HLTH5653 Module 3 payer mix and reimbursement analysis example

Three Points of Payer Mix Worth $5.2 Million: How a Shift From Commercial to Public Coverage Explains a Hospital's Operating Loss

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American College of Education

HLTH5653: Financial Analysis and Assessment in Healthcare Administration

Module 3 Assignment

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July 17, 2028

Why Payer Mix Belongs in the Revenue Picture

The first two modules found that the composite 124-bed nonprofit hospital in this course moved from an operating income of $3.1 million to an operating loss of $2.2 million in one year, a swing of $5.3 million, and that its revenue grew more slowly than its patient volume. Labor costs explain much of the expense side. This module examines the revenue side, where the hospital's income depends less on how many patients it treats than on who pays for their care and how. All figures are in millions of dollars unless noted.

Hospitals set a single list price, their charges, for each service, but almost no payer pays it. Medicare and Medicaid pay rates set by the government, commercial insurers pay rates negotiated in contracts and uninsured patients often pay little. Net patient service revenue is what remains after these contractual adjustments and estimated bad debt. Payer mix, the share of the hospital's business from each payer, therefore shapes net revenue as much as volume or price does. Two hospitals with the same patients and the same charges can have very different revenues because different people are paying for them.

Charges and Net Revenue by Payer

Gross charges for the year were $654.9, up 6.4 percent from $615.7, reflecting a 3 percent increase in the charge master and higher volume. Net patient service revenue was $212.4, or 32.4 percent of charges, down from 33.2 percent the year before. The breakdown by payer explains why. Medicare accounted for 47 percent of gross charges, up from 45 percent, and the hospital collected about 27 percent of Medicare charges, producing net revenue of $83.1. Medicaid accounted for 19 percent of charges, up from 18, with about 22 percent collected, for $27.4. Commercial insurers accounted for 27 percent of charges, down from 30, with about 52 percent collected, for $92.0. Self-pay patients were 4 percent of charges with 8 percent collected, and other payers, such as workers' compensation and veterans' programs, 3 percent with 40 percent collected.

The result is that commercial insurers, just over a quarter of charges, provide 43 percent of net patient revenue, while Medicare, nearly half of charges, provides 39 percent. Each percentage point of charges that moves from commercial insurance to Medicare reduces net revenue by about $1.6, because the hospital collects 52 cents on each dollar of commercial charges and 27 cents on each dollar of Medicare charges.

What the Shift Cost

If the payer mix had stayed where it was the year before, the same gross charges would have produced net revenue of about $217.6 instead of $212.4. The three-point shift away from commercial coverage, toward Medicare and Medicaid, therefore cost about $5.2 in net revenue in one year, almost exactly the $5.3 swing in operating income. Labor costs rose by more than the shift cost, but growth in volume and price absorbed most of that increase; without the shift, the hospital would have earned about $3.0 on operations, close to the prior year's result. The two problems compound each other: the labor increase left no room to absorb the mix shift.

The shift has identifiable causes. The county's population is aging, so more patients are moving into Medicare each year. The state's Medicaid redetermination process ended in the prior year, and some patients who lost coverage moved to self-pay while others who gained employer coverage stayed with it. The largest local employer, a manufacturing plant, reduced its workforce by 400 positions, and the notes show that commercial inpatient days fell 8 percent. Selden et al. (2015) showed, with national data, that what private insurers pay hospitals for inpatient care has pulled steadily away from what public programs pay, and that gap is what makes a small mix shift so costly for this hospital.

How Each Payer Pays

The payers differ in how they pay as well as how much. Medicare pays for inpatient stays under a prospective system that assigns each stay to a diagnosis-related group with a fixed payment, modified for local labor costs and a few other hospital characteristics, regardless of the hospital's actual cost or the length of the stay. Outpatient services are paid under a similar prospective system organized by ambulatory payment classifications. The hospital cannot negotiate these rates; it can only control its cost per case and ensure its documentation supports the correct group.

Medicaid pays under the state's rate schedule, which for this state is also a per-case system for inpatient care, set well below Medicare. Commercial insurers pay under contracts. The hospital's three largest commercial contracts pay a percentage of charges for outpatient services and a per-case rate for inpatient stays, renegotiated every three years. The largest commercial insurer, covering about 40 percent of the hospital's commercial business, has a contract expiring in eleven months.

Which Payers Cover Their Cost

The hospital's cost-to-charge ratio, patient care expenses divided by gross charges, is about 0.31, meaning that on average each dollar of charges represents about 31 cents of cost. Comparing collection rates with this ratio gives a rough estimate of how much of its cost each payer covers. Commercial insurers, paying about 52 cents per dollar of charges, cover about 168 percent of cost. Medicare, at 27 cents, covers about 87 percent. Medicaid, at 22 cents, covers about 71 percent, and self-pay patients cover very little.

These estimates are approximate, because costs vary by service and payers use different services, but the pattern is clear: the hospital loses money on its public payers and depends on commercial margins to cover those losses. That dependence is what made the mix shift so damaging, and it is why the expiring commercial contract is the most important revenue event of the coming year.

What the Hospital Can and Cannot Change

An obvious response is to ask the commercial insurer for a larger increase to offset the public shortfall. The research suggests caution. Frakt (2011), reviewing the evidence on cost shifting, concluded that hospitals can and do shift costs to private payers when public payments fall, but usually at a relatively low rate, and that market power between hospitals and insurers strongly influences private prices. As the only hospital in its county, this hospital has some bargaining power, but the insurer can direct patients to hospitals in neighboring counties for elective care.

The other side of the equation is cost. Stensland et al. (2010) found that hospitals with strong market power and high private revenue face less pressure to constrain costs and tend to lose money on Medicare, while hospitals under more financial pressure often constrain costs and can generate profits on Medicare patients. For this hospital, the implication is that reducing cost per case, especially the contract labor identified in Module 1, would improve its result on every payer at once, whereas a commercial rate increase would help only on the shrinking share of patients with commercial coverage.

Assumptions for the Budget

The analysis gives Module 4's budget four assumptions to state explicitly. First, the payer mix should be projected to continue shifting by about one point a year from commercial to Medicare, given the county's aging population, which would reduce net revenue by about $1.6 a year at current volumes. Second, the commercial contract renewal should be budgeted at a 4 percent rate increase, not the 7 percent the hospital may request, with the difference shown as a scenario. Third, Medicare rates should be budgeted at the published annual update. Fourth, cost reduction per case should be treated as the main lever the hospital controls. A budget that assumes last year's payer mix will be wrong before the first month closes.

References

Frakt, A. B. (2011). How much do hospitals cost shift? A review of the evidence. The Milbank Quarterly, 89(1), 90-130. https://doi.org/10.1111/j.1468-0009.2011.00621.x

Selden, T. M., Karaca, Z., Keenan, P., White, C., & Kronick, R. (2015). The growing difference between public and private payment rates for inpatient hospital care. Health Affairs, 34(12), 2147-2150. https://doi.org/10.1377/hlthaff.2015.0706

Stensland, J., Gaumer, Z. R., & Miller, M. E. (2010). Private-payer profits can induce negative Medicare margins. Health Affairs, 29(5), 1045-1051. https://doi.org/10.1377/hlthaff.2009.0599