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1. Chapter 8
Financing Health
Care

2. Chapter Objectives
• Understand the scope and magnitude of U.S.
healthcare spending in relationship with other
developed countries.
• Review evolution of the U.S. healthcare
financing system, trends, and initiatives of the
ACA of 2010 and the MACRA of 2015.
• Review ongoing efforts to link costs with quality
of care.
• Understand the related roles of government and
the private sector in financing health care and
roles of respective sector stakeholders.

3. Major Themes (1 of 2)
• Origins of U.S. healthcare financing systems
• Employer-based health insurance remains the
predominant source of health insurance for
working Americans.
• Payment for health services as a mosaic of
government and private sources
• While more than 21 million Americans gained
health insurance due to the ACA and Medicaid
expansion, millions remain uninsured
• Effects of managed care on costs, quality, and
access to health care; implications of financial
risk-sharing

4. Major Themes (2 of 2)
• Population-based, value-driven (not volume-
driven) payment
• Ongoing of cost control efforts linked with
quality
• Reasons for continued cost increases, waste,
fraud, and abuse
• Market reforms through consolidations and
mergers accommodate new payment systems
and quality requirements
• Financing experimentation through the ACA,
MACRA

5. Overview
• ACA Immediate effects, e.g., health insurance
regulations; full effects of policy changes unfold
over many years
– ACA did not change fundamental public/private
financing mechanisms of U.S. healthcare
• Most Americans’ health coverage provided by
employers’ private insurance
• Uninsured numbers increased 40+ million until
2011; immediate decrease by 1 million, due to
ACA allowing children on parents’ coverage
until age 26

6. Healthcare Expenditures in
Perspective (1 of 2)
• National healthcare expenditures reported
yearly by National Center for Health Statistics
(2014: $3 trillion+; $ 9,523/capita; 17.5% GDP;
Top personal: Hospital ($971.8 billion),
physicians + clinical services ($603.7 billion)
prescription drugs ($297.7 billion)
• Top 2011 payment sources: Private health
insurance ($991 billion); Medicare ($618.7
billion); Medicaid ($495.8 billion); all public
sources = 43% of total payments (see Figures
and Tables)

7. Healthcare Expenditures in
Perspective (2 of 2)
• Expenditure growth rate outstrips general
inflation by large margins—unsustainable
• Among 12 other developed nations, U.S. has
largest percentage of national economy
devoted to health, but lower life expectancy and
health outcomes
– U.S. GDP is 50% higher than next largest spender,
twice that of the U.K. and five times France’s per
capita costs; others use more health services, more
technology at lower costs
– U.S. spends far less on social services

8. Waste, Fraud, Abuse
• “Waste” = 30–40% total U.S. health care
spending: $476–$992 billion/year
• Causes:
– Failures in care delivery
– Failures in care coordination
– Overtreatment
– Administrative complexity
– Overpricing
• Fraud, abuse = $75–250 billion/year
– FBI, DOJ, OIG, states’
prevention/prosecution

9. Drivers of Healthcare Expenditures
• Aging population: Longevity = hospital care,
drugs; unrestricted high cost interventions
• Medical technology: Diagnostic, treatment
equipment, and pharmaceuticals; specialties
• Un- and under-insured
• Fee-for-service reimbursement creates
incentives for high volume
• Labor intensity

10. Blue Cross, Blue Shield, and
Commercial Health Insurance (1 of 3)
• Insurance payments began in 1930s with
BC hospital coverage
– Antithetical to “insurance” to guard against
unlikely events, health insurance pays for
both routine and unexpected events
– Blue Shield for physician payment followed
in 1940s
• Coverage paid whatever was billed;
prevailed 1930s–1980s until introduction
of prospective payment (DRGs) and
managed care

11. Blue Cross, Blue Shield, and
Commercial Health Insurance (2 of 3)
• “Blues” put hospital and physician care
within all working Americans’ reach w/o
financial worry
• Silenced lobbying for “universal
coverage”
• Elective hospital admissions skyrocketed

