Gauging the fallout from
  outpatient PPS

November 2000
Cover Story

Anne Paxton

When it ordered the use of diagnosis-related groups to pay flat rates for inpatient care in 1983, Congress hoped it had found a way to tame skyrocketing Medicare hospital costs once and for all. But while prospective payment was successful, it had one major side effect: It encouraged hospitals to shift many procedures from inpatient to outpatient care.

Now, 17 years later, the other shoe has dropped. Aug. 1, 2000 marked the first day of the new outpatient prospective payment system and the deepening of hospital fears for their financial solvency as they face the virtual end of cost-based reimbursement. For pathology, the main story has been the "rebundling" requirements for independent laboratories that furnish anatomic pathology services to hospital outpatients. Because of outpatient prospective payment, beginning in January 2001 independent laboratories can no longer include the technical component, or TC, in their bill to Medicare. A new physician fee schedule rule set the same requirement for inpatient services. So for both inpatients and outpatients, the independent laboratory will have to negotiate the TC payment with the hospital.

But some experts believe that the potential impact of outpatient PPS on pathology goes far beyond the technical component issue. "APCs [ambulatory payment classifications] are the DRGs of the outpatient world," declares Robert DeCresce, MD, director of laboratories at Rush-Presbyterian-St. Luke’s Medical Center, Chicago. "This is an enormous change, just as big as DRGs were, and it’s going to really knock hospitals for a loop."

"I think in the laboratory we tend to focus very narrowly on what’s going to happen specifically to our CPT codes," says Dr. DeCresce. "My bigger concern, quite honestly, is that APCs are going to have a very negative effect on hospitals’ overall financial position. When you’re a pathologist, you’re in a hospital-based specialty, and you need the hospital to be healthy."

Mandated by the Balanced Budget Act of 1997, outpatient PPS pays hospitals set amounts for each of 451 ambulatory payment classification groups. Using the median of 1996 outpatient costs reported by hospitals, with adjustments for inflation and regional differences in wages, Medicare has set fixed payment rates for each APC. If the outpatient care costs less, hospitals can keep the excess; if it costs more, hospitals must absorb the loss. As with DRGs, the Health Care Financing Administration hopes that prospective payment will give hospitals incentives to keep outpatient care costs under control.

There isn’t a wholesale transition to the new system. While anatomic pathology is included in outpatient PPS, clinical laboratory services will continue to be paid under the Medicare fee schedule. "Critical access" hospitals will be exempt from outpatient PPS, and small rural hospitals are guaranteed at least their pre-PPS payment levels until 2004. APCs also won’t take full effect immediately. In the first year, payment will still be mostly based on cost, and only a small percentage on the APC. The APC will be phased in over three years. "It’s the exact same way they started DRGs," Dr. DeCresce says.

The College has been concerned that the new TC payment provisions included in outpatient PPS will squeeze laboratories that have filled a critical need in local communities. Since small hospitals often cannot afford their own histology departments, arrangements under which hospitals send out technicals to local pathologists have been around since the beginning of the Medicare program.

Earlier this year, the CAP’s request that HCFA exempt existing arrangements from technical component billing was denied. Thus, the College has been lobbying for congressional action to add a "grandfather" clause that would allow independent laboratories to continue receiving direct TC payments if they had arrangements with hospitals to provide inpatient TC services in effect on July 22, 1999.

Outpatient PPS was on the drawing board for years as a means of stemming growing costs. While DRGs brought inpatient expenses under control, Medicare outlays for hospital outpatient-care charges rose 13.4 percent annually from 1984 to 1994, when they hit $11.9 billion. In 1998 they were $18.6 billion-about 17 percent of total Medicare payments to hospitals.

"The big push with DRGs was to do more outpatient surgery," Dr. DeCresce says. "And as more and more things moved from a DRG-controlled environment to the outpatient environment, hospitals have been able to make more money. But this is going to change under the new system."

