VA Health Care: Third-Party Charges Based on Sound Methodology; Implementation Challenges Remain

Published by the Government Accountability Office on 1999-06-11.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  United States General Accounting Office

GAO               Report to the Chairmen and Ranking
                  Minority Members, Committees on
                  Veterans’ Affairs, U.S. Senate and House
                  of Representatives

June 1999
                  VA HEALTH CARE
                  Third-Party Charges
                  Based on Sound
                  Challenges Remain

      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Health, Education, and
      Human Services Division


      June 11, 1999

      The Honorable Arlen Specter
      The Honorable John D. Rockefeller
      Ranking Minority Member
      Committee on Veterans’ Affairs
      United States Senate

      The Honorable Bob Stump
      The Honorable Lane Evans
      Ranking Minority Member
      Committee on Veterans’ Affairs
      House of Representatives

      The Department of Veterans Affairs (VA) operates the nation’s largest
      integrated health care system, providing care for eligible veterans with
      service-connected and non-service-connected conditions. For veterans
      who have private health insurance, VA was authorized, under the Veterans
      Health Care Amendments Act of 1986, to bill their private insurers on a
      “reasonable cost” basis for care provided to veterans for
      non-service-connected conditions. The Balanced Budget Act of 1997 (BBA)
      amended this authority to specify “reasonable charges” as the basis for
      billing private insurers and directed VA to develop a rule to change its basis
      for billing. Reasonable cost billing is designed to recover VA’s costs of
      furnishing care, while reasonable charge billing is designed to obtain the
      same payment for VA that insurers make to other providers. The shift to
      reasonable charges is intended to enhance VA collections to the extent that
      reasonable charges result in higher payments than reasonable costs. BBA
      also allowed VA to retain all collections, whereas before it had to return
      collections, minus collection costs, to the U.S. Treasury.

      Obtaining revenue from third-party payments is a key element of VA’s
      strategic plan to expand and improve health care for veterans without
      increasing its appropriations. Specifically, VA estimated it could generate
      10 percent of its health care budget from nonappropriated funds by fiscal
      year 2002. This, along with its plan to lower unit costs of providing
      services by 30 percent, was expected to allow VA to serve 20 percent more
      veterans while operating without a budget increase over the fiscal year
      1997-2002 period. In fiscal year 1998, nonappropriated funds totaled

      Page 1                                    GAO/HEHS-99-124 VA Reasonable Charges

                   $560.1 million from collections and users’ fees, 79 percent of which came
                   from collections from insurers.

                   On April 27, 1999, VA published the final rule reflecting the change in its
                   medical billing rates to private insurers from a reasonable cost to a
                   reasonable charge basis. The method VA used to develop reasonable
                   charges was designed to estimate the 80th percentile of local charges so
                   that its reasonable charges to private insurers would typically equal or
                   exceed 80 percent of all charges submitted for the services provided. VA
                   received six comments on its proposed rule (published on October 13,
                   1998), which generally did not discuss in detail the validity of VA’s
                   methodology. An association of insurers asked for additional time to
                   submit comments on VA’s methodology and prepare their claims systems
                   to process VA’s new reasonable charge claims. VA delayed implementation
                   of the final rule until September 1, 1999.

                   In response to the requirements of 38 U.S.C. 1729(c)(2)(C), this report
                   provides our findings concerning (1) the soundness of VA’s methodology
                   for setting reasonable charges for inpatient facility, skilled nursing,
                   outpatient facility, physician, and nonphysician services and (2) potential
                   effects of the new charge-based system on VA, insurers, and veterans. We
                   performed our evaluation from September 1998 through May 1999 in
                   accordance with generally accepted government auditing standards. For
                   details on our scope and methodology, see appendix I.

                   We believe VA’s methodology provides a sound basis for setting reasonable
Results in Brief   charges and optimizing its collection revenues. Its methodology logically
                   applies available data to set local market charges for each geographic area
                   where VA provides care. In cases where VA’s charges are higher than the
                   insurers’ usual payments to other providers for the same care, insurers are
                   permitted by law to pay VA these usual amounts rather than VA’s billed
                   charges. However, if VA submits charges that are less than the insurers’
                   usual payments, the insurers may pay the lower amounts. Therefore, if VA
                   sets its charges below market prices, it will forego some of the revenue it
                   could collect from private insurers. VA is currently working with a
                   contractor to establish a way to identify charges that need to be modified
                   to better reflect market prices.

                   VA expects that the shift to reasonable charges will increase collections
                   from private insurers, but it cannot accurately project the amount. The
                   potential revenue gain is dependent on the difference between the

                   Page 2                                   GAO/HEHS-99-124 VA Reasonable Charges

             reasonable cost and reasonable charge payments and the volume of
             payments received from third-party payers. However, VA does not have
             sufficient reliable data on either. For example, VA databases do not contain
             sufficient detail on the type of insurance coverage veterans have or the
             specific care provided to insured veterans in order to project revenue
             changes. Consequently, we agree that the effect on VA’s collections—and
             the corresponding effect on insurers’ costs—cannot be accurately
             determined. Moreover, in cases where insurers exercise their option to
             pay their usual amounts instead of VA’s proposed reasonable charge, VA
             faces the challenge of determining whether the payments it receives from
             insurers are in fact the appropriate amount. VA has not established
             procedures to make this determination. We are recommending that VA take
             the appropriate steps to ensure it receives payment comparable to other
             providers. While the effect of the shift to reasonable charges on VA revenue
             and insurers’ costs is not precisely predictable, it should not have an
             appreciable effect on veterans because it does not change the copayment
             and per diem payments set by statute that are required of some veterans
             receiving VA care.

