finance management

Variance Analysis Case Study

Venture Mental Health

Venture Mental Health is a not-for-profit, multidisciplinary mental health provider that offers both inpatient and outpatient services on a full-risk (capitated) basis to members of managed care plans. Its clinical staff consists primarily of psychiatrists, psychologists, psychiatric nurses, social workers, and chemical dependency counselors. Currently, Venture has major contracts with two large managed care organizations in its service area: Physician Care (PC) and Share Healthplans (SH). Each of these organizations has both commercial and Medicare HMO contracts with Venture. Thus, in total, there are four separate product lines.

Venture is partially funded by state and local governments. The agreement with the funding agencies is that funds received will be used to cover overhead and capital expenses. Furthermore, expenses for drugs and other medical and administrative supplies are billed separately to the HMOs at cost. Therefore, overhead and supplies expenses are not part of this budget, which means that the analysis focuses on clinical labor expenses. If the assumption is made that other payment mechanisms cover overhead, capital expenses, and supplies at cost, then Venture's profitability is solely a function of its ability to create revenues that exceed labor costs. Thus, its operating budget focuses on enrollment, per member premiums, utilization, and labor costs.

Table 1 has the assumptions used to prepare Venture's 2006 operating budget. Note that the four product lines are expected to provide a total of 4,551,000 member-months of revenue during 2006. Also, note that each product line has a different per member per month (PMPM) payment (premium) amount. Table 1 also has expected admission (for inpatients), referral rate (for outpatients), and labor cost and utilization data for each product line. Because of the unique employment arrangements between Venture and its clinical staff, in which they are paid on the basis of the number of patient service units provided, clinical labor costs are virtually all variable, and hence costs are not identified as fixed or variable.

Table 2 shows the forecasted 2006 budget. In essence, data from Table 1 are used to forecast revenues and costs, both in the aggregate and by product line. Overall, Venture expects to earn a profit of $129,828 on these product lines in 2006.

During the first quarter of 2006, Venture's managers noted a higher utilization rate than budgeted. To add to their concern, the monthly enrollment figures supplied by the contracting managed care plans were less than those budgeted. Together, these trends indicated lower revenues and higher per enrollee costs, and hence lower profits, than forecasted in Table 2, although a higher premium amount on one plan partially offset the lower enrollment. These concerns were borne when the first quarter profits came in lower than budget. To help stem the adverse trend, Venture's managers instituted a utilization management system in which all inpatient stays were required to be approved by the clinic's medical director—a senior staff psychiatrist.

Unfortunately, the action taken was too little, too late to save the year. Table 3 has operating results for 2006, while Table 4 has the realized aggregate and product line profit and loss (P&L) statements. A quick review of Table 4 reveals that the signals conveyed by the first quarter data were indeed correct—2006 ended with a loss. When the results were submitted to Venture's CEO, Janet Johnson, she grimaced and said, "I knew it was coming, but I did not expect the year to be that bad." It was immediately apparent to Janet that Venture could not afford similar results in 2007. She knew that something had to be done, but the best course of action was not clear.

To help plan for next year, Janet asks Venture's finance and accounting department head, Bob Mitchell, to perform a variance analysis on the data to help identify problems that led to poor financial results for 2006. Unfortunately, Bob's area of expertise is dealing with lenders and other capital suppliers, so he passes the assignment on to you, a newly hired financial analyst. Additionally, to help with the calculations, you jot down an equation list for calculating variances. (Note that not all equations listed In Table 5 are necessarily applicable to this analysis.)

Of course, both Janet and Bob are more concerned with what the numbers mean than what the numbers are. Therefore, your variance analysis should include a great deal of interpretation along with numbers. Finally, you want to use this assignment to help advance your career within the organization, so you are going to go one step further. You plan to offer recommendations for management action along with the numbers and interpretation.

Table 1: Venture Mental Health: 2006 Operating Budget Assumption
Expected Enrollment (Member-Months)
PC Commercial	3,365,000
PC Medicare	4,69,000
SH Commercial	502,000
SH Medicare	215,000
Total	4,551,000
Expected Premium Data (Per Member Per Month)
PC Commercial	0.65
PC Medicare	0.81
SH Commercial	0.58
SH Medicare	0.72
Expected Labor Data (Per Admission or Session)
	Inpatient	Outpatient
	No. of Hours	Hourly Rate	No. of Hours	Hourly Rate
PC Commercial	53.74	35	1.04	100
PC Medicare	68.43	35	1.30	100
SH Commercial	47.77	35	1.15	100
SH Medicare	56.86	35	1.14	100
Plan Type	Inpatient	Outpatient
	Average no. of members (in thousands)	Admission rate	Cost per admission	Total Costs	Referral Rate	Cost per session	Total costs	Total costs
PC
Commercial	280.417	3.81	1,881	2,009,639	2.00	104	58,327	2,067,966
Medicare	39.083	3.96	2,395	370,671	2.00	130	10,162	380,833
Total	319.500			2,380,310			68,489	2,448,799
Grand total
SH	41.833	3.89	1,672	272,085	2.00	115	9,622	281,707
Commercial	17.917	4.17	1,990	148,681	2.00	114	4,085	152,766
Medicare	59.750			420,766			13,707	434,473
Total	379.250			2,801,076			82,196	2,883,272
Grand total

