Given the increasing prevalence of risk-based contracts with purchasers, healthcare finance leaders should consider strategies to assess and mitigate their risk under these arrangements.  

At a Glance

To prepare for managing risk-based contracts with payers and other purchasers, providers should:

  •  Identify operational, competitive, and financial risks associated with the relevant patient populations
  • Improve organizational abilities related to patient care management, which is the key to managing operational risk
  • Address the competitive risks that can ensue when traditional lines of demarcation between providers and payers are crossed
  • Adopt strategies and tactics to manage financial risk, beyond buying malpractice and stop-loss insurance

A growing number of providers are eyeing opportunities to participate in risk-based contracts involving arrangements such as bundled payments, shared savings, and capitation. Some health systems also are considering taking on insurance risk by going “direct to employers,” bypassing brokers, benefit consultants, and payers.

Before entering into risk-based contracts with payers and other purchasers, providers should assess the advantages and disadvantages of such contracts. To this end, providers should create a comprehensive road map to identify the relevant risks, define day-to-day functions associated with those risks, assign responsibility for risk management (including a clearly defined role for finance), and specify risk-specific success metrics (i.e., what a successful risk management program would yield for each type of risk). This road map should be developed in the context of an overall risk management framework.

Categories of Risk

Providers that are contemplating entering into risk-based contracts should first assess their readiness to manage three types of risk:

  • Clinical and administrative operational risk
  • Competitive market risk
  • Financial risk 

Clinical and administrative operational risk. This type of risk relates to how an organization delivers care and performs administrative functions such as staffing, scheduling, and coding. Operational risk is rooted in the disease burden of a population. For example, clinical and operational risks differ between an aged population with multiple comorbidities and a young, health-conscious population. The chief clinical officer and COO typically share responsibility for managing operational risk. 

Competitive market risk. This type of risk stems from competitors’ decisions about whether to participate in a particular delivery network, product, or service offering. A health system’s strategic planning, business development, and sales staff (if applicable) usually manage this risk day to day, although the entire management team is responsible for enterprisewide strategy.

Financial risk. The CFO is typically responsible for managing financial risk, which relates to budgeting, pricing, investing, distributing, and reserving funds to cover random events, operational risk, and market competition (none of which can ever be fully controlled). Financial risk is linked to operational and competitive risks, which is why risk-based contracting warrants the attention of the entire executive team. 

Exhibit 1


Managing Clinical and Administrative Operational Risk 

Managing clinical and administrative risks starts and ends with effective patient care management. To manage these risks, it is first necessary to evaluate the underlying disease prevalence, comorbidities, severity of illness, information, and cost burdens associated with the populations and customers an organization serves. When a hospital patient care management function lacks data and tools to identify unmet patient needs, both the patients and the provider can suffer.

Disease prevalence. Leaders should gain insight into disease prevalence patterns of a patient population by acquiring historical utilization and cost data. Hospitals are increasingly turning to commercial payers and the Centers for Medicare & Medicaid Services for detailed utilization and cost data on patients. 

Comorbidities. Comorbidities, such as asthma, diabetes, and heart disease make treatment more complex and costly, and should be factored into patient care plans, staffing, scheduling, and delivery. For example, a large, East Coast independent practice association (IPA) and a Blues plan discovered that the 10 percent of patients incurring 70 percent of the cost were highly comorbid patients. Before the IPA signed the risk contract, it began to track patient compliance with prescribed treatment regimens, created patient-specific care plans for the sickest patients, and invested in a team-based approach to managing care, including advanced practice nurses, social workers, and a nurse hotline to manage the sickest of the sick.

Severity of illness/disease stage. Severity of illness (e.g., stage 1 versus stage 4 cancer) affects overall resource needs and costs. A hospital should have people and systems in place to analyze the severity of illness and disease states of its population before taking on risk for population health. 

Cost burdens. As patient out-of-pocket payments increase, patients may tend to postpone receiving healthcare services. The evolution of high-deductible health plans and value-based health plans, particularly in challenging economic times, is changing patient behaviors at the point of care and point of insurance enrollment. Clinicians should be aware of patients’ increasing cost burdens and how those obligations affect when and how patients seek care. 

