Why We Should Standardize Provider Cost Measurement

Although President Joe Biden’s American Rescue Plan Act of 2021 will benefit hospitals through its expansion of subsidies to private insurance coverage, forthcoming federal budget pressure from the enormous deficit and the need to take action to extend the life of Medicare’s hospital trust fund likely will lead to renewed pressure on Medicare payment rates and greater need for hospitals to address their costs. To better prepare to control costs, many US health care providers have adopted internal cost measurement systems. While the cost data produced by these systems are quite detailed, most providers have struggled to meaningfully translate the data into operational improvements and cost savings.

The internal cost measurement systems that many US hospitals have adopted are individually configured by each provider. As a result, the cost data currently produced by the internal cost measurement systems cannot meaningfully be compared across organizations. I believe that standardizing internal cost measurement would provide a number of significant benefits to providers by addressing important impediments to taking advantage of the data produced by their internal cost systems.

Standardizing internal cost measurement means that providers produce cost data that can be compared across organizations. To facilitate this, there must be standardization in the clinical items for which cost data are produced. In fact, providers already track more than 16,000 clinical items as part of the Current Procedural Terminology/Healthcare Common Procedure Coding System coding methodology required for outpatient and professional billing. This existing catalogue covers a wide range of detailed items, such as “C1728: Catheter, brachytherapy seed administration,” (a supply item); “95812: Electroencephalogram extended monitoring; 41-60 min,” (a diagnostic test); and “85670: Thrombin clotting time” (a laboratory test). Moreover, providers record inpatient procedures using the ICD-10 procedure coding system, which includes more than 70,000 items. These could be built upon and refined and be expanded to non-procedural inpatient services.

The accounting rules and standards that are applied to produce the cost data for each clinical item must be uniform across providers. Specifically, rules need to be developed around issues such as the treatment of direct costs, which are costs that are unambiguously related to specific clinical items, such as the purchase price of supplies; the definition of cost centers and the assignment of costs to them; the grouping of costs in the cost centers into cost categories such as labor or equipment; and the allocation of costs to the individual clinical items.

With respect to the treatment of direct costs, the rules must specify whether the costs are broken out and assigned directly to the clinical items or whether they are included in the costs in the cost centers and then traced to the clinical items via the allocation mechanism. For example, the cost accounting rules developed and used by the regulator in Germany include an explicit list of expensive drugs, blood products, implants, and transplants whose (average) acquisition costs paid by the provider are to be assigned directly to the clinical items, and thus be excluded from the costs allocated from the cost centers.

With respect to the definition of cost centers, the current reporting requirements in the Medicare Hospital Cost Report and in certain state-level financial reports such as the Hospital Annual Financial Report mandated in California instruct providers to assign costs to between 100 and 150 cost centers, which constitutes a good starting point. The report required in California also asks providers to group the costs within the cost centers into categories such as “salaries and wages,” “employee benefits,” “supplies,” “depreciation,” and so forth, which is a sensible suggestion for the grouping of costs.

The internal cost measurement systems that many US hospitals currently have in place produce cost data for the clinical items on their chargemasters, which are developed for billing purposes and typically contain tens of thousands of items. Chargemasters are provider specific and not standardized. Moreover, the cost centers and allocation mechanisms used in the cost measurement systems are also idiosyncratic to the provider. As a result, the cost data currently produced by the internal cost measurement systems cannot meaningfully be compared across organizations.

Effectively, a standardized cost measurement system that I am proposing would amount to an enhancement of the cost finding sections currently required in the Medicare Cost Report and in state reporting requirements, such as the Hospital Annual Financial Report mandated by the regulator of California. A certification or audit mechanism will be required that can attest that a provider followed the rules and standards in producing its cost data.

A standardized internal cost measurement system would provide a number of benefits to providers. First, it would allow providers to reliably benchmark their costs to other providers, and to thereby learn where and how they can improve the efficiency of their organizations. High participation rates in cost benchmarking programs such as the one offered by Vizient (formerly University HealthSystem Consortium) highlight providers’ interest in comparing themselves to and learning from their peers.

Second, internal discussions in provider organizations between administrators and physicians and other clinicians around cost savings and cost-savings targets are expected to be much easier when cost data are certifiably produced following a standard approach. Patient-care decisions by physicians determine a large proportion of health care costs (a frequently cited number is 80 percent), putting physicians in the center of provider cost-savings efforts. Lack of trust in the produced cost data by physicians and other clinicians is, in my observation, one of the most important barriers that provider organizations are currently facing in the effort to translate internal cost data into operational improvements. Cost-savings goals that are based on comparable costs of peer institutions constitute objective and transparent targets that could help mitigate internal pushback. In general, cost data that are produced according to a standard methodology might be received with a lot less skepticism.

