FINANCES

INTRODUCTION         Top

A Governing Board’s fiduciary responsibility includes protecting its hospital/health system’s financial status. Financial and strategic planning must be integrated. The Board establishes financial goals for growth, debt capacity and return on equity. It approves the annual operating and capital budgets, receives and approves budget reports throughout the year and sets and monitors investment policies and goals.

Boards are involved in assessing pricing strategies, discounts, contract arrangements and business plans. Their role includes setting criteria for return on investment and new business ventures. Boards determine policy on uncompensated care, provision of needed community services and development of alternative revenue sources.

Boards are responsible for making sure their organization complies with relevant laws and regulations. The health care industry has come under increased scrutiny by regulatory authorities, including the Department of Justice and the Internal Revenue Service. A board’s financial fiduciary responsibility includes the organization’s compliance with the overall intent of laws and regulations. The board also is responsible for creating and maintaining an ethical business climate.

A variety of Board committees may be involved in reviewing, analyzing and making recommendations to the Board. These could include the finance, compliance, planning, audit, investment and fundraising committees. Most trustees will serve on one of these committees.

BUDGET         Top

One of the Board’s key responsibilities is to determine the hospital’s financial goals and monitor operations continually to see that those goals are attained. The annual budget is the primary means for both the trustees and the CEO to set financial goals for the hospital.

The Board’s responsibility in understanding and approving the budget cannot be overemphasized. First, the assumptions upon which the budget is based should be clearly spelled out. These assumptions should describe how the budget fits into the Board’s financial and strategic plan. The Board should be satisfied with the reasonableness of budget assumptions and projections. These projections should incorporate variables such as potential for retroactive cost report settlements, expected changes in third-party payer contracts, managed care penetration, changes in Medicare and Medicaid and changes in rules and regulations that affect such things as Occupational Safety Health Administration (OSHA) standards.

Public Hospital Districts are required by statute to use a budgeting process. Each district must: Develop a proposed budget by September 1 Publish the budget in the newspaper Hold a hearing on the first Monday in October Adopt the budget by resolution after the hearing

Throughout the budget review process, the Board should remember the mission, goals and financial and strategic plans of the hospital to be sure that the budget provides the necessary means for the hospital to reach its goals.

There are three types of budgets:

• The operating budget, covering a one-year period
• The cash flow budget, supplementing the operating budget
• The capital budget, generally covering a three-year span

The following section provides an overview of the budget process and the inter-relationahip between governing board members, administration and physicians.

Budget preparation is usually an extensive process. Typically, each hospital department receives a "budget package" from the hospital’s accounting department. These worksheets detail the current year’s volume, revenue and expenses, as well as volume projection, rate increases and inflation factors for the coming year. Department directors use these figures as guidelines, in conjunction with the hospital’s strategic and financial plans, for making their initial budget projections. Completed worksheets show projected volumes of services provided by each department along with estimated staffing figures, expenses (salary, materials, supplies) and equipment that would be required to support each volume. Certain statistics should also be budgeted. These include patient days or discharges, outpatient visits, surgical procedures, acuity index and payer percentages. This process produces information that the accounting department needs to complete the initial revenue and expense budget.

With the advent of the prospective payment system, many hospitals create budgets based on the expected mix of patients. This number is based on payer mix and may include variables such as changes in case mix. Depending on the sophistication of the hospital’s management information systems, computer programs may be used to model the results of various third-party payer contracts and expected payment changes in Medicare and Medicaid on the hospital’s revenues. This type of information, presented in an easily understood form, allows the hospital to project net revenue more accurately.

ANNUAL AUDIT         Top

It is the Governing Board’s responsibility to engage external auditors to perform an independent audit of the hospital’s financial records each year. Such an audit will determine if the hospital’s financial position and its financial operations are presented fairly and in accordance with generally accepted accounting principles (GAAP). Governmental entities like public hospitals use governmental accounting standards (GASB). In addition to auditing the hospital’s accounting records, reviewing existing internal controls and providing an opinion as to the fairness of the financial statements, the outside accounting firm may present the Board with a management letter commenting on the hospital’s management and accounting practices. Note that the independent accountants report to the Board of the hospital. The auditors must also have a working relationship with hospital management in order to perform the audit. They will often be involved in the preparation of the Medicare/Medicaid cost reports.

