Assuming at least one of the products violates the OIG?s suggestion for ?substantially in excess,? discuss the impact of the following three potential solutions to this dilemma on DMS?s market share, operations, exposure to liability, and so on. In your assessment, consider the future financial implications of the three alternatives along with the assumptions you have made in your analysis. a.

Raise prices charged to cash and carry customers such that the government programs reimbursement rate is no more than 20% higher than the newly calculated amount

ISSN 1940-204X Dynamic Medical Solutions: Expanding the Application of Cost Management Principles to Channel and Customer Profitability Analysis Casey J. McNellis, Ph.D., CPA University of Montana Ronald F. Premuroso, Ph.D., CPA, CFE University of Montana COMPANY INTRODUCTION AND CASE BACKGROUND purchase goods at one of the company's five retail stores via the company's website or through the phone/fax process with a sales representative. In regard to cash and carry customers, DMS strives to offer competitive prices as the company is directly competing with large national retail stores that offer many types of medical products and operate on small profit margins. Serving cash and carry customers is fairly straightforward, involving no other considerations beyond the typical sales initiation (i.e., visits from a sales representative), point-of-sale sales, and warehouse shipping or customer pick-up processes. On the other hand, serving government programs customers is more restrictive and requires an extensive number of internal processes and procedures. The prices charged to these customers (i.e., the reimbursement amount) are set by the program entity (i.e., Medicaid or Medicare). Most importantly, the process of selling goods involves additional mandated (by law) considerations beyond the normal cash-and-carry process, including the written verification of medical necessity from the customer's physician, the processing of insurance claims, and the substantiation of product delivery. For many of the nondurable medical supplies, such as nutrition supplements and gloves, the process is even more cumbersome as these products are supplied to customers on a monthly basis. Accordingly, proof of medical necessity for these products also has to be updated on a recurring basis. This involves Dynamic Medical Solutions (DMS) is a small company that sells (as a retailer of products manufactured by others) durable and nondurable medical products to customers in seven states across the United States. Some of the popular durable products sold by the company are hospital beds, diabetic footwear, and mobility equipment (i.e., wheelchairs, scooters, etc.). A large portion of the company's business involves the sale of durable and nondurable medical supplies including nutrition supplements, gloves, and personal care products used in patient care. All of the products carried by DMS are over-the-counter items and thus do not require a physician's prescription.1 Like most companies in the medical products supply industry, DMS serves a multitude of customers, including those with (1) no insurance (i.e., cash and carry), (2) Medicare and Medicaid benefits (i.e., government programs),2 and (3) private insurance. Accordingly, DMS has a billing department internally for customers with such benefits and insurance. Many customers, including those enrolled in government programs and those who pay for products out of pocket (i.e., cash and carry) are elderly and/or reside in assisted-living facilities. The company employs sales representatives who visit these facilities and interact with the customers and their caregivers on a regular basis and establish the ordering process for the customers via phone or fax. Customers also are able to IM A ED U C ATIO NA L C A S E JOURNAL 1 VOL. 7, N O. 2, ART. 3, JUNE 2014 REGULATORY ENVIRONMENT additional interaction by the company with primary care physicians and Medicare/Medicaid representatives, as well as increased processing of paperwork. Sales to customers using private insurance comprise an immaterial amount of the company's revenues. Most private insurance companies cover only a minor amount of the charges for the products offered by DMS, often after a government program has been billed first and has paid for the majority of the charge billed by DMS. Table 1 provides a breakdown of DMS's sales for the most recent financial year, along with other relevant financial information (excluding an immaterial amount for private insurance-related sales). As Table 1 depicts, DMS's primary source of sales are from customers who are eligible for assistance from governmentrelated healthcare programs. As such, the company's success is largely based on understanding government regulations, policies, and procedures governing Medicare and Medicaid programs, including reimbursements. Because of past alleged abuses of these government insurance programs by healthcare providers, Federal and state authorities have enacted several regulations under the Social Security Act for providers like DMS involved with submitting reimbursement claims under government programs. For example, the Department of Health and Human Services (HHS) has the power to revoke a company's privileges to serve Medicare and Medicaid customers if the company has been involved in criminal activity, patient abuse, and/or healthcare fraud. Additionally, the Act also allows HHS to prohibit a company from engaging in business activities with Medicare and/or Medicaid