THE CRIMSON PRESS CURRICULUM CENTER THE CRIMSON GROUP, INC. Converse Health System don’t get it! We switched St. Luke's from a profit center to a standard expense center, and yet they continue to encourage the PCPs to admit patients that we all know could be treated as outpatients, What's going on? Maybe we should just switch back to profit centers and be done with it The speaker was Gus Mahler, Chief Financial Officer of Converse Health System (CHS). He was speaking with Rob Shuman, M.D., CHS’s Senior Vice President for Medical Affairs, about his concer that, despite a change in the control structure and incentive system at one of the sys- tom's hospitals, many primary cage physicians (PCPs) were continuing to admit to the hospital pa- tients who could be treated appropriately in a less expensive setting. He wanted to enlist Dr. Shu- man’s help with the problem. BACKGROUND Converse Health System began through a merger of St. Luke's Hospital and Medical Center with HealthGroup. St. Luke's 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. Luke's. Lakeview was a smaller hospital about 2 miles from Manstield and St. Luke's ‘The merger also involved a large visiting nurse association and several smaller providers cluding an occupational medicine group practice. two urgent care centers, a sub- a skilled nursing facility, a birthing center, and a mortua Some two years later, the management and medical staffs at Mansfield, St. Luke's, 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 consumima- tion During the next two years, SecureHealth’s 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 system's operating entities provided care oaly to the enrollees of SecureHealth, in- cute care hospital, Mansfield Area Market Approximately 85 percent of the Mansfield metropolitan area population was enrolled in man- aged care plans, Over 70 percent of the Medicare cligible population and all of the Medicaid popu lation were enrolled in federally qualified HMOs. Inpatient utilization for the Mansfield area aver- aged 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. ike many markets, Mansfield was characterized by an oversupply of physicians, especially spe Cialists, which created a highly competitive physician macket, Because of this competition, one of the exceptions to Converse’s 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 prac- tices in each specialty; the specialists also provided care to patients outside SecureHealth. See Agsigumest gn pyle + Pleere ance all Kuce Queat Sits BR a EPR *Converse Organization Exhibit 1 shows Converse’s organizational structure. As it indicates. the provider units (St Luke's Hospital Mansfield Memorial Hospital. Lakeview Medical Center, Mansfield VNA. the af filiated providers, and the 15 physician group practices) were supported by Administrative Services, Information Resources, Materials Management, Quality Leadership, Financial Services, Coxporate 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 ditection of Dr. Shuman. Role of SecureHealth. SecureHealth is not shown on Exhibit 1. In effect, the entire organ- izational 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, Johnson's 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 out- comes. 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 sumplus it would gen- erate. Ms. Johnson and Mr. Mabler 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 igure was tken tothe board's finance commie, and discussed. Ir necessa 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, Tle board vote usually ‘was in support of the finance committee's 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 theit own, Instead, most of their reve- Tue Was coming in the form of “sales” to SecureHealth. Mr. Mahler realized that, while there al- ways 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 board’s finance committee, Mr. Mahler decided to eliminate profit centers at the provider level. Or so he thought He commented 1k was pretty crazy, with all the double counting and what not. We brought in some consultants who cone Vinced us that the only profit center that made any sense was the HMO. Tt generated most of the system's revenue, Beyond billing the HMO, which is what created all the double counting the providers were genes ing very litte 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 @ hospital, the HMO would “buy” care from the hospital atthe transier price While that may not seem like much of a change from the pas, it made a big difference o the hospitals financial responsibility. In particular, « hospital no longer needed to worry about marketing or mecting vole lume projections. Instead, all admission decisions would be inthe 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 ot 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 hospital's ace tual expenses. Well, they didn’t like it, in part, I think, because they saw « big decrease in their power within the sys- tem. The discussions seemed endless. Everyone feared a loss of bonus. That's what it came down to. At the end, we agreed to try the new system on an experimental basis with St, Luke's. We