Principles and Practices (P&P) Board Statement No. 11, Accounting and Reporting by Institutional Healthcare Providers for Risk Contracts, deals with the unique accounting considerations providers of healthcare services confront when entering into risk contracts. A lack of guidance for managed care programs which enter into risk contracts also led the American Institute of Certified Public Accountants (AICPA) to address these issues in AICPA Statement of Position (SOP) 89-5, "Financial Accounting and Reporting by Providers of Prepaid Health Care Services." SOP 89-5 was subsequently incorporated in and superceded by the AICPA Audit and Accounting Guide, Health Care Organizations, new edition as of June 1, 1996 (the guide).

Statement No. 11 was published in Healthcare Financial Management in August 1989. Statement No. 11 was reviewed for conformity with the guide, and technical references were published in January 1997. 


Accounting and Reporting by Institutional Healthcare Providers for Risk Contracts

Introduction

1.1 Institutional healthcare providers1 are increasingly entering into contracts with managed healthcare plans that obligate the providers to provide healthcare services to enrollees of the plans in exchange for payments established under a variety of methods. When the contract exposes the provider to the uncertainty of financial gain or loss, it is generally referred to as a "risk contract." Uncertainty of financial gain or loss in this sense relates to the adequacy of contract revenues relative to contract costs -- it does not include other types of business risks.

1.2 Under a risk contract, the provider agrees to furnish specified healthcare services for a negotiated price, which may be an amount per case, service, or day; the price may vary based on the volume of services furnished during the contract period. Or, the provider may contract to provide all defined healthcare services to a specific beneficiary group in return for a predetermined capitation fee. A risk contract may also provide for a sharing of risk through the establishment of risk pools designed to create financial incentives to the providers and, in some instances, to the plan (payer), to control costs.

1.3 This statement has been prepared to address revenue recognition, expense recognition, loss accruals, accounting for risk pools, and stop-loss insurance by institutional healthcare providers that have entered into risk contracts.

General Background

2.1 The contractual arrangement between the managed healthcare plan (payer) and the provider determines the extent to which each entity bears the financial risk (or reward) for unfavorable (or favorable) experience. The contract generally describes covered and noncovered services, payment arrangements, responsibilities of the parties, and administrative policies and procedures, and may subject providers to risks they may not have previously assumed. For example, a hospital may agree to furnish all covered services to enrollees who are authorized, under the terms of the contract, by a participating physician. Where the hospital is also responsible for services furnished to enrollees by other healthcare institutions (for example, when enrollees are outside the area served by the hospital and they require emergency services), the contract specifies the approval and payment process for those services.

2.2 Payment terms are also set forth in the contract. Where applicable, risk pool arrangements and settlement terms are also described. The contract identifies the party responsible for holding risk pool assets and usually requires that settlement be administered by the payer. Also, rights and responsibilities for collecting payments from sources other than the payer are described. For example, the payer usually is responsible for collecting and has the right to retain payments from an enrollee's primary insurer under coordination of benefits provisions, and providers may be responsible for collecting copayments and deductibles from patients who are enrollees.

Revenue Recognition

3.1 The Financial Accounting Standards Board (FASB) in FASB Concepts Statement No. 5, "Recognition and Measurement in Financial Statements of Business Enterprises," states that "revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." The risk contract specifies what must be accomplished by the institutional healthcare provider in order to earn revenues under the contract.

3.2 Under contracts that call for fee-for-service, discounted fee-for-service, and per diem payment arrangements, the provider earns revenue for providing patient services. Accordingly, revenue should be recorded when the service is provided.

3.3 Discounted fee-for-service and per diem payment arrangements may call for varying rates of payment based on the volume generated under the contract. If the amount of the payment is contingent upon factors that are not determinable until the end of the contract term, an estimate may be required. For example, a contract may state that a hospital will be paid $750 per day for the first 5,000 patient days under the contract, $675 for the next 3,000 patient days, and $600 for all patient days in excess of 8,000. The revenue earned under the contract, therefore, is dependent upon the total volume of patient days rendered during the contract period. For interim reporting purposes, and for annual reporting purposes when the contract period does not coincide with the hospital's fiscal period, an estimate of the revenue earned will be required. Accounting Principles Board (APB) Opinion No. 28, "Interim Financial Reporting," states, "When quarterly discounts are allowed customers based upon annual sales volume, the amount of such discounts charged to each interim period should be based on the sales to customers during the interim period in relation to estimated annual sales." Accordingly, the hospital should estimate its total volume under the contract based on factors such as current and prior period experience, seasonal trends, changes in the contract population base, and other significant factors that may affect volume.

