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Increasing hospital operation costs in the USA

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Image: Increasing hospital operation costs in the USA US health care costs are increasing at a rate roughly three times inflation. In 2008, the US health care industry was estimated to be worth $2.3 trillion or 16.5 per cent of gross domestic product (GDP) and was projected to be 17.9 per cent or $2.6 trillion by 2010.

In 2008, 43.8 million US people were uninsured – 17 per cent of the total population, up 6 per cent from 2000. In 2008, employer health insurance premiums increased 5 per cent – two times the rate of inflation. The annual premium for an employer health plan covering a family of four averaged nearly $12,700. The annual premium for single coverage averaged over $4,700.

The following table shows US national health expenditure and GDP projected to 2010. It also shows national health expenditure as: GDP percentage; and expenditure per capita, which shows an alarming growth trend over 50 per cent and the health expenditure per capita over 45 per cent, respectively.

Figure 1: Historical and forecast NHE and hospital expenses for the USA (1995-2010)

Figure 1. Historical and forecast NHE and hospital expenses for the USA (1995-2010)

Health care is currently a major fiscal problem. If this trend continues beyond 2010 then corporation managers will stop offering health care (some already have) to employees, or they will keep passing along premium increases to employees as many currently do. If the health care burden is left in the average consumer's hands then it will cripple the economy. Approximately 44 million US people either cannot afford health care, or simply do not have health care for some reason. Consequently, they use hospital emergency rooms as their family clinic. This is obviously more expensive and inefficient than seeing a clinic family practice physician. But, more importantly, it takes precious time away from patients with potentially life-threatening problems.

The US health care rising cost trend will continue unless the industry can find ways to reduce the burden placed on the consumer. People cannot continue to afford health care at this increasing rate. One way to accomplish affordable health care is to find ways to reduce costs and run a more efficient operation. Hospitals comprise about 30 per cent of the health care industry's expenditure.

Current industry trends: hospital costs

Current industry trends reveal escalating health care costs. The entire US health care industry accounts for 16-17 per cent, or approximately $1.9 trillion dollars GDP. Of that, hospital costs comprise roughly 30 per cent, which increased over 9 per cent per year for the past five years and continue to increase. There are three major expenses in a hospital:

  1. fixed;
  2. variable; and
  3. administrative/overhead costs.

Administrative costs are defined as non-patient contact costs incurred by hospital staff. These are non-revenue generating activities that need to be allocated to the revenue generating departments and are typically allocated according to users in each department or by facility space department staff use. There are some arguments regarding costs that comprise administration: maintaining medical records; medical records filing; billing; nursing administration; general and administration departments (IT, finance and plant operations); supplies ordering; and central services.

The US hospital administrative costs are approximately 60 per cent higher than Canada's and 97 per cent above Great Britain's. There are several reasons that US administrative costs are high relative to other countries. Its insurance system consists of more than 1,500 service providers through which insurance can be obtained. Each company markets, creates and sells its own insurance to US individuals and companies. To complicate matters for hospitals and their billing departments, most carriers have different billing requirements.

Hospital variable costs are expenses that vary by patient with different medical needs. In other words, variable expenses can be viewed as expenses that are outside the physicians' control. Examples include: laboratory tests; medications; medical supplies and nursing expenses. Variable expenses account for approximately 35 per cent to 42 per cent of total patient expenses. Variable hospital expenses are a significant issue for hospital managers who are reluctant to make changes to the way variable spending occurs because cutting them compromise patient care. Supplies are the second largest expense for hospitals after salaries.

The problem is that many hospital managers allow each department to purchase their own supplies, causing them to act independently creating wasted time and spending. If staff in each department order their supplies then managers lose purchasing power. Hospital staff rely on nurses and doctors to manage inventory as well as patient care, the latter is where clinicians' focus should be.

"Each year, hospital costs are becoming a larger percentage of US GDP, and in a country where, for the most part, people are wealthy, there is a concern because 45 million people cannot afford to buy health care."

