ASO: Determining the Financial Feasibility of an Administrative Services Organization (ASO)
Key variables and options

by Mike Fadden
DRIS Feasibility Consultant

Marty Campbell, Program Director and Director of Evaluation for The James Irvine Foundation, Luisa Buada, CIRHM Executive Director and Mike Fadden, DRIS Feasibility Consultant, during a plenary session

Two articles in the Winter issue of DRIS News discussed a community managed care model for an ASO (Administrative Services Organization) and the related financial feasibility and business planning process. As a follow-up to these topics, several rural managed care financial models were presented at the Annual DRIS Meeting held in January. These models were developed to assist the feasibility consultant and each Community Health Council (CHC) in determining the financial feasibility of their particular ASO. In this issue, we will discuss the key variables used in the models to determine the financial feasibility of the ASO and several options for the CHC to consider if the ASO is not feasible.

Rural Managed Care Financial Models

In order to assess the feasibility of developing a community-based ASO, a set of rural managed care financial models was created based on a CIRHM sponsored independent survey of California health plans and ASOs. Staffing patterns at various levels of subscriber enrollment, staff compensation costs, development costs and other operating costs were obtained as a result of the survey. This information was utilized to build the models as well as the three financial scenarios for each model using different enrollment levels. Depending upon the functions selected by each DRIS community, the most appropriate model can be used, modified by local data and assessed through a financial feasibility analysis.

Key Feasibility Variables

Once a DRIS site has defined the scope and functions of its ASO, achieved its pre-feasibility planning milestones and collected appropriate local data, the financial feasibility analysis can be undertaken. While each proposed ASO differs by site, the ultimate outcome of the analysis is determined by the following key variables:

• potential volume of business;
• operating revenue;
• staffing expense;
• functions outsourced; and
• capital requirements.

All of these key variables play off of each other. However, it is the potential volume of business and associated operating revenue which are nearly always the most crucial variables in a financial feasibility analysis. They determine how the dollars can be spread over the fixed and fixed-variable expenses required to operate the ASO. For a managed care ASO, the primary source of revenue is the fees generated by providing plan administration and medical management services to provider-owned risk bearing entities and self-insured employers. The combination of these fees and the potential number and types of covered lives determine the revenue. For example, an ASO with a balanced mix of commercial HMO lives, Medicare HMO lives and self-insured lives, is more likely to reach a break even point with a lower number of total lives than an ASO with commercial HMO lives only. This is because typical plan administration and medical management fees charged by an ASO are higher per covered life for Medicare HMO and self-insured lives than for commercial HMO lives. Our rural managed care financial models show that a full blown ASO, with claims administration outsourced, would need at least 15,000 covered commercial HMO lives to break even. Whereas, an ASO with a more balanced mix of lives would break even at approximately 11,000 lives. Whatever the payer mix, the projected number of lives must be realistic when weighed against the specific demographic and market conditions of each DRIS site.

The staffing requirements of an ASO are directly related to the functions to be undertaken by the ASO as well as those functions which the ASO intends to outsource. Two critical functions which are being considered for outsourcing by the DRIS sites are medical directorship and claims processing. While our financial models show that developing claims processing capabilities internally is more cost efficient in the long run, the additional $250,000 to $400,000 investment required is beyond what most DRIS sites are willing to invest up-front. Costs for outsourcing claims administration services can range from $2.50 PMPM to $5.50 PMPM or more. The exact amount is critical because these costs are a recurring variable expense that continues regardless of the number of enrolled lives. For example, in negotiating with an external claims processing company, the difference between the low and high of this range can mean a $360,000 swing in the annual expenses of an ASO with 10,000 covered lives. Just as importantly, on a much smaller scale, the fees paid to a medical director can also have a significant impact on expenses if the fee is based on covered lives.

