Healthcare provider reimbursement has been moving away from fee-for-service (FFS) payment and toward value-based care, where providers’ payments are tied to quality and performance rather than the volume of services performed. One form of value-based care used to achieve this is a capitation payment model.

This paper is a primer on capitation and explores some of the challenges that are unique to commercial health insurance lines of business.

What is capitation?

Capitation is a payment model involving fixed, predetermined monthly payments made for each enrolled patient attributed to a provider. Unlike other forms of provider payment, capitation payments are made to the provider regardless of whether the patient seeks care or not. Capitation allows front-end funds to be paid to providers for stability in revenue, funding of new infrastructure, and new patient management programs.

Capitation represents one of the highest degrees of risk transfer for providers, aside from starting their own insurance plan.

Figure 1: Continuum of risk for providers

Constructing and evaluating capitation rates requires knowledge of myriad assumptions, including estimated utilization rates, level of expected care management, implied payment rates, benefit plan designs, provider costs (both fixed and variable), healthcare cost trends, and, potentially, premium rate levels. Historical claim data is typically used as a starting point for developing capitation rates. The capitation rates are managed as a budget for providing care to patients. If the cost of care for a provider’s attributed patient panel is less than the budgeted amount, then the differential results in a greater payment yield and potential profit or surplus for the provider. But if the cost of care exceeds the budgeted amount, then the provider experiences a lower payment yield and a potential loss, as there would be no additional revenue beyond the negotiated capitation rate. Reinsurance can be used to manage the provider’s risk of unexpected costs, but the trade-off is lower expected profitability due to the cost of premiums paid to cede the risk to a reinsurer. Additionally, capitation agreements may use risk adjustment to pay differing rates according to the morbidity of the covered population. The members belonging to commercial insurance products are not homogenous and range from highly regulated individual products to large self-insured group products, with very different regulatory requirements. Including a mechanism to account for this diversity in the capitation rates can help providers with financial viability.

Capitation can have both positive and negative impacts for providers and payers. For providers, it improves financial stability through regularly recurring payments, has the potential to reduce operating expenses, and discourages excessive billing and more costly procedures, while encouraging them to avoid ordering unnecessary tests and procedures. However, because providers are responsible for managing their patient populations’ healthcare costs, the use of utilization management techniques should be weighed against the ability to maintain quality objectives. Providers must find the balance between meeting the needs of their patients while ensuring the right care is provided to the right patient at the right time to achieve the best quality outcome.

For commercial payers, a capitation model presents different challenges and rewards. In the same way capitation provides stable predictable revenue for providers, it provides predictable costs for payers as long as participating patient volumes do not fluctuate significantly. If providers are successful in managing patient costs and health outcomes, it may result in having or maintaining competitive premiums for their fully insured members as well as containing costs for self-funded employer groups, which assists in retaining existing business and acquiring new business. Challenges exist, however, in updating claim adjudication systems to accommodate a capitation payment arrangement, as it is different from FFS and other standard payment methodologies that have been in place for decades. This may also result in modifications that are needed for the member’s Explanation of Benefits (EOBs) as well as the provider’s payment remittance statements, which both indicate patient financial responsibility, provider write-off amounts, and payer payments toward services rendered. An alternative to modifying claim adjudication systems to accommodate new prospective capitation models is to allow claims to continue to be paid FFS and allow for a retrospective financial reconciliation on a determined timeframe.

Additional payer challenges exist with monitoring provider performance results and outcomes. While claim data is readily available for payers, other pertinent data elements (lab results, biometrics, etc.) may not be accessible without enhanced collaboration and data sharing with engaged providers. Depending on the quality measurements agreed upon between the provider and payer, additional information technology resources, such as access to electronic medical records, may be necessary to ensure the capitation model is achieving the goals set forth within the payer/provider contract. Because capitation decouples claim submission from payment, it is important for payers to anticipate the possibility that submitted claims under capitation may be less rigorous than under FFS. Payers should consider addressing data submission requirements in the capitation contract to avoid the challenges associated with less complete claim submissions. This is especially true when capitation is used for products that are materially impacted by the completeness of diagnosis codes for their members, e.g., individual and small group Patient Protection and Affordable Care Act (ACA) products.

What are the types of capitation?

Global: Full-risk global capitation models encompass all services provided. The provider is responsible for its attributed population’s total cost of care, including care from providers outside their organization.

