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Health-Care Capitation: What Goes Around, Comes Around

By Gerald J. Archibald


“Necessity is the mother of invention.”  — Anonymous

Back in 1996, when I was young and optimistic, I wrote a column about the evils and “benefits” of health-care “capitation” in a “managed-care” model. This column will prove, once again, that “what goes around, comes around.” And, not always with desirable results. Read on.

First, a definition: capitation is the transfer of financial risk from the payer (government/insurer) to the health-care provider. Capitation = insurance risk. Some providers refer to it as “decapitation.” 

Our nation has three large industries in various stages of major reform or restructuring. Health care, education, and government represent a significant component of our gross national product. Each of these industries now follows in the footsteps of those that have gone before: automotive, banking, communications, airlines, manufacturing, technology, and retailing, to name a few.

Unlike these other industries, however, health care, education, and government are comprised of largely nonprofit entities. And we now have both government and health-care payers embracing the capitation contract model for purposes of controlling/reducing health-care and human-service delivery costs.

Still, there are two common underpinnings to the process of restructuring and reform in any industry. Advancements in technology create opportunities for significant labor and cost efficiencies. And basic economic principles of supply and demand create the market forces in which productive, cost-effective service providers will be successful.

As Lee Iacocca, former chairman of Chrysler Corp., said in one of his famous television ads, “In this business, you need to lead, follow, or get out of the way.”

Our community is not immune to any of these changes. Of the three industries mentioned above, the health-care industry is furthest along in the process of reform and restructuring. The industry is filled with technological advances and discoveries that affect providers on a daily basis. Shifts in supply and demand for health-care services create an environment in which change is a constant: Hospitals and nursing homes closing, home and hospice care increasing exponentially. 

Much of the change in health and human-service care delivery systems is being prompted by the people of our nation having accepted a health-care services concept known as managed care. Managed care is a system of health-care delivery and financing structured to encourage preventive and primary care through review and reimbursement methodologies that make service providers accountable for the health status of their patients and for the utilization of health-care services. The expected advantage is more efficient and reduced cost of care, which equals lower insurance premiums. You may find the preceding statement surprising, since it hasn’t worked out, according to plan, in most cases.

At the federal level, the basic foundation of the Patient Protection and Affordable Care Act (also called “Obamacare”) adopts these principles. In the legislation, the formation of an “Accountable Care Organization” by health-care providers traces its roots to managed-care principles.

Now, the state Health Department and its human-services department are moving aggressively towards the formation of Health Homes for Medicaid recipients. Most recently, Medicaid services for the mental health, substance abuse, and developmentally disabled population are being forced, dragged, or driven into managed-care models. The provider attitude towards these changes is varied depending upon whether the changes represent a “win” (i.e., more revenue) or a “loss (fewer billable services or lower reimbursement rates) for the organization.

After three decades of managed-care models failing to control the rapid increase in health-care costs, the federal and state governments are convinced that managed-care principles will work, this time in spite of the 50 million uninsured Americans, nearly 9 percent unemployment, and most employers trying to figure out a way to pay less for health care. Now, believe it or not, Mr. Ripley, our most vulnerable populations are being thrown into the magic fountain of managed care. Medicaid recipients with substance abuse, mental health, and developmental disabilities, not to mention the elderly, are now a key component of the Grand Government Managed Care Experiment.

I will be the first to acknowledge, as a fiscal conservative, that something needs to be done. I fear, however, that our most vulnerable populations will be subjected to rationing, access issues, reduced quality of care, and ultimately some avoidable deaths under the guise of managed care.

The managed-care industry traces its roots back to the early part of last century. In its earliest form, managed-care plans were prepaid health plans. That is, you or your employer paid a predetermined amount each month for health-care services provided by a predetermined network of health-care providers. These managed care plans were viewed as offering the potential for being more cost-effective.

The managed-care movement was a relatively small, specialty niche of the health-care delivery system until the early 1970s, when the federal government embraced managed-care concepts through legislation. The Federal HMO Act created the legislative vehicle through which managed-care insurance plans known as health-maintenance organizations were established.

