Question
The speaker was Gus Mahler, Chief Financial Officer of Converse Health System (CHS). He was speaking with Rob Shuman, M.D., CHSs Senior Vice President for
The speaker was Gus Mahler, Chief Financial Officer of Converse Health System (CHS). He was speaking with Rob Shuman, M.D., CHSs Senior Vice President for Medical Affairs, about his concern that, despite a change in the control structure and incentive system at one of the systems hospitals, many primary care physicians (PCPs) were continuing to admit to the hospital patients who could be treated appropriately in a less expensive setting. He wanted to enlist Dr. Shumans help with the problem.
BACKGROUND
Converse Health System began through a merger of St. Lukes Hospital and Medical Center with HealthGroup. St. Lukes was a 283 bed tertiary care facility located in downtown Mansfield. HealthGroup consisted of two hospitals: Mansfield Memorial Hospital and Lakeview Medical Center. Mansfield Memorial was a 454 bed tertiary care facility located approximately 2 miles from St. Lukes. Lakeview was a smaller hospital about 2 miles from Mansfield and St. Lukes. The merger also involved a large visiting nurse association and several smaller providers, including an occupational medicine group practice, two urgent care centers, a sub-acute care hospital, a skilled nursing facility, a birthing center, and a mortuary. Some two years later, the management and medical staffs at Mansfield, St. Lukes, and Lakeview were consolidated. For the next two years, the three hospitals, plus the other providers and several physician group practices that had been acquired, were run as Affiliated Health Care. Two years after that, Affiliated was acquired by SecureHealth, a large (150,000 member) health maintenance organization. The resulting entity was named Converse Health System in memory of the board member who had initiated the acquisition and who had died shortly before its consummation. During the next two years, SecureHealths enrollees doubled, slightly exceeding 300,000. In addition, Converse acquired several more physician group practices, and became, in the words of Kerry Johnson, its CEO, a fully-integrated and exclusive integrated delivery system. That is, with a few exceptions, patients received all their care within the system, and the systems operating entities provided care only to the enrollees of SecureHealth.
Mansfield Area Market
Approximately 85 percent of the Mansfield metropolitan area population was enrolled in managed care plans. Over 70 percent of the Medicare eligible population and all of the Medicaid population were enrolled in federally qualified HMOs. Inpatient utilization for the Mansfield area averaged 340 days per 1,000, well below the national average. There were seven hospitals in the area, operating at an overall occupancy of about 65 percent. The Mansfield area market was dominated by Converse and one other major delivery system. Like many markets, Mansfield was characterized by an oversupply of physicians, especially specialists, which created a highly competitive physician market. Because of this competition, one of the exceptions to Converses fully integrated and exclusive status was that it did not own a large number of specialist physician groups. Instead, it had contractual relationships with physician practices in each specialty; the specialists also provided care to patients outside SecureHealth.
Converse Organization
Exhibit 1 shows Converses organizational structure. As it indicates, the provider units (St. Lukes Hospital Mansfield Memorial Hospital, Lakeview Medical Center, Mansfield VNA, the affiliated providers, and the 15 physician group practices) were supported by Administrative Services, Information Resources, Materials Management, Quality Leadership, Financial Services, Corporate Development, Marketing, Legal Services, and Human Resources. Converse had a single Board of Directors. In addition, each operating unit had a community board that oversaw local issues, including fund raising activities. Medical staff credentialling and quality assurance were centralized functions under the direction of Dr. Shuman.Role of SecureHealth. SecureHealth is not shown on Exhibit 1. In effect, the entire organizational structure in Exhibit 1 comprised the HMO. Marketing, for example, was oriented toward purchasers, such as corporations, other businesses, and state and local government. Medical care was provided by the physicians in the 15 group practices, the specialists under contract, and the various delivery entities. In effect, Ms. Johnsons role as CEO was to:
- Coordinate strategic planning and marketing functions for the entire system, including the HMO.
- Coordinate the effective and efficient use of resources throughout the system.
- Assure timely access to the information needed to manage care.
