Question

Article:Mr. Pasture was concerned about Green Guard’s profitability. Last year, Green Guard negotiated with Arc Electric to charge a fixed premium of $250 per employee per month. The total premium revenue is allocated as follows: 55% to hospital and surgical services, 30% to physician visits, and 15% for other services, administration, and profit. These allocations are used to establish budgets in the different departments at Green Guard. The Arc Electric contract would expire next month, at which time Green Guard would need to renegotiate the terms of its contract with Arc Electric. Mr. Pasture feared that Green Guard would have to request a sharp rate increase to remain profitable. Green Guard’s monthly cost of administering the health plan was fixed, but the increases in the use of health care services were eroding Green Guard’s profits. He suspected that other health plans were planning to increase premiums by 5-10 percent, which was reasonable given the recent statistics on national health expenditures. A report from 2004, the most recent he could find, indicated that total national health expenditures rose 7.9 percent from 2003 to 2004 -- over three times the rate of inflation.

Exhibit 1 Monthly Report of Health Care Utilization Total Costs Incurred - Arc Electric, Inc.

Category of Service	July 2006	August 2006
Hospital Services– Inpatient	$203,425	$212,250
Hospital Services – Outpatient	$182,440	$212,250
Surgical Services	$101,250	$103,400
Physician Office Visits	$337,900	$391,450
Administrative Expenses	$90,000	$90,000
TOTAL	$915,015	$977,800

Number of members, July 31, 2006: 4129

Number of members, August 31, 2006: 4137

Using only the information provided in Exhibit 1, explain why further analysis of physician visits may be needed. Compare the profitability of hospital and surgical services to physician services, using the allocation of revenue that was given. Show the breakdown of the $250 premium using a pie chart. Does the allocation of the $250 per employee per month payment across the types of health care services seem reasonable, given the past two months’ utilization?

Answer 1

The total of August 2016 is wrong in this table. It actually is 1,009,350 and all calculations below will be based on it.

While the total expenditure increased by only 6%, physician office visits expenditure increased by 15%. Physician office visits also have the biggest slice of the expenditure pie. In August 2016 physician visits accounted for 40% of total expenditure which is huge. It means either the company is either paying a lot to their physicians or they are visiting the office a lot. Either way, this can be reduced by limiting the no. of office visits or charging more after a certain number of visits or its cost can be compensated by charging more from the company. One thing to note here is that the Green Guard allocated 30% to physician visits while spending 38% on them. The company does not allocate the revenue by guessing, they have data from previous customers and from other companies so the Green Guard needs to investigate further into the matter.

Hospital and surgical services meant to account for 55% of total revenue but its expenditure is 52% of the total expenditure and physician office visits should account for 30% of total expenditure but they are 38%. so Hospital and surgical services are clearly more profitable because physician visits are causing losses to the company. In absolute terms, expenditure for Hospital and surgical services should be 568,837.5 but it is 527,900 while physician expenditure should be 310,275 while it is 391,450.

Category of Service	Cost(July)	Cost(August)
Hospital Services– Inpatient	49.26737709	51.30529369
Hospital Services – Outpatient	44.1850327	51.30529369
Surgical Services	24.52167595	24.99395697
Physician Office Visits	81.83579559	94.62170655
Administrative Expenses	21.79704529	21.75489485
Profits	28.39307338	6.018854242
Total	250	250

Cost(August) , Hospital Services- Inpatient 21.75 6.02 51.31 , Hospital Services, Outpatient Surgical Services Physician Office Visits 94.62 51.31 Administrative Expenses 24.99 . Profits

Cost(July) Hospital Services-Inpatient 28.39 21.80 49.27 Hospital Services- Outpatient Surgical Services 44.19 Physician Office Visits 81.84 24.52 Administrative Expenses Profits

It can be seen that due to a sharp increase in expenses in August profit margin greatly declined. In July the company got earned $28.39 from every employee while in August it earned only $6.02 per employee. To earn 20% profit given that expenditure increased 10% in the month and assuming it will be the same next month the company will have to increase the premium by:

1,009350 + 10% = 110285 ( this is the predicted expenditure in the next month)

To earn 20% profit:

110285 + 20% = 1332342 which given the no. of employees be the same gives us $322 per employee