Principles of Healthcare

Reimbursement

Anne B. Casto, RHIA, CCS

Elizabeth Layman, PhD, RHIA, CCS, FAHIMA
Copyright ©2006 by the American Health Information Management Association. All
rights reserved. No part of this publication may be reproduced, stored in a retrieval
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ISBN 1-58426-070-X
AHIMA Product No. AB202006

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 Contents

About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .ix

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xi

Chapter 1 Healthcare Reimbursement Methodologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

Introduction to Healthcare Reimbursement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Types of Healthcare Reimbursement Methodologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
Future of Healthcare Reimbursement Methodologies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

Chapter 2 Clinical Coding and Coding Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

The Clinical Coding–Reimbursement Connection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
Coding Compliance and Reimbursement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40
Chapter Appendix: Standards of Ethical Coding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43

Chapter 3 Voluntary Healthcare Insurance Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45

Voluntary Healthcare Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47
Provisions and Functioning of Healthcare Insurance Plans . . . . . . . . . . . . . . . . . . . . . . . . .48
Sections of a Healthcare Insurance Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49
Determination of Covered Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54
Private (Individual) Healthcare Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55
Employer-Based (Group) Healthcare Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55
Blue Cross and Blue Shield Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58

iii
iv Contents

Chapter 4 Government-Sponsored Healthcare Programs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59

Medicare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61
Medicaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63
Other Government-Sponsored Healthcare Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .69
Chapter 5 Managed Care Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71
Introduction to Managed Care. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73
Managed Care Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73
Integrated Delivery Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83
Medical Foundations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .84
Future Trends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .84
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85
Chapter 6 Medicare-Medicaid Prospective Payment Systems for Inpatients . . . . . . . . . . . . . . . . .87
Introduction to Inpatient Prospective Payment Systems (PPSs) . . . . . . . . . . . . . . . . . . . . . .89
Acute Care Prospective Payment System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .89
Skilled Nursing Facility Prospective Payment System . . . . . . . . . . . . . . . . . . . . . . . . . . . .107
Long-Term Care Hospital Prospective Payment System . . . . . . . . . . . . . . . . . . . . . . . . . .113
Inpatient Rehabilitation Facility Prospective Payment System. . . . . . . . . . . . . . . . . . . . . .116
Inpatient Psychiatric Facility Prospective Payment System . . . . . . . . . . . . . . . . . . . . . . . .129
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136
Chapter 7 Ambulatory and Other Medicare-Medicaid Reimbursement Systems . . . . . . . . . . . .139
Introduction to Reimbursement Systems for Physicians and Ambulatory Settings . . . . . .141
Resource-Based Relative Value Scale for Physician Payments . . . . . . . . . . . . . . . . . . . . .141
Ambulance Fee Schedule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .144
Ambulatory Surgical Center Prospective Payment System . . . . . . . . . . . . . . . . . . . . . . . .152
Hospital Outpatient Prospective Payment System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .157
Home Health Prospective Payment System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173
Chapter 8 Revenue Cycle Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .177
Introduction to Revenue Cycle Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .179
Multidisciplinary Approach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .179
Components of the Revenue Cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .179
Revenue Cycle Management Team . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .184
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188
Appendix A Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .191
Appendix B Additional Readings and Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .211
Appendix C Answer Key for "Check Your Understanding" Questions . . . . . . . . . . . . . . . . . . . . . .281
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .285
 About the Authors

Anne B. Casto, RHIA, CCS, is the program manager Elizabeth Layman, PhD, RHIA, CCS, FAHIMA,
for the Health Information Management and Systems is professor and chair in the Department of Health
Division at Ohio State University in Columbus, Ohio. Services and Information Management at East
She teaches courses in ICD-9-CM and CPT coding, Carolina University, Greenville, North Carolina.
as well as healthcare reimbursement systems. She previously worked at Hennepin County
After earning her baccalaureate degree from Medical Center and the University of Minnesota
Ohio State University in 1995, Anne was employed Hospitals, both in Minneapolis, Minnesota, from
at Mount Sinai Medical Center and Beth Israel 1974 through 1990. She worked in several depart-
Medical Center in New York City managing several ments, such as third-party reimbursement, credit
units including coding and abstracting, discharge and collections, account auditing, outpatient regis-
processing, and DRG auditing. tration, inpatient admissions, research studies, and
In 1998, Anne moved into the healthcare finan- quality management.
cial arena and worked for the Center for Healthcare Elizabeth has her baccalaureate degree from
Performance Industry Studies as product manager the University of Minnesota. While working, she
of clinical information. She then served as vice returned to school to earn her associate’s degree
president of clinical products for Cleverley and in medical record technology. She completed St.
Associates. Scholastica’s progression program to earn her post-
Anne earned her CCS credential in 1998. baccalaureate certificate in health information
administration.
After earning her master’s degree in organi-
zational leadership from the College of St. Cath-
erine’s, Elizabeth joined the faculty of the Medical
College of Georgia in Augusta, Georgia. She also
consulted for the Physicians’ Practice Group.
Elizabeth successfully sat for the first CCS
examination in 1992. In 1995, she earned her doc-
torate in higher education from Georgia State Uni-
versity. In 2001, she was awarded the designation
of Fellow of the American Health Information Man-
agement Association, one of the first two individuals
in the country to receive this award.

v
 Acknowledgments

The authors wish to thank

Eleanor Ann Joseph, MPA, RHIA, CHP, CPHQ, CCS, CCS-P, CPC,
and Leona Thomas, MHS, RHIA,
who served as external reviewers of the text
and provided excellent suggestions for its improvement.

vii
 Foreword
by William O. Cleverley, Ph.D.
Professor Emeritus, Ohio State University

