Charles Kim
Daniel Majka
Jason H. Sussman

Is your financial planning sufficient to assess the effect of payment and care delivery changes during the next 10 years? You need to understand clearly your organization's current position, where you need to go, and whether you have the resources to get there.


At a Glance  

  • To succeed in today's changing environment, hospitals and health systems must gain new competencies in the areas of physician integration, care management, information systems, service distribution, payer relationships, and scale/market essentiality.
  • Organizations should model the potential impacts of healthcare reform and market forces on volume, capacity, payment, and other variables likely to change.  
  • They also should thoroughly examine the cumulative projected impact of strategic initiatives and reform-related changes.  

The economics of health care are changing as a new value-based business model, accelerated by healthcare reform, is emerging to replace the volume-based model that has been in place for many decades. Although many of the mandates included in reform legislation have not yet been crafted into regulations and the timing and breadth of implementation could be affected by the recent change in the composition of the House and Senate, their basic principles-bending the cost curve while ensuring more effective care with better outcomes and improved access-are widely known.

Moreover, regardless of the ultimate status of the legislation, the healthcare industry, in general, has embraced the legislation's basic principles and has already begun to instill those principles in care provider relationships and contract structures. Hospitals and health systems are responding rapidly to gain the new competencies required for success in a changing environment. Hospital-physician integration, care management, information systems, service distribution, payer relationships, and scale/market essentiality are key focus areas.

To develop, enhance, and finance these competencies, hospitals and health systems must engage in the highest possible level of planning and analysis. As Moody's Investors Service notes in a Special Comment, "The passage of healthcare reform ... will require healthcare leaders to focus even more on multi-year strategies to assure long-term financial sustainability in an era of reform and newly constrained economic reality" ("Transforming Not-for-Profit Healthcare in the Reform Era," May 2010). Notwithstanding continuing legislative initiatives, the movement of the industry as a whole makes this focus an absolute requirement for long-term success.

Impact Evaluation Builds from a Solid Plan

Development of such multiyear strategies and related decision making should be guided by robust planning, modeling, budgeting, and reporting. Such an effort ensures the alignment of strategic initiatives with the new-era requirements and an organizationwide understanding of the financial and capital capacity implications.

As a first step, organizations should revisit their financial plans. Even plans developed within the past year require close review to ensure a comprehensive consideration of new needs, challenges, and risks. The sidebar below outlines the critical components of a high-quality plan.

Plans should be structured and populated with enough data to make it possible to model "moving parts" in different ways. For example, payer mix information should be rich enough and structured to support analysis of the mix shifts that are likely as the newly insured move into government and private programs, and of the impact of such changes on specific service lines. Detailed net revenue calculations, which include supplemental revenue, such as disproportionate share hospital (DSH) payments, will be particularly important. High-quality planning tools are definitely required.

This approach is not new. It is a corporate finance-based planning process that has been used widely for more than two decades. Thousands of hospitals and health systems are applying this approach and the tools required to support it, to good effect; many of these organizations have maintained the analytic rigor required at each step. Yet with the recent years of stable healthcare operations and relatively easy access to capital, many other organizations may have taken shortcuts. Now, it is incumbent on all provider organizations to reevaluate their financial-analysis structure and reinforce their planning process.

Modeling of Currently Identified Impacts

All hospitals and health systems should model the potential impacts of healthcare reform and market forces. Modeling will help to identify:

  • Projected volume of business, including volume created through the expansion of Medicaid and the new state insurance exchanges
  • Capacity needed to accommodate this volume, along with potential shifts in care sites and inpatient and outpatient locations/services
  • The financial implications of payment rates and payer mix resulting from the newly insured and overall payment pressure from both government and commercial payers
  • The operating impacts, capital requirements, and capital access implications of expanded hospital-physician organizations and relationships
  • The capital and operating costs of IT
  • The capital needs for other strategic initiatives and routine operating requirements

These impacts raise numerous issues that organizations need to consider.

Volume

Utilization trends into the future are uncertain, with conflicting forces indicating the potential for both growth and declines in utilization. Although current legislation and the assumption of adequate state funding for Medicaid may drive some of these changes, organizations should understand and assess the various impacts.

Changes contributing to utilization growth. Increases in the insured population, with 16 million residents to become Medicaid eligible by 2014 and an equal number to be covered through commercial insurance programs by 2019, will likely increase utilization, particularly in outpatient services.

Changes constraining utilization growth. At the same time, insufficient capacity for primary care services and physicians' reluctance to expand their Medicaid patient base may constrain utilization growth or potentially drive the volume to higher-cost settings, such as hospital emergency departments (EDs) and walk-in clinics. Utilization growth also is likely to be restricted by new payment models from government and commercial payers, aimed at cost control.

Changes promoting reduced utilization. Higher deductibles and copayments in the commercial market will likely contribute to reduced utilization, particularly in elective outpatient care. Provider initiatives aimed at reducing preventable admissions, "excess" readmissions, and hospital-acquired infections can also be expected to decrease utilization.

