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4.2 Risk contracting by institutional providers
Publication date: 31 Mar 2023
us Health care guide
The discussion in this section pertains to risk contracting issues from the perspective of an institutional provider of health care services (e.g., a hospital); risk contracting issues for non-institutional providers (e.g., managed care organizations (MCOs), accountable care organizations (ACOs), and other types of organizations) are discussed at HC 4.3. This section presumes that the contract has been determined, at least in part, to be in the scope of ASC 606. See HC 4.1 for considerations as to other guidance that could apply. See Healthcare Financial Management Association's (HFMA) Principles & Practices Board Statement 11, Accounting and Reporting by Institutional Health Care Providers for Risk Contracts, and Issue Analysis: Revenue Recognition Implications Under Topic 606 for Capitation and Risk Sharing Arrangements, for additional nonauthoritative guidance on this topic.
4.2.1 Revenue recognition—institutional risk contracts
Risk contracts are arrangements in which providers and payers agree to share in the financial risk associated with providing health care services to patients. The compensation to institutional providers in some risk contracts is based on services provided to patients under fee-for-service, per diem, per case, or per episode arrangements and include an adjustment to the volume-based transaction price based on pre-defined risk metrics. Revenue recognition considerations for volume-based pricing arrangements are discussed at HC 3. The predominant payment arrangement under most risk contracts, however, is a per-patient (member) capitation payment, which entitles the provider to a fixed amount for each member of a defined member (patient) population.
In capitation arrangements, institutional providers such as hospitals generally agree to provide (or arrange to provide) all of the inpatient services a patient will require. Therefore, the hospital may have to subcontract with other providers to perform any services that it is unable to provide. Examples of common subcontracted services include ancillary diagnostic services (e.g., imaging services such as MRIs and CT scans) or specialized inpatient services (such as burn intensive care, heart surgery, or skilled nursing).
4.2.1.1 Step 1 – identify the contract
As discussed in HC 3, health care revenue transactions often involve multiple parties: the patient, the provider, and a third-party payer who pays the provider on behalf of the patient (e.g., insurance companies, health plans, governmental programs such as Medicaid or Medicare). Thus, the key question in any health care arrangement is whether, from the perspective of the institutional provider, the customer is the patient that receives the health care services or the third party that pays the provider for those services.
According to section 7.6.46 in the AICPA’s Audit and Accounting Guide (AAG) for revenue recognition (AAG-REV), from the perspective of the health care provider and for purposes of applying ASC 606, the contract with the customer is the arrangement between the health care provider and the patient. Separate contracts between health care providers and third-party payers, which establish negotiated prices for services, are not “contracts with customers” under ASC 606 but are instead considered in determining the transaction price for the goods or services provided under the contract between the patient and the health care provider.
The conclusion reached in AAG-REV 7.6.46 extends to capitation arrangements; the “contract with the customer” under the ASC 606 criteria is between the provider and the patient receiving the services. Capitation contracts, similar to fee-for-service contracts, establish the negotiated price for the health care services and thus impact the determination of the transaction price (step 3, see HC 4.2.1.3) for the services provided to the patient.
4.2.1.2 Step 2 – identify the performance obligations
Under a capitation arrangement, the health care provider promises to provide care to a group of patients over a stated term. At the beginning of the capitation period, the provider does not know the volume or type of services each patient will require over the contract term, but if a covered patient seeks care, the provider must treat the patient. Therefore, the provider has a stand-ready obligation throughout the contract term.
Stand-ready obligations are considered promises within a contract under ASC 606-10-25-18(e). These obligations will typically meet the criteria to be accounted for as a series of distinct goods or services and therefore, a single performance obligation. Refer to RR 3.3.2 and RR 6.4.3 for additional discussion of the series guidance and stand-ready obligations.
4.2.1.3 Step 3 – determine the transaction price
The determination of the transaction price can be one of the more challenging steps in the accounting for risk contracts because of the impact of variable consideration. Capitation arrangements typically include two transaction price components. The first is a fixed, periodic fee that is paid on a per member, per month (PMPM) basis. In a risk arrangement that contains only a PMPM fee, the entity assumes all of the financial risk . In order to calibrate the level of financial risk each party is willing to bear and the compensation for that risk, many risk arrangements include a second, variable component that may either result in a surrender of a portion of the PMPM fee, or additional considerationbased on various contractually specified performance metrics. Providers should consider both components in determining the overall transaction price of the contract.
In addition, while a provider (or a group of providers) may enter into a primary risk contract with a payer, individual health care providers are likely not providing the totality of health care services to the population of patients covered under the primary risk contract. Therefore, an individual provider will need to separately evaluate and calculate how the total contract consideration from the payer will be split between the individual providers in the group.
Fixed component – capitation or PMPM fee
Payers typically make PMPM payments to providers in exchange for the provider agreeing to stand ready to provide services to the covered patients over the contract period. These fees are fixed and are made to the health care providers regardless of the volume of services provided.
Variable component – risk adjustments
Risk-based arrangements can contain a variety of mechanisms for adjusting the transaction price. The list below includes some common types, but these mechanisms may be referred to by various terms and may be combined in contracts.
- Risk corridors allow the parties to share in cost or savings beyond a certain threshold. For example, if claim costs exceed 105% of a target amount, the payer could be required to make additional payments to the provider. Conversely, if claim costs are less than a target amount (e.g., 95% or less than the target), the provider could be required to repay a portion of the PMPM amount.
