Last Thursday’s post showed that workers comp is a huge money maker for hospitals, generating about 16% of their profits on less than 2% of revenue.
The attempts to date to control hospital costs have been to set WC reimbursement using primarily DRGs (Medicare Diagnosis Related Groups) (NY), a percentage discount below charges (as in Florida), or on the basis of the facility’s cost to deliver that service (Connecticut).
But it is never as simple as setting rates at DRGs or a discount below charges.
For the latter, a hospital could charge a billion dollars for an epidural, and the payer would (conceivably) have to pay 60% or 75% of that rate. So states add language around that provision requiring payment to be based on ‘usual and customary’ charges – which sounds fine until you try to define usual and customary. Florida is in the midst of just such an effort, and the process has become pretty contentious.
Using Medicare as a basis is also problematic. DRGs were developed for Medicare patients – older with different conditions and often not working. The resources – procedures, services, therapies, setting, providers – employed in providing care to an 88 year old with herniated disk are likely quite different from those provided to a 33 year old with the same condition.
Yet these differences have never been evaluated. To my knowledge, there has never been any thorough study of how the inpatient or outpatient hospital resources used by workers compensation patients compare with resources used by Medicare patents per Medicare’s inpatient MS-DRG groups or Medicare’s outpatient APC groups.
Another option, and one I would argue is highly problematic, is to pay based on some multiple of Medicare. Several states use this methodology, including South Carolina (which has seen rapidly rising WC medical expenses). Texas recently announced that it is moving in this direction. The problem for payers, is that Texas is paying hospitals an extremely high multiple of Medicare. According to FairPay Solutions CEO VIncent Drucker (and HSA client); “This provides huge financial incentives for over-utilization of high cost hospital and hospital-based-specialist services [emphasis added]. Over utilization that Wennberg, for example, reports account for 25 percent of wasted dollars for Medicare chronically ill patients.” (Drucker is referring to Dr John Wennberg’s recently-published Dartmouth Atlas of Health Care.)
As a commenter noted last week, “TX and CA have a Medicare based system with a mark-up ranging from 25% – 100%. However most hospital contracts with group health insurers and PPO networks are below Medicare rates.”
Why?
Why do workers comp payers consistently overpay for hospital services? Why can’t comp networks deliver the kind of reductions that are commonplace among group health insurers?
And why do employers allow their payers and managed care firms to spend their dollars so carelessly?

Following up on yesterday’s post on supply chain management, today we’ll discuss what happens when a company cedes too much power and control to a vendor.
Years ago Compaq (remember them?) was a leader in the PC industry. Now, they no longer exist. Why? In large part because they outsourced key parts of their business to a vendor that became a partner that became a competitor.
As Clayton Christensen put it in an interview; “there’s a tendency in the supply chain for the vendor in the emerging market to integrate forward until they hollow out their customer, and in many ways what they do is they commoditize their customers.
Christensen likes to cite Compaq. Like many electronics firms, Compaq outsourced parts of their product to off-shore companies. In this case, Compaq outsourced the simple circuit boards in their computers to Flextronics, a Singapore-based company. After a few years, Flextronics “came back to Compaq and said as long as we’re doing the circuit boards, let us do the whole mother board, because it’s not really your core competency, and we can do it for 20 percent less. Compaq says, you could do it for 20 percent less. If we outsource that to you we could get all of these circuit manufacturing assets off our balance sheet. They make the transfer, and Compaq’s revenues are unaffected, but its cost actually improved by 20 percent. At Flextronics, their revenue and profitability improved smartly. Wall Street likes what Compaq and Flextronics did.
Then Flextronics says, as long as we’re doing the mother board, why don’t you just let us assemble the whole computer, because that’s not really your core competency, and we can do it for 20 percent less.
Compaq looks at that and says, we could get rid of all our manufacturing assets. They make that transfer. Compaq’s revenues are unchanged but its profitability improves, and Wall Street really likes this. At Flextronics, revenue and profitability improve as well. Wall Street likes this too. This goes on as Flextronics takes over the manufacture of the whole computer followed by the supply chain.
From Flextronics’ point of view, it’s getting into value-added services now. So not only does its revenue improve, but its gross margins improve. Finally, Flextronics says, as long as we’re managing the whole supply chain for you, why even bother designing the dumb computer? That’s not really your core competency, and we’re dealing with all the component vendors anyway. Compaq says, yeah, our core competency really is our brand. We can fire all of our engineers if you do that for us.
So little by little the supplier in the Third World starts to eat their way up inside of the customer, and every step forward they take progressively trivializes the remaining value that Compaq adds, until in the end they’re providing almost no value and the company vaporizes.” [emphasis added] (quote from WorldTrade Magazine, The Supply Chain as ‘Disruptive Technology, December 12, 2006)
Compaq is to Big Insurance Co as Flextronics is to Big Managed Care Co., except it sounds like the folks at Flextronics moved a little slower, and were a bit less heavy-handed. Because what is happening in the market now is large payers (and small and medium ones too) are effectively outsourcing medical management to network/bill review/case management vendors. BigInsCo will argue that no, the adjusters are still in control – sure, just like the engineers were at Compaq. Meanwhile, BigMgdCareCo is busy figuring out how to maximize its revenue from BigInsCo.
And as we’ve seen, BigMgdCareCo succeeds when there are lots of medical bills with high medical charges.
So maybe my original thesis statement was wrong. Perhaps what’s really going to happen is not that managed care firms are going to ‘hollow out’ insurers, but instead they are going to bleed them dry.
And because the insurers no longer control the medical, there’s not a damn thing they can do about it.

