BEWARE THE HMO IN FINANCIAL TROUBLE

How the Budget Setting Process Can Make You A Loser, Too

Across the country, HMOs are experiencing record financial losses. A number of factors are contributing to this phenomenon, including the underwriting cycle, low unemployment, increased market share bringing increased adverse selection, and a backlash against utilization control.

The underwriting cycle, like many industry business cycles, reflects the period of time before multi-year contracts are due for renewal and premium increases can be negotiated to catch up with increases in costs. With nationwide unemployment at record low levels, many people have health insurance and a feeling of enhanced job security. In addition, certain of the market reforms with respect to portability of health insurance and limitations on exclusions for pre-existing conditions are likely leading to increased demand for services by consumers, who may have previously been afraid that having a procedure or surgery would lead to a loss of coverage.

HMOs grew rapidly throughout the nineties, bringing larger numbers of individuals into their products. However, this growth came from segments of the population which were less healthy than the traditional HMO population. In addition, aggressive pricing strategies to build market share narrowed or eliminated profit margins.

As plans approach the year 2000, significant premium increases are planned. However, much of the premium increase will not find its way into the budgets of capitated providers as the Plans will use the money to recover some of the losses from prior years. Providers faced with renewing risk capitation contracts, or negotiating one for the first time, need to be aware of some of the perverse results that can occur in the present environment of increased utilization and decreased budgets.

A basic form of risk sharing for physicians is to have a portion of their fee-for-service or capitated payment "withheld" as a form of guaranty of utilization targets. If the targets are not met, the physicians will forfeit all or a portion of the withhold. If the targets are met, an increasingly unlikely result, the withhold is returned. If the utilization is below the target, the physicians will receive a portion of the savings in addition to the return of the withhold.

If the withhold is already being forfeited in the present environment, increasing the withhold will likely simply increase the amount of the forfeiture. The Plan will argue that it will generate additional incentive to control utilization, but this is only true in circumstances where the losses are relatively narrow. For example, if the risk unit is experiencing deficits of $2.0 million against a withhold of $200,000, doubling the withhold will simply cost the physicians an extra $200,000 and save a like amount for the Plan.

A strategy we have recently encountered in our healthcare consulting practice involves HMOs assigning physicians to risk pools. Risk is generally successfully managed only in units comprised of like-minded physicians. A basic element of risk-based contracting is to carefully evaluate your partners in the venture. Physicians who are not invited to join a risk unit are often lumped together into a large "risk unit" with no common utilization goals, other than those set by the HMO Medical Director. Without any common thinking or direct management, these units generally have very high utilization and lose their withhold. The HMOs often sustain losses well in excess of the withhold, however, and herein lies the problem.

If the HMOs assign these unaffiliated physicians with their high utilization to successful risk-units, there may be some change in the utilization patterns of the previously unaffiliated. More likely, however, is that the successful risk units will see their profits eroded as they absorb the losses generated by their new "partners" which losses were previously the responsibility of the HMO.

Before agreeing to undertake risk, we advise clients to determine if there is a reasonable prospect of beating the budget and making a profit. A withhold, in the ideal world, is a form of a bet that the physicians will be able to do better than budget. We look for that bet to be "even money" meaning that there should be a 50-50 chance that the savings in the budget will be at least equal to the withhold. Otherwise, the withhold is simply a form of a reduced fee-for-service payment.

Assume that the physicians are 50% at risk for the performance of the medical budget. In the most recent year, a deficit of $1.0 million against a budget of $10 million was incurred (total medical expenses of $11.0 million), offset by a withhold of $250,000, requiring the physicians to pay $250,000 out of pocket. For the next year, during the course of negotiations, the HMO proposes a budget of increase of 3% to $10.3 million, although announced premium increases are 8%. Assuming the same utilization and costs in the next year, or total expenses of $11 million, a deficit of $700,000 will be incurred, resulting in the physicians absorbing $350,000 through the withhold and out of pocket payments. If costs go up 5% to a total of $11.55 million (a more likely occurrence), the total loss will be $1.25 million, and the physicians will be responsible for $612,500. The lesson here is that, given a choice, there is no point to signing a guaranteed loss contract.

This type of example is particularly significant to a group considering taking on additional risk, and moving away from a withhold only environment to one in which risk can exceed the withhold. If the withhold was lost in the most recent budget year, a group should not consider taking on more risk unless the budget for the subsequent year is close to the expenses in the current year. Even if the HMO threatens to terminate the physicians’ altogether, the potential losses in some risk contracts make loss of the patients a better option.

Contracts should always been read very carefully, and particularly so with respect to the annual settlement of the budget. Generally, a risk-based contract will be settled six months after the end of the contract year, typically with an additional offset for Incurred But Not Reported (IBNR) claims. One would think that six months plus IBNR would be sufficient to close out the budget for the year.

Recently, we witnessed an HMO notify the various IPAs and other risk units in its network that, as a result of a review of two and three year old claims, it had determined that additional expenses had been incurred. It then proceeded to take the purported old claims out of current year settlements! Fortunately for our clients, the contract language for the prior years made it clear that, once settled under their terms, retroactive adjustments were not permitted. A strongly worded letter from the client’s attorney resulted in the money being restored to the current year budget.

In addition, it should be noted that the likelihood that a review of prior claims would result only in additional expense as opposed to reductions in expenses is virtually zero. Since all clams go through the same processing system, there is an equal likelihood that invalid claims will be approved and valid claims will be denied. Without a complete (statistical) review of all claims, no IPA would ever agree to a retroactive charge, even if one would be permitted under the terms of the contract.

