How Do Health Plans Pay Physicians?

There are seven basic terms you need to know to understand how health plans pay physicians. Four payment methods (fee-for-service, discounted fee-for-service, capitation, and salary) and three payment adjustments (withholds, bonuses, and retrospective utilization targets) are the basis for nearly all contracts between health plans and your physicians, and they are described below. These payment methods and adjustments for primary care physicians are particularly important, because physicians act as gatekeepers by managing patient access to specialist referrals and hospital care. The four payment methods are designed to affect treatment patterns, while the payment adjustments are designed to affect both treatment and referral patterns. Since most physicians practice medicine in groups or clinics, they share the financial responsibility for their patients with all physicians in their group or clinic. All words in italics are defined in a glossary at the end of this document.

Four Payment Methods

The four payment methods that health plans use to pay physicians are:

• Fee-for-service - physicians are paid for every service and test that they provide based on the usual and customary charges of physicians in the local area.
• Discounted fee-for-service - physicians are paid for every service and test they provide based on a fee schedule or pre-determined discount of the usual and customary price charged by physicians in the local area.
• Capitation - physicians are paid a fixed amount per enrollee, not per service, on a monthly basis.
• Salary - physicians are paid a fixed weekly or monthly amount, and pay is not tied to enrollees or services rendered.

The example below illustrates how fee-for-service (FFS), discounted fee-for-service (FFS), and capitation work. Suppose that a health plan has 200 enrollees. 100 of these enrollees make a total of 200 office visits to primary care physicians over one year and each visit costs the physician $75. The total cost for all of these office visits is $15,000. The physician charges $100 per visit to pay for staff salaries, medicine, tests, and overhead. The health plan that pays according to discounted fee-for-service has a 20% discount on all physician charges, so pays only 80% of all physician charges. The health plan that pays according to capitation pays the primary care physician $80 per enrollee for all care, whether or not the enrollee sees the physician or how many times the physician sees the patient. Physicians who work for a clinic and are paid a salary receive a fixed annual income that is not tied to the number of patients that choose them or the number of office visits that patients make.

In this example, physicians reimbursed on a fee-for-service basis receive the highest health plan payments, because they are paid the full price for each office visit. Physicians reimbursed on a discounted fee-for-service basis receive the next highest total payments, due to lower (discounted) payment that the health plan was able to negotiate with this physician. Physicians under capitation receive health plan payments based upon the number of enrollees not the number of office visits or physician charges. These physicians under capitation cannot increase their reimbursement from the health plan by having more office visits or higher charges for each office visit, the way they can if paid by FFS or discounted FFS.

Capitation: Physicians paid by capitation have incentives to contain costs and financial risk because of the fixed budget that the health plan gives these physicians to allocate for the care of 200 enrollees. If no health plan enrollees seek care, physicians under capitation face no financial risk. They simply receive the monthly payment for each enrollee. If all health plan enrollees seek care and their actual costs are greater than the monthly payments (which are based on estimated costs), then the physician must cover the cost of care that exceeds the monthly payment. Physicians cannot ask the health plan for extra payments to cover the additional costs of care, and face financial risk in this situation. Many physicians reduce their financial risk by purchasing insurance policies that will cover significant expenses if they occur in a group of patients. In reality, some enrollees never seek care, some seek basic care, and other enrollees need extensive care and access to specialists.

To ensure that health plan payments cover their expenses, physicians under capitation have an incentive to manage and provide appropriate care to their patients. They have an incentive to provide more preventive care that catches illnesses early (e.g., mammograms). Preventive and primary care intends to keep patients healthy so they need fewer tests and procedures when they do see the physician. Physicians under capitation also have an incentive to contain costs by providing more preventive care that limits the number of additional office visits that patients need.

Fee-for-Service: Physicians reimbursed on a FFS basis have the opposite incentives and face much less financial risk than physicians paid by capitation. These physicians have an incentive to increase the number of services they provide during each visit, as well as the number of visits. The health plan will pay these physicians for every test and procedure that they provide without regard to total costs to the health plan. These physicians have no incentive to avoid more costly tests and procedures, unlike physicians paid under capitation, because they do not have a budget that introduces financial risk. Physicians that are paid on a fee-for-service (FFS) basis have no financial risk for the care they provide or the patients that they see, so patients with chronic illnesses or needs for specialist care or special services should have little problem getting the care they require.

Discounted Fee-for-Service: Discounted FFS works in a similar way to FFS except that physicians are reimbursed a specific dollar amount or percentage of their total charge. Under discounted fee-for-service, physicians are only at risk if the cost of their care is greater than the payment the health plan will give them. There is little chance that physicians will receive payments that are consistently lower than the cost, but physicians may be slightly more conservative in treating patients. Discounted fee-for-service provides a slight incentive for physicians to balance the effectiveness of treatment with its cost, instead of treating patients without consideration of cost. They also have no incentive to change their referral patterns to specialists, unless their payment has withholds, bonuses, or retrospective utilization targets (see page 7). All Minnesota health plans have moved away from FFS to discounted FFS and capitation to contain costs and to encourage physicians to practice cost-effective medicine.