agreed that if we could make it work for St. Luke's, we would expand it to the other hospitals, and then to the afilited proe viders ‘We also knew that, once we bad the kinks worked out, we would need to expand the new budgeting proc- 68810 include the physician practices, But no one even wanted to go near that one. So we left it alone for a \shile. For the time being. however, we agreed that the physicians would be allowed to shate in any bonuses ‘hat St. Luke's eamed under the new system, We figured that doing so would give them an incentive to ex. i their ordering putters. and also pave the way for some more substantial changes later on, We ine teased the bors 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. Luke's began as part of the current year's budget cycle. Late last year, unlike previous years, St. Luke's 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 ex- penses of $136,858.946 and total projected discharges of 17.310, resulting in a transfer price of 37.906 per discharge. Exhibit 2 contains the details for Pediatric Cardiology. This was patt of the budget 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. Mahler's comment at the beginning of the case. He elaborated Look, 17,310 annual discharges works out to an average of about 1440 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 4 profit center, but why when it’s a standard expense center? ‘When I began to look into it, I found that the physicians were making all sorts of questionable admis- sions. Things like childhood asthma, which could be treated in most instances on an outpatient basis. then found that the hospital's 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 eusier to. treat their patients if they put them in the hospital Although no one will say 0,1 slso think the hospital people figured out what would happen to the sur Plases, and made it clear to the docs that their bonuses would be higher if they admitted the patients, But I'm ot going to raise that one... atleast not yet. Now. I've got to prepare an explanation to the finance committee, They're furious. I had convinced them that this standard expense center approach was a good idea, and now it's killing us. If can't convince them it's @ good idea—which I still think it s—I won't be able to extend it to the other hospitals and provid ers inthe system, ‘The Finance Committee Meeting Atthe Finance Committee Meeting, Mr. Mahler's first challenge came from Richard Strauss, a professor of accounting at a local university, and a member of the committee ‘The problem's pretty simple, Gus. You've ignored the fact that St. Luke's has both fixed and variable costs. Obviously, when they inerease their volume, they increase only their variable costs, not thet fixed ones, While the fixed/variable split no doubt varies from department to department [ used an average of $4,000 variable cost per case. Then, by treating fixed costs as the residual, Icame up with a set of num- bers that was identical to St. Luike's frst quarter results, except with fixed and variable costs split out (Exhibit 5), Mr. Mahler's response was not especially respectful a1s not that simple, Rick. Fist, while neat splits between fixed and variable costs may work in the class- room, they don't work so exsily hee. Where did you get the 54000 figuse for example? What makes it Tight? And what about the fat that your so-called fixed expenses are aetually increasing each month? But leave all that aside forthe moment. How does your analysis help me deal with the bigger prob- lem? It scems to me that it doesn't mater whether we do the fixed/vaiable splits or not. The fact i that by increasing discharges above budget, St. Luke's can increase its surplus, and hence its bonuses, while at the same time decreasing the system's surplus. How can having information on tixed/varisble splits help ‘me deal with that? At this point, John Bach, the treasurer of the board, and finance committee chair intervened: 1 don’t want you to think we're 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 hospital’s case imix in setting the per-discharge transier price. We're not sure Why since, as we all know, case mix ean have a pretty profound impact on costs Since that’s an even trickier item to deal with than variable costs, I prepared a relatively simple exam- ple to illustrate my point [Exhibit 6]. It's oll hypothetical, of course, But note that the only change 1 ‘made was in case mix. TTeft the number of cases ai 1,000, and kept all the resources the same, although I did separate them into their fixed and varixblepigess. Look what happens. The wansier price changes by almost 14 petoent! What this tells me is that if 1 were St. Luke's, I'd be budgeting for a complicated case mix. getting a high transfer price, and then trying to bring ina less complicated case mix. Wouldn't you? Mr. Mahler responded: Well, 1 guess so, but I'm not sure, I'm also a litle confused by your example. Tt has a lot of elee ‘ments that weren't in our original budget, Are you suggesting that I try @ get St. Luke's to develop something like this? If so, Think Tl 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 re- instating profit centers would help either. He reviewed the information that his staff and the accounting people at St. Luke's had devel- oped for St. Luke's 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 fi- nancial 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 pa- tients inappropriately. Assignment: 1, Be sure you understand how Exhibit 6 was prepared. Do you agree that a change in case mix can leud to the kind of results shown here? Do you agree with Mr. Bach’s assessment of how St. Luke's would pre- pare its budget under these ciscumstances? 