Price and cost: Both are important to achieve value-based care

Insurers increasingly tell surgeons that they need to reduce costs as health care grows unaffordable for a growing proportion of Americans. Similarly, hospital administrators frequently challenge surgeons to reduce their costs, reminding them that hospital resources are finite and profit margins are slim or even nonexistent. Surgeons can feel caught in the middle when it comes to the affordability of health care. Such considerations of the financial side of health care can quickly lead to misunderstanding, with one party’s cost functioning as another’s price.

Cost and price are two sides of the same coin, but they are not identical. To clear up any confusion, for the purposes of this article, we use “price” to describe how much is ultimately paid for something and “cost” to refer to the resources used and personnel required to deliver the goods and services. For a health care system to remain financially viable, the price paid for care must exceed the cost.

For each condition or procedure, price less cost creates a contribution margin that helps ensure profitability and sustainability. Hospitals must balance maintaining their facilities in the face of depreciation, procuring new technologies, and meeting other priorities, such as investments in their quality improvement efforts. Thus, from the perspective of the surgeon and the hospital, cost refers to the resources used to provide care, and price refers to the amount a patient or insurer pays for those services.

Health care as an industry has traditionally priced goods and services based on historical charges. Unfortunately, this system has not accounted for advances in medicine and technology and the resources necessary to ensure optimal care. Therefore, hospitals and health care systems sometimes cross-subsidize unprofitable but necessary services with other, more profitable procedures and services. Inadequate price and cost scenarios create negative contribution margins for unprofitable services, which further clouds the true picture of the cost of health care and what represents a reasonable and true price, creating distortions and tensions in the health care marketplace.

To transform health care with value-based incentives, including alternative payment models, it is important to better define contemporary surgical care, its supply chain, and, ultimately, the cost of producing optimal outcomes. It is just as important to price care in a manner that creates an adequate contribution margin to sustain the business and avoid excessive cross-subsidization of poorly financed care models.

Not a simple task

Intuitively, it would seem that determining how much something costs should be a simple matter. What is the cost to deliver care, and what is the appropriate price to purchase that care for the insurer and the patient who needs to cover out-of-pocket expenses? Unfortunately, health care is complicated these days, and so is the payment environment. Measuring how much a service, procedure, or item costs; defining what you are trying to measure; or, in fact, even defining what cost and price mean can be tricky, and different parties have different perspectives.

Patients may find themselves in an office visit with a charge for services, followed by diagnostic tests in labs and imaging centers. Often these services are provided at different places and by different providers—each with different bills. Other consultants pile on to the patient journey to prepare a patient for further tests or procedures. Facilities add in their charges; rehabilitation and skilled nursing facilities add costs, too. Submitting individual charges for each encounter, item, or service adds up quickly, and patients experience multi-page explanations of benefits (EOBs), covered and uncovered services, network and out-of-network fees, and so on.

These complexities are the result of continuous advances in the applied sciences of medicine, coupled with complex and competing insurance rules and state and federal regulations. Patients increasingly have become frustrated with health care finance, and all parties involved would benefit from a better health care system, a more understandable purchasing model, and affordable care.

The price of a surgical procedure may be referred to as a cost or an expenditure to the insurer and patient. The same price from within a hospital or ambulatory surgery center would be seen from a different perspective when considering the cost to provide the care. These fiscal perspectives are further complicated when deductibles, copayments, and payment ceilings (patient out-of-pocket maximums or limits) are added to the cost or price calculus. Patients who have met their annual deductible and payment ceiling at the end of a year may transfer all fiscal responsibility to their insurer.

These insurance and business rules demonstrate why talking about health care finance benefits from establishing definitions that are meaningful to patients, surgeons, and others. Patients, payors, physicians, and even federal and state governments all need reliable and timely data to inform decisions, develop payment models, negotiate contracts, and, ultimately, improve the value of care.

Cost confusion

As noted previously, for the sake of clarity, the American College of Surgeons (ACS) prefers to separate this topic into cost—the cost of delivering care to a patient—and price—the amount paid for that care. Within these two broad categories are many different ways to measure health care expenditures. This article uses these meanings for cost and price (see Figure 1).

FIGURE 1. COST VS. PRICE

Determining either cost or price comes with its own challenges. Most surgeons and health care facilities do not have a clear understanding of the production costs for common or costly procedures. Chief financial officers rely on the chargemaster in their revenue cycle to establish a price. The chargemaster list often contains 20,000 to 50,000 individual line items to consider when building an understanding of cost and price, and the prices in the chargemaster do not typically reflect what patients and insurers ultimately pay for care. Few facilities are able to continuously update and maintain their chargemaster without a major cost to the institution.

