Saturday, November 10, 2007

Where does that money go, anyway?



Several months ago, I related the sad story that resulted from the merger of the New England Deaconess and Beth Israel Hospitals in the mid-1990s. Fortunately, the troubled times are behind us, and BIDMC has been quite successful in providing clinical care, conducting research, and offering training to the medical professions. Along with that success has been financial progress. The millions of dollars in operating losses have been turned around to show operating surpluses. This trend is seen in Chart 3 above. (The numbers for fiscal year 2007 will be available in several weeks, after the annual audit is well under way.)

Since we are non-profit, these gains do not go to stockholders. They are plowed back into the hospital in the form of investment in buildings, facilities, and equipment to provide patient care and carry out research. Every year, we have to replace aged plant and equipment and also investment in new technology to provide the highest levels of care.

During the period of financial turn-around, we intentionally underinvested in the hospital because we needed money to meet the payroll and other operating expenses, and we knew we would not generate enough margin to cover all the capital needs. So we fell behind each year. One way of measuring this is shown in Chart 1, where I compare the amount spent on capital each year compared to annual depreciation. If you look at the bars below the line, you can see the cumulative amount we fell behind in the early years. Later, when earnings improved, we were able to increase capital investment and begin to catch up. By this year (fiscal year '07) we had caught up on the previous years' deficiencies, based on this metric.

But, as anybody in health care will tell you, if you just invest an amount equal to depreciation, you are falling behind. This is because depreciation is based on the original cost of plant and equipment, not replacement cost. If you consider the current costs of buildings and equipment, you need to invest much more than depreciation to stay even, much less get ahead. In Chart 2, I show how our cumulative capital spending during this period has compared to 130% of depreciation -- a number that is at the low end of desired investment for major facilities like ours. On this chart, you can see that we are still catching up for those bad years. It will take several more years of very good earnings to get current.

Our hope is to continue to make a healthy operating margin to renew and refresh old buildings and equipment and also invest in needed expansion both at BIDMC and our Needham affiliate. The demand for our clinical services continues to grow, and we need have adequate facilities to meet our obligations to the public. To answer the question posed in the title, that is where that money will go. But we are also very cognizant of the importance of balancing capital requirements against the very real needs of our staff -- in terms of salaries and benefits and career advancement opportunities and appropriate staffing ratios. It doesn't do you much good to invest in capital if you don't also invest in people. So, we do the operating budget first, based on staff needs and quality and safety requirements. It is the margin available after that which is available for capital investments.

15 comments:

Elliott said...

Little preemptive spin to your wonderful 2007 results? Congratulations on an amazingly profitable year.

Paul Levy said...

I don't know about preemptive, Elliott, in that I wrote about the most successful year in our history, in terms of 2007 financial results, in an email to 6000+ employees and about 800 MDs faculty members back in early September. When you write to that many people, word gets pretty broadly spread! So that story has been circulating around town for two months before this posting and actually prompted several folks, inside and outside, to ask what we do with the operating margin we achieve.

Paul Levy said...

... anyway, thanks for the congratulations. Stay tuned for the actual number.

Terry at Counting Sheep said...

Whew, I don't know how you do it, but I'm glad you do! I can resuscitate you from the jaws of death in the operating room, but when it comes to financial pie charts and analysis, I just get woozy!

It's good for me to hear about a hospital's health from the CEO's perspective, something that I've never really been privy to and have even less understanding of. Thank you for sharing not only the information, but your concern for fiscal health.

The CEO truly is responsible for the vision of the hospital.

Paul Levy said...

Thanks, Terry. Somehow I think it is more important that you can rescue me! But, you are right, if the hospital does not run well financially, it becomes harder and harder for the providers to get what they need to do their job.

These places run on pretty narrow margins, maybe 3 or 4 percent. If you have a good year and can be above that, it never lasts and is inevitably followed by a lower one.

Peter S. said...

Paul, Can you tell us your operating results as a percent, and your total margin also? That would let us scale how BICMC is doing compared to other health systems. Thanks. Peter

Paul Levy said...

