CHAPTER 3 Paying for Health Services Basic insurance concepts Third-party payers Reimbursement (payment) approaches Medicare payment methods Impact of reimbursement approach on provider incentives and risk Coding Copyright 2009 Health Administration Press 3 - ‹#› For insurance to “work,” it must have these basic characteristics: Pooling of losses Payment only for random losses Risk transfer Indemnification However, two problems often arise in insurance programs: Adverse selection Moral hazard Insurance Concepts Copyright 2009 Health Administration Press 3 - ‹#› Adverse selection means those with greater risk are more likely to purchase insurance. The problem exists because of asymmetric information. Insurance companies use underwriting provisions to minimize adverse selection. Cross-subsidies may exist among different groups. Adverse Selection Copyright 2009 Health Administration Press 3 - ‹#› There are two opposing positions that insurers can take regarding underwriting: Community rating Experience rating Insurers also typically include preexisting condition clauses. The Health Insurance Portability and Accountability Act (HIPAA) sets national standards for underwriting: Limits on preexisting conditions Rights to purchase insurance Consumer protection Underwriting Provisions Copyright 2009 Health Administration Press 3 - ‹#› Moral hazard is the overuse of health services or forgoing of prevention because the individual does not bear the full cost of the consequences. Insurers protect themselves by deductibles, copayment, coinsurance, stop-loss limits, and policy restrictions. Moral Hazard Copyright 2009 Health Administration Press 3 - ‹#› For the most part, provider revenues come from third-party payers rather than from patients. Private insurers: Blue Cross/Blue Shield Commercial insurers Self-insurers Public insurers: Medicare Medicaid Third-Party Payers Copyright 2009 Health Administration Press 3 - ‹#› MCOs combine insurance and provider functions. Types of MCOs: Health maintenance organizations (HMOs) Provider panel Gatekeeper Preferred provider organizations (PPOs) Less restrictive than HMOs Various others In general, MCOs attempt to limit utilization. Is this bad? Managed Care Organizations (MCOs) Copyright 2009 Health Administration Press 3 - ‹#› Regardless of the payer, there are only a limited number of approaches to reimbursement (payment for services). There are two broad categories: Fee-for-service (FFS): Payment is tied to the amount of services provided: Cost based Charge based Prospective payment Capitation: Payment is tied to the patient population (number of enrollees). Reimbursement Approaches Copyright 2009 Health Administration Press 3 - ‹#› Payer pays all allowable costs incurred in providing services. Typically, periodic interim payments are made, with a final reconciliation at the end of each year. Medicare used this method for hospital payment in its early years (1966–1983). FFS: Cost-Bas.

1. CHAPTER 3
Paying for Health Services
Basic insurance concepts
Third-party payers
Reimbursement (payment) approaches
Medicare payment methods
Impact of reimbursement approach on provider incentives and
risk
Coding
Copyright 2009 Health Administration Press
3 - ‹#›
For insurance to “work,” it must have these basic
characteristics:
Pooling of losses
Payment only for random losses
Risk transfer
Indemnification
However, two problems often arise in insurance programs:
Adverse selection
Moral hazard
Insurance Concepts
Copyright 2009 Health Administration Press
3 - ‹#›
Adverse selection means those with greater risk are more likely
to purchase insurance.
The problem exists because of asymmetric information.
Insurance companies use underwriting provisions to minimize

2. adverse selection.
Cross-subsidies may exist among different groups.
Adverse Selection
Copyright 2009 Health Administration Press
3 - ‹#›
There are two opposing positions that insurers can take
regarding underwriting:
Community rating
Experience rating
Insurers also typically include preexisting condition clauses.
The Health Insurance Portability and Accountability Act
(HIPAA) sets national standards for underwriting:
Limits on preexisting conditions
Rights to purchase insurance
Consumer protection
Underwriting Provisions
Copyright 2009 Health Administration Press
3 - ‹#›
Moral hazard is the overuse of health services or forgoing of
prevention because the individual does not bear the full cost of
the consequences.
Insurers protect themselves by
deductibles,
copayment,
coinsurance,
stop-loss limits, and
policy restrictions.
Moral Hazard
Copyright 2009 Health Administration Press

