Service Funds: What are they?

Service Funds are financial accounting ledgers used to compute risk-based components of direct provider compensation.  Payments of positive balances associated with Service Funds are usually one of the three major sources of revenue for provider practices: fee-for-service (FFS), capitation, and risk-based incentive payments.  They are typically governed by the Provider Incentive Plan (PIP) regulations on the Federal Register.

Fee-for-service is a well-established system of payment for healthcare services. In FFS payment models, which go back decades, health care providers are paid a fee for each service they provide patients.  This framework rewards them directly for the volume of services provided and is often the foundation of compensation agreements, business plans and productivity metrics.  FFS payment models traditionally have not been tied directly to the quality of each healthcare experience since they are often associated with duplication of effort, but in some circumstances, quality bonus programs link activity related to closing care gaps in the office visit to financial reward (e.g., specific reimbursement for providing immunizations or screenings).

Capitation, on the other hand, reduces the frequency of transactions between a health plan and a medical provider by establishing population-based prices for rendering service.  This fee is typically based on an expected volume of activity as a function of the aggregate panel size and is set regardless of actual activity.  Such frameworks include metrics like $65 per patient per month for primary care.  For a panel of 100 patients, the provider will receive $6,500 per month upfront.  As a result, although a record of each transaction needs to be created, a charge is not incurred each time a visit occurs.

Capitation involves some uncertainty of activity levels, but it is different than the risk associated with Service Funds.  Capitation risk is related to over or underutilization but guarantees a minimum payment to the provider and a maximum outlay by the payor.  Of course, the payer is at risk of having overpaid the provider if actual volume is low, and some risk of underpayment is taken by the provider if actual volume is higher than expected. However, many providers will elect to participate in a “risk contract” that engages them to manage more than their own contribution to the care of a population.

A Service Fund, the third of these pieces, provides an accounting of how well or poorly a provider has done at managing the total cost of care for the panel, not just their own utilization.  The accounting typically relates the following summation: membership (informational), medical cost budget (the first main figure, based on a target of premium or historical expenditure) less itemized charges for medical cost items by category (inpatient, outpatient, emergency, urgent care, physician FFS, physician capitation, pharmacy, etc.).  In some sense, therefore, the Service Fund is simply a ledger, but it implies the presence of a risk contract.  It becomes the basis for a flow of funds when the ledger shows that the provider has managed the care of a population well.

Any surplus, the term describing when expense is lower than the medical cost budget, may be payable to the provider and any deficit, the opposite circumstance, may be payable by the provider to the carrier, according to specific rules governed by law.  In this sense, Service Fund payments are incentives to manage care efficiently.

10 Facts About Service Funds & Risk Contracts

In the list below, FRG presents the most important considerations for organizations planning to create, administer, or participate in a service fund incentive contract.

  1. Service Funds can be an additional source of provider compensation. FFS payments, capitation payments, and incentive payments (often from service funds) are the three main provider compensation sources.
  2. A Risk Contract creates a relationship between an insurer and a provider that expands the financial relationship beyond the traditional transactional limits.Risk Contracts specify the opportunity to earn incentives or incur liability, and they itemize the appropriate regulatory criteria, including care delivery and reinsurance requirements.
  3. These contracts involve “risk” because of the underlying uncertainty of their outcome in financial terms. In full and partial-risk arrangements, providers can earn bonus payments, but they can also end up owing money to the contract writer (i.e. health plan) if medical costs exceed budget targets. The outcomes of upside-only and shared savings arrangements are also uncertain, but providers are not subject to cost overrun repayment penalties, so the “risk” is one-sided.
  4. Risk in these contracts is primarily “medical cost risk,” meaning uncertainty in the amount of total medical expenditure they will accrue. However, this risk is realized when it exceeds expectations and creates liabilities for the risk-bearing entity. Providers can manage medical cost risk by actively managing patient medical conditions and referral patterns to influence unit cost and utilization. In some circumstances, patient engagement can also enhance the alignment of cost expectations and total expenditure through risk adjustment.
  5. The most important component of a risk contract is incentive alignment. Health plans write risk contracts to encourage provider organizations to manage unit cost and utilization, capture risk adjustment data and achieve quality goals. If a risk contract doesn’t link attaining these goals with provider action, it can be ineffective and may encourage unexpected behavior or inattentiveness.
  6. The most common measure of aggregate medical cost vs expectations is the Medical Loss Ratio, MLR (alternatively the Medical Benefit Ratio, MBR). The MLR is computed as the total medical cost divided by the revenue available. MLR targets are commonly used to set the medical cost budget for service funds. MLR targets can be achieved through cost management activities that influence the numerator and risk adjustment activities, which appropriately enhances the denominator in a coordinated fashion.
  7. An MLR target for a risk group should be below the health plan’s own goals. The primary objective of extending total cost of care risk to a provider group is to transfer the medical cost risk for the population managed by the provider to the provider itself and thereby align the incentives of the two organizations.
  8. When revenue is fixed or uncertain, MLR targets are often replaced with cost trend reduction targets. Both create a medical cost budget against which incurred medical cost trends can be compared and evaluated against goals. MLR targets create medical cost budgets by multiplying the MLR target percentage against revenue available. Trend-based targets, on the other hand, create medical cost budgets based on reductions to the trend by the savings objective.
  9. Monitoring performance, managing clarity of attribution, and providing risk groups with information are vital capabilities for health plans writing risk contracts. Provider groups need consistent, timely, and reliable data about the population they are charged with managing to do it successfully, and experienced groups won’t enter a risk contract without it.
  10. Transparency provides the best chance for success. Its three pillars are: full disclosure, frequent data sharing, and consistent data processing. FRG provides AccuReports® software as a service to help health plans and physician groups achieve transparency and deliver on their shared goals.

Each of these will be discussed in additional articles over the next few months as we further explore 10 facts about service funds and risk contracts.

The discussion is timely, as the Centers for Medicare & Medicaid Services (CMS) aims to have all Medicare beneficiaries and most Medicaid beneficiaries enrolled in accountable care programs by 2030, which may usher a movement to a value-based healthcare system that will present new challenges for many physicians and payers, but not all.

Indeed, the shift from transactional medicine to a more collaborative, results-oriented, and economically responsible medical economy will transform provider compensation models dramatically. Value based care models integrate incentives that reward alignment of resources with care needs over increased transactional volume—but only for some. The configuration and administration of Service Funds is an established discipline.

Stay tuned as we explain.