By obtaining a better understanding of their organization’s populations, a health system’s leaders can identify the functions, infrastructure, and programs required to manage the unexplained variations in care delivery that are so critical to managing risks. For example, a study published in Health Affairs found wide, unexplained variation in blood pressure medication prescription patterns among physicians in an IPA. Analysis disclosed that promoting the use of practice patterns of the lowest-cost group (i.e., prescribing lower-cost, clinically equivalent blood pressure medications in accordance with national guidelines) throughout the IPA would maintain or improve quality while reducing costs.a Providers that consider taking on risk should adopt such techniques for analyzing clinical practice variation on a broader scale. Until providers have accurate and timely data to risk-stratify and treat patients and can distinguish explained from unexplained variations in utilization and cost, they should be cautious about taking delegated risk or pursuing a direct-to-employer strategy. 

Market Dynamics

Simply reducing operational risk is not enough to succeed with a population health management initiative. Another risk—sometimes the most important—relates to the competitive risk providers and payers face when they get into each other’s business. Certain provider actions are likely to spur counterproductive payer reactions, and vice versa.

Provider actions and payer reactions. Many health systems have sought to create clinically integrated networks (CINs) to bolster their competitive position, quality, and financial stability and attract physicians. Although some payers have been wary of these initiatives, others have found CINs to be excellent partners to reduce medical cost trends, allocate revenue based on performance, transparently allocate and manage risks, and even mutually grow top-line revenue from weaker competitors. Likewise, several IPAs have succeeded under similar arrangements, where payers have steered Medicare Advantage patients/members to IPAs that deliver lower costs, accurate documentation, and high patient satisfaction scores. 

Payer-provider relations have become strained, however, when health systems have entered insurance markets to compete directly for insured lives. Incumbent payers have been particularly hostile to provider competitors they perceive as cherry-picking the least risky lives, even when the provider entered the market solely to increase future referrals. In some major urban markets, some health plans have reacted by terminating providers that have chosen to compete with the health plans. In others, payers have temporarily discounted insurance premiums to prevent providers from entering particular product markets, including Medicare Advantage. In some instances, providers have overlooked these competitive risks; as a result, they have significantly over-invested in their own provider-sponsored health plans.

Payer actions and provider reactions. Payer-provider relations have become strained when payers have aggressively pursued exclusive network contracting and product strategies that reduce patients’ ability to access certain providers. A number of well-publicized negotiation standoffs are related to which lives providers have access to serve at what price point or points in the market. Payer-provider relations also have been strained by two provider perceptions: that plans are allocating excessive downside risk to providers—particularly where the providers lack the systems to manage, budget, or price that risk—and that plans are attempting to create new physician contracting entities (e.g., IPAs) and rewarding them with lucrative bonus payments in return for reduced hospital utilization. 

Managing Competitive Risks 

In light of these market dynamics and competitive risks, there are several ways to manage competitive risks, including negotiating favorable contract language, developing a strategic pricing structure, managing payer relationships, and gaining market essentiality by creating value. 

Negotiating favorable contract language. Some providers have been able to negotiate contract language that prevents commercial payers from tiering or relegating a provider to a narrow network without the provider’s permission. In such cases, if the payer tiers a provider or excludes the provider from a network, the payer must pay the provider (not reimburse the patient) a percentage of charges, by default. This competitive risk management approach may not be very sustainable, though, particularly if the payer doesn’t consider the provider to be a “must have” system.

Developing a strategic pricing structure. Many providers are creating a tiered pricing structure to compete most effectively in price-sensitive markets. In these structures, favorable pricing is negotiated with payers and brokers that are capable of expanding a provider’s market share and margins through either a new product or service-specific steerage (e.g., steering patients to an organization’s ambulatory surgery center). In the absence of such policies, a health system may make a rash competitive decision to reduce fee schedule prices, with no guarantee of market share growth, only to have competitors cut their prices, too. This market dynamic occurred in many markets in the 1980s and 1990s, and health systems that lack pricing policies and procedures are likely to experience a similar situation today.

Managing payer relationships. Providers should seek to establish or improve strong working relationships with their largest payers, brokers, and employers to manage competitive risks. Proactively managing relationships, forecasting medical spend budgets, and sharing data are key to managing the competitive risks that will emerge as payers, providers, and other actors compete for patients.

