What ASCs Should Learn from the HealthSouth Scandal

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By: Shannon Smith

Published: 10/10/2007

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Not only can careful patient accounting improve your financial performance ??? it can keep you out of trouble as well.


The accounting troubles at the nation's largest ambulatory surgery center network should serve as a wake-up call for ASCs everywhere. Errors in contractual adjustments, a poorly understood area of healthcare accounting, were reportedly responsible for $1.7 billion of HealthSouth Corp.'s $2.5 billion overstatement of its profits.

Although HealthSouth employees clearly were fraudulently manipulating the system rather than making simple mistakes, contractual adjustments are a dangerous trap for even the most honest, well-meaning ASC management teams. Errors are extremely easy to make in this area, and while they may not result in jail time for ASC managers, they can and do result in serious cash flow and tax issues. I'll explain this area in layperson's terms and what to do about it.

A problem of time and information
Contractual adjustment is a technical term relating to the discounts that all healthcare providers offer to insurers. All surgery centers have a charge master, or fee schedule. Those contracted with third-party insurers provide discounts off this charge master. In fact, between 40 and 60 percent of a typical ASC's income comes from discounted third-party contracts. When a center records income using accrual accounting, it reports the full charge for a procedure from the charge master as gross revenue and then reports the discount as a deduction from revenue. Sounds simple, but it's not. Unfortunately, many contracted payers make payments on an exceedingly slow schedule, as much as 180 days with some insurers. As a result, healthcare providers must estimate the contractual adjustment until the corresponding patient accounts are paid (see "Why Not Cash?" on page 30). Not surprisingly, the actual discount often differs from the estimate.

Here are two common ways to estimate what you will get paid for procedures you perform.

  • Use historical collection results. Here, you estimate what payment will be based on what you've been paid before. Some facilities may calculate a general discount for each payer (we normally collect 40 percent of our charge master charges from Blue Cross, for example), but most use payer data summarized by financial class (we normally collect 40 percent from all HMO payers, for example). This is a valid approach, but if used alone, it will provide only a very rough idea of what collections will be. This historical method, while very inexact and error-prone, is popular for its simple accounting mechanics.
  • Use your patient accounting system. The other way to estimate what you will get paid is to use your patient accounting system to prospectively estimate the contractual adjustments. Here, the software facilitates a prospective estimate of what you will get paid for each procedure from each insurer with which you do business. Inherently, it produces more reliable estimates because changes in case mix and payer mix are automatically factored into the calculation. It also facilitates the reconciliation of the estimated contractual adjustment to the actual contracted discount because the estimate is associated with the specific patient accounts. Your staff knows immediately when there is an inconsistency. This is a very valuable benefit considering the average ASC experiences 25 percent annual turnover of its collections staff. Using your system to calculate the expected payment will minimize inappropriate write-offs and will help ensure the full amount due is collected.

One challenge of using this method is that all payer contract information has to be loaded to the patient accounting system accurately - a daunting task considering most ASCs contract with many third-party payers. An even bigger challenge for most is ensuring that every patient account is associated with the correct payer and every transaction is captured with the right code within the patient accounting system.

Patient accounting
When correctly set up, information systems should enable 80 percent of all transactions to be processed correctly with little human intervention. But the other 20 percent usually require some thought. Patient accounting is no different.

  • The most popular ASC billing software funnels codes into one of nine reimbursement "groupers," as per Medicare. But some insurers use the Ambulatory Payment Classifications (APCs) rather than groupers. Some also allow "carve-outs" for certain supplies, particularly for orthopedic cases where implants can be extremely expensive and cause the cost of the case to exceed the reimbursement. Many software systems do not easily accommodate this.
  • Some third-party payers can access the rates of other contracted payers, despite not having their own contract with the center. Reimbursement is often dependent on the office and the contract chosen to adjudicate the claim. One payer can pay similar claims very differently, making estimating the contractual adjustment a challenge.
  • A new trend here in California is pre-paid health insurance cards. An uninsured consumer who knows he is going to need a procedure purchases one of these cards from a company that has purchased "piggyback" rights to the rates of one or more large health insurers like Blue Cross. ASCs that would expect full payment of charges from these patients must now discount them.

The Fallout from a Troubled Healthcare Titan

Federal regulators have accused HealthSouth Corp. and now-fired Chief Executive Richard Scrushy of fabricating $1.4 billion in earnings over the past four years. The Birmingham, Ala., company, which has the largest network of both ASCs and rehab hospitals in the country and became well known for its "McDonald's-style" franchising of health care, will decide whether it must call for Chapter 11 bankruptcy protection at the end of June. Here's a look at the early damage the HealthSouth corporate scandal has caused:

' Lawsuits will be filed. Two former National Surgery Centers (NSC) shareholders last month filed a class action suit in federal court on behalf of other NSC shareholders who sold their holdings five years ago to HealthSouth Corp. based on financial statements now believed to be fraudulent, causing NSC shareholders to receive HealthSouth stock that was overvalued due to the fraud. The complaint states that the shareholders may not have agreed to sell the ASC company in 1998 in a stock transaction valued at $590 million had they known that HealthSouth had overstated its earnings by more than $1 billion. The more than 21.4 million HealthSouth shares given to NSC shareholders would be worth just $3 million at the current price of 14 cents.

"My prediction is there will be a groundswell of lawsuits as a few physicians get involved with a few attorneys," says Rick Holdren, owner of Appraisal and Mentor Group, one of the country's largest appraisers of medical facilities. "When the damn breaks, it will break big time."

