American College of Physicians: Internal Medicine — Doctors for Adults ®

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Medicine on 36 cents a day

How to take the fear and risk out of capitated payments

From the March 1995 ACP Observer, copyright 1995 by the American College of Physicians.

By Edward Doyle

For physicians used to practicing fee-for-service medicine, the idea of capitation can be frightening. For many, the chief concern is simple: learning to live on those seemingly small capitated fees without going broke. But according to capitation experts--physicians and practice consultants who work in some of the nation's most competitive managed care markets--taking capitation doesn't have to mean financial ruin. By using a few tried-and-true techniques, they say, physicians can avoid making costly mistakes and can actually prosper under capitation.

The easiest way to understand capitation is to look at the industry standard--the per member, per month fee formula that many HMOs use to pay their physicians-in terms you already know. Daniel Merlino, a practice consultant with ECG Management Consultants in Seattle, suggests novices start by using some simple capitation formulas based on their existing practice revenues.

For example, if your practice generates $400,000 a year and cares for 3,000 patients, you are collecting an average of $133 each year from each patient (see chart). To maintain your current income under capitation, you would need to collect $133.33 a year for each patient in your care, or $11.11 per member, per month.

Or assume it costs $225,000 to employ a primary care physician, including salary, benefits and overhead; divide that cost by 1,700 (the industry standard for the number of patients a typical physician can handle in a year). The resulting figure--$11.03--is how much you would need to collect per member, per month to reimburse that physician under capitation.

Beyond simple formulas

These formulas may be simplistic, but they provide what Mr. Merlino calls a "drop-dead figure" to tell you what kind of profit--or loss--you face from taking on a capitated contract. And while they are particularly good for physicians in young managed care markets, they will not be as practical in more mature markets.

In areas such as Southern California, for example, physicians' expenses rarely determine capitation rates. Instead, some HMOs simply give physicians a percentage of the premium they collect from employers. In many of these cases, primary care physicians receive up to 80% of the premium to provide primary care services, referrals to subspecialists, and hospital care and pharmacy services.

While such full-risk contracts may be terrifying to physicians new to capitation, Tom Mayer, MD, a practice consultant in Brea, Calif., said that they actually produce the most profits for practices. When physicians reduce hospitalization costs by caring for more patients on an outpatient basis or by seeing them more frequently in the office, they keep those savings as profit. The opposite, however, is also true; if they spend more than the HMO has given them for hospitalization or pharmacy, that comes out of their pockets.

"The waste in the system isn't at the primary care level," Dr. Mayer explained. "The waste is at the specialty level and even more so at the hospital level. And unless you take risk on those dollars, the likelihood that you're going to have anything that looks like a profit is pretty slim."

Particularly in markets where managed care is still a budding force, however, many physicians prefer to dabble in capitation and take only a small amount of risk on relatively few patients. But there is evidence that when they limit either the amount of risk they take or the size of their capitated populations, physicians can actually find themselves in the red.

Nicholas Anton, FACP, an internist in Santa Rosa, Calif., and president of the Redwood Empire Medical Group IPA, said that physicians who enter capitated contracts halfway often see their revenues decline. "We've had several physicians who start taking capitation and after the first year, they drop out," he explained. "If you enter capitation in a very slow fashion, you're going to look back at your numbers on a monthly or yearly basis and wonder why you're doing it."

According to Steven Shufro, who works with practices affiliated with Harvard Community Health Plan and Lahey Clinic, physicians who embrace capitation too slowly may find that they have too many sick patients in their care. If even one or two capitated patients in a group of 50 became ill, for example, a practice could find itself spending more to care for those patients than it receives in capitated fees for the entire group. "When you're dealing with smaller patient populations," Mr. Shufro explained, "any little factor can blow you out of the water."

Patient mix

To avoid spending more on patients than they receive in capitated fees, physicians need to look to demographic factors--like age and sex--of their patient population to predict how many medical services patients will use.

Actuarial research shows, for example, that infants less than a year old generally use almost 1.5 times as much care as an average patient. And while males age 20 to 29 use almost half as many medical services as the average patient, females in the same age group use about 1.2 times as many services, primarily because they are in their main childbearing years. Not surprisingly, Medicare patients on the average use almost twice as many medical services as younger patients.

So how do you know what type of patient mix to expect? If your payer has implemented capitated compensation, start by asking for detailed information on its patient population during negotiations. Will you care primarily for younger families with children and teenagers who won't use many services, or older working adults who typically require more care? Ask for statistics indicating how many services the payer's population typically uses based on past records; this will give you detailed information about how many services you can expect to provide and the capitation rate you'll need to survive.

Since you can't typically control which or how many patients you will see from an HMO, you need to make sure that the per member, per month fee you agree to will suffice to cover the sick and the healthy patients. Otherwise, you may find yourself losing money on a contract.

Beth Freeman, a practice consultant from Union, Miss., worked with one practice that had agreed to accept a per member, per month fee to care for a broad range of patients. When the practice began losing money on the contract, it discovered that it was seeing far fewer pediatric patients than expected. Ms. Freeman explained that because providing care for adults is more costly than caring for pediatric patients, the practice took a financial hit.

What can a practice do in such situations? Mr. Merlino, the Seattle consultant, suggests going back to the payer and trying to renegotiate the capitation rate, but only if you can show that the patient population you are treating is different from the one you were promised. Dr. Anton, on the other hand, said that his practice has at times temporarily stopped accepting new Medicare patients to attract younger patients who use fewer resources and often provide significantly more income. (He noted, though, that some of the most profitable capitated contracts are being offered by Medicare HMOs.)

But one of the best solutions, according to Ms. Freeman, is to request a per member, per month capitation fee that reflects each patient's age and sex. Instead of paying the same flat rate for every patient, she said, some payers are giving physicians fees that are age- and sex-sensitive. A 55-year-old woman, for example, would probably carry a higher capitated fee than a 29-year-old man.

Reducing the financial risk

Finally, physicians need to limit their financial liability when dealing with patients who become critically ill. A single patient who requires months of hospitalization is enough to break the bank of even a large group practice.

The solution is to buy reinsurance, also known as stop-loss insurance. Reinsurance puts a limit on physicians' financial liability for critically ill patients; once the patient's care exceeds a certain dollar limit, the insurer (often the payer) picks up the tab.

Ms. Freeman compared reinsurance to the deductible on an automobile insurance policy. "When you buy your car insurance, you're saying, 'How lucky do I feel? Do I want the $250 deductible or the $1,000 deductible?' This is exactly what you're doing with reinsurance, except you're saying, 'Do I want the stop-loss at $7,500 for my Medicare patients or at $15,000?' "

Experts say you can expect to pay about $1.50 per patient per month for this type of insurance, depending on the type of patient (old or young) and how high you set the financial liability. And while giving up more than one dollar of a $10 to $15 monthly fee might be hard to swallow, Ms. Freeman deemed it necessary, particularly for physicians caring for Medicare patients. As a rule of thumb, she explained, you can expect two of every 1,000 non-Medicare patients to need reinsurance, and that figure will only be higher for Medicare. "In Medicare contracting, you definitely have to have some kind of reinsurance," she said.

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