I have taught healthcare financial management to tors, the differences are not all that significant.
graduate students for thirty years and have always Generic principles for cost management might
believed that the critical area of understanding apply equally in a software firm or a hospital. The
was reimbursement. When I first started teach- revenue function is, however, a completely differ-
ing, the primary—perhaps exclusive—focus was ent manner.
on hospitals, but that has changed. Financing and Why is the revenue function so different for
organizational patterns have shifted over time to healthcare firms compared to other industries? I
create large healthcare firms in other sectors, such as believe there are at least four reasons. First, the vast
medical groups, nursing facilities, imaging centers, majority of payment is not actually paid by the cli-
surgery centers, home health firms, and many oth- ent (patient), but rather by a third party on behalf of
ers. The primary focal point of difference between the patient. Second, the level of payment for a set
healthcare firms and businesses in other industries of identical services may vary dramatically based
is still, however, payment. Healthcare firms are upon the actual third party payer. Third, the actual
very unique in the manner in which they receive determination of payment for a specific third party
compensation for the services that they provide. I payer is often complex, based upon preestablished
could not find any other industry that had as com- or negotiated rules of payment that are frequently
plex a revenue function as healthcare firms when I related to the codes entered upon a patient’s bill or
started teaching thirty years ago, and that statement claim. Fourth, the government is often the largest
is still true today. In fact, the level of complexity for single payer and does not negotiate payment but
healthcare firms has increased exponentially over simply defines the rules for payment upon which it
the last thirty years. will render compensation for services provided to
Noting that the revenue function, or reimburse- its beneficiaries.
ment, is complex for a healthcare firm does not To get a partial view of the complexity of reim-
explain why this is critical. Let’s examine the bursement in the healthcare industry, let’s describe
very basis of management in any business. Simply a typical managed care contract with a hospital.
stated, management must control the difference Let’s assume this payer pays for inpatient services
between revenue and cost, which we define as on a per-diem basis, with separate rates for medi-
profit. It makes little difference whether the firm cal and surgical cases. In addition, carve-outs are
is a taxable or tax-exempt entity. Viable businesses present for cardiology DRGs. Finally, obstetrics
must manage that profit function. Although there and nursery care services are paid on case rates. To
are clearly differences in cost functions between provide some additional risk protection to the hos-
healthcare firms and firms in other industrial sec- pital, a stop loss provision is also inserted after total

ix
x Foreword

charges exceed a certain limit. Outpatient services claims and the rules for final payment determina-
are paid on a mix of fee schedules and discounted tion. Medicare payment provisions are covered in
billed charges. Outpatient surgical cases are paid great detail, but the text also includes other payers.
on a fee schedule based upon designated ambula- It covers payment provisions for hospitals, but it
tory surgical groups. Emergency visits are also on also covers payment for other payers including
a fee schedule, based upon level of service. Other managed care plans.
fee schedules exist for specific imaging procedures, I believe this book is a must-read reference for
and everything else is paid on a discounted, billed- healthcare executives who need a comprehensive
charge basis. Multiply this one payer by 100 to reference on payment in the healthcare industry. It
recognize other payers and throw in Medicare and will be a fine supplement for healthcare manage-
Medicaid payment rules, and you have a nightmare ment students who need to know how the firms
in administration. It may be a nightmare, but it is they will manage will be paid and how coding and
very real to most healthcare firms; their very finan- billing functions can impact results. It is also a
cial viability is contingent upon successful man- critical text for health information managers and
agement of this complex revenue function. students. It is often easy to lose sight of the forest
Coding and billing issues are central to most when you are engaged in tree cutting. This text
of the present reimbursement plans. In fact, many provides a clear, concise description of the pay-
healthcare firms can lose substantial sums of money ment landscape for healthcare firms, which will
because they are not coding their patients’ claims in enable health information managers to better inte-
an accurate and complete manner. For example, grate their functions into the overall organizational
failing to code an additional diagnosis can result strategic position of the healthcare firms where
in assignment of a lower DRG, and therefore lost they work. A large number of specific examples are
revenue. While some healthcare executives may also provided to help cement conceptual frame-
fail to understand the importance of the coding works with operational reality. Another great fea-
function, it would behoove them to acquire an ture of this text is its explanation of the myriad
appreciation of coding because so much of their acronyms and jargon used in the healthcare indus-
revenue function is related to what is done by cod- try. Short, concise definitions are given for every-
ers. Conversely, many people in health information thing from APCs to RBRVS.
management may understand the technical side of This text met and exceeded the three R’s that I
what they do, but they don’t appreciate their role in use in evaluation. First, the text is very readable and
the overall financial success of the health firm in easy to understand. Second, the text is especially
which they work. relevant to all healthcare managers as they seek to
This background explains why I am so excited improve financial performance. Third, the text is
about the publication of this book. Anne Casto rich in detail and practical illustrations. This book
and Elizabeth Layman have put together a much- will occupy a prominent position on my bookshelf
needed text on reimbursement that fills a void. I and will be a great reference.
believe that this text is a first. It provides a com-
William O. Cleverley, Ph.D.
prehensive review of the reimbursement world for
Professor Emeritus
healthcare firms of multiple types. It also provides
Ohio State University
very specific material on the actual completion of
 Preface

Health information management (HIM) profes- cepts and principles of healthcare reimbursement in
sionals play a critical role in the delivery of health- step-by-step, simple terms. This introduction pro-
care services in the United States. To be fully vides the reader with the solid foundation needed to
effective in their roles, however, HIM professionals understand the more detailed and complex discus-
need an indepth understanding of healthcare reim- sions that follow in later sections of the book.
bursement systems, reimbursement methodologies, Chapter 2, Clinical Coding and Coding Com-
and payment processes throughout the healthcare pliance, presents baseline information about today’s
industry. approved code sets and their functionality and explains
Principles of Healthcare Reimbursement inte- the complex interrelationships between reimburse-
grates information about all U.S. healthcare pay- ment, coded data, and compliance with the rules and
ment systems into one authoritative source. It regulations of public and private third party payers.
examines the complex financial systems within Chapter 3, Voluntary Healthcare Insurance Plans,
today’s healthcare environment and provides an explains private or commercial healthcare insurance
understanding of the basics of health insurance and plans and Blue Cross/Blue Shield plans, and pro-
public funding programs, managed care contract- vides the reader with a detailed understanding of the
ing, and how services are paid. Not only does the sections of a healthcare insurance policy.
text provide step-by-step detail about how each pay- Chapter 4, Government-Sponsored Health-
ment system functions, but the history behind each care Programs, differentiates among the various
is provided. This gives the reader an appreciation government-sponsored healthcare programs in
for the complexity of reimbursement systems and an effect today, explains the impact that these pro-
understanding of the profound impact they have had grams have had on the American healthcare sys-
on providers and payers, consumers, public policy tem, and presents the history of Medicare and
makers, and the development of classification and Medicaid programs in America.
information technology systems over the years. Chapter 5, Managed Care Plans, describes the
Healthcare leaders and administrators often origins, evolution, and principles of managed care
have to learn about healthcare payment systems on- and discusses the numerous types of plans that have
the-job and on-the-fly. Other texts feature health- emerged through the integration of administrative,
care finance and healthcare economics, but not the financial, and clinical systems to both deliver and
bottom-line and nitty-gritty of the healthcare pay- finance healthcare services.
ment systems themselves. This book fills that gap. Chapter 6, Medicare-Medicaid Prospective Pay-
Chapter 1, Healthcare Reimbursement Meth- ment Systems (PPSs) for Inpatients, explains com-
odologies, introduces and explains the basic con- mon models and policies of payment for inpatient

