An In-Sourcing Decision in the Health Care Industry: Should an Orthopedic Practice Buy an MRI?: A Case Study
Devine, Kevin, Ealey, Thomas, O'Clock, Priscilla, Journal of the International Academy for Case Studies
The primary subject matter of this case is a capital budgeting decision. Capital budgeting issues are appropriately discussed in accounting and/or finance disciplines, as well as healthcare management courses. The case and teaching note support the discussion and analysis of several secondary issues, in addition to the quantitative and qualitative factors incorporated in capital budgeting decisions. These issues include, but are not limited to, ethical issues, government policy practices, and sensitivity analysis. The quantitative analysis requires the student to demonstrate an understanding of the complexity that may be involved in determining relevant factors included in a capital budgeting decision, as contrasted with the simplicity of most textbook capital budgeting problems. The case is appropriate for use in junior level classes (level three) and above. There is a great deal of flexibility incorporated in the case, dependent on the instructor's desire to pursue, or not pursue, discussion of the secondary issues. This flexibility makes the case suitable for advanced analysis and discussions at higher course levels, up to and including first year graduate levels (level five). The number of class hours required to teach the case is dependent on the depth explored by the individual professor. However, class hours would be expected to range from one to two hours; preferably over two class meetings. Preparation hours required of the student are expected to average two to four hours.
This case considers the dilemma being confronted by an orthopedic physicians group. The practice is facing shrinking revenues driven by government plans to reduce Medicare reimbursements. In an effort to avoid salary cuts to physicians that appear imminent, members of the practice suggest raising rates to private payers. When this alternative is ruled out, it is decided that an expansion of ancillary services may provide a solution to the dilemma. The primary decision is whether to expand services by in-sourcing the Magnetic Resonance Imaging (MRI) diagnostic tool. Quantitative analysis of this decision requires the student to identify and determine the projected cashflows, associated with acquiring the MRI, over a twelve year period using net present value analysis. The realism of this decision problem is enhanced due to the fact that the physician's group serves several different classes of customers as well as using the MRI as a diagnostic tool for a variety of ailments/injuries. Each patient group and procedure results in a different reimbursement amount. This analysis is then expanded with two potential alternatives; a ten percent increase in prescribed MRIs or elimination of service to Medicare/Medicaid patients. Students should identify the quantitative impact of acquiring the MRI versus the status quo, as well as the ethical considerations associated with eliminating services to Medicare/Medicaid patients. This addition invites the discussion of business ethics from a stakeholder perspective.
BODY OF THE CASE
The following exchange recently took place at Physicians Orthopedic Group, Inc. (POGI) in response to recently proposed Medicare reimbursements. Dr. Adams and Dr. Baker are the original founders of the practice group and are currently serving the group as president and treasurer. Carolyn Conway is the office manager.
Ms. Conway: Medicare just announced cuts in the reimbursements for all covered
healthcare services by five percent. If we don't find a way to make up this loss in revenues we are going to have to find a way to cut costs, including, reducing physician and staff salaries.
Dr. Adams (visibly concerned): Can't we just charge our private insurance patients more for their services to make-up for the Medicare cuts?
Ms. Conway: No. Insurance companies rarely pay us the amount that we bill them and their reimbursement rates are also fixed by contract. To make matters worse most of the insurance companies tie their reimbursements to the Medicare allowance. It is typically more than the Medicare allowance, however, if Medicare reimbursements are declining it is likely that insurance reimbursements will also decline or at best stay the same (e.g., private reimbursement equals 130% of Medicare rate).
Dr. Baker: Can we raise rates on the patients that don't have health insurance or don't have insurance linked to the Medicare rate?
Ms. Conway: I suppose we could but the problem with that approach is that many of those people can't afford to pay us the full amount for major services already. Often times I have to negotiate reduced charges with them in order to entice them to pay us anything.
Dr. Adams: OK--then what would you suggest we do?
Ms. Conway: I believe we need to consider expanding our services.
Dr. Baker: Given the talents of all the doctors in the group, we pretty much cover all of the orthopedic surgeries and rehabilitative services that are needed in this community.
Ms. Conway: Well, if we can't provide additional physician and rehab treatments, maybe we should focus on diagnostic equipment. Perhaps instead of sending our patients to the hospital for MRIs we should offer the service in house
Dr. Baker: If we are seeing cutbacks in revenue, how in the world can we afford a million dollar MRI machine? (See Glossary at end of case)
Ms. Conway: We are currently sending about 800 patients a year to the local hospitals for MRIs. At that volume we might be able to justify the investment.
Dr. Adams: That might be a great idea. Why don't you get some information together and see what it looks like.
Dr. Baker: Yes, but it sounds like you will need to get the information by types of patients, since not all patients pay the same. You might also try to project what amount we will receive given these new Medicare cuts.
