Flying Under the Radar: The Converging Paths of Drones and Hospital Administrative Expenses




Tom Robertson, Executive Director, Vizient Research Institute

I was walking on a bluff overlooking Lake Michigan just before sunset when the peaceful lapping of the waves was interrupted by what sounded like a swarm of angry bees. The hum alternately grew louder then faded. Glancing up, I saw not a swarm of bees but a hovering camera, held aloft by four vertical propellers, with blinking red and green lights. A drone. It was my first close encounter with one of the tiny airships and it prompted me to do a little reading about the phenomenon of private drones. What I discovered surprised me.

There are 2.5 million drones flying in the U.S.; their typical range is two or three miles. A circle with a radius of 2 miles has an area of 12.5 square miles. The continental U.S. covers 2.9 million square miles. That means, if evenly spaced, 232,000 drones could cover the United States without overlapping their territories. We have 11 times as many drones in service today and sales are expected to add another 2.8 million buzzing hover craft this year. What had been a novelty – encountering a drone on an evening walk – is likely to become a regular occurrence as millions of the aircraft flit around overhead. The rapid expansion of drones has largely gone unnoticed until now, but we will reach a threshold where they will become impossible to ignore and the prospect of unintended consequences is likely.

Two articles, one recently published in JAMA and the other appearing in Health Affairs in 2014, cite a marked run up in hospital administrative expenses over the past decade. Largely occurring under the radar, the growth in administrative costs for hospitals may come as something of an unexpected surprise, not unlike the proliferation of drones. And like an increasingly crowded air space, the rate of increase in hospital administrative costs has consequences.

Administrative expenses now account for 25% of total hospital costs. Between 2000 and 2011, hospital administrative costs increased by 7.4% per year, outpacing costs directly related to patient care, which increased by 6.5% over the same period. The U.S. economy, meanwhile, was growing at a rate of 3.8% per year. The higher rate of increase in administrative expenses intensified pressure on hospitals to increase prices or grow volume to prevent erosion of margins. It is interesting to note that the observed growth in administrative costs occurred during a time of consolidation marked by mergers, acquisitions, and the formation and expansion of health systems, all of which were predicated at least in part on the promise of economies of scale – and the expectation that expenses would be spread over a larger base, reducing unit costs. With administrative costs growing faster than total costs, the evidence seems to indicate that the anticipated economies of scale failed to materialize.

By contrast, administrative expenses account for significantly lower percentages of total hospital costs in many other European countries and Canada, an observation that is even more striking when you consider that total hospital costs in those countries are much lower than those in the United States. Canada, the Netherlands, and England have administrative costs that represent 12.4% to 19.8% of their total hospital expenses. In 2010, hospital costs per capita in those countries were 38% to 52% lower than the $2,634 in the United States. Hospital administrative costs per capita were nearly three times higher in the U.S. than in peer OECD countries. Since 2010, additional expenditures for electronic medical records and ACO infrastructure have only added to the administrative costs for U.S. hospitals.

It is tempting to attribute the higher administrative costs here to the Byzantine patchwork of public and private payers. Proponents of a single-payer system might argue that hospital administrative costs would plummet – perhaps even coming in line with OECD peers, if we simplified the payment system. It is not immediately clear that the numbers support such an assertion.

According to a 2013 study by McKesson, administrative expenses associated with the “revenue cycle” – everything from patient registration and eligibility verification through billing and ultimate collection – consumed 2.6% to 4.2% of hospital net revenue. A single-payer system may well reduce revenue cycle costs, but even if those costs were cut in half, the savings would be in the order of magnitude of 1% to 2%, amounting to only a marginal impact on what has grown to be 25% of total hospital costs.

A major contributing factor behind the rapid expansion of hospital administrative costs is the investment in infrastructure to support risk-sharing and other provider reactions to recurring cycles of public policy founded on the assumption that financial incentives for lower utilization would make health care more affordable. Integrated delivery networks from the 1990s have been reincarnated as accountable care organizations since 2010, each time prodding hospitals and health systems to invest millions of dollars in administrative capabilities chasing what have turned out to be elusive systemic savings.

The administrative dilemma facing hospitals is more complicated than can simply be attributed to an inefficient payer system. Compliance with a complex web of regulations, an intricate system of reporting requirements, and an almost insatiable compulsion to measure nearly everything, results in an enormous amount of activity that is not directly involved in patient care. One category of administrative expense that is directly related to patient care – IT infrastructure and electronic medical records – has added billions of dollars in incremental administrative costs to hospital operating statements.

It would be disingenuous not to mention another fundamental difference between health care in the U.S. and other countries that contributes to the higher administrative costs here. American health care is a business. Competition for market share, an arms race for facilities and equipment, expenses associated with business development, mergers and acquisitions, and the preservation of sometimes redundant competitive programs all play a role in driving administrative costs higher in the U.S. delivery system.

The increase in administrative costs has to some extent snuck up on the hospital industry, the result of a wide range of business decisions that each had merit, but the combined impact now has serious implications for the financial well-being of hospitals and the affordability of health care for the American middle class. Now accounting for 25% of total hospital costs and growing faster than direct clinical costs and twice as fast as the rest of the economy, administrative costs have hit the radar screen.

About the author and the Vizient Research Institute. As executive director of the Vizient Research Institute, Tom Robertson and his team have conducted strategic research on clinical enterprise challenges for 20 years. The groundbreaking work at the Vizient Research Institute drives exceptional member value using a systematic, integrated approach. The investigations quickly uncover practical, tested results that lead to measurable improvement in clinical and economic performance.

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