Cost Allocation
In a prospective pay and managed care environment, identifying and controlling costs per covered life is crucial for medical practices. To control costs per covered life, a practice management professional must understand the costs of its healthcare services.
The first step in achieving this objective is for practices to understand what activities they perform (outputs) and what resources (inputs) go into performing these activities. Examples of outputs include surgical and radiology procedures; inputs include support staff labor, physician labor, supplies, rent, and insurance. Input costs can allocate to one or more activities to determine cost per activity or procedure. Evaluation at this level helps practices benchmark cost performance and budget and analyze payer contracts.
Using input and output data collected in the survey, Data Solutions developed an activity-based cost allocation model that allocates medical practice input costs to medical practice outputs. The model calculates operating cost, provider cost, and total cost per procedure. We collected the procedure and charge data for the six types of medical practice activities listed in Table 1: Outputs, Procedures, and Charges.
Cost data fell into two categories: operating cost and provider cost, as shown in Table 2: Inputs, Costs, and Allocation Patterns. These data provided the framework for the model.
Due to the complexity of the model, a case study best illustrates the model’s structure, how costs allocate to activities, and the method used to determine cost per procedure. The medical practice in the example is a multispecialty practice with 40 FTE physicians. Tables 1 and 2 show the case study data. This case study only calculates total cost per procedure. We applied the same logic to generate the operating cost per procedure and provider cost per procedure data that appear in the Cost and Revenue Survey tables.
Step 1: Identify the procedure(s) to receive cost allocations. Data Solutions staff analyzed each cost in Table 2 to determine which procedure or procedures should receive an allocation of the cost. We considered the type of procedure and whether the procedure took place inside or outside the practice. Depending on the costs’ characteristics, we allocated costs to one or multiple types of procedures. For instance, general administrative support staff cost and total physician cost allocate to all six types of procedures (A through F), while registered nurses’ support staff costs allocate only to medical and surgical procedures that took place within the practice (A and C). Clinical laboratory costs allocate only to laboratory procedures (E). In Table 2, the Cost Allocation Pattern column shows the allocation pattern for each cost.
The following summary outlines the cost allocation patterns in Table 2, where the letters refer to the procedure types described in Table 1:
ABCDEF – All procedures
ACEF– Medical and surgical procedures that occur inside the practice’s facilities and the ancillary procedures of laboratory and radiology
AC – Medical and surgical procedures that occur inside the practice’s facilities but not ancillary procedures
E – Laboratory procedures only
F – Radiology procedures only
Step 2: Determine the total cost associated with each cost allocation pattern. Using the last column in Table 2 to identify the cost allocation pattern, sum the associated costs for each pattern. For example, the first five cost rows listed in Table 2 would all be added to the total for pattern ABCDEF, and so on. The second column of Table 8: Total Cost per Procedure Worksheet lists total costs for each pattern. This column sums to $21,780,000, which is equal to total cost listed on the bottom row of Table 2.
