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

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Amid tough times with capitation, doctors struggle to balance risk

From the May 2000 ACP-ASIM Observer, copyright © 2000 by the American College of Physicians-American Society of Internal Medicine.

By Phyllis Maguire

Throughout the early 1990s, Bristol Park Medical Group Inc. thrived on risk contracts. The 100-physician practice in Orange County, Calif., was a pioneer in capitation, taking risk for 70% of its 145,000 managed care patients. The group enjoyed hefty profits and increased its patient base some years by as much as 40%.

But between 1994 and 1998, the boom times came to an end. Capitated payments slid 12%, triggering huge losses in 1998 and 1999. Bristol Park was forced to cut back on the services it offered and lay off several physicians, as well as an entire department of nurse practitioners. Patient complaints, which had been rare, began to soar.

This year, however, the group appears to be poised for a turnaround. Capitation rates are back to 1994 levels, largely because Bristol Park banded together with several other medical groups to form a management services organization (MSO) that has been able to negotiate much better rates. The group expects its strategy of consolidation to put it back in the black as early as next year.

While Bristol Park's financial troubles have been severe, they are far from unique among physician organizations taking risk. While managing risk has never been easy, physicians in both small practices and giant independent practice associations (IPAs) say that turning a profit from risk is increasingly difficult. Reimbursement cuts, combined with rising costs of drugs and hospital services, are putting new pressures on physicians who take risk. In some cases, those forces have helped put practices out of business.

Despite such problems, physician groups like Bristol Park are finding new ways to make risk work. Because they view capitation as the only realistic way to profit from managed care, they are fine-tuning their business strategies and their practices so they can continue to take risk.

Reassessing risk

In the 1990s, analysts and physicians alike claimed that the only way physicians could survive managed care was by assuming financial risk for patient care. Physicians could do a better job than insurance companies of managing care, the thinking went, so why should insurers keep all of the profits? Doctors and hospitals rushed to join physician hospital organizations, link up with integrated delivery systems and sell out to physician practice management companies (PPMCs), in large part to help negotiate and manage risk.

When it comes to global risk, however, where physicians take risk for their own services as well as other aspects of care like hospitalization and drugs, that thinking has not panned out. In competitive markets like southern California, a number of large physician groups have gone bankrupt, in part because of problems they had managing global risk.

Yet even as global risk falls out of favor in some markets, professional risk--where physicians are capitated for their own services--is on the rise. According to Medical Economics magazine, 69% of internists in 1998 accepted some form of professional capitation, up from 62% in 1996. That survey also found that capitated contracts accounted for 18% of general internists' gross income in 1998, a jump from 10% two years before.

Professional risk is also becoming more common for subspecialists. According to a survey from National Health Information (NHI), an Atlanta-based health care information publisher, the percentage of total subspecialist revenues from capitation in 1999 was 17.8%, a jump of almost 9% from the year before.

But those figures don't tell the whole story. While the number of physicians taking capitation is growing, their payments are not. From 1998 to 1999, primary care capitation rates dropped 9%, according to NHI survey results. Only 34% of all physicians in 1999 reported profits from capitated contracts, down from 42% in 1998 and 52% in 1997.

Subspecialists aren't faring much better. While 11 subspecialties--including oncology/hematology and allergy--saw higher capitation rates in 1999, 17 other subspecialties watched their rates drop. They included cardiology, infectious diseases, rheumatology, endocrinology and pulmonology. While half the surveyed subspecialists say they broke even on capitated contracts in 1999, 29% lost money.

There are several reasons that profitability has suffered. For one, HMOs hell-bent on market share gave employers cut-rate premiums--and ratcheted down physician fees. Many medical groups and IPAs bought into the flawed notion that accepting bargain-basement rates was one way to boost enrollment. As a result, many physicians signed risk contracts that were shaped more by market pressures than by their actual costs.

Coping mechanisms

Analysts cautiously agree, however, that the worst of the slump in capitation may be over and that capitated payments are becoming more competitive. They claim that capitation rates may have bottomed out and are on the rise again; NHI figures, for example, predict that capitation will rise 4% this year.

