Financial crisis and hospitals - III

Previous blog entries have discussed the stresses that hospitals are facing in these tough times (e.g. see links below). How Do Hospitals Get Paid? A Primer explains how hospitals make their money. In brief and simplified: The hospitals' list of prices for their services is call the chargemaster. No one actually pays those rates, everyone pays at some discount to these "list" prices. Hospitals essentially get money either from the government (Medicare and/or Medicaid) or from commercial insurance. Yes there are some other additional income streams from operations (e.g. self pay patients, etc.) but these are often much smaller. Medicare pays flat fees related to "diagnostics related groups, DRGs", Medicaid pays flat fees, per diem payments, or fee for service. Finally, the commercial insures generally pay via per diems or fee for service. The bottom line to remember is that in general commercial insurance "overpays" while the government "underpays" and the hospitals net out (i.e. significant cost-shifting occurs)

So, let's look at our simplified model (numbers in USD millions). Let's make some assumptions - the hospital's commercial insurers are on average paying 80% of list, while the government on average reimburses 40%, and the hospital breaks even at 60% (i.e. as noted above, it is losing money on 'government' business while making "excess profit" on the 'commercial' business to balance this out...) The hospital is in the relatively decent position of a 60% commercial and 40% government payor mix

OK, the hospital bills USD 500 million, gets USD 320 million of revenue and it operates at a healthy six point seven percent margin. Now, given the economic distress that the country is going through many people lose their jobs, and thus their insurance (ignoring COBRA). Assume that they all get on a government program and remain covered, the payor mix changes, as the government portion increases and the commercial portion decreases. Let us model a 44%-56 payor mix. We see that the hospital's margin goes down to (a still reasonable) four percent.

This simple and simplified model is intended to illustrate that all other things being equal, a shift in payor mix from commercial to government will have a significant, negative impact on a hospital's bottom line! The hospital does the exact same amount of work, needs the same number of employees, has to buy the same amount of supplies, pays the same for utilities, etc. etc. Expenses are the same, but due to the way the system works revenue will be decreased, resulting in a lower margin. (Note: we are not discussing re if hospital executives are paid appropriately or are overpaid; if hospitals are as efficient as they may be or are full of duplication and waste; if 'investing' more in primary care will reduce overall healthcare expenditures; if a single-payor model is better or not; etc.) The move from scenario one to scenario two is what is happening in real life right now, and the result is a weakening in the bottom lines of most hospitals - some hospitals which were doing very well are now doing OK, some which were doing OK are closer to break-even, and those that were at break-even now have negative margins. All while the other forces hammering them (see links) are increasing.

Financial crisis and hospitals II - January 27th
Financial crisis and hospitals (updated) - November 14th