The Hospital Cost Index: A New Way to Assess Relative Cost Efficiency

Setting Defensible s
Written by

William O. Cleverley, PhD

Cleverley + Associates 438 e wilson bridge road, suite 200 Worthington, oh 43085 888-779-5663 info@cleverleyassociates.com

THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

Abstract

Hospital senior executives and board members routinely review measures of facility cost to assess the relative cost efficiency of their firms. The most commonly used measures are cost per adjusted discharge or cost per adjusted patient day. These measures have serious flaws, which limit their comparability to other hospitals. We propose a new measure, the Hospital Cost Index, as a better measure of relative hospital efficiency. The measure adjusts for case mix complexity in both inpatient and outpatient operations and can be computed from present publicly available databases. This permits comparison of specific hospitals, including direct competitors, and provides easily available benchmarks for cost efficiency that are highly reliable. Controlling cost in an economic environment where prices are fixed and often set by external parties is absolutely essential if financial viability is to be achieved. Most hospitals are clearly in this type of environment and a great emphasis has been placed upon cost management. A large number of cost metrics are routinely measured, reported, and compared to external benchmarks to assess relative performance. Many of these cost measures are arrayed in a drill down format, going from facility-wide to departmental or specific procedure-level detail. It has been our experience that many facility measures are biased either upward or downward, preventing effective benchmark comparisons at the facility level. Most of these facility-wide measures rely on an adjusted discharge or patient-day framework, which incorporates a weighting for outpatient activity. We believe that the introduction of the Outpatient Prospective Payment System (OPPS) in conjunction with the inpatient prospective payment system, utilizing specific Diagnosis Related Group (DRG) case weights, now provides a unique opportunity to develop a meaningful measure of overall hospital cost efficiency. The remainder of this paper will describe the framework and methodology for the creation of the Hospital Cost Index .

Problems with Adjusted-Discharge Measures of Cost Most US hospitals can divide their patient operations into inpatient and outpatient areas. Gross patient revenue is often subdivided along these lines. In the last 20 years, outpatient activity has gone from under 20% in most hospitals to close to 40% in 1999. This dramatic increase in outpatient revenue has caused more individuals to question the validity of incorporating outpatient activity into a consolidated measure of cost, using adjusted discharges or adjusted patient days. The critical measurement concept in an adjusted discharge or day measure is the weighting for outpatient revenue. The usual methodology for defining adjusted discharges or days is expressed as a formula:

Adjusted Dischar ges (days ) = Inpatient Discharges (days ) 1 +

Gross Outpatient Revenue Gross Inpatient Revenue

To best identify the specific issues that affect the comparability of the adjusted day or discharge concept, we will utilize an actual case example. The hospital in question is a teaching hospital with approximately $380 million in gross charges in 2000, with 60% of total revenue being inpatient. Presented in Table 1 are several measures of cost for the past two years. Both measures of Cost, Cost per Adjusted Discharge (CPAD), and Cost per Adjusted Discharge Case Mix and Wage Index Adjusted (CPADADJ) suggest that the hospital is costly and has substantial opportunity for cost reduction. Senior management and board members would most likely direct staff to drill down to lower levels of analysis at the departmental or procedure level to isolate specific areas of cost excess. The dilemma that occurred post drill down was the

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THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

inconsistency of findings. Departmental cost comparisons suggested that the hospital was not inefficient and, in fact, was relatively cost effective, especially given its teaching status. Which data set is more accurate was the question raised by both board members and senior executives. To answer the question, let us review specific problems with the facility-level measures, using adjusted discharges.