Even during the dark years of capitation, many practices decided to stick with risk. Physicians in competitive markets had few other options because fee-for-service medicine was disappearing in their areas. Groups like Bristol Park, however, remain committed to the idea of taking risk for different reasons. With capitation, they claim, comes more autonomy and better cash flow, as checks arrive on a set schedule instead of languishing for months as unpaid claims. They would rather fight for better capitated rates than return to fee-for-service.

"I believe in risk as the right way to practice medicine," said Bristol Park's medical director Andrew P. Siskind, FACP. "It's been underfunded, but that has nothing to do with the concept of capitation. I think that it is the only type of medicine where the incentives are aligned correctly so that the healthier you keep a patient, the more money you make."

To cope with lackluster capitated rates, many practices are looking to strength in numbers. The MSO that Bristol Park formed with three other medical groups, for example, now represents 450,000 patients, or roughly one-third of the Orange County market. That kind of market share gives physicians much more muscle when bargaining with mammoth health plans and employer groups, and it has convinced Dr. Siskind that "size in a geographic area" is the key to succeeding at risk.

Dr. Siskind said that in areas of the country like southern California, where competition is fierce because of the presence of managed care, market dominance is a medical group's only hope of survival. "Everyone has got to be in one of maybe three major systems," Dr. Siskind said. "You either have to join or fall."

Even in markets where competition is not so cutthroat, physicians are finding success banding together to negotiate not just better capitation fees, but also better risk arrangements. For instance, cardiologists in Denver, as well as orthopedic surgeons, united to campaign against the third-party administrator being used by United HealthCare of Colorado for its subspecialty capitation program. Physicians claimed that inadequate data and late payments were making it impossible to manage risk contracts tightly enough to turn a profit.

After six months of meetings, the physicians convinced United earlier this year to fire its third-party administrator and put the administrative fees into a risk pool for physicians. They also persuaded United to abandon episode-of-care payments—a flat fee for all subspecialist services performed in a certain period of time—and to adopt capitation rates based on Medicare's resource-based relative value scale, which are more lucrative for the physicians.

Tighter management

To help make risk contracting more profitable, practices are also experimenting with ways to better manage their practices. New West Physicians in Lakewood, Colo., a group with 75 primary care physicians, is one of the few risk-bearing medical groups still standing in the Denver area. The group takes full professional risk and varying levels of shared risk for both hospital and pharmacy for 45,000 commercial patients and 10,000 Medicare patients.

The group has a dedicated internal medicine rounding team of physicians and registered nurses for its hospitalized patients. It relies on a formulary that has helped it achieve surpluses in its commercial pharmacy risk, an almost unheard of feat. And it conducts weekly peer review meetings to discuss ways in which physicians can achieve better utilization.

Despite those efforts, New West lost money last year. It survived, however, because of its tight management in another area: fiscal reserves.

When the group began taking risk in 1994, it held fast to a policy of saving 10% of its bonus dollars. In some years, that strategy meant that individual physicians gave up about $10,000 of bonus income, according to Kenneth R. Cohen, FACP, New West's medical director. When times got tough and other risk-bearing medical groups in the area went under, the practice survived. Now, with capitation rates slowly climbing again, the group has almost replenished the reserves it depleted.

Saving for a rainy day might sound like an obvious strategy, but it's one that many practices fail to use. Health care groups are notorious for spending every cent earned, sometimes on large physician bonuses.

The issue has come under close scrutiny in states where high-profile HMO and PPMC failures have forced states to rescue patients left without coverage and to compensate physicians for unpaid bills. New reserve and solvency requirements for HMOs—as well as for risk-bearing physician organizations—are now being considered in New Jersey, California, Illinois, Texas, New York and Florida.

Requiring reserves for physician groups that take risk is controversial. On the one hand, evidence from groups like New West highlights the fact that reserves can save medical groups during low points of insurance cycles. At the same time, however, some analysts claim that too stringent reserve or solvency requirements will impede physicians' ability to enter into risk arrangements and further isolate independent physicians.

'Blending' risk

While medical societies and trade associations argue those issues with state regulators and legislators, some IPAs are trying another tack and putting their efforts into finding new ways to adjust risk for patients' severity of illness.

Internists have always had more trouble profiting from risk contracts; while they tend to provide a broader range of medical services to patients than family physicians, they typically receive the same per-member per-month fee. Internists argue that capitated fees should be adjusted for illness severity to make payments more fair, but health plans continue to pay one rate to all primary care physicians.