xi
xii Preface

Medicare and Medicaid prospective payment sys- Chapter 8, Revenue Cycle Management, explains
tems and defines basic language associated with the components of the revenue cycle, defines reve-
reimbursement under PPSs in acute care hospitals nue cycle management, and describes the connec-
and inpatient skilled nursing, long-term care, reha- tion between effective revenue cycle management
bilitation, and psychiatric facilities. and providers’ fiscal stability.
Chapter 7, Ambulatory and Other Medicare- A complete glossary of reimbursement termi-
Medicaid Reimbursement Systems, explains com- nology is included at the end of the book. Through-
mon models and policies of payment for Medicare out the text chapters, boldface type is used to
and Medicaid healthcare payment systems for phy- indicate the first substantial reference to key terms
sicians and outpatient settings, which include physi- included in the glossary. A detailed content index is
cian offices, ambulance services, ambulatory surgery also included at the conclusion of the text.
centers, hospital outpatient services, and home health
agencies.

Notes to educators:
Each chapter contains “Check Your Understand- Instructors who are AHIMA members can sign
ing” questions for discussion and/or to help the up for this private community by clicking on the
reader in focusing on important points within the help icon with the CoP home page and request-
text. The answers to these questions are included at ing additional information on becoming an AOE
the end of the book. CoP member. An instructor who is not an AHIMA
Review quizzes also follow each chapter. The member or a member who is not an instructor may
answer key for the review quizzes is available to contact the publisher at [email protected].
instructors in online format from the individual The instructor materials are not available to stu-
book pages in the AHIMA Bookstore or through dents enrolled in college or university programs.
the Assembly on Education (AOE) Community of
Practice (CoP).
 Chapter 1
Healthcare Reimbursement Methodologies

Objectives Key Terms

• To use basic language associated with health- Allowable fee
care reimbursement methodologies Block grant
Capitation
• To differentiate payment methods on unit of
Case-based payment
payment, timeframe, and risk
Cases
• To distinguish major payment methods in the Charges
United States Claim
Copayments
CPR
Deductibles
Episode-of-care reimbursement
Fee
Fee schedule
Fee-for-service reimbursement
Global payment method
Guarantors
Insurance
Per-diem payment
Premium
Prospective payment method
Providers
Reimbursement
Resource-based relative value scale
Retrospective payment method
Risk pool
Self-insured plan
Third party payers
Third party payment
UCR

1
 Healthcare Reimbursement Methodologies 3

Introduction to Healthcare to pay for all the potential covered healthcare costs
for an entire group of patients.
Reimbursement
The healthcare system of the United States (U.S.) Historical Perspectives
is complex. New payment methods and rules con- Health insurance in the U.S. has been made avail-
tribute to the complexity. In 1999, this complexity able to help offset the expenses of the treatment of
was listed as one of five trends threatening the illness and injury. The first “sickness” clause was
very future of medicine (Washburn 1999, 34). For inserted in an insurance document in 1847. How-
example, a physician’s office might have “at least ever, health insurance did not become established
a dozen separate contracts for providing healthcare until 1929, when Blue Cross first covered school
services” (Washburn 1999, 35). Surely, if “insid- teachers in Texas. In 1932, a city-wide plan was
ers” find the system confusing, “outsiders,” the begun in Sacramento, California. As an industry,
patients, confront a veritable maze. health insurance became widespread after World
War II (Longest, Rakich, and Darr 2000, 89–90).
Health Insurance
Generally, reimbursement for healthcare services Health Insurance and Employment
is dependent upon patients having health insur- In the U.S. health insurance is usually tied to
ance. Insurance is a system of reducing a person’s employment. Many larger employers as part of a
exposure to risk of loss by having another party package of employment benefits pay a portion of
(insurance company or insurer) assume the risk. In the health insurance premium. Employees may be
healthcare, the risk the healthcare insurance com- required to pay extra for health insurance for their
pany assumes is the unknown cost of healthcare for spouse or children (dependent coverage). Medicare
a person or group of persons. is also considered insurance because payroll taxes,
However, the insurance company that assumes through both employers’ and employees’ contribu-
the risk reduces its own risk by distributing the tions, finance one portion of Medicare coverage.
risk among a larger group of persons (insureds). Premiums paid by eligible individuals and matched
This group of persons has similar risks of loss by the federal government also finance Medicare’s
and is known as a risk pool. In healthcare, the supplemental medical insurance program.
variability of health statuses across many people When people lose their jobs, they often lose
allows the healthcare insurance company to make their health insurance. Although people can con-
a better estimate of the average costs of health- tinue their health insurance by paying for the
care. insurance entirely by themselves, the payments are
The insurance company, though, receives a pre- expensive, and people can only extend their health
mium payment in return for assuming the insureds’ insurance for a limited period. Therefore, people
exposure to risk of loss. The premium payments for without jobs are unlikely to have adequate health
all the insureds in the group are pooled. Insurers insurance.
use actuarial data to calculate the premiums so that For some employed people, the adequacy of
the pool is sufficiently large to pay losses of the the health insurance is an issue. Some health insur-
entire group. Thus, specific to healthcare, the risk ance plans require patients or their families to pay
is the potential that a person will get sick or require 20 percent or more of the costs of their healthcare.
health services and will incur bills (costs) associ- Healthcare costs can easily be in the thousands of
ated with his or her treatment or services. The pre- dollars; 20 percent of $10,000 is $2,000—a sizable
mium payments for health insurance are calculated sum for many people. Other employees work for
4 Chapter 1

