Then go to Case 9 Cambridge Transplant Center. Read the case study and then recommend a fixed reimbursement amount (base rate) that should be proposed in the contract negotiations for Phase 4 hospital services. Use excel to compute the base Then provide the following on the organization: what is its underlying cost structure; should the hospital worry about a long-term pricing strategy or only think in terms of each contract year; and lastly, if the price is set significantly lower than the average reimbursement amount paid by current payers, what impact would that have on future negotiations with those payers. CAMBRIDGE TRANSPLANT CENTER (the Center), which is part of University Healthcare System, is a regional leader in the very intense and medically sophisticated area of organ transplantation. All transplants are performed at Cambridge General Hospital, the 400-bed flagship of University. The administrative director of the Center, Josh Zimmerman, has been on the job for ten years, during which time significant growth has occurred in both the number of transplant programs and the volume of procedures performed. When Josh joined the Center, he was put in charge of a kidney transplant program that averaged 60 transplants per year and a heart transplant program that performed 40 transplants annually. Today, the Center performs more than 500 transplants per year, including transplants from liver, lung, and pancreas programs. Of all of the Center's organ programs, the liver transplant program is the most successful in terms of volume and revenue. Last year, volume totaled 120 transplants, bringing in more than $50 million in total revenues. This year, Josh is optimistic that the liver program can do even better. However, he knows that increased volume is largely dependent on the number of organ donors and on his success in negotiating a new contract with Lifecare Transplant Network (LTNET), the largest transplant benefits company in the nation. Although most health insurers can identify those patients who are good candidates for transplant services, only the largest health insurers have the expertise to manage the transplant process. Transplants are relatively rare compared with other, more conventional medical procedures. However, the costs to insurers for transplant services are typically very largeusually in the six- to seven-figure range. To ensure the best and most cost-effective management of transplant services, most insurers outsource transplant management to companies that specialize in these services, such as LTNET. Contracting for transplant services is unique and complex because of the sophistication of the medical procedures involved. Transplant services consist of five phases: (1) patient evaluation, (2) patient care while awaiting surgery, (3) organ procurement, (4) surgery and the attendant inpatient stay, and (5) one year of follow-up visits. The costs involved in Phase 1 are relatively simple to estimate, but the resource utilization, and hence costs, of the remaining phases can be extremely variable because they differ in patient acuity and surgical outcomes. Historically, reimbursement for transplant services has been handled in a number of ways. Initially, many transplant providers bundled all five phases and offered insurers a single, global rate. This method simplified the contracting process, but the rate set for this method was often chosen on the basis of building market share rather than on covering costs. Indeed, many institutions could not even estimate with any confidence the true costs of providing transplant services. Ironically, success in gaining market share usually increases the financial risk of the transplant program because higher volumes increase the likelihood of attracting higher-acuity patients. Furthermore, changes in the organ allocation system have promoted the acceptance of sicker patients into transplant programs. Although the total costs associated with all phases of a liver transplant average about $500,000, the amount can more than quadruple if the patient requires a re-transplant or if other complications occur. Because of this extreme variability in costs, outlier protection is a critical aspect of contract negotiations if the reimbursement methodology is a fixed prospective rate, such as a global rate. The LTNET contract requires the approval of Dr. Anjali Desai, the newly appointed surgical director of the liver transplant program. Fortunately, like Josh, Dr. Desai is enthusiastic about turning the liver transplant program into one of the largest in the country and is motivated to secure the contract. In his second meeting with Dr. Desai, Josh discussed the specifics of the current contract negotiations. Phases 1, 2, and 5 will be reimbursed at a set discount from charges. Furthermore, to reduce the amount of financial risk borne by the Center, Phase 3 (organ procurement) will be reimbursed on a cost basis, which makes sense because the cost of Phase 3 is almost completely uncontrollable by the Center. Thus, the primary focus of the negotiations, and the make-or-break part of the contract, is the reimbursement amount for Phase 4. (For more information on organ procurement, see the United Network for Organ Sharing website at www.unos.org.) Phase 4 costs are divided into two categories: hospital costs and physician costs. Physician reimbursement has already been agreed on, with LTNET committing to pay a fixed amount per physician work relative value unit (RVU). Thus, the primary matter at hand involves only Phase 4 hospital costs. To aid in the negotiations, Josh compiled the Phase 4 hospital costs of the 12 most recent liver transplant patients. These data are presented in exhibit 9.1. Dr. Desai was amazed when she read the numbers. A total average cost of $119,805 for 19 days average length of stay (ALOS) translates to a per diem average cost of more than $6,000. She was sure that LTNET would not be willing to sign a contract that paid the hospital $120,000 (or more) to cover Phase 4 hospital costs. Thus, she suggested that Josh reexamine the cost structure to see if these costs could be reduced. At first glance, it appeared that a large cost savings could be realized by merely reducing ALOS. For example, Phase 4 hospital costs associated with a particular patient could be reduced by more than $12,000 by decreasing ALOS by two days. However, further analysis revealed that the costs associated with Phase 4 are not a linear function of ALOS. Internal studies at the Center indicated that the first day of Phase 4 is usually the most costly and the last day is usually the least costly. Indeed, roughly 70 percent of Phase 4 costs occur in the first 24 hours of hospitalization. When lowering Phase 4 hospital costs appeared to be difficult, Josh decided to pursue a different strategy. He believed that economies of scale are present in liver transplants, and hence the marginal cost of each transplant is lower than the average cost. Thus, he proposed that the Phase 4 hospital reimbursement amount be based on marginal rather than total (full) costs. You have been hired as a consultant to recommend a fixed reimbursement amount (the base rate) to propose during the contract negotiations for Phase 4 hospital services. To help in the analysis, Josh has indicated that approximately 60 percent of nursing, ancillary, operating room, and laboratory costs are fixed. The remaining costsradiology, drug, and other servicesare predominantly variable. Furthermore, current payers are reimbursing the hospital at roughly $140,000 for Phase 4 services. The Center has sufficient capacity to handle about 30 more transplants before fixed costs would increase by a meaningful amount. If marginal volume exceeds 30 transplants, the best estimate is that fixed costs would increase somewhere between 15 and 25 percent. In addition, you have been asked to recommend a method for handling outliers, including the threshold amount and additional reimbursement scheme. Other programs within the Center use two methods for outlier payments. One method is to charge an additional per diem amount based on a length-of-stay threshold. Alternatively, some percentage of costs above the threshold can be charged when a cost threshold is reached. As you think about the problem at hand, several other issues will come to mind. First, is it useful to identify the underlying cost structure of the Phase 4 hospital services? (It might help in thinking about the relevant issues.) Second, should the hospital worry about a long-term pricing strategy, or is it sufficient to think only of the first-year contract? Finally, if the price is set significantly lower than the average reimbursement amount paid by current payers, what impact would that have on future negotiations with those payers? H A Exhibit 9.1 ! e Cambridge Transplant Center: Phase 4 Hospital Costs (in Millions of Dollars) dovs Pateint Age (years) LOS

My main concern is estimating the fixed costs. Please see highlighted portion. Thanks!