if the company submits product reimbursement claims for government programs customers significantly higher than amounts charged to cash and carry customers. Specifically, Section 1128(b) of the Act states that HHS: \"...may exclude...from participation in any Federal health care program...any individual or entity that the Secretary determines...has submitted or caused to be submitted bills or requests for payment (where such bills or requests are based on charges or cost) under Title XVIII or a State health care program containing charges (or, in applicable cases, requests for payment of costs) for items or services furnished substantially in excess of such individual's or entity's usual charges (or, in applicable cases, substantially in excess of such individual's or entity's costs) for such items or services, unless the Secretary finds there is good cause for such bills or requests containing such charges or costs.\" (Emphasis added.) The language of this regulation was further interpreted in a proposal by the Office of the Inspector General (OIG) in June 2007.3 The phrase \"usual charges\" was suggested to include \"charges billed directly to cash paying patients\" (i.e., cash and carry customers). The term \"substantially in excess\" was defined by the OIG proposal as charges exceeding \"120 percent of an individual's or entity's usual charges.\" Finally, the OIG proposed that \"good cause\" for \"substantially in excess\" charges could be established in a number of ways, including, for example, evidence of \"increased costs associated with serving Medicare or Medicaid beneficiaries.\" Table 1: DMS Sales by Customer Type and Other Financial Information Sales % of Total Sales Government Programs Sales $3,000,000 75.0% Cash and Carry Sales $1,000,000 25.0% Total Net Sales $4,000,000 100.0% Cost of Sales ($1,300,000) 32.5% Gross Profit $2,700,000 67.5% Operating Expenses ($2,200,000) 55.0% Operating Income $ 500,000 12.5% The company's operations are divided into five departments: Customer Service, Shipping, Billing, Compliance, and Administration. Table 2 includes a breakdown of the operating expenses by department along with a brief description of the general functions carried out by each department for the most recent financial year. Table 2: Department Operating Expenses and Descriptions Operating Expenses Description of Functions Customer Service $660,000 Process sales orders; support customer base Shipping $870,000 Prepare orders for shipment; track shipments to delivery Billing $120,000 Submit insurance claims; monitor customer eligibility for government programs Compliance $120,000 Monitor company policies regarding government programs Administration $430,000 Perform bookkeeping, payroll, and marketing functions; heat, light, and power; insurance expenses; execute strategic plan Total Operating Expenses $2,200,000 Department IM A ED U C ATIO NA L C A S E JOURNAL 2 VOL. 7, N O. 2, ART. 3, JUNE 2014 DMS'S DILEMMA carry customers. Discouraged by the findings and faced with uncertainty and potentially disastrous consequences, the DMS management team members contemplated their next moves. DMS sends a member of the management team to a government programs seminar, where firms are provided information and guidelines regarding Federal regulations governing Medicare and Medicaid reimbursements. The team member is amazed by the number of regulations governing these programs, including the one mentioned earlier. Because the team member is not familiar with the methods that ensure DMS is in compliance with these regulations, he holds a meeting with the rest of the management team to discuss the regulations. The management team agrees it is necessary to hire a healthcare consultant to review DMS's policies, procedures, and billing practices for products sold to customers under government programs. After examining DMS's operations in some detail, the healthcare consultant hired by DMS informed management of a grim, unexpected finding: DMS's product pricing appeared to be in violation of Federal regulations governing Medicare and Medicaid reimbursements. The aforementioned regulation was the issue referenced by the healthcare consultant in determining DMS was potentially in violation of the Federal Act. The consultant examined all of the company's products and determined many of them had Medicaid reimbursement rates \"substantially in excess\" of prices charged to cash and carry customers. According to the consultant, DMS would likely have to change its pricing structure and/or potentially eliminate the sale of certain products sold by the company to remedy the violation. Accordingly, the company was advised to employ one of the following courses of action: either raise cash and carry prices for products not complying with the 120% proposed \"rule,\" or eliminate sales of the two selected products to cash and DMS'S INITIAL CONCERNS AND RESPONSE Given the substantial portion of DMS's sales from customers eligible for government program reimbursements, the issue of product pricing is therefore critical to the company. Prices offered to cash and carry customers must be competitive, yet they must be within a certain percentage of government program reimbursement claims in order for DMS to comply with government regulations. As such, pricing decisions have the potential to not only adversely impact DMS's market share of cash and carry customers but also may put the company's ability to sell and receive reimbursement for these products under the respective government programs in