             In proposing its fiscal year 1999 and fiscal year 2000 budgets, VA assumed
Background   that it would be increasing collections from insurers and user fees
             (copayments and per diems from certain veterans). VA projected fiscal year
             1999 collections would increase by 14 percent from fiscal year 1998 levels
             to $637.5 million through better administrative efficiency and
             implementation of billing rates based on reasonable charges. In fiscal year
             2000, VA expects collections to increase about another 19 percent to
             $761.6 million. However, the Administration’s plan to substantially
             increase such nonappropriated funds in the long term hinges on the
             authorization of reimbursement through Medicare subvention,1 which was
             not enacted at the time of the publication of the final rule on reasonable

             Under VA’s cost-based charge system, VA’s charges to insurers have not
             been specific to the particular service VA provided—or the resources that it
             costs VA to provide a particular service—because reasonable cost charges
             are based on average costs. Reasonable cost charges include relatively few
             rates—nine inpatient rates based on the patient’s location in the hospital,
             one nursing home rate, and one outpatient visit rate. When proposing a
             shift to reasonable charges, the House Committee noted that VA’s

             Medicare subvention would authorize VA to bill Medicare for health care provided to
             Medicare-eligible, higher-income veterans who do not have compensable disabilities.

             Page 3                                                GAO/HEHS-99-124 VA Reasonable Charges

                     cost-based charges are often below VA’s costs but exceed such levels in
                     other instances. For example, VA currently charges $229—its estimated
                     average nationwide cost for an outpatient visit—for both a brief office visit
                     and outpatient surgery. For inpatient stays in the surgical bed section, VA
                     charges $2,079 per day, regardless of the treatment.2

                     VA took guidance from the Conference Report (H.R. 105-217) that indicated
                     reasonable charges should resemble market pricing for health care
                     services. VA interpreted this to mean that reasonable charges should be
                     based on charges to payers in local markets. Setting reasonable charges
                     according to the market could allow VA to receive revenues in excess of
                     VA’s costs. Such reasonable charges would not necessarily reflect market
                     payments because, as VA recognized, charges serve as asking prices in the
                     marketplace and often exceed final payments.

                     In establishing its reasonable charge rule, VA wanted to directly reflect
VA Used a Sound      local market charges for all services in all locations, but these data were
Methodology to Set   not available. VA instead selected a methodology that used available data
Charges              to set local charges indirectly. Specifically, VA estimated the 80th
                     percentile of charges submitted by nonfederal providers to insurers
                     nationwide, then adjusted these nationwide charges—using a geographic
                     adjustment factor that it developed—to local market prices at each VA
                     facility location. Using available data in this way, VA was able to set
                     charges for hundreds of medical diagnoses groups and thousands of
                     procedures at many locations.

                     VA used various data sources as needed to set the charges. Inpatient
                     facility charges, for example, were estimated nationwide using 1995
                     charge data from both Medicare and MedStat databases.3 VA’s
                     methodology applied hospital components of the Consumer Price Index to
                     project these charges forward to a 1998 to 1999 billing period. VA also used
                     the Medicare and MedStat data to develop its geographic adjustment
                     factors. (See app. II for a detailed description of VA’s methodology and
                     data sources.)

                      In special cases, such as for care furnished in a medical emergency or to certain beneficiaries of the
                     Department of Defense or other federal agencies, VA will continue to use reasonable cost charges after
                     implementing reasonable charges.
                      The Medicare data represented the amounts Medicare was charged from claims paid for a 5-percent
                     sample of beneficiaries in 1995. The MedStat data represented 1995 claims data from over 200
                     insurance companies for over 7 million beneficiaries.

                     Page 4                                                 GAO/HEHS-99-124 VA Reasonable Charges

In our view, setting charges at the 80th percentile level is a reasonable
strategy for optimizing revenue. By setting charges at this level, VA can
expect to receive insurers’ usual payments even when they are more than
average charges, with the exception of those that exceed the 80th
percentile.4 Payers whose usual payments are lower are protected by a
statutory provision (38 U.S.C. 1729(c)(2)(B)) that limits their liability to
the amount they would pay to nonfederal facilities in the same area for the
same care or services provided. Assuming that insurers will pay no more
than their usual payments, this provision essentially reduces VA’s charges
to local market prices when the charges exceed those levels.

We anticipate that VA’s method generally estimates above-average
local-market charges for services, as was intended. We confirmed that, at
least for inpatient facility charges, the method generally results in
above-average market charges, although not always at the 80th percentile.
We reviewed charges for eight selected diagnosis related group (DRG)
codes in five metropolitan areas.5 For these 40 charges, we found that
70 percent of VA’s charges fell between the 50th and 80th percentile of
charges and another 12.5 percent of the charges fell above the 80th
percentile. However, the remaining 17.5 percent of charges fell below the
50th percentile. For example, the 50th percentile charge for major joint
and limb reattachment procedures for the lower extremity (DRG 209) is
about $3,300 per diem in the Baltimore metropolitan area, while the
corresponding VA reasonable charge is about $2,700.

