This document discusses various methods of health care financing in the United States including private insurance, public programs, and the Affordable Care Act. It covers key topics like the role of insurance, common health insurance terminology, types of private plans including employer-sponsored and individual plans, public programs like Medicare and Medicaid, and provisions and impacts of the ACA. The learning objectives are to understand concepts of health insurance, distinguish various plan types, examine public programs and insurance trends, and assess directions in health care financing.

2. Chapter 6
Health Services Financing

3. Learning Objectives
• To study the role of health care financing and its
impact on the delivery of health care
• To understand the basic concept of insurance and
how general insurance terminology applies to health
insurance
• To differentiate between group insurance, self-
insurance, individual health insurance, managed
care, high-deductible plans with savings, and
Medigap plans
• To explore trends in employer-based health
insurance

4. Learning Objectives
• To examine the distinctive features of public insurance
programs
• To understand the various methods of reimbursement
and developing trends
• To discuss national health care and personal health care
expenditures and trends in private and public financing
• To become familiar with the requirements of the
Affordable Care Act and their likely effects on financing
and insurance
• To assess current directions and issues in health care
financing

5. Introduction
• Complexity of financing in the US:
– many private plans
– many government programs
– many payment methods
– loss of insurance by many under the ACA
– government is expected to facilitate the
purchase of insurance under the ACA

6. Role and Scope of Health Care
Financing
• Financing is needed to pay health insurance
premiums
• Health insurance is the primary mechanism to
obtain health care services
• Despite the ACA, charity will play a noteworthy
role for the uninsured
• Insurance increases demand for health care
• Insurance lowers out-of-pocket costs
– patients consume more (moral hazard)

7. Role and Scope of Health Care
Financing
• Financing influences supply of health care
– Production of health care services – capital
expenditures, renovations, expansions
– New services and technology proliferate
when they are covered by health insurance
• New models of health care organization may
form
• Supply and distribution of health care
professionals is affected
• Effect on total health care expenditures

8. Financing and Cost Control
• Expenditures are increased by
– Expansion of health insurance
– Increase in health insurance premiums
• Expenditures can be reduced by
– Restricting insurance (demand-side rationing)
– Restricting reimbursement to providers
– Having fewer specialists
– Spending less on R&D
– Direct control over utilization (supply-side rationing)
– Designating certain services as noncovered (rationing)

9. The Insurance Function
• Insurance
– protects against risk
• Risk
– the possibility of substantial financial loss from
some event, where
– probability of occurrence is small

10. The Insurance Function
• Insured
– an individual protected by insurance
• Insurer
– an insurance agency that assumes the risk
• Underwriting
– evaluation, selection (or rejection), classification,
and rating of risk

11. The Insurance Function
Four Principles of Insurance:
1) Risk is unpredictable
2) Risk can be predicted with some accuracy in a
large group
3) Insurance can transfer risk from the individual to
group through pooling of resources
4) Losses are shared by all members

12. Private Health Insurance Concepts
• Beneficiary
– “the insured”
• Premium
– amount charged by insurer to insure against risk
– Employer-employee cost sharing

13. Health Insurance Terminology
• Premium
– amount charged by insurer to insure against risk
– Employer-employee cost sharing
• Risk Rating:
– Experience rating – premiums can be unaffordable
for high-risk groups
– Community rating – good risks subsidize poor risks
– Adjusted community rating – overcomes some of
the above drawbacks (required by the ACA)

14. Health Insurance Terminology
• Cost Sharing
– Deductible
•Amount the insured pays first before benefits
are paid by the plan
•Applied annually
– Copayment
•Flat amount paid per service
– Coinsurance
•Set proportion of medical costs

15. Why Cost Sharing?
Cost sharing reduces moral hazard
•Rand Health Insurance Experiment
Cost sharing had a material impact on
lowering utilization, without any
significant negative health consequences

16. Health Insurance Terminology
• Covered Services
– Benefits
•Services covered by an insurance plan
(medically necessary)
•Specified in a contract
•Vision and dental coverage are generally not
included in health insurance

17. Types of Private Insurance
• Group insurance
– Tax advantages when it is obtained through the
employer
– Comprehensive coverage is an anomaly to the
fundamental concepts of insurance
• Self-insurance
– Spurred by public policy
• No premium tax on employers
• ERISA 1974
• Exempt from some of the ACA requirements

