Chapter 3

Financial Environment of Healthcare Organizations

LEarning ObjECtivEs

After studying this chapter, you should be able to do the following:

1. Describe factors that influence the financial viability of a healthcare organization. 2. Describe the financial environment of the largest segments of the healthcare industry. 3. Discuss the major reimbursement methods used in health care. 4. Discuss the major aspects of Medicare benefits. 5. Describe how Medicare reimburses the major types of providers, and discuss the

implications of these methods for an organization’s resource management.

rEaL-WOrLd sCEnariO

Joshua Douglas, chief financial officer at Marshall Regional Hospital, was exploring an option to convert his hospital to critical access hospital (CAH) status under the Medicare program. The CEO of the hospital, Mikaela Grace, had directed Josh to investigate this possible option at the last hospital board meeting. The hospital has been losing money for the last 4 years, and cash positions have been eroding to the point of possible default on a small debt issue.

Marshall Regional is a 13-bed acute-care hospital with a 10-bed skilled-nursing facility. It is located in a rural area of a western state and is 50 miles from the nearest hospital. The cur- rent economic climate in the region is not good and is not expected to improve in the near future. Because of its low volume, Marshall’s cost per unit for acute inpatient and outpatient procedures is very high. As a result the hospital has been losing large sums of money on its sizable Medicare volume. The situation has only gotten worse since Medicare shifted to pro- spective payment for outpatient services in August 2000. Josh has estimated that his hospital loses 45 cents for every dollar of Medicare payment. Because a high percentage of the local population is elderly, Medicare is the hospital’s largest source of business. Medicare repre- sents 50% of all outpatient revenue and 65% of inpatient revenue. Most inpatient procedures are not complex, and severely ill patients are transferred to a larger hospital 50 miles up the interstate.

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34 Chapter 3 FinanCial environment oF healthCare organizations

Almost any measure of size indicates that the health- care industry is big business. Its proportion of the gross domestic product has been steadily increasing for several decades and now represents approximately 16% of the gross domestic product, with over 2 trillion dollars in expenditures. Paralleling this growth, the pressures for cost control within the system have in- creased tremendously, especially at the federal and state levels for control of Medicare and Medicaid. Healthcare organizations (HCOs) not able to deal ef- fectively with these pressures face an uncertain future. In short, as the expected demand for health services continues to increase during the next several decades as our population ages, successful HCOs must become increasingly cost efficient.

LEarning ObjECtivE 1

Describe factors that influence the financial viability of a healthcare organization.

FinanCiaL viabiLitY

An HCO is a basic provider of health services but is also a business. The environment of an HCO viewed from a financial perspective is depicted in Figure 3–1.

In the long run the HCO must receive dollar pay- ments from the community in an amount at least equal to the dollar payments it makes to its suppliers. In very simple terms, this is the essence of financial viability.

The community in Figure 3–1 is the provider of funds to the HCO. The flow of funds is either directly or indirectly related to the delivery of services by the HCO. For our purposes, the community may be cate- gorized as follows:

1. Patients a. Self-payer b. Third-party payer

• Blue Cross and Blue Shield • Commercial insurance, including managed

care • Medicaid • Medicare • Self-insured employer • Other

2. Nonpatients a. Grants b. Contributions c. Tax support d. Miscellaneous

In most HCOs the greater proportion of funds is derived from patients who receive services directly. The largest percentage of these payments usually comes from third-party sources such as Blue Cross, Medicare, Medicaid, and managed care organiza- tions. In addition, some nonpatient funds are derived from government sources in the form of grants for research purposes or direct payments to subsidized HCOs, such as county facilities. Some HCOs also receive significant sums of money from individuals, foundations, or corporations in the form of contribu- tions. Although these sums may be small relative to

Mikaela Grace had been to a recent seminar and learned that her hospital might be eligible for CAH status. If the hospital was successful in its application for CAH status, it would no longer be paid under prospective payment. Instead, Marshall regional would receive the cost incurred in delivering services to Medicare patients plus 1%. Joshua Douglas estimated that this change in payment could result in a substantial improvement in operating margins and should help the hospital to secure its financial future.

Upon Josh’s review of CAH materials, he learned that over 1,300 hospitals in the United States are designated as CAH. Although a number of criteria must be met, it seemed that the hospital would be eligible. It was under the 25-bed maximum, and it was more than 35 miles from the nearest hospital. It also maintained an acute-care length of stay less than 96 hours and had round-the-clock emergency care available. Although there were other criteria, Josh was very optimistic about Marshall’s chances of receiving CAH status, and he prepared a memo to Mikaela Grace recommending that they move forward with an application.

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Sources of Operating Revenue 35

sOurCEs OF OpErating rEvEnuE

Table 3–2 provides a historical breakdown of the relative size of the healthcare industry and its indi- vidual industrial segments. The largest segment is the hospital industry, which absorbs about 31% of all healthcare expenditure dollars (in per capita terms). This percentage has been declining over the last few years and is expected to decline further as other indus- try segments grow more quickly. The physician seg- ment absorbs approximately 21% of total healthcare expenditures; this has been steady in recent years but still represents a modest increase over the prior de- cade when expressed as a percentage of total health- care expenditures. Prescription drugs represent the third largest healthcare segment, reflecting the rapid rise in prescription drug use. Whereas in the past nurs- ing homes represented the third largest healthcare segment, prescription drugs have overtaken nursing homes. Prescription drugs now constitute about 10% of all per capita healthcare expenditures.

Another area experiencing significant growth has been the administration of private health insurance, representing 7% of health expenditures. The once- rapid increases in Medicare spending for skilled nurs- ing facilities (SNFs) have been tempered by the change to prospective payment (explained later in the chapter). Annual growth rates in spending for nursing home care have been cut almost in half in recent years, as providers reacted to the changes in reim- bursement method. Demographic factors, however, still will tend to put upward pressure on national nurs- ing home expenditures. Many people believe that the nursing home segment will grow faster as the popula- tion ages.

Table 3–3 depicts the sources of operating funds for the four largest healthcare segments: hospitals,

the total amounts of money received from patient ser- vices, their importance in overall viability should not be understated. In many HCOs these contributed dol- lars mean the difference between net income and loss.

The suppliers in Figure 3–1 provide the HCO with resources that are necessary in the delivery of quality health care. The major categories of suppliers are the following:

• Employees • Equipment suppliers • Service contractors • Vendors of consumable supplies • Lenders

Payments for employees usually represent the larg- est single category of expenditures. For example, in many hospitals payments for employees represent about 60% of total expenditures. Table 3–1 is an ex- ample of a statement of operations (similar to an in- come statement for a for-profit firm) that shows percentages of revenues and expenses for a hospital. Payments for physicians’ services also represent im- portant financial requirements. In addition, lenders such as commercial banks or investment bankers sup- ply dollars in the form of loans and receive from the HCO a promise to repay the loans with interest accord- ing to a defined repayment schedule. This financial requirement has grown steadily as HCOs have become more dependent on debt financing.

LEarning ObjECtivE 2

Describe the financial environment of the largest segments of the healthcare industry.