Just as the annual budget permits the Board to express specific financial goals for the hospital, the annual audited financial statements and management letter provide the Board with added information to measure the attainment of those goals. The Board should use the audited statements to determine whether the hospital is reaching the financial and operational goals that they set, and if not, the hospital’s current operations and long-range strategic plan should be modified so that the goals are more realistic.

FINANCIAL REPORTS         Top

The hospital’s financial staff is responsible for providing the Board with accurate financial statements on a timely basis. The financial statements of a hospital are similar to the financial statements of any other industry, with certain exceptions. The main financial reports include a Balance Sheet, Income Statement and Cash Flow Statement, all of which are prepared on a monthly basis by the hospital’s accounting department. Financial reports should provide historical trend and budget information.

These reports should compare the current month’s financial situation to that of the same month in the previous year and the budgeted amount. The accounting staff should also prepare monthly reports to track key operating and utilization statistics. These include account receivable analyses, physician utilization, outpatient visits, full-time equivalent personnel (FTE), patient days or discharges, payer percentages and acuity index. Graphs showing this information make it easy to see trends. For a monthly report to be useful to the board, it should not be overly complex or voluminous. The board should review the financial report annually to determine if there are unneeded and/or missing items.

Separate financial reports may be completed for each corporate entity or hospital fund. There are at least two types of funds – general and restricted. The general, or operating, fund is the fund that the hospital uses on a daily basis to record continuing and ongoing hospital operations. This may also be called the unrestricted fund. The restricted fund, of which there may be several, is a fund whose purpose has been restricted to a specific use. These restricted funds may include an endowment fund and a plant fund to replace buildings and equipment. The hospital should have a reserve fund for "rainy days," uninsured emergencies, unanticipated business trends and leverage, to replace capital equipment, and to obtain financing. The Board should determine the appropriate amount of the reserve fund and set policy.

The balance sheet reports the hospital’s assets, liabilities and fund balance.

• Assets can be "current," "property, plant, equipment," "designated" or "other." "Current" assets have an expected life of one year or less. These include cash, accounts receivable and inventories. It is expected that inventory supplies will be used within one year of purchase. "Property, plant and equipment" assets have a life of more than one year. For example, equipment might have a useful life of 10 years before it is fully depreciated. "Designated" assets may be either Board-designated accounts such as fund depreciation, self insurance reserves or other reserve accounts, or trustee-designated accounts which include interest and sinking funds as required by bond trustees. "Other" assets include donated property, bond issuance costs and deferred charges. These funds are not available for current operations.
• Liabilities are the monies a hospital owes to other parties, or benefits that the hospital has accrued but not yet earned. Liabilities are recorded in two categories – current liabilities and long-term liabilities. Current liabilities are those that are expected to be paid by the hospital within one year. For example, under "Accounts Payable," paying vendors for hospital supplies. Long-term liabilities require extended payments; the hospital’s long-term debt is a long-term liability.
• The fund balance or retained earnings is the difference between total assets and total liabilities and represents the equity of the hospital. It is an accumulation of all the prior year’s earnings and contributed capital such as stock or donations.

The income statement is also known as the "Statement of Revenue and Expenses" or the "Profit and Loss Statement" (P&L). It represents the hospital’s financial operations for a limited amount of time up to one year (e.g., annually or monthly).

