Case Study Background Reading Strategic Management – Banks The CEO of St. Sebastian Health System, a moderate-sized hospital system in a mid-sized, Midwest cityhas hired you to help turn things around. The CFO is projecting a $3.7 million operating loss this year,which will be more than offset by non-operating income. However, the board has made it clear that thesituation must improve. If the system cannot produce a positive operating margin in 2017, someone elseis going to be the CEO. The CEO and CFO have asked you to recommend strategic approaches to sellingtheir services in the community that will help turn the financial ship around.Your Health SystemSt. Sebastian is a community-based health system. The senior management team has an average tenureof 17 years. The exception is the Chief Medical Officer (CMO). She has been in her position for two yearsand is the fourth CMO in that role in the past ten years. The CEO and COO have each been in theircurrent roles for ten years. The system is comprised of the following:1.2.3.4.5.6.7.8. Two large, acute care hospitalsTwo long term care facilitiesTwo skilled nursing facilitiesOne long-term acute-care hospital (LTAC)Four geographically distributed outpatient centersFour Urgent Care CentersTwo free-standing ambulatory surgery centers (ASCs)A 400 member employed physician group that includes 180 Primary Care Providers (PCPs). All 28PCP practices are certified Level III Patient Centered Medical Homes by NCQA. The remainder of the 1,000 member medical staff is generally comprised of large, independent groupswho have varying degrees of loyalty to the system. The Radiology and Emergency groups, for exampledo 100% of their work at St. Sebastian and have no ownership of any outside facilities. TheGastroenterology group, on the other hand, does work at the hospital, but also owns their own,freestanding endoscopy center. The orthopedic group does 75% of their work at St. Sebastian, butmaintains privileges at other facilities. They do not own their own ASC.In the current year, St. Sebastian is projecting 220,000 patient visits (combined IP and OP) with anaverage cost per visit of $1,727. They have an average charge per visit of $4,545.Over the past ten years, St. Sebastian has been active in pursuing a number of different strategicprojects including:1. They have established clinical institutes in cardiovascular, orthopedic, oncology, maternity andneurologic care. Each of these has been built through a co-management agreement betweenthe system and the internal or external physician group who would be most logical. Eachinstitute is led by a dyad of an administrator and medical director.2. Five years ago, they consolidated maternity programs to one facility, a move that justifiedinvesting in a Level III Neonatal Intensive Care Unit (NICU)3. They have established a research division in the hopes of working with national pharmaceuticalcompanies and/or tertiary care hospitals in the Midwest.4. They have established a Physician Hospital Organization (PHO) and intend to become anAccountable Care Organization (ACO) that can participate in the Medicare Shared Savings Program (MSSP) and/or enter into global risk contracts with third party payers. The PHO iscurrently evaluating whether or not they should purchase an insurance license so that theycould offer commercial, Medicare Advantage and Managed Medicaid insurance products.5. They have established a Business Health division to service the corporate health needs of theemployers in the region. This would include things like EAP programs, on-site wellness, drugscreening, on-site clinics, etc. This division also recently built two large, full-service fitnesscenters.The competition The community is currently served by three other major health providers:1. Mercy is the competitor acute care system in town and has two hospitals and variousoutpatient centers. They have not been active in physician employment they employ agroup of 60 PCPs, but no specialists. Similarly, they have not been engaged in branchingout with different strategic initiatives, preferring instead to focus on cost efficient care.They do not have clinical institutes, research divisions, a PHO or a Business Health division.They have 230,000 visits per year, with an average cost of $1,435 per visit and an averagecharge of $4,348.2. General Pediatric is a pediatric teaching hospital. Five years ago, they signed an affiliationagreement with Johns Hopkins to gain access to clinical and research capabilities that wouldhave been beyond their reach, given their size. They employee essentially all of the pediatricsubspecialists and have a PHO, which includes 75% of the regions primary carepediatricians. They will have 200,000 visits this year, with an average cost of $2,100 per visitand an average charge of $5,000 per visit.3. General University is an adult teaching hospital affiliated with the local universitys medicalschool. They staff the regions free-care clinics and historically, have been the regionshospital for indigent/uninsured patients. They are the regions Level I trauma center and arewell regarded for intensive services like trauma, stroke and cancer care. However, theirlocation and reputation for taking indigent patients means that they are not preferred fornormal medical care by commercially insured or Medicare patients. Besides the communityhealth centers, they own an inpatient rehab hospital, but not other facilities. They haveexplored affiliations with national leaders in academic medicine, but so far have not signedany such agreements. They see 180,000 visits per year with an average cost of $1,833 andan average charge of $5,556 per visit.There are no other hospitals currently operating, though there are 23 skilled nursing facilities (SNFs) and3 inpatient rehab facilities throughout the region. They are independent actors and for the most part arestruggling to stay profitable. There are several single-specialty physician groups who operate ambulatorysurgery centers and one chain of independent diagnostic treatment facilities (IDTFs). Three years ago,there was a significant change in the state government, and that resulted in the long-time Certificate ofNeed (CON) program being all but scrapped (Skilled Nursing Facilities are still heavily regulated). Severalfor-profit hospital companies have recently done some analysis around entering your market, but havenot done so yet.The Community The community is a Midwest city and surrounding suburbs in the midst of a transitionfrom a manufacturing employment base, which unfortunately accelerated with the 2008 economicdownturn. The hospitals have seen this over the past