An alternative to chargemaster pricing involves time-driven activity-based costing (TDABC). Robert Kaplan, PhD, Harvard Business School (HBS), Cambridge, MA, is a key developer and advocate of using TDABC as slide-rule level accuracy of the production cost of care; not precise to the last cent, but providing a much more detailed understanding of what contributes to cost. If the chargemaster is an overbearing, detailed microscopic assessment of cost, TDABC provides a more clinically logical assignment of the resources required to deliver care in a manner that is meaningful and actionable to both the clinical team and the finance office. Hospital chargemasters rely on traditional codes and thousands of individual inputs. TDABC follows the patient through the care encounter and maps the personnel who contribute to the episode of care. Each staff effort is assigned the time to deliver a service and the cost per minute for the staff category (surgeon, nurse, administrative staff, and so on) TDABC provides clinical teams with a picture of the clinicians and allows for better resource management than codes listed in a chargemaster.¹

To establish the overall production cost, an episode of care is defined for a condition, such as colon cancer (see Figure 2), or a procedure, such as colectomy. The episode occurs over several months and involves various services preoperatively, in-facility services (a hospital or an ambulatory surgical center), and post-discharge to skilled nursing centers, long-term acute care, home, rehabilitation centers, and so forth. TDABC uses process mappings for each phase of care and details every step, the personnel, and the time in minutes for each element. The sum of the personnel, time, and assigned cost per minute establishes the total estimated cost for the services provided across the entire episode.

FIGURE 2. COLON CANCER SURGERY PROCESS MAP 1: SURGEON’S OFFICE VISIT

Price and transparency

Price refers to what patients and insurers pay for the care received. The U.S. health care system tends to involve insurers, third-party payors, and government agencies, which cover the bulk of the cost of care, and patients who contribute deductibles, copayments, and other costs up to the limits or caps on their total annual spending. Because federal health insurance plans and private insurers have moved away from cost-based reimbursement, the price that the patient and, if applicable, a third-party payor pays is rarely related to the cost of delivering that care. Therefore, it is possible for the price of care to be higher or lower than the cost of delivering that care, with the higher payors offsetting the lower (see Figure 3).

FIGURE 3. U.S. PRICE OF CARE BREAKDOWN

Physicians naturally tend to prefer to focus on patient care, rather than on the business aspects of the profession. They have been able to do so with the help of an army of practice managers, hospital administrators, insurance companies, and government health programs, which have, for better or worse, largely accepted the task of figuring out how much each party pays. Separating complex care decisions from cost considerations may allow surgeons to focus on optimal patient care, but when patients and clinicians consume health care resources without regard to societal cost, this system can create adverse incentives that lead to an unaffordable overabundance of care.

Many experts now suggest that slowing the growth in U.S. health care expenditures will require greater transparency in spending. To achieve this goal, such transparency must extend to physicians, third-party payors, and patients and must lead to a better understanding of production cost, total price, and patient responsibility.

Creating true transparency will prove difficult if not impossible if we do not first define what we are trying to make transparent. It is possible to itemize every visit, procedure, lab imaging, and more using a chargemaster approach. The result would be to convey price for every transaction in a very complex care model. Under this chargemaster approach, patients likely would be swamped with a laundry list of services and prices without regard for how these services are interrelated.

Patients would benefit from (and presumably prefer) having a single price for a defined episode of care that includes all the services and charges typically experienced by patients like them. For example, if a major operation involves 30 to 40 different services that are combined into several separate bills paid out over months of care, it is nearly impossible for patients to comprehend the total sum as one true price for their condition. Nor is it feasible for them to shop around for these individual services among different hospitals or providers, as that is not how care is delivered. The many services these patients need may include the work of a surgeon, anesthesiologist, radiologist, pathologist, medical consultants, lab fees, imaging fees, and more. Patients are concerned about their health and should not have to navigate a litany of itemized services.

Should the price for all these services be combined into a single price for a typical patient? It is possible to create a standard that portrays a defined set of services for the typical patient with a particular condition or procedure. Focusing too narrowly on individual services within an episode obscures the true price paid for a patient seeking care.

Bundled payment models

Broad measures like those used in many bundled payment models, which include all services in a specified time window, regardless of whether they were related to the condition or diagnosis for which the patient was seeking care, are imprecise.

The health care industry has explored bundled payment models using episode groupers that dig through claims and group-related charges into episodes of care. Some of these business logic systems are dependent upon a hospital admission and build a hospital-based bundled care price using a triggering event such as diagnosis-related groups (DRGs). Other groups have taken a slightly different approach, using Current Procedural Terminology (CPT)* codes as the basis of the triggering event.

