Financing Health Services
John A. Graves, Ph.D.
Professor of Health Policy and Medicine, Vanderbilt University School of Medicine
Professor of Management, Owen Graduate School of Management
Plan for Today
- Physician Payment
- Hospital Payment
- Financing the Social Mission
Act I: Physician Payment
So you want to get reimbursed for that 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
9.26416 = W + P + M
Total RVUs for a Colonoscopy
- We next need a way to map these RVUs into a reimbursed amount.
9.26416 = W + P + M
Total RVUs and Conversion Factor
9.26416
$32.3465
Total Payment for a Colonoscopy
$299.66 =
9.26416
\times
$32.3465`
Total Payment for a Colonoscopy (2025)
Total Payment for a Colonoscopy (2025)
A Simple (E&M) Clinic Visit
Extra: 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”
Extra: 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”
Extra: 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”
How did FHD2 do at pricing colonoscopies?
Medicare vs. FHD2
| CMS | FHD |
|---|---|
| $300 | $250 |
Medicare vs. FHD Students
Medicare vs. FHD Students
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.
A $1.00 increase in Medicare’s fees increases corresponding private prices by $1.16
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
- Physicians and facilities paid separately for an inpatient stay.
- 1965 to 1983: Hospitals paid based on “reasonable costs.”
- Seems bulletproof. What could possibly go wrong??
Hospital Days per 1,000 Medicare enrollees
Hospital Days per 1,000 Medicare enrollees
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.
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
$7,137
- 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
$6,624 Operating
$512 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
$7,137
- To simplify things, we’ll just show the total base payment moving forward.
Geographic Adjustment
$6,896
- 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
$6,896
$393
- 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)
$6,896
$1,443
- VUMC also receives additional payments to compensate for the costs associated with teaching activities.
Federal Base Payment
\quad \quad $8,732
- 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.
Diagnosis Related Groups
CC stands for complication or comorbidity.
Distinctions are made between major CCs (MCC), CCs and non-CCs.
Diagnosis Related Groups
- In total, there are 761 MS-DRGs.
- Next step: determine the relative resource used by each …
- These are captured by DRG weights
- But how are DRG weights determined?
Detour: Hospital Charges
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.
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 |
|---|---|---|
| 601 | NON-MALIGNANT BREAST DISORDERS WITHOUT CC/MCC | 0.5995 |
| 594 | SKIN ULCERS WITHOUT CC/MCC | 0.8486 |
| 667 | PROSTATECTOMY WITHOUT CC/MCC | 1.0277 |
| 308 | CARDIAC ARRHYTHMIA AND CONDUCTION DISORDERS WITH MCC | 1.2060 |
| 584 | BREAST BIOPSY, LOCAL EXCISION AND OTHER BREAST PROCEDURES WITH CC/MCC | 2.0473 |
| 219 | CARDIAC VALVE AND OTHER MAJOR CARDIOTHORACIC PROCEDURES WITHOUT CARDIAC CATHETERIZATION WITH MCC | 7.7370 |
| 018 | CHIMERIC ANTIGEN RECEPTOR (CAR) T-CELL AND OTHER IMMUNOTHERAPIES | 37.7102 |
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 $8,732
| ms_drg | ms_drg_title | drg |
|---|---|---|
| 481 | HIP AND FEMUR PROCEDURES EXCEPT MAJOR JOINT WITH CC | 2.0749 |
Back to Sara
\quad \quad $18,118
| ms_drg | ms_drg_title | drg |
|---|---|---|
| 481 | HIP AND FEMUR PROCEDURES EXCEPT MAJOR JOINT WITH CC | 2.0749 |
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 $18,118
- In 2022, VUMC was penalized $17.28 per discharge (for DRG weight = 1.0).
- For Sara’s discharge (weight 2.0749), the total reimbursed is reduced by $35.85.
Quality Based Adjustments
\quad \quad $18,082
- In 2022, VUMC was penalized $17.28 per discharge (for DRG weight = 1.0).
- For Sara’s discharge (weight 2.0749), the total reimbursed is reduced by $35.85.
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
Uncompensated Care Pool
\quad \quad $18,082
$1,776.19
- VUMC receives an estimated per discharge uncompensated care payment amount calculated and published by CMS for each hospital.
Further Adjustments
Per diem passthroughs for Sara’s stay …
- Costs of organ transplant acquisition ($836.15 per day).
- Allogenic stem cell ($16.17 per day)
- 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; $342.68 per day)
Act III: Financing the Social Mission
Financing the Social Mission
- Uncompensated care
- Community benefit expenditure and nonprofit designation
- 340b Drug Discount Program
1. Uncompensated Care
1. Uncompensated Care
- Sum of charity care and bad debt
- Usually measured (and proclaimed …) in charges, though policymaking often reels this back in using a cost-to-charge ratio.