Although the insurer’s option to pay usual payments can reduce higher VA
charges to a particular insurer’s market prices, there is no mechanism to
raise VA’s charges if they fall below an insurer’s usual payments. This is
important because our analysis suggests that some reasonable charges fall
well below the 80th percentile and, therefore, are more likely to fall below
insurers’ usual payments. VA is seeking assistance from a contractor on
how to measure whether its charges fall below payers’ usual payments.
Appropriate monitoring should reveal the extent to which collections are

 VA considered using Medicare’s payment schedule to set its charges but decided those rates would be
too low to ensure insurers’ payments at their usual amounts. For example, a study by the Physician
Payment Review Commission found that in 1995, Medicare paid physicians roughly 68 percent of
average private payer rates (Annual Report to Congress, 1995, p. 83).
 Confirming the reasonableness of VA’s new charges is limited by insufficient data for all services in all
places, which led VA to abandon a direct measurement of local market charges. To ensure sufficient
data, we limited our selective examination to (1) VA facilities in five large metropolitan areas (New
York, Los Angeles, Chicago, Baltimore, and San Francisco) and (2) eight DRG conditions—such as
heart failure and shock, coronary bypass, and rehabilitation—which accounted for about 18 percent of
all veteran admissions in fiscal year 1997.

Page 5                                                   GAO/HEHS-99-124 VA Reasonable Charges

                     below market payments and provide a way of identifying where VA charges
                     need to be modified to better reflect market prices.

                     VA views reasonable charges as an opportunity to increase its revenue
Effects of New       collections. This will occur to the extent that the total payments to VA
Charges Uncertain,   under the new reasonable charge billings are greater than those VA would
and Implementation   have received from billing the old reasonable cost charges for the same
                     health care. To accurately predict and compare these two total payments,
Challenges Remain    VA would need data on the volume of services it would deliver and, for
                     those services, the change in payment from the cost-based system to the
                     charge-based system. For example, an outpatient surgery to repair a hernia
                     would result in a single-visit, all-inclusive charge under reasonable cost
                     billing, whereas it would create two physician charges and an outpatient
                     facility charge under reasonable charge billing. In addition, estimated
                     payment levels resulting from the various charges would also be needed to
                     compute total payments for each set of old and new charges.

                     Although VA tentatively estimated that the shift to reasonable charges
                     would increase its revenue by $44 million in 1999,6 it acknowledged that
                     the amount cannot be accurately predicted. We agree for several reasons.
                     First, the data that are critical to an accurate prediction—especially data
                     on the procedures and diagnoses codes for veterans’ care that would aid
                     predicting the reasonable charges that will be billed—are not readily
                     available. VA also does not have a history of payments that would result
                     from reasonable charges. Moreover, VA lacks data on the types of
                     insurance veterans have. This is critical data for predicting payments
                     because insurers’ liability is limited to the terms of their coverage. For
                     instance, over half of VA’s billings have apparently gone to Medicare
                     supplemental insurers, but reasonable charges will not typically affect the
                     Medicare deductibles and coinsurance received as payments from these

                     VA’s potential revenue will also be affected by its ability to overcome past
                     collection problems. Three recent studies have highlighted several
                     inefficiencies in VA’s collection operations, such as slow billing, inadequate
                     follow-up of delinquent accounts receivable, significant errors and rework,

                      Reasonable charges will actually have only a limited impact on collections this fiscal year because
                     implementation has been delayed until Sept. 1, 1999.

                     Page 6                                                  GAO/HEHS-99-124 VA Reasonable Charges

and ineffective use of available automation.7 VA revenue will further be
affected by its ability to manage the effects of demographic and health
care trends. The declining number of veterans—from 25.1 million in 1998
to an estimated 23.1 million in 2003—will reduce the pool of veterans who
could be served, and the aging of the veteran population will likely
increase the number of veterans with Medicare or Medicare supplemental
insurance. In addition, if veteran enrollment in managed care follows the
insurance industry’s trend, VA may face a situation where it cannot collect
revenue for a growing number of veterans. (VA is generally not a
participating provider in managed care plans and, therefore, under typical
health maintenance organization and other managed care insurance
contracts, cannot expect to collect from them for nonemergency services.)

VA also faces some challenging new tasks for administering its new
reasonable charges billing system. For example, VA will have to prepare
accurate bills for the specific services furnished and support these coded
charges with documentation if insurers ask for additional information.
Before implementation, VA plans to test its ability to produce reasonable
charge bills in a format that insurance companies can process. VA will also
examine the adequacy of training provided to intake clerks, physicians,
and collection staff to ensure accurate coding and documentation. A
second challenge will be verifying that it is receiving appropriate payments
from insurers when insurers pay usual payments rather than billed
charges. Neither the law nor VA’s regulations give criteria for determining
appropriate payment when insurers make different payments to different
providers in the same geographic location. VA’s decentralized system of
verification is intended to give local employees flexibility in working with
particular insurers and relies on local employees’ determination of what
constitutes insurers’ usual payments. VA officials stated that VA plans to
have a contractor assist in developing recommendations for selecting
insurers for verification.

