Welcome to the 2018 Iowa Small Hospital Improvement Program (SHIP) - - PDF document

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Welcome to the 2018 Iowa Small Hospital Improvement Program (SHIP) Workshop

September 19, 2018

Service Line Profitability (SLP)

About Draffin & Tucker

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Founded in 1948, Draffin & Tucker is a privately held, limited liability partnership headquartered in Albany, Georgia with a second office in Atlanta primarily serving clients throughout the

• Southeast. It is ranked among the top 250 largest CPA firms in

the country (out of over 40,000 CPA firms across the nation). With approximately 80 professionals, of which 40 are CPAs, our firm is comprised of 14 partners, one principal, 15 managers and the remaining supporting staff.

Quick Facts

• Firm Size: Approximately 80 Professionals
• Firm Office Locations: Albany, Georgia and Atlanta, Georgia
• Firm Service Area: Predominantly Southeastern United States
• Audit Clients: Approximately 160 Organizations
• Firm Longevity: Since 1948 (70 years)
• International Professional Association: Leading Edge Alliance
• Draffin & Tucker has a strong specialization in the healthcare

industry, particularly in the not-for-profit and government sectors of the industry.

• Since 1965, our healthcare practice has grown from

approximately four (4) hospitals in the southwest Georgia area to over one hundred and fifty (150) healthcare providers throughout the southeastern states.

• We specialize in providing a full range of services to hospitals

and hospital systems, hospices, nursing homes, home health agencies, rural health clinics, community health centers, physician practices, and other healthcare related entities.

Healthcare Focus

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• 11 partners dedicated to the healthcare industry
• 260 combined years of healthcare experience
• 150+ current healthcare clients
• 65 healthcare audits in 2017
• 40+ service offerings for healthcare
• 80 firm members supporting our healthcare clients on a daily

basis

• 93% of our clients would recommend us (based on an independent survey)

Healthcare by the Numbers

Learning Objectives

• Why understand the cost of specific services
• Use of Medicare Cost Report
• Service line costing methodologies
• Opportunities to use Service Line Profitability

for tactical purposes

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What is this? What is this?

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Why is an Understanding of Service Line Profitability Important?

Begin with the End in Mind to Avoid the End!

Current Environment

• Uncertainty surrounding health care reform

– Health Insurance Exchanges – ACOs – Population Health Management

• Declining volumes
• Declining reimbursement
• Increasing pressure to reduce costs
• Increasing pressure to streamline processes

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Helps Answer the Following Questions

• What drives institutional profitability?
• What is the physician-specific profitability?
• Which services produce value?
• How do service costs compare to negotiated and

fixed reimbursement arrangements?

• Are services being provided in an efficient

manner?

• At what level of operating capacity are services

being provided?

• Do feasible growth opportunities exist?

Presents a Fantastic Opportunity to Direct the Hospital’s…

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Poll Question

Does your hospital use a cost accounting system?

Poll Question

Does your hospital operate a Business Intelligence or Decision Support department?

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Significant Considerations

Information Overload!

What You Need to Know

• Market awareness
• Definition of “service lines”
• Costing methodologies
• How the hospital is paid for services
• Level of contribution to the hospital’s mission

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Market Awareness

• Service area

– What population are you serving? – Who are your customers? – Ability to analyze current and recent historical patient service data to determine primary and secondary service areas

• Government data sources are typically dated

Market Awareness

• Community Health Needs

– Identify service opportunities – Identify educational opportunities – Identify wellness opportunities – Enhance image

• Are county officials receptive to providing

financial support?

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Market Awareness

• Major Employers in the Service Area

– Insurance status

• Who are they purchasing coverage from?

– Build relationships – Business development – Direct contracting opportunity? – Are there opportunities to help them control their costs without adversely affecting the hospital’s bottom line?

Market Awareness

• Competition

– Institutional

• Neighboring hospitals

– Freestanding Diagnostic and Specialty

• Lab, Imaging, Surgical, Orthopedic
• Physician owned and operated entities

– Outmigration

• Services provided to primary market by competitors

– Differentiation opportunities

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Poll Question

When was the last time the hospital performed an in-depth market analysis?

Defining “Service Lines”

• Foundation should be based on patient

encounter attributes

• Source of patient visit:

– Emergency Room – Observation – Inpatient Admission – Diagnostic Test

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Defining “Service Lines”

• Payer

– Medicare, Medicaid, Commercial, Uninsured

• Physician

– A, B, C

• Service Area

– Zip Code – County

Defining “Service Lines”

• Any combination of all of the preceding

– Inpatient by service by payer by physician – Outpatient by service by payer by physician – Inpatient by service by physician by zip code – Outpatient by service by physician by zip code – Inpatient by MDC by physician – Inpatient by DRG by physician – I think you get the point.

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Poll Question

Does defining service lines at this level of detail appear feasible for your hospital?

Mechanics

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Mechanics

Net Revenue – Cost = Profit

What’s the Goal?

• To match up and allocate costs to the service

being provided at the lowest service transaction level possible.

