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Until CMS or Congress acts, we are forced to continue with this concatenation of cost-to-charge ratio calculations, leading to high charges and more media attention.

On the last Monitor Monday broadcast, we heard from Matthew Albright about how several states are demanding that hospitals lower their outrageous charges. This is not a new issue, as there seem to be weekly new articles about patients receiving outrageous bills.

Congress has given this issue a lot of attention. The price transparency regulations require more public-facing data about charges for healthcare. The No Surprises Act requires certain patients to be given a good-faith estimate of charges, and provides an arbitration process if provider and payer disagree on a payment rate for an out-of-network service. But let us take a step back and take some time to understand how charges for medical services are actually set.

When I was in private practice, we set our charges based on what Medicare and the other insurers were contracted to pay us. It certainly made no sense at all to charge $40 for a service when the payer had already agreed to pay $50 for that service, so we used contracted rates as a guide. We expected there to be contractual adjustments made, so if we had one payer that would only pay $50, but another would pay $60, we would charge everyone at least $60, and write off the difference.

Unfortunately, it is not so simple for hospitals. First, a disclaimer: I am not a hospital finance expert, and not an MBA. But I am certified in revenue integrity from the National Association of Healthcare Revenue Integrity (NAHRI), so I know at least enough to pass that exam. So, understand that what I write is my semi-educated explanation of the system.

Payment for hospital services is much different than for physician services. When an insurer is “buying” an office visit from me, they get an office visit for their insured patient. But with hospitals, while they do provide medical services to patients on an individual basis, like imaging studies, surgery, or physical therapy, there are also a myriad of added factors, like payment for medical education, disaster planning, community health initiatives, care for uninsured patients, and so on, all of which get figured into how much the hospital is paid. Many talk about site neutrality, which seems at first to be reasonable, but I have yet to see an ambulatory surgery center that is open 24/7 and is required by the Emergency Medical Treatment and Labor Act (EMTALA) to see every patient that presents for care. These added costs of operating a hospital must be accounted for in payments from payers.

The way hospitals are paid for these added services is beyond complex. In overly simplistic terms, for medical education, there is a direct government payment to the hospital for each resident, and there is an indirect amount paid to the hospital as part of each Medicare inpatient admission. Hospitals get paid what is called a Disproportionate Share Hospital payment with each Medicare admission to cover the cost of providing care to other patients without insurance, and so on.

Somehow, all these payments get calculated and balanced by the hospital finance team and the Medicare Administrative Contractors (MACs) through cost reporting. If you want to sound like you know how this all works, just refer to Worksheet S-10. People will assume you are an expert and stop asking hard questions.

But back to charges. The Centers for Medicare & Medicaid Services (CMS) also does something strange with hospital charges. They know that because of the complexity of the system and the myriad of payment arrangements, and contracting with payers that pay a fixed, negotiated percentage of the charges, hospitals will charge more than it actually costs to provide a service. But who doesn’t? Do the parts and labor that go into manufacturing a Ferrari F4 actually cost $284,000? Of course not. The price also includes the costs of running the factory, advertising, developing new cars, paying for a Formula 1 team, profits for the owners, and so on.

What is the actual cost of the plastic and water that go into that $2 bottle of water you buy at the convenience store? Maybe a few pennies. Figuring actual costs of medical services is beyond complex. If an MRI machine costs $2 million and can be expected to last for 100,000 imaging studies, that is a fixed per-use cost of $20 per study. But then you have to add in the cost of the technician, the cost of the room, the supplies used, any repair and maintenance costs, and so on.

To compensate for this complexity and uncertainty, hospitals are assigned a cost-to-charge ratio (CCR). (There are actually multiple CCRs, but that would make this totally incomprehensible, especially to me.) The 1:5 CCR tells CMS that if a charge is $500, the actual cost of the service, as best can be estimated, is $100. CMS would then look at that $100 when it comes to deciding how much it wants to pay for the service. Somewhere, in giant computers, every hospital claim for every service is inputted and compared to the hospital CCR, and CMS then knows what it costs across the country to provide care.

Now, here is how CMS describes this, from the 2022 Outpatient Prospective Payment System (OPPS) Final Rule: “For the proposed … payment rates, we used the set of CY 2019 claims processed through June 30, 2020. We applied the hospital-specific CCR to the hospital’s charges at the most detailed level possible, based on a revenue code-to-cost center crosswalk that contains a hierarchy of CCRs used to estimate costs from charges for each revenue code.” In case you are curious, CMS traditionally will use the most recent complete fiscal-year data for rate setting, but because of the COVID-19 public health emergency (PHE), they used 2019 data to set 2022 rates, instead of 2020.