- Withholds are a mechanism for the payer to withhold a portion of the PMPM amount until certain benchmarks or quality metrics are achieved.
- Shared savings/shared losses contracts are similar to risk corridors but the shared savings or losses may be based on non-financial metrics, such as improved quality. Shared savings/shared loss arrangements may also be used as an add-on to a traditional fee-for-service arrangement.
- Risk pools are a common term for the group of providers in a risk contract to share favorable and unfavorable financial results.
Payments for risk adjustments (often called settlements) may be calculated at various interim settlement dates throughout the contract term or at the end of a contract period. In either case, these settlement amounts would be applied to all of the services rendered under the contract (i.e., both retroactively to services previously provided and prospectively to services not yet rendered) to determine the ultimate transaction price for a given risk contract. This is similar to cost-based Medicare revenue, which is discussed in HC 2.2.1.2. Because the ultimate transaction price will depend on the final settlement for a particular contract period, estimates of the settlement need to be made, and the transaction price and revenue adjusted each period for this variable consideration using either the expected value or most likely amount method (see HC 3.3). The provider will also need to consider the constraint on the recognition of variable consideration in ASC 606 (see RR 4.3.2).
Two of the more significant challenges in estimating the ultimate transaction price from a risk contract are (1) significant timing mismatches between cash flows and revenue to be recognized and (2) the inability to timely access the data needed to make the estimate.
With respect to the mismatch between cash flow and revenues, consider, for example, a risk adjustment for high utilization or catastrophic cases. In this type of arrangement, the payer often withholds a portion of the agreed-upon capitation fees each month, effectively creating a “reserve” account. When the provider submits claims for payment for services that exceed a specified ceiling, the provider receives an additional payment (for the amount of the excess) from the reserve account. If the reserve account is exhausted, the payer must continue to pay the difference on such claims from its own funds. If funds remain in the reserve account at the end of the contract term, they are remitted to the provider. In this example, since the provider is entitled to the amounts remaining in the reserve account , the distribution is not additional revenue; rather, it represents payment of the originally agreed-upon transaction price (i.e., PMPM amount).
With respect to the inability to timely access data needed to estimate variable consideration, providers may not have timely access to all relevant claims data to definitively calculate the provider’s risk share. Settlements are typically calculated by comparing actual cost incurred throughout the duration of the contract to a pre-established benchmark; actual costs incurred are usually based on member claims data from multiple providers. In some instances, the payer is the only party with full access to the underlying claims data for the member population and only shares the information with individual providers on a periodic basis. Nevertheless, providers are required to estimate variable consideration and cannot simply default to fully constraining the estimate due to that lack of information. Providers should consider all available information, likely including historical performance for similar contracts or patient populations, to estimate risk settlements.
4.2.1.4 Step 4 – allocate the transaction price
As discussed in HC 4.2.1.2, obligations under a capitation arrangement will likely meet the criteria to be accounted for as a series, and therefore, a single performance obligation. When a contract contains a single performance obligation, no allocation of the transaction price is required. However, if the contract contains more than one distinct performance obligation, the transaction price determined in Step 3 must be allocated to each of the distinct performance obligations in the contract based on the relative standalone selling price of the goods and services being provided to the patient. The best evidence of a standalone selling price is the price an entity charges for that good or service when sold in similar circumstances to similar customers. For components that are not normally sold separately, guidance on estimating standalone selling prices is provided in ASC 606-10-32-32 to ASC 606-10-32-35.
For a comprehensive discussion of Step 4 considerations, see RR 5.
4.2.1.5 Step 5 – recognize revenue
As discussed above, under a capitation arrangement, the provider’s obligation to provide health care services to patients over the contract term represents a stand-ready obligation that is treated as a series under ASC 606-10-25-15 (see RR 3.3.2). Revenue under capitation arrangements should be recognized based on an appropriate measure of progress toward completing the performance obligation. In a capitation arrangement, it is typically appropriate to utilize a time-based measure of progress and recognize the transaction price (any fixed capitation fees plus an estimate of the variable consideration from any risk-sharing pools) using a straight-line method over the contract period.
If a provider presents a line item captioned “Patient Service Revenue,” revenue recorded under capitation arrangements may be presented within the same financial statement line item as patient service revenue recorded under other payment arrangements (e.g., fee-for-service). If capitation payments are received in excess of the amount of revenue recognizable under the estimate of variable consideration and the applicable measure of progress, those amounts should be reported as a contract liability (traditionally referred to as deferred revenue).
Example HC 4-1 illustrates application of ASC 606 to a capitation arrangement.
EXAMPLE HC 4-1
Recognition of revenue under a capitation arrangement
Recognition of revenue under a capitation arrangement
Hospital enters into an arrangement with Insurance Company to provide inpatient services for 1,000 members of Insurance Company’s health plan. Insurance Company agrees to pay Hospital $500 per member per month for all services provided during the month. The payments are fixed regardless of the nature or cost of the actual services provided to Insurance Company’s health plan members by Hospital. The contract does not contain any risk pools or risk-sharing provisions.
How should Hospital recognize revenue for the capitation arrangement?
Analysis
Hospital’s promise to Insurance Company’s health plan members is a stand-ready obligation to provide inpatient services over the contract term. Hospital would determine a measure of progress that best reflects its performance in satisfying this obligation. Assuming Hospital concludes that a time-based measure of progress is appropriate, Hospital would recognize $500,000 in revenue ($500 per member per month x 1,000 members) each month.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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