Project Management Institute

Contract management = cost management

by Julie H. Hertenstein and Kimberly A. Vallancourt

LIKE MANY OTHER health maintenance organizations (HMOs), Neighborhood Health Plan (NHP) faced falling revenues and rising costs. Founded in 1987, NHP was the result of a collaboration between community health centers and other providers seeking to provide health care for low-income and uninsured patients in Massachusetts. They have approximately 40,000 members or subscribers, of whom approximately 75 percent are Medicaid recipients. NHP's primary source of revenue is reimbursement received directly from Medicaid to provide all health care services needed by these individuals.

NHP contracts with physician practices, community-based health centers and hospital outpatient departments to provide primary care to subscribers, and pays each physician practice or health center (called participating provider groups, or PPGs) a fixed rate per subscriber per month.

When a subscriber needs additional treatment (e.g., hospitalization for surgery, an MRI test or a visit to a dermatologist), NHP contracts with professionals to provide access to quality health care at a “reasonable” price. Hospitals and specialist physicians bill NHP for services provided to NHP's subscribers at previously contracted rates. While it's network of more than 94 member PPGs provides some leverage in price negotiations, NHP is a small entity in the Massachusetts health care market.

Since 1987, NHP's reimbursement from Medicaid had been adequate to cover its costs. However, Medicaid reduced its rate of reimbursement by 11 percent in 1995 and by an additional 9 percent in 1996. At the same time, NHP's subscriber base declined because Massachusetts imposed higher eligibility standards, which reduced welfare rolls. Both of these events combined to reduce NHP's revenues.

Taming Costs Through Contract Management

Prior to 1995, NHP used the industry standard contracting approach with hospitals known as “discount on charges.” The higher the discount NHP negotiated, the more favorable the contract was thought to be. To determine if proposed rates were viable financially for NHP, an actuarial consultant was hired to evaluate proposed contracts. Due to NHP's limited resources, the consultant's judgment was essentially accepted, with little in-house verification of the impact of proposed rates for the particular hospital. When a hospital added new services, the contract was rarely renegotiated to include, exclude, or set special rates for them, and these services were paid at existing contract rates. This could result in unexpected high costs. For example, in several instances hospitals added neonatal intensive care services, which were high-technology, high-cost services; NHP paid for these services at a rate negotiated under existing contracts for services such as pediatric intensive care. NHP analysts concluded these services were significantly more costly than when NHP had separately and specifically negotiated for neonatal intensive care services under other contracts. Despite recognized problems, little consideration had been given to changing the existing contracting methodology, since the Medicaid reimbursement covered NHP's costs.


A Hypothetical Hospital Contract Analysis

The Hospital Contracting Project developed a method for balancing the need for financial health with the mandate to provide high-quality patient services. Their efforts resulted in a shift to a fixed cost per episode philosophy

Exhibit 1. The Hospital Contracting Project developed a method for balancing the need for financial health with the mandate to provide high-quality patient services. Their efforts resulted in a shift to a fixed cost per episode philosophy.

Thus, prior to the Medicaid reductions, NHP did not focus a great deal of attention on contracted reimbursement rates for hospitals. Its small size and limited resources forced NHP to choose priorities carefully, and NHP focused primarily on improving the quality of care and on “managing the care” of their subscribers. The plan managed costs and care by controlling hospital bed utilization and increasing use of primary care physicians for preventive medicine. However, no matter how low hospital utilization is, if contract rates are expensive, costs to NHP will be high. Although NHP had effectively reduced the length of hospital stays, costs overall had increased.

Because NHP was contractually committed to certain rates with hospital providers, the Medicaid reimbursement reductions threatened its financial viability. In response, NHP determined that an entirely new mode of contracting was needed—a proactive contracting philosophy and new contracting approaches that would enable it to forecast and manage costs. NHP also needed to understand what rates were appropriate, so that it could renegotiate each contract and develop alliances with new hospitals.

