International Journal of Health Care Quality Assurance Emerald Article: Hospital cost structure in the USA: what's behind the costs? A business case Charu Chandra, Sameer Kumar, Neha S. Ghildayal Article information: To cite this document: Charu Chandra, Sameer Kumar, Neha S. Ghildayal, (2011),"Hospital cost structure in the USA: what's behind the costs? A business case", International Journal of Health Care Quality Assurance, Vol. 24 Iss: 4 pp. 314 - 328 Permanent link to this document: http://dx.doi.org/10.1108/09526861111125624 Downloaded on: 06-06-2012 References: This document contains references to 26 other documents To copy this document: [email protected] This document has been downloaded 981 times since 2011. * Users who downloaded this Article also downloaded: * Sameer Kumar, Neha S. Ghildayal, Ronak N. 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The current issue and full text archive of this journal is available at www.emeraldinsight.com/0952-6862.htm IJHCQA 24,4 Hospital cost structure in the USA: what’s behind the costs? A business case 314 Received 29 August 2009 Revised 10 December 2009 Accepted 23 December 2009 Charu Chandra Department of Management Studies, College of Business, University of Michigan-Dearborn, Dearborn, Michigan, USA Sameer Kumar Department of Operations and Supply Chain Management, Opus College of Business, University of St Thomas, Minneapolis, Minnesota, USA, and Neha S. Ghildayal School of Public Health, Division of Health Services Research, Policy and Administration, University of Minnesota, Minneapolis, Minnesota, USA Abstract Purpose – Hospital costs in the USA are a large part of the national GDP. Medical billing and supplies processes are significant and growing contributors to hospital operations costs in the USA. This article aims to identify cost drivers associated with these processes and to suggest improvements to reduce hospital costs. Design/methodology/approach – A Monte Carlo simulation model that uses @Risk software facilitates cost analysis and captures variability associated with the medical billing process (administrative) and medical supplies process (variable). The model produces estimated savings for implementing new processes. Findings – Significant waste exists across the entire medical supply process that needs to be eliminated. Annual savings, by implementing the improved process, have the potential to save several billion dollars annually in US hospitals. The other analysis in this study is related to hospital billing processes. Increased spending on hospital billing processes is not entirely due to hospital inefficiency. Research limitations/implications – The study lacks concrete data for accurately measuring cost savings, but there is obviously room for improvement in the two US healthcare processes. This article only looks at two specific costs associated with medical supply and medical billing processes, respectively. Practical implications – This study facilitates awareness of escalating US hospital expenditures. Cost categories, namely, fixed, variable and administrative, are presented to identify the greatest areas for improvement. Originality/value – The study will be valuable to US Congress policy makers and US healthcare industry decision makers. Medical billing process, part of a hospital’s administrative costs, and hospital supplies management processes are part of variable costs. These are the two major cost drivers of US hospitals’ expenditures that were examined and analyzed. International Journal of Health Care Quality Assurance Vol. 24 No. 4, 2011 pp. 314-328 q Emerald Group Publishing Limited 0952-6862 DOI 10.1108/09526861111125624 Keywords Hospitals, Cost drivers, Cost analysis, Health services, United States of America Paper type General review Introduction US healthcare costs are increasing at a rate roughly three times inflation. In 2008, the US healthcare industry was estimated to be worth $2.3 trillion or 16.5 per cent of gross domestic product (GDP) and is projected to be 17.9 per cent or $2.6 trillion by 2010 (Foster and Heffler, 2009). In 2008, 43.8 million US people were uninsured – 17 per cent of the total population, up 6 per cent from 2000 (Centers for Disease Control and Prevention, 2009a). In 2008, employer health insurance premiums increased 5 per cent – two times the rate of inflation. The annual premium for an employer health plan covering a family of four averaged nearly $12,700. The annual premium for single coverage averaged over $4,700 (The National Coalition on Health Care, 2009). Table I shows US national health expenditure and GDP projected to 2010. It also shows national health expenditure as: GDP percentage; and expenditure per capita, which shows an alarming growth trend over 50 per cent and the health expenditure per capita over 45 per cent, respectively. Healthcare is currently a major fiscal problem. If this trend continues to 2010 and beyond then corporation managers will stop offering healthcare (some already have) to employees, or they will keep passing along premium increases to employees as many currently do (Murdock, 2008). If the healthcare