• Revenue in the income statement represents patient revenues or charges to the patient for hospital services provided. Revenue is the accumulation of total patient billings. Gross revenue is the total charge that the hospital has billed for services provided to the patient. Net revenue is the amount that is expected to be paid by the patient, the insurance carrier or a third-party payer, such as Medicare, Medicaid or Blue Cross.
• Contractual allowances, bad debt, discounts and charity care account for the difference between gross revenue and net revenue. These allowances are one of the features that make hospital accounting different from most other industries’ accounting practices. The "contractual allowance" is the difference between the hospital’s gross charge and what the third party will be paying under the reimbursement system. Different payers have different reimbursement methodologies, and each third-party payer has different systems for reimbursing inpatient and outpatient services. They usually pay less than actual charges. The amount of contractual allowances fluctuates and is an estimate.
• GAAP requires that bad debt expense be listed as an expense item and not a deduction from revenue. Many hospitals still list it as a deduction from revenue, producing a discrepancy with how bad debt is listed in their audited financial statements. Bad debt is considered a revenue deduction in the case of net revenue per patient day and net revenue in accounts receivable.
• Expenses in hospital accounting are fairly straightforward. There are two broad categories of expenses -"operating expenses" and "capital expenses." Operating expenses consist of salary and non-salary expenses (supplies and materials, fringe benefits, etc.). Capital expenses represent the depreciation, amortization and interest expense associated with capital purchases or leases.
• The gain or loss from operations is the difference between net patient revenue and operating expenses.
• "Non-operating revenue" and "other income" represent income from investments, gifts, grants and bequests, tax revenue, disproportionate share funds and gains on the sale of assets.
• The "net gain or loss" represents the bottom-line difference between total revenues (operating and non-operating) and expenses. Other "operating revenues" are a very important source of funds for hospitals and often determine whether the facility is financially viable or in distress.

RATIO ANALYSIS         Top

Numerous ratios measure every aspect of the financial statement. Trustees should be familiar with the following terms and what each of the terms means to their own hospital.

Liquidity refers to the hospital’s ability to meet its current debt obligations. It is most often calculated by the "current ratio," which measures how much cash a hospital has on hand. The more cash or current assets that the hospital has available to pay its debts, the more "liquid" it is said to be. The current ratio is expressed as total current assets divided by total current liabilities, and it should be greater than 1.80.

Total Current Assets (excluding restricted funds)
Total Current Liabilities (from unrestricted funds) = the current ratio.

This ratio provides a generally reliable indication of a hospital’s liquidity.

"Days in Accounts Receivable" is the term used to indicate the length of the cycle from the date of the patient bill to the date payment is received. Days in Accounts Receivable should be approximately 50 to 70 days or less. When a hospital’s assets are uselessly tied up in Accounts Receivable, serious cash flow problems can result.

Net Patient Accounts Receivable


Net Patient Service Revenue    / 365 =

days of revenue in patient accounts receivable.

"Capital structure" refers to the amount of long-term debt included in the hospital’s capital. The strength of a hospital’s capital structure can be measured by several ratios. "Leverage" refers to the hospital’s use of borrowed capital to increase the return on equity. Financial leverage may be an indicator of the hospital’s ability to meet long-term debt obligations. A frequently used ratio is the debt service coverage ratio which measures the capacity of the hospital to make debt service payments (i.e., interest expense plus principal) from operations. The ratio should be at least 2.0 and should also be increasing. The calculation is as follows:

Cash Flow + Interest Expense_______
Principal Payment + Interest Expense = the debt service coverage ratio.

FINANCIAL MONITORING AND ASSESSMENT PROCESS         Top

Ratio analysis combined with variance analysis (comparing budget projections with results) are important ways of determining the relative financial strength of a hospital. Board members should be familiar with the financial ratios of their own hospital, what these ratios indicate and trends that the hospital is experiencing.

Reprinted with permission from Pointer, Dennis D. and Jamie E. Orlikoff, Board Work, Governing Health Care Organizations, Copyright 1999 Pointer and Orlikoff, Published by Jossey-Bass Inc., Publishers, 350 Sansome Street, San Francisco, CA 94104 (800) 956-7739

FINANCIAL PLANNING         Top

Financial planning functions develop as a result of the hospital’s long-range strategic planning. When a Board is reviewing its hospital’s mission statement and the health care needs of its community, there are several key questions which should be posed regarding the addition or elimination of services. The first question the Board must answer is: Is there a need for this service? The second question is always: Is this a financially feasible program? Often, there is a tremendous need for the new program, but it is not financially feasible. If the program is important but apparently not financially viable, then the third question to be addressed is: What can we do to make it work?

It important to perform studies of the financial feasibility of new programs or capital acquisitions. Such questions as: How much financing is necessary and what type of financing is available? What about fund raising? Do we lease or purchase? need to be thoroughly researched.

