The annual budget process for the hospital typically starts about six months before the start of the new fiscal year on October 1. The challenges of the local healthcare market and the unfavorable trends in healthcare reimbursements have made the annual business planning process more difficult for many managers.
As a result, the involvement of our physicians in this annual planning exercise is becoming an increasingly important ingredient to the ultimate realization of a meaningful outcome.
Although the process itself can be complex, the driving factors that ultimately impact
earnings are quite straightforward. The process emanates from a multi-year financial plan that provides targeted earnings for all Partners affiliates. These earnings targets are determined by forecasting cash requirements to provide adequate cash reserves, to fund capital outlays, and to cover debt repayments. An earnings surplus or positive margin is needed to produce adequate cash flow to cover the above needs. As a not for profit organization, the hospital does not need to reserve any of its cash flow to pay dividends but it does need a favorable margin for these other purposes. Based on a forecast of the combined cash flow requirements of all affiliates within Partners, a 3% overall profit margin is needed. BWH's share of this margin is 3.9%, with the current multi-year plan moving toward that earnings target over a four-year period. For the 2001 fiscal year, the targeted margin for the hospital is 1.5%.
The next step is to calculate a preliminary budget gap by adding to the margin target a projection of operating results with estimated adjustments for cost inflation and rate increases. The hospital's initial gap for FY01 ranged between a $40-50 million shortfall, which becomes the hurdle to overcome.
A significant issue for BWH is the size of its gap and the persistence of the factors that contribute to this gap. Over the past several years, the hospital has been financially challenged by an increasing imbalance between annual cost inflation and corresponding increases in payment rates. This problem is not particular to BWH. The majority of Massachusetts hospitals are suffering from the same conditions. The principal culprit has been and continues to be a deterioration in rate relief from Medicare (BBA reduction), Medicaid (long intervals between fee schedule updates), and managed care payers (below cost pricing) and continuing inflationary pressures on the health care industry. The imbalance or "gap" for Brigham is about 4-5% with net revenue updates averaging 1-2% and cost inflation running at 5-6%.
There are two basic ways to eliminate a gap. Either business has to grow at a favorable variance between incremental costs and revenues or operating costs have to be cut. With the good fortune of having an increasing demand for hospital services at BWH, our gap solutions have concentrated on increasing revenues by growing patient volume and increasing the intensity of care in our product mix.
However after several years of successfully employing this gap closing strategy, an effective means to overcome capacity constraints had to be identified to continue employing a revenue solution to close the gap. This resulted this year in a concerted and focused effort to move non-tertiary services to Faulkner Hospital and to backfill the relieved capacity at BWH with high acuity services. This "move" strategy will allow BWH to accommodate 1462 new discharges, of which 607 will replace transferred patients and 862 will occupy expanded inpatient facilities with the expansion of ICU capacity and a limited reconfiguration of inpatient beds.
The final results of our FY01 budget process is a small projected gap of $1.4 million but with favorable earnings of $9.3 million on total revenues of $981 million or just
under a 1% profit margin. With future growth increasingly becoming capacity bound, our challenge in future years will be to effectively address inadequate payment updates from managed care products and to seriously consider dropping our most unprofitable payers.