Surprised that the national average rate that employer-sponsored health plans pay hospitals is 2.5-times higher than Medicare’s reimbursement rate? Or that there is actually no relationship between the volume of publicly covered patients a hospital serves to the prices it charges commercially-insured patients? This price transparency is important as states and employers work to rein in health care spending, but what do health care purchasers know about a hospital’s costs for providing patient care?
The Hospital Cost Tool developed by the National Academy for State Health Policy (NASHP) with support from Arnold Ventures can be used as a complement to recent findings reported in RAND Corp.’s Nationwide Evaluation of Health Care Prices Paid by Private Health Plans to help purchasers and regulators better understand hospitals’ costs, their public and commercial payer mix, and their cost recovery from Medicare, Medicaid, and commercial payers.
State officials responsible for cost containment strategies, including administrators of state employee health plans, and employers can use NASHP’s hospital cost tool to understand the relationship between health plans’ hospital payments and the hospital’s reported costs. Understanding the difference between a hospitals’ costs and the payments it receives is critical data that can be used to initiate informed conversations about appropriate payment reimbursements.
The tool uses Medicare cost report (MCR) data that is annually submitted by hospitals to the federal government to calculate a number of cost variables for individual hospitals, including cost-to-charge ratios, profit margin, and more. There is no additional reporting burden on hospitals for states and employers to use this tool. The tool includes detailed instructions and has embedded formulas to help users access and leverage critical information from MCRs, which are often hundreds of pages long for each hospital. The MCR is the only nationally available, public information that provides hospital cost data.
The federal reporting instructions are standard for all hospitals so the information in each hosptial’s MCR is comparable across hospitals. While all hospitals receiving Medicare payments must submit these reports to the federal government, some may be hard to find. Some states require hospitals to submit their MCRs to a certain state agency that is permitted access to the data. Also, there are organizations that provide these reports in a well-organized manner for a fee (annual and/or per hospital MCR). For more information on MCRs, read the NASHP blog, Why Compare What Employers Pay to What Medicare Pays?
While the tool can be used to analyze hosptials’ costs, it is not currently designed to provide analysis about a hospital’s level of efficiency or whether the costs are appropriate given the quality of care provided. However, because the tool uses the MCR data, comparing multiple hospitals is one way to account for efficiency. For example, in comparing two hospitals in a state, if the data from Hospital A shows that Medicare covers 88 percent of its costs, and at Hospital B Medicare covers 103 percent of its costs, that could indicate that hospital B uses its reimbursements more efficiently to provide patient care.
However, there may be additional criteria to consider— some of which is highlighted in the tool – such as payer mix. The tool uses weighted data to account for each payer’s proportion of the population served by the hospital so that comparisons across hospitals with different payer mixes can be made. But, other considerations may be necessary. For example, it may useful to review a hospital’s MCR data over time using the tool to identify a cost trend. Has a hospital made capital investments, such as building or purchasing new facilities, in recent years that increased its costs? Such information could be useful in considering a hospital’s certificate-of-need application. NASHP will continue to refine this tool to integrate potential efficiency and quality measures, but the data on costs is a valuable place to start. The tool’s goal is to provide data to inform discussions between purchasers of care and hospitals.
Officials from several states have reviewed the tool and expressed interest in leveraging what they are learning from its analysis of their hospitals in different ways, such as:
- Pursuing a more robust insurance rate review process to help contain health care cost growth;
- Further informing hospital global budget parameters; and
- Negotiating hospital reimbursement as a reference to Medicare rates.
An early version of this tool, with more limited calculations, was used by the Montana State Employee Health Plan to negotiate with hospitals and providers to establish a reimbursement rate based on Medicare rates.
While the tool includes numerous metrics for analyses, there are several that stand out:
- Financial statements. Net income, reserves, and profit margins are reported for the entire hospital, with no adjustments made for Medicare-disallowed costs. (Medicare disallowed costs include those unrelated to patient care, like research and lobbying, as well as non-patient care-related revenues such as those from hospital cafeterias and parking lots.)
These data points are clearly important to a state or other purchaser in gaining an understanding of some basic information on the financial health of a hospital when pursuing cost-containment measures, as the goal of this initiative is to stem rising health care costs, not impoverish hospitals.
