Healthcare Economics of Critical Access Hospitals

Abstract

This week’s written assignment sought to identify what critical access hospitals (CAH) are, whether or not they are profitable, barriers to their profitability, and possible alternatives to CAHs. CAHs came into existence following the passage of the 1997 Balanced Budget Act (BBA) with the primary aim of increasing access to care in rural communities. Their distinguishing feature is the use of the cost-based Medicare reimbursement system as opposed to the traditional prospective payment system. The cost-based reimbursement system is where Medicare reimburses hospitals based on costs rather than at a standard flat rate. The subsequent sections of this text demonstrate that CAHs are not operating profitably despite running under the cost-based system. Most of them are operating inefficiently, incurring high costs for serving a relatively small number of patients. This text provides possible reasons for the high costs that characterize CAH and recommends the adoption of community outpatient hospitals as a possible alternative.

Transforming Critical Access Hospitals into Profitable Organizations

Introduction of Topics and Facts as Presented in the Case

This written assignment focused on critical access hospitals (CAH), their costs, and strategies for increasing their profitability. More specifically, the assignment explains what critical access hospitals are, whether or not they are profitable, barriers to their profitability, and possible alternatives to CAHs. CAHs came into existence following the passage of the 1997 Balanced Budget Act (BBA). The Act sought to protect citizens in the rural areas by increasing access to healthcare services. With the passage of the Act, rural hospitals could transform into CAHs, which are characterized by the cost-based Medicare reimbursement as opposed to the Prospective Payment System that sets a standard amount of Medicare reimbursement independent of costs. As per the provisions of the BBA, CAHs have the following fundamental features: they are located in non-metropolitan areas, are non-profit nature, are located at least35 miles away from the next nearest general hospital, have a maximum of 25 beds, and limit patients’ hospital stays to not more than 96 hours.

Sources contend that CAHs are typically not profitable. The immediate effect of conversion was an increase in profitability and improvement in liquidity. However, the operational costs of CAHs have continued to increase, resulting in low margins. Despite using the cost-based system, CAH margins have been low. This is because not all costs are eligible for coverage under the Medicare cost-based system, the only costs eligible for reimbursement are those that relate to Medicare patients, the amount that Medicare reimburses is reduced by the cost-sharing amount the customer covers, and Medicare reimbursement rates have reduced due to sequestration rules. The text hypothesizes that CAHs have high costs because the low patient numbers and few services limit the realization of cost savings due to economies of scale and economies of scope. To minimize costs, the text proposes the adoption of community outpatient hospitals as an alternative to CAHs. These would be structured to serve a larger number of outpatients, without offering inpatient care, which would ensure they serve more patients at a relatively lower cost.

A Summary of the Areas Pertinent to the Course

The case of critical access hospitals’ profitability demonstrates several fundamental concepts covered in the course. The first is the idea of average costs, and inefficiency as presented in chapter 5. In chapter 5, Lee (2019) identifies the different categories of costs, including average costs, the per-case cost obtained by dividing total costs with the level of output. Firms which produce in large quantities are able to enjoy economies of scale and scope from being able to spread their fixed costs over a large and wide product base respectively (Lee, 2019). An example of economies of scale is when a large pharmacy uses the same dispensing machine to serve a larger number of prescriptions. The cost of maintaining and servicing the machine are spread out across a wide product base, resulting in lower per-capita costs (Lee, 2019). The concept of average costs and economies of scale and scope are used in the case to explain why critical access hospitals charge higher healthcare costs than other hospitals (Lee, 2019).

Finally, a moral hazard occurs when one party in a contractual arrangement takes advantage of information asymmetry to benefit themselves to the detriment of the other party (Lee, 2019). The party engaging in the moral hazard enjoys protection and the burden of their actions will be borne by the other party (Lee, 2019). For instance, an insured person engages in a moral hazard if they fail to take proper action to prevent a hazard from occurring because the insurer will bear the burden of loss. The moral hazard concept could come in handy in explaining why critical access hospitals served by the cost-based Medicare system have high costs despite serving low patient numbers.

A Detailed Case Discussion

What is a critical access hospital?

Most hospitals in rural areas were unable to cover their operation costs under Medicare’s Prospective Payment System (PPS) and had to close down (Li, Schneider & Ward, 2009). Li et al. (2009) state that between 1990 and 1997 alone, approximately 150 hospitals closed down due to rising costs and declining revenues. To ensure that citizens in rural areas still had access to care, Congress passed the 1997 Balanced Budget Act (BBA), which sought to protect rural hospitals by transforming them to critical access hospitals (CAHs) (Li et al., 2009). Critical access hospitals are rural hospitals that use the cost-based system of Medicare reimbursement rather than the prospective payment system (Li et al., 2009). Under the cost-based system, Medicare reimbursements are made based on a hospital’s operational costs, as opposed to as a fixed, predetermined amount (Li et al., 2009). According to Li et al. (2009), rural hospitals are able to receive, on average, $850,000 more in Medicare payments as critical care hospitals than they would have received under the PPS.

Under the BBA critical access hospitals are characterized by certain features. First, they are located in non-metropolitan areas, are non-profit nature, and have to be located at least35 miles away from the next nearest general hospital (Li et al., 2009). They have a maximum of 25 beds, among them 15 or fewer acute care beds and limit patients’ hospital stays to not more than 96 hours (Li et al., 2009). The number of allowable acute care beds in critical care hospitals rose to 25 with the passage of the Medicare Modernization Act of 2003 (Li et al., 2003).

