Fee-for-Service Reimbursement

Fee for service (FFS) rewards physicians for work on a per-item basis. It provides a strong motivation to work productively, but not necessarily cost efficiently. It is strongly favored by physicians but is viewed by payers as an incentive for physicians to overuse medical services, or at least to remove inhibitions from recommending services.

Indemnity Insurance

Indemnity insurance covers expenses for the medical benefits that are defined in its plan. It allows payment for necessary, often large, and sometimes unexpected medical expenses. It insulates the patient from the true cost of treatment, lowers price sensitivity, and creates a tendency to overuse services. Physicians may order more tests and services because of defensive medicine or because payment is ensured; and patients may accept more because no personal financial consequence is perceived.

Technical Complexity Basis of Quality

Technical complexity is the sine qua non of surgery. Greater benefit is perceived to be associated with instruments and techniques of greater intricacy. Greater perceived benefit is equated with higher quality and thus greater value. From the payer’s perspective, however, greater technical complexity translates simply into greater expense but often without better value as measured by functional outcome.

Single-Specialty Group

The simplest form of organization is the single-specialty group practice. The advantages of this form—shared office expenses to reduce overhead, shared service call to increase free time, and shared case information to enlarge on personal experience—make professional life more efficient and productive. Beyond simple office sharing, however, lies a quantum leap in business control opportunity through corporate organization. Corporate integration allows sharing of records, production pools, owned business assets, financial risk, policies, planning, and reputation. More important, corporate integration, such as a professional service corporation or limited liability corporation, allows group decisions about fees, contract participation, services offered, and extent of geographic coverage. In short, it allows, within legal antitrust limitations of group size and market monopoly, the control of price and participation conditions in the market in a way that is unavailable to single practitioners.

The advantages of single-specialty group practice persist into more complex arrangements, such as multispecialty network or multispecialty group arrangements. The organizational potentials of practice should be considered as multiple tiers of organization, the larger arrangements being dependent on the sound structure and function of the smaller units. The basic unit is the individual, with thorough training, reliable practice habits, and cooperative group behavior. The next level is the foundational organization: the single-specialty corporate unit, with the specialty expertise on which each large unit builds and capitalizes. The last level is multispecialty affiliation, such as the independent practice association (IPA) contracting networks, which serve as the common contractor (similar to the general contractor in construction) for its individually autonomous functional specialty units. An alternative to loose affiliation is the higher integrative level of an incorporated multispecialty medical group, which involves central governance and shared financial risk yet is still dependent on the competence and effective functioning of its component single-specialty units.

The key to single-specialty groups is the efficient use of individual resources. Internal competition should be minimized, and differences in individual interests and experience should be exploited and individual strengths maximized. To do so, effort and production should be fairly rewarded (however, the group collectively defines the term fairly).

The tendency toward subspecialty differentiation within specialty groups can be expected to grow. The 1995 Comprehensive Neurosurgical Practice Survey found that 23% of respondents had completed a fellowship, but only 11% listed the spine as the area of special training. Of the 16% who practiced only a subspecialty, over one third were spine surgeons.⁴ About two thirds of neurosurgical practice involves spine work, traditionally by neurosurgeons in a general neurosurgical practice.⁵ As the size of neurosurgical groups grows, an increase in subspecialization may be expected, with a larger number of neurosurgeons limiting practice exclusively to spine disorders.

Subspecialization creates higher levels of efficiency for three reasons: (1) It allows concentration of experience in a few individuals, which improves technical ability, tends to reduce both operative time and complications, and creates local expertise; (2) it allows concentration of interest, particularly for learning, researching, and designing innovative techniques; and (3) it improves marketability of the practice in a competitive market, in which expertise, especially if cost efficient, holds a high premium.

Contracting Network

An intermediate form of integration of independent practices is the IPA, which is an affiliation of otherwise independent physicians or groups organized for the purpose of entering into contracts for medical service with one or more payers.

