Time-Driven Activity-Based Costing: A Better Way to Understand the Cost of Caring for Hip Fractures

Background

Healthcare expenditure in the United States has risen drastically over the past several decades; it constituted 17.8% of the gross domestic product (GDP) in 2015, and is projected to reach 20% by 2021, far outpacing the rate of inflation. ¹ Hip fractures alone cost $17 billion annually, ² and are expected to rapidly increase in incidence in the coming decades as the population ages. ³ In response to rising expenses there has been a movement by payers toward alternative payment models (APMs) such as bundled payments to contain costs. Bundled payments have already been implemented in orthopaedic care in total joint replacement ^{4 -7} and are on the horizon for orthopaedic trauma. ^4,5,8,9 These models shift risk to physicians or hospitals depending on the convener and replace traditional fee-for-service models, which reward high volumes with a new focus on value. Value in healthcare is defined as outcome over cost for a specific condition; an equation wherein patient outcomes achieved serve as the numerator and the cost of care serves as the denominator. ¹⁰

Patient-reported outcomes (PROs) are increasingly collected for both research and clinical practice as a gold standard of outcomes measurement ^11,12 : The American Board of Orthopaedic Surgery (ABOS) now collects PROs for Part II board certification, and The Centers for Medicare & Medicaid Services (CMS) encourage reporting of PRO data for joint replacement. ¹³ PRO data will continue to be central to improving outcomes as we shift toward a value-based healthcare system. However, identifying the cost of care delivery across healthcare organizations has proved a significant challenge. Idiosyncratic costing policies and accounting systems among hospitals and health systems prevent fair comparisons of costing between systems, and traditional hospital accounting methods are not linked to conditions or outcomes. Nor are they measured over a complete cycle of care for a particular condition. In the complex field of orthopaedic trauma, there has been little inquiry into the actual costs of hip fracture care. In contrast to arthroplasty, the patient population of hip fractures is heterogeneous and difficult to model; creating challenges around policy making and development of optimized value based care. Furthermore, there is little transparency that might guide efforts to improve processes or reduce costs without sacrificing patient outcomes, making traditional costing methods untenable for value-based payment models, which require knowledge of the cost of treating a condition at the patient level. ¹⁴

Time-driven activity-based costing (TDABC) has been presented as a costing solution well suited to the value-based healthcare movement. TDABC estimates costs of care based on the rate of consumption of each resource in a care cycle by a patient. Using process mapping and time equations, TDABC is able to capture the true complexity of activities at the patient level, while also accounting for the many care pathways among heterogeneous populations like hip fracture patients. ^15,16 As a methodology that combines accurate costing with opportunities to optimize care delivery, TDABC meets the need for value-based costing that will be required before APMs can be feasible for hip fracture care.

Costing Methodologies

Traditional hospital cost accounting methodology uses a “top-down” approach, in which all direct and indirect costs are accounted for by summing total costs and then allocating costs to patients using arbitrary cost-to-charge ratios (CCRs). This approach allows for larger-scale financial evaluations and ensures solvency, but is not accurate at the patient-level because it assumes that each type of service utilizes indirect costs in the same proportion and from a single shared well without regard to differences in time or personnel required on an individual basis. ^{16 -19} Relative value units (RVUs) are, in theory, more refined than CCRs because they estimate the time and complexity of services before allocating costs to specific procedures. However, they are imprecise, leading to “unintended cost distortions” in practice. ¹⁸ Neither CCRs nor RVU account for time-based differences among individual instances of the same procedure and current billing and reimbursement practices further foster obfuscation in costing data. ¹⁸

Activity-based costing (ABC), developed in 1988 by Cooper et al, ²⁰ assigns activity costs to all services according to their consumption. Using a “bottom-up” approach, ABC determines the unit cost for each resource by using employee estimates of time devoted to each activity, as well as the costs of the materials and equipment used in the activity. By sorting indirect and overhead costs into distinct pools that can be allocated on an individual basis according to actual utilization. ABC accounts for indirect costs more precisely than traditional hospital costing. However, relying on self-reported time estimates introduces bias, particularly because productivity is often reported at 100% theoretical capacity, when in reality productivity levels tend to be closer to 80-85% of theoretical capacity. ¹⁹ This bias puts cost driver rates too high. Furthermore, the implementation of ABC is an enormous burden in terms of data collection and analysis. Whenever there is a change the entire model requires updating, including re-interviewing staff to update the cost drivers of activities. ¹⁹

Time-driven activity-based costing (TDABC) was developed as a response to the accuracy issues and burdens of employing ABC. It requires just 2 parameters: (1) cost per unit time of an activity at practical capacity, and (2) unit times of consumption of the resource or, in simpler terms, time required to perform the activity. ¹⁵ Applying these parameters to the healthcare setting can be accomplished through a series of 7 steps laid out by Kaplan and Porter, ²¹ in which (1) a medical condition is selected, (2) the care delivery value chain identified and (3) process maps generated for each step of a patient’s care delivery chain. (4) Time estimates are obtained for each process step and (5) the cost of supplying all patient care resources is calculated, including direct and indirect costs. (6) Capacity cost rates are then calculated for each resource, typically by estimating 80% of theoretical cost rates, and finally, (7) total costs are calculated by multiplying capacity cost rates for each resource used in each step by the time spent by the patient with each resource.

