The incredible impact of the COVID-19 pandemic on both the world economy and the very fabric of modern society cannot be overstated. Events of this magnitude will inevitably result in some permanent changes to industries or societal norms that were not previously contemplated. This pandemic will likely also accelerate major changes that were already underway but progressing at a much slower pace.

The cliché, “the beginning of the end”, goes back to the days of the Napoleonic wars. It is credited to the Prince of Talleyrand, who evidently uttered those words to Napoleon after the French loss at the Battle of Leipzig.1 The phrase is defined as the “start of a decline” or “start of a disaster”, either of which would accurately describe the current state of the longstanding payment system of fee-for-service medicine.

Although fee-for-service has been the primary payment method for healthcare services for over six decades, it has more recently been challenged as being a major cause of unsustainable growth in health care costs. It has been argued that this payment method gives inappropriate incentives to healthcare providers to overutilize tests and procedures. These incentives, when combined with continual growth in healthcare demand from an aging population, have produced shortages of and higher costs for clinical staff and other healthcare resources. In turn, those higher costs result in higher healthcare prices and higher health insurance premiums for both commercial and governmental payers.

The fee-for-service payment system has also been blamed for being too complex for healthcare consumers to understand, resulting in both a lack of transparency and affordability for many healthcare services. I was co-author of a recent article which focused on the need for healthcare providers to redesign their fee-for-service pricing models to better align individual prices with cost to provide better transparency and affordability or face significant disruptive competition.2

Despite these challenges, both healthcare providers and public/private insurers have been reticent to abandon the fee-for-service payment system. Over the past decade, new payment methodologies such as bundled pricing, population health management and value-based care have begun to proliferate. However, progress has been slow since most healthcare revenue management and payment information systems are designed around fee-for-service transactions. In addition, both independent and employed physicians have historically been compensated at least partially on individual productivity based on patient utilization.

Last month, we discussed the current substantial financial stress facing the U.S. healthcare system due to the COVID-19 pandemic. Over the most recent quarter, hospitals devoted substantial resources and bed capacity to treating potential COVID-19 patients, while deferring most elective procedures and outpatient visits out of patient safety concerns. In fact, significant COVID-19 inpatient volume has not yet come to fruition for many hospitals. That, combined with the deferral of other profitable services, has reduced patient volumes by 20% to 35% and devastated hospitals’ operating revenue.

Consequently, for the first time in almost four decades, providers have felt the double-edged sword of fee-for-service medicine. It is ironic that a healthcare pandemic would devastate patient utilization across all healthcare providers instead of increasing it. Although some of the deferred patient care is now returning, many patients are continuing to avoid healthcare facilities due to the fear of COVID-19.

Kaufman Hall reported that April 2020 represented the worst monthly financial performance in history for over 800 hospitals nationwide. They reported a median hospital operating loss of 29% for the month, despite $50 billion in relief provided by The CARES Act.3

A June report by the American Hospital Association (AHA) estimated that U.S. hospitals and health systems could lose over $323 billion in 2020, excluding the increased costs associated with COVID-19 patients. Just this week, released another report commissioned from Kaufman Hall that projected negative hospital margins of -7% in the second half of 2020 without further government support.4 This has resulted in hospitals and physician practices having to implement dramatic cost reduction measures, including significant furloughs of both staff and employed physicians, while these providers are still also dealing with the pandemic.5

We also indicated last month that a majority of the 7 million projected newly uninsured resulting from the pandemic could potentially not qualify for Medicaid under current guidelines. Most of this working poor population struggles to meet even the subsidized commercial premiums and their related higher deductibles and co-insurance requirements of Affordable Care Act (ACA) health plans. This situation will add yet another financial pressure to healthcare providers in the form of increased uncompensated care.

The AHA report this week was a cry for help from the federal government to provide additional financial relief to a financially at-risk U.S. healthcare system. Although this financial support would certainly help stabilize healthcare providers, it would not stop the fundamental changes occurring which threaten the fee-for-service payment system. It only continues the band-aid approach that has been going on for decades. It also makes the healthcare system even more reliant on governmental payers, who have knowingly reimbursed healthcare providers at below cost levels for years.

We have previously discussed that in 2017, the Medicare Payment Advisory Committee (MedPAC) reported that 2015 hospital margins for Medicare were a negative 7.1% and that combined losses from Medicare and Medicaid payers approximated $58 billion.6 More recently, the American Hospital Association reported that in 2017, U.S. hospitals lost approximately $77 billion from Medicare and Medicaid patients, including $54 billion from Medicare and $23 billion from Medicaid.7 These losses have historically been covered by commercial payers through employer-sponsored health insurance. This commercial subsidy is essentially a “hidden tax” that employers pay to support the viability of healthcare providers in their regions.

The most recent MedPAC report showed that for 2017, hospitals’ aggregate Medicare margin was down even further to -9.9%.8 This is in large part due to their philosophy to set provider reimbursement rates that are only above providers’ marginal (direct) costs of treating patients. In other words, Medicare rates are no longer intended to cover the full costs (including fixed overhead) of healthcare providers. This philosophy will continue to increase provider losses from government payers and increase the “hidden tax” on commercial insurers and employers that is no longer sustainable.

On the flip side of this financial devastation of healthcare providers are the insurers, who have been the financial benefactors of the pandemic’s dampening effect on healthcare utilization. The first major commercial insurer to report its 2020 second quarter results was UnitedHealth Group. It’s second quarter earnings of $6.7 billion were almost double that of the same quarter in the prior year. The major factor identified for that operating earnings increase was a 11.5% reduction in medical costs, which resulted in a medical cost ratio of approximately 13 percentage points below the same quarter in the prior year.9

There has been significant recent merger & acquisition activity among hospitals and health systems to substantially increase their horizontal scale. However, very few healthcare systems are vertically integrated with the advantage of a large health plan membership. Kaiser Permanente is an obvious exception, and it will be interesting to see their 2020 second quarter results. Our prediction is that Kaiser will likely incur much less in financial losses than its health system peers or perhaps may even show earnings more like its health insurer peers.

If ever there was a time for a new healthcare payment paradigm, the time is now. Healthcare providers can no longer rely upon an outdated fee-for-service payment model to provide long term financial health for their organizations. They need to consider an immediate redesign their operating revenue portfolios to (1) better align their fee-for-service prices with actual cost; (2) convert more of their physician services to managed risk and value-based care arrangements; and (3) consider strategic alignments or potential mergers with health insurers of scale in their markets.

C. Ammer, The Dictionary of Clichés, 2013
L. Brauner & S. Glasrud, Healthcare Financial Management Association, Reconciling charges and pricing through charge description master redesign, November 2018.
Kaufman Hall, National Hospital Flash Report, May 2020
American Hospital Association, New analysis shows dramatic impact of COVID-19 on hospital & health system financial health, July 21, 2020
S. Thomas MD, Coronavirus Frontlines, Forbes, There Are Tough Financial Days Ahead for U.S. Healthcare In The Wake Of The Coronavirus Pandemic
V. Dickson, Modern Healthcare, Slumping Medicare Margins Put Hospitals on Precarious Cliff, November 25, 2017
Healthcare Finance News, “Medicare, Medicaid Underpaid U.S. Hospitals by $76.8 billion in 2017, AHA Says”, January 4, 2019
Medicare Payment Advisory Committee, Report to Congress: Medicare Payment Policy, March 2019
S. Livingston, Modern Healthcare, United Health nearly doubles second-quarter profit amid OVID-19 crisis, July 15, 2020