The 2% solution

Health systems are looking to slash millions of dollars from their operations to prepare for upcoming Medicare cuts and other expected revenue reductions.

Medicare spending is scheduled to drop by 2%, starting in January, under a deficit-reduction deal reached by Congress last year. The cuts, which would total $123 billion through 2021, went from possibility to inevitability—at least without further intervention from lawmakers—last November after a congressional supercommittee failed to propose $1.2 trillion in federal cuts. That will trigger automatic cuts, including the Medicare reduction scheduled for 2013.

Healthcare executives, working to draft and finalize fiscal year budgets that can start in July or October, say they have built lost revenue from Medicare's cuts into their projections.

“We can't put our heads in the sand on that,” says Jim Budzinski, executive vice president and chief financial officer for five-hospital WellStar Health System Marietta, Ga. In recent meetings with WellStar's 12,000 employees, management explained the cuts would reduce its yearly revenue by $8 million to $10 million a year.

“It's not an easy thing to digest for our organization,” he says.

The cuts come as healthcare executives have seen revenue growth slow and states that help to finance safety net insurance struggle with budget stress. That has prompted some to plan for significant cuts to operating expenses, even as executives acknowledge they are not fully sure how to achieve projected reductions.

Executives at health systems in Florida, Illinois, Ohio and Texas say they already have planned hundreds of millions of dollars in expense reductions over the next three to five years. To get there will require savings beyond straightforward reductions to supply and labor costs, they say. Hospitals will need to find ways to treat patients more efficiently, a more difficult and less certain prospect for cutting costs.

William Santulli, executive vice president and chief operating officer at Advocate Health Care, says the nine-hospital system based in Oak Brook, Ill., will cut $350 million from its operations through 2015. Advocate ended its fiscal year in December 2011 with operating income of $300.8 million on revenue of $4.4 billion. That's compared with operating income of $335 million in 2010 on revenue of $4.3 billion. Expenses totaled $4.1 billion in 2011 and $4 billion the prior year.

Projected Medicare reductions will trim $50 million in revenue during the period, Santulli says.

Advocate officials say they already are seeing falling demand for inpatient services, and also expect cuts in Medicaid payments from the state of Illinois. The system has seen Medicare patients who previously were hospitalized are now treated under observation, a category of outpatient care, he says.

In Illinois, where unemployment remains above the national average, more patients are also without insurance and struggle to pay medical bills, he says.

“We do not yet have this … bogie figured out,” Santulli says. “It will take us the better part of this year to have a plan that will add up” to cover proposed expense cuts.

That plan has executives combing for cuts in costs for supplies and operations such as laundry, food and environmental services.

Also under consideration: labor. “We're taking a hard look at productivity and labor expenses,” he says.

He stresses that the system will seek to reduce expenses through attrition.

Officials are also looking to better management of clinical resources—use of imaging and medication management—to reduce costs.

At Catholic Health Partners, a Cincinnati-based system with 29 hospitals, the 2% reduction to Medicare will amount to a revenue hit of $23 million to

$25 million a year, says James Gravell, senior vice president and CFO.

The system, which closed its books last December with operating income of $120 million on revenue of $3.6 billion, has targeted expense cuts of $250 million over five years to offset an expected drop in revenue and additional capital expenses, Gravell says. It reported operating income of $100 million on revenue of $3.4 billion in 2010.

Similar to other health system executives, Gravell says it's not yet clear how the system, which reported $3.5 billion in expenses for fiscal 2011 compared with

$3.3 billion the prior year, will meet that target.

“There's nothing that's a sacred cow,” he says, though officials have ruled out across-the-board cuts to healthcare professionals.

Investments in information technology, including computers stationed inside patients' rooms, have improved efficiency, he says, as have other investments that have reduced the length of a patient visit by 11% in the past five years. That leaves the system with fewer obvious options to reduce costs.

The system has launched an effort with its employees to promote wellness and better manage chronic disease, with the aim of lowering the system's health benefit expense.

“We're not totally discouraged,” Gravell says. “We're challenged and concerned.”

At Baylor Health Care System, where executives are in the middle of budget plans, officials have set a target to cut $680 million over five years.

That includes $150 million for the current fiscal year, of which executives hope to squeeze $90 million from hospital operations and $60 million from administration, says Gary Brock, COO for the 11-hospital Dallas-based system.

Baylor will scour labor and supply budgets for savings, but Brock says he believes more efficient care, through use of electronic health records and evidence-based protocols, hold the greatest potential for savings.

Medicare's proposed reductions are projected to reduce Baylor's revenue by $12.5 million a year. The system reported operating income of $285.7 million for the year ended June 30, 2011, on revenue of about $4 billion compared with operating income of $305.1 million and revenue of $3.8 billion in the prior year. Baylor's expenses that year totaled roughly $3.7 billion in 2011 and $3.5 billion the prior year.

Executives also are expecting cuts to Medicaid payments from Texas.

“We think we know where the puck is going,” Brock says, “and obviously things continue to shift and change. I think the big word is flexibility.”

Brock says the system has also already pruned the most straightforward expenses and now will work to admit, care for and discharge patients as efficiently as possible to reduce a patient's length of stay and the materials used during patient visits.

In Florida, efforts began last October at Lee Memorial Health System to offset an expected $125 million squeeze on revenue over five years, ahead of the supercommittee's failure to broker a deficit-reduction deal, says James Nathan, the system's president and CEO. That's because executives expected cuts regardless of whether the supercommittee succeeded or failed, he says. The system's budget calls for $35 million in cuts to expenses or new revenue during the first year.

However, cuts alone won't be sufficient, says CFO Mike German. Lee Memorial will look for opportunities to expand its post-acute and outpatient services to generate revenue even as it seeks to more efficiently move patients from admittance to discharge. Administration may also face reductions, he says. “Everything is being looked at.”

Lee Memorial reported $59.6 million in operating income on revenue of about $1 billion for the year that ended last September, compared with operating income of $65.8 million on revenue of $1.1 billion the prior year.

Nathan says the Fort Myers, Fla.-based system has focused on the role of hospitalists, who are central to coordination of care between primary-care doctors, specialists and nurses, as one way to improve the quality and efficiency of patient care.

In Charlotte, N.C., meanwhile, Carolinas HealthCare System has asked employees to share ideas for how to curb costs across the system, which owns and manages 23 hospitals, says Greg Gombar, its executive vice president of administrative services and CFO.

Carolinas expects to see its revenue drop by $25 million over four years with an up to 2% Medicare cut, he says. The system reported $154.2 million in operating income on revenue of $3.7 billion for the year ended in December, compared with operating income of $129.2 million on revenue of $3.4 billion the prior year.

Employees have submitted ideas to reduce costs, including one that management already has adopted: lower copayments for generic drugs as an incentive to stay away from more expensive brand-name drugs, he says.

The system will seek to cut $80 million from expenses over four years to offset Medicare cuts and other expected budget pressures.

“Our assumption is that we're going to see reduction” to revenue, Gombar says. “We're not assuming we're going to get more. You have to operate under that scenario.”