WK3AC

• •Intensity of service • •Charges for specific procedures

(Cleverley 243-254) Cleverley, William O. Essentials of Health Care Finance, 7th Edition. Jones & Bartlett Learning, 20101022. VitalBook file.

Chapter 12 Financial Analysis of Alternative Healthcare Firms LEARNING OBJECTIVES After studying this chapter, you should be able to do the following:

• 1.List some of the major nonhospital and nonphysician sectors of the healthcare industry.

• 2.Discuss the sources of revenue for the nursing home industry.

Average Case Weight =

36

30

=

1.2

• 3.Discuss the major sources of revenue and expenses of medical groups.

• 4.List and describe the major organizational types of physician groups.

• 5.Describe alternative health maintenance organization arrangements.

REAL-WORLD SCENARIO Laura Rose has been recently appointed to the Board of ElderCare, a large, for-profit operator of skilled nursing facilities (SNFs) around the country. Laura’s first committee assignment is to the Treasury Committee because of her prior business experience. Although Laura had extensive experience as a hospital administrator, she had relatively little familiarity with the SNF industry. Upon reviewing ElderCare’s recent financial statements, she was concerned about the dramatically declining financial position. She noticed that revenues were declining on per facility and per patient bases. Meanwhile, the company’s debt had been downgraded, and its borrowing costs had risen substantially. She is aware that Medicare implemented a SNF prospective payment system as part of the Balanced Budget Act of 1997. Payment increases by Medicare and Medicaid have not kept pace with increases in costs in recent years. She wonders whether this might be a factor in the company’s financing issues. In general, profitability in the long-term care industry has declined significantly in recent years, and several industry leaders had filed for bankruptcy protection. Although some believe that SNF prospective payment systems were largely to blame, other factors, such as ill-advised acquisitions, excessive long-term debt, and poor balance sheets, probably contributed as well. In essence, she is unsure whether ElderCare’s financing difficulties are unique to management issues at ElderCare or whether they reflect more general market conditions and economic and reimbursement trends.

To understand the issue better, Laura needs to estimate the direct financial impact of SNF reimbursement. She asked the ElderCare

treasury and controller’s office staff to prepare an analysis of the financial performance of selected long-term care facilities over the period 2006 to 2010. In particular, she wants to know how SNF-bond ratings have been affected by prospective payment systems and what other factors might have contributed to the industry’s deteriorating financial performance. In Chapter 11 we discussed the measures and concepts of financial analysis in some detail, but most of the examples and industry standards were from the hospital sector. The hospital industry is by far the largest sector in the healthcare industry, but it is not the only sector; its rate of growth in recent years has been slower than in other areas. This chapter provides some additional information about alternative health-care firms. LEARNING OBJECTIVE 1 List some of the major nonhospital and non-physician sectors of the healthcare industry. First, we discuss the financial characteristics of the following three specific alternative sectors:

• 1.Nursing homes • 2.Medical groups • 3.Health plans

It is impossible to describe all the specific operating characteristics for these three sectors in one chapter, but we highlight the important differences that affect financial measures. It is important to remember that the financial measures and concepts discussed in Chapter 11 are still applicable. For example, the concept and measurement of liquidity are the same for a hospital as they are for a health plan. However, operating differences between health plans and hospitals produce different values and standards. Health plans have much lower days in receivables than do hospitals and are required to carry much higher cash balances to meet transaction needs, namely claims payment. It is not just the higher relative growth rates of non-hospital sectors that cause us to separately examine the topic of financial analysis for alternative health-care firms. Many of the alternative healthcare firms have been consolidating through both horizontal and vertical mergers

and have now become major corporations in our nation’s economy. For example, UnitedHealth Group, Aetna, and Wellpoint are among the largest corporations in the country, employing large numbers of people and absorbing significant amounts of capital to finance their continued growth. Much financial analysis and discussion are now devoted to these firms because of their almost continuous needs for financing. Major brokerage houses now have analysts who devote their time to narrow sectors of the healthcare industry, such as home health firms or medical groups. Table 12–1 presents 2008 financial ratio medians for two of the three sectors, along with comparative values for the investor-owned hospital-industry sector. We calculated ratio averages by computing the ratio average for three large publicly traded firms in each industrial group. Table 12–2 shows the composition for each of the three groups.

