How to Improve Operating Margins

Chapter 12

Financial Analysis of Alternative Health Care Firms

Learning Objectives •  List the major non-hospital and non-physician sectors

of the health care industry. •  Discuss the sources of revenue for the nursing-home

industry. •  Discuss the major sources of revenue and expenses of

medical groups. •  List and describe the major organizational types of

physician groups.

•  Describe alternative HMO organizational arrangements.

Alternative (Non-Hospital) Health Care Firms

•  Financial measures and concepts discussed in Chpt 11, but different sectors within the health care industry have different operating values and standards. –  e.g. health plans have lower days in receivables than

hospitals, and are required to carry higher cash balances to pay claims

•  Three major alternative health care sectors we will consider here: –  Long-term Care Facilities & Nursing homes –  Medical groups –  Health plans

Long-term Care Facilities & Nursing Homes

•  Have been growing in the last decade as baby boomers reach the age of 75 plus

•  2007: 15,827 nursing homes in the U.S. •  65% of nursing homes are investor owned (IO) or

for-profit •  Many IO nursing homes are part of large national

chains (e.g. Kindred Healthcare, Sun Healthcare Group)

•  Nursing home care is heavily financed by the government through Medicaid

Nursing Homes, cont. •  Data show increase in public sources of financing and

reduction in private financing •  Early 1990s: % of Medicare financing increased due

to higher hospital discharges •  Federal government pays Medicaid nursing home

care, but payments are determined at the state level –  Wide variation in payment methodology (retrospective,

prospective, case-mix adjustment) –  Often the one of the largest state expenditures –  Subject to changes based on economic condition of the

state

Supply of Nursing Homes

•  Wide variation in nursing home supply by state

•  Many states control nursing home care supply & expenditures through : – Licensure laws and Certificate of Need (CON)

laws –  Payments rates for Medicaid patients

•  Restrictive state policies may influence where IO chains operate.

Continuing Care Retirement Communities

•  Many nursing homes are becoming continuing care retirement communities (CCRCs) – Provide a continuum of care from independent

living, to assisted living, to skilled care •  Market themselves to HMOs that want to

cover more residents of CCRCs through Medicare risk contracts

Continuing Care Retirement Communities, cont.

•  Often residents progress through three levels of care:

Nursing home care → assisted living → independent living

•  Many CCRCs also have specialized units, –  e.g. Alzheimer’s disease or stroke programs

•  Consider the following example of financial statements of Friendly Village, church-owned CCRC

Friendly Village Revenues, cont.

Note the major sources of revenue: – Largest source – routine health care center services

($6,214,764 in 2010) – Next – fees from care and services to residents of

independent-living apartments or assisted-living center ($4,039,897 in 2010)

– Other sources – entrance fees ($1,080,635 from amortization and $287,261 from investment of fee fund)

Entrance Fees Fund

•  Guarantees 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

•  Represents funds available to meet contractual commitment to provide future care to residents

•  May be based on age at entrance and is amortized as income as the patient ages or dies

Friendly Village Expenses, cont.

•  Expense structure is similar to other health care providers

•  Salaries and wages constitute >50% of total expenses

•  Depreciation not shown in expense section, but is separately shown as other expense – Common for non-for-profit (NFP) CCRCs, where

replacement of existing assets is not operating expense

Medical Groups

•  Approximately 300,000 physicians in the U.S. –  2/3 operate in 1-2 person practices

•  Physician expenditures represented $478 billion in 2007 –  Physicians play an important role in controlling health care

costs –  Challenge for physicians to realize cost and quality

decision making power in small practices –  Trend toward physicians becoming part of larger

organization, e.g. hospitals, health plans, and physician- controlled medical groups

Physician Expenditures, cont.

•  Significant trend – reduction in financing through out-of-pocket payments from patients

•  Possible reasons – decline of indemnity coverage and corresponding increase in HMO and preferred provider organizations (PPO) plans: –  HMO require low or no co-payment for routine visits –  Traditional indemnity plans require coinsurance and

deductibles •  Move toward consumer driven health plans may

reverse this trend

Physician Revenue

•  Physicians receive larger % of total revenue from private insurers than other major health care sectors (e.g. 2007: 66% vs. 41%)

•  Medicare covers nearly 100% of hospital service charges for the elderly with 20% coinsurance for physician services

•  Utilization of physician services is also increasing

Physician Groups

•  Physicians may choose to align themselves with other physicians through: – Medical groups – Hospitals – Health plans – Physician practice-management firms

•  Physicians prefer to align with other physicians to maximize their control

Sources of Capital for Physician Groups

•  For large-scale integration, massive amounts of financial and human capital are required

•  Recently investors started proving external capital •  Hospitals do possess capital to create large physician

groups, but are limit investment in this area due to: –  Lack administrative experience with physician-practice

management –  Different incentives

Sources of Capital, cont.

•  Health plans – also have resources, but have differing incentives – Reduce fees or salaries of doctors and control

utilization •  Physician practice management firms – offer

physicians some type of profit sharing and equity stake in the firm – Often acquire physician practices and provide

physicians with strong autonomy

Example: Waverly Health Clinic

•  Waverly Health Clinic (WHC) is a hospital- owned physician network –  8 primary care clinics, 24 full-time physicians,

122 non-physician employees •  101,542 patient encounters in past year •  WHS is a separately incorporate for-profit

subsidiary of the hospital. All physicians are employed by the hospital

WHC: Lack of Profitability

•  Income statement indicates loss of $1,825,716 •  Often revenues are less than expenses for

physician-owned practices •  Benchmark operating norms for WHC and

national values for primary care medical group practices

•  Main issue - WHC generates $78,054 less revenue per physician full-time equivalent (FTE) than the national norm

Private Insurance

•  Most Americans are covered by either public, private insurance, or combination of both

•  Cost of private insurance is rapidly increasing due to administration, reserve retention, and profit

•  Addition of administrative costs to cost of health care have been debated by policy makers as unnecessary

Health Care Insurance Companies

•  Main types: – Commercial – Blue Cross Blue Shield – Health maintenance organizations (HMOs)

•  Some commercial and Blue Cross Blue Shield companies may provide an HMO option

•  HMOs provide traditional indemnity programs and allow enrollees to go outside the network

Managed Care Organizations

•  Managed care – system that integrates financing and delivery of health care services to enrollees

•  Most common examples – HMOs and PPOs (preferred provider organizations)

•  PPO – more flexible than HMO to allow more provider choice

Health Management Organizations

Main types of HMOs: staff model, group model, network model, independent practice association (IPA) mode, mixed model

•  Staff model - physicians are employees of the HMO and usually paid a salary

•  Group model - physicians are employees of the HMO and usually paid a salary

Health Management Organizations, cont.

•  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

•  IPA model - HMO contracts with individual physicians or with associations of independent physicians and pays them a per-capita rate or a negotiated fee-for-service rate

•  Mixed model – combines two or more of previous options

HMO Financial Structure

•  Small percentage of assets are invested in property, plant, and equipment; majority – in cash and investments

•  Consider example - net income and expenses are influenced by member months on a per- member-per-month (PMPM) basis

•  Administration expenses increased – may be due to higher rates per hospital visit or higher utilization

HMO Example

•  Net income decline in this example is directly related to PMPM premiums increasing less than expenses

•  Administrative expenses increased though most of this cost is fixed

•  Further research revealed increased inpatient utilization and higher per diems paid to hospitals contributed to the inpatient expense increase