Partial: Partial capitation models include only selected services. For example, a primary care capitation model may only include those services provided within that scope of service or clinic as opposed to the patient’s total cost of care, which would also include specialty and institutional services. Another example is when providers only choose to include a subset of procedures (e.g., office visits, lab tests) in the capitation model and allow all other procedures to continue to be paid FFS; this approach is similar to how some direct primary care (DPC) payment models have been designed.

Contact: Contact capitation begins payment to the provider upon the first contact with a patient (as opposed to beginning payment upon the start date of the capitation agreement). This differs from global or partial capitation as the provider does not receive a capitation payment for patients who do not utilize services.

What does a capitation amount represent?

The capitation amount generally represents the expected cost to provide healthcare services to the attributed patients and is often stated as a per member per month (PMPM) amount. There may be expected care management savings and/or explicit margin or some provision for adverse deviation included in the capitation amount, but in essence it represents a certain level of expected resource consumption at a certain level of price.

Capitation agreements should specify the services included in the monthly payment, which can be different based on the agreement with the payer. Preventive services, evaluation and management visits, medications and immunizations, lab tests, routine screenings, and other diagnostic services are often considered. It is equally important to identify services that are excluded from the capitation agreement, such as unavoidable high-cost events and occurrences that can skew patient costs such as transplants or rare genetic disorders.

The capitation PMPM amount is typically based on historical claim experience, considering a combination of utilization and the price of the services provided (where price may be based on a previously agreed-upon fee schedule between the provider and the payer). Depending on the contract terms, risk scores may be incorporated to adjust for differences in morbidity. The table in Figure 2 provides an example of how to construct a capitation rate starting point using historical claim data.

Figure 2: Using Historical Data as Starting Point for Capitation Rate Development

In Figure 2, the total patient-specific cost for the 12-month period is $480, or $40.00 PMPM ($480 divided by 12). From this starting point, assumptions about trend, care management efficiencies, and demographic and risk changes would be applied to develop a capitation rate for a future period. This is an actuarial exercise and can be considered through the concepts of frequency (”how often will something happen?”) and severity (”how much will it cost when it happens?”’). In this example, the units per period represent frequency and the unit price represents severity.

There are other ways of determining capitation amounts, such as a percentage of revenue arrangement, which is more common in Medicare Advantage (MA) plans. Another approach would be to leverage information about the provider’s fixed and variable costs, desired profit margins, and estimated utilization to develop the capitation rate from the "ground up."

Uniqueness of commercial capitation contracts

For MA and Managed Medicaid (MM) lines of business, the severity is largely fixed (using MA as an example, the unit price used in developing the capitation rate might deviate by a few percentage points around 100% of the Medicare payment). The assumed payment rate reflected by the capitation amount may be consistent with the existing fee schedule, and in this case, the capitation amount would essentially represent a prepayment of utilization. Said differently, the risk associated with MA or MM capitation is generally focused on the frequency side of the equation and may not involve an explicit reduction to the provider’s typical payment rates.

Unlike MA and MM lines of business, commercial lines of business typically exhibit significant differences in fee schedule amounts (both from the provider’s perspective and from the payer’s perspective). Commercial programs can have large variability based on factors such as: the relationship between the payer and the provider, the financial goals for both parties short-term and long-term, claim filing practices and any needed adjudication modifications, application of differing member benefits, coverage of services, rate filing requirements, medical policy implications, and the degree to which patient care best practices are followed.

Commercial lines of business can include products that have significant differences in the morbidity of the covered population and differing degrees of regulatory oversight. For example, the resource needs for a population enrolled in an individual product may be very different from a population enrolled in a large group product. Also, individual products are generally more regulated than large group products. It is important that the capitation contract specifies the included commercial products and the mechanism for accounting for differences in morbidity (e.g., age and sex factors, risk scores, etc.).

As revealed in recent efforts to study hospital price transparency files, providers typically maintain several different commercial prices and they might differ by double or triple (or more for a given service depending on the payer).¹ Therefore, when constructing and assessing capitation amounts for commercial lines of business, it is important to understand the anticipated utilization as well as the underlying payment rate, which may be benchmarked as a percentage of the Medicare fee schedule or may be a payer/provider-specific payment rate.

Do providers need additional protection?

