By Dean D. Baker, Director of Quantalyst Consulting, LLC.

With the advent of the Affordable Care Act, a number of new tools are under consideration to improve health care quality and to lower costs. One promising initiative spearheaded by the Centers for Medicare & Medicaid Services is the bundling of payments for an episode of care. How can provider groups manage the contracts in terms of cost, quality and utilization? Standard costing has a role.

Currently, when a patient is treated for an illness or undergoes a course of treatment, such as a heart bypass or hip replacement surgery, providers bill separately for their services.  This leads to a fragmented approach to healthcare, with minimal coordination across providers and heath care settings.  With a bundled approach, a single payment will be made to a linked team of providers, creating a financial incentive to adhere to a common protocol of treatment and creating incentives for the providers to better coordinate approaches that lead to the improved quality of healthcare while simultaneously decreasing costs.  In fact, trials of bundled payment programs have yielded promising results in terms of cost savings and quality of care[1].

It will be up to the provider to define the services that will be included in the bundled payment scheme, as well as carefully excluding those services that are too difficult to standardize due to excess (justified) variation.  Once the services are defined and accepted for bundling, the provider will require a means to monitor the performance of the services in terms of cost, quality and utilization.  Standard costing is a tool that can be brought to bear to address these needs.

Of course, the provision of medical services is a highly complex, and to an extent, a subjective effort.  This seems to contradict the foundation of standard costing, as, to be effective, standard costing requires a very specific “bill of services and consumed resources”, including budgeted costs with which to compare the actual services and costs incurred.  Every patient is unique.  So, how does one begin to set the “standards” to apply the proven power of standard costing to control cost, improve quality and improve utilization?

Part of the answer is found in the efforts that linked the types of patients that a hospital treats to the costs incurred by the hospital.  This initiative was the codification of Diagnostic Related Groups (DRG).  Through the analysis of DRGs, It has been found that groups of patients have demographic, diagnostic, and therapeutic attributes in common that determine their level of resource intensity.  Thus, while the precise resource intensity of a particular patient cannot be predicted by knowing to which DRG the patient belongs, the average pattern of resource intensity of a group of patients in a DRG can be accurately predicted[2].

Within any DRG selected for bundled payment lie several challenges, including a physician consensus around treatment protocols[3].  However, it is this very consensus regarding treatment protocol that will give the provider the means to create a standard “bill of services and resources consumed” that will define the planned (budgeted) course of treatment for the bundled services.  By comparing the standard, expected costs and resources against the actual costs and resources, an assessment of where the course of  treatment differs from the expected can be made.  In analyzing where significant differentials occur, it will be important to allow for flexibility in treating a particular patient’s condition (justifiable variations), but over a large population, root cause analysis can reveal where controls or procedures can be implemented that will positively influence the beneficial outcome of the bundled payment model.

The implementation complexities for a valid standard costing approach in the provision of medical services are many, and, may not be valid for all courses of treatment.  With that caveat in mind, standard costing has the capability to be a powerful tool in the control of cost and the improvement of quality in medical services, and is a tool that the medical community would be amiss to overlook.

Special thanks to Jonathan Pearce of Singletrack Analytics who provided valuable input to this post.

[1] The American Hospital Association Committee on Research report, “Bundled Payment – AHA Research Synthesis Report”, May 2010.

[2] 3M Health Information Systems, et al., “All Patient Refined Diagnosis Related Groups (APR-DRGs) v20.0 Methodology Overview”, 2003.

[3] Healthcare Financial Management Association, Andrew Draper, “Managing Bundled Payments”.


This entry was posted in Healthcare, Standard Cost. Bookmark the permalink.