It wasn’t just the modified cost reimbursement by Medicare that made outpatient medical care one of the more profitable sectors of hospital services, he adds. It was also the way copayments were structured. "The copayment really has not been based on cost but based on charges, so hospitals have actually been able to get far more on outpatient because of the way the copayment system works. If Medicare determined the hospital reimbursement for outpatient surgery was $6,000 based on costs, it would pay 80 percent of that. But when the hospital billed the patient it would bill 20 percent of the actual charge, which could be much higher than $6,000."

In the government’s view, those copayments have been more than twice as high as they should be. As of Aug. 1, HCFA froze copayments at current levels, which are estimated to run at about 47 percent of Medicare payments under the new system. Gradually over the next several decades, that percentage will be cut under APCs, so that eventually the hospital will be able to collect only 20 percent of the Medicare fee schedule for the APC.

A major factor behind outpatient PPS was the desire to reduce patients’ outlays, Dr. DeCresce says, and because patients will be saving money, politically there is not going to be much chance for hospitals to get relief. With lower copayments, "The patients are coming out ahead—but it’s coming out of hospitals’ hides." And although APCs apply only to Medicare, he predicts third-party payers won’t take long to adopt them. "It’s inevitable that other insurers are going to pick up on it and start reimbursing hospitals the same way."

Larry Peterson, president of Torrey Consulting Group, El Paso, Tex., says hospitals will have new incentives to sharpen up their accounting under APCs. Inpatient DRGs encouraged a certain sloppiness in both inpatient and outpatient charges, he contends. "Under DRGs, it’s academic whether you charge with precision or not, because all you have to do is identify the proper DRG code for the case. If a hospital just had one large charge for the preparation of blocks and slides, and then wasn’t that accurate about charging for special stains and other services, it didn’t really matter."

"When you look at the hospital in totality, the anatomic laboratory is such a small part," Peterson points out. "The whole laboratory accounts for only three to five percent of the hospital’s costs, so most hospital CFOs don’t pay attention to details of laboratory operations compared to other areas. Many CFOs just assumed the whole laboratory was subject to the fee schedule, so these anatomic services were not properly identified in the cost reports during the last seven years."

Because the government has now assigned fixed payment amounts, however, "the hospital will have to have precision in charging or else it won’t recover its costs." That upgrade will include adding several CPT codes in pathology, he says. "Out of the CPT codes related to non-fee schedule laboratory services there are about six or eight that many hospitals don’t have in their chargemaster. Most of them relate to a report-only on the part of the pathologist."

In the past, those codes were considered professional services only. But the codes have a technical cost. "If you dictate a report on a transfusion reaction, there are transcription costs as well as computer costs. The same applies to code 80500, which is a consultation. So these codes fall within the APC even though they relate to clinical pathology rather than anatomic."

The way many hospitals prepared Medicare cost reports ended up diluting the real cost of anatomic pathology, in some cases producing ridiculous data, which HCFA used as the basis for setting the APC payments, Peterson adds. "When you look at the range of costs HCFA had in its database for CPT code 88305, the bread and butter code for pathology, the costs range from $2.39 to $199.96." After weighting the claims in the sample, HCFA ended up with a payment of $21.82.

Despite such anomalies, Peterson believes there is some hope payment for anatomic pathology will improve. "With permission from the fiscal intermediary, hospitals can file their cost reports for open years as well as the current and future years using the more definitive accounting, and there are obvious benefits in that. As you move forward, the APC prices now in place are not locked in," he explains. HCFA is telling hospitals to bill according to the APC groupings now, but at the end of the year the agency will look at the hospital cost report, then give back 80 percent of the aggregate difference between the old cost-based outpatient reimbursement and the new APC payment reimbursement. To adjust the APCs properly, Medicare needs refined data, he says. "The government, in effect, is paying, even bribing hospitals to give them cost and charge information the way the government wants it."

