Capitation Payments: Definition, How They Work, and Calculation

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas' experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.

What Are Capitation Payments?

Capitation payments are payments agreed upon in a capitated contract by a health insurance company and a medical provider. They are fixed, pre-arranged monthly payments received by a physician, clinic, or hospital per patient enrolled in a health plan, or per capita. The monthly payment is calculated one year in advance and remains fixed for that year, regardless of how often the patient needs services.

Key Takeaways

• Capitation payments are fixed payment amounts between insurers and medical providers as part of the capitation health care payment system.
• It is used by physician associations or insurers to pay hospitals or doctors per enrolled patient for a specific amount of time.
• Rates for capitation payments are developed using local costs and average utilization of services
• HMOs and IPAs tend to benefit from operating in a healthcare capitation payment system.
• Capitation payments are designed to lower the high costs of healthcare.

How Capitation Payment Plans Work

Rates for capitation payments are developed using local costs and average utilization of services, and therefore, can vary from one region of the country to another. Many plans establish risk pools as a percentage of the capitation payment.

Money in this risk pool is withheld from the physician until the end of the fiscal year. If the health plan does well financially, the medical provider receives this money; if the health plan does poorly, the money is kept to pay the deficit expenses.

The amount of the capitation will be determined, in part, by the number of services provided and will vary from health plan to health plan. Most capitation payment plans for primary care services include basic areas of healthcare:

• Preventive, diagnostic, and treatment services
• Injections, immunizations, and medications administered in the office
• Outpatient laboratory tests that are done in the office or at a designated laboratory
• Health education and counseling services performed in the office
• Routine vision and hearing screening

There are two types of capitation relationships. The first is where the provider is paid directly by the insurer, also called a primary capitation. Then, a secondary capitation is where another provider (such as a lab or medical specialist) is paid out of the provider’s funds.

Another form of capitation may encourage preventative health services. With capitations that encourage preventative care, the provider is rewarded for providing preventive health care services. This incentivizes the doctor or provider to help avoid expensive medical services.

Capitation agreements will provide a list of specific included services in the contract.

Capitation is meant to help limit excessive costs and the performance of unnecessary services. But on the downside, it might also mean that patients get less facetime with the doctor. Providers may look to increase profitability under the capitation model by cutting down on the time that patients see the doctor.

Compared with the capitation alternative, fee-for-service (FFS), it’s supposed to be more cost-effective, hence the reason providers look to limit face time with doctors. FFS pays providers based on the number of services provided—unlike capitations that pay based on the number of participants in the group. Studies from many years suggest capitation is more cost-effective among groups that have a high amount of individuals with moderate health care needs.

At the same time, it’s been shown that capitation systems encourage doctors to reduce services. A Center for Studying Health System Change study found that 7% of doctors in a capitation system reduce services because there’s financial incentive to do so.

Advantages and Disadvantages of Capitation Payments

Capitation payments have various advantages when it comes to the alternative—FFS. However, some providers may still opt for FFS given its advantages over capitation.

Advantages of Capitation

The alternative to capitation payments is FFS, where providers are paid based on the number of services provided. Perhaps the biggest benefit to capitation contracts is that they provide fixed payments to providers, dissuading the incentive to order more procedures than necessary, which can be an issue with FFS (i.e. capitation provides greater provider accountability).

As well, the fixed payments by capitation offer greater financial certainty for providers. They can focus on face-to-face services and explore cost-effective care that provides the best treatment. Along those lines, providers have a greater incentive to encourage preventative care.

Disadvantages of Capitation

On the downside, a capitation arrangement can lead providers to opt for less expensive drugs or procedures. That is, providers opt to not use name-brand products to save money. Capitation can also encourage providers to enroll large numbers of patients, which can lead to short visits for patients and long wait times.

Financial risk for patients with major medical issues is borne by the provider in the case of capitation agreements. In higher population areas, the capitation rates might be on the low side. In those circumstances, the provider may supplement the capitation model with FFS.

• • Dissuades providers from unnecessary services
  • Promotes efficiency and cost-control
  • Reduces bookkeeping overhead
  • Allows providers to focus on face-to-face services, preventative care
  • • May cause providers to use cheaper drugs/services
    • Encourages providing fewer services
    • High population areas means low capitation rates
    • Can lead to long wait times and short visits

    Special Considerations

    Capitation payments are defined, periodic, per-patient payments (usually monthly) for each individual enrolled in a capitated insurance plan. For example, a provider could be paid per month, per patient, despite how many times the patient comes in for treatment or how many services are needed. Capitation programs can cover individuals or families. Health maintenance organizations (HMOs) and independent practice associations (IPAs) often use capitation programs.

    The payment varies depending on the capitation agreement, but generally, they are based on characteristics such as the age of the individual enrolled in the plan. Modifying the plan, according to specific characteristics for groups of patients, is one way to compensate providers for the medical care expected for similar ailments within a group.

    Health insurance companies use capitation payments to control health care costs. Capitation payments control the use of healthcare resources by putting the physician at financial risk for patient services.

    At the same time, in order to ensure that patients do not receive suboptimal care through the under-utilization of health care services, insurance companies measure rates of resource utilization in physician practices. These reports are publicly available and can be linked to financial rewards, such as bonuses.

    One major drawback of capitation is that it incentivizes physicians to spend less time with patients—i.e. spending only a few minutes on appointments.

    Example of a Capitation Payment

    A capitation example would be an IPA—a type of HMO—that has 5,000 patients. The IPA needs to secure insurance coverage for its patients for the upcoming year. Thus, it would enter into a capitation contract with a physician.

    The physician would be paid a fixed payment to treat all 5,000 patients. For example, say the capitation fee is $400 per year per patient. The physician would collect $2 million per year from the IPA. In return, the physician would be expected to cover all expenses related to treating those 5,000 patients.

    The idea is that not all patients will use $400 in services over the course of the year. Some may use $2,000, but others may only use $100 or none at all. Overall, the doctor is assuming that (on average) the patients from this IPA will use less than $400 each in services.

    The capitation payment amount is expected on how much each patient is expected to use the service. Patients, such as those with preexisting conditions, are likely to have higher expected medical needs and costs. It’s in the IPA or HMO's best interest to try and estimate as best as possible the potential utilization of services.

    Caput (which means head) is the Latin word that capitation is derived from. Capitation is the headcount for a group (such as IPA or HMO) that the fees are based on.

    Capitation FAQs

    What Is a Capitation Agreement?

    A capitation agreement is an actual contract between the HMO or IPA and the medical provider or doctor. This agreement lays out the details and expectations between the two, including the fixed amount of money (fee) to be paid to the health care provider.

    What Are Capitation Fees?

    Capitation fee, or capitation rate, is the fixed amount paid from an insurer to a provider. This is the amount that is paid (generally monthly) to cover the cost of services performed for a patient. Capitation fees can be lower in higher population areas.

    What Is the Difference Between Capitation and Fee-For-Service?

    Capitation is a model that pays a fixed amount to providers based on the number of patients they have or see. Meanwhile, fee-for-service (FFS) pays based on the procedures or services that providers perform. Both these systems are used in the U.S. healthcare system.

    Bottom Line

    Capitation payments are payments made to health care providers for providing services to patients. These payments are fixed and generally paid monthly (based on yearly contracts—i.e. capitation contracts).

    This system helps doctors reduce bookkeeping, accounting, and other operating costs. Capitation also benefits the HMO or IPA by ensuring that providers don’t undertake more services than necessary. The idea is that it reduces the potential for excessive billing.