Understanding Managed Care Lessor Of Provisions

by Seth Avery
President and CEO of AppRev

February 8, 2017

Hospitals sometimes enter into managed care agreements that contain “lessor of” provisions. In this type of arrangement, the payer agrees to pay and the provider agrees to accept the lessor of either the contracted rate or the billed charges.

If a charge for a particular coded service is too low, you’ll receive less of a payment than you would have if you’d used an agreed upon rate. We refer to these as the lessor of “loss”. By understanding the scope and detail of these losses, providers can develop strategies to limit them. The analysis of losses is usually split into two categories: Outpatient and Inpatient.


Lessor of may be applied in the outpatient two different ways: at the service level (most common) and at the claim charge level.

In the service level calculation every service’s charge is compared to the contract rate, which is driven by the contracted HCPCS. In the example below, the chest x-ray, single view (CPT 71010), has a contract rate of $100. If the provider bills a charge of $80 where there is a service level lessor of term, the payment will be based on the lessor of the charge of $80, and the rate of $100. In this instance there will be a lessor of loss of $20. (For this analysis the term “payment” is used to represent the total amount due to the provider or otherwise known as the “allowable”. The allowable is the combination of the payer payment and the patient responsibility)

In the claim level calculation, the results are different. The charge for the x-ray is under the contracted rate, but the CBC (CPT 85025) has charge of $45, which exceeds the contract rate of $24 by $21. If the total charges of $125 are compared to the total payment rate of $124, there is no lessor of loss.

Contract Rate Charge Service Level Claim Level
X-Ray of the chest $100 $80 $80 $100
CBC test $24 $45 $24 $24
Total $124 $125 $104 $124


What if the rate is based on a case rate such as MS-DRG?  If the sum of the charges is less than the payment rate for the MS-DRG or other case rate, then the payment is based on the charge. There may be an additional term that modifies the payment for a short stay or patient discharge status. In those instances the payment rate may be a portion of the full case rate. When we observe the charges as less than the case rate, it is often due to a shorter hospital stay than expected.

Case rate lessor of analysis

When working with hospitals that perceive that they have a inpatient lessor of issue we perform a detailed analysis.

  1. Identify all payers that have case rates and the corresponding rates
  2. Select inpatient account data for patients who have been discharged and have a payer identified as having a lessor of
  3. Data elements should include:
  • Payer
  • Account number (or reference number)
  • Charges at the revenue code summary level
  • DRG or case rate indicator
  • Length of stay
  • Discharge status
  • ICD-10 Diagnosis and procedure codes

We compare the charge totals to the corresponding rates to identify those that are paid using the lessor of term or the case rates. When attempting to get to the bottom of inpatient lessor of issues, you will generally find that only a handful of discharges are driving the numbers. It’s the opposite of the 80/20 rule: typically you will find that a relatively small number of short stays experience larger differences between the charges and the contracted rate.

To help understand some or root causes we add the Geometric Mean Length of Stay (GMLOS) from the Centers for Medicare and Medicaid Services (CMS) Inpatient Prospective Payment System Final Rule, Table 5.

By assuming there is a relationship between the length of stay and the expected charges we can identify the cases where we would expect the charges to be low and the opportunity to recover the difference to also be low. Coding and documentation issues often underlie the lessor of loss. We have found accounts where coding errors have led to higher level DRG assignment, thus the length of stay on the paid DRG and the case rate was higher than the result would be with accurate coding. When the length of stay for a discharge to home is at 20-30% of the GMLOS, this is typically not an issue of undercharging.

Another wrinkle in this analysis is the impact of carve outs, so named because this separate payment rate is “carved out” of the case rate. Carve outs are terms in which devices, implants or high cost drugs are typically paid based on a percentage of the hospital charge. To understand the impact of the carve out the analyst must understand how the charge for carve is used on the overall payment calculation.

Please note the impact of carve outs in the following examples:

Example 1

Case Rate $80,000
Charges (excluding device) $70,000
Device Charge $20,000
Total Charges $90,000

In the example above, the device is reimbursed at 60% of the device charge. In this case the payer identified the device charge by totaling the charges in the revenue code 0278. There are two possible calculations for the total payment; case rate and lessor of rate.

