330 michelson and pandey

HFMA Dixie
February 19th
3:30pm ET
A Crash Course in Cost Accounting and Cost Reduction
Dan Michelson
Chief Executive Officer
Strata Decision Technology
Tushar Pandey
Director of Consulting Services, Decision Support
Strata Decision Technology

Today’s Topics
Six quick “lessons” in our crash course
1. Why do we need Cost Accounting?
2. How does Cost Accounting work?
3. What Cost Buckets should we use and how should we
allocate overhead?
4. What Costing Methodologies should we use?
5. How is Advanced Cost Accounting different?
6. How can we leverage cost data to take action and drive out
costs?
©2015 Strata Decision Technology

Historic Announcement…
News
FOR IMMEDIATE RELEASE
January 26, 2015
Contact: HHS Press Office
Better, Smarter, Healthier: In historic announcement,
HHS sets clear goals and timeline for shifting Medicare
reimbursements from volume to value
In a meeting with nearly two dozen leaders representing
consumers, insurers, providers, and business leaders, Health and
Human Services Secretary Sylvia M. Burwell today announced
measurable goals and a timeline to move the Medicare program,
and the health care system at large, toward paying providers based
on the quality, rather than the quantity of care they give patients.
HHS has set a goal of tying 30 percent of traditional, or fee-for-
service, Medicare payments to quality or value through alternative
payment models, such as Accountable Care Organizations (ACOs)
or bundled payment arrangements by the end of 2016, and tying
50 percent of payments to these models by the end of 2018. HHS
also set a goal of tying 85 percent of all traditional Medicare
payments to quality or value by 2016 and 90 percent by 2018
through programs such as the Hospital Value Based Purchasing and
the Hospital Readmissions Reduction Programs. This is the first
time in the history of the Medicare program that HHS has set
explicit goals for alternative payment models and value-based
payments.
% of payments
Program 2016 2018
Medicare payments
to quality or value
through alternative
payment models, such
as Accountable Care
Organizations (ACOs) or
bundled payment
arrangements
30%
50%
Traditional Medicare
payments to quality
or value via programs like
Hospital Value Based
Purchasing and the Hospital
Readmissions Reduction
Programs
85%
90%

A Major Shift…
RCM
REVENUE CYCLE
MANAGEMENT
MOM
MARGIN &
OUTCOMES
MANAGEMENT
2014 2017
% OF INSURED
COVERED BY
PAYMENT
APPROACH
LOW
HIGH
2015 2016
2018

The Financial Challenge
1 Centers for Medicare & Medicaid Services, Office of the Actuary, 2012 data
2 Annual Cost of Waste in the US Healthcare System according to a 2012 CBO report
3 HIMSS Innovation Survey 2013
BY THE NUMBERS
2.2%
Hospitals are
struggling
The average operating
margin for hospitals is
~2.2% (1/3 have negative
operating margins)1,2
$700B
There is significant
waste…and opportunity
Over $700B spent on healthcare
annually is considered waste
(overuse, misuse, variation,
inefficiency, harm)2
#1
Cost reduction has
taken center stage
Finding cost reduction
solutions has emerged as
the #1 priority for
healthcare providers3

As revenue shrinks
and margins tighten,
providers have identified
cost reduction as
their #1 priority
Facing reimbursement pressure, hospitals must dramatically lower their cost structure and reduce waste while delivering
outstanding care in order to remain viable.
1 HIMSS Innovation Survey (2013)
26%
40%
46%
51%
52%
54%
64%
65%
New Patient Acquisition
Service Expansion to
New Markets / Populations
Hospital Readmission
Reduction
Better Manage Risk and
Value-Based Payments
Medical Error Reduction
Improve Knowledge
Sharing & Management
Improve Patient
Satisfaction
Cost Reduction
Hospitals and Health Systems Must Cut Costs to Survive
HIGHEST PRIORITY FOR HEALTHCARE PROVIDERS1

$330M
$220M
$40M
$200M
$1B
$300M
$150M
$100M
Everyone has a target…

Physicians are Ready to Engage in Driving Down Costs
Physicians play a key role in reducing healthcare costs. However, they don’t have access to cost data. Closing this gap
represents one of the most significant opportunities to drive value in healthcare.
~20%
Only 1 in 5 MDs could correctly
estimate the cost for common
orthopedic devices
>80%
Over 8 of 10 MDs would consider
cost as a key criteria in the selection
of a medical device
PHYSICIANS AT SIX MAJOR HEALTHCARE SYSTEMS WERE ASKED TO ESTIMATE THE COST OF 13 COMMONLY USED ORTHOPEDIC DEVICES
(ESTIMATES WITHIN 20% OF ACTUAL COSTS WERE CONSIDERED CORRECT)1
Physicians don’t know… …but do care about cost
n =503 MDs at orthopedic departments at Duke, Harvard, University of Maryland, Mayo, University of Pennsylvania, Stanford, and Washington University
1Survey Finds Few Orthopedic Surgeons Know the Costs of the Devices They Implant, Health Affairs, January 2014.