Salary: Salaried physicians have no financial incentive to change their treatment patterns, either in terms of what is done during each visit or the number of visits. Physicians paid by salary face no financial risk, unlike physicians under capitation, unless their contracts include withholds, bonuses, or retrospective utilization targets or performance goals linked to future salary increases.

The overall impacts of each these four payment methods on patient care and referrals are illustrated in the table below.

In summary, the incentives of these payment methods may have different effects on a physician's treatment style, and these methods can be combined with adjustments to the physician's payment (discussed below) which affect both treatment and referral patterns. FFS, discounted FFS, capitation, and salary will have its greatest effect on treatment, while payment adjustments will have effects on both treatment and referral patterns. It should be noted that the same physician may see patients from many different health plans, and their style of care will be influenced as much by their own education and experience as it is by payment methods used by a particular patient's health plan. If you have questions about your care, talk with your primary care physician and he/she should be able to address any questions that you have.

Payment Adjustments

The three adjustments that health plans can make to the three basic methods of paying physicians discussed above are:

• Withhold - percentage of the capitation or fee-for-service payment from each service that is retained by the health plan to finance potential deficits if health plan premiums from enrollees are less than health plan payments to physicians. Withhold funds may be returned to physicians at the end of the year as bonuses.
• Retrospective utilization target - a pre-determined number or level of services that an insured group of patients is predicted by the health plan to need over a one-year period. This baseline prediction is compared with actual utilization by patients over the year to determine a bonus payment.
• Bonuses - physicians can be paid extra payments at the end of the year for keeping the health plan's payments, particularly to specialists and hospitals, below a pre-determined budget or utilization target. Bonuses may also be determined from measures of patient satisfaction, access and outcomes of care. In some bonus systems, physicians may have to return payments to the health plan if utilization is above a target.

These three payment adjustments are designed to have effects on physician treatment and referral patterns.

Withholds: Withholds are generally used by health plans to give financial risk to primary care physicians who are paid by fee-for-service, discounted fee-for-service, or capitation. Many times, withholds will also be included in contracts with specialists. Health plans withhold a certain percentage (e.g., 20%) of every physician payment to cover a deficit if health plan premiums from enrollees are lower than health plan payments to physicians. If primary care physicians' referrals to specialists and hospitals use up the withhold funds, then they receive no bonus. If these physicians restrain utilization in general, and referrals and hospitalization in particular, then unspent withhold funds are shared with the physicians in the form of bonuses. The use of withholds and bonuses create incentives for primary care physicians to restrict access to specialists and hospital services, because more service use decreases the chance that the health plan will give bonuses. Since withholds are commonly applied to all services, withholds support the incentives that already exist in capitation or discounted fee-for-service for physicians to be conservative in treating patients.

Retrospective utilization targets: Retrospective utilization targets are the financial benchmark used by a health plan to determine physician bonuses. If a physician meets the predetermined baseline or target of medical service use, the physician receives a bonus. These targets are incentives to manage a patient's care cost-effectively. Utilization targets for specialty care and hospital care are important benchmarks that health plans work with physicians to achieve. Many times, health plans base a utilization target on the experience of a group of physicians (or risk pool), not just one physician. By being in a risk pool, a specific physician is less constrained to provide fewer tests and procedures for a specific patient than if a utilization target was based on him/her alone. Utilization targets create incentives for physicians to treat patients appropriately and cost-effectively, particularly for specialty and hospital care. Individuals with chronic conditions or need for specialty care may have to work with their primary care physicians to ensure that they can access preferred physicians and/or services.

Bonuses: Bonuses are provided from unspent withhold funds if and when the utilization of medical services by a physician's patients is lower than an estimated utilization target. A physician's bonus may also be based on measures of patient satisfaction, access, and outcomes of care. A bonus rewards physicians for providing more primary and preventive care, and also for doing fewer tests and procedures. Primary care physicians may also receive bonuses tied to managing access to specialists and hospitals. In some bonus arrangements, individual physicians or groups of physicians who greatly exceed the utilization target may have to make payments to the health plan at the end of the year. This constraint puts primary care physicians at even greater financial risk than arrangements with only simple bonuses, because physicians with simple bonuses don't have to worry about returning payments to the health plans. Physicians who may have to return funds to the health plan have an even greater incentive to manage access through referrals to specialists and hospitals. A provider's bonus may also be based on measures of patient satisfaction, access, and outcomes of care.