Activity-Based Management in a Medical Practice

T

A BRIEF INTRODUCTION TO THE HEALTH CARE INDUSTRY

he Office of Health Policy of the Assistant Secretary for Planning and Evaluation in the Department of Health and Human Services released a study in 20051 that analyzed the effects of cost increases in health care on the U.S. economy. This

report states that 2003 spending in the U.S. was $1.67 trillion, or $5,670 per person. These costs have been increasing at a rate that is nearly triple the rate of increase in the U.S. Gross Domestic Product since the late 1990s. By 2002, 46 percent of all health care spending came from public funding, up from 25 percent in 1960. Health care is a significant portion of the U.S. economy and U.S. health care policies and funding have a major impact on all Americans.

Most physicians and surgeons in the U.S. receive a substantial portion of their revenues from third-party payors (insurance companies or government Medicare or Medicaid reimbursements). In many instances, the amount a surgeon receives for a particular service has declined over the years because doctors have less bargaining power with the U.S. government and insurance companies than they had when they received payments from their patients. This has made cost control in a medical practice more important than ever.

CASE INTRODUCTION

Thoracic surgeons treat diseases involving organs of the chest. Cardiac surgery (a type of thoracic surgery) is the surgical management of diseases of the blood supply to the heart, heart valves and the arteries and veins in the chest. Cardiac surgeons replace and repair valves in the heart, install pacemakers, perform coronary artery bypass graft (CABG) surgery for disease, treat cancers of the lung and esophagus, treat tumors of the chest, and perform heart and lung transplants. General thoracic surgery, on the other hand, focuses on treatments for problems of the lungs and esophagus.

Dr. Don Fannon and Dr. Dan Martens are two renowned thoracic surgeons. They are graduates of the Stanford University School of Medicine and have each worked in the fields of cardiac and thoracic surgery for more than 30 years. Both are frequent speakers at medical conferences. In 1981, they formed the Fannon and Martens Cardiac and Thoracic Surgery Medical Group (FMMG) in the San Francisco Bay Area.

Drs. Mikos, Cord, Carson, and Smith (MCCS) are also thoracic surgeons. They have been practicing together in San Francisco for more than 11 years, and they have all known Drs. Fannon and Marten of FMMG for just as long.

All six surgeons (the four from MCCS and the two from FMMG) attended last year?s annual meeting of the Society of Thoracic Surgeons (STS), and during a break between sessions, began talking about the way they manage their respective practices. There are numerous differences between the two practices. For example, FMMG maintains a central location?a traditional medical office?for patient examinations. Although they have surgical privileges at several hospitals, all patients are seen in the exam rooms at the FMMG office. Drs. Fannon and Marten prefer this, as it saves them (and their junior partner) a great deal of travel time.

1 See: http: / / aspe.hhs.gov / health / costgrowth / index.htm.

MCCS, on the other hand, maintains only an administrative office. That is, no patients are seen at the MCCS office. All patient office visits are handled at examination rooms close to the hospital where the surgery was performed or will be performed. Some of the rooms where patients are examined are in the hospital itself, or in office facilities located close to the hospital. Of course, MCCS? patients prefer this as they have a shorter drive for pre-op and post-op office visits, but the MCCS surgeons spend much more time com- muting to various hospitals than do the FMMG surgeons.

After hearing of this arrangement, Drs. Fannon and Marten expressed surprise that their MCCS colleagues would be willing to spend so much time on the road. Additionally, they question their friends about the heavy fees they must pay for the occasional use of such examination rooms in hospitals and ambulatory surgical centers. They are convinced that MCCS is headed for trouble with such a strategy. However, the MCCS surgeons believe that it is FMMG that has over-burdened itself with avoidable overhead. The MCCS surgeons say that the office space they use is essentially free. That is, in almost all cases, they pay nothing for the use of the space to examine patients. There is only one hospital that charges them for the use of the space.

The two groups of surgeons agree to compare financial information about their practices in order to determine who is right.

THE STS COST STUDY

Both FMMG and MCCS previously participated in a cost study project sponsored by the Society of Thoracic Surgeons. This study built an activity-based costing (ABC) model for indirect costs, which generated the cost of each process (activity) and the unit costs of the four cost objects for the practices that participated in this study. Table 1 describes the business processes that generate the indirect costs of these thoracic medical practices. The Center for Medicare and Medicaid Services (CMS) administers U.S. government re- imbursement to physicians giving care to persons covered under Medicare and Medicaid. In the CMS nomenclature, these indirect costs are known as practice expense.

Table 2 gives the results of this cost study for FMMG, MCCS, and the average for the practices that participated in the study. The assignment of process costs to the cost objects in the study is shown in Figure 1. The costs of two of the processes, Sustain and Manage Business and Maintain Facility, were not allocated directly to the cost objects. Rather, the costs of these processes were allocated back to the other processes. Hence, the total costs listed for these two processes are displayed for informational purposes only; these amounts are included in the total process costs because they were already reallocated to the other processes. Table 2 also lists the final indirect cost / unit for the four cost objects in this study, the count for each of the four cost objects, and the number of full-time equivalent (FTE) MDs.

According to CMS, the reimbursement to physicians for the work they perform is based on three components: work, malpractice insurance, and practice expense. The work component compensates physicians for the estimated time required by the physician to perform a certain procedure. The more complex the procedure, the more time is required, and hence, the greater the reimbursement. The work component is a reimbursement for the direct cost of providing a medical service. Practice expense includes all the costs of running a medical practice other than physician compensation and malpractice insurance. In accounting terms, practice expense is an indirect cost.

In the STS cost study, the purpose was to build and implement an ABC model for practice expenses, the indirect costs of a medical practice. Therefore, information about the direct costs (compensation to doctors and malpractice insurance) was not collected. Information about the effort levels of the physicians across the types of services rendered was not relevant because physician compensation is considered a direct cost. For this case, however, we want to focus on practice profitability. Consequently, we have to add both revenue and direct cost to the model.

