What is contractual allowance?
Contractual allowance is the difference between the standard charges for healthcare services and the amount healthcare providers receive from insurance companies or other payers. This allowance accounts for the discounts or adjustments negotiated in contracts between healthcare providers and insurers, ensuring that patients and insurers are billed at a lower rate than the provider's standard or list charges.
What is the purpose of contractual allowance?
The contractual allowance adjusts the difference between a healthcare provider's standard charges and the rates negotiated with insurance companies or other payers. This adjustment ensures that patients and insurers are billed a reduced, agreed-upon rate, promoting affordability and access to healthcare services. It also aids healthcare providers in maintaining consistent revenue streams and facilitates smoother billing and reimbursement processes by standardizing payments according to pre-established agreements.2
How do you calculate contractual allowance?
Calculating contractual allowance starts by identifying the healthcare provider's standard charges for the services rendered. Next, refer to the contractual agreement with the payer (such as an insurance company) to find the negotiated rates for those services. Subtract the negotiated rate from the standard charge for each service. The resulting difference is the contractual allowance.
This calculation helps adjust the provider's revenue to reflect the agreed-upon payment terms with payers, ensuring accurate financial reporting and billing.
What is the difference between contractual allowance and write-offs?
While both contractual allowances and write-offs are adjustments made to healthcare billing, they serve different purposes:
- Contractual Allowances: Represent the negotiated reduction in charges that healthcare providers agree to with insurance companies, reflecting the difference between standard charges and the agreed-upon rates.
- Write-Offs: Refer to amounts that providers remove from their accounts receivable because they are deemed uncollectible, such as bad debts or charity care.
Examples of contractual allowance
Example 1:
A hospital charges $10,000 for a surgical procedure. However, it has a contract with an insurance company that agrees to pay $7,000 for the same procedure. In this case, the contractual allowance is $3,000, which is the difference between the standard charge and the negotiated rate. The hospital adjusts its billing to reflect the $7,000 payment from the insurance company rather than the full $10,000 charge.
Example 2:
A physician charges $200 for a consultation. Under the agreement with Medicare, the allowed amount for this consultation is $120. The contractual allowance here is $80, which is the reduction from the physician's standard charge to the Medicare-approved amount. The physician bills Medicare $120 and writes off the $80 difference as the contractual allowance.