2, 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 $? Can an analysis ofthis sort be done in the real world? 3. What changes should Mr. Muller make to the management control system? Be suie to adeess (a) whether St. Luke's should be a profit center ora standard expense center, (b) how transfer prices between the HMO and the hospitals should be set to encourage behavior by a hospital's senior management and physicians that is in the best interest of CHS, (c) how, if at all, he structure of information in Exhibit 6 can be used for management contol purposes, and (d) what role physicians might play in the control system.CONVERSE HEALTH SYSTEM Exhibit 1, Organizational Structure Touro Directors Chief Legal oncer ‘ise Presiden rent { Sein ie Presiden } i tt ui — ce Presiden Huan esate Vise Peters fermion Regus Viee President Mut Management PSRITTT FaTTROe FeeRc CET = PeeaTERTCET st Lakes Hospiat Matsild ateview Medial | | Mansfeld VNA Atte Powders ot Hospi ‘Cee Lt ‘Subacute Case x (ccpatonl Ls Skea Nursing Binhing emer LV ‘MorusryCONVERSE HEALTH SYSTEM Exhibit 2. Budget for Inpatient Pediatric Cardiology VBL. FIXED TOTAL ALLOC. AVERAGE, NO. DIRECT DIRECT DIRECT IND. TOTAL PER _CA’ CO! + COST = COST +__ COST __=__CosT CASE DRG 108 10 131,454 40,808 172,262 112,096 284,358, 28,436 DRG 125, 35 66,926 29.464 9639 56,967 153,357 4382 DRG 241/137 35 370042 28.201 65.243 33611 98.894 2,824 OTHER 107 210,608 051 325,659 142,206 467.865, 4373 TOTAL 187 446,030 213,524 659.554 44.8801 004.434 5371 Note: This budget was part of the overall budget for Pediatrics. Exhibit 3. Inpatient Budget for St. Luke's Hospital Direct Indirect Total Department Cases Costs, Costs Costs per Case MEDICINE (ADULT) — 5,308 25,452,159 10,511,742 35,963,901 6,782 MIXED CARDIAC ATT 7257949 2,558,427 9,816,376 20,579 SURGERY 7.887 41,527,509 19650817 61,178,326 7157 PEDIATRICS 2.450 15,083,385 3,185,611 18,268,996 7457 REHAB 190 2,462,157 372,549 2,834,706 14.920 PSYCHIATRY 432 4,436,975 457,008 4,893,983 29 NEUROLOGY 555 3.132073 725,545 3.857.618 6951 OTHER 16 40,983 4.057 45,040 2815, TOTAL, ITSO 99,393,190 37,465,756 136,858,946 7906LIPTCOTS Taorols _ozr'zeze SOUDIIAFIP [EUISLUQ, GeSLBLS OLPOETS (9|qeUea ss9} you!Fu0) sasuadxo porte 597] Isso Ogs'si's sasuadxa paxyy or uoRNgUITOD 00 IPL'9 — OOD'OZO'9 —_->82eYDSIP/OOO' PS Iw) sesuadxo a]quUEA :s577] 860 16M PIS OLDIZEEIS OES S68" 11S yedipng aouruuojod [RUsLIG uuodoy 1sv09y LIF OTS DES86S I80'P6L$ Oty ZHTH ouarayyi 12 689'Le TBLSOSEL GES LES ZL OL OST TT sasuadygy SESTILEES SOT TOP'PIS VIVITZEEIS OES ROR wipng sourausopiog £20's ees S¥9" 0st so®inyostp Jo s0quuiny 906'LS 906 68 906 asea sod aousd soysue], suuany [LUISA [ TOL, wen | Aienaqay | cienwep - ~ muon sp aend SALT JO SIMS IEIMA “SHEEP LIP TOTS 2ousiayytC Ter o99'Le astiadyo (rny BESTIL OSS yaipng sourwsopr9g, £u0's ees sso" Ip yo s5quunu yemoy 906'LS 906-08 906 LS sea sad aoud 19ysue4, — way TO, AW | Anemagag | crenwey oo | so tend SAL JO SHAS “pUIUNT WALSAS HLIVAH ASYAANODCONVERSE HEALTH SYST! Exhibit 6 Role of Case Mix {All numbers are hypothetien!) ase Mie Seana Coe MT Seanario (Cost-nfvencing Variables EMRE SD om 2 DRES, DREX!—TaaT— Forecast number of ase 10 200-300 4001000 | 00300 200 101.000 Resources per case No’ of patent ys per case 2 55 33 3a 2 55 3338 No.of xray prcave 5 1 1 37 TT Nav of CBs par sae Bo}: 2 530202 Factor prices ost per minute for nes s050 S050 $050 3050 $050 Gos: pr mine for ery technicians $020 $020 $020 5020 $020 Gon: ber minus for lab technicians $030 3020 $020 5020 $020 Gos: eri forostine care supplies 513 S350 $130 S130 $450 Gos: stu forty spies, $500 $300 $500 §son os: peti for CBC supple S200 5200 $200 $200 Eficiene of Resource Detivery ‘ov mining minutes pe patent ay ee) ws as Xo. tecnisan minute per ay 2 & & 2 4 | No technician mines per CBG » » dD » > » H | Nov wits of supplies per paint dy 338 wo 3 $8 o-unis of pple per ay 30303 3 3030S No.of suppliss pr CBC a 4 a4 4 4 Fixed costs Departenal administration 109000 100.000 ‘ating sopersston hard) 30200 so. Eguipment deprecation 10.000 s00000 Space Jepreiton 200.000, 200.00 Allosted cots i000 00,00 ‘caleaatans Variable cost per resouree unit Patt ay so 32 sme sso 512 sm se6 Jen S38 SSS Bs Ss SS cae sks S22 siz 3S sa [Variable cst per ease Rouine cae S810 $6666 s1s6 $510 $60 65156 eke is "23 “338 ms mo 38 cee ojo 36 he “Tott vanebe cost per ese SS [Tota varabe costs per cae type 68500 25000 33900 81360 $208,760 224000 37500 22400 20:40 s3s440 Pin Department fixe este 380,000 so.n00 “Total cost 7 “3720880 [nranter price per charge $1939 igus