How Capitation Turned Red Ink to Black at Harris Methodist Health Systems

MANAGED CARE August 1997. ©1997 Stezzi Communications

It would be wrong to say that capitation has become the obligatory payment system under managed care, but it is used by many plans. Through their contracting organizations, however, physicians can translate capitation into other forms of payment. Here's how three organizations faced the issue.

When Harris Health System began posting losses, it became apparent that a new compensation system, with incentives to providers to control costs, was in order. Risk sharing was the answer.

Neil A. Godbey

As much as anything, managed care has meant change in the way physicians are paid. Capitation is becoming more widespread: Recent reports show 36-percent penetration in the largest managed care markets. But how capitation is implemented varies widely. For integrated Harris Methodist Health System, with its hospitals, HMO, indemnity plan and physician network, the process was complex, the result straightforward.

In 12 months, Harris Methodist Health Plan went from a $20 million loss to a $19.6 million profit.

HMHS, a system with annual revenue of approximately $1 billion, contracts with more than 5,000 physicians and 60 acute and tertiary level facilities across northeast central Texas. The system has approximately 350,000 risk lives and another 450,000 non-risk lives through exclusive relationships with local HMOs and preferred-provider organizations. Harris's HMO, Texas Healthplan, has about 297,000 members. Harris Methodist Health Insurance Co. is the point-of-service plan for live indemnity and accidental death and dismemberment coverage. The foundation-model Harris Methodist Select is the physician network. The newest addition to the system is Harris Methodist Health Inc., a new corporation that is the "back office" handling such administrative functions as claims processing, legal services, utilization review, credentialing and financial services.

Market stimulus

Managed care exerts certain stimuli on the market. The main stimulus is for lower premiums. In 1992, HMHS had approximately 55,000 covered lives with premiums in the neighborhood of $147 per member, per month. There was no medical management, and fees to physicians and hospitals were 200 percent above Medicare. HMHS had 25 percent of the insured market and 75 percent of the HMO market.

Then, in 1994, 25 new HMOs entered the market. By January of this year, HMHS had more than 300,000 covered lives and premiums were down to $116. There are markets across the country where premiums have stabilized, but at $85; some may be even lower. In 1995, Harris Methodist Health Plan experienced a $20 million loss.

Additionally, the administrative staff was being overwhelmed by the volume of work in dealing with, at that time, some 2,000 physicians, 22 hospitals and 226,000 covered lives. So, for reasons administrative as well as financial, HMHS management decided to consolidate the primary care physicians into groups. Within a year, there were seven primary care groups, and 65 percent of their patients were under risk contracts.

Primary care risk

One of those groups, with 45 primary care physicians, held 30,000 risk lives. Imagine what accepting the responsibility of full professional capitation for 30,000 patients meant to those physicians who had no previous experience with capitation.

In the next step, the primary care groups were put into eight economic pools according to budget performance, because that was the only standard available. We created five tiers. The fifth tier ranked the provider as operating at a level of 50 percent over budget, resulting in a 50-percent withhold. Imagine what that meant to those practices. Twenty-five percent of each practice's revenue was exposed to a 50-percent withhold, because 25 percent of every primary care physician's practice was with the Texas Health Plan.

In the Fort Worth market, about 45 percent of a provider's practice came through Harris Methodist Select, the physician organization at risk for $180 million worth of physician services. Harris Select has an exclusive contract for all professional services with Texas Health Plan, Aetna Health Plan and for another 450,000 PPO lives. The four primary care physicians and three specialists on its board decide the organizational structure and changes and withholds that are put before the physicians.

Specialists and hospitals assume risk

The specialists had to be grouped as well. Texas law permits physicians to form organizations that can assume risk and that act as one physician. They are called 501A foundations, and are unique in the country. So an HMO can deal with a 501A. HMHS asked the specialty physicians, through its contracts with them, to develop 501As or independent practice associations that would be aligned with individual network hospitals. The hospitals had to assume risk under this scenario.

There are very few hospitals today that are assuming risk. The network's 22 hospitals in the Fort Worth market agreed to do so. They told the physicians on their medical staffs to set up 501A organizations and begin working with the hospitals in managing the risk that the hospitals had accepted.

HMHS requires the primary care physicians, now in seven groups and eight different economic pools, to choose one Select Plus (IPA or 501A) organization. And that organization had to be a group of specialists representing all 22 specialties and operating from one hospital. A specialist could belong to just one Select Plus organization.

We also required that 95 percent of referrals from primary care physicians go to the Select Plus organization and that the 5 percent that are outside referrals be based on medical necessity. The primary care doctors got approximately 17 months to comply with the 95-percent rule. So 95 percent of all of the dollars spent on referrals had to move to the 501A/IPA groups.

The hospital could select only one specialty 501A, which assumed responsibility for the risk pool for specialists; the hospital assumed the risk pool for inpatient/outpatient services. So now we have three distinct risk pools: primary care, hospitals, and specialists — all capitated.

There is a simple reason behind the 95-percent rule and the 501A mandate. In most managed care markets, unless you are a single-source provider (one hospital or one physician group), there is no way of determining how many dollars you need to fund the risk pool. By having a primary care group select one of the seven 501A organizations, HMHS could identify the number of members that went into that risk pool and every month could fund each one of those pools with its percentage of the premium.

Premium flow

Here's an example of premium flow: The buyer pays 100 percent as premium, say $150. HMO administration takes 10 percent (in other organizations it is up to 16 percent). Marketing is 5 percent. That's a total of 15 percent. HMO profit is 5 percent (some others are at 11 or 12 percent, and those on stock exchanges strive for the highest levels). But HMHS's goal is 5 percent. That adds up to 20 percent, leaving 80 percent for medical loss.

Risk pools

There are four risk pools that divide up the medical percentage.

The first is 12.8 percent, which goes to the primary care doctors not at risk but who must select a 501A and adhere to the rest of the contract requirements. The least they can receive is 10 percent unless they are in the lower tiers, the lowest of which has up to a 50-percent withhold.

The second risk pool, specialists, contains 22.2 percent. They are paid on a fee-for-service basis out of that pool. At the end of the quarter, if there aren't any losses, according to the contract, 100 percent goes back to the primary care physicians. Specialists believe they are the ones actually achieving the savings, so they are allowed to go to the primary care physicians and negotiate how much will be kept in the pool for their bonuses. Most have negotiated a 50/50 split.

The third pool is hospital risk, containing 35.4 percent of the 80-percent medical loss percentage, if the pool has a surplus. If it has a deficit, the hospital is responsible. Distribution is 40 percent to primary care, 40 percent to the specialist and 20 percent back up to the hospital.

Pharmacy is the fourth pool. It is funded with 9.6 percent of premium. The physicians are at risk for 50 percent of the deficit, split 35 percent primary and 65 percent specialist. A surplus is split 50/50.

Bottom line: Whatever is left in any of the pools goes to the providers under contract and assuming risk. Nothing goes to the HMO.

Primary care: $16.80 per month

The physician's base capitation is 10 percent on a $150 premium, or $15. HMHS primary care physicians get an additional 1.2 percent if they're in the upper three tiers of the five-tier economic pool. Placement in the upper three tiers means ranking as a good primary care physician who manages patients economically and is therefore eligible for bonuses. An additional 1.6 percent is based on medical management. A physician contracts for that 1.6 percent to manage patients, to meet NCQA requirements and to allow our patients to make up as much as 60 percent of his practice.

