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Capitation is a payment arrangement for health care service providers such as physicians or nurse practitioners. It pays a physician or group of physicians a set amount for each enrolled person assigned to them, per period of time, whether or not that person seeks care. These providers generally are contracted with a type of health maintenance organization (HMO) known as an independent practice association (IPA), which enlists the providers to care for HMO-enrolled patients. The amount of remuneration is based on the average expected health care utilization of that patient, with greater payment for patients with significant medical history. Rates are also affected by age, race, sex, type of employment, and geographical location, as these factors typically influence the cost of providing care.
Primary Capitation: A relationship between a managed care organization (MCO) and primary care physician (PCP), in which the PCP is paid directly by the MCO for those enrolled members who have selected the physician as their provider.
Secondary Capitation: A relationship arranged by the MCO between a PCP and a secondary or specialist provider, such as an X-ray facility or ancillary facility such as a Durable Medical Equipment supplier, where the secondary provider is also paid capitation based on that PCP’s enrolled membership.
Global Capitation: A relationship based on a provider who provides services and is reimbursed per-member per-month (PMPM) for the entire network population.
Under capitation, physicians are given incentive to consider the cost of treatment. Pure capitation pays a set fee per patient, regardless of their degree of infirmity, and gives physicians an incentive to avoid the most costly patients.
Providers who work under these plans focus on preventive health care, as there is greater financial reward in prevention of illness than in treatment of the ill. Such plans avert providers from the use of expensive, newly developed treatment options that may be less effective or have only a marginally higher success rate than alternatives.
The financial risks providers accept in capitation are traditional insurance risks. Provider revenues are fixed, and each enrolled patient makes his or her claims against the full resources of the provider. In exchange for this fixed payment, physicians essentially become the enrolled clients' insurers, who resolve their patients' claims at the point of care and assume the responsibility for their unknown future health care costs. Large providers tend to manage this risk better than do smaller providers, because they are better prepared for variations in service demand and costs, but even large providers are inefficient risk managers in comparison to large insurers. Providers tend to be small in comparison to insurers, and so are more like individual consumers, whose annual costs as a percentage of their annual cash flow fluctuate far more than do those of large insurers. For example, a capitated eye care program for 25,000 patients is more viable than a capitated eye program for 10,000 patients. The smaller the roster of patients, the greater the variation in annual costs, and the more likely that the costs may exceed the resources of the provider. In very small capitation portfolios, a small number of costly patients can dramatically affect a provider's overall costs, and increase the provider's risk of insolvency(1).
Physicians and other health care providers lack the necessary actuarial, underwriting, accounting and finance skills for insurance risk management, but their most severe problem is the greater variation in their estimates of the average patient cost, which leaves them at a financial disadvantage as compared to insurers whose estimates are far more accurate. Because their risks are a function of portfolio size, providers can only reduce their risks by increasing the numbers of patients they carry on their rosters, but their inefficiency relative to that of the insurers' is far greater than can be mitigated by these increases. To manage risk as efficiently as an insurer, a provider would have to assume 100% of the insurer's portfolio. HMOs and insurers manage their costs better than risk-assuming healthcare providers, and cannot make risk-adjusted capitation payments without sacrificing profitability. The risk-transferring entities will only enter into such agreements if they can maintain the levels of profits they achieve by retaining risks.
Providers cannot afford reinsurance, which would further deplete their inadequate capitation payments, as the re-insurer's expected loss costs, expenses, profits and risk loads must be paid by the providers. The goal of reinsurance is to offload risk and reward to the re-insurer in return for more stable operating results, but the provider's additional costs make this impractical. Reinsurance assumes that the insurance-risk-transferring entities do not create inefficiencies when they shift insurance risks to providers. Absent any induced inefficiencies, providers would be able to pass on a portion of their risk premiums to reinsurers, but the premiums that providers would have to receive would exceed the premiums that risk-transferring entities could charge in competitive insurance markets. Re-insurers are wary of contracting with physicians, as they believe that if providers think they can collect more than they pay in premiums, they would tend to revert to the same excesses encouraged by fee-for-service payment systems.