Please Read the Case Study. Class will begin promptly at 4:25pm.

Credence Goods

  • A good for which the consumer does not know how much they need.
  • Examples?

Credence Goods

  • Not necessarily bad.
  • Become problematic when those selling/providing the credence good faces financial incentives to sell more (less).

The Case Of Paclitaxel

The Case Of Paclitaxel

Sources: Jacobson, Mireille, et al. “How Medicare’s payment cuts for cancer chemotherapy drugs changed patterns of treatment.” Health Affairs 29.7 (2010): 1391-1399; Gross and Notowidigdo, Better Health Economics. University of Chicaco Press (2024)

The Case Of Paclitaxel

Sources: Jacobson, Mireille, et al. “How Medicare’s payment cuts for cancer chemotherapy drugs changed patterns of treatment.” Health Affairs 29.7 (2010): 1391-1399; Gross and Notowidigdo, Better Health Economics. University of Chicaco Press (2024)

The Case of Long-Term Care Hospitals

The Case of Long-Term Care Hospitals

Sources: Jacobson, Mireille, et al. “How Medicare’s payment cuts for cancer chemotherapy drugs changed patterns of treatment.” Health Affairs 29.7 (2010): 1391-1399; Gross and Notowidigdo, Better Health Economics. University of Chicaco Press (2024)

The Case of Long-Term Care Hospitals

Sources: Eliason, Paul J., et al. “Strategic patient discharge: The case of long-term care hospitals.” American Economic Review 108.11 (2018): 3232-3265.; Gross and Notowidigdo, Better Health Economics. University of Chicaco Press (2024)

The Case of Long-Term Care Hospitals

Sources: Eliason, Paul J., et al. “Strategic patient discharge: The case of long-term care hospitals.” American Economic Review 108.11 (2018): 3232-3265.; Gross and Notowidigdo, Better Health Economics. University of Chicaco Press (2024)

Plan for Today

  1. Physician Payment and induced demand.
  2. Hospital Payment and the “throughput model” of hospital operations.

Act I: Physician Payment

Let’s think about how doctors are paid for a colonoscopy…

First, think about the relative effort needed to perform a mammography

Work Effort for a Mammogram

Diagnostic mammography, including computer-aided detection (CAD) when performed; bilateral

Work Effort

Work Effort for a Colonoscopy

Colonoscopy, flexible; diagnostic, including collection of specimen(s) by brushing or washing, when performed (separate procedure)

Work Effort

Relative Value Units

Work Effort

Relative Value Units

W

What other costs are involved?

W

Relative Value Units

W

Practice Expense

Relative Value Units

W

P

Any other costs we should account for?

W

P

Relative Value Units

W

P

Malpractice Expense

Relative Value Units

W

P

M

Further adjustments?

  • Need to account for geographic differences in the cost of delivering these categories of care.

W

P

M

RVUs After Geographic Adjustment

  • Relative to the US average, Nashville is a less expensive health care market.

W

P

M

RVUs After Geographic Adjustment

  • Relative to the US average, Nashville is a less expensive health care market.

W

P

M

Total RVUs for a Colonoscopy

W

M

W + P + M

Total RVUs for a Colonoscopy

9.397 = W + P + M

Total RVUs for a Colonoscopy

  • We next need a way to map these RVUs into a reimbursed amount.

9.397 = W + P + M

Total RVUs and Conversion Factor

9.397

$34.6062

Total Payment for a Colonoscopy

$325.21 =

9.397

\times

$34.6062

Total Payment for a Colonoscopy (2022)

How is the Conversion Factor Updated?

CF is based on last years’s CF and adjusted for:

  • Medical Economic Index
    • Inflation rate for medical services (4.6% in 2024)

Source: Seidenwurm DJ and Burleson JH. “The Medicare Conversion Factor”

How is the Conversion Factor Updated?

CF is based on last years’s CF and adjusted for:

  • Update Adjustment Factor
    • Mechanism through which the relative proportion of Medicare (physician) spending is maintained at an acceptable level with respect to overall government spending and the size of the economy as a whole.