employers that do not offer health benefits. These the unit of payment, the time orientation, and the
persons must purchase their own insurance, at an degree of financial risk for the parties (Wouters,
extremely high rate, or have no health insurance. Bennett, and Leighton 1998, 3). The unit of pay-
Obtaining and retaining adequate health insurance ment can range from a payment for each service,
are problems for many U.S. workers. such as a payment for each laboratory test, to a
block payment for an entire population for a period
Compensation for Healthcare of time, such as a governmental budget transfer to
Reimbursement is the healthcare term that refers the state health department. The time orientation
to the compensation or repayment for health- is retrospective versus prospective. In retrospective
care services. Reimbursement is being repaid or payment methods, the payer learns of the costs
compensated for expenses already incurred or, as of the health services after the patient has already
in the case of healthcare, for services that have received the services. The provider also receives
already been provided. In healthcare, services are payment after the services have been provided. In
often provided before payment is made. Unlike a prospective payment method, the payments are
the car dealership, in which customers pay for preset before care is delivered. Financial risk refers
a car or arrange a loan before driving the car off back to the definition of health insurance. When the
the lot, patients walk out of the hospital treated. costs of health services are learned after the care is
Therefore, the physicians and clinics must seek to provided, the third party payer (health insurance
be paid back for services that they have already entity) is at risk. When providers must project the
provided and for expenses, such as supplies, that costs of treating patients into the future and con-
they have already incurred. These physicians, tract to provide all care for those estimated costs,
clinics, hospitals, and other healthcare organiza- the provider is at risk. Patients assume risk as they
tions and practitioners are requesting reimburse- must pay higher and higher percentages of the costs
ment for health services. as their share.
Third Party Payment
Experts in healthcare finance refer to third party Types of Healthcare
payment or third party payers. Who or what are
these parties? The first party is the patient himself
Reimbursement Methodologies
or herself or the person, such as a parent, respon- This chapter discusses the fundamental concepts
sible for the patient’s health bill. The second party in healthcare reimbursement methodologies. The
is the physician, clinic, hospital, nursing home, or chapter is organized by the two major types of
other healthcare entity rendering the care. These unit of payment: fee-for-service reimbursement
second parties are often called providers because or episode-of-care reimbursement. Also briefly
they provide healthcare. The third party is the unin- addressed are the other characteristics of health-
volved insurance company or health agency that care payment methods—time frame and risk. The
pays the physician, clinic, or other second party chapter concludes with a peek into the future of
provider for the care or services to the first party healthcare reimbursement.
(patient).
Fee-for-Service Reimbursement
Characteristics of Reimbursement
Methodologies Fee-for-service reimbursement is a healthcare
Three characteristics describe various methods of payment method in which providers receive pay-
healthcare reimbursement. These characteristics are ment for each service rendered. Fee-for-service is
 Healthcare Reimbursement Methodologies 5

a common method of calculating healthcare reim- expensive services are substituted for less expen-
bursement. sive services. Examples of fee-for-service reim-
A fee is a set amount or a set price. Fee-for- bursement are self-pay, retrospective payment, and
service means a specific payment is made for each managed care.
specific service provided (“rendered”). In the fee-
Self-Pay
for-service method, the provider of the healthcare
Self-pay is a type of fee-for-service because the
service (the second party) charges a fee for each
patients or their guarantors (responsible persons,
type of service, and the health insurance company
such as parents for children) pay a specific amount
pays each fee for a covered service. These fees or
for each service received. The patients or guaran-
prices are known as charges in healthcare. Some-
tors make such payments themselves to the pro-
times, there is little relationship between the actual
viders, such as physicians, clinics, or hospitals, that
costs to provide a service and its charge.
rendered each service. The patients or guarantors
Typically, the physician, healthcare organiza-
then seek reimbursement from their private health
tion, or other practitioner bills for each service
insurance or the governmental agency that covers
provided on a claim that lists the fees or charges
their health benefits.
for each service. The claim is sent to the third party
As previously discussed, some patients and
payer (health insurance company or health agency).
guarantors do not have health insurance. These
In healthcare, sending the claim to the third party
patients have not made advanced payments via an
payer is known as submitting a claim. Within the
insurance premium. For these individuals, self-pay
stipulations of the health insurance policy (con-
results because they lack health insurance or ben-
tract) or the governmental regulations, the third
efits under governmental health programs.
party pays the claim. The majority of U.S. physi-
In self-pay, patients pay for all the costs of their
cians use this method of billing.
healthcare themselves. Some may seek recompense
People who have health insurance that reim-
from a third party payer and others may bear the
burses on the basis of fee-for-service have the advan-
burden of the costs of their healthcare themselves.
tage of great independence. Their health insurance
A related concept is the self-insured plan.
plans allow them to make almost all health decisions
A self-insured plan is one in which the employer
about which physician to see and about which condi-
eliminates the “middle-man.” The employer admin-
tions to have treated. The patient or the provider sub-
isters its own health insurance benefits. Rather
mits a claim to the health insurance company, and, if
than shift the risk to a health insurance entity, the
the service is covered in the health insurance policy,
employer (or other entity, such as a professional
the patient or provider receives reimbursement. For
association) assumes the costs of healthcare for its
the patient, the disadvantage of fee-for service is that
employees or members and their dependents.
fee-for-service plans often have higher deductibles
or copayments than other types of health insurance, Traditional Retrospective Payment
such as managed care plans. The retrospective payment method of reimburse-
For health insurance plans, fee-for-service has ment pays providers after the services have been
the disadvantage of uncertainty. The costs of reim- rendered. Retrospective reimbursement is a type
bursing the providers are unknown because the of fee-for-service because the providers are reim-
services that patients will receive are unknown. bursed for each service rendered. Third party
Moreover, costs will increase if the providers payers reimburse providers for costs or charges
increase the fees for each service, if patients previously incurred. The reimbursement payments
receive more services than expected, and if more are based on the charges for the services provided.
6 Chapter 1