INVESTMENT POLICY         Top

The Board should have an investment policy. Public hospital districts must have such a policy. This policy includes who has authority to make investments, the distribution between long- and short-term investments, use of outside consultants, acceptable risk parameters, investment restrictions, expected objectives and how the risks taken and rates of return will be maintained and evaluated. The policy should be reviewed annually along with the performance of the investment portfolio.

PAYMENT         Top

President Lyndon B. Johnson’s Medicare program, introduced in 1965, completely revolutionized the financial aspects of all health care in this country. This federal program, known as Title XVIII, was established to provide the elderly population with necessary hospital and physician care. Initially, all persons who were at least 65 years of age and covered by the Social Security program were eligible for Medicare benefits. Eligibility requirements were then extended to cover certain categories of disabled patients and hemodialysis end stage renal disease patients.

Medicare comes under the jurisdiction of the Health Care Finance Administration (HCFA), an agency of the federal government’s Department of Health and Human Services (DHHS). When it was first established, Medicare reimbursed hospitals for reasonable and allowable costs incurred for all patient-related activities. But the reasonable cost-based methodology did not promote cost containment or efficiency. A completely new reimbursement methodology was developed and introduced to hospitals beginning in 1983.

Inpatient acute care services rendered to Medicare beneficiaries are now reimbursed on the basis of the Prospective Payment System (PPS), which reimburses hospitals for discharges in specific Diagnosis Related Groups (DRGs). Every diagnosis is assigned a weighing factor. These weighing factors are multiplied by a standard payment amount to arrive at the reimbursement for a specific discharge. For example, for every patient who has X diagnosis, barring complications, the hospital is reimbursed X amount.

Standard payment amounts vary between hospitals for wage area differences and teaching costs. The standard payment amounts are adjusted upward each year for inflation. However, Congress usually does not give an increase equal to the rate of inflation. Payments for inpatient capital costs are now part of the PPS methodology and the hospital is reimbursed either under the "Fully Prospective" or "Hold Harmless" method. These methods are in use to calculate the standard payment amount for the capital cost.

The Balanced Budget Act (BBA) was signed into law by President Clinton in August 1997 with the primary intent of saving money, extending the life of the Medicare Trust Fund and reducing Medicaid spending. Medicare payment reductions of $71.2 billion began in 1998 and will extend over a five year period. The idea was to save money by cutting what Medicare pays caregivers to take care of patient in hospitals, skilled nursing units, at home, and as outpatients.

The payment reductions are substantially affecting hospitals across Washington state and the nation. Both urban and rural facilities are reducing services in order to maintain quality of care.

Board members should be aware of the current and anticipated impact of the the BBA on their organization.

As part of the Balanced Budget Act passed in 1997, Medicare will be moving toward a prospective system for outpatient services as well as inpatient services. The prospective system will pay a set amount for each case-mix adjusted visit. Currently Medicare is considering using APCs or Ambulatory Payment Classification to group visits for the prospective system. The new system is targeted for implementation in FY2000.

The existing reimbursement system for most Medicare outpatient services is a blend of the retrospective cost-based system and PPS. Under this system, clinical lab services are not reimbursed on a prospective payment basis. Ambulatory surgery, radiology and other diagnostic services are reimbursed based on a blend of the PPS system and the retrospective cost-based system, which is subject to retroactive adjustments. A hospital receives an interim rate of reimbursement which is based on averages. Assumptions based on interim reimbursement often result in the hospital receiving less.

The Medicare program does have an HMO alternative, Medicare+Choice. Changes in the Balanced Budget Act were intended to promote more plans to participate in this program, but it is unclear how fast this alternative will grow.

The Medicaid program, Title XIX of the Social Security Act, was established by the federal government in 1965 to provide medical assistance to low-income people with no health insurance or other means of obtaining health care. Each state pays for part of its program – about 20 to 50 percent – and the federal government pays the rest. A state’s share is determined by its per-capita income; higher-income states pay the most. Washington State generally receives about 50% in federal matching funds for its Medicaid program.

Each state designs and administers its own Medicaid program, setting eligibility and coverage standards within broad federal guidelines. The states therefore differ markedly in their eligibility requirements, services offered and reimbursement policies.

Medicaid is an entitlement program. Those who meet the eligibility criteria are entitled to medically necessary covered services. The Medicaid program places both the state and federal government at financial risk for Medicaid expenditures.