Cost Objects in the STS Study

The ABC model built to determine the practice expense per unit of cost object identified four major groups of services delivered by thoracic surgeons. These were the cost objects for thoracic surgery, and are shown below.

? No-Charge Office Visits: These are the post-operative outpatient office visits that are not chargeable within the ??global period?? (usually 90 days for most surgeries).

? Chargeable Office Visits: These are pre-operative visits or outpatient visits not within the global period.

? Chargeable Hospital Visits: These are in-patient visits that could have been triggered by the patient?s admission to an emergency room or post-operative visits not within the global period.

TABLE 1

Medical and Business Activities (Processes) in the STS Cost Study

(1) Service Patients in Office

This is the process of treating and managing patients during office visits. Two categories of

patients are seen this way: initial office visit and post-op visits. The process includes all activities

necessary to service the patients including taking patient history, scheduling appointments, pre-

paring examination rooms, typing prescriptions, ordering tests, answering patient / family ques-

tions (in person and on the phone), transcribing dictation, completing disability forms, etc. This

process includes providing information and reports to the referring physician. The process does

not include maintaining medical records or obtaining insurance authorization?these are separate

processes.

(2) Service Patients in Hospital and Other Facilities

This is the process of treating patients in the hospital and interacting with patients and family

in the hospital. It includes making rounds, examining patients, etc.

(3) Obtain Insurance Authorization

This is the process of verifying insurance coverage, contacting the insurance company, HMO,

or Workers? Compensation to obtain permission to provide services to a patient, etc.

(4) Maintain Medical Records

This is the process of collecting, entering, and copying information for patients? medical charts.

It includes pulling charts and re-filing charts, etc.

(5) Schedule and Coordinate Surgery Patients in Hospital

This is the process of keeping track of patients in the hospital. It includes arranging patient

admissions, managing transportation of patients, scheduling physician rounds and surgeries,

keeping track of every patient in the hospital: where they are and why they are there, delivering

and picking up medical records, recording all daily physician services, scheduling physician

meetings, etc.

(6) Billing

This is the process of recording patient charges for services rendered and submitting claims to

insurance companies, Medicare, HMO, Workers? Compensation, etc.

(7) Collect Payments

This process includes collecting funds from individuals, insurance companies, HMOs, etc., main-

taining accounts receivable records, making bank deposits, etc.

(8) Resolve Collection Disputes and Re-Bill Charges

This is the process of evaluating EOBs and working with insurance companies, HMOs, etc., to

resolve payment / billing disputes, submitting additional information to payors, rebilling, etc.

(9) Provide Information to Third Parties

This process involves providing information to third parties, such as attorneys, insurance com-

panies, etc. It does not include providing information to the referring physician.

(10) Teaching and Research

This is the process of conducting medical research and teaching medical students, interns, and

residents.

(11) Maintain Professional Education

This is the process of the physicians and office staff maintaining their respective intellectual

capital.

(12) Sustain Business by Managing and Coordinating Practice

This is the process of running the business side of a medical practice. Activities include general

office management, STS database reporting, accounting, marketing, negotiating contracts, com-

plying with regulatory requirements, managing human resources, taxes, etc.

(13) Maintain Facility

This is the process of maintaining an environment in which to practice medicine and run the

business. It includes negotiating leases, acquiring medical and office equipment, installing communications systems, etc.

TABLE 2

Process Costs and Practice Information from the STS Cost Study

Total Cost of Processes		MCCS		FMMG		Database Average		Process Abbvn
Service Patients in the Office		$39,970		$347,045		$212,046		SPO
Service Patients in the Hospital		$94,018		$186,764		$173,192		SPH
Obtain Insurance Authorization (a)		$94,743		$45,930		$28,991		Auth
Billing (a)		$20,487		$64,950		$45,352		Bill
Collect Payments (a)		$17,979		$54,199		$26,234		Collect
Resolve Collection Disputes (a)		$13,799		$58,333		$32,792		Disputes
Maintain Medical Records		$43,342		$69,705		$57,133		MMR
Schedule & Coordinate Surgeries		$121,783		$30,915		$36,415		Sched
Provide Information to 3rd Parties		$23,805		$16,989		$17,230		3rd pties
Teaching & Research		$0		$0		$297		T&R
Maintain Professional Education		$51,411		$31,118		$37,163		MPE
Total $521,337 $905,948 $666,845
(a) Total Reimbursement Processes		$147,008		$223,412		$133,369		Reimb
Sustain & Manage Business		$191,547		$153,906		$170,211		Sust Bus
Maintain Facility		$59,429		$223,180		$121,203		Facility
Number of MDs		4		3		4.1
Number of no-charge office visits		1,424		1,188		1,038
Number of charge office visits		288		1,975		422
Number of charge hospital visits		530		779		97
Number of surgeries / procedures		1,312		639		727
Indirect cost / unit: No-charge office visit		$41		$139		$190
Charge office visit		$82		$169		$227
Charge hospital visit		$26		$45		$66
Surgery		$324		$581		$505

Note: Of the total practice expense for MCCS, $24,000 is for rental fees for examination rooms, $94,000 is for automobile leases and expenses, and $44,000 was for rent expense for the administrative offices. The $24,000 was assigned to Service Patients in the Office, the $94,000 was assigned to Service Patients in the Hospital, and the $44,000 was assigned to Maintain Facility.

? Surgeries and Procedures: Although a surgeon?s effort across types of surgeries or procedures varies greatly, there is not a large difference in the administrative resources consumed by a minor surgery or a major surgery. Therefore, the original ABC model grouped all surgeries and procedures together so that the practice expense assigned to each surgery was the same.