When DRG- or CPT-based triggers are used, these bundled prices for an episode have the same general construct. Through computerized logic encoded in an episode grouper, the triggering event opens a bundle by using either a specific DRG or CPT code or some combination of codes. Once an episode is triggered, the business logic looks back and ahead for a specified time period, such as three days before and 90 days after the trigger. The physician-enhanced algorithm inside the logic detects all the related services, including office visits, lab tests, and imaging as it builds the entire list of services to include in the bundle.

Episode Grouper for Medicare

The Episode Grouper for Medicare (EGM) is an episode logic developed for CMS and is now available to the public.² The EGM business logic is unique because it relies on extensive clinical inputs from physicians, which define the plausible services for inclusion in an episode of care. These clinical inputs are designed for regular interval updates from clinicians so that the episodes remain relevant as care evolves. The ACS has worked closely with the EGM development team and continues to provide input on maintaining the episode definitions to be consistent with plausible surgical services.

The ACS supports the EGM definitions and clinical logic as a national standard for providing surgeons and patients with a clinically appropriate price for an episode of care. It is a consensus-based, community-developed methodology that could be used as a national standard across payors to inform patients about price by providing information on what a typical patient could expect to pay based on real data.

It also is possible to compare price across delivery systems and to portray the price related to complications or other variables. For example, Medicare price for an episode could serve as a benchmark for comparing surgical care at one facility to another. Commercial payors could use the same EGM episode to establish their price comparisons across care delivery systems.

Patient-Centered Episode System

The College recognizes the need for standards and has partnered with like-minded stakeholders in support of a newly formed not-for-profit organization to develop and maintain standard episode definitions and the computer software needed to group claims into these episodes. This organization, known as the Patient-Centered Episode System (PACES) Center for Value in Healthcare, was formally incorporated in 2019 with the goal of creating a single industry standard for defining clinical episodes of care. PACES episode definitions and grouper logic are based on the EGM and, therefore, have been developed using input from multiple stakeholders and current medical record and payment systems. This framework will allow the PACES standard episodes to be used across delivery systems and payors to provide meaningful comparisons and an unprecedented level of price transparency.³

Using PACES standard episode definitions, the ACS can define a condition or a procedure as an episode of care and sum all the relevant services into a single price. Applying the PACES logical code onto a payor’s claims database can accurately define the mean or median price for elective, uncomplicated care. It also is possible to report price estimates for all patients including individuals experiencing complications. However, the price variations for reporting on all patients lack risk adjustment and could be misleading. For example, health care centers with highly complex patients and poor support systems based on social determinants of health will differ greatly in price.

The ACS is exploring various ways of using this capability. For example, we can specify a colon cancer diagnosis and apply pricing for the total cost of care for a colectomy. Applying the EGM logic within the context of a colectomy for cancer using the CMS sample database reveals colectomy prices vary from as low as $9,249 to as much as $77,924 across the nation. The variability likely is related to omissions or errors in billing as well as added services for complicated care and other factors. Figure 4 demonstrates the mean colectomy price for hospitals located in a large metropolitan statistical area. One focal hospital demonstrates an episode mean of $27,530 for 194 cases. Uncomplicated cases in this focal hospital had a mean of $22,286, whereas complicated cases had a mean of $29,617.

FIGURE 4. MEAN COLECTOMY PRICE IN A MAJOR METROPOLITAN AREA BY HOSPITAL

It also is possible to break down the overall price for colectomy into various phases of care such as prehospital, inpatient, and postdischarge care. Using these reports, a surgeon can compare the production cost with the price for a colectomy.

Bringing cost and price together

Understanding the cost of an episode, all the steps involved, and the overall price to the patient and insurer affords many opportunities to surgeons and delivery systems. Comparisons across the market will stimulate innovations for exploring efficiencies, removing waste, and increasing value. Understanding the contribution margin of a service line along with overall quality will aid in ensuring adequate payments for services and allow surgeons and delivery systems to modernize and secure the future of their care delivery. A service with a negative contribution margin should address quality, cost overruns, and adequacy of price from insurers.

Also, with a clear understanding of cost and price, surgeons and delivery systems can begin to provide value-based care. Value is typically described as quality/cost. Unfortunately, the sum of this equation typically has been evaluated in a disjointed way, using quality measures from existing federal programs and cost measures representing the price the payor pays.

