What if Medicare Were the Only Payer?

Viewed in a vacuum, no other program in the U.S. healthcare system has been as influential during the past 50 years than Medicare.

Medicare has mostly done what President Lyndon B. Johnson and other social reformers had hoped it would do: provide healthcare access to the nation's oldest citizens. For hospitals and health systems, Medicare is the benchmark for all reimbursements, and depending who you ask, that may be a good or bad thing.

According to the Medicare Payment Advisory Commission, the average Medicare margin for a U.S. hospital in 2012 was -5.4 percent. That means for every dollar a hospital spent treating a Medicare patient, the hospital received a little less than 95 cents in return.

Looking at MedPAC's data, hospitals that typically lose the most on Medicare patients are nonprofit, urban hospitals without a teaching program. Hospitals that perform the best are for-profit, rural hospitals and some major teaching hospitals. However, MedPAC noted that although most hospitals continued to lose money on Medicare patients, the average all-payer margin for hospitals reached a 20-year high in 2012. The total margins for hospitals increased to 6.5 percent in 2012, meaning hospitals posted solid operating profits thanks in part to higher reimbursements from commercial payers.

But the days of cushy pay from private insurers may be coming to gradual end. More insurers are moving toward capitated payments and shared savings contracts, which put greater pressure on reimbursement. Analysts at Moody's Investors Service have also said rate increases from commercial payers, from a broad perspective, have been lackluster the past few years, which have contributed to slow revenue growth. Hospital executives may not want to admit it, but Medicare is becoming an even more important baseline than ever before.

Whether the U.S. healthcare system is heading toward a Medicare-for-all, single-payer type of design — that's a different conversation for another day. But right now, for the most progressive and financially attuned hospitals, it's worth asking: Would I survive if Medicare were my only payer?

The power of Medicare breakeven
For executives like John Goodnow, CEO of Benefis Health System in Great Falls, Mont., that question has been top-of-mind for the past half decade.

"Hospitals have traditionally cost-shifted from payers that are worse than Medicare and from people that don't pay onto commercial payers," Mr. Goodnow says. "But the days of being able to cost-shift are rapidly coming to a close. Those strategies that worked in days past aren't going to work in the future."

So what strategies will work? "It's important to get to Medicare breakeven," he says.

Benefis is a two-hospital system and includes the only tertiary hospital for a 37,800-square-mile area, which is a shade bigger than Indiana. Most of its service area is in Montana, a relatively poor state, and the system mostly treats patients with government insurance: 53 percent Medicare, 11 percent Medicaid and 6 percent Tricare, Indian Health Service and other government programs. With almost 70 percent of Benefis' payer mix coming from the government, Mr. Goodnow and his team knew the system had to fundamentally change its fiscal structure.

In 2009, Benefis made Medicare breakeven a long-term goal, if for nothing else to stabilize that half of its revenue base. Every year since then, Benefis has maintained an operating margin of at least 3.6 percent (in 2013, it was 4.1 percent). Perhaps most strikingly, the health system has already achieved Medicare breakeven: In 2012, Benefis posted a positive 2.6 percent margin on its Medicare services, which was vetted and confirmed by financial advisers.

How can hospitals actually record a profit on their Medicare business? It's not a mirage, Mr. Goodnow says, and the strategy generally requires the same starting point.

Why labor strategies rule the day
"The big dog in the room for almost any organization, particularly at the beginning of the process, is you need to look at it as a marathon and not a little sprint race," Mr. Goodnow says. "At the beginning of the marathon, the biggest opportunities typically lie in productivity improvement."

According to Fitch Ratings, personnel costs represented 54.2 percent of hospital operating revenue on average in fiscal year 2012, one of the highest figures of the past several years. Benefis has about 2,800 employees, and Mr. Goodnow says their personnel-to-revenue ratio is running at about 48 percent, well below average. If Benefis had been at the Fitch median, Mr. Goodnow says the system's $13 million operating profit would've been completely wiped out — and the system would've been deep into the red.

"Most hospitals are fairly heavily staffed, at least not-for-profit hospitals," Mr. Goodnow says. "If you put in place a very good productivity tracking and monitoring system, and you're pretty adamant about achieving productivity standards and holding people accountable, that's where you're going to get the single biggest improvement in cost reduction."

Jason Barrett agrees that labor costs must be handled to have a shot at earning a margin on Medicare. Mr. Barrett serves as chief integration officer and executive vice president of strategy at Flagler Hospital in St. Augustine, Fla. He says Flagler — which is one of 15 hospitals most exposed to Medicare in Moody's portfolio — just started its Medicare breakeven project in 2012. The executive team found that from 2012 through 2019, the hospital would have to shave $30 million in operating costs to maintain a 2 percent operating margin. About one-fifth of the savings had to come from the labor side.