burden is left in the average consumer’s hands then it will cripple the economy. Approximately 44 million US people either cannot afford healthcare, or simply do not have healthcare for some reason. Consequently, they use hospital emergency rooms as their family clinic (Lavey, 2006; Centers for Disease Control and Prevention, 2009b). This is obviously more expensive and inefficient than seeing a clinic family practice physician (Taheri et al., 2000). But, more importantly, it takes precious time away from patients with potentially life-threatening problems. The US healthcare rising cost trend will continue unless the industry can find ways to reduce the burden placed on the consumer. People cannot continue to afford healthcare at this increasing rate. One way to accomplish affordable healthcare is to find ways to reduce costs and run a more efficient operation (Woolhandler and Himmelstien, 2007). Hospitals comprise about 30 per cent of the healthcare industry’s expenditure (Figure 1). We examine healthcare’s rising costs, specifically related to hospital expenditure and focus on key hospital operations. Costs are broken down into fixed, variable and administrative overhead and spending – areas that are most out-of-control. Medical billing and supplies processes are significant and growing contributors to US hospital costs. We identify cost drivers associated with these processes and suggest improvements to reduce hospital costs in the medical billing and supplies processes areas. We use Monte-Carlo simulation models to analyze costs associated with medical billing and supplies processes. These models provide lower bound saving estimates for implementing improvements in these processes used in US hospital operations. We examine the following questions to determine where hospital spending can be successfully trimmed: what hospital cost is fixed, variable and general overhead? What hospital spending can be better controlled? How can the spending be controlled and what savings can be quantified by analyzing hospital spending? Current industry trends: hospital costs Current industry trends reveal escalating healthcare costs. The entire US healthcare industry accounts for 16-17 per cent, or approximately $1.9 trillion dollars GDP (Gold and Diller, 2006). Of that, hospital costs comprise roughly 30 per cent, which increased over 9 per cent per year for the past five years and continue to increase (National Health Expenditure Data, 2004-1960). There are three major expenses in a hospital: Hospital cost structure in the USA 315 Table I. Healthcare industry indicators 1,981 690 12,638 15.67 295.6 258.8 36.7 6,701 41.2 41.0 2,113 731 13,399 15.77 298.4 261.2 37.2 7,079 43.6 43.3 2006 2,241 775 14,078 15.92 301.3 263.4 37.9 7,439 43.1 42.8 2007 2,379 817 14,441 16.47 304.2 265.5 38.7 7,818 43.8 43.6 E2008a 2,509 854 14,150 17.74 307.2 267.7 39.5 8,169 F2009a 2,624 892 14,647 17.92 310.2 270.0 40.2 8,459 F2010a Notes: a E-estimated, F-forecasted Sources: NHE – Centers for Medicare and Medicaid Services (2009); GDP – Bureau of Economic Analysis (2009); Forecast GDP – BMO Capital Markets Economics (2009); Population – US Census Bureau (2009); Uninsured Population – Centers for Disease Control and Prevention (2009b) 1,855 646 11,868 15.63 292.8 256.5 36.3 6,335 42.1 41.7 2005 316 National health expenditures (NHE) (US$ billion) Private health insurance (US$ billion) Gross domestic product (GDP) (US$ billion) NHE as % of GDP US population (millions) Under 65 (millions) Over 65 (millions) NHE per capita (US$) Number of people uninsured, all ages (millions) Number of people uninsured, under 65 (millions) 2004 IJHCQA 24,4 Hospital cost structure in the USA 317 Figure 1. Historical and forecast NHE and hospital expenses for the USA (1995-2010) (1) fixed; (2) variable; and (3) administrative/overhead costs. We define administrative costs as non-patient contact costs incurred by hospital staff. These are non-revenue generating activities that need to be allocated to the revenue generating departments and are typically allocated according to users in each department or by facility space department staff use. There are some arguments regarding costs that comprise administration: maintaining medical records; medical records filing; billing; nursing administration; general and administration departments (IT, finance and plant operations); supplies ordering; and central services. A 2003 study shows that hospital administrative costs range from 19.3 per cent to 24.8 per cent (Mehrotra et al., 2003). The US hospital administrative costs are approximately 8.4 per cent to 11.1; 60 per cent higher than Canada’s and 97 per cent above Great Britain’s (Mehrotra et al., 2003). There are several reasons that US administrative costs are high relative to other countries. Its insurance system consists of more than 1,500 service providers through which insurance can be obtained. Each company markets, creates and sells its own insurance to US individuals and companies. To complicate matters for hospitals and their billing departments, most carriers have different billing requirements (Mehrotra et al., 2003). Hospital