Jyoti Osten

Improved management of commercial health plan contracts is critical to meeting financial targets, particularly in an era of reform.

At a Glance

Hospitals that are successful in managing their contracts with commercial health plans share three characteristics:

  • They use internal and external benchmarking data to set meaningful targets for revenue from commercial health plans.  
  • They evaluate the revenue they are receiving from commercial insurers on an ongoing basis to see if targets are being met.  
  • They make adjustments to their contract management plans to meet those targets.  

Cost cutting within hospitals can go only so far before patient care begins to suffer, a risk no healthcare organization can afford. In an era of reform, the most financially healthy hospitals will be the ones that rely less on cost cutting and more on effectively managing commercial health plan contracts.

Typically, when it comes to managed care contracts, many hospitals negotiate for the "best rate," then put aside the contract until the next negotiation cycle begins. However, as market forces and other factors cause contract values to shift, a gap emerges between what the hospital thought it would earn from a contract and what the hospital actually receives in payments.

That leaves money on the table.

Best-practice hospitals have a better way of managing contracts with commercial health plans. They view managed care contracts as part of an ongoing process to make sure the actual revenue they receive from an insurer-the bottom line of the contract-reflects the financial targets they established before signing the contracts.

To get appropriate revenue, these hospitals:

  • Use internal and external benchmarking data to set meaningful targets for payment from commercial health plans
  • Evaluate the revenue they are receiving from commercial insurers on an ongoing basis to see if targets are being met
  • Make adjustments to their contract management plans to meet those targets

Factors to Consider

Hospitals face challenges on many fronts when it comes time to negotiate "best-case" managed care contracts, including those stemming from clinical changes and changes in payer behavior.
Among the factors at play are the following.

A shift in case mix. If contracts were negotiated assuming a certain mix, it's likely that lower rates were accepted in some areas in exchange for higher rates in others. A shift in case mix to the lower paying populations would have an impact on the bottom line.

Level of care. Actual payment for services rendered will be affected if per diem rates were negotiated based on volume assumptions by level of care (critical care, routine medical/surgical, step down) and with increased use of practices that reduce length of stay (LOS) in the ICU.

Treatment setting. As more surgeries are performed on an outpatient basis, some could be shifted away from the hospital to an ambulatory surgery center. Even if surgeries were to continue to be performed in the hospital setting, the number of cases treated as 23-hour holds rather than as inpatient stays would likely increase. Shorter inpatient days with longer subacute stays for selected procedures would affect actual payment from insurers depending on how the contracts were negotiated.

Shorter LOS. Case management efforts to reduce LOS would reduce payment on per diem contracts.

Payer behavior. An increase in denied days and underpayment by payers would affect the actual amount a hospital receives from a contract. In addition, as payers offer plans with lower monthly payments in exchange for a higher deductible, this cost shifting makes the hospital responsible for collecting the deductible from patients and could lower the total payment for services.

Healthcare reform. The uncertainties of reform make it even more crucial to maximize payment from commercial health plans now. The volume of insured Americans is expected to rise, but it is uncertain what level of payment hospitals can expect to receive from the newly insured.

The Solution: A Sophisticated Database of Paid Claims

Given all these factors, how can a hospital know how its contracts are performing relative to one another (internal comparison) and relative to contracts managed by organizations in the hospital's peer group (external comparison)? Hospitals should be able to evaluate each contract at the service line or diagnosis-related group level to determine whether the actual revenue they receive from commercial insurers is where it needs to be to meet the organizations' financial goals. Hospitals also need access to market revenue data to determine where the payments they receive from commercial insurers stand. Without these data, hospitals can only guess how their contracts are performing relative to the market. And worse, they can only guess what their expectations for a given contract should be.

Creating a database of paid claims from hospital-selected peer groups is the answer. The database should:

  • Contain payments from all sources for all services performed
  • Be updated on an ongoing basis and contain both historical and current information
  • Conform to all federal antitrust reporting requirements
  • Allow for an apples-to-apples comparison by normalizing data based upon the target contract's case mix of patients

As an example, let's consider that one hospital is performing below its peer group with respect to its total payments from commercial contracts, indicating an opportunity for increased revenue.

Using market data, this hospital may also decide it needs to improve its market position. But where should the hospital's efforts begin? Market revenue data can be used to evaluate how the hospital's contracts are performing relative to each other (internal parity) and relative to the hospital's peer group (external parity). Peer group selection will vary according to what the hospital chooses to evaluate, and should be a dynamic process. For some service lines, such as obstetrics, the peer group may be local hospitals. For specialized services, such as specialized surgeries and transplants, the peer group may be drawn from hospitals across the state or even the nation.

Let's also consider that some of the hospital's contracts are performing much better than others, but many of the other contracts are performing below their peer group average. One strategy would be to first focus on the low-performing/ high-volume contracts to improve total contract value.

Now that the hospital has been given a good overview of its contracts and its market position, the next step would be to determine how each insurer's payments to the hospital have been trending over time. It is then helpful to determine whether particular service lines are being paid at a lower rate than that which is received by the hospital's peer group.

Once these analyses are complete, the same data used to set the targets must be evaluated on an ongoing basis to make sure those targets are being met. For example, suppose a shift in treatment setting or an increase in denied days occurs for the newly negotiated contract. There will now be a gap between what the hospital thought it would receive from the contract and the actual payments received.

How can the hospital compensate for this revenue gap?

Because the hospital in this example is now evaluating all contracts and service lines on an ongoing basis, one strategy to close the gap would be to identify opportunities in other contracts coming up for negotiation to make up the revenue gap.

As an example, suppose a hospital experiences a reduction in LOS across several service lines, causing its mostly per diem payments from one commercial payer ("Payer A") to fall $2 million below original targets. Let's also suppose that the hospital's contract with another commercial payer ("Payer B") is performing $8 million below contracts held by other hospitals within its peer group. If the contract with Payer B is up for negotiation, but the contract with the Payer A is not, this hospital can confidently negotiate for rates closer its peer group while also taking into account the shorter LOS its patients are experiencing. This approach will allow the hospital to experience an improvement in margins despite the shortfall in expected payments from Payer A.

As the market becomes increasingly competitive in an era of reform, it is essential that hospitals have data they can trust to set goals for contract performance improvement and the tools they need to better manage contract performance. These resources can help hospitals protect their market position-and their bottom line.

Jyoti Osten is a director, Professional Data Services, Los Angeles (josten@hasc.org).


5 Questions Hospitals Should Ask Themselves Regarding Managed Care Contracts  

With access to market data, hospital leaders can begin to ask the following questions related to managed care contract performance:

  • Where are we in the market compared with where we want to be?
  • How are our contracts trending over time?
  • How do our contracts compare with our peer group's contracts?
  • Where are our top opportunities for contract revenue improvement by payer?
  • Where are our top opportunities for revenue improvement by service line?

Publication Date: Tuesday, March 01, 2011

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