CMS also uses the CCR in calculating outlier payments made to hospitals for extraordinarily costly care. Again, quoting CMS themselves, “Hospital-specific cost-to-charge ratios are applied to the covered charges for a case to determine whether the costs of the case exceed the fixed-loss outlier threshold.” In Chapter 4 of the Medicare Claims Processing Manual, CMS reiterates that, stating that “It is extremely important that hospitals report all HCPCS codes consistent with their descriptors; CPT and/or CMS instructions and correct coding principles, and all charges for all services they furnish, whether payment for the services is made separately paid or is packaged.”

What this means is that CMS has created a vicious cycle that cannot be stopped by anyone other than themselves. What are the consequences of this? It was apparent in the 2022 OPPS Final Rule, when CMS set a payment rate for HeartFlow FFR, a computerized interpretation of a CT scan of the arteries of the heart. “For this final rule with comment period, we identified 3,188 claims billed with CPT code 0503T, including 465 single frequency claims for CPT code 0503T using claims from CY 2019,” the text read. “Our analysis has found that the geometric mean cost for CPT code 0503T is $807.58. However, multiple commenters have noted that the FFRCT service costs $1,100, and that there are additional staff costs related to the submission of coronary CT image data for processing by HeartFlow.”

In other words, the hospital must pay the company that performs the computerized interpretation $1,100, but for some of those 3,188 claims, the hospital did not properly apply their CCR to that cost and charge Medicare the proper amount. As a result, CMS was going to significantly cut reimbursement, thinking the cost of the test was much less than they were previously paying. Now, if a new company started offering the same service at a lesser charge, then a lower charge would be justified. But that is not what had happened here.

At a national revenue integrity conference several years ago, John Settlemeyer of Atrium Health and Jugna Shah of Nimitt Consulting went through an exercise regarding the pricing of CAR-T therapy for cancer. This is a new, very costly therapy that is quite effective when it works for cancers that had no other treatments available. The patient’s blood is sent to a lab, where specific cells are isolated and “engineered” and then injected back into the patient to attack the cancer cells. I could never explain the pricing aspects as well as those two experts, but in short, this treatment had an approved add-on payment amount from Medicare; however, that payment was only made if the claim was priced properly. That meant that engineering of the cells, for which hospitals must pay the company approximately $375,000, must be listed on the claim as a line item, with a charge of over $1.8 million.

That charge, as outrageous as it sounds, allows CMS to make the appropriate CCR adjustment, see that the therapy cost $375,000, and then pay the hospital the correct amount. The patient who just underwent a lifesaving cancer treatment will receive a statement from the hospital, often labeled “not a bill,” that will indicate that $1.8 million charge, potentially prompting some questions. If the hospital did not list that high charge, the claim would be unlikely to qualify for the add-on and outlier payments, and few hospitals are in the financial position to write off hundreds of thousands of dollars for one claim. But as long as CMS continues to apply the CCR to past charges to determine future payments, hospitals cannot start reducing their charges. If a hospital lowers its charges, CMS will then calculate a lower cost and start paying less. That lesser payment will then be used by other payers that set their rate as a percentage of Medicare rates, and they will pay less. I suspect that not one hospital CFO likes to see a $1.8 million charge on a patient statement, but they know that the CAR-T company will soon be asking for their $375,000 – so until CMS or Congress acts, we are forced to continue with this concatenation of cost-to-charge ratio calculations, leading to high charges and more media attention.


Ronald Hirsch, MD, FACP, CHCQM, CHRI

Ronald Hirsch, MD, is vice president of the Regulations and Education Group at R1 Physician Advisory Services. Dr. Hirsch’s career in medicine includes many clinical leadership roles at healthcare organizations ranging from acute-care hospitals and home health agencies to long-term care facilities and group medical practices. In addition to serving as a medical director of case management and medical necessity reviewer throughout his career, Dr. Hirsch has delivered numerous peer lectures on case management best practices and is a published author on the topic. He is a member of the Advisory Board of the American College of Physician Advisors, a member of the American Case Management Association, and a Fellow of the American College of Physicians. Dr. Hirsch is a member of the RACmonitor editorial board and is regular panelist on Monitor Mondays. The opinions expressed are those of the author and do not necessarily reflect the views, policies, or opinions of R1 RCM, Inc. or R1 Physician Advisory Services (R1 PAS).

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