Health reform implementation transforms hospital financial management

A healthcare revolution is underway and a fundamental change in healthcare delivery and payment models is taking place. Providers are consolidating into large systems and payments are being aligned with value delivered. Only highly-integrated networks with proven care management capability will be optimally positioned to compete in the new environment.

Hospital financial managers are sailing in heavy crosswinds amidst increasingly turbulent economic waters. According to the American College of Healthcare Executives’ annual member survey of top issues confronting community hospitals, financial challenges again ranked number one on the list in 2014 – ahead of healthcare reform implementation, governmental mandates, patient safety and quality, care for the uninsured/underinsured, patient satisfaction, physician-hospital relations, population health management, technology and personnel shortages. 

The financial challenges cited and ranked were adequacy and timeliness of payment under Medicare and Medicaid, uncollectable emergency department charges and other bad debt, decreasing inpatient volumes, competition from other providers, government funding cuts, rising costs, inadequate funding for capital improvements, and converting charges to cash through effective revenue cycle management.

Largely macro-economic factors have driven community hospital net operating margins from patient revenue to 0.7 percent and the sources for patient revenue that are most regulated and volatile – Medicare, Medicaid and other government-funded sources – have collectively grown to 43 percent of all personal health expenditures (ACHE Key Industry Facts 2014; 2012 data). 

While the financial storm at the surface rightfully earns its place as the top issue confronting hospitals, it is the tempest on the sea floor (ranked #2 on the ACHE survey) – healthcare reform implementation – that is the most transformative source of economic pressure and concern for hospital financial managers.

There’s a hole in the bottom of the sea!

To implement healthcare reform initiatives, hospitals are faced with enormous capital investments over and above the day-to-day financial challenges noted in the survey. Hundreds of millions of operating and capital budget dollars are being invested to standardize processes, eliminate waste, avoid readmissions/infections that increase costs and incur penalties, position for the shift to value-based purchasing, create and manage new economic models that align incentives of payers and providers, and build physician networks.

The following are four of the most notable capital-intensive activities that are driving the sea change for hospitals.

Technology.  The American Recovery and Reinvestment Act of 2009 (ARRA) set forth a plan for the advancement of a nationwide health information network to improve the quality and efficiency of care. Central to this vision is the widespread adoption of enterprise electronic health records (EHR) for hospitals. While this plan and subsequent legislation were designed with financial rewards to incentivize adoption by hospitals, determining the anticipated costs to implement an EHR has proved difficult and is usually underestimated.

A 2011 Altarum Institute study reported the average five-year EHR total cost of ownership for small, rural hospitals was about $1.6 million. Large hospitals and health systems invest millions more – including initial costs of the software, upgrades, annual maintenance and support fees, training costs, computer and networking hardware costs, costs associated with backup and possible disaster recovery of the system and more.

Physician Integration & Alignment.  Hospital-physician economic integration and alignment activity, as measured by physician employment trends, is on the rise. This vertical integration is not driven by the explicit goals of reducing cost or improving quality. Rather, the drivers are financial need and competitive advantage on the part of physicians and response to the 2010 Affordable Care Act (ACA) – calling for accountable care organizations (ACO), bundled payments, medical homes, and value-based purchasing – on the part of hospitals.

Merritt Hawkins’ 2014 Review of Physician and Advance Practitioner Recruiting Incentives shows physicians employed by hospitals increased from 11 percent in 2004 to 64 percent in 2014, so there is a significant trend to employment. The capital investment to acquire physician practices is material, but it is the recurring annual loss per hospital-employed physician that hospital financial managers feel most. The MGMA 2013 Cost Survey Report (2012 data) put the median annual loss at $176,463 per hospital-employed FTE physician and the 2014 report (2013 data) reveals losses greater than prior levels for primary care, non-surgical specialties and surgical specialties.

A recent 2014 Kentucky Healthcare Industry Study entitled “The Challenges of Integrating Physician Group Operations” supports the MGMA data showing 92 percent of hospital-employed physicians with a reported loss in 2014 and 58 percent with a loss in excess of $100,000. That study also found that, the longer physicians have been employed by a hospital or system, the higher the likelihood for increased operating losses.

Hospital Mergers/Acquisitions & Affiliations.  The volume of mergers and acquisitions in the healthcare sector has steadily climbed and now exceeds M&A in all other industries. Within the healthcare sector, there were 166 hospital/clinic M&A deals valued at over $4 billion in 2014 (Dealogic; 2014 data) and the growth trend is expected to continue into 2015. Industry analysts also anticipate non-transaction hospital activity, including cost-sharing affiliations and joint operating agreements, to be robust and growing into 2015. These affiliations do not necessarily involve changes in governance or ownership, but are an effort of the hospitals/health systems to achieve more scale, which translates into negotiating clout with payers who are developing narrow networks – and they cost hospitals millions of dollars annually.

Narrow Network Development.  Narrow networks existed long before ACA. They were developed in the 1990s by insurance companies and large employers to control healthcare costs.  Narrow provider networks are logical in healthcare for the same reasons narrow supplier networks exist in every other industry – value is created by selecting the low-cost providers that meet quality standards. Community hospitals are now in on the act in a big way because ACA will usher in dramatic shifts in health insurance coverage over the next decade. They are investing heavily in narrow network development, either on their own or through affiliations with large systems. The enormous capital investment to develop and manage these networks, coupled with the anticipated price-sensitive shopping on the exchanges has huge implications for the future finances of hospitals.

Austin B. Kirkland is the principal & founder of Outperform, LLC and a member of The National Society of Certified Healthcare Business Consultants.