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Cost Dynamics Of Frontier Mental Health ServicesLetter to the Field No. 12by James E. Sorensen, Ph.D., CPA, School of Accountancy, University of Denver Table of Contents INTRODUCTIONMental health programs in frontier areas of the United States face many challenges. Frontier areas suffer from a lack of health-care resources (any resources present are often underfunded and understaffed) and an absence of integrated health-care systems. Funding methods are changing as Medicaid expenditures grow and federal funds to states and local governments are concurrently cut. New service systems are developing with a shift from provider-centered to client-centered services. Pressures are increasing for assessment of client and program outcomes and effectiveness. Demands are also increasing for more organized and efficient services, all resulting in a thrust toward managed care (Broskowski, 1991; Feldman, 1992; Wagenfeld, Murray, Mohatt, & DeBruyn, 1994; Van Hook & Ford, 1995; Minden, & Hassol, 1996; Manderscheid & Henderson, 1997; "Study Finds Mental Health Spending," 1998). Managed care is now an omnipresent pressure in health care (American Managed Care and Review Association [AMCRA], 1995). State mental health authorities (SMHAs) are reporting widespread current (or intended) use of managed care operations or contracts and the use of Medicaid funds to finance managed care (Sherman, Zahniser, & Smukler, 1995). While some states with large frontier populations show low penetration of managed care, states with somewhat smaller frontier populations show higher utilization of managed care (AMCRA, 1995). In mental health services, managed care seeks to reduce or eliminate unnecessary services, reduce the costs of care and maintain or increase effectiveness. The aim is to improve client outcomes, control costs, and decrease system fragmentation. The ultimate goal is mental health care equal to or better than in the past for less cost and with more accountability. However, managed care is not without its critics or problems. Managed behavioral health care in its various forms appears to reduce costs and improve access, but the effect on quality has not been conclusively demonstrated (Minden & Hassol, 1996). Reduction of costs in public sector managed behavioral health care programs also remains inconclusive (Minden & Hassol, 1996). As mental health services increase as a part of total health services (Broskowski, 1991), new emphasis is placed on costs and outcomes of these services (Mirin & Namerow, 1991). Managing care requires careful documentation of the costs of services and of clinical outcomes. Strategies to monitor and assess treatment plans and outcomes take many forms ranging from preadmission reviews, continuing treatment authorizations, concurrent review, screens (often computerized), to performance outcome measures (Austin, Blum & Murtaza, 1995). This documentation of cost and outcome can be used, in addition, to respond to consumer and management concerns. Consumers (including clients, employers and payers) are beginning to demand accountability for the consumption of resources and the client outcomes in mental health programs. Good managers of mental health programs need to know how well their program and their clients are doing. Information systems (IS) to meet these needs should focus on systematic cost reports, indicators to assess clinical outcomes, and analyses of costs and outcomes to evaluate cost-effectiveness. Today's complex mental health environment gives neither easy nor clear-cut guidelines for these information requirements. Coping with these constraints and opportunities in a frontier mental health setting requires both efficiency and effectiveness. Efficiency is the accomplishment of objectives at a minimum cost, while effectiveness measures how well objectives are achieved. This Letter focuses on how the key tools of cost analysis can aid the manager of frontier mental health programs in the developing managed care environment. Subsequent Letters to the Field will cover the topics of linking costs and client outcomes and choosing cost-effective management strategies. COST ANALYSIS and REPORTINGManagers of frontier mental health organizations are expected to acquire and use resources to create effective mental health services at minimum cost. Cost containment is also a primary motivation for today's health care reform (Freeman & Trabin, 1994). Sound cost management requires an understanding of cost behavior, cost distinctions for planning and control, and unit-of-service costs (Sorensen, Hanbery & Kucic, 1983). Unit cost information will be increasingly important in the era of managed mental