Figure 3–1 Financial Environment of Healthcare Organizations Source: Centers for Medicare & Medicaid Services, office of Financial and Actuarial Analysis, Division of

National Cost Estimates. Retrieved from http://www.cms.gov on March 10, 2010.

Suppliers Community HCO

$

Resources

$

Services

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36 Chapter 3 FinanCial environment oF healthCare organizations

Table 3–1 Statement of Operations for Memorial Hospital, Year Ended 20X7 (000s Omitted)

20X7 %

Unrestricted revenues, gains, and other support: Net patient service revenue $85,502 85.84 Premium revenue 11,195 11.24 Other operating revenue 2,913 2.92

Total operating revenue $99,610 100.0

Expenses Salaries and benefits 40,258 40.41 Medical supplies and drugs 27,542 27.65 Professional fees 16,857 16.92 Insurance 5,568 5.59 Depreciation and amortization 3,952 3.97 Interest 1,456 1.46 Provision for bad debts 1,152 1.16 Other 523 0.53

Total expenses $97,308 97.69

Operating income 2,302 2.31

Investment income 1,846 1.86

Excess of revenues, gains, and other support over expenses 4,148 4.17

Net assets released from restrictions used for purchase of property and equipment

192 0.19

Increase in unrestricted net assets $ 4,340 4.36

Source: Centers for Medicare & Medicaid Services, Office of Financial and Actuarial Analysis, Division of National Cost Estimates.

physicians, prescription drugs, and nursing homes. Dramatic differences in financing among these four segments can be seen easily.

The hospital industry derives more than 50% of its total funding from public sources, largely from Medicare and Medicaid. Of the two, Medicare is by far the larger, representing about 30% of all hospital rev- enue. This gives the federal government enormous control over hospitals and their financial positions. Few hospitals can choose to ignore the Medicare pro- gram because of its sheer size. Another 36% of total hospital funding results from private insurance, largely from Blue Cross, commercial insurance carriers, man- aged care organizations, and self-insured employers. Direct payments by patients to hospitals represent ap-

proximately 3% of total revenue. The implication of this distribution for hospitals is the creation of an oli- gopsonistic marketplace. The buying power for hospi- tal services is concentrated in relatively few third-party purchasers, namely the federal government, the state government, Blue Cross, a few commercial insurance carriers, and some large self-insured employers.

The physician marketplace is somewhat different from the marketplace for hospital services. A much larger percentage of physician funding is derived from direct payments by patients (approximately 10%). Compared with hospital funding, a slightly larger percentage of physician funding results from private insurance sources, largely from Blue Cross and commercial insurance carriers. Physicians derive

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Sources of Operating Revenue 37

Table 3–2 National Healthcare Expenditures

2000 2008

2000–2008 Annual Growth

2019 Projected

2008–2019 Annual Growth

National health expenditures (millions) 1,855,389 2,338,746 6.0% 4,482,696 5.1% Population (millions) 293.2 304.5 0.9% 334.8 0.7%

Per capita expenditures

Hospital care 1,481 2,359 6.0% 4,105 5.2% Physician and clinical services 1,026 1,629 6.0% 2,635 4.5% Prescription drugs 429 769 7.6% 1,367 5.4% Administration and net cost of private

health insurance 291 524 7.6% 957 5.6% Nursing home care 339 455 3.8% 735 4.5% Investment: structures and equipment 225 374 6.6% 663 5.3% Other personal health care 132 224 6.8% 551 8.6% Dental services 220 332 5.3% 539 4.5% Home health care 108 212 8.8% 459 7.3% Government public health activity 153 228 5.1% 419 5.7% Other professional care 139 216 5.7% 369 5.0% Investment: research 91 143 5.9% 272 6.0% Other nondurable medical products 106 128 2.4% 189 3.6% Durable medical equipment 69 87 3.0% 129 3.6%

National health expenditures 4,808 7,681 6.0% 13,389 5.2%

Source: Centers for Medicare & Medicaid Services, Office of Financial and Actuarial Analysis, Division of National Cost Estimates. Retrieved from http://www.cms.gov on March 10, 2010.

Table 3–3 Sources of Health Services Funding: 2008 and Projected 2019

Hospitals Physicians Prescription Drugs Nursing Homes

Source 2008 2019 2008 2019 2008 2019 2008 2019

Private payments (%) 43 38 65 65 63 53 38 33 Private health insurance 36 32 49 47 42 36 7 6 Out-of-pocket payments 3 3 10 11 21 17 27 24 Other private funds 4 3 6 7 0 0 4 4

Government payments (%) 57 62 35 35 37 47 62 67 Medicare 29 33 21 20 22 30 19 21 Medicaid 17 18 7 9 8 10 41 43 Other 10 11 7 6 7 8 3 3

Total payments (%) 100 100 100 100 100 100 100 100

Source: Centers for Medicare & Medicaid Services, Office of Financial and Actuarial Analysis, Division of National Cost Estimates. Retrieved from http://www.cms.gov on March 10, 2010.

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38 Chapter 3 FinanCial environment oF healthCare organizations

In contrast, the typical healthcare firm may have several hundred different contractual relationships with payers, which specify different rates of payment for an identical basket of services. Although different payers may negotiate different rates of payment, the critical distinction is the unit of payment. For exam- ple, some payers pay physicians a discount from their charges, other payers pay on fee schedule, Medicare pays on a relative value scale referred to as the resource-based relative value scale (rbrvs), and some health maintenance organizations may pay on an enrolled or capitated basis. Similar scenarios apply in other sectors of the healthcare industry. Alternative payment units have a different effect on the firm’s financial position and might lead to different conclu- sions with respect to business strategy. It is thus ex- tremely important to understand the financial implications of the various payment units used to pay healthcare firms. Four major payment units are discussed:

1. Historical cost reimbursement 2. Specific services (charge payment) 3. Capitated rates 4. Bundled services

Historical Cost reimbursement

Cost reimbursement was the predominant form of payment for most hospitals and other institutional pro- viders by Medicare until the early 1980s. In addition to Medicare, most state Medicaid plans and a large num- ber of Blue Cross plans paid hospitals on the basis of “reasonable” historical costs. Today, the major payers have abandoned historical cost reimbursement and substituted other payment systems. We provide some discussion of cost reimbursement for two reasons. First, it is used in some limited settings for payment. For example, Medicare still pays on a cost basis for services performed in comprehensive cancer centers and critical-access hospitals (CAHs). Second, some policy analysts have suggested that “regulated cost reimbursement” might be a legitimate way to maintain the quality of patient care.

Two key elements in historical cost reimbursement are reasonable cost and apportionment. reasonable cost is simply a qualification introduced by the payer to limit its total payment by excluding certain catego- ries of cost or placing limits on costs that the payer

approximately 49% of their total funds from this source; the hospital segment derives 36% of total funds from this source. Public programs, although still sig- nificant, are the smallest source of physician funding, representing 35% of total funds. This situation results because more physician services, such as routine phys- ical examinations and many deductible and copayment services, are excluded from Medicare payment.

