iProtean—Introduction to Finance

The U.S. Supreme Court will decide on the constitutionality of the Affordable Care Act in June.  Experts expect one of three possible outcomes:  the Supreme Court will rule the entire healthcare law unconstitutional, rule the entire law constitutional, or rule that the individual mandate is unconstitutional while upholding the remaining provisions of the law.


A recently released Special Comment from Moody’s Investors Service focused on the potential effects of striking down the individual mandate, specifically that “the individual mandate is the most credit positive feature of healthcare reform, and its elimination would be a clear credit negative for the not-for-profit healthcare sector.”  This combined with the increasing cuts in Medicare and Medicaid under the health reform law and other federal and state budget cuts substantially intensifies financial risk for hospitals.   (Supreme Decision:  Prohibition of Individual Mandate Would Remove Healthcare Reform’s Best Feature for Hospitals. Special Comment from Moody’s Investors Service, April 23, 2012.)


In the iProtean course Introduction to Finance, Lisa Goldstein from Moody’s Investors Service and Marian Jennings from M. Jennings Consulting discuss challenges associated with payers as well as hospital accounting basics, tools for monitoring financial performance and the role of the finance committee.


Lisa Goldstein, Moody’s Investors Service

Revenues can be very complex.  What is most important for a board member is an understanding of the payers that reimburse the hospital for the services that they provide, for the patients that walk in the front door or through the emergency room.


From a revenue perspective there are three to four large payers that board members should be somewhat familiar with and I’ll discuss those.  The largest payer for any hospital is Medicare . . . Medicare on average is 40 to 50 percent, almost half of any hospital’s revenue base.  And there is no negotiating with Medicare.


Our primary concern with Medicare, given that it is the largest single payer for any hospital, is what happens when we’re in a state of fiscal crisis like the country is now.  And what we’re seeing now, as we’ve seen in past historical performance, is Congress will reduce Medicare reimbursement to hospitals.  It’s up to the hospitals to commensurately reduce costs in line with the Medicare cuts . . .


The second payer, usually about 10% of any hospital’s revenue base, is Medicaid.  Medicaid is primarily for people who do not make a certain amount of income and cannot afford healthcare insurance, or their employer provides no healthcare insurance.  So if they qualify, they can sign up for Medicaid.  Medicaid is funded both by the federal government and by every state and, as we all know, currently states are under tremendous fiscal pressure.  So we are expecting Medicaid reimbursement to be cut to hospitals as well.  Like Medicare, there is no negotiating with Medicaid.  So Medicaid and Medicare combined represent 50 to 60% of any hospital’s revenue base and there’s no negotiating.


The next most important payers for hospitals are the commercial payers—Blue Cross, Aetna, United, Oxford, Kaiser, etc.  Those are payers that hospitals can negotiate with and, indeed, on an annual basis or every two to three years, senior management teams negotiate with the commercial payers . . . But we’re starting to head into an era or a trend of tougher rate negotiations.


These negotiations with the commercial payers are very important because it is the negotiations with the commercial payers that allow the hospitals to subsidize the losses under Medicare or Medicaid.  Sometimes the industry refers to this as cost shifting . . . In the hierarchy of profitability under payers, usually hospitals earn the most margin under the commercial payers where they can negotiate, then Medicare and then Medicaid.


The final bucket of reimbursement where there’s really no negotiating—there’s no one to negotiate with or receive rates from—are the people who have no insurance and do not qualify for Medicaid. We sometimes call this self-pay, which refers to people who usually pay their hospital bills out-of-pocket.  This can be anywhere from one to seven percent of the average hospital’s payer mix . . .


Marian Jennings, M. Jennings Consulting

It’s really very interesting because I’ve worked in healthcare for over 30 years and we’ve been using the term reimbursement that entire time period, but in fact payers stopped reimbursing hospitals at least 20 years ago and I think that that term “reimbursement” has an implication that is still embedded in our minds—that somehow we incur costs and then someone else will reimburse us for those costs, but in fact that is not how payment for hospitals works in large part.  There are some exceptions.


The first payer we always talk about is Medicare.  W I was growing up we had a saying that, ‘when GM sneezed, the country got a cold.’  Now I would say that when Medicare even thinks about sneezing, the whole healthcare industry gets pneumonia.  They’re the biggest payer of healthcare of all types across the country, but in addition, their policies tend to be adopted by the commercial payers and others.  In terms of challenges with working with Medicare, the challenge is you don’t work with Medicare.  There’s absolutely no negotiation.  It’s a federal program and let’s face it, if you ran a federal program, you’re attitude would be, ‘Here’s how much I’m paying.  You can take it or leave it.’  And that is their attitude . . .