18. Types of Private Insurance
• Individual private health insurance
– Nongroup plans
– Premiums based on individual’s health and
demographics
– Many lost coverage under the ACA
• Managed care plans
– Initially, these plans were different from
commercial health insurance
– Now, most health insurance is in the form of
managed care plans

19. Types of Private Insurance
• High-deductible health plans/savings options
– HRA:
•Funded by the employer
•HDHP is optional
– HSA:
•Employer contribution is optional
•HDHP is required
See Exhibit 6-1

20. Types of Private Insurance
• Medigap: Medicare supplement insurance
- To cover the high out-of-pocket costs in the
original Medicare program
- Not available to those covered by Medicare
Advantage (Part C of Medicare)

21. Trends in Employment-Based Health
Insurance
• 2005: 91.6% of private health insurance was
employment based
• 2011: The figure dropped to 89%
• The declining trend is shown in Fig. 6-4
• Other trends:
– Fewer small businesses offered health insurance
– Decreasing premium subsidies from employers
– Higher out-of-pocket costs

22. COBRA 1985
• Employment-based coverage can continue for 18
months after separation from a job
• 29 month coverage for individuals declared to be
disabled (HIPAA 1996)
• Family coverage for 36 months if the former
worker dies, enrolls in Medicare, or is divorced
• The individual must pay 102% of the group
premium
• The ACA does not affect COBRA

23. Other Trends
• The number of uninsured increased dramatically
between 2000 and 2009
• Ironically, despite tax credits under the ACA,
small business insurance coverage declined
(Figure 6-3)
• Premium increases between 2008 and 2013:
– 25% for single plans; 29% for family plans)
• Deductible increase between 2008 and 2013:
– Increased from $735 to $1,135 on an average

24. Private Health Insurance and the ACA
• Numerous employment-based plans are losing
their “grandfathered” status
• Fees imposed on insurers:
– A flat fee imposed on plans operating outside of
ERISA (self-insurance market)
– Additional fee is imposed on plans sold through
the exchanges
– These costs will be passed on in the form of
higher premiums

25. Compliance Requirements by Health
Plans
• Must cover young adults under 26 in their parents’
plans
• Coverage for preexisting conditions
Effects: Premiums will rise for everyone; the healthy
will subsidize the unhealthy

26. Compliance Requirements by
Health Plans
• Coverage for preventive services without cost
sharing
• No dollar limits on benefits
• Limits on out-of-pocket costs
• Set minimum medical loss ratios
Likely effects: Rise in premiums;
consolidation of the insurance industry and
less competition

27. The Individual Mandate
• All legal residents must have “minimum essential
coverage” or pay a penalty (individual shared
responsibility)
• To meet the definition of “minimum essential
coverage,” private and public plans must include
Essential Health Benefits in 10 categories (Exhibit 6-2)
• Exemptions from “individual shared responsibility”
– Having to spend more than 8% of household income on
health insurance
– Religious opposition to insurance
– Certain other exemptions

28. The Individual Mandate
• Healthy individuals may choose to pay the penalty
instead of buying health insurance
• Health insurance marketplaces: Exchanges
– Plans offered must be certified as “qualified health plans”
– Four tiers of standardized plans are offered – plans differ
by actuarial value; premiums costs; and level of cost
sharing
• Premium subsidies for people between 100% and
400% of the FPL

29. The Employer Mandate
“Employer shared responsibility”
• Postponed until January 2015
• Play or pay
• Applies to employers with 50 or more full-time
equivalent workers (full time is 30+ hours per week)
• Tests that health plans must meet:
– “Minimum value” test – plans must be at least equivalent
to the Bronze plan offered through the exchanges
– “Affordability” test – Employee’s share of the premium for
a single plan must not exceed 9.5% of household income –
it leaves plenty of room to shift cost to the employee (see
example on p. 213)

30. The Employer Mandate
• Penalties apply when an employee employed by a large
employer (50+ FTE employees) gets federal subsidy
• Another penalty applies when the health plan offered
fails the “minimum value” and “affordability” tests
• Businesses may reduce labor force, but will have to find a
balance between cost and compliance factors imposed
by the ACA and achieving production objectives
• Government projections: 3 to 5 million fewer people will
have employment-based health insurance

31. Public Health Insurance
• 2011: Almost ⅓ of Americans had public
health insurance
• Public financing supports categorical
programs
– Medicare
– Medicaid
– CHIP
– Military Health Services
– Veterans Health Administration
– Etc.

