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.
ASC 954-450-30-3
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.
ASC 954-450-30-4
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
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.