The Tariff – traps for the unwary


Until very recently, clinicians have spent little time considering the financial consequences of their clinical decisions or how their organisations can become more efficient or financially successful. Over the last 20 years, clinicians in a number of countries have paid much more attention to how their organisations actually function. The interest in the financial issues around the provision of medical care, that is evidenced in this [1] and recent [2–9] issues of Anaesthesia, reflects the impact of the growth of payment mechanisms linking activity directly to funding (e.g. ‘Payment by Results’; PbR) that are now common in Europe, North America and Australia. This parallels the development of internal management systems that attempt to provide measures of the economic success or otherwise of particular hospital services or departments. These changes are often driven by the realisation of many clinicians that they can improve patient care by ensuring that their services are well managed, and by many hospital managers appreciating that clinicians are most likely to have the insight, motivation and ability to make positive changes.

All this provides opportunities for data-literate clinicians with a systems perspective to improve how their services work, as well as ensure that resources are being used effectively and funded fairly. It must therefore be a concern to those managing the NHS that clinicians performing these analyses are concluding that the payment systems can create huge funding shortfalls [1] and/or offer little or no incentive for them to work efficiently [2, 3, 5].

Reasons for caution

An important reason for caution in interpreting this financial information is that the ‘tariff’– the fee received by a hospital for carrying out an operation or other treatment – reflects the average cost from two years ago, and in recent years the rate at which the tariff has been increased has reflected the need to increase ‘efficiency’ rather than the true costs of providing services. The data underpinning the tariffs are collected from all English hospitals and so encompass a variety of practices and a wide range of levels of performance, but also a number of factors that have relatively little to do with the actual costs of providing the service. One of these is whether the coding is accurate. The Audit Commission has found that while there has been significant improvement in the accuracy of the reference costs used to build the tariff, 12% of organisations submitted returns that were not materially correct and at the level of the individual code, there was a higher level of error [10]. Miscoding of complications and co-morbidities can affect the Healthcare Resource Group (HRG) to which a case is assigned, and may also be important for risk adjustment in the calculation of outcome measures.

A second issue is how the tariff deals with indirect costs. A significant proportion of the HRG tariff price represents payment for a variety of fixed or overhead costs; some are important for supporting the service while others are just part of running a hospital but may have little to do with the service on a day-to-day basis. These costs often do not change very much in response to changes in the volume of a particular service. So while anaesthetic time can be quantified fairly precisely and the costs of an operation built ‘bottom-up’ through recording the activities, consumables and time taken, there is no easy way of calculating the cost of providing services such as heating or maintenance and other shared resources. The usual approach is to apportion these across departments in some way, for example on head count for personnel and human resource management functions, square metres used for energy, etc. The Department of Health has issued a complex costing manual with a method for doing this [10, 11] but there will always be a number of cases where these ‘top-down’ rules of thumb for allocating costs produce inaccurate or perverse results. This means that the tariff for an individual procedure only reflects an approximation of the share of the overhead and other indirect costs of the average hospital.

The tariff only represents a proportion of the costs of the hospital. All hospitals in the NHS have an adjustment made to reflect ‘market forces’ issues. These include factors such as the costs of land and building, and pay rates in the local economy; these are added as a percentage uplift that ranges from 0 to 32% of the total tariff income. Training and education costs are excluded and paid to hospitals separately, through the training and education levies [12]. In general, 30-40% of hospital income remains outside the tariff [13] and over the last few years the proportion of non-tariff income (e.g. block contracts) has increased. This seems to reflect the fact that the increase in the tariff has been controlled very tightly, with effectively real-term reductions imposed on it. Hospitals have found it easier to grow their share of non-tariff income as they have proved to be better negotiators than the Primary Care Trusts. The consequence of this has been that more overhead and indirect costs have been loaded on to this non-tariff activity, which may further undermine the accuracy of the tariff for an individual procedure [14]. One crucial omission from the tariff is critical care during a spell, which is generally the subject of local agreement. Certain high-cost drugs are also outside the tariff [15].

A recent review of the tariff system for the regulator Monitor found high levels of variability: “30% of the unit costs reported by providers, by HRG, were at least 50% higher or lower than the national average unit cost for that HRG (weighted by activity)”. The authors conclude that it is not possible to tell how far this variation is the result of legitimate variations in costs [18].

Improvements to tariffs are coming

A number of significant developments have made tariffs more granular and up-to-date. However, although there is some capacity for innovations to be incorporated more quickly where the National Institute for Health and Clinical Excellence (NICE) has reviewed them, the tariff will lag behind current practice, and any innovation that increases cost will be a problem even if it demonstrably improves outcomes, since payers are sometimes reluctant to depart from the tariff. There has been some development of ‘best practice tariffs’ that reward evidence-based approaches, but these are expensive to develop and so far only cover a small number of procedures (see:

Over the last few years, the development of patient-level costing approaches that use a ‘bottom-up’ method, to try and construct much more accurate accounts of the resources used, have been developed. These seem to produce more clinically and managerially meaningful information, but these too take time and effort to develop [16]. However, these systems are potentially very useful tools for clinical managers to understand the opportunities for improvement and to ensure that the costing information that goes to make the tariff is more accurate.

