Managed Care, Prospective Payment, and Reimbursement Trends



A Concern for Costs

It's an interesting fact that, even though cost containment is the driving force in health care, we always have a difficult time identifying people who can write good chapters about health care costs related to nursing. Not many nurses have developed programs of research or careers around nursing economics. Until recently, this was not a subject that was taught in many schools of nursing or a source of concern for many nurses. Things have changed. The concern for costs is determining a number of decisions that affect nurses and our patients. This section introduces some of the issues around the costs of nursing and health care.

In their debate chapter, Seefeldt, Garg, and Grace overview the two major approaches to the control of health care costs: regulation and competition. This is a very informative chapter and contains a clear overview of a number of cost-control initiatives. Total U.S. health expenditures grew from $41.9 billion in 1965 to $425 billion in 1985. The authors review the various regulatory (government intervention) initiatives of the past 30 years: certificate of need, economic stabilization program, professional standards review organization, prospective rate setting, and prospective payment systems. In the past two decades competitive approaches, such as competitive contracting, managed care and health maintenance organizations, preferred provider organizations, cost sharing, medical savings accounts, and managed competition, have been used to supplement or supplant regulatory approaches. Each of the regulatory and competitive approaches is described with some information about its advantages and disadvantages. Despite all of the approaches, the major problems remain: escalating costs, increasing numbers of individuals without any insurance, and uneven access and quality of care. The Medicare population is using resources at a much higher rate than their contributions; the Medicaid program is now funding more elderly care than care of children. The solutions to the problems, according to the authors, do not lie with government or insurers or providers or employers, but with the consumers of health services. Yet, they point out, the consumer is not part of the debate. Seefeldt, Garg, and Grace want to end the outdated model of health care in which "professionals are the all-knowing" and empower the people. They believe that until the consumer becomes an active partner in the system, the problems are insoluble. The chapter provides an excellent overview of past measures to control costs and raises many important issues that should be carefully digested and debated.

In the first viewpoint chapter Maddox examines the evolution of managed care, the financial factors that have created the current health care system, and the impact of the changes on nursing. The chapter contains numerous financial facts. For example, in the past the categories of services generating the most growth in expenditures were hospitals and physician cost, but since 1998, the fastest rising spending category is prescription drugs. Maddox demonstrates that the federal government is increasing its role in the financing of U.S. health services. She covers the evolution of the third-party pay system and clearly explains the functions of Medicare and Medicaid and prospective payment systems. She overviews the different models of managed care and discusses in some detail the preferred provider organization (PPO) and the health maintenance organization (HMO). She spends the last half of her chapter discussing the impact of managed care and current reimbursement methods on hospitals, ambulatory and outpatient services, long-term care, nurse staffing, and selected nursing roles such as the advance practice nurse and the nurse manager. Three utilization management strategies are discussed: prospective, concurrent, and retrospective. The Balanced Budget Act of 1997 brought several changes, including the recognition of nurse practitioners, clinical specialists, and physician assistants as authorized Medicare providers, eligible for direct reimbursement. But with this new role comes increased responsibility for the provider. This is an informative chapter about the history and current issues related to reimbursement trends in the United States and the impact on health care and nursing.

The cost of home care for a person with a disability is the topic of the next chapter by Aronow. This is an increasingly important topic in nursing because the number of persons in society with a disability is growing. The increase is due to the aging of society and the better survival rate of those with a disability. As Aronow states, the reorganization of care away from large institutions and toward home care and homelike residences requires a clear analysis of services and costs to the disabled community. Aronow structures her chapter by four types of care in the home: short-term recovery, long-term care, technology-supported care, and end of life care. For each type of care she presents a patient example and discusses the components of cost. She concludes her chapter with a discussion of the responsibilities of professionals. Whereas the home has become a viable alternative for care of persons with disabilities, the cost of home care is not well understood. She believes that the nurse has some responsibility to help explain costs associated with alternative choices and that the nurse should be prepared to become a part of the family negotiations that involve the patient and the informal caregivers. The chapter provides an excellent overview of the financial and care burden issues related to caring for a variety of diverse patients in the home.