Source: Seidenwurm DJ and Burleson JH. “The Medicare Conversion Factor”

How is the Conversion Factor Updated?

CF is based on last years’s CF and adjusted for:

  • Legislative Change
  • Budget Neutrality
    • Any increase in one area of the Medicare program must be offset by cuts in other areas.
    • Must result in a budget for Medicare that is within $20 million of the target.

Source: Seidenwurm DJ and Burleson JH. “The Medicare Conversion Factor”

The RUC Doctors

What About Private Prices?

  • Outside of the US, hospitals and physicians in virtually every other developed nation are paid via some form of government-regulated reimbursement.

  • Private insurers cover approximately 60% of the population and negotiate market-determined prices.

  • Well, kind of.

What About Private Prices?

  • It turns out that private payers just key off the Medicare fee schedule.
  • A $1.00 increase in Medicare’s fees increases corresponding private prices by $1.16 (Clemens and Gottlieb 2017).
  • Medicare’s influence is strongest in areas with concentrated insurers and competitive physician markets.

What About Private Prices?

Source: Clemens and Gottlieb (2017)

Act II: Hospital Payment

A Brief History of Hospital Payment

Sec.1801 42 U.S.C. 1395

Nothing in this title shall be construed to authorize any Federal officer or employee to exercise any supervision or control over the practice of medicine or the manner in which medical services are provided …

Sec. 1802 42 U.S.C. 1395a

Any individual entitled to insurance benefits under this title may obtain health services from any institution, agency, or person qualified to participate under this title if such institution, agency, or person undertakes to provide him such services.

A Brief History of Hospital Payment

  1. Physicians and facilities paid separately for an inpatient stay.
  2. 1965 to 1983: Hospitals paid based on “reasonable costs.”
  3. Seems bulletproof. What could possibly go wrong??

Average Length of Stay in US Hospitals

Source: OECD Data

Average Length of Stay in US Hospitals

Source: OECD Data

Hospital Days per 1,000 Medicare enrollees

Sources:Gross and Notowidigdo, Better Health Economics. University of Chicaco Press (2024) [note: via David Cutler and Dan Ly]

The Hospital Inpatient Prospective Payment System

Inpatient Prospective Payment System

  • Under the IPPS, hospitals receive predetermined fees (case rates) for inpatient admissions.
  • Fees are based on the health conditions treated and the procedures performed, rather than the costs that were actually incurred.
  • Organized around Diagnosis Related Groups, or DRGs.

What About Private Prices?

  • Once again, the private sector followed Medicare in implementing prospective payment of hospitals (Mayes and Berenson 2006).

Hospital Payment: Case Study

Sara, a 72 year old widow, fell off of her front porch. An ambulance transported her to Vanderbilt University Medical Center. She is diagnosed with an open fracture of the left femur requiring surgical intervention. In addition, the physician determines from her medical history that she has non-insulin dependent diabetes with associated peripheral vascular disorders.

Note: Case adapted for VUMC from a CMS payment example.

Federal Base Payment

$6,595

  • Hospital payment begins with a base payment rate, which is the amount Medicare pays for a single “unit” of an inpatient episode.
  • Think of this rate as analogous to the conversion factor (for an RVU of 1.0) we used for physician payment.

Federal Base Payment

$6,122 Operating

$473 Capital

  • The total base payment rate reflects two sources of reimbursement.
  • Operating base payments are tied to labor and supply costs.
  • Capital base payments are tied to costs for depreciation, interest, rent, and property- related insurance and taxes.

Federal Base Payment

$6,595

  • To simplify things, we’ll just show the total base payment moving forward.

Geographic Adjustment

$6,058

  • The base payment rate is adjusted upwards or downwards based on the local wage index.
  • Nashville is regarded as a “cheaper” labor force market, so the base rate is adjusted slightly downwards.

Additional Base Payments

  • Concern: hospitals that treat low-income / uninsured populations unfairly disadvantaged.
  • Teaching hospitals incur higher costs related to teaching activities.
  • Consequently, hospitals that serve indigent populations and teaching hospitals get “add-on” payments to compensate them for higher costs.

