Neil Caesar, J.D.
MANAGED CARE March 1998. ©1998 Stezzi Communications

Neil Caesar, J.D.

The ability of a physician or medical group to determine an affordable fee payment level is a cornerstone of effective managed care contract negotiation. Last month, we focused on an easy way for a practice to identify its current profit margin for clinical services. From this information, the effect of managed care discounts can be evaluated.

This same information is a starting point for calculating a target capitation rate or global budget for risk-assuming managed care services. Even if you do not have capitated or budgeted contracts, it makes good sense to become familiar with this approach because you can use this information to help negotiate other contract issues.

To figure a target capitation rate, the first step is to determine your target earnings. In other words, what profit margin do you want? It is foolish to peg a capitation rate without first identifying the profit you expect to get from it. Since the calculations we discussed last month can help physicians identify the profit consequences of various levels of managed care discounting, it is fairly easy to use that same information to figure a profit margin in a risk-based contract.

Know your customers

Step two: Determine annual visits from patients who receive the types of services included in your profit calculations. If you focus only on certain services in the profit analysis, include only visits for those services.

The third step enables you to identify how many of your "active" patients are needed to support the total office visit calculation determined in step two. For our purposes, active patients means those with whom your practice has enough contact for you to consider them loyal to the practice. This will differ from physician to physician. For many physicians, this will mean activity every six months; for others, every three years may be appropriate. Divide gross revenues by your active patient population, which gives you base revenue per active patient, per year.

How much do you need?

Step four is to determine gross revenues needed to support your target profit margin. Let's assume for the moment that all future revenues will be derived from capitated or budgeted managed care relationships. Divide your nonowner related overhead by existing gross revenues to determine your overhead percentage, excluding overhead items which may be considered as "disguised income" to the owners (car rentals, telephones and certain continuing education expenses, to name a few.) If you subtract this figure from 100%, you will identify the practice's profit percentage. The profit percentage includes compensation and benefits for the practice's physician owners. Then, by dividing your target profit level by this profit percentage amount, you reveal total gross revenues necessary to support your profit target, assuming that patient volume remains constant.

Finally, by dividing target gross revenues by your active patient base, you can determine annual revenues per patient. Dividing that amount by 12 yields your target per-member, per-month capitation rate. Compare this to your existing rate (determined in step three) to assess whether your target profit is reasonable.

Step five is the most difficult: forecasting how many patients you may expect to receive by signing a managed care contract. This figure comes from discussion with plan representatives and colleagues. Remember that because your profit margins are premised on the rough accuracy of projected member volume, you need to know about the plan's ability to deliver patients. This means that you will want the plan to assume some of the risk for inaccurate projections.

If you are negotiating a capitation rate, for example, based on 1,000 covered lives, you should not be bound to the negotiated rate if the plan only delivers 200 lives. This can be handled any number of ways: Negotiating a higher rate for lesser enrollment; starting with a higher rate and lowering it if anticipated volume levels are achieved; working for discounted fee-for-service payments until you hit that volume, or shifting from a capitation/global budget arrangement to discounted fee-for-service practice if the plan does not deliver the patients.

This suggests that a plan that imposes procedural burdens or slow payments should be offered a capitated rate higher than the target amount because of increased overhead. A plan that brings incremental growth to the practice may warrant a lower rate, since increased volume means greater profits — as long as the practice can handle the influx of patients.

Avoid adverse selection

To make this work, patients offered by a managed care plan should be compatible with your existing patient base — age, sex, location or whatever criteria are important to your practice. For negotiation purposes, the suggestions regarding patient volume can be applied to ensure an appropriate patient mix.

The covered lives analysis is a bit misleading. A managed care company will pay a capitated rate based on patients who name a particular physician as their primary provider. Not all of those patients would be considered active as defined above. If a significant percentage of plan members are not likely to use your services on a regular basis, you can afford to discount your target capitation/budgeted rate to some extent.

There is one issue that dramatically complicates this risk assessment analysis: outliers! We will address this problem and its resolution next month.

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


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