At the Margins

Your approach to cost could be costing you narrow network contracts


I was recently talking to the CEO of a regional health system in the Southeast (the largest system in his market) who was shocked to have lost a narrow network bid from the region’s largest payer.

The shock came in part because the health system had just undergone a huge financial improvement effort, which positively impacted the system’s margins by over $100 million. The effort included reducing staffing levels, lowering supply costs, and improving the revenue cycle. You would think that this health system would be well-positioned to win a narrow network contract.

So where did they go wrong? They weren’t looking at cost improvement from the payer’s perspective. They corrected supply and labor costs, as well as revenue. However, the payer’s priorities included utilization and variation in practice, continuum of care resources, and care management capabilities, and none of these priorities were addressed in the $100 million improvement effort.

Costs from the payer's perspective

My colleagues have posted several articles about the different kinds of health care costs to add clarity around the common statement, “the cost of health care is too high.” But with so many different kinds of “costs” in health care, which ones should hospital CFOs work to reduce?

In our rapidly changing industry, we are seeing one cost emerge as a new focus for hospital leaders—the payers’ costs.

This answer might surprise you because what payers consider costs is what hospitals consider revenue. It’s the actual money that commercial insurers, patients, self-funded employers or the government pay to hospitals in exchange for providing care.

With the introduction of the Affordable Care Act’s health insurance exchanges, and the burden that benefits costs places on American companies, there is a heightened demand for less expensive insurance options. Commercial insurers and other payers are aggressively seeking out ways to provide less expensive offerings—including the assembly of narrow networks.

Win market share not once—but twice

From the perspective of the hospital, what is the impact of the introduction of the narrow network? The opportunity is to gain market share, but at a lower reimbursement than traditional commercial rates. By winning a narrow network bid, you will certainly gain market share. However, you will only win a narrow network bid if you are the low-cost partner to the payer that is assembling the network.

It’s not enough for hospitals to reduce the costs they incur and be prepared to accept or negotiate lower rates. Hospitals must prove they can reduce “cost-per-case”—the costs to payers that are associated with individual hospitalizations.

From cost-per-case to competitive advantage

There are a few metrics we suggest you use to begin focusing your efforts on improving cost-per-case: length of stay compared to Medicare geometric mean; per case cost variability across similar diagnoses; ambulatory-sensitive admissions; and avoidable readmissions. These are metrics you are probably already monitoring, but now you need to evaluate them from a different perspective—your payer’s perspective.

The hospitals that are taking a comprehensive approach to improve their performance in the areas listed above are making huge strides with payers compared to their competitors. They are driving cost-per-case down and are in a position to effectively negotiate lower rates.

Done right, narrow networks have advantages for patients

Yes, we need to come to terms with the reality that reducing cost-per-case actually means reducing revenue for some of your payer contracts, but when you win the narrow network contract, you win more volume. If you reduce cost-per-case but don’t win a narrow network contract, you’ve still improved performance in a way that can be financially beneficial. Having the ability to better control variation and utilization, with fewer readmissions, means reduced Medicare and Medicaid losses.

Finally, if you recently lost a narrow network deal, this is only the first round of these contracts. There will be other opportunities to win the next narrow network bid. Now you know what you need to do to prepare.

Primer on avoidable costs

Every provider needs to focus on reducing avoidable costs—even if risk-based reimbursement contracts are not on the horizon. Here's what you need to know.

Download the primer


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