32. Medicare
– Title 18 of Social Security Act
– Beneficiaries
1) those 65 years old or older
2) disabled who are entitled to Social
Security
3) those with end-stage renal disease
– 83% are age 65 and older
– Federal program consistent across the nation
– A four-part program

33. Medicare – Part A (HI)
– Financed by mandatory payroll taxes
•Employer and employee pay equally into the
Hospital Insurance Trust Fund
– No premiums are required if a person or spouse
has worked and earned 40 credits
– A person can buy into Part A if accumulated
credits are below 40

34. Part A Benefits
Exhibit 6-3
• 90 days of inpatient hospital care per benefit period
(a lifetime reserve of 60 additional days)
• Lifetime care of 190 days in a psychiatric hospital
• Up to 100 days of care in a Medicare-certified SNF
• Home health care through a Medicare-certified
agency
• Hospice care

35. Medicare – Part B (SMI)
– A voluntary program paid partly by general
tax revenue and a premium
– In 2007, premiums became means-tested
(MMA 2003) - IRMAA
– Covers various outpatient services
• See Exhibit 6-4

36. Medicare – Part C
(Medicare Advantage)
• Created in 1997 as Medicare+Choice
• Current name adopted under MMA
• Voluntary enrollment in managed care for
both Parts A and B
• Otherwise the beneficiary remains in the
original Medicare program
• Does not add any specific benefits, but
managed care may provide some extras
• Additional premiums, but no need for
Medigap

37. Part C under the ACA
ACA aims to reduce payment to MA plans by
8% in 2014.
The goal is to achieve some level of parity
between the expenditures for Part C
compared to expenditures in the original
Medicare program.
The government has contended that MA
plans have been overpaid.

38. Medicare – Part D (Prescription Drug
Coverage)
• Created under MMA 2003; implemented in 2006
• Enrollees can choose between
» Stand-alone plans for prescriptions only
» Part C (all services through managed care)
• Voluntary enrollment
• Subsidized premiums; IRMAA imposed by ACA
• See Exhibit 6-5

39. Medicare Out-of-Pocket Costs
• No limits on out-of-pocket expenses in the original
Medicare program – a typical beneficiary spends
about 20% of income on cost sharing
• Nearly half of the MA plans have cost sharing limits

40. Medicare Financing and Spending
– Medicare consumes over one-fifth of national
health expenditures
– HI and SMI Trust Funds; both incurred deficits in
2012
– Medicare is financially sick and headed for
insolvency unless it is steered around
– Three main issues:
•Rising cost of delivering health care
•An aging population
•Shrinking workforce to support tax revenues

41. Medicaid
– Title 19 of Social Security Act
– Finances health care for the indigent as
determined by each state (means tested)
– Jointly financed by federal and state governments

42. Medicaid under the ACA
The Supreme Court’s Decision
• The US Supreme Court struck down the
mandates under the ACA, giving states a
choice to either expand or not expand their
Medicaid programs without any penalty from
the federal government.
• Hence, coverage and benefits for many low-
income people remain in a state of
uncertainty

43. Medicaid under the ACA
Two Ironies
• It appears that states can no longer use the
assets test to determine eligibility
• Preventive services are at the states’
discretion for existing beneficiaries

44. Old Medicaid Option
• For states that choose not to comply with the ACA
• Automatic eligibility:
•TANF recipients
•SSI recipients
•Children and pregnant women if income is at or
below 133% of FPL
•“Medically needy” designated by a state

45. Dual-Eligible Beneficiaries
– Eligible for both Medicare and Medicaid
•Full duals
•Partial duals
– Under the ACA
•Demonstration projects to integrate Medicare
and Medicaid for full duals
•Capitated model and managed care fee-for-
service model

46. Medicaid Enrollment and Spending
Enrollment and cost figures will not be
available until well into 2015

47. CHIP (Children’s Health Insurance
Program)
– Title 21 of Social Security Act
– Federal block grants to states to expand Medicaid
eligibility
– No federal income threshold, but states typically
cover children (up to age 19) in families with
incomes up to 200% of federal poverty level
– First enroll in Medicaid if qualify

48. Health Care for the Military
• U.S. Department of Defense
– Health care for active duty and retirees, their
dependents and survivors
– Each branch of the military operates its own
medical facilities; services are also obtained
through civilian providers
– TRICARE is the insurance arm

