Service Funds: What are they?

Service Funds are a means of determining one piece of direct provider compensation. Compensation typically takes a mixture of three forms: fee-for-service (FFS), capitation, and incentive payments. FFS payments are well established. Capitation is typically a mechanism to simplify the financial relationship between payor and provider. It does this by establishing a fixed price for servicing a population based on an expected volume but regardless of actual volume. Some risk is born by the payer of overpayment if actual volume is low, and some risk of underpayment is taken by the provider if actual volume is higher than expected. Each of these provides a baseline compensation structure for a provider.

In addition, 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 provides an accounting of how well or poorly they have done so in the form of a ledger. In some sense, therefore, the Service Fund is simply a ledger, but it implies the presence of a risk contract. When the ledger shows that the provider has managed the care of a population well (as defined by the terms of the contract), then an incentive payment is earned.

In this article, 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. Fee-For-Service (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” chiefly 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 chiefly “medical cost risk,” meaning uncertainty in the amount of total medical expenditure they will accrue. However, this risk is chiefly 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) which 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 which influence the numerator and risk adjustment activities which appropriately enhance 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 create medical cost budgets when the budget is set as the trend less 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 explore 10 facts about service funds and risk contracts.  The discussion is timely since the passage of the Medicare Access and Chip Reauthorization Act of 2015 (MACRA) is beginning to 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 by integrating 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.