Publication: Healthcare Financial Management
Date published:
Language: English
PMID: 17804
ISSN: 07350732
Journal code: HFM

Bundled pricing is an innovation in healthcare delivery that promises to deliver reduced costs, improved quality, and greater transparency. At a high level, the concept is a single fixed price for a defined set of physician and facility services with a specified quality outcome. Currently piloted by a few market leaders and used in some pilot projects sponsored by the Centers for Medicare & Medicaid Services (CMS), this payment mechanism represents a significant departure from the current fee-for-service model. By changing utilization incentives and shifting some financial risk from payers to providers, bundled payment presents an opportunity for providers and physicians to work together to drive better, more efficient care. But it also presents significant challenges.

In theory, the development of a bundled price is simple-on the surface. An organization simply needs to ensure that its bundled price represents at least the amount it would be paid under current payment mechanisms. Yet healthcare finance professionals face significant hurdles in preparing their organizations for bundled pricing.

Convincing Your Organization to Start Moving Toward Bundled Pricing

Bundled pricing has generated a lot of "buzz" in the world of healthcare finance. Many hospitals are discussing it, but not so many are working toward bundled pricing. For most, the question is, Why should my organization make the investment in developing a bundled price offering and take on the financial risk in the absence of clear demand from payers or patients?

This question can be answered in two ways, depending on whether one takes a long- or short-term perspective.

Long-term view: an unsustainable situation. Given looming deficits in Medicare and broad resistance to continuing private insurance premium increases, payers have no choice but to find a new payment model that promises lower utilization and better care than fee-for-service. Bundled pricing represents a more market-based approach to these ends than accountable care organizations and comes with less regulatory overhead. From that perspective, it's just a matter of time before payers demand a bundled pricing option of providers, at least for high-cost, high-volume, acute and chronic conditions.

Short-term view: an opportunity to improve margins, differentiation, and physician relations. In the short term, building the process management and analytic infrastructure enables a provider to differentiate itself to payers, employers, and patients, and to use that infrastructure to improve margins, even in advance of offering a bundled price. With the implementation of bundled pricing, a healthcare organization significantly advances clinical alignment and its ability to manage its core production process, such as diagnosing and treating patients. This payment model is radical in that it runs counter to one of the fundamental, unwritten rules of healthcare delivery: Administrators take care of business, and physicians take care of clinical matters, and the former will not meddle in the business of the latter. In acute care settings, clinical decisions drive the majority of costs. These decisions have generally been seen as the legitimate purview of physicians, with the key consideration being clinical judgment regarding what is best for the patient.

Implementation of bundled pricing, however, requires managers and clinicians to discuss the clinical decisions being made-in the aggregate and at the individual physician level. With the industry moving beyond fee-for-service payment, it has become essential to monitor variation in clinical decisions and their associated costs (assuming the adoption of evidence-based clinical practice reflecting patient needs) to ensure that payment continues to surpass expenses.

Whetheryou offer a bundled price or not, it can pay to get ready today.

As payment rates decline, managing the cost of production and ensuring optimal outcomes becomes increasingly important to maintain and improve margins. Organizations that build the infrastructure for bundled pricing can use it to manage cost and quality, even under continued fee-for-service pricing. Because there is a significant learning curve for building that infrastructure, leaders are being prudent when they undertake that process now. The decision to offer a service at a bundled price is complex, hinging on several factors, but opting to develop the tools to control core production costs is an easy decision. The fact that this infrastructure development helps the organization to offer a bundled price is an added bonus. Ultimately, the successful management of costs, especially in high volume areas, will be critical in defending profit margins in the face of shrinking payments.

Determining Which Services to Bundle

For many organizations, the first step in a bundled offering is deciding what treatment to bundle. Does it make sense to start with obstetrics or cardiology, mental illness, or substance abuse? The decision can have long-term implications for the organization. Consideration should be given to payers, competitors, and capacity.

