusted in a price increase, but they can also be adjusted in a price decrease.

Other charges may be appropriately bundled with the primary service, which can then simplify the charges. For example, most hospitals charge for the monitor(s) and other equipment and supplies used with an intensive care unit patient – when, in fact, access to these items is one of the reasons that the patient is in ICU.

In examining existing cost structures and possible adjustments, hospitals have to use common sense in determining what is reasonable, while, at the same time, looking at each department’s overhead consumption and cost-to-charge ratio.

The Impact of Charge Reduction

As a hospital begins to look at reducing charges, it must also be monitoring the impact of those reductions on the financial condition of the hospital. The following points must be considered:

  • How many patients or their insurers are paying (really paying, as in cash) based on charges and for which items are they paying charges?
  • Review each managed-care contract to identify which services are charge-based, and quantify the payor volume for each effected department. (For example, a payor may have a schedule for lab, radiology, outpatient surgery, but not the level 5 emergency room visit or pacemakers and other implants).
  • Discuss with the revenue cycle manager, or patient accounting director the types of charge-based payments being received.
  • Identify outlier payments at the patient level. (Each hospital should be monitoring this as part of their contract management). Calculate the impact of a charge reduction on each patient and collectively by payor.
  • Medicare outliers as the calculation can be self-correcting with a filed cost report and the prescribed reconciliation. However, hospitals will have to press the issue with the Medicare contractor and be prepared for delays in any retroactive change.

In the case of Medicare outlier changes, hospitals will have to work with their cost report preparer to monitor the short-term impact. Also, hospitals, whenever possible, should reduce the charges enough to require the Medicare Contractor to do an outlier reconciliation on the year in which the reduction occurs. Still Medicare Contractors may not be aware or willing to make the required reconciliation. The threshold to trigger a reconciliation is the following:

  • An absolute change in the cost-to-charge ratio of at least 10 points (rise from .3 to .4, not from .3 to .33).
  • Reported outlier amounts in excess of $500,000.
  • Medicare Contractors can make other reconciliations on an exception basis and hospitals should claim the appropriate amount on the cost report in order to protect appeal rights.
  • Review the managed-care contracts for payment limitations based on billed charges. Some contracts may limit the payment to the lesser of the scheduled payment or billed charges. This is most often an issue with short-stay inpatients cases, because outpatients are most often paid on a fee schedule.
  • Review historical data on self-pay patients to identify those who have made substantial charge-based payments, excluding non-covered services such as cosmetic surgery, which is often priced competitively.

Negotiating with payors will be a difficult challenge because, in making these modifications to the rate structure, hospitals will be promoting fundamental changes to a complex and long-standing system of commerce. It stands to reason that payors will be skeptical of a hospital’s motives. Based on past history of charge increases, it is logical to expect some of the skepticism.

Yet, over the past few years, the major payors have expressed a desire for more transparency. It is reasonable to expect the major payors will be open to listening, and they will be interested in developing a manageable process that can satisfy concerns of both parties.

To be successful with the payors, a hospital must prepare and educate the major payors on the front end of the process.

Model proposed changes in the charge structure to help the payor understand the impact and to demonstrate productivity by doing the following:

  • Be sensitive to the payors respective payment systems as they are unlikely to make changes to accommodate one hospital system.
  • Show the reset of any percent-of-charge payments to reflect new price structures or offer alternatives to the percent-of-charge. In most competitive markets, the existence of percent-of-charge payments is declining.
  • Renegotiate outlier thresholds or alternatively add the value of reduced outliers back into per diems or DRG rates.
  • Renegotiate lower-of-payment, or bill-charge provisions. Insurers have largely based their own pricing on the payment rate with little expectation of paying less. Many payors will argue that their customer will not understand why they paid more than changers. Be prepared to quantify the effect on payment as a result of lowering charges and add the savings back to conversion factors for per diem or DRG rates.

Being Prepared for the Changes Ahead

There are a myriad of reasons not to fix hospital charge structures — not the least of which includes the time and effort required, the financial risk and the skeptical payor community. There is only one reason to fix the charge structure. Simply stated, addressing the current cost structure is the right thing to do. While the average health consumer might not make a deep study of Chargemaster rates, these same potential patients will definitely be focusing on a hospital’s pricing structure going forward.

Mainstream media outlets have begun to shine a brighter light on the rising costs patients encounter during hospital visits. A recent feature on NBC’s Nightly News reported that hospitalization costs for childbirth in the United States have risen an average of 300 percent since 2004. Regardless of how cost and charges are understood within the hospital and insurance industries, the fact remains the price of any service matters to the public. Healthcare, while the costing is complex, does ultimately have price tags – with pricing the public will doubtlessly seek to better understand.

As the efforts for transparency in pricing gain momentum and do move forward, keep in mind that the hospital industry did not get to this point overnight. It stands to reason that the solution will not happen overnight either. Logic should also dictate that an industry focused on healing can appreciate the need to not delay the process that leads us to more transparent pricing.

Patience and perseverance will definitely be required in administering the prescription that can offer the best cure for the most effective approach to hospital pricing.

We Can Help!

The revision of pricing structures and cost models within the hospital industry is an intricate process. Hospitals must address several key questions, including the following: What is your hospital’s position on price transparency? What is your organization’s view of its Chargemaster rates? What role does price transparency and the Chargemaster play in your contract negotiations with payors? What steps have you taken to prepare your staff to answer pricing questions from patients and prospective patients?

The Elliott Davis Decosimo Healthcare Services Team can assist hospitals in finding the answers to an efficient and effective price transparency/costing model strategy. By utilizing our team of experienced professionals, hospitals can develop a costing structure with the type of transparency in pricing that can offer your facility a competitive advantage in your market. Let our advisors evaluate your strategic needs on pricing and cost structure.