BY: DAVID FOSHAGE
Mr. Foshage is a consultant with Catholic Managed Care
Consortium, Clayton, MO.
"Can't act. Can't sing. Balding. Can dance a little."
— an MGM executive on Fred Astaire's screen test1
"You'll never make it — four groups are out. Go back to Liverpool!"
— a Decca Records executive to the Beatles in 19622
"I don't need bodyguards."
— Jimmy Hoffa in a December 1975 interview3
Predicting the future is a risky but necessary activity for
developing principles that will carry businesses into the next
quarter, the next year, or the next decade. Because such predictions
are necessarily inexact, it is critical that they be confirmed,
modified, or discarded. Fortunately for MGM, other executives
saw the brilliance in Fred Astaire that the above-quoted person
did not. Mr. Hoffa's erroneous prediction led to a tragic result.
Over the past six or seven years, predictions regarding managed
care focused on capture of enrolled lives. Hospitals, working
with physicians, long-term care centers, home health providers,
and others, attempted to convert themselves into integrated
delivery systems (IDSs), intending to provide cradle-to-grave
services on a capitated basis. Many providers did, in fact,
enter into capitated contracts, but enrollment levels were generally
far below expectations and financial performance was disappointing.
Capitation and risk sharing have not grown nearly to the extent
anticipated, and most experts now believe that fee-for-service
will remain the dominant managed care payment system, at least
in the near future.
During the period that saw the growth of IDSs, managed care
plans were having difficulties. Operating margins shrank dramatically
in the mid- to late 1990s. According to Interstudy, the median
profit margin for HMOs declined from 2.4 percent in 1994 to
–3.5 percent in both 1997 and 1998 before rebounding somewhat
to –1.3 percent in 1999.4
Consequently, at the same time that HMOs were sharpening their
focus on operational performance, hospitals were distracted
by problems associated with building IDSs, primarily losses
from employed physician practices. The result has been declining
net revenue from managed care plans. That decline has taught
health care leaders they need to pay greater attention to factors
affecting managed care payments. This article focuses on three
key components of this "back-to-basics" approach to managed
care: contracting, pricing, and collections.
Recently, a regional commercial managed care plan began treating
patient transfers from a medical/surgical unit to a rehabilitation
unit as a discharge and an admission. By doing so, the plan
could calculate the dollar stop-loss thresholds separately for
each "stay." Consequently, the threshold was never reached.
Because the contract between the plan and the hospital did not
define what constituted an admission or a discharge, the cases
in question are now the subject of binding arbitration.
This example demonstrates two important points. First, the
requirements for getting paid are a moving target. Representatives
of the aforesaid plan acknowledged that, in certain cases, they
had not followed their newly stated policy, but they dismissed
those cases as incorrectly paid. Representatives of the hospital
believed that the plan had simply changed its policy to reduce
its payments. Second, and more important, the example demonstrates
the importance of a well-constructed contract in avoiding or×resolving
administrative issues. Although most hospitals carefully review
contract terms during initial negotiations, some, unfortunately,
neglect to review language provisions in the annual renegotiation
The Catholic Managed Care Consortium (CMCC) has published
a brochure entitled Guidelines for Managed Care Agreements
for use by its members. Nonmember hospitals should develop similar
guidelines for themselves. These guidelines should prioritize
typical contract provisions as either "desirable," "critical,"
or "absolute." Hospital negotiators should agree in advance
about their priorities and then evaluate contracts and contract
renewals according to those criteria. If they do not, they are
likely to omit critical features because of pressure to complete
the contract negotiations.
Hospital negotiators should make sure that the language included
in the contract is enforceable. Contract provisions that require
payment of clean claims within 30 days of receipt will be useless
if the hospital is unable or unwilling to track "time to payment."
In CMCC experience, failure to enforce stringent contract provisions
is the rule rather than the exception. The lesson here is simple:
Rather than abandon these worthwhile contract provisions, hospitals
should build the mechanisms to enforce them.
