Payment systems: moving from the present to the future

Healthcare Financial Management, April, 1994 by Richard L. Clarke

In 1986, then-incoming HFMA Chairman Ken Hews, FHFMA, said, "It's hard to see the handwriting on the wall when your back is against it!" True enough. More and more, healthcare executives seem to find their backs against the wall because of pressures brought about by new approaches to payment for healthcare services.

For financial managers who work in medical group practices, the challenge for the next three to five years will be to manage the finances of their practices with one eye on fee-for-service payment issues and the other on issues related to capitated payment. The financial incentives are quite different.

Under a fee-for-service payment, issues revolve around setting charges within a framework of "usual and customary" fees and past practice. Financial analysis of new procedures and technologies is based on anticipated volumes and allowable charges.

Medicare's Resource Based Relative Value Scale (RBRVS) adds an additional dimension to the process, forcing group practice financial managers to become experts in the complex RBRVS payment rules. Under both fee-for-service payment systems and RBRVS payment systems, however, practice income depends on the volume and mix of services rendered.

In a capitated managed care environment, the financial incentives are reversed. With a single capitated payment per enrollee per month, group practice financial managers must manage their practices' finances with a fixed-payment revenue stream. Increasing the volume or intensity of physician and ancillary services does not increase the amount of revenue that flows into the practice. Financial management becomes focused on ensuring the adequacy of capitated payments, withholds, and risk pools, while controlling utilization. Practice income is related primarily to the number of individuals covered and cost management.

For financial managers who work for managed care organizations, the environment is changing as well. Today, about half of the non-Medicare population's healthcare needs are covered by indemnity or managed indemnity health insurance. The healthcare needs of the other half of the population are covered by managed care organizations such as HMOs and PPOs. Premium setting and product design in this environment focus on competing effectively against indemnity plans and gaining public acceptance of a more structured approach to healthcare delivery. Because of the structured approach to healthcare delivery, managed care organizations have been able to set prices for their products below those of major competitors.

Increasingly, however, competitors of managed care organizations are other managed care organizations or integrated systems of providers that contract directly with employers and sponsors. Since these organizations have the same approach to structured health care, price competition is tougher. This competition requires tighter management of medical service contracts, as well as tighter management of administrative expenses.

Finally, financial managers in hospitals must adjust to living in two worlds simultaneously. In one world, they must deal with payment techniques that are based on patient volume, such as per-case, per-diem, and ambulatory care price schedules. Medicare's Prospective Payment System is an example of a volume-related payment scheme.

In the other world, hospital

financial managers also must deal with an increasing range of payment techniques used by employers, managed care organizations, and independent practice associations--techniques that shift the volume risk to them. These payment techniques also change the financial incentives from being volume related to fixed payments per covered individual.

What does this mean for financial managers who must deal with two different and conflicting payment systems? Healthcare financial managers must learn to work comfortably in both worlds at the same time. Financial managers must keep current their skills related to Medicare payment, investment analysis, and pricing. Additionally, they must learn how capitated payment systems and different forms of competition affect their organizations. Financial managers should help their organizations identify and manage costs. Cost management is the common thread that links these two new approaches to payment.

Moving from the present to the future will be a difficult journey. In some cases, it will require increased effort to keep track of current as well as future issues. Some may find the changes too frustrating and challenging.

For those who stick with it, however, the healthcare financial environment of the future will be exciting and rewarding.

Richard L. Clarke, FHFMA President, HFMA