Mr. Barrett says one of the major initiatives was finding a way to make overtime pay for nurses more sustainable. "We worked with our nursing ranks to say we want to make sure we are able to [reduce premium pay], and they came up with the restructuring of schedules to get it," Mr. Barrett says. "That's the thing I'm most proud of. It was the nurses championing the effort. It wasn't an edict from administration."

However, controlling labor does not necessarily mean hospitals and health systems have to resort to layoffs. Under Mr. Goodnow, Benefis has never laid off anyone. In fact, in each of the past 12 years, Mr. Goodnow has promised raises to everyone across the system. The key, he says, is making sure the organization is right-sized to a level that ensures quality care.

"We have lots of quality accolades, so [labor strategies] haven't made quality suffer here," Mr. Goodnow says, noting Benefis has received several awards from Healthgrades. "And you might think, yeah, but well, you're going to really hurt employee satisfaction. No, actually not. Employee satisfaction has gone up every year. We've tightened productivity dramatically without having employee satisfaction or quality suffer."

"I have those personal promises to employees that you're getting raises and won't be laid off," Mr. Goodnow adds. "The tie-in I make: There is no way we could make those kinds of assurances if we weren't focused on, and good at, cost reduction."

The pertinent components beyond labor
Labor costs continually present areas of improvement for hospitals and health systems. While labor is an essential area of emphasis, it's still a mere piece in the Medicare profit puzzle.

At Flagler, executives knew they had to get personnel costs in line, but of the $30 million they had to save, half actually had to come from a different source: physician alignment.

Specifically, Flagler had to start reducing variation and length of stay. The hospital also created a clinically integrated network and invested more in accountable care contracts.

"We recognized if we're going to still have Flagler on the front of the building in the future, we'll have to be more economically integrated with our physician partners," Mr. Barrett says. "We have 200 physicians who now participate in our clinically integrated network. Our message to get them to join was that it is always about quality. It sounds like mom and apple pie, but we said if we don't do this, your access to patients will be compromised, as will your way of practicing medicine."

Shelly Hunter, CFO of Mercy Joplin/Kansas, a five-hospital division of Mercy, agrees. She says if her system's commercial payers went to Medicare rates, the system would lose between $6 million and $12 million in net revenue every year. Preparing for the worst, Mercy Joplin/Kansas has drilled down into care path management to find out how its Medicare cases can become profitable. For example, executives and clinicians have worked diligently to identify septicemia patients early, particularly those who walk through the emergency department.

"Septicemia is very scary, the mortality rate gets to be very high and it's also very expensive," Ms. Hunter says. "Certain measures [like septicemia] have better outcomes when they are standardized. We find we have fewer readmissions in those cases, which is clearly better for us financially but also better for the patient and care quality, as well."

Small actions that make a big difference
Mr. Goodnow says Benefis has been successful today in its pursuit of Medicare breakeven because the entire organization has bought into the idea. He shared 10 imperatives other hospitals and health systems should follow if they want to find similar results.

•    Build commitment among all senior management, led by the CEO, as well as the board of directors.
•    Entrench the cost reduction mindset throughout the management and supervisory ranks, and consider including cost reduction incentives within compensation.
•    Show the strategic important of cost reduction consistently and often.
•    Emphasize why cost reduction is important for all employees through clear communication.
•    Measure results, report the results often and celebrate actual successes.
•    Include physicians, employed and independent, as cost reduction partners.
•    Be prepared to look beyond the low-hanging fruit.
•    Know that there are always ways to reduce costs, and leave no rock unturned.
•    Evaluate external partners, like GPOs, to see if they are helping or hurting your cost reduction process.
•    Be persistent, and don't get discouraged.

"Leaving no rock unturned" is one of the system's most intriguing strategies. Benefis employees scrutinize literally every expense to find savings. For example, in 2013, a renegotiated contract for food and environmental services saved more than $184,000; taking control of sprinkler head maintenance netted $18,000; Benefis even saved $3,000 by notifying employees of their annual pay increase via online methods instead of using snail mail.

Although surviving on Medicare rates is still more of a mental exercise than a reality at this point, the mindset may benefit hospitals in the long run. But it's worth reiterating, according to some, that strategic changes of this magnitude don't happen overnight.

"I hope no one has that Wall Street analyst outlook, where you're looking at next quarter's earnings," Flagler's Mr. Barrett says. "These efforts take time to accrue benefits. The community provider doesn't have to go the way of the dodo bird."

More Articles on Hospitals and Medicare:
CMS' 2015 IPPS Proposed Rule: 10 Points to Know
Medicare RACs Take Back $665M in Q2
Hospitals Feeling the Squeeze: 4 CFOs on Today's Most Pressing Financial Issues

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