• Lower service level = Higher reporting

capability

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What’s the Goal?

• Match and Allocate:

– Data often housed in separate components of the hospital’s information system – Cost (operating expense)

• General ledger module

– Patient service records

• Patient accounting module

Cost

Operating Expense An expense by any other name is still an expense.

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Operating Expenses

• Revenue Producing
• Direct
• Overhead
• Indirect
• Functional Classification

– Departmental – Where

• Natural Classification

– Type – What

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Natural Classification

– Salaries and Wages – Employee Benefits – Contract Labor – Medical Supplies – General Supplies – Drugs – Professional Fees – Depreciation – Rent – Etc.

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Departmental Direct Expense (Revenue Producing)

• Patient Care

– Nursing Care – Operating Room – Radiology – Lab – Therapies – Emergency Room

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Departmental Indirect Expense (Overhead)

– Capital – Human Resources – Administrative – Plant – Laundry – Housekeeping – Dietary – Medical Records

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Hospital Departmental Expenses

45% 55%

Indirect Direct

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Direct and Indirect Cost

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How do we accomplish our goal?

“A goal without a plan is just a wish.”

Costing Methodologies

• Ranked in order of common use:
• 1. Ratio of Cost to Charge (RCC) (Focus)
• 2. Hybrid (RVU/RCC)
• 3. Relative Value Unit (RVU)
• 4. Activity Based Costing (ABC)

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Costing Methodologies

• Ranked in order of accuracy of output:
• 1. Activity Based Costing (ABC)
• 2. Relative Value Unit (RVU)
• 3. Hybrid (RVU/RCC)
• 4. Ratio of Cost to Charge (RCC)

Costing Methodologies

• Ranked in order of resource consumption:
• 1. Activity Based Costing (ABC)
• 2. Relative Value Unit (RVU)
• 3. Hybrid (RVU/RCC)
• 4. Ratio of Cost to Charge (RCC)

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Poll Question

Which of the preceding costing methodologies is your hospital using?

Ratio of Cost to Charge (RCC)

• Most commonly used
• Based on an assumed relationship of costs to

charges

• Begins with charges and assumes that costs

are a certain % of this amount

• Charge amount is the measure used to

allocate cost at the procedural service level

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TERMINOLOGY

• CHARGES = GROSS REVENUES

– Amounts billed to patients at the facility’s established rates for services rendered – Gross patient service revenue

• FULLY ALLOCATED COSTS = EXPENSES

– Expenses incurred in rendering services to patients – Operating expenses excluding bad debt expense

TERMINOLOGY

• RATIO OF COST TO CHARGE (RCC)

– Departmental costs divided by departmental charges to patients.

Ancillary Department Cost Charges CCR Radiology 1,900,000 $ ÷ 6,500,000 $ = 29% Lab 1,600,000 ÷ 3,150,000 = 51% Pharmacy 660,000 ÷ 1,850,000 = 36% 4,160,000 $ 11,500,000 $ 36% Aggregate

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TERMINOLOGY

• INPATIENT COSTS = Routine + Ancillary

– Routine

• Primarily nursing salaries and overhead

– Ancillary

• Salaries and overhead related to inpatient revenue

producing departments:

– Operating Room – Radiology – Medical supplies – Etc.

TERMINOLOGY

• SWING BED COSTS = Routine + Ancillary

– Routine (same as Inpatient)

• Primarily nursing salaries and overhead

– Ancillary (not the same as Inpatient)

• Salaries and overhead related to swing bed revenue

producing departments:

– Physical Therapy – Drugs – Lab – Etc.

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TERMINOLOGY

• OUTPATIENT COSTS

– Ancillary

• Salaries and overhead related to outpatient revenue

producing departments:

– Operating room – Radiology – Medical supplies – Etc.

Overhead Allocation

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Step-Down Method

• The following section is presented to provide

some instruction on the methodology used during cost report preparation in order to provide a practical and theoretical reference point.

• Similar consideration will need to be given to the

allocation of overhead when determining how to develop cost for more detailed cost objects as referenced in our service line definitions discussion.

Step-Down Method

• 4 Steps:
• 1. Determine an allocation basis
• 2. Compile statistics
• 3. Calculate allocation %’s
• 4. Allocate costs from support centers to each of

the centers below it

– Step down

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Cost Report Allocation Base = Statistics

• Order of allocation

– Creates differences in fully allocated costs between cost objects

• Typically 2 rules of thumb in determining
• rder
• 1. Rank cost centers based on dollar value
• High to Low
• 2. Rank cost centers based on # of other cost

centers they service/support

• High to Low

Step-Down Method

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Order of Allocation Allocated Costs and %’s

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• Direct cost
• +
• Indirect (Allocated) cost
• =
• Fully Allocated Costs

Fully Allocated Costs

Charges

Gross or Net? Why can’t net be gross?

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Charges

• Gross patient service revenue

– Driven by Charge Description Master (CDM) – Units of service X established rates – What level of detail is available?