This method has historically been the traditional great uncertainty. The payers have no way of know-
method of reimbursement. ing the total charges that will be incurred and for
which they must reimburse the providers.
Fee Schedules
In a fee-for-service environment, third party pay- Managed Care Methods
ers establish a fee schedule. A fee schedule is a In managed care reimbursement methods (discussed
predetermined list of fees that the third party payer fully in Chapter 5), third party payers “manage” both
allows for payment for all healthcare services. The the costs of healthcare and the outcomes of care.
allowable fee represents the average or maximum In managed care plans, the third party payer has
amount the third party payer will reimburse provid- implemented some provisions to control the costs of
ers for the service. healthcare while maintaining quality care.
Features of Managed Care
Discounted Fee-for-Service Payments
Common features of managed care include:
To begin to control costs, the third party pay-
ers negotiated reduced fees for their members or
• Comprehensiveness
insureds. The payment method using these reduced
fees is known as discounted fee-for-service. Ver- • Coordination and planning
sions of the discounted fee-for-service payment
• Education of patients and providers
method are the UCR, the CPR, and the resource-
based relative value scale (RBRVS) (Blount and • Assessment of quality
Waters 2001, 6).
• Control of costs
UCR stands for usual, customary, and rea-
sonable. “Usual” is for usual in the provider’s Purposes of Managed Care
practice; “customary” is for customary in the The two purposes of the management or control are
community; and “reasonable” is for reasonable for to (1) reduce the costs of healthcare for which the
the situation. CPR stands for customary, prevail- third party payer must reimburse the providers and
ing, and reasonable. The UCR and the CPR were (2) ensure continuing quality of care.
methods of payment within the type of traditional Managed care payers have instituted many
retrospective payment. Both methods were based means to control the costs and quality of health-
on data from past claims. Private insurance com- care. One example of a provision is the requirement
panies used the UCR method. Medicare prior to that patients obtain prior approvals for surgeries.
the implementation of its current payment meth- Another example is a hybrid of the discounted fee-
ods employed CPR. based system in which the payer reimburses the
Established in 1992, the resource-based relative provider up to a percentage of the allowable fee
value scale (RBRVS) is a discounted fee schedule and the insured must pay the remaining percent-
that Medicare uses to reimburse physicians. The age (Koch 2002, 109). Finally, having one primary
RBRVS is a payment method that classifies health care provider to coordinate all aspects of healthcare
services based on the cost of providing physician supports the quality of healthcare by reducing frag-
services in terms of effort, practice expenses (over- mentation and enhancing integration.
head), and malpractice insurance.
Forms of Managed Care
Uncertainty for Third Party Payers There are numerous forms of managed care. These
For third party payers, the retrospective fee-for- forms include health maintenance organizations
service payment method has the disadvantage of (HMOs), exclusive provider organizations (EPOs),
 Healthcare Reimbursement Methodologies 7

point-of-service plans (POSs), and preferred pro- • For a particular health condition or illness
vider organizations (PPOs). One can imagine these
• During a period of relatively continuous
forms as a continuum of control with the HMOs
care from a provider
representing the most controlled and the PPOs rep-
resenting the least controlled.
In the episode of care, one amount is set for
Criticisms of Managed Care all the care associated with the condition or illness.
Some critics of managed care argue that managed Forms of episode-of-care reimbursement are capi-
care too severely limits the following capabilities: tation, global payment, and prospective payment.
Occasionally, an episode of care is defined as a
• Patients’ access to care and their freedom specific number of days. The federal government’s
to choose healthcare providers payment method for home care services is an
• Providers’ ability to order diagnostic tests example. The per-episode home health payment
and therapeutic procedures covers all home care services and nonroutine medi-
cal supplies delivered to the patient during a 60-day
These critics contend that administrators rather period.
than medical and health personnel are making deci- Capitated Payment Method
sions about patients’ health futures. Capitation is a method of payment for health ser-
In general, in a fee-for-service environment, vices in which the third party payer reimburses
providers are reimbursed for each service they pro- providers a fixed, per capita amount for a period.
vide. In a fee-for-service environment, the more “Per capita” means “per head” or “per person.” A
services a provider renders, the more reimburse- common phrase in capitated contracts is “per mem-
ment the provider receives. Some experts contend ber per month” (PMPM). The PMPM is the amount
that fee-for-service reimbursement inappropriately of money paid each month for each individual
inflates the costs of health care because the pay- enrolled in the health insurance plan. Capitation is
ment method rewards providers for more services, characteristic of health maintenance organizations.
whether or not these services are warranted. In capitation, the actual volume or intensity
of services provided to each patient has no effect
Episode-of-Care Reimbursement on the payment. More services do not increase the
Episode-of-care reimbursement is a healthcare payment, nor do fewer services decrease the pay-
payment method in which providers receive one ment. If the provider contracts with a third party
lump sum for all the services they provide related payer to provide services to a group of workers
to a condition or disease. In the episode-of-care for a capitated rate, the provider receives the pay-
payment method, the unit of payment is the epi- ments for each member of the group regardless of
sode, not each individual health service. Therefore, whether all the members receive the provider’s ser-
the episode-of-care payment method eliminates vices. There are no adjustments for the complexity
individual fees or charges. The episode-of-care or extent of the health services.
payment method is an attempt to correct perceived
faults in the fee-for-service reimbursement method. Example:
Thus, the episode-of-care reimbursement method Z Company has a health insurance plan for its workers
controls costs on a grand or systematic scale. and their families through Wellness Health Mainte-
An episode of care is the health services that a nance Organization (HMO). Wellness HMO has con-
patient receives: tracted with Dr. T to provide health services (care) to
8 Chapter 1

