How Do Health Insurance Companies Set Costs for Procedures?

With health care costs rising faster than the rate of inflation, you might wonder how health insurance companies and their reimbursements figure into the problem. Insurance companies reserve the right to set the amount they'll pay for any procedure covered by their policies; physicians either accept that reimbursement or step out of their contracts with the carriers. The actual number depends on several variables, including location, demand, and competition in the marketplace.

As anyone who has examined a medical billing statement will soon realize, the charge for the service and the amount actually paid by the insurance company are two different numbers. A doctor may set a fee of $100 for an office visit, while the insurance company may only pay $80. By the contract he signs with the carrier, the doctor is obligated to accept that reimbursement, if the patient is covered by the insurance. The balance is either collected from the patient (as a required "co-pay") or written off.

Several different methods are used to set reimbursement rates. Many insurance carriers negotiate contracts with providers based on a fee schedule of flat rates for each procedure, test or operation. They also may set rates according to a schedule of nearly 8,000 procedures that conform to Current Procedural Terminology or CPT codes. The carriers base their reimbursement rates as a multiple of those set by Medicare, a health insurance program for the elderly that is administered by the federal government. This is the largest single insurance carrier, and one that the majority of doctors must deal with. In a health maintenance organization, the carrier may simply pay a flat monthly rate for each patient that has selected a doctor as his primary care physician.

Doctors and hospitals have costs, and as those costs rise they must charge more for their services. It's a basic truth for anyone in a private-sector service business: as costs rise, so must revenues. When an insurance company pays for the service, however, conflicts easily arise. The insurance company wants to keep its costs steady, and hold on to customers by minimizing premium hikes. The carrier may not accept the suggested rate rise by the physician, as it contributes to higher premium charges. If the two parties can't come to an agreement, the contract expires and the doctor no longer "accepts" the insurance. Patients must pay on their own (at the doctor's full rate) or find another doctor.

In a never-ending quest to get their costs under control, insurance companies review medical research and make their decisions on new procedures, tests and medications. If a procedure promises to save money and costs (and incidentally improve the outcome for the patient), the insurance company has an incentive to cover it. If the medical jury is still out on the procedure, the insurance company will call it "experimental" and refuse to cover it. This decisionmaking has a direct effect on the demand for the procedure among patients, and the general availability of that procedure among doctors.