Hospitals have to totally revamp their billing systems, Dr. DeCresce agrees. At Oak Park (Ill.) Hospital, adapting to APCs has meant completely redoing the chargemaster, then re-inputting that into the billing systems, and hiring additional coders to turn physician descriptions into billable services, says Bruce M. Elegant, president and CEO.

Complicating the claims process is that some procedures have migrated out of the inpatient sphere since 1995, while others didn’t make the cut under APCs and will have to be performed on inpatients only. "It’s an oddity under APCs," Elegant says. "There are several dozen things we were coding as outpatient that HCFA now will not pay for unless they are done as inpatient procedures. The reason is they did not have enough claims experience to be able to determine what the payment rate should be." Pacemaker insertion, for example, after which a stable patient might be sent home in less than 24 hours, is now only reimbursable as an inpatient procedure.

Sheer paperwork is going to account for a significant part of the added cost of outpatient PPS for laboratories, says Joe Plandowski, president of Lakewood Consulting Group, Lake Forest, Ill. "A reference laboratory, instead of billing the hospital monthly, will actually have to bill daily, because the hospital will need this information in order to bill Medicare. That means the reference laboratory costs for billing will escalate dramatically." A "sleeper" issue, he adds, is the 72-hour rule. "There is a problem if the patient had a test done, then was admitted to the hospital within the 72-hour window." In that case, the test would no longer qualify as an outpatient test. "How do you sort through the mechanics of getting payment when that happens?"

Peterson says pathology groups that subcontract with large independent laboratories may face significant changes under APCs. One national laboratory has already decided it cannot split the bill for anatomic pathology services, and has notified hospitals it will bill them the global fee, he reports. "Some hospitals probably will decide to find a pathology group that will actually split the bill, so the national lab will probably lose those hospitals. They may not lose the clinical work, but they will probably lose the anatomic work. It’s just so small, compared to their total business, that the complexity presented doesn’t warrant the attention."

In examining his clients’ data, Peterson has determined that the Medicare physician fee schedule TC generally produces about 10 percent higher payments for independent laboratories that have been billing the global fee to the government than the APC fee schedule will-depending on the service mix at each hospital. "It swings around to a break-even situation if you don’t include flow cytometry and immunoperoxidase stains," he says. But APCs are a "moving target"; because they will be recalibrated each year, he expects that four years from now, they will be roughly the same as the Medicare technical fee schedule.

Hospitals, however, are already under financial pressure. Aggregate total profits for hospitals fell to 2.7 percent last year, down from 3.9 percent in 1998 and six percent in 1997, according to the federal National Health Indicators Survey, which looks at 1,200 facilities. The Medicare Payment Advisory Commission, an independent federal body established to advise Congress on Medicare issues, says that based on preliminary cost report data, 34.2 percent of hospitals lost money in 1999.

Hospitals are not going to give a lot of ground in negotiations with laboratories, Plandowski predicts. On CPT 88305, for example, the technical component reimbursement is $31.12. "Now when the PPS rules go into effect, that $31.12 will not be paid to the reference laboratory but to the hospital. The reference laboratory is supposed to go to the hospital and negotiate some technical fee, and the laboratory will probably say, ’Look, we got $31.12 in the year 2000 and that’s what we’d like in 2001.’"

"However, the hospital will say, ’Wait, the APC payment for 88305 is $21.82. Now how do you expect us to pay you $31.12 when we only get $21.82?’ That’s a 30 percent decrease. The hospital’s position is going to be, ’The most we can ever pay you is the APC rate.’ So you see how roughly $10 got taken off the table in this transaction."

Consultant Joan Logue says APCs increase the pressure on pathologists that have spun off an anatomic pathology business and are serving as an independent reference laboratory to hospitals. "I think the problem is that on the physician fee schedule the TC portion went up last year," says Logue, who is a principal with Health Systems Concepts Inc., Longwood, Fla. "Now, is the hospital going to be willing to pay at that same rate? It’s more than likely the hospitals are going to want to negotiate that down."