Procedure Pricing The computation of adjusted discharges is heavily influenced by specific procedure prices in the hospitals Charge Description Master (CDM). Some hospitals may price procedures with high outpatient utilization at higher levels to take advantage of the greater presence of percentage of billed charges payment arrangements. Other hospitals may keep high outpatient procedures at lower levels because of a large self-pay presence, implying greater price elasticity. Some data suggest that the majority of hospitals overstate outpatient costs because of higher procedure 2 prices. If this is so, hospitals with heavier percentages of outpatient activity or higher outpatient prices would have larger values for adjusted discharges and, therefore, lower costs per adjusted discharge. This may partially explain why smaller hospitals, which often have greater percentages of outpatient revenue, have lower costs per adjusted discharge. The data in Table 2 illustrate the effects of pricing differentials. Assume both hospitals are identical in every respect: they have the same volume and mix for both inpatient and outpatient services. Hospital B, however, prices its outpatient procedures 10% higher than does Hospital A. The net effect of this is to make Hospital B look more cost effective when, in fact, it is not. Output Differences Another major factor which affects the comparability of cost measures using an adjusted discharge basis is output differences. Even if there were only inpatient discharges and no outpatient activity, discharges would not be an ideal measure to make comparisons of cost across hospitals because of case mix differences. Many cost-per-adjusted-discharge measures are further adjusted by dividing by the case mix index of the hospital for the time period. There are two alternative case mix indexes that are often used: All Payer Case Mix Index Medicare Case Mix Index

Obviously, the All-Payer Case Mix Index will do a better job of reflecting output differences than will a Medicare-only Case Mix Index. There is one major issue, however, with the utilization of All-Payer Case Mix Index adjustments. You may be able to adjust your cost for case mix effects, but will the external comparative cost measures be adjusted in similar fashion? Competitor data extracted from public-use files such as Medicare Cost Reports will not have All-Payer Case Mix Index values. For controlled subscriber-based benchmarking services, the All-Payer Case Mix Index adjustments may be accurate, but the comparisons will be limited to other subscribing hospitals and will exclude specific competitor comparisons. For the above reasons, Medicare Case Mix Index adjustments are often utilized in a number of comparative reports. The case hospital of Table 1 used a Medicare Case Mix Index, and the spread between hospital and US medians narrowed considerably. In many cases, the Medicare Case Mix Index can remove cost variance and better isolate possible problems. The Medicare Case Mix Index adjustment will be an issue, however, when the non-Medicare patient population differs dramatically from the Medicare patient population. For example, a hospital that specialized in orthopedics and obstetrics would present problems. Using the Medicare Case Mix Index would grossly overstate case mix complexity because all of the obstetric cases, which would be lower case weighted, would be non-Medicare.

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THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

A Case Mix Index adjustment, whether All-Payer or Medicare, becomes less effective the larger the percentage of outpatient activity. Hospitals with complex inpatient cases, as measured by high Case Mix Index values, may not have similar degrees of complexity in outpatient arenas. In fact, the degree of case mix variation in outpatient arenas across hospitals appears to be less dramatic than inpatient variations (see Table 3). Table 3 provides values for the average Medicare Case Mix Index for inpatients and the average Medicare relative weight based upon OPPS values for outpatient claims by net patient revenue size. While larger hospitals have higher levels of inpatient complexity as measured by the Medicare Case Mix Index, there is no clear pattern for outpatient complexity. This pattern would tend to produce understated estimates of CPADADJ in larger hospitals because their outpatient complexity does not match their inpatient complexity.

Geographical Cost of Living Differences The final area affecting the comparability of Cost per Adjusted Discharge measures is geographic cost-of-living differences. Hospitals in Oakland, California, have higher operating costs than do hospitals in rural North Dakota. The usual method of adjustment is to divide the unadjusted cost measure by the local area cost-of-living index. This division would restate costs into a cost-ofliving index equal to 1.0. The wage index used by Medicare is the most often-used index and may be applied to total cost or some percentage of total cost. The rationale for a percentage is that some portion of hospital costs, e.g., supplies, may not be affected by cost-of-living differences. Medicare assumes that the wage index affects 71% of total cost. The remaining 29% is presumed not to be affected by wage variation. Cost-of-living differences are important, and the adjustments can be easily handled. Of the three problems affecting cost comparability (Procedure Pricing, Output Differences, and Geographical Cost-of-Living Differences), Cost-of-Living Differences can be resolved. The problems with procedure pricing and output differences are still present in a CPAD measure, even after Case Mix Indexes have been applied.

