The health industry is an important industry in business, politics, and our personal lives. The success of the medical industry as a whole is paramount to all of us. Although doctors have provided excellent health care in the United States, their ability to run successful businesses has been questioned.
Many people wonder why it is important that doctors run successful businesses. This is probably a question that wouldn’t have been asked 10-15 years ago, but nowadays many extremists are pushing the idea that businesses are evil and don’t provide as much value to society as was previously thought (see Michael Moore’s movies). Doctors need to run successful businesses so that there is an incentive for the best and brightest to become doctors, so that medical centers will have enough money to purchase the best equipment and medicines, and so that supply will equal demand.
One area where medical centers have been particularly porous in the past includes collecting accounts receivable. Over the period of 1991-2001 the average collection period for medical centers was between 67-71 days. This data is a bit outdated, but it is hard to believe that much has changed in doctor’s collection habits over the past nine years.
It is hard to say who is to blame for these long collection periods. Some experts blame the doctors for being lackadaisical about collecting while others point to the fact that insurance companies are taking an ever increasing role in the payment process. The truth probably lies more towards the latter. Insurance companies are becoming such an important part of the health care industry that there is little doctors can do to make the agency pay faster.
Having to wait more than two months to collect payment is challenging for both new and established health centers. Paying doctors, assistants, and other employees can be difficult when the practice doesn’t have cash. This is an especially frustrating experience when the medical center is always busy with patients, has thousands or millions of dollars locked up in receivables, but just can’t collect right now.
There are several solutions to cash flow and receivables problems, but this article will focus on medical receivable factoring.
How It Works
There are two ways that factoring works in the medical industry. There are subtle differences between the two methods (which will be described below in detail) but in essence the methods are the same.
Method 1
Under this method, the medical facility actually sells its receivables to a third party investment company—the Factor. Receivables in the health industry are different than receivables in other industries. An account receivable in the health industry probably means that the insurance claim has not yet been paid. In other industries it usually means that the customer has not yet paid.
Under this method of medical receivables factoring, the medical facility approaches the factoring company with its insurance claims. The financing company will pay the medical practice anywhere from 60 to 90 percent of the value of the receivable. The Factor then collects the insurance money from the insurance agency and remits the remaining 10 to 40 percent to the medical firm, minus a fee of course. The fee for this service is usually anywhere from one to four percent per month.
What does the medical factoring company look at when determining advances/fees?
The number one factor for the advance rate and fee that a medical practice will receive from a Factor is risk of collection. The higher the risk of not collecting the full amount of the insurance claim, the lower the amount the medical firm will be advanced. Unfortunately insurance agencies don’t have a strong reputation for trust built up so this damages advance rates.
Insurance policies can become extremely convoluted and this complicates advance rates. Even though a practice might believe that it has a $100,000 receivable, the insurance agency might not see it that way (any doctor who has been in this business for long knows that insurance agencies don’t always see eye-to-eye with medical firms on payment issues). A medical factoring company will heavily scrutinize insurance policies and claims before deciding on how much to advance.
The financing fee charged by factors depends on the collection period and the amount of factoring being done. The longer it takes for the factor to collect the insurance claims, the higher the fee.
Factoring companies usually want to have a semblance of a long-term relationship. They aren’t necessarily thinking decades, but they’ll usually want to keep a health-care firm on board for a year or two. After the factoring company has worked with the medical firm for a few months, the factor has a good idea on the risks associated with collection from that particular firm and may be able to offer better advances and fees if it finds the firms insurance claims are always paid in the correct amounts.
Method 2
The first method of medical account receivable factoring consists of an actual sale of the receivables to a third party. The second method, not as common in practice, is using insurance claims as collateral. The idea is that a third party financing company will open a line of credit for the practice based upon the amount of receivables outstanding. The amount of the credit line is usually somewhere between 60-90 percent of the alleged value of the claim (note that this is the same amount that is advanced under method 1). Under this method there is also a financing fee that is between one to four percent per month.
Here is an example of how this method works. A patient comes into a medical facility and is treated. The patient’s insurance company plans to pay for the treatment within the next few months. The facility now has a receivable or claim. The medical firm takes this claim to a factoring or financing institution and asks to open up a line of credit based upon this claim and other claims. The financing company extends a line of credit between 60-90 percent of the face value of the accounts receivable. There is usually a charge for simply opening the credit line, and obviously interest is charged when money is borrowed. The medical practice borrows money using its credit line. The insurance agency pays its claims to the medical practice. At this point the practice usually pays off some or all of its credit line. Note that the credit line can be increased if the practice brings more claims to the factoring company and they work out a new agreement.
