How You Can Get the Most Out of Contract Negotiations


Last month, we lamented some physicians’ indifference towards the contract negotiation process–the result of which is unprofitable, impractical managed care contracts. This attitude makes it unlikely that a managed care organization will view any such physician as a premier partner deserving of special entitlements or responsibilities. Instead, managed care will become a drain on profits–not an opportunity for growth.

As health care reform continues to reshape markets, the consequences of indifferent negotiation will only become worse. Poor contractual arrangements will make physicians more vulnerable to losses from fee withholds, capitation and other risk-shifting models. The same problems stemming from poor contracts become issues of confrontation when added to those concerning duties and entitlements of members of a provider alliance.

Of course, the reverse holds true as well. Because alliance options (physician-hospital organizations, independent practice associations, provider-sponsored organizations) exist–each with its own advantages–the best approach for successful contract negotiation will depend on the type of alliance to which you belong. But two rules of thumb can be applied to any negotiations.

First, fact-finding is an essential part of effective negotiation. During the process, you must assess your ability to meet certain contractual obligations and to maximize value from contract opportunities. This means that a significant part of the negotiation process will include discussion about the managed care organization itself.

Investigate the company’s background, reliability and history. The key is to remember why you want this information: First, to identify whether you should get involved with the company at all; and second, to identify which of yours and the managed care organization’s weaknesses need to be addressed in future talks. In other words, effective contract negotiation requires you to resolve issues created by a plan’s idiosyncrasies, as well as issues created by your own idiosyncrasies.

Know your needs

Second, your self-assessment should answer the question, “What do I want out of this?” While the answer may seem simple, it is not. A physician who wants to prevent erosion of an existing patient base, for example, should care more about contract security and patient protection than should a group seeking to penetrate a new market. As another example, if you are willing to assume financial or other risks in exchange for greater reward, you will be concerned with contract provisions that offer autonomy and prompt informational support. Unfortunately, many providers limit their self-assessment to, “If we don’t sign this contract, someone will steal all of our patients! How much of a discount do they want?” Put another way, “Can I make this bad dream go away?”

That is a shame. When a managed care contract is shaped by a thorough and realistic assessment of your needs and goals, it will be far more likely to be profitable and satisfying. You also learn when a health plan is unable or unwilling to offer an attractive contract.

Identifying your needs, wants and goals can be broken down into three discrete tasks:

  • Determine what you can afford or are willing to accept financially.
  • Determine what you can manage and are willing to manage.
  • Determine what support and/or protections you will need from the health plan to achieve a fiscal comfort level and to manage the contractual relationship effectively.

The first task, determining what you can afford and are willing to accept, requires you to develop quantifiable data about internal costs and realistic profit expectations. When you can track outcomes, you can identify expenditures that lead to improved long-term results and patient satisfaction–key elements of any capitated or budgeted relationship.

By the formula

This does not require sophisticated computer models. There are many ways to approach this. Here is a simple example.

Step One: Determine your costs of providing services, expressed in terms of relative value units. To figure costs, first determine the RVU for each contracted service you intend to offer. Alternatively, a quicker way to answer this question with rough accuracy is to identify RVUs for, say, 20 top procedures.

Next, identify operational overhead, excluding salaries and other compensation paid to owners (e.g., the physician shareholders in a medical practice). Be sure to address variable costs incurred while rendering the service, as well as a portion of the fixed costs that are necessary to support these services but that do not vary with volume (e.g., rents and most personnel costs). Remember to include billing services, fees paid to accountants and administrative salaries.

To determine cost per RVU, divide aggregate RVUs by aggregate, fully loaded operational overhead costs associated with those RVUs. That is, divide values determined two paragraphs above by those of the next paragraph. The result is your incremental break-even threshold–the amount of revenue you need to pay care-related expenses.

Step Two: Determine income per RVU. Identify your aggregate income for the services you want to analyze, and divide that amount by the aggregate RVUs for those services. Or, if you can determine average reimbursement for a service, divide that amount by the RVUs associated with that service. (Remember to differentiate between fees charged and amounts ultimately collected. Contract disallowances and bad debts should be deducted from revenue calculations.)

Step Three: Identify your profit margin by subtracting costs per RVU (step one) from revenues per RVU (step two). The result is your gross profit on a unit basis. Now you have enough information to anticipate profit levels from discounted fee-for-service contracts. The impact a 10-percent fee reduction would have on profits can be determined by taking the per-unit revenue (step two), reducing it by 10 percent, then subtracting the per-unit cost (step one).

If you know what profit level you can afford, you can figure an acceptable discount. Remember, any additional costs imposed by the contract (including bookkeeping and personnel time associated with working under a plan’s procedures) will reduce profits. On the other hand, a contract that reduces incremental costs will improve profits. For example, if the additional patient base offered by a health plan allows you to make use of excess resources (an underutilized second office, for example), this reduces your unit costs.

Additional calculations are required to assess how many (and what sort of) financial risks you may be ready to assume under capitation or global budgets, as well as to assess the cost-effectiveness of various treatment protocols.

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