We Pay in Dollars, Not Medicares

As of the 2020 Census, about 18% of Americans have health insurance coverage from Medicare. That number is significant, but Medicare’s influence on our health system extends far beyond that 18%. Medicare sets many standards in healthcare administration. One of the most important roles Medicare plays is setting the most common standard for healthcare service pricing. That standard  has led to some significant problems in understanding healthcare pricing.

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Medicare sets unique rates of reimbursement at each provider that it does business with. Medicare bases that payment on a public set of standards that it believes represents “fair payment”. Many groups, including Medicaid agencies, commercial carriers, and Medicare Advantage plans, use Medicare's pricing as a contractual reference to determine their own reimbursements.

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In commercial healthcare, it is common to discuss negotiated rates as a percent of Medicare. Take this RAND Corporation study, entitled “Prices Paid to Hospitals by Private Health Plans Are High Relative to Medicare and Vary Widely.” The study examines hospital prices relative to Medicare across the United States. It includes findings like, “Prices paid to hospitals during 2020 by employers and private insurers for both inpatient and outpatient services averaged 224 percent of what Medicare would have paid.”

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On the surface, this pricing and reference system seems reasonable. Yet, there are issues with Medicare-based price analysis that hamper its effectiveness in understanding healthcare prices. A key problem is a simple one: the units of measurement don’t line up with the units of transaction. In other words, when we pay for healthcare, we don’t pay in “Medicares” — we pay in dollars. Medicare’s prices at each provider, service definition, and pricing methodology is inconsistent. This inconsistency is not widely understood and can obfuscate real prices. In turn, it makes it near-impossible to analyze or manage the true value of care delivered.

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Inpatient Medicare Pricing

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The Medicare cost for a specific inpatient (IP) service — or “DRG” (diagnosis-related group) — is not fixed. Instead, the DRG price is a moving target based partly on the features of the hospital rather than the exact service delivered. Given that we express Medicare pricing as a“reference”, this inconsistency is a problem!

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The determination of the cost of a DRG does have a standard payment based on the expected services. But that is only one component of the total payment amount. The rest is dependent on variables like: outlier payments, capital payments, and medical education payments. These variables all change between hospitals, even for ones that can deliver the same DRGs. The table below provides an example of everything that goes into a specific DRG price.

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What this means is that two hospitals can offer equal IP procedures, both at 150% of Medicare. Yet, at one hospital, the Medicare price could be $20,000, and at the other it could be $18,000. So while the prices look equal as a percent of Medicare, they are in fact 10% different in real money.

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Outpatient Medicare Pricing

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This variability is even more pronounced in an outpatient (OP) setting. Medicare reimburses on a different fee schedule or method based on location. An example is how Medicare reimburses care ambulatory surgical centers (ASC) versus a hospital’s outpatient department (HOPD). Let’s use a “colonoscopy with biopsy” as our example. At an ASC, this procedure costs an average of $728 with Medicare. At a HOPD, it’s $1240.

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If you only knew that the HOPD billed at 250% of Medicare and the ASC billed at 300% of Medicare, you’d assume the HOPD was the better deal for the same procedure. But because the underlying dollar prices are different, the ASC ($728 * 3.00 = $2184) is still much cheaper than the HOPD ($1240 * 2.50 = $3100).

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Those prices are just estimates. The exact price of a procedure varies by location and is also subject to more variables. For example, some providers use anesthesia as part of a colonoscopy, others do not. Those differences will affect the price. Knowing the price of a procedure compared to Medicare still leaves us wondering exactly how much we will pay in dollars.

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When summed from the procedure level to the healthcare system level, "percent of Medicare" analyses become less clear. We do not know the mix of services provided on a regional basis. In other words, the amount that the market provides ASC-based or Office-based services compared to HOPD services can be more impactful on prices than the percent of Medicare reimbursement.

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Inconsistent Units

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Compounding this issue even more is the inconsistent way that Medicare reimburses and defines clinically equivalent services. There are different reimbursement methodologies and names that Medicare assigns based on the site of care. A few of them are:

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• IPPS: Inpatient Prospective Payment System. These are the previously discussed DRGs
• OPPS: Outpatient Prospective Payment System. These are certain HOPD services reimbursed in a bundled form. They are called Ambulatory Payment Classification (APC)
• Physician Fee Schedule: System for reimbursing physicians,office-based services, independent facility services, and some hospital services.

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As in the ASC vs. HOPD example, there is overlap between services in these categories. Medicare will refer to the same clinical service, like a Knee Replacement, under two different names depending on the site of care: APC 5115 – “Level 4 Musculoskeletal Procedures and DRG 470 – Total Joint Replacement. The issue remains in the HOPD vs Office or Independent setting where services, like imaging, are defined in APC terms when in the hospital while on the fee schedule when in another setting. In all of these cases, both the naming and reimbursement for equivalent services can be different.

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This variation obscures real prices, units, and the extent to which the healthcare system is allocating volume well. If we are only looking at Medicare-defined units, we lose the ability to understand the issues and how to solve them.

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A Better Way

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When we don’t have a clear picture of price and units, we lose the ability to control costs — this is seen clearly in the U.S., where commercial healthcare costs have grown over 250% in the last two decades. What we need are standardized units of care, where clinically equivalent services are consistently defined and comparable to each other. Ideally, any analysis would take the form of a price index for a representative set of standardized healthcare services. Because, in order to build a better healthcare system, services must be priced, managed, and understood in a way that reflects how we will pay for them — in dollars, not in “Medicares”.