Avoid Common Problems In Risk-Sharing Contracts

These arrangements too often become a hindrance instead of a help. Simple precautions today can help prevent major headaches later on.


It seems as though every week, another managed care organization announces that its financial targets cannot be met, or even that it is heading into insolvency. In contrast to fee-for-service health care, the managed care system is closely monitored, with standards based on medical “best practices.” In general, most HMOs deliver high-quality care. So why do they have so many problems?

One little-discussed reason is the burden created by contracts that were intended to spread the risk of doing business among health plans and physicians. These risk-sharing contracts may impose enormous operational burdens.

Inadequate systems

The problem is that health plans and physicians often lack the data-management systems to perform well under these contracts. Most payer systems were designed to process claims. Provider systems were designed in a fee-for-service environment in which doctors were paid every time they performed a service. To comply with the terms of many risk-sharing contracts, both physicians and health plans have to operate outside the design of their normal systems.

In our work helping MCOs get back on track, we’ve seen some risk-sharing contracts end up in litigation and even force some physicians into a bankruptcy that can cause financial hardship to the HMO as well. The problem is communication: The people who negotiate the contracts are not the people who administer them.

Common problems

Most difficulties emerge during implementation of a contract. For instance, many health plans build provisions into an agreement that require adjustments to their accounting systems and those of physicians. These provisions require administrative oversight, but are often addressed after the contract is signed instead of during negotiations. Here are three common problems that arise with risk-sharing contracts, along with suggestions for addressing them.

Problem #1. You lack systems to address provisions in the contract.

When HMOs developed their computer systems, the primary goal was to administer health benefit plans for their members. They frequently created systems that were either medically driven (focusing on issues like utilization management) or financially driven (to process claims and financial information). The computer systems were not very flexible, and it was hard to blend one with the other.

When health plans began offering risk-sharing contracts, their computer systems weren’t equipped to deal with the intricacies of implementing them. In theory, sharing risk seemed logical. Initially doctors were reluctant to join HMOs, but as health plans grew, more physicians wanted to join exclusive networks. At the same time, the profit margins of health plans declined, and health plans were often very creative in developing more efficient provisions for their provider contracts. As a result, HMOs offered shared risk and built in a series of incentives to reach profitability targets.

Let’s say a health plan has negotiated risk-sharing arrangements with a dozen practice groups in one market. Each contract contains different elements of risk in a wide variety of specialties, such as obstetrics, cardiology, urology, and radiology. On paper, that sounds fine. But the health plan must be able to process the claim, determine if it is associated with a risk arrangement, assign the claim to the proper risk pool, and provide periodic reporting to the provider groups. This system must include timely accounting for incurred but not reported (IBNR) claims to keep up with the terms of each deal and to inform the physician groups how they are performing under the contract. Complex calculations are required to determine whether an individual physician practice group is meeting those terms. The added accounting and personnel burdens on the MCO are enormous, but frequently they are not taken into consideration when a deal is structured.

As a result, the MCO often cannot administer the terms of the contract without making special offline analyses that require a significant amount of time and coordination between administrative departments. At the end of the year the doctor’s records — which may be on paper and not particularly good — indicate that the doctor has met the contract terms, while the HMO’s records say the doctor falls below them. Determining who is right is even harder, and the contract blows up in everyone’s face.

What to do: Before entering into specialty arrangements with physicians, a health plan needs to be sure it has the processes in place to administer the terms. This means that marketing, provider relations, and/or the legal department, which are responsible for structuring the benefit plan and lining up physicians and writing risk-sharing contracts, need to open a dialogue with the senior management for financial reporting, utilization management, claims, and accounting to determine if what they are proposing is possible. The people who are writing the contract must learn about the systems capability of their health plan before structuring the terms of a deal.

If the health plan’s systems are not capable of implementing the contract terms, it will need to develop contingency plans. This may mean adding personnel, outsourcing record keeping, or making changes to a computer system. The health plan should also check with its claims department to be sure the doctors have historically provided information on time. The HMO needs to know if the doctor files claims within 30, 60, 90, or 120 days. If the doctor is late with claims, a huge backlog can accumulate that will cause headaches at the back end of the contract, requiring larger estimates of ultimate claims expense.