Capitation models shift the risk from the payer to the provider so reinsurance or stop-loss protection may be a good consideration for providers to help mitigate the high costs associated with outlier patients. Reinsurance provides financial protection from catastrophic or other unexpected losses and can be tailored to the contract and the provider’s risk appetite to mitigate financial exposure. Reinsurance may be available from the payer or it could be obtained through a third-party reinsurer.

Conclusion

Capitation models are not one-size-fits-all solutions. Payers and providers have to meet each other’s tolerance levels for taking on risk, considering different phase-in models, managing patient costs, investing in needed changes in infrastructure to support the capitation design, and reporting financial and quality results in a meaningful, actionable, constructive way, all the while keeping patient care at the forefront. Providers accepting capitation rates should understand the actuarial nature of the agreement and be fully aware of the nature of the risk being transferred via the capitation arrangement.

Appendix: Commercial capitation contracting

Key points to consider:

• Covered services: Consider the ideal services to be included and excluded from the capitation payment, which can vary depending on the capitation model.
• Patient cost sharing: Consider the variety of patient cost-sharing options and their impact on the capitation rate. They can create the need for a more complicated capitation rate structure.
• Demographics: Some services vary significantly by age and gender, so consideration should be given to the mix of patients and whether an age/gender-based capitation rate is necessary.
• Population: Consider the mix of products within the line of business as there can be significant utilization differences for individual versus small group versus large group products.
• Types of providers included: Consider primary care versus specialty or institutional care as well as any provider-specific requirements, such as board certification or accreditation.
• Patient attribution: Knowing the attributed patient population that a provider or provider group is responsible for is critical, as it can lead to changes in care practices (i.e., patient outreach for preventive services, timely follow-up visits post-surgery, proactive disease management) that will impact performance results. In addition, knowing and understanding the logic used to attribute patients to providers is important. Whether it is prospective or retrospective, or to a single provider or multiple providers, this logic may influence the provider practice patterns.
• Triggers for entry and exit: Knowing the patients included and excluded from the capitation model will help in determining the steps to take to manage patient care.
• Performance measures and benchmarks: This is typically a negotiable area with commercial payers and is critically important as it impacts financial payouts and the ability to show performance improvement over time.
• Performance period: Historical periods and future performance periods for evaluation are important to negotiate with commercial payers, including any potential phase-in terms and risk-sharing arrangements that advance over time.
• Data sharing: Data and information reporting responsibilities on both the provider and payer play a key role in monitoring both cost and quality performance and measuring the financial results of the capitation model. Specific topics to consider when negotiating are the types of data to be furnished, the timeline for sharing data from both parties, and the ability to discuss the data results to determine next actions.
• Deadline for submitting quality data: Not all data elements can be pulled from submitted claims. Some data elements, such as biometrics or lab results, must be submitted by providers to payers to feed into performance measurement monitoring. Providers must ensure timely submission of these types of data elements to have the most accurate performance scores calculated.
• Right to audit provisions: Payers are often the reporting hub for developing and distributing performance information results. Providers need the ability to audit their own results to validate and ensure that the financials tied to performance results are adequate and accurate and do not rely solely on the payer’s analytical capabilities.
• Dispute resolution and appeals: When differences arise, providers need to have the ability within their contracts to challenge both cost and performance results with a clearly documented process to reach a consensus between both parties, which may involve an independent third party’s evaluation and review.
• Payment terms: Commercial payers have flexibility and negotiable payment terms when entering into capitation models. Terms can be tailored by the provider if negotiated properly. Important items to consider are financial risk levels (e.g., partial vs. global) as well as any implied payment rate reductions.
• Provider participation requirements: Certain items to consider when entering a capitation model with a commercial payer include: Are all providers in the practice eligible for participation? Does the payer have participation requirements (e.g., board certification, participation in a government program, the ability to submit quality data electronically)?
• Risk adjustment and methodology: Capitation rates will need to account for the morbidity of the attributed population. Demographic factors reflecting expected claim cost differences based on age and sex are common, and it’s possible that a commercial risk adjustor could be used to account for the specific disease burden of a population.
• Frequency of renegotiation: Consider the time period for renegotiation of terms, quality measures, and payment amounts. A good rule of thumb is to include a renegotiation clause to account for unexpected occurrences, such as the COVID-19 pandemic, and the impact these occurrences can have on financial stability and patient experiences and outcomes.

¹See https://www.nytimes.com/interactive/2021/08/22/upshot/hospital-prices.html?smid=em-share (subscription required).