The Future of Healthcare Organizations Depends on Managing Medicare Costs

Hospitals and health systems need to widen the circle of Medicare cost awareness to include their physicians.

As the federal budget deficit continues to grow, all eyes are on Medicare—one of the largest sources of federal spending annually—as a source of significant cuts in the years ahead. In 2016, the federal government spent 15 percent of its annual budget on Medicare, and the Kaiser Family Foundation projects that Medicare spending will increase to 17.5 percent of total federal spending by 2027.

Unfortunately for hospitals, more than 35 percent of their revenue comes from Medicare, says Jeff Goldsmith, national advisor at Navigant Consulting, Inc. By 2024, this will increase to 40 percent, he adds. As an aging population drives Medicare enrollment upward, healthcare organizations may face significant financial hardships if they don’t focus their efforts on Medicare cost containment, he says. Goldsmith recently shared the challenges presented by current Medicare payments and how CFOs can make cost containment a priority to offset future Medicare cuts.

How much do hospitals lose on their Medicare patients annually?

Goldsmith: Three quarters of hospitals that lose money treating Medicare patients lose an average of 18 cents on every dollar spent on their care. This means that Medicare DRG/APG [ambulatory payment classification] payment covers only 82 percent of the cost to deliver services. For the industry as a whole, this was a net loss of more than $35 billion in 2014. What’s shocking is that historically, Medicaid was the worst payer. That’s no longer the case. Hospitals lose three times as much treating Medicare patients as they do treating Medicaid patients, according to an American Hospital Association analysis in its 2016 annual hospital survey.

The remaining quarter of hospitals that don’t lose money on Medicare either strive to contain Medicare costs, or they receive subsidies such as Medicare indirect medical education payments or Medicare disproportionate share hospital payments.

Why is Medicare payment continuously on the decline?

Goldsmith: As the largest single non-defense domestic program, Medicare is an unavoidable place to cut spending. In addition, decreased Medicare payment stemmed from the Affordable Care Act. As part of the ways to pay for this legislation, the hospital industry agreed to what it thought was $155 billion in Medicare payment reductions over the first 10 years of the program. Turns out, these update reductions occur in perpetuity. In 2012, there was an additional 2 percent reduction from the sequester that took place as a result of the budget deal. Hospitals also can potentially lose even more revenue if they fail to meet performance targets, such as readmissions reductions, that were developed as part of the move toward value-based payment.

What’s the danger in not focusing on Medicare cost containment?

Goldsmith: Widening losses. Decreased Medicare payment poses a significant strategic threat to hospital financial performance going forward. If hospitals don’t do anything to manage the costs associated with delivering care for Medicare patients, their financial losses will only increase. Hospitals need to take action to bring the cost of caring for Medicare patients more in line with what they’re going to get paid. Cost containment really goes beyond Medicare—it’s important for all payers. It’s going to be a bleak future unless organizations change the way they do business.

Are most hospital executive teams in agreement about the significance of the threat of decreasing Medicare payment and how to address it?

Goldsmith: They are, but the challenge goes beyond the executive team. Hospitals need to widen the circle of awareness to include their physicians. Medicare’s cost containment challenge has existed since DRGs took effect in the mid-80s. DRGs were an enormous threat to hospital financial performance because it was a major shift in risk. Hospitals lost money when the cost of delivering care during an admission exceeded this fixed payment. They couldn’t change that cost meaningfully without involving their physicians.

Reducing variation in care among physicians is the core challenge. Fifteen physicians, for example, could perform the same procedure but have thousands of dollars of variance from case to case due to longer lengths of stay, excessive testing, and other factors. And the worst offender could be the chief of staff, making it difficult to effect change.

What about corporate services? Does it help to curb spending on these services? If so, how can organizations accomplish this?

Goldsmith: Yes, this can make a big difference, and it presents a huge opportunity especially for large health systems. In some cases, performing an in-depth operational assessment—and making necessary changes—can reduce corporate expenses from 15 percent or more into the high single digits.

These assessments force organizations to identity services they can perform at each of these levels—hospital, regional, and corporate. For example, functions that touch patients directly must remain at the hospital level; however, there’s often massive duplication of other key functions such as finance, human resources, purchasing/materials management, information technology, strategy, and marketing.

To be successful, organizations must make strategic decisions that are in the best interest of long-term financial viability. For example, as hospitals merge, do they really need two CEOs or two CFOs? What about a corporate and regional and hospital CFO? Theoretically, overhead expenses should go down due to economies of scale. They shouldn’t go up. It may also be possible to streamline middle management. In a large teaching institution, for example, there could be seven layers of managers between the patient and the chief executive officer. What value do each of these layers add to the patient care process? These are the questions hospitals should be asking.

How can organizations contain costs related to medical technology?

Goldsmith: They need to make more strategic and standardized purchasing decisions. For example, each physician may prefer a certain type of implant for hip replacements. If a hospital performs 1,000 of these procedures annually—but it doesn’t use the same implant—it’s missing out on the opportunity to use its purchasing power to lower the costs. Many institutions have been able to reduce costs by getting their surgeons to agree on the best implant to use. Then you can purchase high volumes to lower the cost per implant.

You could make the same argument about pharmacy costs. There are a ton of new drugs for cancer that range from $80,000 to $100,000 per course of treatment. How many of these drugs really make a difference in the lives of patients? That requires clinical consensus and an evidence-based purchasing process. Relatively few organizations are doing this. Performing these types of analyses may help organizations lower their spending on medical technology by 5 percent or more.

If it’s so beneficial, why aren’t more hospitals doing this?

Goldsmith: Some management teams want to stay away from forcing clinicians to make choices. However, they need to convey to physicians that it’s a question of the survival of the institution. The inability of institutions to survive compromises physicians’ abilities to meet their patients’ needs. That’s the argument that needs to be pursued.

What about bundled payments? Would they help get physicians on board with cost containment?

Goldsmith: They would help if they happen. The problem is that CMS [Centers for Medicare and Medicaid Services] is challenged in the administration of these new payment models. The process is so burdensome from a reporting standpoint that the potential savings are negated.

Lisa A. Eramo is a freelance writer based in Rhode Island.

Interviewed for this article:

Jeff Goldsmith, PhD, is national advisor at Navigant Consulting Inc.