health care (McFarland, Smith, Bigelow, & Mofidi, 1995; Zelman, McCue, & Millikan, 1998). Cost behavior-in total. Management accounting examines cost behavior in relation to volume of activity. As volume of activity varies, a cost may increase proportionally to volume (a variable cost), may not change as volume changes (a fixed cost) or may change in stepwise fashion (a step-variable cost) as volume changes. Some costs may contain both variable and fixed components and are called "mixed costs." The left column of Figure 1 portrays the graphical behavior of these total costs. Copying costs, for example, may vary directly with the number of copies (e.g., a variable cost), while annual lease payments may remain constant (e.g., a fixed cost) regardless of client volume. The number of administrative assistants may increase as the volume of activity (e.g., number of contracts) changes. This cost behaves in a stair-step fashion (e.g., step-variable cost), since each assistant can handle up to a certain number of contracts before another assistant is required. Utilities like heat and light may be mixed costs if there is a minimum (fixed) charge regardless of the level of service and a variable component depending of how much gas or electricity was used beyond the minimum. Cost behavior-per unit. These cost categories, however, take on different behaviors when expressed on a per unit basis. Variable costs on a per unit basis are assumed to be constant. For instance, the first copy costs the same as each subsequent copy. Fixed costs, on the other hand vary inversely with volume. For example, the constant monthly rent is divided by a varying number depending on the volume; lower volumes create higher unit costs while higher volumes create lower unit costs. The step-variable and mixed costs tend to vary inversely with volume since they have a mixture of variable and fixed costs (e.g., the variable costs are constant per unit while the fixed costs vary per unit depending on the volume, thus leading to a decreasing cost per unit as volume increases). The right column of Figure 1 portrays the graphical behavior of these unit costs. Short-run behavior of cost and volume changes deserves a special comment. If a step-variable cost is increased, the cost of the first few units of service after the new cost step is added may be higher than the former unit cost. As volume increases, however, the unit cost drops and is expected eventually (as economic return-to-scale emerges) to be lower than the unit cost before the new cost is added. For example, assume the following:
Cost distinctions for planning and control. Fixed costs can be either committed or discretionary. Committed fixed costs are fundamental (e.g., property taxes, bond interest payments, key personnel) and reflect long-run capacity needs. Typically these costs are not responsive to short run variations in activity. Discretionary fixed costs, on the other hand, are periodic costs influenced by management decisions (e.g., scheduled maintenance, staff training, professional travel). They often bear little relationship to volume of activity. In times of hardship, discretionary fixed costs are subject to reduction, although long-term effects can be negative. Variable costs are either engineered or discretionary. Engineered costs represent a defined cost to produce a given service or product (e.g., cost of a psychologist to perform testing). Shifts in engineered costs change the resulting service or product (e.g., moving from a Ph.D. to a Masters level psychologist). Discretionary variable costs represent managerial choices that may be altered without a fundamental effect on the service or product (e.g., switching from a brand name drug to a generic type). When management is looking for short-term cost reductions, discretionary variable and discretionary fixed costs become prime targets. Often these costs are subject to reduction without immediate adverse effects, but, some, if postponed indefinitely, will produce adverse effects (e.g., training or maintenance). Unit-of-service costs for rate-setting, contracts and performance evaluation. Unit-of-service costs serve several essential purposes:
Unit-of-service cost procedures. Costs are associated with some activity, event,
situation, product, or service--in short, with some cost objective. If the cost objective
is the unit cost of services (or cost-per-unit), competent costfinding requires ten (10)
procedures (Vermont Department of Mental Health, 1988). Table 1
