Contracting for Institutional Services In a Managed Care Environment

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This is the tenth article in the Managed Care Contracting"Signature Series" by Managed Care Resources, Inc. -- articles on topics in managed care written by experts in the field. The author of this article is Ira H. Rosenberg.

One might think that the easiest contracts for managed care organizations (MCOs) to negotiate would be those for institutional services, given that the majority of all health care dollars go to these services. And especially given that many hospitals have such highly sophisticated financial management systems that one would expect their CFOs to be extremely knowledgeable about costs. However, this is far from the truth. Even today, most hospitals find accurate definition of their costs to be extremely difficult:

• Tools used previously by managed care payers to help frame negotiations are antiquated and no longer useful,
• To make contracting even more complex, typical hospital negotiation is not driven by pure economics.
• Because of regional biases, there is no national uniformity vis-a-vis the methodology used to develop the reimbursement structure of a contractual relationship.
• As claims systems are being consolidated across the country, hospital claims managers are telling their clients that creative solutions to difficult negotiations can't be implemented because the "computer" can't handle the unique aspects of the terms of the agreement.

This article provides an overview of the various methods MCOs use to contract for institutional services. The focus here is primarily on acute general hospital negotiation, but many of the same issues exist for sub-acute care, skilled nursing, ambulatory surgery, and specialty institutional care contracting.

In most parts of the country, contracting for institutional services has historically been a secondary negotiation for the managed care payer. Most MCOs felt that if they were able to negotiate successfully with the community physicians, that the community hospital would be certain to follow. And for the most part they were right. Hospitals, fearing that they could lose admissions, fell in line and agreed to reimbursement that did not always appropriately reflect their costs. (Indeed, in some cases the reverse was true.) Conversely, if the physicians refused to contract with MCOs, then the shortsighted hospital might also refuse to develop a relation with the payer. In these cases it certainly appeared on the surface that the providers had a cohesive managed care strategy. For the most part this was not (and is not) the case. For example, in many instances MCOs were able to contract with a core of physicians by offering them incentives that came largely from savings derived by reducing hospital utilization. The MCOs shared these savings with physicians, while leaving hospitals no choice but to accept a fixed rate for services while watching volume decrease.

As penetration by MCOs increased, some hospitals attempted to recoup part of the losses due to reduced utilization by developing Physician Hospital Organizations (PHOs), which have theoretically brought together the contracting functions for both institutional and physician services. However, this has not always worked, and for the most part hospitals today still find themselves outside the incentive plans payers have developed to encourage the provision of care in a more cost-effective setting.

While I am certain that one could find many variations on the theme, there are four basic ways that a hospital receives reimbursement for services from a MCO: (1) per diem, (2) discount from charges, (3) case rates and (4) capitation. Discount from charges is the methodology hospitals usually prefer, while MCOs tend to look at per diems as the most effective negotiation. In a few areas of the country, hospitals have been able to negotiate case rates similar to HCFA's DRG reimbursement system, and in a few instances have negotiated capitated agreements, usually in tandem with a global capitation arrangement for both professional and institutional services. It is interesting to note that in some areas MCOs are moving away from capitation at all levels, while at the same time some of their colleagues are moving to assign all of the risk for medical care delivery.

• Discount From Charges

  It would seem that the easiest service contract to negotiate and administer would be a discounted fee for service arrangement. Early on in the development of hospital contracting that was true. But today it is difficult for such contracts to reflect a consistent relationship between a hospital's costs and charges. As hospitals have changed their rates to maximize reimbursement under certain government programs, and raised rates so that non-managed care payers pay a portion of the loses incurred under managed care contracting, the relation between cost and charges has become blurred. This makes it difficult to negotiate a "fair" arrangement. Today you may see a few contracts which offers a 70% discount from charges, but in most instances discount from charges contracts for inpatient services are negotiated in areas that either have little managed care, or where a particular institution is receiving very little volume from MCOs. At the same time though, discount from charges are still prevalent for ancillary services (with the exception of ambulatory surgery reimbursement, which more and more MCOs are basing on Medicare groupings, with a negotiated percentage of Medicare rates). This is primarily due to the fact that even the largest claims systems have difficulty administering a fee schedule for those services.

• Per Diems

  In most instances hospitals and MCOs now negotiate per diem arrangements for the inpatient portion of the reimbursement, while maintaining a discount from charges for the ancillary services. This allows the hospital to cost shift to a certain extent. When the MCO has sophisticated claims systems, it uses them to monitor such shifting, and build safeguards against it into their future negotiations. Once MCOs are able to administer fee-based reimbursement for ancillary services, the hospital's ability to cost shift under managed care will cease.

  Per diem arrangements have evolved over time, becoming increasingly complicated as the negotiators develop rates by products and by services. In addition, the evolution of the per diem rate has brought about the concept of including a stop-loss provision in the contract to protect the institution against a catastrophic occurrence.

  Originally, per diems were a blended rate for all services. As negotiations matured and became more sophisticated, separate rates for ICU, OB, Chemical Dependency, Neonatology and other services were developed. In many instances per diem contacts were a blend of specific service rates and cases rates (such as a specific cardiovascular rate). In addition, a number of institutions negotiated separate rates for Commercial, Medicare and Medicaid populations. In some instances there are also separate schedules for HMO days versus Point of Service days. To say that negotiation under this manner is complex is an understatement. Such a contract is almost impossible to administer.