variable costs are expenses that vary by patient with different medical needs. In other words, variable expenses can be viewed as expenses that are outside the physicians’ control. Examples include: laboratory tests; medications; medical supplies and nursing expenses. Variable expenses account for approximately 35 per cent to 42 per cent of total patient expenses (Roberts et al., 1999). Variable hospital expenses are a significant issue for hospital managers who are reluctant to make changes to the way variable spending occurs because cutting them compromise patient care. Supplies are the second largest expense for hospitals after salaries (McGourty and Shulkin, 2005). The problem is that many hospital managers allow each department to purchase their own supplies, causing them to act independently creating wasted time and spending. If IJHCQA 24,4 318 staff in each department order their supplies then managers lose purchasing power. Hospital staff rely on nurses and doctors to manage inventory as well as patient care, the latter is where clinicians’ focus should be. Fixed and administrative costs are the most difficult to differentiate. Because of fixed costs’ nature, these are also the most difficult spending areas to control. For our purposes, fixed costs are related to equipment amortization, facilities, building leases, utilities and building maintenance. Capital expenditure amortization can be affected through capital spending cuts. Conscientious employees and corporate awareness can help curb utility expenses. Building leases are not changeable unless one can take less space or somehow adjust the contract. Building maintenance is a requirement and an ongoing expense that is hard to control. Hospitals can keep the building well maintained to avoid extremely expensive unexpected repair costs. For these reasons, we focus on the variable and administrative costs. In the short term, there is more value that can be extracted from those two cost categories. Based on administrative and variable costs data, it can be deduced that hospital fixed costs comprise 34 per cent to 46 per cent of hospital expenses. These costs to change the way hospitals operate. Hospital managers have very little profit margin, not because their revenues are flat or decreasing, but, because their costs are increasing at a rate more than three times inflation. Each year, hospital costs are becoming a larger percentage of US GDP. By 2010, healthcare costs will be nearly 20 per cent of GDP. In a country where, for the most part, people are wealthy, there is a concern because 45 million people cannot afford to buy healthcare (Lavey, 2006). We look at some specific expenses that can be reduced through more efficient operations and waste elimination. We use a statistical model with scenario analysis to determine the potential savings related to changes in the way hospitals treat their medical supply procurement process. The model is also used to determine potential savings related to hospital administration costs including bill processing and the insurance claim process. These two spending areas waste processing time and money spent. This model clearly pictures potential savings and since scenario analysis is being used, there will be a most likely outcome and best and worst-case scenarios. Method We use @Risk Program (2007) Monte Carlo simulation modeling software, which is an add-on tool, with a spreadsheet interface to run scenarios. Various business scenarios are studied to understand possible outcomes using average estimates and adding an element of variability to them. By adding variability to the modeling, we can come up with expected outcomes to give a more realistic view how the proposed changes affect hospital costs. Owing to hospital operation complexity, we model two business processes. The first looks into the medical billing (administrative costs) and the second medical supplies (variable costs). There is other Monte Carlo simulation modeling software having similar capabilities as @Risk. Standard statistics tools used to produce similar results (Figures 2 and 3) will require more elaborate efforts compared to @Risk or other similar software such as Crystal Ball, which are specifically designed to carry out Monte Carlo simulation and regression sensitivity analysis shown in these figures. Results shown in Figures 2 through 5 are based on running Monte Carlo simulation using @Risk simulation modeling software. Hospital cost structure in the USA 319 Figure 2. Supply process model results for 2000-2004 The first model reviews the hospital medical billing process – a process that is an administrative expense because it is related to non-patient activities done behind the hospital scenes. Hospital administrative costs run around 19 per cent to 24 per cent of total hospital costs, which is significantly higher than other modern hospital cost structures. The reason this process is significant to analyze is because of the IJHCQA 24,4 320 Figure 3. Medical billing process model results for 2000-2004 processes’ cumbersome nature. There are more than 1,500 US companies that market and sell health