How Capitation in Healthcare Works

Capitation is a type of healthcare payment system in which a physician or hospital is paid a fixed amount per patient for a prescribed period by an insurer or physician association. The cost is based on the expected healthcare utilization costs for a group of patients for that year.

With capitation, the physician—otherwise known as the primary care physician (PCP)— is paid a set amount for each enrolled patient whether a patient seeks care or not. The PCP is usually contracted with a health maintenance organization (HMO) whose role it is to recruit patients.

This article explains how capitation works, including the different capitation models used in healthcare. It also lists the pros and cons of capitation and how it affects you as an individual.

How Does Capitation Work?

Capitation payments are those agreed upon by contract with an HMO or a business entity of independent physicians called an independent practice association (IPA).

Capitations are fixed monthly payments received by a physician, hospital, or clinic per member enrolled in a health plan. The monthly payment is calculated one year in advance and remains fixed regardless of how often a member accesses services.

Capitation payments are calculated based on the local costs and average utilization of services in that area. Because of this, the remuneration (payment for services) can vary from one state or city to the next.

The amount of the capitation is also influenced by the number of services that an HMO or IPA chooses to provide its members, including:

• Diagnostic and treatment service
• Preventive services
• Immunizations
• Healthcare screening
• Counseling and therapy
• Telehealth services
• Vision and hearing benefits

In some cases, a separate capitation fee may be provided for "extra" services (like screenings or tests) that the physician can draw upon when needed. Other plans allow physicians to charge a fee for the "extra" service at a discounted rate.

Capitation by Risk Pool

Capitation can also be based on "risk pools." These are the groups of individuals whose medical costs are combined to calculate premiums. The risk is based on an evaluation by a financial analyst known as an actuary.

Conceptually, larger risk pools have lower utilization costs because the risk is spread between many members. However, this is not always the case as some groups, such as those with an older population, utilize healthcare much more.

If the capitation is based on a high-risk pool, the HMO or IPA may offer incentives to physicians or hospitals to keep their members healthy.

In such cases, an agreed amount of money may be withheld until the end of the fiscal year and only released if the total amount spent by the HMO or IPA falls beneath a certain threshold. If it does not, some or all of the money may be kept to pay the excess amount.

Examples of Healthcare Capitation

An example of capitation is an HMO that negotiates a fee of $500 per year per member with an approved PCP. For an HMO group comprised of 1,000 members, the PCP would be paid $500,000 per year and, in return, be expected to supply all authorized medical services to those members for that year.

If an individual patient utilizes $2,000 worth of healthcare services, the practice would end up losing $1,500 on that patient. On the other hand, if someone uses only $10 worth of healthcare services, the practice would stand to make a profit of $490.

Projected profitability is ultimately based on how much healthcare the group is likely to need. Given that older people with pre-existing conditions will be often mixed with younger and healthier people, the project profits can differ considerably from the actual profit.

There are primary and secondary capitation payments:

• Primary capitation is when the PCP is paid directly by the HMO or IPA.
• Secondary capitation is when a secondary in-network provider (like a lab or specialist) is paid out of the PCP's funds.

Another form of capitation will reward PCPs for preventing illness. In this model, the PCP may offer more preventive health screenings and services to avoid more expensive medical procedures. This model is more common in PCPs who manage high-risk pools.

Benefits of a Capitation System

The groups most likely to benefit from a healthcare capitation system are the HMOs and IPAs. It does so by discouraging PCPs from providing more care than is necessary or using costly procedures that may be no more effective than less costly ones. It alleviates the risk of excessive billing for procedures that may or may not be necessary.

The chief benefit to PCPs is the decreased costs of bookkeeping. A contracted PCP does not need to maintain a larger billing staff. It also doesn't have to wait to be reimbursed for its services. Alleviating these costs can allow a practice to treat more patients at a lower overall operating expense.

The main benefit to patients is the avoidance of unnecessary and often time-consuming procedures that may trigger high out-of-pocket expenses.

Some argue that capitation is a more cost-efficient and responsible healthcare model, and there is some evidence to support the claim.

A 2022 study in BMC Health Service Research looked at indicators of health such as high blood pressure, diabetes, and chronic kidney disease and found no difference in outcomes between physicians who operate on a fee-for-service basis and those who are reimbursed by capitation.

Drawbacks of a Capitation System

One of the main concerns about healthcare capitation is that it incentivizes PCPs to enroll as many patients as possible, leaving less and less time to see them.

While capitation can help prevent premiums from skyrocketing by discouraging excessive spending, it may do so to the detriment of the individual patient. It is not unusual, for example, to hear how HMO appointments can last no more than a few minutes or how physicians offer diagnoses without ever touching a patient.

To increase profitability, a practice may institute policies that exclude procedures to which the patient may be entitled. This is called "healthcare rationing," a practice in which access to essential health services is restricted due to budgetary constraints or policies. In this instance, the only person who truly suffers is the patient.

Some researchers warn that while capitation can improve margins for insurers, this doesn't translate to improvement in the range or quality of benefits offered to members. While this doesn't necessarily mean that the services are inadequate, it also doesn't suggest that the capitation model is "better" than the traditional fee-for-service insurance model.

Summary

Capitation is a method of payment in which a physician or hospital is paid an annual fixed fee upfront to provide primary healthcare services to a group of patients for that year. The capitation payment is based on local costs and the projected healthcare expenditure for that group or area.

Benefits of capitation include simplified billing for the physician and the avoidance of unnecessary tests or procedures for the patient. Drawbacks include shorter visits and fewer member benefits as physicians are encouraged to enroll as many members as possible while keeping costs down.