Lesson 5 - Financing

U.S. Health Care Delivery
Financing & Reimbursement
• Learn about U.S. health care financing
• Identify different payers for health care
– Private insurance
– Public insurance
– Employers
– Citizens
• Discuss insurance, reimbursement methods,
and their effects on health care
U.S. Health Care Financing
• Financing: includes two functions
– Payment for delivery of services
– Purchase of health insurance
• U.S. health care delivery financing is very
– Health insurance is the most common avenue for
receiving care
• Health care financing through various public
and private sources ultimately aggregates into
national health care expenditures
Who Pays for Health Care?
• Employers? The U.S. Government?
– Employers and the government are the primary
financiers of health care in the U.S.
– Private and government insurance plans pay the bulk
of health care costs
• Patients? American Citizens?
– Patients often directly pay a relatively small portion of
the costs of services received
– Americans indirectly finance health care through
employment and taxes
• Payment to providers of care is handled in
numerous ways
An Illustration of Financing
The Sandwich Guy
I’ve started a sandwich shop!
My sandwiches cost me
$4.50 to make on average
I’ll charge $5 for each sandwich
to cover my costs and wages
You Guys Are In the Mood
For a Great Sandwich!
Everything is going okay…
Folks are buying sandwiches, and I’m making
50₵ on each sandwich
But things could be better…
Some of you don’t have $5 to spend on a
Some of you would like to eat sandwiches more
often, but your budget limits the number of
times you can eat out
Health Insurance: Basic Concepts
• Insurance is a mechanism for protection against
– Risk = possibility of substantial financial loss
– Insured = individual protected against risk by
• Also referred to as enrollee or beneficiary
– Insurer = insuring agency that assumes risk
• Also referred to as underwriter
– Underwriting = technique for evaluating, selecting,
classifying, and rating risks
– Premium = amount charged for insurance coverage
Health Insurance: Four Principles
• Four fundamental principles underlying the
concept of insurance
– Risk is unpredictable for the individual insured
– Risk is generally predictable for a group or
– Insurance provides a mechanism to transfer or
shift risk from the individual to the group by
pooling resources
– Actual losses are shared on some equitable basis
by all members of the insured group
Health Insurance & Cost Sharing
• Cost sharing = insured assumes part of the risk
– Three types of cost sharing
• Premium cost sharing
– Insured workers pay 15% for single plans, 26.5% for family
– Payroll deductions
• Deductible
– Amount insured pays before plan benefits are payable
– Usually paid on an annual basis
– May have separate deductibles for hospitalization, outpatient
• Copayment
– Amount paid out of pocket each time health service provided
– Includes co-insurance, which is the ratio of cost sharing
– Marginal vs. Total Cost
Health Insurance & Cost Sharing
• Cost sharing example
– Bob pays $400 each month in insurance premiums
– His plan requires a $500 deductible
– His plan also offers 80:20 coinsurance
• The ratio of cost sharing = coinsurance
• The dollar amount paid = copayment
– Stop-loss provision of $1,500
• Maximum out-of-pocket liability incurred per year
Health Insurance & Cost Sharing
• Why do we have cost sharing?
– Reduces misuse of insurance benefits
– Control utilization of health care services
– Addresses moral hazard by making the insured
more responsible for health care costs
– Promotes responsible behavior in health care
Private Insurance
• Recall the history of health insurance
• Five types
– Group insurance
– Self-insurance
– Individual private insurance
– Managed care plans
– High-deductible health plans
Group Insurance
• Obtained through employers, unions, or
professional organizations
– Sponsors purchase insurance for participants
• Spreads out risk and costs
of health care across a
substantial number of people
Change is in the Air…
A number of you work for TU…
…RIGHT NEXT to The Sandwich Guy! You sure
would love to eat the sandwiches there more
often during lunchtime.
Trinity wants to keep you as good employees,
and they know you love sandwiches. They
worry you’ll start thinking about working
Here Comes Mr. Private Insurance
He’s got a special deal to offer TU
“If your employees just pitch in $20/month,
they’ll receive a “membership” into the
Healthy Appetite Club!”