As with Medicare, federal responsibility for the Medicaid program lies with HCFA. State responsibility belongs to the Washington State Department of Social and Health Services and its Medical Assistance Administration.

For urban and larger rural hospitals, the payment methodology for inpatient services for Medicaid patients is similar to that for Medicare, except that there is no separate payment for capital costs. Like the Medicare program, the Medicaid program uses a prospective system based on Diagnosis Related Groups. For Medicaid, however, the standard payment amounts differ for each hospital based on its prior costs and negotiated discounts. For small rural hospitals, the Medicaid program pays for inpatient services based on costs. The major difference is that the standard Medicaid payment amount (also called the "standard dollar amount") is subject to increases based on individual hospital actual costs, rather than a global increase for all hospitals. For hospitals with fewer than 100 beds, Medicaid adjusts the PPS reimbursement to the greater of the PPS payment or the actual cost incurred. Payment for outpatient Medicaid services is currently based primarily on cost, with lab, radiology, pathology and other selected services paid fees reimbursed on a fee schedule or PPS basis. Medicaid is also currently considering implementing a prospective system for outpatient services.

During fiscal year 1998, over 732,000 Washington state residents were eligible for medical services administered through the Medical Assistance Administration (MAA). Most members of this group, over 690,000 (94 percent) received coverage through the federal/state Medicaid program. The majority of clients (458,000) are enrolled in Healthy Options managed care.

During Fiscal Year 1998, MAA contracted with 14 health maintenance organizations (HMOs) and health care service contractors to provide needed services. The managed care plans are paid a capitated monthly premium for Medicaid enrollees.

While MAA contracted with managed care plans in pocket communities as early as 1986, the phased-in mandatory statewide enrollment was implemented in 1994. In all areas possible, clients have a choice of two or more plans from which to choose. Some rural areas, however, have access to one or no plans. When the traveling distance to visit the assigned provider is a hardship, clients may be exempted from managed care and receive their services through the fee for service delivery system.

Beginning in 1998, MAA and the state's Health Care Authority (HCA) issued a joint Request For Proposal and entered into joint contract for health care coverage for Public Employees Benefits Board (PEBB), Basic Health Plan programs and MAA's Healthy Options program.

This joint endeavor eliminates duplicative efforts and increases efficiency for the agencies as well as for the managed care plans.

In addition to the Medicaid program, Washington state has a number of other programs to help pay for low income patients. The Medical Assistance Administration pays hospitals for care for Medically Indigent patients and General Assistance patients. Payments for these programs are heavily discounted. Medical Assistance is also currently implemeting a Children’s Health Insurance Program (CHIP) under Title XXI of the Social Security Act. This program will cover children in families with incomes between 200 and 250% of the federal poverty level. The Health Care Authority runs the Basic Health Program, which provides subsidized care to families with incomes under 200% of the federal poverty level.

The Medicaid Disproportionate-Share Hospital Program provides extra payments to hospitals serving a disproportionate percentage of Medicaid patients to help make up for low reimbursement rates. Unlike other Medicaid reimbursements, DSH payments to hospitals do not correspond to treatment for individual Medicaid patients. The Balanced Budget Act cut DSH payments, and so hospitals may face cuts in DSH funding in the next few years.

The purpose of the annual cost report is to calculate the cost of providing Medicare and Medicaid services for each type of service – inpatient, outpatient, skilled nursing facilities (SNFs) and home health agencies (HHAs). The data in the cost report provides the basis for calculating each third-party payer’s share of the hospital’s total activity for that year. Cost reports are also used by other payers such as PPOs and HMOs for rate determination.

COMPLIANCE         Top

Health care fraud has become a national problem, with high exposure in the news media and before Congress. Some "experts" say that health care fraud is costing $44 billion a year. With little information available on provider practices and weaknesses inherent in the health insurance system, fighting health care fraud and controlling costs have become popular, high profile issues.

Detecting and punishing health care fraud and abuse have become a high priority for the federal government. The U.S. Department of Justice (DOJ) has targeted some 4,700 hospitals nationwide in investigations of Medicare billing. With fiduciary responsibility for the hospital, trustees have a significant stake in these investigations and in implementing compliance activities. As policy makers for their institutions, trustees have the responsibility for creating and maintaining an ethical business climate.