3. 3 - ‹#›
For the most part, provider revenues come from third-party
payers rather than from patients.
Private insurers:
Blue Cross/Blue Shield
Commercial insurers
Self-insurers
Public insurers:
Medicare
Medicaid
Third-Party Payers
Copyright 2009 Health Administration Press
3 - ‹#›
MCOs combine insurance and provider functions.
Types of MCOs:
Health maintenance organizations (HMOs)
Provider panel
Gatekeeper
Preferred provider organizations (PPOs)
Less restrictive than HMOs
Various others
In general, MCOs attempt to limit utilization. Is this bad?
Managed Care Organizations (MCOs)
Copyright 2009 Health Administration Press
3 - ‹#›
Regardless of the payer, there are only a limited number of
approaches to reimbursement (payment for services).
There are two broad categories:

4. Fee-for-service (FFS): Payment is tied to the amount of services
provided:
Cost based
Charge based
Prospective payment
Capitation: Payment is tied to the patient population (number of
enrollees).
Reimbursement Approaches
Copyright 2009 Health Administration Press
3 - ‹#›
Payer pays all allowable costs incurred in providing services.
Typically, periodic interim payments are made, with a final
reconciliation at the end of each year.
Medicare used this method for hospital payment in its early
years (1966–1983).
FFS: Cost-Based Reimbursement
Copyright 2009 Health Administration Press
3 - ‹#›
Payer pays billed charges for services rendered to covered
patients.
Historically, all third-party payers paid for services on the basis
of charges (chargemaster prices).
Some payers still use charges as the payment method but often
negotiate a discount from full charges that usually ranges from
20 to 50 percent.
FFS: Charge-Based Reimbursement
Copyright 2009 Health Administration Press

5. 3 - ‹#›
Prospective payment methods charge a fixed amount determined
beforehand that is, at least in theory, unrelated to either costs or
charges.
Prospective payment may be
per procedure,
per diagnosis (diagnosis-related group),
per diem (per day), or
bundled (global pricing) (episode of care).
FFS: Prospective Payment
Copyright 2009 Health Administration Press
3 - ‹#›
Capitation is different from FFS reimbursement.
Payment is not tied to utilization but rather to the number of
covered lives.
Payment to providers usually is made on a per member per
month (PMPM) basis.
It is used primarily by managed care organizations.
Capitation
Copyright 2009 Health Administration Press
3 - ‹#›
Many insurers are developing reimbursement methods that
reward “performance.”
Most P4P plans provide extra amounts to providers that meet
performance goals that are usually related to quality.
The idea is to incent providers to improve quality of care.
Do P4P plans benefit insurers?
Pay for Performance (P4P)

6. Copyright 2009 Health Administration Press
3 - ‹#›
Inpatient Prospective Payment System (IPPS) is designed to
reduce Medicare outlays,
provide cost-containment incentives, and
maintain quality of care.
Hospitals are paid a fixed amount per admission on the basis of
diagnosis.
If cost is less than reimbursement, the hospital keeps the
difference.
If cost is more than reimbursement, the hospital bears the loss.
Medicare Hospital Payments
Copyright 2009 Health Administration Press
3 - ‹#›
IPPS payments are based on 334 base diagnosis-related groups
(DRGs), which are further subdivided into 745 MS-DRGs based
on complications. (MS stands for medical severity.)
Each MS-DRG has an assigned relative weight. The more
complex the diagnosis and complications are, the higher the
weight.
The DRG weight is then multiplied by an adjusted base rate
(dollar amount for the hospital) to obtain the reimbursement
amount.
Medicare Hospital Payments (cont.)
Copyright 2009 Health Administration Press
3 - ‹#›
Outlier payments:
Based on length of stay