APCs will affect some pathology services companies more than others. Dianon Systems Inc., Stratford, Conn., gets a majority of its anatomic pathology business from independent outpatient facilities like surgi-centers and physician offices, says its president and CEO Kevin Johnson. With most of Dianon’s pathology revenue derived from non-hospital settings, "APCs will have little to no effect on our company," Johnson says, predicting that companies that are highly reliant on hospital-based pathology will bear the brunt of the revenue cuts.

Plandowski says, "The places that will get hurt are laboratories like IMPATH, which focuses on anatomic pathology, more than general reference laboratories like Lab Corp."

Alan Levin, MD, chief operating officer of AmeriPath Inc., Riviera Beach, Fla., predicts outpatient PPS will have a minimal impact on his company, which provides integrated anatomic pathology services to hospitals, managed care organizations, physicians, and national clinical laboratories in 14 states, including 29 outpatient laboratories, 165 hospital locations, and 57 outpatient surgery centers. "We have been working with our hospitals since the beginning of the year on reimbursement methodologies for the technical component, and so far we haven’t had any major stumbling blocks. Our financial people have looked at this pretty carefully, and they don’t see a major impact on our company going forward."

"I’m sure some of the negotiations [with the hospitals] will be more difficult than others," he concedes. But he believes the company can insist on being paid fairly, in part because of federal compliance guidelines. "There are fraud and abuse concerns if we are providing services below cost," Dr. Levin points out. "And we take that pretty seriously."

For at least some hospitals, prospective payment may be a boon to the bottom line. "Clearly there’s an opportunity under APCs," says Dr. DeCresce. "In fact, if you can do procedures for less than the APC payment, you can make money." By the same token, it’s possible that surgi-centers will be able to take some business from the hospital. "You may see a movement of certain things away from hospitals," he says, "because all of a sudden the other guy can make money on it."

"Of course it changes the competitive situation," Oak Park Hospital’s Elegant agrees. "Teaching hospitals like Rush-Presbyterian-St. Luke’s have by and large been the hardest hit by the Balanced Budget Act, and this is just one more negative reimbursement change they have to cope with." Non-teaching hospitals like Oak Park, on the other hand, are expected to see a small increase in payment for the first year, he says, "but it’s too soon to know if that [prediction] is accurate or not." APCs will not change the current pattern of consolidation, he believes. "Hospitals are extremely resilient institutions. In many cases they’re the largest employer in the community and they’re very difficult to close. For that reason, I don’t think you’ll see a large number of closures," says Elegant. Large numbers of hospitals have negative operating margins, and he says reorganization and changes in ownership are more likely.

Dr. DeCresce urges pathologists not to lose sight of their basic source of income. "Outpatient care is one of the last remaining areas for hospitals to make money-and that’s going away," he maintains. "If we focus on the technical component changes and how they affect us, we may win the TC battle, and that’s great, but that doesn’t help us if the hospital is mortally wounded.

"Let’s imagine APCs were great for pathologists; say they made more money," he continues. "I’d still be very nervous, because if the hospital goes broke, it doesn’t do me much good."

Plandowski is more sanguine about the downstream impact of APCs on both independent laboratories and hospitals. "Pathologists still get to bill the professional side. That’s unaffected by what’s going on with APCs," he says. "And I think efficiently run hospitals will do okay. When DRGs came into play we all thought hospitals would disappear from the face of the earth," he recalls. "But what they did is specialize in certain areas, phase out of some surgery, and so on. They became more focused and got rid of a lot of the ’fluff,’ the areas it was nice to be in but without the critical mass. But it took a number of years for that to happen."

He predicts the same outcome with APCs as hospitals take a closer look at their outpatient services. "Maybe they’ll bleed for a year or two, but eventually they’ll straighten out one way or another."

Anne Paxton is a freelance writer in Seattle.