This method is sometimes known as medical invoice discounting or receivables discounting. It differs from the aforementioned way of factoring in several key ways:
(1) This is a loan, not a sale. Under the first method, the practice is actually selling the insurance claim. Under this method the practice is potentially opening up a floating credit line that moves according to the amount of claims outstanding.
(2) Another difference between these two methods is that under the discounting or second method, the practice doesn’t have to borrow all of the credit line. The practice has a bit more flexibility under the second method, because under the first method the claim is sold and the money has essentially been “borrowed.”
(3) Another big difference between these two methods is who performs the collection services. Usually in a medical factoring agreement where the receivables are sold to the factor, the factor will collect. This has advantages and disadvantages. One advantage is that it frees up time and resources, one disadvantage is that the factoring company may not handle the insurance claims or receivables the same way that the medical practice would.
Under the second method (the credit line method) the physician’s practice almost always collects from the insurance companies. As mentioned above, this has advantages and disadvantages.
Advantages and Disadvantages of Medical Receivable Factoring
Advantages:
• A medical practice’s net cash position improves. When using factoring a medical firm knows exactly when it will be receiving cash. This makes it easier to budget and make important business decisions. Instead of taking 70 days to receive money for work done today, practices can receive money within one to two days. Having cash sooner creates opportunities for growth.
• No set limit on amount of money “borrowed.” Under traditional financing methods (going to the bank to get a loan) a medical institution can only borrow a specific amount, there isn’t much flexibility. In fact, if a practice goes back to the bank and ask for a larger loan, the bank will think something is amiss with the practice. However, with factoring, a health institution can take as many or as few claims to the factoring company as they want. This means that if a medical facility is doing a lot of business, it will be able to borrow a lot of money from a factoring institution.
• Possible collection outsourcing. Working with insurance companies to collect claims costs practices extraordinary amounts of time, money, and energy. Depending on the factoring agreement, the factor might actually be the one that collects the money. This means that they deal with all of the headaches of working with the insurance agencies.
• May be easier to qualify for a factoring loan, than a traditional loan. This is due to the fact that with factoring, there is collateral (the insurance claim), whereas with normal loans, there often isn’t any collateral. Note that with factoring the receivable isn’t really collateral, it is actually an asset being bought, but it is referred to as collateral here for pedagogical purposes.
Disadvantages of Medical Accounts Receivable Factoring
• The biggest disadvantage to the medical office is that it won’t be receiving 100% of the insurance claims it is entitled to. It will be receiving somewhere between 95 to 98 percent.
• Another disadvantage often cited towards medical factoring is the abnormally large financing fee. If the factor charges two percent per month that’s an annual rate of 24 percent. That is an insanely large interest rate (read below to see why anyone would consider factoring).
• The collections process may be outsourced depending on the factoring arrangement. This disadvantage is unique in that it is also cited as an advantage above. Most medical offices become well-versed in working with insurance agencies (they have to in order to survive). The factoring company may not have the same working relationship with the insurance agencies as an individual practice does. The factor may not have as much expertise or incentive to collect the full amount. For example, if the factor advances 75% to a medical practice, and the insurance agency decides to only pay 80% of what the practice thought they would pay, the factor doesn’t have as much incentive to collect as the practice does (either way they get their fee). This is rarely an issue in practice, but theoretically it could happen.
Why anyone would pay the large annual factoring fee?
So a 24% annual loan doesn’t sound that great to you? Well, you’re not alone. The high interest rate charged by medical factoring companies has scared plenty of doctors away. High-interest traditional bank loans are usually only around 10-14 percent; these rates make factoring look incredibly expensive. So with that in mind, let’s take a look at why intelligent people are using factoring. An example of Jim’s medical firm should help explain.
Jim’s medical firm is always busy. They have plenty of doctors and patients and business seems to be going well except for one thing: cash flows are sparse. Jim wants to continue paying his employees and he wants to continue growing his practice. In reality he has two options: a traditional bank loan or accounts receivable factoring. Jim’s average collection period is 60 days.
The bank offers Jim a 10 percent rate on a one-year $1,200,000 loan. That means Jim has to pay $1,320,000 at the end of the year when the loan comes due ($1,200,000 for the principal and $120,000 in interest).
