Why distressed hospitals need better internal audit controls

A growing number of U.S. hospitals are breaching contractual obligations with their banks, highlighting the need for greater internal audit controls that can flag such issues and stop a problem from becoming a crisis.

These hospitals, often smaller, rural facilities, are financed with bond debt or bank loans that require they remain in line with certain financial goals or covenants. For example, a hospital may have to hold sufficient cash to cover 150 days of expenses, or maintain a certain debt coverage ratio — sufficient free cash flow to potentially service debts. When a hospital falls below specific thresholds, such as having 110 days of cash on hand, they are obliged to hire consultants to help fix the problem. Lately, a growing number of hospitals is being forced by creditors to get such help, discovering that internal audit controls are needed.

Administrators complain that they’re distracted by myriad other problems — from boosting patient volumes to upgrading outdated equipment and recruiting clinicians — but what’s really needed is a proper risk strategy and auditing system that can mitigate risk.

Without audit controls in place, hospitals risk becoming financially distressed, or even bankrupt — a rising problem in the industry. Bankruptcy filings among health-care entities are more than 20% above 2010 levels, according to the Polsinelli/TrollerBK Distress Index.

Every institution that is struggling financially faces different problems. However, troubled hospitals often repeat many of the same mistakes that an audit would catch. Good internal controls are a leading indicator of problems and lead to more timely and appropriate mitigation efforts to resolve those issues. A number of those common problems are related to contracts with insurance companies and with physicians.

When it comes to insurance companies, many hospitals fail to keep their contracts with managed care organizations and others up to date. As a result, the hospital might not be capturing fees they could be charging or could have missed an opportunity to negotiate better reimbursement rates. Hospitals also need to be mindful of the timeless of their insurance company’s coding compliance review. That can result in penalties when the wrong codes are used, or can cause a hospital to bill an insurance company for too little. Another common problem is not updating computer systems, resulting in the hospital’s billing department preparing invoices that under charge insurance companies and patients for services. Having the right controls in place can spot these problems early and develop a plan of action that stops the problem from becoming serious.

Hospitals also often have audit-related issues with their physicians. Frequently, hospitals have failed to review and update their physician agreements in line with best practices in the industry. Hospitals still paying doctors a salary should shift to a relative value unit approach to compensation, where clinicians are paid in a way that supports the “Triple Aim” of improving population health, better patient engagement and lowering per capita costs. Hospitals also often fail to undertake a risk assessment to quantify the physician needs of the community and how demographic trends will change those needs over time.

All of that can be a significant burden for the administrative staff of a small hospitals. That’s especially true because these organizations often have trouble hiring and retaining talented business office staff, and because these hospitals are more susceptible to fluctuations in patient volumes that affect their financial position. Despite those challenges, there are a number of ways that hospitals lacking internal audit controls can resolve the situation.

Hospitals can coordinate with other organizations to share the cost of putting such audits in place and to hire and retain top talent to manage the audit process. Alternatively, hospitals can contract out the work of conducting regular internal audit reviews. Hospitals can also seek out an alliance or partnership with a larger hospital system for help on these governance issues. Finally, if the hospital has particularly intractable problems, preparing the institution for a sale or merger with a larger organization may be an option worth consideration.

Whatever option a hospital pursues, breaching creditor covenants is never sustainable, so figuring out how to fix these underlying problems is crucial to the institution’s long-term financial health. It also gives administrators a roadmap of the most serious challenges facing the organization, ensuring that business staff are all pulling in the right direction.

(Tony Colarossi leads Plante Moran’s acute healthcare consulting services.)

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