Example 2

Case Rate $80,000
Device $12,000
Total Payment $92,000

In this payment calculation, the payer has used the total charges to satisfy the lessor of calculation and added the carve out payment.

Example 3

Lessor of Rate $70,000
Device $12,000
Total Payment $82,000

In the second payment calculation the payer has excluded the charges paid under the device carve out from the lessor of calculation. As you can see, it is very important to understand how the payer actually calculates this term.

Pricing Implications

A provider’s overall rate increase is typically limited by their managed care agreements, usually expressed as a gross charge increase. Many providers may simply perform an “across the board” price increase by raising all of their prices by a set percentage equally. While this may have a minor impact on lessor of loss, it does not target specific components for increases.

A more sophisticated approach would be to identify line items that are suffering lessor of losses and raise those prices by more than the overall increase. It is then usually necessary to offset those increases with other line item decreases so that the overall gross increase conforms to the contracted increase. An actual decrease in net revenue can be an unintended consequence of this approach.


Assuming that we have a payer cap on our overall price increase of 5%, we had a lessor of loss because the charge was $20 below the contract rate above.

Let’s say the payer quantity for this service for the year was 100 – the lessor of loss would then be $2,000. To eliminate this loss the price would need to be increased by $20 for each one of $2,000 in gross charges. So far, so good: We have a 100% return on our price increase, but…we have other payers with their own terms and quantitates.

X-Ray of the chest A B C D E F
Payer Rates $100 $40 $100 $70 $80 $60
Quantity 100 300 50 150 100 250
Gross Revenue $8,000 $24,000 $4,000 $12,000 $8,000 $20,000
Lessor of ? Y N Y Y Y N
Net Revenue $8,000 $12,000 $4,000 $10,500 $8,000 $15,000
Lessor of loss $2,000 $1,000
Total Quantity 950
Total lessor of loss $3,000
Total Gross $76,000
Total Net $57,500

To eliminate the lessor of loss for payer A and C, the price for the service would need to be increased by $20 (or 25%). Unfortunately, this increases the rate for all payers. We can’t just increase the rate by the $3,000 to equal the total lessor of loss. Doing so would result in a $19,000 (950 X $20) increase! We will then have exceeded our gross charge increase cap by $15,200 ($76,000 x 0.05 = $3,800).

To make this work we need to decrease prices in other areas by $15,200 to break even. In doing so, we may inadvertently impact another service with a lessor of term.

To further complicate things, some payers pay as a percentage of charges (POC). When we lower prices where there are POC volumes, we have a similar impact to lessor of loss. We will experience a POC loss for each dollar of decrease multiplied by the quantity of the payer for the service.

So how do we make this analysis manageable? We calculate the price sensitivity for each service by using the payment term for each specific quantity of service and patient type. This eliminates the problems associated with across the board price increases, such as payer increases, exceeding gross charge increase cap and taking on POC losses.

In Conclusion

Because of the many moving parts associated with lessor of reduction, hospitals should approach the issue with caution. Additional complications not addressed in this paper include outpatient grouper hierarchy, outpatient case rates, grouped services and others.

The impact of this issue also tends to change from state to state. Payers in some states may tend to have more percent of charge and fewer lessor or terms. We also encourage hospitals to adopt technology or processes to detect “hidden” lessor of, much as they would with a silent PPO discount.

With planning, intent and attention to detail, hospitals can develop strategies to reduce lessor of losses.

About the Author

Seth Avery has over 25 years of experience as a healthcare executive, serving as auditor, consultant, Administrator and Chief Financial Officer (CFO). Mr. Avery has served as the CFO for a major teaching hospital in Texas and as the Executive Director of a leading New Jersey Medical School. He has worked at government, for-profit, and not-for-profit health care providers, as well as at a Big 6 organization.

Seth has been certified by the American Academy of Professional Coders (AAPC) as a Certified Professional Coder (CPC) and is a past member of the National Advisory Board for the AAPC. Seth has a B.S. from Campbell University, an M.A. in Economics from the University of New Mexico and a Juris Doctor from Texas Wesleyan University. Seth is also a 14 year veteran of the U.S. Military, serving both as a member of 5th Special Forces Group and as a Medical Service Corps officer.

He is a frequent speaker at Healthcare Financial Management Association conferences and presents webinars providing education on various healthcare finance topics.


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