3.4 An illustration of the estimates and calculations required using the facts set forth above follows:

    Hospital's fiscal year end: 12/31
    Term of contract: 4/1-3/31
    Actual and estimated covered days during contract term:
        4/1-12/31 (actual)            6,000 days
        1/1-3/31 (estimated)        3,000 days
                                             9,000 days

    Actual and estimated revenue during contract term:
        Actual
        5,000 days x $750 =    $3,750,000
        1,000 days x   675 =         675,000
            Total to 12/31           $4,425,000

        Estimated
        2,000 days x $675 =   $1,350,000
        1,000 days x    600 =       600,000
        Total 4/1 to 3/31          $6,375,000

    Average per day                      $ 708

    Revenue earned to 12/31
        ($708 x 6,000)            $4,248,000

3.5 Throughout the contract period, previously recorded revenue may be determined to be inaccurate. Any necessary adjustment should be accounted for as a change in estimate at the time such determination is made. Prior interim and annual periods should not be adjusted or restated.

3.6 When the payment method is a per case payment, revenue is earned when services are rendered. When a patient is hospitalized at the end of an accounting period, a portion of the total revenue for the case is earned in one period and the balance will be earned in the next period. Therefore, the total revenue for the case should be allocated between the two accounting periods using an allocation method that fairly apportions the revenue to each period. In addition, if the contract provides for discounts based on the number of cases or types of cases served under the contract, the accounting for discounts previously described would apply.

3.7 Capitation revenue is earned as a result of agreeing to provide services to enrollees without regard to the actual amount of services provided. Therefore, revenue should be recorded in the period that beneficiaries are entitled to healthcare services. Most hospitals record patient revenue and the related receivables as services are rendered. Therefore, revenue adjustments and valuation allowances must also be recorded so that only the amount of contract revenue earned is reflected.

3.8 The amount of contract revenue actually earned may be affected by other factors, such as, reinsurance recoveries, deductibles and coinsurance, and risk pool settlements.

Expense Recognition

4.1 Under risk contracts that pay the provider on the basis of fee-for-service, discounted fee-for-service, per diem, and per case methods, the provider should recognize patient care expenses in the period the related services are provided to achieve an appropriate mAudio Webcasthing of revenues and expenses.

4.2 Under risk contracts that make capitation payments to the provider, there are differing views on expense recognition. Some believe that because capitation fees are recognized as revenue in the period that enrollees are entitled to services, expenses should be recorded as services are rendered. Others contend that once an incident (for example, accident or illness) occurs, all estimated future expenses required to provide covered services should be recognized.

4.3 While obligations vary depending upon the specific terms of the contract or regulatory requirements, managed healthcare plans and institutional healthcare providers participating in capitation arrangements usually are not obligated to provide services to noninstitutionalized enrollees beyond the contract period or beyond the month for which the premium is paid. Continued service to institutionalized enrollees is, however, customary, irrespective of premium payment. Accordingly, the Principles and Practices Board (P&P Board) believes that institutional healthcare providers with capitated payment contracts should recognize healthcare expenses as services are rendered, including estimates of the costs of services rendered but not yet reported and costs to be incurred for currently institutionalized enrollees until discharge. Amounts payable to physicians or other contracted providers under risk retention, bonus, or similar programs should be accrued during the contract period based on relevant factors, such as experience to date. In addition, if specific circumstances, such as contractual provisions or regulatory requirements, obligate the provider for services beyond the period of the contract, the estimated cost of those services, net of any related anticipated revenues under the contract, should also be accrued.

4.4 To illustrate this conclusion, assume that a hospital with a risk contract is preparing its financial statements as of December 31 of a given year. The hospital would accrue its obligation for all covered services actually provided through December 31, whether or not invoices have been received from physicians or outside contract providers entitled to payment for those services. The hospital would also accrue costs to be incurred for currently institutionalized enrollees until discharge. Further, under this conclusion, the hospital would not accrue costs for covered services rendered after December 31, unless it is obligated to render services to specific enrollees beyond the current period due to provisions in the contract or regulatory requirements. Therefore, it usually would not be appropriate for a hospital to record estimates of the costs of future services even though an incident has occurred.