12. Blue Cross, Blue Shield, and
Commercial Health Insurance (3 of 3)
• Community-rated insurance: Premiums
set for defined groups w/o regard to age,
gender, occupation, or health status
• Experience-rated insurance: Premiums
based on historical patterns of service use
• Commercial insurers (for-profit) entered
market in late 1940s; experience-rated
competitive premiums

13. Transformation of Health
Insurance: Managed Care (1 of 5)
• Managed Care (MCOs)
– Cost increases, quality concerns → Nixon
administration enacted Health Maintenance
Organization Act (HMO) Act of 1973 with
loans, grants
– Combined insurance and health care
delivery organizations; focus on cost
containment and quality; emphases on
primary care and prevention

14. Transformation of Health
Insurance: Managed Care (2 of 5)
• Financial risk sharing
– Providers: Capitation pays pre-set, per-
member-per-month amount whether or not
services are used; physicians spending
lesser amounts retain profits, exceeding
amounts incurs penalty
– Consumers: Co-payments by visit;
deductibles require pre-determined out-of-
pocket expenditures before insurance
coverage begins; encourage consumer cost-
consciousness

15. Transformation of Health
Insurance: Managed Care (3 of 5)
– Staff model: Employed physicians in HMO-
owned facilities
– Independent practice association:
Independent physicians contracted to
provide services
• MCO payment population-based:
– Pre-payment for groups, encourage cost-
conscious care
– Actuarially determines projected service use
for age, gender, occupation, other factors to
estimate expected costs and set premiums

16. Transformation of Health
Insurance: Managed Care (4 of 5)
• Hybrid MCO Plans, for example:
– Preferred Provider Organizations (PPOs)
formed by physicians and hospitals to serve
private payers and self-insured organizations:
guarantee volume of business to hospitals and
physicians in return for fee discounts; in 2015,
56% of covered employees in large firms; 41%
of workers in small firms
– Point of Service Plans (POS) allow members
to use providers outside networks at increased
co-pays and deductibles

17. Transformation of Health
Insurance: Managed Care (5 of 5)
• Early 1990s: Average annual healthcare cost
growth declined; after initial decline, cost growth
surged as markets consolidated
• Staff model fell to virtual non-existence
• Research analysis: MCOs did not change clinical
practice, reduce costs, improve quality; more
changes needed: information systems,
appropriate incentives, revised clinical processes
• Late 1990s “backlash”: Laws in all states to
protect rights of consumers and providers against
MCO restrictions

18. High-Deductible Health Plans
• Response to managed care “backlash” to allow
more employee choice of health insurance
plans
– Entice employees with lower premiums in exchange
for out-of-pocket expenses before insurance pays
– Today, 2nd most common type of employer plans—
24% of U.S. workers select this option
– Since 2009, the percent of employees covered by
HDHPs has tripled
– IRS governs plan parameters and “portability”
between employers

19. Managed Care Today
• More than 75% of employees covered by
employer health insurance (111 million)
are enrolled in managed care plans
• 2016: 31% of 57 million Americans
covered by Medicare are enrolled in
Medicare Advantage managed care (17+
million)
• 2014: 77% of Medicaid beneficiaries (55.2
million) are enrolled in managed care

20. Managed Care Quality (1 of 3)
• National Committee for Quality Assurance
(NCQA): Independent, not-for-profit
organization funded by accreditation services
fees; accredits health plans serving 136+ million
Americans on voluntary basis
• NCQA services: Accreditation for MCOs, PPOs,
MBHCOs, new health plans, disease
management programs, PCMHs, etc.
• HEDIS

21. Managed Care Quality (2 of 3)
Healthcare Effectiveness Data and
Information Set (HEDIS)
• NCQA, MCOs, employer partnership: Created a
standardized method for MCOs to collect,
analyze, and report performance allowing
comparisons among MCO plans
– Criteria: Effectiveness of care; access/availability of care;
satisfaction with care; health plan business stability;
service use and cost; informed health care choices
– CMS requires all Medicare MCOs to publicly report
HEDIS data; many state Medicaid programs require
same