• General ledger department
• Revenue code
• Procedure code
• Patient

– Need to develop a table of revenue code mapping to cost report cost center

Cost Report Matching Principle

(Costs / Charges) x Program Charge = Estimated Cost

• Goal is to MATCH cost with related revenue in

appropriate buckets in order to develop a cost to charge ratio to apply to revenue code level charges in determining program cost.

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Cost Report Matching Principle Routine Unit Cost Allocation

• How are routine costs determined?

– Fully allocated costs to routine areas

• Adults & Pediatrics, Swing-bed, Nursery, ICU

– Divided by units of service

• Days

– Results in an average cost per day

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Taking it to the Next Level Relative Value Unit (RVU)

• RVU methodology involves cost studies to

determine the amount of resources utilized by a service

– Costs are componentized (wages, supplies, etc…) – Weights are assigned to each component – The component weights for each service or product are combined to determine an overall consumption factor (RVU weight)

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Relative Value Unit (RVU)

• Service assigned a RVU weight of 2 consumes

twice the resources of a service assigned a RVU weight of 1

– DRGs are assigned weights for PPS payment purposes

• American Medical Association developed RVUs

that are used to determine physician fee schedule payments (Resource-Based Relative Value Scale)

– Include components for physician work(52%), practice expense(44%) and malpractice (4%)

Relative Value Unit (RVU)

Pros

• More reliable than RCC method
• Predictable cost estimates

Cons

• Complex
• Requires maintenance

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Hybrid RVU/RCC

• RVUs are developed for the items that

comprise 80% of revenue in a given department

• The remaining items that comprise the other

20% of revenue use the RCC method to estimate cost

Activity Based Costing (ABC)

• Method to estimate costs of a service or

product by measuring the costs of the activities it takes to produce that service or product

– Bottom-up approach – Also known as “Micro Costing”

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Activity Based Costing (ABC)

Resources Activities & Processes Products

Activity Based Costing (ABC)

Pros

• Most precise

Cons

• Utilizes the most resources
• Challenging to maintain

Rarely found among U.S. based healthcare provider

• rganizations

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Net Revenue

Gross or Net? Why can’t net be gross?

Gross Revenue

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Net Revenue Net Revenue

• How does the hospital get paid by payer by

type of service?

– Medicare, Medicaid, Uninsured, Commercial, Managed Care, etc.

• Yes we did include uninsured as a payer above

– Inpatient, Outpatient, Physician Services

• How does the hospital warehouse and

monitor its commercial and managed care contracts?

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Net Revenue

• Does the hospital use contract management

software?

– Calculates anticipated reimbursement for each contract – Contains an “audit” function that compares actual claims payment against contractual terms

• How will the shift from volume to value affect

the hospital?

– Population Health Management

How to Proceed?

Doing more with less…or…just doing the best you can.

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What Level of Implementation is Feasible?

• Recap:

– We’ve discussed 4 different costing methodologies

• 1 in detail for understanding
• 3 in summary for awareness

Poll Question

Which costing methodology did we spend the most time discussing?

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• Obtain patient encounter claims level procedural

detail with charges by revenue code and length of stay if an inpatient claim

• Cost claims by applying calculated cost center

cost to charge ratios to charges by revenue code plus routine cost per day if an inpatient claim

• Determine net reimbursement on a per claim

basis for the particular patient

• Subtract per claim cost from per claim

reimbursement to determine profitability

Practical Approach

• The preceding information should be

manageable in an Excel or Access database

• Once the data is established it can be

manipulated/queried to determine estimated profitability for a multitude of service lines

– Patient Demographic – Payer – Physician – MDC, DRG, etc.

Practical Approach

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Advantages of RCC

• Familiarity with use in Medicare cost report
• Relatively simple to understand
• Relatively simple to implement
• Relatively simple to maintain

– Excel or Access

Disadvantages of RCC

• Simplicity comes with a price
• Less accuracy in comparison to other methods
• Could understate or overstate cost at

procedural level

• Could lead to the wrong conclusion

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Disadvantages of RCC

• Assumes charge directly correlates to resource

consumption

• Sensitive to Charge Master revisions
• Exempts department managers from:

– Data analysis – Identification of cost drivers – Measurement of resource consumption

Strategy

What was this all about?

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Tool for Developing Strategy

• Process improvement

– Focus on resource consumption – Lean – Six Sigma

• Service focus

– Evaluate new service opportunity – Expansion of current service – Elimination of current service

Tool for Developing Strategy

• Gain knowledge of your costs levels
• Assist in more effective payer contractual

negotiations

• Provide a clearer picture of current operating

cost and determine how it fits in the future or if modifications are necessary

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Recommended Reading Not specific to SLP but The future state of Health care.

Charles R. Horne, CPA Partner Draffin & Tucker, LLP 229.883.7878 chorne@draffin-tucker.com

• C. Bert Bennett, CPA

Partner Draffin & Tucker, LLP 229.883.7878 bbennett@draffin-tucker.com