We Examine Myths of Healthcare Pricing

Hospital pricing is on the minds of many in the healthcare industry today, especially since the initiation of hospital transparency reporting.  It is our belief, that many hospital pricing decisions often rely on widely believed pricing myths.  The body of this article will attempt to define and confront some of these “myths.”

Myth # 1 Pricing makes a small difference in overall profitability when most of the revenue is fixed fee based.

While on the surface this argument seems true, most contracts do have specific provisions that can make price a critical factor in the final determination of net revenues.  Many commercial contracts have contract language that contain “lesser than” clauses.  If claim charges are below the fee payment schedule, then the payer will pay charges.  For example, a contract may specify a payment of $5,600 for a Normal Newborn MSDRG (795), but if charges are less than $5,600 that amount will be paid.  Another important area where prices can affect payment in fixed fee-based payment plans is inpatient stop loss provisions.  When charges exceed a specified threshold e.g., $200,000, the hospital is paid on a percentage of billed charge basis.  We have many large tertiary care facilities where stop loss impact can account for 50% or more of the total change in net revenues from pricing changes.

Myth # 2 Prices do not affect volume because healthcare is price inelastic.

While this may be true for a number of health care services from a relative industry perspective, the degree of price elasticity in the health care industry has increased dramatically in the last decade.  The rapid rise in the number of health plans with high deductible provisions has made patient consumers more sensitive to hospital prices, especially for outpatient services.  In insurance plans with restricted provider networks, patients will also be affected by hospital gross charges.  Finally, small insurance plans that have not contracted with hospital providers will become percent of charge payers and patients may be liable for copayments that are related to actual hospital charges.  These conditions have led many patients to request estimates of prices for common elective procedures such as endoscopies and imaging procedures.

Myth #3 Comparing hospital gross and negotiated charges is easy given hospital transparency reporting.

Consider a local newspaper calling a hospital administrator to inquire about the differences between charges for a particular service at the hospital and its local competitor that they obtained from their websites.  Specifically, Hospital A reports a gross charge of $3,000 for CPT code 45380 (Colonoscopy and Biopsy) while Hospital B charges $2,000.  However, when all charges for the encounter are included Hospital A’s total charges are $4,000 while Hospital B’s total charges are $5,000.  We believe gross charge and payer specific negotiated charge comparisons are much more meaningful when the reporting is at the patient encounter level.  Since Medicare is the largest payer of hospital services, we believe that their payment methodology should be adopted.  This means payment at the MSDRG level for inpatient reporting and payment at the APC level for outpatient reporting.

Myth # 4- Prices should be set at a constant mark-up for all services

The price defensibility discussion has prompted some hospitals administrators to consider a constant mark-up for all services.  Ideally, many believe, all prices should reflect cost in the same way, however, no major industries establish pricing in this manner.  While there are benefits to pursuing this strategy in terms of communicating pricing methodology to the community, there are also concerns.  Chief among the concerns is the financial impact that can result from setting prices in this manner.

As part of our client price/payment engagements, we will produce at least one model where all services are priced at a constant mark-up from cost.  In almost every case we see a negative return from this pricing strategy.  This means that a 5% increase in prices will usually result in a reduction in net patient revenue as opposed to an increase.  It is also common to see dramatic changes in individual rates by as much as 75% or more when cost- based pricing is used for all services.    Of course, a constant mark-up can be beneficial for defensibility; however, it is our contention that a move to this pricing strategy be conducted over time with sensitivity to the bottom line.

It is also important to recognize that pricing decisions in almost every industry are market based and relate to the firm’s strategic goals.  In this regards, the hospital industry is facing significant competitive pressure from free standing outpatient centers providing a range of services from imaging to surgery.  Growth is also more rapid in these areas than in traditional inpatient acute care services.  Given greater market share in inpatient services and slower growth, economics would suggest setting higher prices in inpatient service sectors while discounting prices in fast growing outpatient arenas to capture market share. A primary concern however is to ensure that prices exceed marginal or variable cost.

Myth #5 Determining the impact of price changes can be accurately evaluated with a revenue and usage summary

Evaluating the impact of pricing decisions for budgetary purposes is a critical process most hospitals undertake at least annually.  When pricing at the line-item level you clearly need data with line-item detail.  This requirement leaves two sources: a revenue and usage summary and actual line-item claims data.  Revenue and usage files are smaller in total size, but do not address the impact of claim-level provisions such as outliers or procedure carve-outs.  The impact of these claim-level provisions can be significant.

Consider a payer that reimburses inpatient care on a case basis with an outlier provision of 75% of billed charges at a $150,000 threshold.  Claims reaching that threshold would not receive any weight using a revenue and usage summary.  However, evaluating the impact of those claims using the line level claims data would produce an accurate estimate of the price change.  Further, consider a payer that pays a percentage of billed charges for outpatient services but has a maximum payment of $1,700.  All outpatient activity for this payer would be estimated on a billed charge basis using the revenue and usage summary.  The end result would be an overestimation of pricing impact for that payer.  Again, using the detailed claims data would produce an accurate estimate of the price change impact.

Strategic pricing is an important part of hospital revenue management and should be carefully undertaken to achieve long term strategic objectives.  We can help you understand the myths and reach your organization’s goals. Utilization of simplistic assumptions can, and often will create undesirable outcomes.