Although the effect of the reasonable charge structure on VA’s revenue and
insurers’ costs is uncertain, it will not affect the copayments and per diem
obligations required by VA for certain veterans. These payments are set by
statute—the Veterans’ Health-Care Amendments Act of 1986 (P.L. 99-272).
The copayment for inpatient hospital and nursing home care is based on
the Medicare deductible, while the copayment for outpatient care is based
on the VA-wide estimated average cost of an outpatient visit. Similarly, the
per diem payments for hospital and nursing home care added by the

 Office of Inspector General, VA, Audit of the Medical Care Cost Recovery Program (July 10, 1998);
Coopers & Lybrand, VA MCCR National Study (Jan. 1998); and VA Medical Care: Increasing Recoveries
From Private Health Insurers Will Prove Difficult (GAO/HEHS-98-4, Oct. 17, 1997).

Page 7                                               GAO/HEHS-99-124 VA Reasonable Charges

                  Omnibus Reconciliation Act of 1990 (P.L. 101-508) are set independently
                  from reasonable charges. While the obligations for veterans are
                  independently set from reasonable charges, the amount collected from
                  insurers under reasonable charges may reduce insured veterans’ actual
                  payments to VA. A recent VA directive states that insurance recoveries will
                  be used to reduce insured veterans’ copayment obligations, in part or full.8
                  Thus, when this occurs, veterans’ payments to VA—as well as VA’s net
                  collections—will be reduced.

                  In our opinion, VA used a sound methodology to replace its cost-based
Conclusions and   system with a charge-based system that better resembles market prices for
Recommendations   thousands of procedures and hundreds of diagnoses groups. Setting these
                  charges at the 80th percentile level helps VA ensure that its
                  reimbursements are not less than the amounts insurers usually pay other
                  providers. Although VA anticipates increased revenues from insurers as a
                  result of billing reasonable charges, VA does not have adequate data to
                  estimate the effect of reasonable charges on VA revenue and corresponding
                  insurer cost. However, reasonable charges will not affect veterans’
                  copayment and per diem obligations.

                  By increasing alternative revenues, reasonable charges are expected to
                  play a key role in VA’s plans to expand and improve health care for
                  veterans without increasing appropriations through fiscal year 2002.
                  However, several factors could limit the contribution that reasonable
                  charges make to VA revenue collections, such as VA’s inability to collect
                  routinely from certain insurers (for example, health maintenance
                  organizations and Medicare) and its ability to overcome past collection
                  problems. In addition, VA’s method will likely set some reasonable charges
                  below market prices, that is, below insurers’ usual payments. To the extent
                  that this may occur, VA will collect less than other providers. Moreover, VA
                  will be vulnerable in instances where insurers pay less than their usual
                  payments because VA currently does not have standardized procedures in
                  place to ensure that insurers’ payments are appropriate if less than
                  reasonable charges.

                  To help ensure that VA does not forego some of the amount that insurers
                  usually pay other providers for the same service in the same locality, we
                  recommend that the Secretary of Veterans Affairs establish and implement
                  policy and procedures to (1) monitor reasonable charges and identify
                  those that should be increased to conform with local market prices and

                   Veterans Health Administration, Directive 99-014 (Apr. 1, 1999).

                  Page 8                                                  GAO/HEHS-99-124 VA Reasonable Charges

                  (2) verify the appropriateness of insurers’ payments when they pay an
                  amount less than VA’s reasonable charges.

                  VA was unable to provide comments on a draft of this report within the
Agency Comments   abbreviated time period available. It said it will provide comments on this
                  report at a later date.

                  We are sending copies of this report to the Honorable Togo D. West, Jr.,
                  Secretary of Veterans Affairs, and other interested parties. We will also
                  make copies available to others upon request.

                  Please contact me at (202) 512-7101 or Shelia Drake, Assistant Director, at
                  (202) 512-7172 if you or your staff have any questions concerning this
                  report. Other GAO staff who made major contributions to this report are
                  Terry Hanford and Sandra Davis.

                  Stephen P. Backhus
                  Director, Veterans’ Affairs and
                    Military Health Care Issues

                  Page 9                                   GAO/HEHS-99-124 VA Reasonable Charges

Letter                                                                                            1

Appendix I                                                                                       12
                       Comparison With Local Market Charges                                      12
Scope and
Appendix II                                                                                      14
                       Methodology for Determining Rates and Adjustment Factors                  15
VA’s Methodology for   Formulas for Facility-Specific Charges                                    19
Setting Reasonable
Tables                 Table II.1: VA’s Reasonable Charge Categories and Services                15
                       Table II.2: Estimating Average National Charges by Categories of          16
                       Table II.3: Estimating the 80th Percentile by Categories of               17
                       Table II.4: Trending Charges Forward by Categories of Charges             18
                       Table II.5: Geographic Adjustment Factors by Categories of                19


                       BBA        Balanced Budget Act of 1997
                       CF         conversion factor
                       CMSA       consolidated metropolitan statistical area
                       CPI        Consumer Price Index
                       CPT        current procedural terminology
                       DRG        diagnosis related group
                       MSA        metropolitan statistical area
                       RVU        relative value unit
                       SNF        skilled nursing facility
                       VA         Department of Veterans Affairs

                       Page 10                                 GAO/HEHS-99-124 VA Reasonable Charges
Page 11   GAO/HEHS-99-124 VA Reasonable Charges
Appendix I

Scope and Methodology

                          To assess the soundness and potential effects of VA’s methodology for
                          setting reasonable charges, we reviewed documentation on the
                          methodology and met with VA’s contractor, Milliman & Robertson, Inc., to
                          gain an understanding of the key assumptions and decisions in its
                          development of the methodology. We also discussed the methodology with
                          VA officials as well as health care experts at the Health Care Financing
                          Administration and the Medicare Payment Advisory Commission. In
                          addition, we reviewed the six public comments VA received on its
                          proposed rule. Because our objective was to assess the reasonableness of
                          the methodology, we did not gather new data on charges, test the
                          reliability of the contractor’s data, or independently verify calculations.

