By Ken Peach, FACHE, HFMA Member

Back in Marketing 101, the instructor taught us about product life cycles. A new product is designed and introduced to the market. Demand builds. Sales increase. The product matures. Eventually, demand drops until a new product replaces the old one.

Today, hospitals are experiencing the beginning of a transition from the wholesale purchase of health care services by insurance companies for their members, to the retail purchase by individual patients.

Philip Kotler, author of Marketing Management, describes wholesaling as including all activities involved in selling services to those who buy for resale or business use. For hospitals,, this has been the case with health insurance and managed care. (Kotler, p. 549)

Retailing, on the other hand, includes all the activities involved in selling services directly to final consumers for their personal, non-business use. (Kotler, p. 535))

Historically, the U.S. healthcare system has provided services essentially on a wholesale basis. Consumers are now on track to take more control of and responsibility for their provider and for the price paid for services. As a result, the hospital will now be providing services directly to the consumer in a retail model. (Honaman, p. 49)

A number of factors are driving this significant change in how consumers purchase health care services.

Consumer Driven Health Plans (CDHP)

With significantly rising health care costs, employers have been seeking a way to cap their exposure to the common defined benefit health plans they offer to employees. Within the past few years, an increasing number of employers have taken advantage of legislation approving defined contribution plans. These plans limit financial exposure for rising health care insurance premiums by giving the employees “skin in the game”.

So far, it seems to be working. CDHP premiums rose 3.4% on average in late 2004 and early 2005, compared with 9.6% for all plans. So while only 2.6% of employers currently offer CDHPs, a much larger percentage have indicated they are considering doing so next year. (D’Cruz, ANI) Current estimates show there are more than three million enrollees in high-deductible health plans with health savings accounts (HFMA Roundtable, HSA, p. 73)

This increasing popularity for consumer driven health plans brings with it a need for employees to understand how these plans work versus the defined benefit plans offered in the past by their employer.

“In an era in which patients are being asked to pay a larger portion of their medical costs, transparency in prices and policies is vital to patients’ ability to make informed choices about their health care” (DelPo, p. 5) As a result, patients are seeing for the first time the impact of their health care decisions on their purse or wallet. “In the old world, HMOs were trying to eliminate explanations of benefits, and patients never saw prices. But now, patients in consumer-driven health plans see those EOBs and prices. It’s become a consumer issue.” (HFMA Roundtable, Strategy, p. 6)

Fewer people have health insurance

There is another reason for the move toward retail pricing. As outlined in the HFMA paper Today’s Charity Care Challenges, What Should You Be Doing, approximately 45 million Americans lack health insurance coverage, and that number is expected to grow. As a result, more patients arriving at the hospital doors for care face buying their health care with insufficient funds to pay for it. “Rising insurance premiums are forcing many small businesses to reduce or stop offering coverage.” (HFMA, Charity, p. 1) Legacy companies are seeking federal approval to modify or drop health care coverage for their retirees. Each of these health care buyers has lost the benefit of purchasing care through a wholesale provider, and as a result, is now a retail buyer at your hospital.

The economic downturn with resulting job reductions is also expected to increase the number of individuals without health insurance these next few years.

Fewer employees are buying health insurance

Just as the increase in health insurance premiums is leading some companies to stop purchasing health insurance coverage for their employees, fewer employees are electing to participate in employer health plans. “Because of these increased premiums, other employers are asking workers to pay a greater portion of the cost, meaning more employees are likely to opt out of coverage even when it is available” (HFMA Charity, p. 1)

We’re Experiencing Radical Change

Any time a product or service nears the end of its product life cycle, turmoil occurs. Many product customers refuse to give up the use of the product with which they have become comfortable. At the same time, with lowered demand, the manufacturer is eager to build sales for the replacement product. Moving from traditional health insurance and managed care to CDHP is a gut wrenching experience. It demands significant change on the part of the hospital as the customer becomes each individual patient rather than a large payer.

