Cost Eats Revenue for Breakfast In the New Value-Based Care (VBC) Payment Landscape

magnifying-glass-1001506_640The payment landscape is shifting dramatically in the US health care industry and this has serious implications for the survival of providers. With the volume-to-value transformation, traditional fee-for-service payments are being replaced with a financial incentive framework that rewards for improved quality and outcomes. Although this impacts only Medicare payments today, it lays the groundwork and provides strong incentives for other payers to move in the same direction, thus potentially disrupting the health care system at all levels.

Ultimately, value-based payments transform traditional business models by putting significant revenue– and risk– at stake. Building the outcomes-based financial models to maximize value-based care (VBC) reimbursement pathways will be fundamental to sustainable growth in the future. The health care players left standing strong will likely be the ones that strategically embrace change starting now. Key to winning the volume-to-value shift hinges on the ability of providers to optimize efficiencies by blending financial, operational and clinical models. It requires a fundamental shift from models designed to drive and cater to volumes and the management of revenue cycles to one where understanding how much it costs to deliver patient care and how those costs compare with the outcomes achieved, becomes central to the financial, operational and clinical model.

Making the transition to a focus on cost is easier said than done! Participants in the health care system do not even agree on what they mean by costs. When politicians and policy makers talk about cost reduction and “bending the cost curve,” they are typically referring to how much the government or insurers pay to providers—not to the costs incurred by providers to deliver health care services. Cutting payor reimbursement does reduce the bill paid by insurers and lowers providers’ revenues, but it does nothing to reduce the actual costs of delivering care. Providers share in this confusion. They often allocate their costs to procedures, departments, and services based not on the actual resources used to deliver care but on how much they are reimbursed. But reimbursement itself is based on arbitrary and inaccurate assumptions about the intensity of care.

Poor costing systems have disastrous consequences. It is a well-known management axiom that what is not measured cannot be managed or improved. Since providers misunderstand their costs, they are unable to link cost to process improvements or outcomes, preventing them from making systemic and sustainable cost reductions. Instead, providers turn to simplistic actions such as across-the-board cuts in expensive services, staff compensation, and head count. But imposing arbitrary spending limits on discrete components of care, or on specific line-item expense categories, achieves only marginal savings that often lead to higher total systems costs and poorer outcomes. For example, as payors introduce high copayments to limit the use of expensive drugs, costs may balloon elsewhere in the system should patients’ overall health deteriorate and they subsequently require more services.

Poor cost measurement has also led to huge cross-subsidies across services. Providers are generously reimbursed for some services and incur losses on others. These cross-subsidies introduce major distortions in the supply and efficiency of care. The inability to properly measure cost and compare cost with outcomes is at the root of the incentive problem in health care and has severely retarded the shift to more effective reimbursement approaches.

Finally, poor measurement of cost and outcomes also means that effective and efficient providers go unrewarded, while inefficient ones have little incentive to improve. Indeed, institutions may be penalized when the improvements they make in treatments and processes reduce the need for highly reimbursed services. Without proper measurement, the healthy dynamic of competition—in which the highest-value providers expand and prosper—breaks down. Instead we have zero-sum competition in which health care providers destroy value by focusing on highly reimbursed services, shifting costs to other entities, or pursuing piecemeal and ineffective line-item cost reductions. Current health care reform initiatives will exacerbate the situation by increasing access to an inefficient system without addressing the fundamental value problem: how to deliver improved outcomes at a lower total cost.

Fortunately, we can change this state of affairs. And the remedy does not require medical science breakthroughs or top-down governmental regulation. It simply requires a new way to accurately measure costs and compare them with outcomes. Accurate cost measurement in health care is challenging, first because of the complexity of health care delivery itself. A patient’s treatment involves many different types of resources—personnel, equipment, space, and supplies—each with different capabilities and costs. These resources are used in processes that start with a patient’s first contact with the organization and continue through a set of clinical consultations, treatments, and administrative processes until the patient’s care is completed. The path that the patient takes through the system depends on his or her medical condition.

The already complex path of care is further complicated by the highly fragmented way in which health care is delivered today. Numerous distinct and largely independent organizational units are involved in treating a patient’s condition. Care is also idiosyncratic; patients with the same condition often take different paths through the system. The lack of standardization stems to some extent from the artisanal nature of medical practice—physicians in the same organizational unit performing the same medical process (for instance, total knee replacement) often use different procedures, drugs, devices, tests, and equipment. In operational terms, you might describe health care today as a highly customized job shop.

Existing costing systems, which measure the costs of individual departments, services, or support activities, often encourage the shifting of costs from one type of service or provider to another, or to the payor or consumer. The micromanagement of costs at the individual organizational unit level does little to reduce total cost or improve value—and may in fact destroy value by reducing the effectiveness of care and driving up administrative costs.

Any accurate costing system must, at a fundamental level, account for the total costs of all the resources used by a patient as she or he traverses the system. That means tracking the sequence and duration of clinical and administrative processes used by individual patients—something that most hospital information systems today are unable to do. This deficiency can be addressed; technology advances will soon greatly improve providers’ ability to track the type and amount of resources used by individual patients. In the meantime, it is possible to determine the predominant paths followed by patients with a particular medical condition.

With good estimates of the typical path an individual patient takes for a medical condition, providers can use the time-driven activity-based costing (TDABC) system to assign costs accurately and relatively easily to each process step along the path. This improved version of activity-based costing requires that providers estimate only two parameters at each process step: the cost of each of the resources used in the process and the quantity of time the patient spends with each resource.

In its initial implementation, such a costing system may appear complex. But the complexity arises not from the methodology but from today’s idiosyncratic delivery system, with its poorly documented processes for treating patients with particular conditions and its inability to map asset and expense categories to patient processes. As health care providers begin to reorganize into units focused on conditions, standardize their protocols and treatment processes, and improve their information systems, using the TDABC system will become much simpler.

Accurately measuring costs and outcomes is the single most powerful lever we have today for transforming the economics of health care. As health care leaders obtain more accurate and appropriate costing numbers, they can make bold and politically difficult decisions to lower costs while sustaining or improving outcomes. As providers and payors better understand costs, they will see numerous opportunities to achieve a true “bending of the cost curve” from within the system, not in response to top-down mandates. Accurate costing also unlocks a whole cascade of opportunities, such as process improvement, better organization of care, and new reimbursement approaches that will accelerate the pace of innovation and value creation. Accurate measurement of costs is the hidden secret for solving the health care cost crisis!

unnamedFEATURED BLOGGER Dr. Rubin Pillay is a medical futurist and international expert in health leadership with a global reputation in innovation and 28-year career clinician & academic leader. 

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