More hospitals calculating actual cost of care

Every month, UPMC’s top brass gathers to study three very important green, red and blue squiggly lines that bounce up and down and up again across the length of several charts. 

The lines represent the academic health system’s “cost per” unit in key areas. Using the numbers, leaders of the Pittsburgh-based system learned, for example, that their nursing cost per case was up 3% in March compared with what had been budgeted, the product of 2% higher expenses and 1% lower volume.

On the bright side, the health system’s drug cost per patient day was down 2% from budget, a product of 2% lower expenses and 1% lower volume.

And cost per surgery had declined 3% over the prior year, the welcome effect of closing two outpatient surgery centers and consolidating cases within existing facilities.

“That’s why you’re seeing that improved productivity, because we actually reduced our fixed-cost infrastructure,” said Robert DeMichiei, executive vice president and chief financial officer at UMPC. “We had not only the data and the measurements and the insight into our operations, but we also had the management willpower and initiative.”

That data comes from the activity-based cost accounting system UPMC has spent years building to its current form. Division leaders use it to decide where spending needs to be adjusted based on whether volumes are up or down. 

Health system leaders like DeMichiei assume tones of urgency when explaining the importance of having methods to accurately measure cost of care in all aspects of health system operations. It’s a decades-old concept, but they insist the tools are now more advanced and the industry’s glacial evolution toward value-based care has passed its tipping point.

Providers have always relied on two levers for managing revenue—getting rate increases from health insurers and driving up volume, DeMichiei said. That model, which has sustained healthcare until this point, has resulted in unsubstantiated rate increases and overutilization. It won’t work anymore, he said.

“So what’s left? Cost efficiency and cost productivity,” DeMichiei said. “That is going to become the only game in town and our industry is right now very ill-prepared to manage their businesses using cost productivity when the majority of health systems in the country don’t even know what their costs are.”

A small survey by the Healthcare Financial Management Association of 41 members found there has been at least some improvement in health systems’ knowledge of what their services cost. At the end of 2016, 38% of respondents said they agree or strongly agree it’s difficult to determine the cost of activities using information provided by their current cost accounting system. That was down from 68% in 2004. 

Several leaders cited activity-based costing, or ABC, as an important method of cost accounting that’s superior to older strategies, namely those using cost-to-charge ratios. It refers to tracking the actual cost of services, supplies and other areas of operations on a per case basis, like what’s done at UPMC.

A complete strategy should incorporate time-driven costing, which refers to timing procedures in operating rooms to get more precise data, said Dan Michelson, CEO of Strata Decision Technology, a Chicago-based company whose cost accounting module is used by more than 200 health systems. 

He added that activity-based costing on its own isn’t practical without automation, which tracks what’s happening in a system’s hospitals and ambulatory settings and ties it together. That way when organizations assume risk in bundled-payment arrangements, they know whether they would make or lose money, he said. 

“The concept was always a good concept, but without the automation it wasn’t really practical,” Michelson said.

A growing number of vendors offer cost accounting programs, each claiming theirs is the best. To help providers assess their efforts in this area, the HFMA recently teamed up with Strata to launch a tool to help members measure the accuracy of their cost-accounting strategies and see how they stack up against their peers. It places systems at one of seven levels, seven being the most advanced.

DeMichiei estimates UPMC is at level 6 on that scale, but that most of the industry is at levels 2 or 3. Over the next five to seven years, he predicts every health system in the country will be using ABC tools. 

The “old math” of healthcare involved flexible revenue, where providers could count on getting paid more for doing the same thing, said David Johnson, CEO of consultancy 4sight Health. Want to get paid more for a knee replacement? Fill out reimbursement codes to get paid 20% more. In that world, expenses weren’t that important, he said. 

The “new math” increasingly involves full-risk, bundled payments in which revenue is largely fixed, Johnson said. Suddenly, expenses become very important.

“Therefore, the companies competing to provide services need to have a much more fundamental understanding of their costs than they currently do in order to operate profitably,” he said. 

An early method of cost accounting—one that’s now widely shunned—was using a ratio of costs to charges. In other words, an organization estimated how much it adds on to its costs to arrive at its charges and uses that ratio to determine costs. It was simple, but for obvious reasons, estimates didn’t work.

Back when Owensboro (Ky.) Health used that method, its costs were way out of whack, said Jeremy Stewart, Owensboro’s manager of decision support. With an accounting system installed about a year ago, the system uses its staffing and other expenses to determine the true cost of each procedure, he said. 

“To us, that’s powerful,” Stewart said. “Whereas before, we were kind of in the dark.”

Using the new cost estimates, Owensboro is looking into areas where it can reduce the amount patients are charged for certain services. It has already lowered the price on one drug after Stewart noticed the system had not done so since it first hit the market three years ago. The list price had dropped 25% since then. 

“The ball is starting to get rolling and people are looking at that,” Stewart said. 

For 11-hospital Baptist Health in Little Rock, Ark., the switch to a new electronic health record platform in 2012 “forced” executives to make drastic improvements to Baptist’s cost accounting strategy, said Brent Beaulieu, the system’s chief financial officer. Suddenly, the new system, sold by Epic Systems Corp., offered clinicians fields to enter information such as what types of providers were in the room for a procedure and for how long, capabilities its previous system didn’t accommodate.

Baptist now runs cost accounting monthly on all of its hospitals that use Epic; that used to happen only twice a year for two hospitals. Under the new system, different types of visits are booked in a way that automatically populates their cost into a report each month, Beaulieu said. “Automate what you can automate,” he said.

Having a solid cost accounting system has also allowed Baptist to become more comfortable in negotiating contracts with payers. In some cases, Baptist has offered to lower its rates because it learned it could perform services at a lower cost, Beaulieu said.

Michelson, of Strata, compares what’s currently happening in cost accounting to the trajectory of EHRs between 1970 and 2004. The uptake was similarly slow, and systems typically got rid of their initial platform in favor of more advanced technology years later. That’s when the market took off. 

Advancement in cost accounting has been slow for more than 40 years, Michelson said. That’s because for the many years that systems used charge-based methodology their processes were very slow, their efforts were limited to the hospital setting and the information was restricted to the back office rather than shared widely, he said. 

But that’s changing, thanks to advances in technology and the pressure to take on more risk. “It’s on hyper-speed over the last three years,” Michelson said. 

UPMC partnered with Health Catalyst to refine and commercialize its cost accounting system, DeMichiei said. 

UPMC also uses the system to study differences in procedure costs. DeMichiei showed a chart depicting variation in physicians’ supply costs at certain hospitals for posterolateral lumbar fusion, a type of spine surgery. 

They ranged from as much as 49% above the median to 87% below it. The system runs the same study for a number of procedures and then explores ways to reduce the variation. 

“We are socializing these stats with our physicians to say, ‘We have this variation,’ ” DeMichiei said.

Dr. Doug Ardoin, a managing principal with Lumina Health Partners, said one mistake health systems can make as a result of cost accounting is getting overzealous about attacking the point of care and making cutbacks for clinicians. “I think that’s where they get sideways,” he said. “Then they realize that patient satisfaction begins to suffer or medical errors occur.” 

Under Baptist’s old cost accounting model, physicians would quickly dismiss the information when administrators couldn’t back it up, Beaulieu said. By contrast, the system’s neurosurgeons now regularly use data from the new system to gauge their performance and learn about variation among their peers, he said. 

“People are not questioning the accuracy of the data as much and they’re relying on it and actually requiring that we rely on it, which was a huge milestone to hit,” Beaulieu said.