The IPA is a corporate entity whose physician members have signed a participation agreement with the IPA. The IPA members remain independent and enter individual participation contracts negotiated by the IPA with insurers. An IPA may be a single-specialty network but more often includes a complete multispecialty panel, which conforms to the contracting need of the health plan. Depending upon the IPA’s agreement with its members, the IPA may either include all its physician members in any medical services contract it negotiates and signs or reserve the right of each physician group to accept or reject each payer contract. The former arrangement, IPA single-signature contracting authority, gives the IPA greater negotiating power and generally the potential for better contract terms. However, physician groups often balk at giving blanket contracting authority to an IPA and sometimes prefer to reserve the right to refuse, despite the weakened bargaining position created for the IPA.

The advantage of an IPA to the physician is the opportunity to participate in contracts attracted by the organized physician panel and to benefit from what negotiating clout the network may have. The disadvantage is the network’s inability to collectively set fees or refuse to deal with an insurer, because antitrust restrictions limit the concerted action of independent physicians affiliated in a network. The advantage of an IPA to an insurer is the simplicity of network building, particularly when entering a new market. The disadvantage to an insurer is the possible cost inefficiency and noncoordination of a loosely affiliated physician network and the weakened control the insurer has over contract conditions with individual physicians.

For physicians outside of multispecialty group practice, in which the administrative arm of the group serves as the negotiating agent for its member physicians, the IPA provides access to group contract-negotiating power while preserving an independent practice. It does not provide all the available practice for its members but serves as a useful supplemental source of managed care contracts.

Multispecialty Group

The most integrated medical practice organization is a multispecialty group practice. Its organizational features are similar to those of single-specialty groups except that many or all specialties are represented. Independence is traded for group financial and practice security. Individual autonomy is traded for group market power. Practice freedoms are traded for practice stability. The defining features of an integrated multispecialty group are a single corporate billing identity and shared financial business risk.

Several advantages accrue to a multispecialty group, compared with networks. The group has greater latitude to set fees and deal collectively with managed care payers and to collectively refuse unfavorable terms. It can pool capital resources for business investment. It can share overhead expenses, information systems, management, and marketing. It can plan collectively and wield significant influence over local market conditions by group price and participation decisions.

Several disadvantages must be borne by multispecialty groups. Income from higher-paid specialties may be shifted to lower-paid primary-care physicians to attract a needed primary-care base. Personal control of practice hours, time off, and vacation time are reduced or lost. Influence over management decisions is diminished in proportion to the size and variety of the group.

The advantage of a multispecialty group to a spine surgeon depends on the local market. Academic practices are generally large multispecialty groups, though commonly with departmental autonomy, so a desire for academic practice usually implies the choice of a multispecialty group. Outside of academic practice, the choice of multispecialty group practice is commonly determined by financial factors, such as ease in start-up, and practice factors, such as ensured referrals. Two considerations make multispecialty group practice attractive. The first is the power of group influence in medical service contract negotiation. The second is shared overhead expenses, which increase under managed care conditions and require heightened efficiency and access to pooled resources.

Fee-for-Service System

The traditional form of reimbursement for medical and surgical services has been an FFS system. The concept is simple, but the problems are legion. As an incentive system, it has worked only too well. It satisfies the physician’s desire for compensation for the amount of work done. However, it is a major contributing factor to cost increases and is subject to assault and modification in the market.

One must understand the economic quandary in FFS to understand the changes offered in reimbursement from payer sources: (1) FFS is a cost-based additive unit pricing system without a budget, which encourages the addition of more units, thus increasing the total charge; (2) FFS discourages the bundling of unit charges into package prices and, in fact, encourages the unbundling of previously packaged prices, such as global surgical charges; (3) FFS developed as individual pricing strategies without a rational or consistent basis for the charges related either to overhead (production) costs or to other physicians (competition) in the market; and (4) the lack of competitive market restraint on fees gave rise to the odd economic response wherein the buyer (insurer) established market fee limits (usual, customary, and reasonable [UCR]) rather than relying on seller (physician) competition.

The payer response to the FFS quandary has been to either modify fee pricing among physicians by contracting with physicians for modified fees or offer alternative payment schedules, such as financial risk sharing or salary. The successive modifications to fee pricing levels in FFS reimbursement have been (1) comparative community average rates (e.g., UCR), (2) discounted fee levels (e.g., 80% of charges), (3) private relative value fee schedules (e.g., California relative value scale [RVS], McGraw-Hill RVS), and (4) a public resource-based RVS (e.g., resource-based RVS [RBRVS], Medicare Fee Schedule [MFS]).

