Capitation, is a method of paying health care service providers (e.g., physicians or nurse practitioners) a set amount for each enrolled person assigned to that physician or group of physicians, whether or not that person seeks care, per period of time.
Generally these providers are contracted with a type of health maintenance organization (HMO) known as an independent practice association (IPA). The HMO contracts with the providers to have the latter take care of patients enrolled in the HMO. Most often, payment for such a service is under the capitation system.
The amount of remuneration is based on the average expected health care utilization of that patient (more remuneration for patients with significant medical history). Other factors considered include age, race, sex, type of employment, and geographical location, as these factors typically influence the cost of providing care.
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Under capitation, physicians are incentivized to consider the cost of treatment. This is unlike fee-for-service, where physicians have no incentive to consider cost. Pure capitation pays only a set fee per patient, regardless of sickness, giving physicians an incentive to avoid the most costly patients.[1]
Providers who work under these plans focus on preventive health care as they will be financially rewarded more to keep a person from becoming ill than to treat them once they have become so.
Providers shift away from performing expensive, newly developed, and possibly less effective treatment options that may have only a marginally higher success rate than alternatives.
The financial risks providers accept in capitation are traditional insurance risks. Since providers have fixed revenues, each enrolled patient makes his/her claims against the full resources of the provider (the value of the capitation). Providers, in exchange for a fixed payment per enrolled client, agree to provide the unknown future benefits and to absorb the costs associated with clinical care. This shift means that the providers become the enrolled client's insurers, resolving claims for care in face-to-face interactions, at the point of care. Hence, capitation places health care providers in the role of micro-health insurers, assuming the responsibility for managing the unknown future health care costs of their patients [2][3][4][5][6]
Large providers tend to manage their health insurance risk assumption better than smaller providers in terms of the predictability of their costs because they are better prepared for variations in service demand and costs and in their overall liquidity. However, even large providers are very inefficient risk managers when compared with large insurers. Because providers tend to be small, compared with insurers, they are more like individual consumers, they tend to have annual costs that fluctuate far more than large insurers as a percentage of their annual cash flow.
For example, a capitated eye care program for 25,000 patients is more viable, in terms of insurance risk management, 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 very small number of costly, or outlier, patients will dramatically affect a capitated provider's overall costs, increasing the risk of provider 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 population costs for eye care (i.e. Their patient's costs) leaving them at a distinct financial disadvantage compared to large insurers whose estimates of the population average costs are far more accurate [2][4].
Because provider 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 relative inefficiency, when compared to that of the insurers', is far greater than can be mitigated by increases in their rosters. To be as efficient risk managers as the insurers from which they accept their risks, the providers would have to assume 100% of the insurer's portfolio.
Since the HMOs and insurance-risk-transferring insurers manage their costs better than risk-assuming healthcare providers, they cannot pay the providers risk-adjusted capitation payments without sacrificing profitability. In fact, the risk-transferring entities will only enter into such agreements if they can maintain the high levels of profits they can achieve by retaining risks [2][4].
Since HMOs, managed care organizations and insurers do not offer risk-adjusted capitation payments, providers cannot afford reinsurance because this would further deplete their inadequate capitation payments because re-insurer's expected loss costs, expenses, profits and risk loads must be paid by the providers. While the goal of reinsurance is to offload risk and reward to the re-insurer in return for more stable operating results, the provider's additional costs mitigate against reinsurance.
The myth of reinsurance is that it assumes that the insurance-risk-transferring entities are not inducing inefficiencies when they shift insurance risks to providers. Absent these induced inefficiencies, providers would be able to pass on a portion of their risk premiums to reinsurers. But the risk premiums that providers would have to receive would exceed the risk premiums that risk-transferring entities could charge in competitive insurance markets [2][3][6].
Re-insurers are wary of contracting with physicians due to the moral hazard problem since if providers think they will be able to collect more than they pay in premiums they would tend to revert to the same excesses encouraged by fee-for-service payment systems.