                          The following sections discuss how we compared reasonable charges with
                          local market charges as a partial check of the ability of VA’s method to
                          produce charges at above-average levels.

                          We limited our comparison of reasonable and local market charges to
Comparison With           inpatient facility charges because we had ready access to Medicare data
Local Market Charges      upon which VA inpatient facility charges are partially based. Because VA’s
                          contractor told us that inpatient facility per diems calculated on the
                          Medicare data and calculated on the commercial data were roughly
                          equivalent, our use of only the one data source should be a minor source
                          of difference between our results and VA’s. Outpatient facility, physician,
                          and nonphysician charges are based on private data sources. We also
                          limited our examination to eight diagnosis related group (DRG) conditions
                          commonly treated at VA and five large metropolitan areas to ensure that
                          we had sufficient data to analyze.

                          Because we judgmentally selected both the locations and DRGs, our
                          analysis is not generalizable to all inpatient facility charges at all VA
                          facilities. It does serve, however, to illustrate the extent to which some
                          reasonable charges fall within a range of above-average local market
                          charges. Because the available VA data were for all admissions in fiscal
                          year 1997, we could not assess whether the eight DRGs we examined were
                          also the most common types of admissions for insured veterans.

Selecting Locations and   For this analysis, we selected large VA facilities in metropolitan areas
Charges                   because we assumed that areas with high populations would provide a
                          sufficient volume of local market charges for our analysis. The facility

                          Page 12                                  GAO/HEHS-99-124 VA Reasonable Charges
             Appendix I
             Scope and Methodology

             locations are New York, West Los Angeles, Chicago, Baltimore, and San

             We analyzed eight DRGs. Seven of these had been identified in a previous VA
             analysis as being frequent conditions treated in VA hospitals during fiscal
             year 1997: three in medicine (DRG 88, chronic obstructive pulmonary
             disease; DRG 89, simple pneumonia and pleurisy; and DRG 127, heart failure
             and shock); three in surgery (DRG 107, coronary bypass; DRG 112,
             percutaneous cardiovascular procedures; and DRG 209, major joint and
             limb surgery, lower extremity); as well as DRG 462, rehabilitation. We
             added DRG 430, psychoses, to our analysis because we found that this
             single condition accounted for almost 7 percent of VA admissions in fiscal
             year 1997.

Comparison   To examine where a reasonable charge fell in the range of local market
             charges for a service, we computed the reasonable charge and the deciles9
             of local market charges. We computed reasonable charges based on VA’s
             directions in its proposed rule on reasonable charges. We estimated local
             market charges based on 1997 Medicare Provider Analysis and Review
             data, which include records for 100 percent of Medicare beneficiaries who
             used hospital inpatient services, whereas the VA reasonable charges were
             based on a 5-percent sample of 1995 Medicare data and private sector data
             from over 200 insurers and other sources. We calculated decile
             distributions for inpatient-facility per diem charges for each DRG code at
             each of the five locations. (Because the Medicare data we analyzed was for
             1997, we trended these decile points forward to March 1, 1999, as VA did
             for reasonable charges.)

             Next, we identified where reasonable charges fell between decile points of
             local market charges. If a reasonable charge fell above the fifth decile
             point (or 50th percentile) and was not greater than the eighth decile point,
             we classified the charge as above average and not exceeding VA’s intended
             80th percentile level. We then calculated the percentages of reasonable
             charges falling into, above, and below this range.

              A decile is a percentile of 10, 20, 30, and so forth.

             Page 13                                                  GAO/HEHS-99-124 VA Reasonable Charges
Appendix II

VA’s Methodology for Setting Reasonable

               VA established reasonable charges for five categories of charges:
               (1) inpatient facility, (2) skilled nursing facility (SNF)/subacute inpatient
               facility, (3) outpatient facility, (4) physicians, and (5) nonphysician
               providers (see table II.1). Because reasonable charges are designed to
               approximate local charges, all categories of charges vary by VA facility
               locations. Billings for inpatient facilities and SNFs are on a per diem basis,
               and, for inpatient facility charges, the per diem charges vary by the treated
               condition as classified by DRG codes. Billings for outpatient facility and
               provider charges vary by procedure performed, as classified by current
               procedural terminology (CPT) codes.

