Capitation Is for Specialists, Not for Primary Care Physicians

On the theory that capitating primary care can lead to unnecessary referrals, a group of California physicians has decided to pay fees to primary care and to capitate specialists. It seems to work.

Capitation is often characterized as a means of cutting physicians’ compensation, but there’s a more positive way to use capitation — as tool for providing proper reimbursement incentives to reduce inpatient bed days and unnecessary specialist procedures.

Pacific Communities Management Services Organization provides services to United Physicians of the South Bay, an independent practice association in the South Bay area of Los Angeles County, an affluent community with an oversupply of physicians and too many specialists. United Physicians has 47,000 commercial equivalent lives. The MSO, owned by United Physicians, is a pass-through organization that does not show a profit. Funds are spent on medical care and administration. All of United Physicians’ contracts with HMOs are capitated, usually based on a percentage of premium for both commercial and senior patients.

To deliver a full range of professional and diagnostic services to commercial patients, United Physicians gets an average of $36 per member per month. Since even one unnecessary trip to an emergency room can use up almost a year’s capitation, it is essential that the medical care be managed very carefully. The only other source of income for the IPA is funds that are retained in risk pools or reinsurance. The risk pool funds are surpluses that remain in the hospital pool, which is shared with the HMO or the hospital.

Hospital risk pools

The hospitals associated with United Physicians have either a capitation contract with the HMO or a per-diem arrangement. Every HMO contract has a financial matrix defining the services that are the responsibility of the medical group or the hospital fund to provide. Not all HMOs have a standard matrix. In most of our IPA contracts, the medical group is responsible for outpatient diagnostic procedures, both the professional and the facility component, such as MRIs, CT scans and cardiac testing. Therefore, expenses must be planned to provide certain facility costs as well as professional fees.

The risk pools depend on the hospital contracts. Very often HMOs will have shared-risk contracts: Physicians are in partnership with the HMO to take the risk, to share the deficits and to share the surplus. Under this system, efficient utilization of hospital services may result in a surplus that is shared with the health plan. There is also a downside risk. A deficit in the hospital fund results in payment by the medical group back to the health plan. In a full-risk contract, both the hospital and the medical group are capitated and risk is shared. For Unified, the $36 per-member per-month commercial premium income is not a break-even amount without some retention of shared risk. The challenge in this situation is to provide the best quality of care in a cost-effective manner.

Only specialists are capitated

Unified Physicians is different from other IPAs in that only the specialists are capitated. Primary care physicians are compensated on a fee-for-service basis. Fee-for-service reimbursement is meant to encourage primary care physicians to provide as much care possible for the patient because overutilizing primary care has significantly less effect on the budget than overutilizing the specialties.

Income limitations necessitate maintaining a realistic budget and tight control of cost overruns. To obtain that control, there is a need to know exactly how much is being spent on primary care, specialists and ancillary care. The IPA spends 23 percent of its capitation dollar on primary care, 56 percent on specialists, 14 percent on ancillary services and 7 per cent on administration. As you can see, specialty care represented more than half of the capitated dollars. This was a significant reason why United Physicians capitated specialty providers. Another reason for capitating specialists stems from dissatisfaction with traditional utilization management, such as services that require prior authorization. Prior authorization is cumbersome — micromanagement of medical care that has minimal effect on utilization management. HMOs don’t like it, nor do waiting patients.

The trend in California is to process direct referrals. In mature managed care organizations, the list of procedures or tests requiring prior authorization gets smaller and smaller as physician practice patterns become more in tune with the managed care program. Prior authorization has become an ineffective cost-control system requiring nursing staff and physician time that can be better directed toward improvements in quality of care.

To capitate or not to capitate

Deciding to move toward capitation is difficult and not necessarily “politically correct” with many physicians. If this is your environment, fee-for-service is still a choice, and is certainly the least political. It is however, difficult to budget or forecast for hundreds of physicians, and the incentive against excessive procedures and consultations isn’t aligned with the goals of the IPA.

A productivity-based compensation system — the more you do, the more you get paid — is the most costly and probably the worst of all options for utilization management. There is no incentive to re-examine the way care is being delivered. It’s the worst option for quality; there is really very little that can be done to control quality of care other than the general things required by health plans, such as credentialing. Productivity-based compensation relies on micromanagement to control clinical variation. It is difficult to develop best-practice guidelines with hundreds of physicians in an IPA.

There are two models for capitation. One is shared capitation, essentially setting a limited budget for the amount allocated for specialty care. This budget can be developed jointly for all specialties or separately by clinical services. The specialists bill into this pool, and reimbursement is adjusted based on the utilization trend. It is politically easy because there continues to be the same number of physicians; everybody is participating. There is a moderate climate of competition among the specialists over the fairness of the distribution of the funds. The drawback, however, is with utilization and budgeting. Because everybody bills into this fund as quickly as possible and utilization is uncontrolled, it is not unusual for the fund to fall short at the end of the first or second quarter. Shared capitation does not help the risk pools because it controls neither inpatient nor outpatient utilization. And it doesn’t solve the clinical variation across the broad range of physicians in the medical group or IPA.