Table 12-1 Financial Ratio Medians, 2008 Nursing Homes

Health Insurers

Investor- Owned ospitals

Liquidity Current 1.41 0.74 1.50 Days in receivables 56.65 16.60 52.04 Days-cash-on-hand 35.21 146.92 14.67 Capital structure Debt financing percentage 62.81 65.22 81.79 Long-term debt to capital 42.72 30.95 73.74 Cash flow to debt percentage

11.39 9.00 9.57

Times interest earned 4.87 8.69 2.82 Activity

LONG-TERM CARE FACILITIES AND NURSING HOMES It is not always clear what types of firms individuals are referring to when they talk about the long-term care industry. For our purposes we refer primarily to nursing homes, both skilled and intermediate-care facilities. The nursing home industry has experienced significant growth during the last decade, and expectations about the aging of America have led many analysts to project even more rapid growth in the future. Growth in the nursing home industry is inextricably linked to government payment and regulatory policy. As of 2007 there were over 15,827 nursing homes in the United States, and of those more than 65% were investor owned. Investor- owned presence in the nursing home industry is much larger than it is in the hospital industry, where only 17% of hospital capacity is

investor owned. Many of the investor-owned nursing homes are part of large national chains, such as Kindred Healthcare, Sun Healthcare Group, and Odyssey Healthcare. However, many investors may own as few as 1 or 2 nursing homes to as many as 20. Most of the large investor-owned chains became involved in the industry when the government started to finance a sizable percentage of nursing home care through the Medicaid program. Heavy government financing provided a stable source of payment that was not present before Medicaid.

Total asset turnover 1.78 1.19 1.06 Fixed asset turnover 11.89 53.84 2.26 Current asset turnover 6.40 5.59 4.57 Profitability Total margin percentage 3.07 4.07 2.09 Return on equity percentage

12.75 14.29 16.75

Table 12-2 Industry Composition, 2008

LEARNING OBJECTIVE 2 Discuss the sources of revenue for the nursing home industry. Financing of nursing home care is a critical driver of nursing home supply as it is for most other health care sectors. Table 12–3 summarizes sources of financing trends for nursing homes as of 2007.

Table 12-3. Financing Percentages for Nursing Home Expenditures

Industry/Firm Most Recent evenue (millions) Health insurance UnitedHealth Group $81,186 WellPoint, Inc. $61,251 Aetna $30,951 Nursing Kindred Healthcare $4,151 Sun Healthcare Group, Inc. $1,824 Odyssey Healthcare $616 Investor-owned hospitals Universal Health Services $5,022 Community Health Systems $10,840 Tenet Healthcare $8,663

1995 2000 2005 2007 Private financing 43 43 37 38 Insurance 8 8 7 7 Out-of-pocket 28 30 26 27

Source: Reprinted from the Centers for Medicare & Medicaid Services, National Health Expenditure Data. Retrieved July 6, 2010, from http://www.cms.gov.

The data in Table 12–3 reflect the dramatic increase in the percentage of nursing home financing derived from public sources and a corresponding reduction in private financing. The percentage of Medicare financing increased sharply in the first half of the 1990s as hospitals discharged more patients into nursing home settings to cut their costs per case and to maximize their profit per Medicare case. Much of this shift probably was related to the financial incentives created by the Medicare program when the government shifted to a per case payment system in 1983. Although the federal government pays more than 50% of Medicaid nursing home costs, actual nursing home payments for Medicaid patients are set by the states. There is wide variation among the states between retrospective and prospective systems. In many states there may be a mix of both systems. For example, capital costs may be paid on a retrospective basis, whereas all other costs may be paid on a prospective basis. Many states also use a case-mix-adjustment methodology to provide higher payments for nursing homes treating more severely ill patients. Medicaid payments from states are usually the second largest state expenditure and, as a result, are subject to dramatic changes based on the economic condition in the state. When economic times are bad and states have a difficult time meeting their budgets, one of the areas usually affected is nursing home payments. The level of nursing home beds by state varies dramatically. Many states have used the supply of nursing home beds as a means to control state expenditures for nursing home care. The number of nursing home beds per 1,000 people older than 85 years ranges from

