Out Of Pocket Healthcare Payments, Part I: A growing problem for hospital finances

Introduction: The Financial Strain on Hospitals

Hospitals are in the business of providing patient care, and largely generate their revenue from insurance reimbursements and out-of-pocket (OOP) expenses. Given the low single digit margins (even dipping to negative during COVID) that hospitals finances typically operate on, and the complexity of healthcare payments, keeping both revenue sources performing at a high level presents unique challenges for hospitals and healthcare providers.

Payor Reimbursements: Misaligned incentives

While insurance payments have traditionally been the backbone of healthcare revenue, they often don’t fully align with the financial wellbeing of providers. Here’s why:

Insurance Payments Don’t Represent Costs of Care

At a high level, rates are determined not by the actual cost of procedures but by negotiated agreements. To understand just how strange and complex this can get, see Dr. Eric Bricker’s excellent breakdown of this issue (https://www.youtube.com/watch?v=1Kh7EA_Lt-c), summarized below:

1. Strategic Pricing and Horse Trading: Hospitals and insurers engage in "horse trading" during negotiations, where they may agree to lower prices for certain services in exchange for higher prices for others. This strategic pricing aims to meet the total contract value goals of both parties.

2. Pricing difference for the same procedure among insurers: The allowed amount for a colonoscopy can vary by as much as 50% among different insurers at the same hospital.

3. Pricing difference for the same procedure within insurers: Even with the same insurance carrier, prices can vary dramatically depending on the plan type, illustrated by the difference in MRI costs under United Healthcare's PPO versus HMO plans at the same hospital.

Imagine being a hospital CFO, trying to reconcile all of these different prices internally and make accurate financial forecasts for your hospital! In fact, securing better negotiated rates ranked as one of the top issues for hospital CFOs.

Lengthy Insurance Payment Cycles

Typical US hospital days in A/R (or the measure of how long it takes for hospitals to receive payment) is 30-70 days. However, hospitals with poor finances have low days cash on hand (how many days hospitals can pay for operating costs with just their cash reserves), and low cash on hand (less than one month) is highly correlated with eventual hospital closures. Considering the complex administrative process and time it takes to receive insurance reimbursement, it’s unlikely that hospitals would be able to improve days in A/R significantly to cover any short term cash needs.

Overall, there are very few immediate levers providers can pull to improve via better insurance reimbursement.

Out-of-Pocket Payments: Challenges and Opportunities

So are there opportunities to improve hospital financials through managing out of pocket costs? Recent trends suggest that hospitals would do well to pay more attention to this source of revenue:

The Growing Burden of Out-of-Pocket Payments

Over the past decade, there has been a noticeable shift in the healthcare payment landscape, with out-of-pocket payments constituting a growing share of hospital revenues. A few statistics stand out:

• In 2000, patient payments accounted for less than 5% of total provider revenue. By 2017, it had risen to 35% and continues to increase.

• Importantly, self-pay after insurance accounted for nearly 58% of bad debt in 2021, compared with only 11% in 2018.

• Patient statements with balances greater than $14,000 nearly quadrupled from 4.4% in 2018 to 16.8% in 2021.

This trend is reflective of broader shifts in healthcare policy and consumer behavior, where patients are increasingly required to bear a larger portion of their healthcare costs.

The Impact of High Deductible Health Plans (HDHPs)

The proliferation of high deductible health plans is also a key driver behind the increase in out-of-pocket payments. HDHPs, designed to lower insurance premiums for consumers, place a greater financial burden on patients before their insurance begins to cover medical costs. A study shows that over half of US workers have high deductible plans in 2021, a growth from ~30% from 2012, and continues to rise. This has led to a situation where patients are often required to pay significant amounts out-of-pocket for their healthcare, turning patient payments into a critical revenue line for hospitals.

Challenges in Collection Rates for Out of Pocket Payments

Given the increase in out of pocket costs, the administrative burden for hospitals to recover payments from patients is also increasing. Many hospitals are already chronically understaffed, which further contributes to poor collection rates of 17-32% for balances over $5000.

Conclusion: Navigating the Out-of-Pocket Payment Challenge

The convergence of these trends presents a clear and immediate opportunity for healthcare providers to reevaluate and improve their approaches to managing out-of-pocket payments to improve hospital finances. The dismal performance in current OOP payment collections is a clear indicator of the systemic issues plaguing the healthcare payment ecosystem, and innovation is sorely needed in this space.

Curious to know what solutions currently exist to improve the out of pocket financial burden for hospitals and patients? Join us next week for Part II of this series on out of pocket payments.

If you hate out of pocket payments as much as patients and providers do, please join us at The Healthcare Syndicate on AngelList in investing in companies that are tackling this growing challenge.