Chapter 7

Provider Payment

7.1 INTRODUCTION

7.2 PHYSICIAN REIMBURSEMENT

7.2.1 Fee-for-service reimbursement

The physician is paid a specific sum for each individual service he or she provides to the patient. The services are broken down into units, such as a complete physical exam, a follow-up visit, a tonsillectomy, and so on.

One type of fee setting is referred to as the UCR (Usual, Customary, and Reasonable) form of reimbursement. Usual refers to the usual or typical fee charged by the billing physician, customary refers to fees charged by all physicians in the community, and reasonable refers to allowances for particular circumstances.

7.2.2 Per case Reimbursement

In this type of reimbursement, the physician is paid a fixed amount for each type of case treated, much like the DRG system.

7.2.3 Per capita and Salary Reimbursement

In both cases, there is some incentive for physicians to provide no more than the basic minimum level of services. However, a physician who intends to remain in practice a long time could not afford to allow the quality of services to fall to a low level.

7.2.4 Agency Theory and Physician Reimbursement

Many investigators have linked the fee-for-service payment system with the generation of a high volume of services and consequently with high expenditure levels. Usually, fee-for-service is compared with capitation funding.

Under any payment system, the physician has the ability to generate additional services because of the information asymmetry between physician and patient. Under fee-for-service, the physician has the incentive to generate more services, especially if the fee exceeds the marginal cost of the service. By comparison, the physician will not have such an incentive under capitation. If the physician is not concerned about repeat visits, then he or she will have an incentive to reduce the volume of visits.

A third-party payer will incur contract costs under both fee-for-service and capitation funding. Under fee-for-service funding, the insurer must monitor for excessive services, while under capitation funding, the insurer must monitor for low quality of care due to inadequate provision.

7.2.5 A Resource-Based Relative Value Scale

Medicare adopted a variant of the UCR system called customary, prevailing, and reasonable (CPR), but it had regulated these fees since 1984. Recently, a new schedule has fixed fees that are based on resource use measures. This system, called RBRVS, attempts to classify costs that will be incurred by physicians operating in a competitive environment.

7.3 HOSPITAL REIMBURSEMENT

7.3.1 Alternative Bases of Reimbursement

Until early 1980s, hospitals were reimbursed on a retrospective basis. That is, a third-party insurer would reimburse a hospital for the expenses it had already incurred (if reimbursement was on a cost basis) or the charges it had already billed (if reimbursement was on a charge basis). Retrospective reimbursement has one overriding effect on supply and on costs: it encourages an organization to expand. Increases in both the scope and quality of services tend to occur, and if the provider is a maximizer of anything (e.g., profits, or perquisites), retrospective reimbursement can lead to higher costs, more services, and higher quality services.

Prospective reimbursement involves setting the basis of reimbursement before the reimbursement period.

7.4 DIAGNOSIS-RELATED GROUPS

In 1983 the federal government introduced a new prospective payment system (PPS) for Medicare hospital patients. Reimbursement for all Medicare discharges is on a per diagnosis basis. There are 511 categories in the 2001 DRG classification system.

With the hospital’s output being measured in terms of case-weighted admissions, a reimbursement rate (called a standardized amount) must be set for each single point (relative weight = 1.00).

Medicare also reimburses hospitals for certain additional costs that fall outside of the basic case-mix formula: outlier-related costs, and direct medical education costs. An outlier is a case whose costs or length of stay is sufficiently high that it falls outside certain pre-determined limits. 2 kinds of outliers—day and cost outliers. A day outlier for a specific DRG is a case whose length of stay exceeds a preset number of days; all days in excess of this trim point are called outlying days. There are similar criteria for cost outliers.