As the previous chapter illustrates, it is more important than ever that nurses understand the business aspects of health care. A different example of this is illustrated in the next chapter by Klemczak and Dontje, who discuss the need for sound business practices in the development and conduction of nursing centers. A nursing center is an organization, controlled by nurses, whose primary mission is to provide nursing services. Although nursing centers have existed for many years, usually attached to schools of nursing, most of them were supported by grants and did not have to be concerned about income generation. As these grants are being reduced or eliminated, the centers are left with commitments and few funds to deliver services. With the 1997 Balanced Budget Act that changed the Medicare law to designate advance practice nurses (APNs) as reimbursable Part B providers, nursing centers that employ APNs can seek new types of funding. Klemczak and Dontje urge existing nursing centers to expand the services they offer to include a complete set of primary health care services, including health screening, testing, prescribing, treatment, referral, case management, and patient teaching. They discuss reimbursement of these services under capitation contracts. The last part of their chapter is a case study of the development of a nurse-managed center at the College of Nursing at Michigan State University. The college has a contract with the Office of Veterans Affairs in Battle Creek to provide primary care services to veterans living in the surrounding community. The authors discuss this experience and conclude with related issues and challenges.

Reimbursement for nurses and other nonphysician providers is the subject of the chapter by Lee. The proliferation in consumer use of alternative therapies, such as autogenic training, biofeedback, massage, acupuncture, Ayurvedic techniques, and reflexology, to name a few, has resulted in the recognition that there needs to be a way to document the use of such therapies and bill for reimbursement as they become more accepted. Consumer demand for alternative therapies has been so dramatic that they are increasingly being included in mainstream practice and medical journals. In 1996, the Health Insurance Portability and Accountability Act called for the setting of a national standard to communicate with all providers (not just physicians) electronically in a standardized way. This act combined with the widespread and growing dissatisfaction with the Current Procedural Terminology (CPT), currently the only coding system approved for Medicare reimbursement by the Health Care Financing Administration (HCFA), opened the door for the development of the Complete Complementary Alternative Medicine Billing and Coding Reference. The Reference, published for the first time in 1999, includes Alternative Billing Codes (ABC Codes) developed by a group known as Alternative Link in Las Cruces, New Mexico. In this Reference, alternative is defined as any provider other than an allopathic physician and the treatments provided by these providers. Thus, nursing is included (although most nurses do not think of themselves as alternative providers). The ABC Codes do include interventions from the Nursing Interventions Classification (NIC), the Home Health Care Classification (HHCC), and the Omaha System. Although the system has not yet been adopted by HCFA for reimbursement, the ABC Codes have been included in the American National Standards Implementation Guideline and the National Library of Medicine Unified Medical Language. The system not only includes language for thousands of alternative therapies, it provides the legal scope of practice for multiple practitioner groups. It will be interesting to see future developments in this area. Will HCFA approve the use of this Reference for reimbursement to alternative providers? If not, how will the growing use of alternative therapies be documented?

The last chapter in the section by Schmidt overviews the financial skills needed by patient care managers. As the role of the nurse manager has grown and become more challenging, the need for financial skills is essential. Schmidt discusses the prerequisite computer skills including spreadsheet applications. She overviews the budget measures of volume, revenue, and labor and nonlabor expenses. She shows how to operationalize the budget with a staffing plan. Several types of productivity measures are defined and four types of analyses are reviewed that can be used to help evaluate cost and productivity performance. These are staffing-to-demand analysis, productivity benchmarking, use of labor dollars analysis, and workforce composition. Schmidt's chapter provides an excellent overview of the financial skills a nurse manager must have to be an effective leader and manager in the ever evolving complex health care environment.