Linking Clinical and Financial Outcomes Will be Critical

Source: Harvard Business Review, The Strategy That Will Fix Healthcare (October 2013)
The Absence of Accurate Cost Information…“Astounding”
“The absence of accurate cost
information in health care is
nothing short of astounding”
“The existing systems are
wholly inadequate”
“Healthcare organizations are
flying blind in deciding how to
improve processes and
redesign care”
“Understanding true costs will
finally allow clinicians to work
with administrators to
improve the value of care”
Michael Porter
Professor
Harvard Business School
SIGNIFICANT MARKET OPPORTUNITY FOR COST
ANALYTICS SOLUTIONS
While hospitals and health systems understand the need to dramatically cut their cost structure, they cannot make
informed decisions due to a lack of information.
Less than 10% of health systems have an
advanced cost accounting solution
10%
51%9%
30%
Advanced Decision Support Legacy Decision Support
Self-Developed No System
Decision Support Market Penetration
Source: HIMSS Analytics, Company Analysis

Today…in Michigan

How do you price…
when you don’t know your cost?

“10 Reasons Hospitals are Shifting
to Advanced Cost Accounting”
The Top10
Reasons
Hospitals are
Shifting
to Advanced Cost
Accounting

10. To Understand True Margins
9. To Identify Opportunities to Reduce Cost
8. To Understand Total Cost of Care from
Both Inpatient and Outpatient Costs
7. To Bring Together Financial + Clinical
Data
6. To Integrate with Organization’s EHR,
ERP and EDW
“10 Reasons Hospitals are Shifting
to Advanced Cost Accounting”
Source: Becker’s Hospital Review, 4-1-2014
5. To Integrate Cost Accounting with
Overall Financial Management
4. To Understand How to Price Right
3. To Run Costing Quickly/Frequently
2. To Improve Accuracy of Costing Data
1. To Make Cost Data More Actionable
via Dashboards

Six quick “lessons” in our crash course today
allocate overhead?
4. What Costing Methodologies should we use?
6. How can we leverage our cost data to take action and
drive out costs?

Payor/Financial Class
Patient Type
Service Line
Understanding Profitability

Making The Vision Reality…Enterprise Profitability

The Costing Process
Decision
Support
EHR
ERP
EDW
Clinical & Financial

1. Department Level Costing (Align GL to Revenue Data)
– Reclassification – moving/aligning direct dollar
– Overhead Allocation – allocating indirect dollars
2. Charge Level Costing (Assigning department expenses to
charge codes/activities)
– Charge Allocation (RCC, RVU, CCR, % Markup, etc)
The Costing Process Cont.

Six quick “lessons” in our crash course today
allocate overhead?
4. What costing methodologies should we use?
6. How can we leverage our cost data to take action and
drive out costs?

Looking at Cost Types
Describes cost source and cost type
– Fixed: Not impacted by volumes (maintenance, utilities)
– Variable: Increases with Volume(supplies, salaries)
– Direct: Directly related to patient care (lab, ICU)
– Indirect: Indirectly related to patient care (IT, Finance)

Looking at Cost Components

Looking at Cost Components Cont.
• Categorization of expenses used in cost reporting and
allocation
– Recommendation: Align with income statement line items
– Recommendation: Typically between 10-20 cost components
• Cost components can contain indirect and direct dollars
– Salaries and Wages (indirect and direct)
• Cost Component can also be specific to a cost type
– Recommendation: Typically between 10-20 cost components

Sample Cost Buckets
Salaries
• Physicians
• Non Physician Medical
Practioners
• RN - Patient Care
• RN - Nonpatient Care
• LPN
• Allied Health Professional
• Allied Health Technical
• Management
• Specialized Professionals
• Clerical and Admin
• Service and Support
• Research
Other
• Employee Benefits
• Medical Supplies
• Pharmaceutical Supplies
• Other Supplies
• Purchased Medical Services
• Purchased Services - Other
• Repairs and Maintenance
• Utilities
• Rent
• Insurance
• General
• Depreciation and Amortization

Must-Have Statistics
• Can be used to allocate expenses rather than using manual
percentages
– Helps to automate costing
– Can be updated monthly, quarterly, or yearly
- Recommendation: Find the right balance!

