Tenet Shifting Its Formula for Reimbursement

Tenet Healthcare Corp., trying to clean up its image after admitting that it aggressively raised hospital charges that inflated Medicare payments, is overhauling the way it is reimbursed for hospital services from managed-care companies.

After weeks of negotiations, Tenet is close to signing a two-year contract with Health Net Inc. that sharply reduces Tenet’s reliance on payments based on a hospital’s retail charges.

The shift signals that Santa Barbara-based Tenet, the nation’s second-biggest hospital chain, is backing away from its much-criticized policy of ramping up hospital prices.

The agreement, expected to be announced early next week, may be a harbinger of broader changes and more turmoil in the health-care industry as insurers and providers battle for an advantage amid soaring medical-care and drug costs, experts say.

In the last month, Blue Cross of California said, Tenet has asked it to reopen contracts covering dozens of Tenet hospitals, and some health insurance companies have given notice to other hospitals that they may want to restructure reimbursement methods in the wake of what has happened at Tenet.

Two managed-care firms “say they are auditing Tenet and will come back and renegotiate with us,” said Ann Pumpian, chief financial officer at Sharp Healthcare, a nonprofit operator of seven hospitals in the San Diego area.

Sharp is not in a position to accept lower reimbursements, Pumpian said. But if Tenet, the state’s biggest hospital chain, retreats from rapidly raising its retail or list prices, “my expectation is that other hospitals will be keeping hospital charges lower than they have,” she said.

Few patients ever pay full retail charges, and Medicare and insurance companies generally pay hospitals fixed rates for certain procedures and services. But Tenet came under fire in the last month for sharply raising its retail prices because that enabled the company to collect a large share of Medicare reimbursements for expensive procedures.

Tenet has said that it did not break any Medicare rules. But the administrator of the Medicare program has accused Tenet of inappropriately gaming the system, and federal regulators are auditing the company’s Medicare reimbursements known as “outlier” payments.

Outlier fees are paid to hospitals for unusually costly cases and are based on a hospital’s costs and retail charges. So the more a hospital raises its list prices -- from X-ray charges to patient room rates -- the more it gets in outlier payments.

Tenet revealed this month that outlier payments were the source of about half of its stellar earnings growth in the last two years.

Similarly, rapid increases in retail prices have allowed Tenet and some other hospital companies to collect more reimbursements from managed-care firms.

Most health insurers pay hospitals a flat, negotiated daily rate for patient care -- usually a fraction of the retail charges. But as with the Medicare system, hospitals also receive “stop-loss” payments from insurers for special cases that can be very expensive. And like outliers, these stop-loss payments are calculated as a percentage of retail charges.

Tenet declined to say how much revenue the company collected from stop-loss payments. But Adam Feinstein, a hospital analyst at Lehman Bros. in New York, estimates that stop-loss fees generally account for 10% of a hospital’s commercial reimbursements. In Tenet’s case, that would translate into about $800 million of its $13.9 billion in revenue in its last fiscal year.

Tenet’s chief executive, Jeffrey C. Barbakow, has initiated a review of the company’s pricing practices at its 113 hospitals nationwide. This month he pushed out his top two managers, and he has all but said that Tenet will back away from its aggressive pricing strategy. But that shift has raised concerns among analysts about Tenet’s future earnings growth.

In an interview this week, Barbakow brushed aside those concerns. He and other Tenet officials declined to elaborate, saying they expect to comment on managed-care contracts as well as the company’s new pricing strategy at a conference in New York on Tuesday.

With 40 hospitals in the state, mostly in Southern California, Tenet still has considerable clout when negotiating rates with health insurers. Tenet is bargaining with PacifiCare Health Systems and will be starting talks with Blue Shield of California soon. If Tenet can negotiate much higher fixed daily rates from insurers -- enough to offset diminished stop-loss payments -- the hospital company could sustain the strong growth in reimbursements from managed-care firms.

But some analysts are skeptical. “It’s going to be tough for the company to exert the kind of leverage they’ve had,” said Sheryl Skolnick, a managing director at Fulcrum Global Partners, which provides investor research.

In the wake of Tenet’s problems, Skolnick cut in half her forecast for the company’s earnings for its next fiscal year. Tenet will lose about $750 million in Medicare outlier payments and face a lower rate of growth in reimbursements from health insurers, she estimates.

Skolnick’s revised forecast also includes legal fees and expenses for Tenet’s other troubles, including a medical fraud investigation at a Tenet hospital in Redding involving two doctors who allegedly performed unnecessary heart operations.

Tenet’s turmoil in the last month has erased about 70% of the value of the company’s stock. Its shares have nudged higher in recent days -- they rose 65 cents Wednesday to $18.15 on the New York Stock Exchange -- but remain well below the 52-week high of $52.50 in early October.

Other stocks in the sector have slid as well, in part because investors are worried that hospitals will be reluctant to boost retail charges in light of the scrutiny that Tenet has drawn.

“That has a certain chilling effect,” said Noah Rosenberg, a Beverly Hills attorney who represents many hospitals and medical groups in negotiations with managed-care companies.

What’s more, health insurers in California -- which have been aligning with employer groups to pressure hospitals to lower their charges -- are likely to use the opportunity to try to extract concessions from hospitals.

Max Brown, a senior vice president at Blue Cross of California, would not comment about the upcoming contract talks with Tenet. He said, however, that Blue Cross has been concerned that hospitals have been raising retail charges sharply to maximize their stop-loss payments from insurers.

Some hospital operators deny that this is the case, saying their charges reflect the rising costs of hiring nurses, adding new technologies and reinvesting in hospitals. Moreover, said Rosenberg, “the kinds of increases hospitals get pale in comparison to what insurers are getting from employers in premiums.”