The medical benefits audit.

Health costs are a major problem for most businesses. In a Fortune magazine survey, nearly two out of three chief executive officers called skyrocketing medical costs one of the most difficult problems facing U.S. corporations. One-third said health care costs were the single biggest problem they would face this decade.

While there are new opportunities for innovative cost control programs, many CPAs are staying away from medical benefits consulting because of its perceived complexity. The result is that most medical benefit consultants are former insurance agents now interested in brokering health insurance. As their primary objective is to sell insurance products, few consultant-brokers have the CPA's objectivity - or financial training. CPAs who gain more knowledge about health care costs not only will fill an urgent need, but also will better understand how to lower medical insurance expenses in their own firms or companies.

While the health care field is complex, there are some basic principles CPAs can use to help dramatically reduce health benefits costs. This article explains the components of the medical benefits audit, whose main thrust is to reduce unnecessary costs that are largely due to overutilization, inappropriate pricing and failure to manage catastrophic care (see exhibit 1, above).

EXHIBIT 1

The medical benefits audit

Cause of unnecessary costs Audit approach

* Benefit design

* Utilization review 

* Precertification Excessive utilization * Financial incentives for providers,

including incentive reimbursement

* Financial incentives for employees

* Preventive medicine programs

* Provider contracts Inappropriate pricing * Provider discounts

* Provider payment systems

* Prenatal programs

* Screening programs

* Contracts with Centers of Failure to manage Excellence catastrophic care * Wellness programs

* Benefit design

* Transplant policies

OVERUTILIZATION

Health benefits now consume 26% of the average employer's net earnings. At current growth rates, health care benefits costs will exceed $22,000 per employee by the year 2000.

Questions about the use of more services and products than are needed to treat the patient successfully should be among the first asked in evaluating a medical benefits plan. Common areas of overutilization include

* Hospital inpatient days.

* Inpatient mental health and substance abuse services.

* Emergency center visits.

* Diagnostic laboratory and radiology tests.

* Prescription drugs.

Hospital inpatient days. Retention of patients longer than necessary and admission of patients who could have been treated on an out-patient basis lead to excessive hospital days. Milliman & Robertson, a national actuarial firm, estimates that more than 50% of U.S. inpatient care is unnecessary. In conducting a medical benefits audit, the CPA should

* Compare hospital use with regional norms. The best measure of hospital day utilization is patient days per 1,000 enrollees per year ("enrollee" includes the employee and his or her enrolled spouse and children). This figure can be obtained from the client's insurance carrier and will depend on benefit design, the utilization management program, employee mix and geographic location. Indemnity plans often generate more than 500 inpatient days per 1,000 enrollees per year, while managed care programs can generate as few as 200 per 1,000. With per diem hospital charges running as high as $1,500, the cost difference between these two figures can exceed $37.50 per enrollee per month.

* Evaluate the health insurance plan's cost control incentives. What percentage of total premium costs does the employee pay? Does the plan use copayments, coinsurance, deductibles and out-of-pocket maximums to reduce unnecessary utilization (see exhibit 2, below)? As a general rule, the higher the percentage of the monthly health insurance premium paid by the employee, the greater the unnecessary utilization. A better option is a copayment, coinsurance or deductible. While these tools save employers money by shifting part of the health care cost to the employee, the primary benefit is reduced discretionary utilization. Actuarial data show a $5 increase in an office visit copayment (from $5 to $10), for example, can reduce the number of office visits by 25% to 30%.

EXHIBIT 2

Cost sharing and control methods

A premium is the monthly amount paid to the carrier for health insurance coverage. We recommend against having the employee pay a portion of the premium as studies show-the higher the percentage of total premiums paid by the employee, the higher the unnecessary utilization.

A copayment is a fixed payment made by the patient at the time of service. They are easy for health care providers to calculate at the time of service and provide the enrollee advance knowledge of the cost of service.

Coinsurance is a variable payment made by the patient - typically a percentage of the total service cost. It is appropriate when the enrollee is given a choice between higher- and lower-cost options. The primary disadvantage is that the cost to the insured may not be known before the service is rendered. A common range is 10% to 30%.

