7-2 Brookwood medical center case study6 questions

7-2 Brookwood Medical Center1 "In 1990, a major insurer asked us to bid on performing all of their openheart surgeries in the Southeast United States. We prepared a bid by pulling charges on all (not just Medicare) patients we had treated in the four diagnostic related groups (DRGs) and applying the hospital-wide cost-to-charge ratio. We did not get the bid and had no idea whether to be disappointed or relieved. From talks with third-party payers and major employers, we believed that by the mid-1990s we would be bidding for portions of business, like open-heart surgeries, on a regular basis. We real- ized that we needed a much better understanding of costs at the DRG and individual patient levels if we're to be able to compete effectively." -Carolyn Johnson, Vice President of finance INTRODUCTION By the end of the 19805, cost management had become one of the most important issues faced by Brookwood Medical Center (BMC) administrators. BMC faced pressure from managed care providers such as health mainte- nance organizations (HMOs) and preferred provider organizations (PPOs) to keep medical costs low while continu- ing to provide high-quality health care services. For the first time, BMC was asked to bid on specific health care services for members of managed care insurance plans. To provide bids that were competitive yet profitable, hospi- tal administrators needed detailed cost information about specific health care procedures. In addition, Medicare and other insurance providers moved to fixed fee reimbursement schedules, paying a defined fixed rate depending on a patient's diagnostic related group (DRG) and severity level. The use of fixed payment rates provided incentives for BMC to identify costs associated with providing health care to specific patients in each DRG. Health care providers realized that reductions in the average length of stay (ALOS) as a result of shorter inpatient hospital stays and in- creased outpatient services could decrease costs without decreasing the quality of care. THE NEW COST SYSTEM As more payers moved to a fixed fee form of reimbursement, BMC administrators determined the existing cost system was not providing sufficiently accurate or detailed cost information. The old methodology provided aggre- gated cost data by department; but no reliable method existed to trace costs to individual patients or diagnostic groups. The new health care environment required hospitals to compete for managed care contracts and to make strategic decisions based on a solid understanding of costs. Jan Kelly, Director of cost accounting, identified the following issues to support the need for a new cost man- agement system: Unexplained variation in practice patterns. Physicians largely drove the health care delivery process through treatment protocols and medical orders that determined patient charges and length of stay. A new cost system could help identify costs associated with specific physician practice patterns. Concern with costs and more appropriate care. BMC recognized the opportunity to reduce tests and proce- dures for patients (e.g, ordering a component test rather than a whole profile on blood work). Some inpa- tient testing and care could be effectively done on an outpatient basis due to advances in medications and other technology. Many diagnostic tests and longer inpatient stays may not result in better patient out- comes. Questions regarding efi'ectiveness. Questions concerning the effectiveness of care, especially when evaluat- ing new technology or treatments, were becoming increasingly commonplace. Thus, BMC required more sophisticated cost management tools. Beliefs regarding cost vs. value of care. Balancing the quality of care with the costs of providing care was a fundamental concern for BMC. For example, if a new surgical procedure allows early discharge or little scarring but costs 10 times more than an old procedure, is it necessary for the hospital to offer the new pro-cedure and incur additional costs? Executives had to identify a strategy for new technology and the existing methodology, management began to explore alternatives to the old cost accounting methodology. They re- quired a cost system that would provide a product-line focus, i.e, open heart surgery, diabetes care, rehabil- itation, or respiratory therapy, and that would permit segmentation of the patient population. Details of Ma- son's oncological study were reviewed, and the results reinforced the belief that costs calculated on a facili- ty-wide basis were not helpful for making decisions that were DRGspecific In March 1991, BMC executives hired an Atlanta-based CPA firm to work with Kelly to gain an understanding of departmental operating costs and to build cost standards. They backloaded cost data for 20 months and identified two types of costs, direct and indirect. Meetings were held twice a week with key hospital administrators and clini- cians to determine activities that caused costs. BMC used a computerized information system known as Transition I (TSI) to assist with standard costing, fi- nancial modeling, and forecasting. The software allowed cost managers at BMC to identify activities, link activities to costs, and categorize costs based on