Loss Recognition

5.1 By contracting to provide services at discounted or capitated rates for the term of the contract, an institutional healthcare provider may incur a loss on the contract. FASB Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies," requires that losses be accrued when it is probable that an asset has been impaired or a liability has been incurred, and the amount of the loss can be reasonably estimated. Furthermore, anticipated gains are not recorded until realized.

5.2 The P&P Board believes that institutional healthcare providers should record a loss on a risk contract if future costs, including contract-related administrative costs (such as medical records, claims processing, billing, and so on), are expected to exceed future revenues and stop-loss recoveries from the contract. The estimated future costs to be considered in determining whether an anticipated loss exists should include fixed and variable direct and allocable indirect costs. Anticipated gains should not be recognized in advance of realization.

Risk Pools

6.1 Risk pools provide a vehicle for sharing favorable and unfavorable financial experience among providers (and, in some instances, the payer, depending on the terms of the risk contract). Final settlements of risk pools typically occur at the end of the contract term. While risk pool settlement arrangements may, in some cases, be relatively straightforward, in other cases they may be complex. For instance, settlement of a risk pool may be dependent upon utilization levels, actual costs incurred, amounts available in the physicians' risk pool, and other factors.

6.2 When the contract term coincides with the provider's fiscal period, the actual settlement of the risk pool should be recorded if available. When those periods are different or when the actual settlement is not known, the provider will be required to estimate the settlement. The estimate should be made using actual year-to-date experience and other data concerning factors that may affect the final settlement. Subsequent adjustments based on the actual settlement should be treated as a change in the accounting estimate that is recognized in the period of the change.

Stop-Loss Insurance

7.1 Some providers view stop-loss insurance premiums as an operating expense and recoveries from stop-loss insurance as additional revenue. Others consider the insurer to be providing a portion of the enrollee's coverage for a premium. Consequently, they view a portion of the risk contract revenue as due to the insurer, and, accordingly, the stop-loss premium as a reduction of that revenue. Because the insurer is considered to have assumed a portion of the risk and to be responsible for that portion of the loss, expenses are reduced by the amount recovered or recoverable from the insurer.

7.2 Some believe that amounts recoverable from insurers for unpaid losses should be applied to reduce accrued risk contract liabilities, while others believe all amounts recoverable from insurers should be classified as assets.

7.3 The P&P Board believes that stop-loss insurance premiums should be included in operating expenses and that stop-loss insurance recoveries should be classified as a reduction of operating expenses. Receivables representing amounts recoverable from insurers should be classified as assets, reduced by appropriate valuation allowances.

Financial Reporting and Disclosures

8.1 The P&P Board believes that for generalpurpose financial reports, revenue of institutional healthcare providers should be reported at the amount that a payer has an obligation to pay. If payment arrangements call for payment of charges, that amount is reported as revenue. If payment arrangements provide for a discount, the amount reported as revenue is net of the discount. If payment arrangements call for payment of a specific amount for a case irrespective of the services rendered, that amount is reported as revenue.

8.2 The P&P Board believes that this conclusion is relevant to reporting revenues of institutional healthcare providers earned under risk contracts. That conclusion is applicable regardless of whether the risk contract payment arrangements are fee-for-service, discounted fee-for-service, per diem, or capitation methods. The guide requires that patient service revenue (which is derived from fees charged for patient care) be reported separately from premium revenue (which is derived from capital arrangements).

8.3 Institutional healthcare providers should disclose the following information with respect to their risk contracts in general purpose external financial reports:

  • The nature and terms of significant risk contract arrangements and the basis of recording revenues, expenses, and losses under those arrangements.
  • The nature of significant stop-loss insurance contracts.
  • If the contract involves a related entity, the disclosures required by FASB Statement No. 57, "Related Party Disclosures."

Summary of Conclusions

9.1 In summary, the conclusions applicable to institutional healthcare providers contained in this statement are:

A. Revenue Recognition

9.2 Under risk contracts that call for fee-for-service, discounted fee-for-service, per diem, and per case payment arrangements, contract revenue should be recorded when the service is provided. If the amount of the payment is contingent upon factors that are not determinable until the end of the contract term, an estimate, in accordance with APB Opinion No. 28, "Interim Financial Reporting," may be required. When the payment is a per case method and the patient is hospitalized at the end of the accounting period, a portion of the payment is earned in that period and the balance will be earned in the next period. Therefore, the total payment should be fairly allocated between the two periods.