members of the Z Company group for the capitated rate The most comprehensive version of the global
of $15 per month ($15 PMPM). payment system is the total-episode-of-care. For an
Dr. T is under contract to receive $15 per month for episode of care, the total-episode-of-care payment
every member of the Z group. The members of the rate is a single price that covers costs across the
Z group total 100. Each month Dr. T receives $1,500 continuum of care, which could include all of the
($15  100 members) from Wellness HMO for the following:
Z group. Dr. T receives $1,500 whether no members
of the group see him in clinic or all the members of • Facility costs across the continuum of
the group see him in clinic. Dr. T receives $1,500 care, such as hospital, nursing home,
whether all the members receive complex care for clinic, and outpatient rehabilitation
cancer or all the members receive simple care for
preventive flu shots. • Technical and professional components of
procedures in radiology, pathology, and
The advantages of capitated payment are that the laboratory
(1) the third party payer has no uncertainty and • Physician professional fees for anesthesia,
(2) the provider has a guaranteed customer base. surgery, and consultation
The third party payer knows exactly what the costs
of healthcare for the group will be and the provid- • Home care costs
ers know that they will have a certain group of
Less comprehensive versions of the global
customers. However, for the provider, there is also
payment method exist. For example, some global
great uncertainty because the patients’ usage of
payment methods include only ambulatory costs
provider services is unknown and the complexity
or only inpatient costs. These methods are termed
and cost of the services are unknowns.
ambulatory-episode-of-care and inpatient-episode-
Global Payment Method of-care, respectively. Another less comprehensive
In the global payment method, the third party version is a global surgical package. The global
payer makes one combined payment to cover the surgical package encompasses the operation, local
services of multiple providers who are treating a or topical anesthesia, a preoperative clinic visit,
single episode of care. Thus, this payment method immediate postoperative care, and usual postop-
consolidates payments. A block grant is a fixed erative follow-up. In the special-procedure pack-
amount of money given or allocated for a specific age, all the costs associated with a diagnostic or
purpose. For example, in a block grant there is therapeutic procedure are included in the payment.
a transfer of governmental funds to cover health Examples include extracorporeal shock wave litho-
services. In the global payment method, there is no tripsy and vasectomy. An ambulatory-visit package
additional payment for higher volumes of services includes all ambulatory services, including the phy-
or more expensive or complex services. sicians’ charges, laboratory tests, x-rays, and other
Medicare’s payment system for home health ambulatory services associated with one clinic
services is an example of a global payment method. visit. The per-episode home health payment is also
Various types of home health services are con- a less comprehensive global payment rate. The
solidated into the single payment. These services single payment covers all home care services and
include all speech therapy, physical therapy, and nonroutine medical supplies that a patient receives
occupational therapy; skilled nursing visits; home during a 60-day period.
health aide visits; medical social services, and non- As can be seen, third party payers and provid-
routine medical supplies. ers have created multiple variations of the global
 Healthcare Reimbursement Methodologies 9

payment method. The multiple variations, however, historical data, third party payers and providers must
have added to the complexity of healthcare reim- consider several factors to establish per-diem rates.
bursement. These factors include costs, lengths of stay, volumes
of service, and patients’ severity of illness.
Prospective Payment Methods
Critics of the per-diem payment method con-
In the prospective payment method, payment rates
tend that the method encourages providers to
for healthcare services are established in advance
increase the number of inpatient admissions, to extend
for a specific time period. The predetermined rates
the lengths of stay, or both. These strategies would
are based on average levels of resource use for
result in increased reimbursements. Another pro-
certain types of healthcare. It is important to note
spective payment method, case-based reimburse-
that prospective payment methods are based upon
ment, corrects the flaws perceived in the per-diem
averages. On individual patients, providers can lose
payment method.
money or make money, but, over time, providers
should come out even. Payment is determined by Case-Based Payment
the resource needs of the average patient for a (a) In the case-based payment method, providers receive
set period of time or (b) given set of conditions or a fixed, preestablished payment for each case. Cases
diseases. Prospective payment methods represent- are patients, residents, or clients who receive health
ing these two situations are per-diem payment and services for a condition or disease. Third party pay-
case-based payment, respectively. ers reimburse providers for each case rather than for
Providers are paid the pre-established rates each service (fee-for-service) or per diem.
regardless of the costs they actually incur. Therefore,
prospective payment is another method in which the Example:
actual number or intensity of the services does not Two patients were hospitalized with pneumonia. One
affect a pre-established compensation. The intent of patient was hospitalized for three days and the other patient
prospective payment methods is to reduce the likeli- was hospitalized for thirty days. Each patient is a case.
hood that charges or costs will increase because limits The third party payer has established a payment rate for
cases with pneumonia. The hospital would receive two
on payments are pre-set for the future time period.
payments, exactly the same, for the two cases.
Per-Diem Payment
Per diem or per day (daily rate) is a limited type of The payment is determined by the historical
prospective payment method. The third party payer resource needs of the average patient for a given set
reimburses the provider a fixed rate for each day a of conditions or diseases. Case-based payment can
covered member is hospitalized. The Indian Health be one flat rate per case or can be multiple rates that
Service and some supplemental health insurance represent categories of cases (sets of conditions or
plans use per-diem methods. Traditionally, the per- diseases).
diem payment method has been used to reimburse An example of the case-based payment sys-
providers for inpatient hospital services. tem built on categories of cases is Medicare’s
Third party payers set the per-diem rates using method of payment for inpatient hospital services
historical data. For example, to establish an inpatient (prospective payment system; PPS). This method
per diem, the total costs for all inpatient services for of payment is based on categories of payment
a population during a period are divided by the sum called “diagnosis related groups” (DRGs). Each
of the lengths of stay in the period. To determine DRG categorizes patients who are homogeneous in
the payment, the per-diem rate is multiplied by the terms of clinical profiles and requisite resources.
number of days of hospitalization. In the absence of Thus, patients classified to the same group have
10 Chapter 1

similar diagnoses and treatments, consumption of of health services and penalizes ineffective and
resources, and lengths of stay. Each DRG has a inefficient delivery. The case-based payment rates
payment rate called a “weight.” Weights are rela- are based on averages of costs for patients within
tive to one another. Higher weights are associ- the group. Generally, costs for providers that treat
ated with groups in which patients require more patients efficiently and effectively are beneath the
resources for care and treatment. Higher resource average costs. The providers make money in this
consumption is related to higher intensity of ser- situation. On the other hand, providers that typi-
vices due to the severity of illness or the types cally exceed average costs lose money. Inefficien-
of services needed for care and treatment, such cies include duplicate laboratory work, scheduling
as expensive equipment or medications. Higher delays, and lost reports. Many healthcare organiza-
weights translate into higher payments. tions have implemented procedures to streamline
Several U.S. federal payment methods are the delivery of health services to offset inefficien-
case-based prospective payment methods. (See cies. Poor clinical diagnostic skills are an example
table 1.1 for a comparison of federal prospective of ineffectiveness. Thus, the more efficiently and
payment systems.) effectively a provider delivers care, the greater its
In summary, the relatively weighted group is operating margin will be.
the basic unit of payment. Higher relative weights Some consumer advocates have voiced con-
link to higher payment rates. cerns about episode-of-care reimbursement. These
advocates have noted that the payment method
Criticisms of Episode-of-Care Reimbursement creates incentives to substitute less expensive diag-
The impact of the case-based payment method nostic and therapeutic procedures and laboratory
is that it rewards effective and efficient delivery and radiologic tests and to delay or deny proce-