In the early days of managed care contracting, conventional
wisdom held that all managed care plans could shift patient
volume (that is, move patients from a nonparticipating hospital
to a participating one), HMOs more so than Preferred Physician
Organizations (PPOs). Consequently, hospitals typically offered
HMOs greater pricing concessions than they offered PPOs. As
exclusive contracting became less prevalent and new benefit
plan designs blurred the distinction between HMOs and PPOs,
many hospitals realized that incremental volume (that is, new
patients) was less likely and changed their pricing strategy
to one that rewarded volume, regardless of product, with more
Despite this shift in approach, many hospitals continue to
find themselves with unsatisfactory managed care rates. "Unsatisfactory"
in this case can mean any number of things. A hospital's rate
may be unsatisfactory because a large account has dropped out
of a managed care plan, thereby reducing the hospital's volume.
Or the hospital, having lost an exclusive arrangement with a
plan, may have to share the plan's business with a competing
hospital, but with no commensurate increase in negotiated rate.
Or a plan in which the hospital has equity does not grow despite
subsidized pricing by the hospital and its other equity partners.
Unfortunately, most rate negotiations between hospitals and
managed care plans begin with the existing rate. That being
so, a 10 percent increase on an unsatisfactory rate will frequently
continue to result in an unsatisfactory rate. To truly improve
the rate, hospital negotiators must propose a rate more appropriate
than the existing one at the start of negotiations. The question
is, of course, what is an appropriate rate? Put another way,
what is market price?
True market pricing can only be established by gathering and
examining competitor-negotiated managed care rates, which are
confidential. However, each hospital has created its own estimate
of market prices throughout its universe of managed care contracts.
The CMCC offers hospitals a product, called Managed Care Revenue
Enhancement, which uses a regression model involving a facility's
contract volume and price relationship to calculate a "line
of best fit." This line, representing the hospital's internal
market price, can be described by an arithmetic equation. By
inserting actual plan volume into this equation, one comes up
with the rate the hospital can expect, given the leverage used
in all other negotiations. In other words, the process produces
the number the hospital representatives should use in negotiations.
The CMCC has conducted more than a dozen Managed Care Revenue
Enhancement engagements and in them has found a number of common
- Negotiated hospital pricing does not appear to approach
the point where plans seriously consider terminating the agreement.
- Collections, in a number of instances, are below variable
- Many small-volume plans pay significantly below negotiated
- Negotiators tend not to reexamine old strategic assumptions;
consequently, the rate remains in place even if the assumptions
Some hospitals are wary of requesting large rate increases
even if they believe that, given increases in volume, they are
justified in doing so. They fear that if they ask for increases,
the plan will terminate the contracts and the hospitals will
lose volume. An increasing number of contracts have been terminated
over the last few years, but these terminations have been almost
exclusively initiated by the hospitals because of insufficient
pricing. Almost no terminations have been initiated by the plans
because the negotiated price was too great. Today's environment
has given increased leverage to providers, particularly hospitals.
In most markets, benefit design and pricing are comparable and
provider networks are almost all inclusive. Plan administrators
know that they cannot afford to terminate a hospital, thereby
creating less marketable provider networks, and therefore do
so only with great trepidation. Realizing this, hospitals should
be bolder in negotiating with managed care plans.
Even with the most hospital-friendly contracting and the most
sophisticated pricing algorithm, managed care will be problematic
if hospitals cannot collect the amounts owed them. The CMCC
has found a number of problems in analyses of hospital managed
care processes. Although the problems vary, the common thread
concerns lack of useable data to diagnose and correct systemic
problems. The two most acute situations concern calculation
of expected reimbursement and categorization of denials.
The CMCC has found, in the course of its Managed Care Revenue
Enhancement engagements, that only about 10 percent of the hospitals
involved have been able to provide reliable expected-reimbursement
information. Hospitals are able to specify the amount owed on
a particular claim, but cannot do so on an aggregate plan basis.
They can determine that CIGNA owes $1,000 for Mr. Smith's claim,
for example, but cannot determine with a reasonable level of
accuracy what CIGNA should have paid for all its claims over
the fiscal year. Hospitals frequently lambaste managed care
plans for overaggressive pricing, being slow to pay, or failing
to pay at all — but are unable to quantify the problem. Underpayments
may be sporadic or epidemic, but hospitals unable to calculate
expected reimbursement will not be able to tell the difference.