- Develop appropriate economic incentives based on shared risk and reward.
- Instill and maintain a shared commitment to high quality patient care with superior outcomes.
FINANCIAL CONTROL ISSUES
Prior to the recent year, all provider entities in Converse had been designated as profit centers. During the budget formulation process, each entity forecasted the amount of surplus it would generate. Ms. Johnson and Mr. Mahler then compared the aggregate surplus for all entities with the expense budgets from the corporate level, and the amount of revenue that the marketing department believed the HMO would generate. The result was a forecast for the overall operating surplus of the system. This figure was taken to the boards finance committee, and discussed. If necessary, the budget was revised by asking service groups to cut their expenses, or provider entities to improve their profitability. The budget then was finalized for presentation to the board. The board vote usually was in support of the finance committees recommendation. Two year ago, in conjunction with the enrollee growth in SecureHealth, it became apparent that the operating entities were generating very little revenue on their own. Instead, most of their revenue was coming in the form of sales to SecureHealth. Mr. Mahler realized that, while there always had been some double-counting of revenue (that he and his staff needed to net out for the overall budget), the double counting had become quite large. After some considerable thought and analysis, and with approval from the boards finance committee, Mr. Mahler decided to eliminate profit centers at the provider level. Or so he thought. He commented:
It was pretty crazy, with all the double counting and what not. We brought in some consultants who convinced us that the only profit center that made any sense was the HMO. It generated most of the systems revenue. Beyond billing the HMO, which is what created all the double counting, the providers were generating very little revenue of their own.
So we told the hospitals and the other providers that from now on they would be standard expense centers. We told them that we would create transfer prices and use them to flex their budgets each month. In effect, when a doc sent a patient to a hospital, the HMO would buy care from the hospital at the transfer price.
While that may not seem like much of a change from the past, it made a big difference to the hospitals financial responsibility. In particular, a hospital no longer needed to worry about marketing or meeting volume projections. Instead, all admission decisions would be in the hands of the PCPs. So, once we flexed the budget with the transfer prices and the actual volume and mix of discharges, the hospitals job would be to spend at or below the flexed amount. We called this amount the performance budget. We said that we planned to tie key managers bonuses to the difference between the performance budget and the hospitals actual expenses.
Well, they didnt like it, in part, I think, because they saw a big decrease in their power within the system. The discussions seemed endless. Everyone feared a loss of bonus. Thats what it came down to. At the end, we agreed to try the new system on an experimental basis with St. Lukes. We agreed that if we could make it work for St. Lukes, we would expand it to the other hospitals, and then to the affiliated providers.
We also knew that, once we had the kinks worked out, we would need to expand the new budgeting process to include the physician practices. But no one even wanted to go near that one. So we left it alone for a while. For the time being, however, we agreed that the physicians would be allowed to share in any bonuses that St. Lukes earned under the new system. We figured that doing so would give them an incentive to examine their ordering patterns, and also pave the way for some more substantial changes later on. We increased the bonus percentage in order to expand the potential pool. That way, no one would be worse off as a result of including the physicians.
THE EXPERIMENT
The experiment with St. Lukes began as part of the current years budget cycle. Late last year, unlike previous years, St. Lukes submitted an expense budget only for the current year. The budget was based on its anticipated volume of discharges. The agreed-upon budget had total expenses of $136,858,946 and total projected discharges of 17,310, resulting in a transfer price of $7,906 per discharge. Exhibit 2 contains the details for Pediatric Cardiology. This was part of thebudget for Pediatrics, which was part of the overall hospital budget (Exhibit 3). The plan was to use actual discharges to flex the budget each month, and to compare the results to the actual expenses for the month. An abbreviated summary of the results for the first three months is shown in Exhibit 4. It was this that prompted Mr. Mahlers comment at the beginning of the case. He elaborated:
Look, 17,310 annual discharges works out to an average of about 1,440 a month. January was a bit high, but not too worrisome. But they kept growing each month. I would expect this from the hospital if it were a profit center, but why when its a standard expense center?