               To establish reasonable charges for each category of charges, VA estimated
               local market charges. VA’s methodology develops nationwide rates and
               geographic and other adjustment factors to make these estimations. The
               method yields tables of data that include nationwide charges by hundreds
               of DRGs, nationwide charges and conversion factors by several thousand
               CPTs, and various groups of geographic adjustment factors by VA facility
               locations. (See 63 Fed. Reg. 54766.) To calculate facility-specific
               reasonable charges, various billing formulas will be applied to the data
               from the tables. Below we describe, first, VA’s method for determining the
               rates and adjustment factors for reasonable charges and, second, the
               formulas for calculating facility-specific charges based on these rates and

               Page 14                                   GAO/HEHS-99-124 VA Reasonable Charges
                                     Appendix II
                                     VA’s Methodology for Setting Reasonable

Table II.1: VA’s Reasonable Charge
Categories and Services Covered      Category                          Services covered                 Charge structure
                                     Inpatient facility                Hospital room and board          Per diem (daily) charges
                                                                       and ancillary services           that vary by about 500 DRG
                                                                                                        codesa and VA facility
                                     SNF/subacute inpatient            Care, including skilled          Per diem charges that vary
                                     facility                          rehabilitation, and              by VA facility
                                                                       associated ancillary
                                                                       services provided under a
                                                                       physician’s orders in a
                                                                       nursing home or hospital
                                                                       inpatient setting and
                                                                       performed by or under the
                                                                       general supervision of
                                                                       professional personnel,
                                                                       such as registered nurses
                                     Outpatient facility               Facility and ancillary           Charges vary by about
                                                                       procedures not customarily       3,900 CPT codesb and VA
                                                                       performed in a private           facility
                                                                       clinician’s office, such as
                                                                       some ambulatory surgeries
                                                                       and diagnostic magnetic
                                                                       resonance imaging
                                     Physician                         Medical procedures           Charges vary by about
                                                                       performed in an inpatient or 7,400 CPT codes and by
                                                                       outpatient setting           VA facility
                                     Nonphysician (nurse               Procedures performed in an Charges are a percentage
                                     practitioner, clinical social     inpatient or outpatient    of physician charges
                                     worker, dietitian, and others)    setting
                                      DRG codes classify patients on the basis of diagnoses groups, such as diabetes or extensive
                                     burns, that are expected to require the same amount of resources to treat.
                                     CPT codes identify the service or procedure performed by a physician.

                                     VA developed all categories of charges following the same general model:
Methodology for                      (1) nationwide rates were established at the 80th percentile of billed
Determining Rates                    charges of private providers, and (2) geographic adjustment factors were
and Adjustment                       estimated to adjust nationwide rates to VA facility location charges.
                                     However, VA’s methodology for determining reasonable charges is actually
Factors                              various methodologies used to determine rates and adjustment factors for
                                     five categories of charges. The methodologies use different data sources
                                     and calculations to derive these rates and various adjustment factors.
                                     (Charges for nonphysician providers are not discussed here because the
                                     charges are calculated in the same way as charges for physicians, except
                                     that a percentage adjustment is applied depending on the type of

                                     Page 15                                              GAO/HEHS-99-124 VA Reasonable Charges
                                            Appendix II
                                            VA’s Methodology for Setting Reasonable

                                            nonphysician provider.) Additional details about the methodology may be
                                            found in VA’s proposed and final rule for reasonable charges.10

Nationwide Charges                          Generally, nationwide charges were developed in three stages. First,
                                            average nationwide charges were estimated. Second, the nationwide
                                            charges were adjusted to an 80th percentile level of charges. Third, the
                                            charges were projected forward to account for changes in charge levels
                                            between the time of the baseline data and the future billing period.
                                            However, the physician charges were developed differently—rather than
                                            estimating an average charge and then adjusting it to the 80th percentile,
                                            the calculation of physician charges began with 80th percentile charges.
                                            Also, the charges based on CPT codes—outpatient facility and physician
                                            charges—involved additional calculations that aligned charges with
                                            relative value units (RVU) associated with the CPT codes. (RVUs serve to
                                            weight services according to their relative work effort and other factors.)

Average Nationwide Charges                  VA first estimated a base national rate by calculating an average charge. A
                                            mean was calculated for inpatient facility and SNF/subacute inpatient
                                            facility charges, and a median was calculated for outpatient facility
                                            charges because the underlying data were significantly influenced by
                                            extreme cases and a median is less sensitive than a mean to extreme
                                            cases. In addition to these calculations, the inpatient facility charge for
                                            each DRG was split into a room and board component and an ancillary
                                            service component (see table II.2).

Table II.2: Estimating Average National Charges by Categories of Charges
Inpatient facility               SNF/subacute inpatient facility Outpatient facility                  Physician
Mean per diem charges by DRG, Mean per diem charge for SNF            Median charges by CPT           Not applicable
weighted average from two data care                                   procedure codes
Data sources
1995 Medicare and 1995           1998 Milliman & Robertson,           1995 MedStat data for billed    Not applicable
MedStat data for total charges   Inc., Health Cost Guidelines         facility charge
and days of stay

                                            Data were taken from public and private sources. The Medicare data are
                                            taken from paid claims for a 5-percent sample of beneficiaries. The
                                            MedStat data reflect claims data from over 7 million employees and
                                            dependents covered by the health benefit programs for large employers

                                              63 Fed. Reg. 54756 and 64 Fed. Reg. 22675.

                                            Page 16                                            GAO/HEHS-99-124 VA Reasonable Charges
                                             Appendix II
                                             VA’s Methodology for Setting Reasonable

                                             and collected from over 200 different insurance companies, Blue Cross
                                             and Blue Shield plans, and third-party administrators. The MedStat data do
                                             not include Medicare, Medicaid, or Workers’ Compensation data. The
                                             Milliman & Robertson nationwide data on SNF care are derived from the
                                             Health Care Financing Administration’s Medicare claims data.