Last week I wrote a post on workers comp insurers’ loss of control over medical costs. The post triggered a good bit of email traffic and requests to expand on my central point –
big networks now dictate terms to insurers, and the network business model is a major reason for the continued growth in work comp medical expense.
Think of the work comp claims process as organizing the products and services necessary to return an injured worker to full employment – and keep him/her there. The services – doctors, nurses, voc rehab, other providers, attorneys, field adjusters, investigators – supply expertise and skills that produces the desired end result – sustained return to work.
This process is analogous to manufacturing’s supply chain management.
A quick explanation – Supply chain management (SCM) has become one of the keys to profitable manufacturing. Defined as the process of planning, implementing and controlling the operations of the supply chain as efficiently as possible, SCM is based on the idea that companies should focus on what they do really well, their core competencies, and outsource tasks and functions that are not ‘core’ to organizations that do those things very well.
This allows the manufacturer to concentrate on what they do well, reduce overhead and staff, and focus management time and expertise on stuff that really drives value.
In the old days, companies tried to control as much of their raw materials – and the refining and transportation of those raw materials – as possible. In addition to auto plants Ford owned iron mines, steel mills, glass factories, rubber plantations, ships, and railroad cars. Nowadays Ford outsources some of its vehicles’ key components (engines, transmissions, steering linkages) to other companies, concentrating on designing, assembling and marketing instead.
Over the last couple of decades, manufacturers found themselves increasingly relying on other companies for critical processes and components – if all worked well, profits zoomed, and if not, heads rolled. Recognizing the importance of their suppliers (important = if they screwed up the manufacturer could be out of business), over time manufacturers combined these processes, approaches, and management techniques into the process of supply chain management.
The purpose of supply chain management is to make sure the company gains all the desired benefits from SCM, and avoids the nasty results of a failure in the supply chain – engines don’t show up at the assembly line, the wrong size tires appear, screws have left handed threads when right handed were spec’ed.
Or, the fancy order tracking system designed to make sure enough widgets are on hand to make the thingies ordered by customers just in time to meet the delivery deadline breaks down, or the investment in automation of central processes is a complete failure, or a working plant is closed and manufacturing sent to a cheaper plant that can’t deliver a quality product.
This happens more often than you might think, and when it does disaster often ensues. There are plenty of examples; reading about them gives one a mild sense of superiority (jeez, we’d never be that dumb) that alternates with a cold dash of reality (uhh, actually I could see us screwing up like that – or worse…).
What’s happening in workers comp (see, I told you we’d get to this eventually) is rather more insidious. I would argue that most payers’ approach to medical is tantamount to Sony outsourcing design and marketing, Honda outsourcing engine R&D, Ruth’s Chris outsourcing cooking, or Dave Mathews outsourcing singing (wait, that might not be a bad idea…). As I argued last week, medical is central, core, a critical function – fixing broken claimants so they can return to work is more important than anything else a comp insurer can do. I know, loss prevention is key as well, but claims will happen, and when they do the payer simply must ensure the claimant gets the right medical care that gets him/her back to full functionality.
But comp payers have, with a few, rare exceptions, completely lost track of what’s important. Fact is, almost all workers comp insurers buy medical care without regard to how good it is, or how fast it returns injured workers to employment. No, they buy it based on how much of a discount the doc or hospital will give them. The bigger the discount, the better – that’s how most comp payers evaluate medical care. While a few insurers are trying to change the model, and a few experiments, albeit on a very small scale, are in place, essentially all medical care for work comp is evaluated not on the basis of performance but on price per service.
Analogy – Sony buys LCD panels not on clarity and brightness but on cost, thinking hey, they are cheap so more folks can afford them – don’t worry if the picture is lousy and colors muddy – in fact don’t even look at the picture before you select a vendor.
Analogy – Airlines decide what travelers really want is low cost – so they remove seats from airplanes and have everyone stand up.
Ridiculous? Absolutely – about as ridiculous as choosing a doctor based on the discount they give your network.
I’m pretty passionate about this, so much so that tomorrow’s post will dive even deeper into the issue of how dumb supply management is killing work comp.

