Chapter4

Copyright © 2008 Thomson Delmar Learning

Chapter 4Chapter 4

Basic Clinical Health Care Economics


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Objectives Objectives

Upon completion of this chapter, the reader should be able to: Analyze why health care must be managed as a

business Apply the cost equation to the mission statement of a

health care enterprise to discover why the enterprise may be thriving or struggling

Analyze the impact of at least three contemporary economic or social pressures driving health care enterprises to be managed in accordance with business principles


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ObjectivesObjectives

Apply the Break-Even formula to compute a break-even point for a piece of equipment your health care organization is planning to purchase

Discover how a health care enterprise is balancing quality and profit by assigning its satisfaction rating and margin to an appropriate square on the Nosek-Androwich Profit: Quality (NAPQ) matrix


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Principles of EconomicsPrinciples of Economics

Scarcity Resources exist in finite quantities, and consumption

demand is typically greater than resource supply

Choice Decisions are made about which resources to produce

and consume among many options

Preference Individual and societal values and preferences

influence the decisions that are made


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Health Care DifferenceHealth Care Difference

In a typical market, the buyer is also the payer

In health care, the payer is not the provider or the buyer

The actual payer is the third-party reimburser (the insurance company or government)

The end result is a skewed financial picture


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Traditional Perspective on Traditional Perspective on Cost of Health Care Cost of Health Care

Health care as altruism Altruism: the unselfish concern for the welfare

of others Ethics: the doctrine that the general welfare of

society is the proper goal of an individual’s actions

Early nursing generally focused on altruistic service, which evolved from early charitable institutions


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Traditional Perspective on Traditional Perspective on Cost of Health CareCost of Health Care

Need for health care determined by provider Paternalistic model of governance and control Health professionals controlled medical knowledge and

skill Knowledge and skill required extensive and expensive

education not shared with “outsiders” Health care professionals determined what health care

was needed and what to charge for it


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Right to health care at any cost Prior to 1960s, Americans considered health

care a “right” American government established Titles XVIII

(Medicare) and XIX (Medicaid) of the Social Security Act, to control spiraling health care costs

Private insurers established their own requirements, beginning the overall budgeting of health care


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Cost plus Includes actual cost incurred by provider plus

profit incentive Incentive was “the more you spend the more

you get” rather than “how can this be accomplished more economically?”


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Contemporary Perspective on Contemporary Perspective on Cost of Health Care Cost of Health Care

Health care as a business HCFA and TEFRA, which established

government payments at flat rates (prospective payment)

Emphasis among providers on providing care for less than prospective payment, thereby making profit

Cost became the focus of managers, administrators, and employees at all levels of health care


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Need for care determined by the consumer Emphasis on cost has led to concerns that

safety and quality have suffered Total quality improvement (TQI) and

continuous quality improvement (CQI) were initiated to assure society that cost management was not compromising safety or quality

Emphasis on involvement of patients, health care consumers, and allied health care providers


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Right to health care at reasonable cost Insurers determine reasonable cost Lack of consensus on what constitutes

reasonable cost is at the heart of contemporary controversy


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Managed care Integrates financial and clinical care delivery

functions into a single organized system by contracting to be responsible for the clinical outcomes of an enrolled population for a fixed fee

Emphasizes delivery of a coordinated continuum of services across the care spectrum from wellness to death, using financial incentives to achieve cost efficiency


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Managed care The only health services program generated from a

market response, rather than from a formal federal government legislative initiative

Is not about providing healthcare; it is about being a for-profit brokerage business

Care is rationed through requirements such as preapproval, physician choice, and copayment

Coordinated care is replacing the term “managed care”


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Contemporary Perspective on Contemporary Perspective on Cost of Health CareCost of Health Care

Socialized health care In theory, socialized medicine provides

complete medical and hospital care to all the citizens in a community, district, or nation (universal access)

Funding usually comes through taxation of citizens


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Future Perspective on Future Perspective on Cost of Health CareCost of Health Care

Future costs may be affected by expensive technologies, new diseases, and an increasingly aged population

Changes in demographics and cost may affect the way health care is provided


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The Cost Equation: The Cost Equation: Money = Mission = MoneyMoney = Mission = Money

There must be cohesion and consistency across the mission, vision, and strategic plan for the business

The health care facility must determine what is the cost in achieving its mission

The health care facility must decide if providing health care services not directly related to the mission is a viable option


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Business ProfitBusiness Profit