Resource-Based Relative Value Scale

The trend in market pricing has been movement from modification 1 (UCR) to modification 4 (RBRVS). One of the goals of development of the Medicare RBRVS was to establish a fee schedule that could be adopted throughout the health-care system by both public and private payers in order to establish uniformity and rationality in the system’s reimbursement methodology.⁶ By paying on the basis of the resources (time, effort, practice expenses) used to provide a service, a rational basis for relating one service to another was introduced. By using a common basic RVS, the variability among different payers is reduced to a simple difference in conversion factor. Many, if not most, PPO and HMO fee schedules currently use the MFS as a benchmark for their own pricing, setting fees as a percentage of Medicare. Depending on the region, the private payer conversion factor may be higher or lower than Medicare’s annually adjusted conversion factor.

Two changes in specialists’ practice accounting can be made to convert from payer reimbursement to the Medicare RBRVS. The first and more radical change is the conversion of current fees to the Medicare RVS. A benchmark code, such as 63030 (lumbar disc excision), is used to establish the conversion factor equating current fees to the Medicare RVS values. This conversion factor is then applied to all other current procedural terminology (CPT) code relative values, and a new RVS fee is derived for each CPT code. The new fee is compared with the practice’s older fee, and the degree of disparity is noted. The problem for physicians is that the disparity between existing practice fees and fees derived from MFS relative values using a single conversion factor may be quite large, throwing the practice’s billing temporarily into disequilibrium. The effect of disparities between current charges and RVS charges can be softened by converting current charges to the RVS incrementally over time, similar to the 4-year transition period adopted by Medicare in converting to the MFS between 1992 and 1996. The value of such a transition may be quickly realized as the relative weighting of CPT code values becomes the same in the practice’s billing system as in payers’ fee schedules. For spine procedures with multiple CPT codes per procedure, this means an ability to consistently prioritize the order of the CPT codes submitted to be sure the primary code, or base code, is the highest-valued code.

The other, less radical option is to continue to use current fees but determine the conversion factor for each fee that would equate it to the Medicare relative value. The result is a confusing array of different conversion factors for each individual CPT code that may range from $35 or less at the low end to over $75 at the high end. This calculation can be useful in equating current fees to a proposed conversion factor using the Medicare RVS and estimating the effect the offered or negotiated conversion factor would have on current fees for individual codes. To simplify the process, the 20 most commonly billed codes should be selected and analyzed to examine the bulk of revenue-producing services without getting lost in detail.

Bundled Service (per Episode of Care)

A variant of FFS is a bundled service for a fixed fee. There is an element of risk sharing, because the fee for the bundle is fixed in advance and any extra unexpected services are included as part of the package. There is a long tradition in surgery of charging a global surgeon’s fee that includes the procedure as well as the hospital visits and postoperative outpatient visits. This is a bundled service but is risk-limited by charging FFS for any additional required surgical procedures and limiting the postoperative outpatient visits to a fixed period, such as 3 months.

Another form of bundled service is a compromise between unit pricing FFS and fixed payment over time, or capitation. This form of bundled service offers a fixed price for a bundled service that includes all charges that are anticipated for an average episode of care, including all professional fees, technical costs, and facility charges. For this bundled price, the surgeon’s fee, anesthesia fee, radiology fee, operating room charge, and all inpatient hospital, pharmacy, and related outpatient charges are included in a single prospective charge to the payer. Charge calculation requires an accurate database of average utilization and FFS reimbursement for all elements of the bundled team. Profitability emerges from heightening efficiencies to reduce expenses while the bundled fee remains the same. Business efficiencies arise from standardized protocols for care, lower complication rates, better coordination among participants, and selection of more economical pharmaceuticals and technical devices.

Bundled services are a marketing tool for specialty services in a competitive market. The entrepreneur offering the package is counting on known reputation combined with reduced financial exposure to the payer to draw business for that particular procedure away from competitors. Bundling services offers specialists a niche in a competitive market where they can increase the referral base beyond usual physician sources and local health plans. The key is to select procedures that are technically complex and expensive, offering payers significant opportunity for savings by concentrating referrals to one physician group or institution. The strategy works best for high-frequency procedures, for which the level of efficiency can be measurably improved and cost can be lowered compared with competitors; for low-frequency conditions, the area of draw simply has to be widened to convert low local frequency to high regional frequency.