9.3 Capitation revenue should be recorded in the month that beneficiaries are entitled to healthcare services.

B. Expense Recognition

9.4 Expenses incurred in providing services under risk contracts should be recorded in the period those services are rendered, including estimates of the costs of services incurred but not yet reported and costs to be incurred for continued service to institutionalized enrollees until discharge. In addition, if specific circumstances, such as contractual provisions or regulatory requirements, obligate the provider for services beyond the period of the contract, the estimated cost of those services, net of any related anticipated revenues under the contract, should also be accrued.

C. Loss Recognition

9.5 A loss on a risk contract should be recorded if future fixed and variable direct and allocable indirect costs, including contract-related administrative costs, are expected to exceed future revenues and stop-loss recoveries from the contract.

D. Risk Pools

9.6 Actual risk pool settlements, if known, should be recorded when the contract term coincides with the provider's fiscal period. When those periods are different or when actual settlement is not known, the provider should record an estimate of the settlement based on actual year-to-date experience and other relevant data.

E. Stop-Loss Insurance

9.7 Stop-loss insurance premiums should be included in operating expenses and stop-loss insurance recoveries should be classified as a reduction of operating expenses. Receivables representing amounts recoverable from insurers should be classified as assets, reduced by appropriate valuation allowances.

F. Financial Reporting and Disclosures

9.8 Revenue under a risk contract should be reported at the amount that a payer has an obligation to pay. Patient service revenue should be reported separately from premium revenue. Financial statements should disclose the following information with respect to risk contracts:

  • The nature and terms of significant risk contract arrangements and the basis of recording revenues, expenses, and losses under those arrangements.
  • The nature of significant stop-loss insurance contracts.
  • If the contract involves a related entity, the disclosures required by FASB Statement No. 57, "Related Party Disclosures."

Glossary

10.1 The following are definitions of terms used in this statement and in the field of risk contracts

Beneficiary -- See "Enrollee."

Capitation Fee -- A fixed amount per member that is paid periodically (usually monthly) to a provider as compensation for agreeing to provide defined healthcare services for the contract period. The fee is set by the contract between a managed healthcare plan and a hospital, physician group or IPA, or other providers, and it may be actuarially determined on the basis of expected costs to be incurred.

Competitive Medical Plan (CMP) -- A health plan option (similar to an HMO) that may be made available to Medicare beneficiaries. CMPs provide a more limited range of services than HMOs, but include physicians' services, laboratory, radiology, emergency, preventive, and inpatient services. The CMP assumes risk for the provision of services and out-of-area coverage and meets certain requirements to ensure financial solvency.

Copayment -- A payment required to be made by an enrollee to a provider when healthcare services are rendered. Examples of typical copayments include charges for each physician office visit, prescriptions, or certain elective hospital procedures. Copayments can be specified as a dollar amount or as a percentage of charges.

Date of Initial Service -- The date when a healthcare provider identifies that an enrollee has an illness or shows symptoms requiring the enrollee to obtain future healthcare services.

Enrollee -- An individual who is enrolled in a managed healthcare plan. An enrollee may also be referred to as a member or a beneficiary.

Fee-for-Service -- A method of billing and payment based on a fee for individual services provided. Under a fee-for-service system, fees are established for each service. Fees may vary by geographic area. The fees themselves are established based upon a methodology that generally considers the type of service rendered, the mode of the service, and who is performing the service.

Guaranteed Renewal Contract -- A contract that guarantees the enrollee the right to continue coverage as long as premiums are paid, with the right reserved by the provider of prepaid health services to change the premium rates.

Health Maintenance Organization (HMO) -- A generic group of medical care entities organized to provide comprehensive healthcare services to enrollees for fixed, prepaid fees (premiums).

Incurred But Not Reported (IBNR) Costs -- Costs associated with healthcare services incurred during the financial reporting period, but not reported to the managed healthcare plan or other prepaid health provider until after the financial reporting date.

Individual Practice Association (IPA) -- A partnership, association, corporation, or other legal entity organized to provide or arrange for the delivery of healthcare services to enrolled members of an HMO or other prepaid healthcare provider (and non-HMO patients). In return, the IPA receives either a capitation fee per member or a fee for the service rendered.

Maintenance Costs -- Costs associated with maintaining enrollment records and processing collections and payments.

Managed Healthcare Plan -- A prepaid healthcare plan or insurance program in which enrollees receive healthcare services in an organized manner so as to control healthcare costs. Managed healthcare plans include HMOs, PPOs, CMPs, and insurance plans that use preadmission and other authorization procedures as well as concurrent review to control utilization of healthcare services. They often use financial incentives to motivate enrollees or "gatekeeper" physicians to achieve prudent use of healthcare services.

Medical Group -- An association of physicians and other licensed healthcare professionals organized on a group basis to practice medicine.

Member -- See "Enrollee."

Occurrence -- The rendering of healthcare services covered by a contract with an HMO or other managed healthcare plan. Occurrences include admissions to a hospital, physician visits, or emergency treatments.

Per Diem Payment -- A specified amount of payment per patient day of healthcare services regardless of the quantity and value of services rendered.

Per Case Payment -- A predetermined payment per case based on diagnoses, procedures, or other factors.

Preferred Provider Organization (PPO) -- A term applied to various contractual arrangements between hospitals and physicians on one hand and insurers, employers, or third-party administrators on the other in which the healthcare providers (preferred) agree with healthcare purchasers to provide health services for a defined population, usually at discounted rates. Many PPOs use review mechanisms to control utilization. PPOs provide financial incentives to eligible employees to select contracting providers for care. Contracting providers are paid using a variety of methods such as per case, per diem, and discounts from established charges. PPOs normally act as brokers and do not accept the transfer of insurance risk, although there are exceptions to this general rule.

Premium -- The consideration paid to an HMO or other prepaid healthcare provider for providing contracted coverage. Premiums are typically established on an individual, two-party, or family basis and paid monthly.

Prepaid Healthcare -- An arrangement between a provider of healthcare services and a sponsoring organization specifying the payment of a fixed sum or a fixed amount per enrollee in advance of the services delivered by the provider. The arrangement may cover a wide range of healthcare services or a specialized aspect of health care (for example, dental and eye care).

Prepaid Healthcare Services -- Any form of healthcare service provided to an enrollee in exchange for a scheduled payment (or payments) established prior to the rendering of care, regardless of the level of service subsequently provided.

Provider, Institutional Healthcare -- An organization that provides healthcare services. For purposes of this statement, the term institutional healthcare provider is limited to an organization that provides or arranges to provide healthcare services to enrollees of an HMO or other managed healthcare plan.

Providers of Prepaid Healthcare Services -- Entities that provide or arrange to provide for the delivery of healthcare services in accordance with the terms and provisions of a prepaid healthcare plan. Providers assume the financial risk of delivering healthcare services for pre-established advance payments. However, this financial risk may be contractually transferred to other providers or insured through the purchase of stop-loss insurance. The most common form of organization providing prepaid healthcare services is the HMO. Other providers of prepaid healthcare services include comprehensive medical plans (CMPs), physician groups (for example, IPAs), and hospitals.

Risk Contract -- A legal agreement that exposes the provider to the uncertainty of financial gain or loss as a result of agreeing to provide healthcare services.

Risk Pool -- A financial arrangement designed to spread the risk of utilization, cost, or both among the participants, generally the prepaid healthcare plan, physicians, and the hospital. Common types of risk pools are: a gain sharing pool, which provides incentives to participants by sharing savings when costs are less than budgeted amounts; a loss sharing pool, which penalizes overutilization by sharing losses when actual costs exceed budgeted amounts; and a combined risk sharing pool, which provides incentives and penalties by spreading both savings and losses.

Stop-loss Insurance (Reinsurance) -- Insurance obtained by a managed healthcare plan, a hospital, or other entity to protect itself against some or all of the losses incurred in the process of satisfying the claims of enrollees or policyholders. Most often, stop-loss insurance covers individual claims with either high cost or long stay. The term "reinsurance" is used extensively by providers of prepaid healthcare services, but generally refers to stop-loss insurance.

1988-89 Principles and Practices Board Members

Clark A. Cable, CPA

Jill E. Egan

Michael A. Engelhart, CPA

James W. Karling, CPA

Richard L. Marrapese, CPA

Robert L. Newton, FHFMA, CMPA

Robert E. Schimmel, CPA

L. Vann Seawell, DBA, CPA

Richard H. Showalter, Jr., CPA

George Shumar, FHFMA

Richard D. Telkamp, FHFMA, CPA

Jerry P. Widman, CPA

HFMA Staff

Ronald R. Kovener, FHFMA, CAE

Footnotes

1. Examples of institutional healthcare providers are hospitals, continuing care retirement communities, skilled nursing facilities, subacute care facilities, multispecialty clinics, and freestanding ambulatory centers.

Publication Date: Wednesday, January 01, 1997