Mapping the Financial Journey for Health Systems

Health system executives understand the move to value-based care is here. But accepting that reality doesn’t answer their questions about when and how to transition from a business model based on fee-for-service payment to one based on payment for value—without degrading their organizations’ financials.

To help answer those questions, we analyzed a large regional health system in California and developed three scenarios, ranging from the implications of inaction through the impact of moving to value, and predicted the potential financial outcomes of each. The study takes into account trends already familiar to health system leaders—the aging of the patient population sparking Medicare growth, stagnant reimbursement rates, and the ongoing shift from inpatient to outpatient care. (To read the full paper, see The Impact of Transitioning to Value on the Financials of a Health System.)

Charting the Options

The California system operates in a fairly geographically defined market featuring significant competition and experiencing strong growth. The scenarios start with 2015 data and project out to 2022. All give estimates for the effect of a 5 and 10 percent drop in inpatient utilization caused by the continued shift toward outpatient care.

Scenario 1: The first scenario predicts what would happen if the system, which does not operate a health plan, were to maintain the status quo. It assumes that 25 percent of reduced inpatient discharges would be offset by increased outpatient visits.

The results show that even with inpatient utilization decreases, net patient revenue would grow due to increased volume. However, the growth wouldn’t be profitable because most of the volume increase would be in traditional Medicare, which typically has a negative margin. Thus, the system’s 2015 operating income of nearly $212 million would drop between $92 million and $114 million by 2022. The operating margin would fall from 10.7 percent in 2015 to between 4.8 and 4.9 percent. A nearly six-point drop in margin would be devastating for hospitals—that typically have margins in the 3 to 4 percent range.

Scenario 2: In the next scenario, Lumeris looked at the volume growth and associated market share increase that would be required to maintain the 2015 operating margin of 10.7 percent, but without transitioning to value-based payments. The analysis found that attaining the necessary market share growth over a seven-year period would be highly improbable and would require massive investment in growth at the expense of profitability. In addition, the system would have to increase its bed capacity to meet demand.

Scenario 3: In the last scenario, the health system and its physician network transition to value-based contracts to cope with the increase in Medicare business and the drop in inpatient utilization. The system and doctors have established contracts with payers that distribute any value generated by coming in below an 85 percent medical loss target between the primary care physicians (20 percent), the health system (30 percent) and health plans (50 percent).

Although it would take two or three years to achieve favorable outcomes, the health system would be able to lower its actual medical-loss ratio by 2.5 to 5 percent. This estimate likely is too conservative because, in Lumeris’ experience, more savings can accrue in Medicare through Medicare Advantage contracts, with their healthy reimbursement potential and ability to manage out unnecessary utilization.

Even so, under this scenario, the health system would have a still-healthy operating margin of 7.9 to 8.5 percent in 2022, and it would limit its operating income drop to between $31 and $40 million—just one-third of what it would be if the status quo were maintained. Additionally, the hospital would not have to invest in expanding its bed capacity.

The Future is Bright—but Requires Change Today

The study’s results might not make health system executives feel overly bullish, but Lumeris believes the future is positive. The analysis shows that opportunity exists to protect health system financials if the organization is willing to go through the transition to value and reduce costs.

The study indicates that the time to begin the transition is now, or else organizations may see their financial futures devastated through inaction. An operating partnership with an entity that has a proven model can accelerate the time to value and help health systems avoid the trial-and-error process that so many providers are struggling through today.

Not sure where to start? Talk to one of our advisors.

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