That 60 percent access is across-the-board for all Select members. It is up from the current 45 percent, and that is because HMHS was having a hard time contracting because a lot of the practices were closed because of the old 80/20 rule. According to the 80/20 rule, no doctor allows a managed care organization more than 20 percent of his or her practice because more would be a controlling amount. To obtain 60 percent, HMHS Select would pay 1.6 percent.

HMHS pediatricians average about $23 PMPM, and the specialty pool (paid fees, not capitated) averages about $33.

Why medical management?

Medical management is important to handle increases in panel size — necessary for primary care physicians to hold onto revenues, because as premiums go down, increasing panel size is the only way to maintain the level of income the physician is accustomed to.

As panel size increases, medical management is a necessity because no one can treat 6,000 patients. But most of the "medical management" that occurs in the United States today is actually just moving papers in terms of referral; actual medical management is moving your abilities to different levels — to triage, to physician assistants, to specialties. How many times do primary care physicians call specialists and tell them how they want their patients managed, what reports they want to see? Few primary care physicians pick up the phone and manage the patient. How many tell the specialist that they want a transfer of knowledge so they can manage the patient in their practice? Very few.

Segmenting risk

There are benefits to distributing risk among all medical care providers. For example, it is easier to manage and distribute information to 15 groups than to 500 primary care providers. For HMHS, about 75 percent of the 1,500 specialists moved to seven 501A organizations. Twenty-two hospitals moved into seven groups accepting risk.

Select developed a multigroup specialty organization over 16 months. In that time, the Select board moved the market toward seven multispecialty groups assuming risk and providing their own medical management. Each group has its own medical management organization.

Select increased access to primary care practices to 60 percent, and increased the primary care income from $12 to almost $17 per member, per month. It went to a percent-of-premium contract that said to doctors, "As premium moves down, your contract moves down, so your 12.8 percent is going to stay the same but the dollar volume will vary as the premium moves in the market."

We put the incentive in the appropriate place: All participants have an incentive to manage their pools, even the specialists and hospitals.

Consolidation, with primary care physicians, specialists and hospitals working as one unit, is what's happening in the medical care market. But don't confuse that with integration, which is achieved only when all three of these organizations come together, sit down and start sharing revenues.

Neil A. Godbey is executive vice president for the Dallas/East Texas regions of Harris Methodist Health Systems and president of the physician organization Harris Methodist Select. He is the only nonphysician on the physician organization's board.


Capitation Is for Specialists, Not for Primary Care Physicians

MANAGED CARE August 1997. ©1997 Stezzi Communications

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.

Shelley Kullman

Pacific Communities Management Services Organization
Harbor City, Calif.

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


Making the Transition From Productivity Compensation to Capitation

MANAGED CARE August 1997. ©1997 Stezzi Communications

How do you devise a capitation plan that works? With understanding, hard work and gumption, says the chief financial officer of Sharp Rees-Stealy Medical Group in San Diego.

Keith Alan Moore

Sharp Rees-Stealy Medical Group,
San Diego, Calif.

Developing a successful compensation system for physicians in a medical group means creating a method that can evolve with the group practice. Of the different schemes around today, Sharp Rees-Stealy Medical Group in San Diego decided to move from fee-for-service productivity-based compensation to capitation. It wasn't an easy transition.

The group has 285 physicians. After the first two years, each receives one share in the medical group. We have 10 locations around San Diego, and about 140,000 covered lives, of which roughly 20,000 are elderly.

Placing incentives

When work began on the plan, there were two things that needed examining: how to influence behavior by using incentives, and how to monitor that behavior. With capitation, money is made if you deny care or just do less — a perverse incentive that was the opposite of what we were used to. So right away we needed to design the correct compensation incentives.

The second half of any capitation compensation plan is monitoring physician behavior and practice. Sharp Rees-Stealy developed a Physician Assessment Report (PAR) to monitor four key areas: quality of care, quality of service, cost-effectiveness and organizational participation. The original plan was to have the PAR account for 20 percent of compensation. It was determined that the tools were not in place to accurately monitor cost-effectiveness, so the percentage was dropped to 14 percent. The physicians have been monitored for the past three years and receive quarterly reports.

Capitation may bring on an abrupt change in physician behavior. Six months after the capitation plan was implemented at Sharp Rees-Stealy, the average number of patient visits per month per physician had dropped from 312 to 284. For some, the attitude was, "I'm not doing all this. I'm going home at five o'clock and I'm not seeing an extra patient." It took a while, but that attitude turned around and the number of patients seen began increasing. Now we're at about 340 visits per month. The physicians could see that if patients started leaving the practice, the whole group would be in trouble.

Know your roots

Before you start building a new compensation plan, take a hard look at your group and thoroughly understand your current formula. Sharp Rees-Stealy was founded in 1923 by two physicians. Right away we had conflict: One physician was a specialist; the other handled primary care. And that conflict remains today with managed care.

In 1985, there were 40 physicians practicing in a multispecialty group. It merged with Sharp Health Care System, which consisted of two hospitals and a nursing home. Within a year, we signed 20,000 Medicare risk patients. By 1993 we had nearly 130,000 Medicare and commercial HMO patients. The compensation model was trying to catch up with what was going on.

Slow start

In January 1993, 80 percent of our patients came through 13 HMOs (one Medicare, 12 commercial). Eighty-three percent of our revenue was from capitation. We had very little fee-for-service business. So we knew that we had to make a change, because we could not continue to pay the physicians on productivity when in reality we were heavily into managed care.

In March 1993, the physicians attended a retreat that involved some real soul-searching about compensation. By June we had started working on what we called division pools, from which salaries would be allocated. We came up with two pools: Pool A for the fee-for-service business — a major occupational medicine program is our main source of fee-for-service income — and pool B, containing all our HMO capitation money.

Choosing panels

In January 1994, we came up with a plan to use patient panel size, adjusted for age and sex, to determine how primary care would be paid. We calculated everyone's panel sizes at that time. The medical director and the board participated in the process as we determined individual capitation by division. We looked at the average income in our area, in our state and by specialty. We knew what our physicians were making, but we needed to be sure that all divisions were paid competitively.

We added up all the individual incomes in a division and used that as the amount needed to pay the division. Then we did that for all the divisions. Not surprisingly, the totals were greater than our income. We made some adjustments to come in line with our income.

We monitor new physicians, but their compensation is fixed and guaranteed until their panel size is sufficient to pay them more than the guarantee.

What about part-timers? We've had physicians come in full time and then say they want to work perhaps three days a week. The board is considering two levels of employment, either full-time or half-time. Half-timers would share a panel with another half-time physician.

Who gets how much?

We didn't want 100 percent of their compensation to be all out of the capitated pool because we wanted to give them some incentive for pool A, the fee-for-service patients. A problem you get with managed care is that there is little incentive to see fee-for-service patients. Their workload and compensation all come from their HMO patients. We decided to pay out fee-for-service income as a percentage of the dollars that they bill. Astoundingly, the best we have been able to do is 21 cents on the dollar. The incentive is just not there, and that continues to be a problem.

As we looked at compensation, probably the most important thing we did was to recognize up front that, especially in Southern California where managed care has penetrated every aspect of health care delivery, physicians were losing autonomy. We even have a call center that was doing patient scheduling. There was such a feeling of loss of control by the physicians that we wanted to give them control over how they distribute the money within their divisions.