7. Based on cost
Medical education payments
Bad-debt loss payments
Disproportionate share of low-income patients payments
Other IPPS Features
Copyright 2009 Health Administration Press
3 - ‹#›
The Outpatient Prospective Payment System (OPPS) consists of
a fixed payment amount for each outpatient visit.
There are 350 ambulatory payment classifications (APCs) for
surgical and nonsurgical procedures, visits to clinics and
emergency departments, and ancillary services.
Payment calculation is similar to that for inpatient services.
Medicare Outpatient Payments (Facility)
Copyright 2009 Health Administration Press
3 - ‹#›
Payments are made according to a resource-based relative value
system with three components:
Physician work
Practice (overhead) expenses
Malpractice insurance expense
Roughly 8,000 procedures have been assigned relative value
units (RVUs) for each of the three components.
The procedure RVU total is multiplied by a dollar conversion
factor and geographic cost index to obtain the payment amount.
Medicare Physician Payments
Copyright 2009 Health Administration Press
3 - ‹#›

8. Cost-based reimbursement: maximizes costs (quality) and
service quantity
Charge-based reimbursement: maximizes charges (price) and
service quantity and minimizes costs
Per procedure: maximizes quantity of profitable procedures and
minimizes cost per procedure
Provider Incentives (FFS)
Copyright 2009 Health Administration Press
3 - ‹#›
Per diagnosis: maximizes quantity of profitable cases and
minimizes cost per case and up-coding
Per diem: maximizes length of stay (LOS) and minimizes cost
per day
Global pricing: maximizes episodes of care and minimizes cost
per episode
Provider Incentives (FFS) (cont.)
Copyright 2009 Health Administration Press
3 - ‹#›
Capitation changes the playing field for providers.
The incentive now is to
increase the number of covered lives, and
decrease the volume of services.
Remember that under FFS, the incentive is to increase the
volume of services.
Provider Incentives (Capitation)
Copyright 2009 Health Administration Press
3 - ‹#›

9. Cost-based reimbursement: Risk is minimal.
Charge-based reimbursement: Discounts may drive
reimbursement below costs.
Per procedure: Costs per procedure may exceed reimbursement.
Per diagnosis: Costs per admission may exceed reimbursement.
Provider Risks
Copyright 2009 Health Administration Press
3 - ‹#›
Per diem: Costs per day may exceed reimbursement.
Global pricing: Costs per episode of care may exceed
reimbursement.
Capitation: Costs per member may exceed reimbursement. Here,
provider costs are driven by both volume and cost of services.
Provider Risks (cont.)
Copyright 2009 Health Administration Press
3 - ‹#›
Different payers use different reimbursement methods, so
providers face conflicting incentives and risks.
Prospective payment transfers cost risk from insurers to
providers.
Capitation transfers both cost risk and volume (utilization) risk.
Risk cannot be avoided, so it must be managed.
Provider Risk Summary
Copyright 2009 Health Administration Press
3 - ‹#›
Coding is the first step in the reimbursement process.

10. Coding is performed by administrative personnel (coders) on the
basis of clinicians’ notes.
Providers use two types of codes:
ICD codes
CPT codes
Coding
Copyright 2009 Health Administration Press
3 - ‹#›
International Classification of Diseases (ICD) codes are used to
specify diseases, symptoms, and injuries.
The codes consist of three to five digits. The greater the number
is, the more detailed the information. For example:
410 means heart attack.
410.0 specifies the anterior wall.
Hospitals use ICD codes to specify inpatient diagnoses.
ICD Codes
Copyright 2009 Health Administration Press
3 - ‹#›
Current Procedural Terminology (CPT) codes are used to
specify medical procedures (treatments).
The codes consist of five digits. For example:
99211 is a simple (short) office visit.
99215 is a complex (long) office visit.
Physicians (and other clinicians) use CPT codes to specify
procedures performed on patients.
CPT Codes
Copyright 2009 Health Administration Press

11. 3 - ‹#›
This concludes our discussion of Chapter 3 (Paying for Health
Services).
Although not all concepts were discussed, you are responsible
for all of the material in the text.
Do you have any questions?
Conclusion
Copyright 2009 Health Administration Press
3 - ‹#›
Healthcare Business Basics
CHAPTER 2
Healthcare Business Basics
Concept of a business
Legal forms of business
For-profit versus not-for-profit ownership
Organizational goals
Financial goals
Taxes
Copyright 2009 Health Administration Press
2 - ‹#›
1
Concept of a Business
A business is an entity that
raises money in the capital markets,
invests these funds in assets (land, buildings, equipment,

