Benchmarking provider cost using Medicare allowed

There are many reliable research statistics from the private sector and the federal agencies that support the evidence that medical costs are rising and the current pace is unsustainable. Medical cost trend has two primary components, the number of services provided to patients (utilization) and the cost of each of those services (unit cost). While utilization management can be important for achieving cost savings, some employers are now giving further attention to the significant price variation in unit cost. Chart 1 below provides an example of the price variation using the average reimbursement as a percentage of Medicare in Buffalo, New York; Indianapolis, Indiana; Ventura, California; and nationwide. As shown, going from Buffalo to Indianapolis reflects an 80% increase in cost, based on unit price alone.

Benchmarking provider cost using Medicare allowed_Figure 1

We regularly encounter employers who don’t fully understand the impact of provider reimbursement variation on their medical plans’ financial performances. This comes as no surprise, given the limited transparency and complexity of current provider reimbursements.

Limited transparency of provider reimbursement (allowed charges)
For employers, the industry standard technique of benchmarking commercial allowable charges has historically been traditional discount analyses, which compare discounts to billed charges. However, these approaches do not provide the required rigor and precision to understand medical service reimbursement analysis—both across markets and within a given market. This is because billed charges are not standardized across providers or different services. As a result, the exact same discount could mean very different things, depending on the provider and service—in some cases, price differences of over 300%. In addition, providers often optimize their billed charges to enhance reimbursement on contracts based on billed charges.

Employers generally have had a difficult time measuring unit cost, which is solely due to the complexity of various medical procedures. There is a large amount of price variation within each inpatient diagnosis-related group (DRG) and outpatient type of service. Chart 2 below provides a powerful illustration of how reimbursement can vary significantly across even a single inpatient DRG or outpatient service category. The chart compares the commercial reimbursement for inpatient joint replacement and an outpatient MRI in three different metropolitan areas with what the government would pay under Medicare allowable. The variation in inpatient joint replacements, a large bundle of complicated services, is much lower than outpatient MRIs, which reflects a specific service that generally has little variation in intensity compared with a joint replacement.

Benchmarking provider cost using Medicare allowed_Figure 2

Measuring unit cost effectively
In our work, we find that using Medicare reimbursement rates as a benchmark can provide much-needed clarity. Specifically, because Medicare is commonly used, and is a widely understood baseline for tracking provider reimbursement, it can serve as an objective measure of the unit price component of employer spend.

Providers are already accepting Medicare payments for a significant portion of their patients, so it provides a meaningful benchmark for making comparisons. Unlike billed charges, Medicare reimbursement can be normalized across providers and geographies. Additionally, pegging allowed charges to Medicare reimbursement can help normalize for changes in service mix (e.g., joint surgery versus MRI) or intensity (e.g., MRI versus x-ray).

Table 1 below shows an example for an employer whose employees currently utilize two hospitals. In this example, we have repriced the employer’s claims to Medicare reimbursement and used Medicare reimbursement as the benchmark.

Benchmarking provider cost using Medicare allowed_Table 1

As shown in Table 1, the employer spent $1.75 million at two hospitals. The cost per case was higher at Hospital B ($1,000 per case) than at Hospital A ($500 per case). However, Hospital B was performing more intensive services. To effectively compare the two hospitals, we repriced all of the claims to Medicare allowable to understand how much Medicare would have paid for these same sets of services. The result is that Hospital B is less costly (150% of Medicare allowable) on a case-mix adjusted basis than Hospital A (200% of Medicare allowable). In fact, we went even further to realize that if every employee went to Hospital B instead of Hospital A, the employer would save $250,000. See Table 2 below.

Benchmarking provider cost using Medicare allowed_Table 2

In summary, using Medicare as a benchmark allows employers to compare the relative prices of all providers and networks. This comparative analysis will drive potential actions that may include:

• Educating employees on local market price differences
• Refining plan design to reward patients who utilize more price-efficient providers and more appropriate settings
• Renegotiating prices with highly utilized, high-cost providers or modifying the provider network
• Providing feedback to current carriers or third-party administrators (TPAs) about price outliers and negotiating unit-price guarantees
• Joining an employer coalition to negotiate better prices and/or engaging in direct-to-provider contracting
• Adding additional carriers or TPAs or optimizing networks

Measurement is a critical and essential component of management. With many existing and emerging cost-control strategies, it is important that employers properly measure their provider reimbursement levels. Despite the terrible complexity of provider reimbursement, with the proper guidance, data, and tools, employers can assess their current positions to guide future action and performance.

This article first appeared in the September 2016 issue of Health and Group Benefits News and Developments.

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