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Patient with Healthcare Nurse

Community Health Plan

A Large Health Maintenance Organization

CHP was large multi-state health maintenance organization (HMO), located in upstate New York and Vermont and Massachusetts.  When CHP costed out several of its new managed care option contacts the prices derived were not in line with market rates.  The CFO wondered, “Is something wrong with our costing system?”

CHP was organized into six operating regions, each with a separate community rate structure and varied product line.  The regions were supported by a central-services support staff.  Like other HMOs, CHP’s primary business is providing comprehensive health care services to its members for a fixed monthly premium.

CHP began offering a new product, managed care option contracts (MCOs).  Under these contacts CHP agreed to provide administrative and medical management services in support of an employer’s health care plan.  The services varied depending upon the employer’s needs.  These can include such services as utilization review, claims processing, and coordination of benefits.  Employers using these plans are self-insured for the cost of the medical services rendered to their employees.

Under its conventional costing system, CHP allocated the cost of central services largely on the basis of regional membership.  When CHP costed out several contacts the prices derived were not in line with market rates.  CHP’s CFO concluded that the information provided by the conventional costing system was unreliable and that an improved accounting system was needed.

CHP’s existing costing system was designed to provide reporting required for regulatory use; it did not provide information useful to managers.  The system did not take into consideration differences in efficiencies in the various regions; in effect it encouraged cost shifting between regions.  Moreover, the costing system was unable to support CHP’s continuous quality improvement (CQI) efforts.

CHP had two primary objectives for designing a new costing system:

  1. Obtain more accurate product costing information, including a framework for costing administrative services for MCO products; and

  2. Promote CQI by promoting process thinking, and changing the view of financial leadership in the organization.


To meet these objectives, CHP implemented a multi-stage activity-based costing (ABC) system. The differences in product costs between the two systems were substantial.  Under the conventional costing system, the administrative cost per member did not vary by more than 5% across all regions.  Under the ABC system, a vastly different picture emerged.  For the HMO product, administrative cost per member by region ranged from 85% to 121% of the organization’s average.  For the MCO product line, the range was from 53% to 2,592% of the average. (The large cost in one region represented the cost of gearing up for a new customer.)

The information from the new costing system provided CHP with a definitive tool for rationalizing the pricing of the MCO services it provides its clients.  The new costing system also better supported CHP’s CQI efforts and provided better information on which to evaluate performance at the various levels of the organization.

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