12. inventories, and so on),
uses these assets to create products or services, and
sells these products or services to sustain itself.
A pure charity is different. Why?
Copyright 2009 Health Administration Press
Concept of a Business
2 - ‹#›
Legal Forms of Business
There are four major categories of business organization (legal
forms of business):
Proprietorship (sole proprietorship)
Partnership
Corporation
Hybrid forms
How much does the organizational form influence the practice
of healthcare finance?
Copyright 2009 Health Administration Press
Legal Forms of Business
2 - ‹#›
Proprietorships and Partnerships
Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages:
Limited life
Difficult to transfer ownership
Unlimited liability
Difficult to raise capital

13. Copyright 2009 Health Administration Press
Proprietorships and Partnerships
2 - ‹#›
Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Cost of formation and reporting
Double (or triple) taxation for investor-owned corporations
Copyright 2009 Health Administration Press
Corporation
2 - ‹#›
Hybrid Gorms of Organization
Limited partnership (LP)
General partners have control
Limited partners are liable only for their initial contribution
Not commonly used by healthcare providers
Limited liability partnership (LLP)
Partners share general business liability
However, partners are liable only for their own malpractice
actions
Copyright 2009 Health Administration Press
Hybrid Forms of Organization
2 - ‹#›

14. Hybrid Forms of Organization (cont.)
Limited liability company (LLC)
Members are taxed like partners
Liability like that of stockholders
Professional corporation (PC) or professional association (PA)
Owners have benefits of incorporation
However, they are still liable for malpractice
Often used by individual clinicians
Copyright 2009 Health Administration Press
Hybrid Forms of Organization (cont.)
2 - ‹#›
Alternative Forms of Ownership
In most industries, the only form of ownership is the investor-
owned (for-profit) business.
However, in the health services industry, a significant
proportion of businesses, particularly hospitals, are organized
as not-for-profit corporations.
Copyright 2009 Health Administration Press
Alternative Forms of Ownership
How much does ownership influence the practice of healthcare
finance?
2 - ‹#›
Investor-Owned (For-Profit) Corporations
Investors become owners by purchasing shares of common
stock.
Primary market transactions
Initial public offerings (IPOs)
New common stock sales
Secondary market transactions
On exchanges

15. In the over-the-counter market
Stockholders have:
right of control, and
claim on residual earnings and residual liquidation proceeds.
Copyright 2009 Health Administration Press
Investor-Owned (For-Profit) Corporations
2 - ‹#›
Not-For-Profit Corporations
If a business meets certain requirements, it can qualify as a not-
for-profit (nonprofit) corporation.
These corporations:
generally have no shareholders and, hence, do not have a single
clientele to which managers are responsible;
receive various tax exemptions; and
can be thought of as being owned by “the community.”
Copyright 2009 Health Administration Press
Not-For-Profit Corporations
2 - ‹#›
Organizational Goals
The primary goal of for-profit corporations is shareholder
wealth (stock price) maximization.
The primary goal of not-for-profit corporations is generally
expressed in a mission statement, often in terms of service to
the community.
What is the primary goal of proprietorships and partnerships?
Copyright 2009 Health Administration Press
Organizational Goals
2 - ‹#›

16. Stakeholders
All businesses have stakeholders, who are parties that have an
interest (often financial) in the business.
Stakeholders include owners (if for profit), managers,
employees, suppliers, patients, and even the community at
large.
Not-for-profit managers must satisfy all stakeholders.
For-profit managers are primarily concerned with satisfying
owners.
Copyright 2009 Health Administration Press
Stakeholders
2 - ‹#›
Discussion Items
What responsibilities do for-profit businesses have to
stakeholders other than owners?
Should for-profit businesses behave ethically? If so, why?
Copyright 2009 Health Administration Press
Discussion Items
2 - ‹#›
Financial Goals
The primary financial goal of investor-owned corporations
stems from their organizational goal: shareholder wealth (stock
price) maximization.
The primary financial goal of not-for-profit corporations is to
ensure the financial viability of the organization.
Does the difference in financial goals lead to different
behavior?