We eventually decided to determine the amount of the salary pools, but not the allocation formula. While the plans had to be approved by the board, how the money was to be divided was up to the division. We stipulated that the ranges had to be fair or they wouldn't be able to hire anyone into the division. We have 29 specialties that probably have 29 different ways of splitting up the money. Three primary care groups split their pools based on panel size and some form of productivity.

For example, a group of five cardiologists divides the total by five and there is no argument about who has the most cases, or who spends the most time in the hospital. They don't care.

The five members of one division last year were paid around $1.5 million. Their capitation pool may have been only a million dollars. Any increase in salary comes from pool A; that's the incentive for them to boost their fee-for-service and hospital risk pools. The base stays the same year after year unless we have a decline in membership.

There is no right or wrong way to allocate compensation, so long as the participants are comfortable, and there are sufficient incentives for individuals and the group as a whole to benefit.

Where the money comes from

Sharp Rees-Stealy Medical Group runs on a foundation model, where the management services organization belongs to the Sharp Healthcare System. The physicians are a personal services corporation. The money all comes into the group and the challenge is how to divide it.

We do allow pass-through. A lot of physicians get involved at hospitals: A cardiologist will read EKGs for the hospitals, some neurologists will read EEGs and so on. We allow the money they earn to pass straight through to them at 100 percent.

Another income source flows from full-risk (as opposed to professional capitation) contracts with HMOs. There is a hospital risk pool. If our bed days stay down and everything else is in line, there is a significant reward. But the hospital risk pools are really an unknown. They have varied from $1 million to $5 million. Planning compensation using risk pools is dangerous.

The hospitals are all under the umbrella of Sharp Healthcare. The risk pools are calculated on an extremely complex point system, but basically the different levels of care at the hospital are worth different levels of points. An ICU day is 10 points, an acute care day is 8 and an emergency department visit is 6. The points are added up, and based on the hospital's historical cost structure, a cost per point is assigned. That is what is put into the risk pools. The system works but doesn't lend itself to monthly tracking to see how the physicians' group is doing. There can be a lot of surprises at the end of the year. The medical group can know during the year what the bed days are, and know if they went up or down. If too many of those were ICU days, the return from the pool will be less than anticipated.

Monitoring behavior

The physicians all get panel reports, so they know the number of active patients, urgent care visits and referrals to our own specialists. Under capitation, the incentive is to have a large panel and send patients to urgent care or specialists or not see them at all. That has to be watched because if patients aren't being seen, they start complaining, or worse, leave the group. We developed the PAR — really a physician report card — and we publish it quarterly. The doctors know how they are performing compared to the others in their division and to the entire group.


The challenges don't stop once you've devised the capitation plan, put it in place and earned compliance from the physicians. Inevitably you have revenue shortfalls in the pools. It happens like this: You create the pools, and then a group needs another physician. You say, you can hire another physician but you have to do it with the same pool of dollars, which is impossible.

Then there is the issue of fee-for-service patients. They are definitely less attractive to physicians, but have the highest compensation rates around. They pay 80 percent, maybe 90 percent of charges. It's wonderful. So we pay the physicians as a percentage of their dollars and they get 30 cents on the dollar to see the occupational medicine patients. It has been a struggle to find and offer enough incentive for the physicians to agree to see the fee-for-service patients. But we can't just give up and say we're only managed care, because there are fee-for-service and PPO patients out there that we can serve.

Pay equity among divisions and departments is another tough nut. Family practice believes the ranking should be family practice, internal medicine and pediatrics; internal medicine believes it should be internal medicine, family practice and pediatrics, and pediatricians think they should be on top. We use our surveys to help us on this issue, but we still go round and round on where everybody fits in.

Too much emphasis on panel size can come back to haunt you as it did us when the physicians got huge panels and then couldn't meet the patients' needs. San Diego is an extremely competitive market. For a breakfast and a visor, senior citizens will switch plans. Employers will drop you and move to somebody else for a dollar a month. In this environment, when the physicians aren't seeing patients and the patients get disgruntled, it is dangerous. In 1996 our dropout rate was about 20 percent. We offset that to achieve a 2-percent net growth in enrollment, but if you can't put a finger in the dike and keep them from leaving, you will never get ahead.

Keith Alan Moore is chief financial officer at Sharp Rees-Stealy Medical Group in San Diego, Calif.


How capitation's prevalence varies with practice size

MANAGED CARE June 1997. ©1997 Stezzi Communications

More than one-third of all physicians now have capitation contracts that account for at least some of their practice revenues, according to recent survey data from the American Medical Association. That proportion rises to one-half when only members of the two main primary care specialties are considered. In general, the larger a physician's practice, the more likely he or she is to draw some income from capitation contracts. Also, while recent years have seen fluctuations in the average size of physician practices (an arithmetic mean pulled upward by the biggest practices), another index of the growing popularity of larger groups — the percentage of practices above a certain size — has shown fairly steady recent growth.



Capitation Contracts: Time for a New Attitude

MANAGED CARE April 1997. ©1997 Stezzi Communications

As the health care market evolves, physicians will be wise to adopt new ways of dealing with managed care organizations, says this consultant, especially when it comes time to ink capitation contracts.

Jeffrey J. Denning

Contributing Editor

Managed care organizations are now part of the fabric of every metropolitan area and many less populous areas. No matter where doctors reside, I hear them wrestling with concepts and practices such as capitation, utilization review and credentialing. Some are trying to adapt their practices and their thinking as they go; others are stuck in neutral, unsure whether to turn right or left. My advice is that physicians adopt new approaches that will allow them to exploit capitation and become more attractive to health plans.

Old thinking: "Under capitation, I'll lose money. You can't do much for people when you're paid only $9.17 per person, per month."

New thinking: "With capitation, I can get paid for more than just providing care; I'll get paid for managing it."

Many physicians are quite skilled in the conservative treatment of patients. They know how to get good results without incurring excess costs; they have learned shortcuts that circumvent exotic diagnostic testing and therapies that keep patients out of the hospital.

Unfortunately, this know-how has never been rewarded under the fee-for-service payment system. It's valuable, and when it is encouraged under a risk contract, there may be new money in the system for the physician. Accepting capitation payment, which factors in all those traditional costs, becomes an opportunity for physicians to participate in the savings their case management brings.

Old thinking: "Patients in capitated or deeply discounted plans are not entitled to good service; if you buy a Chevy, you shouldn't expect Ferrari performance."

New thinking: "These patients aren't signing up for second-class care. If they leave our practice thinking that's what they got, we won't last long on the plan."

Patients are more demanding than ever before. Many know at least a bit about managed care and are on guard against being shortchanged. So the practices that treat managed care patients like second-class citizens run the risk of generating complaints that will go back to the employers who pay the bills and the managed care organizations that contract for the care.

Old thinking: "We make the most money if the capitation patients don't come in at all; let's make our practice unattractive and 'hard to get' for these managed care patients."

New thinking: "The more attractive my practice is to patients and their plans, the more plans I can sign with and the more capitation dollars I can bargain for."

Smart practices are honing service levels as a way of sending the signal to managed care organizations that "ours is the only logical practice to contract with." When you have the best doctors and the best staff and give the best care, you're likely to attract more than your fair share of capitation enrollments. And you're more likely to negotiate a higher capitation premium if the plan sees your service as essential to its continued success. If you're ordinary, expect to be treated as a replaceable resource and priced accordingly.