Copyright 2008 Cleverley + Associates. All Rights Reserved

THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

Hospital Cost Index

We believe that a better measure of facility-wide hospital costliness can be constructed by weighting two measures: 1. Medicare Cost per Discharge Case Mix and Wage Index Adjusted (MCPD) 2. Medicare Cost per Outpatient Claim Relative Value Unit and Wage Index Adjusted (MCPC) The Hospital Cost Index is then constructed as follows:

HCI

= % Inpatient Revenue

MCPD $5,226

+ % Outpatient Revenue

MCPC $72

Medicare Cost per Discharge (MCPD) MCPD is a good reflection of inpatient cost. Data for computing this measure can be derived from the public-use files: MedPAR and Medicare Cost Reports. Each Medicare inpatient claim is costed using the relevant departmental ratio of cost-to-charge (DRCC) values derived from the Medicare Cost Report applied to charges from the inpatient claim. The DRCC values are mapped to specific revenue codes in the claims file. Finally, a wage index assigned to the hospital by Medicare is used to restate costs to an index of 1.0. This process results in a unique publicly available number for most hospitals in the US. The MCPD is not a perfect measure of relative inpatient costs, but we believe it is better than any other publicly available measure of cost or inpatient cost at the facility level for several reasons. The output unit is more comparable than any other. There is no application of outpatientequivalent discharges to distort output similarity. The Case Mix Index used to adjust is specific to those patients and is not extended to non-Medicare patients. The cost measures are adjusted using department-specific cost-to-charge ratios, not facility-wide cost-to-charge ratios. Finally, the costs are adjusted for cost-of-living differences. The major problem with MCPD is its comprehensiveness. In short, the measure may or may not be reflective of costs in other non-Medicare areas. We believe that this is not a major issue for the following reasons. First, Medicare represents the largest payer for most hospitals: approximately 53% of all inpatient days and 44% of discharges. Second, with fixed payment per DRG, there is an incentive to keep costs low. If costs are high in the Medicare area, they will most likely be high in other non-Medicare areas.

Medicare Cost per Outpatient Claim (MCPC) We use MCPC to assess costliness on the outpatient side of hospital operations. We can construct this measure from public-use files Medicare Outpatient Claims and Medicare Cost Reports which makes its availability for most US hospitals a reality. To derive the measure, we divide the cost per claim defined through the DRCC extensions by the relative value units of the claim. Table 4 provides an example of this process. Until the introduction of the OPPS, there was no universal method to compute RVUs for outpatient claims. We estimate RVUs based on the following taxonomy:

Copyright 2008 Cleverley + Associates. All Rights Reserved

THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

Line-Item Type APC Fee Schedule Pass-through Drug & Biololgicals Pass-through Device

RVU Assignment APC Weight Fee Schedule/National Price per APC = 1.0 Avg Wholesale Price/Natl Price per APC = 1.0 Estimate Payment/Natl Price per APC = 1.0

We believe the introduction of the OPPS has provided an opportunity to adjust outpatient costs for relative value unit differences in a manner similar to Case Mix Index adjustment on the inpatient side. We do not know of any other measure of facility-wide outpatient cost that incorporates relative value unit adjustment to this degree. Medical groups have used ResourceBased Relative Value Scales (RBRVS) measure, but these were not applicable to hospital outpatient operations. The MCPC is not a perfect measure of outpatient costliness. Like the MCPD, the MCPC does not necessarily reflect cost for non-Medicare patients. Medicare patients are, however, a significant percentage of total outpatient business (21% in 1999). Medicare also pays on a fixedfee basis now, so a strong incentive to keep costs low should exist. If costs are high for Medicare outpatients, it seems reasonable to conclude that they would be high for other categories.

Merging the MCPD and the MCPC

The final step in the development of the Hospital Cost Index is to combine the MCPD and MCPC. To combine these two measures, we must weight them by the percentage of business activity. The MCPD is, therefore, multiplied by the percentage of inpatient revenue, and the MCPC is multiplied by the percentage of outpatient revenue. The total of inpatient revenue and outpatient revenue percentages should equal 1.0. Data for these values will be taken from Medicare Cost Reports.