insurance, which have multiple products that further compounds the confusion – a problem primarily because most companies have their own billing requirements as well. All insurance companies do not require the same data. Hospital managers remain flexible and abide by this process because as a for-profit business Hospital cost structure in the USA 321 Figure 4. Estimated minimum, average and maximum supply cost savings for years 2000 to 2004 Figure 5. Medical billing savings (minimum, mean and maximum) per year entity they need customers to generate revenue and remain profitable. The burden has been placed on hospital staff to comply with insurance carrier requirements. Figure 6 illustrates a Monte Carlo simulation model used to estimate total annual US hospital medical billing cost savings based on available estimates of various input parameters. The second model reviews hospital supply processes. Supply expenses are part of the hospital’s variable costs – a significant statistic to consider because hospital supply expense is the second largest next to salaries ( Johnson, 2004). Supply expenses comprise 18 per cent of US hospital total operating expenses (Editor, 2005). We look at IJHCQA 24,4 322 Figure 6. Monte Carlo simulation model for total US hospital medical billing savings hospitals’ current inefficient supply process and offer a solution to make this process more efficient and save hospitals significant capital. The model uses the streamlined process and scenario analysis introducing variability in an attempt to measure cost savings. The reason supplies expense is an important factor is not only because expenses are so high but also the process is inefficient. Most hospital managers let each department handle their own supply ordering. Hospitals lose buying power and fail to use centralized purchasing department staff expertise. Doctors and nurses spend hours ordering supplies, thereby taking away significant time from patients. Using the process in this article, hospital managers will be able to free time and use a more efficient process (Efficiency cure, 2004). Figure 7 illustrates a Monte Carlo simulation model that estimates total annual US hospital supply cost savings based on available estimates of various input parameters. Hospital cost structure in the USA 323 Figure 7. Monte Carlo simulation model for total US hospital supply cost savings Analysis In the current supply procurement process, departments operate independently when purchasing supplies and assuring adequate stock. Hospitals operate this way primarily because different departments need different supplies and doctors and nurses may prefer different product brands. This sounds a reasonable approach at first, but, from an operational perspective, there are many problems. First, the basic supply needs in different departments are primarily the same. Department-specific items are what differentiate them. Second, having nurses and doctors order supplies causes concern. Supply chain processes in hospitals should be centralized. It will be more efficient and less expensive than the current process. Hospital departments are operating in silos as decentralized functions. They need to have communication and consistency between departments to create an efficient supply purchasing IJHCQA 24,4 324 environment. The centralized supply chain process will effectively integrate the procurement activities across all departments in a hospital as it will force economy of scale, economy of scope and improved negotiating capabilities with suppliers for the entire hospital operation (Efficiency cure, 2004). Both hospital supply chain process efficiency and effectiveness will be enhanced through centralized supply procurement business model. This process, however, is not without costs. To implement this process hospital staff may have to invest in inventory management and automated supply ordering systems. However, these two systems will free up time for doctors and nurses so they are able to focus solely on patient care. Hospital managers will need to hire a full-time experienced supply manager in charge of the entire vendor maintenance process, vendor management procurement process, terms and conditions negotiation, etc. This process also allows the materials manager to consolidate suppliers, reduce brand variation and total items and makes the process more efficient (Contino, 2001). Variable hospital costs are approximately 35-42 per cent of total hospital costs (Roberts et al., 1999; Alexander, 2006). Supplies are the second largest hospital expense at 18 per cent of operating expenses (Editor, 2005). Using @RISK software to estimate cost savings allows users to provide value ranges for any analysis (we use 2000-2004 spending data). Table II lists various inputs to the supply cost model. The variable cost percentage is the mean value of the ranges given in the literature. Using the @RISK software, a distribution is fitted to the variable cost percentage that coincides with value ranges given. Estimated cost savings is a per cent savings estimate after process implementation discussed above. Savings are conservatively