Activity-based cost system eliminates the money guessing game

Schematic models offer a problem-free program

Chances are your hospital's senior management encouraged the development and implementation of critical pathways as a means to ensure quality and control costs. And likely, senior management is asking if those critical paths are making or losing money for the hospital.

Knowing if the hospital's plan of care is profitable -- or to what degree it is profitable -- can be invaluable when negotiating for managed care contracts. But all too often, hospitals are limited to making educated guesses when negotiating, because clinical and financial data are not integrated.

That's the scenario Northwestern Memorial Hospital in Chicago faced when administrators wanted to know if critical paths were effective at managing patient care costs. "We lacked a tool to cost the paths to determine if they were making or losing money," says Jafar Asadi, director of management engineering at the 678-bed hospital. Asadi presented Northwestern's recently developed costing system model at the Chicago-based Healthcare Information and Management Systems Society's 1996 annual conference and exhibition, held March 3-7 in Atlanta.

Northwestern used the NetProphet software program to help develop its base case model for myocardial infarction (MI). NetProphet is manufactured by Sapling Company in Fort Lee, NJ. (For ordering information, see editor's note at end of article.)

Critical path teams at Northwestern will be using the costing system to measure critical path profitability hospitalwide based on Asadi's preliminary model developed for Northwestern's MI critical path. The model took Asadi and three data management staff members three weeks to develop. He says case managers in other facilities can follow the same model.

"The principles involved are the same as developing a critical path. In most cases, the information needed to start is already available from the pathway development phase," he says.

Business model adapts to health care

Asadi and his team used activity-based costing (ABC), an accounting method typically used in general business that attributes costs to procedures and services based on actual resources consumed. ABC systems combine clinical and financial data to quickly determine if human, material, and capital resources are allocated in a method that is profitable for the organization.

The ABC system is highly applicable to health care because services and procedures typical in clinical settings can be measured by the consumption of human and financial resources rather than an overall distribution, he says. Conventional hospital cost systems, on the other hand, tend to allocate costs by distributing overhead to all services provided. Usually, patient accounting costs are allocated based on the number of procedures performed or treatments provided. But hospitals may be over-costing surgical procedures and under-costing treatment procedures, Asadi warns.

"If a hospital performs more surgeries than outpatient kidney dialysis, traditional methods would allocate more costs to surgical services, when in fact, more work is generated in the dialysis treatment, and more resources are consumed," Asadi explains.

Developing an ABC system also can help improve operational and financial functions, Asadi says. ABC systems can be used to:

* plan and manage operations through effective allocation of resources as patient demands change;

* measure performance by evaluating activities and processes performed on patients;

* understand where money is gained or lost through the use of critical pathways;

* ensure patient demands are met by determining the impact of resource restraints;

* improve efficiency by reducing the amount of idle time among staff.

Accounting involves 5 steps

This is how Asadi and his team used both qualitative and quantitative information available to them to perform critical path cost accounting:

1. Use pathway model to identify steps and key players in the plan of care.

First, develop a flowchart or schematic diagram of one day on your clinical pathway. Asadi and his team refer to the flowcharts as base case models because a basic case model is developed and then adapted to meet changing circumstances. (To see how to develop a base case model, see the related story, p. 53.)

For Northwestern's MI pathway on day one, for example, the following departments and functions are identified as key players:

* intensive care unit;

* emergency department (ED);

* vital sign monitoring;

* administer cardiac medications;

* draw and test blood;

* perform electrocardiogram (EKG);

* nurse labor;

* lab technicians;

* lab supplies;

* medical equipment.

(To see how Northwestern's flowchart for day one of the MI pathway appears in a base case format, see the Operational Flowchart, p. 52.)

For greater financial impact, concentrate on paths with the most impact on quality of care. Asadi and his team developed the first ABC model on Northwestern's high-cost, high-volume MI patient group. Targeting the high-cost and high-volume patient groups gives the hospital more immediate and worthwhile results, notes Asadi.

2. Interview caregivers in the process about time and resources necessary to provide care.

Nurses from the ED and intensive care unit, laboratory and pharmacy technicians, radiologists, and physicians were interviewed regarding the steps involved in providing care to MI patients. Information from interviews was used to allocate costs of care and then placed in the the step-by-step process of care.