The current environment in the healthcare industry has resulted in physicians' groups facing revenue compression. Government reimbursement for Medicare/Medicaid services has been flat or declining with private pay reimbursement sometimes a percentage of government reimbursement. Meanwhile, the costs incurred in order to provide health care are continuing to increase. In the face of shrinking profits, physicians groups are frequently facing difficult decisions in order to grow or maintain profits. Alternatives may include adding another physician to the group, withdrawal from Federal/State Medicare/Medicaid programs (or refusing to accept new Medicare/Medicaid patients), or offer in-house services to patients that have previously been referred to a hospital.
Physicians Orthopedic Group, Inc., located in Mason, Ohio, consists of ten physicians, nine are generalist orthopedic physicians and one specializes in spine surgery. All of the physicians in the group serve the local hospital trauma unit on an "on call" basis. X-rays are routinely performed "in-house" and POGI has three x-ray rooms and five technicians employed; three full time and two part time. If more detailed information is needed for a proper diagnosis and treatment, an MRI scan may be ordered. POGI currently out sources all MRIs and approximately 800 scans are ordered per year. Patients are referred to the local community hospital or to an independent open MRI unit. In either case there is no revenue or cost impact to POGI.
MEETING ONE WEEK LATER:
Ms. Conway: I have put together information regarding our patient mix and MRIs prescribed, on average, for each patient group (See Table 1, Panel A). I have also estimated the percent of MRIs ordered for each typical procedure (See Table 1, Panel B). I have further summarized the reimbursement fees that I think we can expect to receive from each patient group, by procedure, if we provide our own MRI service (See Table 1, Panel C). Preliminary information regarding the cost to acquire and operate an MRI machine has also been accumulated (See Table 2).
Dr. Adams: I know that the hospital charges the patients a lot more for MRIs than what you are showing in this chart.
Ms. Conway: They do, but insurance companies and Medicare provide greater reimbursements to hospitals than they do for clinics like ours.
Dr. Adams: Well that doesn't seem fair! Why do they do it?
Ms. Conway: They figure that hospitals are more complicated and have greater overhead to support and justify it from that perspective.
Dr. Adams: This looks like an awful lot of information--how will we determine if it makes sense to invest.
Ms. Conway: If you want to proceed, I can put together an analysis to determine the NPV of this project to help us make the decision.
Dr. Adams: I don't care about your NP what ever you call it just let me know if it will save us from cutting physician salaries.
Dr. Baker: Perhaps we can attract more patients in the future if we make it known to other doctors and insurance companies that we can provide the MRI service cheaper than the hospital.
Dr. Adams: That's a good idea--and maybe we can attract some that pay more than Medicare patients. On the other hand, I think that because of the convenience of having our own magnet the number of times our Docs request MRIs will increase; simply as a precautionary diagnostic tool, of course, particularly since we can offer it for a lower fee than the hospital with more convenience to the patient.
Dr. Baker: I think you might be right about attracting more regular pay customers. In fact, it would be nice if we could move toward not accepting Medicare patients in the future. All the Doctors tend to spend a lot more time trying to explain things to the older patients which hurts our productivity. That, combined with the low reimbursements that Ms. Conway explains the government is providing for Medicare patients, might make it more attractive to phase out taking care of Medicare patients in the future.
Ms. Conway: I can look into that, but you know that Medicaid reimbursements are even less than Medicare.
Dr. Baker: OK! Why don't you look into not providing services for either Medicare or Medicaid patients.
Dr. Adams: Now wait a minute!! I'm not sure it's really ethical to stop seeing Medicare and Medicaid patients just because they can't pay us as much.
Ms. Conway: A number of practices have discontinued seeing these patients. As they make up a larger percentage of the practice it is difficult to make enough money to pay competitive salaries to the Docs. I am not sure it becomes more ethical to ask Doctors to continue working here versus accepting a large salary increase at another practice that limits the types of patients serviced.
Dr. Baker: If we lose Doctors to the competition it certainly doesn't do our patients any good if we are forced to hire new or less qualified Doctors just because we can get them cheap!! I certainly don't think that is a good ethical practice.
Ms. Conway: You may want to talk to the staff about the wisdom of discontinuing service to the Medicare and Medicaid patients. In the mean time I can do several analyses related to the acquisition of the MRI machine. I can look at using the MRI for our existing patient mix and about 800 patients per year as kind of "worst case" scenario. I can look at increasing patients by about 10 percent assuming we will have more self referrals or referrals from other physicians' groups and, finally, I can look at dropping Medicare and Medicaid patients and assume that we can maintain 800 MRIs with private pay, insurance and workmen's comp patients. From a quantitative perspective we can see how these alternatives affect the potential profitability of the investment.
Dr. Adams: I suppose it doesn't hurt to run the numbers but while you are doing that I think we need to have a staff meeting and get everyone's input on the possibility of discontinuing Medicare and Medicaid patients. I know some of the Docs take serving others very seriously and aren't going to like not serving the elderly and poor just because they can't pay as much.