DSH Add-On

  • Disproportionate Share Hospitals serve a significantly disproportionate number of low-income patients.
  • VUMC qualifies as a DSH hospital and receives a percentage add-on to help offset the costs of providing care to uninsured patients.

DSH Add-On

DSH Add-On

$6,058

$320

  • VUMC qualifies as a DSH hospital and receives a percentage add-on.

Indirect Medical Education (IME)

  • VUMC also receives additional payments to compensate for the costs associated with teaching activities.

  • Why? Treatment by a resident may incur some additional costs (e.g., testing) and in general be less “efficient.”

Indirect Medical Education (IME)

$6,058

$1,348

  • VUMC also receives additional payments to compensate for the costs associated with teaching activities.

Federal Base Payment

\quad \quad $8,221

  • VUMC’s federal base payment is the primary “building block” for reimbursement.
  • How is this building block adjusted for case mix, acuity, and treatment intensity?

DRG Weight

  • When Sara is discharged, her inpatient stay will be assigned a Diagnosis Related Group (DRG) based on the care she needed while hospitalized.

Major Diagnostic Categories

  • To define a DRG, different admissions must be assigned to one of 25 Major Diagnostic Categories (MDCs).
  • MDCs are formed by physician panels.
  • MDCs are organized around organ systems, not etiology (e.g., malignancies, infectious diseases, etc.).

Major Diagnostic Categories

  • To define a DRG, different admissions must be assigned to one of 25 Major Diagnostic Categories (MDCs).
  • MDCs are formed by physician panels.
  • MDCs are organized around organ systems, not etiology (e.g., malignancies, infectious diseases, etc.).

Major Diagnostic Categories

  • MDCs are next split into whether the inpatient stay involved a surgical procedure.

  • This medical-surgical distinction is also useful in further defining the clinical specialty involved.

Major Diagnostic Categories

No OR Procedure Requires OR Procedure
Thoracentesis Closed heart valvotomies
Bronchoscopy Cerebral meninges biopsies
Skin sutures Total cholecystectomies

Major Diagnostic Categories

  • Additional branching is performed to group patients into the groups that require a similar level of intensity, skill, etc.

Major Diagnostic Categories

Major Diagnostic Categories

Major Diagnostic Categories

  • Further splits based on determination of whether complications, comorbidities, the patient’s age or discharge status consistent affects the use of hospital resources.

  • Thought experiment: presence of a secondary diagnosis, complication, or comorbidity that would cause an increase in length of stay by at least one day in at least 75% of patients.

  • Examples: sarcoidosis of lung, chronic obstructive pulmonary disease and pneumococcal pneumonia.

Charges are born in the land of unicorns and fairies

A brief chat with ChatGPT:

Detour: Hospital Charges

Detour: Hospital Charges

The average charge-to-cost ratios—which measure what the hospital charged compared to the actual medical expense—for different departments vary from a low of 1.8 for inpatient general routine care to a high of 28.5 for computed tomography, or CT, scan, with anesthesiology right behind at 23.5. This means that a hospital whose costs in the CT department are $100 will charge a patient without health insurance and an out-of-network privately insured patient $2,850 for a CT scan.

Source

Detour: Hospital Charges

Charge for a Cervical Spine CT At VUMC

Charge for a Cervical Spine CT At TriStar Centennial

Detour: Hospital Charges

Detour: Hospital Charges

Cost-to-Charge Ratios in Nashville

  • VUMC: 0.188

  • TriStar Centennial : 0.108

  • TriStar Southern Hills: 0.15

  • Nashville General 0.396

  • St. Thomas West: 0.184

Note: lower number means a higher charge markup relative to cost

How Are DRG Weights Determined?

For each DRG:

  • Determine average standardized charges for the DRG.
  • These charges are deflated by revenue center-specific cost-to-charge ratios (CCRs).
  • Divide by the national average standardized charge per case to determine the weighting factor.