Table 1 summarizes these 10 cost-finding procedures required to produce unit costs for services. Each procedure is linked to an illustrative example in Figure 2. Procedure 1 identifies the organizational units and services as one administrative (and other support) services and two mental health services (A and B) in this hypothetical example. Costs are assigned to each service using procedures 2 through 6 (see footnote 1). Costs are totaled for administration ($60,000) and for the two services (A = $300,000 and B = $200,000). Procedure 7 assigns the administration costs of $60,000 based on the relative cost of each service program (A= $300,000, B= $200,000) to the total organization costs less the assigned costs ($560,000 less $60,000 = $500,000). A is assigned $36,000 ($300,000/$500,000 or 60% of $60,000) and B is assigned $24,000 ($200,000/$500,000 or 40% of $60,000). Total program costs are $336,000 for A ($300,000 + $36,000) and $224,000 for B ($200,000 + 24,000). Procedure 8 defines the units of service and procedure 9 inserts actual (or estimated) levels of service (A = 6720 and B = 3200). Procedure 10 computes the cost of per unit of service for A at $50 ($336,000/6720) and $70 for B ($224,000/3200). Activity-based costing suggests costs should be assigned to cost pools and then to specific services. This two-stage allocation procedure can result in improved cost assignments. For instance, the costs of an information system (e.g., IS personnel, computer, processing costs) may be collected in a cost pool and then assigned to organizational units based on use (e.g., number of transactions or hours of usage). Administrative costs may also be collected in a cost pool and assigned to other organizational units based on the number of full time equivalent (FTE) personnel (e.g., two half-time persons equal one FTE) employed in each unit (e.g., if a unit had 1 FTE out of a total of 10 FTE in the organization, the unit's assignment would be 10%). An illustration of unit costing with typical services. Typical frontier organizations offer five to seven services. Versions of these services along with illustrative definitions include:
Appendix A contains an extended example adapted from an actual frontier mental health organization. It illustrates the foregoing procedures using seven services found typically in frontier service delivery organizations and it offers a guide for the frontier mental manager embarking on an (or evaluating a current) unit-of-service costing system.
Use as a key performance indicator in financial management. Managing mental health organizations with key performance indicators, including unit costs, is expanded by Sorensen, Zelman, Hanbery, and Kucic (1987) to 25 measures covering the mixes of revenues, clients, staff and services. When unit cost performance indicators are computed as budgetary estimates and then compared to actual achievements, the comparison (of budgeted to actual cost per unit of service) can be used to maintain financial control of services and programs. Apparent performance deficiencies (Sherman, 1986) of a service or program indicator may be a function of:
If an entity is not performing up to standards, managerial attention may focus on unit costs where the numerator is cost and denominator is units of service. Numerator issues may include excessive professional, support, operating or overhead costs. Denominator issues may include time devoted to indirect services, time used in administrative activity, time lost in poor time management, excessive leave time, poor productivity requirements, and excessive staff turnover. More refined unit service costs. The Substance Abuse and Mental Health Services Administration (SAMHSA) has sponsored research (Capital Consulting Corporation, 1993) to produced more refined unit service costs. These unit service costs disaggregate the earlier analyses into more specific component costs based on activity based cost (ABC) methods. The approach identifies the activities of the service path in more detail. The following service events are identified and applied to measure program cost profiles (Capital Consulting Corporation, personal communication,1996):
A traditional step-down allocation assigns depreciation, rent and interest, administrative, and other support services to the client-oriented services. An illustrative application of these newer methods is found in Anderson, Bowland, Cartwright, and Bassin (1996, in press) applied to substance abuse treatment program costs. The expanded level of analysis requires a more sophisticated cost accounting and statistical information system than is found usually in frontier mental health organizations. Costs not discussed. A comprehensive concept of costs includes the use of resources, loss of resources and money transfers (Kamper-Jorgensen, 1976). The foregoing analysis bears only on the resources used to provide direct mental health care