1. TRANSFORMATIONAL PRICING: STRATEGIES FOR THE CDM, PAYERS, AND PATIENTS VA-DC HFMA SPRING EDUCATION CONFERENCE March 24, 2016 Presented by: Jamie Cleverley, MHA Cleverley + Associates jcleverley@cleverleyassociates.com

2. | 2 | Today’s Objectives 1)Describe how providers are approaching transparency and defensibility initiatives 2)Articulate the payment implications for making transformational pricing changes and how financial impact can be managed through specific payer strategies 3)List the steps necessary for implementing transformational pricing CDM strategies along with payer impact analysis and mitigation

3. HOW ARE HOSPITALS APPROACHING TRANSPARENCY/DEFENSIBILITY?

4. | 4 | Facility-level charge measure: Hospital Charge Index ® Outpatient Charges Outpatient Charge Index Formula: Your Medicare Charge per Visit (RW/WI adj) US Median Medicare Charge per Visit (RW/WI adj) Inpatient Charges Inpatient Charge Index Formula: Your Medicare Charge per Discharge (CMI/WI adj) US Median Medicare Charge per Discharge (CMI/WI adj) Provider research 2014 Survey: 78 hospital finance leaders representing 185 hospitals and health systems 2015 Survey: 58 hospital finance leaders representing 156 hospitals and health systems Linkage of both to facility charge information via Hospital Charge Index® Results published in HFMAs hfm (September 2014 Cover Story) and Strategic Financial Planning publications (Summer 2015 Cover Story)

5. | 5 | What does pricing transparency mean to you? Source: Cleverley + Associates

6. | 6 | How do you currently communicate prices to your patients? Source: Cleverley + Associates

7. | 7 | What makes a pricing strategy defensible? Source: Cleverley + Associates

8. | 8 | If you make your charges public (transparent), are you confident that you can defend and explain those charges when compared to other facilities? Source: Cleverley + Associates

9. | 9 | Source: Cleverley + Associates What makes a pricing strategy defensible?

10. | 10 | Is pricing transparency a factor you consider when planning yearly rate adjustments? Source: Cleverley + Associates

11. WHAT CDM ACTIONS ARE HOSPITALS TAKING?

12. | 12 | Inflationary Changes by Metric & Year Hospital charge inflation is decreasing

13. | 13 | Average Annual Inflation by Charge Growth Quartile Groups (2011-2014) Source: Cleverley + Associates Rate change varies significantly

14. | 14 | Inflation Impact on Hospital Charge Index® by Charge Growth Quartile Groups Source: Cleverley + Associates Rate change can quickly alter a hospital’s relative charge position

15. | 15 | WEST 2011 HCI118.3 2014 HCI114.0 IP Inflation2.9% OP Inflation2.8% MIDWEST 2011 HCI93.3 2014 HCI91.6 IP Inflation4.0% OP Inflation3.6% NORTHEAST 2011 HCI87.4 2014 HCI83.6 IP Inflation3.1% OP Inflation2.6% SOUTH 2011 HCI115.0 2014 HCI117.1 IP Inflation5.3% OP Inflation5.1% Rate change and charge positions vary by region

16. | 16 | Lowest Charge Growth Group Lower Charge Growth Group Higher Charge Growth Group Highest Charge Growth Group All U.S. Group Emergency Room -4.5%-0.8%0.3%3.1%0.2% Surgical Procedures -1.5%1.5%3.4%6.7%2.8% Imaging 1.2%4.2%6.5%9.5%5.9% Lab 1.2%4.0%5.6%8.2%5.5% Therapy 0.7%3.2%4.8%6.4%4.3% Routine Room Rates 1.8%4.4%4.7%7.3%4.9% Key products/services are experiencing different levels of change Average Annual Rate Change by Charge Growth Quartile Groups (2011-2014)