A distinction is made between chargeable and no-charge office visits because they consume activities differently. No-charge office visits do not require the staff to obtain insurance authorization (because the authorization for the surgery includes the follow-up office visits) or to process the collection of payments. However, a bill for $0 is prepared for a no-charge office visit. Therefore, the CPT codes for chargeable office visits were

FIGURE 1

Flow of Process Costs to Cost Objects in the STS Cost Study

Processes Cost Objects

Service Patients in the Office

Service Patients in the Hosp.

No-Charge Office Visits

Obtain Ins. Authorization

Billing

Collect Payments

Charge Office Visits

Resolve Collect?n Disputes

Maintain Medical Records

Schedule & Coordin. Surgeries

Charge Hospital Visits

Provide Info to 3rd Parties

Teaching & Research

Maintain Profess?l Education

Surgeries/Procedures

Sust. & Manage Business

Maintain Facility

The lines show how process costs were assigned to the cost objects in the STS Cost Study, using various cost drivers. For example, Service Patients in the Office Process costs were assigned to No-Charge Office Visits and Charge Office Visits. Maintain Medical Records and Billing process costs were assigned to all four cost objects.

bundled as a separate cost object from the CPT codes for no-charge office visits because they consume process costs differently.

All chargeable office visits, regardless of length or physician services provided, were considered as a single cost object because these office visits consume practice expense at about the same rate. A chargeable hospital visit does not usually require insurance authorization as this authorization is linked to the surgery, and it does not consume any office- related processes.

All surgeries and procedures, regardless of complexity, consumed about the same amount of practice expense. Therefore, all surgical CPT codes were bundled together as a single cost object.

Expanding the Model to Include Direct Costs

In order to expand the ABC model to include direct costs such as physician compensation and malpractice insurance, the number of cost objects must be increased. This is because, within each major cost object category, there are a number of different services rendered. For example, office visits and surgeries vary widely in terms of the amount of physician time consumed. MCCS has been maintaining records that will allow for a rea- sonable grouping of the CPT codes3 when different surgeon effort levels are taken into consideration. MCCS uses, in addition to the No-Charge Office Visit code, six different codes for Chargeable Office Visits (Outpatient E&M4 codes) and seven different codes for Chargeable Hospital Visits (Inpatient E&M codes). In order to better manage information for decision-making purposes, Linda, the MCCS practice manager, has grouped the surgical/ procedural codes that MCCS uses into 11 categories that represent the ??product lines?? of MCCS. These categories are:

? CABG (Coronary Artery Bypass Graft)

? Renal access (the vascular connection between the patient and a hemodialysis machine, where cleansing of the blood takes place for persons with kidney disease)

? Vascular surgeries (for example, removal of obstructions in veins or arteries)

? Bronch / Mediastinoscopy (surgical procedure to allow physicians to view areas of the cavity behind the breastbone)

? Thoracotomy (lung cancer surgery)

? Tracheostomy (for emergencies or patients on long-term ventilation)

? Pacemakers (insertion and management)

? Debridement (removing nonliving tissue from wounds)

? Other cardiac surgeries

? Valve repair and replacement (to correct a malfunctioning heart valve)

? Other surgeries

Table 3 gives additional information about the direct costs MCCS incurs for each of these, as well as estimates for the amount of doctor time spent, on average, for the various cost objects. Surprisingly, MCCS? malpractice insurance costs are computed based on the practice?s geographical region, its volume, its broad specialty (e.g. thoracic and / or cardiac surgery), and the practice?s claims experience. The specific case mix for the practice is not taken into consideration in determining malpractice rates. Since MCCS? geographic location

3 CPT codes are used in billing Medicare and other third-party payors. There is a code (designated as either a CPT code or a HCPCS code) for each type of service offered by a medical practice.

4 The codes that are used for in-patient and outpatient consultations with the surgeon are called Evaluation and

Management (E&M) codes.

TABLE 3

MCCS? Direct Costs and Direct Cost Drivers

Direct Costs:

Malpractice insurance $329,976

Doctors? compensation $2,020,775

Total direct costs $2,350,751

Information about Cost Objects:

Avg MD

Minutes Count

Total MD Minutes

No-Charge office visit 20 1424 28,480

Chargeable office visits:

/ outpatient visit, est level 1 15 18 270

/ outpatient visit, est level 2 25 7 175

consultation, level 1 30 14 420

consultation, level 2 40 45 1,800

consultation, level 3 60 117 7,020

consultation, level 4 80 87 6,960

Total chargeable office visits 288 16,645

Chargeable hospital visits:

inpatient consult, level 1	20	5		100
inpatient consult, level 2	32	20		640
inpatient consult, level 3	45	99		4,455
inpatient consult, level 4	65	184		11,960
inpatient consult, level 5	88	217		19,096
-up inpatient consult, level 2	20	4		80
-up inpatient consult, level 3	30	1		30
		530		36,361

Surgeries/procedures:

Coronary Artery Bypass Graft (CABG)	320	421		134,720
Renal Access	243	18		4,374
Vascular	163	68		11,084
Bronch / Mediastinoscopy	125	82		10,250
Thoracotomy	132	223		29,436
Trach	75	60		4,500
Pacemaker / AICD	128	53		6,784
Debridement	54	20		1,080
Other cardiac surgery	220	151		33,220
Valve repair / replacement	248	134		33,232
Other surgery	200	82		16,400
		1312		285,080

Total MD minutes for all services rendered 366,566

and its specialty are fixed, the MCCS surgeons feel that they can decrease malpractice premiums only by reducing the limits of coverage, reducing patient volume, or attempting to reduce malpractice claims. The first two alternatives are not seen as viable by the MCCS surgeons, and they feel they already use all their expertise and resources to minimize malpractice claims. The surgeons therefore feel that the cost of malpractice insurance is

not within their control. Most malpractice claims come from patients that have had a surgery or procedure, and to date MCCS has never been found to be liable for any claim (although the insurance company has sometimes settled with the plaintiff). MCCS has not noticed a pattern where these claims are associated with a specific type of surgery or procedure.