DIRECT METHOD SEQUENTIAL/STEP-DOWN METHOD SIMULTANEOUS/RECIPROCAL METHOD
Allocate Overhead Expenses
Increasing accuracy of costing results
Allocation of overhead expenses as indirect dollars to revenue department.
Example: IS and Accounting

• Allocates overhead costs only to
revenue generating cost centers
• No interaction between overhead
cost centers prior to allocation
Advantages:
• Simplistic costing model
• Easy to use and maintain
Disadvantages:
• Inaccurate costing results
DIRECT METHOD SEQUENTIAL/STEP-DOWN METHOD SIMULTANEOUS/RECIPROCAL METHOD
Overhead Methods - Compare and Contrast
• Allocates overhead costs one cost
center at a time to remaining
overhead and revenue generating
cost centers in a cascading manner
• One-way interaction between
overhead cost centers prior to
allocation
Advantages:
• Simplistic costing model
• Easy to validate
Disadvantages:
• Costing results not very precise
• Allocates overhead costs to revenue
generating cost centers by fully
recognizing the mutual services
provided among all overhead cost
centers
• Full two-way interaction between
overhead cost centers prior to
allocation
Advantages:
• Precise costing results
• Easy to maintain
Disadvantages:
• More complex to understand and
validate
Increasing accuracy of costing results

What Costing Methodology Should You Use?
1. Standard Cost: ‘hard coded’ based on charge code
2. RCC: ratio of cost to charge
3. RVU: relative value unit
4. CCR: ratio of cost to charge at the test level (encounter level)
5. % Markup: reverse markup charge schedule (encounter level)
6. Supply Cost: acquisition cost (encounter level)
7. Activity Based Costing (ABC) – allocation to chargeable and non-
chargeable activities
8. Time Driven Activity Based Costing (TDABC) – identify max capacity

Cost Accounting is Not One Thing (e.g. TD-ABC)
Private & Confidential ©2015 Strata Decision Technology
RELATIVE VALUE UNIT
(RVU)
ACCURATE
FLEXIBLE
COVERS MOST COST
TYPES
REQUIRES SOME
MAINTENANCE
SUPPLY/INVOICE
BASED
VERY ACCURATE
TRACKS PREFERENCES
TIMELY TRENDING OF
COSTS
REQUIRES ADDITIONAL
INTEGRATION
% MARKUPS
ALLOWS ACCURATE
COSTING OF BUNDLED
SUPPLIES
FOR SUPPLIES ONLY
DEPENDENT ON
ACCURACY OF CHARGES
AND MARKUP SCHEDULE
RCC
EASY TO UNDERSTAND
& MAINTAIN
ASSUMES COSTS ARE
PROPORTIONAL TO
CHARGES
OUTDATED
ABC
EASY TO UNDERSTAND
IN CLINICAL SETTINGS
COMPLEX TO
IMPLEMENT
TDABC
IDENTIFIES EFFICIENCY
BASED COST SAVINGS
VERY LABOR INTENSIVE
TO IMPLEMENT
APPLICABLE TO LABOR
ONLY

Charge
Direct
Labor
Indirect
Labor
Physician
Labor
Supplies
Asset
Cost
Contracted
Services
Other
CHEST X-RAY
(2 VIEWS)
3 1 1 1 1 1
CHEST X-RAY
(4 OR MORE VIEWS)
4 1 1 1 1 1
HIP
(1 VIEW)
6 1 3 1 1 1
HIP
(2 VIEWS)
6 1 3 1 1 1
The RVU approach
• Determine RVU’s for each charge for each cost category

Every patient is different …
so why is their cost the same?
PATIENT ACCOUNTING &
MEDICAL RECORDS
D
E
C
I
S
I
O
N
S
U
P
P
O
R
T
PRACTICE MANAGEMENT
GENERAL LEDGER
& PAYROLL
TraditionalDataElements
OR SUPPLIES/IMPLANT
COSTS FROM SURGICAL
SYSTEMS

Unit Charge Qty RVU AVERAGE COST RVU + AVERAGE COST
Hip Implant $8,500 1 200.0 $4,000 $4,200
OR Level 3 Per Minute $200 120 3.5 $12 $5,640
All Other Expenses $5,000
$14,840
The Impact of Advanced Methodologies
Variable LABOR
Expense
Variable SUPPLY
Expense
TOTAL Variable
Expense
Unit Charge Qty RCC RCC RCC
Hip Implant $8,500 1 $1,000 $3,000 $4,000
Hip Implant OR Time $9,600 1 $3,300 $1,500 $4,800
$13,800
Unit Charge Qty ABC ACQUISITION COST ABC + ACQSTN COST
Hip Implant - Uber Max $8,500 1 $400 $5,000 $5,400
OR Level 3 Per Minute $200 120 $50 $13 $7,560
$17,960Patient Level … More Accurate Cost of Care

