navigating the gap between volume and value · 8/14/2014 · navigating the gap between volume and...

© 2014 Kaufman, Hall & Associates, Inc. All rights reserved.

Navigating the Gap Between Volume and Value

Brian Kelly, Executive Vice President and CFO Excela Health

Jason Sussman, Managing Director Managing Director, Kaufman, Hall & Associates

August 14, 2014

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Navigating the Gap Between Volume and Value © 2014 Kaufman, Hall & Associates, Inc. All rights reserved. 1

The Healthcare Business Model Is Changing

1946-Today 2014 and Beyond

Historically, hospital generally attracted patients through

physicians and their referrals, with some patients making a choice

based on the hospital itself.

A new model is emerging wherein patients will chose a

company that organizes the care for them; Healthcare Companies

may be health systems, plans, IPAs or another entity.


Every Healthcare Organization is Trying to Address this Changing Business Model


This Requires Real Integration of Strategic Financial Planning and Operational Execution

Strategy Development

Operational Execution

Financial Modeling

• A continuous process

• Frequent updates of strategies and modeling

• Accelerated market movement requires more vigilance


A Disciplined Financial Planning Process Provides the Foundation for Integrated Planning and Execution


Strategic Financial Planning is More Important Than Ever

• The basic tenets remain unchanged Cash flow must be sufficient to meet the strategic capital needs of an

organization within an acceptable risk tolerance Credit and Capital Position, Financial Projections and Sensitivity Analysis Net Capital Capacity

• Status Quo is no longer the “baseline” The typical baseline financial projections include challenges to utilization and

revenue streams, significant investment around core competencies, and deteriorating financial performance

• Analytic sophistication must be consistent with industry strategies and disruptors Evolving reimbursement models, physician alignment, exchange exposure, retail

initiatives, and strategic cost management


The Ability to Achieve a Balance Between Strategic Requirements and Capital Capability Drives Strategic Direction

Short-term concern

Long-term concern

High $ Strategy and Related Investment Low $

Capital Capability High $

“Over investment”

“Under investment”

The corridor of control is the balancing point between two opposing goals:

1. Compete as effectively as you can, which requires aggressive investment of capital and commitment of operating dollars, BUT

2. Respect the fiduciary role of management and the board to maintain the long-term financial integrity of a community asset.


Uses of Cash 2014 - 2018 2014 - 2018

Capital InvestmentRoutine/ Ongoing $593.3 Unrestricted Cash (2013 End Balance) $890.5IT Capital 149.0Known Strategic Initiatives 130.0Total Capital Investment $872.3

Funding of Minimum Cash Position 1,157.2 New Debt (Net Proceeds) 100.0 (End Balance, 225 days cash)

Pension Funding 50.0

Principal Payments on Existing Debt: 32.2 Monetization, Philanthropy, Other 100.0

Working Capital (estimated) 10.0

Total Capital Uses $2,121.6 $1,090.5

$1,031.2 ($206.2 annually)

2013 ACTUAL: $153.32012 ACTUAL: $91.52011 ACTUAL: $219.02010 ACTUAL: $178.1

Sources of Cash

Total Capital Sources

Cumulative 5-year Cash Flow Requirement :

Historical Cash Flow:

The Capital Position Analysis Creates the Framework Against Which to Quantify the Need for Change


Metric XYZ

2013

XYZ Budget

2014 ‘A3’

Medians XYZ

Targets

XYZ Minimum Threshold

Days Cash on Hand 185.0 185.7 175.9 200.0 175.0

Operating Margin -3.1% 0.0% 1.6% 5.0% 2.0%

Operating EBIDA Margin 5.1% 7.6% 10.0% 12.0% 10.0%

Debt Service Coverage 4.3x 6.2x 4.2x 4.5x 3.5x

Debt to Capitalization 31.7% 30.7% 41.0% 35.0% 45.0%

Cash to Debt 179.7% 181.5% 112.7% 150.0% 110.0%

Capital Expenditure Ratio 120.1% 133.0% 113.6% 120.0% 100.0%

Specific Operating and Balance Sheet Targets Provide a Strategic Financial Context Against Which to Evaluate Projected Futures


A Realistic Baseline Financial Projection Provides the Foundation for Targeted Internal and External

Strategy Development


Developing Baseline Projections in Uncertain Times Requires Rigor and Structure

• Defined operational performance targets provide the required quantitative framework

