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If you work in the healthcare space, you often hear the term “Total Cost of Care”.  The more you hear the term the more you may wonder what it means and why it is important.  To define the Total Cost of Care, you need to define the perspective you want to look at it from.  Total Cost of Care from a member perspective will differ from an insurer, while it also differs for a medical group in a capitated arrangement or an individual doctor delivering care.  There are many perspectives, but Total Cost of Care for the overall system is the most important.

To better understand the idea of differing costs I am going to use an example of building / buying a house.

  1. The total cost to a person who wants to build themselves a house using their own talents would be the total cost of goods purchased.
  2. The total cost to the same person who subcontracts out the work would be the cost of hiring the people to do the work. This price would include the cost of goods purchased from point 1, but would also include a margin the subcontractor may put on the goods, as well as a cost of using the subcontractor.
  3. The total cost of building this same house when using a general contractor would include both the costs in points 1 and 2 above. The same goods are needed, similar subcontractors would be needed, but now you are adding another cost to the equation.  You are adding the cost of having someone else manage the project.
  4. Finally, if the same person wanted to buy a house and went to a local neighborhood selling new houses they would incur yet another cost. This cost would now include all the three points above, but now you are also are paying the homebuilding company.  They want to make appropriate profit for selling the house, but they also have to pay all the people and material costs as before.

Healthcare is a lot like building houses, there are material costs, but they often get lost among all of the other costs in the system.  The cost at the lowest level is the material costs, but unlike building a house, I cannot just decide to go and give myself a knee replacement.  The Total Cost of Care is different for a knee replacement depending on the perspective you are looking at it from.  The following points will look at the cost of care from several different perspectives.

  1. The Total Cost of Care for the patient would be the cost sharing they would need to pay.This knee replacement has a cost to the patient, and it may be in the form of a copay, deductible or coinsurance. Depending on how you look at the Total Cost of Care for the member you could even include the premium you paid in order to have the opportunity to get care.
  2. Now the Total Cost of Care for this same knee surgery is different for the individual doctor.They have costs associated with this, and include the device, hospital time, nurses, pay for doctor’s time, insurance, etc.  These all add up into a Total Cost of Care from the doctor’s perspective.
  3. To go out another level this same doctor may be a part of a medical group. This medical group may be in a capitated arrangement for a group of members.  The Total Cost of Care would need to cover the costs in point 2 (doctor administering care) but there would also be the need to be a margin to cover the risk to the medical group for covering members under a capitated arrangement.  The doctors should be compensated fairly, and the medical group has costs above and beyond the doctor and risk cost.
  4. If we move to the insurance company, they are now many levels removed from the basic material costs of providing care. They sell insurance and collect premiums and need to be able to offer coverage to their members.  Most insurance companies do not employ all their own doctors and thus need to contract with medical groups and or individual doctors to make sure that they can adequately cover their members.  They now have costs in point 2 and 3 but also costs above that.  From an insurance company’s point of view the Total Cost of Care could be looked at as the total cost of the insurance being offered.

It would be inappropriate to say that Total Cost of Care from the different perspectives presented above is wrong, but at the same time we need to get to a working definition that most can agree on and what is generally accepted in the market.  When healthcare experts talk about the Total Cost of Care, they are most often referring to the total cost of a population and what it costs to care for them medically.  Total Cost of Care should be limited to the costs that are incurred to be able to provide care.  Yes, these will include additional margins doctors or medical groups add, but these are a cost of doing business for an insurance company.

When looking at Total Cost of Care it is often broken down into specific costs and utilization categories. For actuaries we call this an actuarial cost model and it takes detailed claims data and organizes it into categories and calculates how often things occur (utilization) and how much they cost (unit cost) and when multiplied together you are able to calculate the PMPM (Per Member Per Month) cost by detailed category.   An example from an actuarial cost model is included in the following table.

As you can see in the inpatient example above, there are utilization statistics as well as different types of unit costs.  On the far right it synthesizes them into a PMPM cost.  The total cost for this population on a PMPM basis is $614.65 and the portion associated with inpatient is $213.53.

The Total Cost of Care attempts to look at what it costs an entity to care for their members. It is the cost associated with a population and their specific conditions.  It does not include the explicit admin costs that are required at a health plan, but would include some of the other costs associated with contracting with providers.

