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4.4 Risk contracts — other accounting considerations
Publication date: 31 Mar 2023
us Health care guide
In instances when an institutional provider enters into a capitated risk contract or a non-institutional provider determines it is providing or arranging for the provision of medical services, the organization’s associated revenues are based on the ultimate transaction price for the health care services delivered to patients. In these instances, organizations would also recognize expenses for the payment to third-party providers or sub-contractors for patient care. The guidance discussed in this section is based on expense and loss recognition codified in ASC 954-405, Health care entities—Liabilities. While in certain circumstances the entity may not be within the scope of ASC 954, we believe it would be appropriate to consider this guidance by analogy.
4.4.1 Timing of expense recognition
One key consideration under a value-based care arrangement is the timing of expense recognition related to patient care. For example, if a patient member is diagnosed as having an illness that will require long-term treatment, should all costs of future treatment be recognized at the date of initial service (that is, the date on which it is identified that the member has an illness or shows symptoms requiring the member to obtain future health care services), or should these be recognized as costs of the periods in which treatment is actually provided to the patient?
The answer depends on the accounting guidance that is relevant to the entity and the contractual arrangement. Entities within the scope of ASC 944 would follow that framework for recognition of expense. Contractual arrangements which are, in full or in part, subject to the guidance in ASC 460 regarding guarantees would have to consider the appropriate timing of recognition of expense under that guidance. For contractual arrangements accounted for under ASC 606, the event that triggers a healthcare provider’s recognition of expenses for medical services is the provision of those services to a patient, not the occurrence of an accident or illness. In accordance with ASC 954-405-25-2, the costs of providing health care services to patients should be reported in the periods in which those services are actually rendered. This is true even if the patient is being treated for an illness that requires long-term treatment. It is not appropriate to estimate and accrue the expense of the entire episode of care in the period in which the diagnosis is made. This model differs from the insurance accounting under ASC 944, which would require that the costs of the patient's entire expected course of treatment be estimated and reported as an expense of the period in which the diagnosis is made. This is because the event that triggers an insurance company to recognize claims expense is the occurrence of a particular accident or illness (the insured event). In certain situations, however, it is appropriate for the organization to accrue the costs of health care services, as described below.
- Contractual or regulatory obligation
ASC 954-405-25-2 requires that an accrual be made in situations when a contract or prevailing regulations obligate the health care provider to continue to provide care to covered patients after the end of the contract period. For instance, if a hospital is contractually obligated to continue to provide coverage for hospital stays that are "in progress" at the end of the contract period, the hospital will have to bear the costs of those hospitalization services regardless of whether they will receive any compensation for services provided following the current contractual term. Therefore, providers with these types of contractual or regulatory obligations should accrue, at the end of the contract period, the cost of any services expected to be rendered after the end of the contract period.
- IBNR accruals
Incurred but not reported (IBNR) accruals may be required for services that have been rendered by third-party providers during the contract term but not reported to the health care organization with the ultimate obligation under the capitation contract as of the financial statement date. For example, providers that accept a capitated health care contract may be required to "subcontract" to other facilities any ancillary services it cannot perform (such as CT scans or MRIs), or specialized inpatient services, such as cardiac surgery or burn treatment, for which the provider is not licensed. Similarly, a capitated provider may pay for subcontracted care when a health plan member requires medical care outside of the provider's service area (such as while traveling). Non-institutional providers may also subcontract the provision of care for its attributed members. In these cases, the organization must accrue the estimated costs of any services subcontracted to other providers for which payment has not been made as of the close of the fiscal period, even if the subcontracting provider has not submitted an invoice for those services.
Example HC 4-4 illustrates when a health care provider may need to accrue expenses at the end of a contract period.
EXAMPLE HC 4-4
Expense accrual at conclusion of contract term
Expense accrual at conclusion of contract term
Hospital and Insurance Company have an agreement under which Hospital agrees to provide inpatient services for all members of Insurance Company’s health plan for calendar 20X1. As part of the contract, Insurance Company requires Hospital to continue to provide inpatient services to hospitalized Insurance Company health plan members until they are discharged regardless of whether the contract expires or is renewed. On December 29, 20X1, an Insurance Company health plan member is admitted to Hospital and is discharged on January 10, 20X2.