• Objective, conservative baseline assumptions are key Need to depict the organization’s financial trajectory absent

management interventions The resulting “gap” quantifies the required return from strategic

initiatives

• Identify what is known and not known

• “Status quo” assumptions are no longer valid Pressures on I/P, O/P volumes and utilization should be included Reimbursement changes are not speculation anymore


Most Organizations Are Concluding That “Status Quo” Is No Longer Their Baseline

• This paradigm increases both the level of analysis required to understand the current trajectory, and the significance of strategic decisions and implementation to the organization’s long-term prognosis

Perf

orm

ance

Baseline

Range of Strategic Potential

Status Quo

Time


Setting Assumptions for the Revenue Side of the Equation

• Baseline revenue must be a key focus area: Understanding of the organization’s current market position is critical Local, state and national use rate trends should be assessed and

incorporated Revenue increases/decreases specified by payer – ties to quality metrics

applied

• Sensitizing the Baseline requires understanding the impacts of: Slowing in Medicare rate increases Larger Medicaid population or lack of Medicaid expansion Changes in payer mix from public and private exchanges High deductible Health Plans Impact on Bad Debt and Uncompensated Care as a result of the

aforementioned


(15%)

(10%)

(5%)

0%

5%

10%

15%

Min

neso

ta

Sout

h Ca

rolin

a

Wisc

onsin

Iowa

Mar

yland

Penn

sylva

nia

New

Jers

ey

Kent

ucky

Colo

rado

Illino

is

Miss

ouri

Oreg

on

Calif

orni

a

New

York

Verm

ont

Arizo

na

Florid

a

2006-2011 Change in Inpatient Use Rates For States in Sample

29% of sample states experienced use rate declines between 0 and 5%

71% of sample states experienced use rate declines greater than 5%

Source: US Census Bureau 2006-2011 Population Estimates; HCUP State Inpatient Databases , Agency for Healthcare Research and Quality (AHRQ), Pennsylvania Health Care Cost Containment Council data set used for Pennsylvania; Illinois Department of Health and Human Services data set used for Illinois. AHCA data set used for Florida.

Downward Pressure on Utilization Exists and Must be Part of the Baseline Equation – All Markets are at Risk


The New Math: Holding Price Constant and Meeting Quality Targets

Price Fee-for-Service Unit of Service

(Volume and Mix) Revenues

Price Shared Savings

Unit of Service (Volume and Mix)

Revenues Savings (Efficiency/ Quality)

Price Shared Savings

and Loss Unit of Service (Volume and Mix)

Revenues

Savings/ Loss

(Efficiency/ Quality)

$ per Member per Month Capitation Members Margin Cost

(Volume and Mix)

• Increase volumes and mix to leverage fixed expenses resulting in higher profits

• Decrease volume (efficiency), reduce variable expenses, offset lower revenues with share of savings generated

• Savings dependent on ability to control volume and mix

• Decrease volume (efficiency), reduce variable expenses, offset lower revenues with share of savings generated

• Savings or loss dependent on ability to control volume and mix

• Introduction of risk – inability to lower cost of providing care results in paying back reimbursement to payers

• Fixed revenues to pay for cost of providing care

• Highest level of risk – higher utilization and higher mix results in lower profits/ higher losses

---------------------------------------------------------------------------------------------------------


Setting Assumptions for the Expense Side of the Equation

• Identifies level of ongoing cost management necessary to maintain competitive financial performance

• Understand impacts of: Physician integration costs Rising benefit costs Impact of increased use of pharmaceuticals Unfunded Pension costs


Baseline Assumptions – Evaluate the “Risk Profile” Created

Conservative Aggressive Moderate

Salary Expense • Grown at +3.0% annually

Reimbursement - Commercial Payers • +3-+5% annual growth

Volumes • IP volume declines FY14-15: 2.3%, FY16-17: 1.6% • OP weighted average annual growth of .8%

Investment Income • +4.0% annual return

Reimbursement – Medicare • Annual inflation averages 1.1%

Capital Spending • $750M over 5-years

Non-Salary Expenses • Grown at an average of ~+3.0% annually

Reimbursement – Medicaid • Annual inflation averages -2%


Moody's (A) S&P (A) Fitch (A)

