|By Young, David W|
Hospitals should develop strategies around four forces that will affect their financial performance in the next five to 10 years.
Hospitals and health systems will face a variety of financial challenges over the next decade, including pressures related to the economy, healthcare reform, and increased demand for care. Addressing these challenges will require, at a minimum, an understanding of the costs associated with care delivery. It also will require that healthcare organizations develop an ability to controlrather than simply understand- their costs.
Combined with pressures related to healthcare reform, the financial challenges facing hospitals and health systems present a "call to action." These organizations will need to conduct more in-depth analyses of the cost implications of care processes and delivery than most have done to date. In particular, they will need to concentrate on four forces that will affect their future costs:
* The impact of demographic changes on the
* Morbidity in the non-
* The complex nature of the healthcare market
The Four Forces at Work
Collectively, the first three forces will create intense pressures on healthcare costs; the fourth- the complex nature of the healthcare market- limits the ability of market mechanisms to control cost increases.
Demographic changes. The exhibit on page 58 shows how annual inpatient days per person change as people age. This is not surprising: As people grow older, they tend to use more inpatient care. The problem is that members of the "baby boom" generation- those born between 1945 and 1955- are now in their late 50s to mid 60s. If the historical pattern of healthcare use continues, the demand for inpatient care for baby boomers will increase geometrically. This idea is supported by an analysis from the
Morbidity in the non-
The complex nature of the healthcare market. The healthcare market is unlike any market described in an economics textbook. In no other market that we know of does Person A (a patient) receive services ordered by Person B (a physician) that are delivered by Person C (a hospital) and paid for by Person D (an insurer), whose revenue comes from Person E (the insured). The result is five separate markets:
* A premium- sharing market (between an employer and its employees)
* A per-member-per-month market (between an employer and a managed care plan)
* A deductible market (between a patient and a managed care plan)
* A copayment market (between a patient and a provider, usually either a physician or a hospital)
* A fee market (between a provider and an insurer)
This last market can be quite complex, involving payment approaches such as fee-for-service (discounted or otherwise), DRGs, bundled prices, and subcapitation.
Responding to the Four Forces
Conceptually, it is relatively easy to describe how these four forces can be addressed. There are only five drivers of healthcare costs:
* Case mix
* Resources used per case
* Cost of a resource unit
* Fixed costs
Each of these cost drivers relates to one or more of the forces creating pressure on healthcare costs.
Case mix and volume. These two drivers are related to morbidity patterns in the population that result mainly from the environment, genetics, and health habits. Although some improvements in the environment (such as cleaner air and water) may have an impact, nothing can be done to alter genetics. Therefore, to address case mix and volume, society should focus primarily on changing health habits, particularly given that nearly 35 percent of all deaths in
Computing the benefits of a prevention or wellness program is by no means easy, in part because not all people want to improve their health. For example, in a 2007 study, the
In addition to computing the benefits of each new programmatic endeavor (in terms of a reduction in morbidity), health policy analysts also should undertake an analysis of the relevant program costs; otherwise, a benefit-cost analysis will not be possible. But determining the "relevant" costs can be difficult. In part, this is because some of the "benefits" will come in the form of cost reductions in the delivery system, such as a decline in hospitalizations for conditions caused by obesity or smoking. To assemble all the disparate pieces into one programmatic package is a daunting challenge, to say the least.
Resources per case. Addressing this cost driver means, in effect, lowering the bars in the exhibit on page 58, in addition to reducing the other resources used to treat a case, such as tests and procedures. The exhibit on page 59 demonstrates this idea conceptually. Because the horizontal axis represents number of cases, and the vertical axis represents cost per case, the area under the curve represents total costs. The obvious goal is to shift the average cost per case to the left, which can be done by, say, using outpatient instead of inpatient care, engaging in preadmission activities or in-home care to shorten a patient's length of stay, or undertaking any of a variety of similar resource - reducing meas - ures. (Note that a focus on outliers has very little cost- saving potential in most hospitals.)
The Dartmouth Atlas working group has studied how resources per case can be reduced without affecting the quality of care (Tracking the Care of Patients with Severe Chronic Illness: The Dartmouth Atlas of Health Care 9008, www.dartmouthatlas.org/ downloads/atlases/30o8_Chronic_Gare_Atlas.pdf). The researchers examined the treatment for chronic conditions in the last two years of life in several organizations where the
Similarly, the exhibit on page 61 shows an alternative (physician- designed) pattern for treating a patient with a certain presenting condition in a hospital emergency department. As this exhibit and the
One of the most dramatic efforts to address resources per case was made in
To better control resources per case, the
The results were impressive:
To assess the options and make the needed tradeoffs to achieve these types of results requires an understanding of the relevant costs under alternative scenarios. Changing the way resources are used to treat a case without understanding the relevant cost implications of doing so is the clinical equivalent of flying blind.b
Cost per resource unit The distinction between resources per case and the cost of a resource unit is important. For example, the number of complete blood counts (CBCs) ordered for a patient during an inpatient stay is a measure of the resources used to treat a case. However, the cost of performing a blood analysis is a separate matter. Few hospitals have engaged in the activities needed to understand the cost of providing such physician- ordered resources as laboratory tests, radiology procedures, and other "intermediate products."
