Why are hospitals cutting costs?

The healthcare industry is feeling pressure to cut costs. As the Affordable Care Act (ACA) continues to bring tighter federal regulations and uncertain insurance payout changes, more healthcare executives are bracing for the unknown by slashing their annual budgets now.

No hospital in the U.S. is immune to this pressure to scale back spending. In Premier Inc.'s fall 2014 Economic Outlook survey, 75 percent of hospital executives reported their hospitals are currently in the process of cutting expenses — especially when it comes to buying costly new medical devices. The survey's respondents were 127 C-suite executives at 112 hospitals across 32 states.

"Providers report a number of initiatives to better control spending and improve overall efficiency," according to the survey's analysis report. "More than three quarters of C-suite executives have resource utilization programs in place to better control the use of expensive supplies and purchases."

How exactly does the ACA impact a hospital's annual budget?

Overall, health care facilities are struggling to comply with the legislation's new insurance reimbursement procedures and coverage mandates, which continue to shift and change each year, according to Premier's survey. Twenty-three percent of respondents listed the legislation's mandates as the top driver of their costs in 2013, more so than in any other category.

"There's no question that reimbursement cuts put a severe strain on tight hospital budgets," Premier COO Michael Alkire said in a press release. "Shifting to new care delivery models designed to better manage population health involves a heavy up-front investment. As more hospitals make this transition, it's probable that we will see these cost centers grow in magnitude over the next few years."

In addition to budget cuts as a result of the ACA's reimbursement guidelines, the legislation's voluntary programs are also impacting a hospital's spending. According to the survey, 26 percent of respondents cited voluntary new care delivery and payment models, such as accountable care and bundling, as a major organizational expense. This figure is up from 14.3 percent just one year ago.

The Scope and Impact of the Mandate

The ACA, otherwise known as Obamacare, began rolling out on January 1, 2013, and the influx of new patients continues to send shockwaves throughout the medical industry. Last year, about 8 million Americans became insured, and even more are expected to do the same as open enrollment gears up, according to the U.S. Department of Health & Human Services.

Going into the new year, more new mandates are slated to take effect. One such provision will tie "physician payments to the quality of care they provide," according to the legislation. Looking forward, physicians who provide "high-quality care" will receive higher payments than those who provide "low-quality care." The level of quality will be measured through a patient's re-admittance rate — or lack thereof.

This is just one example of how the ACA's changing medicaid and medicare reimbursement amounts and payout procedures continue to put pressure on hospital executives to cut costs. Coverage estimations and long-term budgeting is a challenge if insurance payouts fluctuate each year. As a result, hospitals are airing on the side of caution by tightening their budgets in advance of impending changes.

Medicare, for instance, often has vastly different and unpredictable rates for patients who appear to have the same condition and require the exact same kind of care. The government will pay out more than three times the rate if a stroke patient using Medicare coverage is discharged to a rehabilitation facility instead of sent home and cared for by health aides, according to the legislation.

Medicare coverage provisions, such as the one listed above, are frustrating for many healthcare professionals, as they may view the ACA's incentives as counterintuitive to long-term spending reduction efforts. Let's revisit the example again from a physician's perspective: Nursing homes and long-term rehabilitation facilities have a terrible record of controlling hospital readmissions and will drive up inpatient costs later on, according to Kaiser Health News. But the ACA is rewarding just that through its new Medicare payout structure.

Put into a broader context, the ACA's Medicare payout changes are impacting hospital spending allocation across the country. Per capita spending on post-acute or post-hospital care has grown at least 5 percent each year in 34 of the nation's 50 most-populated hospital markets, according to an analysis by health care economist Chapin White for Kaiser.

As part of the healthcare mandate, physicians now have transparent Medicare payout information available from the Centers for Medicare & Medicaid Services. But the reports appear to be adding more confusion and uncertainty, as some information remains unreported and unknown.