There has been some discussion about whether the tariff should only be constructed based on cost data from hospitals that have an accredited patient-level costing system, that allows costs to be accurately allocated to procedures through ‘bottom-up’ methods. Germany, France and Finland all use sampled data [3] and so avoid the inclusion of hospitals with poor quality data in their calculations of the tariff.

Caution in making comparisons between departments or services using tariffs

The direct costs of care, that vary according to whether the care is provided, are generally a relatively small proportion of the tariff price. This means that caution is needed in interpreting the tariffs as a performance benchmark, and a proper understanding of what is happening inside the organisation (and in those being compared) is required before strong conclusions can be drawn. It is important to disentangle the reasons for cost disparities that are driven by real differences in practice, as opposed to artefacts of cost allocation or other local factors. It is of no help to be told that a service is more expensive if the reasons for this are outside the control of the clinical department. Abbott et al. attempted to disentangle these factors by modelling operating lists that are ‘perfectly efficient’ (in the clinical management sense of being fully utilised but suffering no cancellations or overruns) [2]. However, the comparison of costs using the tariff should be regarded as a diagnostic test with relatively weak sensitivity and specificity – possibly useful if combined with other data, a good history and some understanding of the underlying processes. This is also illustrated by the analysis by Shapfer et al. [1] in this issue of the Journal, who find that the HRG tariff poorly reflects the actual cost of laparotomy. It is also worth bearing in mind that the designers of payment systems may be more interested in the performance of the classification system in explaining cost variance between providers, rather than the absolute accuracy of individual procedures (Prof. R. Busse, personal communication).

Caution in making decisions based on tariffs

The changes and improvements to the tariff bring their own hazards. Because of the need to improve the costing of work, continuing improvements in coding accuracy and depth, development of a refined version of the casemix system with more categories, and continual updating of costing information, the tariff has been relatively unstable (i.e. variable over time). This has made attempts to identify profitable and loss-making activities rather difficult, and there is a danger that apparently profitable lines of business could become unattractive, simply due to a recalculation of the tariff. Finding significant funding gaps for certain procedures (as some clinicians have found [1–3, 5] should not necessarily mean that the service in question is inherently unprofitable and therefore should be closed.

Perhaps most caution in using the HRG tariff is required when calculating savings from changes in the casemix purchased by commissioners (e.g. how much can be saved by commissioning X rather than Y). Costs in hospitals are much less variable than many economists and payers assume. In a recent paper, Rauh et al. argue that a much more sophisticated approach to thinking about the costs of hospitals is required [17]. Some costs do not vary significantly with activity at all and others only vary when there are relatively large changes in activity. One example is emergency surgery and anaesthesia. Adding or subtracting cases only makes a significant impact on this cost when there are no patients or where there are so many that an additional team of staff is needed. Facilities such as emergency magnetic resonance imaging or spare capacity in a critical care unit need to be paid for whether or not they are used, and so the cost of such stand-by capacity does not vary greatly with activity.

This means that from the hospital’s perspective, the savings made by a payer’s discontinuing an activity, or moving it to another setting, tend to be significantly over-estimated. When a service is discontinued in Hospital A to be provided in Hospital B, the costs of overhead activities and the other semi-variable costs at Hospital A remain, and need to be reallocated to the work remaining in the hospital. Only the most direct costs – consumables and some staffing – can be saved. Thus while relocating care from one setting to another may look cheaper, this may not lead to reductions in overall spending, especially if there are start-up costs to relocating the service. Hospitals need to cover their overheads; either they find more work to do or the prices they charge must rise to cover the costs left uncovered by the change, an issue in the NHS where prices are fixed. Rauh et al. show that this is also a significant problem for making the economic case for quality improvement [17]. Many improvements allow hospitals to treat additional patients at a lower average cost. Unfortunately, the cost structure is asymmetrical – it may not be possible to treat fewer patients for less, at least not without a major redesign of the entire hospital. In a pure market, where the payer has no interest in the survival or viability of the provider (hospital), this inconvenient piece of practical economics can be ignored and the problem left with the providers. However, where it is politically and/or socially impossible for hospitals simply to close, this results in volumes of activity increasing and often proves self-defeating. In the economic environment of Europe and North America, this volume growth is now financially unsustainable.


The PbR tariff is a useful starting point for investigation of local costs, and forms one of a number of tools that clinicians need to understand to be able improve their services. Its use on its own, without an understanding of how it is constructed or its inevitable shortcomings, may lead to misleading conclusions. Unpicking the data and understanding the hospital processes that should be used for comparisons, and combining this with a more sophisticated approach to designing systems of care, is valuable – and can only be done if clinicians are closely involved. Local costing systems that use patient-level data are likely to produce more useful information for anaesthetic departments, and over time it is likely that the data from these will be used in setting prices. Perhaps the overall lesson from this is that the tariff is only an approximation, it will never be exactly right, and there will need to be an amount of local cross-subsidy to deal with the fact it is just an average. Understanding what is really going on locally is the priority.

Competing interests

No external funding and no competing interests declared.