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Rural Health Information Hub

May 18, 2022

Let's Get a Good Deal on Health Care

by A. Clinton MacKinney, MD, MS

graphic showing a stethoscope and bar chartWe all like a good deal — from cars to groceries. But are we getting a good deal on health care? Probably not. U.S. health care is the most expensive in the world with uneven quality. Big-idea solutions are hard to come by in a $4.1 trillion system where one person's cost is another person's profit. That's a cost of over $12,500 a year for every man, woman, and child in the nation!

Economic theory suggests that people respond to incentives. So, when searching for fixes to our exorbitantly costly health care, we should examine the healthcare system's predominant payment (AKA incentive!) system — fee-for-service. In fee-for-service, doctors and hospitals are paid more for each additional service they provide — whether that service helps, hurts, or does nothing for the patient. That said, fee-for-service is not all bad. Fee-for-service is easily understood, rewards industriousness, is accounted for by generally-accepted accounting principles, and adapts to multiple sites of care, such as doctor's offices and hospitals. Plus, it's familiar, like a factory paid to produce widgets. But fee-for-service financially rewards more procedures, more office visits, and more hospitalizations — at least occasionally beyond what is necessary. When I practiced as a rural family physician, I was too busy to think much about volume incentives. But on the other hand, I was never offered incentives to redesign my practice to offer care focused on improving health outcomes and patient convenience.

Fee-For-Service and the Rural Hospital

In a fee-for-service world, Price x Volume = Revenue. But low-volume rural hospital revenue is compromised by fee-for-service because the costs of operating a small rural hospital are rising faster than prices. Furthermore, volumes (essential to revenue) are always precarious in low-population-density areas. Large urban hospitals, with their economies of scale and large populations, can weather price cuts more easily, offsetting price losses with volume increases. Small rural hospitals aren't so fortunate.

In 1983, Congress established the Inpatient Prospective Payment System (IPPS) as a strategy to control rising Medicare hospital costs. IPPS is a predetermined, standardized payment for an entire inpatient hospital stay. The system provides financial incentive to manage hospital stays efficiently and discharge patients expeditiously. But this is still fee-for-service! Volume is still king! Hospitals financially benefit when a patient is discharged quickly, and another patient is admitted. But rural areas may not have another patient at the ready for admission, and consequently, rural hospitals financially suffered under IPPS. As a remedy, the Balanced Budget Act of 1997 created the Critical Access Hospital (CAH). In 2021, there were 1,353 CAHs representing about a quarter of all acute care hospitals in the country. CAHs receive cost-based reimbursement (CBR) from Medicare; that is, Medicare pays only for the hospital's cost of care. But that means there is no CAH profit when serving Medicare beneficiaries! And even nonprofit hospitals need at least some profit to remain viable. Plus, CBR is still built on a fee-for-service chassis. The more services a CAH provides, the more profitable the CAH's non-Medicare contracts become. Once again, volume is king.

Most of us can agree that rural hospitals provide important health care services that are essential to rural Americans, like primary care and emergency care. And unless those services are conveniently accessible to rural residents and delivered with quality elsewhere, rural hospitals should be supported. Yet despite implementation of Medicare CBR as a lifeline to rural hospitals, many rural hospitals remain in financial distress. Therefore, it seems that the fee-for-service payment system (including PPS and CBR) may be the wrong fit for low-volume rural hospitals. And if the Center for Healthcare Quality and Payment Reform and others are right, we'll see rural hospital closures ramp up as pandemic funding runs out. We need a new rural hospital payment chassis, not the same old model where rural hospitals require higher prices than urban (because rural hospitals are essential, at least to the folks that use them) or we bemoan our low-volume situation (even though some volume loss may be within hospital leadership control). Rural hospitals need new payment incentives for better patient care and improved community health, not increased volumes. That's where value-based payment comes in.

Designing a Better Rural Payment System

Medicare, Medicaid, and commercial health insurers are finding early success improving clinical quality and taming the healthcare cost-beast in value-based payment. Value-based payment pays for better health care and patient outcomes rather than paying fee-for-service for individual healthcare services (like CT scans and office visits). This is called the volume-to-value transition.

To reiterate, value-based payment is not payment for additional healthcare services. Instead, value-based payment rewards better care, improved health, and/or smarter spending. A new payment system should differentiate between rural hospital fixed costs and variable costs. Fixed costs are costs that maintain facilities, support clinical care, and are ready for deployment in case of surging need (as during a pandemic). We'll throw acceptable profit into fixed costs with an acknowledgement that profit (or lack thereof) is partly the result of management practice. Variable costs represent costs that vary directly with patient volume, such as drugs, lab test reagents, and tongue blades. Low-volume rural hospitals need payments that cover their fixed costs until unnecessary fixed costs can be repurposed or eliminated. Staffing costs, representing a large share of hospital operating expenses, are generally considered both fixed and variable costs. However, a greater percentage of small rural hospital staffing costs are fixed (compared to urban hospitals) due to a rural hospital's need for staff on standby in case of unexpected emergency or volume surge.

Reasonable fixed costs should be paid by an appropriate mix of payers, including federal, state, and commercial payers. A public commission, similar to a public utility commission, could set these fixed-cost payment rates. On the other hand, variable costs should be paid based on a blend of three factors: (1) the volume and type of services provided (fee-for-service), (2) the number of people under care (capitation), and (3) the quality of care provided (pay-for-performance). The greater the number of people cared for and the better the quality of care provided, the greater the hospital payment and thus the greater the potential hospital profit. This blended payment system is used in several physician payment demonstrations, but uniquely high rural hospital fixed costs need to be addressed.

Admittedly, when it comes to value-based care and payment, the devil is in the details. For example, who serves on the public commission and how does the commission determine fixed costs? What is the proper percentage distribution of the variable cost payment factors? And importantly, how do rural hospitals make the transition from fee-for-service to the new payment system without disruptions that might compromise access to care? These are critical considerations, but the longer we remain tethered to fee-for-service, the longer we will prioritize volume over what our patients and communities really want – better care, improved health, and smarter spending.

A. Clinton (Clint) MacKinney, MD, MS has worked in health care for nearly 40 years – including as a rural family physician practicing the full scope of family medicine. Dr. MacKinney completed his clinical career as an emergency department physician in rural Minnesota. Dr. MacKinney also has worked as a national rural healthcare consultant providing services to approximately 75 rural hospitals and communities. Dr. MacKinney currently is a Clinical Associate Professor at the University of Iowa College of Public Health with professional interests in value-based care, rural hospital payment, and physician/administration relationships.

Opinions expressed in this column are those of the author and do not necessarily reflect the views of the Rural Health Information Hub.