No Method To The Madness: The Divergence Between Hospital Billed Charges And Payments, And What To Do About It
October 7th, 2013
“As we went through the years, we had these cockamamie formulas.” William McGowan, CFO of the UC Davis Health System, as quoted in The Wall Street Journal, December 27, 2004
The May 2013 release by the Centers for Medicare and Medicaid Services (CMS) of hospital charges for the most common inpatient and outpatient procedures, which followed Steven Brill’s earlier extensive reporting for Time magazine, renewed attention on variation in billed charges among hospitals. The CMS data highlighted the exorbitant mark-up of charges over actual Medicare payments, confirming that hospitals charge, on average, 2.6 to 4.7 times the amount paid by Medicare.
And it isn’t just Medicare getting a steep discount. According to 2011 data from the California Office of Statewide Health Planning and Development (OSHPD), hospitals in the state were paid on average just less than one quarter of the amount they billed — that is, net revenues were only 24 percent of gross revenues. (See exhibit below, click to enlarge.)
At one time billed charges did matter. When Medicare was established in 1965 the program required hospitals to collect uniform charge information. While Medicare paid hospitals on the basis of costs, the program used hospital charge information to ensure that hospitals were not over-allocating costs to Medicare. Charges mattered even more directly to private insurance companies, who typically paid on the basis of charges at that time.
However, beginning in the early 80s, payments became divorced from charges and the madness began. Looking back, there were a number of factors driving the divergence:
- Cost shifting. With the advent of Medicare fixed-price payment per admission, via diagnostic related groups (DRGs), hospitals responded by raising prices faster than costs, hoping to offset their losses from third-party payers who remained charge-based.
- Selective contracting. In response, health plans deployed new payment models based on selective contracting with hospitals. The plans used increased market leverage — and the threat of excluding hospitals from emerging managed care contracts — to move away from paying hospitals based on charges. As a result, the market for charge-based contracts dwindled. With fewer payers negotiating charge-based contracts, hospitals raised charges even higher to increase revenue from the few remaining third-party payers negotiating percent-of-charges contracts.
- Outlier Payments. Though most Medicare stays were paid based on DRGs, payment for extremely high-cost cases were supplemented with additional payments for outlier claims. By rapidly increasing their charges, hospitals could trigger higher payments. In 2003, CMS revised their outlier payment policy, removing the incentive to use higher charges to trigger outlier payments.
- Charity care. Many hospitals used to calculate and report the value of their charity care based on charges rather than costs, which helped to inflate their stated amount of charity care. A 2005 Pricewaterhouse Coopers’ survey found that three-quarters of hospitals reported calculating charity care in terms of charges rather than costs, with an additional 9 percent using a combination of costs and charges. In 2008, the IRS began requiring that hospitals report charity care on the basis of costs, not charges.
Charges Remain High
Through regulatory changes and an ever-decreasing pool of non-contracted payers, the items above are no longer significant drivers of pricing policy. So if, for the most part, charges are no longer relevant, why do they remain insanely high? Because there are two groups for which billed charges still apply: the uninsured and out-of-network patients.
The uninsured. Though the uninsured are hopefully a declining group, with the full implementation of the ACA in 2014, charging the highest prices to the group least able to pay the tab has sparked the greatest amount of outrage in the press. There are policy levers, however. In 2006, California passed the Fair Hospital Pricing Act; this law requires hospitals to develop written financial assistance policies that limit the amount hospitals can charge to uninsured patients with incomes at or below 350 percent of the federal poverty level (FPL), and to insured patients with annual medical expenses in excess of 10 percent of family income. In effect, hospitals have to charge these patients Medicare rates or lower.
A recent Health Affairs article found that 81 percent of California hospitals’ reported policies were in compliance with the new law, and many had adopted policies more generous than required. Although the law did not stipulate the provision of free care, more than 90 percent of hospitals offer free care to patients under 150 percent of the FPL. All told, under these policies, 61 percent of uninsured Californians would be eligible for free care, with another 20 percent eligible for care at or below Medicare rates.
Though this has gone a long way towards ensuring that low-income uninsured patients will not face excessive hospital bills, higher income patients (above 350 percent FPL) are often still at risk for high hospital charges. It’s estimated that there are over one million uninsured Californians with incomes above 400 percent of the poverty level.
Out-of-network patients. An equally troubling driver of high charges is the business strategy adopted by some hospitals to aggressively pursue out-of-network patients — to bill them, or their health plans, full charges. In the absence of a contract specifying an alternative payment amount, charges become the default basis for payment, or at least the starting point for negotiations.
A few hospital systems are notorious for embracing such a strategy. Bayonne Medical Center in New Jersey cancelled existing contracts with insurers, relying on out-of-network patients arriving in its emergency room as the cornerstone of its financial recovery. Similarly, Prime Healthcare in California has been accused of unnecessarily hospitalizing out-of-network patients who seek care in their emergency rooms.
What Can Be Done?
Relief is expected with implementation of the ACA. New IRS rules related to ACA implementation require tax-exempt hospitals to establish financial assistance policies that stipulate the eligibility criteria for financial assistance, note whether assistance includes free or discounted care, and describe the basis for calculating rates charged to patients. The new rules require tax-exempt hospitals to base the amounts charged to eligible patients for emergency care and other necessary medical care on the average of the three best commercial rates or Medicare rates.
Even so, since the rules do not stipulate what income levels should be eligible for assistance, that decision is left to individual hospitals. Furthermore, in contrast to California’s Fair Pricing Policy, the federal rules do not apply to investor-owned hospitals, one-fifth of hospitals in the nation.
The problem of hospitals capturing emergency out-of-network patients and billing their insurance companies at the rack rate is thornier. Legislative hearings have been held in California on the issue, but at this point a firm solution has not been developed. California Senate Bill 351 was introduced this year in an attempt to limit out-of-network balance billing by using an independent review body to assess the appropriateness of charges and to recommend payment amounts. The bill was held in the Appropriations Committee but may emerge again next year.
The solution is transparency of true prices, not just billed charges. While the recent attention on billed charges has opened the door for a meaningful conversation about improving the current system, price transparency requires public sharing of actual hospital payment amounts. All Payer Claims Databases in 12 states (though, sadly, not California) begin to provide a window into a more realistic set of prices and provide a more practical tool for consumers.
Even the American Hospital Association recognizes that the time has come to address the issue of charges. Fostering a debate using “real” prices is a better starting point to develop policies that actually address rapidly escalating health care expenditures and don’t divert attention to sticker prices nobody pays … well, almost nobody.
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