Methodist Medical Center (MMC) offers inpatient critical care and is currently partnered with an insurance company to take care of 15,000 members. The insurance company is reimbursing MMC by fee-for-service and the average reimbursement rate is $10,000 per admission. Financial information of MMC is as the following: Average revenue per admission = $ 10,000. Average variable cost per admission = $ 4,000. Direct fixed cost or overhead = $9,000,000.

1. Whats the break-even volume of MMC?

2. MMC offered service to 1,800 patients last year to members covered by this insurance company. At this service volume, how much is the degree of operating leverage?

The payer is negotiating the managed care contract for the coming year and proposed two alternative reimbursement options:

Option A: Discounted fee-for-service with 5% on average reimbursement per admission

Option B: Capitation payment and pay $90 Per Member Per Month (PMPM) for the 15,000 member. In the meantime, the insurer will jointly work on a preventive care department project with the hospital and cover the initial investment. The new preventive care department is to deliver preventive care to members covered, which aims population health improvement. The admission is expected to reduce to 1,600 and the variable cost per admission is expected to reduce to $3,500. However, fixed cost to run the preventive care department will cost additional $500,000 to MMC.

3. Compute the profit and the degree of operating leverage for option A assuming the same volume as last year (1,800). Discuss the profit and business risk compared to the current fee-for-service payment.

4. Compute the profit for option B.

5. Compute the minimum PMPM rate to charge in option B in order to breakeven.

6. Discuss the pros and cons of each payment option in terms of profit and financial risk for MMC.