To make the process easier, break the development process down to manageable levels.

Rather than create an ABC model for an entire pathway, Asadi and his team concentrated on Northwestern's day one treatments for MI patients. "We looked at the first column only, which involves both intensive care and emergency room phases. We then took our findings to senior management for feedback before moving on to the next procedure," Asadi explains.

Don't rush the process

Developing ABC models in increments also makes information gathering and analysis more accurate, which is crucial to the process, Asadi says. "There is no quick and dirty way to accomplish this without devoting the time and effort. You need the most accurate data, and most of that is already available."

An analysis for one day of treatment, which may sound elementary, can quickly add time to the project. In-depth information and data analyses were gathered in 10 different areas for one day of care for MI patients, for example.

Cost information regarding treatments and procedures was gained from data first gathered by pathway development teams and from cost tables distributed by the accounting team. Figures were then verified through each department to ensure they reflected current prices. Pharmacy, for example, verified the costs for medications administered during intensive care and ED phases of care.

3. Include what-if scenarios.

Part of the development process should include several what-if scenarios, Asadi says. The what-if scenarios provide the ABC team with a variety of conditions with which to test the model. Increased patient volume, for example, should be included to determine its impact on existing staff, supplies, and equipment. Improvements such as fewer steps in drawing blood also could be considered.

Decreasing ED nurse regular labor hours, for example, was an unprofitable option for the hospital. Asadi and the ABC development team created a what-if scenario where ED nurse hours were significantly decreased. However, that would have increased overtime, resulting in a loss to the hospital of as much as $49,000 annually.

In a second scenario, if ED physicians performed patient documentation 15% more efficiently and ED nurses performed patient documentation 10% more efficiently, $93 in savings could be achieved daily. As a result, this suggestion could offer the hospital an annual savings of $33,945.

Compile cost information

4. Develop a cost table.

Another useful tool to develop along with an ABC system is a cost table, notes Asadi. Cost tables are used by individual departments to compile cost information. Data obtained from departmental cost tables are then compiled by staff responsible for managed care contract negotiation, and used for reference, he adds.

Cost tables should be given to each department head or placed in a central location for completion by representatives from the department. The information, along with the interview conducted earlier, is used by the ABC team to construct a schematic.

For example, the laboratory, radiology, pharmacy, patient accounts, plant services, biomedical engineering, and human resources departments would provide the costs associated with MI patient care, including:

* laboratory tests;

* X-rays;

* medication preparation;

* billing;

* room cleaning;

* equipment maintenance;

* other activities.

5. Add in nonclinical costs.

One important factor to include when developing an ABC system is nonclinical costs associated with patient care. Demand categories should be created to capture services associated with financial and support activities, notes Asadi.

Northwestern's ABC team identified the following financial and clinical support services, resources, and activities when developing its ABC model for MI patients:

* ED patient -- non-admission;

* ED patient -- admission;

* scheduled outpatient;

* ambulatory patient;

* medical inpatient;

* observation patient -- non-admission;

* observation patient -- admission;

* surgical inpatient;

* surgical outpatient;

* unit clerical support;

* nursing;

* patient accounting;

* admission/registration;

* utilization review;

* social services;

* discharge planning;

* information systems;

* universal billing editing;

* payment posting;

* insurance verification;

* posting contractual adjustments;

* supplies ordering;

* medical records maintenance;

* patient discharging;

* inpatient appointment scheduling;

* patient data maintenance.

Working with other institutions either before or after starting an ABC project can improve best practice patterns at your hospital, Asadi says. Comparing costs associated with treatments and procedures will help ABC development teams create efficient and effective models or improve models already developed. "If you work with other institutions, you'll be able to compare costs and resources, and find the best practice information available."

[Editor's note: For more information on NetProphet, contact Sapling Company at 2050 Center Ave., Suite 325, Fort Lee, NJ 07024. Telephone: (800) 335-5050.] *

Operational Flowchart

Activity-Based Costing Model for MI - Day One

Northwestern Memorial Hospital, Chicago