ACO Value Metrics Series: Need-to-Know Basics on the Costs of Forming an ACO

The four-part HC Topics Series: ACO Value Metrics will consider the value metrics and capital formation costs associated with forming accountable care organizations (ACOs). This first installment provides the background of the value metrics used to assess these emerging healthcare entities, and Part II will discuss the cost-benefit analysis that must be conducted in considering ACO formation. Part III will address the in-depth valuation that must be performed for prospective ACOs, and Part IV will consider the noncost-based value metrics that should also be evaluated. This HC Topics Series is excerpted from the book authored by HCC President, Bob Cimasi, entitled, “Accountable Care Organizations: Value Metrics and Capital Formation,” to be published by Taylor and Francis Group later this year.

The Patient Protection and Affordable Care Act (ACA) places significant emphasis on the formation of ACOs, which are models of care that use clinical integration and financial incentives to attempt to improve quality while decreasing cost.¹ Under a variety of entity structures, providers receive bonuses for meeting quality and patient expenditure targets, while those who fail to meet requirements may be subject to penalties.² These financial incentives are expected to reduce Medicare spending by shifting some provider reimbursement away from existing fee-for-service models that reward only the volume, rather than the value, of services provided.³ The decision to form an ACO involves a complex financial analysis that ultimately centers on whether the entity is likely to succeed, i.e., provide a significant return on investment. In determining the value an ACO is likely to provide, value metrics considers both economic and non-economic aspects of an entity, such as lower costs and community benefit, respectively. The two primary forms of ACOs are federal and commercial, and due to the variety of reimbursement and organization structures experienced in the commercial ACO market, this article will examine the basic financial considerations involved in the investment decision to form a federal ACO.

Among the different categories of ACOs, federal ACOs are those governed by the Medicare Shared Savings Program (MSSP) mandated under §3022 of the ACA, which was designed to encourage the development of ACOs for specific Medicare populations.⁴ Under the MSSP, revenue generation in the federal ACO model is derived from entities’ achievement of patient expenditure cost reductions that are a minimum percentage below a benchmark established by the Centers for Medicare and Medicaid Services (CMS). Each benchmark is specific to the individual ACO and is based on the entity’s patient expenditures during a performance year. Although a federal ACO that achieves sufficient expenditure reductions will receive a shared savings payment based on the first dollar under the CMS-established benchmark, that ACO is only eligible for shared savings if its expenditures are a certain percentage below the benchmark. This percentage threshold represents the minimum savings rate (MSR).⁵ If the ACO’s expenditures are below the MSR threshold, then a portion of the difference between the CMS-calculated benchmark expenditures and the actual expenditures will be provided to the ACO as a shared savings payment.⁶ This portion of the ACO’s achieved expenditure reduction is known as the shared savings rate. The Medicare program retains the remainder.⁷ Note: if a federal ACO achieves actual patient expenditures below the CMS benchmark, but not enough to satisfy the MSR, the ACO will not receive a shared savings payment, and CMS will retain all cost savings.

For entities forming a federal ACO, the MSSP offers a choice of two models through which entities may receive shared saving disbursements, based on the amount of risk assumed by the ACO: (1) the one-sided model; and, (2) the two-sided model. The one-sided model is a “shared savings only” model, meaning if the ACO’s actual expenditures on patient care are above the benchmark established by the CMS, adjusted by the MSR, they are not subject to shared losses, in contrast to the two-sided model.⁸ CMS has stated that the lack of risk sharing makes the one-sided model most appropriate for entities that are smaller and less mature in terms of their level of integration and coordination of care.⁹ In exchange for greater possible shared savings payments, ACOs under the two-sided model are responsible for sharing any losses incurred by the Medicare program; hence, ACOs that are able to assume greater risk may be better suited for the two-sided model.¹⁰ Although the MSSP allows ACOs to choose which distribution model is best suited to their organization, following the initial three-year contract, all ACOs must operate under the two-sided model.¹¹ Thus, if an organization chooses to continue operating as a federal ACO, it must eventually be able to accommodate some shared risk.

ACO formation is expected to require significant capital investments in order to establish the infrastructure required under the MSSP. These investments include: network development and management; clinical information systems; care coordination, quality improvement and utilization management; and, data analytics.¹² The portion of an organization’s startup costs required for network development and management can vary significantly. CMS initially estimated this cost at $1.7 million and the American Hospital Association (AHA) predicted it would require an amount closer to $12 million.¹³Capital requirements for clinical information systems will be the most significant expense, as electronic health record (EHR) implementation is required for efficient data gathering and reporting, despite not being required under the MSSP.¹⁴ For care coordination, quality improvement, and utilization management, a study of several healthcare systems found that the capital requirements for these functions will likely range from $160,000 to $250,000 annually, with more capital likely to be allocated for the first year.¹⁵ The use of data analytics systems to track and report on quality measures may require a separate allocation of capital; however, the capital costs associated with these systems will likely be significantly less than those associated with EHR development.¹⁶ In addition to start-up costs, ACOs must also anticipate the costs associated with each of these categories for its ongoing operation. Total ongoing costs for a small hospital will be roughly $2.9 million a year, whereas a large hospital may require roughly $5.7 million a year.¹⁷

Healthcare entities capable of reducing Medicare patient expenditures will share in a portion of the cost savings achieved under the MSSP, which may help to offset some of the entity’s start-up or ongoing operational costs.¹⁸ Managers of healthcare organizations contemplating investment in an ACO should carefully assess their organization’s ability to achieve the required cost reduction benchmarks, as this ability is the basis of obtaining the MSSP shared payments and making the ACO a successful endeavor. The decision to form an ACO requires an in-depth analysis of the possible impacts of such an investment, and next month’s installment of the HC Topics Series: ACO Value Metrics will consider a basic cost-benefit analysis for organizations contemplating ACO formation.

For more information on ACOs, see the following Health Capital Consultants publications:

ACO Value Metrics Series: Need-to-Know Basics on the Costs of Forming an ACO

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