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Jul 17, 2012 - Using business practices known as supply chain and revenue management, the objective was to establish a new cochlear implant program ...
The Laryngoscope C 2012 The American Laryngological, V

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Cochlear Implant Programs: Balancing Clinical and Financial Sustainability Brian J. McKinnon, MD, MBA Objectives/Hypothesis: In 2006, a tertiary academic medical center’s adult and pediatric cochlear implant program was closed due to financial losses. Using business practices known as supply chain and revenue management, the objective was to establish a new cochlear implant program that was financially viable. Study Design: Retrospective cohort study using a nonequivalent historical comparison group design. Methods: Using available financial data from the period of 1999 to 2006, cost and revenue figures were estimated, and a business plan developed using supply chain and revenue management principles to re-establish the cochlear implant program in 2007. Actual cost and revenue data from 2007 to 2011, the current program, were assessed for current financial performance and compared to the historical data. Results: In comparing the period of 1999 to 2006 to the period of 2007 to 2011, the net loss per implanted patient went from $22,365 to $976. Profitable gross and net margins were achieved for all payers except Medicaid, for which the loss per case remained unchanged. This per case loss may change with receipt of pending Medicaid Upper Payment Limit supplemental payments. Conclusions: Use of supply chain and revenue management principles markedly improved the financial performance of the re-established cochlear implant program. With improved cost and revenue outcomes, the overall negative net margin was reduced. Physicians who learn and use supply chain and revenue management methods can work to ensure that their patients will have continued access to cochlear implant surgery, and are applicable to any clinical services or procedures that must meet the challenge of achieving financial sustainability. Key Words: otology, health policy, pediatric otology, cochlear implant. Laryngoscope, 123:233–238, 2013

INTRODUCTION In the spring of 2006, a tertiary academic medical center’s pediatric and adult cochlear implant program was closed due to excessive cumulative financial losses incurred by the hospital over the proceeding seven years. During its existence as a publicly supported hospital, the cochlear implant program had gradually grown in size and had expanded its services to underinsured and uninsured patients. In 2003, the previously public tertiary academic medical center became a semi-

From the Department of Otolaryngology–Head and Neck Surgery, Georgia Health Sciences University, Augusta, Georgia, U.S.A. Editor’s Note: This Manuscript was accepted for publication July 17, 2012. Dr. McKinnon is solely responsible for the preparation and contents of this article. This work was accepted as a Candidate Thesis by the Council of the Triological Society. Dr. McKinnon has received compensation as a member of the Surgical Advisory Board and has received research funding from MED-EL. The author has no other funding, financial relationships, or conflicts of interest to disclose. Send correspondence to Brian J. McKinnon, MD, MBA Associate Professor, Otology/Neurotology, Department of Otolaryngology–Head and Neck Surgery, Georgia Health Sciences University, Augusta, GA 30912. E-mail: [email protected] DOI: 10.1002/lary.23651

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autonomous corporate entity. As a not-for-profit organization, the hospital was required to be managed in a manner that allowed it to remain financially solvent within its payment structure. Gradually, public funding was withdrawn, and programs such as the cochlear implant program came under close financial scrutiny by the hospital. Ultimately, the cochlear implant program was closed in 2006 due to the losses from cochlear implantation surgical services. Unique to this story was its resurrection as financially sustainable using cost and revenue management. Cochlear implantation has become a well-established means of addressing severe to profound sensorineural hearing loss in patients who cannot benefit from conventional amplification. Understood to be both clinically effective and cost-effective,1–3 it is estimated that over 219,000 patients have received this medical device.4 Nevertheless, the evidence supporting the benefits of cochlear implantation, and the worldwide growth in the number of patients being implanted, masks the very real financial challenges that cochlear implant programs face. A 2002 RAND Corporation-funded study5 reviewed payments received for cochlear implants by providers and facilities in the United States and found substantial McKinnon: Cochlear Implant Program Sustainability