Table 1: Outputs, Procedures, and Charges
| Procedure Type | Procedure (Activity) Name | Number of Procedures | Total Gross Charges |
|---|---|---|---|
| A | Medical procedures inside the practice | 200,000 | 200,000 |
| B | Medical procedures outside the practice | 30,000 | 30,000 |
| C | Surgery and anesthesia procedures inside the practice | 10,000 | 10,000 |
| D | Surgery and anesthesia procedures outside the practice | 10,000 | 10,000 |
| E | Clinical laboratory and pathology procedures | 135,000 | 135,000 |
| F | Diagnostic radiology and imaging procedures | 25,000 | 25,000 |
| Totals | 410,000 | $38,600,000 |
Table 2a: Inputs, Costs, and Allocation Patters (APP as a Provider Cost)
| Inputs (Type of Cost) | Cost | Cost Allocation Pattern |
|---|---|---|
| General administrative | $400,000 | ABCDEF |
| Patient accounting | $400,000 | ABCDEF |
| General accounting | $100,000 | ABCDEF |
| Managed care administrative | $200,000 | ABCDEF |
| Information technology | $100,000 | ABCDEF |
| Housekeeping, maintenance, security | $20,000 | ACEF |
| Medical receptionists | $500,000 | ACEF |
| Medical secretaries, transcribers | $200,000 | ABCDEF |
| Medical records | $200,000 | ABCDEF |
| Other administrative support | $30,000 | ACEF |
| Registered Nurses | $100,000 | AC |
| Licensed Practical Nurses | $500,000 | AC |
| Medical assistants, nurse’s aides | $600,000 | AC |
| Clinical laboratory | $300,000 | E |
| Radiology and imaging | $200,000 | F |
| Other medical support services | $250,000 | ACEF |
| Total employed support staff benefits | $800,000 | ABCDEF |
| Total contracted support staff | $300,000 | ABCDEF |
| Total operating cost, support staff | $5,200,000 | |
| Information technology | $225,000 | ABCDEF |
| Drug supply | $500,000 | AC |
| Medical and surgical supply | $275,000 | AC |
| Building and occupancy | $1,000,000 | ACEF |
| Building depreciation | $350,000 | ACEF |
| Furniture and equipment | $300,000 | AC |
| Furniture and equipment depreciation | $175,000 | AC |
| Administrative supplies and services | $300,000 | ABCDEF |
| Professional liability insurance | $450,000 | ABCDEF |
| Other insurance premiums | $10,000 | ABCDEF |
| Legal fees | $15,000 | ABCDEF |
| Consulting fees | $10,000 | ABCDEF |
| Outside professional fees | $60,000 | ABCDEF |
| Promotion and marketing | $35,000 | ABCDEF |
| Clinical laboratory | $700,000 | E |
| Radiology and imaging | $300,000 | F |
| Other ancillary services | $150,000 | ACEF |
| Billing and collections purchased services | $0 | ABCDEF |
| Management fees paid to MSO or PPMC | $100,000 | ABCDEF |
| Miscellaneous operating cost | $1,375,000 | ABCDEF |
| Cost allocated to practice from parent organization | $0 | ABCDEF |
| Total operating cost, general | $6,330,000 | |
| Total operating cost | $6,330,000 | |
| Total nonphysician provider cost | $250,000 | AC |
| Total physician cost | $10,000,000 | ABCDEF |
| Total provider cost | $10,250,000 | |
| Total cost | $21,780,000 |
Table 2B: Inputs, Costs, and Allocation Patters (APP as an Operating Cost)
| Inputs (Type of Cost) | Cost | Cost Allocation Pattern |
|---|---|---|
| General administrative | $400,000 | ABCDEF |
| Patient accounting | $400,000 | ABCDEF |
| General accounting | $100,000 | ABCDEF |
| Managed care administrative | $200,000 | ABCDEF |
| Information technology | $100,000 | ABCDEF |
| Housekeeping, maintenance, security | $20,000 | ACEF |
| Medical receptionists | $500,000 | ACEF |
| Medical secretaries, transcribers | $200,000 | ABCDEF |
| Medical records | $200,000 | ABCDEF |
| Other administrative support | $30,000 | ACEF |
| Registered Nurses | $100,000 | AC |
| Licensed Practical Nurses | $500,000 | AC |
| Medical assistants, nurse’s aides | $600,000 | AC |
| Clinical laboratory | $300,000 | E |
| Radiology and imaging | $200,000 | F |
| Other medical support services | $250,000 | ACEF |
| Total employed support staff benefits | $800,000 | ABCDEF |