One of the reasons Total Cost of Care can be confusing is it has the word “cost” in it.  Cost in medical terms can be very confusing.  At a hospital for instance they have an amount they “charge” for services often called a “billed charge”.  They also have what is often called amount “paid”, and they are much lower than what is billed.  These are the amounts paid by the insurance companies after adjusting the charges for the contract parameters.  The difference between the charge amount and paid amount is called the “discount”. All these values can be considered costs, but none of them get down to the actual hard costs it takes to do services. A hospital has what they call a “charge master” and this puts a charge on everything from a Band-Aid, meal, or pacemaker to surgery supplies, wheelchair or hand soap.  Finally, there is a term called a “cost to charge ratio”, these take the all the charges and translates them to approximate hard costs.

The term Total Cost of Care it is often used in the conversation about “Burden of Illness”.  The burden of illness is determined by comparing the total PMPM cost of a population to a different population.  If one population has a significantly higher PMPM then the other, they most often would be considered to have a higher burden of illness.  There are many things that need to be adjusted for to properly compare the burden of illness between populations, but if they are similar groups of people, in similar areas, under similar network pricing, a comparison of the PMPMs can tell you a lot about a groups burden of illness.

Below are some additional ways that Total Cost of Care is used in the healthcare:

  1. Cost of Care analysis is most often used to measure efficiency. By looking at utilization rates you can measure how good a care management department is doing or where they can improve. It can also be a proxy to how healthy or unhealthy a population is based on certain metrics (ER, Office visits, Prescriptions).

Care management can be done internally at a health plan or can be delegated to medical groups that are contracted with them.  An insurance company needs to understand how effective the medical groups are at managing care in order to confidently delegate those responsibilities.

  1. Looking at the average length of stay at a hospital can allow for comparisons to other hospitals to see how efficient they are in certain services. Actuarial cost models as talked about above, show not only utilization and cost, but for inpatient activities they also show days.   When insurance companies are negotiating with hospitals and creating networks, they need to understand how the costs and efficiencies of different hospitals affect the Total Cost of Care.

Medicare already looks at many Total Cost of Care metrics when it calculates payments to hospitals and if they see high efficiency they can often get paid more (Value Based Purchasing).

  1. If an ACO / Medical Group / Doctor wants to accept a bundled payment from an insurer they would want to fully understand the Total Cost of Care of the population and how it would affect them under certain procedures. A doctor could potentially afford to take less money if they think that they may be able to make it up with volume.  An ACO may believe that they can do things more cost effectively than what is expected by the Total Cost of Care analysis and that could benefit them.
  2. Value based reimbursement hinges on understanding the Total Cost of Care. In order to be able to take risk, the entities involved need to understand what the Total Cost of Care looks like and what portions of the Total Cost of Care they are at risk for.  The division of financial responsibility (DOFR) distributes the procedures into who is responsible for doing them.  For instance, a certain group may be at risk for all facility care while another would be responsible for all professional services.  There may be incentive payments to the different groups if they perform better than expected or may also have incentives for certain practitioners that are managing care well.  These incentives are often triggered from lower admits to the hospital, or higher percentage of people having wellness visits, or lower ER utilization.  As these items, and others are optimized, the Total Cost of Care often comes down.

In conclusion, the Total Cost of Care should be viewed in a macro level where you are analyzing groups of people to understand the cost that it takes to care for them.  Cost of delivering care at the perspectives discussed early in this article are important to understand for their own business reasons, but it is not the same Total Cost of Care that most are concerned with. Health care costs are rising and finding ways to lower the Total Cost of Care is important to figure out.  There are many components to building up costs, and the issue with the rising Total Cost of Care cannot be blamed on one thing individually.  It would be easy to blame many things for driving up the cost of healthcare, but in the end, it is the combination of them all that is really driving the costs. Total Cost of Care needs to be a focal point going forward and we as healthcare professionals need to continue to find ways to bend the trend and attempt to lower the Total Cost of Care.

In our work at Axene Health Partners we feel the best way to lower the Total Cost of Care is to increase focus on managed care operations and to remove as much potentially avoidable care as possible.  It is true some of the material costs are higher here in the USA than other parts of the word, but we also have created a system where people often feel more care is better and are not always concerned with getting the right care at the right time.

About the Author

Joshua W. Axene, FSA, FCA, MAAA, is a Partner and Consulting Actuary at Axene Health Partners, LLC and is based in AHP’s Temecula, CA office.