Even without having good cost information, any hospital manager knows that cost reductions can take place with an increase in efficiency, or with a decrease in hourly wage rates or unit supply costs (such as a shift from name -brand to generic drugs). However, computing the cost implications of these decisions can be tricky.
To make accurate unit cost computations, hospitals need to adopt the technique of activity-based costing (ABC). The use of
Nonetheless, to make informed decisions regarding ways to reduce the cost per resource unit, a hospital's financial managers must implement
Fixed costs. Most healthcare organizations incur significant fixed costs. For example, depreciation of physical plants and equipment can represent a large percentage of a hospital's annual operating budget. Indeed, because the healthcare sector is characterized by a high rate of technological change, many hospitals (as well as other provider organizations) are likely to experience continuous growth in their annual depreciation expense. To avoid the resulting fiscal difficulties, senior managers and physician leaders need to make judicious choices regarding the acquisition of new technology. In
Full-time employees whose daily activities are largely unrelated to the volume of care provided also constitute fixed costs. Unless there is a significant change in a hospital's average occupancy, the salaries of people such as admitting clerks, schedulers, housekeepers, dieticians, laundry staff, and department administrators will remain largely unchanged over the course of a year. By the same token, if a hospital's average occupancy declines, the hospital will need to make some difficult choices regarding staffing patterns.
The Healthcare Food Chain
These difficult choices emerge, in part, because a reduction in one entity's costs in a healthcare system is accompanied by an equivalent reduction in another entity's revenue. As a result, implementing cost reduction efforts can become complicated.
For example, consider the scenario shown in the exhibit on page 61. The cost reductions shown in this exhibit are for the payer, not the hospital. That is, the payer (be it
The nature of this healthcare "food chain" is shown in the exhibit on page 6?. As it indicates, at each step along the way, the expense for one entity represents revenue for another. Unless physicians and hospital managers have a good understanding of their costs- and unless they design good systems to control their costs- they will be at the mercy of entities higher up in the food chain. And of course, the same principle applies to those entities (such as pharmaceutical firms) to which hospitals or physician group practices make payments.
In this respect, it is important to note that many of the "entities" to which hospitals make payments are employees. It should be noted that in a hospital or physician-hospital organizationwhere many costs are in the form of salaries and wages- cost reductions will inevitably require a "resizing" of the work force.
There are some early indications of the ways that costs will be affected under the ACA. The following efforts are expected to emerge over the next few years, most of which will attempt to reduce resources per case:d
* A focus on providing more coordinated care for patients with chronic conditions
* An increase in the use of electronic medical records to help physicians choose the right tests and treatments
* A reform of the healthcare system's infrastructure that will "enhance horizontal coordination among providers and provide more constant monitoring of patients"
* An imposition of penalties for hospitals with high risk-adjusted readmission rates, to address the fact that 20 percent of
* A provision of incentives for hospitals to adopt practices that reduce rates of hospital-acquired conditions, via penalties for hospitals with high rates
* Use of "bundled" payments to provide physicians and hospitals with incentives to coordinate care for patients with chronic illnesses
* Evaluation and testing of new programs that enhance quality and reduce cost
All of the above measures- but especially the last two- will require an understanding of a hospital's costs and an ability to address the cost implications of alternative approaches to care delivery. These measures also will require an understanding of when to use full cost accounting and when to use differential cost accounting. And they will require hospitals and other provider entities to have much more sophisticated cost control systems than many now have.
Moreover, if the decline in Part A (hospital payments) of the
The "handwriting on the wall" was revealed in a recent study of variations in 3009
Cost Control Is Everyone's Business
Controlling costs in hospitals and health systems requires the involvement of managers at all levels in the organization. Healthcare accounting professionals can be helpful in establishing transfer prices, designing a budget formulation process that relies on the five cost drivers discussed here, and preparing analyses of variances from the budget using these same cost drivers. However, both senior managers and line managers throughout the organization need to be solidly behind- and deeply involved in- the organization's cost-control efforts.
Perhaps less obviously, physician leaders also must be heavily engaged in cost control, as they are the only ones who can both establish clinical pathways (resources per case) and monitor their colleagues' use of them. Indeed, without a collaborative effort among physician leaders, senior and middle managers, and the accounting staff, a provider entity may find itself being mercilessly devoured by those entities higher up in its food chain.
* In a reform environment, hospitals and health systems should be able to controlrather than simply understand- their costs.
* Senior managers and line managers throughout a healthcare organization should be solidly behind- and deeply involved in- the organization's cost -control efforts.
* Physicians also should be heavily engaged in cost control, as they are the only ones who can both establish clinical pathways and monitor their colleagues' use of them.
Go to hfma.org/hfm to view estimates of the
a. Mokdad, A.H., Marks, J.S., Stroup, D.F., and Gerberding, J.L, "Actual Causes of Death in
b. Knowing the relevant cost implications does not mean reducing resources per case without a consideration of the clinical consequences. For a discussion of some of the related issues, see Neumann, P.J., and Chambers, J.D., "
c. For a discussion of how
d. Orszag, P.R., and Emanuel, EJ., "Health Reform and Cost Control,"
e. For details on how the cost curve will "bend," see
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