jeopardy. Unhappy with these two alternatives suggested by the consultant, company officials began compiling product pricing and costing data, as well as observing and documenting key operational aspects of the business to determine the extent of the problem revealed by the consultant and to develop potential alternative courses of action. SELECTED PRODUCT PRICING DATA The first two products examined by management were the nutrition supplement and nondurable gloves, two products eligible for reimbursement under government insurance programs. Table 3 includes selected information for these two products in the latest financial year. Table 3: Information for Selected Products Offered by DMS Nutrition Supplement (1 can) Nondurable Gloves (1 box) Retail sales price (paid by cash and carry customers) $1.54 $6.95 Maximum permitted selling price to government* $2.20 $8.82 Product cost $0.66 $2.65 3% 4% Quantity of product sold to cash and carry customers 19,480 cans 5,755 boxes Product sales as a % of government programs sales 6% 6% 81,800 cans 20,408 boxes Product sales as a % of cash and carry sales Quantity of product sold to government programs customers *This maximum permitted selling price to the government applies to all companies in general under specific regulations pertaining to these products issued by the government. IM A ED U C ATIO NA L C A S E JOURNAL 3 VOL. 7, N O. 2, ART. 3, JUNE 2014 BUSINESS OBSERVATIONS processes, separately, for the cash and carry and government program customers. Information about these processes from new sales origination all of the way through billing are detailed in Table 4. As part of these observations, company employees from selected departments were asked to keep track of the amount of time they spent on the different types of customer orders and related activities for a one-month period. Because of increased work demands at the time the study was performed, similar time data was not immediately obtained from employees working in the Shipping or Administration departments. The results are presented in Table 5.4 Management was inclined to believe disproportionate shares of company resources were being devoted to serving government program customers, especially in the case of nutrition and nondurable products (i.e., gloves), which involved additional processing costs in order to comply with regulations. But they had no formal evidence to support this belief and thus needed to obtain relevant information about the efforts being exerted to serve the two different customer types: cash and carry and government programs. As a first step, the officials observed employees from each department to obtain an understanding of the sales and order fulfillment Table 4: Summary of Relevant Portions of Company Processes New sales origination Cash and carry: A company salesperson visits nursing homes, hospitals, and assisted-living facilities, speaking with potential customers and guardians. The salesperson takes orders and phones/faxes them to warehouse customer service representatives. Government programs: Same as cash and carry. Recurring sales Cash and carry: A customer service representative contacts customers and takes sales orders. Government programs: Same as cash and carry. Order fulfillment Cash and carry: A representative from customer service enters the order into the company's accounting system. The system produces a pick slip, which is forwarded to Shipping. The employees in Shipping fill the order, which is then given to a third-party courier for delivery. A copy of the pick slip is sent back to the customer service representative. Government programs: Per regulations, DMS must obtain a valid identification card proving the customer's eligibility for the government program. To establish medical necessity, a doctor's order is required to be submitted with each order. A customer service representative prepares fax inquiries to the customer's physician (to establish medical necessity) and to the customer for valid proof of eligibility (if a copy was not obtained by the salesperson). Upon receipt of this documentation, the order is entered into the accounting system. The system produces a pick slip, which is forwarded to Shipping. The employees in Shipping fill the order, which is then given to a third-party courier for delivery. A copy of the pick slip is sent to a Billing representative. Shipping employees track shipments with the courier's website to confirm delivery. Billing Cash and carry: A representative from customer service examines the pick slips sent back from Shipping and prepares an invoice to the customer. The customer has 30 days to pay the invoice. Government programs: A representative from Billing prepares a government program claim and submits it. The reimbursement usually takes between 15-60 days. Other Government programs: Renewals for nutrition and nondurable goods: Periodically, a customer's physician order and proof of eligibility documentation are required to be renewed. A billing representative tracks these customers and prepares renewal requests when appropriate. Government programs: Oversight: Per regulations, DMS is required to have a compliance program staffed with a compliance officer, whose sole responsibility is to oversee compliance issues and related employee training. Retail store and website transactions Customers also visit the company's retail stores and website on their own. For cash and carry customers, the retail store process in similar to point-of-sale transactions of major retail stores. For website sales, a sales representative is not involved. Rather, the customer places the order, which is then sent to a customer service representative. At that point, the customer service representative processes the order in the same way as described under \"Order fulfillment.