In November 1995, NHP chartered the Hospital Contracting Project team to help it manage costs through better selection and management of hospital contracts. Three types of expertise were essential to the team. One was expertise in negotiating and contracting with hospitals. At NHP, the network development group did these tasks, and all four members became part of the Hospital Contracting Project team. A second type was expertise on costs and financial analysis; thus, the three members of NHP's finance group joined the team. Finally, because the team needed to be able to project the future implications of contracts, the actuarial consultant was included.

The team brought together finance and network development individuals who had never collaborated. Moreover, finance had been viewed suspiciously, as a kind of naysayer, and had often been left out of decision-making. Nonetheless, with the increased need to manage costs, it was important to incorporate finance expertise into business analysis and decisions. This was underscored by NHP's new CEO and new COO, who emphasized the need for good financial and managerial data and supported initiatives that produced better management and analysis of financial and other data. Finance and network development collaborated to specify goals for contract evaluation, which produced agreement on the data required. This agreement increased the credibility of these data and the confidence of each group in the outcomes. The two groups also agreed that finance would review contracts being renegotiated.

Prior work patterns influenced relationships between the actuary and other team members. The routine interactions between network development and the actuary during past contract negotiations made it easy for them to work together comfortably on the Hospital Contracting Project. However, finance and the actuary had traditionally worked at arm's length, primarily through exchanges of formal data such as those related to the financial statements. This relationship made people reluctant to disclose calculations and assumptions, and produced a lack of understanding and confidence in each others’ skills and expertise. These individuals found it more difficult to develop and manage an effective working relationship.

The Hospital Contracting Project team's charter was to develop a method to examine hospital contracts to assure that proposed rates would not harm NHP's financial health, and that high-quality services would be available as needed. In addition, the team hoped to develop several tools to enable NHP to examine and respond to contracts in a timely and informed manner.

The team initially divided NHP's hospitals into two groups. The top 10 to 20 hospitals, based on total annual payments from NHP in recent years, were the first group. They were most critical to NHP's financial viability and their contracts would have to be renegotiated first. The second group was the remaining institutions, which would be addressed later.

Next, the team determined what information was necessary to analyze and manage a proposed hospital rate. They realized that, to control costs effectively, the focus of NHP's management efforts and its contracting philosophy had to shift to a fixed cost per episode or set rate per day of type of stay. Thus, instead of paying 95 percent of each of the line item costs associated with neonatal intensive care (food, supplies, room/incubator, etc.), a rate would be fixed per day for neonatal intensive care (see Exhibit 1).

Proposed Hospital Matrix

Still “under construction,” the Provider Service Matrix will be used not only to compare rates for various services at competing hospitals, but to propose rates to facilities whose rates are out of line

Exhibit 2. Still “under construction,” the Provider Service Matrix will be used not only to compare rates for various services at competing hospitals, but to propose rates to facilities whose rates are out of line.

Profiles of the hospitals in the first group were created. The team identified the type of hospital (teaching, nonteaching; acute, non-acute; etc.), location, the type of stay (obstetric, medical, surgical, etc.), the amount paid for each (cost per day, number of days, and total), and other information on NHP's prior experience. These profiles would allow NHP to analyze newly proposed rates at any of these institutions. Later, data from all hospitals would be arranged in a Provider Service Matrix allowing NHP to compare hospitals with existing contracts and to develop a sound basis for setting contractual rates with new hospitals.

The team soon discovered that data critical to the project's (and the organization's) success were at best difficult to access and at worst nonexistent. Like many other health care organizations, NHP's information technology had been designed to support a reimbursement system that was becoming obsolete; it was then modified piecemeal as needed to support that reimbursement system. In addition, IS had not been considered vital to the organization's strategic mission. Useful hospital data were both difficult to access and inconsistent. Many difficulties resulted from the fact that the system design was not intended for its current applications and uses.

To compile accurate and adequate data for a provider profile and hospital contract analysis, the team had to access up to six different databases. Each request had to be carefully framed so that the “correct” information was obtained in a form appropriate for the analysis. This difficulty paralleled others that NHP was having in retrieving information useful to management decision-making. These difficulties led NHP to begin developing a data warehouse system capable of collecting and analyzing clinical, financial, and management information. When complete, the data warehouse will eliminate inconsistent data reporting and analysis and support the Provider Service Matrix.