…sounds like a “premium”…
…what’s the catch?
The Healthy Appetite Club
In addition to your $20/month premium…
You pay for your first sandwich (…$5 deductible)
After that, you pay only 20% of retail price on
sandwiches! (…$1 copayment)
After you eat 6 sandwiches in a month, the rest of
your sandwiches that month are FREE (…$30
maximum out-of-pocket liability)
It would have cost $30 for 6 sandwiches
With a membership, you start saving LOTS of
money once you’ve eaten 7 or more sandwiches
Your incentive is to EAT MORE SANDWICHES!!!
(…sounds like moral hazard…we’ll revisit that…)
Behind the Scenes…
Mr. Private Insurance approaches me:
“Here’s the deal Sandwich Guy…
I’ve got these TU employees signed up as members, and
they’re ready to eat sandwiches.
I’ll include you in my “club” so they get a great deal by
eating sandwiches at YOUR shop…
…BUT instead of paying you $5 for a sandwich, I’m going
to pay you $4.75 each time I pay for one of my
members’ sandwiches.
Don’t like it? I’ll be happy to go across the street and
make The Sandwich Dude a participating restaurant of
my club.” (my biggest competitor!)
…how can I refuse???
Now I’ve Got a Problem…
I was making 50₵ for each sandwich
Now I’m only getting $4.75 for a lot of the
sandwiches being purchased…
…I’m not making as much per sandwich!
But I have an incentive to sell more
If I have the power, I might increase the price of
my sandwiches for other customers to make
sure I earn income to provide for my family.
But think about what this implies.
• Some employers are big enough they can selfinsure by budgeting a certain amount of
money to pay for employees’ medical claims
• Provides employers with greater degree of
• Protected from risk of high losses by
purchasing reinsurance from private insurance
• Exempts them from many state insurance
Individual Private Insurance
• Rather than spread out risk across a group of
participants, premium price and eligibility is
determined based upon individual health status
and demographics
– Barrier for high-risk individuals
• Who pays for individual private insurance?
– Self-employed
– Employees whose employer doesn’t offer insurance
– Early retirees
• ACA – Public insurance exchanges or
How Can I Get In On This???
A few of you are getting annoyed…your friends
keep bragging about the deals they get on
sandwiches, and you want in!
You call up Mr. Private Insurance and ask if he’ll
help you get a discount on your sandwiches…
How Can I Get In On This???
To one of you, he says:
“Okay, can I get a list of your favorite foods and
how often you eat out at local restaurants?”
He figures there’s NO WAY he’ll have to pay
much for sandwiches, so he lets you in on the
deal by paying $25/month for his bargain rates
How Can I Get In On This???
To another, he says:
“Okay, can I get a list of your favorite foods and how
often you eat out at local restaurants?”
But this time he’s worried he might have to pay
more than he’d like based on his prediction of
your eating habits
He’ll let you in on the deal too, but you have to pay
…AND you’ll pay $1.50/sandwich after the 1st
…AND you won’t get free sandwiches until the 10th
How Can I Get In On This???
To the third one of you, he says:
“Okay, can I get a list of your favorite foods and
how often you eat out at local restaurants?”
But he KNOWS you love sandwiches and will eat
at The Sandwich Guy all the time…
…so he refuses to let you in on his deal.
You’ve been denied coverage!
Managed Care Plans
• Like health insurance, they assume risk in
exchange for insurance premiums
• Contract with a network of providers to assume
responsibility for delivering care to enrollees
– Patients expected to stay in-network for care
– Higher out-of-pocket expenses incurred for going outof-network
• Monitor utilization, adopt a variety of different
reimbursement methods
High Deductible Health Plans
• Also referred to as consumer-driven health plans
• Link personal savings account to insurance
– HDHP/Health Reimbursement Arrangement (HRA)
• HRA funded by employer
• Funds reimburse insured for qualified medical expenses,
including premiums
– HDHP/Health Savings Account (HSA)
• Employers may contribute, but are not required
• Funds belong to account holder and accumulate
• Benefits of tax exemption & tax-deductible contributions
Public Insurance
• Recall the creation of Medicare & Medicaid
• Public insurance financed by government;
services purchased from private providers
– Some exceptions – for example, V.A.