Payers. Seeking to reduce financial risk, payers are interested in bundled pricing for high-cost, high-volume services. CMS is evaluating, as part of its three-year Acute Care Episode (ACE) demonstration project, bundled payments for 28 cardiovascular DRGs and nine orthopedic DRGs, including valve replacements, defibrillator implants, coronary artery bypass graft (CABG) procedures, pacemaker revisions, and hip and knee replacements. Bundled payments for these procedures enable payers to significantly reduce their liability for high-end payments. Organizations determining services to bundle would be wise to consider bundling high- cost, high-volume services because they are especially attractive to payers.

Competitors. As with any launch of a new product or service, healthcare providers will have the greatest success when introducing a bundled offer for a service line in which they have an advantage against competitors.

Early adopters of new payment models have a head start because there are few offers in the marketplace currently. However, as this innovation moves along the adoption curve, having a bundled offer will become an expectation rather than a market advantage. For that reason, providers will be wise to enter into bundled pricing in an area of strength for their institutions. As adoption of this payment model increases, institutions will need to look to the marketplace to ensure that they are not lagging behind their peers in making bundled payment offers available. For example, several of California's best-known healthcare providers-including Cedars-Sinai Medical Center, the UCLA Health System, and Hoag Memorial Hospital Presbyterian in Newport Beach-began charging bundled rates for hip and knee replacements in 3010. Whether a provider arrives first to market, or comparable offers already exist, a strong case for economic and clinical value will be critical to near-term and long-term success.

Capacity/volume. Organizations that promote a bundled price for services may find volumes increasing as a result of the offering. With greater predictability in pricing, incentives for appropriate utilization, and accountability for quality, payers and employers will try to drive patients toward the institutions with a bundled offer.

Sensitized by their increasing liability for healthcare costs, consumers may be persuaded by the availability of a predefined, up-front price for a service. Although the ACE demonstration project has just begun, preliminary results indicate that the five participating hospitals have already seen an increase in volume for bundled services. Before establishing a bundled offer, providers should be ready to handle the increase in volume that may result. The desire to increase volumes for certain services, especially profitable services for the organization, also can be a determining factor when selecting services to bundle.

Defining the Episode of Care

After the organization determines which services will be bundled, it needs to define what it will call an episode of care. Standard definitions for an episode of care generally don't exist but may be forthcoming. The national Medicare bundled pricing pilot has defined an episode of care as the three days prior to a hospitalization for an applicable condition, the hospitalization, and up to 3o days after hospital discharge. As payers seek to standardize their bundled pricing contracts, they are likely to look to CMS for guidance.

From a financial and operational perspective, a key consideration in defining the episode of care is determining clear, unambiguous, beginning and ending points for the bundle of services. These points may be defined in terms of time (e.g., all of the care provided for a chronic condition within a three-month period) or events (e.g., prenatal care and deliveiy, with the bundle running from the first prenatal visit, through the delivery, and on through the second post-natal visit).

Generally, physician and hospital services always will be included in the episode of care. In some cases, additional services such as outpatient care, home health services, and skilled nursing services, for example, may also be included. The inclusion of additional services, especially post-acute services, will have implications for the endpoints used to define the episode.

Developing and Using Care Paths to Manage Cost and Quality

After the endpoints for the episode of care are defined, the next challenge is identifying specific services that are essential for diagnosis and treatment. Obviously, the answer must represent consensus among physicians who do the work, which highlights the second biggest organizational component to this hurdle: getting physicians to agree on which practice protocols (or care path) should be followed for diagnosis and treatment of the condition.

A care path itself is simply a graphic representation of the primaiy sequence of actions and decisions that encompass treatment for the majority of patients with the specified diagnosis. Care paths should be consistent with guidelines published by relevant professional organizations and should incorporate the latest generally accepted evidence-based medical conclusions about interventions that should be used. They should be flexible enough to accommodate variation in use of tests, drugs, and services that will inevitably occur across patients. At the same time, they need to have sufficient structure to enable the modeling of costs and revenues, as well as differences in severity and the impact of changes in clinical processes. The care path should provide the right level of detail while allowing for flexible decision making.