22. Managed Care Quality (3 of 3)
• Evidence-based clinical practice guidelines and
disease management programs (DMPs)
monitor costs and quality to avoid
exacerbations, ED use, hospitalizations
– Disease management program: System of
coordinated health care interventions and
communication for high-risk patients identified from
claims data: patient education, proactive patient
outreach, feedback to providers; research results
currently yield questionable DMP effectiveness

23. Private Health Insurance Cost
Trends
• 2005–2015, annual employer-sponsored health
insurance premiums increased 5%
– 2015: Major employee health insurance costs
substantial with deductible plans
– Employees with deductible plans increased from
55% in 2006 to 81% in 2015
– Since 2010, deductibles (out-of pocket
payments before insurance pays) increased by
67%
• Benefit “buy-downs” control rising premiums
• Wellness programs to avert illness

24. Self-Funded Insurance Programs
• Large employers collect premiums and pool
funds into accounts to pay medical claims
instead of using a commercial carrier
– Actuarial firms set premium rates; third-party firms
(TPAs) administer benefits, pay claims, collect
utilization data; TPAs may provide case
management for high-cost illnesses
– Employer advantages: Avoid commercial carrier
administrative charges, premium taxes; accrue
interest on cash reserves

25. Government as a Source of Payment:
A System in Name Only
• Early focus: Government employees, special
populations, e.g., Native Americans
• Now: Medicare, Medicaid, 9 DHHS divisions
include health professional development,
military and veterans’ health services, research.
Reimbursement mosaic: vendors/purchaser
relationships, e.g., Medicare, Medicaid

26. Medicare (1 of 3)
• 1965: Title XVIII of Social Security Act
• All Americans ≥ 65 yrs. entitled to health
insurance benefits; today, 57 million covered;
“universal coverage” for elderly; covers others
with certain health conditions
• Financed by payroll taxes
• Conceded hospital accreditation to private
sector- “Joint Commission”
• Hospital payments by local Blue Cross
intermediaries

27. Medicare (2 of 3)
• Part A (1965): Mandatory; hospital coverage,
limited-time skilled nursing care, post-
hospitalization home healthcare; funded by
payroll taxes; no cost for most
• Part B (1965): Voluntary; physician services;
outpatient hospital; end-state renal disease;
outpatient diagnostic tests, medical
equipment/supplies, certain home health
services; funded by beneficiary premiums
matched with federal revenues

28. Medicare (3 of 3)
• Part C (1997): Voluntary: managed care options
through “Medicare Advantage”; beneficiaries
may pay premium
• Part D (2003): Voluntary; prescription drug
coverage (2003); beneficiaries pay premium;
significant gaps to be closed by ACA

29. Medicare Cost Containment and
Quality: Brief History (1 of 2)
• Costs rose rapidly; early amendments added
costs; later amendments sought to control cost
growth
• 1976 study: > 10% cost increase due to service
use by older Americans; almost 66% due to
hospital payroll, non-payroll, and profits

30. Medicare Cost Containment and
Quality: Brief History (2 of 2)
• Hospital reimbursement cost-based,
retrospective; fueled utilization, hospital
expansions, technology; no incentives for
efficiency
• By 1967, healthcare expenditures rising at
double the prior rate of growth; by 1972, federal
health expenditures had risen six-fold over the
1965 level

31. Medicare Cost Containment and
Quality: 1965–1985 (1 of 5)
• Legislative, regulatory attempts to slow cost
growth, improve quality. For example:
– 1966 Comprehensive Health Planning Act
– 1972 Professional Standards Review
Organizations
– 1974 Health Planning and Resources
Development state certificates-of-need
requirements
– 1984 Professional Review Organizations, now
Quality Improvement Organizations (QIOs)