Old thinking: "Maybe I'll try a little capitation with only a few patients to see how it goes."

New thinking: "Capitation means accepting insurance risk. If the number of members is too small, the risk is unacceptably high. I need to commit myself to the concept and take on a significant number of patients to justify the risk."

If a physician isn't willing to dedicate at least a third of his or her productive capacity to capitation patients, it might be a mistake to enter risk contracting. It takes about 2,100 people to keep a single family physician busy. A third of one FP practice is about 700 people. But why lose sleep over capitation contracting if there are only 3,900 patients available from the HMO and they will be shared among 21 primary care physicians?

Old thinking: "If they're managed care patients, I just give them medication for six months and let them monitor themselves."

New thinking: "Deep discounting or capitation payment is not license to deny needed care. We agreed to provide the care and we'll do it."

The whole "denial of care" clamor is a tempest in a teapot. There are plaintiffs' attorneys out there just waiting for doctors to give substandard care resulting in poor outcomes. And that's just the civil exposure. In most states, abandonment is a criminal violation of the health and safety code. It's probably not too far a stretch to consider denial of needed care a partial abandonment of the patient.

Managed care means still getting a good result, just at the lowest possible cost.

The author, a practice management consultant in Long Beach, Calif., edits Uncommon Sense, a monthly newsletter for physicians.

When your capitation check is overdue

There's one kind of receivable you cannot allow to go into the delinquent category — even a little. Here's a time line for capitation payments, showing both a commendably rapid process and a more typical one. Use it to help you keep track of when it's time to call the health plan's management.

Best-case scenario

  • 1-1    New employee reports for first day of work and completes all paper work, including selection of plan and primary care physician practice.
  • 4-1    New employee becomes eligible for health insurance.
  • 4-10    Employer reports new employee to insurance carrier.
  • 4-25    Insurance carrier updates eligibility system with new, transferred and deleted numbers; sends new employee's name and April and May premium to independent practice association with May premium check.
  • 4-28    IPA receives monthly update of "adds, deletes and transfers" from insurer with payment for May.
  • 5-8    IPA completes audit of payment and computer updates.
  • 5-9    Your eligibility listing is printed by IPA, your capitation check is cut and both are sent by overnight delivery to you.
  • 5-10    You audit the payment and deposit the check.


More common scenario

  • 1-1    New employee reports for first day of work.
  • 4-1    New employee becomes eligible for health insurance.
  • 4-8    New employee is given health plan paper work.
  • 4-15    New employee completes paper work, including plan selection and choice of primary care physician, after consultation with spouse.
  • 5-10    Employer reports new employee to insurance carrier with following month's invoice.
  • 6-25    Backlogged insurance carrier updates eligibility system with new, transferred and deleted members from May submissions.
  • 6-28    IPA receives monthly update of "adds, deletes and transfers" from insurance carrier with payment for May. Check deposited.
  • 7-20    Backlogged IPA completes audit of payment and eligibility computer updates.
  • 7-21    Your eligibility listing is printed by IPA, your capitation check is cut, but it is held until sufficient funds are received from insurers and HMOs to cover the check.
  • ??    You audit the payment and deposit the check.


The growth of capitation continues

MANAGED CARE January 1997. ©1997 Stezzi Communications

Capitated payment for physician groups has had its critics lately, but a recent survey by a stop-loss insurance brokerage firm shows that its prevalence is still on the rise. Nearly 60 percent of physician groups now report receiving some compensation through capitation arrangements, and another 30 percent say they'll be doing so within two years. Last year, the average group accepting capitation had five different HMO capitation contracts, along with three other contracts that used different payment mechanisms, the survey also said.



Will States Ban Capitation?

Salem, Ore., ophthalmologist Gordon Miller wants to ban capitated payments to physicians. His ballot measure apparently didn't light up the skies, but some wonder if a brushfire could yet spread.

Chuck Appleby

Contributing Editor

See also an accompanying story in November 1996, Is Paying Physicians By Capitation Wrong?

UPDATE: The vote totals on Oregon's Measure 35
In favor 236,152 (23.7%)
Opposed 761,440 (77.3%)

Ballot Measure 35 appeared headed for defeat in Oregon as Election Day 1996 neared, but the sighs of relief in the managed care community were incomplete. To many, the mere fact that Salem ophthalmologist Gordon Miller's anti-capitation initiative could attract the required 65,000 signatures to appear on the ballot — and earn national and international media renown in the fall campaign — was cause for unease.

By providing that physicians could be paid in only five ways and not listing capitation among them, Measure 35 would effectively have banned the prepayment of doctors on a per-patient, per-month basis, causing license forfeiture by doctors who were paid that way. To say that that would have had jarring implications for health care in one of the nation's most advanced managed care states is an understatement the size of Mt. Hood.

Many observers have argued that capitated payment of physicians creates "perverse incentives" — a problem it shares with traditional fee-for-service payment. But Miller goes further.

"With capitation we are undoing 2,500 years of Hippocratic oath-based medicine," he says, "and replacing it with a veterinary ethic in which we say we'll do for you whatever your master or owner wants — read HMO, employer and government. The patient is no longer the important thing; it's what the master or owner wants. That's why I say this is so wrong."

Miller says he spent about $65,000 — a dollar a signature — to get his measure on the ballot. And he hired professional political consultant Thomas Mann to run the Measure 35 campaign for him. But despite a fairly narrow 1994 loss as the Republican nominee for a seat in the state legislature (If elected, said Miller, he'd allow lobbyists to meet with him only in the presence of opposing lobbyists) the self-described "loner" hasn't gone all out to broaden his initiative's appeal to its sizable potential base of support: citizens who for one reason or another are unhappy with managed care.

As the Portland newspaper Willamette Week wrote recently, "Miller has mastered the difficult art of eye surgery, but he is finding that the art of politics requires an even more delicate touch."

An eccentric state

Oregon, of course, has long had a reputation for being politically quirky. It embraced Dewey, Nixon and Dukakis while the country was choosing Truman, Kennedy and Bush, and its primary voters picked Nelson Rockefeller when his divorce had doomed him elsewhere, and Eugene McCarthy when other states were smitten with Robert Kennedy. After Pacific neighbors California and Washington — themselves often innovators — failed to approve ballot measures that would give doctors permission to prescribe lethal medications to dying patients, Oregon narrowly passed such a measure in November 1994. And the Oregon Health Plan, an expansion of Medicaid with a rank-ordered list of approved services, represents a bold attempt to substitute rational rationing of health care by procedure for de facto rationing by socioeconomic class.

However special Oregon may be, though, managed care executives elsewhere could be forgiven for wondering: If this much noise can be made by a medical maverick in a state that has already made its peace with managed care, what fresh hell might be unleashed by a canny coalition-builder in a state where HMOs still raise eyebrows?

True enough, Miller's Oregon measure served as an effective unifier — for the opposition. Battling the measure to the tune of $1 million — mostly for radio and TV ads — was the state's medical establishment, a coalition of insurers, providers and employers called Oregonians for Quality Health Care. No groundswell of support apparently materialized among doctors disgruntled with HMOs and capitation. And voters were genuinely confused by the issue.

