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University Hospital is a regional leader in the very intense and medically




University Hospital is a regional leader in the very intense and medically;sophisticated area of organ transplants. Mark Lewis, the director of the;Transplant Center, has been with the Hospital for ten years. When Mark joined;the Hospital he was put in charge of a kidney and heart transplant program;that was averaged 50 transplants per year. Today, the Transplant Center;performs over 200 transplants annually, including transplants from the newly;initiated liver, lung, and pancreas programs.;The liver transplant program is the most successful of all organ programs in;terms of volume and revenues. Last year, volume totaled 100 transplants, and;this year Mark is optimistic that the liver program can do even better.;However, he knows that increased volume is largely dependent on the number of;organ donors and his success in negotiating a new contract with the;Transplant Management Corporation (TMC), the largest transplant-benefits;company in the nation.;Because transplants are relatively rare in comparison with other, more;conventional medical treatments, only the largest health insurers have the;expertise to manage transplant services. However, the costs to insurers for;transplant services are typically very large?usually in the six-to-sevenfigure;range. To ensure the best and most cost-effective management of;transplant;services, most health insurers outsource transplant management to;companies;such as TMC, that specialize in these services.;Contracting;for transplant services is unique and complex because of the;sophistication of the medical procedures involved. Transplant services;consist of five phases: (1) patient evaluation, (2) patient care while;awaiting surgery, (3) organ procurement, (4) surgery and the attendant;inpatient stay, and (5) one year of follow-up visits. The costs involved in;Phase 1 are relatively simple to estimate, but the remaining phases can be;extremely variable in terms of resource utilization, and hence costs, because;of differences in patient acuity and surgical outcomes.;Historically, reimbursement for transplant services has been handled in a;number of different ways. Initially, many providers bundled all five phases;together and offered insurers a single, global rate. Although this method;simplified the contracting process, the rate set was often chosen more on the;1;basis of building market share than on covering costs. Indeed, many providers;could not even estimate with any confidence the true costs of providing;transplant services.;Somewhat ironically, success in gaining market share usually increases the;financial risk of the transplant program because higher volumes increase the;likelihood of higher acuity patients. Although the total costs associated;with all phases of a liver transplant average about $400,000, the amount can;more than quadruple if the patient requires a re-transplant or if other;complications occur. Because of this extreme variability in costs, outlier;protection is a critical aspect of contract negotiations if the reimbursement;methodology is a fixed prospective rate.;Thus far, several elements of the proposed contract with TMC have been;finalized. Specifically, Phases 1, 2, and 5 will be reimbursed at a set;discount from charges. Furthermore, to reduce the amount of financial risk;borne by University Hospital, Phase 3 (organ procurement) will be reimbursed;on a cost basis. This makes sense because the cost of Phase 3 is almost;completely uncontrollable by the Center. In general, Phase 4 costs are;divided into two categories: hospital costs and physician costs. Physician;costs have already been agreed on, so what needs to be hammered out (and the;make-or-break part of the contract) is the hospital reimbursement amount for;Phase 4.;The key to a sound negotiation with TMC is to identify relevant costs. Mark;plans to be aggressive in pricing these services, because he wants the;contract. He feels that the additional volume will lower per transplant cost;and hence increase the Center?s profitability. Still, he wants to set a price;that does not degrade the current profitability of the Center, which is good;but not spectacular.;To help with the decision, Mark compiled the Phase 4 hospital costs of 12;recent liver transplant patients. In reviewing these data, shown in