VA Health Care: Third-Party Charges Based on Sound Methodology;
Implementation Challenges Remain (Letter Report, 06/11/1999,
GAO/HEHS-99-124).

The Department of Veterans Affairs (VA) used a sound methodology to
replace its cost-based system with a charge-based system that sets
charges at the 80th percentile level and better resembles market prices
for thousands of health procedures and hundreds of diagnosis groups. VA
expects higher revenues from insurers as a result but it lacks adequate
data to estimate the effect of reasonable charges on its revenue and
corresponding insurer cost. However, reasonable charges will not affect
veterans' copayment and per diem obligations. Reasonable charges are
expected to play a key role in VA's plans to expand and improve
veterans' health care without increasing appropriations through fiscal
year 2002, but factors that could limit the contribution that reasonable
charges make to its revenue collections include VA's inability to
collect routinely from health maintenance organizations and Medicare and
its overcoming past collection problems. To the extent that VA's method
will set some reasonable charges below insurers' usual payments, VA will
collect less than other providers. VA does not have standardized
procedures to ensure that insurers' payments are appropriate if less
than reasonable charges. GAO recommends (1) monitoring reasonable
charges and identifying those that should be increased to conform with
local market prices and (2) verifying the appropriateness of insurers'
payments when they are less than VA's reasonable charge.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-99-124
     TITLE:  VA Health Care: Third-Party Charges Based on Sound
	     Methodology; Implementation Challenges Remain
      DATE:  06/11/1999
   SUBJECT:  Veterans benefits
	     Health insurance cost control
	     Health care programs
	     Claims settlement
	     Veterans
	     Insurance companies
	     Patient care services
	     Prices and pricing
	     Health insurance
	     Medical services rates

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    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
    Methodology; Implementation Challenges Remain GAO/HEHS-99-124 GAO
    United States General Accounting Office Washington, D.C. 20548
    Health, Education, and Human Services Division B-281154 June 11,
    1999 The Honorable Arlen Specter Chairman The Honorable John D.
    Rockefeller Ranking Minority Member Committee on Veterans' Affairs
    United States Senate The Honorable Bob Stump Chairman 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 B-281154 $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. Results
    in Brief    We believe VA's methodology provides a sound basis for
    setting reasonable 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 B-281154 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. Background    In
    proposing its fiscal year 1999 and fiscal year 2000 budgets, VA
    assumed 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 charges. 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 1Medicare 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 B-281154 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. VA Used a Sound
    In establishing its reasonable charge rule, VA wanted to directly
    reflect Methodology to Set    local market charges for all
    services in all locations, but these data were 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.) 2In 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. 3The 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 B-281154 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 4VA 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). 5Confirming 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 B-281154 below market
    payments and provide a way of identifying where VA charges need to
    be modified to better reflect market prices. Effects of New
    VA views reasonable charges as an opportunity to increase its
    revenue Charges Uncertain,    collections. This will occur to the
    extent that the total payments to VA 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 Challenges Remain     health care. To accurately predict and
    compare these two total payments, 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 insurers. 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,
    6Reasonable 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 B-281154 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 7Office 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 B-281154 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. Conclusions and    In our opinion, VA used a sound
    methodology to replace its cost-based Recommendations    system
    with a charge-based system that better resembles market prices for
    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
    8Veterans Health Administration, Directive 99-014 (Apr. 1, 1999).
    Page 8                                                  GAO/HEHS-
    99-124 VA Reasonable Charges B-281154 (2) verify the
    appropriateness of insurers' payments when they pay an amount less
    than VA's reasonable charges. Agency Comments    VA was unable to
    provide comments on a draft of this report within the 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 Contents Letter
    1 Appendix I
    12 Scope and               Comparison With Local Market Charges
    12 Methodology Appendix II
    14 VA's Methodology for    Methodology for Determining Rates and
    Adjustment Factors                            15 Formulas for
    Facility-Specific Charges
    19 Setting Reasonable Charges Tables                  Table II.1:
    VA's Reasonable Charge Categories and Services
    15 Covered Table II.2: Estimating Average National Charges by
    Categories of                    16 Charges Table II.3: Estimating
    the 80th Percentile by Categories of                         17
    Charges Table II.4: Trending Charges Forward by Categories of
    Charges                       18 Table II.5: Geographic Adjustment
    Factors by Categories of                          19 Charges
    Abbreviations 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. Comparison With
    We limited our comparison of reasonable and local market charges
    to Local Market Charges       inpatient facility charges because
    we had ready access to Medicare data 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 Francisco. 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. 9A 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 Charges 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 factors. Page 14
    GAO/HEHS-99-124 VA Reasonable Charges Appendix II VA's Methodology
    for Setting Reasonable Charges 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 aDRG 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. bCPT codes identify the service or procedure
    performed by a physician. Methodology for                       VA
    developed all categories of charges following the same general
    model: Determining Rates                     (1) nationwide rates
    were established at the 80th percentile of billed charges of
    private providers, and (2) geographic adjustment factors were and
    Adjustment                        estimated to adjust nationwide
    rates to VA facility location charges. Factors
    However, VA's methodology for determining reasonable charges is
    actually 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 Charges 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 Calculations 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 sources 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 1063 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 Charges 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 Calculations (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
    aMediCode is a database of outpatient facility charges gathered
    from numerous commercial sources. bThe 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 11RVU data came from St. Anthony's Complete RBRVS
    (resource-based relative value scale) and other sources. Page 17
    GAO/HEHS-99-124 VA Reasonable Charges Appendix II VA's Methodology
    for Setting Reasonable Charges 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 Calculations
    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 aIn 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 Charges ratios differ in the boundaries
    placed around VA facility areas (metropolitan statistical area
    (MSA), three-digit zip code, or state) and data sources. Table
    II.5: Geographic Adjustment Factors by Categories of Charges
    Inpatient facility                   SNF/subacute inpatient
    facility Outpatient facility                    Physician
    Calculations 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. Formulas for
    To determine the amount to bill insurers under reasonable charges,
    a VA Facility-Specific                              facility will
    use a formula appropriate to the category of charge. (A single
    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 Charges 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 stay. * 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, respectively. *
    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 Charges * 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
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