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.