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Exploring the Relationship Between Quality and Cost in Hospital Data

CMS has recently released its 5-star hospital compare ratings with the distribution shown in Table 1. The ratings are based upon metrics in five areas: Mortality (22%), Safety (22%), Readmission (22%), Patient Experience (22%), and Timely and Effective Care (12%).

These quality metrics are important because Medicare does pay hospitals based on quality through several programs. These programs are part of an effort to improve healthcare outcomes and ensure that patients receive high-quality care. Some of the key initiatives include:

1. Hospital Value-Based Purchasing (VBP) Program: This program rewards acute care hospitals with incentive payments for the quality of care they provide to Medicare patients. Hospitals are measured on various quality measures, such as mortality and complications, healthcare associated infections, patient experience, Patient safety, and efficiency.
2. Hospital Readmissions Reduction Program (HRRP): Under this program, Medicare reduces payments to hospitals with excess readmissions for certain conditions. The goal is to encourage hospitals to improve the quality of care during the initial hospital stay and ensure better post-discharge planning.
3. Hospital-Acquired Condition (HAC) Reduction Program: This program aims to reduce the incidence of hospital-acquired conditions by penalizing hospitals that rank in the worst-performing quartile for certain HACs. The program targets conditions that are considered preventable with proper care.
4. Quality Reporting Programs: Hospitals are required to report various quality measures to Medicare. The data collected through these programs help in benchmarking performance and identifying areas for improvement.

These initiatives are part of Medicare’s broader strategy to transition from volume-based to value-based care, focusing on the quality and outcomes of healthcare services rather than the quantity. Implicit in the push to relate quality and payment is an assumption that improvements in quality can be realized with little or no increase in cost of care. While there have been some past studies of the quality-cost relationship, none have been conclusive. In this short article we will relate specific performance metrics to CMS’s 5-star ratings.

Table 1 provides a comparison of the 1,522 CMS rated hospitals that we were able to obtain 2023 Medicare data with the 2,847 hospitals rated by CMS. The distribution of hospitals in the data set appears like the distribution in the CMS report which should make the results valid for the larger CMS file.

Table 2 shows average values for the Hospital Cost Index^TM (HCI) for each of the 5-star categories. The HCI provides a composite measure of a hospital’s relative costliness for both inpatient and outpatient encounters adjusting for both case mix and cost of living differences. There is a clear relationship between the star rating and cost; hospitals with higher quality ratings have lower costs per encounter after adjusting for both case mix and cost of living. Table 2 also provides additional relationships between the 5-star quality ratings and selected cost influencing variables. Two of the more significant relationships are Medicaid volumes and relative size. Higher quality rated hospitals are larger with lower percentages of Medicaid patients. Larger hospitals may be able to realize greater economies of scale than smaller hospitals while higher relative volumes of Medicaid patients may indicate patients who have postponed medical care and therefore have higher degrees of complications and comorbidities. There are other explanations, and we are simply identifying existing associations which may or may not be causal.

Table 3 examines the possible impact of teaching status upon quality and cost. Both teaching and nonteaching hospitals have similar representation in each of the five quality categories, e.g., 13.4% of teaching hospitals have a 5-star rating and 12.3% of nonteaching hospitals have a 5-star rating. There is however a much larger variation in cost between lower rated teaching hospitals and top-quality rated teaching hospitals, e.g., an HCI of 123.2 for one star teaching hospitals compared to an HCI of 100.6 for five star rated teaching hospitals. The variance in HCI values between one star nonteaching and 5-star nonteaching hospitals was much smaller, 105.4 to 102.8.  Lower quality rated teaching hospitals also have higher costs that similar rated nonteaching hospitals. While the expectation was for teaching hospitals to have higher overall costs, this did not appear to be true for the higher quality rated hospitals.

Table 4 provides data showing cost quality relationships by ownership and control classifications. Hospitals designated as government show higher costs for each quality rating category and they also have lower representation in the higher quality ratings. Proprietary hospitals also have less representation in the higher quality rating categories, but their Hospital Cost Index values are the lowest for all five quality rating categories. There is also slight variation in cost between quality ratings. Voluntary hospitals have the highest representation in the higher quality rating categories, and they also have a clear pattern of decreasing costs with improving quality.