| Total contracted support staff | $300,000 | ABCDEF |
| Total operating cost, support staff | $5,200,000 | |
| Information technology | $225,000 | ABCDEF |
| Drug supply | $500,000 | AC |
| Medical and surgical supply | $275,000 | AC |
| Building and occupancy | $1,000,000 | ACEF |
| Building depreciation | $350,000 | ACEF |
| Furniture and equipment | $300,000 | AC |
| Furniture and equipment depreciation | $175,000 | AC |
| Administrative supplies and services | $300,000 | ABCDEF |
| Professional liability insurance | $450,000 | ABCDEF |
| Other insurance premiums | $10,000 | ABCDEF |
| Legal fees | $15,000 | ABCDEF |
| Consulting fees | $10,000 | ABCDEF |
| Outside professional fees | $60,000 | ABCDEF |
| Promotion and marketing | $35,000 | ABCDEF |
| Clinical laboratory | $700,000 | E |
| Radiology and imaging | $300,000 | F |
| Other ancillary services | $150,000 | ACEF |
| Billing and collections purchased services | $0 | ABCDEF |
| Management fees paid to MSO or PPMC | $100,000 | ABCDEF |
| Miscellaneous operating cost | $1,375,000 | ABCDEF |
| Cost allocated to practice from parent organization | $0 | ABCDEF |
| Total operating cost, general | $6,330,000 | |
| Total nonphysician provider cost | $250,000 | AC |
| Total operating cost | $6,330,000 | |
| Total physician cost | $10,000,000 | ABCDEF |
| Total provider cost | $10,000,000 | |
| Total cost | $21,780,000 |
Step 3: Use procedural gross charges data to calculate ratios of specific procedure charges to total charges.
The cost allocated to each procedure type depends on the gross charges generated by each procedure compared to total gross charges for all procedures. In this case study, Table 1 shows the charges generated by each procedure type. For example, surgical procedures performed outside the practice generated 33.68 percent of the total gross charges for cost allocation pattern ABCDEF (see row D in Table 3). For costs that allocate to all procedures (the ABCDEF pattern costs), surgical procedures performed outside the practice would share 33.68 percent of the ABCDEF total costs. In the model, the ratios of procedure gross charges to total gross charges determine the proportion of total cost allocated to each procedure type.
For each cost allocation pattern, Data Solutions summed the gross charges for each type of procedure (see the bottom row of Tables 3 through 7 for these sums). Then, we calculated the ratios of procedure charges to total charges (the allocation ratios) by dividing the individual procedure charge amount by the total gross charges. Tables 3 through 7: Ratio of Procedure Charges to Total Charges for Cost Allocation Patterns present the complete set of ratios for all cost allocation patterns.
Step 4: Calculate the total cost allocated to each procedure type. The structure of the cost allocation model is now in place. Table 8: Total Cost per Procedure Worksheet illustrates the final step in this process. Data Solutions determined the total cost allocated to each procedure by multiplying the total cost (column 2 of Table 8) by the appropriate ratio of procedure charges to total charges.
Table 3: Ratio of Procedure Charges to Total Charges for Cost Allocation Pattern ABCDEF
| Procedure Type | Procedure Name | Total Gross Charges | Ratio of Procedure Charges to Total Charges |
|---|---|---|---|
| A | Medical procedures inside the practice | $11,000,000 | 0.2850 |
| B | Medical procedures outside the practice | $6,300,000 | 0.1632 |
| C | Surgery and anesthesia procedures inside the practice | $1,300,000 | 0.0337 |
| D | Surgery and anesthesia procedures outside the practice | $13,000,000 | 0.3368 |
| E | Clinical laboratory and pathology procedures | $4,000,000 | 0.1036 |
| F | Diagnostic radiology and imaging procedures | $3,000,000 | 0.0777 |
| Totals | $38,600,000 | 1.0000 |
Table 4: Ratio of Procedure Charges to Total Charges for Cost Allocation Pattern ACEF
