TRANSFORMATIONAL PRICING ESTABLISHING DEFENSIBLE PRICING IN TRANSPARENT TIMES

TRANSFORMATIONAL PRICING: ESTABLISHING DEFENSIBLE PRICING IN TRANSPARENT TIMES WESTERN MICHIGAN REVENUE CYCLE CONFERENCE January 20, 2016 Presented by: Scott Houk, CPA Cleverley + Associates shouk@cleverleyassociates. com

Today’s Objectives 1) Understand how providers are approaching transparency and defensibility 2) Discuss the payment implications for making transformational pricing changes 3) Achieve meaningful change for patients through pricing objectives that move charges closer to payment and/or existing and emerging competition |2|

HOW ARE HOSPITALS APPROACHING TRANSPARENCY/DEFENSIBILITY?

• • 2014 Survey: 78 hospital finance leaders representing 185 hospitals and health systems 2015 Survey: 58 hospital finance leaders representing 156 hospitals and health systems Linkage of both to facility charge information via Hospital Charge Index® Results published in HFMAs hfm (September 2014 Cover Story) and Strategic Financial Planning publications (Summer 2015 Cover Story) Facility-level charge measure: Hospital Charge Index® Inpatient Charges Inpatient Charge Index Formula: Your Medicare Charge per Discharge (CMI/WI adj) US Median Medicare Charge per Discharge (CMI/WI adj) Outpatient Charges Outpatient Charge Index Formula: Your Medicare Charge per Visit (RW/WI adj) US Median Medicare Charge per Visit (RW/WI adj) How hospitals approach transparency/defensibility Provider research |4|

Source: Cleverley + Associates How hospitals approach transparency/defensibility What does pricing transparency mean to you? |5|

Source: Cleverley + Associates How hospitals approach transparency/defensibility How do you currently communicate prices to your patients? |6|

Source: Cleverley + Associates How hospitals approach transparency/defensibility What makes a pricing strategy defensible? |7|

Source: Cleverley + Associates How hospitals approach transparency/defensibility If you make your charges public (transparent), are you confident that you can defend and explain those charges when compared to other facilities? |8|

Source: Cleverley + Associates How hospitals approach transparency/defensibility What makes a pricing strategy defensible? |9|

Source: Cleverley + Associates How hospitals approach transparency/defensibility Is pricing transparency a factor you consider when planning yearly rate adjustments? | 10 |

WHAT CDM ACTIONS ARE HOSPITALS TAKING?

Inflationary Changes by Metric & Year What CDM actions are hospitals taking? Hospital charge inflation is decreasing | 12 |

Average Annual Inflation by Charge Growth Quartile Groups (2011 -2014) Source: Cleverley + Associates What CDM actions are hospitals taking? Rate change varies significantly | 13 |

Inflation Impact on Hospital Charge Index® by Charge Growth Quartile Groups Source: Cleverley + Associates What CDM actions are hospitals taking? Rate change can quickly alter a hospital’s relative charge position | 14 |

MIDWEST 2011 HCI 93. 3 2011 HCI 118. 3 2014 HCI 91. 6 2014 HCI 114. 0 IP Inflation 4. 0% IP Inflation 2. 9% OP Inflation 3. 6% OP Inflation 2. 8% NORTHEAST 2011 HCI 87. 4 2014 HCI 83. 6 IP Inflation 3. 1% OP Inflation 2. 6% SOUTH 2011 HCI 115. 0 2014 HCI 117. 1 IP Inflation 5. 3% OP Inflation 5. 1% What CDM actions are hospitals taking? Rate change and charge positions vary by region | 15 |

Average Annual Rate Change by Charge Growth Quartile Groups (2011 -2014) Lowest Charge Growth Group Lower Charge Growth Group Highest Charge Growth Group All U. S. Group Emergency Room -4. 5% -0. 8% 0. 3% 3. 1% 0. 2% Surgical Procedures -1. 5% 3. 4% 6. 7% 2. 8% Imaging 1. 2% 4. 2% 6. 5% 9. 5% 5. 9% Lab 1. 2% 4. 0% 5. 6% 8. 2% 5. 5% Therapy 0. 7% 3. 2% 4. 8% 6. 4% 4. 3% Routine Room Rates 1. 8% 4. 4% 4. 7% 7. 3% 4. 9% What CDM actions are hospitals taking? Key products/services are experiencing different levels of change | 16 |

