Richard Warren feels strongly about capitation, and he doesn't care who knows it.
"We got sold a bill of goods. I don't know anybody who's making money on it," says Warren, chief executive officer of El Camino Hospital in Mountain View, Calif., a 290-bed stand-alone facility in the heart of Silicon Valley.
According to Warren, most of the large integrated systems in California-capitation's heartland, if there still is one-are quietly moving away from the global capitation model. Under that model, an HMO makes a set monthly payment for each enrollee. That payment is expected to cover any and all healthcare services provided by a hospital, physicians and ancillary services.
Modified versions set various limits on the level of financial risk involved. Global capitation, in which hospitals and doctors assume and split all insurance-related risks and rewards, has been less common.
El Camino, known in the mid-1990s as Camino Healthcare, will consider renegotiating its capitated HMO contracts, Warren says, because the contracts are likely to pull the hospital into the red by next year if it doesn't. "I'm trying to find a valid reason to continue with it, and I'm having trouble finding one," he says.
In the mid-1990s globally capitated contracts seemed like the wave of the future, making per diems and DRGs look like yesterday's news. But things have changed dramatically as managed care has evolved into a more dominant but much more troubled industry.
A number of sources contacted by MODERN HEALTHCARE said the momentum toward capitation has stopped or even reversed itself.
Unhappy experiences. "The all-encompassing global contracts have generally been financial disasters, and so have the hospital-only capitation agreements," says Larry Foust, a healthcare lawyer at Jenkens & Gilchrist in Houston. Many providers didn't have the technological infrastructure and expertise to track costs and quantify risks, Foust says, and "realized too late" that they couldn't rely on a third party to supply the data they needed.
In other cases, he says, managed-care plans are encouraging a departure from capitated contracts now that many hospitals have squeezed out previous inefficiencies. With utilization way down, the plans would rather pay per diems. Because many hospitals are now more efficient, HMOs figure they can make more money by paying hospitals a negotiated fee for each day a patient uses the facility rather than prepaid, capitated amounts.
That can penalize acute-care facilities that have done the best job of getting their costs in line.
"Hospitals are finally beginning to understand that it doesn't matter if you have (patient) volume if the capitation rates are not adequate," says Gary Hagen, a Yountville, Calif.-based senior vice president at Managed Care Resources, a Princeton, N.J., underwriting firm specializing in financial solvency and reinsurance. Hagen is a former managed-care regulator in California.
On the provider side, "hospitals and integrated delivery systems aren't very interested in taking on full risk," says Mark Rucci, a principal at Apex Management Group, a Princeton, N.J.-based healthcare actuarial and consulting firm.
John Bertko, a principal at Reden and Anders, a managed-care consulting firm in San Francisco, is less diplomatic.
The rush away from capitation has become a stampede, Bertko says. Even so, he warns hospitals not to join that movement without considering their specific situations.
Getting out of the water. Many hospitals jumped into capitation in the mid-1990s, attracted by what they saw as the potential upside of risk sharing. But many facilities only "stuck their toe in the water," says Ellen Pryga, director of policy development at the American Hospital Association.
Now many hospitals, fearing the downside, have decided the experiment was a flop and are rapidly changing course.
"We may see a sea change (in the 1999 and 2000 data)," Pryga says.
In 1997, the last year for which figures are available, 981 U.S. acute-care hospitals-of a total 5,057-received a cumulative $7.6 billion in capitated payments, according to an AHA survey (See chart, p. 55). But the average percentage of revenues coming from capitation that year was just 8.7%, down sharply from 10% in 1994.
Pryga points out that capitation accounted for less than 20% of revenues at 89% of hospitals surveyed in 1997.
Consequently, many providers are becoming more attracted to other models, such as fee-for-service within a global budget, percentage-of-premium deals, capitated contracts that share risk with health plans or traditional per diem payments.
Under capitation, a hospital in effect debits itself to pay for all inpatient care. This can mean nasty surprises at year-end if utilization is high or if hugely expensive catastrophic cases upset the hospital's financial projections.
Hospitals often also have risk-sharing arrangements with their physicians, including shared-risk pools. Physicians, however, are usually happier about taking shared-risk profits than bearing their fair share of risk-pool losses, hospital executives say.
Some hospitals continue to chase after capitated contracts, Foust says, but "they're about three years behind the cycle."
Fading star. Other observers say capitation still has potential in geographic areas where hospital utilization is extremely high. But capitation's star is fading in mature markets, such as California and Colorado, where managed care has beaten down the use of services.
Some providers clearly jumped into capitation as an experiment, says Robert Trinka, a Miami-based vice president at McKenna and Associates Managed Care Insurance Services, based in Newport Beach, Calif, which offers insurance services to healthcare providers, HMOs and medical groups. Others initially subsidized capitated business with different lines of business, but as Medicare and other funding dried up, "there isn't any subsidy any more, and capitated deals have to stand on their own," Trinka says.