All other 7 5 4 4 Public 57 57 63 62 Medicare 9 11 16 18 Medicaid 46 44 45 42 All other 2 2 2 2

184.8 in West Virginia to 504.4 in Indiana (Centers for Medicare & Medicaid Services, Division of Payment Systems, 1999, http:// www.cms.gov). Licensure laws and certificate of need have been the primary means for controlling nursing home beds in most states. Rates of payment for Medicaid patients also serve as an indirect method of controlling nursing home capacity. As rates are held down, less capital becomes available for expansion and renovation. Major national nursing home chains have been known to sell all their nursing homes in certain states where they believed that reasonable profits would be difficult to obtain because of restrictive state payment policies. It is expected that demand for nursing home care will increase dramatically in the next 30 years as the baby boomers reach the age of 75 plus, which is the age at which nursing home demand peaks. Nursing homes are also diversifying and expanding their product lines. For example, many nursing homes are becoming continuing care retirement communities (CCRCs). In a CCRC there is a continuum of care that runs the gamut from independent living to assisted living to skilled care. CCRCs also have discovered that their resident populations are desirable targets for health maintenance organizations (HMOs) that are seeking to expand their Medicare risk contracts. The CCRC is in a strong position to market itself to a managed care group because of the economies of scale provided from its continuum of care and its personal relationship to a Medicare population. At the same time, hospitals are looking for ways to expand their revenue base and have begun to develop skilled care units and other subacute units that can expand their business along the continuum of care and compete with existing nursing homes. In many respects some of the historical distinctions among healthcare industry segments are becoming blurred as vertical integration accelerates. The financial statements in Tables 12–4 and 12–5 reflect the operations of Friendly Village, a church-owned CCRC. A review of these financial statements gives the reader some idea of the nature of business operations in this type of healthcare organization. A CCRC usually provides three levels of care: nursing home care, assisted

living, and independent living. Often, residents progress through these three levels of care. An elderly person may enter the CCRC in an independent-living status and occupy one of the independent-living apartments. These apartments often are similar to apartments in other settings except residents are all retired and keep active through a variety of social activities. As the health of a resident erodes, that resident may move to an assisted-living environment. In an assisted- living environment some healthcare services are provided to enable the resident to maintain daily activities. For example, medication administration, medical monitoring, or some help with daily living functions such as bathing, toileting, and cooking may be required. Many residents are prolonging admission into an assisted-living center, and assisted-living residents are becoming similar to the nursing home residents of 10 years ago. The last level of care is nursing home services, either intermediate or skilled.

Table 12-4. Friendly Village and Subsidiary Consolidated Balance Sheets

June

2010 2009 Assets General funds Current assets Cash and cash equivalents $228,693 $173,134 Investments (at cost-approximate market value of $293,000 in 2010 and $530,000 in 2009)

199,811 409,393

Cash and investments that have limited use

634,918 310,629

Receivable-Friendly Church entrance-fee fund

2,151,994 2,169,635

Resident and patient accounts receivable, less allowance for doubtful accounts (2010— $195,000; 2009—$115,000)

803,634 445,291

Mortgage escrow deposits 30,891 81,961 Inventories, prepaid expenses, and other assets

118,565 144,093

Total current assets $4,168,506 $3,734,136 Assets that have limited use Cash and investments (at cost, which approximates market value): Under bond indenture agreement- held by trustee

$5,103,399 $662,217

Repair and replacement—held by trustee

283,179 355,392

Resident deposits 292,762 284,749 $5,679,340 $1,302,358

less cash and investments required for current liabilities

(634,918) (310,629)

$5,044,422 $991,728 Receivable-Friendly Church fee- fee fund, less portion classified as current assets

5,862,673 5,142,678

$10,907,095 $6,134,406 Property and equipment, less allowances for depreciation

$13,312,799 $10,747,006

Unamortized debt financing costs 551,700 226,100

Total general funds $28,940,101 $20,841,648 Donor-restricted funds Cash and investments (at cost- approximate market value of $1,121,000 in 2010 and $1,210,000 in 2009)

$1,206,604 $1,075,115

Receivable-Friendly Foundation 198,414 189,608 Due from general funds 196,594 188,578 Due from nurse scholarship recipients

