The Peter G. Peterson Foundation reports that the U.S. allocates significantly more funds to fee-for-service healthcare than any other nation, nearly double the amount. Operating under a fee-for-service model incentivizes increased service volume over quality, which frequently results in excessive use of unnecessary treatments, labs and prescriptions.

Moreover, the same report states that administrative expenses associated with managing healthcare in America are four times more than those in other affluent countries. These costs include processes such as preauthorization, claim denials, assessment of medical necessity and dealing with multiple payers.

Top issues plaguing healthcare CEOs and CFOs

These issues have long plagued executives, but to make matters worse, the COVID-19 pandemic exacerbated challenges, and the following issues have persisted:

• Increased medication needs and supply costs. The post-COVID-19 environment requires hospitals to have a more extensive inventory as supply chains remain disrupted.
• Increased payroll and contract labor. Labor is costly, representing 50% to 60% of net patient service revenue, according to a May 2024 report from the American Hospital Association.¹
• Capped and shrinking reimbursements. Insurance providers are placing caps on services, and Medicare is increasingly bundling various services. This shift means that pricing can no longer be relied upon to adjust profit margins, as was previously possible.

Considering these issues, the U.S. healthcare system must focus on managing expenses and controlling costs, since fees and reimbursements are hard to change.

The value creation framework and the importance of healthcare data

A value creation framework, a process improvement methodology, addresses improving margins, boosting quality and eliminating waste by implementing best practices, employing data and analytics and adopting a new culture.

Creating a value creation framework involves the following initial steps:

• Quantify ideal process potential gains.
• Identify the root cause of process challenges and pains.
• Re-design and improve processes.

Data and analytics play a critical role in this process improvement methodology. Health systems must capture the correct and relevant data about their processes to employ the value creation framework and ensure that this data is broadly accessible.

Tackling charge capture leakage: a cost-containment missing link

Inconsistent data can lead to revenue leaks that drain resources. For example, capturing charge master data has become a critical priority, as charge capture leakage in healthcare hovers around 1% nationally.²

Despite automation-driven improvements, charge capture processes still occur within silos, continuing the charge loss phenomenon that degrades hospital margins. Failing to secure potential reimbursements leads to a decline in revenue, while incurred expenses diminish profit margins related to costs and charges. 

Consequently, healthcare organizations must proactively oversee charges before claim submission and prevent complications linked with charge leakage and delayed billing. Achieving this necessitates moving past simple charge reconciliation toward a more comprehensive, data-oriented approach that leverages appropriate technologies.

Traditional cost management methods fail to meet complex needs

The issue of charge capture management is just one example of why healthcare systems need a much more effective and comprehensive cost management system.

The cost-to-charge ratio (CCR) and relative value units (RVU) have long been used in healthcare to estimate costs. However, both methods have significant limitations:

• CCR calculates costs by applying a standard ratio to charges, which often fails to account for the complexity and variability of healthcare services beyond the limitations of charge codes.
• RVU assigns relative weights to services based on the required resources, such as physician work, practice expense and malpractice insurance. While RVU can offer more granularity than CCR, they still lack the ability needed to capture the true cost of care since patients with the same billing or RVU data will look the same.

Without a reliable understanding of what it costs to provide patient care, health systems continue to struggle to agree on basic information about their services, such as their relative profitability.

The shift to activity-based costing (ABC) to gauge the true costs of patient care

Activity-based costing (ABC) offers a more accurate and comprehensive approach to understanding the true costs of service delivery by tracing costs to specific activities and resources used in patient care. ABC leverages detailed data, often collected through electronic medical records (EMRs), allowing for precise cost assessment and allocation.

Health systems have observed the following advantages of using the ABC approach:

1. Granular cost tracking: ABC can distinguish between different levels of resource use for patients.
2. Detailed analysis: ABC allows for detailed analysis at various levels, including provider, service line or patient care path.
3. Informed decision-making: ABC provides a more nuanced understanding of the true costs of care.

Leveraging healthcare data for value-based care, cost management

The ability to capture and analyze data is crucial for implementing value-based pricing models. Health systems need data sets that give them the granularity and specificity required to make decisions, but that can also scale so leaders can view these data sets at a high level.

Advanced technologies allow providers and executives to examine any procedure or group of procedures across providers and to see payment variability to determine which procedures best support the organization’s bottom line.

Moving the needle on value-based care through improved cost management methods

The transition from volume to value in healthcare requires more than just a change in payment models; it demands a fundamental shift in how costs are understood and managed. 

By leveraging detailed information from EMRs and focusing on the actual costs of delivering care, health systems can make data-driven decisions, reduce waste and optimize the use of resources, leading to improved margins and a more manageable shift to value-based care.

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References

1. American Hospital Association. May 2024. Costs of caring. https://www.aha.org/costsofcaring.
2. Johnson, H. and Ward, D. August 23, 2017. Avoiding the High Cost of High-Capture Leakage. Healthcare Financial Management Association (HFMA). https://www.hfma.org/revenue-cycle/charge-capture/55358/.