Nursing's ability to identify and deal with economic issues has come a long way in the past decade. More and more, all nurses and nursing students are gaining knowledge about costs of health care, but nursing is still not a major player in health care cost-containment efforts. We need to make the concern for costs a nursing concern and voice this concern and appropriate actions whenever the opportunities arise.

Controlling Health Care Costs

Regulation vs. Competition

The issue of controlling health care costs hits at the heart of a major social dilemma that grows out of the American character and the values surrounding the practice of medicine: the rights of the individual versus responsibility for the larger social group. The tensions between balancing individual rights against the common social good become compounded in the area of medical care because the physician and, more recently, the provider organization become the arbiter between the individual and society. Although there was a time when the physician could make decisions largely on the basis of what was deemed best for the patient, today's concerns over the rising costs of medical care services and the large numbers of people without access to these services have made it increasingly difficult to practice in this simplistic manner. With the costs of medical care rising far more rapidly than those of other parts of the economy, the concern for controlling these costs has become an increasing preoccupation in recent years.

Before the 1960s, most medical care costs were covered by insurance that was provided as part of the benefits package paid by employers for their workers. This system worked effectively for those who were employed and provided reimbursement to physicians and hospitals in a satisfactory manner. Over the years, however, an aging population, increased numbers of people who are not part of the workforce, and increasing costs of insurance to employers have resulted in a situation open for governmental intervention. The enactment of Medicare and Medicaid legislation in 1965 signaled the beginning of a new chapter for medical care in this country. The intent behind Medicaid and Medicare was to provide health care to the two most vulnerable groups: the elderly and the indigent who were not covered by employer-provided health care insurance and were unable to pay out of pocket. In effect, the federal government became the insurer for these uninsured populations. Soon after the enactment of these programs, it was realized that health care expenditures were rising much faster than the economy, and initiatives were undertaken to address the issue. The agreed payment system based on "reasonable" costs for hospitals and "reasonable prevailing charges for physicians" provided little incentive for patients or providers to control health care costs. Over the past 30 years a variety of legislative approaches have been taken to try to control escalating costs. A systematic display of major initiatives is presented in Figure 51-1. These approaches can be classified either as competitive, describing a condition of the workings of the free market in which the unfettered private sector forces of supply and demand determine the most efficient allocation of resources, or regulatory, which assumes that market forces function imperfectly and that government intervention is required to control costs. This chapter reviews the approaches taken and encourages the reader to consider the pros and cons of regulation vs. competition in controlling medical care costs.


The reimbursement system of Medicare and, to some extent, Medicaid, which was based on "reasonable charges," created intense inflationary pressure on health care costs. Earlier, much of the health care for the elderly had been offered as charity and was not reimbursable. In addition, there had been no incentives to add new expensive procedures before Medicare. That changed dramatically. Substantial reimbursement was available for increasing hospital revenue for providing additional procedures requiring new staff and equipment. By creating a surplus of income over revenues, this money went back into fur ther expansion of facilities and staff, ultimately resulting in increased cost.

 This increased cost, which was not retrievable from public sources, was then passed on to private patients and their insurers, creating inflationary pressures on the entire system. Total health expenditures grew from $41.9 billion in 1965 to $425 billion in 1985. This increase occurred despite governmental efforts to control costs. From 1971 to 1983 the major efforts to control costs were through regulatory efforts. None appreciably slowed the growth in total health care costs

Certificate of Need

One type of intervention used the strategy of controlling the structure of medical care (i.e., the settings and instruments available and used for the provision of care) by limiting the development of hospital capacity. Built on a certificate of need (CON) law initiated in New York State in 1964, Congress in 1972 passed amendments to the Social Security Act to give planning agencies more authority. In 1974, Congress passed the National Health Planning and Resources Development Act, which required every state to pass a CON law allowing it to review plans by any institutional provider for capital expenditures over $150,000 or a change in the number of beds and services. The impact of CON programs was minimal. A number of studies indicate that the review boards passed nearly everything that was brought to them (Begley, Schoeman, & Traxler, 1982; Lewin Associates, Inc., 1975; Salkever & Bice, 1976; Sloan & Steinwald, 1980). However, one side effect of the CON program was that hospitals gained sophistication about market conditions, long-range planning, and resource use-expertise easily adapted to a competitive market.

