Unique Cash-flow Issues Facing Health Care Companies

Unique Cash-flow Issues Facing Health Care Companies

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Paramount in dealing with health care companies is an appreciation for the technical expertise needed to understand the potential pitfalls and uncertainties of the billing and collection cycle. Health care companies suffer from an often unpredictable and largely misunderstood cash-flow cycle—both of which are the result of the complicated governmental payment methodologies. (It almost makes preparing tax returns look simple). But it's not all bad news, believe it or not; the government agencies overpay as well as underpay providers. Holding onto the government's money can be great for the troubled company's cash flow—until they ask for it back.

Health Care Receivables

Accounts receivable in the health care industry are primarily generated by three classes of payors: (a) Medicare, (b) Medicaid and (c) other payors, primarily consisting of private insurance, managed care and self-pay. As payors, these entities agree to accept financial responsibility for payment of medical costs incurred by a patient.

Medicare was first established to provide health insurance for the nation's elderly and was later expanded to include coverage for disabled individuals and individuals suffering from certain terminal diseases. Medicare is administered through two parts—Part A and Part B. Part A provides coverage for hospitalization and other inpatient services, such as care at a skilled nursing facility; Part B covers outpatient services, such as traditional physician care and physical therapy. The U.S. Department of Health and Human Services (HHS) operates and manages Medicare through the Health Care Financing Administration (HCFA). A network of non-governmental "fiscal intermediaries" and Part B carriers are contracted by HCFA to process claims, audit cost reports, detect overpayments and issue payments to entities that provide health care-related services to patients. These health care providers include, but are not limited to, physicians, hospitals, nursing facilities, therapists, laboratories, radiological groups and medical equipment suppliers. The fiscal intermediaries and Part B carriers are insurance companies such as Blue Cross/Blue Shield or Mutual of Omaha.

Medicaid is a joint federal and state program established to provide basic medical care for the nation's indigent. Broad federal guidelines issued by HCFA generally govern Medicaid; however, specific program parameters are controlled on the state level and vary from state to state, further complicating the billing and collections cycle. Additionally, individual states are responsible for administering all aspects of the program, including provider reimbursement.

Most facility-based providers derive the majority of their revenue from government payors, with other payors such as private insurance, HMOs and PPOs, Veterans Administration and self-pay comprising the balance.

The administrative burden of the varied and complex billing and collection requirements and voluminous patient data, combined with unstable operations, could dramatically impact the cash flow of a health care company in financial distress.

Cash-flow Issues

Medicare. Services covered by Medicare are usually subject to the establishment of medical necessity. Failure by the providers to establish and document medical necessity for services rendered can result in denied claims, an extended billing and collections process or, in certain circumstances, allegations of fraud.

Medicare determines provider reimbursement by using two general payment methodologies—retrospective and prospective determination. Under retrospective reimbursement, providers are reimbursed for services rendered to Medicare beneficiaries via interim payments (based on the provider's historical cost structure) with a periodic adjustment based on the provider's actual costs, subject to certain limitations. Generally, this adjustment is triggered by the filing of a cost report—a detailed report of actual revenue and expenses recorded by the provider and subsequently used by the fiscal intermediary to determine the provider's final reimbursement. The settlement usually involves a cost report audit by the fiscal intermediary, and finalization of the provider's reimbursement generally takes several years.

Under prospective reimbursement, providers are paid based on a pre-determined "fee schedule" that is adjusted periodically based on inflation and other factors. Medicare is in the process of eliminating most retrospective reimbursement programs, due in part to the disincentives for providers to reduce costs, thereby increasing its overall Medicare reimbursement. Prospective reimbursement methodologies eliminate these trend disincentives and allow providers to benefit from cost improvements.

Regardless of the reimbursement methodology, Medicare calculates provider payments on either estimated service volumes, which are referred to as provider interim payments (PIP), or actual service levels determined by periodic claim submissions. The PIP payment method routinely results in providers being under- or over-paid due to changes in the providers' service volume. Periodic PIP adjustments are made by the fiscal intermediary to reflect current service volumes.

Therefore, the process for determining final provider reimbursement (retrospective or prospective), the manner in which providers are paid on an interim basis (PIP estimates or actual claims) and the lengthy settlement process all contribute to volatile cash flow cycles.

Medicaid. Medicaid pays most providers under prospective payment systems. However, some states reimburse providers on a retrospective basis for certain types of services—usually inpatient. Under Medicaid, retrospectively reimbursed providers face the same reimbursement and cost-report exposure issues arising under Medicare retrospective reimbursement programs, thus contributing to cash-flow uncertainties.

Private Insurance/Managed Care. With private insurance and managed care, payors generally require pre-certification for non-primary care services and often require concurrent review for inpatient and other intense outpatient services. Managed-care companies impose extensive administrative billing requirements and often delay payments by requesting additional supporting documentation. Providers often deal with many different managed-care plans and insurance companies, each having unique billing and collection methodologies. Managed-care payors are often the slowest payors and the most expensive to bill and collect.

Disputes between providers and managed-care payors over appropriate rates and fee schedules occur often and are difficult to resolve. Material disputes over fee schedules, discounts and covered benefits can adversely affect cash flows, and may ultimately result in revenue recognition issues.