A managed care bastion

Even managed care's strongest boosters say capitation isn't the only arrow in their quiver (just as Miller was careful to say it was capitation, not managed care itself, that he opposed). But HMOs obviously don't want to lose the right to capitate physicians. That's why they may put a more positive spin on what happened in Oregon: In a state where voters have had ample chance to see managed care's warts, they still rejected this purported remedy as too extreme.

Indeed, about half of Oregon's citizens are already in managed care of various kinds, and that proportion rises to about 70 percent in the dominant metropolis of Portland. But 21 other states also offer voters the initiative and referendum process, and then there are the 50 state legislatures. Most of them have recently considered some kind of legislation aimed at managed care — with minimum maternity hospital stays, anti-gag rule provisions and "any willing provider" laws prominent among them. If capitation comes to be perceived broadly as "paying doctors not to provide care," there is enormous potential for mischief.

Partly because Oregon voters faced a welter of other ballot measures competing for their attention, the final vote tally (see above right) may not do justice to the issue's potential as an emotional symbol of consumer anxiety. Half of the state's voters reportedly remained undecided about the measure until nearly Election Day. Some radio talk shows had callers three to one in favor of it. As one Oregon physician familiar with the politics of health care explained a few months ago, public half-understanding of capitation could be a dangerous thing. "If I had no scruples and Gordon Miller wrote me a check for $150,000," he said then, "I could make Measure 35 pass."

Despite its apparent failure, the Measure 35 campaign clearly deserves study by managed care government relations professionals for the arguments it brought forth — arguments of which American voters may not have heard the last.

What the two sides said

"We are supposed to be in a profession, which means we have a covenant relationship with our patients, not a contract relationship," said Miller. "When you go to capitation, it becomes a contract relationship. In a covenant relationship it's like a parent and child: You do whatever you can for your child. The same thing with a physician — you do whatever you can for the patient, not doing any harm and doing what's best on his behalf, if the patient wants it done. That's really the Hippocratic oath: You do what you can for the patient, regardless of his status in life."

Of course, opponents had their say, too. Besides drawing fire from many insurers, doctors, nurses and employers, Measure 35 was opposed by Democratic Gov. John Kitzhaber, M.D., an author of the Oregon Health Plan. He contended that the measure would have increased costs and reduced access to health care. The Oregonian, the state's biggest newspaper, also joined the nays. Said its editorial page: "The fact is that there are problems with all forms of reimbursement."

There were two levels of debate — one on the merits of the measure itself and another on perceived abuses of managed care.

"We were against the initiative for several reasons," says Glenn Rodriguez, M.D., medical director for Portland-based PacifiCare of Oregon. "It really would have straitjacketed the industry from a health care policy and financing perspective," he says.

Passage of such a measure would close the door on any new or evolving forms of payment, limiting innovation in financing, managed care executives argued. "None of us believes there's any single right way to pay physicians under managed care," says Rodriguez. Restricting payment mechanisms threatens incentives-based systems that aim to increase quality of care and patient satisfaction.

Cost was one of the biggest concerns. Rodriguez estimated that the measure's passage would have increased costs by $100 per member per month across the state, leaving 100,000 fewer people with access to care, reversing the progress of the Oregon Health Plan, Under the state plan, nearly all of Oregon's Medicaid population is in HMOs, many of which involve capitation.

But capitation should be used thoughtfully, Rodriguez adds. He says PacifiCare does not capitate individual physicians precisely because such a strategy might lead to the kinds of ethical conflicts Miller ascribes — unfairly, in Rod-riguez's view — to all forms of capitation.

"Dr. Miller paints capitation to be so extreme that a patient waits in the exam room while the physician writes out a check to send him for an MRI," says Rodriguez. "Blanket elimination of capitation would roll back the clock on progress.

"If the anti-capitation initiative passed, we'd have to go back to systems of micromanagement of fee-for-service. I don't think those systems add a lot of value or quality to care," says Rodriguez.

"Outlawing capitation is throwing the baby out with the bath water," declares Peter Boland, president of Boland Healthcare Inc. in Berkeley, Calif. It would be better to try to clean up abuses through self-policing and the regulatory process. "There are real drawbacks to making it illegal. Even if all you do is eliminate capitation as we know it, I doubt it removes all potential for abuse. Then you get into hybrid forms of risk arrangements," says Boland.

But an HMO executive acknowledges that the political climate is ripe for initiatives like Measure 35. "There's a growing concern about managed care and its impact on quality," says Ruth Rogers Bauman, vice president for actuarial and underwriting services with HMO Oregon, a 450,000-member HMO with its base in Portland. But she says people often forget that there are probably as many medical accidents under other systems as there are under managed care.

"We heard about those for years under fee-for-service, but they didn't blame it on the payment mechanism. There's not a lot of proof that it happens more under managed care. Not doing things can often be helpful, and doing more can be harmful," Bauman says.

But taken from a national perspective, says managed care analyst Boland, the campaign was not surprising. The Oregon anti-capitation initiative reflects a growing national discontent with managed care, manifested in the passage of a number of state laws to regulate the industry. Add to the mix the loss of jobs due to hospital downsizing and medical-office and health-plan consolidation and the climate becomes even more politically volatile, he says.

"You have a lot of political, economic and consumer interests dovetailing. It's resulting in some interesting political bedfellows, such as chiropractors and nurses. This kind of discontent is being tapped and orchestrated pretty skillfully. I'm not criticizing it; it's marketplace dynamics."

What's best for consumers?

But at least one health care consumer advocate believes that from the consumer's point of view, capitation is the wrong bogeyman. "It's clear why a physician would want to oppose capitation, because capitation requires that physicians share the financial risk," says Charles Inlander, president of the People's Medical Society in Allentown, Pa., a consumer advocacy group with 80,000 members.

"I like the idea of doctors sharing risk because it makes the physician more of a partner with the consumer and lets the consumer know the doctor has an investment in the relationship," he says, adding that capitation is a much better system in the long run than traditional indemnity insurance because the latter paid doctors for anything they did or ordered.

"There's not much evidence that doctors are doing too little with managed care. There's anecdotal stuff that people aren't getting enough surgery, tests or office visits — and that should be monitored," he says.

"But actually, we're still doing too much of certain things. At least with capitation they're not going to have the incentive that doing more is making more," Inlander says. He argues that today's C-section rate should be cut in half, that nine out of 10 hysterectomies do not meet clinical guidelines, and that the surgical removal of prostate glands in virtually 100 percent of prostate cancer patients over age 70 is wrongheaded.

"Capitating a doctor takes away the economic incentive to do more. While it's a heavier burden for the consumer to monitor, it's a worse burden to have too much done. I'd rather know the doctor is going to do it because it needs to be done."

Despite the dry tinder — widespread disaffection with some aspects of managed care and the potential for focusing that disaffection on capitation — Inlander doubts that the Oregon "brushfire" will spread across the country.

"I don't think we'll see too many similar initiatives in the states," says Inlander. "Physicians have shot their wad over the years with such things as 'any willing provider' laws. Big business is more important to legislators. Employers are saying they want accountability. The day of physicians and hospitals telling legislators 'We want this' is long gone."

Besides, he says, most physicians are on the side of payment regardless of the mechanism used. "State medical associations are all running scared. They want as many payment mechanisms as possible. Have you heard the AMA say, 'Stop Medicare'? Of course not, because 60 percent of their members' income comes from Medicare. They're not in business to help consumers."

And consumers are even less likely to champion an initiative to restrict types of physician payments, Inlander adds. "The public doesn't care how doctors are paid, any more than it cares how law-firm partners are paid."