A deductible is a fixed aggregate amount the patient must pay for some or all health care services before calculation of the carrier's payment and any employee copayment or coinsurance. A common range is $50 to $500.

An out-of pocket maximum limits the amount a patient must pay annually for copayments, coinsurance and deductibles. A common practice is to limit total employee expenditures for health care to $1,000 (or some other fixed amount) per year.

* Determine whether the benefit design provides the patient with incentives to seek appropriate preventive care. It's typically cheaper to prevent an illness than to treat it - particularly in its early stages. A health insurance policy designed to aggressively control health care costs should mandate low (or no) copayments for preventive services (see exhibit 3, at right) to reduce avoidable hospitalization.

EXHIBIT 3

Encouraging health

The following services should be provided at a low (or no) cost to reduce avoidable hospitalization:

* Physicals according to a prescribed schedule for Identified high-risk groups only.

* Specific screenings, including diabetes, hypertension, prostate specific antigen, PAP tests, mammograms and glaucoma for identified populations.

* Prenatal and child care services and immunizations.

* Ask whether the client's insurance carriers use incentive reimbursement systems that reward physicians and hospitals for effective utilization and cost control.

* Examine the insurance carrier's precertification and utilization management programs. The carrier should be able to provide baseline as well as client-specific data that can be used to evaluate these programs' effectiveness in reducing unnecessary hospital days.

If the employer has more than one health plan

* Consider mandating one benefit design for all plans. Variations in plan design - whether items such as vision care or prenatal visits are covered, for example - make it difficult to shop on the basis of price. With one design, the primary difference in monthly premiums will reflect each plan's efficiency in controlling health care costs. Some companies pay 100% of the most efficient plan and ask the employee to pick up the monthly premium difference if he or she selects a less efficient, more costly plan.

* Consider replacing or phasing out less efficient plans, especially those with an indemnity design.

* Have the insurance carrier, or an actuary who specializes in health care, calculate a "richness" index for all of the employer's plans as well as for competing plans. This index provides an indication of the richness or comprehensiveness of the benefits the patient receives, regardless of premium cost. Compare plan richness with premium costs. The most costly plans are not necessarily the richest.

* Determine the claims-to-premium ratio. This figure (obtainable from the insurance carrier) helps assess the profitability (to the carrier) of each of the employer's health plans and the probability of a substantial premium increase next year. It also can help flush out carriers that won contracts by underbidding and who plan to recoup losses later with higher premiums once the employer is locked into the plan. A claims-to-premium ratio of more than .9 usually means claim costs exceed premiums.

* If there's more than one hospital in the area, calculate patient days and average length of stay by hospital. Review provider contracts for volume discounts (these typically range from 5% to 15%). Cross-reference the percentage of employee patient days by hospital with discounts by hospital.

Inpatient mental health and substance abuse. These services are one of the fastest growing components of health care costs, consuming 12% to 14% of America's total health care costs.

The American Psychological Association reports $55 billion of the $74 billion spent last year for mental health services went for inpatient treatment. It says up to 50% of adolescent hospital patients could have been treated as effectively in less expensive outpatient settings. In a medical benefits audit, the CPA should

* Determine psychiatric inpatient days per 1,000 enrollees. These should not exceed 45 per 1,000.

* Evaluate incentives for using outpatient facilities when appropriate, such as a high coinsurance payment or deductible with an out-of-pocket maximum.

* Evaluate preventive programs designed to lower costs - such as counseling and employee assistance programs - to see if they exist, what they cover and how effective they are.

Emergency center use. National studies show as much as 60% of all cases treated in hospital emergency rooms are not emergencies. This happens because it is sometimes easier for a patient to receive care in an emergency room than to get a timely appointment with a general practitioner; employees cannot always determine which injuries and illnesses require emergency care; and, in some geographic locations, there are no after-hours treatment alternatives. The emergency center is the most expensive and least efficient treatment alternative for nonemergency cases. The CPA should

* Determine annual emergency center visits per 1,000 enrollees. In Sunbelt states, a good figure is 75 visits per 1,000 enrollees; in Snowbelt states, it is 150 per 1,000.