Charity Care
- Patient is uninsured or cannot afford what she is billed.
- Based on patient income, the hospital may “write down” the charge (to $0 or some discounted amount)
- The difference between the charge and what is collected contributes to the charity care amount.
Bad Debt
- Patient is billed 20% coinsurance for her inpatient stay.
- She does not pay the bill, and the hospital is unable to recover payment.
- The uncollected amount contributes to bad debt.
Example
Discounted cash price: $7,856
- Patient receives a Cervical Spine CT at TriStar Centennial
- Patient is low-income and applies for charity care, and is deemed eligble at 60%.
Example
Charity Care: $4,714
Pt. Liability: $3,142
- 60% of the discounted cash price ($4,714) accrues to the charity care total.
Example
Charity Care: $4,714
Pt. Liability: $2,142
Paid: $1,000
- The patient pays $1,000 towards his liability.
Example
Charity Care: $4,714
Bad Debt: $2,142
Paid: $1,000
- The remaining $2,142 is written off as bad debt.
Example
Total Uncompensated Care: $6,856
Paid: $1,000
- Total uncompensated care (charity + bad debt) is $6,856.
- Reminder: this is all based on the charge!
Example
Total Uncompensated Care: $6,856
Paid: $1,000
- TriStar Centennial has a cost-to-charge ratio of 0.108
- An estimate of the real “cost” of the CT scan is 0.108 * $7,856 = $848.
- So the CT scan had an estimated cost of $848, and the patient paid $1,000. Yet there is $6,856 in recorded uncompensated care … 🤔
2. Community Benefit Expenditure and Nonprofit Status
2. Community Benefit Expenditure and Nonprofit Status
- Nearly two-thirds of general acute care hospitals are nonprofit.
- Locally: VUMC, St. Thomas Midtown, St. Thomas West
- Nearly three-quarters of admissions (71%) are at nonprofit hospitals.
- What does “nonprofit” mean? How does a hospital get designated as nonprofit?
A Brief History of Nonprofits
The existence of nonprofits predates the establishment of the Internal Revenue Service (IRS).
The modern nonprofit hospital industry arose from “voluntary hospitals” that originated within religious societies in the nineteenth century.
These institutions operated on donations and had clinical staff who provided mostly voluntary labor.
Operating structure reflected the idea that the provision of medicine—especially for the poor—should be stripped of incentives for financial profit.
Nonprofit Designation
Modern nonprofits are exempt from corporate income and certain state and local taxes.
- Tax expenditure results in over $25 billion in forgone revenue each year.
To be designated as nonprofit, must serve a “public rather than a private interest.”
Some states (CT and NY) prohibit investor-owned facilities.
Nonprofit Designation
Tax exemption is based on a requirement that nonprofits provide “community benefits”
General term capturing activities and expenditures that (potentially) improve patient health.
Community Benefit
- Discounts and access to charity care for low-income patients
- Medical education and research programs
- Population health education and screening programs
- Provision of services that operate with low or negative profit margins (e.g., free clinics for indigent and uninsured patients, inpatient psychiatric care, etc.)
- Documentation of an accounting shortfall between costs incurred and payment received for publicly-insured (Medicare and Medicaid) patients also counts.
There is no specific level or set of community benefit expenditures a hospital must provide.
Community Benefit Expenditure
- As a percentage of operating revenues, community benefits varied from less than 1% to 20% among nonprofits (Young et al. 2013).
- Charitable medical care is concentrated among a relatively few nonprofit hospitals and over half provide benefits significantly less than the value of their tax exemption.
- In 2018, the top 10% of nonprofit hospitals spent approximately 9% of hospital operating revenues on uncompensated care, while the top 10% of investor-owned hospitals spent 8%.
3. The 340B Drug Discount Program
3. The 340B Drug Discount Program
- Another way that (some) hospitals can finance their social mission is through purchasing drugs at steep discounts.
3. The 340B Drug Discount Program
- The 340B program was initiated in 1992.
- Participating hospitals (nonprofit and public) can purchase drugs for outpatient care at steep discounts.
- There are no restrictions on what hospitals charge payers.
- The discounts also extend to an unlimited number of affiliated clinics, offices, and contracted retail pharmacies.
340B Participation
- Nikpay, Buntin and Conti (JAMA IM 2018)
Major Issues in 340B
- Coming under more scrutiny as now more than 2,000 hospitals qualify.
- Locally: VUMC and Nashville General
- Drugmakers really pushing back:
- Estimated $44 billion in discounted purchases in 2021 (7% of drug market).
- Policymakers have generally sided with the hospitals, but lots of legal challenges.
The End