In its latest Consumerism in Health Care report, the Healthcare Financial Management Association writes “Healthcare financial services will need to become more patient-centric in focus. This means coming up with new ways to identify and address patient needs, learning how to communicate with patients as partners, and incorporating such patient-friendly concepts as pricing transparency, point-of-service payment, and simplified charge structures.” (HFMA, Consumerism, p. 3)

What Consumers Want to Know

For years, a clothing store in the northeast advertised “An educated consumer is our best customer”. Just as hospitals are experiencing major change, employees who could use health care coverage purchased by their employer must suddenly learn to make choices that simply were not there before. This requires that they understand what their new plan covers, how to use it, and how to make wise decisions.

Information needs differ by type of health insurance coverage

Depending on the type of insurance someone has, what information they need to make an educated decision will differ.
Traditional insurance – likely to want information about wheat their personal out-of-pocket cost will be
HMO insurance – simply likely to be concerned only about using a network provider as they face no additional cost for care beyond their premium, deductible and co-payment
High-deductible or Health Savings Account (HAS) insurance – since most hospital admissions will cost in excess of the typical HSA deductible of $2,500, information will likely be most important for physician and ambulatory care - not hospital care
Uninsured – need to know what percentage of their bill they may be responsible for, depending on whether they qualify for state insurance programs, free care provided by the hospital, or other financial assistance.

Information in a standard format

Consumers also want to be able to make comparisons between hospitals based on prices for a defined market basket. That capability must be offered, but recent studies show it is not yet in place. “Among the hospitals, there was very little consistency in the prices given to the mystery shoppers. Some prices were estimates, while others were more firm; some prices were discounted, while others were quoted as published charges with a percentage of discount noted.” (DelPo, p. 8)

How Hospitals Are Adapting To Retail

Prices must reflect actual costs

Years of selling bed capacity to insurance companies has resulted in a charge structure that encourages discounting to achieve the same bottom line. This has contributed to the public view that hospitals are way overpriced while in reality very few health plans actually pay the billed charges.

Hospitals will be under increasing pressure to defend billing practices that have resulted in the growth of the average ratio of charges to payment received from 1.1 to 2.6 over the last 25 years. There is an urgent need for hospitals to stop charging the uninsured the highest prices, a move that may result in hospitals dropping “fictional charges” and replacing them with prices that reflect actual costs. (HFMA News, March 6, 2006))

Speaking recently in Orlando, Dr. William O. Cleverley, President, Cleverley & Associates, defined what he called the best approach to pricing –“Here are our costs. Here is what we need. Pay this.” (Cleverley, Developing, ANI))

This sentiment was echoed by Joseph F. Corfits, Jr., CFO of Iowa Health-Des Moines, who said recently “We ask our hospitals without a cost-accounting system to look at the direct costs of each department – right off of their general ledger –and apply an overhead component that is generally based on the Medicare cost-to-charge ratio.” (HFMA, Strategy, p. 3)

Returning to cost based negotiations with managed care will eliminate the need to mark up charges simply to negotiate them back down. In turn, the self-pay issue of overcharging patients without insurance becomes mute when prices are based on covering costs with the same overhead component billed to all.

Written estimate policies are being implemented

Another recommendation in this new retail environment is to improve the capability of providing patients with advance price quotes. “Leading provider organizations are beginning to offer true price transparency by providing the consumer with an estimate of the final amount of payment expected from an episode of care” says Richard L. Clarke, President and CEO of HFMA (Clarke, p.170). Since most retail buying will be done before the high deductible insurance policy kicks in, the greatest need for written estimates occurs in outpatient services. Fortunately, that is where it is easiest to generate these estimates based on what is being purchased rather than the inpatient setting with its many variables on what is or is not included in a service.

