Making prices make sense: a balanced approach to defensible prices: this project is a collaborative effort by MedAssets and the Healthcare Financial Management Association

Healthcare Financial Management, July, 2005

It used to be that a hospital supply, pharmaceutical, or service would cost a certain amount and the hospital would charge a certain amount. Any relationship between the two was something that perhaps only a CFO could decipher.

But fundamental changes in the healthcare market are prompting hospitals to rethink their pricing strategies--or even come up with some new ones.

For one, consumers are increasingly bearing the burden of their medical expenses. And just as they might shop around for the best price for a ticket to Hawaii or a new car, consumers are increasingly focusing on what they are getting for their healthcare dollars and asking whether their dollars will go further elsewhere.

Such scrutiny by patients is just one aspect of the increasing public scrutiny that hospitals are receiving. Payers of all kinds also increasingly want to know what hospitals are charging and why. Some of this scrutiny stems from alleged wrongdoings where hospitals have been accused of overcharging certain payers or inflating prices to increase the amount of Medicare outlier payments. Recent corporate scandals have also placed increased pressure on hospital board members to ensure that the institutions they serve are being open and fair.

In the face of these trends, providers have a greater need to be able to defend their pricing. Hospitals today need to tool themselves with the appropriate knowledge to ensure that prices have a reasonable relationship to the cost of the item and comparative industry price benchmarks.

An effective tool for this purpose is defensible price modeling.

Making Sense Before Making Dollars

In essence, price modeling is a strategy for setting prices and markups on the chargemaster so that there is a clear rationale that makes sense to a variety of concerned parties, from providers and payers to the general public, and for a variety of reasons, from covering actual costs and optimizing net revenues to avoiding payment confrontations and lawsuits. In light of the current healthcare market, however, the latter has taken precedence.

The current trend toward consumer-directed health care means that as consumers increasingly assume responsibility for their own healthcare costs, they look for ways to trim expenses. Cost savings mechanisms like healthcare spending accounts and high insurance deductibles are becoming increasingly popular ways for consumers to take control of their healthcare dollars. As a result, consumers are looking more closely at their medical bills and may even be doing some competitive shopping--an incentive for hospitals to make certain that their charges are appropriate and defendable.

Existing or impending legislation is allowing a more transparent view of prices. Currently, at least eight states have laws requiring that hospitals make their chargemasters available for public viewing, and other states are considering doing so. (It's worth checking to see if your state has this legislation pending, if it hasn't yet adopted it.)

As public scrutiny increases, hospitals need to have a way to defend the logic of their chargemasters. When confronted with pricing questions from more and more payers, hospitals will need to be able to show a defendable pricing strategy. Such a strategy at a minimum might include ensuring that prices are within a reasonable range of market benchmarks and are set at no more than X% of fully allocated costs for the item.

The market shift in payers is also forcing hospitals to shift their reasons for implementing price modeling strategies.

For example, the goal of the price modeling used by Washoe Health Systems, Reno, Nev., is to ensure that the overall strategy is applied consistently throughout the organization without exception, says Catherine Harris, director, revenue cycle, for Washoe.

"So we're constantly reviewing departments, reviewing the pricing, and making sure that we put the proper controls in place with chargemaster maintenance," Harris says.

Washoe has a number of hospital facilities, all in the Reno area, including two acute medical/surgical hospitals, an acute rehab facility, a skilled nursing facility, and several outpatient clinics.

Harris says market factors, such as the growing number of high-risk insurance products geared toward the underinsured and the growing number of uninsured have resulted in an increased focus on hospital pricing. This emerging population of self-pay payers has caused health systems like Washoe to refocus their pricing strategies.

"Defendable pricing is our goal," she explains. "If somebody asks us what we charge for X, Y, and Z, our answer should always make sense to the community. In my view, the emphasis throughout the industry has changed from revenue enhancement to defendable pricing. That's the biggest key."

Figuring Out What to Include

Effective price modeling incorporates three important factors: costs, comparative market data, and reimbursement.

Pricing strategy revolves around reviewing the chargemaster on a regular basis to determine whether any changes are required. Modeling may involve a host of different methods, but there are generally two main methodologies: benchmarking, or market analysis, and cost-based markup.