* Ask the insurance carrier for a printout of all employee emergency center visits, sorted by diagnosis, and calculate the percentage of true emergency center cases. If the auditor is unable to identify these, it may be appropriate to hire a nurse, physician or utilization review organization to do the review.

* Recommend the client or firm negotiate a contract with afterhours clinics for evening and weekend coverage. Then, review benefit design to see if patients have sufficient incentives to use an after-hours clinic, even when it may not be as convenient as an emergency center. We recommend at least a $50 copayment for the use of an emergency room, refundable if the patient is admitted.

Diagnostic radiology and laboratory services. Outpatient diagnostic tests continue to be a source of unnecessary health care costs. In conducting a medical benefits audit, ask the insurance carrier for the average number of diagnostic tests per physician office visit. For a general practitioner, this figure normally should not exceed 1.4 tests per visit. While a significantly higher figure may not mean inappropriate utilization, this possibility at least should be discussed with the client's insurance carrier or utilization management organization.

Prescription drug use. The average prescription drug cost per person, per month continues to escalate as high-cost drugs are substituted for older, cheaper therapeutic equivalents. Prescription drug inflation is currently growing at about three times the rate of overall consumer price inflation - almost 20% faster than medical inflation. Unnecessary prescription drug costs arise when

* Employees fail to shop for better prices on prescription drugs.

* Doctors fail to recommend high-quality generic drug substitutes when they are available and appropriate. Approximately one-third of the prescription drugs taken by an insured population have generic equivalents (often manufactured by the same pharmaceutical company) that typically cost from 40% to 50% of the brand-name drugs. Quality can be assured by confirming the generic drug has received an AB bioequivalency certification - which establishes a drug's effectiveness - from the Food and Drug Administration.

* Patients don't take prescriptions properly. Studies show half of all patients don't take their prescriptions as directed and as many as 30% take too many or too few pills or take them with food or other drugs that adversely affect their effectiveness. The National Pharmaceutical Council estimates drag noncompliance adds $100 billion to the nation's health care bill.

The CPA should

* Ask the insurance carrier for the average number of prescriptions per enrollee per year. For average populations, this figure runs from 4.5 to 6.5. (It is typically higher for employees enrolled in HMOs as these organizations have a tendency to medicate rather than perform surgery.)

* Restrict the purchase of certain expensive drugs (such as Prozac) to vendors who provide substantial volume discounts.

* Review the carrier's contractual arrangements with pharmacies. Does the carrier pay 1) average wholesale costs, 2) average wholesale costs with a discount, 3) the retail price or 4) billed charges? What is the dispensing fee? Does it provide an incentive for the use of generic drugs? Most pharmacies make more money by filling prescriptions with brand-name drugs as their profits are calculated as a percentage of wholesale price. To overcome this adverse incentive, recommend paying the pharmacy a larger dispensing fee for generic drugs.

* Determine whether employees have a financial incentive to ask that their prescriptions be filled with generic drugs and to take their prescriptions as directed. We recommend employees pay a percentage of total prescription costs rather than a fixed price for all prescriptions. Out-of-pocket maximums can protect employees with catastrophic illnesses.

* See whether employees have access to a mail-order drug program, which can provide substantial savings for those on long-term maintenance medications.

INAPPROPRIATE PRICING

Most hospitals still do not have cost-based pricing. Practitioners should review the carrier's contracts with hospitals, physicians and managed care organizations to determine whether discounts have been negotiated for all health care plans that mandate specific health care providers. They also should find out whether the carrier uses incentive reimbursement (see exhibits 4 and 5 on pages 59 and 60 for more on reimbursement.)