Economic Stabilization Program

This program, introduced during the Nixon administration, was developed in two phases. Phase 1 (August 15, 1971, to November 13,1971) involved a 90-day freeze on all wages and prices, and phase II (November 14,1971, to April 30,1974) limited institutional health care providers to a 6% annual limit in price increases in aggregate revenue, subject to cost justification. These controls applied to both hospital and physician fees. The Economic Stabi lization Program appears to have moderated both the increase in average cost per hospital day (Salkever, 1979) and also the growth of physician fees; but there is some evidence that while fees were frozen, physicians classified visits into more expensive categories, thereby holding the line on price while allowing revenues to increase (Holahan & Scanlon, 1978).

Professional Standards Review

The quality, quantity, and cost of hospital care provided under Medicare was to be monitored primarily through mandatory establishment of utilization review committees in participating hospitals Through review processes conducted under the supervision of physicians, their function was to control medical services such as admissions, diagnostic investigations, and therapeutic interventions provided by physicians to their hospitalized patients. A 1970 Senate Finance Committee Report judged the utilization reviews to be of a token nature and ineffective as a curb to unnecessary use of institutional care and services. The criticism of the utilization review led the American Medical Association to propose a Medicare peer review system to be controlled by the medical societies. Legislative action led to the establishment of professional standards review organizations with responsibility to review hospital care under their jurisdiction, with particular emphasis on the appropriateness of admission and the length of stay for hospitalization. Evaluations of the program are mixed, with one study concluding that the savings to Medicare and Medicaid exceeded the cost of the program by 10% to 15% (Smits, 1981), whereas another study concluded that it cost Medicare and Medicaid an estimated $1.80 for every $1 the program spent (Alpem, 1980).

 Prospective Rate Setting

By 1980, most states had some form of hospital rate-setting program, but the programs varied considerably. Most were voluntary, with hospitals choosing whether to participate or comply. Only eight states had programs that involved mandatory review and compliance with rates set by a rate-setting authority. Mandatory rate-setting programs initiated by several states resulted in slowing the rate of growth of expenditures per patient day.

Prospective Payment Systems

In 1983, Congress established the Medicare Prospective Payment System (PPS), which replaced retrospective cost-based reimbursement for hospital care. The primary objective was that of controlling escalating hospital costs. Under the PPS, inpatient hospital services for Medicare eligibles were bundled into 468 diagnosis-related groups, each with a fixed reimbursement schedule. Adjustments were made for important factors such as case severity; rural, urban, and regional labor cost differentials; teaching costs; and disproportionate shares of uncompensated care. During the first 3 years of the PPS, inflation in hospital expense was reduced by about 5% to 7% from the pre-PPS double-digit levels.

Despite these major regulatory programs, health care costs continued to escalate at a higher rate than the general economy. Expenditures for health care in 1985 totaled $420.1 billion compared with $74.4 billion in 1970. The share of health care expenditures as a percentage of the gross national product increased from 7.3% in 1970 to 10.5% in 1985, with hospital expenditures accounting for 40% of all health care spending.


As health care costs have continued to escalate in the past two decades, attempts to contain costs by restructuring the health care market to make cost-effective competition possible have supplemented, and in some cases supplanted, the regulatory programs described previously. For economists, competition in a perfectly competitive or "free" market implies rivalry between sellers of comparable goods for customers. Customers will then choose the goods that cost less, knowing that they are not sacrificing quality, and thus the operation of the market encourages suppliers to keep prices down. The model of free market competition fully applies only when all product attributes other than prices are standardized. Obviously, many of the products in health care are not standardized.

