Hospital leaders need to be more proactive about maintaining margins in a post-reform environment. How ready is your organization to measure-let alone manage-its margins?

As 2011 dawns, many finance leaders have run preliminary "impact assessments" on what healthcare reform might mean to them. Hospitals, in particular, are facing deep reimbursement cuts, including $148.7 billion in Medicare and disproportionate share hospital payments over the next 10 years.

"Tight margins promise only to get tighter-or enter negative ranges-unless hospital leaders work together to determine how to absorb anticipated revenue declines," says Michael E. Nugent, CHFP, managing director, Navigant Consulting Inc., Chicago.

Eventually, margin management will require hands-on, roll-up-your-sleeves work aimed at cutting costs, selectively growing programs, and negotiating unit reimbursement increases. To get the ball rolling, Nugent urges leaders to develop what he terms a "strategic margin transition plan" that projects revenue shortfalls, identifies tactical strategies, and ensures patients are not marginalized for sake of the margin.

"The purpose of a strategic margin transition plan is to help providers manage how their margins will transition in a softer unit reimbursement and volume environment," says Nugent.
"The providers that successfully plan and execute their strategic margin plans-in coordination with physicians and payers on behalf of patients-will attain a competitive advantage over those that don't."

A Four-Step Process

Nugent outlines the following steps for strategic margin planning.

Project revenue gap in light of likely reform and market scenarios. Healthcare organizations will experience different financial and operational pressures in coming years, depending on the type of facility, patient population, and other factors. That's why it is vital for finance, operational, and clinical leaders to work together to plot out organization-specific margin projections, says Nugent. He recommends the following steps:

  • Acquire your current operating, cash, and capital budgets to better understand where your organization assumes volume, payer mix, unit reimbursement, and cost will drive margins
  • Project bad debt, charity care, volumes, and write offs based on projected payer mix, insurance, and demographic changes
  • Project anticipated Medicare cuts associated with payment reductions outlined in the Affordable Care Act, including:
    • Disproportionate share reimbursement reductions
    • Financial penalties from avoidable readmissions and hospital-acquired conditions
    • Wage and index reclassifications

Benchmark unit costs and utilization savings opportunities. The next step is to identify the organization-specific potential for reducing costs. "We anticipate that providers are going to have to be much more aggressive in managing their margins as purchasers and payers continue to cut back," says Nugent. For every 1 percent reduction in net revenue, hospitals, on average, need to reduce variable costs by 5 percent to maintain their historical 4 to 6 percent margins, he says.

Yet a February 2010 HFMA Pulse survey found that only 21 percent of hospitals surveyed had reduced costs by 5 percent or more over the last fiscal year. And 24 percent of hospitals had not reduced costs at all (HFMA, Cost Management: Trends, Outlook, and Keys to Success).

Clearly, more hospitals need to identify cost reduction opportunities to make up for anticipated revenue declines, says Nugent. To do this, he recommends categorizing avoidable costs into three buckets-and benchmarking hospital performance on these costs against peers and top performers.

  • Traditional variable unit cost and utilization savings (for example, supplies, pharmaceuticals)
  • Next-level variable and semi-fixed costs and utilization savings (for example, partnering with a lab vendor to deliver services at a lower cost and divesting an underperforming lab business in the process, or substituting lower cost resources for higher cost labor)
  • Reductions in preventable readmissions, hospital-acquired conditions, and admissions for patients with chronic conditions, such as diabetes (for example, through the creation of case management positions)

Array or itemize short- and long-term care delivery and financial management tactics to close the margin gap over time. A leadership team, which includes finance, clinical, and operational representatives, should lay out specific cost reduction strategies under each of the following categories, says Nugent:

  • Traditional and variable utilization savings: supplies and pharmacy over time, agency staffing, and length of stay reductions
    • Opportunity: 5 percent of total savings
     
  • Salary benefits and staffing levels/mix: This typically requires some process reengineering and space reconfiguration, as well as the divestment of underperforming service lines or businesses.
    • Opportunity: 5 percent of total savings
     
  • Eliminating avoidable readmissions, medical errors, and hospital-acquired conditions-and associated utilization costs: This typically requires significant process reengineering, space reconfiguration, and aligned incentives with physicians.
    • Opportunity: Greater than 5 percent of total savings

"Providers that can eliminate avoidable readmissions or hospital-acquired conditions will have an opportunity to backfill freed up capacity with profitable patients," says Nugent. "If those providers can partner with insurers to share these savings and steer patients to this freed up capacity at a unit reimbursement that covers costs, then payers, patients, and providers all stand to gain."