14,357 6,064

Due from employee hardship recipients

3,266 0

Total donor-restricted funds $1,619,235 $1,459,364 Liabilities and fund balances General funds Current liabilities Accounts payable $888,489 $694,390 Interest payable 340,460 220,318 Salaries, wages, and related liabilities

759,495 696,458

Funds held for others 30,562 30,077 Due to donor-restricted funds 196,594 188,597 Estimated third-party settlement 45,842 441 Current portion of deferred entrance fees

824,000 987,251

Current portion of note payable to Friendly Church fee-fee fund

28,291 40,889

Current portion of long-term liabilities

426,163 374,663

Many CCRCs also may have specialized units to treat patients with Alzheimer’s disease or who have experienced a stroke. The income statement of Table 12–5 reports revenues from a variety of sources. The largest share is from the nursing home and is referred to as routine healthcare center services ($6,214,764 in 2010). The second largest source of revenue is fees generated from care and

Total current liabilities $3,539,897 $3,233,083 Deferred entrance fees, less current portion

2,975,343 4,284,149

Deposits—residents 288,040 274,578 Note payable to the fee-fee fund, less current portion

635,776 666,549

Long-term liabilities, less current portion

15,972,531 8,265,908

Refundable entrance fees 28,110 29,907 Obligation to provide future services and use of facilities

190,550 190,550

General fund balance 5,309,854 3,942,682 Total general funds 28,940,101 $26,365,697 Donor-restricted funds Fund balances Sustaining fund $751,708 $692,320 Foundation fund 198,413 189,608 Medical-memorial fund 344,657 336,169 Specific-purpose fund 196,595 188,597 Nurse-scholarship fund 47,451 45,624 Employee-hardship fund 12,227 7,066 Pooled-income fund 68,184 0 Total donor-restricted funds $1,619,235 $1,459,383

services provided to residents of the assisted-living center or the independent-living apartments ($4,039,897 in 2010). Some other revenue is generated from entrance fees and consists of $1,080,635 from an amortization of entrance fees and $287,261 from investment income earned on the entrance fee fund. Some residents pay entrance fees upon entrance into the independent-living or assisted- living center. These deposits guarantee that a nursing home bed will be available if needed and that the rate for that nursing home bed will be less than the nursing home’s current rates. For example, the CCRC may guarantee the resident to pay only 50% of the posted rate for a nursing home bed if needed.

Table 12-5. Friendly Village and Subsidiary Consolidated Statements of Revenues and Expenses of General Funds

Year Ended June 30

2010 2009 Revenues

Routine healthcare

center services —net

$6,214,764 $5,863,469

Care and service fees—

net

4,039,897 3,795,875

Amortization of entrance fees

1,080,635 987,252

Other medical services

690,593 676,216

Applicant fees 6,386 6,077

Investment income on

restricted funds

287,261 97,265

Other 284,761 209,449 Total revenues $12,604,296 $11,635,603 Expenses

Salaries and wages

$5,903,470 5,581,287

Employee benefits

1,052,944 964,048

Purchased services

1,023,900 976,639

Other medical services

780,176 763,314

Supplies 1,076,176 953,586 Repairs and

maintenance 137,898 109,047

Utilities 600,423 534,664 Equipment

rental 7,757 4,881

Interest and amortization

1,312,727 793,622

Provision for doubtful

accounts

65,718 25,415

Taxes 388,164 370,308 Insurance-

property, liability, and general

78,830 93,782

Other 84,098 87,618

Total expenses $12,512,281 $11,258,211 Gain from operations before depreciation and other operating revenues

$92,015 $377,392

Other operating revenues and expenses

Unrestricted contributions

19,807 67,504

Investment income on

entrance-fee- fund, net(1)

2,174,411 774,901

Gain from operations

before depreciation

$2,286,233 $1,219,797

Provision for depreciation

(922,501) (825,221)

Gain from operations

$1,363,732 $394,577

Nonoperating loss

Loss on disposal of

property and equipment

(51,082) (10,096)