Jim’s other option is to factor his insurance claims at 2% per month. Jim will factor $100,000 in claims every month or $1,200,000 throughout the year (equivalent to the bank loan). In month one Jim’s medical firm doesn’t pay a factoring fee because this is usually paid when the Factor collects the money (remember that Jim’s average collection rate is 60 days or two months). At the end of month two the medical practice pays ($100,000 *2%*2months)=$4,000 in interest or financing fees. They end up paying this factoring fee a total of 12 times so the total interest for the year is $4,000 interest fees times 12 months equals $48,000 in interest. Let’s compare the two methods.
Traditional Medical Loan From Bank
Money Borrowed: $1,200,000
Interest (at 10%): $120,000
Final Payment: $1,320,000
Medical Receivable Factoring Method
Money Borrowed: $100,000 a month for 12 months = $1,200,000
Interest: $48,000 –see above for calculation
Final Payment: $4,000
Further Discussion
With a traditional loan the money is all received up front. This means that large purchases can be made at the beginning of the year. It also means the money can be disbursed however the medical practice decides throughout the year.
It is interesting to note that a medical practice actually pays less interest using medical receivables factoring. This is a little bit deceiving because Jim’s medical firm is actually receiving twelve $120,000 sixty day advances. Instead of getting the money a year in advance, they are getting it 60 days in advance. This is a very important point and it illustrates that these two types of financing are very different indeed and comparing them is more complex than simply extrapolating and comparing annual interest fees.
Another advantage of factoring illustrated in the above comparison is that the final payment is much easier to swallow with a factoring arrangement than with a banking loan arrangement. With factoring, at the end of the year, there is no huge principal payment that has to be made. The medical firm has already sold the receivables and simply has to wait for the Factor to collect from the insurance agency.
Hopefully this conversation has at least enlightened some people who seem to think that factoring should be lumped alongside payday loans. Factoring can be a better way of financing than traditional bank loans. If a medical practice needs to buy a multi-million dollar piece of equipment then perhaps a traditional loan is better. However, if a medical firm simply needs to stabilize cash flows, improve the working capital of the firm, and grow through making “smaller” purchases then factoring very well might be a better financing option. In the above example Jim’s medical firm is receiving $100,000 advances (60 days ahead of time) twelve times throughout the year, and the factoring arrangement was less expensive than simply borrowing $1,200,000 at the beginning of the year and paying it back at the end of the year with 10% interest. Needless to say, you’ll want to get your best financial people together to come up with a complete analysis of both of these options before simply dismissing one or the other. You’ll also need to ensure you know exactly what the medical firm needs. Here’s a spreadsheet created by Sam Thacker, an expert in factoring, that will give your experts some ideas on some of the fees that might be charged in a factoring contract: http://www.lesliethacker.com/Resources/Blank%20Factor%20comparison%20worksheet.xls
What Happens if the Insurance Company Doesn’t Pay?
This is a frequently asked question by responsible doctors who enter into factoring agreements. The answer depends largely on whether your company enters into recourse or non-recourse factoring arrangement. A recourse arrangement means that the factor can seek payment from the medical institution if the insurance agency claim is not paid. In other words, if your insurance company or your customers don’t make the payments to the Factor, then your medical practice will have to.
In a non-recourse arrangement the medical receivable is completely sold along with all rights and obligations. This means that if the insurance agency doesn’t make payment, the Factor has to eat the money.
There are several advantages and disadvantages to choosing a recourse or non-recourse agreement. Recourse agreements usually come with lower interest rates because there is less risk for the financing company. Non-recourse agreements are advantageous because the receivable is sold and the medical firm never has to worry about it again. Another issue to consider here is how your customers and the insurance agency will be treated. In a non-recourse arrangement the Factor can get nasty with your customers in order to receive payment (note that this isn’t as big of an issue in the health industry because normally the Factor is dealing with insurance agencies instead of customers). Typically in a recourse arrangement the Factor won’t collect as aggressively.
Collecting receivables has long been a problem in the health industry and it looks like it will only get worse under the new health-care plan. Nobody really knows what’s in the bill (including the politicians) but the basic message seems to be that medical centers will receive less money for the work they perform, and it’s going to take longer for them to receive the money. One way for medical practice to combat this problem is medical receivable factoring.
Sources:
http://www.ccapital.net/html/medical_factoring.html
http://answers.google.com/answers/threadview/id/98822.html
http://factormoney.com/factoring-company-for-you.htm
http://www.bestinvoicefactoring.com/
http://www.allbusiness.com/company-activities-management/operations/12804979-1.html