"A3" "A-" "A-" 2013 2014 2015 2016 2017

Net Patient Service Revenue $428.7 $892.7 --- $1,987.8 $2,020.3 $2,096.5 $2,222.8 $2,351.4Operating Income $9.4 --- --- $115.5 $52.5 ($1.2) ($29.3) ($55.1)Operating EBIDA $42.2 --- --- $247.5 $212.1 $173.1 $158.3 $142.7Cash Flow (Net Inc + Depr) $46.6 --- --- $248.0 $212.6 $173.6 $158.8 $143.2Unrestricted Cash $179.2 $343.1 --- $727.7 $724.9 $716.9 $706.9 $689.9Total Debt $161.2 --- --- $498.4 $472.5 $448.5 $420.3 $380.4Capital Expenditures $30.8 --- --- $237.0 $165.7 $134.3 $116.8 $97.6

ProfitabilityOperating Margin 2.4% 1.4% 2.0% 5.2% 2.2% (0.0%) (1.1%) (1.9%)Operating EBIDA Margin 9.2% 8.4% 8.5% 11.1% 9.0% 6.9% 5.9% 4.9%

Debt PositionMADS Coverage (x) 4.3 --- --- 4.1 3.6 2.9 2.7 2.4Debt to Capitalization 40.5% 61.7% 48.8% 33.2% 31.0% 30.0% 29.3% 28.5%

LiquidityCash to Total Debt 104.0% 76.7% 87.4% 146.0% 153.4% 159.8% 168.2% 181.4%Days Cash on Hand (days) 168.5 171.8 152.1 132.1 122.7 111.8 101.1 90.9

OtherAverage Age of Plant 10.6 10.8 10.9 9.2 9.7 10.0 10.2 10.5Capital Spending Ratio 120.0% 103.0% 138.9% 216.4% 120.3% 87.8% 69.9% 54.7%

Ratio / StatisticFiscal Year Ended December 31,

Resulting Baseline Projections – Present for Impact, Not Detail ($ millions)

Note(A): Based on Moody’s, S&P and Fitch August 2012 Not-for-Profit Health System Medians.

These baseline financial projections depict significant deterioration in profitability as well as liquidity


Strategic Analytics Must Quantify Initiatives to Fill the “Gap” Identified by the Baseline Projections


Internal Strategies First – Identification of Sustainable Transformation Requires Comprehensive Evaluation

Physician Enterprise

Clinical Practice

Variation

Business Restructuring

Merger Integration

Strategic Cost Management

Strategic Transformation



Strategic Cost Management is a Given – A Sustainable Performance Improvement Process is the Goal


Labor Cost

Productivity and Overhead

Excess Capacity

Cost Flying Below the Radar

Non-Labor Cost

Product Use/ Standardization

Pricing and Contracting

Processes and Infrastructure

The cornerstone to effective cost management is the establishment of specific, strategy-based targets


The First Level of Strategic Analytics Should Include Cost Restructuring and Strategic Repositioning Initiatives

• Traditional Cost Management Initiatives Labor and Non labor

• Facilities Planning and IT Initiatives Convert unneeded capacity to new functions Investments required to improve efficiencies

• Business/service line rationalization • Potential Partnership synergies

Integration of service delivery Risk sharing and management Physician engagement Primary care network development IT connectivity and platform development


Quantifying Broader Strategies Will Be Necessary to Project Sustainable Transformation

• Physician Enterprise Compensation and productivity Medical director/hospital-based contracts Provider structure (mid-level practitioners and hospitalists)

• Clinical Practice Variation Identify, understand levers, engage leadership, define changes

• Business Restructuring Businesses/services offered Service Distribution Capital Allocation Organizational simplification


Quantifying Impacts of Changing Payment Models is the Next-Level Analytic Challenge


Conversion From Fee-for-Service to Value-Based Contracts

Tomorrow

No risk

FFS Incentive

-Based FFS

P4P Case Rates

Partial Risk

Full Risk

Health Plan

• VBP • Bonuses • Withholds

• Episodic • Bundled

payments

• Limited scope

• Gain-share

• MSSP

• PMPM • Percent of

premium

• Full integration

• Health plan and delivery system

• Quality and cost payments

• PQRS

Today

“When 30 percent of your business is in a non-fee-for-service model, your structure starts to change.”

Stephen M. Shortell, Ph.D., M.P.H.

Sources: (graphic) UnitedHealthcare: Value-based Contracting and Accountable Care Organizations. www.uhc.com/live/uhc_com/Assets/Documents/ViewpointACO.pdf. (quote) Dr. Shortell, as quoted in Thomas Lee, M.D.: Massachusetts Health Care Reform: An Academic Provider’s Perspective. Health Affairs Blog, Aug. 13, 2012.