32. Medicare Cost Containment and
Quality: 1965–1985(2 of 5)
• 1980 Federal Budget Reconciliation Act sought
reduction in hospital lengths of stays through
expanded home care
– Failed to reduce hospital stays; fueled explosive
home care expenses and provider fraud/abuse
• 1983: Medicare prospective payment system
(PPS) radically altered hospital reimbursement
from retrospective to prospective basis with
Diagnosis-related Groups (DRGs)

33. Medicare Cost Containment and
Quality: 1965–1985 (3 of 5)
• DRGs: Base pre-payments on treating specific
diagnoses rather than discreet units of service;
grouped 10,000+ ICD codes into 500+ patient
categories for similar conditions and expected
resource use; DRGs include factors such as
hospital teaching status and wage levels in
specific geographic locations
• Incentive: Treatment cost lower than DRG,
hospitals retain excess as profit; treatment cost
higher than DRG, hospitals absorb excess as
loss

34. Medicare Cost Containment and
Quality: 1965–1985 (4 of 5)
DRGs (cont’d)
• Excluded teaching hospitals’ direct medical
education costs, outpatient expenses, and
capital expenditures
• By 1993, DRGs adopted by 21 state Medicaid
plans and 2/3 of Blue Cross/Blue Shield plans
• Initial concerns regarding effects on
readmission rates, mortality proved unfounded;
DRGs reduced lengths of stay and mortality
rates, slowed cost growth

35. Medicare Cost Containment and
Quality: 1965–1985 (5 of 5)
• Emergency Medical Treatment and Labor Act
(EMTALA) of 1986: To prevent hospitals from
inappropriately transferring potentially high-cost
and unprofitable DRG cases to other hospitals;
imposed stiff penalties and risk of Medicare de-
certification
• DRGs financially benefited hospitals and many
posted surpluses

36. Medicare Cost Containment and
Quality: 1986–2006 (1 of 4)
• Medicare physician fee-for-service charges un-
regulated; significant MD charge increases 
legislative actions: 1984—Temporary freeze
on MD payments ineffective as MDs increased
patient visits to compensate for price reductions
• 1992: Resource-based Relative Value Scale
(RBRVS) for equitable reimbursement across
specialties, services, geographic regions;
discourage overuse of expensive services
– RBRVS continues with AMA and national medical
society input

37. Medicare Cost Containment and
Quality: 1986–2006 (2 of 4)
• PPS reforms, market competition, technology,
consumerism drove delivery changes
• National Health Security Act proposal gave
focus to rising Medicare costs, service barriers,
provider choice 
• BBA of 1997: Reduce Medicare spending;
extend PPS to hospital outpatient services,
home health, skilled nursing, inpatient rehab

38. Medicare Cost Containment and
Quality: 1986–2006 (3 of 4)
• BBA: Slowed Medicare growth; enacted
Medicare Part C managed care; established
Medicare Payment Advisory Commission
(MedPAC) to monitor Medicare status
• BBA challenges: Subsequent legislation
restored some budget cuts, increased
payments to Part C managed care companies

39. Medicare Cost Containment and
Quality: 1986–2006 (4 of 4)
• 2001: Medicare “Quality Initiative” and
“Medicare Quality Monitoring System” to collect,
analyze data on all Medicare fee-for-service
beneficiaries
• 2005: “Hospital Compare” website: conformity
with evidence-based practice
– 2006: Hospital Consumer Assessment of Healthcare
Providers and Systems (HCAHPS) added to
“Hospital Compare” to report patient perspectives

40. Medicare Cost Containment and
Quality: 2007–Present (1 of 5)
• 2008: No Medicare payment for “Hospital
Acquired Conditions” (HACs), e.g., catheter-
related infections, foreign objects retained after
surgery, falls, other traumas sustained during
hospitalization
– No payment for “never-events”: egregious, usually
preventable errors resulting in death or significant
disability, e.g., wrong-site surgery, contaminated
drugs or devices
• 2011: Partnership for Patients—demonstration
to reduce HACs

