Managed Care Plan and Physicians Contracting

Most physicians have contracts with physician managed care plans. The Center for Studying Health System Change (2002) reported that 91 percent of physicians had one or more managed care contracts in 2001. On average, responding physicians had contracts with 13 managed care plans and received nearly 46 percent of their practice revenue from these plans. These reports are broadly consistent with earlier surveys conducted by the American Medical Association (AMA 1998), which reported similar proportions of physicians with managed care contracts (92 percent) and the shares of revenue from private managed care plans (32 percent) in 1997.

With regard to compensation arrangements, however, the story is a bit more complicated. Physicians or medical groups can be compensated in a variety of ways, and each provides a different set of incentives. Salary arrangements, for example, imply no direct link between the quantity or quality of physician effort and the physician’s compensation. Fee-for-service means that the physician or medical group is paid directly on the basis of the volume of services provided. More office visits means greater fees and, therefore, greater revenue. Capitation means that the physician or medical group is paid on the basis of the number of covered lives for which they are responsible. Under capitation, the physician or medical group will only make money if the visits they provide and the services they order cost less than the capitaled amount.

Within each of these generic models, all sorts of variations are possible. For example, the physician or medical group may be paid fee-for-service up to a “withhold.” Under this sort of contract, the physician or medical group is paid, say, 80 percent of the fee-for-service amount at the time the bill is submitted. The other 20 percent is paid if the managed care plan is able to cover its overall claims costs. Within the capitation model, the physician or medical group may be responsible for all care, only ambulatory care, or only ambulatory primary care services.

A further complicating factor is that there may be substantial differences between the nature of the contracts negotiated between the managed care plan and the medical group, and the compensation arrangements between the medical group and individual physicians. Hillman, Welch, and Pauly (1992) were the first to describe these arrangements, reporting that in 1988 approximately 35 percent of health maintenance organizations (HMOs) were “three-tier” models in which the HMO paid the medical group, and the medical group, in turn, paid the physician. The remaining 65 percent were two-tier models in which the HMO paid the physician directly. However, adjusted for patient volume, the three-tier models were much more important, representing some 60 percent of enrollment. The payment system used at the medical group level is often not used to pay the participating physicians. For example, Hillman, Welch, and Pauly (1992) reported that among three-tier plans, only 27 percent of the medical groups paid under a capitation arrangement also paid their physicians on a capitated basis.

It is also the case that the use of capitation payment for physicians has been declining over time. As Figure 10-1 shows, between 1997 and 1999, the percentage of physician practice income reported to come from capitated contracts declined markedly. This should come as no surprise. Recall the Chapter 5 discussion of the nature of objective risk. If a medical group accepts a capitated contract, it has essentially become an insurance company bearing risk. Objective risk depends on the expected loss, the variance, and the number of covered lives. An individual physician may have roughly 6,500 patients. Even if all of them are members of the same managed care plan, this is a small risk pool and represents substantial objective risk. If only 20 percent of these are in a given managed care plan, the risk is even greater. Thus, as physicians became more aware of the risks associated with capitates contracts, they shied away from them. The AMA (1998) reported that 57 percent of those doctors with capitated contracts had stoploss provisions or reinsurance that limited their liability. However, the use of capitation has continued to decline. The Center for Studying Health System Change (2002) reported that the proportion of physicians with managed care contracts who derived at least some revenue from capitation declined from 59 percent in 1999 to 49 percent in 2001.