estimated at 10 per cent. There is also a slight distribution fit to the expense savings to give that value some variability. The first graph in Figure 2 depicts outcome values based on the above data. Standard deviation varies because the potential savings are relatively unknown, but are perceived to be potentially large. The graphs were done using a lognormal distribution because multiple factors affect the three input variables. Distribution shows that with 90 per cent certainty, the result, based on these inputs, by implementing the new supply process, will save between $3bn and $20bn dollars per year – significant savings that cannot be ignored. The second graph in Figure 2 is a regression sensitivity tornado graph, which highlights the variables that carry the most weight in the outcome analysis. In the healthcare example, estimated expense savings variable is the biggest cost savings driver by a significant margin. Our second analysis is related to hospital medical billing processes and related expenses that are part of the hospital’s administrative expenses. We saw earlier that the hospital administrative expenses are 19 per cent to 24 per cent of total hospital expenses (Mehrotra et al., 2003; Alexander, 2006). The medical billing process is cumbersome and costly to hospitals. Data in Table III were used as inputs to the medical billing process cost model. Hospital managers have to make sure that different Input variables Table II. Inputs to the supply cost savings model Percent hospital care of total healthcare expense Supply cost per cent of total hospital expenses Estimated per cent cost savings Estimated average Variability (standard deviation) 30 18 10 5 2 5 paperwork and requests from each insurance company are correct so they will be reimbursed for their services. Salary per employee was gathered from the Almanac of Hospital Financial and Operating Indicators (Alexander, 2006).The salary information was adjusted for wage index and reduced to account for the medical billing specialist’s lower wage. A statistical distribution was fitted to the medical biller’s salary to account for salary variability. We also looked at Medical Biller Salary (2006) on Salary.com. The time savings was an estimate based on the process’s cumbersome nature described in the literature. This conservatively estimates the time saved. A distribution was also fitted to this number to account for time saving variability. Full-time employees was also estimated and averaged based on hospital size. Some variability was also added to this figure because hospitals are managed differently and the number of employees needed for billing can vary greatly. The model’s average savings were $900 million to $1 billion dollars a year by streamlining the medical billing process. The distribution graph in Figure 3 shows that within a 90 per cent certainty, based on information in Table III, savings resulting from streamlining the medical billing process will be within $300 million to $2 billion dollars annually, which are significant. The regression sensitivity tornado graph in Figure 3 shows that the estimated time saved carries most weight. The next largest factor is employee number and the salary per employee is least. Figure 5 shows estimated minimum, mean and maximum medical billing expense savings for years 2000 to 2004. Hospital cost structure in the USA 325 Findings and limitations Healthcare industry spending, specifically hospitals, can be improved. We have looked at three types of hospital spending: (1) administrative; (2) variable; and (3) fixed costs. We examined medical billing process and expenditures specifically, which are part of a hospital’s administrative costs. The other analysis was related to hospital supplies expense processes, which is a variable cost. Based on our research, those two specific costs were the most problematic that needed to change. Data gathered in the literature, supported by our analysis, show that changing the medical supply process has a significant impact on the industry. Waste is endemic to the entire process and needs to be eliminated. We believe that improving processes will likely result in a cost savings between $2 and $20 billion. Our other analysis – the hospital billing process – showed that increased spending in this area is not entirely a hospital inefficiency fault. The Input variables Medical billing salary (salary.com) ($) Estimated time saved (%) Medical billers (employees) Number of hospitals (from US Census Bureau, 2005) Estimated input (mean) Variability (standard deviation) 26,813-30,287 30 15 7,569 3,000 10 4.5 0 Table III. Medical billing process inputs IJHCQA 24,4 326 health insurance industry with their multiplicity of complex requirements and administrative paperwork is a primary factor. But, hospital managers need to confront the insurance industries. The US administrative costs are double Canada’s, so by streamlining medical billing processes, we believe that hospitals could save $600-$700 million annually. However, we were limited by meager concrete and current data for estimating cost savings. We were still able to estimate