Summary

The data presented in this paper suggest that there is a favorable relationship between the quality of care and the cost of delivering that care. Hospitals that received higher quality scores from CMS did exhibit lower costs per encounter of care after adjusting for both case mix and cost of living. We also documented that larger hospitals with lower percentages of Medicaid patients were more likely to receive higher CMS quality ratings and have lower costs. The relationship between cost and quality in teaching and non-teaching hospitals were similar except teaching hospitals had higher costs in the lower quality score categories. Ownership and control variations in quality and cost were present. Government and Proprietary hospitals had lower representation in the higher quality scores compared to Voluntary hospitals. Proprietary hospitals had lower costs compared to both Government and Voluntary hospitals but exhibited little variation across quality ratings.

Cleverley + Associates has a variety of services and tools to help you benchmark your facility. You can get a free month of one of our proprietary tools here!

Are Health Insurance Firms Putting Profits Over Patient Care?

There have been some advertisements on various media platforms suggesting that major health insurance firms are prioritizing profits over the health of patients. The website that contains more information is  www.healthcomesfirst.org and is an initiative of Trinity Health. The primary focus of the commercials and the website is that hospitals are not being fairly reimbursed by major health insurance firms and are realizing inadequate levels of profitability while health insurance firms are making record profits. One claim is “in 2022, the top 6 health insurance companies made $41.5 billion”. We are not certain how the 6 firms were identified but decided to do our own assessment of the reasonableness of profitability for major health insurance companies. We identified the following 6 firms based upon their 2022 revenue.

1. UnitedHealth Group (UNH) $324.1 billion
2. Cigna Group (CI) $180.5 billion
3. Elevance Health (ELV) $156.6 billion
4. Centene Corp (CNC) $144.5 billion
5. Humana (HUM) $92.9 billion
6. Molina Healthcare (MOH) $32.0 billion

Noticeably absent in this list is CVS Healthcare which would include Aetna. In 2022, CVS reported $91.4 billion in revenue from their Healthcare Benefits segment, however identifying actual profitability in this segment was not possible and so they were not included in our final list.

The realization of profit in any business is not a crime, and in fact is a requirement for the continued viability of any business. This is true for both for-profit and non-profit organizations. The question is however whether that level of profit is reasonable. To answer this question, we examined values for two primary measures of profitability, Total Margin (TM) and Return on Equity (ROE). TM measures the amount of profit realized per dollar of revenue. Margin requirements vary across industries and even among firms within an industry because of differences in the level of capital intensity and financing patterns. Industries or firms with large investments in capital assets such as manufacturing need to realize higher margins to offset lower levels of revenue generation per dollar of investment. Ultimately, it is ROE (the ratio of net income to equity) that is the primary financial measure of performance for both for-profit and non-profit firms.  Low ROE values in a for-profit firm will limit its ability to reward its suppliers of capital and to finance growth. In non-profit firms ROE values determine growth rates. For example, a non-profit hospital with a long-term average ROE of 5% will be limited to a 5% growth rate in assets which most likely would not be sufficient to meet its replacement cost needs given normal inflation and expected health care technology improvements.

The table below presents values for TM and ROE for each of the 6 health insurance firms for the years 2018 to 2022. There are some major differences in profits across the 6 firms with UNH reporting the highest levels for TM and the second highest levels of ROE, while ELV (Anthem) reported the second highest TM values, but their ROE average was below the 6-firm average.  MOH might appear to be an enigma because their TM values were the second lowest, but their ROE values were the highest. The high ROE values in their case are the result of significant financial leverage (76% of their assets are financed with debt) and lower levels of capital intensity (MOH generated $2.60 of revenue for every dollar of investment in assets in 2022—while the value for UNH was 1.32 in 2022).

So, are the reported values of profitability reasonable? The average ROE across all industries as reported by New York University in January 2024 was 15.98% and the average net margin was 7.58%. Values for the 6 health insurance firms do not seem to be unreasonable and are close enough to industry averages that most people would not raise questions regarding their values. However, the “healthcomesfirst” web site and their ads are comparing health insurance firm levels of profit to hospital values. Presented below are the median values for TM and ROE for the hospital industry for the period 2018 to 2022. These values were computed from filed Medicare Cost Reports for all acute care hospitals.

