By their nature, fee-for-service reimbursement schemes incentivize procedures over prevention. This creates a serious moral hazard: If you keep your patient panel healthy through early interventions and exhaustive lifestyle counseling, then there are fewer profitable procedures to do. On the other hand, if you let your patients become critically ill, then you will be rewarded handsomely for all of the (now) medically necessary procedures and tests that you can perform on them.
Third-party payers, such as private insurers and the Centers for Medicare and Medicaid Services (CMS), have attempted to temper this hazard over the years by imposing ever greater administrative pressure on providers and health care systems. Unfortunately, health care costs in the U.S. have continued to rise out of proportion to improvements in outcome. This suggests that administrative micromanagement of providers, no matter how intense, does not overcome the fundamental moral hazard of fee-for-service reimbursement.
An alternative reimbursement scheme called capitation does away with this moral hazard by paying a flat fee per patient per month to be distributed among all of the patient’s providers. If the patient’s medical issues are resolved under budget, providers get to keep the money saved. If the providers spend carelessly, they must eat the excess cost. This creates a direct incentive for providers to choose diagnostics and therapies wisely, thereby reducing wasteful spending and also reducing the need for administrative micromanagement — a win-win scenario for providers and patients. However, despite the likely cost savings that would come from capitation, it has been unfeasible on a large scale until recently.
The problem with reimbursement by capitation is that patients’ health care needs vary unpredictably. If providers are offered the same flat fee for each patient, then practices that see complex patients with above average needs run a very high risk of bankruptcy. Physicians would be incentivized to take on only healthy patients just to stay in business. Complex patients would be untreated, or they would be pushed back into fee-for-service arrangements, negating the usefulness of capitation.
In order for capitation to work for all patients, the monthly payment for each patient must accurately reflect the expected cost of their care. Predicting an individual patient’s future health care expenses is impossible; predicting the future costs of a group of patients is more feasible, especially when patients are pooled into very large groups, thus reducing the variance of the sample and averaging out the risks of overspending. Designing a system based on large risk pools requires an immense investment in statistical analysis, which has been quietly happening since at least the 1980s when CMS began building and analyzing huge data sets of Medicare patient records in order to devise a risk stratification scheme that predicts future costs based on current comorbidities. The end result, a risk adjustment system based on hierarchical condition categories (HCCs), finally went mainstream in 2017.
For primary care providers, it is crucial to understand the structure of risk and payments in the HCC system because the financial rewards of good preventive care in a capitation system will not automatically be passed down in the HCC system unless providers negotiate for their fair share of these rewards. As mentioned before, the HCC system can only predict average spending over a large cohort of patients with a given condition; the larger the group of patients pooled together, the smaller the variance in the sample, and the lower the risk of overspending (and therefore bankruptcy) due to random chance. In practice, even huge hospital systems are too small to buffer against this risk. Therefore, patients must be pooled together at the level of a large insurance policy that takes capitated payments from a larger payer such as CMS and then pays out individual patient bills from hospitals and providers. That means that the insurance company takes on the risk of overspending, but if it succeeds in cutting costs, it gets to keep the money saved.
Because insurance companies only control costs indirectly, they must find a way to motivate providers to cut costs for them; either they can continue using administrative pressure to force providers’ hands, or they can offer financial incentives to providers who save them money. In the former situation, administrative micromanagement continues, as does the moral hazard of fee-for-service reimbursements between providers and the insurer. In the latter situation, when the insurer shares its profits with providers who reduce wasteful spending, there is less conflict between finances and ethics, and there is less need for administrative pressure on providers. In other words, through profit-sharing arrangements, the benefits of capitation can be realized in the HCC-based system.
Providers employed in large health care systems may well discover that their employer has negotiated profit-sharing arrangements with HCC-based insurance policies, but the employer may not pass down the financial rewards to individual providers. Instead, the employer may elect to use administrative pressure to cut costs, keeping all net savings for its executives, or it may limit financial incentives to specific metrics such as compliance with screening recommendations. Providers who have grown inured to ever-encroaching administrative burdens may simply accept the increased micromanagement. However, primary care providers need to ask this question: would they more effectively lower health care costs if, instead of being pressured to meet standardized measures that are associated with good care, they were rewarded with a cut of the total costs saved by giving actual good care?
Providers who believe that effective health care cannot be neatly summed up in terms of measurable goals like A1C control and influenza vaccine compliance, who believe that there are subtle aspects of medical treatment that defy immediate documentation but lead to real, measurable benefits in the long run in terms of a patient’s health and medical expenses, who believe that they would do a better job of promoting health and reducing overall costs if they had greater autonomy and were rewarded appropriately for saving healthcare dollars through health promotion — these providers can and should negotiate for less micromanagement and more direct profit sharing in the HCC system.
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