Similar to the market for physicians, most payments for prescription drugs (42%) come from private insur- ance sources. The impact of Medicare coverage can be clearly seen in Table 3–3. By 2019 projections show that Medicare will be funding 30% of all prescription drug costs. Many state Medicaid plans (which are more than 50% federally funded) do provide prescrip- tion drug benefits. Medicaid represents over 8% of prescription drug payments.

The nursing home segment receives almost no fund- ing from private insurance sources. The major public program for nursing homes is Medicaid, not Medicare. However, the federal government pays more than 50% of all Medicaid expenditures. Medicare payments to nursing homes are largely restricted to skilled nursing care, whereas most Medicaid payments to nursing homes are for intermediate-level (custodial) care.

LEarning ObjECtivE 3

Discuss the major reimbursement methods that are used in health care.

HEaLtHCarE paYMEnt sYstEMs

One of the most important financial differences be- tween healthcare firms and other businesses is the way in which their customers or patients make payment for the services they receive. Most businesses have only one basic type of payment: billed charges. Each cus- tomer is presented with a bill that represents the prod- uct of the quantity of goods or services received and their appropriate prices. Some selective discounting of the price may take place to move slow inventory dur- ing slack periods or to encourage large-volume orders. The basic payment system, however, remains the same: a fixed price per unit of service that is set by the business, not the customer.

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Healthcare Payment Systems 39

(CMS)- 1450 or Uniform Bill 2004 (UB-04). Physician bills are often submitted on a CMS-1500. A sample of both the UB-04 and the CMS-1500 are presented in Appendix 2–A. Both forms are designed by the CMS and are standards for claims submission that are re- quired by most payers.

Many medical and surgical procedures often have an assigned code designated as either current proce- dural terminology (CPT, developed and maintained by the American Medical Association) or Healthcare Common procedure Coding system (HCPCS, devel- oped and maintained by the CMS). Supply and phar- maceutical items do not usually have CPT codes but may have specific HCPCS codes, although most do not have either. The example UB-04 in Appendix 2–A consolidates individual charges for specific services by departmental or revenue code. Note that there is no listing of specific services in this bill because the ser- vices are consolidated to a revenue code level. If the patient or their insurance plan requested a detailed bill, then the specific services provided would be listed.

Payers who pay on a specific-service basis usually fall into three categories. First, they could be patients who do not have any insurance coverage or lack cover- age for the procedures performed. These patients are usually responsible for the total billed charges repre- sented on the claim. Second, the patients could have coverage from an insurance firm that does not have any formal contract with the provider. In the absence of a contract, the patient and/or his or her carrier is responsible for the entire billed charges. This often happens when a provider that is out of the carrier’s network treats a patient. Third, some insurance firms negotiate contracts with providers on a discounted- charge basis. The carrier agrees to make payment based on the total billed charges for the claim but at something less than 100%.

Payment for specific services has several important implications for financial management. First, revenue from specific services may represent the major source of profit for many healthcare firms. In these situations pricing or rate setting becomes an important policy (rate setting is addressed in Chapter 6). Second, the firm’s rate structure should be based on projected vol- ume and cost. Any unexpected deviation from the projections may require pricing changes. If these changes are not made, there could be a significant ef- fect on the firm’s cash flow.

deems reasonable. Examples of costs often defined as unreasonable and therefore not reimbursable are costs for charity care, patient telephones, and nursing educa- tion. Apportionment refers to the manner in which costs are assigned or allocated to a specific payer such as Medicaid. For example, assume that a nursing home has total reasonable costs of $10 million, which repre- sent the costs of servicing all patients. If Medicaid is a historical cost reimbursement payer, an allocation or apportionment of that $10 million is necessary to de- termine Medicaid’s share of the total cost. Quite often, the apportionment is related to billed charges. For ex- ample, if charges for services to Medicaid patients were $3 million and total charges to all patients were $15 million, then 3/15 or 20% of the $10 million cost would be apportioned to Medicaid.

Several important financial principles of cost reim- bursement should be emphasized. First, cost reim- bursement can insulate management somewhat from the financial results of poor financial planning. New clinical programs that do not achieve targeted volume or exceed projected costs may still be viable because of extensive cost reimbursement. This assumes that the payer does not regard the costs as unreasonable. Second, cost reimbursement can often be increased through careful planning, just as taxes can often be reduced through tax planning. The key objective is to maximize the amount of cost apportioned to cost pay- ers subject to any tests for reasonableness.

specific services

Most healthcare firms have some master price list that identifies the appropriate charge for a defined unit of service. These master price lists are often re- ferred to as charge description masters. The charges that are applicable for specific services may bear no relationship to amounts actually paid. For example, a hospital may have charges for a patient categorized as Medicare severity-diagnosis related group (MS-DRG) #293 (Heart Failure and Shock) for $15,000, but Medicare could determine that the applicable rate of payment was $4,000. Although the charges for spe- cific services of $15,000 are recorded on the patient’s bill, the actual charges for specific services are not the basis for payment.

Most institutional providers such as hospitals and nursing homes record their charges for specific ser- vices on a Centers for Medicare & Medicaid Services

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40 Chapter 3 FinanCial environment oF healthCare organizations

incremental basis. This simply means that manage- ment is interested in the change in costs and change in revenue that result if the contract is signed. The firm’s cost accounting system should be able to define the incremental costs likely to be incurred in a given con- tract so they can be compared with the incremental revenue likely to result from the contract.

bundled services

Many payment plans used to pay healthcare provid- ers in today’s environment could be classified as bun- dled services arrangements. A bundled services payment plan has two key features. First, payments to the provider are not necessarily related to the list of specific services provided the patient and identified in the UB-04 or the CMS-1500. Instead, payment is grouped into a mutually exclusive set of service cate- gories. For example, hospitals are paid by some health- care plans on a per diem (meaning per day) or per case payment rate. Both are examples of bundled service payment. Second, bundled services arrangements have a fixed fee specified per unit of service. For example, in the per diem arrangement, revenue from treating a patient is equal to the length of stay times the negoti- ated per diem rate.

Medicare has developed bundled services payment plans for most healthcare providers. We discuss some of these plans in detail later in this chapter. Medicare’s pay- ment methods have a profound impact on the rest of the industry because they tend to become the standard for payment by many health plans. For example, Medicare pays physicians on an RBRVS basis, which is often used as the payment basis by many healthcare plans with one slight wrinkle. Most often, these plans will not pay 100% of Medicare’s rates but some greater or lesser percent- age, such as 110% of RBRVS. Table 3–4 presents the unit of payment used by Medicare in a variety of health- care sectors.

Capitated rates

Capitated rates represent a rare and declining type of payment for many healthcare providers. In some re- spects a capitated rate is a form of bundled service be- cause the unit of payment is the enrollee. A medical group, hospital, or some association of providers may agree to provide some or all healthcare services for enrollees during a specified period of time. Most often the provider agrees to pay only for specific services they perform. For example, a cardiology group might agree to provide all cardiology services to an employer or a health maintenance organization for a fixed fee per member per month. It is rare that a single healthcare provider will agree to provide for all medical services to an enrolled population. When this does occur, the term “global capitation” is used to describe the nature of the contractual relationship. Global capitation rates are very uncommon because most healthcare firms are not in a position to control all healthcare costs. Capitation arrangements were more common in the mid-1990s and have been declining since that point.