Ultimately, value in health care can best be defined from the patient’s perspective; that is, the end user of the services and care provided. Thus, a better definition is quality/price. Value for the patient can be described as receiving care that meets the patient’s needs and goals and avoids harm or adverse outcomes at the best possible price. The ACS vision for quality in a value-based payment environment was described in a previous Bulletin article.⁴ The price component should be similarly patient-centered. It should account for the full price paid by the patient for all items and services provided in the entire episode of care, including both the amount that the patient paid directly and the amount insurers paid, as these expenses are ultimately passed on to the patient. Coupling the patient’s quality experience with the full price paid for the episode of care would provide an expression of value that is meaningful to the patient and more accurate for use in value-based payment designs.

ACS THRIVE: Bringing cost and price together to create value

Recognizing the challenges facing all parties in a health care system in the midst of a value transformation, the ACS has partnered with the HBS Institute for Strategy and Competitiveness to develop a value measurement framework. This framework, known as the Transforming Health Resources to Improve Value and Efficiency (ACS THRIVE) is designed to help hospitals and surgical practices improve patient outcomes while lowering the cost of delivering care.

The need for a better value measurement framework has grown as reimbursement shifts to bundled payments and other methods intended to incentivize cost efficiency—an approach that increases transparency and accountability while further shifting risk from the payor to the provider. By knowing internal cost and information on price, ACS THRIVE should help participants reduce or at least manage this risk. When coupled with the ACS approach to quality as a system, a clear picture of value emerges, which can be tailored to both payors and patients. This newly designed value measurement process is being piloted at a small number of U.S. hospitals, focusing on measuring the full cycle of care—including its key surgical, medical, behavioral, and social elements—for a surgical condition.

ACS THRIVE will look specifically at surgical spending from the different perspectives of price (how much the patient and the payor spend) and cost (the resources used to provide care). The ACS is working with the PACES Center to develop price information dashboards for THRIVE participants that will allow them to drill down to the price of care over the prehospital, hospital, and postdischarge stages of care. For information related to the cost of care, the project will use the TDABC method described previously to thoroughly document all the personnel, materials, and other resources used throughout an episode of care for all the services assigned to that episode.

Examining both the actual cost of providing care as well as the price shines a light on hidden opportunities for cost saving. For example, TDABC cost information could improve efficiency by ensuring that clinicians are working at the “top of their license” and reducing excess capacity in physical resources, allowing the delivery system to function more efficiently. PACES price information will yield other highly actionable knowledge, such as identification of duplicative or potentially unnecessary services that don’t add value and can be eliminated safely. PACES also allows for comparison across hospitals or delivery systems of the types of services billed and the number and types of clinicians involved in care for that episode, both of which can vary greatly.

The ACS THRIVE pilot will be used to create a scalable approach that other hospitals can use to measure and improve value. The method will include risk-adjusted benchmarks, so hospitals can compare their value with one another to generate systemwide improvement. It is anticipated that the lessons learned will lead to best practices that can then benefit a wider range of practices and delivery systems.

Conclusion

Close evaluation of both cost and price can play an important role as the nation transitions to a value-based health care system. The information derived from these efforts will allow for the transparency patients and payors desire. The cost and price information can further be built into programs, such as the ACS THRIVE pilot, which should allow physicians and hospitals to create value. Physician practices and hospitals, armed with information on both cost and price, along with meaningful quality measures, can redesign care models to deliver the same or better outcomes with a lower cost mix of resources—especially personnel, equipment, devices, and drugs—and yield an expression of value that is truly meaningful to patients.

^*All specific references to CPT codes and descriptions are © 2020 American Medical Association. All rights reserved. CPT is a registered trademark of the American Medical Association.

References

1. Kaplan RS. Improving value with TDABC. June 2014. Harvard Healthcare Financial Management. Available at: www.hbs.edu/faculty/Pages/item.aspx?num=47638 (Password protected). Accessed December 18, 2020.
2. Centers for Medicare and Medicaid Services. Method A Episode Grouper for Medicare Design Report. February 29, 2016. Available at: www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Value-Based-Programs/MACRA-MIPS-and-APMs/EGM-Design-Report.pdf. Accessed December 18, 2020.
3. The PACES Center for Value in Healthcare. Use case: Price transparency for patients using PACES. Available at: www.pacescenter.org/static/PatientPriceTransparencyRev1.pdf. Accessed December 18, 2020.
4. Sage J, Opelka FG, Ko CY. Quality as a program, not a measure: An opportunity for health insurers to value quality as a comprehensive program. Bull Am Coll Surg. 2020;105(6):58-63. Available at: https://bulletin.facs.org/2020/10/quality-as-a-program-not-a-measure-an-opportunity-for-health-insurers-to-value-quality-as-a-comprehensive-program/. Accessed December 18, 2020.