For spine surgery, the concept of bundled service has a natural appeal because all the features coexist that lend themselves to successful bundling: (1) a competitive, oversupplied market, (2) technical complexity, (3) coordination of multiple service components, (4) high expense, (5) high variability in cost and outcome, and (6) payer control of referral.

The drawback for physicians using bundled case rates, or per-episode-of-care rates, is the risk of loss to physicians if their payment is combined with a facility payment. Any time the physician fee is included in a facility payment, the physician risks reduced reimbursement, particularly if excess facility costs are taken out of the fixed-rate payment, reducing funds available for the physician’s reimbursement.

Capitation

Capitated reimbursement is a practical means for managed care organizations to shift financial risk for medical care from insurers to medical providers. Two principles are involved. First, the payer’s annual budget is relatively fixed by the contract with providers, who become responsible for a share in cost overruns. Second, the incentive to increase services, as is the case under an FFS mode, is reversed, so provider profit increases as service volume is reduced. Capitation usually begins with primary-care physicians (gatekeepers), who are expected to control utilization of specialty referrals, hospitalization, and surgical services. Specialty capitation may follow thereafter, mandating that spine surgeons be educated about this form of reimbursement. Some plans have even reversed the order, capitating specialists and hospital services, for which the highest utilization costs exist, while maintaining FFS to primary-care physicians.

A specialist’s association with capitation comes in several forms. In its simplest form, the primary-care physician is capitated, while specialists continue to receive a modified FFS reimbursement for referrals that pass the capitated gatekeeper. The model is simple for accounting purposes, but it creates conflicting incentives within the plan between primary-care and specialist physicians, with a tendency to retain high specialty utilization and costs once the gatekeeper barrier has been breached.

At the next level, the specialist agrees to share risk but without fully capitating. The simplest risk sharing is a percentage withholding of fees, such as 10% to 20%, which is returned at the end of the period of risk (e.g., 1 year) if specialty-generated expenses have not exceeded budget. The more complex risk-sharing arrangement is capitation modified by risk limits. The risk limit is set in one of two ways. The first is stop-loss insurance, such that any expense above a fixed percentage of capitated risk, such as 10%, is covered by an insurance policy. The second is a window or corridor of risk negotiated with the payer. Under this arrangement, the capitation rate is set on the basis of an expected utilization. If utilization exceeds a limit, such as 110% of what was anticipated, the plan provides the physician additional reimbursement, commonly on a discounted FFS. On the other hand, cost savings for utilization that is less than anticipated may be shared by both plan and physician when less than a threshold amount, such as 90% of expected cost, occurs.

The highest level of risk is full capitation. For a specialist, this means receiving a periodic payment, generally once a month, for all anticipated specialty services for a defined population of plan enrollees. The advantage of the plan is that financial risk for that service is fixed in advance, and the person with most control over the generation of expenses (the specialist physician) pays the financial consequence for overuse. The advantage to the specialist is the chance to profit by careful restriction of services or a more efficient use of services. The risk, of course, is a failure to do so, resulting in financial loss for the specialist. The ultimate risk is financial insolvency if miscalculation is profound.

Several conditions must exist before a specialty physician can safely accept a capitation reimbursement, even on a partial risk-sharing basis. These include an understanding of the change in incentives that the capitation payment creates, a belief that it can work, and a determination to react responsibly by controlling unnecessary utilization without jeopardizing patient welfare. However, good intention is not enough; only data analysis can allow a practice to safely accept a capitation payment.

The calculation that is necessary to negotiate a capitation rate for a practice is complex and will likely require actuarial help. The first requirement is access to organized, reliable data on the physician’s practice as well as data on the patient base in the plan. The two data sources are necessary to show two things: (1) how the revenue from the capitation payment will likely compare with revenue under current FFS reimbursement and (2) what the expected utilization and thus the practice expenses will be. The difficult task in negotiation is to reach an equivalency between the reimbursement under FFS and the lump capitation fee and then to use practice efficiency measures to reduce nonessential high-cost service utilization and convert practice expenses to profit.

