Understanding Unit Costs & Why They Matter So Much In Value-Based Reimbursement

By Ken Carr

Many health and human service executives are under the impression that value-based reimbursement (VBR) models alleviate the need for organizations to worry about unit costs and productivity anymore. This is definitely not the case. In fact, managing unit cost is just as critical, if not more, in a value-based payment environment (see Value-Based Reimbursement: The Three Strategy Questions).

VBR models are focused on realigning incentives to provide high quality service while keeping the cost of services down. And now, more than 93% of health plans — including commercial plans, Medicaid, and Medicare — have implemented some type of pay-for-performance reimbursement models (see Trends In Behavioral Health: A Reference Guide On The U.S. Behavioral Health Financing & Delivery System). In addition, the use of episodic or bundled payments for specific acute care episodes is gaining traction, with 59% of plans using this model. While only 40% of commercial health plans use episodic payments, 71% of Medicare and 88% of Medicaid health plans use these payment arrangements for behavioral health. And, the Health Care Payment Learning & Action Network (LAN), a coalition of public and private health care provider organizations and health plans—working to accelerate the adoption of two-sided risk and alternative payment models—estimates that by 2025, 100% of Medicare and 50% of Medicaid and commercial payments will be value-based (see LAN Goal Statement FAQs). But even with all these shifts in payment models, unit costs still are a critical element in the evolving value equation – and controlling unit costs will remain an important strategic issue.

And for those organizations still working with legacy fee-for-service (FFS) reimbursements, our current market is making managing unit costs more vital than ever. A review of Medicare and Medicaid fee-for-service (FFS) payment rates show minor increases in FFS rates – certainly not enough to keep up with operating costs; especially with rising per-consumer costs due to the increase in volume of services, new technology, and the increasing number of consumers with multiple chronic conditions. Plus, many of these additional costs are passed on to consumers as out-of-pocket expenses to individuals are seeing their monthly incomes shrink under the weight of such pressures (see Medicare Raising Consumer Out-of-Pocket Costs for 2022).

The question for most executive teams is how to improve their unit cost management. The key is to “think about manufacturing around a particular price. It’s not just math – a lot of what we’re talking about is understanding the operations and the workflow, because you can’t do all of that without the pieces. There are four keys to best practice management of unit costs:

Service line-specific cost accounting The first component in the process is the ability to understand and measure costs in general (and unit costs in particular) by service line. More “global” measurement and management of costs is not useful as executive teams think more about the financial sustainability of specific services (see VBR & I/DD–The Wave Begins).

Target costing This is a pricing method to reengineer the cost of a service to hit a specific target market rate, or the maximum amount of cost for a service that can be incurred to earn the required profit margin. The key element is the ability to reengineer your costs so your price to the payer or consumer is within their “acceptable” range. After you determine the acceptable rate for the service, you determine what it costs your organization to deliver that unit of services — and if your costs exceed the rate, its time for “backwards engineering” to bring your costs in line. The reality is, there are only so many cost variables that you alter – including wages and benefits of direct care staff, staff productivity, volume of consumers served, administration/overhead, etc. (see How To Develop Your Next Big Thing: The OPEN MINDS Framework For New Service Line Design & Development). But this is a necessary step to be competitive in our value-driven market.

Automated process measurement (and management) systems Performance measurement needs to be automated with multiple systems connected to monitor unit costs in the real time. Electronic health record systems, financial management systems, human resource management systems, and customer relationship management systems all must be integrated and aligned to provide the real-time monitoring and reporting data you need to manage on a daily basis. Automated, up-to-date process measurement will allow you to make data-driven management decisions and take action quickly to address problems (see If You Can’t Keep Score, You Can’t Be In The Game).

Metrics-based business process management Metrics-based management is a model of managing processes, outcomes, and performance that relies on qualitative and quantitative measurement of the current performance, the desired performance, and the objectives and action plans to improve performance. Metrics-based management requires both strategic management to identify your performance goals, and business process management to optimize day-to-day organizational processes (see If You Don’t Measure It, You Won’t Implement It: Setting Strategic Plan Metrics). Metrics-based measures are also increasingly being used by payors as a way to measure the quality of care as much of the information already collected by providers through their electronic health records can be used to improve outcomes (see Using the Data You Already Collect to Measurably Improve Clinical Outcomes).

A big piece of the metrics-based management process is operational reengineering – driving operational change for the organization’s structure, staff/jobs, and technology. And in those areas, your goal is to “track the people and what they do” (including consumers, staff, and administration), and “track the paper and where it goes” (including consumer medical records, service delivery and billing, and routine financial workflows).