Table 1.1. Federal prospective payment systems

Site System Relative Weighted Group Abbreviation Effective Date

Ambulatory Ambulatory surgery center Ambulatory surgery center group ASC group 1980
Surgery Center (ASC) payment method

Inpatient Acute Prospective payment system Diagnosis related group DRG October 1, 1983
Care Hospital (PPS)

Skilled Nursing Skilled nursing facility Resource utilization group, version III RUG III July 1, 1998
Facility prospective payment system
(SNF PPS)

Home Health Home health prospective Home health resource group HHRG October 1, 2000
Agency payment system (HHPPS)

Outpatient Hospital Outpatient prospective payment Ambulatory payment classification group APC group October 1, 2001
Service system (OPPS)

Inpatient Inpatient rehabilitation facility Case mix group CMG January 1, 2002
Rehabilitation prospective payment system
Facility (IRF PPS)

Long Term Care Long term care hospital Diagnosis related group DRG October 1, 2002
Hospital prospective payment system
(LTCH PPS)
 Healthcare Reimbursement Methodologies 11

dures and treatments. Healthcare analysts, on the Physician Care Groups

other hand, point out the savings associated with
Physician care groups (PCGs) is a prospective
eliminating wasteful or unnecessary procedures
payment method for physician services in ambula-
and tests and that volume and expense do not nec-
tory settings. This method classifies patients into
essarily define quality.
similar, homogenous categories (groups). PCGs
are visit-based and classify services according to
Check Your Understanding 1.1
clinical similarity and setting (Averill et al. 1999).
1. Insurers pool premium payments for all the
Proponents of the PCG payment method empha-
insureds in a group, then use actuarial data to cal-
culate the group’s premiums so that:
size that the basis of payment is the purpose of the
visit, necessitating clear definition of the patient’s
a. Premium payments are lowered for insurance
plan payers problem (Averill et al. 1999). The various ambula-
b. The pool is large enough to pay losses of the tory settings included in this payment method are
entire group “physician offices, hospital outpatient departments,
c. Accounting for the group’s plan is simplified hospital emergency rooms, ambulatory surgical
d. All of the above are reasons for using the data centers, community mental health centers, compre-
hensive outpatient rehabilitation facilities, state or
2. Where and when did health insurance become local public health facilities, and rural health clin-
established in the U.S.? ics” (Averill et al. 1999, 4).
3. All of the following are types of episode-of-care The payment method accounts for resource use
reimbursement except: in terms of (1) physician’s (professional) services,
a. Global payment (2) technical services (equipment and technicians),
b. Prospective payment (3) interpretation (by the same physician or another
c. Capitation physician), (4) facility overhead, and (5) ancillary
d. Self-insured plan services (laboratory tests) (Averill et al. 1999, 4–5).
It is important to note the payment method also
4. What discounted fee schedule does Medicare use
accounts for differences in resource use across
to reimburse physicians?
ambulatory settings. Averill and colleagues explain
5. Name and describe some versions of the global that settings vary in terms of consuming the five
payment method. components (1999, 4–5).

Future of Healthcare Example:

Reimbursement Methodologies Patient A is seen in a hospital outpatient department for
pneumonia. The hospital bills the third party payer for
The prospective payment system (PPS) for inpa- the facility overhead, technical services, interpretation,
tient hospital services that Medicare implemented and ancillary services. The PCG for the physician’s ser-
in 1983 proved to be very successful. Based on that vices include only the physician’s professional services.
success, many future healthcare reimbursement However, if the same physician sees Patient A in her
methodologies are refinements and derivations clinic instead of the hospital outpatient department, the
of the PPS. This section addresses three of these PCG needs to account for resources for all five compo-
future payment methods: physician care groups, nents (physician’s services, technical services, interpre-
tation, facility overhead, and ancillary services; Averill
refinements in case-based payment methods, and
et al. 1999, 4–5).
clinical risk groups.
12 Chapter 1