The final step is to normalize the MCPD and MCPC around some central value. We have selected $5,226 for MCPD, which was the estimated 2000 median MCPD, and $72 for MCPC, which was the 1999 median MCPC. Case Study Hospital
The Hospital Cost Index is calculated for the case study hospital in Table 5. The results suggest that the hospital is not high cost and is, in fact, relatively efficient. Its HCI in 1999 was 0.877 and increased to 0.931 in 2000. Outpatient costs are especially low at the case study hospital, while inpatient costs are very similar to US averages. The case hospital also had established lower prices for outpatient services to recognize greater price elasticity for these services, which artificially reduced the number of adjusted discharges, inflating their CPAD and CPADADJ values in Table 1. The Hospital Cost Index values are similar to departmentspecific measures, which suggested the case study hospital was relatively cost efficient.

Summary While the Hospital Cost Index is not a perfect facility-wide measure of hospital cost, we believe that it is the best measure available that can be produced form publicly available data. The Hospital Cost Index assumes that relative cost efficiency for Medicare inpatients and outpatients will be similar to that in non-Medicare patients. The use of publicly available data sets permits cost comparisons with competitors, which is especially critical in todays economic

Copyright 2008 Cleverley + Associates. All Rights Reserved

THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

environment. It also permits comparisons with any specific US hospital or group of US hospitals to make reasonable comparisons for similar hospitals. The measure also appears to track more closely with subscriber-based departmental benchmarking comparisons. This makes the reliability of the Hospital Cost Index very high and permits boards and senior managers to focus on more macro measures of cost that are relevant for their analysis and review.

Copyright 2008 Cleverley + Associates. All Rights Reserved

THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

1. State of the Hospital Industry 2001 Edition, Cleverley & Associates, Columbus, Ohio, p. 38. 2. John L. Ashby, The Accuracy of Cost Measures Derived from Medicare Cost Reports, reprinted in Cost Accounting for Health Care Organizations, Aspen Publishers, 1994.

Table 1. Case Study Hospital Measures of Cost

US Median (1999)*

1999

2000

Cost per Adjusted Discharge Cost per Adjusted Discharge Case Mix and Wage Index Adjusted

$8,260

$9,177

$5,225

$4,831

$5,019

$4,507

* 2002 Almanac of Hospital Financial and Operating Indicators, Ingenix, pp. 450-452.

Table 2. Impact of Pricing

Hospital A Gross Inpatient Charges Gross Outpatient Charges Cost Inpatient Discharges Adjusted Discharge Cost per Adjusted Discharge $100,000,000 $90,000,000 $100,000,000 10,000 19,000 $5,263 Hospital B $100,000,000 $99,000,000 $100,000,000 10,000 19,900 $5,025

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THE HOSPITAL COST INDEX: A NEW WAY TO ASSESS RELATIVE COST EFFICIENCY

Table 3. Measures of Relative Case Mix Complexity

Net Patient Revenue Size < $10 million $10-50 million $50-100 million $100-200 million > $200 million Medicare Case Mix Index 1.001 1.207 1.346 1.598 1.782 Medicare Average Relative Weight per Outpatient Claim 10.71 6.22 10.90 7.26 8.31

Source: 2000 MedPAR and 1999 Outpatient Standard Analytical File

Table 4. Cost per Outpatient Claim RVU Adjusted

Revenue Code 250 270 301 305 309 320 450 CPT/ HCPS n/a n/a 82150 85025 G0001 74022 99283 Status N N A A A X V Units 2 8 1 1 1 1 1 Charges $6.00 226.25 32.00 39.75 11.75 176.75 160.75 $653.25 DRCC .50 .55 .60 .60 .60 .45 .55 Cost $3.00 124.44 19.20 23.85 7.05 79.54 88.41 $345.49 APC Payment 0 0 $8.96 10.74 3.00 66.90 102.29 $191.89 RVUs 0 0 .185 .222 0.062 1.380 2.110 3.959

Table 5. Hospital Cost Index of Case Study Hospital

US Median (1999) 1999 Medicare Cost per Discharge Case Mix and Wage Index Adjusted Medicare Cost per Claim Relative Value and Wage Index Adjusted ` % Inpatient Revenue % Outpatient Revenue $4,774 2000 $5,282 $5,226

$58.96 60.8 39.2 0.877

$58.40 60.2 39.8 0.931

$72.00 56.9 43.1 0.991

Hospital Cost Index

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