Third, a standardized methodology would provide valuable guidance to provider organizations on how to best configure their cost measurement systems. Currently, there is a lot of uncertainty among providers around the best practices of internal cost measurement. Many providers are spending a lot of resources in the form of consultants and staff time trying to build up expertise around cost measurement. A standardized methodology would save providers significant resources and speed up the adoption of good cost measurement techniques in the industry.

In addition to benefits for providers, a standardized internal cost measurement system would address some of the challenges that the cost-effectiveness analysis discipline has been facing. Cost-effectiveness analysis is concerned with choosing among treatment alternatives and aims to maximize the health outcomes for a given amount of resources spent. A key component of cost-effectiveness analysis is identifying the costs that are incurred in providing a specific intervention. While there has been growing interest in the discipline from various groups within the medical community, lack of confidence in the cost data and underlying cost measurement approaches used has remained an important barrier to broader acceptance of cost-effectiveness analysis and the results and implications developed by the field. The cost measurement approaches used in cost-effectiveness studies vary significantly, and the details of the methodology used in a particular analysis are often times not transparent. As a result, cost-effectiveness studies are difficult to compare, and their findings and conclusions remain open to the caveat that they are not robust to alternative cost measurement approaches. A standardized provider cost measurement system could be used to generate cost inputs that are arrived at in a transparent and consistent fashion. As a result, the reliability and comparability of cost-effectiveness analyses would be significantly enhanced.

The standardizing of internal cost measurement that I propose here can be delineated using some analogies. For example, publicly traded companies in the US follow standardized financial accounting rules, called Generally Accepted Accounting Principles, when preparing their quarterly and annual financial statements. The application of the financial accounting standards, in combination with verification from auditors, yields reliable and comparable financial information, such as earnings, for investors and creditors, contributing to the smooth functioning of the capital markets. With respect to the health care industry, standardized quality metrics such as hospital-acquired infection rates and rates of adherence to best clinical practices around testing of blood pressure and blood sugar allow for the comparison between providers.

How can the provider community arrive at a standardized internal cost measurement framework? Both top-down and bottom-up approaches have potential. In a top-down approach, the Centers for Medicare and Medicaid Services (CMS) would develop a standardized internal cost measurement approach and require its implementation as part of Medicare providers’ cost reporting obligation, effectively expanding the current cost reporting requirements stipulated in the Medicare Hospital Cost Report. CMS could use the more accurate cost data to refine relative values used to set payment rates. Not requiring public disclosure of the cost data under this approach would help maintain provider confidentiality. Such a top-down approach would facilitate the simultaneous adoption of the standardized approach by all Medicare providers. As with other regulations, CMS would draw on comments from a wide range of stakeholders and professional organizations.

A standardized internal costing system could also develop in a bottom-up approach. Specifically, a large provider or provider system or a third party such as an accounting or analytics company could independently develop a set of internal cost accounting rules and standards. The accounting rules and standards could be copyrighted and licensed; alternatively, the standards could be provided for free, and the developer could obtain revenue from certifying/auditing of adherence to the standards. Each provider organization could choose whether to adopt the standards. A provider’s decision to adopt the standards is essentially a decision of whether the organization wants to join the network of providers that share the same standardized internal cost accounting system. The value of the network in terms of providing benchmarking data would increase with each member. The bottom-up approach has the advantage over the top-down approach that it allows for more than one set of accounting rules and standards to be developed at the same time, facilitating competition to develop high-quality standards and large networks of participants, and to lower prices for participating providers. Such competition could foster innovation in cost accounting in the US health care industry.

But we need to raise the question of why this has not already happened and a standardized internal cost measurement system has not already emerged in the industry. One reason is that some of the players who are in the position to develop standards have been profiting handsomely by instead selling consulting services to individual providers. Another reason may be the investment required to develop a set of high-quality standards. One option would be for CMS to fund the development of internal cost measurement standards at one or more nonprofit organizations.

A standardized internal cost measurement system would provide a number of benefits to providers. It would allow providers to reliably benchmark their costs to other providers, stimulating efficiency improvements of their organizations; enhance clinicians’ trust in the produced cost data, facilitating discussions between administrators and clinicians around cost savings and cost-savings targets, thereby enabling operational improvements; and provide guidance to providers on how to best configure their cost measurement systems, saving resources currently spent on consultants and staff and fostering the adoption of good cost measurement techniques in the industry. The medical coding and accounting infrastructure already in place through provider billing and reporting requirements provides a good starting point that can be built upon to develop a standardized internal cost measurement system. The standardized costing framework could be developed in a top-down approach by CMS through an expansion of existing provider cost reporting requirements or in a bottom-up approach by a large provider or third party, with network effects as one possible business model.