Thoughts from Ken Kaufman

Healthcare Costs Post-Pandemic: A Different Perspective

6 minute
Covid mask

For many hospitals and health systems around the country, COVID-19 threatens to create long-term negative changes to volumes, revenues, and margins on top of the pressures that weighed on hospitals even before the pandemic.

In January and February of 2021, adjusted discharges were down 17% and ED visits were down 28% compared with the same period in 2020, according to the latest Kaufman Hall Hospital Flash Report. In addition, Kaufman Hall forecasts that hospital revenue could be down between $53 billion and $122 billion in 2021 compared with pre-pandemic levels. We also forecast that median operating margins in 2021 could decline by 10% or greater from pre-pandemic levels, depending on the path of the virus and the ultimate effectiveness of the vaccine rollout. By the end of 2021, we expect from one-third to one-half of U.S. hospitals to have negative operating margins. In addition, we are seeing significant changes in payer mix for some organizations, with greater percentages of government payers—another potential disruptor for margins.

Despite the volume and revenue blows that hospitals have felt, many have been reluctant to start aggressive cost control. In some cases, hospitals have expected—or at least hoped—that volumes and revenues would return to pre-pandemic levels, and in the meantime have leaned on their balance sheets and temporary government funding. Other hospitals are concerned about the possible ramifications of cost reduction at a time when COVID has already caused economic upheaval in their communities.

Given the nature of the problem, hospitals cannot wait much longer to recalibrate revenue and costs. At some point in the very near future, organizations need to come to a reckoning about the current state. What are current inpatient (medical and surgical), outpatient, and ED volumes; how do they compare with pre-pandemic levels; what are possible scenarios for the future? What has been the financial damage, with and without CARES Act funding? And is there a level of financial damage to the organization that appears to be permanent?

Any financial damage will have to be addressed: operating results will need to get back, if not to pre-COVID levels, to levels that are acceptable going forward.

As we have talked with hospital and health system executives around the country about this situation, a number of best practices for smart, assertive cost reduction have emerged that warrant serious leadership attention.

Update the financial plan. A foundational step is to update the organization’s financial plan in order to determine cost goals over time. With the latest information on volumes, revenues, and expenses, along with scenarios about the path of COVID and possible changes in consumer behavior, executives need to extend the revenue line and the expense line over a period of years, absent any management action. What is the resulting gap between the organization’s necessary financial state and what the plan shows?

Recognize that much of the low-hanging fruit has been picked. Hospitals have been toiling for years to reduce supply, labor, and overhead costs. In some cases, those costs have crept back in, and in some cases those opportunities have been achieved to a degree that is reasonable using traditional methods. On top of that, the new environment caused by COVID is changing the degree of cost reductions necessary. All these factors mean that new and smarter approaches to cost reduction are imperative.

Think of cost reduction as continuous. As executives look back at their organizations’ financial histories and look forward at their financial plans, it will be apparent that one-time cost actions cannot do the job. Every year will likely require a measure of cost reduction. Therefore, plans should be designed from the start with the idea of being scalable for future requirements.

Focus on corporate overhead and shared services. During COVID, hospital front-line staff have carried an enormous burden of crushing hours, intense clinical uncertainty, personal sacrifices, and in many cases personal loss. As front-line staff continue to face the effects and unpredictability of COVID, and organizations look ahead to the workforce effects of burnout and the clinical needs for the next clinical crisis, executives are justifiably reluctant to reduce costs in a way that affects patient-facing staff. For that reason, in the face of continuing annual gaps in financial performance, executives should push as hard as possible on corporate overhead and—for systems—shared services.

Consider automation, outsourcing, and offshoring. As with other areas of cost reduction, traditional approaches to attacking overhead costs have yielded mixed results. Given the accelerating nature of the cost problem, organizations need to think more broadly about cost-reduction tactics. Among those that American corporations have used successfully for years are automation, outsourcing, and offshoring, specifically of transactional activities and functions—those that are rules based and repetitive. Examples include financial reporting, payroll, accounts payable, billing, insurance verification, and clinical documentation. Although not transactional, certain IT functions such as including desktop services, applications support, and coding work have a successful history of outsourcing in corporate environments.

Calculate and present the full opportunity. Organizations should start by calculating the full cost opportunity from a proposal that includes all strategies to their maximum effect. Then, without any alteration, this proposal should be presented to management. In effect, this approach says, “This is what we could do. Now tell us why we can’t.” Function leaders can review each area’s cost-reduction strategies and, where necessary, the executive team may decide to postpone or phase in a particular strategy for a particular part of the organization. However, starting with the full opportunity helps manage the degree of change that will be necessary for these actions to be successful.

When outsourcing, consider the question of control. When outsourcing, two basic options exist regarding control. In one, the organization outsources a total function to a vendor, including leadership, design, and execution. In another option, the organization retains leadership and design, and outsources execution to a vendor. Neither approach is inherently right or wrong; both deserve serious management analysis and consideration.

Cost-reduction suggestions such as these push up against longstanding cultural characteristics of most not-for-profit healthcare organizations. For one, hospitals and health systems tend toward a desire to be all things to all people. These cost-savings approaches propose that certain functions can be done more effectively and efficiently by others.

An even more challenging cultural characteristic is not-for-profit healthcare’s notorious aversion to risk. However, as one executive said to us, “In not-for-profit healthcare, risk-free cost-reduction plans don’t exist anymore.”

Innovative, assertive, and necessary cost reduction involves risk. Organizations need to ensure they have the right risk-mitigation strategies in place: for example, providing a safety net and retraining programs for displaced employees, or having an onshore backup for offshored functions.

With appropriate risk management in place, management and boards need to accept that a certain amount of risk is inevitable. There will be pitfalls along the way. However, if an organization is going to make the necessary adjustments to its cost structure on a recurring basis, bold moves are needed. Those moves are reasonable, given the opportunity. And they are necessary, given the alternative.

Traditional cost reduction strategies work on the premise that hospitals and health systems can lower their costs while maintaining full control of all aspects of operations, and that having full control lowers perceived risk. For the low-hanging fruit of cost reduction, that was largely true. At this point, however, maintaining that same level of control increasingly will mean that costs will be higher. For the next generation of cost reduction, most hospitals and health systems will have to accept something less than total control, and something greater than no perceived risk, in order to achieve their critical organizational goals over time.

Lance Robinson
Lance Robinson is a Managing Director of Kaufman Hall and Leader of the firm’s Revenue and Operations Improvement (ROI) practice, which includes individuals with deep expertise in labor, non-labor, productivity, supply chain, contracted services, overhead, clinical service mix, and revenue cycle management.
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