While values for 2023 are still not complete, there is significant decline 2022 for both TM and ROE. Most people would agree that the 2022 values are well below levels that are essential to maintain financial viability and any continuation or further decline will result in more hospital closures. So, what has been the cause for the significant decline in hospital profitability in 2022? Reviewing the data shows that the average rate of increase in cost per equivalent discharge in 2022 was 6.0% which was slightly below the 6.5% increase in the Consumer Price Index. The average rate of increase in net revenue per equivalent discharge was only 3.2%. While these are hospital industry medians, they do document the simple fact that when revenues increase at a rate less than costs, profit margins will decline. Since the increase in hospital costs is less than the overall increase in general inflation, it suggests that hospitals cannot be criticized for failure to control their costs. The actual increase in revenue however was well below the increase in general inflation and clearly demonstrates that revenue increases have not kept pace with inflationary changes.

Does this however imply that commercial health insurance plans are the primary culprit? There has been a number of recent hospital newsletter pieces documenting three major trends in managed care payers, especially managed Medicaid, and managed Medicare, which have contributed to the decline in hospital payment. Chief among these factors is the increasing frequency of denying claims. In the “healthcomesfirst” website Trinity Health states that they lost $120 million in denied claims. There is also some indication that managed care payers are slowing their payment of claims and increasing requirements for prior authorization.

While we believe these changes are contributing factors, it must be understood that the primary cause of poor hospital profitability is linked to inadequate payment from major government payers. Pasted below is some data from one of our clients that shows the relationship of payment to cost for payer categories. While these values may not be representative of your hospital, we believe that the relative values are close to reality for many hospitals in the US. The actual relationship between Medicaid payment and “Medicaid allocated cost” taken from Worksheet S-10 for all US acute care hospitals in 2022 was 74% with state variation running from 38% to 142%. An AHA analysis published Jan. 10 shows that Medicare paid 82 cents for every dollar hospitals spent on care for Medicare patients in 2022 — the most recent year for which data is available.

What is the primary takeaway from all of this? First, we believe that most health insurance firms are not realizing excessive profits and are not the primary villain for low hospital profitability. Second, health insurance firms are making payments that are well above costs in most situations and are helping to subsidize inadequate governmental reimbursement. Finally, the real question is should health insurance firms be obligated to cover payment deficiencies by governmental programs? Historically, health insurance firms have subsidized government payment deficiencies and losses on self- pay patients, but their ability to continue this policy will become increasingly constrained as the percentage of commercial payers’ declines.

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Should Healthcare Services be Priced at Identical Cost Markups?

Over the last 25 years our firm has received a large number of proposed pricing strategies from our clients. One of those strategies is to set all prices for their Charge Description Master (CDM) codes at a constant markup from cost. To put this in perspective, the 2021 US median hospital markup for acute care hospitals not designated as Critical Access was 3.80. For the average US acute care hospital that would equate to every charge code priced at 3.8 times its defined cost. As expected, there is a great deal of variation in markups across hospitals that is primarily related to payer mix. Hospitals with heavy governmental payer mixes will usually post higher markups that are the result of cost shifting.

The logic for constant markup pricing is often based on three key assumptions. First, it should be simple to do and can therefore be the basis for all future pricing decisions. Second, with most revenue based on fixed fee schedules, net revenues should not be affected materially. Third, it represents a defensible and equitable pricing policy that can be explained and justified to the public.

Let us examine these points to assess their validity. First, is it easy to do? The underlying assumption is that the hospital has an accurate measure of cost for each CDM charge code. Most of our clients can now provide us with a value for cost at the charge code level, and in many cases may even provide both direct and fully allocated cost measures. The data does seem to be available, but is it accurate? Costing thousands of specific charge codes will invariably involve a good deal of averaging and in many cases a portion of that averaging is related to current cost to charge relationships. Changing prices will therefore change cost measures which involves a bit of circular logic. When our firm tests alternative pricing strategies, we always test at least one cost model. The results of that model will usually produce large price swings, perhaps minus 90% to plus 200% or more. One can argue that this result is legitimate and reflects prior pricing strategies based more on revenue maximization than cost, and that would be true to a degree. Explaining this to an imaging director who just witnessed 80% of their charges vanish can however be a tough task. To the extent that revenue departments use charges as a measure of activity to assess performance, large price swings will affect current performance evaluation.