The second significant problem with collection involves the
categorization of denials. Hospitals generally have increasingly
decried the rise in denials by managed care plans. But many
of those same hospitals are unable to provide the details concerning
denials that could help them reduce the denial rate. At a minimum,
hospitals should be collecting the following information about
denied (including reduced payment) claims:
- Diagnosis-Related Group (DRG)
- Place of service
- DRG or outpatient classification
- Reason for the denial (e.g., lack of preauthorization)
- Amount denied
- Appeal status
- Final disposition
In the CMCC's experience, traditional denial management has
focused retrospectively on dollar recovery. The hospital involved
hires a firm to appeal the denials and to collect amounts owed
from overturned denials — but neglects to attack the underlying
problems causing the denials. The winner in this scenario is
the denial recovery firm, which will have a steady client base
year after year. A hospital will see a genuine decline in its
denial rates only when it begins to collect comprehensive revenue
cycle data and address the underlying revenue cycle and clinical
It has become increasingly clear over the past three years
that hospitals must sharpen their focus on basic managed care
issues. Renewed vigor is required to offset plans' efforts to
reduce medical expenses through additional administrative processes.
The CMCC has recommended that its members undertake the following
strategies as a countervailing force to plan efforts.
Reexamine Traditional Points of Negotiating Leverage Critically
evaluate the true potential for plans to terminate hospital
contracts. Most hospitals have found that the risk of losing
a contract is relatively small and have begun to negotiate accordingly.
Develop a Contract Language Template Make sure that
the organization's negotiators agree on and understand the contract's
language before negotiations start. Too often, poor contract
language is the result of perceived pressures to finalize negotiations.
The time to make rational decisions about contracting strategy
is not when $1 million in patient revenue is in play.
Don't Automatically Use the Existing Rate as the Starting
Point in Negotiations A 10 percent increase on a crummy
rate is still a crummy rate. View managed care contracts as
a portfolio, not as individual business arrangements. Understand
the relationship between price and volume for the entire portfolio
and determine which contracts are underperforming. Make it a
priority to improve those contracts to the level at which other
contracts are performing.
Develop or Invest in Systems that Measure Your Expected
Payments from Managed Care Plans The claims recovery industry
has grown out of the difficulties hospitals have had in collecting
accurate payments from managed care plans, in combination with
hospitals' inability to actually determine the amounts owed.
Without resolving underlying claim denial or underpayment issues,
claims audits can become an annual event. Hospitals should develop
and staff efforts designed to accurately calculate expected
reimbursement and collect all monies owed at the time the claims
Manage Claim Denials The Health Care Advisory Board
reports that the percentage of Maryland hospital claims denied
increased from 3 percent in 1996 to 6 percent in 1997 and 9
percent in 1998.5 As the number of denials and the
dollars denied continue to increase, hospitals must begin to
understand the reasons for denials and take corrective action.
Until they begin understanding basic information — such as that
involving a claim's attending physician, DRG, place of service,
and denial category — hospitals will find it impossible to correct
the problem in a systematic way.
Even successful managed care departments will be under continuing
pressure from both senior managers (who require contracts to
be profitable) and managed care plans administrators (who want
to reduce expenditures). To satisfy management and resist plan
administrators, managed care departments require a back-to-basics
approach that aggressively manages solidly drafted contracts,
negotiating appropriate rates, and collecting all monies owed.
- Ross and Kathryn Petras, The 776 Even Stupider Things
Ever Said, HarperCollins, New York City, 1994, p. 21.
- Ross and Kathryn Petras, The 776 Stupidest Things Ever
Said, HarperCollins, New York City, 1993, p. 156.
- Petras and Petras, The 776 Even Stupider Things Ever
Said, p. 11.
- InterStudy, "HMO Industry
Report," The Competitive Edge, 11.2 Edition, January
1, 2001, p. 52.
- Health Care Advisory Board, The
Commanding Heights,p. 44.
Copyright © 2002 by the Catholic Health Association of the United States
For reprint permission, contact Betty Crosby or call (314) 253-3477.