Lisa Goldstein, Moody’s Investors Service

We view the finance committee as probably one of the most important committees of the board.  Usually the finance committee meets once a quarter, if not once a month, to review financial statements.  With senior management the finance committee helps from a big picture perspective, from a macro perspective, develop the budget . . .


When strategies are laid out by a hospital—it’s a mix of financial strategies, capital strategies and fundamental strategies—they should all be enveloped into one main strategy.  Of course, those three components are very much interrelated.  When a hospital develops its budget or long term financial forecast, there can be instances when financial performance greatly deviates from expectations, either to the negative or to the positive.  The finance committee is charged with making any midcourse, swift or unexpected changes to strategy if financial performance is not meeting expectations by a wide degree. And that change in strategy should be developed by the finance committee and the senior management team; for example, the range or margin acceptable to be off budget, either to the negative or to the positive.  If things are going wildly beyond anyone’s expectations, the finance committee may be charged with making, again, mid-course, swift changes to move the organization along to continue to meet these higher performance levels . . .


Marian Jennings, M. Jennings Consulting

The finance committee should be a group of individuals who have the background and competencies and interest in finance who can take time every month to focus solely on the financial performance of the organization. The board has a packed agenda and it could not possibly spend that amount of time at every board meeting to ensure the financial integrity of the organization and, therefore, the board needs to appropriately rely on the finance committee.


The finance committee, I think of it as a giant schedule or calendar in my head.  That is, there are some things that the finance committee is going to do every month, month in and month out . . . The finance committee also conducts some activities that typically occur on an annual cycle and most importantly the finance committee oversees the development of the operating budget and the capital budget . . .


In addition, the finance committee has a core responsibility related to the long-term financial integrity of the organization and that focuses on insuring that we have long-term financial targets that are clear.  For example, what is our financial target for 2016?  What is our expected and targeted bond rating in five years?  How much cash do we want to have on our balance sheet five years from now?  The long term financial policies and goals of the organization need to be formulated by the finance committee, communicated to the board for its consideration and approval, but also, most importantly, understood by every board member.


In addition, the finance committee has an enormous amount of what I would call, routine work that it undertakes.  That has to do with approving financial transactions that come about in the course of business for a hospital . . . and debt financing.  Most organizations do not do a debt financing every year, but in terms of looking at the borrowing options, evaluating the pros and cons of each one, insuring that the organization is taking on prudent risk, insuring that they have selected the most appropriate financing vehicle, those are all things that the finance committee would undertake on an ad hoc basis.


More from Moody’s Special Comment

“In its entirety, the healthcare reform law is a long-term credit negative for not-for-profit hospitals given the hardwired Medicare rate reductions embedded in the law along with new forms of reimbursement models (such as bundled payments) that also lower reimbursement to hospitals.


“Some aspects of healthcare reform have positive credit implications for hospitals, however. Specifically, the individual mandate is the most credit positive feature of healthcare reform, and its elimination would be a clear credit negative for the not-for-profit healthcare sector. The requirement for individuals to obtain insurance, or pay a fine, would result in a significant reduction in uncompensated care delivered by hospitals. It also would improve efficiency in the healthcare system by reducing utilization of expensive emergency room services. Removing the mandate would make the negative features of reform loom much larger compared to the remaining positive elements:

  • An estimated 16.7% of the US does not have health insurance.  Without the individual mandate, this large uninsured share of the patient population would likely continue to grow as employers will be unable or unwilling to bear the growing cost of health benefits. The continued rise in uncompensated care will reduce hospital margins and suppress debt service coverage, creating added credit stress in the sector.
  • Medicare and Medicaid reimbursements are likely to be reduced due to features of the reform law, as well as the systemic pressure to reduce spending on most federal budget programs. Healthcare reform includes more than $150 billion of reduced Medicare reimbursement payments to hospitals and $14 billion of Medicaid disproportionate share funding cuts, spread over 10 years. In addition to provisions in healthcare reform, given the extent of the federal budget deficit and failure of the 2011 Congressional budget “super committee,” additional Medicare spending reductions are certain (this is true irrespective of the Supreme Court’s decision regarding healthcare reform). The most vulnerable not-for-profit hospitals and health systems will be those with the highest reliance on federal government payers.
  • Hospitals will receive lower reimbursement from commercial insurers as these payers will be under intense pressure to offset the increase in premiums resulting from the absence of the individual mandate, which would have allowed insurers to spread the costs of covering the sick among a broader population, including the healthy.”

Supreme Decision:  Prohibition of Individual Mandate Would Remove Healthcare Reform’s Best Feature for Hospitals. Special Comment from Moody’s Investors Service, April 23, 2012.


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iProtean Symposium & Workshop

Mark the Date!! October 10 – 12, 2012 at The Lodge at Torrey Pines, La Jolla, CA. Faculty: Barry Bader, Dan Grauman, Marian Jennings and Brian Wong, M.D. For more information, click here.


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