- Cost-to-charge ratio (CCR). The CCR shows the percentage of charges that represent actual operating costs during a one-year period. The ratio generated by the tool is displayed in two formats:
- CCR: This ratio equals costs divided by charges. For example, a CCR of 25 percent means that a hospital’s costs are 25 percent of charges. The lower the percentage, the larger the profit margin on its charges.
- Charges as percentage of costs: This ratio equals charges divided by costs. A ratio of 500 percent means costs are multiplied by – or grossed up – by 500 percent to establish charges.
These ratios are useful when evaluating insurer or third-party administrator (TPA) network discounts off a hospital’s chargemaster rates, which are like list prices for a car and often bear little relation to what providing services actually cost. Insurers often boast about their negotiated discounts with hospitals, but if a hospital’s costs are only 25 percent of its charges, is a discount of 30 percent off chargemaster rates really a good deal?
- Charity care/bad debt/uninsured patients: The NASHP tool specifically uses a hospital’s costs – and not its higher chargemaster rates – for this calculation. Typically, hospitals report their expenses for charity care, bad debt, and services for the uninsured at their chargemaster rates. However, recent changes in accounting rules require these calculations to now be based on costs and, as a result, in their audited financial statements hospitals may no longer report the higher chargemaster rates. While the Centers for Medicare & Medicaid Services and the Internal Revenue Services have not adopted the new accounting rules requiring costs – not chargemaster rates – to be reported, the tool does report at the cost level.
Using costs to indicate a hospital’s uncompensated care is a more accurate representation of this category and can be used to more clearly understand a hospital’s overall profit margin.
- Payer mix: Payer mix is the percentage of hospital patient care charges attributable to Medicare, Medicaid, and commercial – which represents insurers, employer self-insured plans, Veterans Administration, and self-pay, etc.
When assessing hospital costs to develop meaningful cost-containment strategies, the payer mix is important as it helps clarify the hospital’s recovery of costs from each category of payer.
- Profit/loss: NASHP’s tool calculates profit and loss by payer type. Using the global CCR applied to specific payer-type charges, the tool is able to calculate the related costs for each group and its profit margins.
It is important to look at payer mix and profit/loss together. Consider the example highlighted by a NASHP analysis using the tool of one hospital in Colorado:
- The hospital’s data showed a 40 percent loss for Medicaid, but because Medicaid was only 9 percent of the hospital’s payer mix, the loss was limited to only that relatively small portion of the facility’s patient population.
- The same hospital showed a 13 percent profit for Medicare, which comprised 21 percent of its patient population.
- And it reported a 54 percent profit for its commercially-insured patients, who made up 70 percent of its patients.
On the whole, this hospital is profitable. By looking at the payer mix and profit/loss indicators or measures in tandem, policymakers can achieve a clearer, more holistic picture of the financial health of a hospital.
- Multiples of Medicare: The tool also includes hospital payments and costs for commercial payers (commercial insurance, employer self-funded plans, etc.) It calculates the required payments from this segment to allow the hospital to break-even.
- The break-even point is the point at which revenue equals costs, which would result in zero profit and zero loss. Break-even is calculated in the tool in the following way:
- Level 1: Commercial patient costs plus any balance of government program payments, charity care, and uninsured.
- Level 2: Level 1 plus all Medicare-allowed costs.
- Level 3: Levels 1 and 2 plus all Medicare disallowed costs. Physician direct patient costs are not included in the add-back of disallowed costs, as related reimbursement is processed through other channels, such as the Medicare resource-based relative value-scale (RBRVS) physicain payment system, fee schedules, etc.)
- Level 4: Levels 1, 2, and 3 plus hospital non-operating income and expenses.
- The break-even point is the point at which revenue equals costs, which would result in zero profit and zero loss. Break-even is calculated in the tool in the following way:
As states develop budgets for state employee health plans and other public purchasers, and consider developing public option health plans, this tool can be useful to lower costs by developing rates using Medicare as a reference, negotiating increases above Medicare reference rates to account for public payer balances, but that are still lower than their current spending. The tool also helps states find an appropriate rate that can achieve savings but still keep hospitals financially viable. What better data to use than a hospital’s own reported costs?