Data in a practice should be collected in advance of the necessity for negotiating a capitated contract. The minimum necessary information from the practice is a frequency list of CPT codes billed in the practice over 1 year and the average treatment plan for the top 20 diagnoses (ICD-9-CM) or CPT codes. The treatment plan is the list of services by code that the practice provides, on average, for a particular problem, such as lumbar disc herniation. This list includes (1) preoperative visits, diagnostic services, operative procedure charges, in-hospital visits, and postdischarge visits; (2) average charge per CPT code (the practice’s listed charge to FFS payers); (3) average allowable per CPT code (the average amount received from all payers [note that the average practice discount equals average charge minus average allowable]); and (4) utilization rate for individual CPT codes in the practice (how often a given CPT code is used for all patient encounters and how often it is used for particular ICD-9-CM diagnoses).⁷ These data provide a window into the volume, composition, and revenue generation of billable practice activity under FFS.

The next information that is needed comes from the plan itself. Demographic data (e.g., age, gender, and possibly occupation) about the plan’s enrollees under FFS reimbursement for a minimum period of at least 1 year, preferably 2 or 3 years, reinforces the accuracy of the actuarially expected utilization by the insured population. The information must be specific for the services that are to be covered by the capitated contract and must include all those services for all plan members, including services by other providers, which may shift to the capitated specialist under a capitation contract. The most important demographic distinction is Medicare risk versus commercial risk, in which the capitation rate for Medicare may be several times greater than general commercial rates.⁸

Finally, the terms of the proposed contract must be examined in order to know exactly what services are included and what the surgeon’s obligation is under the agreement. Terms such as “all necessary neurosurgery services” or “all spine surgery services” are too vague. The contract should detail the specific capitated services by CPT code. Some services that are high-expense, that are rarely done, or that the provider simply does not do may be excluded and provided either as a carveout by another provider or simply on a modified FFS basis. At the same time, it is important to know whether patients from other specialists will be shifted to the capitated provider, necessitating a higher capitation rate to cover the increased volume. Along the same lines, it is important to ensure that inappropriate patient referral, sometimes known as dumping, does not occur in a flood once the capitation rate ensures no increased financial risk to primary-care physicians for early referral to ease their own office burden. This risk is reduced by retaining external health plan utilization controls, developing referral guidelines, using telephone consultations prior to referrals, or conducting informal or formal primary-care physician education. Early referral for specialty management may be appropriate, ultimately providing cost saving, but must be covered by the capitation rate.

The actual base per member per month (PMPM) rate is calculated as a sum of individual rates for each CPT code used by the practice. To make this calculation, an actuarially determined annual utilization table is required, either from national data, such as the Medical Group Management Association data, or from local plan data. The utilization rate for each code is a fraction reflecting the expected frequency of the procedure among the defined population in 1 year (e.g., 0.000900 = the per member per year [1] [PMPY] utilization rate for CPT code 63030). The average allowable charge in the practice for each code is multiplied by the actuarially determined utilization factor to arrive at a PMPY rate that matches current average practice reimbursement. Additional services are added that compose the average treatment plan for the code, also multiplied by the actuarial utilization rate. The total (procedure plus additional services) PMPY rates for all CPT codes to be included in the capitation rate are added together and divided by 12, and the result is the PMPM rate that would allow that practice to maintain an FFS level reimbursement. This figure is used as a benchmark in negotiating a capitation rate. At this point, the practice negotiator must understand that the practice expense data for the capitation rate offered by the plan is likely to be lower than the FFS equivalency rate calculated previously. Only knowledge of the practice expense can reveal what the actual profit margin will be for a compromise cap rate and whether the practice is willing to accept the rate, negotiate the rate, or refuse the offer.

It is important that the number of covered lives in the contract be large enough to prevent unexpected outliers (high-expense cases) from devouring all profitability. Small populations of covered lives make this fluctuation more likely and the chance of loss relatively high. A specialist capitated for fewer than 15,000 lives is taking a high risk. However, it may be prudent for a practice to enter capitation arrangements gradually, initially with a small proportion of the practice volume, thereby limiting the effect of errors in calculation early in the capitation experience, which later might overwhelm the practice with unanticipated expenses.