The amount of the entrance fee may be based on age at entrance. The fund is then amortized or recognized as income as the patient ages or dies. There is also income earned on the deposits that is recognized as income each year. The entrance fee fund is listed several times in the balance sheet depicted in Table 12–4. On the asset side, there is a receivable from the church, which holds the entrance fees, in both the current asset and assets that have limited- use sections. On the liability side, there are accounts in both the current and noncurrent sections that represent deferred entrance fees. We discuss below what these accounts represent because they are one of the most confusing accounting aspects of CCRCs. The expense structure of a CCRC or nursing home is similar to other healthcare providers and is labor

intensive. At Friendly Village salaries and wages plus benefits constitute slightly more than 50% of total expenses. Also, notice that depreciation is not shown in the expense section but is separately shown as other expense. This is not uncommon for not-for-profit CCRCs that often regard capital as a gift and do not regard replacement of the existing assets as an operating expense. Perhaps the most unusual feature of a CCRC’s financial statement relates to the entrance fee fund and the deferred revenue that results from the receipt of those moneys upon admission to the retirement community. To understand the concepts of entrance fees and their amortization and deferred revenue recognition, we use a simple example and then relate those concepts to the data for Friendly Village. Let’s

assume that a resident enters the CCRC at the beginning of the year and contributes $35,000 to the entrance fee fund. This amount is amortized over the expected life of the resident, which we will assume to be 7 years. During the year the resident spends 20 days in the SNF and is required to pay only 60% of the $150 per day charge, or $90 per day. This means that a payment of $60 per day for 20 days, or

Excess of revenues over expenses & nonoperating loss

$1,312,651 $384,480

$1,200, will be paid to the SNF for 40% of the residents’ charges by the entrance fee fund. Finally, assume that the $35,000 entrance fee fund earned investment income during the year in the amount of $2,000. The following entries would be made:

These are the accounting entries made to reflect activities related to the entrance fee fund and the deferred revenue account relating to the entrance fee fund. The entrance fee fund is an asset account that represents the funds available to meet contractual commitments to provide future healthcare services to residents. The deferred revenue account is a liability account that represents the estimated present value of future contractual obligations to provide healthcare services to residents.

LEARNING OBJECTIVE 3 Discuss the major sources of revenue and expenses of medical groups.

MEDICAL GROUPS

Entry No. 1 Record receipt of the $35,000 entrance fee Increase entrance fee fund by $35,000 Increase deferred revenue by $35,000

Entry No. 2 Record transfer of money to SNF Increase unrestricted cash by $1,200 Decrease entrance fee fund by $1,200

Entry No. 3 Record annual amortization of entrance fee fund Increase revenue account amortization of entrance fees by $5,000 Decrease deferred revenue by $5,000

Entry No. 4 Record the investment income earned during the year Increase entrance fee fund by $2,000 Increase investment income on entrance fee fund by $2,000

Expenditures for physician and clinical services amounted in 2007 to approximately $479 billion and are second only to hospital expenditures. Physician expenditures have been increasing more rapidly than expenditures of most other sectors of the healthcare industry, which has increased the relative importance of physicians. However, it is not just the absolute level of expenditures made to physicians that make doctors an important element in our healthcare industry. It is widely believed that doctors directly or indirectly control up to 85% of all healthcare expenditures. Doctors admit and discharge patients to hospitals, prescribe drugs, order expensive diagnostic imaging services, and schedule rehabilitative services. The stroke of a doctor’s pen directs a massive amount of healthcare resources to or away from an individual patient. Managed care plans realized the demand-influencing behavior of physicians early and have attempted to incorporate incentives for cost control in physician payment plans. Although few would debate the importance of physicians in controlling healthcare costs, physicians have yet to realize their importance in the medical marketplace because of their lack of organization. Of the 300,000 physicians in the United States, two-thirds operate in one- or two-person practices. It is difficult for physicians to realize their central role in cost and quality decision making in healthcare negotiations. This is because most of them are part of delivery organizations that are too small to exert much, if any, bargaining leverage in healthcare negotiations. Physicians are slowly realizing this weakness and are now becoming part of larger organizations being developed by hospitals, health plans, large practice management companies, and large physician-controlled medical groups. Table 12–6 presents some data on sources of financing for the physician sector of the healthcare industry. Perhaps the most significant trend is the dramatic reduction in the percentage of physician expenditures financed by out-of-pocket payments from patients. From 1985 to 2007 the percentage dropped from 27% to 10%. It is not exactly clear what caused this decrease, but the decline of indemnity coverage and the corresponding increase in HMO and preferred provider organization plans may be possible causes. Many HMO plans require a low copayment or no copayment for routine

office visits, whereas most traditional indemnity programs have a coinsurance and deductible provision. For example,

indemnity programs may require a subscriber to make all routine physician payments until some deductible is met, for example, $500. This might change in the years ahead if consumer-driven health plans with large deductibles become more pervasive.