shortfalls in reimbursement. With Medicare alone, the study determined that on average a hospital faced a $5,000 to $10,000 loss on every Medicare patient implanted. When the study reviewed Medicaid data, 18 of the 44 states for which data were available also failed to cover the costs of cochlear implantation in their beneficiaries. These findings have received support6 in the literature. Taken together, the lack of adequate reimbursement risks loss of access to cochlear implantation for many patients. Attempts to improve levels of reimbursement for cochlear implants are being impeded by the trend to control health care costs in the context of the current economic crisis and the future implementation of health care reform legislation, the Patient Protection and Affordable Care Act.7 There has been only very limited discussion or investigation of how cochlear implant programs can be managed to ensure their financial sustainability.5,8,9 That business acumen is important to the provision of health care services is becoming more apparent to physicians and other health care professionals, even in singlepayer systems.10 Physicians pursue formal business training because of a perceived lack of understanding of business thinking and practices, particularly in areas of antitrust, financial management, fraud and abuse, and financial accounting.11 Those that completed formal business education overwhelmingly felt it was essential to their practice of medicine,12 with the majority of those who sought training continuing in clinical roles.13 Supply chain management was developed within manufacturing as a means of increasing operational efficiency and effectiveness, from the understanding that purchasers and suppliers operate in the marketplace through coordination of interdependencies.14 Using contracting techniques that share risks and rewards between purchaser and supplier, supply chain management’s intent is to align the incentives of both parties to achieve better coordination, greater cost reductions, and improve information flows.14 Interestingly and importantly, these purchaser–supplier relationships typically do not originate through a central plan or traditional hierarchies. Unfortunately, hospitals fail to utilize the tools of supply chain management. For example, electronic health records are designed for clinical decision making and billing support, and are used to track and restock supplies; however, these systems are not designed or used to develop data on more effective supply chain, cost, and risk management.15,16 With few exceptions, hospitals and other health care delivery systems do not fully understand their costs, their cost drivers, and their management in general, or supply chain management in particular.17 Therefore, a physician knowledgeable of the unique clinical and business facets of cochlear implantation can effectively influence and participate in the development of hospitals’ supply chain activities related to cochlear implantation. Revenue management for cochlear implant programs is an extraordinarily complex challenge, involving separate payments for provider and facility, as well as for preimplantation, implantation, and postimplantation Laryngoscope 123: January 2013


services.18 The diversity and variability of contractual payments and contractual exclusions of public and private insurers contribute to this complexity. The need for a physician to be equally well versed in the clinical and business aspects of their practice to maintain financial sustainability of the cochlear implant program is hinted at by the following discussion of two major payers, Medicare and Medicaid. Both Medicare’s and Medicaid’s reimbursement can be increased by a hospital’s disproportionate share of poor and uninsured patients. In the case of Medicare, reimbursement can also be increased by the hospital’s Graduate Medical Education indices.18 In the case of Medicaid, a federal health insurance program managed by the states, a designated hospital may receive Disproportionate Share Hospital (DSH) and Upper Payment Limit (UPL) supplemental payments.18,19 DSH payments are intended to provide additional monies to health care facilities with large poor populations. UPL payments are intended to supplement the shortfall in Medicaid reimbursement. Both supplemental payments were intended to be a payment from the state, combined with matching federal dollars. However, following payment, states have used various means to reclaim the state portion of the supplemental payments, and sometimes the matching federal dollars as well, leaving the designated facilities with a persistent shortfall.19 In a review of 2005 supplemental payment data,19 where the expected share should be equal between the state and federal government, the average federal share of supplemental payments retained by the hospitals was 86.4%, indicating that the major portion of the supplemental payment paid out by the state had then been returned to the state. In the state that the hospital in this review is located, the reported rate was 98.21%.19 The objective of this investigation was to report on how, starting with a review of the original cochlear implant program’s financial information, a substantial restructuring of the new cochlear implant program achieved financial sustainability. The business tools of supply chain management and revenue management were used to evaluate the financial performance of the closed program, and establish financial parameters for the new program that serves a primarily economically disadvantaged population. These changes enabled the successful re-establishment of an adult cochlear implant program in the fall of 2007, followed by the pediatric cochlear implant program in 2010.

MATERIALS AND METHODS Financial records were obtained from a tertiary academic medical center after the institution’s Human Assurance Committee determined that its approval was not required as this study was a financial analysis and did not involve protected health information. Hospital reimbursement and cost data (total reimbursement, direct costs, device costs, gross margin) were gathered and analyzed from two periods: the time prior to the initial programs closure (from June 1999 through June 2006) and the time of the current programs existence (from October 2007 through May 2011).

