Shooting Yourself In The Head – PPO Fees as Percentage of Discounts

     I recently gave a keynote speech to a group of insurance brokers affiliated with the Institute for Work Comp Professionals; the talk focused on cost drivers in WC, with special emphasis on medical costs.

The part of the talk that generated the most discussion was the section on networks, and specifically how most WC networks have completely failed to reduce medical expenses.

My net is insurers are shooting themselves in the head, with a pistol provided by their managed care departments.

PPOs contract with providers to deliver services at a discount. Most PPOs get paid a percentage of the savings that is delivered by that discount, typically 15 to 22 percent of the savings. So, the more the PPO ‘saves’ the more it makes. On the surface, this sounds good: the system rewards the PPO for saving money and does not pay it when it delivers no savings.

However, a closer look reveals that when the PPO vendors win, the payer loses. The ugly head of the Law of Unintended Consequences emerges again.

At the most basic level, health care costs are driven by a relatively simple equation:

Price per Unit x Number of Units = Total Costs

Under a percentage-of-savings arrangement, reducing total cost is ignored in favor of saving money on unit costs. The PPO gets paid for savings on individual bills. Therefore, the more services that are delivered and the more bills generated, the greater the ‘savings’ and the more money the PPO makes.

The system encourages over utilization because it is in the PPO’s best interest financially to have numerous providers generate lots of bills for lots of services. Also, the providers, squeezed by a per-unit fee schedule that is lower than fee schedule/Usual and Customary Rates (UCR), have a perverse incentive to make up for that discount by performing more services.

The industry has been hit, and hit hard, by the Law of Unintended Consequences. Two of the top managed care “fixes” – fee schedules and PPOs with pricing based on percentage of savings, encourage over-utilization, a major cost driver for workers’ compensation.

It’s no wonder that most PPOs like this model, but why would any of their customers?

The simple answer is that managed care departments at many carriers and third party administrators (TPAs) are evaluated on the basis of their network penetration (the percentage of dollars that flow through a network provider) and network savings (on a per-bill basis).Their internal and external customers have bought into the per-unit discount model, and measure the success of their managed care programs on the dollars and/or bills that flow thru the network, and the savings below fee schedule or UCR delivered by the network.

The fact is few carriers, TPAs, or employers have realized that per-bill ‘savings’ is the wrong way to assess a managed care program. And unless senior management changes their evaluation methodology, their managed care departments will have no incentive to change their program to one that actually does reduce total costs.

After my conversation with a hall full of brokers, my bet is more carriers are going to be getting more questions about this.

Editor’s Note: This was written by Joe Paduda

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