80th Percentile Adjustment                   VA’s methodology generally uses ratios to adjust national averages to 80th
                                             percentile charges. Physician charges at the 80th percentile were extracted
                                             from already calculated levels in a nationwide commercial insurance
                                             database (see table II.3).

Table II.3: Estimating the 80th Percentile by Categories of Charges
Inpatient facility                SNF/subacute inpatient facility Outpatient facility                      Physician
(1) Average of consolidated       (1) Average of state ratios: 80th   (1) Divide CPT codes into 37         80th percentile charges for
metropolitan statistical areas    percentile of SNF provider          groups; (2) for each code            representative CPT procedure
(CMSA) ratios: 80th percentile    median charges divided by the       group, divide the 80th               codes split into 24 medical
semiprivate room and board per    average of statewide                percentile by the median             service groups
diem charge divided by the        accommodation charges; (2)          charge; (3) if the ratio exceeds
average per diem for CMSAs; (2)   multiply ratio by average           115 percent, then cut excess
ratio applied to both room and    national charge                     percentage by half; (4) for each
board and ancillary services                                          code group, multiply associated
components                                                            ratio by median national charges
Data sources
1995 Medicare data for medical    1995 Medicare data                  For four code groups, 1995       Health Insurance Association of
and surgical admissions                                               MedStat data; for all other code America data on 80th percentile
                                                                      groups, 1996 MediCode dataa      charges, various datesb
                                              MediCode is a database of outpatient facility charges gathered from numerous commercial
                                              The Health Insurance Association of America compiles a nationwide commercial insurance
                                             database of provider charges based on millions of claims records.

                                             Although not shown in table II.3, the first calculations for developing
                                             physician charges transform 80th percentile charge data into conversion
                                             factors, that is, monetary rates per RVU. VA constructed a conversion factor
                                             for each of 24 physician CPT code groups, such as inpatient visits, surgery,
                                             pathology, and anesthesia. The conversion factor (a dollar amount per
                                             RVU) for a group was computed by dividing the weighted average charge
                                             (at the 80th percentile level) by the weighted average RVU for the selected
                                             CPT codes.11 Departing from Medicare practice, VA’s method removes

                                                RVU data came from St. Anthony’s Complete RBRVS (resource-based relative value scale) and other

                                             Page 17                                              GAO/HEHS-99-124 VA Reasonable Charges
                                             Appendix II
                                             VA’s Methodology for Setting Reasonable

                                             charges for the malpractice component since the costs associated with
                                             malpractice are not the responsibility of VA.

Trending Charges Forward                     Because the charge data were gathered at various times in the past and
                                             charges can be anticipated to change over time, VA trended the data
                                             forward to approximate charges during its anticipated first year of
                                             implementing reasonable charges—August 1998 through September 1999.
                                             Its general methodology was to identify indexes of relevant price trends
                                             and then estimate the price changes between the time of VA’s baseline data
                                             and the midpoint of the charge period. As shown in table II.4, various
                                             components of the Consumer Price Index (CPI) were generally the data
                                             source for the indexes. (The CPI-U series covers all urban consumers,
                                             whereas the CPI-W series covers urban wage earners and clerical workers.)

Table II.4: Trending Charges Forward by Categories of Charges
Inpatient facility               SNF/subacute inpatient facility Outpatient facility                        Physician
Projected price change from        Projected change in Medicare       Projected price change from           Projected price change from
1995 to midpoint of VA charge      reimbursement for SNF from         1995 to midpoint of VA charge         various 1996 to 1997 dates to
period (Aug. 1998 to Sept. 1999)   July 1, 1998, to midpoint of VA    period multiplied by 1995             the midpoint of VA charge
multiplied by the adjusted 1995    charge period multiplied by the    adjusted 80th percentile              period multiplied by adjusted
80th percentile charges            adjusted July 1, 1998, 80th        charges                               80th percentile conversion
                                   percentile SNF charge                                                    factors
Data sources
CPI-W, hospital room and other     Annual Report of the Board of    CPI-U, outpatient hospital              CPI-U, physician component
hospital components (1995 to       Trustees of the Federal Hospital component
Jan. 1997); CPI-U, inpatient       Insurance Trust Fund
hospital component (Jan. 1997
and forward)a
                                              In January 1997, the Bureau of Labor Statistics revised CPI’s hospital components.

                                             The outpatient facility nationwide charges reflect one more adjustment
                                             (not indicated in table II.4). After trending forward, the outpatient charges
                                             were adjusted to make them relative to the RVUs within each of the 37
                                             outpatient facility CPT code groups.

