What Is The Relationship Between Payment and Profitability?

July 2, 2008

Payer mix — the relative proportions of Medicare, Medicaid, commercial, and uninsured patients — is often used to assess hospital financial performance. However, the relationship between payer mix and margin can run counter to expectation.

To determine the effects of payer mix on hospital financial performance, researchers at Thomson Reuters examined inpatient discharges, lengths of stay (LOS), gross and net charges, and operating expenses separately by payer at 307 general, acute care community hospitals. The findings are reported in HFMA's new publication Healthcare Cost Containment.

Research disclosed that higher-profit hospitals:

• Generally produce better inpatient operating margins overall and for most payers
• Enjoy a payer mix that favors managed care and indemnity payers
• Have a lower-than-average length of stay (LOS) for all payers, suggesting greater efficiency
• Have a lower operating expense for all payers except for Medicare, also suggesting greater efficiency
• Have a higher case mix index (i.e., higher-profit hospitals do not achieve lower average LOS and operating expense through fewer acute patients)

Payer mix differs between higher- and lower-profit hospitals. Lower-profit hospitals have larger proportions of Medicaid and self-pay patients. Higher-profit hospitals have a larger proportion of Medicare patients, as well as more managed care or commercially insured patients. However, these differences in payer mix fail to explain the observed magnitude of the discrepancy in operating margin between higher- and lower-profit hospitals. Researchers estimated a separate operating margin for each payer in each hospital and allocated hospital operating costs to each payer proportional to each payer's gross patient revenue. The difference between payer net revenue and payer operating expense relative to payer gross revenues yields a payer-specific operating margin. Higher-profit hospitals enjoyed better median operating margins for all but self-pay patients. Both higher- and lower-profit hospitals operated at a loss for Medicare and Medicaid patient care.

Higher-profit hospitals appear to obtain this advantage through greater operating efficiencies. Higher-profit hospitals had a shorter median average LOS for every payer despite having a greater average case mix index. Higher-profit hospitals had a median all-payer case-mix index of 139.11, compared with a median case-mix index of 132.27 for lower-profit hospitals. Higher-profit hospitals also had a lower median operating expense per adjusted discharge (at $9,771) than did lower-profit hospitals (at $12,236), despite a higher average case mix index.

If anything, more-profitable hospitals have a disadvantage: a higher case mix index. This suggests higher, not lower, patient acuity. Case mix indexes for the less-profitable hospitals are similar. Higher case mix indexes combined with lower average LOS suggest that the most-profitable hospitals are more efficient. The most-profitable hospitals do not achieve lower average LOS and operating expense through lower-acuity patients.

These efficiencies did not come at the expense of clinical performance. Clinical performance was measured as an equally weighted composite of risk-adjusted mortality, risk-adjusted complications, patient safety indicators, and core measures converted to a percentile rank within each hospital class. There were no significant differences in clinical performance between higher- and lower-profit hospitals overall or for any class of hospital. Instead, there was considerable variation in clinical performance across both higher- and lower-profit hospitals in each class.

More strategies for high financial performance can be found in each issue of HFMA's Healthcare Cost Containment.

Achieving needed margins requires hospitals to capture all the payment they are due. One way that is accomplished for Medicare is through appeal to the Provider Reimbursement Review Board (PRRB). The most significant changes to the PRRB rules in decades will become effective August 21, 2008. These rules affect not just the technical aspects of how to pursue an appeal, but will result in the forfeiture of appeal rights for those who do not pay close attention to these changes, beginning with the initial cost report submission. The changes affect how self-disallowed items must be protested on the cost report to protect appeal rights, limit the ability to add issues to appeals, require greater specificity in the initial request for hearing, and alter rules on discovery of evidence from CMS. You can get more details from the HFMA July 24 audio webcast "CMS's Provider Reimbursement Review Board (PRRB): Grasping the Recent Changes to the Appeal Process.

Of course, cost is a huge factor in margin both for providers and for the health system as a whole. For the past six years, the growth rate of medical costs has been dropping, which in turn has helped to hold down increases in health insurance premiums. However, this downward trend will level off in the coming year, according to a new PricewaterhouseCoopers report. Get more information from the the HFMA July 21 audio webcast "HFMA's Forums and attend this webcast at no charge.

Visit HFMA's web site for more answers to pressing healthcare business questions.