Wednesday, August 06, 2008

Budget Time

It's budget-making time in the hospital world, as many of us prepare for the fiscal year starting October 1. I suppose there was an era when this was easy, but those days are long gone. To put it simply, the cost curve is going up faster than the revenue curve. Other types of business deal with this by adding new product lines, enhancing the value of those products already offered, increasing marketing to gain market share, and garnering efficiencies in the production process. Most of those options are not so available in the hospital sector, and particularly for academic medical centers.

Like other hospitals, we at BIDMC have five revenue sources, in size order, clinical services, research, current use philanthropy, investment returns on our cash assets, and royalty or equity payments from the sale or licensing of intellectual property. Of our $1.2 billion in revenues, though, the first two predominate by far. About $1 billion comes from delivery of inpatient and outpatient care, and $200 million comes from research grants. The remaining three items are measured in the $10's of millions, all together.

The business model for academic medical centers has been to enhance clinical revenues by building sufficient bed and clinic capacity to increase both the volume and acuity of patient visits. On the research side, the business model had been to take a loss-leader for several years by providing laboratory space and salary support for the best scientists, with the expectation that they will be sufficiently productive over time to cover both their direct costs and also contribute to overall corporate revenues through indirect cost recovery.

Thus, hospitals faced a clear growth imperative. As long as your incremental revenues from treating more patients exceeded the incremental costs of treating those patients, each year could show improvement over the last. Likewise, as long as you could count on those new researchers to get off the dole and eventually cover their space and personnel expenses with ever-increasing grant revenues, all would be fine. Indeed, the expanding research enterprise would contribute enhanced indirect revenues to help offset the hospital's fixed overhead costs.

For years, all was well on the clinical side of the house. While government payers (Medicare and, especially, Medicaid) did not cover their full cost of service, payments from private insurers would make up the difference. Now, though, we can project a declining rate of payment increase from both the federal and state governments, increasing the needed subsidy for those elderly and poor patients -- but precisely at the time private insurers are recoiling from doing so because of pressure they feel from their business and individual subscribers. Private insurers are making clear that they don't want their rates to increase faster than their estimate of overall (not health care) inflation, and, also, they feel less obligation to make up the shortfall in government payments.

The private payers are also more and more interested in move towards some kind of capitated rate system (i.e., paying $x per year for the full spectrum of medical care) for those patients covered by their insurance products. In the past, if their rate was a bit too low, selling more units of care to an ever more service-demanding population could make up the difference. Now, though, they are looking to control the product (rate X units) and therefore want to move to a more global fee per patient per year.

On the research front, a dramatically slower growth rate in NIH funding for biomedical research means that many more of those bright researchers you recruited or were just about to recruit into the research labs you just constructed will find themselves unfunded for longer periods of time. You either have to cover their salaries, lab expenses, and space costs from general hospital revenues, or lay off scientists and just cover their now empty space costs -- all the while explaining to your highly skeptical faculty that you remain fully committed to a strong research program.

What, then, is a business plan that is most likely to produce overall positive net income for a hospital over the coming years, income that is essential for capital investment for renewal, replacement, and enhancement of clinical and research functions? (For the accountants out there, think about a target of funding 130% to 140% of depreciation each year -- requiring an operating margin of at least 4%. Please note that I am talking about a hospital in good standing, not one that is engaged in a financial turnaround.)

1) Focus on growth in clinical services that are most suitable for a high level tertiary facility, those that coincidentally produce the best margins. Meanwhile, stabilize, reduce, decant, or eliminate those that do not. But decisions here must reflect the interdependencies of low-margin and high-margin specialties. For example, you cannot eliminate the low-margin nephrology division if you intend to expand your high-margin kidney transplant program. And, you can't eliminate money-losing psychiatry at all, given the pervasive co-morbidity of mental illness with many physical illnesses, especially among the elderly.

2) Optimize use of space. To the extent you can avoid expensive new construction (currently priced at over $1000 per square foot for construction costs alone) by reconfiguring space use, you avoid new fixed costs and are able to expand volume at lower incremental cost.