As part of the Health Insurance Portability and Accountability Act of 1996 (HIPPA), Congress mandated the creation of a fraud and abuse control program. Funding from Medicare’s Federal Hospital Insurance Trust Fund provided a significant increase in resources. The HIPPA strengthened the civil and criminal penalties for health care fraud and abuse. The law also created an incentive program to encourage individuals to report suspected fraud, and authorized rewarding 15 - 30 percent of the damages, plus reasonable expenses and attorney fees, to the "whistle blower."

The False Claims Act was enacted in 1863 to outlaw certain practices in the trading of horses and the manufacture of government weapons during the Civil War. The law’s general terms give the DOJ broad discretion to act. A violation of the False Claims Act occurs if a person submits a claim to the U.S. government with actual knowledge of its falsity, in deliberate ignorance of its falsity, or with a reckless disregard for its accuracy. The DOJ has taken the position that a pattern of inappropriate billings by a hospital constitutes a reckless disregard of the Medicare billing rules, making the False Claims Act applicable.

Historically, the U.S. Department of Health and Human Services and the Office of the Inspector General (OIG) have used administrative procedures to correct billing errors. Annual claim reviews and audits are conducted, and if billing errors are discovered, the amount in error plus interest is returned to the federal government.

If your facility has been the target of a federal billing investigation, your settlement agreement likely required establishment of a compliance plan. Even if your facility has not yet been investigated, establishing a compliance plan is essential. Such a plan is more than a broad policy stating the hospital’s intent to follow the law and urge employees to engage in legal and ethical conduct.

A compliance plan is a comprehensive strategy to ensure that the organization consistently complies with all state and federal laws relating to its activities and the delivery of health care. It ensures that the organization consistently complies with applicable laws relating to its business activities and contains mechanisms for oversight and internal enforcement. In addition, a compliance plan reduces the chances that the organization will violate laws, and it provides internal reporting and follow-up procedures. While compliance plans are new to hospitals, other types of businesses have used them for years.

In addition to understanding the regulatory environment in which it operates, the hospital must ensure that all employees understand how the applicable law affects their job functions and know which practices are prohibited. Employees must be aware of their obligation to be active participants in the hospital’s effort to comply with the law and to identify incidents of non-compliance.

When an organization has a mechanism that encourages employees to report concerns internally, the risk of government investigation is reduced. Identifying and correcting non-compliant conduct quickly reduces the risk of government intervention. Discovering and reporting offenses voluntarily is evidence of the hospital’s good faith efforts to comply with the law.

Corporate entities may be held liable for the criminal conduct of employees who acted with an intent to benefit the corporation, even if the action is contrary to corporate policy or instructions. However, an effective plan for preventing and detecting violations of the law can be a mitigating factor.

Hospitals operate within a broad framework of laws and regulations. Although the content of a compliance plan varies by the size and services of the hospital, some areas which may be appropriate for inclusion include billing and claims for payment, payments and illegal remuneration, patient referrals, physician recruitment, patient transfers, fund raising, controlled substances and mental health services.

The OIG is developing model compliance programs for hospitals and managed care organizations. The seven requirements for an effective compliance plan are as follows:

• Establish standards. The standards to which employees will be held and the types of conduct which the plan is intended to eliminate must be clearly identified; a mere statement of intent to comply with the law is inadequate. Employees should seek clarification when they are unsure if their conduct is consistent with the standards, and they should report suspected violations to the appropriate person. General codes of conduct apply to all employees, while specific rules and procedures may be appropriate for specific jobs.
• Compliance plan oversight. A "high level" person in the organization must oversee the compliance plan, and be responsible and accountable for the hospital’s compliance activities. This person may be supported by a compliance committee.
• Careful employee selection. Potential employees should be screened, especially those with substantial supervisory authority or discretion within the organization. Diligence should be exercised in all hiring, particularly for those who will be preparing claims.
• Auditing program. The plan should include a regular and systematic auditing program as well as a system for reporting suspected improper practices without fear of retribution or negative consequences. All reports must be investigated promptly.
• Education and training. Education and training of all employees involved in preparing Medicare and Medicaid claims or other compliance areas must be provided and participation documented. Training also must include physicians.
• Corrective action. Once an offense has been identified, the hospital must take reasonable steps to change procedures to prevent its re-occurrence. Additionally, the hospital should respond appropriately to the offense, such as voluntary disclosure to government officials and repayment of potential overpayments.
• Written enforcement and discipline policy. The plan must include a written enforcement and discipline policy. Not only should employees who violate compliance standards or program requirements be punished, but also employees who fail to report or investigate concerns which should have been apparent.