Ms. Conway: That's a good idea but be sure you tell them that it could affect their salary long-term.
Dr. Adams: I'll wait for that until you tell me what the impact is.
Ms Conway: Sounds good--I will get this analysis done by next week and we can talk again.
Dr. Adams: That would be great! In the meantime, I will talk to the staff and then we can make a decision on the best course of action with all things considered.
MRI Magnetic Resonance Imaging; a high-tech diagnostic tool allowing detailed views of the inside of the body.
Magnet Short hand for the hardware used in MRI technology.
Medicare Federal health insurance programs covering most elderly Americans and some disabled Americans.
Medicaid Federal/state health insurance program covering indigent Americans.
Private pay Private health insurers (Anthem, Aetna, Humana, etc.) providing private health insurance policies, usually purchased by employers.
Workers' compensation Insurance limited to job-related injuries.
Film Large sheets of heavy film on which MRI images are printed.
Kevin Devine, Xavier University
Thomas Ealey, Alma College
Priscilla O'Clock, Xavier University
Table 1: Patient Mix, Procedure Mix, and Average Reimbursement Panel A: Current Patient Mix and Mri Percent by Patient Group (a) Percent of Percent Payer Group Practice of Mris Private Payer 35% 40% Medicare 25% 25% Medicaid 12% 10% Workers' Compensation 18% 20% Uninsured (typically due to trauma call at the local 10% 5% hospital) (a) On average, 800 MRIs are ordered annually. Panel B: Current Procedure Mix for Mris Procedure Percent of Mris Spines 20% Knees 30% Hips 25% Shoulders 5% Wrist/arm 5% C-spine and head 10% Bi-lateral knee 5% Panel C: Average Reimbursement for Mri by Procedure and Payer Group Procedure Payer Group Reimbursement (a) Medicare $ 850 Spines: Private pay $ 1,084 (average) Workers' $ 1,020 compensation Medicaid $ 550 Medicare $ 400 Knees: Private pay $ 538 (average) Workers' $ 480 compensation Medicaid $ 285 Medicare $ 750 Hips: Private pay $ 918 (average) Workers' $ 900 compensation Medicaid $ 475 Medicare $ 440 Shoulders: Private pay $ 640 (average) Workers' $ 528 compensation Medicaid $ 350 Medicare $ 325 Wrist/arm: Private pay $ 452 (average) Workers' $ 390 compensation Medicaid $ 225 Medicare $ 700 C-spine Private pay $ 1,116 (average) and head: Workers' $ 840 compensation Medicaid $ 225 Medicare $ 770 Bi-lateral Private pay $ 985 (average) knee: Workers' $ 924 compensation Medicaid $ 550 (a) Annual procedure reimbursement is projected to increase at 1.5% per year. Table 2: Projected out of Pocket Costs to Acquire and Operate Mri (a) Purchase of the "magnet," at $1.3 million dollars, plus $75,000 remodeling and electrical work, 12 year life before major overhaul, 5 year financing at prime plus one percent (assume prime is 6%). POGI's cost of capital is approximately 8%. (b) One full-time tech, with backup coverage by techs already in x-ray [($18 per hour x 2080 hours) + 27% add on for taxes and benefits. Salaries are projected to increase at 4% per year. Malpractice insurance costs will increase approximately $25,000 with a 5% annual increase. Annual property insurance will increase $8,000 per year (2% annual increase). Film, $24,000 per year with annual 2% increases in cost. Maintenance contract after first year, $16,000 per year until year six when the contract cost will increase to $20,000 and in year eleven it will increase to $25,000. Training and recertification for technicians average $2,500 per year (4% annual increase). (a) The additional costs for electricity and billing for MRI procedures are expected to be negligible. Formal readings of the film will not be performed by POGI. These will continue to be outsourced to a radiology group; again, no revenue or cost impact. Prior to an office visit or surgery, POGI physicians will routinely re-read the film but this is not a billable service. POGI is a personal service corporation and pays tax at the rate of 35%. (b) For tax depreciation purposes, the MRI machine is a five year asset that will be depreciated using MACRS. It is expected that this machine will have no residual value other than scrap value (which is negligible) at the end of twelve years (Internal Revenue Service, 2008)…
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Publication information: Article title: An In-Sourcing Decision in the Health Care Industry: Should an Orthopedic Practice Buy an MRI?: A Case Study. Contributors: Devine, Kevin - Author, Ealey, Thomas - Author, O'Clock, Priscilla - Author. Journal title: Journal of the International Academy for Case Studies. Volume: 16. Issue: 3 Publication date: April 2010. Page number: 107+. © The DreamCatchers Group, LLC 2008. COPYRIGHT 2010 Gale Group.
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