Information is limited and markets may evolve differently, so precise quantification of reform's impact on provider volumes is not possible at this time. However, it is possible to leverage analysis and publicly available data to assess a portion of the impact on a specific hospital or health system's volume as related to:

  • Reduced average length of stay (ALOS)
  • Reduced preventable admissions
  • Reduced end-of-life care

ALOS. This measure continues to be highly variable by hospital and region. Hospitals can benchmark their performance against Medicare data by diagnosis-related group (DRG) and calculate the "overage" or "underage" in days. Using the geometric mean, which eliminates high averages caused by mathematical "outliers," is recommended. To assess the possible full impact of ALOS reductions, organizations can apply the average percentage rates evident with their Medicare patients to patients with commercial and other types of insurance. This extrapolation to a broader patient population can provide helpful, but rough, approximations. Organizations with materially high lengths of stay should expect a reduction, over time, to national levels.

The exhibit below illustrates one health system's modeling of the impact of reduced ALOS on bed needs and bed supply, having previously factored in the disproportionate costs associated with the early days of acute care stays. The estimated operating savings for this organization was nearly $20 million, based on 117 fewer beds and a per-bed cost avoidance of $1.5 million. The health system also modeled the revenue implications of ALOS reductions, which showed lower per diem and charge-based payments.

Exhibit 1

cf_kim_exh1

Preventable admissions. Data from the Agency for Healthcare Research and Quality's Healthcare Cost and Utilization Project can be used to model the impact of reduced utilization due to a reduction of preventable admissions (www.qualityindicators.ahrq.gov/technicalspecs41.htm#PQI41). This source provides national use rates for potentially preventable conditions, including diabetes, chronic cardiac, chronic respiratory, and numerous acute conditions. An organization can compare its use-rate data with the national averages.

End-of-life care. To model the impact of reduced utilization of end-of-life care, benchmark data are available through the Dartmouth Atlas project (www.cecsweb.darthmount.edu/atlas08/datatools/bench_s1.php )The data reflect the treatment of Medicare patients with serious chronic illnesses who were in their last two years of life. Organizations can calculate the surplus or deficit in every area of utilization (e.g., total hospital days, total physician visits, skilled nursing facility days) and compare their own data with state averages or with data for specific organizations. The exhibit below illustrates the impact of end-of-life care-related utilization changes for an organization that compared its performance with that of a leading clinic.

Exhibit 2

cf_kim_exh2

Overall impact on utilization. The utilization impact of covering the uninsured population is difficult to generalize and should be analyzed market by market. However, at this point, the following trends are likely:

  • Demand for physician office services will increase.
  • A shortage of private primary care sources to meet this demand will result in increased visits to hospital EDs, walk-in clinics, and urgent care centers.
  • Use of inpatient elective procedures by the newly insured may increase somewhat.
  • Use of outpatient diagnostic and treatment services (imaging and surgery) by the newly insured will increase moderately.
  • Organizations operating in markets with a disproportionately large percentage of uninsured residents may experience significant shifts in overall market share.

To meet the government's long-term goal of bending the cost curve, price (payment) decreases clearly will not be enough; the rate of increase in use of services on a relative basis will need to decline as well. Organizations should be tracking possible effects closely and identifying whether and how to revise their utilization projections.

Capacity

As utilization changes (assuming it does change), organizations need to ensure viable strategies to increase or decrease capacity, as appropriate to higher or lower volumes and financial resources.

At this point, organizations can assume that additional capacity for physician office services, outpatient diagnostic and treatment services (particularly ED and urgent care services), and post-acute services, such as home care and hospice, will probably be needed nationwide. The emphasis on providing the right treatment in the right setting is likely to increase care delivery in nonacute settings.

Payment

Most organizations have started to assess the financial implications of changes to Medicare and Medicaid payment rates and their payer mix as affected by the newly insured. Payer mix will change as the uninsured move to Medicaid coverage or to commercial insurance exchanges.

Medicaid coverage will be expanded in 2014 to individuals with incomes at 133 percent of the federal poverty level. Nationally, about 47 percent of uninsured adults have incomes below this level and, hence, will qualify. Organizations can expect a three-year ramp up beginning in 2014, as forecasted by the Congressional Budget Office (CBO). To estimate their share of the newly insured Medicaid population, hospitals can obtain and use income profiles of the service area or a representative service area.

When projecting the likely number of uninsured covered via insurance exchanges, one approach for a hospital could be to assume that roughly 3 to 6 percent of the population will likely remain uninsured, approximating Massachusetts' actual experience and CBO projections. The estimate of the hospital's number of newly insured would be the remainder of the current total uninsured population, less the new Medicaid-eligible individuals, less the newly remaining uninsured individuals.

Medicare payment rates during the next 10 years will be affected by market basket update changes, adjustments to DSH payments, and adjustments to neutralize the impact of coding "inflation." The effects of these changes could significantly damage the financial base of many hospitals, so organizations will need to develop new projections that account for each one. The effects could be particularly damaging if all Medicare basket cuts and coding and other adjustments are experienced simultaneously, as projected in the exhibit on page 56, and within programs core to a hospital's revenue base. Lowering Medicare payments is a key strategy to meet overall U.S. economic targets.