When I began to look into it, I found that the physicians were making all sorts of questionable admissions. Things like childhood asthma, which could be treated in most instances on an outpatient basis. I then found that the hospitals senior management was meeting with the docs, and telling them that there were plenty of empty beds. They were telling the docs that it would be easier to treat their patients if they put them in the hospital.
Although no one will say so, I also think the hospital people figured out what would happen to the surpluses, and made it clear to the docs that their bonuses would be higher if they admitted the patients. But Im not going to raise that one...at least not yet.
Now, Ive got to prepare an explanation to the finance committee. Theyre furious. I had convinced them that this standard expense center approach was a good idea, and now its killing us. If I cant convince them its a good ideawhich I still think it isI wont be able to extend it to the other hospitals and providers in the system.
The Finance Committee Meeting
At the Finance Committee Meeting, Mr. Mahlers first challenge came from Richard Strauss, a professor of accounting at a local university, and a member of the committee:
The problems pretty simple, Gus. Youve ignored the fact that St. Lukes has both fixed and variable costs. Obviously, when they increase their volume, they increase only their variable costs, not their fixed ones. While the fixed/variable split no doubt varies from department to department, I used an average of $4,000 variable cost per case. Then, by treating fixed costs as the residual, I came up with a set of numbers that was identical to St. Lukes first quarter results, except with fixed and variable costs split out (Exhibit 5).
Mr. Mahlers response was not especially respectful:
Its not that simple, Rick. First, while neat splits between fixed and variable costs may work in the classroom, they dont work so easily here. Where did you get the $4,000 figure for example? What makes it right? And what about the fact that your so-called fixed expenses are actually increasing each month?
But leave all that aside for the moment. How does your analysis help me deal with the bigger problem? It seems to me that it doesnt matter whether we do the fixed/variable splits or not. The fact is that by increasing discharges above budget, St. Lukes can increase its surplus, and hence its bonuses, while at the same time decreasing the systems surplus. How can having information on fixed/variable splits help me deal with that?
At this point, John Bach, the treasurer of the board, and finance committee chair intervened:
I dont want you to think were ganging up on you, Gus, but Rick and I actually spent some time working through this. In addition to ignoring fixed/variable splits, you also ignored the hospitals case mix in setting the per-discharge transfer price. Were not sure why since, as we all know, case mix can have a pretty profound impact on costs.
Since thats an even trickier item to deal with than variable costs, I prepared a relatively simple example to illustrate my point [Exhibit 6]. Its all hypothetical, of course. But note that the only change I made was in case mix. I left the number of cases at 1,000, and kept all the resources the same, although I did separate them into their fixed and variable pieces. Look what happens. The transfer price changes by almost 14 percent! What this tells me is that if I were St. Lukes, Id be budgeting for a complicated case mix, getting a high transfer price, and then trying to bring in a less complicated case mix. Wouldnt you?
Mr. Mahler responded:
Well, I guess so, but Im not sure. Im also a little confused by your example. It has a lot of elements that werent in our original budget. Are you suggesting that I try to get St. Lukes to develop something like this? If so, I think Ill have a palace revolt on my hands!
As the meeting broke up, Mr. Mahler realized that he had a complicated task before him if he was to preserve the idea of standard expense centers, although he now was wondering whether standard expense centers were appropriate under the circumstances. Yet, he could not see how reinstating profit centers would help either.
He reviewed the information that his staff and the accounting people at St. Lukes had developed for St. Lukes budget, as well as the first quarter report he had received and the information provided to him by the finance committee. In doing so, he wondered how he might change the financial control system to deal with the various problems that had arisen, including the incentives that existed under both the profit center and standard expense center structures to hospitalize patients inappropriately.
- What is your assessment of the way Mr. Bach has structured Exhibit 6? What is the value of having fixed and variable costs separated in this way? Is the Exhibit 6 analysis an improvement over Mr. Strauss analysis in Exhibit 5? Can an analysis of this sort be done in the real world?
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Rethinking Public Private Partnerships
Authors: Mervyn K. Lewis
1st Edition
1789906393, 9781789906394