Diagnosis Relatd Groups

ms_drg ms_drg_title drg
293 HEART FAILURE AND SHOCK WITHOUT CC/MCC 0.5899
312 SYNCOPE AND COLLAPSE 0.8387
667 PROSTATECTOMY WITHOUT CC/MCC 0.9975
546 CONNECTIVE TISSUE DISORDERS WITH CC 1.2080
415 CHOLECYSTECTOMY EXCEPT BY LAPAROSCOPE WITHOUT C.D.E. WITH CC 2.0317
219 CARDIAC VALVE AND OTHER MAJOR CARDIOTHORACIC PROCEDURES WITHOUT CARDIAC CATHETERIZATION WITH MCC 8.0576
018 CHIMERIC ANTIGEN RECEPTOR (CAR) T-CELL AND OTHER IMMUNOTHERAPIES 37.4501

Changes in Severity

Gluckman TJ, Spinelli KJ, Wang M, et al. Trends in Diagnosis Related Groups for Inpatient Admissions and Associated Changes in Payment From 2012 to 2016. JAMA Netw Open. 2020;3(12):e2028470.

Back to Sara

\quad \quad $8,221

ms_drg ms_drg_title drg
481 HIP AND FEMUR PROCEDURES EXCEPT MAJOR JOINT WITH CC 2.0961

Back to Sara

\quad \quad $17,232

ms_drg ms_drg_title drg
481 HIP AND FEMUR PROCEDURES EXCEPT MAJOR JOINT WITH CC 2.0961

We’re Not Done Yet

  • As part of the Affordable Care Act, hospitals are penalized for excess readmissions and if they score poorly on other quality measures.

We’re Not Done Yet

  • Readmissions reduction program: hospitals that have excess Medicare readmissions for selected conditions have their adjusted operating base payments reduced by up to 3 percent.

  • Readmission rate based on five conditions (acute myocardial infarction, heart failure, chronic obstructive pulmonary disease, total hip and knee arthroplasty, and coronary artery bypass graft).

  • Readmission penalty applied to all discharges.

Other Quality-Based Adjustments

  • Value-based incentive payments: CMS redistributes a pool of dollars equal to 2 percent of adjusted operating base payments based on performance on a set of outcome, patient experience, safety, and efficiency measures.

  • Hospital-acquired conditions penalty: hospitals are ranked on their total rate of preventable conditions such as falls, surgical site infections, and catheter-associated urinary tract infections.

    • The 25 percent of hospitals with the highest rates of preventable conditions receive a 1 percent reduction in all inpatient payments.

Quality Based Adjustments

\quad \quad $17,232

  • In 2022, VUMC was penalized $11.81 per discharge (for DRG weight = 1.0).
  • For Sarah’s discharge (weight 2.09), the total reimbursed is reduced by $24.78.

Quality Based Adjustments

\quad \quad $17,208

  • In 2022, VUMC was penalized $11.81 per discharge (for DRG weight = 1.0).
  • For Sarah’s discharge (weight 2.09), the total reimbursed is reduced by $24.78.

Yeah, We’re Still Not Done …

  • The Medicare program also reimburses hospitals for uncompensated care out of a pool.
  • Uncompensated care is the sum of charity care and bad debt.
  • It’s typically measured in charges (grrr…).
  • Eligible hospitals receive a fixed per discharge payment (i.e., not tied to DRG weight).

Uncompensated Care Pool

Source

Uncompensated Care Pool

\quad \quad $17,208

$1,820

  • VUMC receives an estimated per discharge uncompensated care payment amount calculated and published by CMS for each hospital.

Further Adjustments

Per diem passthroughs …

  • Costs of organ transplant acquisition.
  • Allogenic stem cell
  • Use of select new treatments that have been proven to be effective but are not yet fully accounted for in the DRG payments
  • Direct medical education (i.e., direct cost of residents)

Unintended Consequences of the PPS

  • Under the PPS, the length of time the patient remains hospitalized doesn’t matter.
  • Revenue became primarily a function of how many patients went through the hospital.
  • Operations coalesced around a “throughput model”
    • Goal: keep beds full and patients flowing through the hospital.

Brainstorm on the unintended consequences and perverse incentives of the PPS