State Interest in the Operating Efficiency of Virginia’s Nonprofit Hospitals

Courtesy AP

by James C. Sherlock

Virginia’s nonprofit hospital systems are partially funded with taxpayer money, pay no taxes, and are protected from competition by the state.  

The state, having provided all of those advantages, needs to make sure its citizens reap as much benefit from them as the hospitals do.

Yesterday I wrote that the state has an obligation to regulate the regional monopoly systems it has created to ensure that their prices are kept within reasonable bounds.

One way to do that is by controlling their allowable operating margins.  

That in turn requires the government to see to it that they are operated efficiently. It must ensure that their operating margins, which are operating income divided operating revenue, reflect best practices in controlling operating expenses.  

Optimized operating efficiency has been shown to improve medical performance as well.

Some nonprofit hospital boards have the skills and oversight reach to ensure operating efficiency. Some do not. If the nonprofits are regulated only on margins, the financial incentive to improve operating efficiency will be removed.

Rural hospitals are in need of improved operating efficiency as a survival mechanism at the same time their small size and stressed finances may prevent them from investing to achieve it.

COVID demonstrated that operating efficiency is also an emergency- preparedness matter.

For-profit hospitals can be presumed to be already governed to optimize operating efficiency. Investors demand it. They can be expected to realize greater operating margins on a given set of prices than do most nonprofits.   

The Commonwealth of Massachusetts has studied the issue of operating efficiency and published interesting findings. 

Even after adjusting for the varying complexity of needs of patients treated by each hospital and for different regional wage levels, hospitals with higher levels of operating expenses spent 23 percent more to provide the same services than those with lower levels of operating expenses. This difference represented thousands of dollars in additional expenses per hospitalization for those hospitals with higher expense structures.

The report dismissed with data the oft-cited theory that teaching hospitals necessarily experience higher operating expenses than non-teaching hospitals.

(T)he difference in median expenses per discharge between teaching hospitals and all hospitals ($1,030) was less than the difference between individual teaching hospitals ($3,107 between the 75th percentile and 25th percentile teaching hospitals). Moreover, there were a number of teaching hospitals that incurred fewer expenses per discharge than the statewide all-hospital median of approximately $9,000 per discharge.

The same study showed that control of expenses — facilities, labor and supplies — with improved operating efficiency can actually improve patient outcomes.

We examined performance by Massachusetts hospitals across select indicators of quality: excess readmission ratio, mortality rate, and process-of-care measures. For each measure of hospital quality, certain hospitals achieved better performance while maintaining lower operating expenses.

Opportunities exist across all measures examined for hospitals to achieve higher quality performance at their current operating expense level or to reduce operating expenses while sustaining quality performance.

(S)tudies have demonstrated that hospitals practicing effective management techniques have lower mortality rates and stronger financial performance.

Nonprofits of course have a head start on optimizing the costs of supplies. They pay no sales taxes when they purchase them.

The study listed three types of strategies that hospitals are pursuing to reduce their operating expenses: procurement and supply chain management; lean operations (Toyota Production System model); and better cost accounting to identify opportunities for cost reduction.

The study gives examples of the optimization of costs in each.   

None of this should be news to the hospitals themselves, but must be understood by regulators and present in regulations. Hospital inspections already examine processes to make sure they meet standards. Those standards, however, currently do not include assessing operating efficiency in any meaningful way.  

The Massachusetts study concluded:

Hospitals vary greatly in their level of operating efficiency, with some capable of delivering high-quality care with lower expenses. These differences between higher- and lower-expense hospitals amount to several thousand dollars per discharge. There are multiple strategies to reduce operating expenses that are being explored around the country, which, if adopted, could enable Massachusetts hospitals to deliver high-quality care at more affordable prices.

Those outcomes — higher quality care at more affordable prices —  are in the public interest in Virginia.  

Given the incredible advantages granted to nonprofit hospitals by the Commonwealth of Virginia by COPN and tax exemptions, it has an obligation to ensure their operating efficiency by regulation and oversight.  

That will include oversight of their structure, makeup, governance reach, and board performance. Finally.

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