Table 12-6. Financing Percentages for Physician Expenditures

Source: Reprinted from the Centers for Medicare & Medicaid Services. Physicians do receive a much larger percentage of their total revenue from the private sector than do most other major healthcare sectors. In 2007 physicians received 66% of their total revenues from the private sector, whereas hospitals received only 41%. Medicare covers nearly 100% of hospital service charges for the elderly but is subject to a 20% coinsurance payment for most physician services. Most Medicare beneficiaries finance this payment with supplemental insurance, which creates a shift from public to private financing. Physician expenditures are increasing because there is increasing usage of physician services. Table 12–7 documents the increasing number of healthcare visits as

1985 1995 2005 2007 Private financing 71 68 66 66 Insurance 37 48 49 49 Out-of-pocket 27 12 10 10 All other 7 8 7 7 Public financing 29 32 34 34 Medicare 19 19 20 20 Medicaid 4 7 7 7 All other 6 5 6 6

Table 12-7. Healthcare Visits Per Year, 2006: Percent Distribution by Age Group

Source: National Center for Health Statistics. Based on a summary measure that combines information about visits to doctors’ offices or clinics, emergency departments, and home visits. Retrieved July 6, 2010, from http://www.cdc.gov. people get older. The number of visits within age groups also is increasing (not shown). As the population ages, demand for physician services is expected to increase sharply. The substitution of ambulatory care for inpatient care also further accelerates demand for physicians. As we discussed earlier, physicians are beginning to align themselves with larger groups and are moving quickly from one- or two-person practices to these larger groups. Some of this movement is a reflection of personal tastes. Physicians who practice in larger groups can make arrangement for weekend or evening coverage. Large group practices often provide their doctors with better consultative services and also reduce administrative burden, permitting greater patient-contact time. Lifestyle considerations may be an important cause of physicians joining larger groups, but the primary cause is related to economics. Physicians have seen hospitals and health plans merge and become more and more dominant in the local healthcare marketplace. Before increasing physician organization to counterbalance these large bargaining entities, physicians perceived themselves as being at a disadvantage.

Age Group None 1–3 4–9 10 or More Under 18

years 10.9 57.2 24.6 7.3

18–44 25.3 45.8 17.8 11 45–64 16.4 44.3 23.6 15.7 65–74 6.7 34.6 36.6 22.1

Older than 74

5.3 31.5 35.7 27.6

LEARNING OBJECTIVE 4 List and describe the major organizational types of physician groups. Physicians can choose whether to align with other physicians or to remain independent. If they choose to align with other physicians, there are four primary organizational alternatives for them to consider:

• •Alignment with other medical groups • •Alignment with hospitals • •Alignment with health plans • •Alignment with physician practice management firms

Alignment with physicians is, in some respects, most appealing to physicians because their control is maximized in this type of organizational setting. Often, the critical limitation is capital. To achieve large-scale integration and development of new information systems and administrative structures, massive amounts of both financial and human capital are required. Only recently have outside investors come forward to provide this

external capital. For integration with other physicians to be successful, a physician activist is needed who will not only arrange the financing of capital needs but who will also provide the administrative leadership. Hospitals have the financial capital to create large groups, but in some cases their administrative experiences with physician practice management are limited. This limitation, coupled with differing incentives, can lead to organizational conflict. In a managed care environment the objective is to empty hospital beds, not fill them, and this often leads to conflict between hospitals and doctors. Hospitals also have been dominated by specialists, but primary care physicians are the key in managed care markets. Primary care physicians often believe that hospitals do not understand them or their needs. Health plans also have the capital to put together large medical groups, but a conflict may arise between the incentives of health plans and its employee doctors. The health plan has a strong incentive to reduce fees or salaries of its doctors while also controlling utilization.