41. Medicare Cost Containment and
Quality: 2007–Present (2 of 5)
• 2013: Bundled Payments for Care Improvement
(BPCI)—links payment to results from a
complete episode of care resulting in
hospitalization involving multiple providers
– 2016: Mandated 800 hospitals’ participation in
bundled Medicare payment for hip and knee
replacements
• 2012–2016: Comprehensive Primary Care
Initiative (CPC)—supplemental payments for
service coordination for seriously ill patients

42. Medicare Cost Containment and
Quality: 2007–Present (3 of 5)
• 2017: Comprehensive Primary Care Plus:
Five-year program using advanced primary
care medical homes; Medicare payment and
performance-based financial incentives
• 2011–2014: FQHC Advanced Primary Care
Practice Demonstration—increase quality,
reduce costs for Medicare patients

43. Medicare Cost Containment and
Quality: 2007–Present (4 of 5)
• Accountable Care Organizations (ACOs):
Private sector experiments since 1998; reduce
service fragmentation across providers; now
23+ million participants; legal entities with ≥
5000 Medicare patients; provider financial
incentives for positive patient outcomes, cost
efficiency
• Hospital Value-based Purchasing Program
(VBP): Financial incentives encourage
appropriate, efficient patient care

44. Medicare Cost Containment and
Quality: 2007–Present (5 of 5)
• Readmissions Reduction Program: Improve quality
and continuity of care post-hospitalization; financial
penalties for readmission with targeted diagnoses
within 30 days of discharge
– 2016 analysis showed readmission reductions for
both targeted and non-targeted diagnoses
• Medicare Access and CHIP Reauthorization Act
(MACRA): New “Quality Payment Program” (QPP)
with physician performance
incentives/disincentives: Merit-based and
Alternative payment models: 50% of Medicare
payments tied to APMs by 2018

45. Medicaid and the Children’s Health
Insurance Program (1 of 3)
• Medicaid: 1965, SSA Title XIX amendment
– Joint federal-state program; federal government
matches state expenses based on federal
medical assistance percentage (FMAP) adjusted
annually on states’ average personal income
– Primary source of medical coverage for low-
income, disabled Americans
– 2016: 72.4 million enrolled: low-income,
disabled adults, children, older Americans
– 19% of $2.6 trillion of personal healthcare
expenses

46. Medicaid and the Children’s Health
Insurance Program (2 of 3)
• Medicaid = 51 different programs (states +
D.C.): federal government sets broad guidelines
but states design, implement, administer
programs
– Recipients must meet financial eligibility criteria;
many work at low wages; children consume 21% of
spending; blind and disabled consume 44% of
spending
– Funded by federal matching $$ to states and state
general funds; third largest U.S. payer for health
insurance after private insurance and Medicare
• Reimbursement directly to providers; no
intermediaries

47. Medicaid and the Children’s Health
Insurance Program (3 of 3)
• Medicaid coverage types:
1. Health insurance for low-income families
w/children
2. Long-term care for older Americans
3. Supplemental coverage for low-income
Americans for services not covered by
Medicare, i.e., “dual-eligibles”
• Core federal coverage requires basic medical
services
• States may add optional benefits or extend
coverage to higher income groups

48. Children’s Health Insurance
Program
• BBA of 1997: State Children’s Health
Insurance Program (SCHIP) to enroll 10
million uninsured children
– Renamed CHIP: Largest expansion of health
insurance coverage since Medicaid in 1965
– Continuously funded: Reauthorized by ACA
until 2015; MACRA reauthorized until 2017
– Enrollment at 2014 = 8.1 million children
– 2016: 34.9 million children in Medicaid and
CHIP combined

49. Medicaid Managed Care
• Prior to 1990s, fee-for-service coverage
– State use managed care for Medicaid under
provider contracts
– MCOs receive monthly capitated payments
– 2016: ~ 2/3 Medicaid beneficiaries in private
managed care plans in 39 states and D.C.
• 2017: Federal “overhaul” to “modernize”
Medicaid managed care: supports states’
delivery system reforms with Advanced
Payment Models and increased program
transparency and accountability