2. Are critical access hospitals typically profitable?

Generally, CAHs have higher liquidity and greater ability to meet their debt obligations as a result of the cost-based Medicare reimbursement system (Holmes, Pink & Slifkin, 2006). One of the challenges of the PPS system is that it forced hospitals to lose money on Medicare patients because Medicare only paid a standard reimbursement amount (Holmes et al., 2006). According to Holmes et al. (2006), the immediate effect of conversion was higher profitability, higher liquidity, and greater ability to settle debts for most of the CAHs. In a study measuring the profitability of 747 CAHs, Holmes et al. (2006) found that over 60 percent of CAHs reported an increase in total margins,63 percent reported an improvement in cash flows, and 62 percent reported improved debt coverage in the year immediately following conversion (Holmes et al., 2006).

Sources contend, however, that the profitability of CAHs has been dwindling over the years due to increasing costs (Holmes et al., 2006; Li et al., 2003). According to Li et al. (2003), CAH costs began to grow immediately after conversion, with operating expenses growing by an average of 1.76 percent in the first year, 2.08 percent in the second year, and 4.94 percent in the third year of conversion. A report by Flex Monitoring Group generated from a survey conducted in 2021 showed that on average, CAHs had a net profit margin of 5.41 percent (Flex Monitoring Team, 2022). The net profit margin is an indicator of profitability calculated by dividing the net profits by total revenues (Flex Monitoring Team, 2022). A good net profit margin is at least 20 percent, and hence, a margin of 5.41 percent as generated by the Flex Team could be termed low (Flex Monitoring Team, 2022). The falling profitability is attributable to several factors.

First, despite the increasing costs, not all costs are eligible for coverage under the Medicare cost-based system (Center for Healthcare Quality and Payment Reform., 2021). Not all services offered by CAHs are eligible for cost-based coverage. For instance, ambulatory services are not eligible for cost-based coverage, implying that the hospital gets standard Medicare coverage for the same (Center for Healthcare Quality and Payment Reform., 2021). Further, even for eligible services, not all costs may be covered under the cost-based system (Center for Healthcare Quality and Payment Reform., 2021). For instance, the time spent by a physician waiting for patients is an eligible cost, but the time they spend attending to the patient in the ED is not an eligible cost (Center for Healthcare Quality and Payment Reform., 2021). Thus, an increase in costs does not automatically translate into increased reimbursement for CAHs.

Secondly, the only costs eligible for reimbursement are those that relate to Medicare patients (Center for Healthcare Quality and Payment Reform., 2021). Within each eligible service, Medicare uses a formula to determine the fraction of costs that are charged to Medicare patients (Center for Healthcare Quality and Payment Reform., 2021). Thus, if 5 percent of the services delivered in an eligible service line were administered to Medicare patients, Medicare will only pay 5 percent of the service line’s eligible costs (Center for Healthcare Quality and Payment Reform., 2021). Costs attributable to non-Medicare patients will not be covered, even when the cost of service is higher than their health plan’s payment) Center for Healthcare Quality and Payment Reform., 2021).

Thirdly, the amount that Medicare reimburses is reduced by the cost-sharing amount the customer covers (Center for Healthcare Quality and Payment Reform., 2021). Before Medicare can cover the cost of a service, beneficiaries have to meet a deductible amount and co-insurance for outpatient services (Center for Healthcare Quality and Payment Reform., 2021). Thus, the amount that Medicare eventually pays excludes this cost-sharing amount, which the hospital has to obtain from the patient. Rural hospitals charge a cost of service higher than what Medicare pays, which implies a high cost-sharing amount as well (Center for Healthcare Quality and Payment Reform., 2021). Most Medicare patients in rural areas do not have insurance to cover their part of the cost-sharing. If these patients cannot meet their cost-sharing obligations, Medicare covers only 65 percent of the bad debt and not the full amount (Center for Healthcare Quality and Payment Reform., 2021).

Finally, the amount of Medicare payment has been reduced through sequestration rules (Center for Healthcare Quality and Payment Reform., 2021). The BBA set the Medicare payment at 101 percent of the eligible cost (Center for Healthcare Quality and Payment Reform., 2021). However, this percentage has been reduced by sequestration rules, and hospitals will normally receive only 99 percent of the eligible costs (Center for Healthcare Quality and Payment Reform., 2021).

3a) What is the fundamental barrier to profitability of critical access hospitals?

The fundamental barrier to profitability of critical access hospitals is low patient numbers (Joynt et al., 2011). Patients requiring specialized care may shun critical access hospitals owing to questions surrounding the quality of care. First, critical access hospitals are not required to report to the Hospital Quality Alliance Program or the Joint Commission Performance Measure Program (Joynt et al., 2011). The effect is that there is little data for ascertaining the quality of care offered at these facilities as there is no means to compare their data to national data (Joynt et al., 2011). Furthermore, critical access hospitals have fewer healthcare providers and specialists in their communities than hospitals located in metropolitan areas (Joynt et al., 2011). This, coupled with less access to capital, makes it challenging for critical care hospitals to deliver quality care (Joynt et al., 2011).