Protect Against Outliers That Destroy Your Profitability Under a Contract

Let’s conclude the first part of our look at how to negotiate fees in risk contracts. So far, we have explored a relatively easy way for a physician or medical group to identify a target capitation rate or global budget, and to ensure that the patients a managed care plan offers are compatible with your existing patient base. But there is one factor that will complicate your profit-and-risk assessment dramatically: outliers!

In this context, outliers refers to patients with medical problems beyond the expected range in your practice. For primary care physicians, this may mean a frequent office visitor, a patient with AIDS or one with a rare form of cancer. For an oncologist, outliers would probably be limited to patients requiring high-cost, rare treatment protocols. Regardless, outliers increase the quantity and cost of services–often substantially. For a physician, one or two outliers can have a dramatic effect on the profitability of a managed care relationship.

This insight yields three lessons. One: Whenever possible, look for a way to minimize outliers. One method would be to limit the services you agree to provide, contractually, to those that will not likely result in excessive utilization. Then, if a patient requires special procedures, you may refer him out or provide those services for a separate fee, as you may negotiate.

Two: Your willingness to negotiate a lower capitated monthly rate should be directly related to how well you are insulated financially from outliers. Often, it makes sense for a managed care organization to accept the cost of outliers because of its deeper pockets. Other times, the provider is at risk up to a negotiated amount, after which the health plan is responsible for treatment costs. Also, stop-loss insurance can provide a cushion against outliers. It may make sense for the managed care company to purchase stop-loss insurance and offer it back to you, because its size often allows it to obtain more favorable premiums than an individual practitioner can negotiate (though this is not always true).

The more, the better

Three: The more patients, or covered lives, that a plan can promise, the lower the risk that outliers will hurt your practice financially. Generally speaking, the larger the patient panel, the smaller the impact of a patient’s unanticipated catastrophic illness on your bottom line. This, in turn, means that your profitability from a negotiated capitated rate will usually be more stable with a larger panel.

For example, say one health plan offers a physician 350 covered lives, and another plan offers only 50. If each plan pays a capitated rate of, say, $9.30 per member, per month, the physician’s revenues would be $39,060 from the larger plan and $5,580 from the smaller plan. Now assume that both plans’ patients average 2.8 office visits per year, and that both plans have three patients who are outliers averaging 1.0 office visits a month. The result is an increase of 33.2 office visits per year for each plan (from 980 to 1013.2 for the larger plan, and from 140 to 173.2 for the smaller plan).

Without the outlier patients, both plans would effectively offer compensation of $39.86 per office visit ($39,060 divided by 980 office visits for the bigger plan, and $5,580 divided by 140 office visits for the other). But because of the outliers, average compensation per visit for the larger plan becomes $38.55–a $1.31 reduction per office visit, or just over 3 percent. For the smaller plan, compensation drops substantially, to $32.22 for each office visit–a $7.64 reduction per visit, or almost 20 percent! Even at these marginal levels, outliers can create a significant problem for a practice–especially when he is in a small pool of patients.

Learning from experience

This type of analysis is important even when you are not looking at unexpected illnesses. One of my clients, a Midwest internist, signed on with a health plan after undertaking an analysis of the mix of services he would offer to it. His existing patient base included sicker patients who required internal medicine services, and healthier patients who used less costly services. Unfortunately, upon joining the plan, my client discovered that a large number of family practitioners were already in his service market. These physicians had captured most of the plan’s generally healthy members, and now welcomed the opportunity to refer sicker patients to the internist after cherry picking the routine cases. Thanks to his contract, my client’s patient profile was skewed toward the more serious–and, more expensive–cases. He lost a significant amount of money under the contract before he bailed out. The lesson here is to try to determine whether a plan’s available members might be costly outliers because their needs exceed those of the patients on whose profiles you based your fee negotiation.

Finally, before you enter into any pricing negotiations with a managed care organization, recognize your options if talks break down. When a health plan and a provider cannot come to terms on payment amounts, the provider has four options:

  1. Reduce earnings expectations: Will you accept less profit than you first sought?
  2. Reduce costs per service: Can you reduce overhead associated with services in the contract, or will the plan agree to some streamlined screening or other cost-saving measures?
  3. Reduce utilization/services provided: Can you eliminate certain high-cost or low-profit services from the capitated rate?
  4. Walk away. Are you prepared to say “no”?

Remember, if you don’t need the contract, you will have greater leverage in negotiation. “No” is a powerful negotiation tool.

Neil Caesar is president of The Health Law Center (Neil B. Caesar Law Associates), a national health law consulting practice in Greenville, S.C.

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