WMBA 6608 Week 3 Reimbursement Model Comparison Example

Four Ways to Be Paid for 400 Joint Replacements: Discounted Charges, Per Diem, a Case Rate and Capitation Compared on One Hospital's Volume, With a Blended Figure for Its Payer Mix and the Behavior Each Model Rewards

Student Name

Walden University

WMBA 6608: Healthcare Financial Management and Economics

Instructor Name

Month Day, Year

Four Ways to Be Paid for 400 Joint Replacements: Discounted Charges, Per Diem, a Case Rate and Capitation Compared on One Hospital's Volume, With a Blended Figure for Its Payer Mix and the Behavior Each Model Rewards

The Service and the Question

Prairie Ridge Medical Center, the course's fictional Iowa hospital, performs about 400 elective hip and knee replacements a year. The average gross charge is $52,000, the average length of stay is 2.4 days and the hospital's full cost per case, including allocated overhead, is about $13,600. The same surgery is paid under four different models depending on the payer. This paper describes each model, runs the 400 cases through each one, blends the results by payer mix and identifies the behavior each model rewards.

The Four Models

Discounted fee for service pays a percentage of the hospital's charges, here 48 percent under the largest commercial contract. The unit of payment is the service; revenue is triggered by each charge on the bill; and the payer holds utilization risk, because more services mean more payment.

Per diem pays a fixed amount per inpatient day, here $6,800 under a second commercial contract. The unit is the day; revenue is triggered by each day in the hospital; and risk is shared, with the payer bearing the number of days and the hospital bearing the cost of services within each day.

A case rate pays one predetermined sum for each admission, keyed to its diagnosis group. Medicare's inpatient system pays this way, about $14,200 for this procedure group at Prairie Ridge after its wage and other adjustments. The unit is the admission; revenue is triggered by the admission and its coded diagnosis group; and the hospital holds the risk of length of stay and services within the stay.

Capitation pays the hospital a flat amount every month for every plan member assigned to it, whatever care that member receives. A Medicare Advantage plan pays Prairie Ridge $11.00 per member per month for the hospital portion of orthopedic surgery for about 60,000 members. The unit is the member; revenue is triggered by enrollment, not care; and the hospital holds both cost and utilization risk. Robinson (2001) described the basic trade-off among payment methods: each unit of payment rewards providers for producing more of that unit and leaves them bearing the risk of everything outside it.

The Worked Scenario

Assumptions: 400 cases, 2.4 days per case, average gross charge $52,000, full cost $13,600 per case. For comparison, every model is applied to all 400 cases, and capitation revenue is the annual payment for the attributed population, assumed to generate 400 cases.

Table 1

Revenue and Margin on 400 Joint Replacements Under Each Model

Composite figures for a classroom case; capitation revenue does not change with the number of cases.

The same 400 surgeries produce revenue ranging from $5.68 million to $9.98 million, depending only on how the hospital is paid.

What Happens When Behavior Changes

The models diverge further when something changes. Suppose Prairie Ridge shortens the average stay from 2.4 to 1.8 days through same-day mobilization, cutting cost per case by about $1,200. Under per diem, revenue per case falls by a quarter, to $12,240, and the hospital loses money on the change. Under the case rate, revenue is unchanged and margin rises by $480,000. Under fee for service, revenue falls slightly as fewer room charges are billed. Under capitation, revenue is unchanged and the full saving is kept.

Now suppose volume rises from 400 to 460 cases because surgeons operate on more borderline candidates. Under fee for service, per diem and the case rate, revenue rises with each case. Under capitation, revenue stays at $7.92 million while cost rises by about $816,000, cutting the margin by a third.

The Payer Mix

Prairie Ridge does not operate under one model. Its joint replacement cases come 30 percent from the fee-for-service contract, 15 percent from the per diem contract, 50 percent from Medicare's case rate and 5 percent from the capitated plan.

Table 2

Blended Revenue per Case by Payer Mix

Weights are shares of cases; capitation is converted to a per-case equivalent at expected volume.

The blended figure, about $18,000 per case, or $7.21 million a year, is the number the hospital's budget should use. It also shows how much the service depends on its commercial fee-for-service contract: 30 percent of cases supply over 40 percent of the revenue.

What Each Model Rewards

Discounted charges pay more for every added service, so they reward volume and fuller bills. Per diem rewards longer stays, which is why commercial payers have moved away from it for surgery. The case rate rewards efficiency within the stay and, because payment depends on the coded diagnosis group, accurate and complete documentation of severity. Capitation rewards keeping members healthy and avoiding procedures that are not needed, while putting the hospital at risk if volume rises. Miller (2009) argued that payment systems should reward value rather than volume, and among these four, only capitation and the case rate reward the hospital for doing less per patient.

For Prairie Ridge, the implication is practical. Its plan to shorten stays makes sense under the case rate and capitation, which cover 55 percent of cases, but would cost money under the per diem contract. The hospital should seek to convert that contract to a case rate at its next renewal. Reiter and Song (2021) note that financial managers must understand how each payer's method shapes the financial effect of operational changes, and this comparison shows why: the same improvement can raise or lower revenue depending on who is paying.

References

Miller, H. D. (2009). From volume to value: Better ways to pay for health care. Health Affairs, 28(5), 1418-1428. https://doi.org/10.1377/hlthaff.28.5.1418

Reiter, K. L., & Song, P. H. (2021). Gapenski's healthcare finance: An introduction to accounting and financial management (7th ed.). Health Administration Press.

Robinson, J. C. (2001). Theory and practice in the design of physician payment incentives. The Milbank Quarterly, 79(2), 149-177. https://doi.org/10.1111/1468-0009.00202