Using benchmarking to bring prices into line

While more a pricing strategy than a retail consumer approach, analyzing market prices using CMS and other data to create a credible market basket will be important so pricing for a particular hospital is not way out of line with other facilities in the market (HFMA, Making, p. 3) Part of the reason for defining a consistent reporting standard is to offer consumers the opportunity to compare apples to apples when examining prices set by different organizations. For that reason, benchmarking is important to consumers as well as to hospitals.

Working with payers and employers to educate employees

Since the consumer will be making so many more decisions regarding how to spend his or her health care dollar, more knowledge is required. “Encourage insurers and employers to fully educate enrollees on their coverage choices, the benefits they will receive, and what they should expect to pay personally for health care services. (Consumerism, p. 9) Indeed, employees should have multiple ways to obtain billing and payment information: through patient education brochures, media, on-the-phone, in person and on-line. (Consumerism, p. 13) Just as in the retail store business, the easier you make it to shop the more likely it is that a patient will choose your hospital if you create additional value by teaching that individual how to access the services your hospital provides.

Replacing across the board price increases

Holding down pricing offers a hospital two benefits with one possible drawback. With lower prices, your hospital becomes more attractive to patients with consumer driven health plans or significant deductibles. Lower prices also enable your hospital to market to local employers who may well view your facility as doing all it can to hold down health care costs. On the other hand, holding down prices can jeopardize your hospital’s financial health if you don’t make up for those low prices somewhere else. Commonly, hospitals will provide an across-the-board adjustment that forces all prices up even when that is not necessary. In fact, when compared to the so-called “across the board” increase, “our experience in pricing studies suggests that selective price increase strategies are more effective” said Cleverley .(Cleverley, Effective, p. 3) Across the board increases also upset the inherent differences you may have built in to account for statistically under priced or over priced items. “There are only a limited number of times that hospitals can do that before their charge master isn’t defensible anymore” says James D. Beck, former CFO at All Saints Healthcare, Racine, Wisconsin. (HFMA Strategy, p. 2)

If at all possible, avoid implementing across the board increases and make these changes:

Adjust pricing to achieve ROI

Public utilities use a standard ROI formula to avoid excessive pricing: ROI = (volume x price) – (volume x cost), all divided by investment. The test for reasonableness for utility customers is to be able to answer “no” to these three questions based on the formula: Is ROI excessive? Is investment excessive? Is cost excessive? (Cleverley, Developing) As a step toward being able to talk about and defend pricing decisions to your patients, use the utility model ROI formula as yet another reason that your prices are appropriate given your production costs and major capital investments in providing for their care.

Clarifying that hospital pricing doesn’t cover everything

As demand increases for sharing hospital prices with your patients and the public at large, it is crucial to explain to consumers that unlike other products they may be familiar with, a hospital’s prices can’t yet reflect important information from other key players like the price of physician care while in the hospital or how much of the bill a patient’s insurance company may cover. Clarify for your patients and consumers calling for price information what is and is not included so they can make an educated choice when selecting a hospital provider.

Providing information for patients

Consumers who are suddenly called upon to make decisions regarding where to seek care and what will be their responsibility require a lot of information. “The key challenge is educating the public; however, because people think what gets paid is the cost.” says Arden Jean Biggar, VP, Revenue Cycle, The Methodist Hospital, Houston. “They don’t understand the charges; they don’t understand the implications of the cost and the price, if you will.” As a result, having educated team members who can spend time with patients will be important. “We need to have people in scheduling and registration equipped with the skills to quote prices and the judgment to negotiate discounts” says Jon M. Foster, CEO, St. David’s HealthCare System, Austin, Texas. “Front end staff have not been expected to discuss financial expectations with patients and may need to upgrade their customer service, financial, and technical skills to do so.” (Consumerism, p. 7)