In an announcement released this morning, MSC has sold their pharmacy division to rival Express Scripts, Inc.
Rumors had been circulating for some time about a potential merger of MSC with rival PMSI-Tmesys, or of a deal wherein MSC would buy PMSI’s ancillary service lines business (durable medical equipment, home health care, etc).
Since the loss of Liberty Mutual’s pharmacy contract (MSC covered one half of the country with Progressive Medical handling the rest) to Progressive Medical last year, MSC has been able to regain momentum. According to MSC CEO Joe Delaney (from a conversation at RIMS in April) the company had essentially sold enough new business to make up for the loss of Liberty, and new business opportunities for 2008 have been plentiful.
Express has long had the second position in the industry behind leader PMSI; the newly merged entity will be a formidable competitor and may well take over the industry leader spot. MSC’s pharmacy revenues totaled close to $200 million.
Sources close to the deal indicated the purchase price is $248 million.
The deal will close within a few weeks, barring any anti-trust issues which sources do not expect to be a factor.
Meetings are starting this morning in MSC’s headquarters in Jacksonville, FL to start the customer contact outreach. They will also begin the “who does what from where’ conversation, as it appears no decisions have been reached regarding leadership of the newly merged entity.
Note – this deal is for the pharmacy business only; MSC will keep its ancillary services operations and it looks like current CEO Joe Delaney will stay in his current position. Delaney has done a good job turning the company around, and he will now be able to focus on this sector. I’d expect that MSC may now start (if they aren’t already) looking for acquisitions in this space.

It is Friday the 13th. That legendary day of mythical fears, the bane of the superstitious, the day of bad luck and portentous omens. A fitting day indeed to tell an all-too-real horror story.
We’ll begin with the dry, dull, numbers, ones that we all know so well their impact has been dulled by their very repetition. But sit up straight and open those eyes, because they tell a very scary story.
59% of work comp claims cost is from medical expense. That percentage has been steadily growing over the last fifteen years. WC medical trend is significantly higher than the medical CPI; comp is up 7.8% per year over the last five years while the medical CPI only increased at an annual rate of 4.2%.
Why? What else happened over the last fifteen years?
Comp carriers came to rely on discount-based generalist networks as the central pillar of their medical management program.
And now the networks are in control.
The industry’s addiction to the easy solution of discount-driven medical care is slamming up against the hard reality that it just doesn’t work. Nationally, workers compensation preferred provider organizations (PPOs) deliver discounts in the range of 10 percent to 12 percent before network access fees. The claim, therefore, is that they deliver “savings” of 10 percent to12 percent. This claim is based on the simple premise that without the network, the cost would have been 10 percent to 12 percent higher. While this argument is logical on its face, there are at least three problems with it. First, the argument assumes that the injured worker would go to the exact same providers without a network. Second, it assumes the providers would deliver care, and bill for it, in exactly the same way. Finally, it does not consider the impact of frequency or utilization of care, merely the price per service.
But there’s an even bigger problem. Consider the incentives of the provider in this model. The PPO has asked the provider for a discount, for without a discount there is no profit for the PPO. The provider agrees and delivers care at a lower price, and thus less profitably. Clearly, the provider has a financial incentive to deliver more services, for if it does not, its decision to join the PPO makes no sense. The incentives for the PPO are equally perverse. The higher the medical cost, the more the “savings,” and the more revenue and profit for the PPO. Everyone benefits from this PPO arrangement; that is, everyone except the payer.
Yet this is the network model in place at almost every payer in the nation. It has been so successful for the biggest managed care firms that they are powerful enough to dictate terms to their ‘customers’ – the insurers and employers.
But relying on vendors to manage medical has clearly failed. If it had worked well, trend rates would not be where they are, and medical would not be eating up so much of the claims dollar.
Many payers are only now beginning to realize the implications of their addiction – their network vendors have the upper hand. Payers are now being confronted with the awful reality that their addiction to the huge discounted network is at its inevitable endpoint of all addictions;
the drug is controlling the addict, while slowly bleeding it dry.
This is not idle speculation. Nor is it hyperbole or exaggeration. In conversations with executives at several very large insurers it has become all too clear that the power is on the other side of the table now. The networks are dictating terms, and payers are confronted with ‘take it or leave it’ ultimatums – ultimatums that include exclusivity across all states, much higher fees, required bundling of services, and lower customer service standards.
Workers comp is now a business of managing medical expense. Medical is core to work comp, a central part of the business. Payers must recognize this and restructure their thinking, their culture, their methods and practices to deal with the new reality.
What does this mean for you?
It is time to regain control.