17. | 17 | External price pressures are increasing – primarily in “retail” areas

18. PAYMENT IMPLICATIONS FOR PRICING CHANGES

19. | 19 | Three spheres of influence on price PRICE

20. | 20 | Payer Number of Patients Net Payment per Patient Total Payment Total Cost Medicare50$92.50$4,625$5,000 Medicaid10$75.00$750$1,000 Uninsured5$5.00$25$500 Managed Care30$125.00$3,750$3,000 Other5???$500 Totals100$9,150$10,000 less Total Cost$10,000 less Required Profit$500 Balance Remaining($1,350) Average Cost per Patient = $100 Required Payment from Five Remaining Patients = $270 ($1,350/5) ??? Payment is the real key in determining hospital pricing

21. | 21 | Price = (NI + fixed pay margin) (1 - charge discount) Pricing Model – Formula for price-setting avg cost + charge volume Average cost increases Use this model for price-setting at facility level: Net income requirements increase Losses from fixed pay business increases The percentage of charge paying patients decreases Price must increase when: The discount from charges increases Payment is the real key in determining hospital pricing

22. | 22 | Average cost =$100 Net income =$4 (4%) Average fixed payment =$100 Average fixed pay margin =$0 Charge payers =20% Charge discount =30% Required price =$171.43 Payment is the real key in determining hospital pricing Average Cost per Patient = $100 Pricing Model – Sample Calculation

23. | 23 | MODEL # 1# 2# 3 Net income = $4 (4%) Fixed pay margin = $1-$3$0 Charge payers = 30%15%100% Charge discount = 50%60%5% Required price = $220$367$109 Payment is the real key in determining hospital pricing Pricing Model – Sensitivity Analysis Average Cost per Patient = $100

24. | 24 | Net income Pricing Model – Revising the formula to evaluate margin impact from desired pricing = [(Price X (1 - charge discount) - avg cost) X charge volume] – fixed pay margin Payment is the real key in determining hospital pricing MODEL # 1# 2# 3 Required price $260$367$109 Desired price $109 Resulting average margin -$12.65-$11.46$0 Average Cost per Patient = $100

25. | 25 | Financial costs of payment reductions RATE OF REDUCTION 10%20%30%40%50% RECOVERY RATE 5%(2,500,000)(5,000,000)(7,500,000)(10,000,000)(12,500,000) 10%(5,000,000)(10,000,000)(15,000,000)(20,000,000)(25,000,000) 15%(7,500,000)(15,000,000)(22,500,000)(30,000,000)(37,500,000) 20%(10,000,000)(20,000,000)(30,000,000)(40,000,000)(50,000,000) 25%(12,500,000)(25,000,000)(37,500,000)(50,000,000)(62,500,000) Annual loss of net revenue associated with differing levels of charge reduction and pricing recovery (based on hospital with $500,000,000 in gross charges)

26. | 26 | Recovery is variable because of lesser-of provisions 1)Non-aggregate claim lesser-of a)Payer evaluates payment based on lesser-of price per unit or fee schedule amount 2)Aggregate claim lesser-of a)Payer evaluates payment based on SUM of payment for all lines or SUM of all charges Examples in presentation appendix

27. ACHIEVING MEANINGFUL CHANGE

28. | 28 | Current Price: $220 New Price: $104 Process Commit to transparency Develop initial guiding policies and goals

29. | 29 | Commit to transparency/defensibility with clear policies and goals 1 2 External Policy Internal Policy o Public facing document for patients to view o Meets or exceeds national and state requirements (as applicable) o Goals for future release of pricing and payment information to the community o Guiding principles on how strategic pricing and pricing transparency will be developed and evaluated