predetermined or specific allocation bases. The system also generated simul- taneous algebraic equations used to allocate indirect costs to revenue-generating departments. TSI allowed the crea- tion of a database with cost and demographic information that could be sorted by both traditional and nontraditional demographic elements. Detailed information allowed BMC to obtain more accurate measurements of costs to pro- vide care and to monitor and improve the quality of care provided to patients. For example, the patient number, length of stay, total charges, direct costs, and indirect costs for all appendectomy patients treated during a specific time period were summarized by the TSI system (see Table l). DIRECT COSTS Direct costs could be traced to a patient or procedure and included resources consumed in providing testing ser- vices, supplies, pharmaceuticals, and nursing care. Costs for patient testing and procedures (including X-ray, labora- tory services, operating room costs, labor and delivery room costs) were associated with each patient, using the in- ternally calculated direct cost for each test or procedure. Major supplies and pharmaceuticals were individually as- signed to the patient based on the actual cost of the supply or drug. Nursing care costs were driven to the patient level through daily patient classification and room rate charges. These charges were based on the nursing skill level required to care for patients in each specialty area, as well as the average acuity levels in each specialty area. Nursing staff skill levels were divided into three classifications as fol- lows: registered nurse (RN), licensed practical nurse (LPN), and aide. Examples of specialty areas were obstetrics, surgical, psychiatric, and cardiovascular. BMC divided six acuity levels according to the level of clinical attention required by the patient. For example, a direct cost of $l23 per day was incurred in the Nursing-MED/SURG de- partment acuity level 1 (see Table 2). The cost system produced departmental reports identifying the daily rate by acuity level and the underlying as- sumptions of the allocation routine (see Table 3). Because the number of minutes required to attend patients varied across acuity levels, the estimated (budgeted) volume of patient days was adjusted for daily service levels, expressed in minutes. The department's budgeted cost was allocated to each acuity level as a percentage of total budgeted minutes. Finally, a daily rate for each acuity level was calculated by dividing the allocated costs by the budgeted volume of days within each acuity level. INDIRECT COSTS Indirect costs such as depreciation, administrative, and general were allocated to revenue-producing activities using simultaneous algebraic equations. The calculations were performed by BMC's computerized accounting sys- tem using allocation percentages based on the amount of services provided to other departments. The system allo- cated costs among several departments with reciprocal service relationships. For example, assume an organization has two support departments, housekeeping, information systems (IS), and two revenue-producing departments, operating room (OR) and emergency room (ER). The IS department manager estimated the housekeeping depart- ment consumed 10% of the IS department's activities, while the ER and OR required 40% and 50%, respectively. Thus, the IS department's direct costs of $lO0,000 were allocated to housekeeping, OR, and ER consistent with the resources demanded (see Table 4). Next, the housekeeping department's direct ($60,000) and allocated ($10,000) costs of $70,000 were allocated to IS, OR, and ER using 30%, 40%, and 30%, respectively. Though the IS depart- ment had allocated all costs total $lO0,000 in the first step, the housekeeping department transferred costs ($21,000)back into the department that had to be reallocated in the second iteration. Iterations continued until the costs re- maining in the support departments were too small to be significant. Thus, after multiple iterations, all support de- partment costs were transferred to the OR and ER (see Table 4). The cost system used by BMC simultaneously allocated costs associated with all indirect activities to revenue- producing activities based on cost drivers identified by BMC. For example, the education department allocated its costs to various departments including pain management, diabetic services, and emergency room using the percent- age of paid hours within each department as the allocation base. Though the process required multiple iterations (see Table 4), the cost management system produced reports after each allocation iteration (see Table 5). When the allo- cation procedure had completed the final iteration, all costs for support-related departments were contained in the accounts of revenue-producing departments. Thus, education costs were included in the emergency room indirect cost per hour of $142 (see Table 2). As the health care environment changed, new information demands were placed on the cost reporting system. The Mason study (discussed in the BMC Introduction) added length of stay as well as direct costs within DRG cate- gories to the cost-to-charge ratio. According to Kelly, "TSI represented a significant step toward understanding and managing the costs of delivering health care services at BMC." REQUIRED: 1. Why didn't the cost data make any sense? 