What CDM actions are hospitals taking? External price pressures are increasing – primarily in “retail” areas | 17 |

PAYMENT IMPLICATIONS FOR PRICING CHANGES

Desired Net Income o Sustainable growth determines reasonableness of target Competitive Position o Quality o Cost o Market Share o Capital Intensity o Payer Mix Market Structure PRICE o Buyers/Sellers o Barriers to Entry o Price Elasticity Payment implications for pricing changes Three spheres of influence on price | 19 |

Average Cost per Patient = $100 Payer Medicare Medicaid Uninsured Managed Care Other Totals Number of Patients 50 10 5 30 5 Net Payment per Patient $92. 50 $75. 00 $125. 00 ? ? ? 100 Total Payment $4, 625 $750 $25 $3, 750 ? ? ? Total Cost $5, 000 $1, 000 $500 $3, 000 $500 $9, 150 $10, 000 less Total Cost less Required Profit $10, 000 $500 Balance Remaining ($1, 350) Payment implications for pricing changes Payment is the real key in determining hospital pricing Required Payment from Five Remaining Patients = $270 ($1, 350/5) | 20 |

Pricing Model – Formula for price-setting Use this model for price-setting at facility level: Price must increase when: Average cost increases Price = avg cost + (NI + fixed pay margin) charge volume (1 - charge discount) Net income requirements increase Losses from fixed pay business increases The percentage of charge paying patients decreases Payment implications for pricing changes Payment is the real key in determining hospital pricing The discount from charges increases | 21 |

Pricing Model – Sample Calculation Average Cost per Patient = $100 Average cost = $100 Net income = $4 (4%) Average fixed payment = $100 Average fixed pay margin = Charge payers = Charge discount = Required price = $0 20% 30% $171. 43 Payment implications for pricing changes Payment is the real key in determining hospital pricing | 22 |

Pricing Model – Sensitivity Analysis Average Cost per Patient = $100 MODEL Net income = Fixed pay margin = Charge payers = Charge discount = Required price = # 1 # 2 # 3 $4 (4%) $1 30% 50% $220 $4 (4%) -$3 15% 60% $367 $4 (4%) $0 100% 5% $109 Payment implications for pricing changes Payment is the real key in determining hospital pricing | 23 |

Pricing Model – Revising the formula to evaluate margin impact from desired pricing Net = [(Price X (1 - charge discount) - avg cost) X charge volume] + fixed pay margin income Average Cost per Patient = $100 MODEL Required price Desired price Resulting average margin # 1 # 2 # 3 $220 $109 -$12. 65 $367 $109 -$11. 46 $109 $3. 55 Payment implications for pricing changes Payment is the real key in determining hospital pricing | 24 |

Annual loss of net revenue associated with differing levels of charge reduction and pricing recovery (based on hospital with $500, 000 in gross charges) RATE OF REDUCTION RECOVERY RATE 10% 20% 30% 40% 5% (2, 500, 000) (5, 000) (7, 500, 000) (10, 000) (12, 500, 000) 10% (5, 000) (10, 000) (15, 000) (20, 000) (25, 000) 15% (7, 500, 000) (15, 000) (22, 500, 000) (30, 000) (37, 500, 000) 20% (10, 000) (20, 000) (30, 000) (40, 000) (50, 000) 25% (12, 500, 000) (25, 000) (37, 500, 000) (50, 000) (62, 500, 000) Payment implications for pricing changes Financial costs of payment reductions | 25 |

Payment implications for pricing changes Recovery is variable because of lesser-of provisions | 26 |

ACHIEVING MEANINGFUL CHANGE

Achieving meaningful change Process Commit to transparency Develop initial guiding policies and goals Current Price: $220 New Price: $104 | 28 |

