An alternative to trauma activation fees: How to use cost-based charging to generate positive margin

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Trauma activation fees are attracting significant media attention. A recent report found that activation fees have risen sharply in the last 6 years and vary widely between hospitals. But according to Mike Williams, president of The Abaris Group, a trauma center consulting firm, activation fees are not just controversial, they are deeply flawed as a mechanism for funding trauma care.

“Trauma centers are getting quite a bit of pushback from payers and the media about activation fees,” Williams said. To avoid trouble, many hospitals set their activation fee by benchmarking against other comparable trauma centers. Williams believes there are two problems with this approach.

First, benchmarking shows what other trauma centers charge, but not whether those charges are appropriate or connected with their actual costs. “What if other hospitals’ activation fees are wrong?” Williams asked.

Second, most trauma fee benchmarks are out of synch with financial reality. “The activation fee looks like a lot of money, but for most trauma centers it doesn’t even begin to cover the real costs of the trauma program,” Williams said. “The fact is that most trauma centers do not charge enough for their services.”

According to Williams, the key to operating a financially sustainable trauma center is to base charges on trauma program costs. Recently, he explained the steps for developing a cost-based charging system for trauma care.

Step 1: Quantify direct and indirect costs
The first step to establishing a cost-based charging system is to identify the trauma program’s total costs. As a starting point, focus on two categories:

Direct costs are all costs directly related to patient care. This category includes labor costs for trauma nurses and the cost of equipment and supplies assignable to the trauma service.

Indirect costs are hospital overhead expenses allocated to the trauma program. These can include billing department and other support staff costs; tax, finance, insurance and legal expenses; facility costs, including utilities and maintenance; and IT and telecommunications expenses. Indirect costs can also include labor costs for nursing staff in units that support the trauma service.

Note that some costs can be considered direct or indirect depending on how the finance department sees them. “These costs include expenses related to program administration, including salaries for the director, program manager, registrars and others,” Williams said.

Step 2: Identify unique trauma program costs
For trauma centers, traditional direct and indirect cost categories are just the starting point. Trauma centers — especially Level I and Level II programs — incur many unique expenses. Program leaders often failed to account for these costs when evaluating program finances.

“Other than direct patient care costs, a trauma center’s largest costs are its payments to physicians for trauma coverage,” Williams said. Hospitals must account for these payments when calculating total program costs. “You also need to try to capture the cost of your prevention programs and the full cost of your registry program,” Williams said. Under the Orange Book, ACS-verified trauma centers need to increase their investment in both programs.

The goal is to look at the whole range of costs that contribute to trauma care. “Trauma centers are increasingly providing case management services,” Williams said. “For example, the hospital might have a patient navigator who shepherds patients through the system, provides continuity of care and helps the trauma program leverage its surgeons.”

Case management is not only a true program cost, it can help the trauma program develop a more defensible charge structure. “Some payers will gladly pay for case management, because it can cut down length of stay and get patients out of the hospital faster,” Williams said.

Step 3: Establish a realistic margin
Once you have captured all the costs of running a trauma program, the next step is to build in appropriate allowances. “A one-to-one ratio on cost-to-price is not adequate,” Williams said. Two considerations are important:

Uncollectable amounts. If a trauma program is going to cover its costs, finance leaders need to take a realistic look at net collections. “Some payers will not pay 100% of your charges, and some will not pay on time,” Williams said. “You need to figure out your uncollectables and build these amounts into program costs.”

Margin. To ensure financial sustainability, trauma charges must include an operating margin. “You need to decide what margin you need on your trauma program, because there will be lean times,” Williams said. He recommends targeting an operating margin of between 8% and 12%.

Step 4: Array costs through services
After you have quantified total trauma program costs (including uncollectables and margin), the final step is to array those costs across the services provided by the program.

The trauma center can use several different “vehicles” for distributing costs into charges, Williams said. “You could array costs through the room charge only, through individual team member activations or through a variety of other vehicles, which is what we recommend.”

The starting point
For most trauma programs, the biggest obstacle to adopting cost-based charging is the hospital accounting department. “Hospitals in general are still struggling to better define their costs, and many do not have a very good cost accounting system,” Williams said.

It is important to develop a cost recovery system that can allocate direct and indirect costs to the trauma program. That means the program must be structured as a cost center with its own profit-and-loss statement. “The trauma program must have its own P&L,” Williams said. “That’s key to tracking program costs specifically, especially for overhead and administration.”

Do the math
While cost-based charging requires an investment in administrative resources, Williams believes this investment will pay off in the long term. “We are learning that trauma centers need to get much more ‘mathematical’ about how they arrive at their charges,” Williams said. “A consistent cost-based method for establishing charges is more defensible with payers. And it will put you in a much stronger position with regard to the media.”

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