Think Obamacare will help hospitals? Think again

April 25, 2014
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All the trend lines are negative for hospitals' profits—even, you might be surprised to hear, the expansion of commercial insurance coverage under Obamacare.

That much was made clear by a recent white paper by L.E.K. Consulting, titled "Hospital Economics and Healthcare Reform," which lays out in great detail the past and future ways in which hospitals try to cover each dollar of their expenses.

“While conventional wisdom suggests that U.S. hospitals, on balance, stand to benefit from the Affordable Care Act, L.E.K. Consulting analysis shows that the net impact of legislative, structural and demographic factors will be materially negative on most hospitals in the country,” the first sentence of the report states.

Yet in Indianapolis, where commercial payments are so much higher than is typical across the country, there’s a thicker cushion hospitals have to work with. And, to the extent there isn’t an extra cushion, it’s because local hospitals have built up cost structures that are outside the norm of hospitals nationally.

To make these points clear, I’ll walk you through the past models of "typical" hospitals nationally and those here in Indianapolis, and then I'll look at how those models will change under Obamacare and the influx of baby boomers into the Medicare program.

Typical past model
(revenue per dollar of expense x percent of revenue)
Commercial: $1.30 x 50% = 65 cents
Medicare: 95 cents x 30% = 28.5 cents
Medicaid: 65 cents x 15% = 9.75 cents
Uninsured: 15 cents x 5 % = .75 cents
Total: 65+28.5+9.75+.75 = $1.04
Margin = 4 percent

As you can see above, each dollar a hospital spends to operate is funded by contributions from a variety of sources, or what the hospitals call payors.

The commercial payors—that’s employer-sponsored and individually purchased health insurance—pay more than what the hospital spends to operate. But every other payor—Medicare, Medicaid and the uninsured—contributes less than what it costs to operate the hospital. According to L.E.K., Medicare pays 95 cents for every $1 of operating expense, Medicaid pays 65 cents for every $1 of expense and the uninsured pay, on average, 15 cents for every $1 of expense.

These are round numbers for hospitals nationally. I’ve typically heard lower numbers for Medicare, Medicaid and the uninsured from Indianapolis-area hospitals--perhaps because the overall expenses of Indianapolis-area hospitals run higher than their national peers. The local rules of thumb have been that Medicare pays 80 cents for every $1 of expense and Medicaid pays 60 cents on the dollar.

Also, local hospital officials have said uninsured patients typically end up paying about 10 percent of the cost of their care.

You can see those lower figures for Medicare, Medicaid and the uninsured in my Indianapolis hospital model below.

Also, I have used somewhat different numbers for the percentage of revenue coming from commercial, Medicare and Medicaid for Indianapolis hospitals. I came up with these percentages by roughly averaging the numbers reported by the four major hospitals systems that operate in Indianapolis. (Medicaid is a smaller percentage for Indiana hospitals than their national peers because Indiana sets the eligibility threshold for Medicaid lower than most other states.)

Indianapolis past model
(revenue per dollar of expense x percent of revenue)
Commercial: $1.59 x 45% = 72 cents
Medicare: 80 cents x 38% = 30.4 cents
Medicaid: 60 cents x 12% = 7.2 cents
Uninsured: 10 cents x 5% = .5 cents
Total: 72+30.4+7.2+.5 = $1.10
Margin = 10 percent

As you can see, even though I’ve used lower numbers for Medicare, Medicaid and the uninsured, I still concluded that Indianapolis hospitals have profit margins significantly higher than the “typical” hospital above.

That’s because the profit margins on commercial insurance are much better here than the 30 percent used in the national model—nearly twice as good, according to my calculations. (For the nitty gritty detail on how I arrived at that $1.59 figure, see the bottom of this post.)

But things are changing. Here is where L.E.K. sees them going:

New typical model
(revenue per dollar of expense x percent of revenue)
Traditional commercial: $1.30 x 30% = 39 cents
Exchange commercial: $1.25 x 10% = 12.5 cents
Medicare: 90 cents x 40% = 36 cents
Medicaid: 65 cents x 19% = 12.35 cents
Uninsured: 15 cents x 1% = .15 cents
Total: 39+12.5+36+12.35+.15 = $1.00
Margin = 0 percent

First of all, the Obamacare exchanges are extending commercial insurance, but the plans sold on the Obamacare exchanges do not, on average, pay quite as handsomely as traditional commercial insurance.

That’s because the insurers, like Anthem Blue Cross and Blue Shield, have sought to pay less to fewer hospitals—on the promise that those fewer hospitals will get larger shares of the insured patients.

L.E.K. assumes those efforts take a nickel off commercial payments per dollar of expense. In my new model for Indianapolis hospitals, I have assumed a dime’s worth of difference.

Either way, it means less revenue per dollar of expense for hospitals.

Also, notice that total commercial revenue (both traditional and exchange) has dropped from 50 percent of revenue to 40 percent.

That’s because the aging of the baby boomers means that, proportionally, more patients will be paying with Medicare than before. So the impact of those lucrative commercial insurance payments goes down as a result.