Table 2: Venture Mental Health: 2006 Operating Budget
Expected Aggregate Profit
Revenues
PC Commercial	3,365,000 x $0.65 =	2,187,250
PC Medicare	469,000 x $0.81 =	379,890
SH Commercial	502,000 x $0.58 =	291,160
SH Medicare	215,000 x $0.72 =	154,800
Total		3,013,100
Costs (from Table 1)
PC Commercial		2,067,966
PC Medicare		380,833
SH Commercial		281,707
SH Medicare		152,766
Total		2,883,272
Profit		129,828
Margin		4.3%
Expected Product Line Profits
	PC Commercial Medicare	SH Commercial Medicare	Total
Revenue	2,187,250	379,890	291,160	154,800	3,013,100
Costs	2,067,966	380,833	281,707	152,766	2,883,272
Profit	119,284	943	9,453	2,034	129,828
Margin	5.4%	0.2%	3.2%	1.3%	4.3%

Table 3: Venture Mental Health: 2006 Operating Results
Actual Enrollment (Member-Months)
PC Commercial	3,073,000
PC Medicare	4,85,000
SH Commercial	547,000
SH Medicare	257,000
Total	4,362,238
Actual Premium Data (Per Member Per Month)
PC Commercial	0.60
PC Medicare	0.81
SH Commercial	0.58
SH Medicare	0.72
Actual Labor Data (Per Admission or Session)
	Inpatient	Outpatient
	No. of Hours	Hourly Rate	No. of Hours	Hourly Rate
PC Commercial	47.32	38	0.95	109.50
PC Medicare	58.66	38	1.15	109.50
SH Commercial	52.06	33	0.98	95
SH Medicare	84.85	33	2.00	95
Actual Utilization and Cost Data
Plan Type	Inpatient	Outpatient
	Average no. of members (in thousands)	Admission rate	Cost per admission	Total Costs	Referral Rate	Cost per session	Total costs	Total
PC
Commercial	256.094	4.33	1,798	1,993,782	3.65	104	97,213	2,090,996
Medicare	40.417	4.68	2,229	421,615	1.86	126	9,472	431,087
Total	296.511			2,415,397			106,685	2,522,083
Grand total
SH					3.35	93	14,204	467,719
Commercial	45.592	5.79	1,718	453,514	1.75	190	7,121	280,569
Medicare	21.417	4.56	2,800	273,448			21,325	748,288
Total	67.009			726,962			128,011	3,270,371
Grand total	363.520			3,142,360

Note: These data were generated on a spreadsheet; hence some rounding differences might occur.

Table 4: Venture Mental Health: 2006 Actual P&L Statements
Aggregate Profit Results
Revenues
PC Commercial	3,073,113 x $0.60 =	1,843,880
PC Medicare
SH Commercial	485,000 x $0.81 =	392,850
SH Medicare	547,105 x $0.58 =	317,321
Total	257,000 x $0.72 =	185,040
Costs (from Table 3)		2,739,091
PC Commercial
PC Medicare		2,090,996
SH Commercial		431,087
SH Medicare		467,719
Total		280,569
Profit		3,270,371
Margin		531,280
Margin (percent)		19.4%
Product Line Profit Results
	PC (Commercial Medicare)	SH (Commercial Medicare)	Total
Revenues	1,843,880	392,850	317,321	185,040	2,739,091
Costs	2,090,996	431,087	467,719	280,569	3,270,371
Profits	247,116	38,237	150,398	95,529	531,280
Margin	13.4%	9.7%	47.4%	51.6%	19.4%

Table 5: Venture Mental Health: Generic Equation List
Total Variance	=	Actual profit – Static profit
Revenue variance	=	Actual revenue – Static revenue
Enrollment variance Rate variance	=	Flexible (enrollment) revenue – Static revenue
Cost variance	=	Actual revenue – Flexible (enrollment) revenue
Volume variance	=	Static costs – Actual costs
Enrollment variance	=	Flexible (enrollment/utilization) profit – Static profit
Utilization variance	=	Flexible (enrollment) profit – Static profit
Management variance	=	Flexible (enrollment/utilization) profit – Flexible (enrollment) profit
Fixed cost variance Staffing variance	=	Actual profit – Flexible (enrollment/utilization) profit
Rate variance	=	Flexible fixed costs – Actual fixed costs.
Efficiency variance	=	Flexible (enrollment/utilization) staffing costs – Actual staffing costs (Static hourly labor rate – Actual hourly labor rate) x Actual number of hours per episode x Actual utilization rate x Actual enrollment
Supplies variance	=	Expected number of hours per episode – Actual number of hours per episode) x Expected hourly labor rate x Actual utilization rate x Actual enrollment
Price variance Usage variance	=	Flexible (enrollment/utilization) supplies costs – Actual supplies costs
	=	(Static price – Actual price) x Actual units
	=	(Flexible units – Actual units) x Static price