As is often the case, one of the driving forces in support of this legislation was the need for government to control rapidly rising health-care costs. The managed-care insurance industry was provided with the kick-start it needed for growth and expansion. From these small beginnings, we now have an industry that will encompass both health and chronic-care services for the vast majority of Medicaid recipients. 

Medicare at the federal level, and Medicaid at the state level, have each embraced the managed-care concept in order to create cost-effective delivery systems for their government-sponsored program participants.

Most Americans now either purchase their health-care services through their employer or have it provided by a government-sponsored program like Medicare or Medicaid. This consolidation of the buying group of consumers creates a strong and powerful negotiating position for government and health-insurance companies that must contract with hospitals, human-service providers, and physicians to provide services to you and me.

By applying managed-care principles, these vulnerable Medicaid populations at the state level are being “controlled” or “managed” by new initiatives under the auspices of:

- Behavioral Health Organizations (BHOs) — most often an insurance company in sheep’s clothing, monitoring services to the mental health and substance-abuse populations.

- Developmental Disability Individual Service Care Organizations (DISCOs) — most often a joint effort of service providers with a managed-care organization (MCO) to monitor, coordinate, and control care and access.

BHOs and DISCOs are a variation on the original managed-care products we all know by name, PHP/MVP.

Consolidation of purchasing power has created a significant opportunity for innovative shifts in financial risk between insurance companies and health-care providers. Since the 1960s, both insurance companies and government have used a traditional fee-for-service/rate-regulated model when paying for hospital and physician services. With managed care, the popular notion has been to transfer some or all of the financial risk from insurance companies and government to the provider sector through the concept known as capitation, thus creating unregulated insurance companies out of provider groups. 

Capitation in its simplest terms is defined as a method of payment for health services in which a provider is paid a fixed amount for each insurance plan member served, regardless of the actual amount of services provided. Rates are generally calculated based on a per-member/per-month formula.

There are many forms of capitated-contract arrangements, including global capitation (all services), specific service capitation (e.g., emergency room visits), primary-care physician capitation, and specialty physician capitation. In any capitation contract, there is a transfer of financial risk from the buying group (insurance company or government) to the provider group (MCOs, BHOs, or DISCOs).

Capitation arrangements dramatically shift the incentives from a fee-for-service environment, where providers make more by doing more, to one in which they make more by doing less. It is this shift in financial risk and related incentives that creates the potential for profiting from restructuring the service delivery system and improving the productivity and efficiency of providers.

Unfortunately, as with any change in economic incentives, capitation also introduces an opportunity for abuse, primarily when necessary services are not provided in the interest or necessity of making a profit for the provider. Capitation-payment methodologies have a rather checkered history in the health-care industry as a result of these shifting, and often conflicting, financial incentives.

There are many instances where capitated-contract arrangements are very appropriate as a mechanism to controls costs and utilization of health and chronic-care services. In order to control the risks associated with capitation, legislative proposals likely will be adopted to address these issues. Among the issues that require specific regulatory or legislative definition: guidelines regarding a patient’s right to information; minimum numbers of patients to be covered under a capitated arrangement; access to care; authorization of services; and numerous issues related to the service provider-patient relationship.

The introduction of competitive-rate negotiation (i.e., capitation) in behavioral health, substance abuse, and disability services will also create an opportunity for for-profit care providers to establish a competitive advantage since their delivery networks are typically not burdened by excess capacity.

Our local health-care community has a long and generally successful history of cooperative community-based health-care planning. The sea change currently in process for mental health, substance abuse, and disability service providers creates an environment that will result in the restructuring of our delivery system for the most vulnerable members of our community. The question is whether a competitive model or a cooperative model will be used. We may need both in order to complete an effective restructuring for the most vulnerable among us.      


Gerald J. Archibald, CPA is a partner with The Bonadio Group. His office is in Syracuse. Contact him at or call (315) 422-7109.

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