3) Achieve operational efficiencies. No, not by an administrative fiat that reduces staffing, but by application of LEAN methods or other improvement programs that tap the know-how and creativity of your front line staff. But, you need to aim for double-digit improvement, not just 1 or 2 percent per year.

4) Work to eliminate preventable harm. When hospital acquired infections, for example, are avoided, the extra costs of extended lengths of stay are also avoided. Even under most current insurance payment methodologies, the business case for harm-avoidance is compelling.

5) To the extent insurance rates move toward capitation, learn to coordinate and manage care across the spectrum of services. This is really hard when you don't control, say, that nursing home that receives your discharged patients. But get ready for the day, by enhancing interoperability of medical record systems and building cooperative relationships among the physicians along the spectrum of care.

6) Meanwhile, research must also be managed, not just to produce higher revenue per square foot, but also to ensure that the research agenda is consistent with the hospital's clinical priorities. There is probably, too, an optimum range in the overall size of the research program for a given overall hospital size. Analyze this, and head towards that target over time.

7) Understand that philanthropy is the fourth line of business -- along with clinical care, research, and teaching -- if an academic medical center is to thrive in doing those functions society expects of it. Whether enhancing the income statement with current-use unrestricted donations or relieving capital budgets with restricted-use investment gifts, philanthropy is an essential component of hospitals' futures given other economic trends. Generally, investments in philanthropy yield about 16 times their annual cost and therefore represent one of the highest and best uses of operating funds.

I don't think that anything I have said here is new or controversial among hospital administrators or their Boards. However, it has become clear to me that many of these concepts are outside of the realm of experience of many hospital doctors, scientists, and other staff. If you are reading this and it is new or strange to you, please comment. If you are reading this and are involved in hospital management or governance and have something to add or subtract, please comment, too.


Anonymous said...

This si the kind of thing that makes me get down on my knees and thank God I don't have to manage anything bigger than an organ recovery department of an organ procurement organization. I can't be completely free-and-easy, but I have a reasonable expectation that my payors will pay the costs I set.

Reading your description, success seems if you can only stretch out the length of time it takes for the facility to go under.

Good luck! As one of my hospital admin friends says, his job is to make chicken salad out of chicken [feces]. Bon appetit!

Anonymous said...

Paul, I will be brave and show my ignorance and hopefully learn something in the process. Admittedly much of what you're speaking of is new for me. In time my hopes are to be in a seat similar to yours but I have loads to learn before that happens. In any event, I understand the fiscal mess that hospitals are in these days.

From a business point of view I have always thought that healthcare was illogical. Hospitals have lines out the front door of customers that don't want to be there but they have to. On top of that most of them cannot afford what we (hospitals) are selling. Finally we (hospitals) find ourselves at the mercy of third party payers that decide how much and of what they will pay for. It doesn’t make a lot of sense.

My question to you and to other healthcare leaders is this. Why do industry leaders and legislators allow payers to drive healthcare so much?

Can you imagine if you or I went into a restaurant and had dinner and then decided we were only going to pay for 60% of the bill? We would end up in jail I suspect. How can payers do the same with reimbursement?

Anonymous said...

I think you just delivered a complete MBA course for hospital management.

I just wish I understood where it all went wrong.

Dino William Ramzi said...

As a primary care physician, I am obliged to point out that the hospital is probably the wrong place to take care of many medical conditions that are better and more cheaply cared for in other environments.

But community hospitals and academic health centers have an incentive to keep that care if it supports their overall margins, especially given the degree of fixed expenses.

Even if it is cheaper to do a mammogram in an ambulatory facility or a cystoscopy at a surgi-center, the hospital must survive and the incentive becomes perverse in a sense...

Now in this environment, I wish I could remember what collaboration was like.

Anonymous said...

Wow. The reference to the MBA course is very close to reality.