Expanding the Model to Include Revenues

In today?s environment of managed care and decreasing Medicare and other third-party reimbursements, surgeons are receiving less for their services than they were under the fee- for-service circumstances of the past. MCCS continues to bill for its services for amounts that are considered ??usual and customary?? charges. Of course, the practice most often does not receive a reimbursement anywhere close to what was billed. It is not unusual to see a ratio of collections to charges (amounts billed) of about 33 percent.

Table 4 presents billing and collection information, as well as count information, about MCCS? services by payor category. The collections listed for Medicare include CMS? three components of reimbursement. In other words, these amounts are intended to reimburse a surgeon for practice expense, malpractice insurance costs, and his or her time. Linda has grouped MCCS? payors into the following categories:

? Medicare: Medicare reimbursements are computed using a formula based on RBRVUs (resource-based relative value units), which are indices of average physician time, ex- perience, and risk for a surgery. A surgeon will receive only the computed reimburse- ment for a particular service, regardless of the amount billed for that service. Often Medicare patients have supplemental health insurance that covers amounts or services that Medicare does not cover. Linda categorizes reimbursements received under these Medicare supplemental policies as payments for a Medicare patient.

? BCBS: A reasonable number of MCCS? patients carry Blue Cross / Blue Shield health insurance where BCBS pays MCCS a reimbursement that is computed based on (al- though it is higher than) the Medicare amount. Usually patients must pay a percentage of the covered amount (patient?s co-pay), up to an annual limit, and the BCBS policy pays the remainder. Linda includes the BCBS payments, as well as the co-pay from a BCBS patient, in this category.

? Commercial: A local laborers? union provides health insurance coverage for its mem- bers. The union is self-insured, so that all reimbursements are paid to the physician directly, and the members are free to choose the physician of their choice. Depending on the nature of the individual?s membership, a small co-pay is sometimes required of the patient. Remittances from the union and the patient are included in this category.

? Department of Public Aid (DPA): A state-sponsored program pays a portion of the medical bills of individuals in financial distress.

? Managed care: This is the term Linda applies to the discounted fee arrangements that MCCS has with some hospitals and health care networks. It is not a ??capitated con- tract?? in the sense that MCCS receives a flat amount per member per month to be the specialist provider of cardiac / thoracic services to a network of enrollees in a Health Maintenance Organization (HMO). Rather, MCCS is compensated by the healthcare networks based on a predetermined fee schedule.

Additional Information about FMMG and MCCS

FMMG consists of two senior partners and one junior partner, all thoracic surgeons who work full-time at the practice. FMMG employs 1.8 FTE physician assistants who assist the surgeons in the operating room and 5.1 FTE administrative staff. All FMMG personnel

TABLE 4

MCCS? Case Mix Billing and Collection Information

Number of Units of Service Amount Billed

Medicare BCBS Comm DPA Mgd Care Medicare BCBS Comm DPA Mgd Care Total

t

No-Charge OV		707		182		81		100		354
Chargeable OV		162		94		17		6		9		$29,160		$17,326		$3,133		$1,106		$1,659		$52,384
Chargeable HV:		252		62		55		19		142		$59,427		$14,589		$12,942		$4,471		$33,414		$124,843
Surgeries / Procedures
CABG		229		38		12		17		125		$2,518,435		$417,906		$131,970		$186,958		$1,374,691		$4,629,961
Renal		6		4		3		1		4		$46,010		$30,673		$23,005		$7,668		$30,673		$138,030
Vascular		39		9		5		4		11		$397,999		$91,846		$51,025		$40,820		$112,256		$693,946
Bronch		33		12		6		12		19		$113,841		$41,397		$20,698		$41,397		$65,545		$282,878
Thoracot		111		31		10		7		64		$397,196		$110,929		$35,783		$25,048		$229,014		$797,971
Trach		18		6		8		13		15		$29,563		$9,854		$13,139		$21,351		$24,636		$98,544
Pacemaker		20		11		5		3		14		$187,990		$103,395		$46,998		$28,199		$131,593		$498,174
Debridement		11		2		1		2		4		$24,969		$4,540		$2,270		$4,540		$9,080		$45,399
Other cardiac		85		21		8		15		22		$157,530		$38,919		$14,826		$27,799		$40,773		$279,848
Valve rep		72		17		11