Physicians do not react favorably to lower income and also object to mandates or controls over their practice patterns. Physician practice management firms are a relatively recent development that has evolved to meet the needs of both the physicians and the marketplace. Some of these firms are publicly traded and can have capital and management pools to draw on to develop large, integrated organizations. Physician practice management firms usually offer physicians some type of profit sharing and also provide for an equity stake in the firm. This equity participation can make the attraction of merger or acquisition by a physician practice management firm hard to resist. In short, physician practice management firms often can afford to pay large sums of money to acquire physician practices and also promise physicians a strong degree of autonomy. The financial statements in Tables 12–8 and 12–9 provide financial information for Waverly Health Clinic (WHC), a hospital-owned network of eight primary care clinics with 24 full-time physicians and 122 nonphysician employees. The clinic recorded 101,542 patient encounters during the past year with an average resource-based relative value scale relative value unit (RBRVS RVU) of 1.5 per patient encounter. WHC is a separately incorporated for-profit subsidiary of the hospital, and all its physicians are salaried with profit and productivity incentives.

Table 12-8 Balance Sheet, WHC, December 31, 2008 Assets Current assets Cash $375,570 Net accounts receivable $1,453,343 Prepaid expenses $147,785 Other current assets $753,497

Table 12-9 Income Statement, WHC, Year Ending December 31, 2008

Total current assets $2,730,195 Net property, plant, & equipment $1,911,545 Intangible assets $194,609 Total assets $4,836,350 Liabilities and equity Current liabilities Accounts payable $173,175 Withheld taxes $87,235 Employee benefits withheld $3,379 Accrued salaries and wages $345,578 Other current liabilities $101,436 Total current liabilities $710,804 Equity Contributed capital $8,481,937 Retained earnings ($4,356,391) Total equity $4,125,546 Total liabilities and equity $4,836,350

Revenue Gross physician charges $13,691,347 Other revenue $2,952,073 Adjustments and write-offs ($3,170,855) Net revenue $13,472,565 Operating expenses

The financial statements of WHC provide some interesting information about physician practices, especially those owned by hospitals. We can see that the practices lost $1,825,716 in the current year. It is not unusual for hospital-owned physician practices to lose money. Revenues from the practice are often less than expenses. Many hospital executives argue that although the direct revenues and expenses of the practice may show a loss, there are substantial benefits realized from operating the practice. These benefits result from the admitting and referral patterns of the acquired physician practices, which raise volume at the hospital. Greater interrogation with the physicians themselves also may result in better cost control, which is important for managed care contracts. Although all this may be true, in many cases it is simply poor management that creates the financial loss. Most of these acquired practices were profitable before hospital acquisition, yet once they become hospital owned and operated, they suddenly become unprofitable. A review of the financial information for WHC can help shed some light on the most common reasons for lack of profitability. Table 12–10 shows values for WHC expressed on a per physician full-time equivalent (FTE) basis, compared with national values for primary care medical group practices derived from a study by the Medical Management Association in 2008.

Personnel expense $6,179,382 Supplies expense $540,956 Occupancy expense $2,530,195 Purchased services $275,422 General and administrative expense

$1,189,032

Total operating expense $10,714,987 Physician expense $4,583,294 Total expense $15,298,281 Net Profit ($1,825,716)

Table 12-10 Comparative Operating Norms for WHC

Source: Cost Survey for Multispecialty Practices, Medical Group Management Association, 2008. WHC has fewer operating expenses than does a typical medical group. Some of this is due to staffing. WHC has 5.08 support staff persons per physician FTE, whereas the national norm is close to 4.54. The bottom line is that WHC spends $28,182 ($473,639 – $445,457) per physician FTE below what a typical medical group would spend for operating expenses. However, WHC generates $78,054 less revenue per physician FTE than the national norm. Therefore, it is clear that the real issue is related to low physician productivity. WHC physicians generated lower RBRVS RVUs than expected when compared with national averages—9,850 versus 12,572. WHC is losing money because its physicians see fewer patients. On a positive note, operating expenses are well below the national average. It is doubtful that these same physicians practiced in this manner when they were in private practice. The critical factor for the long-term

Indicator WHC Value Medical Managemen t Association

Median Operating expense per physician FTE $445,457 $473,639 Revenue per physician FTE $561,356 $637,677 Physician compensation per physician FTE

