Medicare services providers and physician capitation

Capitation applied to Medicare

Under a capitation system, physicians are paid a predetermined amount for each patient for whom they are responsible. As applied to Medicare, physicians could be capitated separately from other providers of Medicare services (for example, with separate rates for hospitals and nursing homes), or a single capitated entity could be responsible for all services covered by Medicare. We have analyzed Medicare capitation extensively. Capitation was introduced into Medicare on a large scale by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). Final regulations to implement TEFRA were published in January 1985. Under TEFRA, prepaid health plans (mostly health maintenance organizations, or HMOs) were paid 95 percent of the cost of caring for an enrolled beneficiary had that beneficiary remained in fee-for-service (FFS) Medicare. Since FFS cost was not observed for beneficiaries choosing the HMO sector, it had to be estimated, and the estimate was obtained by calculating the cost of FFS enrollees who were similar to HMO enrollees with respect to age, gender, disability, Medicaid and institutional status, and county of residence.

Medicare capitation program

I identified several problems with the Medicare capitation program as it was originally designed. One was that the administrative method used to determine the payment rates had little to do with HMOs' actual costs of providing the statutory Medicare benefits. In most cases, the payments were higher than HMOs' actual costs, leading them to provide many optional (that is, nonstatutory) benefits for little or no out-of-pocket premium. Because HMOs were not permitted to give the overpayments to enrollees in the form of premium rebates, some of the additional benefits were inefficient, in the sense that beneficiaries would not have been willing to pay as much as the benefits actually cost.

A second problem was that the FFS system, with its open-ended expenditures, was protected from competition with the capitated plans. The Medicare capitation program has been modified many times, and some of the problems we identified have been solved or at least mitigated. Since 2003, premium rebates to HMO enrollees have been permitted. Except for a "tax" that the HMO has to pay on the payment reduction, these premium rebates solve the problem of inefficient benefits in areas where the capitation payment is too high. The capitation program was modified most recently by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA). As a short-term measure, the MMA added a new payment option of 100 percent of fee-for-service costs in 2004 and increased all payment rates by the growth in per-capita FFS Medicare spending in 2005. Since 2006, HMOs wanting to participate in Medicare have had to submit "bids" indicating the per-capita revenue at which they are willing to provide Part A and B services to Medicare. Medicare compares the bids against "benchmarks," which must be at least as great as per-capita FFS expenditures in each county and are higher than FFS expenditures in many counties. The benchmark for local plans (those choosing their own service areas) is a weighted average of the capitation rates for the service area. The benchmark for regional plans (those operating in service areas defined by Medicare), which otherwise operate under the same rules as local plans, is a blend of the weighted capitation rate for the region and a plan bid component that is a weighted average of all bids in the region. Plans bidding less than the benchmarks are paid their bid, plus 75 percent of the difference between their bid and the benchmark. Plans must then return that 75 percent to beneficiaries in the form of extra benefits or Part B or Part D rebates. Plans bidding above the benchmarks are paid the benchmark and must charge the difference between their bid and the benchmark to enrollees as an additional out-of-pocket premium.

The MMA bidding system for local plans - which are mainly HMOs - is flawed on two accounts. First, although the language of the MMA suggests a competitive bidding system, HMOs continue to be paid at rates that are set almost entirely administratively, just as they were before the MMA. The administratively set benchmarks in the HMO sector result in wide variation in the difference between the benchmark and average bids across counties. In counties where bids are lower than benchmarks and the difference is large, HMOs can afford to offer a rich package of premium rebates and extra benefits - even some with limited appeal to beneficiaries. In other counties such benefits are not available. If HMO payments were linked more tightly to average bids, the allocation of Medicare benefits across plan types and counties would be both more equitable and more cost-effective. In contrast, regional plans - including prescription drug plans (PDPs) - are paid relative to a benchmark that is a function of the average bid. In principle, at least, this crucial distinction should make price competition among PDPs much more intense than among HMOs.

Local bidding system

The second flaw of the local bidding system, which is shared by regional bidding, is that neither system solves the last problem: Fee-for-service Medicare is exempt from the competitive bidding system, at least until 2010. In that year, a six-year demonstration of competitive bidding known as the Comparative Cost Adjustment (CCA) program is scheduled to begin in at least six metropolitan statistical areas (MSAs). Demonstration sites will be chosen from among MSAs that have two or more local private plans with at least 25 percent total penetration. A benchmark local premium will be set by the enrollmentweighted average of the bids by private plans and FFS Medicare. If a plan - including FFS Medicare - bids above the benchmark, the beneficiary will pay the difference between the plan's bid and the benchmark. Although FFS beneficiaries will be partially protected from competition by a restriction that their premium cannot change by more than 5 percent in any given year, this program, if allowed to proceed as scheduled, will bring FFS Medicare into the competitive fray for the first time.

Medicare health plans

Capitation has the potential to be a powerful method for determining how much to pay Medicare health plans, including traditional fee-for-service Medicare. We recommended that Medicare take bids and set the government contribution to premiums equal to the lowest bid submitted by a qualified plan in a local market area. Beneficiaries would be responsible for paying the difference between the low bid and the premiums charged by higher bidders. Under a capitated payment system, Medicare does not worry about how much to pay providers. That is left up to the health plans, which are free to experiment with different payment systems, including fee-for-service, salary, and risk-sharing arrangements with physicians. Although it promotes such experimentation, however, capitation cannot be a complete solution to Medicare's problem of paying providers. In the first place, capitated health plans do not serve all areas of the country. In sparsely populated rural areas, in particular, low population density and high entry costs make it difficult to form networks of health-care providers. In addition, in areas where capitated plans compete with traditional Medicare, many beneficiaries will choose the traditional program. Finally, the politics of capitation are extremely contentious, and it is questionable whether the Comparative Cost Adjustment demonstration will be implemented at all, let alone as a national payment system.

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