What's wrong with provider discounts - managed health care plans - column

What's wrong with provider discounts

Employers need to be aware that, in today's world of managed health care plans, there is a near obsession with getting a discount from regular charges when developing a provider network.

There are two major problems with provider discounts being the top priority of network development: * First, they divert management attention from the far more important issue of designating certain physicians and hospitals as "preferred" based on their ability to provide efficient medical care of proven quality.

A physician who offers a discount, but who overutilizes service--scheduling unnecessary visits or procedures, for example--may cost a health plan far more than a cost efficient physician paid full price. * Second, in a medical marketplace characterized by deep discounts to HMOs, PPOs, and other forms of managed care, physicians and hospitals establish a "phantom fee schedule" which is actually charged at full rate to a small and shrinking class of payers.

As a result, any real price advantage to the health plan from provider discounts rapidly diminishes as provider discounts become available to an increasing number of health plans. That is, the discounted charge becomes the usual charge for medical services.

Cost shifting has long been practiced by medical providers as a way of recovering lost income from classes of payers who did not pay their fair share for medical services consumed--such as Medicare beneficiaries and the indigent.

When physicians and hospitals grant discounts of varying degree in exchange for concentrated patient volume, and charge schedules are set below the actual cost of providing medical services, the losses must somehow be made up. The inevitable result is that providers increase charges to patients whose insurer doesn't have as deep a discount--or any discount at all.

The strategy of cost shifting to other payers breaks down when there is an ever-expanding class of payers receiving discounts below the true cost of providing medical services. If volume discounts are offered to a large patient population, there won't be enough full-fee patients left to cover the actual provider costs.

Often, many of the patients newly covered under a volume discount arrangement formerly were full-fee patients of the network physicians or hospitals.

Fair market value: a better way

A better way of purchasing medical services is to abandon the struggle to find deeper and deeper discounts, and instead to determine fair market value.

In the past, it was common to find a wide range of charges for essentially the same medical service--with little or no apparent justification for the price differences. This wide variation was obvious not only when comparing one region of the country with another, but also when comparing providers in the same community.

The concept of a fair market value for a medical service does not allow for price variations without some sort of demonstrable difference in quality. Fair market value demands a unit price that covers the cost of providing medical services in an efficient manner--plus a reasonable profit margin.

Fair market value may not be what a particular physician currently charges for a particular medical procedure. Instead, it should reflect relative skill, resources--such as high-tech equipment or special training--and medical risk factors associated with a specific medical service. Medicare's new Resource-Based Relative Value Scale is an attempt to establish a fair market value for physician services.

Too often, discounts have become the centerpiece of managed care strategy. Successful managed health plans of the 1990s will intensify their emphasis on identifying and selectively contracting with providers who have demonstrated both cost effectiveness and attention to quality. Only then will "preferred provider" become a meaningful description.

Ralph D. Alexander is senior consultant with Milliman & Robertson, Inc., consulting actuaries, St. Louis.

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