Small % of financial risk Moderate % of financial risk Large % of financial risk


Key Drivers of the Incremental Financial Impact of Managing Defined Populations Under Shared Savings Arrangements

Reduced Utilization

Market Capture

Opportunity

Shared Savings

Lost Contribution Margin (CM)

Shared Savings Revenue

1 2 3

Driver

Gained Contribution Margin (CM)

Financial Impact


Scenario/Sensitivity Checklist related to Payment and Health Reform

• Medicare payment rates – Market basket factor – DSH – GME payments – Penalties

• Medicaid Payment Rates • Annual commercial insurance rate

increases • Inclusion/exclusion from narrow

networks

• Impact of Medicaid expansion

• Impact of private exchanges on Payer mix

• Impact of public exchanges on payer mix

• Increase/decrease in bad debts and uncompensated care (expanded coverage but higher co-pays and deductibles)


Strategic Financial Projections


Sample Strategic Financial Projections – Presenting the Key Credit Ratios ($ millions)

Note(A): Based on Moody’s, S&P and Fitch August 2012 Not-for-Profit Health System Medians.

Moody's (A) S&P (A) Fitch (A)

"A3" "A-" "A-" 2013 2014 2015 2016 2017

Net Patient Service Revenue $428.7 $892.7 --- $1,979.9 $2,067.5 $2,201.8 $2,387.3 $2,577.6Operating Income $9.4 --- --- $145.5 $97.9 $79.0 $90.7 $105.6Operating EBIDA $42.2 --- --- $276.2 $255.5 $250.7 $275.1 $299.6Cash Flow (Net Inc + Depr) $46.6 --- --- $310.6 $291.9 $289.1 $316.1 $343.2Unrestricted Cash $179.2 $343.1 --- $769.7 $839.6 $930.8 $1,053.8 $1,203.2Total Debt $161.2 --- --- $498.4 $472.5 $448.5 $420.3 $380.4Capital Expenditures $30.8 --- --- $249.8 $176.5 $145.4 $128.3 $109.7

ProfitabilityOperating Margin 2.4% 1.4% 2.0% 6.8% 4.4% 3.4% 3.6% 3.9%Operating EBIDA Margin 9.2% 8.4% 8.5% 12.9% 11.5% 10.7% 10.8% 11.0%

Debt PositionMADS Coverage (x) 4.3 --- --- 5.2 4.9 4.8 5.3 5.7Debt to Capitalization 40.5% 61.7% 48.8% 32.0% 28.6% 26.0% 23.3% 20.2%

LiquidityCash to Total Debt 104.0% 76.7% 87.4% 154.5% 177.7% 207.5% 250.8% 316.3%Days Cash on Hand (days) 168.5 171.8 152.1 149.4 154.0 160.0 168.5 179.5

OtherCapital Spending Ratio 120.0% 103.0% 138.9% 230.8% 130.0% 96.6% 78.2% 62.8%

Ratio / StatisticFiscal Year Ended December 31,


$299.6 $295.3

$266.5

$228.6

$158.9

$299.6

11.0% 10.8%

9.9%

8.4%

6.6%

11.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

$0

$50

$100

$150

$200

$250

$300

$350

FY17 Final Plan 1% Lower AnnualMedicaid Increase

1% Lower AnnualCommercial

Increase

Salary InflationRemains at 3%

Flat Market Share 50% PlannedCapital Spending

FY17 Operating EBIDA M

argin

FY17

Ope

ratin

g EB

IDA

($ m

illio

ns)

Resulting Operating EBIDA Resulting Operating EBIDA Margin

Focus on Key Risk Variables and Sensitivity Analysis Results: What are Our Most “Vulnerable Variables”?

FY2017 Days Cash on Hand: 177.6 164.5 144.5 137.6 214.0 179.5

Note(A): All sensitivities are calculated independent of each other.


Concluding Thoughts


Traditional Financial and Capital Planning Still Makes Sense in the Face of a Changing Business Model

• Current industry stresses demand rigorous, comprehensive financial planning Quantification of strategic initiatives Objective definition of operating assumptions Establishment of specific Board- and management-level success metrics Integration of metrics into the annual operating budget process

• Risk and sensitivity analyses are vital to validating affordability of the plan Ability to access required external capital (understanding scenarios) Understanding variability of the plan results Definition of proactive management responses to industry/market changes


Strategic Financial Planning Must Ask, and Answer, Critical Questions

1. What must we do to ensure we remain “relevant” in our local healthcare market? Can we stand alone in the new business model? Are we “big enough” to handle the intellectual demands of reform and the new business model?

