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“What You Don’t Know Will Hurt You”
– Jim Rohn, American entrepreneur, author and motivational speaker.


As risk contracting becomes more prevalent, the best practices skillset and knowledge base for provider organizations to successfully negotiate contracts with commercial health insurers are expanding to include those of health actuaries. The financial targets in these deals are typically based on projections performed by insurers’ staff actuaries that are often confusing to non-actuaries. These actuarial projections are frequently complex, subject to state and federal regulations, and often result in targets that are unrealistic for the provider organization. To deal with these issues, the most experienced provider organizations are bringing in their own health actuaries to level the playing field in risk contracting negotiations.

Risk Contracting

The purpose of risk contracting, also known as Value-Based Reimbursement (i.e., VBR), is to incentivize providers to lower the cost of care through increased efficiency while maintaining or increasing quality. To hold provider organizations accountable to this purpose, risk contracts typically contain quality benchmarks and financial targets that the provider organization must meet or exceed. If the provider organization meets both the quality and financial targets, the provider organization is entitled to a share of a “savings” payment. These savings represent the difference between the actual cost of care under the risk contract, and the theoretical cost of care that would have occurred absent the risk contract. Under some VBR arrangements, like Medicare Shared Savings Program Tracks 2 and 3, provider organizations that fail to meet the financial target are also required to pay a share of the “loss” back to the payer.

The Financial Target

The function of a financial target is straight-forward, but the setting of one is more difficult than many would expect. While contract negotiations between provider organizations and insurers have sometimes been adversarial, creating a successful VBR arrangement, which includes setting a financial target that is reasonable, achievable, and mutually beneficial, requires a collaborative effort that leverages the expertise of both parties.

Setting a financial target too low or too high threatens the long-term success of the VBR arrangement. If the financial target is too low, the provider organization will quickly discover this fact and lose interest in becoming a more efficient and effective operation. Likewise, if the target is set too high, financial incentive payments will be too easy for the provider organization to reach, and there will be little incentive for providers to maximize their efficiency and effectiveness. While the provider organization may want to continue with the same easy-to-reach financial targets, the insurer will assuredly work to restructure the deal to be more favorable to their interests. The end result of both situations supports the status quo of a health care system that is increasingly becoming too expensive for many to afford.

Issues to Consider When Setting Financial Targets and Measuring Results

When setting financial targets for risk contracts, there are several issues that need to be considered to ensure that the financial target is reasonable, achievable, and fair to both parties. Typical issues include who sets the financial target, how to ensure the financial target is consistent with the actuarial projections, what sort of adjustments are applied to actual results when comparing them to the financial target, what population should be included in the financial target and actual results, and what sort of data needs to be shared to allow both provider organizations and insurers to validate actual results with the financial target.

It is typical for insurers to set the financial target for VBR arrangements, however provider organizations need to thoroughly vet any proposed financial target before agreeing to it. This means that the provider organization needs to understand how the financial target is set, how the financial target is influenced by, or how it influences related actuarial projections, and how the provider organization will validate the actual results.

Another issue that impacts the setting of financial targets for VBR arrangements is the types of adjustments required to ensure that the actual results are on an equivalent basis with the financial target. Actuarial projections are based on assumptions about the inherent risk of the population included in the projection. Actual results can vary from these assumptions, and some of that variance is out of the control of the provider organization. Therefore, it is necessary to adjust the results for these variances so that they can be compared fairly against the financial target. Examples of necessary adjustments to actual results include incurred but not reported claim estimates, large claims pooling, and risk adjustment to account for community rating rules.

Actuarial projections are based on assumptions about the inherent risk of the population included in the projection.

Another issue to be considered is the selection of a population cohort to use when setting the financial target and measuring the actual results. Since there are many factors that can impact period to period financial results for a specific population or product, it is important to eliminate population “mix” issues that might distort the impact of care management initiatives or other interventions that would lower the cost of care and improve quality. Therefore, it might be necessary to only include a subset of the population for the sake of measurement to eliminate any “noise” in the actual results. Mix issues could include plan mix, demographic mix, and differences in the number of months that an average member is enrolled (duration mix).

The final issue that will be discussed is what data will be shared to support the actual results versus the financial target. It is important that both parties agree with the actual results that are reported by the insurer. For the sake of building a collaborative relationship, it serves the insurer to work with the provider organization to develop a reasonable level of transparency and confidence concerning the data used to calculate the actual results of a VBR arrangement in a specific contract year. Examples of types of data include those used to develop large claims pooling, risk adjustment, and risk mitigation program payments.

How Actuaries Can Level the Playing Field for Provider Organizations

Typically, a health insurance company’s actuarial department will be very involved in the development of the financial target, and the calculation of the results of a VBR arrangement. Provider organizations can often benefit from their own actuarial expertise for the sake of understanding the insurer’s actuarial projections and calculations. A health actuary working with a provider organization can point out issues with proposed contract provisions, determine the data necessary to validate any assumptions used in applicable actuarial projections or the calculated results of the VBR arrangement, and suggest revisions to the contract’s language to ensure fair treatment of the provider organization.

Additionally, a provider organization can work with a health actuary to develop a statistical model to estimate the financial results of any proposed risk contracting arrangement. Such a model would incorporate the provider’s cost structure, the relevant claims and enrollment experience of the population being measured, any upfront care coordination or equivalent payments made to the provider organization, expectations about the ability of the provider organization’s clinicians to meet quality targets, and the insurer’s expense structure for the population being measured. Using this model, the provider organization and their actuary can determine the reasonableness of any proposed financial target.


Risk contracting presents challenges to provider organizations that they did not face in the fee-for-service world. The assumption of risk for the sake of determining financial results is something that many provider organizations have little to no recent experience with. Conversely, the assumption of risk is one of the main functions of health insurance companies. Therefore, most provider organizations tend to not have the same level of institutional knowledge necessary to successfully negotiate some aspects of risk contracting, specifically those dealing with insurance regulations and actuarial projections. Provider organizations lacking meaningful experience with insurance regulations and actuarial projections should obtain the necessary actuarial support to ensure that they enjoy a level-playing field when negotiating risk contracts with their health insurance company partners.

About the Author

Joe Slater, FSA, MAAA, is a Partner and Consulting Actuary with Axene Health Partners, LLC and is based in AHP’s Charlotte, NC office.