Establishing Patient Contracts: As Easy as ABCPeter Valencia, M.D., M.B.A., F.A.A.F.P. *

ue to increasing health insurance premiums, many small businessowners are unable to provide benefits to their employees. Someare now opting to negotiate directly with physicians for preventiveand acute care services. When properly implemented, these agree-ments have resulted in huge savings for employers as well as de-creased insurance headaches for providers. This article describeshow to perform an activity-based cost analysis to decide whetherthis form of healthcare services is right for your practice.

Key •words: Activity-based cost; cost analysis; capitation; employee health ser-vices; time studies.

With health insurance premiums skyrocketing, manysmall business owners are unable to provide health benefitsto their employees. Some are now opting to negotiate di-rectly with physicians for preventive and acute care services.This has resulted in huge savings for employers as well asfewer insurance headaches for providers. But before youcan decide what rates to charge these small businesses, youneed to have a strong grasp of your cost for services.

An ABC analysis can be used to evaluatenew services in a practice such as bonedensitometry or laser therapy.

An activity-based cost (ABC) analysis is a great tech-nique used by many healthcare organizations to evaluatethese costs. The key concept is to identify an activity, suchas providing a medical service, with the costs associated toperform the activity. ABC analysis can also be used to eval-uate new services in a practice, such as performing bonedensity examinations or laser therapy.

OPPORTUNITY COST

Before establishing an employer contract, analyzeyour opportunity cost. Ask yourself, "Does the clinic haveexcess capacity?" In other words, can you accommodate

'Regional Chair, Department of Family & Community Medicine, andAssistant Dean for Clinical Affairs, Texas Tech University Health SciencesCenter at the Permian Basin, 800 W. 4th Street, Odessa, TX 79763; phone:432-335-5311; e-mail: peter.valenzuela@ttuhsc.edu.Copyright ©2009 by Greenbranch Publishing LLC,

additional patients or will the new contract mean that newpatients will simply be replacing other patients? In addi-tion, what else could be done with the physician time, stafftime, or your facility? Once you've answered these ques-tions, you can gain a better picture in deciding if employeragreements would be a good fit. Keep in mind that if youcan't negotiate a fair discount or capitation rate with theemployer, then it would be smarter to use your clinic timepursuing other ventures.

CAPITATION OR DISCOUNTEDFEE FOR SERVICE?

Most physicians would prefer to set up a discountedfee-for-service agreement with small businesses. Beware,because if not handled properly, this method could resultin a loss of total net revenue for the practice. For exam-ple, if a practice collects $300,000 and has overhead of$150,000, the physician would take home $150,000.However, if services were discounted by 30% resulting incollections of $210,000, the physician would now takehome only $60,000, assuming overhead stays the same.1

Discounted fees could force providers to work twice ashard in order to make the same amount of money. If youdecide on discounted fees, make sure the rates establishedmeet your desired profit margin.

With capitation, payments are made per-member-per-month, independent of the amount of patient servicesutilized. Although capitation is much riskier than dis-counting fees, it forces your practice to manage care effi-ciently and monitor revenue closely. Again, use caution

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200 Medical Practice Management • January/February 2009

because all capitated agreements bear a degree of uncer-tainty by shifting risk to the practice. The benefits of cap-itated agreements are that they provide steady revenuefor the practice and minimize billing expenses as fees arepaid regardless of patient visits. Private employers also likebeing able to budget for this monthly.

EVALUATING A CONTRACT

Whether you decide on capitation or discounted fees,the ABC analysis will help you uncover your costs for ser-vices. For our purposes, we will apply the ABC analysis to asample capitation. Imagine a small company approaches youto serve as the exclusive primary care provider for its 100employees at a capitated rate of $210 per member annuallybased on an estimated three visits per employee. In this case,most of us would be more than happy to jump on guaran-teed income of $21,000 a year. But wait, die employer tlienasks that a few ancillary services be included for each em-ployee once a year. The additional services requested in-clude a complete blood count (CBC), basic metabolic panel(BMP), and lipid panel. Although you are able to performthese tests in your office and your patient visits are not atfull capacity, you start to wonder if the contract is still worthit. Before jumping into the ABC analysis, I want to sharemy previous experience witli a capitation agreement.

PATIENT POPULATION

During my first few years as medical director of acommunity health clinic, our facility held a capitated con-tract with a regional VA hospital to provide ambulatorycare and ancillary services for 191 veterans. I knew rightaway that this was not an ideal patient mix for a capitatedcontract. However, just as in many small communities,politics played a key role in negotiating the agreement.We were paid a small amount per veteran per month.Unfortunately, many veterans treated the clinic like a cof-fee shop and frequented our office almost weekly. Tomake matters worse, most veterans had multiple diseasesrequiring several lab draws despite the fact that we'd bepaid only for blood tests once a year per veteran.

This leads to an important lesson. Always look atdemographic factors, like age and sex of the patient pop-ulation, to determine the amount of services that will berequired in a capitation contract. For example, males be-tween 20 and 29 years of age use half as many medicalservices as the average patient. On the other hand, Medi-care patients use about twice as many medical services asyounger patients.2 Make sure to ask the contractor for theprevious year's utilization of patient services if available.This will aid in calculating the monthly fee per memberneeded to cover both the healthy and the sick patients.Remember, it only takes a few very sick patients to blowyour profit margin.

