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The Wonder Drug of Capitation by J.D. Kleinke

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Excerpted from Bleeding Edge: The Business of Health Care in the New Century by J.D. Kleinke. Copyright 1998, Aspen Publishing Inc., Gaithersburg, MD. Reprinted with permission.
The source of capitation's greatest strengths--and its greatest peril--is the immutable fact that this type of reimbursement carries with it all the economics, risks, and rewards of insurance. This simple fact is the axis upon which the entire restructuring of the health care system will turn as it moves into the new century: it explains why providers need to consolidate (to pool risk and reduce financial exposure); integrate (to offer the lowest cost settings); and industrialize (to reduce costs and improve predictability).

A capitation payment to a group of providers is an insurance premium and it is meant to cover the entire insured population. A small minority of patients in the capitated population will require far more care than the fixed payment amount covers, and providers are obliged to deliver that care without additional payment. But that care is subsidized by the capitated payments banked by the providers for all the other patients in the population who require little or no care. Capitation is the logical endpoint of a system that will fix its underlying economic problem only when it has shifted all of its health: insurance risk fully onto providers.

Under capitation, a hospital's and physician's entire income is based on their success in keeping patients healthy, rather than on maximizing the number of medical services delivered to those patients. As a consequence, capitation turns a number of key aspects of health care delivery inside out:

· the least busy physicians and emptiest hospitals are the most profitable ones;

· excessive or unnecessary interventions cost the physicians and the hospitals money, not the patient or the payer;

· expensive medical technologies are liabilities to be used judiciously to minimize costs, not assets to be exploited to maximize fee-for-service reimbursements; and

· physicians and hospitals readily provide their own utilization management....

Though capitation was not widely put into practice until the early 1990s, its clearly superior economics have a snowball effect on any given market, and thus on the health care system in general. Once introduced into a market, few groups of physicians or hospitals can compete on something as old-fashioned as price with those willing to assume all medical/financial risk. Why? Because under capitation, all the resource consumption patterns (i.e., the 70 to 90 percent total health care costs that physicians control) change radically. Physicians under full capitation manage patients better, hospitalize them less often, and ultimately allocate total medical resources more efficiently. A landmark New England Journal of Medicine study of capitation in California found that between 1990 and 1994, the number of MCO enrollees covered under capitation increased 91 percent. In 1993, near the end of this period, the authors calculated that the number of inpatient days per 1,000 non-Medicare enrollees among the capitated groups ranged from 120 to 149 days, versus 232 for all of California and 297 for the total United States.[1]

With total hospitalization days running at half the rate, capitation sets up a medical cost downdraft that rushes through entire markets. In order to compete in such markets, all providers are compelled to convert to capitation, often in one or two insurance purchasing cycles. As a result, more than half of organized physician networks around the United States now compensate their physicians through some form of capitation.[2] And those are the organized networks. As for the entire universe of physicians, 81 percent expect to accept capitated patients by the year 2000.[3] Those who already do accept them anticipate that half their practice revenues will be derived from capitation.[4]

The Greedy Docs Who Keep Their Patients Healthy

The use of capitation removes all the clumsiness, inefficiency, and antagonism inherent in the three ring circus typical of providers, patients, and "utilization managers" in traditional managed care settings. Pushing all the financial risk and associated medical responsibility for an insured population past the MCOs and squarely onto hospitals and physicians greatly simplifies the process of "managing care," rendering the phrase a long overdue redundancy. Most importantly, capitation aligns the incentives of providers with those of patients. Under capitation, physicians and hospitals

· have a heavily vested interest in maintaining the health, rather than treating the illnesses, of their capitated patients;

· are forced to balance profit-seeking behavior and the clinical needs of patients; and

· are finally required to act like all other free-market producers of goods, motivated to focus not only on maximizing revenues, which they have done with abandon in the past, but also on the cost of goods sold.

Critics of capitation argue that the system introduces a new economic tension into the relationship between providers and patients. They claim that capitation forces physicians and hospitals to choose between their own financial enrichment and the health of their patients, introducing an insurmountable conflict of interest into the health care system. Under capitation, they argue, the foxes are guarding the henhouse.

This is a knee-jerk reaction, borne of a naiveté jolted from its ignorance over the reality of fee-for-service medicine. How exactly is capitation's conflict of interest any different from its inversion? How is the physician who, under fee-for-service, is paid handsomely for performing a surgery, not subject to the same conflict of interest when making the decision to operate or not operate? The reality is there is no difference whatsoever. It is simply a reworking of an unchanging equation; with the plus and minus dollar signs on either side reversed, the other variable--namely utilization--moves in the opposite direction, and total health care costs are reduced....

Capitation is scandalous because it is new, and because it questions our faith in the purity of medical science and the motives of our personal physicians. Capitation forces people to confront the reality that physicians are self-interested economic agents, just like the rest of us and that perhaps a lifetime of our own medical care may have been delivered to us only because we had the ability to pay and not because of the dedication of "our" physicians to us personally. But the fears embodied in such criticism--primarily those of patient underdiagnosis, undertreatment, and neglect--are groundless. The medical malpractice community has, since the 1950s, provided the nation's health care consumers with vigilant service in the fight [against what it alone managed to identify as the teeming and widespread incompetence of physicians. These lawyers will no doubt prove even more effective in defending patients against capitated physicians who fail to provide needed care, given the legal profession's general familiarity with self-serving economic motives.

As the specter of professional liability and, failing that, professional conscience police against the withholding of needed patient care under capitation, even better safeguards exist with the long- term financial interest inherent in the capitation system itself. Herein lies the purest elegance of capitation as an economic tool. A capitated hospital that prematurely discharges a patient to improve its own profit on that patient will lose this profit many times over when the patient returns with complications associated with the premature discharge. If the patient does not re-admit, then the discharge, however inconvenient or unpleasant, was obviously not medically premature. Similarly, capitated physicians who line their pockets by denying needed treatment to sick people under their capitated care will be contractually obligated to treat those people when they become very sick. Under capitation, the foxes may be guarding the henhouse but they are also responsible for egg production.

The public policy debate notwithstanding, capitation is the system that the market--no longer tolerant of runaway health costs-- clearly wants. Not only does this explain why managed care uses capitation aggressively to isolate and predict its medical costs; it describes the very origins of managed care as an organization. The original concept of the MCO is based on the principle of capitation: it theorizes that an organization designed specifically to maintain people's health will be able to resolve all the medical needs of a population for a fixed fee per member; it also theorizes that the organizations that do so effectively will earn a profit for their efforts.[5]

[1] J. Robinson and L. Casalino, "The Growth of Medical Groups Paid through Capitation in California," New England Journal of Medicine, 21 December 1995, 1684.

[2] H. Brown and R. Shinto, "Making Physicians Networks Work," Health Care Strategic Management, April 1996, 22.

[3] Survey conducted by Evergreen Re and reported in Modern health care, 5 January, 1998, 50.

[4] Survey, Modern health care, 50.

[5] P. Starr, The Social Transformation of American Medicine (New York: Basic Books/HarperCollins, 1982), 395.

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