In a capitated payment environment, financial plan- ning and control are critical—even more critical than in a bundled services payment situation. In a capitated payment arrangement the provider is responsible not only for the costs of services provided but also their utilization. Changes in either costs or utilization can have a dramatic effect on profitability. Unexpected increases in costs are not usually a basis for contract renegotiation. It is imperative therefore that manage- ment knows the cost of providing a unit of service re- quired in the contract. For example, if the negotiated rate is to provide all hospital services to subscribers of a health maintenance organization for a fixed fee per subscriber (or capitation), the hospital must know both the utilization and the cost per unit of the required services. Sometimes management may assess the financial desirability of a capitation contract on an

Table 3–4 Medicare Payment Units for Healthcare Sectors

Healthcare Sector Payment Unit

Hospital inpatient Medicare Severity-Diagnosis Related Groups (MS-DRGs) Hospital outpatient Ambulatory patient classifications (APCs) Physicians Resource-Based Relative Value Scale (RBRVS) Skilled Nursing Facilities (SNFs) Resource utilization groups (RUGs) Home health agencies Home health resource groups (HHRGs)

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Medicare Benefits 41

Medicare benefits are provided to three categories of individuals. Far and away the largest single group is the aged, beneficiaries over 65 years of age. The second group consists of disabled individuals, and the third group includes people with end-stage renal disease.

There are two primary ways that Medicare benefi- ciaries may receive care through the system. The most popular method is the so-called traditional or original plan. In this plan Medicare beneficiaries can go to any hospital, doctor, or specialist that accepts Medicare to receive care. The second method is a Medicare man- aged care plan (e.g., Medicare Advantage). Under this method beneficiaries are enrolled in a private health- care plan or health maintenance organization, and they are usually limited in terms of the providers that they can visit for care to those included in the plan’s net- work. Usually, Medicare managed care plans provide a wider range of benefits, such as routine physicals and prescription drugs, to offset their restricted networks.

Benefits under Part A include hospital stays, skilled nursing care, hospice care, and some home health ser- vices. Under Part A there is a deductible, which means the patient is responsible for this dollar amount before any payment by Medicare. In 2010 the hospital de- ductible was $1,100. Coinsurance arrangements also exist under Part A coverage. Patients who stay beyond 60 days in a hospital were required to pay $275 per day in 2010. Patients in SNFs had no deductible but were required to pay an additional $137.50 per day for lengths of stay between 21 and 100 days.

Benefits under Part B include a wide range of services, such as doctor’s fees, hospital outpatient services, clinical laboratory tests, durable medical equipment, and a number of other preventive medical services. There was a $155 deductible for medical ser- vices received under Part B in 2010. Part B benefits also require a coinsurance payment in many cases. This coinsurance is 20% of approved amounts. This coinsurance amount can be no less than 20% of the total payment due (although it can be larger) to the provider of services, which includes Medicare’s pay- ment and the coinsurance. For example, Medicare may determine that total payment for ambulatory payment classification (APC) #83 (Coronary Angioplasty) is $3,500. The required coinsurance on this claim may be $1,750 as set by Medicare, which represents 50% of the total payment (which is greater than 20%).

Part D, the Medicare drug plan, was initiated on January 1, 2006. Medicare beneficiaries have the ability

Healthcare providers who are paid under bundled service arrangements need to understand and monitor their costs of production. A bundled service unit is simply a set of specific services that may be grouped or classified into a bundled unit of some kind. Total cost of producing the bundled services unit is therefore a product of two factors.

• Services provided • Cost per unit of services provided

First, the set of specific services that comprises a bundled unit forms the basis for the cost computation. It is important to recognize, however, that the set of services may not always be fixed. For example, home health firms are paid on a 60-day episode of care basis. The number of specific visits per episode is not neces- sarily fixed. In some cases there may be 30 individual case visits to the patient in the 60-day episode, whereas in other cases 45 individual visits may be necessary. Second, the cost of producing each of the specific ser- vices that comprises the bundled unit is multiplied times the number of units required. Whether 30 or 45 visits of care are required, management must control the unit cost of individual visits by monitoring the productivity of nursing staff. Management’s overall objective is to minimize the total cost of production, which means keeping total units of service provided at a minimum and producing each unit of service at an efficient level of cost. Naturally, all this must happen within a quality-of-care constraint.

LEarning ObjECtivE 4

Discuss the major aspects of Medicare benefits.

MEdiCarE bEnEFits

Medicare has three basic benefit programs for its beneficiaries: Part A, Part B, and a prescription drug benefit, Part D. Part A, or hospital insurance, typically is provided free to all beneficiaries if they have 40 or more covered quarters of Medicare employment. Part B, or Medical insurance, usually requires a monthly payment by the beneficiary. In 2010 this pay- ment was $96.40 per month for most beneficiaries.

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42 Chapter 3 FinanCial environment oF healthCare organizations

The basis of PPS payment is the DRG system devel- oped by Yale University, which takes all possible diag- noses from the International Classification of Diseases, 9th revision, Clinical Modification (ICD-9-CM) sys- tem and classifies them into 25 major diagnostic cate- gories based on organ systems. These 25 categories are further broken down into distinct medically meaning- ful groupings or DRGs. Medicare contends that the resources required to treat a given DRG entity should be similar for all patients within a DRG category. However, in federal fiscal year 2008, DRGs were ex- panded to account for patient acuity. The number of DRGs increased significantly as a result. At the time of publication, the total number of MS-DRGs was 746. (Appendix 3−A lists 746 MS-DRGs.)

Total payments to a hospital under Medicare can be split into the following elements (see Figure 3−2):

• Prospective payments • DRG operating payment • DRG capital payment

• Reasonable cost payments

The MS-DRG operating payment results from the multiplication of the hospital dollar rate and the spe- cific case weight of the MS-DRG. Appendix 3−A provides the most recent case weight for the 746 MS- DRGs. The case weight for MS-DRG 001, Heart Transplant with MCC, is 24.8548. This measure indi- cates that in terms of expected cost, MS-DRG 001 would cost about 25 times more than the average case. A specific value is assigned to each of the 746 MS- DRGs.

The dollar rate is broken down into labor and nonla- bor components. The labor component is adjusted for cost of living. Table 3−5 provides hypothetical rates that might be defined by Medicare.

Every hospital in the United States has a wage index value assigned to it. That wage index is multiplied by the labor component of the Medicare standardized payment to yield the DRG operating payment. If we

to choose from a variety of plan providers that fall into two categories: a prescription drug plan (covering drugs only) or Medicare advantage plan (covering medical services and drugs). Both plan types have differing costs and benefits for beneficiaries, although some basic re- quirements are stipulated by the government.