Indirect costs accounted for by TDABC include informational technology (IT), administration, maintenance, and billing. Other overhead costs not directly related to patient care, such as construction and legal services, are excluded. By performing a practical capacity rate adjustment, TDABC also captures indirect personnel costs such as benefits, vacation time, sick days, etc. Notably, the indirect costs included in TDABC methodology are generally those considered as overhead to the healthcare institution, and do not account for wider nonmedical and societal costs, such as patients’ travel expenses or time lost from work. With a stronger focus on costs that are more under the control of the provider, there is more opportunity to increase value.

The granular level of analysis derived through TDABC essentially creates “apples” for comparison where fair comparison is otherwise impossible. Its process maps lend the model the visibility necessary to reveal high cost-drivers, non-value-added steps and unused resource capacity; which can then inform decisions about how to optimize value over the care cycle.

Barriers and Limitations

TDABC is not without its limitations. Lower costing results from TDABC have frequently been attributed to greater accuracy than traditional methods, when in fact these results can only truly be called different. ²⁹ Because TDABC excludes substantial indirect overhead costs, it can neither guarantee solvency nor replace traditional methodology for capturing total costs. ³³ Furthermore, direct and indirect costs, while calculated at the patient level, are considered from the institution’s perspective, and cannot account for wider indirect costs to patients and society that are typically accounted for in traditional cost-effectiveness analyses, for example: transportation, childcare expenses, lost time, and reduced productivity.

Assuming a uniform capacity cost rate for all departments’ activities may also be problematic, particularly in the healthcare field where some providers have no unused capacity costs. For example, while a practical capacity adjustment is logical for some salaried positions such as nurses, for whom benefits and lost productivity due to vacation and sick time contribute to indirect cost, other providers such as surgeons utilize costing structures that allocate pay by the unit of service provided regardless of time spent, making capacity adjustments in these cases inappropriate. Ultimately, TDABC is a new methodology with much still to prove, yet its strength lies in its combination of meticulous costing and process mapping, which produce not only micro-costing results, but opportunities to improve efficiency and value.

Challenges remain in the application of TDABC. Initial implementation is expensive and resource heavy, especially the creation of process maps. Existing software is not well integrated with institutional financial processes. Current information systems are not set up to calculate costs or determine the exact amount of time each resource used, ³⁴ and it is difficult to determine the amount of time spent on patient care outside of direct patient interactions. ¹⁶ At the systemic level, fee-for-service payments tend to penalize lower-cost higher-quality care, which will impede TDABC-driven improvements until alternative payments are more widely implemented. ^14,17 Furthermore, there seems to be little agreement on how to implement TDABC in the healthcare system, with huge variations in the application of TDABC methodology.

Among these variations the prime example is in the inclusion of indirect costs. Some include indirect costs as a flat rate portion. One study assumed indirect costs to be 60% of direct costs, ¹⁶ while another assumed indirect costs to be 16.5% of total costs. ²² Still another assumed indirect costs to be 43.8% of the difference between revenue and cost. ²⁷ Others include some indirect costs, such as medical testing and cleaning, but not building, equipment utilities, or administration. ²⁵ Many studies exclude indirect costs completely. ^26,28 It should be noted here that, perhaps anticipating this issue, Kaplan rejects the “myth” that indirect costs cannot be accounted for, and denounces the “peanut butter” approach of estimating costs as a flat-rate portion of direct costs in his article, “How to Solve the Cost Crisis in Health Care,” though he does not offer an alternative method to calculate indirect costs. One systematic review recommends that a set of principles be standardized to guide TDABC implementation, especially in regard to indirect costing, proposing that, at a minimum, maintenance, informational technology (IT), hospital administration, and billing costs be included as standard in TDABC costing since these are most commonly recorded and constitute the largest sources of indirect cost. ¹⁹

These and other considerations regarding the development of process maps, adjustments from theoretical to practical capacity, and the determination of what constitutes a full care pathway would benefit from a set consensus, and from carefully following all steps outlined by Kaplan and Porter. ²¹ This would allow for better comparison across systems and prepare providers for the implementation of alternative payment models.

Conclusion

Employing TDABC in hip fracture care will require support and sponsorship from executives and hospital administration, engagement from providers and dedicated project management, particularly at the beginning. ²⁹ However, once a curriculum for TDABC is standardized, the benefits will be sundry: a transparent and shared understanding of costs among surgeons, clinicians, administrators, and finance professionals within and across organizations. This can inform decisions regarding resource allocation and process improvement, align incentives to optimize treatment across care delivery chains, and mitigate risk in future value-based payment initiatives—this is the denominator of value-based healthcare.