17. Copyright 2009 Health Administration Press
Financial Goals
2 - ‹#›
Tax Laws
Some understanding of tax laws is necessary because taxes
influence
financing decisions,
the operating cash flows available to an investor-owned
business, and
the ability to raise contribution capital.
There are several types of taxes:
Federal, state, and local
Personal versus corporate
Ordinary income versus capital gains
Copyright 2009 Health Administration Press
Tax Laws
2 - ‹#›
Personal Taxes
Individuals pay federal (and perhaps state) taxes on salaries,
interest, and other income at rates that can approach 50%.
(Capital gains and dividends [in some years] are taxed at lower
rates.)
Taxes reduce the amount of useable income. Consider a person
paying 40% in taxes who receives $100 in interest:
Copyright 2009 Health Administration Press
Personal Taxes
After-tax amount = Before-tax amount × (1 − T)
= $100 × (1 − .40)
= $100 × .60 = $60

18. 2 - ‹#›
Corporate Taxes
Investor-owned corporations pay federal and state taxes on
corporate income at rates that can exceed 40%.
Not-for-profit corporations, for the most part, are not subject to
taxation.
Not-for-profit corporations have two additional tax benefits:
Can issue tax-exempt (municipal) bonds
Can receive tax-exempt contributions
Copyright 2009 Health Administration Press
Corporate Taxes
2 - ‹#›
Taxable Versus Muni Bonds
Assume that a for-profit healthcare organization must offer a
10% interest rate on its new bonds.
Jane Green, an individual investor with a 28% tax rate, buys
one $1,000 bond. What is the effective (after-tax) annual
interest?
AT$ = (.10 × $1,000) × (1 − .28)
= $100 × .72 = $72
AT% = 10% × (1 − .28) = 10% × .72
= 7.2%
Taxable Versus Muni Bonds
Copyright 2009 Health Administration Press
2 - ‹#›
18

19. Discussion Items
Assume that a not-for-profit healthcare organization can issue
similar-risk municipal bonds with an 8% interest rate. Should
Jane buy the not-for-profit bond rather than the for-profit bond?
At what rate on the for-profit bond would Jane be
indifferent between the two bonds?
AT% = BT% × (1 − T)
8% = BT% × (1 − .28) = BT% × .72
BT% = 8% ÷ .72 = 11.1%
Discussion
Copyright 2009 Health Administration Press
2 - ‹#›
19
Discussion Item
Not-for-profit businesses generally are exempt from local
property taxes and state and federal income taxes. Should
policymakers mandate that not-for-profit healthcare
organizations provide indigent (charity care) services equal to
the tax benefits received?
Copyright 2009 Health Administration Press
Discussion Item
2 - ‹#›
Conclusion
This concludes our discussion of Chapter 2 (Healthcare
Business Basics).

20. Although not all concepts were discussed, you are responsible
for all of the material in the text.
Do you have any questions?
Copyright 2009 Health Administration Press
Conclusion
2 - ‹#›
CHAPTER 1
Introduction to Healthcare Finance
Definition of healthcare finance
Course goal
The role of healthcare finance
Finance department structure
The health services industry
Regulatory and legal issues
Copyright 2009 Health Administration Press
1 - ‹#›
Definition of Healthcare Finance
The definition depends on the context:
Policymaker or manager
Type of healthcare organization
For our purposes, healthcare finance is the practice of finance in
health services organizations, which includes accounting and
financial management.
Copyright 2009 Health Administration Press
1 - ‹#›
Accounting Versus
Financial Management