by a specified organization . Left out are direct services received from other providers (e.g., state hospital inpatient stays, social services), private costs of clients (e.g., transportation to receive mental health services, family burden), loss of resources (e.g., time-off from work or illness episode [loss of earnings and labor productivity], permanent disability [capitalized losses of earnings and labor productivity], destroyed private or public property [via accidents]), and money transfers (e.g., governmental benefits or pensions and personal income taxes paid). Sharfstein and Clark (1978), however, challenge public money transfers as "costs." Money transfers such as public aid, disability pension pay, disability insurance receipts or other cash payments do not use up resources, but only transfer title to resources from one group to another. The expanded version of costs is more likely to be accounted for in controlled cost-effectiveness or cost-benefit research studies. Role of the Independent Public Accountant (Auditor). In most states with frontier service areas, the independent public accountant (usually a Certified Public Accountant or CPA), is required to examine and report on the financial statements of the mental health organization(s). Audits by a CPA requires adherence to the American Institute of Certified Public Accountants (AICPA) Audits of Providers of Health Care Services (1994), referred to as the Health Care Audit Guide, or the AICPA Audits of Not-for-Profit Organizations (1996), referred to as the Not-for-Profit Audit Guide. The Health Care Audit Guide applies to 1) investor-owned businesses, 2) not-for-profit enterprises with no ownership interest and are essentially self-sustaining from fees or 3) a governmental entity. The Not-for-Profit Audit Guide may be appropriate for a non-governmental Voluntary Health and Welfare Organization (VHWO) if a not-for-profit organization provides services to individuals, but derives its revenues primarily from voluntary contributions. The not-for-profit status implies 1) contributions are a significant source of resources and the resource providers do not expect any meaningful pecuniary returns, 2) operating purposes other than profits, and 3) an absence of a business type ownership. A mental health organization that derives a majority of its support from public grants and donations (rather than fee for services, capitated care contracts or other health care payment arrangements) may use the audit guide for Guide for Not-for-Profit Organizations. If an organization qualifies as a non-governmental VHWO, then a Statement of Functional Expenses is required (along with the Balance Sheet, the Statement of Activities, and the Statement of Cash Flows). The Statement of Functional Expenses assigns costs to program services and supporting services of the organization. When these costs by service are related to the units of service provided, unit costs can be derived. Alert funding agencies (e.g., State Department of Mental Health) will add additional reporting requirements for the auditor to review and evaluate the statistical information system and to express an opinion on the units of service and/or clients service in relation to the basic financial statements taken as a whole and the related costs per unit of service. Typically the independent auditor is involved in detecting undisclosed liabilities. A major liability could arise because of inaccurate reporting on costs and services to one or more funding agencies. Because of a need to identify undisclosed liabilities as part of the audit, the independent auditor must review both the accounting and statistical systems related to unit costs, thus nominal costs are incurred usually by expanding the reporting requirements to unit-of-service costs. By adding the independent auditor's opinion to the unit costs, however, the power and credibility of the unit costs are increased enormously. Now the unit costs are appropriate for contracting, reimbursement, internal financial management and as an input to cost-outcome and cost-effectiveness analyses. For Colorado mental health service providers funded by the Department of Human Services-Mental Health Services, as an example-the independent auditor is required to review the expenses assigned to services and the accumulation of units of service and is required to express an opinion on the service unit costs (see "Chapter 5: Auditing and Financial Reporting Guidelines" in the 1997 Acounting and Auditing Guidelines, Mental Health Services, Colorado Department of Human Services.)
Schedule of Unit Costs Example The Schedule of Unit Costs (Figure A.1) follows the 10 procedures outlined in Table 1 and Figure 2.