\" Transactions with government programs customers visiting the retail stores are still processed in accordance with the steps above. But no sales representative is involved in the transaction. In general, government programs customers do not place orders via the company website. IM A ED U C ATIO NA L C A S E JOURNAL 4 VOL. 7, N O. 2, ART. 3, JUNE 2014 Table 5: Results of Employee Study and Selection of Operating Cost Allocation Bases Department Average % Time - Government Programs Average % Time - Cash and Carry 85% 15% Customer Service Shipping No Data Available No Data Available Billing 100% 0% Compliance 100% 0% No Data Available No Data Available Administration CASE QUESTIONS 5. \u0007Looking back at your calculations and analyses performed in question 4c, do you believe the company can establish and support \"good cause' in submitting claims for the maximum allowable rates offered by government programs? In answering the question, first consider the qualitative evidence you have already developed. Second, develop a quantitative analysis appropriate to use in establishing or supporting your qualitative evidence. 6. \u0007In anticipation of the regulating agencies performing an investigation into the pricing structure of DMS, identify the strengths and weaknesses of the work performed by DMS in response to the consultant's findings as well as the analysis you provided in the previous questions. How should DMS address the weaknesses in preparation for the audit? 1.\t\u0007Why are government regulators sensitive to the amount of claims submitted to the government insurance programs in comparison to retail prices? 2.\t\u0007Why potentially could/would government programs reimbursement amounts exceed the retail sales prices for products? 3. \u0007Consider the information provided for the two products shown in Table 3. In accordance with the OIG's suggestions for \"substantially in excess,\" are the government programs reimbursement rates for each product presently \"substantially in excess\" of the \"usual charges\"? Provide the details of your calculations in your submission. 4. \u0007Assuming at least one of the products violates the OIG's suggestion for \"substantially in excess,\" discuss the impact of the following three potential solutions to this dilemma on DMS's market share, operations, exposure to liability, and so on. In your assessment, consider the future financial implications of the three alternatives along with the assumptions you have made in your analysis. a. \u0007Raise prices charged to cash and carry customers such that the government programs reimbursement rate is no more than 20% higher than the newly calculated amount. b. \u0007When submitting government program claims, request reimbursement amounts below the maximum allowable reimbursement rates in order to be within 20% of the prices charged to cash and carry customers. c.\t\u0007 Attempt to establish \"good cause.\" Refer to some of the principles and concepts you have learned or are learning in your cost management course (for example, Customer Profitability Analysis and allocations of overhead) in establishing \"good cause.\" Provide details of your calculations, which will aid DMS in establishing \"good cause\" and apply them to the two specific products shown in Table 3. (Hint: This will require you to perform cost allocations and select appropriate bases for the allocation(s).) What are your revised total cost per unit and overall profit margin amounts on the two products? IM A ED U C ATIO NA L C A S E JOURNAL ENDNOTES \u0007 n the other hand, customers with private insurance or O access to government medical programs are required to provide evidence of medical necessity, which is often indicated by physician orders, for reimbursement. 2 \u0007Medicare is a national social insurance program administered by the U.S. Federal Government since 1966, which guarantees access to health insurance coverage for U.S. citizens age 65 or older who have worked and paid into the program. Medicaid is a U.S. government insurance program for all U.S. citizens whose income or personal resources are unable to pay for their personal healthcare. 3 \u0007Department of Health and Human Services (HHS) and the Office of the Inspector General (OIG), \"Medicare and State Health Care Programs: Fraud and Abuse; Clarification of Terms and Application of Program Exclusion Authority for Submitting Claims Containing Excessive Charges,\" Federal Register Volume 72, No. 116, June 18, 2007. 4 \u0007The firm does not have any type of bank borrowings or debt, and thus there is no interest expense in overheadrelated expenses to consider. 1 5 VOL. 7, N O. 2, ART. 3, JUNE 2014 ABOUT IMA With a worldwide network of more than 70,000 professionals, IMA (Institute of Management Accountants) is the world's leading organization dedicated to empowering accounting and finance professionals to drive business performance. IMA provides a dynamic forum for professionals to advance their careers through CMA (Certified Management Accountant) certification, research, professional education, networking, and advocacy of the highest ethical and professional standards. For more information about IMA, please visit www.imanet.org. IM A ED U C ATIO NA L C A S E JOURNAL 6 VOL. 7, N O. 2, ART. 3, JUNE 2014