A recent survey of 39 health plans conducted by Catalyst for Payment Reform reported that more health care providers are becoming comfortable with incentive-based capitation systems that reward quality and lower costs. The capitation model was at the peak of its popularity in the 1990s, but quickly lost favor with providers, as they suffered heavy losses due to the rapidly rising cost of care. However, this recent resurgence in interest suggests that improved electronic health data and cost management capabilities may be encouraging the providers to take another crack at capitation.

Can the capitation trend be more successful the second time around? Provider networks today are better equipped to handle cost constraints than two decades ago, but the ultimate success of capitation depends on the level of integration within the provider network, as well as the extent of risk sharing between the provider networks and the payers.

Capitation is a payment model where an insurance company pays a periodic fixed lump sum payment per patient to a healthcare provider to cover all of a patient’s care expenses. Capitation could be “global,” meaning a payment for the entire network of providers, or “partial,” meaning a payment designated to a physician’s group or a hospital. An incentive-based capitation potentially provides more financial rewards for delivering higher quality care at lower costs, based on preset performance targets.

The first boom of capitation in early 1990s fizzled as quickly as it started because providers lacked a systems perspective. In systems of non-integrated providers, the capitation model meant one entity’s gain was another’s loss. The third-party payer system was also not equipped to adjust to rapidly progressing medical science and technology, and unable to deal with the rising cost of care.

The disruptive innovation theory explains that non-integrated healthcare providers face daunting challenges under the capitation model due to misalignments in financial incentives within provider’s networks. Moreover, the theory implies that payers who do not have a truly aligned relationship with providers face difficulties in forecasting and managing the cost of care. We offer the following three reasons why performance-based incentives may not be enough to make the capitation model successful in the absence of structural integration.

First, we think performance incentives are insufficient catalysts to overcome competing underlying financial objectives within non-integrated provider networks. While today’s healthcare networks have much improved technological capabilities and business models compared to those of the previous managed care generation, the dis-integrated care model is the main culprit of cost escalation. The capitation model could not work properly without all key stakeholders in the network working for common financial objectives.

Second, the payers who are not integrated with the care providers in providing capitation will be unable to push back on the providers seeking higher capitation over time. Some of the new models have adopted risk-sharing programs to encourage both the providers and payers work under the same financial goal, but we find a third party payer model is inherently challenged in properly forecasting and budgeting the provider’s costs of care over time. We are concerned that too much incentive sharing without proper coordination between the providers and payers could lead to deterioration in patient care, as the providers and payers might neglect some patient needs in pursuing their separate interests or prematurely abandon the model.

Finally, the recent headlines reporting that the Medicare’s Pioneer accountable care program is struggling are also potential warning signals for the providers considering incentive-driven capitation. Due to the lack of clarity in the process, common metrics, and organization, 13 of the 32 providers have already dropped out, just two years into the program. This implies that accountable care metrics need more time and effort to be refined before implementation. Incentives based on quality of care and cost control are a great idea as long as the metrics are well defined. We worry whether those jumping on the new capitation bandwagon have done their homework on understanding how accountable care metrics will be applied to their performance.

The disruptive innovation theory suggests that fundamentally different business models cannot coexist in the same organization. This statement also implies that two fundamentally similar business models should merge to take advantage of full synergy. Any capitation model applied to a non-integrated providers and payers will likely face a myriad of challenges. Integrated delivery networks should carefully assess the extent of their systemic integration before instituting a capitated business model.


  • Spencer Nam
    Spencer Nam