Problem #2. You haven’t specified in the contract the historical data on which the benchmark is based.

HMOs often set performance benchmarks for physicians based on the historical performance of a provider group or a defined population. Many health plans will pay physicians a per-member, per-month fee to treat a population of patients in a plan no matter how often they visit the doctor. As a result, the doctors are at risk for the services performed in a given period. Medical groups often prefer this system because it generates a reliable stream of revenue, and the physicians may also receive incentives. For instance, a contract may allow the medical group to receive a bonus if it reduces the number of days the HMO’s patient population spends in a hospital during a specified time.

On paper, such a capitation system sounds good. The doctors get what they want (referrals and cash flow), and the health plan can keep its costs under control because it knows, within a very limited range, what its costs will be for this provider group. The problem is that medical groups often don’t have very good historical records, so they don’t know how frequently the patient population visits the doctor. To set a benchmark, the medical group must rely on the health plan for data.

To understand the specifics of its own practice, a medical group must analyze its data over a couple of years to determine utilization patterns and adjust for IBNR, inflation, and demographic changes. This is a massive endeavor. The medical group rarely has the time or expertise to assume the additional responsibility and do the complex calculations to determine how and why visits occur.

As a result, benchmarks are set on “best-guess” estimates or market rates; sometimes the incentive benchmarks are never set. The best-guess or market-rate benchmark is often wrong, which can result in the HMO, the physician, or both losing money on the contract. If benchmarks are never set, the contract may eventually be challenged in a lawsuit.

What to do: The HMO needs to understand the demographics of the population at risk for a specific practice by analyzing historical claims data. The health plan can set benchmarks based on historical data from physicians with similar practices. For instance, in a 100,000-patient population, the health plan can determine how many births and what types of illnesses occur in a given geographic region. Then it needs to ensure the provider group can manage the risk as set forth in the contract.

Although the HMO needs to negotiate a profitable arrangement, the plan must also ensure that the physicians can handle the risk and not set the provider group up for failure, which could fall back on the HMO as a liability. It must make sure the physicians are sufficiently capitalized, so that they will be able to weather the storm if there are problems with the benchmarking program.

The only way for the HMO to protect itself is to spell out, in the contract, what the benchmarks will be, rather than simply to state that a benchmark will be set. If parameters are defined at the outset, they can be addressed no matter what happens during the life of the contract.

Problem #3. The terms of the contract are ambiguous.

Even though it negotiates a global-risk contract with a provider network, the HMO may still be responsible for hospital, physician, and all other medical claims should the provider network fail to pay claims. Since the provider is assuming all of the risk, it’s particularly critical that every element of the contract be followed to the letter. If there is ambiguity in a series of contracts, the health plan can incur additional cost in situations in which it did not expect to have any costs.

Let’s say the health plan negotiates a deal with Hospital X for a reduced rate if it refers a certain number of patients to Hospital X in a year. The physician practice group and doctors in the area also sign contracts stating they will “make their best effort” to steer all their patients to the same hospital. If a doctor group sends all of its patients to Hospital X, it gets a bonus.

What’s missing is a percentage for leakage to other area hospitals. Doctors tend to think that if they make a compelling case to a patient for going to a particular hospital, he will do what the doctor wants. However, there will always be patients who, for whatever reason, will insist on going to another hospital. In most situations, particularly in an emergency, the doctor has no choice but to honor the patient’s wishes.

Many such contracts are written to say physicians will make their “best efforts” to ensure that patients go to the hospital of choice. But then the physicians do not keep records of their conversations with patients about which hospital they choose, so they can’t document why leakage occurred.

What to do: Ambiguity can be costly. Before entering into this type of contract, the plan needs to determine what it considers the doctor’s “best effort” to be. Then the doctors may want to begin dictating into their notes the conversations they had with patients which hospital to go to. They can say that the patient was advised to go to Hospital X several times but the patient refused. The contract terms should also be written to reflect the number of alternate facilities in the immediate area and the preferred institutions’ reputations in the community.

Risk-sharing contracts are good in theory. After all, their goal is to place decisions about medical necessity in the hands of the person delivering the care. But before a risk-sharing contract is put into effect, health plans must make sure their systems can implement its terms. Otherwise, we will see more of these deals disintegrate.

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