Medical Practice Strategies:  Systems Based Practice - Business Laws Ethics

Janet Lerman, J.D.

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Providers were customarily paid for medical services rendered at a rate based on the providerís cost and profit margin as determined by the provider. This is known as retrospective reimbursement, where reimbursement came after medical care was delivered. Then came "discounted fee-for-service" which is prospective pricing such as a negotiated discount to customary charges (such as reimbursement at 80% of usual and customary charges). Other forms of prospective pricing include fee schedules (set prices for specific items or services), maximum price limits imposed through determinations of reasonableness, and services bundling. An example of services bundling is the Medicare Prospective Payment System ("PPS") that bundled hospital services into 468 packages referred to as Diagnosis Related Groups ("DRG").L Basically, there is no risk for the provider in a fee-for-service or discounted fee-for-service reimbursement system because the provider gets paid for services rendered. The more services the provider renders, the more money the provider earns. Under these type of reimbursement methods, providers essentially have control over the cost of medicine and there is no financial incentive to keep patientís healthy.

Pre-paid medical plans looked at holding the providers to an established rate prior to the rendering of medical services. These pre-paid medical plans (meaning payment is made prior to the rendering of services) involved the payment to providers of a flat fee per patient where this fee covers all medical services (as spelled out in the agreement) whether rendered or not, and the provider is exposed to financial risk. For example, if the provider has a sickly group of patients covered by this method of payment, called capitation, and the capitated rate does not cover the providerís actual costs, then the provider may suffer financially as care is provided at a higher caseload level than anticipated. There are different types of risk-sharing methods besides capitation, such as withholds (or frequently called "bonuses") and risk-sharing pools as discussed in later chapters of this book.

The evolution of paying for medical services went from retrospective reimbursement fee-for-service and discounted-fee-for-service, where there was basically no financial risk involved for the provider in rendering medical care, to a system of risk-sharing involving capitation, withholds and risk-sharing p


bulletRetrospective Reimbursement
bulletProviders Cost Plus Profit Margin
Per Diem Payment:
bulletPer Day Payment/ Transfers Some Utilization Management

ools which shifts some financial risk to the provider and also entails a change in the providerís approach of rendering care. In the retrospective fee methods of reimbursement where payment is made after services are rendered, providers make more money with sicker patients because the more services these providers render the more money they make. This is a cost-oriented system in which "sick-care" and hospital in-patient admissions and multi-specialty services are the norm. Under the prospective capitation method in which the system is oriented toward cost-saving, "health-care" and out-patient facilities, and preventative care is emphasized.


Fee-for-Service is the traditional system of payment to providers in which providers are paid their costs along with a profit margin for rendering services. Under this system a fee is charged for each service provided on a retrospective basis. This means that after the services are rendered the fee is determined as compared to a prospective, fixed rate basis commonly used by HMOís.


Discounted Fee-For-Service is a variation of the traditional system of payment to providers in which providers agree in advance to what they will charge for the provision of their services prior to the services being rendered. There are different methods in presenting this discount to the providerís usual and customary fee. For example, a specified discount to customary fee for services, or a bulk rate such as a package rate (services bundling), or a diagnosis related group rate based on a certain dollar amount per service or item.

Hospitalís per diem payment method is an example of a prospective discounted fee-for-service where there is some transfer of utilization management responsibilities to the health care provider. A hospital per diem payment amount is the same regardless of the number, scope or intensity of services provided. It is a flat fee per day for services rendered. This causes the hospital to scrutinize the necessity of services, such as laboratory tests or prescription drugs, that are part of each day of hospital stay.M However, this is not considered assuming risk, like under capitation, because the hospital is still paid an amount for services rendered. There may be a risk to the hospital that the payment amount does not cover costs, but there is still a payment rate for each day of patient stay.


Capitation is a fixed dollar amount payment to providers based on a per member per month calculation paid in advance to services being rendered by the provider. The capitated amount is payment for the designated services whether such services are rendered or not. This payment is the same regardless of the amount of services rendered by the group. This method of payment puts the provider at-risk. The risk is that the provider is responsible for providing services even if the capitated amount does not cover the cost of those services. The provider must understand how much the services cost and the profit margin in relation to the capitated rate, and the estimated utilization of medical services by the patient pool provided by the HMO.

The traditional fee-for-service payment method paid providers when they provided service. In contrast, managed care pays them whether or not they see patients, though they have to see the patients when theyíre sick. Under managed care, physicians have more of an incentive to keep their patients well, placing a new ethical burden on physicians. Theoretically, an unscrupulous doctor could make more money by collecting capitated fees and withholding care to patients. However, it is said that this situation is not likely because in some current and most future managed care systems, peer review panels and other utilization review physicians will look at practice patterns to ensure high-quality care and limit statistical variations. Also, supporters of managed care claim that capitation will prove most rewarding to physicians who invest in their patients by providing appropriate quality care including preventive care.

The following is a chart comparing capitation to fee for service:


Fee for Service

Providers assume Risk No or little risk for Providers
Withholds or Bonuses/ Risk Sharing Pools Traditional system of payment for Providers
Management Center: Manage the spectrum of health care services - financial incentive to keep patient treatment cost low

Cost Center: Financial incentive to maximize reasonable patient treatment costs

Health/ Preventive Care Sick Care
Health maintenance/ Preventative medicine/ Bonus for appropriate and efficient use of resources More income is derived from frequent patient-physician encounters since physicians are paid for each visit. Physicians do not pay for services (including consultations/ tests/ procedures, etc.) out of pre-arranged capitation. More tests ordered/More services rendered/ May possibly mean more $ for physician
Outpatient care preferred over inpatient care Oriented to both Inpatient care and Outpatient care
Know costs of services provided Charge cost plus profit margin
Financial risk to physicians if treatment costs exceeds proceeds from capitation payments No or very low financial risk to physicians

Capitation check every month


Time intensive collection process - Charges plus collection percentage determines income

Relationship with MCOís, other Providers, interactive, communicative oriented, money required to build information structure that is vital to operation of a continuum of care Can be more isolated, emphasizes independence (though consultants are indirectly rewarded and independence is from insurance payor), autonomy


To improve quality and reduce healthcare costs various payors, such as government and private sector plans, are increasingly using incentive programs connecting payment to performance against nationally accepted and health plan standards.  Also, with consumer directed health plans, consumers use of performance indicators is predicted to increase as consumers are encouraged through financial incentives and education to use data to select physicians and hospitals.  Many believe electronic health records are essential to better clinical integration and pay for performance (ďP4PĒ).

Most P4P initiatives focused on physician groups, however there is movement toward also using P4P for hospitals.  The Centers for Medicare & Medicaid Services (CMS) awarded participating hospitals bonuses in its Medicare payments based on performance on quality measures. 

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