AAOS Bulletin - October, 2005

Evaluating reimbursement contracts with third-party payers

How to make sure your institution isn’t losing out

By Frederick N. Meyer, MD

In these days of increasing overhead and decreasing reimbursement, it’s more important than ever that orthopaedic surgeons adequately evaluate the contracts we make with third-party payers. Rising health care costs are forcing payers to cut back on reimbursements while rising medical liability insurance costs and increasing government regulation are increasing our overhead expenses.

In academic medical centers, the need to maximize reimbursement is even greater. Increased regulations limiting work hours for residents and decreased funding have taken a heavy toll. Because many academic medical centers are the “safety net” providers in their areas, they have a poorer payer mix than private institutions. Cuts in spending for “safety net” programs such as Medicaid further decrease their revenues. As government support falls, academic medical centers have become increasingly dependent on funding from clinical revenue, intensifying the need for satisfactory contracts.

Take the first step

Before you begin to evaluate your third-party contracts, you must examine your own practice and determine your costs of doing business.

First determine your fixed costs (the costs of practice such as rent or equipment that remain relatively constant no matter how many patients you see) and your variable costs (the costs that increase with increasing numbers of patients seen). In most practices, the majority of costs are fixed.

Then calculate your cost per relative value unit (RVU) for both your fixed costs and your variable costs. Refer to the article by James J. Hamilton, MD, in the October 2004 Bulletin (available online at www.aaos.org/bulletin) for a description of how to calculate costs per RVU.

Next determine the demographics of your area. If a single large carrier is dominant in your practice area, your negotiating strategy will be considerably different than if there are several different major health care payers in your area.

Finally, ask yourself these questions: How busy is your practice? Are you seeing as many patients a day as you possibly can? What is the wait time for a new patient to get into your practice? Can new patients get an appointment today or must they wait several weeks to be seen?

Understand obligations: Yours and theirs

Once you have analyzed your own situation, you should perform a careful analysis with financial projections for any managed care contract you are considering. The managed care contract imposes obligations on both the provider and the payer. The provider’s obligations to the managed care organization may include:

• collecting co-payments

• obtaining pre-approval for tests or surgery

• participating in peer review

• complying with other policies

You should be aware of what services the contract requires you to provide. Be careful you do not obligate yourself to provide services you are unwilling or unable to provide.

You should also be aware of the payer’s obligations. How will the payer verify patients’ eligibility? What support will it provide to your staff? How does the company resolve grievances? Most importantly, how and when will it make payments to you? Be aware of any quality assurance or utilization review procedures that you will be expected to comply with, as well as any procedures or protocols that will be imposed on you and what potential expense these might create.

Setting the terms

Consider limiting contracts to one year without automatic renewal. Be sure to include a termination agreement (with and without cause). You should be able to terminate the agreement with a reasonable notice, usually 30 to 90 days. Any amendments to the managed care contract should be agreed upon by both parties in writing.

When you negotiate a managed care contract, insist on having all data available from the managed care organization for review. Be sure to review the complete contract. If the contract refers to an addendum, insist on reviewing that also. Some contracts can be extremely complex in their wording. Do not hesitate to consult an expert advisor if you feel it necessary.

When negotiating reimbursement, consider whether you can afford the managed care fee schedule. If you have determined your costs per RVU, you can compare it to the offered fee schedule to determine if you are making a reasonable profit. One excellent idea is to keep all your discounted fee schedules on a spreadsheet so you can easily compare them to each other and to national trends. This will enable you to spot a fee schedule that is significantly lower than others.

Some payers list their fee schedule as a percentage of Medicare. When dealing with this type of fee schedule, you must obtain specific information. Ask whether the payer is referring to the current Medicare fee schedule. If you are in a high-cost area, ask whether the fees are adjusted for your geographic region. You also need to know whether the fees are adjusted whenever the Medicare fee schedule is adjusted. Do not take the payer’s word for it...compare the proposed fee schedule to the Medicare schedule yourself.