A modified form of competition can occur between suppliers of noncomparable products in a particular market, but there is no guarantee that this kind of competition will result in lowered prices. This modified form of (nonprice) competition did occur among health care providers during the regulated era that followed the enactment of Medicare in 1965. During this period, hospitals competed for doctors and patients primarily on the basis of availability of sophisticated diagnostic and therapeutic technology. Patient comforts such as food quality, friendliness of staff, and cleanliness also played a major role in attracting patients to a particular facility. Despite nonstandardized "products" (in this case medical services), prices may have played a role in the competition if patients paid their own bills. However, during this period most patients had insurance, so price did not play any role in their choices. Thus, relevant competitive variables included service offerings and amenities but not price. Furthermore, as third-party payers, health insurance companies did not promote price competition because they were not able to exclude providers on the basis of price. Hospitals and physicians were reimbursed on a "reasonable costs" and "reasonable charges" basis, respectively, but there was no competitive mechanism preventing "reasonable costs" from rising over time. Several factors such as collusion within the medical profession promoted increasing costs.

Competitive Contracting

In 1982 the State of California enacted legislation providing a mandate for "selective contracting." This approach was designed to reshape the health-care market by enabling third-party payers to legally exclude providers from their list of participants without significant risk of antitrust prosecution. Under this legislation, both private and public payers, including health maintenance organizations (HMOs) and preferred provider organizations (PPOs), could negotiate terms and conditions with specific providers such as physicians or physician groups and hospitals, who they would reimburse for services to their subscribers. Two hundred fifty hospitals negotiated agreements with the state to provide services to Medi-Cal eligibles (Medicaid) and accepted reductions in their normal payments ranging from 5% to 20%. As a consequence of the selective contracting, California saved an estimated $470 million in fiscal year 1983-1984 (Iglehart, 1984). Following the trend set by California, other states began to follow various forms of competitive contracting.

Managed Care and HMOs

The main feature of managed care that distinguishes it from retrospective and fee-for-service payments is that payment under managed care is prospective and capitated. Under such a system the financial risk no longer resides with the patient or the third-party payer as distinct from the provider; instead the managed care entity becomes a financial risk bearer, as well as a patient care provider. This means that the organizational focus of care shifts from individual illness care to concern for the health of a defined population: the membership of the plan or HMO. The incentives shift from performing unreviewed, high-intensity patient care to a case management function in which primary care providers coordinate all care and limit access to costly specialization and hospitalization.

Preferred Provider Organizations

Changes in state insurance laws have permitted payers to contract selectively with providers such as hospitals and physicians' groups, including those not run by HMOs. Under such schemes most payers have started identifying a subset of hospitals and physicians to be "preferred providers" on the basis of a predetermined rate of reimbursement. Patients are steered to those hospitals and physicians through financial incentives such as lower copayments and deductibles. The providers sign agreements with payers to deliver services to their enrollees and are designated as preferred providers, and the organizations are designated as preferred provider organizations. To select these preferred providers, payers generally demand price discounts or strict utilization review procedures from the providers.

Cost Sharing

Cost sharing through increased coinsurance and larger deductibles is a relatively simple plan for providing disincentives for overuse of the system by insured individuals by requiring them to pay more out of pocket. This approach addresses the concern that third-party payment shields the patient from the costs of his or her care.

Medical Savings Accounts

If cost sharing means that individual consumers have to pay more out of their own pockets, it becomes a matter of concern how deep those pockets are. Cost sharing as a form of cost containment will not work if consumers cannot pay their bills. The concept of medical savings accounts (MSAs) was developed as a type of cost-sharing program that encourages people to save to pay for their own health care costs, thus ensuring that the money to pay health bills will be there when they need it. This is how the MSA would work. Currently, on average, nearly $4,500 per year per worker is paid by employers for health insurance. Of this amount the employer would put $3,000 annually into each employee's MSA, which the employee would use to pay the first $3,000 of his or her medical costs. For the remaining $1,500 the employer would purchase an insurance policy that would take care of medical expenses above $3,000. It is recommended that (1) an MSA would be the personal property of the employee, so that it would be portable if the individual changed jobs, (2) an MSA would be allowed to grow tax free, and (3) the employee would draw from it to pay for medical expenses. Under this arrangement, MSAs will provide consumers with built-in incentives to control health care expenditures because they will benefit directly if they spend less.

