Physician's Capitation Trend-'Float your own boat' by wise use of capitation arbitrage

Look beyond the contract's payment levels

When negotiating capitation contracts, physician groups often get so focused on the actual capitation payment amount that they forget other key factors that can affect their contract's viability just as much.

In particular, the following four elements play a critical role in capitation contracts and should be identified and negotiated to a practice's best benefit, even though they aren't as obvious on the contract's pages when you first study the proposal:

settlement interval;

withhold amount;

which party holds the withhold;

incurred but not reported (IBNR) expenses.

That's the recommendation of Andrew J. Sussman, MD, MBA, and colleagues at Brigham & Women's Physician Hospital Organization in Boston. Sussman is on a key managed care team with two other physicians and an administrator at Brigham & Women's Hospital, which is distinguishing itself as a leader in the scholarship and practice of capitation. (See article on a study conducted by another managed care team at Brigham & Women's Hospital to assess physician views of capitation, Physician's Managed Care Report, October 1999, pp. 153-154.) Sussman's team published an article on managed care negotiation strategies in a recent issue of the Westchester, IL-based Healthcare Financial Management Association's professional journal.1

Sussman recently spoke with PMCR regarding the four key contract elements listed above. Overall, the key here lies in an accounting term known as arbitrage, or in lay terms, "the float."

"We use the word 'arbitrage' rather loosely, but the notion is holding on to withhold dollars so that something is happening to the money while care is being provided," Sussman advises. "Who holds the money and for how long has an impact on overall performance outcome. It is superior to have control over those dollars prior to settling."

'Budgeted capitation' requires withholds

Sussman and his team are referring to a second generation of capitation models, which they call "budgeted capitation." First-generation capitation is the system wherein a physician simply contracts for a set per-member-per-month (PMPM) amount. In budgeted capitation, however, participants go a bit further by setting aside a withhold account in case payments for care go over or below projected levels. At various intervals, insurers then either pay back or get paid back, based on physician expenditures on patient care.

Here are the recommendations of Sussman and his team regarding these contractual elements (beyond PMPM amounts) for physicians engaged in budgeted capitation:

Settlement interval.

In some capitation contracts, a "settlement" process and the frequency of the settlements is agreed upon up front. Settlement refers to a pay-back to either the provider or the insurer of medical payments once expenses are covered.

For example, a contract may call for insurers to make regular, timely payments to providers. Then, at regular intervals — quarterly, semiannually, or annually — total medical expenses are compared with the capitation budget. If the insurer's expenditures for patient care exceed the amount budgeted via the capitation rate, the physician group pays back that excess amount to the insurer. If medical spending is less than the capitated amount, the insurer pays the difference to the physician group so the agreed-upon cap payment level is met. The difference in those two amounts represents the settlement and is paid on whatever interval schedule is negotiated in the contract.

Thus, there is a financial penalty for physicians if utilization drives expenditures beyond the forecasted level set by the capitation rate. By contrast, there is a financial gain for physicians if expenses are kept below the capitation payment level.

Focus on how often you settle up

But the key point here is less about the settlement amount than about the intervals at which the settlements are made. You might call it "capturing the float." Settlement intervals can have a major effect on the practice's cash flow, Sussman points out.

For example, a large integrated health system may provide inpatient care for 1,000 patients per week and receive payments of $6,000 per case. For each $6,000 payment, it may cost the practice $5,000 to cover patient expenses, leaving a $1,000 surplus per case. When the total $6 million payment is made to cover the whole system's cost, the organization has access to $5 million to cover their costs and $1 million for investment. Keep in mind that the $6,000 paid per patient is not paid immediately when the patient is treated; these payments can trickle in at varying times.

At settlement time, however, the insurer will compare claims paid with the capitation amount agreed upon. If the agreed-upon capitated amount was $5 million, then the physicians would have to make a $1 million payment to the insurer. But the practice could be earning interest on the $1 million float for as long as the interval is determined to last by the terms of the contract — it could be for three, six, or 12 months. Even if the practice has to pay back some money at the end of the interval, it has compensated for that disbursement by investing the capitation payments prior to settlement. These earnings probably won't erase the whole settlement, but they do help defray some losses, Sussman says. It's a system Sussman and team refer to as "capitation arbitrage."

So which settlement interval is best for your practice? Say your practice expects to only break even or take a loss with a particular capitation contract. For example, if the practice is inexperienced in capitation or its leaders took a low capitation rate because they felt it would be good for market share or other reasons, a loss or break-even stance might be reasonable to expect. In that scenario, Sussman suggests the practice negotiate for fewer settlement intervals and low withholds, held by the physician group if possible.

In contrast, if the practice leaders feel confident they can earn a surplus from the contract, then frequent settlements are better.

The longer the settlement interval, the longer you have for the float to earn interest and the more room you have to delay losses in the capitation payment process. The shorter the interval, the less time you have to earn interest but the quicker you gain your surplus, if in fact you're making money on the contract.

Withhold amount and who controls the withhold.

While the example above assumes that physicians will receive full capitation payments, some contracts actually include a withhold clause, which means some of the payment will be withheld or set aside in a separate pool in case of revenue shortfalls. In many cases, the withhold amount is 10% of the capitation payment, and it may be held by either the insurer or the physician.

Control over the withhold amount can be hotly contested, but it's worth fighting over, Sussman says. If the physician group controls the withhold funds, the group can invest that money during the course of the contract. If the insurer holds it, the insurer gets those investment benefits. In addition, if the payment settlements are slow in coming to the physician group, then not having the withhold earning interest can make the penalty even greater.

There is one technique you can try if it might help your withhold situation, Sussman says. Some insurers will agree to adjust the percentage of the withhold amount during the course of the contract based upon certain performance variables, such as utilization levels.

Incurred but not reported expenses.

The IBNR is the estimated cost for health care services that have been provided to patients in a capitation contract but have not yet been paid for by the insurer. In many large organizations, even though the group is operating on a capitation contract, doctors will file claims as a way of tracking medical costs and utilization. In that scenario, the IBNR may be reflected as accounts receivable.

Specify payment deadlines in contract

Here's where physicians need to be cautious about insurers using the arbitrage process to their benefit. By delaying capitation payments to the provider, the insurer can hold on to their funds longer, leaving the practice with high IBNR and no opportunity to invest the payments due to them. The greater the IBNR expense and the longer the payments can be delayed, the more benefit the insurer gains. In negotiating, physician groups should aim for specific deadlines for payments to be made so IBNR can be kept as low as possible.

Overall, say Sussman and colleagues, be sure to explore all the arbitrage (cash flow and investment) opportunities that capitation contracts can provide. It's not only the capitation payment amount, but the flow of the funds and your investing skills that can make a big difference.

In the future, Sussman expects more capitation variations, particularly for specialists. "I can't speak for the country, but in my area, I'd call capitation stable. But insurers are looking beyond the gatekeeper model." Contracts increasingly are calling for budgeted capitation for both primary care and specialists, he says.

"Basically, you are setting a budget and comparing performance over time," says Sussman. And because specialty costs are less contained right now than primary care services, that's where the capitation focus is likely to go.


1. Sussman AJ, Fairchild DG, Brennan TA, Coiling MC. Realizing the financial benefits of capitation arbitrage. J Healthcare Financial Management Assoc 1999; 53:48-49.