several years in a tightening of benefits offered bylocal employers. Benefits continue to be offered, but increasingly are likely to have a significantdeductible associated with them. Unemployment has been above the national average and is projected to remain that way. This means that the average wage in the region is actually below where it was in2008, when the last recession hit. The number of Medicare-age residents are projected to rise over thenext 10-20 years, while working age patients are projected to stay flat or fall slightly. Similarly, birthrates are expected to fall slightly over the coming decade.The community is 60 miles south, 45 miles east and 50 miles north of other, similarly sized cities. Until20 years ago, that made this city effectively an island unto itself. Increasingly, however, the suburbs ofeach of these communities have become very close to each other. As that has happened, providers ineach community have followed and established practice sites and free-standing outpatient centers.The payers The community has a normal looking mix of Commercial, Medicare and Medicaid patients.Because the states governor was fiercely against the Affordable Care Act, the Medicaid expansion thathappened in other states hasnt happened here. Thus, the community also has a sizable populationwithout insurance today. As youd expect, different hospitals see a different mix of these patients. Thelocal health council was able to provide you with the most recent years payer mix by hospital below:Patient visitsMercySt. SebastianGen. PediatricGen. UniversityCommunity Total Commercial 80,50099,00070,00063,000312,500 Medicare 105,800101,2004,00045,000256,000 Medicaid 23,00011,000110,00045,000189,000 Uninsured/Self-pay 20,7008,80016,00027,00072,500 Reimbursement the CFO was able to supply you with their best estimate for what various payers arereimbursing for services. In general, the commercial plans are paying 50% of charges, regardless oflocation, except at General Pediatric. There, the monopoly on pediatric services has allowed them tonegotiate rates of 80% of charge, but only for the commercial plans. Medicare currently pays 30% ofcharges at all hospitals, and Medicaid pays 25% of charges everywhere. Uninsured patients are generallypaying 2% of charges.Case #1 A Market on the MoveYouve read everything you can about the legislative environment (both regionally and nationally) andspoken to several brokers who together advise most of the local employers in the region. You believethe most important changes that are about to hit this region are the following:1. As Medicare reduces DSH and other payments, reimbursement from Medicare will drop from 30%of charges to 28%2. The health exchanges established in the ACA have not been much of a factor in the region so far, butthats about to change. The two largest payers in your state both plan to really step up in theexchanges and market these plans aggressively both to currently un-insured and those with current,but unattractive employer-based coverage. They believe that by 2017, theyll have 25% of allcommercially insured patients in exchange-based products.3. There has been a change in both governor and the makeup of the state legislature, which meansyour state will engage in Medicaid expansion next year. Thus, more people will have coverage, andthe uninsured population will diminish, but not go away entirely. Your best estimate is thatuninsured visits community-wide will reduce from 72,500 to 8,300. You estimate that, of thepatients who have new coverage, half will be Medicaid recipients and half will enter the commercialplans.The assignment as you consider how to guide the CEO, answering the following questions should help:Part A1. Using the information provided, estimate total gross and net patient service revenue per hospitalcurrently (2016). What is each hospitals operating margin in terms of dollars and percentage? Basedon this, who is doing well, and who is not? Who has the most to gain and lose as the currentenvironment changes?2. Based on what you know will happen with the next year, re-calculate the estimates from question#1 for 2017. In your estimate, assume that commercial, Medicaid and uninsured patients still paythe same % of charges. As you consider the population that moves into commercial insurance andMedicaid, you can assume that each hospital continues to take the same share of each payercategory (in other words, if hospital A had 20% of the commercial visits in 2016, they will have 20%in 2017). You can also assume that total visits and charge and cost per visit numbers will remain asthey were in 2017.3. Based on everything youve read, the payers putting products into the health exchanges want tomarket these as true, lower cost options. To get there, they will not reimburse as much as othercommercial products. In fact, your best estimate is that they will pay 120% of the Medicarereimbursement rate. If that is the case, how does your estimate of 2017 performance change? Is thisgood or bad? You may want to answer that question from the perspective of the region as a wholeand then for each hospital. Assuming it was optional, would you recommend that St. Sebastianparticipate in the exchange-based products?Part B4. In this city, there are two major payers who together cover 85% of the commercial insured lives.They have both approached St. Sebastian about forming narrow networks as a vehicle for sellingproducts in the exchanges. Your hospital has an excellent reputation, and both payers would like tosell a product that features your hospital as the only in-network option for adult care. So, inexchange for agreeing to a reimbursement rate of 120% of Medicare, St. Sebastian would garner75% of the hospital visits in the exchanges. For the rest, assume Pediatric continues to serve thesame number of patients (i.e. same as youve projected for 2017 previously) and the remaining visitsare evenly split between Mercy and University. Is this an offer that St. Sebastian should accept?5. You strongly suspect that both payers also made this offer to your competitor, Mercy. Based only onwhat you know about the financials, are they likely to accept this deal? If the payers are going tochoose only one partner, do you advise your CEO to aggressively pursue a first to sign strategy, orhang back and allow Mercy to act first?6. Thus far, weve assumed that all costs are variable (i.e. $2,100 per visit for Pediatric), but is thatnecessarily true? Suppose for a moment that each hospitals cost structure is essentially fixed? Howdoes that change your answers to #2, 3, 4 and 5 above?

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