Payment trends achieving stability amid uncertainty: preparing for future payment policies and practices will require a balancing act involving a broad range of revenue-enhancing strategies

Healthcare Financial Management, Dec, 2003 by William O. Cleverley, James O. Cleverley

Hospital executives believe that poor payment is the primary obstacle facing hospitals today, according to a recent Cap Gemini/Ernst & Young report. (a) As executives strive to improve the financial standing of their organizations, many wonder what payment policies and practices will become prevalent in the future, and what payment strategies will be critical to enhancing hospital revenue. Although there is no crystal ball in health care, a look at recent trends and influences can provide some answers.

Hospital Market Structure and Driving Forces

Payment or pricing in any industry is largely determined by the underlying market structure. The hospital industry is no exception. Such factors as number of buyers and sellers, barriers to entry, price elasticity, and technology shape the ability of hospital providers to recover their costs and earn reasonable levels of profit.

Regional nature of services. Although mergers, acquisitions, and the creation of large health systems have changed organizational structure, health care is still primarily delivered at the local level. Regionalized care has a profound impact on market structure, and most hospital executives recognize its importance in pricing and payment. issues. Market share has been a critical factor in most studies of organization profitability. Although hospital size does not necessarily correlate to success, dominance in the identified market is a key competitive advantage.

Public and private payers. Unlike many other U.S. industries, health care has a limited number of buyers. Most Americans are purchasers of health services, but the majority of health expenditures are made by a limited number of large public of private payers. Medicare and Medicaid represent the bulk of public payment, while private health insurance comprises the largest source of private payment.

Public dollars represent the largest source of payment for hospital services, 58 percent in 2001. It is interesting to note, however, the relative decline in percentage terms since 1998, the year after the Balanced Budget Act was implemented. Projections by CMS in a January 2003 report on national healthcare expenditures forecast stabilization in the public expenditure share until 20l0, when the projected level of public financing will be 57 percent.

Medicare alone accounts for 30 percent of all hospital expenditures. For the vast majority of community hospitals, the Medicare percentage is even larger and will likely increase when the first wave of baby boomers turn 65 in 2011. The added fiscal pressure on the Medicare trust funds will have dramatic effects upon hospital and healthcare financing in the United States. Possible responses of the federal government include raising taxes, increasing beneficiary payments for wealthier beneficiaries, reducing benefits, and constraining provider payments. None of these moves will be popular. However, Medicare financing has never been based upon actuarially sound principles, and the day of reckoning is coming.

In the end, although public source payments to hospitals will increase, the relationship of payment to cost will almost certainly be reduced in the years ahead for both Medicare and Medicaid. Just as public payment is dominated by Medicare and Medicaid, private payment in health care is dominated across the country by a small number of private health plans. CMS reported that the nation's 10 largest managed care firms provide coverage for two-thirds of all managed care enrollees. (b) This market concentration was created by a wave of managed care mergers and acquisitions in the 1990s--more than 275 merger and acquisition transactions between 1994, and 1999. (c) The result, of course, is fewer plans for hospitals and employers to negotiate with for health services.

Recent headlines have documented the burden many employers face with regard to escalating healthcare expenses. A fourth consecutive year of double-digit percentage increases in health expenses has prompted many employers to cut costs by shifting a greater portion of expenses to employees and changing covered benefit services. (d)

The impact of this cost--shifting to employees has been a continued rise in the number of uninsured. The number of uninsured rose 5.8 percent between 2001 and 2002 and, for 2002, is at 43.6 million Americans. That figure represents 15.2 percent of the U.S. population. (e) Contributing to the increase has been a decline in the number of people covered by employer based insurance, possibly because more younger workers are opting out of employer-based coverage because of higher employee contributions. This market dynamic could result in portions of hospital charges being paid by the patient, or some elective hospital procedures being delayed or forgone by patients. Some health policy analysts have already linked current declines in hospital volumes to the declining economy and reduced insurance coverage.

Although hospital mergers and acquisitions increased dramatically during the late 1990s, they have slowed significantly in recent years. The number of hospitals involved in mergers dropped from 323 in 1996 to 101 in 2002--a 69 percent decline. (f) The merger and acquisition activity left fewer independent facilities and more multi-hospital health systems, resulting in a few large players controlling many of the largest metropolitan areas in the United States. In many U.S. metropolitan areas, it is common for the vast majority of hospital revenue to be controlled by three hospital systems. This gives these hospital systems added negotiating leverage with large health payers. Additional merger movement on the hospital side is likely to create antitrust scrutiny that may prevent additional consolidation.