Read the case study, Boston Children's Hospital - Measuring Patient Costs. What was the costing method previously used by BCH? Why are clinical department heads Drs. Meara and Waters interested in developing more accurate cost estimates for their procedures? What strategic mistakes might the their department make due to incorrect estimates of costs?

914--07 Boston Children's Hospital: Measuring Patient Costs (Abridged) Boston Children's Hospital: Measuring Patient Costs (Abridged) 914-407 BCH Physicians were employed by 15 Foundations, not the hospital itself. Each clinical department had a Foundation that ran the physician practices, independently of both the hospital and each other. A Foundation rented clinical space from the hospital and charged patients for the professional services rendered by its physicians, a charge separate from that charged by BCH for non- physician services. While financially and legally distinct , the 15 Foundations were organized into one central Physician's Organization (the "P.O."). The P.O. oversaw collective contracting and shared management initiatives. The P.O. had a defined working relationship with the hospital; P.O. directors served on the hospital's board of directors and hospital executives served on the P.O.'s board. Amidst these private insurer initiatives, financially-pressured state and local governments had been reducing their reimbursements to medical care providers. BCH's contract with New Hampshire's Medicaid program had recently lapsed, and the state was unsure whether it could continue to afford to send patients to BCH. If other states made similar decisions, fewer low-income patients would have access to BCH facilities and care, Dr. John Meara, Chair of the Department of Plastic and Oral Surgery, had been conducting a pilot project in his department to better measure costs and outcomes. Meara was convinced that the care provided at BCH was outstanding: Our outcomes are superior to those of our competitors, and even though we may have higher unit prices for individual procedures, we believe that our total medical expenses for a particular condition are lower over the full care cycle. We treat patients more efficiently with fewer complications and fewer visits than other providers. He knew, however, that more accurate cost information would help him define and negotiate bundled payments with payors. BCH management wondered whether Meara's costing initiative could provide additional insight into the drivers of cost at BCH and help BCH further improve its care delivery processes and create forward-looking value-based reimbursement mechanisms. Cost Measurement at BCH Not all physician foundations used a costing system. Those that did, such as the Department of Plastic and Oral Surgery and the Department of Orthopaedic Surgery, used the Ratio-of-Cost-to- Charges (RCC) approach. RCC was a simple and easy to use cost system for hospital departments and physician practices. First developed in the 1960s, the RCC approach assumed that costs were proportional to charges, which allowed financial managers to use readily available charge data to calculate costs. Local and National Market for Pediatric Care In 2006, Massachusetts began enacting health reforms that expanded insurance coverage to all residents through a combination of mandates and subsidies. In 2008, the state formed a Special Commission on the Health Care Payment System to address rising health care costs. The commission's final report recommended a transition to risk-adjusted global payments for all providers in the state. Many believed that the health reforms in Massachusetts foreshadowed coverage expansions and new national payment models in response to rising cost pressure. BCH, the only freestanding pediatric hospital in Boston, had historically reported higher costs (and prices) than local pediatric wards embedded within adult hospitals (see Exhibit 4). One local alternative, Tufts Floating Hospital for Children, a unit embedded within the much larger Tufts' Medical Center in downtown Boston, had been recognized for charging prices 50% lower than BCH's while producing comparable outcomes.3.6 Floating Hospital had seen its volume and revenue from pediatric care grow significantly over the last few years. Payors, reacting to BCH's higher prices, began excluding BCH from certain offerings while simultaneously increasing cost sharing in their tiered/limited network plans that still included BCH. In 2012, these tiered/limited network plans represented almost 15% of the Massachusetts market.' BCH executives clearly saw the challenge of sustaining its industry-leading ranking and research agenda amidst the intense local and national pressure to reduce costs. They knew that their prices were comparable to other free-standing pediatric hospitals around the country, and suspected that the costs reported by pediatric wards within full service hospitals might be under-reported due to cross-subsidies from more lucrative adult departments. They knew, however, that BCH did incur higher costs fulfill its substantial research and teaching missions and to care for a significantly more complex and resource-intensive patient population. BCH had been experimenting with new reimbursement approaches and, in 2012, became the first pediatric hospital to enter into an Alternative Quality Contract (AQC) with Blue Cross Blue Shield of Massachusetts. This three-year AQC signaled a shift from fee-for-service reimbursement to fixed payments with additional rewards based on savings generated and quality targets reached. The contract specified no rate increases for 2012 and modest increases below inflation for the remainder of the agreement. Other public and private payors were also approaching BCH to negotiate bundled payments that would cover whole episodes of care that would replace traditional fee-for-service reimbursements. The RCC method first collected all the charges produced by a revenue-producing clinical department, such as Orthopaedic Surgery. It then aggregated all the department's traceable expenses, such as the costs of personnel compensation, equipment , supplies, information systems, and billing. To these, it added the hospital's allocations of shared costs-such as for utilities, space, and housekeeping-to the department. The method divided the sum of all departmental traceable and allocated costs by the department's total charges to calculate the department's RCC rate. To calculate the cost of any particular departmental procedure or intervention, it multiplied the procedure's charge by the department's RCC rate. For example, a department with total costs of $4.2 million and total annual charges of $7.0 million would have an RCC of 0.6. The cost of any single billable event was estimated by multiplying the procedure's charge, say $800, by the RCC (for a cost of $480). The charges in the RCC calculation came from physician practices' charge masters, in effect, the "list prices" for these services, which were based on physician fee schedules established by the Centers for Medicare and Medicaid Services (CMS) (see Exhibit 5). Tufts network estimated an average of $6,000 lower per comparable admission. Martha Coakley's 2008 report estimated that BCH was paid almost twice as much per patient as Floating for similar care; but these figures are averages not adjusted for the complexity of patients Many hospital units also used the RCC method to assign departmental costs to procedures and services. Some used a more sophisticated and complex allocation method based on internally-derived Relative Value Units (RVU). 3