In preparation for an upcoming article, we’re returning to the Safety Net Series to discuss the incredibly odd world of medical billing. This article will take a quick look at how prices are set, along with how the users of medical care interact with this system.

The most important thing to understand how medical billing works is to examine how we got to this third-party payer system. There is a previous North Star article that details this history, but here are the vastly abbreviated notes. Back in the early 20th century, pretty much everybody paid for doctor or hospital care out of their own pocket, otherwise known as fee-for-service (FFS). This system worked like any other service: the doctor renders a service, they give the patient a bill, and they pay it. This system worked well enough for people that could afford it, but for the majority of people  the standard cost of care was far too high. An Employer-based insurance model developed at Baylor University in the 1930s, grew to be the major model for health care coverage in the US by the 1950s. This system introduced more safety and reliability into the system by utilizing third parties that could take on the risk that individuals couldn’t.

The major components of this employer-based system were:

• Insured employees paid monthly premiums and deductibles for coverage to the insurance company which are used to reimburse doctors for services.
• Insurance companies accumulated premiums to cover the costs of the people who buy the insurance, with the hope that some of their members will not use as much health care that they pay for in each year.
• Finally, individuals could also be charged copayments or coinsurance for each physician and hospital visit to ensure care fits medical needs of patients.

Employer based coverage has a variety of benefits over FFS. First, it guarantees that people receiving covered services won’t go bankrupt if they fall on hard times and encourages regular preventive-based care.  It also guarantees that providers are reimbursed for the care they provide, which was hardly a given before. Lastly, it enables insurance companies to negotiate reimbursements with providers to lower costs given the volume of members and prospective patients and could theoretically make up any lost income through volume of patients.

To better explain this dynamic of negotiated reimbursements, an example is useful to visualize how this works in the real world.

Here is a real summary of care from an insurance company. All identifiable information, including the physician’s name, insurance claim number, and dates of services have been redacted. This bill was for a Medicare-aged man (65 years or older) who received a flu and pneumococcal shot, as well as several other preventative services.

Going over the layout of the summary of care, there are six columns: Service, Date of Service, Amount the Provider Billed, Total Cost Approved (this is the negotiated price), Plan’s Share of Costs, and the Individual’s Share of Costs. The first two columns are self-explanatory, so we’ll focus on the last four.

• Amount the Provider Billed is what the provider charges everybody. This number is usually listed in the provider’s charge master, which is essentially a big book of charges for every single procedure. They bill this number for every person who receives this service, regardless of the kind of insurance they have (or don’t have). In the example above, this number totals $534.
• Total Cost Approved is the negotiated cost between the insurance company, which can be the private insurance company or public insurance like Medicare, Medical Assistance, or MinnesotaCare. As a rule, public reimbursement rates are significantly cheaper than commercial rates, because the government has significantly more negotiating power than the private insurance companies. (Quick fact: approximately 38% of Minnesotans are on public insurance.) In the example above, this number totals $294.68, with some services reimbursed fully while others are reimbursed at a fraction of the cost. There is greater consistency with public insurance, not so much with private insurance.
• The Plan’s Share and Your Share columns detail how much each party is responsible for paying to the health care provider. For preventative services like in the example, the patient’s share is almost always $0 (as is the case here), since the Affordable Care Act mandates that any preventative services are free in-network. Had the services been non-preventative (say they included stitches for a cut, or an MRI on a sore knee), the plan’s share might be $0 if the insured patient had not yet reached their annual deductible, or it could be a more even split given the details of a given health insurance plan.

This example was a simple (if mundane) look into how medical billing actually works on the patient’s end of the deal. For those who have comprehensive and affordable health insurance plans, this system works well enough. However, please note that many bills are significantly more expensive for the patient than this one, particularly when they include visits to the emergency department or complex surgeries. They also are alarmingly expensive for people who receive services outside of their provider network, or are uninsured. If there wasn’t a third party (be it the insurance company or the government) to negotiate the bill down, this person would have paid every dollar of the original amount the provider billed, in this example, over $500 for standard preventative care.  As we’ll see in a future article, the amounts providers bill are significantly more expensive than the negotiated rates.