Also, Obamacare includes cuts to Medicare reimbursement, which L.E.K. figures will reduce average Medicare payment rates from 95 cents per dollar of expense to just 90 cents. That hurts too.

Meanwhile, Medicaid’s contribution goes up because Obamacare is paying states to expand eligibility for the program up to 138 percent of the federal poverty limit. But with hospitals losing money on each Medicaid patient, having a lot more of them provides only a modest benefit, compared with the overall expenses.

The net result: the typical hospital goes from averaging 4 percent profits before to just breaking even. And that is why hospitals are scrambling to cut costs any way they can.

Now let’s look at how these trends will affect Indianapolis hospitals:

New Indianapolis model
(revenue per dollar of expense x percent of revenue)
Traditional commercial: $1.59 x 30% = 48 cents
Exchange commercial: $1.49 x 10% = 15 cents
Medicare: 75 cents x 40% = 30 cents
Medicaid: 60 cents x 19% = 11 cents
Uninsured: 10 cents x 1% = .1 cents
Total: 48+15+30+11+.1 = $1.04
Margin = 4 percent

As I said before, in my new Indianapolis model, I reduced exchange payments by a dime compared with traditional commercial payments. Also, I have followed L.E.K.’s example by reducing Medicare payments by a nickel.

Also, I have assumed that Indiana does, eventually, expand Medicaid coverage. But I have not adjusted the figures to reflect that it may do so using the Healthy Indiana Plan, which pays near Medicare rates. So I’m kind of splitting the difference between the possibilities of no expansion at all (worst case scenario for hospitals) and an expansion that includes much higher payments (best case scenario for hospitals).

The result of these very rough approximations is that Indianapolis hospitals will see their profits fall from 10 percent before, to 4 percent in the future.

That’s cause for concern, certainly. But, it’s worth pointing out, that the changes from Obamacare may—even using my conservative assumptions—leave Indianapolis’ hospitals in the same profit position their peers have been for years and years.

Calculating commercially insured profit margins

We know from this study released last year that Indianapolis-area hospitals, on average, receive commercial insurance payments for inpatient services that were eqaul to 188 percent of Medicare rates. And they received commercial insurance payments for outpatient services equal to 364 percent of Medicare rates.

We also know that among all hospitals nationally, 56 percent of revenue comes from inpatient services and 44 percent comes from outpatient services. (Although, as just one local example, Franciscan St. Francis Health derives 74 percent of its commercial revenue from outpatients, and just 26 percent from inpatients. Still, to be conservative, I'll use the national figures, which include the higher inpatient percentages that are typical for Medicare and Medicaid patients.)

So to calculate what hospitals receive for commercially insured inpatients, I multiplied 1.88 (the commercial inpatient price as a multiple of Medicare) by .80 (the percent of Medicare payments to hospital expenses) by .56 (the percentage of revenue coming from inpatients) to get 84 cents.

Then for outpatients, I multiplied 3.64 (the commercial outpatient price as a multiple of Medicare) by .80 (the percent of Medicare payments to hospital expenses) by .44 (the percentage of revenue coming from outpatients) to get $1.28 cents.

Adding inpatients and outpatients together, I got $2.12 of revenue per dollar of expense.

However, I made one further adjustment to that figure, because commercially insured patients do not typically receive quite so many procedures as Medicare patients do. So even though the commercial prices I’ve used are accurate, I need to adjust for how often those prices are paid, compared with Medicare's prices.

To do this I pulled data from Franciscan Alliance’s financial reports, which helpfully broke out its Medicare “case mix index” from its case mix for non-Medicare patients. “Case mix” is hospital jargon for the the amount of things done to each patient. For Franciscan, non-Medicare patients had about 25 percent less stuff done to them than Medicare patients.

So I multiplied my $2.12 figure by .75, to reflect fewer procedures done to commercially insured patients. That yielded total revenue for commercially insured of $1.59 for every dollar of expense.

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  • nice work
    Very interesting analysis. Indianapolis has long been the poster child for above market health care costs...because they are starting from a better place, they will do better than others. Long term the macroeconomics will drive us to single-payer,
  • What About Wellness
    Another consideration may be the impact of wellness initiatives. There should be some positive revenue for people exercising, screenings, wearing out their joints.... but this increased healthiness might further drive down revenue by decreasing sickness.
  • Hospitals expanding
    Now several months into the ACA and yes lots of job cuts, but I see nearly every hospital adding on new wings. St. Vincent has a new 3 story structure being added alone. Seems that the hospitals are using the ACA as an excuse to cut the fat while adding on to get ready for the 30 million more insured and then there will be a hiring boom. Investors would not add on if they thought for a minute they would loose money.
  • Boring
    Just for once call it ACA ,tired of reading Obamacare.
  • St. Franciscan Alliance
    It deserves mention that Franciscan Alliance has "purchased" several facilities so that it can charge the "outpatient" rate which pays higher than inpatient. They have further inflated the cost of procedures at these "outpatient" facilities to gain additional dollars from commercial insurers and private payers. As an example a procedure such as a standard CT scan would cost about $700.00-$800.00 total, Franciscan Alliance is billing $1400.00-$1500.00 to private insurers.

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