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Figure 1. Patient encounter cycle.

COST FOR SERVICES

In an ABC analysis, costs are grouped into activitiesinvolving direct care and indirect care. Examples of directcare expenses include: scheduling the appointment, pa-tient check-in, nurse or medical assistant time, physiciantime, patient check-out, and most importantly, billing andcollection. Indirect care expenses include: building andequipment, utilities, office supplies, malpractice insurance,and administration. Costs can further be categorized asfixed, variable, or semi-variable. Fixed costs remain thesame regardless of the number of patients seen. Variablecosts are dependent on the number of patients treated orprocedures performed. Semi-variable costs (also calledstep-variable) remain the same up to a certain thresholdand then increase. For our purposes, we will focus on di-rect care and indirect care costs. In order to measure cost,we can use time studies and historical data.

Time StudiesTime studies have many benefits for a practice. Com-

panies use time studies to analyze office efficiency andadequate staffing. The easiest way to perform a time study isby attaching a time sheet to the patient's chart and havingeach employee log time spent performing his or her dutiesduring the patient's visit (Figure 1). Although these studiesmay involve several months of data collection, the}' providevaluable information about clinic operations. In our clinic,we discovered that extra staff time was spent completing newpatient forms, searching for charts when patients arrived,and pursuing lab results once the patient was already in theexam room. By making small changes such as pulling charts

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Va/enzue/a/Patieht Contracts 201

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Figure 2. Spreadsheet for calculating costs. Data within dotted boxes can be modifiedbased on your own data. CBC, complete blood count; BMP, basic metabolic panel.

prior to scheduled patient visits and placing labs in the chartprior to calling the patient into the exam room, staff and pa-tient times were significantly decreased. In addition, new pa-tients are now advised to arrive early to fill out paperworkor offered the option to print out forms from our Web siteto be completed before their visit. Although we haven'tstepped up to electronic medical records, these small changeshave helped streamline patient visits.

Time studies can also be used to calculate direct pa-tient care cost with die highest level of accuracy. When cal-culating activity cost per staff member, be sure to includesalary as well as benefits. Break each employee's pay downto the minute. For example, if the front desk clerk werepaid a total of $8.50 an hour, then each minute wouldamount to approximately 14 cents. Use this method to

calculate the rest of the staff's activity cost per minute.Once all of the staff's cost per minute is calculated, chartthe amount of time it takes each employee to complete hisor her part of a patient visit.

In our sample contract, each patient will have labsdrawn only once out of the three visits, therefore timespent drawing labs as well as the cost for the CBC, BMP,and lipid panel should be divided by three. Keep in mindthat cost will also vary based on the use of nurses or med-ical assistants as well as the type of provider examining thepatient. Remember, in a capitated contract, billing timeis nonexistent as the per-member-per-month fees have al-ready been negotiated. To make things easier, you cansimply plug these data into an Excel spreadsheet such asthat shown in Figure 2.

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Medical Practice Management • January/February 2009

Historical DataHistorical data can be used to reflect the average costs

associated with indirect curt. Items that should be includedare: administrative support; building and equipment (talcinginto account all utilities); film and lab supply costs; mal-practice insurance costs; and miscellaneous items such as of-fice supplies. To find administrative costs using historicaldata, divide the total administrative staff cost by the num-ber of patient visits annually. For example, if your clinic ad-ministrator is paid $50,000 dollars (with benefits) and youhad 4500 visits the previous year, then your administrativecost would be $ 11.11 per patient visit. Use this method tofind the rest of the indirect costs per patient. You can alsobenchmark your costs with other practices of your sizethrough the Medical Group Management Association.Once again, simply input the numbers into the spreadsheetand allow it to perform the calculations.

ResultsBased on our example, the practice would theoreti-

cally spend $54.05 per patient visit, with a total of $16,216for 300 patient visits. The practice could potentially bene-fit from this capitated contract with net earnings of $4784,which is a profit of approximately 23%. This amount mayvary from practice to practice depending on total expensesand office efficiency. Once again, this spreadsheet can alsobe applied for discounted fee-for-service agreements be-cause staff activity costs remain essentially the same with a

few modifications for billing and ancillary services. Re-member, once you have covered the fixed costs of theclinic, then each additional patient under contract is con-tributing to covering the variable costs and then the over-all profit of the clinic.

FINAL REMARKS

Negotiating contracts directly with employers couldeliminate the headaches of dealing with insurance compa-nies, but it comes with some risks. Always weigh your op-portunity costs first. If your practice has no other venturesin the pipeline, then an employer contract may be ideal.Whether you decide on capitation or discounted fees, youneed a strong grasp of your cost for services. Remember toconsider patient population when negotiating capitatedcontracts because it only takes a few sick patients to losemoney for the entire group. In addition, spend extra timemaking your office as efficient as possible to help cut ex-penses. Benchmark your practice's costs with other facili-ties your size to see how you compare. Finally, before youaccept a new contract or consider a new service for pa-tients, perform an ABC analysis to see if it will be a finan-cially rewarding endeavor for your practice.

REFERENCES

1. Aymond R. Monitoring your practice's financial data: 10 vitalsigns. Fam Pract Manuj}. July/August 1999:42-45.

2. Dovle E. Medicine on 36 cents a day. ACP Observer. March 1995.

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