' Some physician-investors will panic. As HealthSouth's value plummets and lenders start calling in their loans to the company, could physicians partnering with HealthSouth see their own cash flow dry up? Even though the company is $1.25 billion in default to its bank lenders, HealthSouth spokesperson Andy Brimmer says the company "has adequate cash on hand to continue to operate normally." Mr. Brimmer says the alleged inflated earnings will not affect HealthSouth's "core group" - its ASCs and rehab units. "People are looking to that core group to keep generating cash because that's how lenders are going to have a recovery," he says. "But I could see doctors saying, 'Gee am I going to get my surgical supplies?' and I would say, 'Yes.' We're making sure that accounts payable at ASCs are current."

' Some physician-owners will sever ties. Some of HealthSouth's 3,500 physician-investors at 203 surgery centers are considering severing ties to HealthSouth to protect their center's reputation and financial integrity. One example: A day after the SEC investigation was announced March 19, the doctors at HealthSouth Outpatient Care Surgery Center in Birmingham voted to remove HealthSouth's name from the exterior of the building, worried the association might hurt business and drag down the center. But the doctors reversed their decision, opting to stick it out with HealthSouth.

' The outpatient surgery industry will suffer. This headline-grabbing scandal could cast a pall over other ASC companies. If investments to these companies wither, ASC companies may reduce the asking prices for independent ASCs, which have commanded prices at five to seven times earnings. "If the HealthSouth model, which was held in high regard by stock analysts, is all wrong, then we may see a dramatic fall in the value of outpatient surgery centers," says Mr. Holdren. "Wall Street is either wildly optimistic or wildly pessimistic." Early this month, Symbion, a Nashville, Tenn.-based ASC company, withdrew plans for an initial public offering, citing continued weakness in equity markets. Symbion says it may offer shares to private investors instead.

- Dan O'Connor

Problems big and small
Improper contractual adjustments can cause serious problems for your center and your investors. One danger is overstatement of earnings. When this occurs, tax liability is typically greater than the cash distributed to the partners - a phenomenon known as "phantom income." This is a special problem for new centers because they have little reimbursement data available for estimating contractual adjustments, and reimbursement often fluctuates until payer contracts are finalized. Until payer contracts are properly loaded to both the payer and the provider's software systems, there is also a risk of lost revenue and again a risk of misstating the contractual adjustments. Improper contractual adjustments could also cause you to overestimate the cash you will have on hand, triggering serious cash-flow deficits and possibly credit-rating damage due to late payments.

Under- or over-reporting your center's income may force you and your investors to file amended tax returns with penalties later. Perhaps most important of all, you could deprive yourself of a management tool that is vital to the health of your business. It may be that you are losing money on some procedures (a very real possibility) and need to either renegotiate some of your contracts or drop them. But you won't know unless your patient accounting system is working properly.

Why Not Cash?

As most businesspeople know, the cash system involves recording and reporting expenses and income in real time, as they happen. For example, let's say your center performs a cataract procedure in March but doesn't get paid until May. Under the cash system, you would record the expenses associated with performing the procedure in March and the income in May.

The cash system clears up a lot of the problems associated with contractual adjustments, since there's no need to estimate what the reimbursement will be. Unfortunately it exacts a high price: Your ability to use the information for management purposes is virtually zero. This is because when you look at your March profit and loss statement, you will be comparing income earned two to six months prior with expenses incurred that month. No matter what the P&L says, you have no way of knowing whether March was a truly profitable month or not, and thus you are impaired from taking any management action.

Some "Mom and Pop" ASCs undoubtedly still use the cash system, and it's acceptable for tax purposes, but the Generally Accepted Accounting Principles, the gold standard of U.S. accounting, require use of the accrual system.

- Shannon Smith, CPA

Toward a solution
In my work with centers around the country, I have found no easy answers. But I do have a few pieces of advice for heading off problems with contractual adjustments:

  • Consult with a healthcare accounting expert. You need someone to set up your patient accounting system, ideally long before the first day of operations. A consultant can develop a logical coding system for you, set up your initial contracts and help you understand how to add new contracts and adjust old ones. Capturing data correctly from the start will save you a lot of money and heartache later.
  • Who's playing the part of CFO? Within your organization, someone needs to take on the role of controller or chief financial officer. In a big company, this is a certified public accountant whose job is to oversee (not do) data entry, to analyze the results, to gain complete command over the figures and to report back to the management on a monthly basis. Most small and even mid-size ASCs cannot afford to hire such a person specifically for this role. So they need to make sure that the business manager or the administrator - whoever is designated - gets the training necessary to play it. General college-level accounting and management courses are an excellent investment. So is industry-specific education.
  • Is your staff up to par? The patient accounting system is a subsidiary ledger to the general ledger. Garbage in results in garbage out. Every business office staff member contributes to the accuracy of an ASC's financial reports. Make sure your entire billing and collections staff understands what needs to happen, why it needs to happen and how to make it happen.
  • Remember the 80-20 rule. In most ASCs, five or six contracts drive 80 percent of the business. Focus on getting the details of those contracts correctly loaded to your patient accounting system. This will improve the accuracy of your contractual adjustments and may enhance your cash flow.

A greater understanding
Mention accounting to many in health care, and their eyes glaze over. I congratulate you for getting this far. Knowing the problem and at least some of the remedies is the first step toward cleaning up contractual adjustment problems before they clean you out.

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