Many Medicare beneficiaries purchase additional insurance from private insurance firms to pay for de- ductibles and coinsurance amounts that exist in the Medicare program. This coverage is often referred to as supplemental or Medigap coverage and may also provide limited coverage for other healthcare services. For a more complete picture of specific benefits under the Medicare program, you might visit Medicare’s website, www.medicare.gov.

LEarning ObjECtivE 5

Describe how Medicare reimburses the major types of providers, and discuss the implications of these methods for an organi- zation’s resource management.

MEdiCarE paYMEnts

Hospital inpatient

Medicare pays hospitals for inpatient care on a bundled services unit basis referred to as a prospective payment system (pps). Medicare officially launched PPS on October 1, 1983. All hospitals participating in the Medicare program are required to participate in PPS, except those excluded by statute:

• Children’s hospitals • Distinct psychiatric and rehabilitation units • Hospitals outside the 50 states • Hospitals in states with an approved waiver • CAHs

PPS provides payment for all hospital nonphysician services provided to hospital inpatients. This payment also covers services provided by outside suppliers, such as laboratory or radiology units. Medicare makes one comprehensive all-inclusive payment to the hospi- tal, which is then responsible for paying outside sup- pliers or nonphysician services.

Table 3–5 Hypothetical Medicare Rates According to Hospital Status

Rate

Labor Non-labor $3,500 $1,600

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Medicare Payments 43

as a disproportionate share payment. Outlier pay- ments are additional payments for patients who use an unusually large amount of resources. We discuss their computation shortly.

There is still a portion of the total Medicare payment that is related to reasonable cost, as shown in Figure 3–2. Costs that are still paid on this basis are:

• Direct medical education costs • Kidney acquisition costs • Bad debts for copayments and deductibles (reim-

bursed at 70%)

There is a national standardized federal payment rate for capital costs that is similar to the national rates for labor and nonlabor costs discussed earlier. In 2010 the federal rate for capital costs was $430.20. This rate would be adjusted for the following factors:

• Geographical adjustment, using the wage index to impute higher costs to higher wage areas

• Case mix, using the MS-DRG relative weight • Disproportionate share adjustment • Indirect medical education • Outlier adjustments (the adjustment is much

lower than before, to recognize the presumed fixed-cost nature of capital costs)

assume that a hospital has a wage index of 1.2509, its DRG operating payment for DRG 001 would be calcu- lated as follows:

Payment = DRG weight × [(labor amount × wage index) + nonlabor amount]

Payment = 24.8548 [($3,500 × 1.2509) + $1,600] = $148,586

This dollar payment may be further increased by additional payments to cover the following areas:

• Indirect medical education • Disproportionate share • Outlier payments

The add-on to a teaching hospital is referred to as an indirect medical education adjustment. This allow- ance is related to the numbers of interns and residents at the hospital and the hospital’s bed size. The allow- ance is over and above salaries paid to interns and resi- dents, which are already covered as a reasonable cost. The additional payment is meant to cover the additional costs that the teaching hospital incurs in the treatment of patients. A separate payment is also provided to a hospital that treats a large percentage of Medicaid and Medicaid-eligible patients. This payment is referred to

Figure 3–2 Breakdown of Medicare Inpatient Payments to a Hospital

Medicare Payment

Prospective portion Reasonable cost

Indirect medical

education Bad debts Kidney

acquisition

Graduate medical

education DRG capitalDRG

operating Cost

outliers

Case weight

Hospital dollar rate

Wage index

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44 Chapter 3 FinanCial environment oF healthCare organizations

the median payment by category in 2008 for all U.S. hospitals for a MS-DRG with a case weight of 1.00.

There are a number of ways that a hospital can try to increase its total payment under Medicare inpatient PPS payment rules. For example, it can try to get the hospital reclassified to a higher wage index, document bad debts better on Medicare patients, change its ratio of residents to beds to increase its indirect medical education payment, and change the MS-DRG assign- ment. Far and away the most likely source of increased payment is MS-DRG reclassification. MS-DRGs are assigned by a software package referred to as a grou- per. That grouper assigns a MS-DRG based on the patient’s age, the principal diagnosis, procedures per- formed, and secondary diagnosis. In many cases missed secondary diagnoses can cost the hospital sig- nificant amounts of reimbursement.

MS-DRG 179 (Respiratory Infections) carries a MS-DRG weight of 1.0088, whereas MS-DRG 195 (Simple Pneumonia and Pleurisy) carries a weight of 0.7095. For a hospital with an average payment of $5,000 per case weight of 1.000, a patient erroneously assigned to MS-DRG 195 instead of MS-DRG 179 would cost the hospital $1,497 [$5,000 × (1.0088 – 0.7095)]. What would cause a patient with an assign- ment of MS-DRG 195 to be moved to MS-DRG 179? Very simply, is there a specified cause for the pneumo- nia? For example, if the physician identified salmo- nella as the bacterial cause, the patient could be legitimately coded as MS-DRG 179. Medical record coders must be on the alert for this information in the physician’s note and other documents, and physicians must be educated about the importance of accurate documentation.

There are literally hundreds of situations like this within a hospital. The importance of accurate coding cannot be overstated in today’s payment environment. On the other hand, hospitals should seek to accurately code and not overcode to maximize reimbursement. Hospital executives who intentionally upcode may fall under the government’s fraud-and-abuse regulations, which can impose severe civil and criminal penalties.

physicians

Beginning in January 1992 Medicare began paying for physician services using a new RBRVS. This new payment system replaced the old reasonable-charge method that had been the basis for physician payment

As an illustration, assume that we wish to calculate capital payment for MS-DRG 001 when the federal payment rate for capital was approximately $430.20. We also assume our hospital is in a large urban area with a geographical adjustment factor of 1.194. Please note that a hospital’s geographical adjustment factor and its wage index are not usually the same. We as- sume that no other adjustments are applicable. The amount of payment would be as follows:

Capital payment = DRG wt. × [standard amount × geographical adjustment factor]

Capital payment = 24.8548 × [$430.20 × 1.194] = $12,767

We now conclude our discussion of Medicare MS- DRG payment with the incorporation of the outlier adjustment. An additional payment for a cost outlier is made when the actual cost of the case exceeds MS- DRG payment by $23,140, the 2010 required amount. To determine whether this threshold is met, one must define actual costs for the specific case under consid- eration. Costs are defined using the hospitals overall ratio of cost to charges. For example, a claim with $100,000 of charges in a hospital with a ratio of cost to charges of 0.75 would have a designated cost of $75,000. If this cost were above the threshold, Medicare would make payment at 80% of the difference. The reason that Medicare does not pay 100% of the differ- ence relates to the concept of marginal cost. Medicare believes that additional costs incurred to treat outlier patients are not 100% of average cost.