What HMOs should do

Still, HMOs could do more to head off such confrontations in the future. Says Inlander: "HMOs have to make the case back to consumers why capitation is good for them, the same way HMOs told them why they can't have just any willing provider by saying, 'We're looking for better doctors at a price that's reasonable.'"

Physicians need to do the same thing, says internist Leigh Dolin, a member of HealthFirst Medical Group in Portland and a past president of the Oregon Medical Association.

"The good thing about the Miller initiative is that it has forced us to talk about managed care capitation and raise the level of education. The level of ignorance is quite high." Dolin recalls that an elderly woman patient came to him and said she was reading bad things about capitated managed care. "'Isn't it terrible?,' she said. I said to her, 'Don't you have Secure Horizons?' 'Yes,' she responded. 'Aren't you happy with it?' 'Oh my, yes,' she said. 'Do you realize Secure Horizons is a capitated program?' 'No, I had no idea.'"

As Dolin puts it, one of the aspects of managed care that people find most threatening is its emphasis on taking care of a population in contrast to an individual. That's a reality of today's health care community. "Everybody is willing to accept rationing for everybody else. But we're all in this together. Medical resources are limited. Everybody can't get everything they want."

Analyst Boland agrees that better communication is paramount. "Administrators need to spend a lot more time and resources on patient communication and consumer education," he says. "They're woefully inadequate."

Needed: consumer awareness

"The average person does not know what an HMO is," says Boland. "It's simply one's health plan. Consumers are confused about health care."

Bauman says HMO Oregon took a neutral stance vis-a-vis the anti-capitation initiative because it didn't want to appear self-serving and because capitation is just a small part of its strategy. "We don't use capitation very much," she says. "It's not the only way to do managed care." However, the HMO recently offered a new capitation model for its over-65 population, setting aside part of the capitation for an incentive fund keyed to patient satisfaction scores.

"If anti-managed care moves are going to be headed off, employers are going to have to say capitation helps cut costs," says Bauman. "Physicians are going to have to speak up and say we can treat patients well under a capitated managed care system," she says, citing the example of her own physician, who claims to feel freer under capitation because she doesn't have to follow the rules of any health plan.

HMOs could emphasize what they do to measure quality and monitor underutilization and patient satisfaction, and how they serve as a watchdog over capitated medical groups. Do they just give them the money and walk away or do they act as ombudsmen protecting the interests of patients? Answers to questions like that can help offset Aunt Maud's negative anecdote.

"If you're satisfying members and holding down costs, voters aren't likely to want to change the system," concludes Bauman. "Let members know, we're capitated and you're still happy. Then combine that with a more visible strategy at statehouses, talking to legislators to head off possible anti-managed care bills. State legislatures are a more likely source of such legislation than voter-sponsored initiatives."

A telling process of elimination

Salem ophthalmologist Gordon Miller's Measure 35 on the Oregon ballot didn't ban capitation explicitly. Instead, it sought the same effect by limiting physician remuneration to five specified kinds — and leaving capitation notably absent. Here are the five payment mechanisms it approved:

  1. "actual work performed"
  2. an hourly wage
  3. a prearranged salary and benefits
  4. bonuses based on work performed
  5. reimbursement for expenses
MANAGED CARE November 1996. ©1996 Stezzi Communications


Is Paying Physicians By Capitation Wrong?

The concerns of Oregon anti-capitation crusader Gordon Miller draw a surprising degree of sympathy from managed care experts. But they say he's tarring good and bad health plans with the same brush.

Timothy Kelley


See also MANAGED CARE's cover story for November 1996, Will States Ban Capitation?

Oregon voters had occasion this month to consider a moral question with enormous bearing on the delivery of health care in the United States. They were deciding the fate of Salem, Ore., ophthalmologist Gordon Miller's attempt to ban capitated payment of physicians (see article on page 26). Though the campaign for his voter initiative didn't seem to be gathering enough steam for victory as Election Day approached, the question Miller raised deserves consideration: Is capitated payment of doctors wrong?

"It violates agency," Miller claimed. "You can only be the agent of one party in a dispute at one time. An attorney, for example, cannot represent both the defendant and the plaintiff. When a physician works for the managed care company and, in effect, splits the profits with it, he becomes its agent — not the patient's. And it is so easy to withhold care and not tell people."

In recent conversations with four authorities on the theory and practice of managed health care, Managed Care found no one ready to second Miller's blanket denunciation. But no one dismissed his concerns outright, either.

When it's a single doctor

"It is widespread, but that doesn't make it right," says Arnold Relman, M.D., editor emeritus of the New England Journal of Medicine, about the practice of capitating individual physicians. "I think the public should be, and is, concerned about the economic pressures that are on doctors who find themselves under that kind of an arrangement. It may prevent doctors from using their best professional judgment in an individual case."

But Relman adds that his is "a quantitative, not a qualitative, concern." Rather than rejecting capitated payment on absolute grounds because it compromises agency, Relman will accept it if it's applied to a large enough group with a large enough patient pool and "if the physicians are self-regulated, if the guidelines they follow and the decisions they make are professionally based, if physicians have the controlling voice in how they're going to use their capitated budget — and if there is no profit taken out of the system."

Relman considers the Oregon anti-capitation initiative "too extreme." "If you want to outlaw capitation," he says, "you want to be sure you don't outlaw capitation of large groups of not-for-profit doctors, because I believe in the long run that's where we're going to have to be if we're going to be able to afford health care in the future."

John La Puma, M.D., a Chicago-area internist who writes Managed Care's Ethics column each month (see page 49), joins Relman in disapproving individual capitation of physicians. "Although our calling is altruistic," he says, "weighing your mortgage payment or your daughter's education against a person's need for an MRI is just too great a personal problem to be surmounted by an individual doctor — or anyone else."

There are different incentives inherent in every method of paying physicians, says La Puma, "but incentives matter only if they distort judgment."

True, says, La Puma, "we've heard horror stories in the media — and we'll probably hear more — that individual patients have been denied treatment because someone wants to save money for someone else, usually a plan for its shareholders. And those stories are deeply disturbing." But that doesn't mean any payment mechanism is inherently right or wrong.

"The question is, when is a group big enough to diffuse the risk of distorted judgment, yet still small enough to let the incentives do their work in encouraging cost-effective care?"

A matter of choices

Gerald Musgrave, an economist and president of Ann Arbor, Mich.-based Economics America, uses a restaurant analogy to characterize the anti-capitation measure. "I don't think there should be a law that forces everyone to go to all-you-can-eat restaurants for a fixed fee," he says. "I'm also very disturbed about any plan that would outlaw all-you-can-eat restaurants. When people want to start managing the restaurant trade by forcing people into one kind of restaurant and outlawing another kind, I think they're crazy."

That metaphor may offer a kind of entrée into the minds of Oregon voters. Once resented as a regimenting force, managed care has now become so much a part of the landscape in the Beaver State that it is Gordon Miller's proposed new law that is seen as the unwanted regimenter that would narrow everyone's health care options.

Actually, capitated payment of individual physicians on a large scale is a relatively new phenomenon, says Emily Friedman, a health policy analyst and a contributing editor of Healthcare Forum Journal, who studies the history of health care. Capitated pay does date back to sugar plantations in Hawaii in the 1830s, where landowners helped to ensure that their imported Asian laborers stayed functional by contracting, sometimes on a capitated basis, with local physicians to provide their health care. But a more typical design of managed care's early prototypes, says Friedman, involved "giving capitated payments to a group practice that either owned or had a relationship with a hospital, and that paid each individual doctor a salary."