$190,970 $269,024

Support staff per physician FTE 5.08 4.54 Operating expenses to net revenue percent

79.50% 66.27%

RBRVS RVUs per physician FTE 9,850 12,572

success of owning physician practices is directly related to the incentive structures used for physicians. Ideally, incentives should promote and not destroy physician entrepreneurial spirit. LEARNING OBJECTIVE 5 Describe alternative health maintenance organization arrangements. HEALTH PLANS Most individuals in the United States are covered by either public or private health insurance. In some cases both public and private coverage may be combined. For example, many Medicare beneficiaries have obtained private health insurance to pay for health expenses not covered by Medicare. At the end of 2008, most of the 40 million Medicare beneficiaries had obtained Medicare supplemental insurance from private insurance companies. Although the vast majority of Americans have health insurance of some type, many Americans do not have either public or private health insurance. The Bureau of the Census estimated that

approximately 46.3 million Americans were uninsured in 2008. This large pool of non-covered Americans creates costs of treatment that must be paid by someone. To date, it is not clear who will be responsible for paying for this group of people. Will it be the government, the health plans, or the providers? The cost of private health insurance has been rapidly increasing during the last 20 years, as Table 12–11 shows. Health insurance companies always have been big business, but the amount of money spent in selling, administration, reserve retention, and profit has increased greatly. In 2008 administrative costs accounted for approximately 13.3% of private health insurance payments. Table 12– 11 shows that the cost of private health insurance in relation to administrative costs have generally increased over the past three decades. It is this administrative cost that has caused much discussion among policy analysis. It is argued that most of these monies spent for administration and profit are not necessary and add to the cost of health care in the United States.

Table 12-11 Private Insurance Trends

The cost of private health insurance may not be wasteful, however. The nature of risk and regulation in the industry may require these levels of expenditures. Insurance companies agree to provide a benefits package of services for some specified sum of money. If costs of services exceed this amount, the insurance company loses money. This is often referred to as underwriting risk. In addition, insurance companies are regulated and are required to maintain certain reserve balances to protect policyholders in the event of a financial catastrophe. The only alternative to private health insurance would be some type of government-financed and -managed program. Government costs might be just as high or higher. Healthcare insurance companies come in many different forms. The Health Insurance Association of America (now known as America’s Health Insurance Plans) categorizes healthcare insurance firms as commercial, Blue Cross Blue Shield, and HMOs. The trend toward managed care has blurred some of these distinctions. Commercial insurance companies often provide an HMO option, as do most Blue Cross Blue Shield plans. HMOs have broadened their coverage plans to include more traditional indemnity programs, and most provide some point-of-service option whereby enrollees can go outside the

Year Personal Health Care

Expenditures (Millions)

Private Health Insurance Payments (Millions)

Administrativ e and Net

Cost of Private Health

Insurance (Millions)

Administrativ e Cost (%)

2008 1,952,255 691,179 91,978 13.3% 2000 1,139,192 402,802 51,983 12.9% 1990 607,563 204,664 29,080 14.2% 1980 214,786 61,205 7,642 12.5%

HMO network for care if they are willing to pay higher copayments or deductibles. In their 1995 Source Book of Health Insurance Data, the Health Insurance Association of America defined managed care as a system that integrates the financing and delivery of appropriate healthcare services to covered individuals. The most common examples of managed care organizations are HMOs and preferred provider organizations. A preferred provider organization typically offers more flexibility than does an HMO by allowing more provider choice, but it attempts to direct patients to providers with whom it has negotiated special contracts. Usually, five types of HMOs are defined in the literature (also discussed in Chapter 7):

• 1.Staff model: Physicians practice as employees of the HMO and are usually paid a salary.

• 2.Group model: HMO pays the physician group a per capita rate, which the physician group then distributes among its members.

• 3.Network model: HMO contracts with two or more groups and pays them on a per capita rate, which the groups then distribute to individual physicians.

• 4.Independent practice association model: HMO contracts with individual physicians or with associations of independent physicians and pays

(Cleverley 267-277) Cleverley, William O. Essentials of Health Care Finance, 7th Edition. Jones & Bartlett Learning, 20101022. VitalBook file.