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    Timothy Smith, CPA, ABV

    Series: Examining Losses in Health System Physician Practices

    As we discussed in the prior installment of this series, health systems may not operate physician practices with a singular focus on practice net earnings. Frequently, they operate their practices as one resource within a larger continuum of services comprising an integrated delivery system (“IDS”). This operational perspective, however, can often depress physician practice net earnings.

    In this article, we'll examine how certain strategic and operational decisions by health systems can negatively impact the bottom-line of a physician practice in terms of revenue generation. While these decisions may serve the overall organization or IDS, they frequently do not maximize revenues for the health system’s physician practices and may even serve to reduce or restrict growth in these revenues.

    There are four key areas where health system strategic choices can result in reduced or sub-optimized revenues for a physician practice. In each of these areas, operational decisions are made that may favor the health system, while resulting in economically negative consequences for the system’s practices.
    The first area relates to clinic locations. A health system may locate a clinic in a new market or a service area with low patient volumes as part of its strategic plans for system growth and expansion. Examples include the following:

    • Placing a physician in a new market where the health system currently does not have a presence. Doing so often requires a “ramp-up” period in which the physician needs to build a new patient base and/or new referral relationships with other physicians in the community. Low volumes are commonly experienced during this ramp-up phase, and the phase may last for a significant period.

    • Creating outreach clinics in smaller markets surrounding a hospital’s or health system’s primary service area to develop new revenue sources for the system. Outreach clinics may also further the system’s mission to meet community need. Yet, the patient volumes may be too low in these service areas to generate levels of practice revenue that cover cost of the clinic.

    Another area is revenue cycle management. Many health systems fail to develop the organizational acumen needed to do billing and collections well. Often, the desire to have a centralized billing/collection function creates a corporate bureaucracy that simply does a bad job at revenue cycle. Worse yet, some health systems may use hospital reimbursement departments to do the billing and collections for their practices, failing to appreciate the complexity in physician revenue cycle management. As a result, many health systems struggle year-after-year with poor collection outcomes.

    Failing to negotiate the best possible commercial payer rates for the physician enterprise is another area that can depress physician practice revenues. Some health systems focus their managed care contracting efforts on obtaining higher commercial payer rates for hospital inpatient and outpatient services. Similar efforts, however, are not made on behalf of their physician practices. In some cases, health systems may even agree to lower physician rates in order to maximize those on the hospital side.

    The fourth area relates to the types of payers from which health system practices will accept patients. A health system’s charitable purpose or IDS growth plans may require that its practices take patients with low paying (or no) insurance, such as Medicaid, self-pay, or charity patients. This requirement is frequently in the form of taking higher proportions of such patients than would otherwise be optimal for the net earnings of the practice or than is needed given patient populations in the local service market. When this happens, practice revenues are generally reduced, even while operating expenses and physician productivity (and thus physician compensation) remain high.

    Indeed, a commonly heard response from many tax-exempt health systems is that their practice losses result from a payer mix that is “mission-driven,” i.e., includes high levels of charity care, self-pay and Medicaid. This payer mix results from the health system serving community need and taking in patients regardless of insurance. Because they are open to patients with low-paying insurance (or no insurance), their physician practices do not collect sufficient amounts to cover practice costs, including physician compensation. In such situations, the physicians are said to have a payer mix that is not of their choosing, but rather is a function of the health system’s charitable purpose.

    These kinds of strategic and operational decisions contrast with how other types of owners would manage their physician practices. Physician-owned practices, as well as those owned by private equity or public companies, would typically operate their practices differently in these areas. They would usually seek to maximize the enterprise value of their physician practices rather than to increase earnings for some other organization, such as an IDS. Yet, since health systems have to contend with the same practice costs as other types of owners, health system practices can lose money in the process of simply being a resource input within a larger organization and continuum of services.

    In the next installment of this series, we’ll examine how health system strategic and operational choices can negatively affect the cost structure and overhead levels of a physician practice.

    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


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