2. Do we have a carefully constructed physician alignment strategy that will meet reform era requirements?

3. Do we have the required infrastructure and culture to effectively manage cost and utilization? Are we making a “real” effort to bend the cost curve?

4. Do we have a quality initiative that recognizes the principles of care coordination, evidence-based medicine and comparative effectiveness?

5. At what level of risk are we able to participate now and at what level do we want to participate in the future?

6. Is our existing portfolio of services and locations the right portfolio for changing competitive conditions?


Presenter Resume Brian Kelly, Executive Vice President and CFO Excela Health Brian Kelly is the Executive Vice President and Chief Financial Officer for Excela Health in Greensburg, PA where he is responsible for oversight of the organization’s accounting , patient financial services, treasury and finance functions. A key aspect of his role is to support the organization’s strategic decision making process by providing insight and guidance on the financial impact of operational and strategic decisions the organization is contemplating so as to establish a fiscally sound roadmap that aligns the organization’s operational and financial goals. Prior to Excela Health, Mr. Kelly was Senior Vice President of Kaufman Hall in the firm’s Strategic Financial and Capital Planning practice. Preceding his work at Kaufman Hall, Mr. Kelly held positions at the University of Pittsburgh Medical Center, Arthur Andersen and Huron Consulting Group. His career has focused on the development of financial, strategic, and capital plans, assessing joint venture, partnership, and affiliation options, advising on merger, acquisition, and divestiture transactions, as well as performing both operational turnarounds and financial restructurings. Mr. Kelly has been a regular speaker at healthcare industry conferences, including those sponsored by the Healthcare Financial Management Association (HFMA) and state hospital associations. He has presented on numerous topics ranging from the changing healthcare industry to the challenges of financial planning in distressed economic environments. Mr. Kelly also has been a contributing author for several industry thought leadership pieces in publications including HFMA’s Healthcare Cost Containment, Healthcare Finance Blog, and Strategic Financial Planning. Mr. Kelly holds an M.B.A., with a concentration in Corporate Finance, and a B.S. in Business Administration from Robert Morris University in Pittsburgh.

Contact information: Brian Kelly, Executive Vice President and CFO Excela Health 532 West Pittsburgh Street, Greensburg, PA 15601 724.832.4561 phone [email protected]


Presenter Resume Jason H. Sussman, Managing Director Kaufman, Hall & Associates, Inc.

Jason Sussman directs the firm’s Strategic Financial and Capital Planning practices, and provides planning and financial advisory services for hospitals, healthcare systems, and physician groups. His areas of expertise include strategic financial planning, capital allocation, mergers and acquisitions, and various financing transactions. Prior to joining Kaufman Hall, Mr. Sussman directed the Chicago Capital Finance Group of a national accounting firm’s healthcare consulting practice. Prior to this, Mr. Sussman was the Special Assistant to the President at Michael Reese Hospital and Medical Center in Chicago, responsible for the Certificate of Need and capital budgeting processes. Mr. Sussman is the author of The Healthcare Executive’s Guide to Allocating Capital, which was published in 2007 by Health Administration Press, the publishing arm of the American College of Healthcare Executives (ACHE). In addition, he has authored articles for various industry periodicals, including hfm magazine, Strategic Financial Planning, and others, and was a contributing author to Best Practice Financial Management: Six Key Concepts for Healthcare Leaders, Third Edition and The Financially Competitive Healthcare Organization. Mr. Sussman received a Helen Yerger/L. Vann Seawell Best Article Award from the Healthcare Financial Management Association (HFMA) for “Ensuring Affordability of Your Hospital’s Strategies.” He co-authored this article, which appeared in the May 2009 issue of hfm magazine. Mr. Sussman is a frequent presenter at national and regional seminars sponsored by the HFMA and its chapters, ACHE, the American Hospital Association, numerous state hospital associations, the National Association of Children’s Hospitals and Related Institutions, and other industry organizations. Mr. Sussman received an M.B.A. in Finance and Accounting with a specialization in Healthcare Management from Northwestern University's J.L. Kellogg Graduate School of Management and a B.A. from the Johns Hopkins University. He holds a CPA certificate in Illinois, is a member of the First Illinois chapter of HFMA, and of the ACHE.

Contact information: Jason H. Sussman, Managing Director Kaufman, Hall & Associates, Inc. 5202 Old Orchard Road, Suite 700N, Skokie, Illinois 60077 847.441.8780, ext. 105 | 847. 441.2505 fax [email protected]

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