Table 2 Process Costs and Practice Information TOTAL COST OF PROCESSES MCCS Service Patients in the Office $39,970 Service Patients in the Hospital $94,018 Obtain Insurance Authorization (a) $94,743 Billing (a) $20,487 Collect Payments (a) $17,979 Resolve Collection Disputes (a) $13,799 Maintain Medical Records $43,342 Schedule & Coordinate Surgeries $121,783 Provide Information to 3rd Parties $23,805 Teaching & Research $0 Maintain Professional Education $51,411 TOTAL $521,337 FMMG $347,045 $186,764 $45,930 $64,950 $54,199 $58,333 $69,705 $30,915 $16,989 $0 $31,118 $905,948 Database Average $212,046 $173,192 $28,991 $45,352 $26,234 $32,792 $57,133 $36,415 $17,230 $297 $37,163 $666,845 (a) Total Reimbursement Processes Sustain & Manage Business Maintain Facility $147,008 $191,547 $59,429 $223,412 $153,906 $223,180 $133,369 Reimb $170,211 Sust Bus $121,203 Facility Number of MDs Number of no-charge office visits Number of charge office visits Number of charge hospital visits Number of surgeries/procedures 4 1,424 288 530 1,312 3 1,188 1,975 779 639 4.1 1,038 422 97 727 Indirect cost/unit: No-charge office visit Charge office visit Charge hospital visit Surgery $41 $82 $26 $324 $139 $169 $45 $581 $190 $227 $66 $505 Process Abbvn SPO SPH Auth Bill Collect Disputes MMR Sched 3rd pties T&R MPE Table 3 Direct Costs and Direct Cost Drivers Direct Costs: Malpractice insurance Doctors' compensation Total direct costs $329,976 $2,020,775 $2,350,751 Information about Cost Objects: Avg MD minutes No-Charge office visit 20 Chargeable office visits: 99213=Office/outpatient visit, est level 1 15 99214=Office/outpatient visit, est level 2 25 99242=Office consultation, level 1 30 99243=Office consultation, level 2 40 99244=Office consultation, level 3 60 99245=Office consultation, level 4 80 Total chargeable office visits Count Total MD minutes 1424 28,480 18 7 14 45 117 87 288 270 175 420 1,800 7,020 6,960 16,645 Chargeable hospital visits: 99251=Initial inpatient consult, level 1 99252=Initial inpatient consult, level 2 99253=Initial inpatient consult, level 3 99254=Initial inpatient consult, level 4 99255=Initial inpatient consult, level 5 99262=Follow-up inpatient consult, level 2 99263=Follow-up inpatient consult, level 3 20 32 45 65 88 20 30 5 20 99 184 217 4 1 530 100 640 4,455 11,960 19,096 80 30 36,361 Surgeries/procedures: Coronary Artery Bypass Graft (CABG) Renal Access Vascular Bronch/Mediastinoscopy Thoracotomy Trach Pacemaker/AICD Debridement Other cardiac surgery Valve repair/replacement Other surgery 320 243 163 125 132 75 128 54 220 248 200 421 18 68 82 223 60 53 20 151 134 82 1312 134,720 4,374 11,084 10,250 29,436 4,500 6,784 1,080 33,220 33,232 16,400 285,080 Total MD minutes for all services rendered 366,566 Table 4 Case Mix Billing and Collection Information Number of Units of Service Medi- BCMgd care BS Comm DPA Care No-Charge OV 707 182 81 100 354 Amount Billed Medicare BCBS Comm Amount Collected DPA Mgd Care Total Medicare BCBS Comm DPA Mgd Care Total Chargeable OV 162 94 17 6 9 $29,160 $17,326 $3,133 $1,106 $1,659 $52,384 $19,826 $12,112 $2,977 $332 $419 $35,665 Chargeable HV: 252 62 55 19 142 $59,427 $14,589 $12,942 $4,471 $33,414 $124,843 $39,973 $13,421 $12,295 $2,912 $9,555 $78,155 229 6 39 33 111 18 20 11 85 72 27 651 38 4 9 12 31 6 11 2 21 17 17 168 12 3 5 6 10 8 5 1 8 11 6 75 17 1 4 12 7 13 3 2 15 6 12 92 125 4 11 19 64 15 14 4 22 28 20 326 $2,518,435 $46,010 $397,999 $113,841 $397,196 $29,563 $187,990 $24,969 $157,530 $481,856 $160,180 $4,515,570 $417,906 $30,673 $91,846 $41,397 $110,929 $9,854 $103,395 $4,540 $38,919 $113,772 $100,854 $1,064,085 $131,970 $23,005 $51,025 $20,698 $35,783 $13,139 $46,998 $2,270 $14,826 $73,617 $35,596 $448,928 $186,958 $7,668 $40,820 $41,397 $25,048 $21,351 $28,199 $4,540 $27,799 $40,155 $71,191 $495,127 $1,374,691 $30,673 $112,256 $65,545 $229,014 $24,636 $131,593 $9,080 $40,773 $187,389 $118,652 $2,324,302 $4,629,961 $138,030 $693,946 $282,878 $797,971 $98,544 $498,174 $45,399 $279,848 $896,788 $486,473 $8,848,012 $1,016,302 $17,588 $158,791 $44,992 $158,467 $14,944 $75,948 $12,088 $61,642 $214,670 $69,713 $1,845,145 $308,356 $17,409 $59,220 $23,790 $69,109 $6,839 $66,415 $3,128 $23,247 $73,880 $60,832 $712,225 $123,120 $21,843 $45,624 $19,320 $33,422 $12,540 $44,478 $2,012 $13,844 $71,821 $34,826 $422,850 $56,082 $1,852 $11,333 $10,800 $7,012 $4,215 $6,214 $855 $6,188 $5,411 $14,222 $124,184 $346,844 $7,014 $18,211 $16,422 $56,873 $7,262 $35,425 $3,306 $12,589 $43,519 $29,124 $576,589 $1,850,704 $65,707 $293,179 $115,324 $324,883 $45,800 $228,480 $21,389 $117,510 $409,301 $208,717 $3,680,993 1772 506 228 217 831 $4,604,157 $1,096,000 $465,004 $500,704 $2,359,375 $9,025,239 $1,904,943 $737,758 $438,122 $127,428 $586,563 $3,794,814 Surgeries/ procedures CABG Renal Vascular Bronch Thoracot Trach Pacemaker Debridement Other cardiac Valve rep Other surgery Activity-Based Management in a Medical Practice A BRIEF INTRODUCTION TO THE HEALTH CARE INDUSTRY he Office of Health Policy of the Assistant Secretary for Planning and Evaluation in the Department of Health and Human Services released a study in 20051 that analyzed the effects of cost increases in health care on the U.S. economy. This report states that 2003 spending in the U.S. was $1.67 trillion, or $5,670 per person. These costs have been increasing at a rate that is nearly triple the rate of increase in the U.S. Gross Domestic Product since the late 1990s. By 2002, 46 percent of all health care spending came from public funding, up from 25 percent in 1960. Health care is a significant portion of the U.S. economy and U.S. health care policies and funding have a major impact on all Americans. Most physicians and surgeons in the U.S. receive a substantial portion of their revenues from third-party payors (insurance companies or government Medicare or Medicaid reimbursements). In many instances, the amount a surgeon receives for a particular service has declined over the years because doctors have less bargaining power with the U.S. government and insurance companies than they had when they received payments from their patients. This has made cost control in a medical practice more important than ever. T CASE INTRODUCTION Thoracic surgeons treat diseases involving organs of the chest. Cardiac surgery (a type of thoracic surgery) is the surgical management of diseases of the blood supply to the heart, heart valves and the arteries and veins in the chest. Cardiac surgeons replace and repair valves in the heart, install pacemakers, perform coronary artery bypass graft (CABG) surgery for disease, treat cancers of the lung and esophagus, treat tumors