To give the reader some idea of payment composi- tion for an average U.S. hospital, Table 3–6 presents

Table 3–6 Median Medicare Payment for U.S. Hospitals, MS-DRG Case Weight of 1.00: 2008

Category Median Payment

DRG operating payment $ 4,771 DRG capital payment 476 Indirect medical education 153 Disproportionate share 577 Coinsurance and deductible 632 Outlier payments 294 Other 43 Total $ 6,946

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Medicare Payments 45

The entire amount will come from the patient di- rectly. No check will be sent to the physician from Medicare. The final total payment could be allocated as follows:

Medicare payment to patient (0.8 × $95.00) $76.00

Patient’s copayment (0.2 × $95.00) 19.00

Additional patient payment 14.25

Total payment to physician $109.25

The nonparticipating physician can also choose to accept assignment on a case-by-case basis. The advan- tage realized with assignment is that Medicare will now pay the physician directly for its portion of the bill. The disadvantage is that the physician must accept the fee schedule for nonparticipating physicians, which is only 95% of the fee approved for participating phy- sicians. In the example above, the nonparticipating physician who agreed to accept assignment on this patient would receive the following payments:

Medicare payment to physician (0.8 × $95.00) $76.00

Patient’s co-payment (0.2 × $95.00) 19.00

Total payment to physician $ 95.00

The participating physician would receive $100.00 for this service because of the higher approved-fee schedule. Of the total $100.00 in payment, $80.00 would come directly from Medicare and $20.00 from the patient as the copayment portion.

At the present time there are Medicare payment rates for more than 10,000 physician services usually broken out by CPT or HCPCS code. There are specific values for those codes that vary by region; presently there are distinct values for each of the Medicare car- rier localities. These payment rates result from the multiplication of three relative values and regional cost indexes. For every procedure there are three compo- nents that together reflect the cost of a particular pro- cedure:

1. Work: This factor represents not only physician time involved but also skill levels, stress, and other factors.

2. Practice expense: This factor represents nonphysician costs, excluding malpractice costs.

3. Malpractice: This factor represents the cost of malpractice insurance.

since the inception of the Medicare program in the 1960s. Medicare pays the lesser of the actual billed charge or the fee-schedule amount.

From Medicare’s perspective, physicians are cate- gorized as participating or nonparticipating physicians. A participating physician is one who agrees to accept Medicare’s payment for a service as payment in full and will bill the patient for the copayment portion only. The copayment portion is usually 20% of the charge. As an example, assume that a patient received a service from a physician who had an approved fee schedule of $100.00. The participating physician re- ceives $80.00 directly from Medicare and then bills the patient for $20.00, which represents the copayment portion of the bill. If the physician’s bill for the service was only $80.00, Medicare would pay 80%, or $64.00, and the patient would be billed 20%, or $16.00. A par- ticipating physician agrees to accept assignment on each and every Medicare patient that he or she treats.

A nonparticipating physician can choose to ac- cept assignment on a case-by-case basis. Although this arrangement initially might seem advantageous, there are several major drawbacks. First, a nonpartici- pating physician has a lower fee schedule. The limit- ing charge is equal to 95% of the approved fee schedule. If the physician in the illustration just dis- cussed were nonparticipating, the amount of the Medicare payment would be $95.00, not $100.00. This difference may not seem all that important if the physician can recover any of the difference from the patient. However, Medicare has placed some limits on the amount that a nonparticipating physician can re- cover from the patient. Medicare sets a maximum fee for a nonparticipating physician equal to 115% of the approved fee for nonparticipating physician, which is already only 95% of the approved fee schedule for a participating physician.

A simple illustration may help to better explain this narrative. Assume that a nonparticipating physician provides services to a patient in the amount of $200.00, but Medicare’s approved schedule for a participating physician is only $100.00. How much can the physi- cian collect? The answer depends on whether the phy- sician accepts or rejects Medicare assignment. First, assume that the physician rejects assignment. The maximum amount that can be collected from this ser- vice is as follows:

$109.25 = [0.95 × $100] × 1.15

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46 Chapter 3 FinanCial environment oF healthCare organizations

may be paid for more than one APC for an encounter. Not all hospital outpatient procedures have an assigned APC code; some procedures are paid on a fee-schedule basis such as lab tests, and others may not be paid at all because they are considered incidental services, such as some drugs and medical supply items.

The Balanced Budget Act also changed the way beneficiary coinsurance is determined for the services included under the PPS. A coinsurance amount is ini- tially calculated for each APC based on 20% of the national median charge for services in the APC. The coinsurance amount for an APC will not change until such time as the amount becomes 20% of the total APC payment. In addition, no coinsurance amount can be greater than the hospital inpatient deductible in a given year. This is a major change for Medicare and means that the total burden of payment shifts more to Medicare in the future. A similar change for physician payment was made in 1992.

Both the total APC payment and the portion paid as coinsurance amounts are adjusted to reflect geographi- cal wage variations using the hospital wage index. It is assumed that 60% of the total payment is labor related and thus subject to the wage-index adjustment. Each APC is assigned a relative weight and then that weight is multiplied times the current conversion factor to determine total payment. This same methodology framework is used throughout most of Medicare’s pay- ment plans.

To illustrate the details discussed, assume that APC #80 (Left Heart Catheterization) has a relative weight of 39.81 when the national conversion rate is $67.40. The total amount paid for this APC is $2,683 (39.81 × $67.40). We further assume that Medicare has set the national coinsurance for APC #80 at $839. To adjust actual payment for a hospital with a wage index of 1.200, the following computations are made to adjust total payment and coinsurance payment:

Total Payment = [0.60 × $2,683 × 1.200] + [0.40 × $2,683] = $3,005

Coinsurance = [0.60 × $839 × 1.200] + [0.40 × $839] = $940

Table 3–8 illustrates the Medicare payment for a specific outpatient claim taken from a hospital-submit- ted UB-04 on a patient who had a left heart cardiac catheterization. The example claim shows that total payment for this claim is $2,750.90, with $844.24

Each individual relative value is then multiplied by a region-specific set of price indexes. To illustrate this adjustment, the weighted value for excision of neck cyst (CPT # 42810) for Los Angeles is presented in Table 3–7. To determine the payment rate for this pro- cedure in Los Angeles, the index-adjusted relative value is multiplied by a conversion factor. If we as- sume that the conversion factor is $40.00, the approved charge for excision of neck cyst in Los Angeles is $309.20 (7.73 × $40.00).

Medicare also differentiates the payment by the set- ting in which the procedure was performed. If the procedure was performed in a facility setting (gener- ally a hospital, SNF, or ambulatory surgery center), the amount allowed for practice expense is reduced from what it would be if the procedure was performed in a nonfacility setting. For example, the allowed practice expense weight for excision of neck cyst in a facility setting is 3.55, but if the procedure was performed in a nonfacility setting, the allowed weight is 5.73. The rationale for these differences is related to the addi- tional payment that Medicare would make to the facil- ity. A procedure performed in a hospital involves a payment to the hospital as well as to the physician.