  There are a number of reasons that these rates have evolved this way. First, the managed care payers want to see the basic premise of the per diem continued. The per diem removes the risk from them for their failure to control the utilization of the physician. At the same time, there is no cost to them for reducing volume. The hospital is left with fewer days with a higher intensity for the same price. It simplifies the claims process for the payer. And with the exception of the catastrophic incident, provides some certainty to the cost of care.

  Even with all of the variation of rates, per diem rates are easier to administer from the MCO's standpoint. The hospital still must capture all of the data related to services provided if it wants to build a case for higher rates in the future. So in essence, the hospital bears significant risk with little or no incentive or reward.

  The use of per diem rates is most common in those markets where the MCOs are dominant. In markets where providers are stronger, other forms of reimbursement seem to prevail.

• Case Rates

  Case rates are a good way to align incentives between the payer and the institutional provider, but they may not allow the physician component to participate in a cost savings program. From a management perspective a case rate plan similar to the Medicare DRG system would be the easiest to manage. The institutional providers would only need to develop case rates for certain obstetrical services and some pediatrics cases in order to have a complete program. The two problems that the payers see with this system are (1) they do not share in any cost savings and (2) primary care physicians who manage the care are not appropriately incentivized to manage the care in a more cost effective manner. The positive aspect for the payer is that the cost per hospitalization is capped. They need not maintain programs for adjudication of stop loss plans, and further Plan medical management costs by forcing the institution to rely on its own utilization management program.

  There are instances where both the physician and institutional providers have accepted case rates. These are usually well-defined cases (such as cardiovascular by-pass surgery) where the payer has been able to arrange a complete cost package for the professional and institutional care. Even in this instance disease management programs that make their money by taking a per cent of demonstrated savings over time are replacing many of these package rates. In these instances, the payer pays the disease management company and shares some of the savings with the primary care physician, thus maintaining its involvement in patient care management. Unfortunately, the institution has no incentive to work cooperatively with the payer or the disease management company from a shared savings perspective.

  Case rates are some times implemented where a PHO has accepted a global capitation arrangement with the payer. The case rate methodology becomes a mechanism for limiting a physician's risk. In this setting the physician is now vested in managing the admission versus the length of stay. A reduction in admissions below the projected budget would result in the sharing of savings between the physician and the institution. But in many parts of the country payers have been unwilling or reluctant to enter into global capitation arrangements, once again limiting the use of case rates as a reimbursement model.

• Capitation

  Capitation models of reimbursement for institutional services have been limited nationally. There are numerous reasons for this. The first is that determining a capitation rate is difficult because predicting out-of-area and out-of-network utilization may fluctuate greatly. Second, the trend in managed care at this time is towards open access plans that allow members to go out of network without getting primary care physician authorization. Unless an institution is willing to accept this risk, the payer is unlikely to agree to this type of arrangement without setting up an elaborate system of withholds. Third, with increasing pressure being placed on the payer by the Health Care Financing Administration (HCFA) for the payment of Medicare claims, many HMOs are unwilling to allow institutional or physician providers to make claims payment. So one of the primary reasons for accepting a capitated contract is eliminated, i.e. getting the funds up front. If a payer is going to be held responsible for paying the claims, it will want to retain the funds.

  Those issues aside, any institution that wants to accept a capitation rate for institutional services needs a very sophisticated system to monitor costs and utilization. Once the payer has transferred risk to the institution, its incentive to monitor utilization is decreased, whereas the institutional provider must have an internal utilization management program in which it has a high degree of confidence.

  On the West Coast, and in certain pockets elsewhere, there are payers who have entered into global capitation for both professional and institutional care. These programs work best for the Medicare programs, which a uniform set of benefits for their beneficiaries. Under commercial products where there may multiple benefit options from employer to employer, it is far more difficult to develop a single capitation rate that would cover the entire population. These types of programs require the provider community to invest in highly sophisticated information systems in order to assure that care is being provided only for covered services. Thus, under a capitated model the provider not only must manage utilization, but also must have expertise in benefits management.

This article has examined pricing methodologies for negotiating an institutional agreement. However, a contract cannot be negotiated on price alone. In addition to the language issues, there are issues of contract administration, access by the MCO's Utilization Management personnel, timeliness of payment, access to Provider Relations services, etc. that make the negotiation a success or a failure. As one can see, negotiating reimbursement under a payer agreement is one issue, implementation is another. A number of these issues have been discussed in previous Signature Series articles, and MCR will examine others in the future.

I hope that you will join us as we explore all of the elements of managed care contracting in the coming months. In addition, we also offer a "Signature Series" on "Medical Management Under Managed Care". We hope that the two series combined will lessen the mystery of managed care and help level the playing field between providers and payers.

Ira H. Rosenberg

President, Managed Care Resources, Inc.

The Managed Care Resources, Inc. team has over 150 years of combined experience in the development and implementation of managed care services. Please visit our home page to learn more about how we can assist you with your managed care needs. We also invite you to contact us with questions or comments.

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