Should Episode-based Economic Profiles be Risk Adjusted to Account for Differences in Patients' Health Risks?

After the medicare prospective payment system was introduced in the early 1980s, some hospitals—especially teaching institutions—were concerned about inadequate reimbursement for the care they delivered. This concern was prompted by findings that: (a) severity-related cost differences existed among hospitalized patients, even after controlling for diagnosis-related group (DRG) (Horn et al. 1985; McMahon and Newbold 1986; Averill et al. 1992); and, (b) within individual DRG categories, teaching hospitals treated a more severe case mix than other hospitals (Berman et al. 1986; McNeil, Kominski, and Williams-Ashman 1988).1 A similar question, based on similar assumptions, has been raised about possible bias of patient health status differences on economic profiles of physicians (Yi et al. 2002). In economic profiling, health plans compare physicians' actual costs for services performed or ordered on behalf of patients to the expected costs of those services. Physicians whose actual costs are less than expected are considered cost efficient,2 while those whose actual costs exceed the expected values are viewed as cost inefficient. On the basis of measured cost efficiency, physicians may find their compensation rates increased or decreased (Strunk and Reschovsky 2002), their placement in provider network tiers determined (Fronstin 2003), or their continued membership in provider networks terminated. In recent years, it has become common for health plans to use episode of care as the unit of analysis for economic profiling. Thus, the first step in economic profiling is to process a claims database through software, such as Symmetry Health Data Systems' Episode-Treatment Group (ETG) system (Symmetry Health Data Systems 2005), that aggregates groups of claims into diagnostically and chronologically related episodes. The actual cost of each defined episode is calculated as the sum of costs associated with included claims, and episode expected costs are determined, typically as the mean cost of all episodes of the same type (e.g., ETG) in the database. Once episodes and their costs are defined, responsibility for each episode is assigned to a physician. Physicians' profiles are then constructed using average actual costs and average expected costs of attributed episodes. In economic profiling of physicians, a concern is that both (a) differences in health status among patients may influence treatment costs within defined episode types and (b) average health status of patients treated may differ significantly among physicians. As a consequence, average cost per episode may be higher for some physicians than for others, not because of poorer cost efficiency, but rather because of the poorer health status of their patients. If episode expected costs were adjusted to account for effects of differences in patient health status, the potential bias against such physicians might be removed. The purpose of the study described here is to answer the following questions: Are episode costs related to patient health status, and, if so, can episode expected costs be risk adjusted to account for relationships that exist? Do cost efficiency rankings that are adjusted for patient health status differ from rankings that are not adjusted? The first of these questions asks whether or not episode definitions themselves account adequately for relationships between patient health status and episode costs. If they do, then no additional risk adjustment is necessary. If they do not, then additional risk adjustment may be needed. Even if relationships between patient health status and episode costs exist, additional risk adjustment may not be needed if these relationships are too small and/or infrequent to influence profile rankings. This is the focus of the second question.