Medicare Payment
Would You Grow This Service?
$13,800
$14,840
$15,200
-$2,760
$1,400
Variable Cost Per Case Margin
∆$1,040RCC Labor & Supplies
ABC + Supply Acquisition Cost
TRUE COST
$15,200$17,960
RVU + Average Supply Cost
∆$3,120
$15,200 $360

Medicare Payment
Would You Take 110% of Medicare in
Exchange for More Volume?
$13,800
$14,840
$16,720
-$1,240
$2,920
Variable Cost Per Case Margin
∆$1,040
RCC
ABC + Acquisition Cost
TRUE COST
$16,720$17,960
RVU + Average Cost
∆$3,120
$16,720 $1,880

FEATURES:
• NOT user-friendly
• Incredibly slow
• Data is not
integrated
• Data is not used
• System has low
utilization
Traditional Decision Support

Advanced Cost Accounting
USES A COMBINATION OF METHODOLOGIES TO PRODUCE THE
MOST ACCURATE COSTING
Creates the Foundation for
Defensible Pricing and Effective
Contracting
Analyze Cost Holistically and
for Specific Populations
ACCOMMODATES DIFFERENCES IN PRICING, ACUITY, & SALARY
PER PATIENT
INCLUDES SERVICES PROVIDED THROUGHOUT THE CONTINUUM
OF CARE
COSTS ARE UPDATED REGULARLY
FLEXIBLE w THOROUGH w ROBUST
ALGORITHMS TO DISCERN EXCESS CAPACITY AND EXPENSE
EXPENSES AND SERVICES ARE ALLOCATED TO SPECIFIC PATIENT
POPULATIONS
Know Your True Cost to
Provide Care
Accepted by Clinicians and
Leaders
Drives to Action

Your Call to Action:
Leverage Data to
Drive Out Costs

Cost Savings Initiatives are Falling Short
55%
44%
44%
27%
26%
Difficult to Quantify & Track Savings
Difficult to Keep Track of Projects
Lack of Accountability
Projects Don't Produce REAL savings
No Staff to Lead Projects
Source: Strata Decision Survey (n=100 providers)
88%
of providers have cost savings initiatives underway
(Range: $50-$400M)
17%
are hitting the target
WHY COST SAVINGS INITIATIVES UNDER DELIVER

MIND SET
SKILL SETTOOL SET
Requirements…

Cost Improvement in Action at CentraCare
• Cost of Variation of 65% of Inpatient Volume (17,500 Cases)
• $11.3M in Savings
• $4M in savings for top 10 DRGs alone
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
$3.5
LOS Supplies Diagnostic
Testing
Pharmacy Therapy Other
Millions
Savings by Cost DriverOpportunity
Size
# of Opps Total
Savings
% of
Savings
$500K+ 4 $2.7M 23%
$100-$400K 21 $4.7M 42%
<$100K 184 $3.9M 34%
Total 209 $11.3M

There is no silver bullet…
everything has to be on
the table STREAMLINE
Systems &
Structures
• Benefits
• PTO days
• Capital
Budget/
Depreciation
• Insurance/
re-insurance
• Outsourced
Services
• Consulting
Services
• Duplicate IT
systems
• Supply Chain
ELIMINATE
VARIATION in
Care
• Implants
• Physician
preference
items
• High cost
drugs
• Duplicate
Imaging
studies
• High cost
labs as inpt
• End of life
care
PURPOSE-
BUILT
Org Structure
• Defining roles
to fill distinct
purpose
• Defining goals
for roles
• Using data to
drive
accountability
for results
LEVERAGE
TECHNOLOGY
for productivity
• Automate
routine work
• Automate
processes
with rules
based
technology
• Identify and
eliminate
duplicative
processes
LEAN OUT
MGT
Structure
• Create ‘flow’
within a
directors span
of functions
• Bring
functions
together than
work together
often
STAFF to
Demand
• Match staffing
levels to
volume levels
• Match skill
level to skill
needs
FLEX
to Volume
• Adjust staffing
levels to
fluctuations in
volume
Brainstorm, Validate, Then Operationalize Savings

Compare cost per case among physicians
Understand the labor cost and labor requirements to care for a
population of patients
Negotiate favorable contracts
Identify opportunities to streamline administrative processes
Manage populations effectively across the continuum of care
Drive accountability for measurable results
With good cost data…

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