NASHP staff is available to state officials who may need technical assistance in using the tool, contact Maureen Hensley-Quinn (email@example.com).
Results from a new RAND Corporation study – Nationwide Evaluation of Health Care Prices Paid By Private Health Plans – show commercial payers reimburse hospitals about 2.5-times more than does Medicare. As expected, hospital officials responded, claiming that public payers underpay for medical services and that it is inappropriate to challenge hospitals now as they battle the pandemic. However, the RAND study revealed a very significant finding – there is no relationship between a hospital’s prices charged to commercial payers and its volume of Medicare and Medicaid patients.
There is never a good time to take on hospital prices, but that task is essential if the nation is ever to get a grip on health care costs. Hospitals are large employers and provide an essential service, never more important than during the pandemic, but they also comprise the biggest chunk of health care spending, driving up insurance premiums and out-of-pocket costs.
Additionally, most hospital markets are now consolidated, creating an imbalance in bargaining power and driving up costs. A growing trend in vertical consolidation – when hospital/heath care systems purchase physician practices and other ancillary services – has resulted in increased costs, in part through the addition of facility fees for non-hospital-based services.
Policymakers are often pressured to protect their local hospitals and avoid the much-needed discussion of what is an adequate payment to sustain quality hospital care. The RAND study provides a great place to start that discussion and the first step is understanding just how Medicare sets its rates. The National Academy for State Health Policy (NASHP) offers this overview on Medicare rates and will soon release more tools to help states take on the important policy question of what is an appropriate hospital payment.
How Are Medicare Rates Calculated?
Since the passage of the Social Security Amendments Act of 1983 that created Medicare, the federal health insurance program covering 40 million older and/or disabled adults has primarily reimbursed providers through prospective fee-for-service (FFS) payments. Under the federal Prospective Payment System (PPS), Medicare reimburses each provider a predetermined amount for each service.
Medicare Advantage plans – established in 1997 as privately administered alternatives to traditional Medicare – are a notable exception from the standard FFS system. For these plans, the Centers for Medicare & Medicaid Services (CMS) pays a private health plan a prospective lump sum based on the number of beneficiaries enrolled in the plan. The health plan then uses these funds to reimburse providers and administer benefits to enrollees.
Medicare payments to some plans are negotiated from a benchmark based on a county’s per capita Medicare spending compared to the national average, as well as plan quality indicators. For other plans, the benchmark is a weighted average of the average county rate and the average health plan’s bid. CMS publishes the statutorily derived formulas for these payments.
Under the PPS for inpatient admissions, CMS bases the amount of reimbursement on a patient’s diagnosis-related group (DRG). Each patient’s case is assigned a different DRG code based largely on five main factors, including the type and severity of their illness. Generally, the more resources (e.g., medical supplies) required to treat a patient, the greater the reimbursement. This amount can vary based on local wages and cost of living, and additional payments are made to teaching hospitals and those that treat a high percentage of low-income patients.
Under the PPS for hospital outpatient services, payments are similarly based on resource costs and complexity. Additionally, hospitals can receive payments for using certain new drugs/devices, providing particularly costly services, or if the hospital is a cancer, children’s, and/or rural hospital. To determine these reimbursement rates, CMS receives recommendations from an advisory panel of 16 full-time hospital employees and outpatient PPS providers.
An important recurring factor in CMS’s payment methodology is its consideration of stakeholder recommendations. Under the Resource-Based Relative Value Scale (RBRVS) FFS payment system, CMS considers recommendations from a 31-member physician committee when quantifying the value of each service rendered, based on the following geographically adjusted costs:
- Physician work – the time, skill, and mental/physical effort required to perform the service
- Practice expense – the cost for the service to be rendered at the specific site of care
- Professional liability insurance – the amount a provider spends on malpractice insurance, based on claims data
The Medicare Payment Advisory Commission (MedPAC) – the independent 17-member Congressional advisory commission of health care delivery and finance experts – meets publicly with beneficiary advocates, researchers, and providers to consider their input before submitting an annual report to Congress detailing the payment adequacy in meeting patient care and provider cost needs, in addition to considering any inequities that may result from payments.