The PCGs simplify payments to physicians addition, groups were created for patients with the
for ambulatory services because there are about following conditions or diseases: human immuno-
400 PCGs compared to the more than 4,000 types deficiency virus (HIV), cystic fibrosis, nutritional
of health services in the RBRVS payment method disorders, acute leukemia, hemophilia, and sickle
(Averill et al. 1999, 12). Each PCG has a predeter- cell anemia. Some Medicaid programs and Blue
mined relative weight. For ambulatory services, it is Cross plans adopted AP-DRGs. The Centers for
envisioned that PCG payment method could replace Medicare and Medicaid Services (CMS) also later
the federal government’s RBRVS payment method. modified and adopted some of these refinements
(Averill et al. 2002) for the inpatient PPS.
Refined Case-Based Payment
All-Patient Refined Diagnosis Related Groups
Refined case-based payment methods enhance
In the mid-1990s, continuing research and refine-
case-based payment methods to include patients
ment by the 3M HIS team resulted in all-patient
from all age groups and from regions of the world
refined DRGs (APR-DRGs). The refinement is the
with varying mixes of diseases and differing pat-
inclusion of adjustments for severity of illness and
terns of healthcare delivery. In the U.S., projects
risk of mortality. These adjustments result in 1,422
investigated means to enhance the inpatient PPS,
APR-DRGs. The classification method allows
the diagnosis related groups (DRGs). In its enhanced
accurate comparisons of patients in terms of length
versions, the payment system is applicable to all
of stay, resource consumption, and outcomes.
types of patients, not the mostly elderly patients as
“Through APR-DRGs, hospitals, consumers, pay-
covered by the DRGs. For international use,
ers, and regulators can gain an understanding of the
researchers created a classification method that,
patients being treated, the costs incurred, and within
independent of coding system, measured patients’
reasonable limits, the outcomes expected” (Averill
severity of illness and consumption of resources
et al. 2002, 50). Developers of the classification
(Mullin et al. 2002).
system suggest that, through APR-DRGs, organiza-
Pediatric Modified Diagnosis Related Groups tional leaders can increase organizational efficiency
In the mid-1980s, the National Association of and effectiveness as well as quality of care.
Children’s Hospitals and Related Institutions
International Refined Diagnosis
developed pediatric modified diagnosis related
Related Groups
groups (PM-DRGs). This classification had clas-
At the global level, the 3M HIS researchers devel-
sifications for neonates and pediatric patients
oped a classification system that could be used
(Averill et al. 2002, 46).
within countries to describe patients’ resource use
All-Patient Diagnosis Related Groups and around the world to compare patients from
In the late 1980s, the New York State Health one country to another (Mullin et al. 2002, 1). The
Department contracted with researchers at 3M international refined DRGs (IR-DRGs) are an inpa-
Health Information Systems (3M HIS) to develop a tient classification system designed specifically to
DRG payment method for non-Medicare patients. become the basis for payment, “budgeting, outcomes
Including the PM-DRGs, the researchers devel- analysis, benchmarking, profiling, and utilization
oped the all-patient DRGs (AP-DRGs; Averill et assessment” of international healthcare (Mullin et al.
al. 2002). AP-DRGs included classifications for 2002, 3). There are 939 IR-DRGs reflecting severity
neonatal patients, pediatric patients, high-risk obstet- of illness and resource consumption. The classifica-
rical patients, multiple trauma patients, organ trans- tion system provides healthcare decision makers
plant patients, and ventilator-dependent patients. In with “a means of making relative comparisons of
 Healthcare Reimbursement Methodologies 13

the resources patients consume and their associated The 1,075 CRGs are not distributed evenly
clinical courses” (Mullin et al. 2002, 2). across the nine statuses. The status with the fewest
CRGs is “Healthy” with one; the status with the
Clinical Risk Groups most CRGs is “Single dominant or moderate chronic
The methodology of clinical risk groups (CRGs) is disease” with 398. Within these statuses, the severity-
a prospective payment system that predicts future of illness level can range from none (healthy) to 6
healthcare expenditures. It is a capitated payment (catastrophically ill) (Averill et al. 2001, table 1.1).
system for healthcare services for populations According to Averill, “The severity level describes
(Averill et al. 2001, 8). Its developers state that the extent and progression of the disease. A high
the methodology is a means to administer clinical level of severity is indicative of a high degree of
pathways, product line management, and case man- treatment difficulty and a need for substantial future
agement (Averill et al. 2001). medical care” (Averill et al. 2001, 6).
The payment method adjusts for risk and sup- Research has supported the ability of CRGs to
ports the clinical management of patients (Averill identify patients who will require interaction with
et al. 2001). CRGs classify patients into catego- the health care system (Neff et al., 2002; 2004).
ries that account for the severity of the patient’s Neff et al. found that CRGs were a useful tool to
illness or condition and that predict the costs of identify, classify, and stratify children with chronic
future medical care, debility, or death (Averill et al. health conditions. Thus, CRGs were found to sup-
2001). To predict future healthcare expenditures, port patient tracking, case management, utilization,
CRGs are assigned prior to health services being and cost prediction (Neff et al., 2002; 2004).
rendered. Moreover, CRGs predict costs for “an To facilitate decision making, the CRGs can
extended period of time” (Averill et al. 2001, 2). be collapsed into three hierarchical tiers of aggre-
CRGs include all age groups and cover the gate groups. Each tier of aggregate clinical risk
continuum of care. There are 1,075 CRGs (Averill groups (ACRGs) has fewer groups and less clinical
et al. 2001, 8). These 1,075 CRGs are organized precision. Thus, ACRG1 has the greatest number
into the following nine statuses: of CRGs, with 413, and ACRG3 the fewest, with
37 (Averill et al. 2001, 8). However, each tier of
• Catastrophic conditions aggregation maintains clinical meaningfulness and
severity levels. Thus, the classification system sup-
• Dominant and metastatic malignancies
ports the various levels of detail needed by payers
• Dominant chronic disease in three or more and providers (Averill et al. 2001).
organ systems The payment weights are calculated based on
two years of historical data. The first year’s data
• Significant chronic disease in multiple
serves to classify the patient into a CRG. Aver-
organ systems
ages of the second year’s data are computed to set
• Single dominant or moderate chronic disease the weights of the CRGs. The second year’s data
predicts healthcare expenditures for patients in
• Minor chronic disease in multiple organ
the CRG (Averill et al. 2001, 9). Higher weights
systems
correspond to higher severity levels. As a pay-
• Single minor chronic disease ment method, CRGs predict future consumption of
healthcare resources. Their clinical precision and
• History of significant acute disease
meaningfulness enable them to be used to manage
• Healthy care and their categorical nature serves as a means
14 Chapter 1

of reporting and communication. Finally, research 7. Describe the major benefits of episode-of-care
has demonstrated that CRGs are able to predict reimbursement according to its advocates and the
payments comparable to other risk adjustment sys- major concerns about episode-of-care reimburse-
tems (Hughes et al. 2004). ment expressed by its critics.

8. How does the payment method used by physician

Summary care groups (PCGs) account for resources used in
patient care?
The U.S. healthcare system is complex, partially
because health insurance and employment are 9. In the episode-of-care reimbursement approach,
closely linked. Multiple methods exist to reimburse providers are reimbursed a lump sum for all
provided services related to a patient’s condition
hospitals, physicians, and other health providers for
or disease. True or false?
the healthcare they render patients. Because recom-
pense occurs after the healthcare has been provided, 10. How do clinical risk groups (CRGs) manage
the term used is reimbursement. Two major types of healthcare costs?
payment methodologies—fee-for-service reimburse-
ment and episode-of-care reimbursement—are based References and Bibliography
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teristics of healthcare payment methods are time D. E. Gannon, B. V. Shafir, and L. W. Gregg. 1999. The
development of a prospective payment system for ambulatory
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1. Who are the first, second, and third parties in
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 Healthcare Reimbursement Methodologies 15

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