– Medicare Part A
– Medicare Part B
– Medicare Part C
– Medicare Part D
– Medicaid
• Finances care for:
– Persons 65 years and older (84%)
– Disabled individuals entitled to Social Security
benefits (regardless of age)
– Persons with permanent kidney failure (end-stage
renal disease, regardless of age)
• Administered by Centers for Medicare and
Medicaid Services (CMS)
• “Of all government programs, Medicare poses
the single greatest future challenge to
taxpayers” (p. 139)
• Economic Rational
– Because employer-provided insurance isolated
retirees, Adverse Selection was a real threat
– Can think of Medicare (and Medicaid) as a
response to market failure
– Cost based reimbursement lead to increased
utilization, DRG prospective payment rearranged
incentives – a form of capitation
• Elderly spend an average of 22% of annual
income on out-of-pocket health expenses
– Deductibles, copayments, noncovered services
• 20% of beneficiaries qualify for Medicaid
– Picks up expenses not covered by Medicare
• 25% of beneficiaries privately pay for
supplemental insurance policies
– “Medigap” policies, covering all or a portion of
Medicare deductibles & copayments
Medicare Part A
• Hospital Insurance
– Inpatient hospital services, skilled nursing
facilities, home health, hospice
• Funded by a tax of 2.9% of earnings paid by
employers and workers (1.45 each)
• ACA increases payroll tax by .9 percentage points for
high income taxpayers (more than $200,000 for an
• Accounts for about 36% of total Medicare spending
• About 46 million enrollees
Medicare Part B
• Supplemental Medical Insurance
– Physician, outpatient, home health, and
preventative services
– Funded by general revenues and beneficiary
premiums – set to cover 25% of spending in the
aggregate. Higher income pay higher premiums
– Accounts for about 27% of total spending
– About 42.4 million enrollees
Medicare Part C
• Medicare Advantage (formerly Medicare+Choice)
– Allows beneficiaries to enroll in a private
insurance plan
– These plans receive payment from Medicare
– Accounts for about 24% of spending
– 11.5 million enrollees
– Evidence suggests these plans have achieved cost
savings over traditional plans
– Less “cream-skimming” than under Medicare
– ACA lowers payment to these payers
Medicare Part D
• Recently implemented (2006)
• Voluntary program, requiring monthly premium
• Two types of private plans
– Stand-alone prescription drug plans (PDPs)
– 17.7 million or 28% of enrollees
• Offer only drug coverage
• Available to those staying in the original Medicare fee-for-service
– Medicare advantage prescription drug plans
• 9.9 million or 21% of enrollees
• Available to those who want to obtain all health care services through
MCOs participating in Medicare Advantage (Medicare Part C)
• ACA removes “doughnut hole” and puts in place income-related
premium similar to the Part B premium
Services Not Covered By Medicare
Vision care
Hearing aids
Routine physical exams
Many preventive services
Long Term Care
• Jointly financed by federal and state
– Federal government provides matching funds to
states based on per capita income in each state
• Administered by each state
– Eligibility criteria, covered services, payments to
providers vary by state
• Means-tested program
• Finances care for:
– Indigent
• But does not provide medical assistance for all poor persons
• Certain low-income people required for coverage by federal
law (many elderly, blind, disabled receiving Supplemental
Security Income, some pregnant women)
– Eligibility criteria established by each state according
to threshold levels for income and other resources
and assets
• Most states defined “medically needy” categories (e.g.,
institutionalized in nursing or psychiatric facilities)
– Instrumental in providing health insurance to children
in low-income families
• State Children’s Health Insurance Program
• Offers additional federal matching funds to states
to expand Medicaid eligibility to enroll children
under 19 years of age
– Also provides coverage to qualifying pregnant women,
parents, and caretaker relatives
• Participating states have three options:
– Expansion of Medicaid
– Establishment of special child-health assistance
– Combination of the two approaches
• Third-party payers
– Insurance companies, MCOs, BC/BS, Government
– Join the patient & provider as “third party”
– Payment by third-party payers to providers for
patient care is reimbursement
• Various methods
Fee for service
Package pricing RBRVS
Managed care reimbursement Retrospective
Prospective (DRGs)
Fee for Service Reimbursement
• Based on assumption that services are
provided in a set of identifiable and
individually distinct units of services
– Each service is separately billed
– Initially set by providers and passively paid for by
insurers, later limited to “usual, customary, and
reasonable” amounts determined by payers
• Resulted in “balance billing” – asking patients to pay for
the difference in actual charges and payments received
Fee for Service Reimbursement
• Are there problems with this arrangement?
