What is a Risk Contract?

A “risk contract” creates a relationship between an insurer and a healthcare provider that expands the financial relationship beyond the traditional transactional limits. Risk contracts extend the responsibilities of participating Primary Care Providers, transfer financial risk from the insurer to provider organization, and align incentives by ensuring insurers and providers are focused on common objectives.

Risk contracts expand the roles and responsibilities of Primary Care Providers.

Typically, a risk contract makes a Primary Care Provider (PCP) (or really, the group practice) responsible for all the other costs incurred in the care of health plan members assigned or attributed to his or her panel. Thus, in addition to primary care-related expenses, the PCP must oversee various costs, including:

Hospital costs
Emergency room costs
Pharmacy costs
Specialist costs

Furthermore, the PCP is often responsible for supporting risk adjustment functions to ensure that the revenue available from the sponsor is matched to the expected expenses for a member. This expansion of the role of the primary care provider is the first characteristic of risk contracts.

These contracts involve “risk” chiefly because of the underlying uncertainty of their financial soundness.

Medical cost risk refers to the chance that the actual costs for care of a population over time may not match the expected costs over the period.

Will revenue exceed expense? Since non-PCP costs of care can vary dramatically and most risk adjustment programs estimate revenue on a prospective basis (forecast), there is always a chance that the answer is “no.”

In many risk contracts, in the circumstance that expense exceeds revenue, the provider organization (not the insurer) will bear financial responsibility for overruns. It is in this way that risk contracts have the net effect of transferring medical financial risk from the insurer to the provider organization. This is the second chief attribute of risk contracts: risk transfer.

However, risk contracts also have upside potential. A provider can recover a substantial bonus payment for participating in a risk contract. Federal law says that in the circumstance that providers earn more than 33% of what he or she would need for direct services (according to primary care costs or capitation), this triggers something known as “Substantial Financial Risk” (SFR). Bonuses obtained through triggering SFR are subject to certain limitations and depend on physicians or physician groups meeting various requirements (see this article for more information about SFR).

For this reason, we understand “risk” as actually meaning “uncertainty”—there can be a savings or a loss!

The most important component of a risk contract is incentive alignment.

Savvy PCPs in risk contracts know that they can take action to mitigate the risk of loss. After all, they often have the strongest relationship to the member (i.e., their patient). Insurers know this, and they write these contracts to make it in the provider’s interest to take those actions.

However, insurers know that when medical costs are lower than revenue, PCPs can earn substantial incentives. They also know that many PCPs in their network will not be successful at managing the expense to funding balance. Risk contracts typically strike a balance of rewarding one provider organization but only up to the point where its accomplishments can still offset those of another. This is accomplished by setting targets which align incentives, the third foundation of risk contracts.