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    Timothy Smith, CPA, ABV

    Series: Examining Losses in Health System Physician Practices

    In this series, we’ve been focusing on the issue of losses in health system-owned physician practices and why health systems uniquely incur losses in comparison to other owner/operators in the industry. It’s important to remember that losses are the result of a simple formula: Revenues less expenses. The prior article examined how certain strategic and operational decisions by health systems can negatively impact practice revenues. In the next couple of articles, we’ll be focusing on how similar considerations affect practice expenses.

    Physician practice expenses can be broken down into two main categories: operating expenses and physician cost (physician compensation and benefits). This article will examine how practice operating expenses can contribute to losses in health system practices.

    When practice operations and resource usage are not optimized and economically efficient, practice losses can occur. In such cases, the operating expenses are higher than they otherwise could be, and therefore, they can either cause practice losses or contribute to such losses. When examining the issue of losses for health system practices, one needs to assess whether the practices are fully optimized and efficient in terms of their operations.

    The question of inefficiency, however, may not be so straightforward. Is the inefficiency simply a result of poor management practices? Or, does it relate to operational and strategic decisions made by the health system to benefit the system, but are detrimental to practice net earnings? For example, are the locations for the practice based on maximizing practice net earnings or on facilitating the larger goals of the health system? To evaluate practice losses, health systems will need to sort out the various reasons why practice operations are not as efficient as they could be.

    A larger question—and one that seems to have gained traction in recent years—is whether health systems simply have higher operating costs as a structural or organizational matter in comparison to other types of owner/operators. If health systems do, then one could expect these higher operating costs to contribute to practice losses.

    One structural issue that does seem to account for higher health-system practice costs is the size effect. Many smaller physician practices have lower salary and benefits costs for support staff because they can fill positions while paying at the lower end of market wages. Larger organizations, however, have to keep parity across the company for comparable positions. Since they have a large number of comparable positions to fill, they often have to pay at higher wage rates to ensure an adequate workforce.

    For similar reasons, benefits offered in small practices may be lower than those normally offered by larger employers. Since salary and benefits costs are one of the largest line items in the operating expenses of a typical practice, these differences can add up to significantly higher costs.
    This size effect, however, may not apply to comparisons with larger physician-owned groups or those owned by private equity. Large groups face the same issues related to offering competitive salaries and benefits for a significant number of employees.

    Another contributor to higher costs for health system practices may be the move away from physician compensation plans that are tied to net practice earnings in favor of those based on compensation-per-wRVU rates. In these plans, physicians often have no “skin in the game” in terms of practice expenses. Their financial incentives are often geared towards wRVU production without regard to the cost of practice resources needed to generate the wRVUs.

    Consequently, physicians are not incentivized to focus on managing costs as part of their job. In fact, some may request staffing and other operational changes that increase their personal productivity, while also increasing practice costs. A prime example is using advance practice clinicians (APCs) to perform shared encounters/visits that increase the physician’s wRVUs. If the physician’s compensation plan does not charge the physician for this additional staffing, the practice gets a double whammy of higher cost: increased physician compensation and higher staffing expense.

    The idea of higher operating costs for health system practices may also raise questions about how health systems do cost accounting for corporate shared services. Is the higher cost associated with operating a hospital being allocated out to nonhospital service lines, thereby inflating their costs? Perhaps re-examining the cost allocation methods used for corporate services might yield a different picture of operating costs for health system practices. Alternatively, health systems could obtain market bids for the equivalent corporate services provided to their practices and only charge the practices at market rates for the services.

    Whether health systems do, in fact, have higher operating costs as an organizational and structural matter is a question for further study. More data-driven and evidenced-based economic modeling needs to be completed to examine this question fully. As the issue of practice losses continues to gain visibility in the industry, one can expect that more attention will be given to this question in the future.

    In the next installment for this series, we’ll discuss how intercompany accounting practices for hospital-related services provided by employed physicians is another contributor to practice losses.

    Click the following to read previous articles in the series:

    Physician practice losses: A tale of two owners

    Physician practice losses: Why physician-owned practices break even or make a profit

    Physician practice losses: Why losses are typical in health system practices

    Physician practice losses: Losses from revenue issues in health system practices


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