Gaining market essentiality by creating value. Ultimately, the best strategy is to be a “must have” provider based on critical mass and the ability to create differentiated value through personalized service, access, quality, and price. The other key is to have a tactical plan and budget for each product (e.g., Medicare Advantage, insurance exchange, traditional preferred provider organization), network (e.g., owned or affiliated), and channel (e.g., direct to employer, insurance broker, business coalition). The product plan should specify the customers and prices that will optimize growth, market share, and patient value. Responsibilities for execution of the plan should be clearly delineated. The leadership team should know its respective roles and responsibilities for execution of the product, network, and channel strategy. The roles of the PHO, IPAs, and medical groups with respect to who manages which populations should be specified to avoid duplication of care management and paper-based systems. In addition, monthly operating progress on management of particular patient populations or products (e.g., Medicare Advantage lives) relative to budgeted financials, quality, satisfaction, and access scores should be tracked and reported to senior executives.

Strategies for Managing Financial Risks 

Most providers have maintained a risk-averse profile and purchased stop-loss, malpractice, and errors-and-omissions insurance to cover various operational risks. But when health systems move into managing population health or sponsoring health plans, the stakes go up. In these instances, finance needs to play the primary role in making operating, competitive, and financial risks as transparent as possible. This effort often starts with basic education on the magnitude of financial risks inherent to particular patient populations based on age, gender, disease prevalence, comorbidities, disease stage, clinical practice, patient incentives, and catastrophic events in the population. 

For example, a provider-owned health plan that profiled the magnitude of risk on several patient populations it served discovered that a total medical cost trend (i.e., the amount the plan paid for medical care) of 5 percent across 300,000 lives masked significant differences among underlying patient cohorts (of 50,000 members each), ranging from 10 percent below the mean to 20 percent above it, as shown in the exhibit on page below. Providers that are interested in starting their own health plan or population health management program should recognize the magnitude of the inherent risk and variability that should be budgeted, priced, allocated, and managed. 

Exhibit 2


The following tactics can help CFOs manage risk, beyond buying malpractice and stop-loss insurance. 

Factor in new clinical programs and technologies. New clinicians and new clinical programs can change the risk profile of the populations served. For example, overlooking the impact of a large group of newly employed specialists who attract a large number of chronically ill patients will likely result in under-pricing and under-budgeting that population. 

Don’t allow others to set your total medical expense budgets and prices. One of the most common problems that arose in the 1990s was when health systems allowed health plans to set premiums without input or review from the provider. Some health plans set the premiums low to stimulate sales. Providers that agreed to manage medical costs to a percentage of the artificially low premium were left “holding the bag” when health plan expenditures exceeded premium revenue. So providers should seek to understand, if not negotiate, the methods for setting risk-adjusted premiums with payers. 

Don’t overpay for services you don’t control. Patients may need expensive care when they are out of town. It is critical to define pricing, contracting terms, or carve-out arrangements for those services with the health plan or employer at the onset. 

Recognize the restrictions on health plans. Owning the entire premium dollar is anything but an easy way to bolster margins, in light of emerging regulations restricting carriers’ margins and administrative costs, such as medical loss ratio requirements. In an environment where regulators specify the percentage of a premium to be spent on medical care, provider-sponsored health plans must become highly efficient to generate a margin. 

Simulate, simulate, simulate. Managed care, finance, and medical leadership should simulate the effect that regulatory changes, age, gender, clinical practice, comorbidities, incentives, and severity of illness have on payer and provider margins, investment, and market share. Ideally, purchasers, payers, and providers should meet regularly to quantify and discuss how various population risks will be managed, budgeted, and priced. For example, the modeling team should determine the financial risk and responsibility assumed by members through the use of copayments and deductibles. Modelers also should determine how the provider will allocate risks and distribute rewards internally. Finally, modelers should identify the remaining risks and responsibilities for the employer and the health plan to assume. 

Exercise Due Diligence

Providers that are considering entering the insurance and population health space should prioritize investments in skills and tools for managing risk. Most important, providers should carefully measure the financial, operational, and competitive risks that need to be managed to help ensure success in this arena. 

Michael Nugent is a managing director, Navigant Consulting, Inc., Chicago, and a member of HFMA’s First Illinois Chapter.


a. Greene, R., Beckman, H., and Mahoney, T., “Beyond the Efficiency Index: Finding a Better Way to Reduce Overuse and Increase Efficiency in Physician Care,” Health Affairs, May 2008.

Publication Date: Monday, December 02, 2013

Login Required

If you are an existing member, please log in below. Username and password are required.



Forgot User Name?
Forgot Password?

If you are not an HFMA member and would like to access portions of our content for 30 days, please fill out the following.

First Name:

Last Name:


   Become an HFMA member instead