Fixed and administrative costs are the most difficult to differentiate. Because of fixed costs' nature, these are also the most difficult spending areas to control. Fixed costs can include equipment amortization, facilities, building leases, utilities and building maintenance. Capital expenditure amortization can be affected through capital spending cuts. Conscientious employees and corporate awareness can help curb utility expenses. Building leases are not changeable unless one can take less space or somehow adjust the contract. Building maintenance is a requirement and an ongoing expense that is hard to control. Hospitals can keep the building well maintained to avoid extremely expensive unexpected repair costs. For these reasons, in the short term, there is more value that can be extracted from variable and administrative costs.

Based on administrative and variable costs data, it can be deduced that hospital fixed costs comprise 34 to 46 per cent of hospital expenses. Hospital managers have very little profit margin, not because their revenues are flat or decreasing, but, because their costs are increasing at a rate more than three times inflation.

Each year, hospital costs are becoming a larger percentage of US GDP, and in a country where, for the most part, people are wealthy, there is a concern because 45 million people cannot afford to buy health care.

There are specific expenses that can be reduced through more efficient operations and waste elimination. The @Risk Program Monte Carlo simulation model, a statistical model with scenario analysis determined potential savings related to changes in the way hospitals treat their medical supply procurement process. The model also determined potential savings related to hospital administration costs including:

  1. bill processing; and
  2. the insurance claim process.

These two spending areas waste both processing time and money spent.

Centralized supply chain

In the current supply procurement process, departments operate independently when purchasing supplies and assuring adequate stock. Hospitals operate this way primarily because different departments need different supplies and doctors and nurses may prefer different product brands. This sounds a reasonable approach at first, but, from an operational perspective, there are many problems.

First, the basic supply needs in different departments are primarily the same. Department-specific items are what differentiate them. Second, having nurses and doctors order supplies causes concern. Supply chain processes in hospitals should be centralized. It will be more efficient and less expensive than the current process. Hospital departments are operating in silos as decentralized functions. They need to have communication and consistency between departments to create an efficient supply purchasing environment.

The centralized supply chain process will effectively integrate the procurement activities across all departments in a hospital as it will force economy of scale, economy of scope and improved negotiating capabilities with suppliers for the entire hospital operation. Both hospital supply chain process efficiency and effectiveness will be enhanced through centralized supply procurement business model.

This process, however, is not without costs. To implement this process hospital staff may have to invest in inventory management and automated supply ordering systems. However, these two systems will free up time for doctors and nurses so they are able to focus solely on patient care. Hospital managers will need to hire a full-time experienced supply manager in charge of the entire vendor maintenance process, vendor management procurement process, terms and conditions negotiation, etc. This process also allows the materials manager to consolidate suppliers, reduce brand variation and total items and makes the process more efficient.

Quality, affordable health care

There is an awareness of increasing US hospital operation costs. The US hospital total operation expenditure falls into three categories: fixed; variable and administrative, which helps to identify the areas for greatest improvement.

Solving the problem is vital to health care and the US economy, overall. The US hospital spending trends are alarming. Health care, the US' largest industry, is 16 per cent of GDP and hospitals are 30 per cent of the health care industry and growing rapidly at around 9 per cent per year.

Two particular hospital costs, namely, the medical billing process (administrative) and the medical supplies spending (variable) were analysed. For each cost, @RISK Monte Carlo simulation modelling software was used to simulate the potential savings from process streamlining. The medical billing process is a challenge and hospital managers need to confront insurance carriers who have complex processing claim procedures. A streamlined process will cut hospital administrative costs significantly. The medical supplies spending process has the greatest savings potential.

Most hospital managers allow departmental staff to purchase supplies. Investing in an automated supply ordering system and a supplies manager allows nurses and doctors to concentrate on patient care. A supply chain person would streamline the process, reduce costs, utilize buying power by negotiating lower pricing and add other potential benefits to hospitals.

Hospital spending is out of control, but the good news is that this is known. There is time to correct this trend before the problem worsens. All hospital processes need to be streamlined into the most cost effective method while allowing the highest patient care level possible.

October 2011.

This is a shortened version of “Hospital cost structure in the USA: what's behind the costs? A business case”, which originally appeared in International Journal of Health Care Quality Assurance, Volume 24 Number 4, 2011.

The authors are Charu Chandra, Sameer Kumar and Neha S. Ghildayal.