HCA hospitals in many markets are now posting selected prices on line to help consumers make comparisons. St. Luke’s Health System in Kansas City encourages consumers to call the hospital to obtain price quotes that are confirmed later in writing for most outpatient and frequently requested inpatient procedures as well. Depending on what insurance coverage the patient has, the hospital can tell them what is included and excluded. (Cirillo, p. 1)

A California hospital survey shows that many hospitals in that state are at least on the right track. “A few of the hospitals had a designated person or department that could handle pricing and self-pay patient questions, but the shoppers were not always referred to the right place.” (DelPo, p. 8)

Technology may play a role here. “It may also help for hospitals to develop more formal, automated systems to aid employees in finding pricing information” (DelPo, p. 10) That same California study revealed a need for clearer signage, brochures, and other communications specifically aimed at uninsured patients. “Written notices communicating financial assistance are often inadequate or inaccessible” says the study (DelPo, p. 9)

Improving internal ability to accept cash up front

Operating in a wholesale environment rather than the new retail one hospitals have been experiencing lately has taught finance teams to focus on negotiation skills and contesting managed care payments rather than how to request payment up front from the patient.. Many hospitals don’t currently have the technology necessary to support high levels of up-front collections. More attention will need to be placed on up-front collections in the retail environment.

Hospital Experiences

There are a number of hospitals that are well along on the retail versus wholesale approach to patients. Much can be learned by how they have changed their practices to accommodate existing wholesale managed care contracts while preparing for a retail onslaught.

MedCentral Health System, Mansfield, Ohio

“The way we have counteracted pricing concerns is by having one of the lowest charge structures in the state. So I can very easily stand in front of my community and say that our charges are defensible.” (HFMA, Strategy, p.6) A study recently published the markup percentage from cost of charges in 155 Ohio hospitals. The study looked at twelve DRGs. MedCentral service markups were well below the median markup for the state.

Saint Vincent Health System, Erie, PA

Former CFO Douglas Myers says” We actually wanted to lower our prices without affecting our net revenue too much – a kind of rate minimization. With help from an outside consultant, we looked at all of our chargeable items and determined which were impacted by prices and which were not.” (HFMA, Strategy, p. 10)

Alegent Health, Omaha, Nebraska

With the belief that a hospital system should drive change instead of receiving it, Alegent Health has rolled out a consumer-directed health option to all of its 8,400 employees at the nine system hospitals in Nebraska and Iowa. When employees were offered the new option, 79 percent selected the new consumer plan. Alegent CEO Wayne Sensor says it is too early to determine the full impact of the new plan on employee health and the increase in healthcare spending, but “he’s more encouraged by what the experiment could mean for Alegent’s business, which is increasingly likely to shift toward a consumer-directed future.”

Community Hospitals of Williams County, Ohio

Community Hospitals has been using a unique pricing strategy for years. CFO Leroy Feather says his hospitals license a patented software system that applies price indexes to mark up, down or to simply pass the unit price listed on the charge master. Contractuals are reduced and cash collections increased. There is no need or expense to optimize the charge master annually. In addition, Community is able to create its annual revenue budget in just 24 hours. Since the price indexes allow focused pricing adjustments, there is no need to implement across-the-board rate increases. “This system takes the guess work out of setting prices” said Feather.

Why Adopt a Retail Focus Now

Avoid legislation

At least eight states have state laws requiring hospitals make their charge masters available for public viewing (HFMA, Strategy, p. 2) Other states are considering similar legislation, even though the charge master information is not what consumers are requesting to help them make decisions.

“In March, national lawmakers concentrated their gaze on health care pricing.” (HFM, May, 2006, p. 18) “I haven’t seen the changes I ought to see (from hospitals). But if I don’t see it very, very soon, we’ll probably be doing some legislating in that area” said U.S. Senator Charles Grassley (R-Iowa) interviewed on the CBS program “60 Minutes” on March 5, 2006 (HFMA News, March 6, 2006))

Your hospital can be proactive in this arena provided you implement a retail pricing strategy now to allow you time to train, equip and prepare your organization.