30. | 30 | FY 2015 Final Rule: In the FY 2015 IPPS/LTCH PPS proposed rule (79 FR 28169), we reminded hospitals of their obligation to comply with the provisions of section 2718(e) of the Public Health Service Act. We appreciate the widespread public support we received for including the reminder in the proposed rule. We reiterate that our guidelines for implementing section 2718(e) of the Public Health Service Act are that hospitals either make public a list of their standard charges (whether that be the chargemaster itself or in another form of their choice), or their policies for allowing the public to view a list of those charges in response to an inquiry. MedPAC suggested that hospitals be required to CMS-1607-F 1205 post the list on the Internet, and while we agree that this would be one approach that would satisfy the guidelines, we believe hospitals are in the best position to determine the exact manner and method by which to make the list public in accordance with the guidelines. Commit to transparency/defensibility with clear policies and goals

31. | 31 | How will prices be defended? 1 23 ROI Model Peer PositionCost Markup

32. | 32 | (volume x price) - (volume x cost) investment ROI Formula ROI = Relating pricing to ROI: the public-utility approach Public utilities have used a Return on Investment (ROI) model to justify price increases to rate regulatory boards. The approach isolates the price variable from the ROI formula (below) and “tests” the remaining elements. If it can be proved that ROI, Cost, and Investment are not excessive, then price must also not be excessive. In the following pages, we present these tests. Tests 1.Is ROI excessive? 2.Is cost excessive? 3.Is investment excessive? If “no” to all three, price is not excessive. Return on Investment Model 1

33. | 33 | VADCWESTMID- WEST SOUTHNORTH- EAST US Return on Equity 7.67.810.38.58.67.98.7 Hospital Cost Index® 99.0101.399.0102.0103.498.2101.2 Fixed Asset Turnover 2.432.442.542.342.362.682.44 Average Age of Plant 12.19.99.211.010.012.410.4 Return on Investment Model 1 Return On Equity: Excess of Revenue over Expenses/Net Assets Fixed Asset Turnover: Total Revenue/Net Fixed Assets Average Age of Plant: Accumulated Depreciation/Depreciation Expense

34. | 34 | CPT® is a registered trademark of the American Medical Association. All rights reserved. Level of ComparisonMetric FACILITYHospital Charge Index® Medicare Charge per Discharge (CMI/WI adj) Medicare Charge per Visit (RW/WI adj) DEPARTMENTBETOS Analysis INPATIENT CASECharge by MS-DRG OUTPATIENT CASECharge by APC PROCEDUREPrice by CPT®/HCPCS Code Bundling Level of Detail Peer Position Model 2 Comparing your pricing to pricing at peer facilities

35. | 35 | Cost/Markup Model 3 Sources of cost data 1)Hospital cost-accounting system o Direct Cost o Fully allocated cost 2)RCCs Two usual outcomes 1)Reduced net patient revenue, e.g., $5.1 million vs. $9.6 million in ATB 2)Major pricing changes -99% to 3,580% Strategy: Relate prices to cost markup (same or different by department)

36. | 36 | Current Price: $220 New Price: $104 Process Commit to transparency Develop initial guiding policies and goals Understand your current position Compare pricing and know where pressure exists

37. | 37 | Secondary/Tertiary Hospital Market Compare prices from multiple perspectives Core Hospital Market Non- Hospital Market WHO?? SERVICES?? PRICE PRESSURE??

38. | 38 | Hospital Charge Index® Understand how prices are changing

39. | 39 | Determine where price pressures are coming from

40. | 40 | Understand current margin levels by payer and product

41. | 41 | Understand current margin levels by payer and product Net Patient Revenue per Equivalent Discharge™ Operating Margin VIRGINIA9,0263.3 DC METRO8,3000.9 WEST8,6304.6 MIDWEST8,8993.7 SOUTH8,7233.1 NORTHEAST7,6271.5 US8,6503.4

42. | 42 | Current Price: $220 New Price: $104 Process Commit to transparency Develop initial guiding policies and goals Understand your current position Compare pricing and know where pressure exists Model impact Understand the financial implications through price, payment, cost and profit modeling

43. | 43 | General impact associated with various rate strategies FINANCIAL IMPACT CONTINUUM LESS IMPACT MORE IMPACT Rate freeze Reduce pricing for select areas/codes Outpatient/Retail price creation for all codes Outpatient/Retail price creation for select codes Across the board reductions Cost based approaches