To the extent that additional functions are outsourced to a medical management and claims processing company, outsourcing costs will be higher. Often, functions such as provider contracting, network management, member services and others are built into the PMPM fee along with claims processing. It is important to remember that these are continuous variable expenses. In other words, these expenses increase in direct proportion to the number of covered lives unless a volume discount can be negotiated. As an ASO develops and grows and more of these functions can be developed and staffed internally, the more the ASO can spread the related fixed and fixed-variable costs over a greater number of covered lives.

Assumptions about the potential volume of business, operating revenue, staffing expense and functions outsourced also affect the ASO’s start-up and development capital requirements. For example, the timing of attaining a specific volume of business will shorten or lengthen the period of time between start-up and break even, requiring more or less working capital. If the intent is to have the local provider-owned risk bearing entities contract with the ASO for plan administration and medical management services, and if these provider entities have multiple existing risk contracts in place, the ASO will have a critical block of business on day one. On the other hand, if these provider entities and the ASO need to acquire new risk contracts, there will be a longer period of time during which working capital will be needed to support operations of the ASO.

As mentioned above, an ASO that develops its claims processing capability internally will invest significantly more dollars up-front on information systems and consulting expenses than an ASO which outsources this function. It will also need a longer development and start-up period resulting in higher working capital requirements for compensating claims and information system staff during this time. Other non-managed care functions to be undertaken by the ASO, such as physician practice management services and community health improvement programs, can also significantly affect development and start-up capital requirements. Ultimately, the resulting requirements will need to be funded. In addition to the Phase III grants from the James Irvine Foundation, most DRIS sites will need to pursue other funding sources, such as grants or local capital contributions.

Options

If the ASO financial feasibility analysis is favorable, the process of developing the business plan continues. (See Figure 1, DRIS Feasibility and Business Planning Process - Decision Tree on page 4). If the analysis is unfavorable, the CHC should identify and evaluate options for achieving feasibility. These can include:

• Revisiting the key variables used in the analysis;
• Altering the scope and functions of the ASO; and/or
• Seeking a partner willing to provide needed capital.

In revisiting the key variables, the CHC should look for ways to increase revenue, decrease expenses and/or decrease development and start-up capital requirements. Questions to consider include:

• Is there any way to realistically increase volume?
• Would the provider-owned risk bearing entities and self-insured employers be willing to pay an additional dollar PMPM for plan administration and medical management services?
• Can we negotiate a dollar PMPM less in our contract with the claims administration company?

This is a small sample of the questions that should be asked. A dollar PMPM more for services provided and a dollar PMPM less for outsourcing costs would produce a favorable swing of $240,000 annually for an ASO with 10,000 lives. Almost always it is the combination of multiple changes in the variables that produces a more favorable result.

Revisiting the ASO’s scope and functions to produce a more favorable outcome may also be necessary. Questions to consider include:

• Can we delay for six months implementation of certain non-revenue producing functions?
• Should we limit our scope to grant-funded community health improvement initiatives?
• Will eliminating our physician practice management program reduce our capital needs?

When depreciated over five years, a $100,000 decrease in development and start-up capital will produce a favorable swing of $20,000 annually.

If revisiting the key variables and altering the ASO’s scope and functions fail to produce an acceptable result, the CHC may want to evaluate seeking needed capital through a partnering arrangement with another health system or health plan. Potentially, a health system or health plan partner may be willing to invest in the ASO in exchange for the opportunity to build a positive, long term relationship with local providers, the ASO and the community. Before undertaking such an effort, however, the CHC should identify potential partners and determine exactly what the ASO or the potential partners want and are willing to do in a partnering relationship. These decisions should be used to develop a Request for Proposal (RFP) which would be sent to the potential partner(s). Responses should be evaluated against criteria established by the CHC in order to identify a potential partner with whom serious discussions can be initiated.

As illustrated in Figure 1, termination of any continued efforts to develop an ASO is also an option, although one that should be considered only after all the other options have been thoroughly evaluated and explored.

DRIS ASO Feasibility and Planning Process Decision Tree, Fig. 1

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