VA Health Economics Course Presentation # 3: Costing Methods April 6, 2006

Health Economics Resource Center2 Costing Methods Mark W. Smith, PhD Associate Director VA Health Economics Resource Center

Health Economics Resource Center3 Focusing Question What is the cost of a health care intervention? Example CSP 530 compares dialysis 3x/week to 6x/week for patients with acute renal failure.

Health Economics Resource Center4 Cost of Health Care Outside of health, most items that we purchase daily have a readily observable cost Not true with health care –Insurance buffers patient from true cost –Charges, payments may not equal cost

Health Economics Resource Center5 Cost Estimation Approaches Two general approaches to costing: –Microcosting –Average costing (gross costing)

Health Economics Resource Center6 Estimating Costs: Micro-costing –Determine each input, find its price, then sum (quantity*price) across all inputs –DSS uses this approach –Researchers use this approach in some circumstances –Gold standard but resource intensive

Health Economics Resource Center7 Estimating Costs: Average Costing –Over a long period, divide total cost by total units of care provided –Less precise than micro-costing

Health Economics Resource Center8 Costing Spectrum Micro costing and average costing represent ends of a spectrum Micro costing Average Costing

Health Economics Resource Center Costing Spectrum Direct measurement Pseudo-bill Reduced list costing Cost regression Estimate Medicare payment Average cost per day microaverage

Microcost method 1 Direct Measurement

Health Economics Resource Center Direct Measurement Used to the find the cost of: –interventions –care unique to VA Method 1.Measure staff activity 2.Find labor cost 3.Find cost of supplies, capital, overhead

Health Economics Resource Center Finding Unit Cost Average cost –Total program cost/number of units –Assumes homogeneous products Relative Values needed for heterogeneous products –Find Relative Value of each product –Find cost per relative value unit (RVU) –Use this to find cost of each product

Health Economics Resource Center Staff Activity Analysis Methods of finding staff activities –Track staff activity in a log –Estimate activity Need not be comprehensive; can sample activity Estimate labor cost Direct Measurement

Health Economics Resource Center Characterizing Staff Activities Cost of patient care may include non- patient care time Activities that produce several products may need to be included, depending on perspective –e.g., time spent on clinical research may be regarded as a research cost, or a patient care cost, depending on analytical goal Direct Measurement

Health Economics Resource Center Exclude and Include Exclude development cost Exclude research-related costs Should measure when program fully implemented Should measure at constant returns to scale Direct Measurement

Health Economics Resource Center Direct vs. Indirect vs. Overhead Direct costs: costs that are tied to a particular encounter (e.g., staff time, medications) Overhead: costs that cannot be tied to particular procedures (e.g., VA police, maintenance, food service)

Health Economics Resource Center Direct vs. Indirect vs. Overhead Indirect: (a)sometimes means overhead (b)sometimes means non-salary benefits (e.g., health care, annual leave) (a)sometimes means secondary impact of treatment on other health care use Example: patient receives better depression care at VA and later has fewer visits for other causes at VA and later has fewer visits for other causes

Health Economics Resource Center18 Poll & Discussion Which of these should be included in the cost of an intervention?  Non-salary benefits  Secondary impact on other health care services  Overhead costs

Health Economics Resource Center Other Costs Survey or actual measure of supply costs Alternatives for overhead –Cost report data –Standard rates Alternatives for capital –Cost report –Rental rates Direct Measurement

Microcost method 2 Pseudo-Bill

Health Economics Resource Center Pseudo-bill Itemize all services utilized/provided Use schedule of cost/reimbursement for each service Example: HERC outpatient costs –Itemized all CPT codes –Used relative value weights to assign costs to procedures

Microcost method 3 Reduced List Costing

Health Economics Resource Center Reduced List Costing Some utilization items in pseudo-bill explain most of variation in cost –e.g., surgical procedures Costing major items may be sufficient Schedule of cost/reimbursement must be adjusted –e.g., new rate for surgical procedures that includes cost of laboratory services

Microcost method #4: Cost Regression

Health Economics Resource Center Cost Regression Dependent variable is charges or cost-adjusted charge from non-VA data Independent variables: –Clinical information –Diagnosis Related Group –Diagnosis –Procedures –Vital status at discharge –Length of stay –Days of ICU care Anything that predicts cost and is in both datasets.

Health Economics Resource Center Transformation of Dependent Variable Cost data are frequently skewed –Skewed errors violates assumptions of Ordinary Least Squares –Error terms not normally distributed with identical means and variance –Transformation  Typical method: log of cost  Can make OLS assumptions more tenable

Health Economics Resource Center References - I Duan, N. (1983) Smearing estimate: a nonparametric retransformation method, Journal of the American Statistical Association, 78, Manning WG, Mullahy J. Estimating log models: to transform or not to transform? J Health Econ 2001 Jul;20(4):

Health Economics Resource Center References - II Basu A, Manning WG, Mullahy J. Comparing alternative models: log vs Cox proportional hazard? Health Economics 2004 Aug;13(8): See HERC web site FAQ response: resources/faq_e02.asp

Health Economics Resource Center29 Limitations Relies on similar cost structures of external and study (internal) data. Reduces the number of outliers. Can create statistical anomalies.