7.5 LONG-TERM CARE FACILITY REIMBURSEMENT

One case mix measure that has been developed is called Resource Utilization Groups (RUGs). This measure has now been superseded by RUGs II, and RUGs III. The RUGs case mix measure is based on a set of five hierarchical groups related to levels and types of services (rehabilitation, extensive services, special care, clinically complex cases, impaired cognition, behavioral problems, and reduced physical functioning) and, within these hierarchical groups, scores on the activities of daily living (ADL) scale, which assigns numerical scores according to degree of physical function; and individual can attain in each of 6 categories: bathing, dressing, toileting, feeding, transferring between locations, and continence). RUGs III uses 4 of these categories: eating, transferring, bed mobility, and toileting. Based on the points assigned to each of these, in combination with the 6 hierarchical groups, the patient is assigned to 1 to 44 RUGs III categories, which are assigned weights according to their relative costs, and reimbursement is made in accordance with these relative weights.

7.6 HMOS

An HMO is responsible, simultaneously, for two types of services—health insurance and health care. Health insurance coverage is sold to customers on a per capita basis. The health care itself is provided, or contracted for, by the HMO directly.

The per capita funding formula provides an incentive for any for-profit HMO to minimize costs (all other factors being held constant). An HMO can reduces its costs by lowering the use of services by existing patients, encouraging the enrollment of members who are at low risk, and disenrolling high-risk patients. Indeed, the likelihood of an HMO’s encouraging self-selection and thus having an enrollee mix that does not reflect the demographics of the general population has resulted in the development of adjustment formulas to compensate for potential differences in enrollee risk and the cost of utilization. These formulas are used to calculate higher payment rates for higher risk individuals, thus inducing HMOs to enroll these individuals.

One such adjustment formula, Medicare’s former average adjusted per capita cost (AAPCC) formula, was used to determine the rates at which Medicare pays HMOs. AAPCCs were calculated for separate groups of patients (factors used in constructing the groups included sex, age bracket, county, welfare status, and institutionalization).

One criticism of this payment system was that it did not pinpoint risk categories accurately enough and that HMO cream skimming was a distinct possibility even with the AAPCC adjustments.

A second problem was that it created a wide regional variation in rates. Medicare paid low rates for residents who lived in counties where costs were low, and HMOs would not offer services in counties with low AAPCC rates.

In order to address these problems, Medicare instituted a new risk-premium-setting mechanism in 2000. This system was called “Medicare + Choice” and was instituted under a new Part C of Medicare. The risk-adjustment factors included sex, age, disability status, Medicaid eligibility, and institutional status.

7.7 PROVIDER SUPPLY UNDER MANAGED CARE

7.7.1 Agency Theory and Incentive Contracts

In order to encourage the providers, who have the best information about the HMO members’ health status, and what treatments are appropriate, to act in the interest of the HMO, the HMO management can design a compensation scheme for the providers. Models that examine such compensation schemes are called agency models. The two contracting bodies in such models are the principals (in this case, the HMOs) and their agents (in this case the providers).

· HMO objectives assumed to maximize profits. Minimum acceptable profit level assumed to be $500,000.

· HMO revenues depend on capitation rate applied to its members and number of members who join HMO.

· HMO costs include those that are incurred in treating HMO members who become patients

· HMO provider interaction. HMO depends on providers for achievement of its profit targets. Providers can influence HMO profits by varying their levels of effort.

Graph A of Fig. 7-3, p. 165 shows relationship between HMO’s profits and efforts of agents.

· Physician objectives: to maximize net income (profits), which is equal to revenues from HMO minus personal costs of supplying care (or exerting effort).

· Physician costs are opportunity costs to physicians of engaging in productive practices. The MC curve of effort is shown in graph B of Fig. 7-3.

· Physician revenues: 1) if physician is paid a straight salary, any additional effort by physician results in costs but yields no extra revenue. Physician will provide minimum acceptable level of effort (level E₁ ) that corresponds to minimum profit target of HMO.

2) if physician is paid $35/service, extra effort will result in extra services provided. Physician will maximize net income at level of effort E₅. However, this will result in HMO’s profits below minimum acceptable level of HMO’s profits →Doctor will reduce effort level to E₄.

3) if the physician is paid a fixed % of HMO profits. However, physician will not choose level of effort that corresponds to maximum HMO profits but will choose E₂ where the MR and MC curves intersect.→lower than maximum profits for HMO but more profits than under a salary compensation scheme.

7.7.2 Management of Provider Behavior