Hospitals are one of our most venerable institutions. They are in the business of taking care of sick people and on a daily basis they save lives. Although most hospitals do a fine job in the delivery of health care many of them are struggling with the issue of financial viability. The issue of financial instability across the hospital industry causes us to raise the following question: Do Hospitals Know How to Save Money?
If a company is going to save money then at a basic level we know that any business must be able to clearly get a handle on two components of their business: Net Revenues and Costs. Let's explore those two concepts a little further from a Hospitals' perspective.
Net Revenue
Net Revenue is sometimes called Net Patient Services Revenue. Net Revenue is the actual amount that a hospital will receive from a payer for services rendered. Many people may be surprised to find out that what a hospital charges is rarely what it will receive as payment for services.
As a matter-of-fact most Insurance companies do not pay the full charges for services rendered. For instance let's say that a person goes to the hospital and when the total itemized billed comes out the total charges are $10,000. An Insurance company will look through the bill and they will start with what they call “Covered Charges”. Covered Charges may be equal to say $7,500. Now let's suppose the Insurance Company pays 80% of the covered charges. That means that the hospital will receive only $6,000 as payment for services rendered. Therefore the $6,000 becomes the Net Revenue for the hospital.
If a hospital is involved in a capitation environment the situation gets murkier and the hospital must function at a greater level of risk. In a capitation environment the Hospital will negotiate with an HMO for a set group of patients. Say a small HMO has 6,000 patients. If the Hospital wants the business the HMO will come back and say “We will pay you ______ amount per member per month (PMPM).” What this means is that if the Hospital says “Yes” they are on the hook to treat these patients for a set amount of Net Revenue no matter what the future costs may be.
In the capitation example if the deal calls for $200 PMPM then the Hospital can book $14,400,000 Net Revenue for the year. The problem is now the Hospital is at the mercy of the HMO statistics. Any Hospital that trusts the statistics of an HMO and bases their financial viability on these numbers is making an asinine decision that will most assuredly come back to bite them really big in the future.
If the HMO tells the hospital you can expect to have 250 admits per 1,000 HMO enrollees on our HMO Panel that means that over the course of the year the Hospital will have about 1,500 admissions. Let's suppose that the actual cost of treating these patients is say $9,500. If that holds up the hospital will make about $150,000 on this contract.
Let's suppose instead of the 250 admits per 1,000 HMO enrollees that the actual number is 400 admits per 1,000 HMO enrollees primarily due to an outbreak of the flu during that particular year. Let's also suppose that the cost per patient is still $9,500 per patient. In this scenario the Hospital will lose $8,400,000 on just this group of patients alone.
Once a hospital receives all its Net Revenue numbers that particular total will be what is used to run the entire Hospital operations.
Costs
Costs are the expenses that it takes to operate a hospital. Within a hospital there are two major types of expenses: direct costs and indirect costs. A direct cost is a cost that can be directly traced to a patients care. Examples of direct costs would include Nursing care, pills taken for care, medications and fluids in a drip, Physical Therapy, etc.
An indirect cost is a cost associated with Hospital operations that may not appear to be directly associated with patient care. Examples of indirect costs include Coding, Billing, Financial Management, Information Systems, General Accounting, etc.
The total cost of care is the combination of both the direct costs plus the indirect costs. Now here is a surprise for most people that are outside of the Hospital industry: Total Costs of patient care are not equal to Total Charges on a patient's bill. Even more surprising is the fact that a great majority of Hospitals do not know how to accurately calculate their actual Total Costs.
If someone would ask the following two questions: “How much does it cost to have _______ procedure performed at your Hospital? Last year what was the average cost of procedure ___________?” I guarantee that the answer received would probably revolve around a calculation that pertains to what is called ratio of cost-to-charges. Sometimes this approach is referred to as RCCs.