| Procedure Type | Procedure Name | Total Gross Charges | Ratio of Procedure Charges to Total Charges |
|---|---|---|---|
| A | Medical procedures inside the practice | $11,000,000 | 0.5699 |
| C | Surgery and anesthesia procedures inside the practice | $1,300,000 | 0.0674 |
| E | Clinical laboratory and pathology procedures | $4,000,000 | 0.2073 |
| F | Diagnostic radiology and imaging procedures | $3,000,000 | 0.1554 |
| Totals | $19,300,000 | 1.0000 |
Table 5: Ratio of procedure Charges to Total Charges for Cost Allocation Pattern AC
| Procedure Type | Procedure Name | Total Gross Charges | Ratio of Procedure Charges to Total Charges |
|---|---|---|---|
| A | Medical procedures inside the practice | $11,000,000 | 0.8943 |
| C | Surgery and anesthesia procedures inside the practice | $1,300,000 | 0.1057 |
| Totals | $12,300,000 | 1.0000 |
Table 6: Ratio of procedure Charges to Total Charges for Cost Allocation Pattern E
| Procedure Type | Procedure Name | Total Gross Charges | Ratio of Procedure Charges to Total Charges |
|---|---|---|---|
| E | Clinical laboratory and pathology procedures | $4,000,000 | 1.0000 |
| Totals | $4,000,000 | 1.0000 |
Table 7: Ratio of procedure Charges to Total Charges for Cost Allocation Pattern F
| Procedure Type | Procedure Name | Total Gross Charges | Ratio of Procedure Charges to Total Charges |
|---|---|---|---|
| F | Diagnostic radiology and imaging procedures | $3,000,000 | 1.0000 |
| Totals | $3,000,000 | 1.0000 |
Then, Data Solutions summed the costs for each combination. Table 8 displays the sums of these costs (the total cost allocated to each procedure type) in columns A through F.
For example, the following calculates the total cost allocated to “medical procedures inside the practice”:
$15,280,000 × 0.2850 = $ 4,354,800
$ 2,300,000 × 0.5699 = $ 1,310,770
$ 2,700,000 × 0.8943 = $ 2,414,610
Total = $ 8,080,180
Table 8, column A presents a total of $8,080,180. The other five procedures allocate total costs in a similar manner.
Step 5: Calculate total cost per procedure. Divide the total cost allocated to each procedure type by the total number of procedures for each procedure type to get the total cost per procedure. Table 8 displays the final results for this case study.
Analyzing the data at the procedural level is now possible. This information can help assess a practice’s fee schedule and the impact of managed care discounts. Also, the data is useful in evaluating capitation contracts and a baseline measurement when compared to national medians. Tables *.11b through *.11g of each data section in the report display these national standards.
Table 8: Total Cost per Procedure Worksheet
| Cost allocation pattern | Total cost for each pattern | Procedure Type | |||||
| A | B | C | D | E | F | ||
| Medical procedures inside the practice | Medical procedures outside the practice | Surgery and anesthesia procedures inside the practice | Surgery and anesthesia procedures outside the practice | Clinical laboratory and pathology procedures | Diagnostic radiology and imaging procedures | ||
| Ratio of procedure charges to total charges by cost allocation pattern | |||||||
| All procedures (ABCDEF) | $15,280,000 | 0.2850 | 0.1632 | 0.0337 | 0.3368 | 0.1036 | 0.0777 |
| Medical/ surgical inside and lab/ radiology (ACEF) | $2,300,000 | 0.5699 | 0.0674 | 0.2073 | 0.1554 | ||
| Medical/ surgical inside (AC) | $2,700,000 | 0.8943 | 0.1057 | ||||
| Laboratory (E) | $1,000,000 | 1.0000 | |||||
| Radiology (F) | $500,000 | 1.0000 | |||||
| Total | $21,780,000 | ||||||
| Total cost allocated to each procedure type | |||||||
| $8,080,180 | $2,493,696 | $955,346 | $5,146,304 | $3,059,798 | $2,044,676 | ||
| Total number of procedures | |||||||
| 200,000 | 30,000 | 10,000 | 10,000 | 135,000 | 25,000 | ||
| Total cost per procedure | |||||||
| $40.40 | $83.12 | $95.53 | $514.63 | $22.67 | $81.79 | ||