MANAGED CARE         Top

Managed care plans create competition between two or more hospitals in an effort to drive down the price that the plan has to pay for health care services. CEOs and Board members must understand the effects that managed care is having on their institutions and take actions to maintain their profitability through cost reductions and/or development of alternative sources of revenue.

Overall in Washington state, health plans are pulling out of Medicaid and Medicare managed care while more commercial business is moving towards managed care. Rural areas are experiencing less managed care overall.

Managed care is a form of health care delivery system that integrates financing and health services by means of:

• Contracts with health care providers that furnish a comprehensive set of services to enrolled members
• Utilization and quality controls
• Financial risk-sharing between the system and the providers
• Financial incentives for members to use these contracted providers

Managed care plans include health maintenance organizations (HMOs) and point-of-service HMOs. Managed care products are regulated by the OIC while PPOs (preferred provider organizations) are not regulated as of yet. Managed care uses a gate-keeper (primary care physician) concept. With PPOs if you use the preferred network then benefits are paid at a higher level. Use outside the network results in consumers paying a higher coinsurance and deductible.

The financing of health care is moving rapidly from fee-for-service to capitated plans in urban areas in Washington state. Capitation is a monthly pre-payment for primary care physicians for each person covered by the plan. The capitation rate varies with the actuarial estimate of the cost of care, usually adjusted by age and sex. The provider is expected to provide a range of services in exchange for the capitated payment, but may collect an additional copayment at the time services are provided. Not all services that can be provided by a physician will be covered by the capitated payment.

The most important aspect of capitation is that the provider must provide all covered and necessary care with no additional charges to the plan. The provider assumes financial risk for the care of each member. In a sense, the managed care organization passes on the "insurance" risk to the provider. As a result, capitation is intended to change incentives and behavior as follows:

• Sickness to wellness
• Specialization to primary care
• Volume driven to controlled/managed care (controlled cost)

From a hospital’s perspective, capitation reverses traditional logic as follows:

Fee-for-Service (FFS)	Capitation
Number of admissions, procedures or visits	Number of covered lives
Cost per procedure	Cost per life, inpatient days/1,000 lives stay and visits/1,000 lives
High occupancy rate	Low occupancy rate

When payment is dependent on utilization rate (as in FFS), the goal is to keep the health care system in heavy use. When the payment is not dependent on utilization, the goal is to keep usage down.

Incentives provided by managed care organizations for members to use contracted providers or networks include the following:

• No benefits (HMO) or lower reimbursement for benefits (POS) point of service obtained outside of the network
• Lower out-of-pocket cost for health services when obtained from contracted providers
• Patient files no claims
• Providers, not patients, are responsible for utilization management or the "hassles" of managed care
• Additional benefits, e.g., preventive care, well-baby care, vision/hearing screens, are included in managed care plans

Hospitals that have excess bed capacity and are experiencing reduced profitability aggressively pursue managed care contracts. Many hospitals now employ a Director of Managed Care. Typical responsibilities include negotiating managed care contracts, assessing the ongoing financial feasibility of managed care contracts and advising the CEO and the Board on the managed care environment and strategies to succeed in that environment. Many Directors of Managed Care have successfully implemented direct employer contracting strategies and created other programs to give employers the benefits typically gained from PPO contracts. In the future, hospitals will continue to develop strategies to gain greater control over the environment in which they operate.

Contracts and arrangements between a hospital and a payer based on anything other than the hospital’s established charges require the hospital to accept some financial risk. Whether it is the hospital or the purchaser that pursues negotiations of special rates, several important factors need to be considered in making the decision to contract for services with an individual third-party payer. The Board must ensure that hospital management has a plan of action for evaluating all proposed negotiated payment arrangements. This plan must require consideration of the following factors: