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Setting Realistic Contract Rates

— Roberta Gardine, Executive Director, Hawthorn Children's Psychiatric Hospital, St. Louis, Missouri, and Stephenie W. Colston, Project Director, State Technical Reviews Project, Johnson, Bassin & Shaw, Inc.

Clearly, the AOD field is facing a significant challenge with managed care. As is typically the case, the experience of providers will guide the field in developing appropriate responses to these issues. If providers are to survive under managed care, they must be able to define and report costs in a way that makes them competitive in the managed care marketplace.

Grant and fee-for-service providers may feel overwhelmed and out of their league when forced to think about, discuss, or operate using managed care financing principles. But providers cannot afford to wait until a cookbook on managed care pricing and service delivery is developed to provide a simplified, step-by-step guide to this process. Providers need to begin the transition by learning about and understanding basic principles of cost accounting for managed care. They need to start now to put systems in place for gathering needed information within their provider agencies.

The Problem of Measuring Service Costs

As managed care initiatives are implemented throughout the country, the AOD field is being forced to face a long-standing problem: the lack of standard ways to measure units of service and their corresponding cost components. This lack of a systematic approach has meant that studies of AOD costs have traditionally calculated the cost per treatment slot, based on dividing the number of enrolled clients into the dollar amount spent on services. With this approach, there is no relationship between discrete treatment units and the resources expended by the provider. To survive under managed care plans, the emphasis has been simultaneously on how to control access, utilization, and the cost of providing services for a variety of payers.

In this managed care environment, it is no longer enough for AOD providers simply to calculate a reimbursement rate based on available staff time. Rates must now take into consideration the actual number of units of service provided.

Providers face this issue of unit costs when they attempt to negotiate contracts with managed care entities. In a number of States, these entities are suddenly in charge of disbursing public AOD funds that had formerly been disbursed by State agencies on either a grant or fee-for-service basis. Providers are learning that managed care entities typically do not negotiate a reimbursement rate. They simply tell providers what the rate will be. Providers must know what the impact of such a rate will be on their agency's overall financing before they decide to sign managed care contracts.

Providers need to consider and take a series of positive, practical steps before they accept contract rates with managed care entities. These steps involve two key elements.

Providers need to understand thoroughly the differences between grant and fee-for-service markets and the emerging managed care markets. And providers need to be aware of the importance of documenting how treatment staff spend their time. They need to know how to use units of staff time for calculating the cost of providing treatment services.

Two Systems:

Two Different Dynamics

The first step in setting a realistic contract rate is to obtain a basic understanding of how operating in a managed care market differs from a grant or fee-for-service market. Most States and providers have enjoyed and managed successfully for years in a market that uses grants or fees-for-service to pay for services. Providers have learned how to make adjustments to maintain the viability and stability of their agencies. Available revenue, more than any other factor, has determined provider costs. Providers frequently respond to revenue cuts by reducing the amount of service, the quality of care, or both, and react to revenue increases with the opposite response — by expanding services and/or improving the quality of care.

In both the grant and fee-for-service markets, payment mechanisms have not been tied to the cost of providing the service. Therefore, providers have had no financial incentives to monitor and contain costs.

In the managed-care market arena, the principles of setting a rate, the incentives, and the resolutions to problems are vastly different. In fact, these principles are diametrically opposite those in the grant and fee-for-service markets. In a grant market, the provider receives the same amount of funding per month regardless of the cost or number of units of service provided. In a fee-for-service market, the provider tries to establish the highest price possible for services and to maximize the number of units of service provided. In grant and fee-for-service systems, there is no incentive to provide either fewer or less costly services. The provider may fix any revenue shortfalls by adjusting the service mix or by increasing service units. To make these changes, providers do not need any individualized client data.

In a managed care environment, the payer has a financial incentive to contain costs. This naturally drives the reimbursement rate down and leaves less flexibility to negotiate a higher contract rate. Additional cost containment or reductions will be achieved by limiting care to service levels that are medically necessary and appropriate and by decreasing the length of authorized service. These critical decision points are largely outside the provider agency's control.

There are also financial disincentives to providing such traditional services as residential treatment, which is a core service to many providers. For providers, the loss of these core services has a multiplying negative impact on revenue, because core services have historically been a vehicle for covering many indirect costs. As a result of this shift in reimbursement and funding, the majority of providers find themselves ill equipped to compete in a managed care environment.

Determining the Provider's

Cost of Service

If they are to survive financially, it is essential that providers know their costs of service before entering into a managed care contract. To be competitive in this environment, the provider must be able to establish a contract rate per service which is at a margin in excess of provider costs. Providers must know their break-even point (the point at which they begin to lose money). If a provider is unable to answer the basic questions about what it costs to provide a service unit, and cannot establish that margin above cost, the provider is not ready for managed care contracting.

If unit costs are not known, the provider may blindly enter into contracts and then subsidize any losses through other agency payer sources. The provider is now robbing Peter to pay Paul. There is a basic flaw in this creative funding strategy. The lack of costing information that led to robbing Peter in the first place contributes to indecision regarding where to stop to avoid losing substantial agency revenues.

Too often, the provider's first response to this problem is to produce more units of service — the strategy that worked under a fee-for-service system. However, if the provider has set a rate at a level that is below cost, increasing the number of units of service will only increase loss. The provider cannot spend itself rich. Intensifying this problem is the fact that most not-for-profit providers have a shortage of available revenue and cash flow. By the time the pricing error is realized, the provider is already in financial trouble.

Costs for an Episode of Care

Providers have traditionally established rates based on overall program expenses. Managed care reimbursement is based on the cost of treating an individual episode of care. To establish a realistic rate, the provider must define an episode of care. The field has been grappling with what constitutes an episode of care since the implementation of managed care. For purposes of this article, we have adopted the definition of McGuirk, et al.: "An episode of care is a construct that groups all the treatment provided for a specific condition over a continuous, defined period of time; [this concept is] often used to analyze service cost, quality, and utilization patterns."⁽¹⁾

To obtain episode-of-care information, the provider must begin to gather data on patient profiles. Through clinical data systems, the provider must be able to document episodes of care per client. This data must then be integrated with financial systems to provide data on treatment and length of stay according to diagnostic category and by client. By analyzing this data, the provider can learn the historical patient profile trends for the agency.

Based on these past utilization patterns, the provider already knows the revenue and financial stability of the agency. It is therefore possible to assess quickly the point at which a change in utilization will negatively impact the agency. Historical data will only produce trends for the agency, not tell the optimal service level needed to produce the desired outcome for each episode of care. In analyzing this data, the provider needs to challenge and question the agency's service delivery patterns. This data provides an invaluable base for making decisions about service utilization. What is needed is to try to move service utilization to the minimal pattern of treatment (in terms of units of care) that can achieve the desired outcome for each patient.

The provider should ask such questions as, "Does an episode of care apply to the acute phase only? Does it include case management or other services to maintain clean and sober status or prevent future problems? If so, how much care is medically necessary to obtain the desired outcomes?" These become pivotal questions in determining how many service units the payer may authorize as "medically necessary."

Providers need to be critical in challenging their agency benchmarks and profiles. Most providers will find it somewhat difficult to be objective as they enter this phase of analysis. Patient profile standards for behavioral health care are almost nonexistent. We need to recognize that these decisions must often be made without good supporting documentation.

Despite the lack of concrete data, providers must start collecting and using whatever patient profile information is available as a basis for pricing a service or negotiating a contract rate. These factors will help the provider establish how many units of service the outside payer sources can realistically be expected to authorize. They can also be used to determine the potential impact of these payer decisions on the provider.

How Staff Time Is Spent

Many public and private nonprofit providers have done less than an adequate job of logging all staff time. Billable units are not usually a problem. Generally, staffs document and log their billable units as requested. Staff compliance with logging nonbillable time has been more difficult to maintain. Supervisory or administrative staff often do not monitor nonbillable time closely, if at all. Providers need to obtain this information so they can determine whether the units of service anticipated to be authorized for an episode of care will actually cover the direct and indirect costs of providing the service. Without this information, the provider cannot determine whether staff can and will generate sufficient reimbursements to cover the real costs of service.

CSAT has funded considerable research geared toward understanding the cost of providing AOD treatment services. This research depends on the appropriate documentation of treatment staff time. CSAT recognizes that such staff time is important for documenting the cost of providing treatment services. One pilot study of patient service costs in selected AOD treatment sites was conducted in 1994 by Johnson, Bassin & Shaw, Inc. (JBS) and its subcontractor, Research Triangle Institute (RTI), under the auspices of the State Technical Reviews Project. This was essentially a cost-finding study of 13 publicly funded treatment programs throughout the United States. The study sought to determine how staff spent time on specific services. This was used as the basis for allocating costs and for providing real-time, full economic costs of services rather than historical costs.

The researchers developed a diary methodology to ascertain how treatment staff spent their time. Each treatment staff person was asked to maintain a time activity diary for 1 week. This provided a 1-week snapshot of the actual time each staff person spent in delivering both treatment and non-treatment services to clients. In this study, the diary methodology thus became an important measure of staff productivity. The compiled diaries made it possible to estimate the quantity of services that each client received during a typical stay. The diaries showed that approximately 100 specific types of services were being provided.

CSAT Study to Aid Providers

CSAT asked JBS and RTI to embark on a second cost study to develop a market-based financial planning model. The goal of this effort is to create a tool for States and providers to project costs and risks under a variety of scenarios that can be tailored to specific market conditions within the changing financial environments. The model is designed to take providers and States from a static analysis of cost and paper-based risk projections to a computer-based simulation model. A software diskette will be produced for providers to use in projecting their costs and revenue, along with a user guide summarizing business planning and cost analysis principles.

Whatever level of fiscal and clinical sophistication you have as a provider, that's where you are and where you must begin to develop cost information. Build on each component as information becomes known. Providers will be surprised at how far they can move by just getting started. Provider cost information is essential for purposes of internal management, MCO contracting, and provider profiling. As more States move towards outcomes-based funding, provider performance will be profiled on the basis of both treatment and cost effectiveness. Providers capable of analyzing their costs will be well prepared to meet this challenge.

1. McGuirk, F.D.; Keller, A.B.; and Croze, C. Blueprints for Managed Care: Mental Health-care Concepts and Structure. Rockville, MD: Center for Mental Health Services, Substance Abuse and Mental Health Services Administration, May 1995, p. 64.

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