Hi Peter,

Our total budget for the last year was about $1.1 billion, so the $40 margin million for that year was just under 4%. In Massachusetts, given the reimbursement rates for clinical care, that is good performance.

We have found that improvement of quality and safety programs, as outlined elsewhere on this blog, helps produce better financial results. For one thing, it helps reduce length of stay in the ICUs and elsewhere, freeing capacity for new patients. For another, you avoid unreimbursed extra costs that would otherwise result from higher rates of infection and the like.

So quality and safety improvements are not only good for health of patients, they are good for the financial health of the hospital.

Patient Dave said...

What stuns me more than anything is that this organization not only produces these results, it does so while never denying care to anyone - everyone gets the same care according to their needs, regardless of ability to pay. (Paul will correct me if I'm wrong, I'm sure.)

A long time ago an employer's VP of HR told me "Good people cost too much." At the time they were industry leaders; now they (and the company that bought them) are out of business. They, I'm sure, would say this couldn't be done.

I've never seen a better application of great management skills, including both building a wonderful empowered team and making it all work financially. It's proof positive that brilliantly successful management isn't limited to greed.

I am inspired.

EB said...

Great post, Paul, and excellent use of the visuals. This is a very helpful presentation of how to assessment your financial performance relative to capital investment.

Do you perform similar analyses to evaluate how your are doing with respect to investment in program expansion (not just plant/property/equipment)? If appropriate to do so, perhaps you can have a future post on such a topic (i.e. investment in a new program/service).

Matt said...

Beyond Length of Stay and savings through quality improvement, how does your organization identify where there are opportunities to save money? Is analyzed on a service line level?

Paul Levy said...

EB and Matt,

Good questions. Will save them for another posting, ok?

And thanks, Dave.

Barry Carol said...

Paul – I wonder about a couple of things. First, what happens when the local market doesn't need any more beds and your plant and equipment is up to date and fully competitive? Is it OK to just let the profits pile up for a while in a reserve fund or endowment? Also, if a hospital operates more efficiently than its competitors and its profit margins move, say, into the high single digits or even low double digits, is there a point at which your tax exemption might be challenged or questioned by legislators? With a large reserve, you would presumably be in a position to buy out an underperforming competitor and add value to the operation by running it better unless your market share is already pushing the upper end of the regulators' tolerable limit. Then again, if there is excess capacity in the market, it might be best if one or more hospitals downsized or closed.

Paul Levy said...

Hi Barry,

On your first point, I don't see profits piling up because things are in a constant state of repair and renewal (but, also, as I have noted elsewhere, there is no sign of slowing demand growth given the demographics of our region). That being said, a small number of hospitals in Boston have indeed seen very substantial growth in their endowments over the last 15 years -- a combination of very good financial results and philanthropy and investment returns. As far as I know, no one has ever questioned their tax exempt status, and there really is no reason to do so, in that they continue to carry out their public service missions. The larger endowment simply gives them a cushion against hard times, and all of its income goes to support their public purposes.

Yes, a larger financial base can permit buy outs of other hospitals -- again something we have seen in Massachusetts and may see over the coming years and months as another wave of consolidation looms. Thus far, in Massachusetts, there appears to be no limit imposed by regulators on expansion by even the dominant provider in the marketplace.

Peter S. said...

Paul, Asking again about BIDMC's total margin--you've only posted the operating margin. I read that many hospitals are having to rely on non-operating income to shore up poor operating results, while other hospitals do well in both areas. wonder how the situation looks at BIDMC?

Paul Levy said...

Total margin would include gains from real estate transactions as well as imputed gains attributable to the market value of the investments in our endowment. Although you will sometimes see that total figure published in newspapers, we don't really pay much attention to these two additional items because they are not reflective of the underlying performance of our clinical and research operations. Also, real estate gains are nonrecurring, and investment gains can be reversed with a simple shift in the stock market. To answer your question, in a good year, these may add a point or two to the margin. I don't have the 2006 numbers with me right now, but I think that was the case in that year.