of the chest, and perform heart and lung transplants. General thoracic surgery, on the other hand, focuses on treatments for problems of the lungs and esophagus. Dr. Don Fannon and Dr. Dan Martens are two renowned thoracic surgeons. They are graduates of the Stanford University School of Medicine and have each worked in the fields of cardiac and thoracic surgery for more than 30 years. Both are frequent speakers at medical conferences. In 1981, they formed the Fannon and Martens Cardiac and Thoracic Surgery Medical Group (FMMG) in the San Francisco Bay Area. Drs. Mikos, Cord, Carson, and Smith (MCCS) are also thoracic surgeons. They have been practicing together in San Francisco for more than 11 years, and they have all known Drs. Fannon and Marten of FMMG for just as long. All six surgeons (the four from MCCS and the two from FMMG) attended last year's annual meeting of the Society of Thoracic Surgeons (STS), and during a break between sessions, began talking about the way they manage their respective practices. There are numerous differences between the two practices. For example, FMMG maintains a central locationa traditional medical officefor patient examinations. Although they have surgical privileges at several hospitals, all patients are seen in the exam rooms at the FMMG office. Drs. Fannon and Marten prefer this, as it saves them (and their junior partner) a great deal of travel time. See: http: / / aspe.hhs.gov / health / costgrowth / index.htm. 1 MCCS, on the other hand, maintains only an administrative office. That is, no patients are seen at the MCCS office. All patient office visits are handled at examination rooms close to the hospital where the surgery was performed or will be performed. Some of the rooms where patients are examined are in the hospital itself, or in office facilities located close to the hospital. Of course, MCCS' patients prefer this as they have a shorter drive for pre-op and post-op office visits, but the MCCS surgeons spend much more time commuting to various hospitals than do the FMMG surgeons. After hearing of this arrangement, Drs. Fannon and Marten expressed surprise that their MCCS colleagues would be willing to spend so much time on the road. Additionally, they question their friends about the heavy fees they must pay for the occasional use of such examination rooms in hospitals and ambulatory surgical centers. They are convinced that MCCS is headed for trouble with such a strategy. However, the MCCS surgeons believe that it is FMMG that has over-burdened itself with avoidable overhead. The MCCS surgeons say that the office space they use is essentially free. That is, in almost all cases, they pay nothing for the use of the space to examine patients. There is only one hospital that charges them for the use of the space. The two groups of surgeons agree to compare financial information about their practices in order to determine who is right. THE STS COST STUDY Both FMMG and MCCS previously participated in a cost study project sponsored by the Society of Thoracic Surgeons. This study built an activity-based costing (ABC) model for indirect costs, which generated the cost of each process (activity) and the unit costs of the four cost objects for the practices that participated in this study. Table 1 describes the business processes that generate the indirect costs of these thoracic medical practices. The Center for Medicare and Medicaid Services (CMS) administers U.S. government reimbursement to physicians giving care to persons covered under Medicare and Medicaid. In the CMS nomenclature, these indirect costs are known as practice expense. Table 2 gives the results of this cost study for FMMG, MCCS, and the average for the practices that participated in the study. The assignment of process costs to the cost objects in the study is shown in Figure 1. The costs of two of the processes, Sustain and Manage Business and Maintain Facility, were not allocated directly to the cost objects. Rather, the costs of these processes were allocated back to the other processes. Hence, the total costs listed for these two processes are displayed for informational purposes only; these amounts are included in the total process costs because they were already reallocated to the other processes. Table 2 also lists the final indirect cost / unit for the four cost objects in this study, the count for each of the four cost objects, and the number of full-time equivalent (FTE) MDs. According to CMS, the reimbursement to physicians for the work they perform is based on three components: work, malpractice insurance, and practice expense. The work component compensates physicians for the estimated time required by the physician to perform a certain procedure. The more complex the procedure, the more time is required, and hence, the greater the reimbursement. The work component is a reimbursement for the direct cost of providing a medical service. Practice expense includes all the costs of running a medical practice other than physician compensation and malpractice insurance. In accounting terms, practice expense is an indirect cost. In the STS cost study, the purpose was to build and implement an ABC model for practice expenses, the indirect costs of a medical practice. Therefore, information about the direct costs (compensation to doctors and malpractice insurance) was not collected. Information about the effort levels of the physicians across the types of services rendered was not relevant because physician compensation is considered a direct cost. For this case, however, we want to focus on practice profitability. Consequently, we have to add both revenue and direct cost to the model. Cost Objects in the STS Study The ABC model built to determine the practice expense per unit of cost object identified four major groups of services delivered by thoracic surgeons. These were the cost objects for thoracic surgery, and are shown below. No-Charge Office Visits: These are the post-operative outpatient office visits that are not chargeable within the ''global period'' (usually 90 days for most surgeries). Chargeable Office Visits: These are pre-operative visits or outpatient visits not within the global period. Chargeable Hospital Visits: These are in-patient visits that could have been triggered by the patient's admission to an emergency room or post-operative visits not within the global period. TABLE 1 Medical and Business Activities (Processes) in the STS Cost Study (1) Service Patients in Office This is the process of treating and managing patients during office visits. Two categories of patients are seen this way: initial