1 2 External Policy Internal Policy o Public facing document for patients to view o Meets or exceeds national and state requirements (as applicable) o Goals for future release of pricing and payment information to the community o Guiding principles on how strategic pricing and pricing transparency will be developed and evaluated Achieving meaningful change Commit to transparency/defensibility with clear policies and goals | 29 |

FY 2015 Final Rule: In the FY 2015 IPPS/LTCH PPS proposed rule (79 FR 28169), we reminded hospitals of their obligation to comply with the provisions of section 2718(e) of the Public Health Service Act. We appreciate the widespread public support we received for including the reminder in the proposed rule. We reiterate that our guidelines for implementing section 2718(e) of the Public Health Service Act are that hospitals either make public a list of their standard charges (whether that be the chargemaster itself or in another form of their choice), or their policies for allowing the public to view a list of those charges in response to an inquiry. Med. PAC suggested that hospitals be required Achieving meaningful change Commit to transparency/defensibility with clear policies and goals to CMS-1607 -F 1205 post the list on the Internet, and while we agree that this would be one approach that would satisfy the guidelines, we believe hospitals are in the best position to determine the exact manner and method by which to make the list public in accordance with the guidelines. | 30 |

1 2 3 ROI Model Peer Position Cost Markup Achieving meaningful change How will prices be defended? | 31 |

Return on Investment Model Relating pricing to ROI: the public-utility approach Public utilities have used a Return on Investment (ROI) model to justify price increases to rate regulatory boards. The approach isolates the price variable from the ROI formula (below) and “tests” the remaining elements. If it can be proven that ROI, Cost, and Investment are not excessive, then price must also not be excessive. ROI Formula ROI = (volume x price) - (volume x cost) investment Achieving meaningful change 1 Tests 1. Is ROI excessive? 2. Is cost excessive? 3. Is investment excessive? If “no” to all three, price is not excessive. | 32 |

Return on Investment Model MI US Return on Equity 6. 1 8. 7 Hospital Cost Index® 95. 6 101. 2 Fixed Asset Turnover 2. 60 2. 44 Average Age of Plant 11. 6 10. 4 Achieving meaningful change 1 Return On Equity: Excess of Revenue over Expenses/Net Assets Fixed Asset Turnover: Total Revenue/Net Fixed Assets Average Age of Plant: Accumulated Depreciation/Depreciation Expense | 33 |

Achieving meaningful change 2 Peer Position Model Comparing your pricing to pricing at peer facilities Level of Comparison Metric FACILITY Hospital Charge Index® Level of Detail Medicare Charge per Discharge (CMI/WI adj) Medicare Charge per Visit (RW/WI adj) DEPARTMENT BETOS Analysis INPATIENT CASE Charge by MS-DRG OUTPATIENT CASE Charge by APC PROCEDURE Price by CPT®/HCPCS Code Bundling CPT® is a registered trademark of the American Medical Association. All rights reserved. | 34 |

Cost/Markup Model Sources of cost data 1) Hospital cost-accounting system Strategy: Relate prices to cost markup (same or different by department) o o Direct Cost Fully allocated cost 2) RCCs Achieving meaningful change 3 Two usual outcomes 1) Reduced net patient revenue, e. g. , $5. 1 million vs. $9. 6 million in ATB 2) Major pricing changes -99% to 3, 580% | 35 |

Achieving meaningful change Process Commit to transparency Develop initial guiding policies and goals Current Price: $220 Understand your current position Compare pricing and know where pressure exists New Price: $104 | 36 |

WHO? ? Secondary/Tertiary Hospital Market Core Hospital Market SERVICES? ? Achieving meaningful change Compare prices from multiple perspectives Non- Hospital Market PRICE PRESSURE? ? | 37 |

Hospital Charge Index® Achieving meaningful change Understand how prices are changing | 38 |

Achieving meaningful change Determine where price pressures are coming from | 39 |

Achieving meaningful change Understand current margin levels by payer and product | 40 |

Michigan US Net Patient Revenue per Equivalent Discharge™ 7, 638 8, 650 Operating Margin 2. 1 3. 4 Achieving meaningful change Understand current margin levels by payer and product | 41 |