McKinnon: Cochlear Implant Program Sustainability

TABLE I. Total Costs, Reimbursement, and Margins. Period

Direct Costs

Device Costs

Surgical Costs












The financial data for the defunct program from June 1999 through June of 2006 were incomplete for the period, although payer information was complete. During the hospital becoming a not-for-profit organization in 2004, and following the cochlea implant program closing in 2006, much of the cost and reimbursement data were lost and determined unrecoverable. Available cost and reimbursement financial data by payer from 1999 to 2006 were used to estimate the missing data. These payer-associated estimates were then used to calculate the approximate financial performance of this time period for analysis and comparison. The financial data for the period from October 2007 through May 2011 were complete, except for data from Medicaid UPL supplemental payments, which at the time of this review were not received. Direct costs included labor (e.g., nurse, technician, anesthesiologist), supplies (e.g., drill bits, disposable surgical items, implantable device), and depreciation on equipment (e.g., drill). Surgical costs were calculated by subtracting device costs from direct costs. Indirect costs (e.g., electricity, administration, information technology) were assumed as being equal to surgical costs, which is the hospital’s practice. All reimbursements and costs were rounded to the nearest dollar. Payer mix and gross margins by payer were calculated from either the estimated or actual data depending on the timeframe. Cost management was achieved through revising the case cart to reduce wasted surgical disposables and other supplies (open only when requested) and contracting with a single manufacturer for an internal device and a single, external processor, cochlear implant device package to decrease device costs. A review of the direct surgical costs was performed, and a metric of direct surgical cost of $2,500 or less was established, with indirect costs assumed to be equal to direct surgical costs. As Medicare has been the dominant payer in the 1999 to 2006 period, the 2007 regionally adjusted Medicare reimbursement less the estimated direct and indirect surgical costs, was used to develop reimbursement-based costing to calculate the device cost

Gross Margins

Indirect Costs

Net Margins

Net Margin Per Case









thresholds needed to achieve financial sustainability. One manufacturer was willing to agree to supply a single-processor device at the specified cost, in exchange for being sole supplier, and at a guaranteed volume. In July 2010, the pediatric cochlear implant program was resumed, and the contract was modified to provide pediatric patients two external processors, although adults continued to receive a single external processor. Reimbursement management was achieved through improved use of procedure preauthorization, documentation and tracking of reimbursements, and collections practices. Negotiations for carve-outs were pursued with managed care payers. Carve-outs are payment rates negotiated for a specific procedure, such as cochlear implantation. These rates are separate from the general services contract that is agreed on by a hospital and managed care payer. Carve-outs, if properly designed, can increase revenue and minimize financial risk to hospitals providing particularly expensive or resource-intensive services. Both the supply chain and revenue management changes were made possible through the active involvement of the cochlear implant program’s surgeon in decision making, planning, and management of the supply chain and revenue challenges. All data were entered into Microsoft Excel (Microsoft, Redmond, WA), and all financial and statistical calculations performed using the same software.

RESULTS A total of 53 cochlear implant procedures were performed from June 1999 through June 2006, including 16 (30%) in patients under the age of 18 years. Complete reimbursement and cost data were available for eight individuals from August 2003 through January 2006. Using the incomplete reimbursement data on the remaining 45, missing data were estimated, and the financial performance approximated for comparison. A total of 46 cochlear implant procedures were performed,

Fig. 1. Direct costs (DirCost) and device costs (DevCosts) were reduced by 22%, surgical costs (SurCost) and indirect costs (InCost) were reduced by 60%, and reimbursement (Reimb), gross margins (GrMarg), and net margins (NMarg) were increased by 104%, 106%, and 96%, respectively.

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Fig. 2. Between 1999 and 2006, and 2007 and 2011, average gross margins per surgery increased for commercial payers (354%), Medicare (108%), and Tricare (179%), and fell slightly for Medicaid ( 3%).

including seven (15%) in patients under the age of 18 years, from October 2007 through May 2011, and complete reimbursement and cost data were available on all. Total direct costs, device costs, surgical costs, reimbursements, gross margins, indirect costs, net margins, and net margins per case are found in Table I for both time periods, and average per case direct costs, device costs, surgical costs, reimbursements, gross margins, indirect costs, and net margins are shown in Figure 1 for both time periods. The average per case surgical case cost for the 2007 to 2011 period was $1,968, which was lower than the initial estimated metric of $2,500, and the standard deviation for direct surgical costs was $4,627. Further data review determined that this large standard deviation in the average per case surgical cost reflected a single postoperative hospitalization of several days. Attempts at achieving carve-outs were of only very limited success. Although all measures showed marked improvement with supply chain and revenue management, net margins remained negative. Per case gross margins by payer are shown in Figure 2 as gross margins are more reflective of the changes made, as gross margins exclude the approximated indirect costs. No intervention was made to alter actual indirect costs, and it is unlikely the reduction in

the assumed indirect costs is accurately reflected in changes in actual direct costs. When average per case assumed indirect costs of $1,968 for the period 2007 to 2011 were included, all net margins by payer, except for Medicaid, were positive under the current program. The payer mix from both time periods is displayed in Figure 3. From 1999 to 2006, 56% of pediatric cochlear implants were reimbursed by Medicaid, and from 2007 to 2011, 57% of pediatric cochlear implants were reimbursed by Medicaid.

