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Managed health care accounting.

The rapid growth of managed health care and changes in the way health care providers are reimbursed for services has created both problems and opportunities for CPAs advising providers on the accounting and tax aspects of a physician's practice. In the past, the traditional approach to physicians' financial and tax reporting has been to record transactions on a cash basis. However, if primary physician groups receive fixed payments under managed care contracts, the cash method may be inappropriate for reporting a group's financial performance and managing a practice.

Managed care is a method third-party payers use to control rising health care costs. To advise physicians, CPAs must understand the terminology associated with managed care contracts. (A glossary of managed care terms appears on page 69. Physicians participating in managed care programs now must share part of the financial risk for enrollees' (patients') use of health care services. Primary care physicians under managed care contracts act as gatekeepers for most or all of the physician services available to enrollees. Physicians also are at risk for enrollees' overuse of hospital services. This article discusses the inadequacies of cash basis reporting for managed care contracts and provides alternatives to improve financial and management information.


The effect managed care has on a physician group's financial reporting can best be explained by an example.

Montclair Medical Associates, a primary care physician group, signed a contract on January 1, 1994, with a health maintenance organization (HMO) to provide a full range of services to enrollees. In exchange for these services, the HMO pays Montelair a full monthly capitation payment. As required in the contract, the group also participates in a hospital risk pool based on the number of bed days used by its enrollees. If the number of bed days exceeds the budget, Montclair will have to reimburse the HMO for part of its costs. If the number of bed days is less than the budget, the physician group will participate in the excess. An amount will be withheld from the capitation payment to fund stop-loss insurance that will cover enrollees' medical expenses exceeding $10,000.

The contract represents over 30% of Montclair's annual cash receipts. While the group refers to and contracts with specialists to provide certain services, the HMO payment is for all services. Therefore, Montelair pays specialists for services rendered to enrollees Montelair refers. The HMO estimates (based on actuarial studies) that 40% of the capitation payment will be needed to fund the cost of outside specialists.

Montelair currently uses the cash method for financial and tax reporting purposes. On December 31, 1994, the group's CPA provided the cash basis financial statement shown in exhibit 1, at left. The statement shows significant cash basis profit. But when the financial statements are restated to an accrual basis (see exhibit 2, page 71), a completely different and more accurate financial picture of the group emerges. A $640,000 net income using the cash basis has been redetermined to be a 350,000 accrual basis loss. Montelair's current ratio is negative and points to serious problems in meeting monthly cash obligations. The group probably is aging its payables to outside specialty groups to maintain current in-house physician salaries and overhead. To add further misery, a substantial income tax liability may be awaiting Montelair on its $640,000 cash basis income, assuming it prepares its tax returns using the cash basis method.

Montclair has not reserved adequate cash to pay outside specialty groups for services rendered to enrollees. Instead, overhead and physician salaries consume cash flow from prepaid capitation payments. Because Montclair physicians do not monitor hospital referrals, the physician group has a liability for exceeding the hospital risk pool budget.

It is imperative for today's health care practitioners to be actively involved in "managing the business of health care" because of significant changes caused by the growing trend toward managed care. To improve its position, Montclair should focus on controlling costs as well as monitoring fees.


CPAs also must review and determine the most appropriate accounting method for income tax reporting purposes. If a physician group's percentage of HMO capitation is anticipated to grow, consideration should be given to changing to the accrual basis to avoid paying taxes on money reserved to pay outside providers. The Internal Revenue Service now allows changes in accounting methods from cash to accrual up to the extended due date of a tax return.

The difficulty in reporting on an accrual basis is determining incurred but not reported claims (IBNR). This liability represents services rendered to enrollees by outside providers and not reported to the physician group. In the Montclair example, the primary care group is responsible for all medical services, whether or not the group has the expertise to perform those services.

Under managed care, primary care physicians receive payment (capitation) whether or not they provide services to patient enrollees. In the first few months as part of a managed care plan, physician groups receive capitation payments but will not yet have any bills submitted by outside third-party providers. It is critical for groups to reserve the amount needed to fund these future claims. For Montclair, the HMO suggested 40% of full capitation be allocated to outside specialists. That amount should be set aside to fund future claims and not be used for physician compensation or overhead. Until a practice has actual experience it can use to make projections, IBNR estimates should be based on the HMO's experience, determined by actuarial studies.

Once an adequate historical period exists (approximately six months) CPAS will need to gather the following information to help a group estimate its own IBNR:

* HMO enrollees by month.

* Claims paid by service month not payment date).

Using this information, CPAs can estimate the average claims per member. This average can be adjusted to reflect any aberrations caused by material changes in member months and fluctuations in claims paid. Once an average has been calculated, CPAs can estimate the IBNR, based on member months and claims paid versus projected claims (see exhibit 3, above). Financial statement accruals can then be adjusted accordingly.

Another management issue for physician groups is comparing the profitability of HMO plans to not only each other, but also to other types of plans, including fee-for-service plans. We solved this problem for our clients by creating supplementary schedules (see exhibit 4, this page) showing the amount of capitation revenue received less

* Actual services provided by outside providers.

* Change in the IBNR accrual.

* Actual production performed by a group for plan patients (at the practice's standard rates).

Even though a group does not charge HMO patients for services rendered, it should record service information through its billing system. Offsetting memo entries can be posted to the general ledger recording this activity.


Despite the uncertain future for health care reform, the trend toward managed care is likely to continue as HMOs proliferate and physicians are attracted to them by the stability they offer. CPAs with health care clients must be familiar with an everchanging situation and be able to properly guide physicians in both financial statement presentation decisions and proper tax planning.