Public disclosure

In addition to hospitals, some hospital associations are already sharing pricing information for their members. Wisconsin Hospital Association uses a public website (www.wirpicepoint.org) to publish average charge information by DRG by hospital (HFMA Strategy, p. 11) Medicare will also share pricing information for their recipients. “Medicare’s website www.medicare.gov will begin posting the prices it pays for the most common elective surgical procedures” (Wessel, p. 1)

Ready or not retail is on the way

No one can predict the best time to move from one product life cycle to another. The rising demand for retail pricing and consumer education may well develop rapidly or take some time. But one thing is for certain - it’s already here.

“We are entering a time when progressive hospitals will realize the emergence of the customer and the diminishment of the charge master – as the winds of market change prompt the need for a new managerial model and approach” says Preston Gee, Senior Managing Director, Phase 2 Consulting, Austin, Texas. “The rapidly emerging trend toward transparent pricing (market pricing) synchronizes appropriately with the IPPS initiative to step back and evaluate the entire pricing configuration.” (Gee, p. 5)

In markets as far apart as Miami, Florida and Tucson, Arizona, patients are actively shopping hospital prices for certain procedures to get the best deal. “It’s happening at least once a week” at University Medical Center, Tucson, Arizona according to CFO Kevin Burns. Prepare now and your hospital can “catch the wave” to the new product life cycle and retail success.

Ken Peach, FACHE, is Vice President of Quest Health Enterprises. He lives in Orlando and can be reached at 888-432-0693 or krpeach@juno.com.

References:

• Betbeze, Philip, Consumerism Litmus Test, HealthLeaders, September, 2006.
• Cirillo, Anthony, Price Packaging and Price Transparency: 4 Things to Do Before the Government Mandates and the Consumer Demands, HealthLeaders News, June, 2006.
• Clarke, Richard L., What is Price Transparency? HFM, April, 2006.
  Cleverley, William O., Developing Justifiable Pricing Methods, ANI presentation, June 17-21, 2006, Orlando, Florida.
• Cleverley, William O., Effective Hospital Pricing Strategy, Cleverley & Associates, Worthington, OH, 2003.
• D’Cruz, Martin and Welter, Terri, Top Commercial Reimbursement Trends for 2006, ANI presentation, June 17-21, 2006, Orlando, Florida.
• DelPo, Amy, Price Check: The Mystery of Hospital Pricing, California Healthcare Foundation, December, 2005.
• Gee, Preston, Paradigm Lost: The Strategic Impact of Revised DRG Payments, HealthLeaders News, July 13, 2006.
• HFMA, Consumerism in Health Care, Summer, 2006.
• HFMA, Making Prices Make Sense: A Balanced Approach to Defensible Prices, July, 2005.
• HFMA News, “60 Minutes” Report Describes How Hospitals Bill the Uninsured, March 6, 2006, http://hfma.typepad.com/news/2006/03/60_minutes_repo.html
• HFMA News, Study Calls for Hospitals to Ste Pricing Reflecting Actual Costs, March 6, 2006, http://hfma.typepad.com/news/2006/03/study_calls_for.html
• HFMA Roundtable, Health Savings Accounts: Are Your Prepared?, HFM, December, 2006.
• HFMA Roundtable, A Strategy for Defensible Prices, HFM, May, 2005.
• HFMA, Today’s Charity Care Challenges: What Should You Be Doing?, October, 2005.
• Honaman, J. Craig, Going Retail, Healthcare Executive, November / December, 2006.
• Kotler, Philip, Marketing Management, Analysis, Planning, Implementation and Control, Prentice Hall, Inc., Englewood Cliffs, NJ, 1991, p. 549.
• Wessel, Harry, Medicare to Post Prices on Website, The Orlando Sentinel, Orlando, FL, April 4, 2006.
• a. (White Paper: 15+1 Ways To Grow Your Hospital Business