The second reason for setting all CDM rates to a constant markup of cost is the belief that there will be little to no impact on the provider’s net revenue because most revenue is related to a fixed fee payment arrangement. On the surface, this makes intuitive sense, but is most often false. While not always true, most price reductions usually occur in ancillary service areas—imaging, lab, and surgery. These are all areas with higher relative outpatient volume and greater levels of percentage of charge payment. The largest areas of increase are generally room rates and other services with heavy inpatient volume. To understand how large swings in prices could affect net revenues in cases where most payment is based on fixed fee arrangements, let us identify three specific areas that will be affected. First, large price swings can and often do impact the number and size of outlier payments. Since outlier payments are usually the greatest in inpatient claims, it is possible that large increase in room rates and other inpatient procedures could increase payments.

A second area is lesser than provisions. Increased prices could reduce the number of claims hitting lesser than values and increase payment. However, large decreases in imaging, lab, surgery, and emergency can also increase lesser than claims causing reduced payment. The third area are claims paid on a percentage of charge (POC) basis and would include contracted commercial payers that pay for all or a portion of service on a POC basis, noncontracted commercial payers, auto liability claims, and self-pay. These areas will have greater volumes of outpatient ancillary services and would show reduced levels of net revenue that would result from constant markup cost-based pricing. Some may reason that replacing percent of charge terms with fixed fee payment terms would be a wise strategy to reduce any revenue impact from cost- based pricing. Our firm’s position has always been that negotiating for more fixed fee schedule payments has never been in the best interests of health care providers (see the January 2020 issue of Healthcare Financial Management “Why Removing Percent of Charge Provisions Will Not Reduce Hospital Prices”. This paper provides empirical data demonstrating greater levels of fixed fee payments lead to higher and not lower prices.).

Finally, the third reason cited for using cost-based pricing is that it will enhance defensibility and acceptance by the public. While cost based pricing may be explainable to the public, I am not certain that this will lead to the desired outcome of defensibility. At the end of the day, the ultimate litmus test is the relationship of prices to prices in other providers. For example, in a recent hospital study setting CDM prices to a constant markup of cost resulted in large increases in procedures which were deemed to be very price sensitive and subject to close public scrutiny. In the current era of hospital transparency reporting price comparisons are more visible and pricing decisions should incorporate competitor prices.

So, do we recommend cost based pricing to our clients? The answer is yes, but with moderation and over an extended time frame. Few hospitals can afford large reductions to their net patient revenue which is often the outcome. Ultimately, pricing decisions are determined by the need for profit and market forces.

On Monday, CMS announced the availability of a standardized machine-readable file format that hospitals can elect to use in complying with the price transparency final rule.  The sample formats, presented in .CSV and .JSON, are accompanied by a data dictionary.  CMS notes that the use of these sample formats are voluntary.  It’s also important to note that the samples contain fields that are not currently required under the hospital price transparency rule.  The data dictionary attempts to display fields that are required in the rule by listing a “Requirement” reference from the rule’s language.  One such field, “Contracting Method”, asks hospitals to “Select the value that most closely represents the contracting method for the payer-specific negotiated charge associated with the item or service.”  For information that doesn’t align with the allowed values, hospitals can use an “Other” type.  These additional fields in the sample formats were presumably created to enhance the utility of disclosed data.  The formats were created with input from a panel that was convened by a CMS contractor.

The link to the CMS voluntary sample file formats and data dictionary can be found here: https://www.cms.gov/hospital-price-transparency/resources

Cleverley + Associates already provides services for hospitals to comply with the machine readable and consumer shoppable disclosure requirements.  As an extension of those services, we will be creating a format option for clients to display under the new CMS voluntary sample format structure, if desired.  For more information on price transparency, please contact us!