Philadelphia Reflections

Health Insurance National, and Otherwise

Health Insurance National, and Otherwise

George Ross Fisher, M.D.

A Message to Big Business

Recently the National Chamber of Commerce studied the question of cost containment in the health field and urged local chambers to organize data reporting systems for employee health and hospital costs. It is not clear what employers could do with such information once they had it since their employees (or unions) are likely to be resentful of intrusion into personal privacy. If the data should by chance demonstrate that one doctor, hospital or HMO was cheaper than another, the more expensive providers of care would surely claim that quality was related to cost. In any event, the American tradition is for the patient, not his employer, to select his doctor.

A far more productive data analysis for employers would be one which helped him select the best insurance company, or the best health insurance benefit package, for the employee group. While it is true that unions have exerted considerable influence on benefits packages or even carrier selection, the unions and the employers unite in a desire to get the most benefits for the least health insurance cost. It, therefore, seems likely that more action would result from examination of the financial data than the medical data, although in both cases it is necessary to be a diligent pupil before the data is intelligible. We here propose that it is worth-while to understand the ratio of hospital costs to hospital charges. Having understood the matter, the Chamber is urged to apply it to local hospitals and individual employee groups.

The examination of internal hospital subsidies is greatly assisted by the existence of an unwieldy document, the SSA-2552. The Medicare agency requires every hospital to complete a 25-page annual financial summary, complete with folded-over pages and filled with numbers. This document is prepared for a public purpose, and under the Freedom of Information Act, is available to all who wish to examine it. For the purpose at hand, it is possible to ignore all of this document except for column 2 on page 18. On page 18 is found “Worksheet C.” Departmental Cost Distribution. In column 1 will be found; the total costs generated by each department during the year (A.), together with the total charges generated by that department (B.) In column 2, the place where present attention is focused, each department displays the ratio of A divided by B, the ratio of Cost to Charges. A quick glance will identify that the ratio is usually less than 1.0, in keeping with the practice of charging more than your costs in order to make a “profit”. A glance down the line will quickly show even a casual reader that there is a very considerable variation in the ratios from one department to another and that there are definitely department with a ratio greater than 1.0, which means that these departments are being subsidized.

The Medicare cost report, available from every hospital, displays the ratio of costs of charges for each revenue-production department of the hospital. The concept of the ratio is simple enough. In a free enterprise system, everyone is accustomed to the idea that the price of things is always a little higher than the cost. The difference is called a profit margin, or mark-up. We are even familiar with the occasional situation where the selling price (charge) is less than the cost; that is called a loss-leader.

Therefore, loss-leaders excluded, we would except the normal ratio of costs to charges to be approximate.90, allowing about a 10% profit for bad debts, charity, etc.

Furthermore, we would expect the individual department of the hospital to display a cost-to-charge ratio which is relatively uniform, and fairly close to overall total for the hospital.

Notice that the important issue is not how close the ratio is to unity (1.0) but rather how close it is to the overall hospital total ratio. That is, how uniform the ratios are between departments.

A great many people assume that, if the cost-charge ratio is less than 1.0 and a profit is therefore generated, any insurance company which pays charges must have higher premiums than an insurance company which pays “costs”. Such an inference is not necessarily correct as a theory and is quite clearly incorrect in certain circumstances. The premium reflects all of the expenses of the insurance company, not just the hospital payments. Subsidy of non-group individual subscribers by group subscribers is a major example of the equalizers affecting health insurance premiums.

The following figures for cost-to-charge ratios were taken from an actual hospital’s Medicare cost report. They fairly represent the national pattern, although there is a great deal of individual variation between hospitals. The important things to notice are the non-uniformity of departments, and the separation of hospital departments into two distinct classes:

Table 1. Ratio of Costs to Hospital Charges by Department

Undercharged (Ratio) Overcharged (Ratio)

Operating Room 1.02 X-Ray .74

Short Procedure 1.20 Isotopes .68

Labor & Delivery 1.32 Laboratory .69

Anesthesia 1.19 Oxygen .59

Physical Therapy 1.38 EKG .22

Daily Room Charge 1.22 EEG .54

Intensive Care 1.25 Medical Supplies .46

Drugs .58

Finally, one dare not assume that the cost-to-charge ratio for a department is reflected in every service performed by that department. The ratio comes about by the cost accountant assigning indirect costs to those departments which have the best cost reimbursement experience. At the same time, charges are raised on those items most likely to be paid for in cash, within the perceived limits of the ability to pay. Charges tend to be closely examined on common items like blood counts and chest x-rays, while uncommon test and services tend to be too much trouble to examine frequently in close detail. Therefore, there are often bargains in rarely-used services whose charges have not been raised in some time. Finally, there are items which can be charged off as bad debts if unpaid by a Medicare patient. Under this heading are personal items like television sets, or uncollected 20% coinsurance on ambulatory services; for setting h charges on these items, maximum brazenness is rewarded.