49. Veterans Health Administration (VHA)
– The largest integrated health service system in the
US
– Both service connected and other conditions are
treated on a priority basis
– Cost control through global budgets
– Services organized through 23 geographically
distributed Veterans Integrated Service Networks
(VISNs)
– CHAMPVA covers dependents of disabled veterans

50. Indian Health Service
• Federal program (IHS)
• Comprehensive care to Native Americans
living on reservations and in rural areas
• IHS operates its own hospitals, health centers,
and health stations

51. The Payment Function
• Third-party payers
– Insurance companies, managed care
organizations, BlueCross BlueShield, government
• Payment function has two facets:
1) Determine methods and amounts of
reimbursement in advance of the delivery
2) Actual payment after services have been
rendered

52. The Payment Function
• Charge
– Price set by provider
• Rate
– Price set by a third party payer
• Fee schedule
– An index of charges listing individual fees for each
type of service

53. Reimbursement
Numerous reimbursement methods exist and
used for different types of services
– Fee for service
– Bundled payments (package pricing)
– RBRVS
– Managed Care Approaches
– Cost-Plus Reimbursement
– Prospective Reimbursement

54. Fee for Service
– Charges are set by the provider
– Each service billed separately
– Later, insurers adopted UCR (usual, customary
and reasonable) charge
– Main drawback
•provider induced demand

55. Bundled Payments
(package pricing)
– A number of related services in one price
– Reduces provider-induced demand because fees are
inclusive of all bundled services
– There is evidence that prospectively set bundled fees
reduce health care spending without compromising
quality of care
– Bundled Payments for Care Improvement (BPCI)
initiative

56. Resource-Based Relative Value Scale
(RBRVS)
– To reimburse physicians
– RVUs are established for each CPT coded physician service
– RVUs reflect time, skill, intensity
– Separate RVUs are assigned for overhead costs and
malpractice insurance costs

57. Resource-Based Relative Value
Scale (RBRVS)
– RVUs are adjusted to reflect geographical cost
variations
– Each year, Medicare establishes a dollar
Conversion Factor (CF). Reimbursement for a
service = RVU x CF
– A type of fee for service; it has not addressed the
issue of volume-driven payment

58. Managed Care Approaches
– Preferred Provider
•Discounted Fee for Service
– Capitation
•Per member per month (PMPM) fee to cover
all needed services
•Monthly fee = PMPM rate x number of
enrollees
•Minimizes provider induced demand and
promotes prudence
– Salary combined with productivity-based
bonuses

59. Cost-Plus Reimbursement
– To reimburse health care institutions
– Per diem rate or per patient day rate (PPD)
– Based on total operating cost + a portion of
capital costs
– Also called retrospective reimbursement
– No incentive to control costs or judicious use of
services
– Largely replaced by prospective methods
– Critical access hospitals in rural areas are still paid
under cost-plus

60. Prospective Reimbursement
– Criteria established to determine in advance the
amount of reimbursement
– Removes incentives to be inefficient (present in
cost-plus)
– Enables Medicare to predict future health care
spending
– Organizations make a profit by keeping their
operating costs below the fixed prospective rates

61. Value-Based Reimbursement
– The ACA directs Medicare to develop “value-based
purchasing” methods that incorporate pay for
performance
– The goal is to reduce reimbursement while
improving quality and efficiency
– Most organizations are required to report quality
data to the CMS, or face penalties

62. Types of Prospective Reimbursement
• Diagnosis-Related Groups (DRGs)
• Psychiatric DRGs
• Outpatient Prospective Payment System
• Case-Mix Methods:
– Resource Utilization Groups
– Case Mix Groups
– Home Health Resource Groups

63. Diagnosis-Related Groups (DRGs)
Overview
– PPS for acute care hospital inpatient reimbursement
– Each DRG groups together principal diagnoses
requiring similar amounts of resources
– A predetermined fixed rate is paid per case
– Hospital must provide whatever services the patient
needs
– Certain adjustments are made, e.g., location,
teaching hospital, disproportionate share hospital,
outliers, etc.