The remaining lines on Figure A.1 are adjustments made to comply with state regulations and reporting requirements. Line 9 subtracts donated resources (since they are not allowed by the state) to compute a net reimbursable rate on line 10. Since there are no donated resources in this example, the adjustments are all zero amounts. Line 11 identifies the unit cost rate from the prior fiscal year and computes a dollar change (line 12) and a percentage change from the prior year (line 13). Lines 12 and 13 are used to track the changes in unit costs to assess the increasing (or decreasing) direction and to test the reasonableness of rate changes from the prior year. Figure A.1 Schedule of Unit Costs Figure A.2 Schedule of Time Allocation American Institute of Certified Public Accountants. (1994). Audits of providers of health care services. New York: Author. American Institute of Certified Public Accountants. (1996). Audits of not-for-profit organizations. New York: Author. American Managed Care and Review Association. (1995). 1994-95 managed health care overview. Washington, DC: AMCRA Foundation. Anderson, D.A., Bowland, B.J., Cartwright, W.S., & Bassin, G. (1995). Drug abuse treatment costs: Findings from a new methodology. Research Triangle Park, NC: Research Triangle Institute, Center for Economics Research. Anderson, D.A., Bowland, B.J., Cartwright, W.S., & Bassin, G. (in press). Service level costing of drug abuse treatment. Journal of Substance Abuse Treatment. Austin, M.J., Blum, S.R., & Murtaza, N. (1995). Local-state government relations and the development of public sector managed mental health care systems. In M.J. Austin & S.R. Blum (Eds.), Public sector planning for managed mental health care. Administration and Policy in Mental Health, 22(3), 203-215. Broskowski, A. (1991). Current mental health care environment: Why managed care is necessary. Professional Psychology: Research and Practice, 22, 6-14. Capital Consulting Corporation. (1993). Uniform system of accounting and cost reporting for substance abuse treatment providers (SAMHSA contract number 271-91-8327). Fairfax, VA: Author. Colorado Department of Human Services, Office of Health and Rehabilitation Services, Mental Health Services. (1997). Accounting and auditing guideline. Denver, CO: Author. Feldman, S. (1992). Managed mental health services. Springfield, IL: Charles C. Thomas. Freeman, M., & Trabin, T. (1994). Managed behavioral healthcare: History, models, key issues, and future course. Rockville, MD: U.S. Center for Mental Health Services, Substance Abuse and Mental Health Services Administration. Kamper-Jorgensen, J. (1976). Cost-benefit analysis in mental health services. Copenhagen: World Health Organization. Manderscheid, RW & Henderson, MJ (1997). Federal and state legislative and program directions for managed care. In E.J. Mullen & J.L. Magnabosco (Eds.), Outcomes measurement in the human services: Cross-cutting issues and methods. Washington, DC: NASW Press. McFarland, B.H., Smith, J.C., Bigelow, D.A., & Mofidi, A. (1995). Administration and Policy in Mental Health, 23, 27-42. Minden, S. & Hassol, A. (1996). Final review of available information on managed behavioral health care. Rockville, MD: Center for Mental Health Services. Mirin, S.M. & Namerow, M.J. (1991). Why study treatment outcome?. Hospital and Community Psychiatry, 42, 1007-1013. Sharfstein, S. & Clark, H.W. (1978). Economics and the chronic mental patient. Schizophrenia Bulletin, 4, 399-414. Sherman, P.S. (1986). Uses of performance measurement systems. In C. Windle, J.H. Jacobs, & P.S. Sherman (Eds.), Mental health program performance measurement (DHHR Pub No (ADM) 86-1441). Washington, DC: National Institute of Mental Health. Sherman, P.S., Zahniser, J., & Smukler, M. (1995). S.M.H.A.'s managed care practices. Evergreen, CO: resources for human service managers, inc. Sorensen, J.E., Hanbery, G.W., & Kucic, A.R. (1983). Accounting and budgeting for mental health organizations. Washington, DC: US Government Printing Office. Sorensen, J.E., Zelman, W., Hanbery, G.W., & Kucic, A.R. (1987). Managing mental health organizations with 25 key performance indicators. Evaluation and Program Planning, 10, 239-246. Study finds mental health spending cut in half over last decade. (1998, May 7). Wall Street Journal. Van Hook, M.P., & Ford, M. (1995). Linking mental and primary health care in rural areas. Administration and Policy in Mental Health, 22, 633-641. Vermont Department of Mental Health. (1988). Mental health/mental retardation guidelines: Services, accounting, auditing, key performance indicators. Montpelier, VT: Agency of Human Services. Wagenfeld, M.O., Murray, J.D., Mohatt, D.F., & DeBruyn, J.C. (1994). Mental health and rural America: 1980-1993 An overview and annotated bibliography (NIH Publication No. 94-3500). Washington, D.C.: Office of Rural Health Policy (HRSA) and Office of Rural Mental Health Research (NIMH). Zelman, W., McCue, M., & Millikan, A. (1998). Financial management of health care organizations: an introduction to fundamental tools, concepts and applications. Malden, MA: Blackwell Publishers, Inc.
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