Hospital spending accounts for a disproportionate portion of health care expenditures in the United States and hospitals will continue to be under constant pressure to improve efficiency with increasingly limited resources. Understanding the flow of money in health care has become an integral part of medicine. As health care reform reshapes a competitive environment, hospitals, hospitalist leaders, and practitioners need a common language and framework as they navigate hospital operations, set budgets for their employees, and achieve financial success. Hospitalists and hospitalist medical directors must be fiscally savvy in order to survive the challenging world of health care. Although a hospital administrator carries out much of the detailed analysis, the hospitalist medical director is responsible for the operation of the practice, which includes managing the Hospital Medicine’s group budget. Beyond billing, the director should be informed of the status of all other revenue resources, including capitated payments, stipends, and other monies.

This chapter will introduce readers to commonly used hospital financial terminology and theory so that they may more effectively communicate with hospital administrators and develop a strategic plan for their practices. This chapter will present the topic of finance in health care in three sections: (1) health care payment schedules, (2) health insurance models, and (3) health care finance. Although the technical aspects of finance can be daunting, this chapter will provide a general overview for understanding reimbursement methods, insurance company models, and revenue maximization techniques.

How Medicare, Medicaid, and insurance companies reimburse hospitals influence cash flow, income statements, and budgeting. Below are some of the generally accepted payment methods in the health care industry.

Capitation

Under this type of payment system a health care provider is paid a fixed payment per member covered for a fixed period of time regardless of service utilization. For example, insurance company X will pay Dr. A $200 per member enrolled in insurance company X per month regardless of whether Dr. A sees the patient or not. In this payment method, the doctor must cover all costs associated with delivering health care in his office or health care setting including laboratory tests, imaging, and office visits. This payer schedule effectively shifts financial risk to the provider. The downside of this system is that risk is shifted to the provider. If the patient mix provided by the insurance company happens to require extensive medical resources during a specific period, all costs that supersede the lump-sum cash provided by the insurer must be paid out-of-pocket by the provider. The upside is the potential for profiting if a provider can make cost effective medical decisions to optimize medical care because all leftover cash from the lump sum payment is retained as profit.

Fee‐for-Service

Under this type of payment system, insurers reimburse a set fee for each service rendered. Typically, the reimbursement is a set percentage of the actual cost, which is a prenegotiated rate. Under this payment schedule, the provider is free to make medical decisions without having to consider costs. The financial risk is primarily assumed by the insurer. The downside of this system is there is no incentive to reduce health care costs by the provider. As a result, premiums for this type of insurance are typically much higher. The upside is the provider takes no financial risk in taking care of these patients.

Prospective Payment System (PPS)

Originally developed by the government to help incentivize health care cost control and increase health care delivery efficiencies, this system of reimbursement gives a fixed, predetermined amount for various services. Unlike the capitation system, which provides a fixed amount per patient covered, the PPS reimburses a fixed sum for specific services. This fixed sum is derived from a classification system set forth by the government that varies depending on the health care setting. For example, Medicare will reimburse hospitals a fixed sum for each patient based on a diagnosis-related group (DRG). Therefore, if a patient is admitted for “community acquired pneumonia,” Medicare will reimburse the hospital X dollars based on the DRG scale regardless of the length of stay (LOS). This method has since been adopted by some insurance companies as well.

In the United States today there are four main types of health insurers: Medicare, Medicaid, Health Maintenance Organizations (HMOs), and Preferred Provider Organizations (PPOs).

Medicare

President Lynden B. Johnson established Medicare in 1965 as part of the Social Security Act. It was originally designed as a government entitlement that provided health care for U.S. citizens age 65 and older who met defined criteria. Since then, Medicare has expanded to cover specific congenital or permanent disabilities. The details of eligibility, benefits, and premiums are beyond the scope of this chapter; however, it should be noted that there are four parts to Medicare. Each part has an optional enrollment and varies in copayments as follows:

• Part A: Covers all inpatient hospital stays.
  
• Part B: Covers services and products not covered by Part A. These typically include outpatient health care including imaging, laboratory tests, and durable medical equipment.
  
• Part C: Allows beneficiaries to select a private health insurance to supplement their Medicare insurance. Through this program, Medicare pays a capitated fee to the private insurance companies, who then provide expanded medical coverage to the enrollee (ie skilled nursing facilities, prescription drugs, etc.). In return however, the enrollee is usually limited to certain providers with whom the insurance company contracts. Furthermore, not all insurance companies provide the same supplemental benefits and therefore have different premiums.
  
• Part D: Offers prescription drug coverage. Implemented in 2006, anyone enrolled in Parts A and B may sign up for Part D.

It is important to note that Medicare reimbursement schedules are different for the various parts. Part A is a PPS while Part B is based on a complex formula that includes relative value units (discussed in more detail later), geography, and inflation. Regardless of the reimbursement method, Medicare sets the standard within the health care industry annually. All insurance companies look to Medicare reimbursement schedules to negotiate their own reimbursement schedules with providers. This is why Medicare cuts in reimbursements over the past 10 years have had such a profound effect on finance within the health care industry. The delicate balance of controlling costs while adequately reimbursing for health care services is a constant struggle within the United States.

Medicaid

Created in 1965 alongside Medicare, Medicaid is a means-tested, needs-based social welfare program. As opposed to Medicare, Medicaid is governed by individual states and funding is shared by both the state and federal governments. Most states have different rules and regulations governing the reimbursement schedules. Some states outsource the insurance to private companies under a capitation system.

HMO

HMOs are a type of managed care organization structured to emphasize primary care. The goal is to make every enrollee visit a primary care physician (PCP) on a regular basis in an effort to minimize the emergent issues that arise with undiagnosed, untreated, chronic medical problems. “Gatekeepers” have traditionally been associated with HMOs and refers to the PCP’s role as the referral center for specialized care. Enrollees are not covered for any care given outside an emergent situation without preapproval or referral from their PCP. In theory this minimizes overutilization of highly expensive resources and maintains affordable premiums.

PPO

PPOs are also a type of managed care organization structured in a similar fashion to HMOs except that PCP referrals are not required in order to visit a specialist. PPOs have contracts with PCPs and specialists with whom an enrollee can schedule an appointment at any time at discounted rates. This allows greater flexibility in the enrollee’s choice and ability to obtain second opinions. However, these insurance companies typically charge higher premiums and still require preapproval for any nonemergent hospitalization or procedures.

Health care finance can be broken up a number of ways, but the following is a description of the key aspects of financial reporting, utilization review, and productivity management. This section should lay the groundwork for understanding the financial goals of both hospitals and hospitalist groups.