Once a practice enters a capitation contract, it becomes more important than ever to continuously track cost and utilization data, particularly with regard to the capitated population. It must be remembered that the penalty for an error in calculation or loose utilization control can quickly become catastrophic. Under FFS, unit reimbursement may be increased to cover expenses for any excess utilization. Under capitation, reimbursement is fixed in advance, based on an estimate of expenses. If utilization is higher than calculated, the only side of the ledger that goes up is expense to the business, which diminishes the profit side. Accurate and frequent analysis of practice cost and utilization data allows the practice to learn quickly whether profitability is maintained and what adjustments in utilization are necessary.

Capitation Carveouts

A capitation carveout is a contract for a particular specialty service directed to a single provider group. A capitated plan seeks a specialty carveout either when the service is not available within its panel of capitated physicians and facilities or when it contracts with independent specialty groups and wishes to concentrate care in exchange for capitation rate negotiation with one group. The capitation rate for the carveout services is not included in the capitation rate of any other provider under contract. A specialty group seeks a carveout when it is competing with other groups in a region and wants to lock in referral within a capitated plan. It is an unnecessary strategy when the specialty offers a full range of services and is part of a large capitated group or network without internal competitors.

Carveout services, such as all spine specialty referrals, or designated subcategories of service, such as all spine surgeries, can be negotiated by spine surgeons. The difference between a carveout service and a bundled service is that the carveout is a capitation variant, with a fixed fee per covered member per month, whereas the bundled service is an FFS variant, with a fee per episode of care. The degree of provider financial risk is greater with the carveout because the calculation requires not just the estimated expenses per episode of care but also the estimated occurrence of need for the episode of care in the covered population.

The calculation necessary to negotiate a reasonable carveout capitation rate may combine the calculations necessary for a full capitation and for a bundled service. If a carveout capitation rate includes only the professional component, the calculation is identical to the full capitation calculation, except that the number of CPT codes analyzed is more limited (those included in the carveout). If the capitation rate includes all charges for the carveout service, including professional, technical, and facility charges, the calculation must include all the average needed services combined with an actuarial estimate of the population need for the service over a fixed period of time.

Practice Cost Categories

A spine surgeon’s operating costs are numerous. They include nonprovider salaries, nonprovider benefit expense, information services expense, occupancy expense, administrative and medical supplies expense, insurance premiums, and capital expenditures such as those for furniture and equipment.

The most significant operating costs are personnel costs. Nonsurgeon employees perform tasks that are done most economically by support medical personnel, such as nurses, physician assistants, and nonprofessional medical assistants. Administrative employees perform administrative functions such as billing and collection, patient registration and reception, appointment scheduling, surgery scheduling and precertification, data processing, transcription, accounting, and personnel management.

Nonprovider benefit expenses include medical, life, or disability insurance; vacation and sick pay; and retirement plans. Advantageous tax treatment is afforded for these types of expenses for both physician and nonphysician employees. To attract and retain high-quality clinic employees, it is necessary to provide attractive benefits. Because employee benefits are very expensive, the employer must maintain flexibility with benefit plan funding requirements and mandate at least some employee contribution toward payment of plan costs.

Information services are of ever-increasing cost and importance, perhaps especially for spine surgeons. Most of the costs associated with information services are capital expenditures. However, also included would be hardware and software maintenance costs and service bureau fees.

Generally, occupancy costs are office space lease payments or depreciation, mortgage principal and interest, property taxes, and maintenance costs. The fluctuating conditions of the health-care industry favor renting over ownership. The accompanying responsibilities of real estate ownership can be a counterproductive distraction to the physician. Changes in the practice and market conditions require flexibility in office space, either expansion or contraction; property ownership or multiyear leases often obstruct rapid adjustment to changing practice space needs. Expensively appointed accommodations could possibly be offensive to patients and payers. Medical offices should be comfortable, spacious, distinguished, and attractive but also modest.

Insurance premiums include employee benefit insurance, general property and liability insurance, professional liability insurance, and perhaps key-person life or business continuation insurance. Professional liability insurance is very expensive. However, because the risks involved in spine surgery are relatively high, the surgeon should usually purchase the most complete coverage that is reasonably available. Only if a group rate is unavailable owing to previous litigation should one undertake asset protection strategies instead of appropriate insurance coverage. Also, if a surgery practice is incorporated, total liability coverage can sometimes be increased economically by purchasing separate coverage for the corporation in addition to coverage for the individual surgeons. The advisability of key-person life or business continuation insurance depends on the configuration of the practice organization and the number of practicing surgeons. This type of insurance is generally useful for covering a contractual buyout obligation between the physician and the corporation.

