Are Your Cost Estimates Leading to the Wrong Decision?

Most hospitals today use cost-to-charge ratios, or RCCs, to determine their overall costs, but this could lead to sub-optimal operational and strategic decisions. In a webinar on May 22, 2012, three executives from Objective Health — Tim Darling, director of product development; Ben Reigle, knowledge expert; and Sapan Anand, product manager — explained how cost-to-charge ratios could be flawed and how hospitals could make adjustments to improve their cost estimates.

Mr. Darling said from their research, they have found roughly 50 to 60 percent of hospitals use RCCs, which is a methodology for allocating costs. Hospital costs are allocated on a patient-by-patient basis, and each patient's bill contains charges. Those charges are then converted to costs using an RCC. For example, according to the American Hospital Directory, if a patient had $300 in pharmacy charges, and the hospital's RCC for pharmacy was 0.5, then the cost would be allocated as $150.

However, RCCs are an imperfect science. Citing various news reports, Mr. Darling said "there is an almost complete lack of understanding of how much it costs to deliver patient care" because hospitals and other providers sometimes do not measure their costs correctly. Assigning costs to patients based on what hospitals charge can sometimes be misleading. "Healthcare leaders must recognize how critical it is for hospitals to improve on cost-to-charge ratios," Mr. Darling said.

To put this problem in context, Mr. Darling gave a case study of a 250-bed rural hospital client in the East North Central region, which he called "Valley Hospital." Drugs and implants are two areas that could have great variation in their actual costs versus their RCCs.

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At "Valley Hospital," many high-cost drugs like enoxaparin had overestimated costs, while many low-cost drugs like acetaminophen had underestimated costs. However, the net result was that drug costs were mostly in line.

However, there was some variation when Mr. Darling and the rest of the Objective Health team looked at two physicians at the hospitals in the same DRG — in this instance, septicemia. One physician mostly used drugs that were overestimated, while the other was a heavy user of underestimated drugs. Although the second physician appeared to be the more cost-efficient of the two based on RCCs and using lower-cost drugs, his actual costs were far higher after looking at the true expenditures of the drugs used.

"In this type of analysis, RCCs are dangerous," Mr. Darling said. "They may work in some cases, but at least in this DRG, the lowest-cost physician in RCC is not actually the lowest cost."

Mr. Reigle said RCCs can also be misleading when it comes to the profitability of service lines. In another example at "Valley Hospital," the Objective Health team looked at orthopedic surgery. Based on RCCs, the hospital thought it was making a $477,000 profit, when in actuality the profit was roughly $170,000 lower. This was due to implant costs, as the hospital grossly underestimated how much hip and knee replacement implants actually cost.

"For years, [the hospital's executives] thought they were making a lot of money, especially on hip replacements, but we had to tell them they were underestimating their implant costs," Mr. Reigle said.

The Objective Health team extrapolated their analysis beyond "Valley Hospital" as well, and they found that "Valley Hospital" appeared to be a decent example of a systemic trend. Based on their research of more than 100 hospitals, most hospitals underestimated costs per case on orthopedic surgery with an RCC approach, perhaps due to underestimated implant costs, and the presenters also found out that cardiovascular catheterization was more profitable than hospitals may realize. "CV-cath is probably more profitable than you believe it to be," Mr. Darling said. "You actually do see this pattern that hospitals overestimate stents, and perhaps they overestimate high-cost drugs."

So what can hospitals do to make adjustments to their cost estimates? Mr. Anand said most hospitals today do not connect patient files (where they estimate costs) to purchasing files (which have actual costs). Linking these massive databases together through a systems solution could lead to better cost estimates and better-connected data sources. "There's complexity in joining all these together, and it is not as seamless as we'd all like it to be," Mr. Anand said.

For smaller hospitals not looking to make million-dollar upgrades on cost estimate systems, Mr. Darling said it takes some effort from the in-house staff to recognize RCCs are not the final word on a hospital's outlays. "This is more about taking a critical eye toward the cost estimates being used today," he said.

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