Initial benefits became apparent early in the effort, while the project team was still developing provider profiles. One of the first deliverables of this project was a cost comparison for contracts under renegotiation. Where new rates were proposed, they were “plugged into” the previous year's utilization amount in the provider profile so that NHP could compare the total cost for the prior year's usage at the old rates with the total cost for the prior year's usage at the rates proposed in the new contract, as shown in Exhibit 1. Another use for these provider profiles was to rank providers to prioritize the order for renegotiation.

Steps remaining include developing profiles for the second group of hospitals, and developing the Provider Service Matrix which in turn is dependent on upgrading the management information system. There are many uses for the Provider Service Matrix (see Exhibit 2). It can be used to propose rates to facilities if their rates are out of line with similar institutions. Alternatively, if hospitals are not flexible in negotiating rates, NHP could ask some health centers to refer elsewhere. NHP can also use these data to develop incentives to encourage hospitals to lower rates if they are guaranteed additional volume/utilization.

The project produced numerous benefits in the area of developing in-house expertise and collaboration. These included increased appreciation by the network development group of the financial implications of the contracts that they negotiate, and some new insights into contracting alternatives. In addition, information produced by finance now has greater credibility, and others, especially network development, rely more heavily on that information. Further, finance has a better appreciation of the contract negotiation process, and is much faster with its responses to questions from network development.

Lessons for Project Management

For organizations like NHP that are relatively new to project management, there are three important lessons that have emerged to date from the Hospital Contracting Project.

Key Skills Must Be Represented on the Team. Matching skills to the problem is critical. At NHP, it was essential to include representatives from finance because of the organization's cost problems. In other words, effective contracting with hospitals required more than contract negotiation skills or actuarial skills. Moreover, the finance team members emphasized the urgency of completing the Hospital Contracting Project because they understood the long-term implications of NHP's financial trends.

Set Realistic Deadlines. The first schedule for the Hospital Contracting Project was not realistic, given the resources available. Efforts had to be halted at one point, and an external vendor used to complete a number of contract analyses. This was not only costly to NHP but it endangered the trust between the finance and network development team members. Once the project effort was back on track, team members began to establish their former levels of trust.

In addition, an overall project workplan must be established, and each participant must clearly understand and commit to what is expected by his or her deadlines. Periodic meetings are required to track progress against the workplan, and to address problems.

Secure Top-Management Support. At NHP, it soon became apparent that top-management recognition of the Hospital Contracting Project's priority goals was essential. In this instance, there were multiple priority goals: managing growth of costs through improved hospital selection and hospital contract management, plus developing in-house skills and expertise. To support this second set of priorities, management had to make resources available to the team and ensure that organizational skills were developed appropriately. Historically, the organization relied on outside actuarial consultants to provide data and analyses. But such data are critical to everyone understanding the financial and strategic situation. With development of data extraction and analytic expertise in-house, people were able to solve problems more effectively and more quickly than before.

MANY ISSUES AND PROBLEMS initially faced by NHP's Hospital Contracting Project team are common to most health care organizations, especially the issues of data (availability, format, usability) and an outmoded information system.

Of course, all that is changing, both within NHP and within the health care industry. NHP is developing a decision support system that integrates clinical, financial, and strategic information; that is easily accessible; and that will support the Provider Service Matrix and other efforts. This information infrastructure is critical to the current projects and to other initiatives that NHP must undertake to remain successful. The future will bring both expected change and unpredictable upheavals of current practice. In such an environment, sophisticated project management skills are required. ■


Julie H. Hertenstein, DBA, is an associate professor in Northeastern University's College of Business Administration. Her research, consulting and teaching focus on managers’ use of accounting and other information. She previously managed MIS projects at Pacific Telephone and Burlington Industries.

Kimberly A. Vallancourt is the budget and cost reporting manager for Neighborhood Health Plan. She was previously budget administrator and senior financial analyst at Blue Cross/Blue Shield of Massachusetts.

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI.

PM Network • July 1997



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