office visit and post-op visits. The process includes all activities necessary to service the patients including taking patient history, scheduling appointments, preparing examination rooms, typing prescriptions, ordering tests, answering patient / family questions (in person and on the phone), transcribing dictation, completing disability forms, etc. This process includes providing information and reports to the referring physician. The process does not include maintaining medical records or obtaining insurance authorizationthese are separate processes. (2) Service Patients in Hospital and Other Facilities This is the process of treating patients in the hospital and interacting with patients and family in the hospital. It includes making rounds, examining patients, etc. (3) Obtain Insurance Authorization This is the process of verifying insurance coverage, contacting the insurance company, HMO, or Workers' Compensation to obtain permission to provide services to a patient, etc. (4) Maintain Medical Records This is the process of collecting, entering, and copying information for patients' medical charts. It includes pulling charts and re-filing charts, etc. (5) Schedule and Coordinate Surgery Patients in Hospital This is the process of keeping track of patients in the hospital. It includes arranging patient admissions, managing transportation of patients, scheduling physician rounds and surgeries, keeping track of every patient in the hospital: where they are and why they are there, delivering and picking up medical records, recording all daily physician services, scheduling physician meetings, etc. (6) Billing This is the process of recording patient charges for services rendered and submitting claims to insurance companies, Medicare, HMO, Workers' Compensation, etc. (7) Collect Payments This process includes collecting funds from individuals, insurance companies, HMOs, etc., maintaining accounts receivable records, making bank deposits, etc. (8) Resolve Collection Disputes and Re-Bill Charges This is the process of evaluating EOBs and working with insurance companies, HMOs, etc., to resolve payment / billing disputes, submitting additional information to payors, rebilling, etc. (9) Provide Information to Third Parties This process involves providing information to third parties, such as attorneys, insurance companies, etc. It does not include providing information to the referring physician. (10) Teaching and Research This is the process of conducting medical research and teaching medical students, interns, and residents. (11) Maintain Professional Education This is the process of the physicians and office staff maintaining their respective intellectual capital. (12) Sustain Business by Managing and Coordinating Practice This is the process of running the business side of a medical practice. Activities include general office management, STS database reporting, accounting, marketing, negotiating contracts, complying with regulatory requirements, managing human resources, taxes, etc. (13) Maintain Facility This is the process of maintaining an environment in which to practice medicine and run the business. It includes negotiating leases, acquiring medical and office equipment, installing communications systems, etc. TABLE 2 Process Costs and Practice Information from the STS Cost Study MCCS FMMG Database Average Process Abbvn Service Patients in the Office Service Patients in the Hospital Obtain Insurance Authorization (a) Billing (a) Collect Payments (a) Resolve Collection Disputes (a) Maintain Medical Records Schedule & Coordinate Surgeries Provide Information to 3rd Parties Teaching & Research Maintain Professional Education Total $39,970 $94,018 $94,743 $20,487 $17,979 $13,799 $43,342 $121,783 $23,805 $0 $51,411 $521,337 $347,045 $186,764 $45,930 $64,950 $54,199 $58,333 $69,705 $30,915 $16,989 $0 $31,118 $905,948 $212,046 $173,192 $28,991 $45,352 $26,234 $32,792 $57,133 $36,415 $17,230 $297 $37,163 $666,845 SPO SPH Auth Bill Collect Disputes MMR Sched 3rd pties T&R MPE (a) Total Reimbursement Processes Sustain & Manage Business Maintain Facility $147,008 $191,547 $59,429 $223,412 $153,906 $223,180 $133,369 $170,211 $121,203 Reimb Sust Bus Facility 4 1,424 288 530 1,312 3 1,188 1,975 779 639 4.1 1,038 422 97 727 $41 $82 $26 $324 $139 $169 $45 $581 $190 $227 $66 $505 Total Cost of Processes Number Number Number Number Number of of of of of MDs no-charge office visits charge office visits charge hospital visits surgeries / procedures Indirect cost / unit: No-charge office visit Charge office visit Charge hospital visit Surgery Note: Of the total practice expense for MCCS, $24,000 is for rental fees for examination rooms, $94,000 is for automobile leases and expenses, and $44,000 was for rent expense for the administrative offices. The $24,000 was assigned to Service Patients in the Office, the $94,000 was assigned to Service Patients in the Hospital, and the $44,000 was assigned to Maintain Facility. Surgeries and Procedures: Although a surgeon's effort across types of surgeries or procedures varies greatly, there is not a large difference in the administrative resources consumed by a minor surgery or a major surgery. Therefore, the original ABC model grouped all surgeries and procedures together so that the practice expense assigned to each surgery was the same. A distinction is made between chargeable and no-charge office visits because they consume activities differently. No-charge office visits do not require the staff to obtain insurance authorization (because the authorization for the surgery includes the follow-up office visits) or to process the collection of payments. However, a bill for $0 is prepared for a no-charge office visit. Therefore, the CPT codes for chargeable office visits were FIGURE 1 Flow of Process Costs to Cost Objects in the STS Cost Study Processes Cost Objects Service Patients in the Office Service Patients in the Hosp. No-Charge Office Visits Obtain Ins. Authorization Billing Collect Payments Charge Office Visits Resolve Collect'n Disputes Maintain Medical Records Schedule & Coordin. Surgeries Charge Hospital Visits Provide Info to 3rd Parties Teaching & Research Maintain Profess'l Education Surgeries/Procedures Sust. & Manage Business Maintain Facility The lines show how process costs were assigned to the cost objects in the STS Cost Study, using various cost drivers. For example, Service Patients in the Office Process costs were assigned to No-Charge Office Visits and Charge Office Visits. Maintain Medical Records and Billing process costs were assigned to all four cost objects. bundled as a separate cost object