significant lower bounds for annual savings from Monte Carlo Simulation model based on available data by improving hospital supply and billing processes in the US healthcare delivery system facing increasing operational inefficiencies and rapidly escalating costs every year. We make two recommendations; first, hospital managers need to implement the new supply chain process immediately. Let clinicians do what they are paid to do and take care of patients. There is a need to hire full-time supply chain managers to handle and monitor the entire process through an inventory tracking and automated ordering systems, which increases buying power. Our second recommendation is to make the medical billing process consistent and cohesive, which increases process efficiency and reduces potential errors. We covered only two specific types of spending. A more comprehensive hospital cost and process study should be done to ensure the greatest efficiency. More detailed research is needed to examine healthcare system successes in other countries. Plans to change US healthcare should be based on proven methods currently in operation to ensure feasibility and cost efficiency. The US service providers cannot afford to let healthcare costs escalate. If significant changes are not undertaken to improve this economic sector then this industry will continue to affect the US economy negatively. Conclusion Our study points to an awareness of increasing US hospital operation costs. The US hospital total operation expenditure fell into three categories: fixed; variable and administrative, which helps us identify the areas for greatest improvement. We tried to elevate this awareness to a level where action is undertaken. Solving the problem is vital to healthcare and the US economy, overall. We only looked at two specific costs associated with medical supply and medical billing processes, respectively. There are many other costs to consider and analyze. Using a simple Monte Carlo simulation modeling framework, we identified major cost drivers within a US hospital associated with the processes we studied. The model showed significant potential savings in hospital operations. Inefficiencies can be corrected in an effort to stop US healthcare costs escalating. We looked at US hospital spending trends, which are alarming. Healthcare, the US’ largest industry, is 16 per cent of GDP and hospitals are 30 per cent of the healthcare industry and growing rapidly, around 9 per cent per year. We looked further into hospital and two particular costs, namely, the medical billing process (administrative) and the medical supplies spending (variable) were then analyzed. For each cost we analyzed, @RISK Monte Carlo simulation modeling software was used to simulate the potential savings from process streamlining. The medical billing process is a challenge and hospital managers need to confront insurance carriers who have complex processing claim procedures. A streamlined process will cut hospital administrative costs significantly. The medical supplies spending process has the greatest savings potential. Most hospital managers allow departmental staff to purchase supplies. Investing in an automated supply ordering system and a supplies manager allows nurses and doctors to concentrate on patient care. A supply chain person would streamline the process, reduce costs, utilize buying power by negotiating lower pricing and add other potential benefits to hospitals. Hospital spending is out of control, but the good news is that this is known. There is time to correct this trend before the problem worsens. All hospital processes need to be streamlined into the most cost effective method while allowing the highest patient care level possible. That is really the bottom line. Americans want to say that they have “quality, affordable healthcare”. References @RISK Program (2007), Palisade Corporation, available at: www.palisade.com/ Alexander, J.A. (2006), Almanac of Hospital Financial and Operating Indicators, Ingenix, Utah. BMO Capital Markets Economics (2009), United States Economic Outlook, available at: www. bmonesbittburns.com/economics/forecast/us/usmodel.pdf (accessed 14 August 2009). 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US Census Bureau (2005), Facts for Features, Document CB05-FFSE.02-2, 29 April, available at: www.census.gov/Press-Release/www/releases/archives/cb05-ffse.02.pdf US Census Bureau (2009), National Population Projections. Released 2008 (Based on Census 2000), available at: www.census.gov/population/www/projections/ natproj.html (accessed 14 August 2009). US Health and Human Services (n.d.), available at: www.cms.hhs.gov/nationalhealthexpenddata/ Woolhandler, S. and Himmelstien, D.U. (2007), “The deteriorating administrative efficiency of the US healthcare system”, The New England Journal of Medicine, May, available at: http//content.nejm.org/cgi/content/abstract/324/18/1253 Corresponding author Sameer Kumar can be contacted at: [email protected] To purchase reprints of this article please e-mail: [email protected] Or visit our web site for further details: www.emeraldinsight.com/reprints