To address those concerns, some IPAs are changing their payment method and turning to what is known as blended capitation, a mix of per-member per-month rates and fee-for-service, to pay primary care physicians.

A case in point is New Century Health Quality Alliance Inc., a multispecialty IPA in the greater Kansas City area. The group recently posted a profit from its first year of full professional risk and partial risk for pharmacy and hospital services for 10,000 patients.

The group's primary care physicians receive capitation, but they also receive fee-for-service payments for "excluded" procedures like immunizations, colonoscopies and echocardiograms. According to executive director and president Elizabeth M. Gallup, MD, the group wanted a payment mechanism that wasn't "inequitable among the family physicians, the pediatricians and the internists." She said that blended capitation gives primary care physicians an incentive to perform more procedures without penalizing them for caring for sicker patients.

Over the next several years, Medicare HMOs are expected to phase in a similar approach to adjust fees for illness severity. Experts predict that if Medicare can successfully tackle the issue, state-based and commercial plans may follow.

It remains to be seen whether legislation and public policy will help or hurt physicians' ability to manage risk. For now, practices that have risk experience have learned to use another key strategy: walking away from deals that are not profitable.

Last month, for example, New West Physicians in Colorado refused to renew a contract with PacifiCare Health Systems, a strategy more and more physician organizations are using when faced with unacceptable rates or risk arrangements. According to Ruth N. Benton, MBA, New West's chief executive officer, PacifiCare last year expected physicians to use 200 days of inpatient care for every thousand patients. When the group brought that figure down to 166 days and pocketed the savings, the health plan wanted to negotiate a new utilization target: 145 days.

Ms. Benton said that she bluntly told the health plan that the negotiations were over—unless the plan could come back with more reasonable terms. "This group is not in the business of doing charity care for insurance companies that make money," she said.


Scrutiny grows as more physicians mix money and care

Do risk arrangements that involve financial incentives constitute a breach of physicians' fiduciary and ethical duties? As the number of physicians accepting risk rises, that question is being raised by a growing number of physicians—and in the courts.

According to a study in the March 13 Archives of Internal Medicine, a majority of physicians find capitation ethically suspect. Less than 20% of the physicians surveyed found financial incentives that could limit services "ethically acceptable."

One physician who shares that view is Harlan Levine, ACP­ASIM Member, president and chief executive officer of Logic Health Systems, a division of the Los Angeles-based Salick Health Care Inc., an oncology disease management and managed care company. While Dr. Levine has worked under capitated contracts in the past, his company no longer accepts capitation.

"It is a difficult situation when you put the people who are actually taking care of the patient in the position of watching the budget and being directly impacted by how they do," Dr. Levine said. "We want people to use our services because we can do the right thing and save money, not because we restrict care."

Some proponents of capitation agree and say that they have taken steps to limit such conflicts. Andrew P. Siskind, FACP, medical director of Bristol Park Medical Group Inc. in Orange County, Calif., calls himself "a total, 100% believer" in full risk. Yet he is quick to point out that while the group gets capitated payments, individual physicians do not. Instead, they are paid according to a productivity and quality formula.

"We even shy away from subcapitating specialists," Dr. Siskind said. "It brings the physician too close to the dollar, and we don't like that."

Several courts have been asked to decide when and if financial incentives—which are at the core of risk contracts—constitute a breach of physicians' fiduciary duty. Class action suits contend that physician financial incentives violate antiracketeering laws, and while more than a dozen states now require health plans to disclose financial incentives to enrollees, cases now being argued may lead to broader disclosure requirements for physicians.

There are other new developments. A settlement reached last month between Aetna U.S. Healthcare and the Texas attorney general allows physician groups in the state to opt out of capitation if they care for fewer than 100 Aetna HMO patients. According to the settlement, Aetna also agrees to define capitation for its members in all of its enrollment materials.

While some physicians applaud a move away from capitation, others point out that patients need to be made aware that risk can translate to cost-effectiveness. "We will gladly abandon the ethical dilemma and exit the risk-contracting business, but the unfortunate consequence will be a very steep rise in medical costs that will be borne by patients," said Kenneth R. Cohen, FACP, medical director of New West Physicians in Lakewood, Colo. "The real dilemma is how to balance cost-effectiveness with patients' willingness to bear increased costs if they want to see risk contracting go away."

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