According to MedPAC’s March 2020 report, Medicare payments covered 8 percent more than hospitals’ allowed variable costs (costs that can change based on utilization of services), which allows for this additional percentage to contribute to coverage of fixed costs. This method provides incentive for hospitals to lower their costs and encourages them to treat Medicare beneficiaries, as an increase in the number of patients a hospital treats results in an increased contribution to fixed costs while covering variable costs.
Medicare payments are determined in part through these various stakeholder recommendations. However, this input is not the sole means by which Medicare rates are set. CMS also collects quantitative data through the Medicare cost report, which is the primary data collection to assess provider costs.
How Does CMS Collect Provider Cost Data?
The costs that a provider’s PPS reimbursement are based on are collected through a publicly available Medicare cost report (MCR). These annual reports, due five months after a fiscal year ends, are required from all Medicare-reimbursable facilities, including hospitals, skilled nursing homes, home health agencies, home offices, hospices, rural health clinics, federally qualified health centers, and comprehensive outpatient rehabilitation facilities.
Each report includes information on hospital revenues, capacity, discharge volume, charges, and operating costs. To ensure accuracy, an officer or administrator of the hospital must certify the reported data complies with relevant laws and regulations and that the MCR is a “true, correct, and complete statement.” These reports are the only national source for hospital operating costs reported in a uniform manner.
Critics argue that the definition of allowable costs under federal code 42 CFR 413.9(c)(3) is too narrow, classifying what some might say are appropriate costs as non-reimbursable. However, only operating costs related to patient care are reimbursable under the program. If operating costs include amounts for “luxury items or services” (more expensive than those generally considered necessary for the provision of needed health services), such amounts are not allowable.
Physician costs are often the largest “disallowed” appropriate costs, according to critics. However, while some of these costs are disallowed by Medicare through the inpatient/outpatient PPS, this is only because they are reimbursed through other payment methods. The MCR splits physician costs into three buckets:
- Non-reimbursable services: These services, of which research is the most common component, are disallowed as they do not provide patient care and are usually reimbursed by other funding.
- Professional services to individual patients: These costs are disallowed as professional service reimbursement is provided through other channels, such as RBRVS, Medicaid/Medicare fee schedules, and commercial network agreements, etc.
- General services that provide benefit to hospital patients: These costs are allowed and reimbursed under the MCR. General services may include emergency room, intensive care unit, and other areas of general care that are not reimbursed through another channel.
The transparency surrounding these allowed and disallowed costs enables states to use tools such as NASHP’s upcoming Hospital Cost Tool, which utilizes data from MCRs to provide a comprehensive view of a hospital’s financial status. This can inform a state’s provider reimbursement negotiations and other cost-containment strategies.
Building on the Progress
Medicare rates are based on provider-attested costs while allowing for a transparent, standard payment system that can evolve. For example, the Medicare Access and Children’s Health Insurance Program Reauthorization Act of 2015 (MACRA) reformed Medicare to replace the population growth-rate based spending cap with two pathways – the Merit-based Incentive Payment System and the Advanced Alternative Payment Models – to base providers’ reimbursements on their performance against various quality and cost measures.
The methodology of Medicare rate determination is annually updated, geographically adjusted, and publicly available through the CMS website that also publishes a complete listing of fees used to pay providers/medical equipment suppliers and a regularly updated tool that allows users to estimate PPS payments based on claims data and provider cost reports.
Multiple stakeholder groups have helped Medicare, the largest health care purchaser in the country, promote equity and transparency in covering nearly every service and paying for health system costs rather than charges.
A hospital does not have to abide by any formula or legal requirement for setting its charges nor does it have to disclose mark-ups on hospital-purchased services or medical supplies, and it may change them at any time. As a result, chargemaster rates (what hospitals list as prices for their services) present an inaccurate benchmark for assessing costs and negotiating reimbursements between commercial payers and providers, resulting in costly bills for patients.
However, when the transparent and standardized Medicare rates are used as the benchmark, states can achieve savings while still covering providers’ costs and they can better explore innovative strategies to improve health care affordability.