from the CPT codes for no-charge office visits because they consume process costs differently. All chargeable office visits, regardless of length or physician services provided, were considered as a single cost object because these office visits consume practice expense at about the same rate. A chargeable hospital visit does not usually require insurance authorization as this authorization is linked to the surgery, and it does not consume any office- related processes. All surgeries and procedures, regardless of complexity, consumed about the same amount of practice expense. Therefore, all surgical CPT codes were bundled together as a single cost object. Expanding the Model to Include Direct Costs In order to expand the ABC model to include direct costs such as physician compensation and malpractice insurance, the number of cost objects must be increased. This is because, within each major cost object category, there are a number of different services rendered. For example, office visits and surgeries vary widely in terms of the amount of physician time consumed. MCCS has been maintaining records that will allow for a reasonable grouping of the CPT codes3 when different surgeon effort levels are taken into consideration. MCCS uses, in addition to the No-Charge Office Visit code, six different codes for Chargeable Office Visits (Outpatient E&M4 codes) and seven different codes for Chargeable Hospital Visits (Inpatient E&M codes). In order to better manage information for decision-making purposes, Linda, the MCCS practice manager, has grouped the surgical/ procedural codes that MCCS uses into 11 categories that represent the ''product lines'' of MCCS. These categories are: CABG (Coronary Artery Bypass Graft) Renal access (the vascular connection between the patient and a hemodialysis machine, where cleansing of the blood takes place for persons with kidney disease) Vascular surgeries (for example, removal of obstructions in veins or arteries) Bronch / Mediastinoscopy (surgical procedure to allow physicians to view areas of the cavity behind the breastbone) Thoracotomy (lung cancer surgery) Tracheostomy (for emergencies or patients on long-term ventilation) Pacemakers (insertion and management) Debridement (removing nonliving tissue from wounds) Other cardiac surgeries Valve repair and replacement (to correct a malfunctioning heart valve) Other surgeries Table 3 gives additional information about the direct costs MCCS incurs for each of these, as well as estimates for the amount of doctor time spent, on average, for the various cost objects. Surprisingly, MCCS' malpractice insurance costs are computed based on the practice's geographical region, its volume, its broad specialty (e.g. thoracic and / or cardiac surgery), and the practice's claims experience. The specific case mix for the practice is not taken into consideration in determining malpractice rates. Since MCCS' geographic location 3 4 CPT codes are used in billing Medicare and other third-party payors. There is a code (designated as either a CPT code or a HCPCS code) for each type of service offered by a medical practice. The codes that are used for in-patient and outpatient consultations with the surgeon are called Evaluation and Management (E&M) codes. TABLE 3 MCCS' Direct Costs and Direct Cost Drivers Direct Costs: Malpractice insurance Doctors' compensation Total direct costs $329,976 $2,020,775 $2,350,751 Avg MD Minutes Count Total MD Minutes No-Charge office visit 20 1424 28,480 Chargeable office visits: 99213=Office / outpatient visit, est level 1 99214=Office / outpatient visit, est level 2 99242=Office consultation, level 1 99243=Office consultation, level 2 99244=Office consultation, level 3 99245=Office consultation, level 4 Total chargeable office visits 15 25 30 40 60 80 18 7 14 45 117 87 288 270 175 420 1,800 7,020 6,960 16,645 20 32 45 65 88 20 30 5 20 99 184 217 4 1 530 100 640 4,455 11,960 19,096 80 30 36,361 320 243 163 125 132 75 128 54 220 248 200 421 18 68 82 223 60 53 20 151 134 82 1312 134,720 4,374 11,084 10,250 29,436 4,500 6,784 1,080 33,220 33,232 16,400 285,080 Information about Cost Objects: Chargeable hospital visits: 99251=Initial inpatient consult, level 1 99252=Initial inpatient consult, level 2 99253=Initial inpatient consult, level 3 99254=Initial inpatient consult, level 4 99255=Initial inpatient consult, level 5 99262=Follow-up inpatient consult, level 2 99263=Follow-up inpatient consult, level 3 Surgeries / procedures: Coronary Artery Bypass Graft (CABG) Renal Access Vascular Bronch / Mediastinoscopy Thoracotomy Trach Pacemaker / AICD Debridement Other cardiac surgery Valve repair / replacement Other surgery Total MD minutes for all services rendered 366,566 and its specialty are fixed, the MCCS surgeons feel that they can decrease malpractice premiums only by reducing the limits of coverage, reducing patient volume, or attempting to reduce malpractice claims. The first two alternatives are not seen as viable by the MCCS surgeons, and they feel they already use all their expertise and resources to minimize malpractice claims. The surgeons therefore feel that the cost of malpractice insurance is not within their control. Most malpractice claims come from patients that have had a surgery or procedure, and to date MCCS has never been found to be liable for any claim (although the insurance company has sometimes settled with the plaintiff). MCCS has not noticed a pattern where these claims are associated with a specific type of surgery or procedure. Expanding the Model to Include Revenues In today's environment of managed care and decreasing Medicare and other third-party reimbursements, surgeons are receiving less for their services than they were under the feefor-service circumstances of the past. MCCS continues to bill for its services for amounts that are considered ''usual and customary'' charges. Of course, the practice most often does not receive a reimbursement anywhere close to what was billed. It is not unusual to see a ratio of collections to charges (amounts billed) of about 33 percent. Table 4 presents billing and collection information, as well as count information, about MCCS' services by payor category. The collections listed for Medicare include CMS' three components of reimbursement. In other words, these amounts are intended to reimburse a surgeon for practice expense, malpractice insurance costs, and his or her time. Linda has grouped MCCS' payors into the following categories: Medicare: Medicare reimbursements are computed using a formula based on RBRVUs (resource-based relative value units), which are indices of average physician