How to Play the Game

The free-market, or Adam Smith, philosophy is presumably highly regarded by the Chamber of Commerce. The theory supposes that every rational person will press his own interest and advantage to the point where he comes into equilibrium with the rest of the community, who are acting on their own separate behalf. It must be clear that the hospital financial and reimbursement system strongly endorses the “every man for himself” philosophy. What follows are a few suggestions for overachievers in the business world who would like to play the hospital game with a little more success than they have demonstrated in the past. Perhaps if they do, the community at large will benefit as a new equilibrium is set.

Notice that a cost/charge ratio greater than unity (1.0) means a loss leader. If your insurance company pays charges, it is paying less than another company which is paying costs. Never mind that the “costs” are inflated with doubtful indirect costs; that’s what the cost-reimbursing insurance company pays.

Notice that the benefits package of a charge-reimbursing insurance company should heavily include the use of those hospital departments which are loss-leaders. Those departments which are highly profitable for the hospital, however, should be avoided, since the presence of insurance just raises the prices still more. Since these services are mainly out-patient (ambulatory) services, tell your employees to go for them to their doctor’s offices. If you must cover them with insurance, specify that the insurance is not valid for use in a hospital. (Don’t worry about anti-trust: plenty of policies are only good in a hospital out-patient department.) If you feel you must cover them, put them in the major medical policy.

Notice that the cost-reimbursing insurance companies have an exactly opposite set of motivations. They need to include a large number of ambulatory benefits since they get a bargain on such services. However, if they are restrained from this endeavor, they will be forced to resist the cost escalation of inpatient-intensive services, which means they resist the current escalation of indirect costs. Since the root cause of hospital inflation is the rampant growth of unrestrained indirect costs, it is possible that restricting Blue Cross to inpatient reimbursement would stop the spiral. It is in the competitive interest of a charge reimbursing carrier to avoid extending out-patient benefits. Blue Cross, by contrast, would have to be forcibly restrained.

If an employer intends to be serious about playing the hospital game, he needs to know what kind of services his own employees are using. He also needs to know what the particular cost/charge quirks are at the local hospitals where most of his employees find themselves from time to time. It is easy to imagine one employer with 30% of his employees' women under the age of thirty, while another employer mostly might have nothing but middle-aged male employees. A new business will have young active employees, an older business may have pensioners to consider. The climate makes a difference, and occupational hazards must be considered. So, what’s good for one employer isn’t necessarily good for others, or necessarily good after the business grows for ten years. And the hospital cost accountant, by the way, isn’t going to be asleep as things change over time.

It would require a rather sophisticated data system for an employer group (or even an insurance company) to analyze its experience in terms of hospital departmental usage. So, a simpler conceptual approach is suggested. The departments with a high cost/charge ratio tend to be used by surgeons and surgical specialties. Conversely, the non-surgical physicians' internists, pediatricians, psychiatrists, family practitioners) tend to use most heavily the hospital departments which have low cost/ charge ratio. There is no conspiracy at work; it just happens to work out that way as a result of independent stresses which have been discussed elsewhere.

So, it would appear that subsidizing is taking place by the patients of non-surgeons for the benefits of patients who have surgery. Somewhat true, although the situation is more complicated.

Both Blue Cross and the commercial carriers employ an analytic system for large employee groups, known as experience-rating on the basis of charges incurred, (even though the plan pays costs, not charges). The commercial carriers experience-rate on the basis of charges, too, but they actually pay the charges. So, an experience-rated group gains nothing by switching carriers so long as the experience-rating continues to be based on hospital charges. The premium they pay will reflect a subsidy of surgical patients by non-surgical ones.

But there is another class of patients for whom the reverse is true. The non-group individual subscribers to Blue Cross have a diversion of premium money toward surgery, while the whole non-group program is receiving a subsidy from the group subscribers. It is difficult to tell whether the continued effect is positive or negative for surgical patients. But the non-surgical, non-group subscribers are certainly getting a bargain. Until someone figures out a way to force subscribers to belong to a group, a company should think twice about forming one. Decreased benefit package? Buy an excess major medical policy and forget it.

Of all the subsidies which characterize this giant medical financial equilibrium, the greatest is on the basis of the age of the subscriber. It scarcely needs proof to recognize that young subscribers do not have the same health costs as older ones, but they do pay the same premium. All health insurance plans would do well to devise a system of vesting before competition exploits this inherent weakness and topples the structure. A movement by groups into non-group would eventually reach an equilibrium, but a selective movement of young subscribers to competitors or self-insurance would start a spiral which could be very drastic, indeed.

Finally, there is one other recourse which subscribers could take to the situation wherein non-surgical hospital patients subsidize surgical ones, while experience-rating prevents them from doing much about it. The recourse would be to seek care outside of a hospital. Nowadays there is not much difference between a first-class nursing home and a hospital, except that you can’t do much surgery there. Next time you hear someone talking about “excess hospital beds”, take a hard look at who is talking.

Originally published: Tuesday, August 21, 2018; most-recently modified: Tuesday, May 21, 2019