EXHIBIT 4

Reimbursement in managed care organizations

Managed care organizations

Health maintenance organizations - HMOs contract with employers to provide a predefined set of medical products and services for an annual capitation payment. The two most common types are the staff model HMO and the independent practice association (IPA) HMO. Both typically receive a capitation payment for the provision of health care services. In the staff model, physicians are employed by the HMO and paid a salary plus a bonus (based on plan profitability). In an IPA, participating physicians retain their private practices but contract to provide services to the IPA (typically on a discounted fee-for-service basis). HMOs emphasize preventive medicine, provider cost control and resource coordination.

Preferred provider organizations - A PPO is a voluntary network of private physicians and hospitals that contract with insurance companies to provide a broad range of health care services. It typically is paid by the insurance company on a discounted fee-for-service basis (as opposed to the capitation fee that HMOs receive). Like IPA HMOs, PPOs usually pay their member physicians a discounted fee for service. While HMOs typically do not allow patients to seek care outside the provider network, PPO patients usually have that option. PPO patients can go directly to any specialist within the network without first contacting a gatekeeper physician. PPOs combine many of the cost control features of HMOs with the freedom of choice of traditional indemnity plans.

EXHIBIT 5

Prospective reimbursement systems

Capitation payment: A health care provider (either an individual or organization) receives a fixed amount per year, per enrollee for which he or she agrees to provide a predefined comprehensive health care package. Per diem reimbursement: A hospital receives a fixed amount per patient day, regardless of services subsequently rendered. Separate per diem rates may be negotiated for maternity, intensive care unit and medical-surgical services. Diagnostic related group (DRG) reimbursement: The hospital receives a fixed amount per disease category per admission, regardless of the services actually rendered. Global pricing: A fixed price that includes the cost of all medical products and services for one incidence of illness. This includes the cost of hospital, primary care physician, specialist, surgeon, anesthesiologist and any other charges the patient incurs. Global pricing systems 1) allow employers to more accurately define the product or service to be purchased and then to shop on a price basis for health care providers, 2) reduce administrative costs and 3) reward more efficient providers who generate lower costs through fewer complications. Some studies show global pricing is a more cost-effective tool than negotiated discounts or utilization review.

FAILURE TO MANAGE

CATASTROPHIC CARE

This is a major cause of high health care costs. Areas of concern include

* Premature babies. They can cost more than $1 million each.

* AIDS. The average total treatment cost is now more than $100,000.

* Organ transplants. As medical technology becomes more advanced, so do the number of organ transplants.

* Newly developed diagnostic procedures and treatments, such as magnetic resonance imaging.

In a medical benefits audit, the consultant should

* Consider caps in certain cases. Some employers limit liability by capping the amount payable on any specific incidence of illness and allowing employees to purchase their own catastrophic care insurance through the company.

* Review the client's transplant policy. Some employers limit circumstances in which transplants are covered.

* Determine whether the carrier has a prenatal screening program. Sixty percent of all premature deliveries can be avoided if expectant mothers are screened during their first trimester of pregnancy and placed on a high-risk prevention and treatment program. Many employers use financial incentives - such as cash, reduced copayments or gifts - to encourage expectant mothers to see their physicians during their first trimester.

* Ask whether the carrier has negotiated contracts with Centers of Excellence-medical centers, which specialize in specific catastrophic cases. Employers report reducing the total treatment costs of AIDS patients, for example, from $100,000 to as low as $35,000 without a reduction in the quality of care.

AN INTRODUCTION TO LOWER

COSTS

Health care costs are a major problem for most businesses and represent a significant growth opportunity for many CPA consulting practices. Although practitioners can't gain all the expertise they need from one article, this introduction should offer an overview of cost considerations in examining health care costs for clients or for their own practices.

RICHARD E. McDERMOTT is professor of accounting and health administration at Weber State University in Ogden, Utah. He has a master's degree in health care administration and a PhD in accounting. A former president of the Utah Health Systems Agency, he spent seven years as a hospital administrator before entering academics. JOAN P. OGDEN is principal of Joan Ogden Actuaries in Slat Lake City, Utah, which specializes in health care. A fellow in the Conference of Consulting Actuaries, she has served a a consulting actuary to the Governor's Health Optimization Committee.