Coming from the dreaded private sector and new to the hospital marketplace, I see a lack of "sales" when comapared to other institutions. While TV time is very expensive and somewhat tacky, Our MD's need to get out among the public more and speak about best practices, our great care, great employees, new procedure.....

They can start with their Church and Synogue groups. New Procudures for old ailments, the list goes on. It is called sales and it works!

Anonymous said...

I think that one of the first steps in fixing this broken (or at least damaged) financial system is to reduce the power of the third party. As a nation, we should be looking towards a day when all insurance companies have a non-profit status.

Anonymous said...

I've had the opportunity to observe the budget process in many NY area hospitals as a budget director on the inside and consultant on the outside. You are 100% correct on all counts. What you present is the problem facing any number of well managed hospitals across the country.

What I fail to understand is why admins seem to want to solve all of these problems at budget time. These aren't temporal problems, they are ongoing issues that need to be addressed each and every day.

I am intrigued about the idea of your payers wanting to move toward an annual capitated rate for all services. If you go down that route, what exactly is the value added by the payer in the first place? It seems to me they are just acting as a middleman between the patient and your facility.

I always wondered why larger hospitals don't just cut out that layer and offer up their own branded insurance plans. It doesn't even have to be labeled as insurance, more like a health management plan where one could pay the capitated fee to the hospital directly and go there for all their services.

Instead of my employer subsidizing me $10k in addition to my $5k contribution, I could pass that $15k along to my closest academic medical center and take my family of 4 in for treatment as needed.

Instead we're lining the pockets of the Blue Crosses and Aetnas and also of all the mom and pop accounts receivable consultancy vendors who you need to use to actually collect from the big guys.

Somethings just not right with this picture.

Anonymous said...


I would be interested in your estimate / guess as to when hospitals like yours might start to see capitated payments. Do you think it could happen without CMS embracing it first so private payers can follow or can private payers push the concept on their own without CMS taking the lead? Would you buy up primary care practices that can keep patients healthy and out of the hospital? It seems like hospitals could be rewarded for doing so. Can you convince doctors, nursing homes and other providers that are not employed or owned by your hospital to work together to fairly divide up a global payment for a complete episode of care, especially for expensive surgical procedures?

The big challenge, it seems to me, is to estimate your costs with sufficient accuracy so that you can work with payers to establish a capitated payment that will cover your costs (assuming efficient operations) and provide an adequate profit margin. I think the theory behind capitation is sound. The devil is in the details.

Anonymous said...

Paul--of course what you are saying is true, and certainly not new. But the net effect (particularly of #1) is to screw over the unfortunate underinsured who land in your emergency room--and the clinicians who care for them--while catering to the well-insured patients and the procedural specialists. This phenomenon is not "outside the realm of experience" of your faculty--it is their daily experience, and I'd guess they don't like it much.

Anonymous said...

Anon 11:30,

I don't quite see that result from what I described. Part of our mission is to deliver the same services to the poor that we do to the wealthy, whether ER services or other procedural services that might occur thereafter. Please explain more of what you mean, ok?

Anonymous said...

barry carol, I think you have outlined many of the issues exactly right. But no, I don't see us buying up practices or other parts of the health care delivery system, so the issue of how you coordinate care -- and divide up the dollars -- is exactly what makes the whole concept problematic.

As for timing and sequence, here in MA, Blue Cross has proposed a plan along these lines as an optional one for hospitals and certain physician groups. I understand that there may be similar thoughts from CMS.

Anonymous said...


Payers have influence because they are the intermediaries between the hospitals and those making the purchase decisions for consumers, i.e., the employers who choose which insurance plans to offer. In some markets where there is only one main hospital, that hospital might have more influence over payment amounts and terms. Not so here. Although, here, the dominant health care system (not ours) does have more market power and influence and gets better rates than anybody else, both for its hospitals and its doctors.

Anonymous said...

Anon 2:33,

There is inconclusive evidence as to whether sales efforts by doctors works to build market share.

Anonymous said...