Achieving meaningful change Process Commit to transparency Develop initial guiding policies and goals Current Price: $220 Understand your current position Compare pricing and know where pressure exists Model impact Understand the financial implications through price, payment, cost and profit modeling New Price: $104 | 42 |

Rate freeze Across the board reductions Cost based approaches FINANCIAL IMPACT CONTINUUM MORE IMPACT LESS IMPACT Reduce pricing for select areas/codes Achieving meaningful change General impact associated with various rate strategies Outpatient/Retail price creation for all codes Outpatient/Retail price creation for select codes | 43 |

Strategy Incremental Charges Net Revenue Impact Additional impact from outlier/lesserof change Across the board reduction $XXX Cost based approach to 2 X $XXX Imaging to freestanding average $XXX Retail pricing for lab $XXX Reduce outpatient prices by 40% $XXX Achieving meaningful change Model impact of different strategies to determine best fit | 44 |

Achieving meaningful change Understand specific impact of different strategies | 45 |

Achieving meaningful change Process Commit to transparency Develop initial guiding policies and goals Current Price: $220 Understand your current position Compare pricing and know where pressure exists Engage in Model mitigation impact Discuss with payers Understand the financial implications through price, payment, cost and profit modeling New Price: $104 | 46 |

Achieving meaningful change Making large changes will likely require payment term changes | 47 |

Article excerpt regarding case hospital Achieving meaningful change Making large changes will likely require payment term changes | 48 |

Contract Carve-out Original Charges Proposed Charges Incremental % Profit Change Payer 1 - PPO I All Other $XXX Payer 1 - PPO I Csection DRG $XXX Payer 1 - PPO I Normal Delivery $XXX Payer 1 - PPO I Normal Newborn DRG - Per Diem $XXX $XXX Payer 1 - PPO I Nursery - General, Newborn - Level 1, Other Ancillary $XXX $XXX Payer 1 - PPO I Nursery - Newborn - Level 2 Ancillary $XXX $XXX Payer 1 - PPO I Nursery - Newborn - Level 3 Ancillary $XXX Payer 1 - PPO O All Other $XXX Payer 1 - PPO O Payer-Provider FS $XXX Payer 1 - PPO O Payer-Provider OP Surg $XXX Payer 1 - PPO O Critical Care $XXX Payer 1 - PPO O ER Level 1 $XXX Payer 1 - PPO O ER Level 2 $XXX Payer 1 - PPO O ER Level 3 $XXX Payer 1 - PPO O ER Level 4 $XXX Payer 1 - PPO O ER Level 5 $XXX $XXX Payer 1 - PPO O Obs - Per Hour Ancillary $XXX Payer 1 - PPO O OP Cardiac Cath $XXX Payer 1 - PPO O Trauma Act $XXX Achieving meaningful change Isolating specific term impact can facilitate easier discussions | 49 |

Commit to transparency Develop initial guiding policies and goals Current Price: $220 Understand your current position Compare pricing and know where pressure exists Engage in Model mitigation impact Discuss with payers Understand the financial implications through price, payment, cost and profit modeling Communicate Revise policies and goals Achieving meaningful change Process New Price: $104 | 50 |

Does the strategy: Meet net income expectations? Maintain or enhance competitive position? Maintain or correct related pricing relationships? Achieving meaningful change Evaluating the rate strategy Establish equitable distribution to case categories? Establish equitable distribution to payers? Meet transparency/defensibility objectives? | 51 |

Summary • Transparency and defensibility initiatives are increasing across the US as hospitals face pressure from patients, payers, and new/existing providers of care. However, there is still significant variation in how individual hospitals are responding. • Hospital pricing is impacted by various demographic and operating factors – among them, payment is critical in rate establishment and change. Payment recovery can change with various rate changes as additional outlier and lesser-of provisions are triggered. • Committing to increased transparency and defensibility can lead to transformational pricing change through policy/goal development, evaluating current and proposed price positions, and communicating with payers and patients. | 52 |

Thank you. Questions? Scott Houk Director, Consulting Services Cleverley + Associates Email: shouk@cleverleyassociates. com Phone: (614) 543 -7777 | 53 |