United Physicians has chosen group capitation. This system has the greatest political risk because physicians are selected to participate and some will be disenfranchised. If the physicians have been participating in the IPA for a number of years, they may be locked out of patients that they have previously seen for some time. Some shareholders may be offended, and it is the most politically risky undertaking.

But group capitation was chosen mainly because it puts utilization back in the hands of the providers. In group capitation, prior authorization is eliminated, as physicians join together to develop guidelines and best practices. They can create guidelines in each specialty and across specialties.

Group capitation can also provide meaningful data. United Physicians now knows exactly how much is spent each year on cardiology, oncology and other capitated specialties, and it can measure utilization trends. Group capitation is an art, not a science. It needs to be constantly adjusted, because the aim the aim is not to reduce physician reimbursement, but to reduce unnecessary utilization.

Proposals from specialists

That decision made, the MSO sent a Request for Proposal (RFP) to current IPA providers only, in specialties where there are large volumes of patients. Considerable time was spent developing the RFP, which included review by various IPA committees and legal review. The RFP consisted of several sections:

1. Geography — How do you plan to cover our large geographic area and participation with three hospitals? The aim was to have one group, not three or four, cover three hospitals and the whole geographic area.

2 . Comprehensive services — Can you provide all of the services in your specialty? For example, when the RFP was sent to oncologists, it was important to know that they could provide chemotherapy services including drugs. The goal was to cover as many services as possible under capitation.

3. Accessibility — Did you have offices in the appropriate areas? Have you passed an office audit? What are your appointment times? Can you cover privileges at three hospitals? There were many categories within this topic.

4. Quality — Unified requested patient satisfaction surveys and credentialing information for physicians and office staff (even though they were already credentialed through the IPA). HMOs were contacted for their satisfaction surveys and utilization data. Assessing the quality of care without sufficient data is difficult, but we did the best we could with the measurements available.

5. Cost of Care — Per-member-per-month bids were requested. Although cost of care was very important, selection was not made according to the lowest bidder.

The RFP stimulated individual physicians and small group practices to join together to respond to the needs of the IPA. There was no way that solo physicians could answer the RFP without getting together with their peers, and that is exactly what happened. Specialists made their own selection as to who was in the group. The IPA did not participate in the selection of these physicians. Who was in and who was out was determined by the group.

In some cases, several groups answered the RFP. The IPA was then faced with making difficult choices. After several committees reviewed the proposals, the ultimate decision was made by a new primary care committee for the purpose of this selection process. Its decision was then approved by the United Physicians board.

Reviewing capitation after implementation

The selected specialty groups formed informal group practices with a new tax identification number for the group. Capitation was then paid to the new entity and the distribution of funds left to the physicians. One of the most difficult aspects of this project was how to pay specialists within the capitated system. The MSO was in the process of working with the physicians to develop a point system that would eliminate the need for payment based on productivity. In addition, although many people will warn you that you should never go back and review capitation after you’ve done it, the MSO believed that this would be the fair thing to do. A six-month review helped develop a good baseline for the capitation amounts.

Pluses and minuses

A disadvantage to group capitation is the potential limiting of patient access to specialists. To counter this, the MSO does regular access studies and patient satisfaction studies. We also surveyed primary care physicians to ascertain their satisfaction with the services provided by the specialty group. Two recent surveys indicated that both patients and primary care physicians were happy with the choices of specialists and the care.

A second pitfall is carve-outs. Specialists were requested to provide comprehensive services in their RFP, but inevitably there were exclusions or carve-outs, anything from chest X-rays to surgical procedures. These exclusions can have a significant adverse effect on utilization and cost savings from specialty capitation. It is extremely difficult to calculate capitation with exclusions. Although actuarial data are available for specialty services, they may not fit the services actually being provided. The six-month review of the capitation amounts was designed to assist both the IPA and physicians. It allowed the IPA to compare previous costs of service under a relative value scale with the cost of capitation and make adjustment up or down.

Achieving a positive outcome with group capitation requires controlling clinical variation. Best practices are being developed and monitored by the capitated group, whose incentive is now aligned with the IPA. Each group has assigned a medical director who interacts with the IPA.

Although it may seem unusual not to capitate primary care physicians, it is working well. The MSO had been collecting referral volume data prior to capitation and is continuing to monitor referrals under capitation. There has not been a trend of inappropriate referrals. When this does occur the specialists are eager to work with the primary care physicians to develop guidelines for care. In the event that the trend should reverse, a redistribution of reimbursement could take place.

Shelley Kullman is chief executive officer of Pacific Communities Management Services Organization, Harbor City, Calif.

Shared capitation


  • Moderate competition among specialists
  • Greatest freedom for primary care physician referrals


  • Productivity-based — first to bill use up the pool
  • Does nothing to control levels of utilization
  • Cannot monitor quality across the board

Group capitation


  • Puts UR back in the hands of providers
  • Each specialty creates its own guidelines
  • Least overhead cost
  • Specialists control their own payments


  • Requires selection (and deselection) of providers
  • Requires solo physicians to band together