2. What motivated the managers to build a new cost system? 3. How does the TSI system attach costs to a patient or procedure? What are the major design issues? 4. How is the daily rate determined for the Nursing Med/Surg department acuity level 1? 5. How does the reciprocal method allocate indirect costs to revenue-producing departments? 6. Given your understanding of the manner in which TSI allocates costs to patients, would you classify Brookwood's cost system as activity based?Table 1 Brookwood Medical Center: Appendectomy Patient Listing Direct Cost Patient Length of Total Direct Cost Direct Cost Number Stay Charges Variable Fixed Indirect Cost Total Cost 1 3 $8,486 751 164 1,187 2,102 2 4 18,394 2,960 566 3,106 6,631 3 2 7,297 926 245 1,280 2,451 4 2 12,350 2,069 258 1,556 3,884 5 2 5,854 765 210 1,152 2,126 6 3 14,574 1,966 395 2,160 4,522 7 2 14,289 2,440 332 1,577 4,349 8 1 5,772 856 102 661 1,619 9 2 11,589 1,404 325 1,553 3,282 10 2 8,398 1,192 365 2,045 3,601 11 2 8,771 1,033 225 901 2,159 12 3 14,920 2,626 295 2,546 5,466 13 3 10,320 1,751 487 2,644 4,882 14 3 8,871 1,097 178 1,460 2,735 15 1 9,103 1,998 221 1,647 3,865 16 2 8,365 1,563 168 1,050 2,781 17 5 13,355 2,195 687 3,237 6,119 18 2 11,235 2,414 258 2,195 4,867 19 1 8,976 1,170 201 1,067 2,438 20 5 18,033 3,123 563 3,457 7,143 21 4 11,756 1,739 229 1,279 3,247 22 1 8,068 1,698 210 1,350 3,258 23 1 8,133 1,669 247 1,257 3,174 24 1 7,396 1,232 160 825 2,217 25 1 6,926 911 147 637 1,695 26 1 7,558 1,268 188 1,141 2,598 27 5 20,14O 3,151 468 3,419 7,037 28 2 6,211 718 167 843 1,728 29 2 8,740 1,324 189 1,212 2,724 30 1 6,931 779 140 736 1,656 31 1 8,493 1,345 152 1,013 2,510 32 1 6,580 1,041 153 863 2,056 33 2 8,646 1,328 195 1,200 2,723 34 2 11,319 1,214 247 1,424 2,885 35 1 7,435 1,042 161 817 2,020 36 2 11,765 1,564 267 1,647 3,478 37 1 9,822 1,443 165 1,143 2,752 38 2 10,354 1,929 184 1,669 3,782 39 3 9,117 1,117 126 1,309 2,552 40 1 11,097 1,623 348 1,847 3,818 41 1 9,03O 900 141 859 1,901 42 1 7,659 1,558 112 1,045 2,716 43 2 9,943 1,619 174 1,217 3,010 44 L 1 1,238 M fl -1,-27-3 2,651 Total 91 $443,309 67,688 1 1,017 66,506 145,210Table 2. DRG 470 - Appendectomy Utilization Report Department Description NURSING - MED/SURG OPERATING ROOM OPERATING ROOM SUPPLIES RECOVERY CENTRAL STORES LABORATORY SERVICES CARDIOLOGY / EKG PHARMACY RESPIRATORY THERAPY EMERGENCY ROOM DIETARY LAUNDRY / LINEN Product Description Acuity level 1 -- daily rate Acuity level 2 -- daily rate Major surgery -- 1 hour Sutures Basic surgical pack Additional OR supplies* Recovery level II -- l/4 hours Central store supplies* Blood profile, potassium, renal profile EKG 3 channel w/o physician in Pharmaceuticals* Incentive spirometer New start spirometer & oxygen ER visit level II - intensive Daily hospital service Daily hospital service * Detail of specific items charged collapsed into one line item. Direct Cost $ 1 23OO 140OO l7400 17.00 17.00 118.00 24.00 25.50 29.50 13OO 16350 4.00 6.00 80.00 24.00 9.00 Indirect Cost $ l 90.00 229.00 l70.00 7.00 6.00 50.00 ILOO 58.00 ILOO 12.00 133.00 3.00 4.00 l42.00 18.00 6.00 Quantity Total Cost $3 l3.00 738.00 344.00 120.00 23.00 168.00 105.00 83.50 81.00 25.00 296.50 35.00 10.00 222.00 126.00 45.00 2.735.00Table 3. Brookwood Medical Center, Department 6103, Nursing MED/SURG Budget $95,759 Budgeted Minutes Volume in Daily Ser- Budgeted Percent Daily Description Days vice Minutes Allocation Allocation Rate Acuity level 1 18 346 ? ? ? ? Acuity level 2 264 394 ? ? ? ? Acuity level 3 199 464 92,336 0.343 $32,864 $l65 Acuity level 4 25 547 l3,675 0.051 4,867 195 Observation 165 40 6,600 0.025 2,349 14 Observation 133 30 3,990 0.015 l,420 l 1 All others 21 l 200 42,200 0.157 15,020 71 Total 269.045 1.000 95.759 Table 4. Calculations for Reciprocal Service Department Allocation Service Departments Revenue Departments IS Housekeeping OR ER Beginning balance 100,000 60,000 0 0 IS allocation (100,000) 10,0001 50,0002 40,0003 Balance after allocation 0 70,000 50,000 40,000 Housekeeping allocation 21,0004 (70,000) 28,0005 21,000" Balance after allocation 21,000 0 78,000 61,000 2nd IS allocation (21,000) 2,100 lO,500 8,4OO Balance after allocation 0 2, 100 88,500 69,400 2nd housekeeping allocation 630 (2, 100) 840 630 Balance after allocation 630 0 89,340 70,030 3rd IS allocation (630) 63 315 252 Balance after allocation 0 63 89,655 70,282 3rd housekeeping allocation 19 (63) 25 19 Balance after allocation 19 0 89,680 70,301 Transfer minimal balances (19) O 10 9 Ending balance 0 0 89,690 70,3 10 '$100,000 * 10% 3$100,000 * 40% 5$70,000 * 40% 2fi3100,000 * 50% 4SB7O,OOO * 30% 6$7O,OOO * 30%Table 5. Brookwood Medical Center, Education Allocation to Emergency Room Department Pain Management Diabetic Services Emergency Room Monitoring Services Quality Assurance Dietary Collections Outpatient Registration All others Total Paid Hours 2,083 8,993 124,212 40,634 21,314 l67,411 l3,650 l9,776 4,488,783 4,886.856 Allocation base: paid hours Budget $500,000 Percentage of paid hours by department wb ND ND N? x? ND 0.279320 0.404677 91.854210 100.00% Amount allocated 0 ND MD MD ND ND $1,3966O $2,023.39 $459,271.05 $500,000.00