Your goal is to "stabilize, reduce, decant, or eliminate" services that are not "suitable for a high level tertiary facility" or "produce the best margins". The inpatient general medicine service meets that description at my hospital (in California) and I am sure yours does also. I'm sure you've heard the aphorism "a medical patient is only slightly better than an empty bed". My patients are mostly underinsured or uninsured--thus producing poor margins--and while some may require tertiary-level care, most do not. Because our patients don't generate revenue and "take up beds" from patients who do, we are under constant pressure to discharge patients as quickly as possible, and do not have the level of support services (discharge planning and social work) that the high-revenue specialties do. So, while taking care of these patients is an essential part of the community mission of the hospital (and is invaluable for teaching purposes), hospital administration consistently sends the message that medical patients are a low priority. You provide a perfect example with nephrology--in your equation, taking care of those low-margin chronic kidney disease patients (who are disproportionately poor, minority, and underinsured) is tolerated only to ensure a supply of patients for the kidney transplant surgeons. How do you think your nephrology division employees feel about that?

Anonymous said...

You are wrong, in our case anyway, about those patients being disproportionately poor, minority, and underinsured. The economic background of patients has nothing to do with the issue here.

Likewise, we do not send a message that medical patients are a low priority. What we are trying to do is to have lesser acuity medical patients be served in settings that make more economic sense, e.g, community hospitals. Meanwhile, we provide substantial financial support, as well, to our hospital based primary care practice (which, if I recall was the first such one based in an academic medical center over 30 years ago.)

What I have described is not a matter of trying to influence social policy. It is trying to rationalize care to have it take place in the most appropriate setting, which also happens to be consistent with a good business plan for both us and the community hospitals in our vicinity.

Scott Hodson said...

Paul: Would it be fair to add Optimize Reimbursement? This would include working with physicians and staff to ensure that care is effectively documented to allow consistent billing and collection of the highest appropriate charge level, developing effective utilization review infrastructure and process to minimize non-chargable days, developing effective financial counseling infrastructure and process to identify payer sources for uninsured patients, and developing strategic relationships to improve bargaining leverage with third party payors.

Anonymous said...

Sure, but that is kind of a baseline effort that should have been in place for years.

Medical Quack said...

After having read this post a short time back I started a bit of a series called "Desperate Hospitals" to bring some of the money and budget items to the attention of everyone, as unless you are in the business, I don't think it gets the attention that it should. It's where we go to heal and sometimes have our life saved.

Out here we had a hospital closure that I posted and even ended up on Reuters too, but it sits on the outskirts of Beverly Hills, and those folks could not get additional funding, so that is a bit scary to many, to include a couple hospitals out here that I have done some business with. If those folks can't get funding, who can? On the other side I linked to a story about Venture Capitalists raising a ton of money to build new hospitals in India and Asia that are from Seattle. I hope I covered issues as fact without stepping on toes too badly, but it just somewhat draws out where the money is and where it is not.

The hospital budget has to be a bit of a nightmare to say the least as there will be items crop up that as of the day you prepare, that do not exist yet, and nobody can predict some of those issues, unless they have one good crystal ball, and even some of those don't work too well either.(grin).

The more those outside the realms of the budget, like you mentioned, healthcare individuals who are not aware of the process and how it all shakes out is huge, as unless someone brings it to their attention, they just don't have a reason to give it much thought, and on the other side of the coin, others inform me too of things I haven't thought of either so it swings both ways.

I hope at least I got part of it right and hopefully will bring about an awareness of what's going on as it moving very fast today.

Anonymous said...

I came across your blog exploring the internet for a Health Care Admin. budget class. How long does the budget planning process take for the hospital's annual budget?

Anonymous said...

About 5 months.

robert said...


I would like to ask a question. What is a good book, or other learning resource, for someone who wants/needs to greatly improve his/her skills in doing a departmental/divisional budget for a large hospital?

Any suggestions or recommendations for books, online instructions, video, or other learning resources will be greatly appreciated.

Thank you.


Anonymous said...

Sorry, I don't know. Perhaps someone reading this will.