Determining an allowance for bad debt

Healthcare Financial Management, April, 1991 by Dan Rode

Determining an allowance for bad debt

Once a healthcare facility has developed policies for bad debt and charity care, its next task is to settle on a method for estimating a bad debt allowance.

Although several approaches can be taken to estimate bad debt, very little has been written about an overall method. Sampling of bad debts is important to determine bad debt allowances and to point out ways that a facility's patient accounting staff could have better handled certain cases. But this information may not always be available.

Unfortunately, some facilities do not approach the question of bad debt allowances until late in the fiscal year, when the task becomes a matter of by-guess-and-by-golly.

Using data and staff experience. Given the potential delays in determining a facility's bad debt allowance at fiscal year-end, the following approach can be integrated into an annual estimate. It uses staff experience when data may not be available. An institution should begin to obtain data from electronic and - if necessary - manual systems, not only to help make an allowance estimate, but also to improve its patient accounting process and reduce bad debts.

Bad debts are a by-product of the business of rendering health care. Unless a facility has funds available for every patient contingency or lives in a world where each account can be accurately assessed at the time of admission, some level of bad debt will exist. The goal is to limit bad debts within the boundaries set by a facility's mission statement and legal requirements. An ongoing study of a facility's bad debts can help keep them to a minimum.

Focus on account groups. Under ideal circumstances, each current account would be reviewed when making a bad debt estimate. An organization with thousands of accounts, however, may find the process overly time consuming and costly. For this reason, a healthcare organization can examine groups of accounts for most of its estimate and rely on a number of individual accounts that may be large enough to warrant a specific review.

Most facilities separate accounts into payer designations that allow them to determine bad debt potential. Not all accounts or groups of accounts have the potential to create a bad debt. By their nature, some will either be paid in full or will have known adjustments or allowances that reduce the balances to zero.

If a facility has a history of misclassifying certain accounts on a regular basis, then some estimate of the error also should be made - and the facility's patient accounts manager should take steps to eliminate the problem. Although account groups without errors could be removed from consideration, they should in fact be included (even if the bad debt amount is zero) so that any audit of the process will show that all accounts have been considered.

Just as a healthcare facility knows of account groups without a bad debt potential, it knows of others with the potential, even if no bad debt reporting system is in place. Patient accounts staff members usually can provide this information.

Some or all patient accounts staff members should be asked to help determine parts of a bad debt allowance model until other feedback reports can be developed and a history can be established. Even then, staff members will be needed to determine changes in the environment, trends, and the outcome of specific high-dollar accounts.

Allowance model. Because a bad debt allowance is based on a particular set of accounts that reside in a facility's accounts receivable on a particular date, a model can be used to project the future of those accounts. Exhibit 1 provides a bad debt allowance model that can be used for each type of account, such as inpatient, outpatient, home health, and so on.

Accounts classified as "paid/adjustment" represent situations in which the current balance will result in a payment and/or an adjustment. The line to the right represents the percentage of dollars that is misclassified and would result in other possible known actions of claims processing and collection.

"Bad debt and charity care" corresponds to accounts that are classified up front in either of the two categories, while "prime" represents accounts that are or will be billed to a primary payer. Patient accounts staff members or receivable reports usually can predict the percentage of accounts for any payer that will result in a payment, an adjustment, a write-off to bad debt, charity care, legal follow-up, self-pay balances, or secondary payer balances.

The "secondary" column represents a step-down of balances from previous columns - and again, a percentage breakdown usually can be determined for these balances.

"Self-pay" corresponds to accounts assigned for billing and collection efforts within the organization, while "collection" generally applies to accounts turned over to outside firms. For some facilities, converting balances from "self-pay" to "collection" represents the point at which bad debt write-offs occur. In these cases, no "collection" column would be used, but some estimate of recoveries after write-off might be desired.