"The data [does] not account for factors such as the age and overall health of patients seen, their degree of medical comorbidities," said Frederick Azar, president of the American Association of Orthopaedic Surgeons (AAOS). "The severity of the conditions being treated, which makes it challenging to compare or assess physicians' cost for similarly coded procedures and treatments."

The Lasting Effects of Cost Cutting

When hospitals scale back their budgets, generally the first thing to get cut or reduced is research and development, which paves the way for future operational and technological innovations that improve patient care. While slashing spending on new medical devices and innovations may save a hospital money in the short-term, the long-term effects of product inefficiency result in significant time, money and patient-care lost.

A Harvard Business Review (HBR) study of more than 30 hospitals demonstrates the negative effects of cutting investments in isolated categories, such as reducing spending for medical device innovation alone. The study, which is a joint program with the Institute for Healthcare Improvement, looked specifically at an orthopedic surgeon's productivity in a hospital environment. The findings uncovered huge knowledge gaps as a result of silod benefit analyses.

The study found that some orthopedic surgeons perform seven to 10 hip replacements a day while others do just two or three — even though the time it takes to perform the procedure doesn't vary much between the two groups. The difference? Surgeons performing seven to 10 hip replacements a day generally have two operating rooms while surgeons performing just two or three online have one operating room. The low-volume group, as a result, must wait for the one operating room to be cleaned and prepped in between surgeries, adding idle time.

Ultimately, a holistic financial analysis found the cost of adding a second operating room is far less expensive than the cost of adding another skilled surgeon. But if hospitals are focusing on higher costs in one specific category, such as an orthopedic surgeon's perceived lack of productivity, they are not seeing the big picture.

"Only by measuring the costs of all the resources used to treat a patient's condition can trade-offs be made that lower the total cost of care," according to the HBR. In the same vein, cutting research and development spending alone can cause a powerful ripple effect in other hospital departments.

Best Practices in Cost Cutting

Medical executives who excel at keeping expenses in check think strategically — in contrast to using a siloed lens. They aim to find savings without adversely affecting patient outcomes and comprising a facility's long-term goals or value system.

When Banner Health sought out to find $70 million in savings between 2012 and 2013, for example, the $5 billion nonprofit healthcare system was steadfast in not losing sight of its long-term vision. Banner's leadership team made a conscious decision to disregard industry benchmarks in cost cutting. Instead, they aligned their cost reduction to the hospital system's three core values: Empathy, collaboration and engagement, according to Banner Health.

Their solution? Rather than tying savings to the performance of other health systems, they identified their own reimbursement margins and set their own benchmarks. In addition, the hospital system partnered with Booz & Company, inviting physicians, administrators, line managers, department heads and support staff from across the country to work together and find innovative cost-cutting measures, according to a HBR analysis.

"This decision to be inclusive and collaborative was essential in identifying tens of millions of dollars in savings while ensuring support of front-line leaders and staff," according to the HBR report. This year, due in part to its cost-cutting strategy, the Phoenix-based nonprofit system reported a $228.8 million operating surplus in a fall press release.

While Banner Health's cost-cutting strategy may not be perfect, it functions as a positive example of big-picture budget reduction strategy. It's never ideal when a healthcare facility must make a choice about spending cuts, but there are ways to make it more manageable for each department and the facility's long-term vision.

The ACA isn't going away, and more changes are on the horizon — is your medical facility prepared to make more tough spending choices?

Bobby Grajewski is President of Edison Nation Medical, a healthcare product and medical device incubator and online community for people that are passionate about healthcare innovation. Prior to joining Edison Nation Medical, Grajewski, a serial entrepreneur, co-founded two online companies (Heritage Handcrafted and eCollector) and spent 5 years in venture capital and private equity both in the middle market (J.H. Whitney Capital Partners & Kamylon Capital) and at larger LBO firms (Permira Advisers) investing in companies across numerous industries. Grajewski holds a MBA from The Wharton School at the University of Pennsylvania, a MPA from Harvard Kennedy School, and a BA from Harvard University.

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