44. | 44 | Model impact of different strategies to determine best fit StrategyIncremental Charges Net Revenue Impact Additional impact from outlier/lesser- of change Across the board reduction $XXX Cost based approach to 2X $XXX Imaging to free- standing average $XXX Retail pricing for lab$XXX Reduce outpatient prices by 40% $XXX

45. | 45 | Understand specific impact of different strategies

46. | 46 | Engage in mitigation Discuss with payers Current Price: $220 New Price: $104 Process Commit to transparency Develop initial guiding policies and goals Understand your current position Compare pricing and know where pressure exists Model impact Understand the financial implications through price, payment, cost and profit modeling

47. | 47 | Making large changes will likely require payment term changes

48. | 48 | Making large changes will likely require payment term changes Article excerpt regarding case hospital

49. | 49 | Isolating specific term impact can facilitate easier discussions ContractCarve-out Original Charges Proposed Charges Incremental Profit % Change Payer 1 - PPOIAll Other$XXX Payer 1 - PPOICsection DRG$XXX Payer 1 - PPOINormal Delivery$XXX Payer 1 - PPOINormal Newborn DRG - Per Diem$XXX Payer 1 - PPOINursery - General, Newborn - Level 1, Other$XXX Payer 1 - PPOINursery - General, Newborn - Level 1, Other Ancillary$XXX Payer 1 - PPOINursery - Newborn - Level 2$XXX Payer 1 - PPOINursery - Newborn - Level 2 Ancillary$XXX Payer 1 - PPOINursery - Newborn - Level 3$XXX Payer 1 - PPOINursery - Newborn - Level 3 Ancillary$XXX Payer 1 - PPOOAll Other$XXX Payer 1 - PPOOPayer-Provider FS$XXX Payer 1 - PPOOPayer-Provider OP Surg$XXX Payer 1 - PPOOCritical Care$XXX Payer 1 - PPOOER Level 1$XXX Payer 1 - PPOOER Level 2$XXX Payer 1 - PPOOER Level 3$XXX Payer 1 - PPOOER Level 4$XXX Payer 1 - PPOOER Level 5$XXX Payer 1 - PPOOObs - Per Hour$XXX Payer 1 - PPOOObs - Per Hour Ancillary$XXX Payer 1 - PPOOOP Cardiac Cath$XXX Payer 1 - PPOOTrauma Act$XXX

50. | 50 | Engage in mitigation Discuss with payers Current Price: $220 New Price: $104 Process Commit to transparency Develop initial guiding policies and goals Understand your current position Compare pricing and know where pressure exists Model impact Understand the financial implications through price, payment, cost and profit modeling Communicate Revise policies and goals

51. | 51 | Meet net income expectations? Maintain or enhance competitive position? Maintain or correct related pricing relationships? Establish equitable distribution to case categories? Establish equitable distribution to payers? Meet transparency/defensibility objectives? Evaluating the rate strategy Does the strategy:

52. | 52 | Summary Transparency and defensibility initiatives are increasing across the US as hospitals face pressure from patients, payers, and new/existing providers of care. However, there is still significant variation in how individual hospitals are responding. Hospital pricing is impacted by various demographic and operating factors – among them, payment is critical in rate establishment and change. Payment recovery can change with various rate changes as additional outlier and lesser-of provisions are triggered. Committing to increased transparency and defensibility can lead to transformational pricing change through policy/goal development, evaluating current and proposed price positions, and communicating with payers and patients.

53. | 53 | Jamie Cleverley President Cleverley + Associates Email: jcleverley@cleverleyassociates.com Phone: (614) 543-7777 Thank you. Questions?

54. APPENDIX A: LESSER-OF CLAIM EXAMPLES

55. | 55 | Appendix B: Non-aggregate Claim Example

56. | 56 | Appendix B: Aggregate Claim Example