But to get there, providers will need to be much more intentional about how they'll maintain margin through volume growth versus payer mix versus cost reduction versus unit reimbursement increases, he says. This requires finance leaders to partner closely with physicians and operations to quantify avoidable costs and complications, and then manage those in tandem with the medical staff and payers.

Integrate margin gap tactics with your care improvement plans to ensure both patients and margins benefit. The final step is to integrate the strategic margin plan with the organization's care transformation plan-or vision/framework for improving the quality, safety, and efficiency of care across the care continuum.

Finance leadership needs to work with clinical counterparts to identify overuse, mis-use, underuse, and excessive input costs across the care continuum-and hold clinical leaders accountable to measure, and ultimately, manage quality as well as resource utilization. For example, preoperatively, which patients require what procedures versus which don't? In the operating room, what technology, staffing model and scheduling changes would help improve both quality and cost, simultaneously? Postoperatively, what processes and procedures must be instituted to get patients safely discharged to the most appropriate site of care?

"Ultimately, this is about the patient-not about the margin," says Nugent.

Achieving this integration requires translating organizationwide cost-saving tactics and goals, which are identified in the strategic margin plan, into specific department/service line tactics and goals-and, in some cases, DRG/diagnosis-specific tactics, he says. It requires clinical and financial leaders to work together and hold each other accountable to new patient service, quality, and affordability standards that have not existed pre-reform.

A Case Example

Nugent points to an integrated health system that is taking a collaborative and thoughtful approach to reducing expenses. The CFO worked with CNO and CMO leadership to quantify avoidable costs and complications. Clinicians then mapped out the clinical pathways necessary to improve quality and efficiency.

The health system focused first on improving diabetes care across the continuum. Using claims data and medical records data, the finance/clinical team quantified the following avoidable costs in diabetes care:

  • Avoidable intensive care unit utilization
  • Excessive readmissions
  • Use of brand name drugs when generics existed
  • Unnecessary ED visits
  • Multiple physician touch points-or patients seeing an unnecessarily large number of physicians
  • Other instances of overuse, misuse, and underuse of key resources across the care continuum

To help inform their work, the team developed case studies of various types of patients with diabetes (for example, a 30 year old and an 80 year old). The case studies outlined the care these patients received-for example, treatments, tests, hospital admissions, physician visits, ED visits-over a specified time range, along with associated costs.

The detailed analysis and research helped the team determine strategic cost-saving opportunities to implement.

  • From an expense management perspective, the health system standardized the drug formulary, ensuring that all patients with diabetes use generic options.
  • From a capital investment perspective, the health system invested in a patient educator who helps the sickest and most complex patients manage their diabetes.
  • From a managed care perspective, the health system invested in telemedicine in the outpatient arena, ensuring that all patients who are discharged to home can visit with their physicians-either remotely or in person.

The health system's program has been up and running for about two to three years, and the results to date are positive. These results include a 20 percent reduction in inpatient days, an 80 percent improvement in in-hospital mortality, and 20 percent reduction in readmissions.

Key to the health system's success is the collaborative approach to planning-not just on clinical quality improvements, but on margin, says Nugent. From day one, finance staff were at the table with clinical and operational leaders plotting out revenue gaps and quantifying avoidable complications.

"Now that the health system has nailed it on diabetes, they can move on to implementing similar cost-saving opportunities for other clinical cohorts, such as knee surgery," says Nugent.

A Mindset Shift

"Providers must figure out how their organizations can do more with less," says Nugent. "The initial reaction is often, 'This is impossible.'" But Nugent believes in the power of planning and analysis.

"After denial recedes, organizations need to rally their internal leaders around managing margins and clinical changes in a unified manner, over a three- to five-year time horizon," he says. "Some leaders are tempted to immediately rush out and talk to payers, patients, or other outsiders. But first, you need to analyze the situation internally and develop a strategic margin transition plan."


Michael E. Nugent, CHFP, is a Managing Director, Navigant Consulting, Inc., Chicago, and a member of HFMA's First Illinois chapter (mnugent@navigantconsulting.com).
 

Publication Date: Monday, December 13, 2010