Cost Report Contingencies. Providers also face the uncertainty of having prior period cost reports audited by their fiscal intermediaries, potentially resulting in additional repayments due to disallowed costs and disagreements over other filing positions taken by providers. For financial statement purposes, providers routinely establish reserves for potential disallowances as a result of cost-report audits, and account for these reserves as a contra-asset netted in the receivable accounts. Although required by the Generally Accepted Accounting Principles (GAAP), these "controversial" reserves were the foundation of the Department of Justice's case against the Columbia/HCA executives recently convicted of Medicare fraud.

Classification Contingencies. Providers are also subject to disputes with Medicare and Medicaid over the classification and intensity of services where reimbursement differentials exist for closely related service levels. An example of this dispute is with Medicare over the classification of a patient's illness into pre-defined categories called Diagnosis Related Groups (DRG), the billing methodology used by Medicare to calculate reimbursement amounts to hospitals. A hospital's clinical documentation of a patient's condition and services provided results in classification into one of many possible DRG categories (i.e., viral pneumonia would have a significantly different reimbursement level than bacterial pneumonia). Problems arise when the provider is unable to document to Medicare's satisfaction that the patient's condition was consistent with the DRG category chosen by the hospital. In situations where the hospital has insufficient documentation to support the DRG category, the hospital must repay the difference between, for example, a $5,000 DRG vs. a $6,000 DRG. Still worse, widespread or systematic instances of unsubstantiated DRG categories often result in allegations of Medicare fraud and abuse. This illustrates the importance of staff training and accurate medical records to ensure correct billing.

Contractual Allowance or Bad Debt? Contractual allowances and bad debt expenses are often misunderstood. Contractual allowances are used to reduce the provider's gross revenue to the level the provider expects to actually receive from the payor. For example, a surgeon may perform a surgical procedure for which she charges $10,000 and expects Medicare to cover $6,000. In this example, the surgeon would record a contractual allowance of $4,000. If Medicare later determines, by clinical review, that the surgical procedure was less complicated than originally claimed and reimburses only $5,500, the recorded contractual allowance of $4,000 is then understated and must be adjusted by the $500 difference. In this scenario, the failure to collect the fully recorded revenue represents an underestimation of the contractual allowance, not bad debt. However, if a managed-care payor unilaterally imposes a fee schedule adjustment to the same procedure (in spite of a valid provider agreement), the potentially uncollectible difference most likely represents a bad debt. The general guideline is that if a provider was never entitled to the recorded revenue, the uncollected amount represents a contractual allowance. If the provider is contractually entitled to the revenue, but does not collect for any reason, the uncollected amount is considered a bad debt.

The administrative burden of the varied and complex billing and collection requirements and voluminous patient data, combined with unstable operations, could dramatically impact the cash flow of a health care company in financial distress.

Bankruptcy Complications

Recoupment and Set-offs. Retrospective reimbursement systems and estimated PIP volumes impose risk and financial exposure to both the provider and the Medicare program itself. In the event that a provider's interim rate was set too high, that provider faces the prospect of repaying potentially large sums of money to the Medicare program. Similarly, if estimated PIP service volumes are higher than the provider's actual service levels, the provider faces either lump-sum repayments or recoupment. Conversely, poor management of receivables can lead to large Medicare or Medicaid underpayments, causing cash shortage issues.

When a health care provider files for protection under chapter 11, Medicare and/or Medicaid may attempt to assert a post-petition right to set-off (i.e., recoupment) in order to satisfy certain pre-petition overpayments or other obligations. If material overpayments have occurred, recoupment actions could potentially devastate the debtor's cash flow and thwart its best efforts to reorganize.

The legal bases used by Medicare and Medicaid to assert their right of set-off, as well as the debtor's defense thereto, are complex and cannot be comprehensively covered in this article. However, the general approaches taken by governmental payors to avoid the automatic stay can be summarized as follows: (a) mutual debts arising from the same transaction, (b) implied assumption of the provider agreement or (c) sovereign immunity. In response, debtors usually argue that (a) the "same transaction" analysis is not valid because periodic true-ups represent new transactions, (b) the debtors have not assumed the provider agreement and (c) the court has an overwhelming public interest in preventing recoupment as it seriously jeopardizes the debtor's ability to reorganize and to continue to provide critical health care services.

The bankruptcy courts are responsible for balancing the public interest factor and the debtors' ability to reorganize with the rights of the government payors. However, in recent Delaware cases, the courts have ruled in favor of the debtors and have not permitted the government to recoup in order to satisfy pre-petition obligations.

In a bankruptcy scenario, managed-care payors may attempt to move toward even slower payment cycles. These payors may attempt to set-off and/or recoup against pre-petition obligations such as incurred-but-not-reported claims, or an estimate of claims liabilities that have been incurred by a covered member but not reported to payors through the claims process.

In bankruptcy situations, health care companies have had some success in maintaining effective control of receipt flow by communicating effectively with government regulators and payors. If the government regulators believe that the provider is in control of the receivables process and is cognizant of the government's interests, as well as its patient care services, the government may be less likely to aggressively assert set-offs and recoupments after the provider files for protection.


The risk factors related to a health care company's cash-flow cycle can jeopardize its management's ability to fund operations and meet debt service. Therefore, it is imperative that health care companies are able to quickly determine the precise reason for any changes in the billing and collections cycle. Simply recognizing that cash flow from receivables has declined is insufficient. Management's reactions must be swift in order to remedy any interruption in the cycle.

Journal Date: 
Thursday, June 1, 2000