by Michael Scott
In the future, the prices charged by a health care provider (along with the provider’s perceived quality) will increasingly shape the public’s perception of value.
This declaration is rapidly evolving from a prediction to an undeniable truth. To underscore this, consider the following:
- In November of 2007, SB337 was introduced in the Wisconsin state senate. Although the bill failed to pass, it would have required health care providers to list the usual and customary charges for their 50 most common health care services, diagnostic tests, or procedures relevant to the treatment of particular presenting conditions. Providers would have been required to make the list available free of charge, in spreadsheet format, to any consumer who requested it.
- Thirty-two states already require hospitals to make pricing information available to the public, either by posting to a hospital, hospital association, or government website, by publication in a government or hospital association report, or by delivery to consumers upon request. Providers in five additional states voluntarily participate in similar programs.
- State efforts on price transparency vary—from making individual hospitals’ master list of charges available to the public (as California does) to providing pricing information on frequent hospital services (as do Missouri, Florida, Nevada, and North Carolina) to providing public access to virtually all inpatient services and even selected outpatient services (as in Colorado, Kentucky, Oregon, Pennsylvania, and Wisconsin).
What questions are being asked?
The Wisconsin Hospital Association’s Wisconsin PricePoint System website provides an excellent example of the ready accessibility of comprehensive information. In a matter of minutes, consumers can obtain access to a hospital’s average charge for various clinical conditions, as grouped under the diagnosis-related group classification system used by the Medicare program.
The PricePoint System also facilitates comparisons with any other hospital in the state and also allows for filtering of this information by the severity of the condition. It goes without saying that Wisconsin hospital providers are and should be comparing their own information to the statewide averages and, especially, their direct competitors.
How should hospitals be responding? What questions should they be asking? As a simple example, we recently compared the average charges per admission for cesarean deliveries for a group of four Wisconsin hospitals.
The hospitals are all located within 20 miles of each other and are arguably competitors. To make the comparison more meaningful, we filtered the results to present only the lowest level of severity. The hospitals’ average charges per admission ranged from a low of just over $8,000 to nearly $11,000, with a mean of about $10,000.
While it may be obvious that the hospital charging the most should be questioning why it is 8-10% more than its competitors, shouldn’t the hospital with the lowest average charge also be concerned as to why its average charges are 15-20% less?
What is driving the pricing decisions at these hospitals? If the answer is “cost of care,” then would it be reasonable to assume that the average cost of caesarian deliveries could vary by 25% among the four competitors? In truth, many hospitals have only an imprecise (at best) understanding of their costs of care, yielding pricing decisions that are equally imprecise.
Rational pricing demands a logical correlation to costs of care, if the hospital provider is to offer consumers a convincing explanation of its pricing (and thus educate the consumer on the value it delivers).
The challenge of developing reliable cost information
Hospital financial managers are continually pursuing reliable methods of asserting costs. Typically efforts have focused on determining department-level or procedure-level direct costs.
While it is relatively straightforward to trace the direct labor and direct supply costs to specific services or departments, these costs generally account for only about 40% of a hospital’s total costs. Significant costs are also incurred in shared resources such as physical plant and equipment or in organization-sustaining resources. Linking these types of resource costs to patient care is more problematic, resulting in a great deal of imprecision in the development of appropriate prices.
Some hospitals utilize the Medicare Cost-to-Charge Ratio (CCR) methodology to develop unit costs of procedures. Generally, the resulting unit costs produced are unreliable, since the CCR methodology assigns costs at a department level and then applies an average cost per dollar charged to all individual services or procedures produced by the department. This method ignores the intensity of resource utilization by specific services or procedures, presenting a misleading view of unit costs. In addition, this method assumes previous pricing decisions have always been consistent and rational.
Alternatively, some hospitals have attempted to implement activity-based costing (ABC) with varied results. ABC focuses on the translation of expenses into activities thus improving the view of resource utilization by type of resource. Activities are then driven into products or customers to determine totals costs.
Our experience regarding ABC is that implementations can often take too long and struggle to remain cost effective. In addition, the solutions tend to be too technical, often resulting in only a few analysts who actually understand what data is in the system and how to use it. Ultimately, too many resources are spent on model development, while not enough resources are then available to use the information in support of strategic decisions.
An advanced approach to costing (and pricing)
A “next generation” of cost modeling is based in part on our past experiences with ABC and in part on our experience with the health care industry. The focus of this approach is on driving value from information by changing the modeling paradigm: Seek to have at least 80% of the time and effort invested in using the information to support strategic analysis and less than 20% expended on data input and model management.
Building upon ABC, this approach explicity considers the intensity of resource use, which differeniates it from other CCR methodologies. However, the modeling approach is a substantial improvement from ABC because it allows for continual consideration of the “ROI” of information: an organization should only pursue more information if it helps to achieve a better decision.
As a result, the model is developed in a top-down hierarchal fashion. Refinement or additional model development is completed only when necessary and is aimed at specific strategic questions or issues.
Unlike other cost model methodologies, the hierarchal development requires less direct involvement from a large cross section of teams. Models are built utilizing data that is typically reported and contained within a health care organization’s current information systems. This avoids the need for complex data extracts and queries. In the end, this allows a model to be constructed rapidly, typically in 6-10 weeks, instead of the several months ABC requires.
As consumers gain greater access to hospitals’ pricing of services and increasingly rely on such information to assess value, reliable cost information to confirm pricing decisions will take on ever more strategic significance to hospital providers.
Accordingly, they should focus on the advancement of cost models, which are timely and reliable (demonstrating a strong “cause and effect” correlation), yet cost effective in their development. Doing so will enable providers to more effectively understand and present a rational case for the pricing of their services.
About the author
Michael Scott is Wipfli's director of health care process costing. His specialty is process-based costing, which allows organizations to view process, customer, and market segment costs simultaneously. For more information, please contact Michael at 217.836.4653 or mscott@wipfli.com.