Hospital Outpatient

The Balanced Budget Act of 1997 directed CMS to implement a prospective payment system (PPS) under Medicare for hospital outpatient services. All services paid under the new PPS are classified into groups called ambulatory payment classifications (APCs). Services in each APC are similar clinically and in terms of the re- sources they require. A payment rate is established for each APC. Depending on the services provided, hospitals

Table 3–7 Components of Price Adjustment for Excision of Neck Cyst in Los Angeles

RVU

Geographical Cost Index for Los Angeles Product

Work 3.25 1.043 3.39 Practice expense 3.55 1.144 4.06 Malpractice 0.29 0.954 .28

Total 7.73

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Medicare Payments 47

50% of the cost of the APC that is above 175% of the actual APC payment. However, in addition to meeting the 175% provision, cost must also exceed a fixed dol- lar threshold of $2,175 (fiscal year 2010 amount) plus the APC payment. For example, if an APC had a total payment, including the coinsurance, of $1,000 and the estimated cost of the APC was $4,000, then Medicare would pay an additional $1,125 [0.50 × ($4,000 – $1,750)]. Please recognize that the cost of the APC does include incidental services or “N”-status items, which makes it important to include these items and to charge for them even if Medicare does not recognize them as APC or fee-schedule items.

Resource management under APC reimbursement is more difficult than it is under DRGs because payment is not fixed. In a DRG payment environment, once the patient is classified, cost minimization is the optimal financial strategy because payment does not increase if additional services are provided. In an APC payment situation, payments may increase when more services are provided. Management must determine from a fi- nancial perspective whether the marginal revenue of additional services is greater than the marginal cost of providing those services.

coming from the patient as coinsurance. A large num- ber of the items are coded as “N” or incidental services that are packaged into the APC rate. Many of these procedures are either imaging procedures or injections that are considered to be a part of CPT 93510 (Left Heart Catheterization). This procedure has a “T” status indicator code, which indicates it is discounted at 50% if another “T”-coded procedure was performed. In our example, there is no other “T”-coded procedure pres- ent in the claim, so the procedure is not discounted. When multiple “T”-coded procedures are performed, the highest-value procedure is paid at 100%, but all other “T”-coded procedures are paid at 50%. The lab procedures are all coded as “A,” which in this case means they are clinically diagnostic laboratory ser- vices that are paid from a fee schedule with no coinsur- ance payments.

There are other examples of “A”-coded procedures, and these are described in Table 3–9. The ECG is coded as an “X” procedure, which implies it is an an- cillary service.

It is also important to note that Medicare provides additional payments to hospitals for outliers. Outlier payments are made on an APC basis and are equal to

Table 3–8 Example Medicare Payment for Outpatient Left Heart Cardiac Catheterization: APC Reimbursement, APC # 80

Revenue Code Description HCPCS Units Total Charges Status Code

APC Total Payment Copayment

300 Lab 80051 1 $27.42 A $10.05 $0 301 Lab 82565 1 7.42 A 7.34 0 301 Lab 84520 1 6.46 A 5.65 0 305 Lab 85027 1 20.77 A 9.27 0 305 Lab 85730 1 14.21 A 8.60 0 460 Pulmonary 94760 1 16.46 N 0 0 481 Cath lab 93510 1 1711.17 T 2,683.43 838.92 481 Cath lab 93539 1 607.79 N 0 0 481 Cath lab 93540 1 607.79 N 0 0 481 Cath lab 93543 1 1288.48 N 0 0 481 Cath lab 93545 1 607.79 N 0 0 481 Cath lab 93555 1 718.29 N 0 0 481 Cath lab 93556 1 718.29 N 0 0 636 Drugs J7040 1 7.13 N 0 0 710 Recovery 6 373.13 N 0 0 730 ECG 93005 1 60.74 X 26.56 5.32

$6,793.34 $2,750.90 $844.24

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48 Chapter 3 FinanCial environment oF healthCare organizations

skilled nursing Facilities

As you can see from our discussion of Medicare payments for hospital inpatient, hospital outpatient, and physician services, Medicare payment is a com- plex set of rules. Medicare has paid SNFs on a pro- spective basis since July 1, 1998. The rate is a per diem rate that is calculated to include the costs of all ser- vices, including routine, ancillary, and capital. Per diem payments for each admission are case-mix ad- justed using a resident classification system known as resource utilization groups iii (RUG III). At the time of publication, an updated version (RUG IV) had been proposed for implementation in 2011. As with most CMS payments, the actual payment amounts are ad- justed for differences in cost of living by the hospital wage index on the labor portion of the payment.

There are seven major categories of patients under RUG III with 53 distinct payment categories, as shown in Table 3–10. Patients are assigned to one of the pay- ment categories by a “RUG III grouper” based on six key determinants:

• Number of minutes per week needed for rehabili- tation services

• Number of different rehabilitation disciplines needed

Table 3–9 Status Codes

Indicator Service Status

A clinical laboratory, ambulance, physical & occupational therapy fee schedule B non-recognized codes not paid C inpatient procedure not paid D discontinued codes not paid E non-allowed item or service not paid F acquisition of corneal tissue reasonable cost G current drug / biological pass-through additional payment H device pass-through additional payment K non-pass-through drug / biological APC rate L vaccine reasonable cost N incidental service packaged P partial hospitalization paid per diem S significant procedure APC rate T significant procedure, reduced when multiple APC rate V clinic or ED visit APC rate X ancillary service APC rate Y non-implant DME not paid under OPPS

• Specific treatments received • Resident’s ability to perform activities of daily

living • ICD-9 diagnoses • Resident’s cognitive performance

To properly classify residents, SNFs must complete resident assessments on the 5th, 14th, 30th, 60th, and 90th days after admission. These forms are extensive and require another layer of administrative support to properly record and report to CMS.

To see how the payment system operates, let us as- sume that a rehabilitation patient has been categorized

Table 3–10 Number of Payment Categories for Major RUG III

Major RUG III Group Number of Payment Categories

Rehabilitation 23 Extensive services 3 Special care 3 Clinically complex 6 Impaired cognition 4 Behavioral problems 4 Reduced physical function 10

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Medicare Payments 49

including the most ill, should ensure that all beneficia- ries have access to home health services for which they are eligible.

The home health PPS is composed of six main fea- tures:

1. 60-Day episode. The unit of payment under HHA PPS is for a 60-day episode of care. An agency receives half of the estimated base payment for the full 60 days as soon as the fiscal intermediary receives the initial claim. This estimate is based on the patient’s condition and care needs (case-mix assignment). The agency receives the residual half of the payment at the close of the 60-day episode unless there is an applicable adjustment to that amount. The full payment is the sum of the initial and residual percentage payments, unless there is an applicable adjustment. This split-percentage payment approach provides reasonable and balanced cash flow for HHAs. Another 60-day episode can be initiated for longer-stay patients.

2. Case-mix adjustment. After a physician prescribes a home health plan of care, the HHA assesses the patient’s condition and likely skilled nursing care, therapy, medical, and social services and home health aide service needs at the beginning of the episode of care. The assessment must be done for each subsequent episode of care a patient receives. A nurse or therapist from the HHA uses the Outcome and Assessment

as “ultra high with treatment minimum of 720 minutes per week.” Payment per day for this patient is com- puted as shown in Table 3–11. The rates used in this example are updated over time as most Medicare rates are adjusted to reflect inflation.