I received a few calls and emails yesterday from workers comp payers asking for clarification about my post on the potential (highly inflationary) changes to the Florida outpatient work comp fee schedule. Evidently there is some confusion out there about the linkage of Medicare to the WC fee schedule, with several entities contending that Florida is actually linking WC reimbursement to Medicare reimbursement.
Kinda sorta but not exactly.
The three member panel (regulatory entity responsible for the FL WC FS) is looking at the difference between Medicare charges and reimbursement, and basing their calculations on that differential.
The proposed change to the FS would link the “usual and customary” payment standard for outpatient hospital claims contained in Fl. St. § 440.13(12) to the ratio between what Florida hospitals charge Medicare and what Medicare actually pays. The net result would be a dramatic increase in the reimbursement for outpatient services billed by hospitals.
Here’s some detail; apologies for the density of the subject, but you wanted details.
The change proposed by the FL Dept of Financial Services (DFS) is to link what Medicare pays hospitals, as defined by the Ambulatory Payment Classifications (APC) payment rate, adjusted to mark up the Medicare APC payment on a hospital’s charge to roughly equate with what DFS thinks are the average charges billed by FL hospitals for that ‘group’ or APCs.
FL is putting APCs into two APC groups – surgical and ‘other hospital outpatient’. DFS’ calculation is that the average mark up – on which payment would be made – is 302% for surgery and 467% of Medicare payment for other hospital outpatient APCs
Thus, per regulation, 60% of the 302% would be paid for surgeries and 75% for other hospital outpatient.
There are a few issues with the methodology, data sources, and assumptions used by DFS, issues that have been raised in past meetings of the panel.
But the real problem is simple – WC costs are going to be substantially higher if this goes through. First, this methodology will increase costs – today – by 181% for surgeries and 330% for other hospital outpatient services.
Second, the annual inflation rate for charges in FL is 14%. So today’s high costs will be tomorrow’s even higher costs and the day after will bring really really high costs…
Third, the location of services will likely change dramatically to the higher cost hospital location. Thus procedures which were being done in offices will now be billed – at the much higher rates – by hospitals.
Fourth surgeries which were done on an outpatient basis will likely shift to inpatient to take advantage of the much higher reimbursement.
What does this mean for you?
The next meeting of the three member panel is June 19. Unless you want to pay a lot more for medical care in Florida, make your voice heard.

I’m mystified, perplexed, confused, confounded, and appalled.
There’s just no other logical reaction to the goings-on in the Sunshine State, where several workers comp payers are actually supporting a major increase in reimbursement for outpatient facilities – an increase that is wildly inflationary and completely unnecessary.
I’ve reported on this impending disaster a couple times over the past month, a disaster that the payers are bringing on them selves. Comp reimbursement in Florida is under the control of the ‘three member panel‘, a triumvirate that is attempting to come up with a clear definition of ‘usual and customary’ – the criteria by which facilities are reimbursed under workers comp.
Here’s a brief video metaphor of the last hearing…
The panel is looking to specifically and clearly define U&C in an effort to eliminate the ongoing legal battles between payers and hospitals over what exactly is ‘usual’ and ‘customary’. The benchmark that the panel seems committed to is the amount hospitals charge Medicare. Not get paid by Medicare, but charge Medicare. According to testimony at one of the panel’s recent hearings, hospitals mark up their Medicare costs by 715% – they charge Medicare seven times more than it costs the hospital to provide the service.
If the proposed regulation is adopted, workers comp’s ‘usual and customary’ would be based on that 715% mark up. Running the numbers, this would result in workers comp payers paying Florida hospitals (and perhaps ASCs) 472% of what Medicare pays for outpatient services – one of the highest rates in the nation.
And this will increase Florida WC costs by about 20%. (the calculations and basis thereof are too lengthy to go into here, email me at infoAThealthstrategyassocDOTcom if you want the gory details)
Yet payers are supporting this change. Why? Do they want to increase policyholders’ costs? Jack up their loss ratios? Are they feeling particularly charitable (always easy when spending policyholders’ money)?
Or is it because they are sitting in the back of the train, relaxing while it hurtles down the tracks, blindly confident in their ability to determine its destination?
In private conversations, they say because it will make it easier to deal with the issue, establish a firm basis for reimbursement, eliminate the hassle, end the litigation.
If that’s the case, why not just set the amount at “whatever the billed amount is, you have to pay it”? That would be even simpler, eliminate the complex calculation needed under the proposed system – and have the same result.
Payers are being incredibly short sighted. Lazy even. And here’s where that train is heading.

What does this mean for you?
(Many) employers in Florida are being ill-served by their insurers and TPAs. Send this post to your broker and ask them to find out what your work comp carrier’s position on this is and why, and what they are doing to protect your interests.
Or you can just hang out in the club car, trusting that someone will get control of this impending disaster before too late.