Chapter 12 Financial Analysis of Alternative Health Care Firms

Learning Objectives List the major non-hospital and non-physician sectors of the health care industry. Discuss the sources of revenue for the nursing-home industry. Discuss the major sources of revenue and expenses of medical groups. List and describe the major organizational types of physician groups. Describe alternative HMO organizational arrangements.

Alternative (Non-Hospital) Health Care Firms Financial measures and concepts discussed in Chpt 11, but different sectors within the health care industry have different operating values and standards. –e.g. health plans have lower days in receivables than hospitals, and are required to carry higher cash balances to pay claims Three major alternative health care sectors we will consider here: –Long-term Care Facilities & Nursing homes –Medical groups –Health plans

Long-term Care Facilities & Nursing Homes Have been growing in the last decade as baby boomers reach the age of 75 plus 2007: 15,827 nursing homes in the U.S. 65% of nursing homes are investor owned (IO) or for-profit Many IO nursing homes are part of large national chains (e.g. Kindred Healthcare, Sun Healthcare Group) Nursing home care is heavily financed by the government through Medicaid

Nursing Homes, cont. Data show increase in public sources of financing and reduction in private financing Early 1990s: % of Medicare financing increased due to higher hospital discharges Federal government pays Medicaid nursing home care, but payments are determined at the state level –Wide variation in payment methodology (retrospective, prospective, case-mix adjustment) –Often the one of the largest state expenditures –Subject to changes based on economic condition of the state

Supply of Nursing Homes Wide variation in nursing home supply by state Many states control nursing home care supply & expenditures through : –Licensure laws and Certificate of Need (CON) laws – Payments rates for Medicaid patients Restrictive state policies may influence where IO chains operate.

Continuing Care Retirement Communities Many nursing homes are becoming continuing care retirement communities (CCRCs) –Provide a continuum of care from independent living, to assisted living, to skilled care Market themselves to HMOs that want to cover more residents of CCRCs through Medicare risk contracts

Continuing Care Retirement Communities, cont. Often residents progress through three levels of care: Nursing home care → assisted living → independent living Many CCRCs also have specialized units, –e.g. Alzheimer’s disease or stroke programs Consider the following example of financial statements of Friendly Village, church-owned CCRC

Friendly Village Revenues, cont. Note the major sources of revenue: –Largest source – routine health care center services ($6,214,764 in 2010) –Next – fees from care and services to residents of independent-living apartments or assisted-living center ($4,039,897 in 2010) –Other sources – entrance fees ($1,080,635 from amortization and $287,261 from investment of fee fund)

Entrance Fees Fund Guarantees that a nursing home bed will be available if needed and that the rate for that nursing home bed will be less than the nursing home’s current rates Represents funds available to meet contractual commitment to provide future care to residents May be based on age at entrance and is amortized as income as the patient ages or dies

Friendly Village Expenses, cont. Expense structure is similar to other health care providers Salaries and wages constitute >50% of total expenses Depreciation not shown in expense section, but is separately shown as other expense –Common for non-for-profit (NFP) CCRCs, where replacement of existing assets is not operating expense

Medical Groups Approximately 300,000 physicians in the U.S. – 2/3 operate in 1-2 person practices Physician expenditures represented $478 billion in 2007 –Physicians play an important role in controlling health care costs –Challenge for physicians to realize cost and quality decision making power in small practices –Trend toward physicians becoming part of larger organization, e.g. hospitals, health plans, and physician- controlled medical groups

Physician Expenditures, cont. Significant trend – reduction in financing through out-of-pocket payments from patients Possible reasons – decline of indemnity coverage and corresponding increase in HMO and preferred provider organizations (PPO) plans: –HMO require low or no co-payment for routine visits –Traditional indemnity plans require coinsurance and deductibles Move toward consumer driven health plans may reverse this trend

Physician Revenue Physicians receive larger % of total revenue from private insurers than other major health care sectors (e.g. 2007: 66% vs. 41%) Medicare covers nearly 100% of hospital service charges for the elderly with 20% coinsurance for physician services Utilization of physician services is also increasing

Physician Groups Physicians may choose to align themselves with other physicians through: –Medical groups –Hospitals –Health plans –Physician practice-management firms Physicians prefer to align with other physicians to maximize their control

Sources of Capital for Physician Groups For large-scale integration, massive amounts of financial and human capital are required Recently investors started proving external capital Hospitals do possess capital to create large physician groups, but are limit investment in this area due to: –Lack administrative experience with physician-practice management –Different incentives

Sources of Capital, cont. Health plans – also have resources, but have differing incentives –Reduce fees or salaries of doctors and control utilization Physician practice management firms – offer physicians some type of profit sharing and equity stake in the firm –Often acquire physician practices and provide physicians with strong autonomy

Example: Waverly Health Clinic Waverly Health Clinic (WHC) is a hospital- owned physician network – 8 primary care clinics, 24 full-time physicians, 122 non-physician employees 101,542 patient encounters in past year WHS is a separately incorporate for-profit subsidiary of the hospital. All physicians are employed by the hospital

WHC: Lack of Profitability Income statement indicates loss of $1,825,716 Often revenues are less than expenses for physician-owned practices Benchmark operating norms for WHC and national values for primary care medical group practices Main issue - WHC generates $78,054 less revenue per physician full-time equivalent (FTE) than the national norm

Private Insurance Most Americans are covered by either public, private insurance, or combination of both Cost of private insurance is rapidly increasing due to administration, reserve retention, and profit Addition of administrative costs to cost of health care have been debated by policy makers as unnecessary

Health Care Insurance Companies Main types: –Commercial –Blue Cross Blue Shield –Health maintenance organizations (HMOs) Some commercial and Blue Cross Blue Shield companies may provide an HMO option HMOs provide traditional indemnity programs and allow enrollees to go outside the network

Managed Care Organizations Managed care – system that integrates financing and delivery of health care services to enrollees Most common examples – HMOs and PPOs (preferred provider organizations) PPO – more flexible than HMO to allow more provider choice

Health Management Organizations Main types of HMOs: staff model, group model, network model, independent practice association (IPA) mode, mixed model Staff model - physicians are employees of the HMO and usually paid a salary Group model - physicians are employees of the HMO and usually paid a salary

Health Management Organizations, cont. Network model – HMO contracts with two or more groups and pays them on a per-capita rate, which the groups then distribute to individual physicians IPA model - HMO contracts with individual physicians or with associations of independent physicians and pays them a per-capita rate or a negotiated fee-for-service rate Mixed model – combines two or more of previous options

HMO Financial Structure Small percentage of assets are invested in property, plant, and equipment; majority – in cash and investments Consider example - net income and expenses are influenced by member months on a per- member-per-month (PMPM) basis Administration expenses increased – may be due to higher rates per hospital visit or higher utilization

HMO Example Net income decline in this example is directly related to PMPM premiums increasing less than expenses Administrative expenses increased though most of this cost is fixed Further research revealed increased inpatient utilization and higher per diems paid to hospitals contributed to the inpatient expense increase