Table 1;Mark noted that a total average cost of $119,805 for 19 days average length;of stay translates to a staggering per diem (per day) average cost of over;$6,000.;Mark is convinced that a price close to $120,000, which would cover total;costs, would not be acceptable to TMC. So, he examined the possibility of;lowering costs by reducing the average length of stay (LOS). However, the;costs associated with Phase 4 are not a linear function of LOS. The first day;of Phase 4 is usually the most costly while the last day is usually the least;costly. Indeed, over half of Phase 4 costs occur in the first 24 hours of;hospitalization.;2;Because it would be difficult to lower Phase 4 hospital costs by reducing;LOS, Mark decided to pursue a different strategy. His experience at the;Transplant Center has convinced him that there are economies of scale present;in liver transplants, and hence the marginal cost of each transplant is lower;than the average cost. Thus, Mark believes that he can base the contract;price on marginal costs rather than total (full) costs. Such a rate would;(hopefully) be attractive to TMC yet, at the same time, preserve the Center?s;profitability.;Assume that you have been hired as a consultant to recommend a fixed price;(the base rate) that should be proposed in the contract negotiations for;Phase 4 hospital services. To help in the analysis, Mark has indicated that;approximately 60 percent of nursing, ancillary, operating room, and;laboratory costs are fixed. The remaining costs--radiology, drug, and other;services--are predominantly variable.;TABLE 1;University Transplant Center;Phase 4 Hospital Costs;Total Nursing Ancillary OR Lab Radiology Drug Other;Patient Age LOS Costs Cost Cost Cost Cost Cost Cost Costs;A 61 25 $141,092 $10,261 $65,416 $6,770 $13,712 $1,483 $20,992 $22,458;B 56 15 139,306 11,969 63,668 8,501 7,409 2,261 24,504 20,994;C 42 12 74,259 6,939 33,661 3,128 5,279 668 6,964 17,620;D 52 13 115,349 7,221 54,063 5,779 6,112 903 7,638 33,633;E 12 26 172,613 28,205 72,204 6,847 10,550 1,766 23,061 29,980;F 59 22 83,807 16,858 33,474 4,654 6,211 1,397 9,698 11,515;G 41 25 136,060 9,645 63,208 6,489 13,091 1,382 20,127 22,118;H 35 17 139,308 11,969 63,669 8,501 7,409 2,261 24,505 20,994;I 52 12 74,259 6,939 33,660 3,128 5,280 668 6,964 17,620;J 38 13 115,348 7,221 54,063 5,778 6,111 903 7,639 33,633;K 59 25 166,224 26,909 69,657 6,765 10,061 1,677 22,007 29,148;L 60 21 80,034 15,629 32,202 4,531 5,937 1,293 9,122 11,320;Average 47 19 $119,805 $13,314 $53,245 $5,906 $8,097 $1,389 $15,268 $22,586;3;QUESTIONS;1. What is the estimate of the marginal cost of the Phase 4 hospital services;assuming, as given in the case, that 60 percent of the designated costs;are fixed and the remaining costs are variable?;2. Assume that the agreed-upon price is $90,000. What is the expected profit;on the contract assuming that it brings in 20 new patients? (Assume for;now that no new fixed costs would be required.);3. Now assume that the additional patients will add $200,000 in total to the;Center?s fixed costs. Now what is the expected profit on 20 new patients?;On 40 new patients? (No new fixed costs are required to support the second;group of 20 patients.);4. What role do the following factors play in the decision as to whether or;not to use marginal cost pricing on the new contract?;a. Reimbursement amounts paid by current transplant third-party payers.;b. The amount of excess capacity in the transplant unit.;c. The potential reaction by current payers to a new, lower price;contract.;5. What is your final recommendation regarding the base rate for Phase 4;hospital services that should be built into the contract?;6. Should you worry only about the contract?s first year pricing, or should;you develop a long-term pricing strategy for TMC? What are some possible;features of a long-term pricing strategy?;7. Briefly describe how outlier payments might be handled to ensure that the;Center does not suffer large losses on outliers (patients with unusually;high costs). (Hint: Cost outliers are identified by having costs that;exceed a specified threshold. Then, in addition to the standard payment;the provider is reimbursement for some percentage of the costs above the;threshold. For this question, you must choose a cost threshold and outlier;payment percentage.);4


Paper#30322 | Written in 18-Jul-2015

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