Today, a different motive

In the 1970s, capitated payment of individual physicians became more common, says Friedman, because "the health care system in most markets did not have the infrastructure to respond to employer demands for managed care with integrated group-practice models." By then, she argues, the goal in expanding managed care was to save money, a motive different from the "messianic zeal of a new way of organizing services" that earlier had spurred the creation of early prepaid group practices, "often by leftists" who were shunned by the medical establishment.

"Health plans today that are capitating individual physicians are doing so to extract the lowest possible price from a disorganized provider sector," says Friedman. "But capitation itself is not the enemy. People are up in arms about capitation because we have broker-type, nonprovider health plans, virtually all of them stockholder-held, that have been behaving badly.

"The Oregon initiative would make it impossible for organizations such as Kaiser Permanente to operate, because it makes no distinction between traditional, honorable, well-operated plans and bandits," concludes Friedman. "That's what so sad about it. It focuses on capitation as the enemy because Americans simply believe that they should not be denied anything.

"But its supporters are shooting at the wrong target. And I think it's going to be very, very sad if these initiatives pass, because when it is done well, managed care is a superior way to organize health care services."

MANAGED CARE November 1996. ©1996 Stezzi Communications


The Smart Way To Take 'The Capitation Plunge'

Think you know everything physicians should consider when they take on a capitated contract? You may be surprised by what you learn from this practice-management consultant's succinct advice.

Gary Grubb, M.B.A.

Whether you're ready or not, capitation is coming to your neighborhood — if it hasn't already moved in. Under capitation, of course, an HMO or other managed care organization pays you a fixed amount of money for each member enrolled in the health insurance plan each month. You are then responsible for any of the plan's members who may need health care or medical services during that month.

In essence, you become a mini-insurance company under capitation by taking on the financial risk of service and resource utilization: You agree to accept a premium payment, and you provide the services when required. Why would any sane medical provider agree to such a thing? In many cases today, you may have no choice but to embrace capitation because many managed care organizations require it.

An improved cash flow

Although capitation can mean significant changes to your practice, they're not all bad. In fact, capitation may prove to be quite beneficial to you if you're a cost-effective provider. The reason? Under capitation you benefit financially from your own efficiencies and efforts to reduce resource utilization.

In addition, capitation can improve your cash flow. You get your payments up front at the beginning of the month, and you get them whether or not patients come through your door. Because of that you have no collection costs for this population, either.

Before you dive in, however, acquire a basic understanding of capitation agreements. They typically come in three forms.

Three kinds of capitation

The first is fixed-rate per-member, per-month (PMPM). For example, ABC HMO may come to you and say it has 7,500 members in its plan and that it will pay you $10.20 PMPM to provide services to this population. Under this agreement, ABC HMO will pay you $76,500 per month, and you will assume the risk of providing whatever care you agree to provide to ABC's 7,500 members whenever they need it.

If ABC's membership increases, your monthly payments will also increase. If the plan's membership decreases, so will your monthly payments. Otherwise, your payments are fixed each month.

The second type of capitation agreement bases the PMPM payment on the sex and age of the covered population. For example, for male members aged 65 — 70, the PMPM payment may be $7; for females aged 65 — 70, $6; for males aged 70 — 85, $21; for females 70 — 85, $10.50, and for both sexes aged 85 and over, $15.

Under the third type of capitation agreement, the payer offers you a percentage of the insurance premiums it charges its members and their employers. For example, ABC HMO may offer to pay you 9.4 percent of the $108 premium it charges each enrollee for membership in its health plan. That means you would get $10.20 PMPM under this agreement.

This third type poses additional risk to you. For example, if the ABC HMO decides to lower its premium charges by 20 percent as a marketing tactic, your payments will also be cut by 20 percent. So if you encounter this type of agreement, be sure to ask the HMO what its marketing plans are and what it expects its rates to be in the year after you sign the agreement. To protect yourself further, negotiate firm percentage-of-premium contracts that are unaffected by the HMO's marketing tactics.

Determining whether PMPM payments are adequate is certainly among the most important considerations when weighing capitation agreements. To calculate whether a PMPM payment will be adequate, answer three crucial questions:

  • How many members were in the health plans last year?
  • What was their utilization history?
  • What will it cost you to meet that demand of resource utilization?

Of course, there's no guarantee that historical resource utilization patterns will match those in future years. But an analysis of historical utilization trends can paint a somewhat reliable picture of what you can expect to encounter as the service provider for a covered population.

Still not ready to take the capitation plunge? Approach a local HMO and suggest working together for a six-month trial period on a fee-for-service basis. Then control utilization as if you were capitated. Use the time to gain experience in operating under a capitated arrangement and gather data on actual utilization patterns. A trial arrangement like this may also benefit the HMO because it can allow the plan to gather and analyze data that can help it set more accurate capitation payments.

Another strategy to consider is asking the HMO to share financial risk with you. Under a shared-risk capitation contract, the HMO will reimburse you an agreed-upon percentage of your losses if your expenses exceed your capitation payments. For example, if your annual capitation payments totaled $950,000 for a year and the value of the services you provided to the HMO was $1 million, the shared loss would be $50,000. If the HMO agreed to a 50/50 shared risk, it would have to pay you $25,000 for that year in addition to the monthly capitated payments you would receive.

However, under a shared-risk agreement, the HMO also gets to share in your profit. So if the annual capitation payment you received was $950,000, but the value of services you provided to the HMO's members was $850,000, you would have to give half of your $100,000 profit to the HMO for that year.

When to share

Shared-risk arrangements often are desirable in the first few years of a contract, because you will probably be learning how to operate under a capitated system. Having some "deep pockets" behind you in your early years of operating under capitation can provide some comfort. However, once you learn what you're doing under capitation, shared-risk arrangements may become less desirable, because you may not want the HMO to share in the benefits of your own efficiency.

When you first embrace capitation you also should consider embracing a reinsurance policy. These policies, which are available from either the HMO or a commercial insurer, help you handle the expenses of catastrophic cases. Reinsurers will help you pay for these cases, but don't expect to make any money from them. All they do is help you flatten out the financial peaks and valleys of providing care under capitation.

Another risk-management strategy is to avoid placing all of your eggs in one payer basket. Maintain a mix of payer sources — some capitated, some noncapitated. Noncapitated payer sources can help you offset any revenue losses you may experience by having to discount fees in capitated arrangements.

In addition to that capitation pitfall, there are others to avoid, and there are areas you should clarify before you sign a capitation contract. For example, find out if the HMO expects you to provide services that you do not provide yourself. If that's the expectation, you'll have to contract for these services yourself.

It's also important for the capitation contract to spell out clearly the criteria to be used in determining when a member should receive services from you. When all of the providers in a continuum of care are capitated, game playing can occur, where providers accuse one another of "dumping" patients to keep from incurring the expense of caring for them. You need to be extremely clear about the criteria that will be used to determine when patients should come to you for care.

Also be sure to investigate the financial incentives the HMO offers to other providers to use your practice appropriately. Under some capitation plans physicians receive financial incentives to discharge their patients as soon as possible from the hospital. This kind of incentive could increase utilization in your practice, so it's important to make sure that patients are sent to you appropriately.

