The CEO of St. Sebastian Health System, a moderate-sized hospital system in a mid-sized, Midwest city has hired you to help turn things around. The CFO is projecting a $3.7 million operating loss this year, which will be more than offset by non-operating income. However, the board has made it clear that the situation must improve. If the system cannot produce a positive operating margin in 2017, someone else is going to be the CEO. The CEO and CFO have asked you to recommend strategic approaches to selling their services in the community that will help turn the financial ship around.

Your Health System

St. Sebastian is a community-based health system. The senior management team has an average tenure of 17 years. The exception is the Chief Medical Officer (CMO). She has been in her position for two years and is the fourth CMO in that role in the past ten years. The CEO and COO have each been in their current roles for ten years. The system is comprised of the following:

Two large, acute care hospitals

Two long term care facilities

Two skilled nursing facilities

One long-term acute-care hospital (LTAC)

Four geographically distributed outpatient centers

Four Urgent Care Centers

Two free-standing ambulatory surgery centers (ASCs)

A 400 member employed physician group that includes 180 Primary Care Providers (PCPs). All 28

PCP practices are certified Level III Patient Centered Medical Homes by NCQA.

The remainder of the 1,000 member medical staff is generally comprised of large, independent groups who have varying degrees of loyalty to the system. The Radiology and Emergency groups, for example do 100% of their work at St. Sebastian and have no ownership of any outside facilities. The Gastroenterology group, on the other hand, does work at the hospital, but also owns their own, freestanding endoscopy center. The orthopedic group does 75% of their work at St. Sebastian, but maintains privileges at other facilities. They do not own their own ASC.

In the current year, St. Sebastian is projecting 220,000 patient visits (combined IP and OP) with an average cost per visit of $1,727. They have an average charge per visit of $4,545.

Over the past ten years, St. Sebastian has been active in pursuing a number of different strategic projects including:

They have established clinical institutes in cardiovascular, orthopedic, oncology, maternity and neurologic care. Each of these has been built through a co-management agreement between the system and the internal or external physician group who would be most logical. Each institute is led by a dyad of an administrator and medical director.

Five years ago, they consolidated maternity programs to one facility, a move that justified investing in a Level III Neonatal Intensive Care Unit (NICU)

They have established a research division in the hopes of working with national pharmaceutical companies and/or tertiary care hospitals in the Midwest.

They have established a Physician Hospital Organization (PHO) and intend to become an Accountable Care Organization (ACO) that can participate in the Medicare Shared Savings

Program (MSSP) and/or enter into global risk contracts with third party payers. The PHO is currently evaluating whether or not they should purchase an insurance license so that they could offer commercial, Medicare Advantage and Managed Medicaid insurance products.

5. They have established a Business Health division to service the corporate health needs of the employers in the region. This would include things like EAP programs, on-site wellness, drug screening, on-site clinics, etc. This division also recently built two large, full-service fitness centers.

The competition The community is currently served by three other major health providers:

Mercy is the competitor acute care system in town and has two hospitals and various outpatient centers. They have not been active in physician employment they employ a group of 60 PCPs, but no specialists. Similarly, they have not been engaged in branching out with different strategic initiatives, preferring instead to focus on cost efficient care. They do not have clinical institutes, research divisions, a PHO or a Business Health division. They have 230,000 visits per year, with an average cost of $1,435 per visit and an average charge of $4,348.

General Pediatric is a pediatric teaching hospital. Five years ago, they signed an affiliation agreement with Johns Hopkins to gain access to clinical and research capabilities that would have been beyond their reach, given their size. They employee essentially all of the pediatric subspecialists and have a PHO, which includes 75% of the regions primary care pediatricians. They will have 200,000 visits this year, with an average cost of $2,100 per visit and an average charge of $5,000 per visit.

General University is an adult teaching hospital affiliated with the local universitys medical school. They staff the regions free-care clinics and historically, have been the regions hospital for indigent/uninsured patients. They are the regions Level I trauma center and are well regarded for intensive services like trauma, stroke and cancer care. However, their location and reputation for taking indigent patients means that they are not preferred for normal medical care by commercially insured or Medicare patients. Besides the community health centers, they own an inpatient rehab hospital, but not other facilities. They have explored affiliations with national leaders in academic medicine, but so far have not signed any such agreements. They see 180,000 visits per year with an average cost of $1,833 and an average charge of $5,556 per visit.

There are no other hospitals currently operating, though there are 23 skilled nursing facilities (SNFs) and 3 inpatient rehab facilities throughout the region. They are independent actors and for the most part are struggling to stay profitable. There are several single-specialty physician groups who operate ambulatory surgery centers and one chain of independent diagnostic treatment facilities (IDTFs). Three years ago, there was a significant change in the state government, and that resulted in the long-time Certificate of Need (CON) program being all but scrapped (Skilled Nursing Facilities are still heavily regulated). Several for-profit hospital companies have recently done some analysis around entering your market, but have not done so yet.