Home Health agencies

The Balanced Budget Act of 1997 called for the development and implementation of a PPS for Medicare home health services to be implemented October 1, 2000. Under prospective payment, Medicare pays home health agencies (HHAs) a predetermined base payment. The payment is adjusted for the health condi- tion and care needs of the beneficiary. The payment is also adjusted for the geographical differences in wages for HHAs across the country. The adjustment for the health condition, or clinical characteristics, and service needs of the beneficiary is referred to as the case-mix adjustment. The home health PPS provides HHAs with payments for each 60-day episode of care for each beneficiary. If a beneficiary is still eligible for care after the end of the first episode, a second episode can begin; there are no limits to the number of episodes a beneficiary who remains eligible for the home health benefit can receive. Although payment for each epi- sode is adjusted to reflect the beneficiary’s health con- dition and needs, a special outlier provision exists to ensure appropriate payment for those beneficiaries who need the most expensive care. Adjusting payment to reflect the HHA’s cost in caring for each beneficiary,

Table 3–11 Components of Payment Under RUG III Categorization of “Ultra High plus Extensive Services, High (RUX)”

Category Dollar Amount

Nursing Care $261.42 Occupational, Physical, and Speech Therapies 233.19 Capital and General and Administrative 70.22

Total Allowed per Diem $564.83 x Labor % .75922 Labor per Diem $428.83 x Wage Index .9907 Labor Adjusted per Diem $424.84 Non-labor per Diem 136.00 Case-Mix Adjusted per Diem $560.84

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50 Chapter 3 FinanCial environment oF healthCare organizations

Information Set (OASIS) instrument to assess the patient’s condition. (All HHAs have been using OASIS since July 19, 1999.) OASIS items describing the patient’s condition and the expected therapy needs (physical, speech- language pathology, or occupational) are used to determine the case-mix adjustment to the standard payment rate. This adjustment is the case-mix adjustment. Eighty case-mix groups, or home health resource groups, are available for patient classification using three classification criteria: clinical severity, functional severity, and service utilization severity. The Home Health Resource Grouping system in the proposed rule uses data from a large-scale case-mix research project conducted between 1997 and 1999.

3. Outlier payments. Additional payments are made to the 60-day case-mix-adjusted episode payments for beneficiaries who incur unusually large costs. These outlier payments are made for episodes whose imputed cost exceeds a threshold amount for each case-mix group. The amount of the outlier payment is a proportion of the amount of imputed costs beyond the threshold. Outlier costs are imputed for each episode by applying standard per-visit amounts to the number of visits by discipline (skilled nursing visits, or physical, speech-language pathology, occupational therapy, or home health aide services) reported on the claims. Total national outlier payments for home health services annually are no more than 5% of estimated total payments under home health PPS.

4. Adjustments for beneficiaries who require only a few visits during the 60-day episode. The proposed home health PPS has a low-utilization payment adjustment for beneficiaries whose episodes consist of four or fewer visits. These episodes are paid the standardized, service- specific, per-visit amount multiplied by the number of visits actually provided during the episode. For 2010 Table 3–12 shows the national payments unadjusted for wage index for HHA’s that submit quality data.

5. Adjustments for beneficiaries who experience a significant change in their condition. When a beneficiary experiences a significant change in condition during the 60-day episode not envisioned in the original physician’s plan of

care and original case-mix assignment, a significant change in condition adjustment can occur. A significant change in condition adjustment requires a new payment amount be determined. The significant change in condition payment adjustment occurs within a given 60-day episode.

6. Adjustments for beneficiaries who change HHAs. The home health PPS includes a partial episode payment adjustment. A new episode clock is triggered when a beneficiary elects to transfer to another HHA or when a beneficiary is discharged and readmitted to the same HHA during the 60-day episode. The partial episode payment provides a simplified approach to the episode definition that takes into account key intervening health events in a patient’s care. The partial episode payment allows the 60-day episode clock to end and a new clock to begin if a beneficiary transfers to another HHA or is discharged but returns because of a decline in his or her condition to the same HHA within the 60-day episode. When a new 60-day episode begins, a new plan of care and a new assessment are necessary. The original 60-day episode payment is proportionally adjusted to reflect the length of time the beneficiary remained under the agency’s care before the intervening event. The new episode is paid an initial episode payment of one-half of the new case-mix group, and the 60-day clock is restarted.

To illustrate the actual payment determination for an episode of care under the HHA PPS program, assume that a patient has been classified as 0 severity for clinical, 1 severity for functional, and 2 severity for

Table 3–12 National HHA Payments Unadjusted for Wage Index

Discipline Per-Visit Rate

Home health aide $51.28 Medical social service 181.51 Occupational therapy 124.64 Physical therapy 123.81 Skilled nursing 113.23 Speech pathology 134.53

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Summary 51

within different segments of the healthcare industry are affected by changes in payment arrangements in different ways.

Healthcare entities also depend quite heavily on a very limited number of key clients for most of their operating funding. Their largest client is often the fed- eral government or the state government. Doing busi- ness with the government involves a significant amount of reporting to ensure compliance and adherence to governmental regulations. Moreover, because the fed- eral government is such a large purchaser of services, a thorough understanding of the nature and implica- tions of the Medicare payment system’s rules and regulations is a must for effective management of an HCO. Important differences exist in setting rates and bundling services between hospital inpatient and out- patient care, physician services, SNFs, and home health care. Each system has differing implications for the management of resources by the HCO.

The revenue function of a typical healthcare entity is usually much more complex than that of a compara- bly sized non-healthcare business. Organizations can have vastly different revenue structures, depending on the segments of the healthcare industry in which they are active. Government commands enormous influ- ence as a purchaser of healthcare services and main- tains complex payment systems. Because payment arrangements are determined primarily by the payer, an effective healthcare administrator must have a firm understanding of the various systems, both public and private, that exist. Yet, although HCOs may be com- plex from a financial perspective, they are still busi- nesses. Their financial viability requires the receipt of funds in amounts sufficient to meet their financial requirements.

services utilization (C0F1S2). Payment for this patient under the PPS program is calculated as follows:

National standardized payment rate $2,320.89

Case weight × 1.5769

Case-mix adjusted payment $3,659.81

This amount is then adjusted for the actual wage index of the provider. Under the HHA PPS program, 77.7% of the payment is assumed to be labor related, whereas the remaining 22.3% is assumed to be nonlabor. Actual payment for a provider with a wage index of 1.2000 is $4,228.54:

[$3,659.81 × 0.777 × 1.2000] + [$3,659.81 × 0.223] = $4,228.54

suMMarY

Compared with most businesses, HCOs are finan- cially complex. Not only do they provide a large num- ber of specific services, but their individual services often also have different effective price structures. Services may be bundled in different ways to deter- mine prices, according to the agreements in place with each specific payer. One customer may choose to pay on the basis of cost, whereas another may pay full charges. Prices may be determined prospectively or may be capitated for broad scopes of care. This varia- tion in payment patterns creates problems in the estab- lishment of prices for products and services. Indeed, the revenue function of a typical healthcare entity is usually much more complex than that of a comparably sized non-healthcare business. Further, organizations

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