The final cost category is capital expenditures for fixed assets, such as furniture and equipment. Most spine surgery procedures are performed in hospitals; therefore, medical equipment is not usually required in the office. The most significant capital expenditures in terms of both cost and value are for management information and communications technologies. Computer hardware and software, network, telephone, facsimile, and transcription and reproduction systems cost tens of thousands of dollars. However, these expenditures are imperative for the successful operation of a surgical practice in the 21st century.

A common measure of practice expenses is the percentage contribution of each cost component to the total practice revenue. Average percentages for a neurosurgery spine practice, for example, are less than 2% for information services, about 5% for occupancy costs, 1% for administrative supplies and services, 4% for professional liability insurance, about 13% for nonprovider salaries, and approximately 4% for nonprovider benefit expenses. Total nonphysician expenses would average about 35%. Furthermore, the average neurosurgical practice would employ 3.6 nonprovider support personnel per surgeon.⁹

Practice Cost Behavior

All of the significant components of the total operating costs of the typical private spine surgery practice are virtually fixed over a wide range of business activities. The expense components that vary with changes in the activity rate tend to do so in discrete increments rather than in a continuous proportional manner (Fig. 206-1). For example, personnel costs generally constitute by far the largest single component of total operating costs. Usually, a private spine surgery practice employs a large number of full-time support personnel. This configuration remains constant over a wide range of practice activities. If business increases or decreases beyond certain points, however, employment will increase or decrease in single full-time employee increments.

FIGURE 206-1 Spine surgery practice cost behavior.

Some spine surgery practices are attempting to create cost structures that are more variable and flexible. These efforts generally involve greater use of hourly or part-time employees for peak activity periods, keeping full-time employment to a minimum. One option is to contract out certain administrative functions, such as billing and collecting, bookkeeping, and even appointment scheduling, to service bureaus, which charge on the basis of the level of activity, thus converting relatively fixed costs to variable costs. The services of some personnel, such as nurses, can be leased from third parties to provide maximum flexibility.

Cost Accounting

Cost accounting is the determination of costs of doing business, or overhead costs. The importance of performing cost accounting arises in the current market when reimbursement levels for services may be so reduced that reimbursement for those services fails to meet costs or exceed costs. In the past, fees could simply be raised when overhead costs cut into profitability. In contract medicine, this can no longer be done. Business efficiencies must be invoked to prevent income loss when fees are fixed or reduced by contract. One form of business efficiency is to learn which services have a narrow, or even negative, margin of profitability and decide whether to offer those services.

Cost accounting is greatly simplified by using a fee schedule in which each CPT code fee is logically related to all other fees by an RVS. A simplified method to determine costs is as follows:

If the practice has adopted an RBRVS fee scale, the comparison to a managed care contracted fee schedule based on the Medicare RBRVS becomes quite simple:

When plan and practice follow the same RVS, the practice expense ratio for every procedure is known as soon as the conversion factor is revealed, simplifying the mental calculation to determine whether the reimbursement offer is acceptable.

This form of cost accounting can be used for practice fees that are not on an RBRVS scale. It remains useful to determine whether negotiated fee schedules offer a sufficient margin of profit compared with calculated expenses to warrant acceptance. For instance, if the practice fee for a myelogram is $300, the calculated practice expense (40%) is $120. If a plan offered $150 reimbursement, the overhead cost for the myelogram service would be 80% (120/150 = 0.8). This allows a margin of profit of 20%, which in this case is $30. This type of calculation must be applied separately to individual codes when the fee schedule is not constructed on a relative value basis. The calculation can be used for each individual code in deciding which to accept and which to negotiate. On a practical basis, the 20 most frequently billed CPT codes in the practice can be analyzed by this method to decide whether the large majority of the fees offer an acceptable margin of profit.

Productivity

Managing operating costs is essential to a profitable practice, but it is not the only significant factor. The most valuable component of spine surgery care is the surgeon’s time and efforts. The amount of the spine surgeon’s available time is finite; therefore, careful management of that time is the most important factor for business efficiency and productivity. Minimal operating costs are clearly not optimal if efficient use of the spine surgeon’s time is compromised.

