Bundled payments give surgeons a powerful new incentive to reduce costs

Companies that sell hip and knee implants to the Surgical Hospital of Phoenix now have one choice: they can accept the prices that the hospital has set or take their devices elsewhere.

The physician-owned hospital has adopted that approach in part because it and its surgeons share financial risk under bundled-payment arrangements with Bridgehealth Medical and EmployerDirect, which direct large, self-insured employers to higher-quality, lower-cost providers. With their profits dependent on getting costs down, both the hospital and surgeons are pressing hard for implant makers to give them the price they demand.

“We have to make ends meet,” said Karen Bonamase, chief nursing officer and chief operating officer of the 33-bed hospital in Phoenix. “You have an implant-intensive surgery and you're only going to get paid so much.”

Surgical Hospital of Phoenix is one of hundreds of hospitals participating in bundled-payment arrangements with public and private payers. These programs, established by Medicare and private payers such as Walmart and Lowe's, vary in design but generally pay a set price for an episode of care. The bundle often includes the costs and fees of the surgeon, the facility, and the anesthesiologist, as well as the cost of the implant or other device. Depending on the type of care covered by the bundled payment, some providers concentrate on reducing readmissions and average length of stay, while others focus on device costs.

The growth of such arrangements is one reason hospitals and physicians increasingly are working together to lower the costs of implants and other supplies. That represents a big change from the past, since many physicians and surgeons traditionally have insisted on their own preferences for devices and other supplies without regard to cost. Now they are being pulled into the value equation by their own financial interests.

Hip and knee replacement operations are the most common types of inpatient procedures involved in bundled payment programs, according to a 2012 report from the Health Care Incentives Improvement Institute. They also are two of the most common operations in the U.S., with more than 285,000 total hip replacements and 600,000 total knee replacements performed each year. These two joint replacement procedures are some of the “most tried-and-true areas for bundled payments,” said Rob Lazerow, practice manager for research and insights at the Advisory Board Co.

Medicare's diagnosis-related group method, a fixed payment for certain procedures, including hip and knee replacements, is often described as the first U.S. bundled payment method, although it does not take into account post-acute care or physician services. A year ago, the CMS announced the Bundled Payments for Care Improvement initiative, involving 450 providers and 48 DRGs, including total hip and knee replacements.

Under bundled payment, hospitals and physicians split any surplus, giving them a powerful joint incentive to not only coordinate care and improve quality, but also to manage supply costs to keep overall expenses low.

“If the surgeon and the hospital are using a very expensive device, or if they don't have a competitive cost for that device, they now have a common cause to work together to negotiate a better price,” said Tom Williams, president and CEO of the Integrated Healthcare Association, a not-for-profit that promotes quality improvement and affordability in California. “The only way you achieve that is if you have the willingness to switch devices. The incentive for the surgeons is to get on board with the hospital and do joint purchasing.”

Hip and knee implant devices constitute up to 40% of the total cost of these joint replacement procedures. So it's no surprise that hospitals are aggressively seeking to reduce the amount they pay for the devices.

Hospitals pay an average of $4,320 for a knee implant device, but the cost can vary from $2,100 to $6,600. The average price for a hip implant is about $4,820, though that cost can vary from $1,000 to $8,000, according to the ECRI Institute's PriceGuide advisory service.

“Why does Southwest Airlines focus on fuel costs? Because that's where the money is,” said Dr. Kevin Bozic, vice chair of the orthopedic surgery department at the University of California, San Francisco. “Sure, (hospitals) are looking at all aspects of care. But the single largest expense for the episode is the device, and that's one easy place to start.”

UCSF is participating in the Medicare bundling initiative for primary hip and knee replacements. Bozic said involving surgeons in bundled payment deals typically drives greater awareness of the costs of implants and gets them more involved in the contracting process.

Even though many experts say there is little clinical variation between types of hip or knee implants, the challenges for hospitals to reduce costs for these high-priced implants are well known. Physicians often develop preferences for certain devices or manufacturers during their medical residencies. And devicemakers and their representatives spend millions of dollars each year ensuring that those relationships are maintained through gifts, paid travel, consulting agreements and on-site technical assistance. Another barrier is that many manufacturers require hospitals to sign gag clauses preventing them from sharing information about pricing—sometimes even among hospitals in the same health system.

“When you don't have the ability to leverage one manufacturer against another, it's harder to negotiate the best price,” Williams said.

Making the challenge even greater for hospitals, most physicians have no idea of how much the devices they're using cost. A study published in January in Health Affairs found that only 21% of 217 attending physicians surveyed could estimate the ballpark price of 13 common orthopedic devices. One hospital supply-chain executive said that a surgeon recently asked him to label every supply's price in the operating room to help doctors better understand the costs associated with each procedure.

Bundled payments create a powerful new dynamic that has the potential to break the stranglehold that devicemakers have had, because it puts hospitals and physicians on the same financial page—achieving the best patient outcome for the lowest cost and making the biggest margin possible. Some experts say this approach has a greater chance of success than other supply-chain strategies, such as narrowing the number of vendors, setting price caps and establishing service line co-management agreements.

Gainsharing, or shared savings, is another incentive for physicians under bundling, because it allows hospitals to pay physicians a percentage of the savings if they keep costs below a certain level, such as agreeing to use an implant for which the hospital has negotiated a lower price. Medicare allows physicians to receive a shared-savings bonus that is up to 50% of the traditional fee rate.

“As organizations look at the range of bundling opportunities, one reason for hospitals to choose to engage in bundling with Medicare is to get protection for gainsharing,” Lazerow said.

Some hospitals have taken cost-cutting efforts further down the surgical supply chain from the implant. At the Cleveland Clinic, which participates in multiple bundled-payment programs for hip and knee replacements, the supply-chain team has also focused on reducing the cost of less-pricey medical supplies. That approach involves the medical operations and finance teams in efforts to change the way that physicians use certain technologies, both within bundled payments and other types of payment models.

The challenge, Cleveland Clinic executives said, is balancing the appropriate needs of surgeons for supplies that enable them to provide the best care with the health system's desire to reduce variation and overall costs. “Where we can standardize, we do so, but we want to make sure the physicians have all the necessary technology that they feel is appropriate to treat their patients and deliver the highest quality of care,” said Allen Passerallo, the clinic's senior director of strategic sourcing and supply-chain management.

Each procedure receives what the Cleveland Clinic calls a preference card that outlines every medical supply used during a particular procedure. The card also shows the cost per case, which includes almost every item used during the surgery.

The system, which spends about $170 million on implantables each year, estimates that the cost of the device accounts for up to 40% of an acute episode of care for a hip or knee replacement.

The Surgical Hospital of Phoenix estimates that hip and knee implants account for up to 34% of the total cost of a joint replacement operation there. But costs associated with labor and lower-cost medical supplies make up the next largest slices of an acute-care bundled payment, hospital officials said. As a result, bundled payment arrangements require a wide range of hospital officials and clinicians working together to identify other ways to lower costs, including reducing readmissions and eliminating unnecessary imaging and laboratory tests.

“All of those strategies have been employed to make the doctor more consciously aware and more directly involved in managing the service line and the cost and outcomes associated with it,” Bozic said. “Bundled payments are a very powerful economic incentive because there's a direct link. The doctor and hospital are joined at the hip in terms of their financial success.”

Follow Jaimy Lee on Twitter: @MHjlee