Know the differences between APCs and current system

By Mason Smith, MD, FACEP

President and CEO

Lynx Medical Systems

Bellevue, WA

What is the Medicare ambulatory payment classification (APC) system? Simply stated, APC is the name that the Health Care Financing Administration (HCFA) has given to its solution for prospectively paying hospitals for outpatient services provided to Medicare beneficiaries.

Please note that APCs have no relationship to ambulatory patient groups (APGs). HCFA considered, and then rejected, using the APG system of prospective payment. Similarity in the names of the two approaches has left many administrators assuming the two methods were simply slightly different forms of the same method. They are not. APGs are a derivative of the diagnosis-related groups (DRGs). APCs are a clone of the Medicare physician payment system.

APCs will replace the present cost-based method by which Medicare reimburses hospitals for outpatient services. The present method has been in use since the Medicare program began in the 1960s. Rapid and continued growth in Medicare outpatient expenditures caused major political concern throughout the last decade. Congress finally mandated a change from cost to prospective reimbursement in the Balanced Budget Act of 1997.

To grasp the magnitude of the change in the payment mechanism, you must appreciate the differences in the incentives between cost reimbursement and prospective payment. Let’s start with an example.

There is a college student, and his parents agree to pay his school costs. In this analogy, the student is a hospital outpatient department, and the parents are the Medicare program.

Medicare cost reimbursement is the equivalent of having the student turn in a report (cost report) to the parents so the parents can reimburse the student for his expenditures. The parents have established certain rules with the student as to what costs they will reimburse and what personal expenses they will not.

But the only limits on reimbursement relate to the fact that the cost was incurred. It does not matter if the student selects an expensive private school or a low-cost public university. In either case, the parents reimburse whatever the tuition expense turns out to be. This is exactly how the Medicare program reimburses hospitals for their expenses related to emergency department care.

The student also incurs ancillary expenses, such as living costs and books, and turns in an expense report to the parents that lists them all. To cover expenses, the parents provide a monthly stipend based on expected costs.

This stipend is similar to the payment Medicare makes for outpatient services when the hospital bills for the service. Medicare’s payment is only an advance payment — not the final amount that the hospital will receive. Later, after reviewing the expense report, excluding any inappropriate costs, the parents write a check or reduce future payments to the student for the allowed (approved) expenses.

Medicare follows the same procedure. Only Medicare is normally two or three years behind in completing the hospital’s cost report.

Prospective payment will work differently. The parents agree to reimburse the student for each college course completed. The student will get a specific payment for each course based on a value the parents have placed on each course.

Like a fee schedule, different courses have different values. The value assigned to each course might depend on the typical number of hours of course work, its difficulty, and its importance for graduation.

An efficient student can keep any money left over after the expenses associated with the course are paid. The parent does not base reimbursement on the cost of the course but instead on the fact the course was completed.

Because full-time student tuition covers an unlimited number of courses, productive students can increase their average net reimbursement per course by taking more courses.

In addition to paying a fixed amount for the course tuition, the parents also agree to pay a fixed price for books, supplies, lab fees, transportation, tutoring, computer fees, and other related expenses — ancillary expenses in the Medicare APC payment system.

The student reports to the parents that he purchased a particular textbook. To reimburse the student, the parent looks up the retail price of the book in the reference list and writes a check for the amount shown in the reference list (Medicare Fee Schedule). The student’s actual cost has no effect on the amount of the reimbursement the parents are willing to pay. In fact, the student can be paid substantially more or less than the cost of the book.

A frugal student can spend less money buying used books, and the parents will not care. This type of student will have extra money to spend on other "uncovered" expenses. If the student buys a full-price version of the same book, he actually may be reimbursed less than the actual cost of the book.

This analogy can help increase understanding to the very significant differences in incentives that are associated with reimbursement based on cost vs. fee schedule. APCs represent the transition from a cost-based reimbursement to a fee schedule method of reimbursement. Prospective reimbursement will reward efficient low-cost providers and punish high-cost providers.

[Lynx Medical Systems is a consulting firm specializing in coding and reimbursement. Smith may be contacted at Lynx Medical Systems, 15325 S.E. 30th Place, Suite 200, Bellevue, WA 98007. Telephone: (425) 641-4451. Fax: (425) 562-4860.]