How should Hospital account for the expenses incurred to treat the Insurance Company health plan member from January 1, 20X2 to January 10, 20X2?
Analysis
Hospital must estimate and accrue the costs of services provided from January 1, 20X2 to January 10, 20X2 in its December 31, 20X1 financial statements because Hospital is obligated to continue to provide services to Insurance Company’s member under the contract, regardless of whether a new contract is entered into in 20X2.
If, on the other hand, the contract did not obligate Hospital to bear the cost of inpatient services that extend into subsequent contract periods, the costs of the services rendered from January 1, 20X2 to January 10, 20X2 would be reflected in the period in which they were rendered (that is, in the 20X2 financial statements).
4.4.1.1 Loss contracts
Risk contracts between a provider and a sponsoring entity (e.g., payer) typically require the provider to either provide or arrange for the provision of health care services for the entity's members for a specified period of time in exchange for an established monthly capitated payment. These capitated payments are established at a level that is estimated to be sufficient to at least cover the cost of providing services to the members during that period. If the capitated payments do not cover the cost of providing services to the members, the provider will sustain an economic loss in fulfilling that particular contract.
ASC 954-450 addresses the types of costs to be considered and when they should be recognized.
The estimated future health care costs and maintenance costs to be considered in determining whether a loss has been incurred shall include fixed and variable, direct and allocable indirect costs.
Losses under prepaid health care services contracts shall be recognized when it is probable that expected future health care costs and maintenance costs under a group of existing contracts will exceed anticipated future premiums and stop-loss insurance recoveries on those contracts.
To determine the need to recognize a loss, contracts shall be grouped in a manner consistent with the provider's method of establishing premium rates, for example, by community rating practices, geographical area, or statutory requirements, to determine whether a loss has been incurred.
The determination of which costs to include is judgmental. The costs considered should include all direct costs of the contracts along with indirect costs identifiable with or allocable to the contracts, and generally requires inclusion of all costs other than general and administrative, selling, marketing, and interest. AAG-HCO 13.16 recommends that entities also consider investment income that is expected to be earned on premiums received in advance of health care costs incurred during the contract period for the group of contracts.
Statement 11 of HFMA's Principles & Practices Board, Accounting and Reporting by Institutional Health Care Providers for Risk Contracts, provides additional discussion of the types of costs that would be considered direct and allocable indirect costs (e.g., medical records, claims processing, billing). The guidance on loss contracts in ASC 954-450-30 was originally developed by analogizing to the accounting guidance for construction-type and production-type contracts, which is now codified in ASC 605-35-25-45 and ASC 605-35-25-46 (and still applicable after the adoption of ASC 606). Therefore, we believe that entities may look to the guidance for loss contracts in ASC 605-35.
Contracts should be grouped in the manner specified in ASC 954-450-30-4 and the aggregate health care costs, maintenance expenses, anticipated future revenue, and stop-loss recoveries projected for the contracts in each group. Furthermore, if any of the contracts in a "loss group" have guaranteed renewal provisions, and the organization is constrained by statutory requirements or community rating practices from increasing the amounts charged on those contracts, the organization should also accrue any losses it expects to incur attributable to the guaranteed renewal periods.
The groupings used for loss determination should correspond with the groupings used by the organization in establishing its capitation rates. For organizations that use community-rating (i.e., one capitation rate is established for all members in a given enrollment population; for instance, a particular geographic area or actuarial class), the contracts grouped together for loss determination would be those considered to be part of the same enrollment "pool" as was used to determine the capitation rate. Contracts that utilize experience-rating would be grouped in the same manner as that used for rate-setting purposes, such as by type of employer.
At the end of each reporting period, the entity should estimate future costs to determine if expected costs exceed future revenues and stop-loss recoveries. An organization will need to analyze the unexpired contracts in force, as well as noncancellable, executed contracts that are not yet in force. No specific guidance is available with regard to the reporting of losses on risk contracts that cover a period of several years. Because the guidance on loss contracts in ASC 954-450-30 was originally developed by analogizing to the accounting guidance for construction-type and production-type contracts, we believe it is reasonable to apply the GAAP for long-term construction contracts in accounting for risk contracts that cover more than one year. In such cases, the full loss estimated for the contract duration should be recognized in the year in which it is determined that an economic loss will be sustained under the contract as a whole.