The Community The community is a Midwest city and surrounding suburbs in the midst of a transition from a manufacturing employment base, which unfortunately accelerated with the 2008 economic downturn. The hospitals have seen this over the past several years in a tightening of benefits offered by local employers. Benefits continue to be offered, but increasingly are likely to have a significant deductible associated with them. Unemployment has been above the national average and is projected

to remain that way. This means that the average wage in the region is actually below where it was in 2008, when the last recession hit. The number of Medicare-age residents are projected to rise over the next 10-20 years, while working age patients are projected to stay flat or fall slightly. Similarly, birth rates are expected to fall slightly over the coming decade.

The community is 60 miles south, 45 miles east and 50 miles north of other, similarly sized cities. Until 20 years ago, that made this city effectively an island unto itself. Increasingly, however, the suburbs of each of these communities have become very close to each other. As that has happened, providers in each community have followed and established practice sites and free-standing outpatient centers.

The payers The community has a normal looking mix of Commercial, Medicare and Medicaid patients. Because the states governor was fiercely against the Affordable Care Act, the Medicaid expansion that happened in other states hasnt happened here. Thus, the community also has a sizable population without insurance today. As youd expect, different hospitals see a different mix of these patients. The local health council was able to provide you with the most recent years payer mix by hospital below:

Patient visits	Commercial	Medicare	Medicaid	Uninsured/Self-pay
Mercy	80,500	105,800	23,000	20,700
St. Sebastian	99,000	101,200	11,000	8,800
Gen. Pediatric	70,000	4,000	110,000	16,000
Gen. University	63,000	45,000	45,000	27,000
Community Total	312,500	256,000	189,000	72,500

Reimbursement the CFO was able to supply you with their best estimate for what various payers are reimbursing for services. In general, the commercial plans are paying 50% of charges, regardless of location, except at General Pediatric. There, the monopoly on pediatric services has allowed them to negotiate rates of 80% of charge, but only for the commercial plans. Medicare currently pays 30% of charges at all hospitals, and Medicaid pays 25% of charges everywhere. Uninsured patients are generally paying 2% of charges.

Case #1 A Market on the Move

Youve read everything you can about the legislative environment (both regionally and nationally) and spoken to several brokers who together advise most of the local employers in the region. You believe the most important changes that are about to hit this region are the following:

As Medicare reduces DSH and other payments, reimbursement from Medicare will drop from 30% of charges to 28%

The health exchanges established in the ACA have not been much of a factor in the region so far, but thats about to change. The two largest payers in your state both plan to really step up in the exchanges and market these plans aggressively both to currently un-insured and those with current, but unattractive employer-based coverage. They believe that by 2017, theyll have 25% of all commercially insured patients in exchange-based products.

There has been a change in both governor and the makeup of the state legislature, which means your state will engage in Medicaid expansion next year. Thus, more people will have coverage, and the uninsured population will diminish, but not go away entirely. Your best estimate is that uninsured visits community-wide will reduce from 72,500 to 8,300. You estimate that, of the patients who have new coverage, half will be Medicaid recipients and half will enter the commercial plans.

The assignment as you consider how to guide the CEO, answering the following questions should help:

Part A

Using the information provided, estimate total gross and net patient service revenue per hospital currently (2016). What is each hospitals operating margin in terms of dollars and percentage? Based on this, who is doing well, and who is not? Who has the most to gain and lose as the current environment changes?

Based on what you know will happen with the next year, re-calculate the estimates from question #1 for 2017. In your estimate, assume that commercial, Medicaid and uninsured patients still pay the same % of charges. As you consider the population that moves into commercial insurance and Medicaid, you can assume that each hospital continues to take the same share of each payer category (in other words, if hospital A had 20% of the commercial visits in 2016, they will have 20% in 2017). You can also assume that total visits and charge and cost per visit numbers will remain as they were in 2017.

Based on everything youve read, the payers putting products into the health exchanges want to market these as true, lower cost options. To get there, they will not reimburse as much as other commercial products. In fact, your best estimate is that they will pay 120% of the Medicare reimbursement rate. If that is the case, how does your estimate of 2017 performance change? Is this good or bad? You may want to answer that question from the perspective of the region as a whole and then for each hospital. Assuming it was optional, would you recommend that St. Sebastian participate in the exchange-based products?

Part B

In this city, there are two major payers who together cover 85% of the commercial insured lives. They have both approached St. Sebastian about forming narrow networks as a vehicle for selling products in the exchanges. Your hospital has an excellent reputation, and both payers would like to sell a product that features your hospital as the only in-network option for adult care. So, in exchange for agreeing to a reimbursement rate of 120% of Medicare, St. Sebastian would garner 75% of the hospital visits in the exchanges. For the rest, assume Pediatric continues to serve the same number of patients (i.e. same as youve projected for 2017 previously) and the remaining visits are evenly split between Mercy and University. Is this an offer that St. Sebastian should accept?

You strongly suspect that both payers also made this offer to your competitor, Mercy. Based only on what you know about the financials, are they likely to accept this deal? If the payers are going to choose only one partner, do you advise your CEO to aggressively pursue a first to sign strategy, or hang back and allow Mercy to act first?

Thus far, weve assumed that all costs are variable (i.e. $2,100 per visit for Pediatric), but is that necessarily true? Suppose for a moment that each hospitals cost structure is essentially fixed? How does that change your answers to #2, 3, 4 and 5 above?