Understanding the payer’s data

Beware of data offered by managed care organizations. Many will only give you a sample of their proposed fee schedule, which may not accurately reflect your most common procedures. The following procedure can be used to analyze a proposed managed care fee schedule:

1. Run a report listing at least one year’s worth of charges by procedure you’ve performed. Format the report to list procedures by total charges in descending order.

2. Include CPT code, description, current fee and item count in the report. If possible, also include RVU data.

3. Add the total charges until you reach 70 percent to 80 percent of your total charges.

4. Present your top codes to the managed care organization and insist on receiving their allowable charges for each code.

If the managed care organization refuses to give you the requested data, think twice before you sign.

Before you begin analyzing the data from the managed care organization, you must understand how well you are currently doing. To do this, you must determine your gross collection ratio, your contractual adjustment ratio, your voluntary adjustment ratio and your bad-debt ratio for each of your current contracts (Table 1).

Table 1: Current Financial Analysis




Gross collections

A summary of each plan’s performance

Total Collections/Gross Charges

Contractual adjustment

How much the plan has discounted your fees

Total Contractual Adjustment/Gross Charges

Voluntary adjustment

How much your practice has been discounting your own fees

Total Voluntary Adjustments/Gross Charges


How much you have written off as not collectable

Total Bad-Debt Write-Off/Gross Charges

Once you have the payer’s data and you’ve calculated your own ratios, you are ready to analyze the proposed fee schedule. One way to do this is to follow the procedure outlined in Table 2.

Table 2: Steps in analyzing a proposed fee schedule

    1. Enter the data in a spreadsheet. This will save you valuable time.

    2. Multiply the number of each procedure performed by your standard fee to determine each procedure’s gross annual charges.

    3. Total the gross annual charges for all your procedures.

    4. Multiply the total number of each procedure by the proposed discounted fee to determine each procedure’s annual discounted charge.

    5. Total the annual discounted charges for all your procedures.

    6. Divide the annual discounted charges by the annual gross charges to determine the discounted charge ratio.

    7. Compare the discounted charge ratio to your overall gross collection ratio.

    8. Compare the discounted charge ratio to your gross collection ratio for similar managed care contracts.

Hopefully, the new contract will be as good as or better than contracts you currently have.

Additional information

Be sure to ask the payer how many covered lives it has in your area, as well as their ages and gender. Ask how many employers in your area participate in the plan. Is the managed care organization established or new to your area? This information is important because an insurance company that covers predominantly young, active workers and few older individuals may pay extremely well for total joint replacement but poorly for knee arthroscopy. Such a situation may not be a profitable arrangment for your practice.

You should also evaluate the state of your practice. If patients must wait weeks for an appointment, you could lose better-paying patients to other practices. In such a case, you might want to reconsider accepting lower paying contracts. On the other hand, if you are scrambling for patients, you need to at least make enough to cover your fixed costs. You therefore might be willing to take lower-paying contracts as long as they are still profitable.

The bottom line is: Are you losing money, breaking even or making money? This requires a careful analysis of your data. Basic economics tells you that if it costs $4 to make a widget, volume sales at $3 won’t make up the difference.

Frederick N. Meyer, MD, is professor and chairman of the department of orthopaedic surgery at the University of South Alabama and a member of the AAOS Academic Business and Practice Management Committee. He can be reached at freddoc937@msn.com


1. Contracting and Negotiating Managed Care Agreements. Rosemont, Ill: American Academy of Orthopaedic Surgeons, 1996.

2. Medical Office Financial Management: A Practical Primer. Advisory Publications, 2002.

3. Hamilton, JJ. “RVUs and you.” AAOS Bulletin 52:5 (2004)

4. McCaslin, MJ. “Relative Value Systems and RVU-Based Cost Accounting” in Performance and Practice of Successful Orthopaedic Groups. V 297-384, 2000.

Close Archives | Previous Page