Although developing care paths is by no means easy, the biggest challenge is getting physicians to use them. Involvingphysicians in the development of a care path and ensuring buy-in to the consensus output is important because that treatment approach is the one they are agreeing to use in their work.

Care paths are essential to the development of a bundled price because they enable the organization to monitor the care provided against a standard. Without a care path, the organization doesn't have insight into the processes that drive changes in costs and variances in outcomes. For example, if at the end of the first quarter of a bundled pricing implementation project, the organization finds the cost of services provided are 10 percent higher than expected, or outcome metrics have declined, there's no analytic basis to determine why the variance occurred without a care path. The use of care paths, therefore, allows the organization to assess variances in the provision of services and in asso - ciated costs. This is a critical function for the successful implementation of a bundled price offering and should not be omitted.

Analyzing Patient Data to Develop a Price

In performing the analysis to determine what fixed rate to charge for a given set of services under bundled pricing, the organization should consider several reference points.

Historical analysis of charges, collected revenue, and costs. Every provider organization maintains extensive files on charges and collected revenue by patient. This source is key to one of the primary reference points in developing a bundled price: what the organization has previously billed and collected for the service. Given that no organization would offer a service with the intent of losing money, the revenue neutral price point (average billed or collected revenue over a period of time-e.g., one year) for a set of services represents a good starting point for determining the bundled price.

Just like any business, a hospital that sets a price lower than cost of production won't make up the difference on volume. Therefore, providers should consider the costs associated with providing the services in the bundle. Comparatively few organizations use activity-based cost accounting that associates direct and indirect labor and capital costs with the deliveiy of each service, so systematic approximations of this reference point are needed.

A database using the appropriate revenue and cost data can support analyses around variation and sensitivity to including or excluding certain procedures and services. Anticipated changes to clinical practice can be modeled to understand forward-looking revenues, costs, and profitability. Additionally, although chargemaster pricing reflects what the market will bear, comparative charge data can be used to incorporate a competitive perspective.

External providers. Data also will be required from each external provider whose services will be included in the bundled offering. Organizations that operate as an integrated delivery network and those with insurance subsidiaries have an advantage over other organizations. They have access to data from upstream and downstream affiliates, which they can use to factor into the bundled price (not to mention an enhanced ability to influence the delivery of care and its associated cost). Freestanding community hospitals developing a bundled price should negotiate contracts with each entity included within their bundled offering, specifying the payment arrangements, baseline service delivery parameters, and quality metrics that will be used to assess the care provided.

Impact of comorbidities. Another important area of analysis is around whether costs for the treatment of comorbid conditions should be included within the bundled price. To maintain simplicity for both the patient and the billing department, the organization might choose to spread the cost of these illnesses over the population of patients paying the bundled price rather than billing separately for such services.

Waiting to Change Is Leaving Money on the Table

Developing a bundled price offer is a challenging undertaking, with several hurdles beyond the inherent determination of the price. In addition to these complexities, providers preparing to compete under new payment models also should be ready to measure and deliver against higher quality standards, and to define and demonstrate economic and clinical value of their services.

Thinking differently about managing costs and quality-and differentiating your organization in the eyes of patients, payers, and physicians-can translate into meaningful financial benefits. Efforts by leading institutions and preliminary results from the ACE demonstration project suggest that organizations can develop more efficient processes for specific episodes of care without compromising quality. These efforts present an opportunity to improve the bottom line through increased volume (by attracting patients who value predictable pricing and quality guarantees) and by realizing greater net revenues (from the provision of more efficient care).

For organizations that are ambivalent about offering a bundled price, preparing for one can still identify new efficiencies and opportunities for increased net revenues. By developing an understanding of clinical activities and associated costs for a specific episode of care, providers can advance toward the goal of better care at lower cost even if they decide to forego a bundled price offering. If the organization decides to offer a bundled price, it gains competitive advantage through its experience with this complex change.

Author affiliation:

About the authors

Michael Abrams

is managing partner, Numerof & Associates, Inc., St. Louis (

Simone Cummings, PhD,

is a research analyst, Numerof & Associates, Inc., St. Louis (

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