Revenue (income) minus cost (expense) equals profit

Every business must generate more income than it spends in order to remain in business

For-profit business The profit is distributed to stockholders and to maintain

and grow the organization Not-for-profit business

All monies are fed back into the business All profit is referred to as margin


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Fundamental CostsFundamental Costs

Direct cost Directly related to patient care (wages and

supplies) Indirect cost

Not explicitly related to care, but are necessary to support care (utilities, maintenance)

Fixed cost One that exists irrespective of the number of

patients for whom care is provided


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Fundamental CostsFundamental Costs

Variable cost Varies with the volume of patients Can increase or decrease with volume of

patients or costs of supplies


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Cost Analysis Cost Analysis

Budget A plan for how much will need to be spent in the

ensuing time period (generally one year) It is based on:

What is known about how much was spent in the past How that will inevitably change in the coming year

A cost prediction is a tool for developing a budget High-low cost analysis Regression analysis Break-even analysis


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High-Low Cost Analysis High-Low Cost Analysis

Not extremely accurate, but provides “good enough” estimate

Examines both fixed and variable cost information from the most recent five years for each category of expense

Both fixed and variable dollars must be adjusted upward to account for inflation


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Regression Analysis Regression Analysis

More precise than high-low analysis Examines all available past cost information

over a specific time period Only one dependent variable: cost Only one independent variable: volume,

which causes change in cost All cost information plotted on a vertical

axis


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Regression AnalysisRegression Analysis

All volume information plotted on a horizontal axis

Scatter diagram results Straight line through scatter diagram best

approximating all the points is used to predict cost at a specific volume of use

Analysis is carried out for each item for which cost needs to be predicted


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Break-Even AnalysisBreak-Even Analysis

Projecting whether and when profitability will be achieved is necessary for both proposed and well-established programs and services

Break-even analysis assists the provider in predicting the volume of services that must be provided (and for which payment must be received) in order for the cost of providing the services to be equally matched by the payment received, yielding neither a profit nor a loss


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Diagnostic, Therapeutic, and Diagnostic, Therapeutic, and Information Technology CostInformation Technology Cost

The most expensive items on the total budget are diagnostic, therapeutic, and information technologies

Managed care programs have begun requiring justification for and preapproval of use of complex, expensive technology

Concerns have arisen about rationing technology to those who can afford to pay


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Nursing CostNursing Cost

Fiscally, nursing is viewed as a cost center that does not independently generate revenue

Ongoing efforts to measure and establish the cost of the various components of nursing care are disappointing

Nursing cost is associated with budgeted and actual nursing care hours per patient day A measure of time rather than a measure of type or

level of care


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Patient Classification System Patient Classification System (PCS) (PCS)

The tool most broadly used to identify nursing cost A system for distinguishing patients based on their

acuity, functional ability, or resource needs

Patients with similar requirements for care are assigned to five progressively weighted categories of acuity The higher the acuity of the patients, the more nursing

resources the PCS assigns


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Relative Value Unit (RVU) Relative Value Unit (RVU)

An index number assigned to various health care services based on the amount of resources used

This approach provides a reasonably accurate per patient costing approach It does not account for the differences in costs

based on the type of health care worker


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Quality MeasurementQuality Measurement

An evidence-based concept of quality Grounded on scientific evidence that a diagnostic or

therapeutic approach to care improves patient outcomes

Four core components A mechanism that establishes consensus about what

constitutes best practices Strong feasible processes to accomplish such practices A disease prevention and health promotion component A system to review actual performance and outcomes


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Regulatory OversightRegulatory Oversight

The quality industry measures and tracks organizational performance The primary accrediting body is The Joint

Commission Accreditation signifies that the organization

meets the standard of practice and influences market perception


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Customer SatisfactionCustomer Satisfaction

No matter how superior providers feel their product is, if customers perceive it not to be needed or wanted, the product will fail

Commercial surveys measure how satisfied customers are with their care, environment, and interactions with the staff


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Health Care Site EconomicsHealth Care Site Economics

Economics focuses on how choices are made to overcome a scarcity of resources

Requires: Redesigning Restructuring Reengineering


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Health Care Provider EconomicsHealth Care Provider Economics

Economic risk is borne by individuals, as well as by organizations

Individual providers receiving direct payment from insurers bear risk when they must lower their usual fees to a flat rate in order to be included for payment by the HMO

Patients bear the risk of being unable to access services they regard as either optimal or as minimal, jeopardizing their health