Losses should be reported consistent with other patient care expenses in the income statement.
Example HC 4-5 illustrates the timing of accruing a loss on a contract.
EXAMPLE HC 4-5
Loss contracts
Loss contracts
Hospital and Insurance Company have an ongoing agreement in which Hospital agrees to provide inpatient services for all members of Insurance Company’s health plan in exchange for $1,000 per member per month. The contract period is from January 1, 20X1 to December 31, 20X1. Hospital’s fiscal year-end is June 30.
On June 30, 20X1, Hospital forecasts an average of $6,500 in medical and administrative costs for each member through December 31, 20X1, which exceeds the remaining $6,000 that will be collected in capitation payments (6 months times $1,000).
How should Hospital account for the forecasted losses through the remainder of the contract period at June 30, 20X1?
Analysis
Based on Hospital’s forecast, the total losses for the remainder of the contract term (July 1, 20X1 – December 31, 20X1) are estimated to be $500 per member ($6,000 revenue less $6,500 in costs). Hospital should accrue the estimated $500 per member loss at June 30, 20X1. The loss accrual should be updated each reporting period through the end of the contract term.
4.4.1.2 Stop-loss insurance
Many health care providers that enter into capitation agreements with payers will transfer a portion of their financial risk to an outside insurer by purchasing stop-loss insurance. Such arrangements may be direct (in which case the provider purchases the coverage from a commercial insurance company or a captive insurance subsidiary) or indirect (in which case the coverage is obtained by the payer and the premiums are withheld from the capitation fees paid to the provider).
Two accounting issues arise with regard to stop-loss insurance. The first concerns whether stop-loss insurance premiums should be recorded as an expense or as a reduction of the provider's revenue, particularly if the premiums are charged indirectly. ASC 954-720-45-1 states that stop-loss premiums should be included in health care costs; this allows the revenue and expenses reported in the income statements of entities to be comparable regardless of whether that coverage is obtained directly or indirectly.
The second issue is whether stop-loss insurance recoveries should be reported as revenue or as a reduction of the related health care costs. ASC 954-720-45-1 states that stop-loss insurance recoveries should be reported as a reduction of health care costs. Because providers can influence their premium expense and the amount of recoveries they expect to receive by taking higher or lower deductibles and risk provisions, this treatment allows the net effect to be comparable between entities.
Amounts recoverable from insurers under stop-loss policies should be reported as assets, reduced by appropriate allowances for credit losses.
4.4.2 Disclosures
In assessing disclosure requirements for risk contracting arrangements, organizations should consider disclosures required under ASC 606 (see FSP 33).
In addition, while the guidance does not outline specific disclosures for risk contracts, we believe the following disclosures are appropriate in financial statements of health care providers that enter into such contracts:
- The nature and terms of risk contract arrangements and the basis of recording revenues, expenses, and losses under those arrangements.
- If the contract period is different from the provider's fiscal year, the estimate recorded for the final settlement and the significant assumptions supporting the estimate.
- The nature, amounts, and effects of stop-loss insurance contracts.
4.4.3 Statutory reporting
Most MCOs and health plans that provide insurance coverage and bear financial risk are regulated by state departments of insurance. The National Association of Insurance Commissioners (NAIC) is the US standard-setting and regulatory support organization created and governed by the chief insurance regulators from the states and territories. For additional information regarding the NAIC, see IG 13.
Among other responsibilities, the NAIC promulgates statutory accounting principles (SAP) that must be used in preparing financial statements used for financial regulatory purposes. IG 13 provides a comprehensive discussion of SAP and highlights differences between SAP and GAAP. HMOs and health plans within the scope of ASC 954 should be mindful that the GAAP references in IG correspond to ASC 944, Financial Services -- Insurance, rather than to the ASC 954 requirements discussed in this guide. Therefore, differences that exist between the requirements of ASC 944 and ASC 954 should be kept in mind.
For additional information on statutory accounting and other regulatory matters specific to HMOs and health plans, see AAG-HCO 2.112 through AAG-HCO 2.115.
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