In addition, some managed-care plans, reportedly including Aetna U.S. Healthcare, Cigna HealthCare and United Healthcare Corp., are demanding that providers hold several months of capitated payments in a reserve that is available to the health plans, according to several industry sources. That's another reason many hospitals are turning away from capitation.
As a result of hospital contract talks, about 6% of the enrollees covered by PacifiCare Health System, Santa Ana, Calif., were shifted this year to noncapitated arrangements such as per diem contracts, and that figure is expected to jump to 10% by next year, says Jeffrey Folick, the company's president and chief operating officer.
Moody's Investors Service hit PacifiCare with a negative rating outlook late last month, partly because of concerns that providers are rebelling against capitated contracts, which Moody's called "a cornerstone" of PacifiCare's contracting strategy.
Some California hospital systems are abandoning capitation, especially capitated Medicare-risk contracts, says Mark Hyde, president and CEO of Lifeguard, a San Jose, Calif.-based HMO. Contributing factors are the financial instability of many of the state's medical groups and independent practice associations, along with capitation's bad public image, Hyde says. "We're going to see failure after failure of IPAs (in California), and that would leave capitated plans without the capacity to provide that product," he says.
Lifeguard, with 250,000 enrollees in Northern and central California, has always avoided capitation, preferring to medically manage its own fee-for-service arrangements with providers. Now, it looks like others are learning the same lesson, Hyde says, as he confidently predicts that "we're entering a period of de-capitation." The joke is likely to have legs.
Columbia's choice. Already, giant Columbia/HCA Healthcare Corp. has decided that the risks of capitation outweigh the rewards.
Bill Piche, CEO of 388-bed Good Samaritan Hospital in San Jose, Calif., says that virtually all Columbia hospitals that have capitated deals with managed-care plans are renegotiating or exiting those contracts.
In the San Jose area alone, three of Columbia's hospitals-Good Samaritan, 327-bed San Jose Medical Center and 93-bed South Valley Hospital in Gilroy, Calif.-will be affected. A fourth hospital, 192-bed Regional Medical Center of San Jose, known as Alexian Brothers Hospital before Columbia acquired it early this year (Jan. 4, p. 15), is covered by other agreements, Piche says.
"That means no more accepting the risk and being responsible for the losses," he says. "We hope to be out of all of them by the first of the year."
Columbia spokesman Jeff Prescott says the company is "taking a hard look" at capitated contracts and believes that "in most cases, they don't make sense for us."
Denver-based HealthOne, a Columbia-owned five-hospital network in Colorado, recently dumped its capitated contracts with PacifiCare of Colorado, replacing them with shared-risk arrangements that limit its financial risk. The new contracts took effect July 1, according to Janet Reese, a PacifiCare of Colorado spokeswoman.
Also in Colorado, Denver-based Centura Health System and Memorial Hospital, a city-owned stand-alone facility in Colorado Springs, successfully revolted this summer against full-risk contracts with PacifiCare.
Memorial lost $2.9 million on capitated contracts last year and is replacing all of them with per diem deals. Ed Arangio, Memorial's administrator for business development, claims capitation gives the hospital "no control on utilization." Blue Cross and Blue Shield of Colorado, Qual-Med and Health Network of Colorado Springs have already agreed to let the 340-bed hospital return to fee-for-service arrangements, he says.
Meanwhile, 10-hospital Centura negotiated a systemwide fee-for-service contract with PacifiCare effective Aug. 1, replacing a capitated agreement. That came after two Centura hospitals, 424-bed Penrose-St. Francis Health Services in Colorado Springs and 261-bed St. Mary-Corwin Medical Center in Pueblo, Colo., grabbed the health plan's attention by giving it a 90-day contract-termination notice.
Chuck Reyman, a Centura spokesman, declined to comment on the PacifiCare resolution, partly because Centura is engaged in similar talks with other health plans.
California discontent. Back in California, quite a few facilities are looking at capitation with a jaundiced eye. Riverside Community Hospital, a 276-bed facility that has a partnership agreement with Columbia, is now looking "far more carefully" at capitation, says Paul Wales, vice president of business development. More than half of the hospital's managed-care business is now capitated, but Riverside Community expects that to decrease "significantly" as contracts come up for renewal, Wales says.
University of California Los Angeles Medical Center, which is now responsible for about 40,000 capitated HMO enrollees, may continue to add new members to that roster, but it is carefully studying the situation, says Francine Chapman, UCLA Medical Center's senior associate director of business development, managed care and strategic planning.
"It's very difficult to manage within the dollars that the health plans are allocating to us right now," Chapman says.
Sutter Health, a 26-hospital system operating primarily in Northern California, has led the acceptance of capitated risk. Now the Sacramento-based system is looking "carefully" at all its managed-care contracts. Sarah Krevans, senior vice president of managed care, acknowledges that some of Sutter's capitated deals "certainly are not covering the cost of care."
Many contracts are under negotiation for the year 2000, and the system is open to moving back to per diem or case-rate arrangements in some cases, Krevans says.