Montclair Medical Associates Statement of assets and liabilities--modified cash basis December 31, 1994 Assets Current assets Cash $600,000 Prepaids 2,000

Total current assets 602,000 Property and equipment (net) 400,000


Liabilities and stockholders' equity Current liabilities Notes payable 267,000 Withholding payable 2,000 Other liabilities 3,000 Total current liabilities 272,000 Stockholders' equity Common stock 10,000 Retained earnings 720,000


$1,002,000 Statement of revenue and expenses--modified cash basis Year ended December 31, 1994 Revenues Net patient service revenue-non-HMO $1,400,000 HMO capitation receipts 2,600,000

4,000,000 Operating expenses Contract providers-specialists 760,000 General expenses 1,200,000 Physician expenses 1,400,000

3,360,000 Net income $ 640,000


Monklair Medical Associates Balance sheet--accrual basis December 31, 1994 Assets Current assets Cash $600,000 Prepaids 2,000 Accounts receivable (net of contractuals and bad debts) 250,000

Total current assets 852,000 Property and equipment (net) 400,000


Liabilities and stockholders' equity Current liabilities Notes payable 267,000 Withholding payable 2,000 Other liabilities Other liabilities 3,000 Accounts payable-specialty groups 740,000 Hospital risk pool assessment 100,000 Total current liabilities 1,112,000

Stockholders, equity Common stock 10,000 Retained earnings 130,000


$1,252,000 Statement of income Year ended Decomber 31, 1994 Revenues Net patient service revenue-non-hmo 1,250,000 HMO capitation receipts 2,600,000

3,850,000 Operating expenses Contract providers-specialists 1,500,000 Risk pool expense 100,000 Genera, expenses 1,200,000 Physician expenses 1,400,000


Net loss $ (350,000)


Estimating a physician group's incurred but not reported (IBNR) claim

Projected Service Member Claims per member Projected month months paid per month claims IBNR January 1,500 $115,000 $83.33 $125,000 $10,000 February 1,500 115,000 83.33 125,000 10,000 March 1,500 115,000 83.33 125,000 10,000 April 1,500 115,000 83.33 125,000 10,000 May 1,500 115,000 83.33 125,000 10,000 June 1,500 75,000 83.33 125,000 50,000 July 1,500 40,000 83.33 125,000 85,000 August 1,500 25,000 83.33 125,000 100,000 September 1,500 25,000 83.33 125,000 100,000 October 1,500 15,000 83.33 125,000 110,000 November 1,500 5,000 83.33 125,000 120,000 December 1,500 0 83.33 125,000 125,000

$760,000 $1,500,000 $740,000


HMO profitability analysis Year ended December 31, 199X Income:

HMO revenue-capitated $ 50,000 HMO expenses:

Contact providers-specialists 3,000

Contact providers-IBNR changes 10,000

In-house production at standard rates 39,000 Net loss $ (2,000)


The primary health care accounting guidance is the American Institute of CPAs audit and accounting guide, entitled Audits of Providers of Health Care Services, revised in 1990. The guide contains a glossary of health care and accounting terms that are useful in determining proper financial statement presentation. Example financial statements for various types of health care providers also are included.


Capitation. A fixed amount per individual paid periodically (usually monthly) to providers for providing comprehensive health care services in that period. Fees are set by contract between a prepaid health care plan and a provider. Contracts generally are with medical groups or independent practice associations but also may be with hospitals and other providers. Capitation fees may be actuarially determined or negotiated based on expected costs.

Enrollee. A patient who is a subscriber, or an eligible dependent of a subscriber, in a prepaid health care plan.

Health maintenance organization (HMO). A generic set of managed medical care organizations that deliver and finance health care services. HMOs provide comprehensive health care services to enrolled members for fixed, prepaid fees (premiums).

Incurred but not reported claims (IBNR). Medical costs that have not yet been asserted. They may relate either to reported or unreported incidents.

Prepaid health care plan. A plan in which providers are compensated in advance by a sponsoring organization. The sponsoring organization pays providers based on either a fixed sum or a per enrollee amount. Prepaid health care plans include HMOS, preferred provider organizations, eye care plans, dental care plans and similar arrangements. Under these plans, the financial risk of delivering health care is shared by the service provider and the plan.

Risk contract. A contract between a provider of health care services and a prepaid health care plan that exposes the provider to financial risk by obligating the provider to provide specified services to enrollees for a preset per-case, per-service or per-day price. The price may vary based on the volume of services furnished during the contract period.

Stop-loss insurance. A contract in which an insurance company agrees to indemnifv the insured in accordance with the terms of the policy. For physicians, the contract limits the potential cost exposure on any one patient.

Third-party pagers. Any agency (such as Blue Cross, the Medicare program or commercial insurance companies) that contracts with health care entities and patients to pay for the care of covered patients.


* THE TREND TOWARD MANAGED care will have a significant impact on financial reporting and tax planning for health care practitioners. The cash method, when used for financial statements, management decisions and income tax purposes, may provide physicians with misleading information

* CPA HEALTH CARE practitioners must be familiar with managed care terminology and the terms of contracts their physician clients have signed. These terms have material impact on financial reporting decisions.

* THE RISK AND RESPONSIBILITY for controlling costs have passed to health care providers; doctors now are partly responsible for controlling medical and hospital costs. This increased responsibility is why physicians must use the accrual method to account for their income.

RONALD A. MITCHELL, CPA, is a partner and director of health services for Grice, Lund & Tarkington, Encinitas and Escondido, California. KEVIN J. CAMPERELL, CPA, is a small business consulting partner of Grice, Lund & Tarkington.
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Author:Camperell, Kevin J.
Publication:Journal of Accountancy
Date:Apr 1, 1995
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