For eight years I was a medical data analyst in the financial department of a large public hospital. The last time I did that was about fifteen years ago, but I doubt that much has changed during the intervening years.
When I read Cindy Ross' recent post "We went broke paying medical bills--and we're insured!" my first instinct was to say "of course you did."
But that would be neither helpful nor polite, so I decided to publish a post that might help people to understand hospital charges and costs, to help them "look under the hood" so to speak, and understnd how all of that works with insurance.
What follows is overly-simplified, but probably adequate for having a basic understanding.
First, Some Definitions
Gross patient revenue -- this is what shows up on your hospital bill. It is also referred to as charges. It is typically an extraordinary number, the kind of number that elicits expletives rarely used even by sailors. It has nothing to do with the actual "cost" of the service rendered, except sometimes by accident (which I'll explain later). The CFO at my hospital used to call it "funny money" because it often had absolutely nothing to do with what the hospital ended up getting paid. Of course, to the patient it is not funny.
Contract allowances -- these are adjustments to gross patient revenue that reduce that number to what the hospital expects to get paid between you and your insurance plan. These are often substantial, and one of the reasons why you want to have insurance. A contract allowance can easily cut the gross patient revenue number to less than half.
Net patient revenue -- this is what the hospital actually collects in the real world. For the sake of simplicity, think of this as "cash."
Bad debt -- what the patient was supposed to pay, but didn't.
Cost -- this is an estimate of the cost of providing care, but it's only an estimate. No one knows what the "real cost" is, nor can that number ever be known. Not even God knows. It often doesn't really make sense at tle level of the individual case, but it does make sense when you start looking at hundreds or thousands of cases.
There are two kinds of cost:
Direct costs -- these are the detailed costs that show up on the general ledger. These include payroll, supplies, payment for services by a particular department, and so on. These are the costs that can be directly attributed to specific departments.
Indirect costs -- these are things such as depreciation, phone, utilities, insurance, advertising, building maintenance, chaplain services, and so on. They are real costs, but costs that typically aren't assignable to any single department. The hospital cost accountants figure out how to allocate these costs to the various hospital departments.
So you add up direct and indirect costs for a department, and that gives you the total cost figure.
Hospitals have various ways of figuring out what to charge for a particular service or item, some of which are related to cost and some of which arent. These include
- Charging based on what you think you can charge
- Charging based on what other hospitals charge
- Charging based on certain "public relations" considerations. For example, the hospital where I used to work basically charged for hospital rooms no more than what they cost. Why? Because hospital room rates often get reported in the local newspaper, so you don't want to get bad press from having room rates that are significantly higher than other hospitals.
- Charging so as not to be embarrassed. For example, you don't want to charge $10 for a box of Kleenex, because people will ask about that and it will be embarrassing to try to explain that. In reality, it doesn't matter what the hospital charges for Kleenex, or if they charge for it at all. More on this later.
- Charging so as to increase revenue. Let's say that it turns out that a lot of people with commercial insurance that pays a percentage of charges use a particular service, and that another service is often used by people whose insurance pays a flat rate. You can do a "strategic rate increase" in which you raise the charge for the first item and reduce it for the second. Overall, that has the effect increasing net patient revenue without increasing gross patient revenue.
The Bottom Line
The bottom line is that public hospitals have to stay in business. This includes not only making enough to cover toal cost, but also making perhaps an additional 6 percent above that to pay for improvements in equipment and facilities. If your facilities and equipment start to become outdated paying patients will go elsewhere and then you end up going out of business or becoming a charity hospital.
Hospital departments develop "cost-charge" ratios. Take, for example, a hypothetical X-ray department:
Direct Costs: $750,000
Indirect Costs: $250,000
Total Cost: $1,000,000
Total Charges: $1,500,000
This department would have a cost-charge ratio of 1.5: $1.5 million divided by $1 million. So as you looked at hundreds or thousands of cases with X-ray charges, you can use the charges as a way of estimating cost. In fact, most of the time, that's how hospitals use charge information -- as a way of estimating cost through the cost-charge ratio. They use these estimated costs in negotiating contract rates with insurance companies.
Hospitals get reimbursed by insurance companies based on contracts that they have with the insurance companies. (Thus the "contract allowance" referred to earlier.) There are several typical ways that hospitals can be reimbursed:
Per diem -- the hospital is paid a certain amount for every day the patient is in the hospital. Typicaly per diem reimbursement is only used for services in which the cost of the service is stable and predictable (e.g., routine vaginal deliveries).
Flat rate -- the hospital receives a defined payment based on the kind of case. This treats hospital stays as if they were "products," so to speak, with each product having a different payment. This is typically how Medicare and Medicad pay, in addition to many commercial insurances.
Percent of charges -- the hospital receives a certain percent of charges (gross patient revenue). This is one situation in which "funny money" isn't funny.
Let's say that a hospital wants to make $1,000 on a particular kind of stay, and this stay involves only a room charge and a box of Kleenex. Let's also say that the hospital has contracts that will pay only 50 percent of charges. That means that the hospital needs to charge $2,000.
So what to do? There are various possibilities:
- Charge $2,000 for the room and give the Kleenex for free.
- Charge $1,999 for the room and $1 for the Kleenex.
- Charge $2,000 for the Kleenex and give the room for free.
From the point of view of reimbursement it doesn't matter. Granted, the $2,000 box of Kleenex would be embarrassing to explain, but from an overall financial point of view how the total charge is generated doesn't matter.
This is why it's hard to criticize any particular line item on a hospital bill. You may be outraged over a $200 EKG that only took five minutes to do, but then you might actually be charged less for the room and nursing than what it cost to provide.
Putting It All Together
Somehow, in the mix of all of this cost accounting, various ways of charging, and various kinds of reimbursement, the hospital has to say in business. The hospital where I used to work basically had to collect around 66 percent of overall gross patient revenue in order to stay in business.
Flying Blind, or Trying to Select An Insurance Plan
Assuming that you are employed (an increasingly inaccurate assumption) every year you have to figure out which of your employer's health plans you are going to select. Most of these health plans talk about their payments as a percent of "covered charges."
The problem is that you don't know what the covered charges are. Covered charges are what's left over after the contract allowance is processed. But the amount of the contract allowance is defined by contracted rates that you are not allowed to see. That's considered proprietary business information.
So great, your insurance plan pays 70 percent of covered charges. But that's 70 percent of WHAT? Or for inpatient psychiatric care it pays $250 per day -- but how much does that leave you paying, and how long is a typical admission? Well, no one knows. Actually the insurance company and the hospitals know, but they aren't talking.
In order for people to make informed decisions about health insurance they need to be able to compare estimates between insurance companies of likely real-world financial outcomes for different kinds of cases.
I think all insurance plans should be required to prepare realistic estimates of treatment costs for a standard set of procedures and diagnoses, a kind of medical "market basket." These could include
- Outpatient annual care for adult with type-2 diabetes
- Routine vaginal delivery
- Single vessel coronary bypass
- Emergency room visit for a simple fracture
- Gall bladder removal
- Cataract surgery
- Knee or hip replacement
- Outpatient annual routine care for a child
- MRI and CAT scans
- Cost of an inpatient psychiatric stay based on average length of stay
Such estimates would include both hospital costs and physician professional fees.
That way people could make realistic comparisons between health plans -- and at least have some idea of the financial consequences in the event that they actually had to use the insurance. Otherwise they really are flying blind.