A Strategic Planning and Cost Management Model for Managed Care Companies

By Kelemen, Dennis M.; MacArthur, John B. et al. | Management Accounting Quarterly, Summer 2007 | Go to article overview

A Strategic Planning and Cost Management Model for Managed Care Companies


Kelemen, Dennis M., MacArthur, John B., Menzel, Charles R., Management Accounting Quarterly


PROPERLY MANAGING THE OPERATING COSTS OF MANAGED CARE COMPANIES REQUIRES CAREFUL LONG-TERM PLANNING AND CONTROL USING STRATEGIC COST MANAGEMENT MODELS AT A PRODUCT-BY-PRODUCT AND CUSTOMER-BY-CUSTOMER LEVEL. THIS ARTICLE DESCRIBES AND ILLUSTRATES AN ACTIVITY-BASED STRATEGIC PLANNING AND COST MANAGEMENT MODEL THAT FACILITATES LONG-TERM PLANNING AND COST MANAGEMENT OF SUPPORT VALUE CHAIN ACTIVITIES OVER THE LIFE CYCLE OF EACH PRODUCT OF A MANAGED CARE COMPANY

Within the U.S. healthcare system, managed care companies finance and manage healthcare delivery and associated costs by structuring insurance healthcare benefits so that services are provided through networks of providers (e.g., hospitals and doctors) with negotiated rate structures. A managed care company's operating income is a function of the premium charged for the type of product sold (e.g., Health Maintenance Organization (HMO), Preferred Provider Organization (PPO), and Exclusive Provider Organization (EPO)); the medical care claims costs associated with the product; and the selling, general, and administrative (SG&A) overhead costs needed to service and support the product.

According to the Centers for Medicare & Medicaid Services (CMS), the SG&A costs in publicly traded managed care companies from 1999 to 2002 comprised 15.9% to 17.0% of premium revenues. (1) Because profit margins are typically small in managed care companies (e.g., 1.8% to 4.4% of premium revenues for publicly traded managed care companies), it is important to seek reductions in SG&A costs as a percentage of premium revenues by managing their cost drivers, such as technology and employee turnover, to increase profit margins. This is a more effective technique than seeking increased enrollment since, as CMS reported, a 1% increase in profit margins would require more than a 5% to 8% increase in enrollment. Therefore, it makes sense to develop cost management models that facilitate optimum utilization of the resources provided by managed care SG&A expenditures. One such example is Blue Cross and Blue Shield of Florida's activity-based "Cost for Pricing" (CFP) model, which is an activity-based model that provides meaningful SG&A expense information for strategic decision making such as product pricing. The CFP model provides accurate and timely cost information about the company's functions/activities and its products and customers to help the company achieve its profitability goals. (2)

In broad, macro terms, in the managed care industry SG&A costs are classified as business acquisition/ marketing costs (24.5%), customer account and membership administration/maintenance costs (41.3%), medical and provider management costs (11%), and corporate services costs (23.2%). (3) To understand SG&A overhead cost behavior in managed care companies, it is important to note that these costs are predominantly fixed costs and do not change in the short term with variations in volume (e.g., number of healthcare plan members).

MAINLY FIXED SG&A COSTS

Robert Kaplan and Robin Cooper stated that the operating costs of service companies in general are "virtually all ... fixed once resource supply has been committed," which is why activity-based costing (ABC) information is of particular importance to service companies. (4) In a managed care company, traditional short-term cost-volume-profit (CVP) analysis can be used to calculate items such as the breakeven point in premium revenue. The annual company-wide data on premium revenue minus medical care claims costs (which are essentially the only variable costs, given miniscule variable SG&A costs) can be used to calculate the overall contribution margin dollars and contribution margin ratio for typical short-run CVP analyses. (5) Properly managing the predominantly fixed SG&A resources, however, requires careful long-term planning and control using strategic planning and cost management models on a product-by-product and customer-by-customer basis. …

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