21. Accounting concerns the measurement, in financial terms, of
events that reflect the resources, operations, and financing of an
organization.
Financial management provides the theory, concepts, and tools
necessary to help managers make better financial decisions.
Are the two disciplines independent?
Copyright 2009 Health Administration Press
1 - ‹#›
Goal of the Course
The primary goal of this course is to introduce you to the field
of healthcare finance, including
principles and concepts,
applications across a variety of provider settings, and
the impact of alternative reimbursement methods.
Along the way, some personal finance concepts are also
discussed.
Copyright 2009 Health Administration Press
1 - ‹#›
Finance Role and Activities
The primary role of finance in health services organizations is
to plan for, acquire, and utilize resources to maximize the
efficiency (and value) of the organization.
Finance activities include
planning and budgeting,
managing financial operations,
financing decisions,
capital investment decisions,
financial reporting,
financial and operational analysis,
contract management, and

22. financial risk management.
Primarily financial staff functions
Copyright 2009 Health Administration Press
1 - ‹#›
Finance activities can be summarized by the four Cs:
Costs. Costs must be continuously monitored to ensure that they
are not excessive for the number of services provided.
Cash. Businesses must have sufficient cash on hand to meet
payment obligations as they occur.
Capital. Businesses must raise the capital (money) necessary to
buy the facilities and equipment needed to provide services.
Control. Businesses must control their resources to ensure that
they are used wisely.
The Four Cs
1 - ‹#›
Importance of Finance Over Time
When most health services organizations were reimbursed on
the basis of costs incurred, the role of finance was secondary.
Today, however, the finance function has increased in
importance.
There are no unimportant functions in health services
organizations. Operations, human resources, facilities, and so
on are all essential to mission accomplishment.
Copyright 2009 Health Administration Press
1 - ‹#›
Finance Department Structure

23. Chief financial officer (CFO)
Comptroller Treasurer
Budgeting Capital acquisition
Reporting Capital employment
Payables Debt management
Financial operations Financial risk management
What about small businesses, such as a three-physician medical
practice?
Copyright 2009 Health Administration Press
1 - ‹#›
Health Services Settings
Health services are provided by numerous types of
organizations in many different settings.
Applications presented in this course include the following
settings:
Hospital (inpatient) care
Ambulatory (outpatient) care
Long-term care
Integrated delivery systems
Copyright 2009 Health Administration Press
1 - ‹#›
Regulatory Issues
Entry into the health services industry is heavily regulated:

24. Licensure
Certificate of need (CON)
Cost containment and rate review
Although regulation is designed primarily to protect consumers,
critics contend that it protects providers more than it does
consumers.
Copyright 2009 Health Administration Press
1 - ‹#›
Legal Issues
The primary legal issue facing healthcare providers is
professional liability.
In addition, other issues include
general liability,
antitrust, and
right to die.
Copyright 2009 Health Administration Press
1 - ‹#›
Current Challenges
Surveys of healthcare managers indicate the following
concerns:
Financial challenges
Level of reimbursement
Bad debt losses
Billing and collections process
Capital acquisition (raising money)
Balancing clinical and financial issues
Human resources
Nurse recruitment and retention
Other clinical employees

25. Copyright 2009 Health Administration Press
1 - ‹#›
Conclusion
This concludes our discussion of Chapter 1 (Introduction to
Healthcare Finance).
Although not all concepts were discussed, you are responsible
for all of the material in the text.
Do you have any questions?
Copyright 2009 Health Administration Press
1 - ‹#›
Chapter 3 Assignment
Points available = 35 Name
___________________________________
Please answer each question thoroughly. Once you have
finished answering the questions, please upload under Chapter 3
assignment link. Your answers will be graded using the grading
rubric below.
1. What purpose does copays and coinsurance serve?
2. Briefly explain what are the origins and purpose of
Medicare?
3. What is Medicaid, and how is it administered?
4. Briefly describe the coding systems for diseases (diagnoses)
and procedures.

26. 5. Explain the difference between MCOs and ACOs.
Grading Rubric
Criterion
Beginning (1)
Developing (3)
Proficient (5)
Distinguished (7)
(1 point)
Explanation Uninformative
(3 point)
Explanation somewhat vague or hard to follow
(5 point) Explanation Clear
(7 point) Explanation clear, authentic, and thoughtful