How Hospital Reimbursement Does and Does Not Work

Hospitals create chargemaster prices by multiplying the cost they pay for a product by 300 to 1200%. Another little hospital secret is what is called an outlier payment…………………….

How Hospital Reimbursement Does and Does Not Work

A veteran sales negotiator provides a primer on how to understand hospital reimbursement procedures.

By Steve Reilly

For the last ten years, I have been in the unique position of helping national health plans such as United HealthCare and Blue Cross/Blue Shield negotiate hospital contracts. At the same time, I have been active in coaching medical device sales people in the field. My expertise in these two areas comes from a sales and sales management career at American Hospital Supply/Baxter Healthcare and negotiation consulting experience based on principles outlined in my 2009 book “You’re Killing Me Here!” When Win-Win Negotiation Doesn’t Work.

In my fieldwork, the most common objection used by hospital economic decision makers to avoid committing to the purchase of new capital equipment or diagnostic tests is, “We can’t add your product because our inpatient reimbursement is based on a fixed diagnosis-related group (DRG) payment.” With a few exceptions, this statement is patently false.

First of all, the only inpatient cases that are reimbursed on a DRG basis are pure Medicare patients, which are becoming more rare as Medicare pushes its members to join Medicare Advantage plans. Medicare is trying to reduce administrative costs by shifting this burden to the Blues, United HealthCare, and other commercial health plans. Knowing that commercial insurers have deeper pockets than the government, hospitals are negotiating higher reimbursement rates as a means of “cost-shifting” from less-profitable government programs.

Many such contracts include percent-of-charge reimbursement methodologies, in which payments are based on a percentage of the chargemaster. A list of items billable to a hospital patient or a patient’s insurance provider, the chargemaster is the dirty little secret hospital administrators would rather no one understand, especially hospital departments responsible for negotiating with vendors. A chargemaster price is required for all hospital billings regardless of the payor—be it the government or a commercial entity. Every hospital has a chargemaster or charge description master (CDM) list that often contains more than 45,000 line items. The CDM list includes every product, procedure, or labor cost incurred by the hospital—up to and including each aspirin, knee implant, diagnostic test, and bed linen.

Hospitals create chargemaster prices by multiplying the cost they pay for a product by 300 to 1200%. Yes, you read that correctly. For example, Meadowlands Hospital Medical Center in Secaucus, NJ marks up every product and procedure by an average of 1192%, making it the most expensive hospital in the country as measured by the National Nurses United labor union.

The other little hospital secret is what is called an outlier payment. An outlier payment is a special clause in most hospital contracts that triggers chargemaster reimbursements if the total CDM charge, not the actual cost of a procedure or treatment, exceeds an agreed upon threshold. For example, if a patient receives a total hip replacement under a commercial contract and the agreed upon reimbursement to the hospital is a bundled payment of $25,000, and if the charges (not the costs) exceed the $25,000 threshold, the entire treatment or procedure converts to a chargemaster reimbursement methodology. In many cases, the terms of a hospital contract with a payor become chargemaster payments from the very first charge! This is called first dollar threshold outlier.

What does this mean?

For one thing, it means that a hospital can increase its revenues simply by raising its chargemaster prices. Most hospitals do this yearly, triggering more outlier payments. This is one reason why hospitals raised their chargemasters by an aggregate 22% when the Affordable Care Act was implemented. They did so just to cover their bases.

For another, it means that because hospital reimbursement contracts are negotiated with each payor separately and depend on the relative leverage the hospital and health plan have with each other, every contract with every payor has different terms and conditions. And most are not based on DRGs. Because Summit Health in Northern California has incredible leverage, it can dictate its contract terms and conditions to payors. But because a small community hospital, in contrast, has little leverage, it usually agrees to what is called “standard contract language” that works to the health plan’s advantage. This level of complexity makes it nearly impossible for Hospital CFOs to figure out how much reimbursement the hospital can expect on a patient-by-patient basis.

So how can a hospital administrator or CFO track the revenue generated by inpatient treatment when every patient has a different health plan, deductible, co-pay, and hospital contract with the health plan? By using something called the cost-to-charge ratio (CTCR).

Calculating the CTCR is simple. If you know the cost of the item and the chargemaster price, simply divide the cost by the chargemaster. Thus, if a hospital pays $1000 for a device and marks it up to $10,000, the CTCR is 0.1. The lower the number, the more likely that a product or procedure is revenue positive for the hospital.

Each year, hospitals submit average CTCRs for their departments to the Centers for Medicare & Medicaid Services. Published in the American Hospital Directory, these data are public. But for some reason, medical device companies do not know how to use these numbers to defend their prices. Most hospital labs have an average CTCR ranging from 0.2 to 0.09, making them one of the most profitable hospital departments, along with surgery, anesthesiology, and radiology. Typical revenue drains, such as labor and delivery departments, can have an average CTCR ranging from 0.9 to 1.5—clearly a less than profitable source of hospital revenue.

Most medical device manufacturers are unaware of the role that hospital chargemaster plays in evaluating new medical device technologies, although it is the most important number to hospital financial decision makers. Thus, many device manufacturers maintain entire departments dedicated to calculating length-of-stay reductions and the impact of lean techniques on labor costs. They also have teams that try to negotiate higher reimbursements at the Medicare level when a simple cost-to-charge analysis would do the job much quicker.

When working with medical device reps, I can quickly overcome a hospital’s cost objection by simply showing it that the amount of revenue it stands to gain from using a product far exceeds the actual cost. And while lower-level hospital decision makers may not understand the numbers, their bosses will.

Steve Reilly can be reached at