64. Diagnosis-Related Groups (DRGs)
Refined Medicare Severity DRGs
– Patient severity was incorporated in 2007 to better
reflect resource use
– 335 base DRGs are split further into 751
MS-DRGs (in 2012) based on comorbidities or
complications
– MS-DRGs are weighted and reviewed annually
– 65% of bad debts are added to reimbursement
– Reimbursement is reduced for certain early
discharges

65. The ACA and Hospital Reimbursement
– The ACA imposes reimbursement penalties for
excessive readmissions – readmission to the same or
another hospital for the same condition within 30
days of discharge
– Readmissions are being viewed as a quality issue
– Hospitals are taking steps to reduce readmissions
– The CMS has been authorized to make value-based
incentive payments for performance on a set of quality
measures

66. Psychiatric DRGs
– Per-diem, not a case-specific, rate is based on
psychiatric DRGs to reimburse psychiatric hospitals
– A stop-loss provision to protect against significant
losses

67. Outpatient Prospective Payment
System (OPPS)
– For services provided by hospital outpatient
departments; OPPS for nonhospital ambulatory
surgery centers
– Ambulatory Payment Classifications (APCs):
• 300 procedural groups
• New technology APCs
• a bundled rate to include anesthesia, drugs, supplies,
recovery
• Physician services are reimbursed separately, based
on RBRVS

68. Case Mix Methods
– Case mix: Aggregate severity of conditions
– Determined through a comprehensive assessment
– Mutually exclusive case mix categories represent
resource use
•Resource Utilization Groups (RUGs) are used to
determine per-diem reimbursement for skilled
nursing facilities
•Case Mix Groups (CMGs) are used to reimburse
inpatient rehabilitation facilities

69. Home Health Resource Groups (HHRG)
– the PPS is fixed, pre-determined for each 60-day
episode of care regardless of specific services
delivered
– services are bundled under one payment on a per
patient basis
– durable medical equipment (DME) and drugs not
included
– Outcome and Assessment Information Set (OASIS)
is used to assign patients to one of 153 HHRG
categories

70. Disbursement of Funds
• Claims processing
– After services are delivered
– Verify and pay claims submitted
• Third-Party Administrator (TPA)
– Self insured employers contract the service
– Process and pay claims
– Monitor utilization
• Fiscal Intermediaries and Carriers
– Medicare and Medicaid

71. National Health Expenditures
• $2.6 trillion spent in 2010
• $8,402 average per capita
• 17.9% of GDP (share of total economic output
consumed by health care)
• 2020 projections:
– $4.4 trillion
– 19.2% of GDP

72. National and Personal Health
Expenditures
• National Health Expenditures: Aggregate of
– All health services, products, and supplies
(personal health exp. – see Table 6-4)
– Public health services
– Health care research
– Administrative costs
– Investments in structures and equipment

73. The Nation’s Health Care Dollar
• Figure 6-6 shows the ongoing proportional
shift from private spending to public spending
• The ACA will significantly shift the ratio toward
public financing starting 2014
• Figure 6-7 shows the sources of financing and
the services for which the funds were used

74. Current Directions and Issues
Value and affordability:
– CBO estimates – 30 million uninsured in 2017
– 10 year federal costs (2014-2023) are estimated
to be $1,375 billion, not including costs to be
borne by the states, employers, and individuals
– Health care utilization costs (by the newly insured)
are also left out
– Several of the ACA provisions will result in higher
insurance premiums and higher taxes

75. Current Directions and Issues
Favorable Risk Selection and Adverse Selection
• High-risk individuals have a greater incentive than
low-risk individuals to enroll in health insurance
• Because state high-risk pools have been abandoned
under the ACA, a large number of low-risk
individuals need to enroll in the ACA plans
• Employers with younger workforces are likely to
opt for self insurance – this could affect the small
group market in the exchanges

76. Current Directions and Issues
Intentional Churning:
Mulvany (2013) assumes that one potential unintended
consequence of the ACA could be individuals
purchasing insurance only after they have a health care
need and, subsequently, cancelling coverage once the
need no longer exists.

77. Current Directions and Issues
Cost shifting:
The ACA coverage expansion will be paid in part by
reducing payments to hospitals and other providers.
Hence, cost shifting will likely occur, which would have
the effect of premium increases for health insurance in
both employment-based and exchange-based plans.

78. Current Directions and Issues
Fraud and Abuse
– Fraudulent billing may amount to 3% to 10% of total
health care spending
– The ACA calls for penalties for delaying or refusing the
DHHS access to information in connection with audits
and investigations.
– Payments can be suspended when fraud is suspected.
– Eligibility for Medicaid and insurance subsidies are
two areas ripe for fraud