Surveys indicate that in 1 week, the average neurosurgeon spends 16 hours evaluating patients in the office, 9 hours making hospital rounds, 19 hours performing surgery, 6 hours on other patient care activities, and 5 hours on administration.⁴ Obviously, the time spent in surgery is by far the most financially productive. Therefore, increased operating costs can be offset many times by added revenue if those costs can increase the portion of the surgeon’s time spent in surgery.

Only 9% of neurosurgeons would prefer to see more patients in their office. In contrast, nearly 32% feel that they have time for a greater surgical volume. The volume of surgery tends to be a function of the number of office visits. The solution is to increase the number of patients who can be seen in the office without increasing the amount of surgeon time devoted to that activity. The best way to do this may be the use of physician extenders (i.e., physician assistants or clinical nurse specialists). For an FFS practice, the new patient or consultation visit is the most productive office time, for that is where new surgical cases are found. An optimal allocation of office visit time is increasing time for new referrals by assigning routine follow-up visits to physician extenders.

As with most personal service businesses, in a spine surgery practice, the revenue producer (the surgeon) is also the owner and manager. The management of any business is usually very time consuming. Professional managers can minimize the amount of time the surgeon must spend on business affairs and can be cost effective. Because qualified professional managers are somewhat expensive, their employment may be an option that is available only to a group practice, which can spread the cost among several producers.

Profitability

Careful management of practice costs can enhance the spine surgeon’s productivity and contribute greatly to the practice’s profitability. Careful management of the types of patients seen by the spine surgeon and those patients’ source of payment can equally determine profitability. Three payment sources that have a unique character are Medicare, workers’ compensation claims, and third-party liability for personal injury claims.

Medicare patients (except Social Security increment patients) are older than 64 years of age. Their age may make their medical treatment more complicated and time consuming. Medicare reimbursement rates are usually the lowest in most markets, the only exceptions involving Medicaid patients, welfare patients, and patients with no insurance (self-pay). Workers’ compensation and liability reimbursement rates are generally greater than Medicare and commercial managed care rates, but they are sometimes less than commercial indemnity FFS rates. Workers’ compensation and liability patients may have their legal claims as a secondary concern to their medical well-being, and this can complicate their treatment; therefore, these patients may consume more of the spine surgeon’s time. Because reimbursement is procedure-based and surgical procedures are reimbursed at much higher rates than evaluation and management office charges, patients who require less of the surgeon’s office time, relative to surgery time, are economically preferable. When evaluating the economic profit potential of patient populations categorized according to payment source, one should consider the rate of reimbursement relative to the total surgeon time consumption implicit in the characteristics of each population subset.

Likewise, one should attempt to maximize the yield of spine surgery cases derived from the total number of patients seen in the office. This can be achieved by tracking the surgery-to-patient ratio in different groups and then favoring the groups that have the higher yields. For example, if workers’ compensation patients tend to have a lower-than-average yield, their office visits might be restricted unless the fee reimbursement rate is relatively high enough to offset the lower yield. Likewise, it might be profitable to accept a managed care plan’s lower rate of reimbursement if the surgery-to-patient ratio is relatively high. However, because many spine surgery reimbursement rates are either negotiated with managed care plans or imposed by the government, general pricing strategies are less relevant than before.

Finally, collecting as much payment as possible as soon as possible is critical to profitability. Conscientious, industrious, and resourceful billing and collection personnel can be one of the most important factors in maintaining profitability. For a mature spine surgery practice, gross accounts receivable should be less than 30% of annual gross billings, and average days in accounts receivable should be kept between 30 and 45 days. Bad debts should average no more than 6% to 7%. Collection-to-charges ratios formerly ranged between 70% and 80%. However, with deep managed care discounting, the collection-to-charge ratio may be as low as 40%, reflecting the widening difference between former standard charge levels and more recent contractual fee levels. If the charges are reduced arbitrarily to conform to typical managed care fees, the charges may be lower than other commercial payers allow, leaving “money on the table.” Therefore, to capture less common—but available—higher fees, it is better to maintain charges at prior levels and accept the large gap between collections and charges and the higher accounts receivable.