Financial difficulties seem to bring out the creativity in HMO employees. Yet another novel idea we encountered was a proposal that a client increase its share of risk for hospital services from 50% to 100%, after the contract year had commenced. When we reviewed the hospital services fund, we found that it had a year-to-date deficit. If the client accepted the change, its loss would be doubled. Naturally, they declined. However, the HMO implemented the change anyway, taking the additional deficit from the profitable physician services fund. Another strongly worded letter from the client’s attorney was required.

In many markets, Medicare, Medicaid and commercial contracts are settled separately. Of course, if all the contracts are full risk, the net effect of separate settlement is no different than combined settlement. However, if the risk-sharing mechanisms in the different product lines are different, separate settlement will give a dramatically different result. For example, Medicare risk contracts often impose substantial risk on physicians, while commercial contracts may limit risk to the amount of the withhold. In this case, it is possible to make a profit on the Medicare contract, and limit losses to the withhold on the commercial contract. If the commercial contract becomes full risk, the losses therein will eat up the Medicare profits. This is the type of a change that should not be agreed to and new Medicare contracts (see next paragraph) should be reviewed carefully to avoid inadvertent agreement.

Clients with Medicare Risk Contracts have a particular problem in this environment. Congress mandated changes in all such contracts in the Balance Budget Act of 1997, and HCFA is now implementing the changes. Operational Policy Letter 77 from HCFA, which details the changes, specifically allows the HMOs to unilaterally modify contracts to comply. However, it seems that certain HMOs have seen this as an opportunity to make other changes in the contracts, unrelated to the HCFA requirements. For example, one such change ostensibly granted the HMO permission not to make any capitation payments unless the physicians were in full compliance with all terms of the contract. Another clever idea permitted the HMO to offset surpluses in the Medicare contract against deficits in the commercial contract. Clients should be advised to study OPL 77 carefully and compare its provisions line by line to any proposed contract from the HMO purporting to implement the changes.

If a physician entity is confronted with assuming risk for a new contract year after a loss year, one possible strategy is to negotiate for a portion of any savings as compared to the prior year, even if the current year expenses exceed budget. For example, assume that the prior year budget was exceeded by $1.0 million. If the physicians can reduce the loss to $800,000, the HMO is still $200,000 better off and should be willing to pay something for that loss reduction. Another version of this strategy is to offer the HMO a fixed "first dollar" amount of the savings, for example $100,000, with the next $100,000 going to the physicians and any excess split equally.

Depending upon the dynamics of a given service area, physicians may simply refuse to accept more risk. Notwithstanding the attempts at unilateral contract modification, in the end, the HMO cannot force physicians to accept increased risk. The two major consequences that may be expected are termination of the contract altogether and loss of patients or substantial reduction in the fee-for-service or other payment to the physicians. If the potential losses associated with the increased risk are greater than the likely fee reduction, the choice is obvious.

The larger the entity representing the physicians in the negotiations, the less likely the HMO will be able to terminate the contract and transfer the patients to another, more susceptible, risk unit. Large entities representing physicians which refuse to sign a contract face anti-trust exposure, but it seems reasonable to conclude that not signing a contract which would cause the physicians to lose substantial sums of money would be defensible. The exposure does suggest however, that such negotiations should be cautiously pursued and well documented, emphasizing the unrealistic budget rather than simply an unwillingness to take risk. Bear in mind that a contract without risk is not acceptable for anti-trust purposes where independent practice entities are negotiating as part of a common IPA or Network. Physicians can hope that in the current anti-HMO environment, regulators may wake up to fact of who holds real control in the healthcare delivery system – and it has not been physicians.

As noted in the preceding paragraph, the ability to successfully manage risk is in large part contingent upon the reasonableness of the budget being managed. If medical costs have risen at a rate of 5% per year and budgets have been fixed, or increased at a lesser rate, it is difficult to argue that the budget is adequate. Key utilization factors should be reviewed, such as Average Length of Stay (ALOS) and Admits per 1000 Insureds (Admits) on the hospital services side, and various specialty referrals on the physician services side. If ALOS and Admits are both within the normal range and the hospital fund is still in deficit, than the budget is clearly too low, due to unrealistic hospital days per 1000 and/or higher than budgeted cost per day. If ALOS is normal and Admits are high, adverse selection could be indicated, or patient-deferred utilization could be present due to job and insurance security.

Performance under a budget is dictated not only by utilization, over which physicians have some control, but also by cost per unit, over which physicians usually have no control. In a percent of premium contract, the HMO may set unrealistic utilization standards in order to compensate for inadequate premiums to support costs per unit. One circumstance where this is common is where a single hospital has a geographic monopoly and the HMO is unable to negotiate low per diems, or to raise premiums to pay for the higher per diems. Since the true hospital budget is simply the product of the negotiated per diem times the days utilized, the days can be determined by dividing the budget by the per diem. The higher the per diem, the lower the days, for a given fixed budget. Knowledge of the mathematics of budget setting can be a powerful, if not always conclusive, negotiating tool.

The healthcare delivery system is entering a period of financial stress not seen for nearly a decade. As once profitable HMOs face mounting losses, they will increasingly seek to lay these losses off on providers. Desperate times lead to desperate actions and the unsuspecting or uneducated will be sitting ducks for the budget balancing arrow.

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