Microcost method # 5: Estimating Medicare reimbursements

Health Economics Resource Center31 Medicare Reimbursements Part A -- Prospective Payment for Inpatient Stays Part B -- Payment for Physician Services to Inpatients

Health Economics Resource Center Medicare Inpatient Facility Payment DRG-based payments adjusted by –Disproportionate share payments –Indirect medical education –Geographic adjustments Outlier payments for unusual cases Direct medical education

Health Economics Resource Center33 Medicare Payments Medicare pays flat rate per DRG, regardless of length of stay (except for outliers) Cost analysis may wish to capture effect of length of stay on cost

Health Economics Resource Center Medicare Pricer Software Computer application for calculating facility payment Requires –6-digit hospital PPS (identifier) –DRG –Admission and discharge dates (LOS)

Health Economics Resource Center Medicare Outpatient Payment Payment based on CPT procedure codes Provider payment and facility payment (if done in hospital) See documentation for HERC Outpatient Average Cost data: methods_data/va_cost_methods_ac.asp

Health Economics Resource Center36 Outpatient Medicare Payments Some CPTs have no APC: –Paid on cost pass-through basis –Paid through another APC (e.g., anesthesia) –Paid through a separate cost list –Multiple CPTs assigned to a single group- APC –Some surgery procedures are discounted

Health Economics Resource Center Selecting a Method Data available? Method feasible? Assumptions appropriate? Method accurate: Will it capture the effect of the intervention on resource use?

Health Economics Resource Center Direct Measurement Assumptions –Activity survey and payroll data are representative –May assume all utilization uses the same amount of resources Advantages –Useful to determine cost of a program that is unique to VA Disadvantages –Limited to small number of programs –Can’t find indirect costs –Can’t find total health care cost

Health Economics Resource Center Pseudo-bill Assumptions –Schedule of charges reflects relative resource use –Cost-adjusted charges reflect VA costs Advantages –Captures effect of intervention on pattern of care within an encounter Disadvantages –Expense of obtaining detailed utilization data

Health Economics Resource Center Reduced List Costing Assumptions –Items on reduced list are sufficient to capture variation in resource use –Cost of items on reduced list is accurate Advantages –Requires less data than pseudo-bill Disadvantages –Needs to find data on cost associated with items on reduced list

Health Economics Resource Center Cost Regression Assumptions –Cost-adjusted charges accurately reflect resource use –The relation between cost and utilization is the same in the current study as in the previous study Advantages –Less effort to obtain reduced list of utilization measures than to prepare pseudo-bill Disadvantages –Must have detailed data –Data from prior study may have error or bias

Health Economics Resource Center Estimate Medicare payments Assumptions –Medicare payments reflect average cost for a population; your sample is generalizable –RVU captures effect of intervention on resources used Advantage: easy to understand Disadvantages: –Accuracy limited – VA may have different cost structures from average non-VA facilities –Inpatient: doesn’t reflect variation in resources beyond DRG (or LOS)

Health Economics Resource Center Combining Methods No single method may fill all needs, even within a single study Hybrid method may be best –Direct method or pseudo-bill on utilization most affected by intervention –Cost regression or Medicare payment for other utilization

Health Economics Resource Center44 Whiteboard Exercise / Discussion CSP 530 compares dialysis 3x/week to 6x/week for patients with acute renal failure. CSP 530 compares dialysis 3x/week to 6x/week for patients with acute renal failure. What are some costs that you could estimate by an average-costing approach? What are some costs that you could estimate by an average-costing approach?

Health Economics Resource Center Reference Barnett PG. Determination of VA health care costs. Medical Care Research and Review 2003;60(3 Suppl.):124S-141S. publications/supplement_mcrr_2003.asp publications/supplement_mcrr_2003.asp

Health Economics Resource Center46 Other Resources HERC web site: FAQ responses, technical reports (click on Publications tab) HERC Help Desk

Health Economics Resource Center47 HERC list To join the HERC list, send a request to

Health Economics Resource Center48 Next session Thursday, 4/16/2006, 2 p.m. ET Estimating the Cost of Health Care: VA Costs Todd Wagner, PhD Reading for next session: M Gold et al. Cost-Effectiveness in Health and Medicine pp Available for purchase at or PG Barnett. Medical Care Research and Review 60(3), pp. 124S-141S. Download from publications/supplement_mcrr_2003.asphttp:// publications/supplement_mcrr_2003.asp