Adjustments to DSH payment rates could increase the severity of impact for academic medical centers, safety net providers, and other organizations that received DSH funds. According to CBO estimates, Medicare DSH payments are scheduled to be cut 27.9 percent by 2019; Medicaid DSH payments will be reduced 50.9 percent by 2019.

Exhibit 3

cf_kim_exh3

Medicare pay-for-performance and pay-for-reporting programs are expected to be expanded beyond current demonstration projects, which would affect payments received by all providers.

Organizations that participate in these Medicare programs should now assess the possible impact of financial penalties beginning in 2013 for "excess" readmissions above the national target for heart attack, heart failure, and pneumonia. The national target will likely be an improvement over the current national average. The penalty is to be capped at 3 percent of payments, but a sizeable proportion of readmission revenue could be vulnerable to penalties. Moreover, beginning in 2015, hospitals in the top quartile of rates of hospital-acquired conditions will incur a 1 percent payment penalty.

Exhibit 4

cf_kim_exh4

Modeling the Financial Impact of New Strategic Initiatives and Reform Adjustments

In revisiting long-term plans, organizations should thoroughly examine the cumulative projected impact of strategic initiatives and reform-related changes.

For example, one community health system revisited its strategic financial plan and identified four focus areas for strategic growth during the next decade:

  • Positioning to capture organic market area growth through development and implementation of a primary care/long-term physician strategy, a master facility plan, and a major physician-hospital organization
  • Program development focused on interventional and vascular services and bariatric surgery
  • An oncology partnership
  • A managed services agreement

The exhibit below illustrates the organization's projections related to inpatient volume and market share in the first five years of the plan. These projections took into account both volume growth associated with newly insured patients and economic development in the region. The exhibit below shows how the organization validated the adequacy of inpatient capacity to meet strategic growth demand projections.

Exhibit 5

cf_kim_exh5

The community health system also projected operating costs associated with physician group development, including the employment of existing primary care physicians and the employment of specialists for targeted programs, and layered all costs onto the baseline financial projections.

To assess organizational risk, the health system's leadership then rigorously tested the plan for market and healthcare reform-related sensitivities, identifying and answering questions such as the following:

  • What would be the effect if all payers adopted Medicare rates?
  • If our volume grew at only 50 percent of our baseline assumption, what effect might this have on our financial performance?
  • How much of an operating loss can the physician practices incur?
  • What might be the net effect of lower bad debt related to the uninsured?
  • If we incur $50 million more debt in 2011 to support our targeted strategies, what impact will this have on our operating margin and days cash on hand?
  • What effect will lower investment income have on our days cash on hand and other financial indicators?

An analysis prompted by the first question, for example, indicated that if all payers adopted Medicare rates, the health system's operating earnings before interest, depreciation, and amortization would decline to approximately -5 percent in 2014 from approximately +9 percent in 2010. Strategies to address this decline would need to be developed in the near term.

Exhibit 6

cf_kim_exh6

An Imperative for Integrated Planning

Over the next several years, as market changes occur and regulations emerge, with or without impetus from reform legislation enacted prior to the November 2010 elections, quantifying impacts and risks will become increasingly critical for healthcare providers. Access to the external capital required to fund strategic plans is contingent on an organization's financial performance. Risk and sensitivity analyses can help to validate the affordability of plans and indicate their effect on financial performance. An organization's leadership can then implement specific responses to industry and market changes as a means to improve financial performance, thereby defending the organization's credit position and capital access.

In short, market and capital strategies, day-to-day operational planning, and financial planning need to be integrated organizationwide. It is no longer possible to address one issue at a time, incrementally. All parameters and forecasts related to payment, volume, capital costs, and other variables will likely change, so their simultaneous modeling will be critical to leaders' understanding of the organization's current position, where it needs to go, and whether it has the resources to get there.


Charles Kim is a vice president Kaufman, Hall & Associates, Inc., and a member of HFMA's First Illinois Chapter (ckim@kaufmanhall.com).

Daniel Majka is a senior vice president, Kaufman, Hall & Associates, Inc., and a member of HFMA's First Illinois Chapter (dmajka@kaufmanhall.com).

Jason H. Sussman is a managing director, Kaufman, Hall & Associates, Inc., and a member of HFMA's First Illinois Chapter (jsussman@kaufmanhall.com).


Sidebar

Essential Components of a High-Quality Plan  

A solid plan accurately assesses the hospital or health system's current financial position, capital capacity available to fund strategic initiatives, and the level of financial performance required for
success going forward, given marketplace changes and new strategic requirements. It includes:

  • Financial projections based on accurate sources and designed to support "real-time" analyses
  • Financial goals
  • Capital expenditure requirements over at least a five-year period (and preferably a 10-year period)
  • Debt capacity and cash requirements
  • A capital position analysis, which compares uses and sources of funds to quantify any capital shortfall
  • The level of profitability required to close the capital shortfall
  • Sensitivity and risk analyses of key assumptions and variables

Source: Kaufman, Hall & Associates, Inc. 

Publication Date: Monday, January 03, 2011

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