Complicating matters, however, is the fact that many medical groups and IPAs rely on capitation, according to Krevans, who admits she is not sure how the landscape will look next year.
Shifting mechanisms. Some shifts from capitation are so recent that the few organizations that track capitation patterns haven't yet captured them.
As of July 1998, for example, data from InterStudy, a Minneapolis-based managed-care research organization, indicated that capitation was still expanding as a payment mechanism for hospitals and other providers. In mid-1998, 32.5% of the HMOs surveyed by InterStudy used capitated contracts for some portion of their hospital payments-up from 26.1% three years earlier.
But other forms of payment still dwarfed capitation. Nearly 72% of all HMOs continued to use fee-for-service payments as part of their overall payment package; 86% also paid per diem rates; and nearly 50% also used DRG-based payments, the study found.
Capitation is still far more common as a payment mechanism for primary-care physicians-and, to a lesser extent, for specialists-than for hospitals, InterStudy found. Capitated contracts accounted for almost 75% of HMO payments to hospitals in Beloit, Wis., compared with nearly 49%in Buffalo, N.Y.; 40% in Salinas, Calif.; and 33% in San Diego.
But capitation has zero penetration in markets such as Abeline, Texas; Cedar Rapids, Iowa; Fargo, N.D.; Lynchburg, Va.; New Bedford, Mass.; and York, Pa., according to InterStudy.
Cities such as Atlanta, Boston, Dallas, Newark, N.J., and Philadelphia have negligible amounts of hospital capitation.
And that was before the recent backlash against hospital capitation gathered steam.
Now major systems in California, such as Roseville-based Adventist Health, San Francisco-based Catholic Healthcare West, Columbia, San Diego-based ScrippsHealth, Sutter Health and Santa Barbara-based Tenet Healthcare Corp., are moving away from capitated arrangements, according to internal and external sources.
For example, at six-hospital ScrippsHealth, about 25% of nongovernment revenues came from risk contracts as recently as 1997, says Executive Vice President Joe Sebastianelli. By next year, the figure will be less than 2% he says.
"In Medicare, capitated hospitals have had their heads cut off," says Ed Berger, former vice president of managed care at Sutter Health.
In commercial managed care, most hospitals have "gotten by," Berger says, but he admits that many would be financially distressed if more than a fraction of their business was capitated.
Berger surveyed 48 California hospitals in the fall of 1998 for the West Coast division of VHA, the Irving, Texas-based not-for-profit hospital alliance. The survey found that only 19% of revenues, on average, came from capitated contracts with managed-care plans (Dec. 7, 1998, p. 20). Year-to-year comparisons were not included because the survey was the first of its kind by the group.
About three-quarters of the hospitals surveyed said they had lost money on capitation in at least one of the past two years.
More than nine of 10 said dealing with capitation "has been more difficult than expected," and one-fourth characterized moving into capitation as a disaster.
"Providers don't understand the risks they are taking," Berger says. "They don't understand risk." For example, he says, Alta Bates Medical Center in Berkeley, Calif., recently was saddled with about $6 million in expenses when a severely compromised infant had to spend more than two years in its neonatal intensive-care unit.
Because the patient was covered by a capitated contract, Alta Bates was responsible for the entire amount, Berger says.
Flying blind. Another recent survey-this one of 322 hospitals and medical groups in markets with significant managed-care penetration-found that 30% of the administrators surveyed had little understanding of their level of financial risk through capitated contracts (April 12, p. 34).
The survey, sponsored by the Stuart, Fla., office of Evergreen Re, a reinsurance consultant and brokerage firm, also revealed that many providers signed capitated agreements without knowing the full costs of the specialty services for which those contracts may have held them accountable. Examples include treatment of burn victims or care of extremely premature babies.
Captitation is clearly taking the heat for one recent fiscal meltdown. In March, Catholic Healthcare Partners, a 29-hospital Cincinnati-based system, earned a negative rating outlook from Moody's Investors Service because of operating problems, including what Moody's later described as management of "onerous capitation contracts."
Moody's reiterated that negative outlook last month.
An unanticipated $80 million decline last year in Catholic Healthcare Partners' operating cash flow can be largely attributed to the system's aggressive assumption of risk-based contracts in the Toledo, Ohio, area and in Pennsylvania, according to Moody's. Commercial managed-care and Medicare-risk contracts were the culprits, according to Moody's.
HMOs could also be at financial risk, according to Lifeguard's Hyde, because many have become accustomed to delegating large chunks of financial risk to providers. Notes Hyde: "I don't see the capitated health plans doing real well."
All this leaves many observers wondering what will come next.
Despite the tumult, capitation remains the best way to instill financial accountability in providers, at least until somebody comes up with something better, McKenna's Trinka says.
Capitation's doldrums could be "more of a lull or a holding pattern than a sign of permanent decline," he says. "We're in the so-called valley of despair (where) everyone begins to understand what the change really means."