Geographic Adjustment                        Because the objective of reasonable charges is to bill at rates
Factors                                      commensurate with local market charges, VA’s methodology produces
                                             geographic adjustment factors to transform nationwide rates into VA
                                             facility-specific charges. As shown in table II.5, these adjustment factors
                                             are derived by creating a ratio of local charges to national charges. These

                                             Page 18                                               GAO/HEHS-99-124 VA Reasonable Charges
                                             Appendix II
                                             VA’s Methodology for Setting Reasonable

                                             ratios differ in the boundaries placed around VA facility areas
                                             (metropolitan statistical area (MSA), three-digit zip code, or state) and data

Table II.5: Geographic Adjustment Factors by Categories of Charges
Inpatient facility              SNF/subacute inpatient facility Outpatient facility                    Physician
Ratio: average per diem charges    Ratio: average per diem for SNF For each VA location, average       (1) Conversion factor (CF)
for each VA facility area (MSA)    charge for each state, divided  of two outpatient area              adjustment for each VA location
divided by the national            by nationwide average per diem adjustment factors: (1) ratio of     (three-digit zip code area) and
average—both averages                                              levels of charges for the VA        procedure code group; ratio of
weighted by national average                                       facility area (MSA) compared to     facility-specific CF divided by
length of stays and fiscal year                                    nationwide and (2) ratio of         nationwide average CF; (2) RVU
1997 VA discharges; four                                           CPT-weighted average charge         adjustments: area adjustments
adjustment ratios: for surgical                                    level for each VA facility area     for work units and practice units
and nonsurgical DRGs and,                                          (three-digit zip code) divided by
within these, for room and board                                   the nationwide CPT-weighted
and ancillary components                                           average charge
Data sources
1995 Medicare data on per diem Milliman & Robertson, Health         Milliman & Robertson, Health  Facility-specific CF calculated
charges; fiscal year 1997 VA      Cost Guidelines                   Cost Guidelines, and MediCode with same data as nationwide
data on its nationwide discharges                                   data                          CF, and Medicare area
by DRG; Medicare and MedStat                                                                      adjustments for RVU
data on average lengths of stay                                                                   components

Other Adjustments                            VA established two other important adjustments to reasonable charges
                                             based on precedence to make them consistent with industry practices.
                                             First, the progressive reductions of outpatient facility charges for multiple
                                             surgeries—that is, charges are 100 percent of the most expensive
                                             procedure, 25 percent of the second most expensive procedure, 15 percent
                                             of the third most expensive procedure, and 0 percent for all other
                                             procedures—were derived from an analysis of MedStat charge data.
                                             According to VA’s contractor, these reductions are consistent with the
                                             reasonable and customary charges recommended by MediCode. Second,
                                             most adjustments of charges for nonphysician providers—as a percentage
                                             of physician charges for performing the same services—were based on
                                             Medicare percentages, when available.

                                             To determine the amount to bill insurers under reasonable charges, a VA
Formulas for                                 facility will use a formula appropriate to the category of charge. (A single
Facility-Specific                            encounter may involve multiple categories of charges. An ambulatory
Charges                                      surgery, for instance, could result in an outpatient facility charge as well as

                                             Page 19                                         GAO/HEHS-99-124 VA Reasonable Charges
    Appendix II
    VA’s Methodology for Setting Reasonable

    physician and nonphysician provider charges.) The formulas adjust a
    nationwide charge to a locality charge for specific VA facility locations by
    applying data from tables of national dollar amounts, geographic
    adjustments, and other factors. For inpatient facility charges or
    SNF/subacute inpatient facility charges that are based on per diem rates,
    calculating total charges also requires data on the number of days in the

•   Inpatient facility charge: First, a nationwide room and board per diem
    charge for a specific DRG is multiplied by the geographic adjustment factor
    specific to the VA facility. Second, the same calculation is done for the
    ancillary component of the per diem charge. Third, the two geographically
    adjusted per diem components are summed, resulting in a dollar amount
    which equals the combined per diem facility charge. Finally, this combined
    facility charge is multiplied by the number of days of stay, which produces
    the total inpatient facility charge. When more than one condition is treated
    during a hospitalization, total charges are the sum of the charges that are
    computed for each of the DRG conditions by allocating the days of stay
    between the DRGs.
•   SNF/subacute inpatient facility charge: A per diem facility rate is calculated
    by multiplying a national rate by a geographic adjustment factor. Then the
    total charge equals the per diem rate multiplied by the number of days in
    the stay.
•   Outpatient facility charge: For those outpatient procedures for which VA
    has established outpatient facility charges, a facility-specific outpatient
    facility charge is computed by multiplying a nationwide CPT procedure rate
    by a geographic adjustment factor. If multiple surgical procedures occur
    during the same outpatient encounter, then no more than the three most
    expensive outpatient facility charges for surgery will be billed, and the
    second and third of these are discounted to 25 percent and 15 percent,
•   Physician charge: Charges are calculated for procedures in one of three
    ways. For most CPT codes—which have both work expense and practice
    expense RVUs—physician charges are calculated by summing these RVUs
    (adjusted for facility location and by a Medicare work expense adjustment
    factor), then multiplying this sum of adjusted RVUs by a facility-adjusted
    conversion factor (a dollar amount per RVU). For CPTs with only total RVUs
    available, charges are equal to the facility-adjusted RVUs multiplied by the
    dollar amount of a facility-adjusted conversion factor. Finally, for
    pathology and anesthesia charges, a nationwide charge for a CPT code is
    multiplied by a geographic adjustment factor.

    Page 20                                   GAO/HEHS-99-124 VA Reasonable Charges
               Appendix II
               VA’s Methodology for Setting Reasonable

           •   Nonphysician provider charge: These charges are a percentage (up to
               100 percent) of the charge for the same procedure performed by a
               physician, depending on the type of nonphysician provider. For example, a
               procedure done by a nurse practitioner would be billed at 85 percent of
               the charge for a physician doing the procedure.

(406157)       Page 21                                   GAO/HEHS-99-124 VA Reasonable Charges
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