50. Medicaid Quality Initiatives
• CMS Center for Medicaid and CHIP
Services: Responsibility for quality initiatives;
working partnerships with state programs
– Voluntary quality monitoring and reporting
programs with states
– Core quality standards for children’s and adult
care, including patient perspectives
• Partnership for Medicaid: Non-partisan, nationwide
coalition of physicians, other providers,
stakeholders advocate standard Medicaid quality
across all states

51. Medicaid Expansion Under the
ACA
• 2012 Supreme Court decision made states’
participation in ACA Medicaid coverage
expansion optional
– 2016: 31 states and D.C. expanded coverage
o ACA pays 100% of state expenses for newly
eligible through 2016 and drops to 90% of state
expenses by 2020 and future years
o Medicaid expansion states’ expenses dropped
significantly in 2015 due to federal funding
• Corollary effects: Streamlined Medicaid
enrollment processes, technology use,
improved reporting systems

52. Disproportionate Share Hospital
Payments (DSH)
• Since 1996, federal law requires Medicaid
payments to states (DSH) for hospitals serving
large numbers of Medicaid, low-income,
uninsured; critical support for hospitals serving
neediest populations
– Annual state DSH allotment limits total federal
contribution per hospital to 100% of costs not
covered by Medicaid; In 2015, $11.9 billion
allotment
– ACA initially reduced state allotments due to
expectation of many more insured by 2014; now,
reductions delayed to 2018

53. Individual Mandate and Health
Insurance Marketplaces (1 of 3)
• ACA requires most Americans to have health
insurance or pay a penalty: “individual
mandate” and “shared responsibility”
requirement includes:
– Employer-provided health insurance
– Medicaid
– Personally purchased health insurance policies
• Health Insurance Marketplaces (HIMs): Provide
consumers with web-based, comparative
information on health plan choices and prices

54. Individual Mandate and Health
Insurance Marketplaces (2 of 3)
• State option to create HIM
– If not, federal government established and
operated; 2016: 13 states and D.C. operated
HIMs; 34 states had federally-administered
HIMs; 4 states operated HIMs w/federal
assistance
– Federal support for HIMs through 2015;
subsequently self-sustaining
– HIMs require accessibility to 10 “essential
health benefits”

55. Individual Mandate and Health
Insurance Marketplaces (3 of 3)
• HIM participation eligibility: American
citizens and legal immigrants without
employer coverage or for whom coverage
is cost-prohibitive; acceptance
guaranteed
– Varying levels of federal financial assistance:
advance and refundable premium tax credits
and cost sharing based on personal income

56. The Employer Mandate
• Began 2015: Businesses with ≥ 50 FTE
employees must provide health insurance
to at least 95% of full-time employees and
dependents up to 26 yrs. of age or pay a
fee
– Non-compliance penalty fee (in general):
$2,000 per full-time employee (in excess of
30 employees)

57. The ACA: Insurance Coverage
Progress and Costs (1 of 2)
Coverage Progress
• Prior to ACA enactment, 48.6 million
Americans uninsured (15.7%)
– By end of 2015, 11.2 million enrolled through
HIMs; 10 million new Medicaid and CHIP
enrollees; 27 million (10%) uninsured, an
unprecedented level
– CBO projects that approx. 10% of < 65-year-
old population will remain uninsured in next
decade

58. The ACA: Insurance Coverage
Progress and Costs (2 of 2)
Costs
• 2016: Approximate net: $110 billion
• 2017–2026: Projected net: $1.4 trillion
– Annual costs: $5,000 per HIM enrollee; $
3,500 per Medicaid and CHIP enrollee
• Net costs include: Subsidies for HIM
enrollees, Medicaid and CHIP costs, tax
credits for small employers and fees,
penalties, tax revenues

59. Continuing Challenges and
Innovations
• Transforming financing system through
payment reform and population health
focus:
– New payment methods
– Departures from prior philosophies, values,
politics that fueled profit-driven waste
• Innovation by insuring millions; payment
systems linking costs with quality (e.g.,
BPCIs, ACOs, MACRA)