• Incentives?
• Induce demand and deliver additional
nonessential services
• Cost escalation
Package Pricing
• Also referred to as bundled charges
– Related services included in one price
• The Patient Protection and Affordable Care
Act of 2010 called for a pilot project on
bundled payments
– Provides acute care provider with single payment
for patient’s entire episode of care
– Provider is responsible to distribute payments to
other participating providers during the episode
Resource-Based Relative Value Scale
• Reimburses physicians according to a “relative
value” assigned to each physician service
• Based on time, skill, and intensity required for
each service
• Reimbursement calculated from a complex
– Published in the Medicare Fee Schedule under
current procedural terminology (CPT) codes
– Adjusted for geographic area
Managed Care Reimbursement
• Three approaches
– PPOs
• Establishes fee schedules based on discounts negotiated
with in-network providers
– HMO physicians
• Have salaried physicians on staff
– HMO capitation
• Provider paid a set monthly fee per enrollee, regardless of
whether or how often enrollee received care
• Removes incentive for provider-induced demand
• Encourages provision of only necessary services
Retrospective Reimbursement
• Medicare and Medicaid established per diem
(or daily) reimbursement rates for hospitals,
nursing homes, home health, and inpatient
• Based on actual costs incurred by providers
during previous year
• Rates set after evaluating costs retrospectively
Retrospective Reimbursement
• Are there problems with this arrangement?
• Based on costs directly tied to length of stay,
services rendered, and service costs
• Incentives?
• No incentive to control costs
– Increase revenue by increasing costs
• No incentive to discriminate services
• No incentive to manage length of stay
Prospective Reimbursement
• Has largely replaced retrospective
reimbursement, doesn’t use historical costs
• Determines payment amounts in advance using
pre-established criteria
– Inpatient: Diagnosis Related Groups (DRGs)
– Outpatient: Ambulatory Payment Classifications
– Skilled Nursing: Resource Utilization Groups (RUGs)
• Determined by case mix (severity of patients’ condition)
– Home Health: Home Health Resource Groups (HHRGs)
• Pays fixed rate for 60-day episode of care
So What?
• What are the effects of all these different
types of financing and insurance
– Access to health care
– Payment to providers
– Unintended consequences
Negative Effects of Financing
• Insurance desensitizes patients to price
– Excessive demand from insured patients who want to
use their benefits
…consumers are driven to utilize more services when
covered under insurance than if they paid out of
pocket… moral hazard
• Insurance desensitizes providers to price
– Services with more liberal reimbursement are favored
by providers
…providers are driven to encourage demand to deliver
additional and more expensive services, regardless of
health benefits… provider-induced demand
Negative Effects of Financing
• To control the growth of health care demand and
health care expenditures, rationing measures are
• Supply-side rationing
– Restricts supply of services through central health
planning (limiting availability of expensive care)
– Experienced in national health care programs
• Demand-side rationing
– Does not extend health insurance to all residents
– Experienced in the U.S.
What We’ve Learned
• Financing is a critical part of the U.S. health
care delivery system
– Insurance coverage for patients
– Reimbursement for provider services
• Private and public forms of insurance
• Methods of reimbursement
• The effects of financing on the U.S. health care
delivery system
Areas of Focus
• Important terms relating to the concept of
• Private and public forms of insurance
• Methods of reimbursement
• The effects of financing on the U.S. health care
delivery system

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