Know eligible services

Another area to attend to is the particulars of the HMO's benefit plan. You'll need to know the services that members are eligible to receive. You'll also need to know how to determine member eligibility. This is critical, because it's the basis upon which you will be paid. Many HMOs can't give you good information on eligibility, so you may find yourself in a situation where you discover three months after the fact that you treated someone who was no longer enrolled in the HMO.

On a related note, be sure to find out who is entitled to the copayments that HMO members may be required to pay. Generally, providers own the copayments, but some managed care organizations say they are entitled to them. You should also be entitled to any money received from coordination of benefits from any third-party payers. In their initial offers to you, many HMOs will claim the money obtained from coordination of benefits, but you should object to that during negotiation.

Clarify payment timing

The timing of your capitation payments — when you'll be paid each month — is another area to clarify. You may think that timely payments won't be a problem, but you could experience a cash-flow crunch if a capitation check floats in the mail for too long. During contract negotiations, it is reasonable to ask that your payments be delivered on the same day each month.

Also ascertain what "risk withholds," if any, will be made from your monthly payment. Managed care arrangements typically include withholds, another form of risk sharing, which they use to provide physicians with incentives to reach certain utilization goals. Under a risk withhold, you will receive a fixed percentage of the reimbursement due, such as 85 percent of a fee schedule amount, with the remaining percentage withheld by the payer. If at the end of the plan's fiscal year pre-established utilization and cost savings goals are satisfied, you are eligible for the payment of all or a pro rata share of the withheld amount.

Make sure you fully understand what the withhold money will be used for and how much of the withhold pool you own. Also find out whether you have recourse to those funds if you terminate your contract.

In embracing capitation, the most important thing to do is change your beliefs about your medical delivery system and how you view yourself in that system. Under capitation you need to stop focusing on revenues and believing, consciously or not, that you're making money when your daily schedule is full. Instead, you need to attend to your costs, managing care and keeping people healthy. Everybody in your practice must passionately adopt this new attitude.

The author is president of The PM Group, a practice-management consulting group based in Battle Creek, Mich.

MANAGED CARE July 1996. ©1996 Stezzi Communications


Should Capitation's Financial Incentives Be Part of Informed Consent to Treatment?

MANAGED CARE April 1996. ©1996 Stezzi Communications

John La Puma, M.D.

Capitation asks doctors to shoulder financial risk for their patients' care. Capitation is defined as a flat "fee per head per time": usually dollars per member per month. Capitation dollars are revenue, which is different from income. Income is what the doctor keeps after health care services are paid for.

Bonuses and withholds are common incentives for both salaried and capitated physicians, and also for chief executives. American Medical News recently reported that chief executive officer Norman Payson of Healthsource Inc. was paid a base salary of $387,000 in 1994. Yet performance incentives brought his income to $14,280,000. But we are doctors, not executives.

In capitated managed care, and especially in global capitation, the doctor who takes home more does so by spending less on patients. With just this conflict in mind, the Health Care Financing Administration's new rules on incentives limit the amount of potential physician bonuses to 25 percent.

Financial incentives

Should doctors disclose to patients the financial incentives they face to limit treatment? If so, should this disclosure be part of informed consent discussions?

Financial incentives in managed care are not new. Patients have them: to stay in network, to use the formulary, to avoid durable medical equipment, to question experimental treatment, to defer cosmetic and alternative treatment. Patients who do these things usually save money.

Physicians have financial incentives too — to limit testing and treatment. Rewards go to physicians who limit referrals, stay within formularies, lessen laboratory use and reduce average hospitalization to 200, 180, and even to 150 days per 1,000 members.

Financial incentives to limit treatment that result in less care for the patient and more reward for the doctor represent an acknowledged conflict of interest, even if less treatment is better, and if the doctor's financial reward is a coincidence. But does this conflict of interest sometimes distort sound judgment or result in patient harm?

Distorted judgment

There are plenty of reasons why financial incentives should not distort judgment. Our historic tradition as an altruistic profession is strong. Physicians in the United States have a ritualistic focus on the individual. Threats of malpractice litigation and the law loom if we do too little. Hospitals and payers police care already, and will help us if we slip. And, of course, many physicians do not know, for example, how much ten days' worth of clarithromycin actually costs.

But financial incentives can distort judgment and sometimes do. Nearly everyone has a price for which he or she would, other things being equal, make decisions that err on the side of keeping 10 percent, 25 percent or 100 percent of income. This is not a moral flaw, but simply human behavior. Doctors are not different from other workers: We do more of what we are paid well to do.

There are at least three ways to minimize the possibility of distortion: informed consent, disclosure and regulation.

Informed consent

Informed consent is information, understanding and noncoercion. The information must be adequate for patient decision-making; the understanding must be genuine, and not simple reiteration; and the decision must be volitional. The most important reason for applying informed consent is to protect patients against any unwanted treatment and its potential risks.

Financial information is not currently part of informed consent, perhaps because conflicts of interest do not present a risk of treatment, but instead, may simply warn people about the limits of their doctor's loyalty. Yet the risk of distorted judgment is the risk that patients take in capitation.


Disclosure to patients is difficult, and may be ineffective. The financial incentives that affect physicians' choices depend in part on the amounts of money involved, and different patients have different ideas of how much money is a lot. The doctor-patient exchange has power and knowledge on one side, and need and fear on the other. And few patients want to choose between accepting their doctor's prescription and pondering his motives.

On the other hand, disclosing conflicts of interest to patients may increase trust, and may meet an objective test of what a reasonable patient should know.


Regulation may also help minimize the distortion of judgment. For example, we can:

  • decrease how often bonuses and withholds are given;
  • create a large minimum for the number of physicians sharing in the reward;
  • create a large minimum for the number of patients for whom physicians are responsible;
  • increase the time between feedback reports to physicians about financial performance.

Irrespective of whether informed consent, disclosure or regulation is chosen, discussion of financial incentives to limit care should move out of the shadows into the bright light of doctor-patient dialogue.

To preserve trust, and show that we are patient advocates, we should tell patients how we are paid, and how managed care payers restrict and encourage us. We should do this because it is honest; because patients want to know; because patients believe in the goodness of their own doctors, and because the information is available in Newsweek, Vogue, and USA Today. It is also on the nightly news and the Internet.

Disclosure of financial incentives, however, is not an office procedure to be performed while examining the breasts of a 45-year-old whose mother died of cancer, or the heart of a 55-year-old whose cardiomyopathy has led to failure.

Instead, honesty should be an office policy. We can use simple, one-page handouts about what managed care is, how it works, and how our offices are reimbursed. We should emphasize our first loyalty, but note that we too have to live within the rules, and that we are learning about this new system, just as patients are. We should use appeal processes when a patient's personal medical interest is at risk. Fortunately, not every patient will need an appeal, but it may be one of 50 or even 20, among the chronically ill. We should present cases in policy settings — in board rooms, medical director meetings, and top management forums.

It is our patients to whom a highly paid executive must respond.

It is, after all, their money.

John La Puma, M.D., practices internal medicine with North Suburban Clinic in Elk Grove, Ill., and is a Chicago-based speaker and educator. With David Schiedermayer, he is the author of The McGraw-Hill Pocket Guide to Managed Care: Business, Practice, Law, Ethics (McGraw-Hill, New York, 1996), from which this column is adapted and excerpted in part.