Problems of Competitive Systems

In a competitive environment, it is the firm or organization that maximizes profits that succeeds at the highest level. Health insurance companies wishing to maximize their profits can do so either by operating at a higher level of efficiency and effectiveness than their competitors or by practicing risk aversion to the highest level possible. Finding ways to avoid insuring the few very sick people can be very rewarding. Insurers practicing risk aversion as their main profit-making approach exclude individuals on the basis of preexisting conditions or by having coverage canceled midtreatment when unexpected illnesses become too large a financial liability to the firm. HMOs are accused of taking only young, healthy members of the workforce, whereas some firms have had their coverage canceled if one worker or his or her dependent is too great a financial risk.

The costs of health insurance have escalated commensurate with increases in the cost of care. An increasing percentage of the population has no health insurance coverage. Of those earning less than $10,000 per year, 32% are uninsured (Wicks, Curtis, & Haugh, 1994). Many businesses that once provided health insurance can no longer do so. Increasing numbers of individuals are employed on a part-time basis, and thus employers avoid paying costly health insurance benefits. A considerable proportion of the increased costs are a result of the inefficiencies in the system and the high administrative costs for managing the plans. It is estimated that one third of all fees paid for health insurance are used for costs other than for the direct provision of coverage. Finally, one of the most commonly voiced concerns of the public is the lack of choice of plan or of provider. The rise of managed care systems, with restrictions on self-referral to specialists by employing a given panel of generalists as gatekeepers, increasingly diminishes individual choice, a value ingrained in the American ethos.


In the late 1980s the dynamics and difficulties described earlier became increasingly problematic, and health care costs continued to escalate despite the innovations in health care financing. A proposal was made by Enthoven on behalf of an ad hoc group called the Jackson Hole Group, espousing a concept called "managed competition." Under managed competition, costs would be controlled by reshaping the health care market through establishing health alliances (sometimes called health insurance purchasing cooperatives), which would represent large groups of consumers. These purchasing cooperatives would have the clout to negotiate lower costs with providers. Furthermore these health alliances would offer not just one health care plan but a variety of plans, providing consumers with adequate information to choose between plans based both on cost and on standardized benefit levels. This would foster price competition and more inclusivity, what Enthoven (1993) calls "value-for-money" competition at the level of individuals making choices about plans. Value-for-money competition emphasizes that what cost-conscious health consumers seek isn't simply the least expensive health care services or health care package available, but the ones that give them the most for their money. The ability of the consumer to make informed choices is crucial. If consumers do not have adequate information, available in a form that makes comparing alternatives easy, then competitive market processes cannot work effectively in containing costs and promoting high-quality health care.

Limitations of Managed Competition

One of the major limitations of managed competition grows out of the fact that it requires competing health plans to work. Where this is a population insufficient to support several health plans functioning independently without collusion, this model cannot apply. Although information technology could be used to overcome some of the problems of serving isolated communities, transportation technologies are also important when it comes to getting people to tertiary care in a timely fashion or for paying specialists to be flown to remote areas when needed. In all of these plans there would be a mandated minimum benefit package. Those who choose the lowcost benefit package will be those who cannot afford a higher level of coverage or those who believe that they do not need more. This leaves room for a new type of "adverse selection," even within managed competition. A further concern is found in the fact that managed competition relies on managed care to achieve much of its savings. Data on the effectiveness of doing so is far from definitive or complete. Although it is clear that HMOs operate at lower costs than traditional fee-for-service plans, it is not yet clear how much of the savings they achieve are due to higher levels of efficiency and how much is due to selection bias (enrolling healthier members) in the markets where they exist. Low-income individuals will still be at a relative disadvantage.