DISCUSSION A financially defunct cochlear implant program can be restructured to achieve financial sustainability. The cochlear implant plant program, by applying the business tools of supply chain and revenue management, reduced the per case net loss by 96%. Supply chain management yielded the most substantial cost reductions through selection of a single external processor cochlear implant combination, contracting with a single supplier to maximize volume discounts, and building in volume guarantees for the supplier. Surgical costs were reduced by practicing opened when requested. Revenue

Fig. 3. Between 1999 and 2006 (A), and 2007 and 2011 (B), the commercial ( 13%), Medicaid ( 6%), and Tricare ( 1%) portions of the payer mix declined, and the portion of Medicare (20%) increased.

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McKinnon: Cochlear Implant Program Sustainability

management included the implementation of an effective accounting, preauthorization, and collections system. A substantial decline in commercial payers and a concurrent increase in Medicare occurred between the two time periods (Fig. 3). During the October 2007 through May 2011 timeframe, substantial economic20 and demographic21 changes occurred within the area serviced by the hospital, possibly contributing to the payer mix changes. The decline of the percentage of Medicaid within the payer mix between the two periods can be explained by the absence of the pediatric cochlear implant program until 2010. It is expected that the Medicaid portion of the payer mix will increase over time as the re-established pediatric cochlear implant program grows. The persistent negative net margins are attributed to the low level of Medicaid reimbursement. At the time of this investigation’s publication, the facility’s Medicaid UPL supplemental payment was still outstanding, and may reduce the deficit for this payer. However, Medicaid reimbursement poses a significant concern for the cochlear implant program, and was the primary contributor to the program not achieving a positive net margin. Medicaid at this facility was the most common payer for pediatric cochlear implant surgeries, a group whose cost, although not specifically calculated for this study, would be expected to be marginally higher due to the decision to provide pediatric cochlear implant patients two external processors. Even in states where Medicaid adequately funds cochlear implant services, and pediatric Medicaid patients achieve the same benefits as privately insured pediatric patients, pediatric Medicaid patients have been reported to have five-fold higher complication rate.22 Medicaid expansion is expected under the Patient Protection and Affordable Care Act to extend coverage to the currently uninsured.23 For a region that, at this time, has a suburban unemployment rate 14% and an urban rate of 24.1%,20,21 this expansion will place an even greater strain on achieving and maintaining financial sustainability. Unless state Medicaid reimbursement is commensurate with cost, even the most austerely managed cochlear implant program may find it financially untenable to continue. There are several weaknesses to this study. The financial data from 1999 to 2006 were incomplete, and the estimates made may not be reflective of the actual financial performance of the program at that time. However, the lack of data points to how critical establishing an effective supply chain and revenue management program is. This investigation is not a cost- effectiveness study, and the clinical outcomes were not investigated. The impact of providing adults a single external processor is not known, but even if the provision of only one external processor is found less clinically effective than two, this may be found to be decrementally cost-effective (i.e., where the cost savings exceeds the reduction in clinical effectiveness).24 Revenue management did not benefit significantly from carve-out agreements, but as has been pointed out by others,18 improperly negotiated carve-out agreements can significantly increase financial risk. The ethics and Laryngoscope 123: January 2013

risks of offering only one manufacturer are also beyond the scope of this investigation, but the repercussions of a black swan event25 from over-reliance on a single manufacturer could be devastating to a program and patients alike. However, without these changes, patients would not have had any local option for cochlear implantation. This was the reality that existed between the closure of the original program and re-establishment of the current program. There are broad implications for other cochlear implant programs, private and publicly funded, from this program’s use of cost and revenue management to maintain access to cochlear implantation for an economically disadvantaged population. The tools, methods, and analysis require training and attention to implement and execute correctly, but are accessible to those with an interest and inclination to learn and use them. There is nothing sufficiently unique to a private or publicly funded program that would preclude their use from helping achieve financial sustainability, and in many ways these tools are the business corollary to tools used to improve clinical outcomes. To deliver good quality clinical care requires a broad view, a view that incorporates the diagnostic and therapeutic knowledge necessary for clinical decision making. The business or financial acumen to make the diagnostic and therapeutic knowledge accessible is equally as valuable as the diagnostic and therapeutic knowledge itself.

CONCLUSION Cochlear implant programs face tremendous financial challenges in maintaining their financial sustainability and may struggle to reach the goal of becoming budget neutral through a combination of increased reimbursements and reduced costs. However, the challenge is not insurmountable. Although the tools of supply chain and revenue management may be unfamiliar to the physician, learning their appropriate use and application is well within the capabilities of providers who also strive to achieve superior clinical outcomes, and the methods used in this investigation can be applied broadly to clinical services and procedures. Ultimately, these business skills may be as critical as the physician’s clinical acumen, as without them, access to care will be limited or nonexistent. The challenge for physicians in this current environment is as much what to do clinically as it is how to pay for it.

Acknowledgments The author acknowledges his sponsor, Dr. David Terris, and seconder, Dr. Stilianos Kountakis, for their encouragement and support of his candidate thesis.

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