Are your economic incentives self-defeating?

in a prior column Long, H., "Group Practices May Ignore Economic

Realities: Commingling of Rents and Returns," Physician Executive

14(5):33-35, Sept.-Oct. 1988), the author discussed the tendency of

many group practices to ignore ordinary business economics. The

example discussed in that column was the inappropriate commingling

of rents and returns from the various factors of production in medical practice. A frequent result of this is physicians who also have ownership interests and/or managerial responsibilities having an inflated perception of their worth as physicians because they are underoompensated for their ownership/ management roles. In this column, the author addresses the inadvertent structuring of physician remuneration via income distribution or externally negotiated formulas that reward individual behavior that actually threatens the economic viability of the group.

At the most basic leveL fee-for-service activity, taken by itself, contains dear economic incentives to expand volume. Figure 1, following page, depicts this phenomenon using standard cost/profit/volume analysis, where the price per unit of service exceeds the variable cost per unit of service and volume refers to the number of real units of service delivered to patients. Increasing volume can reduce losses, change losses into profits, or increase profits, depending on the starting point. Volume can be increased by acquiring more patients (from a growing service area and/or by increasing market share) or by increasing intensity of service through increased encounters and/or application of more resources per encounter. As long as increased volume is consistent with patient welfare (does no harm), the physician's responsibility to the patient and the physician's economic interests are not in conflict. This is why, traditionally, most group practice income distribution formulas contain both a fixed share component reflecting the fundamental philosophy of a group and a productivity based component regarding the generation of income by high producers through volume/intensity-related activity. In the 1970s and since, prepaid practice has emerged as a significant part of the group practice sector. When studied under cost/profit/volume analysis, pure prepayment displays economic incentives precisely the opposite of those under pure fee-for-service. Figure 2, following page, shows that loss reduction, loss-to-profit conversion, and profit enhancement are directly associated with constraining volume (again, in terms of real service delivered to patients-increased volume in the sense of larger prepaid enrollment being economically beneficial if the additional enrollees do not consume more real services per capita than the original enrollees). In the original staff model HMOS, placing physicians on salary (a fixed cost) was wholly consistent with the fixed revenue environment, because physician income would not increase with greater volume. Even without positive incentives to physicians to increase volume, utilization controls were implemented to ensure HMO profitability. The problem occurs when both fee-for-service and prepayment mechanisms are encountered simultaneously by a provider. What is economically valuable behavior under one mechanism is clearly economically detrimental under the other. Indeed, many group practices that were traditionally fee-for-service and then added a prepaid patient population, first as a very small proportion (2-5 percent) of total patient care activity and then growing to 40-60 percent of patient revenue, found themselves in serious financial difficulty if they retained an income distribution formula that favored high producers. High producers were rewarded for income-diminishing behavior, and the entire group was worse off. A further case in point is the generally unsatisfactory nature of individual practice association (IPA) risk-pool arrangements. The IPA is a prepaid plan that contracts with primary care givers (among others) on a discounted fee-for-service basis (just as do preferred provider organizations, PPOS) in exchange for guaranteed market share). A fixed-dollar pool is established each year to pay for contractual primary care, and if the pool has remaining monies in it at the end of the year, care givers recover some or afl of their discounts (unlike a PPO, where discounts are never recovered). If the pool is exhausted at yearend, no monies are available to be disbursed. (Discounted care is still paid for, of course, even if the pool amount has been exceeded.) Why doesn't this work? Suppose a physician's usual office visit charge is $25 and the IPA negotiates a 20 percent discount, resulting in an initial payment of $20 per visit. Suppose further that the baseline number of IPA enrollee visits per year to this physician is expected to be 1,200, but that the physician has several hundred open appointment slots over the year (idle capacity). Assume also that the average out-of-pocket cost to the physician of an additional office visit is 4 (the variable or incremental cost per unit of service). The likelihood of the physician's recovering all or any part of the $6,000 aggregate discount (1,200 visits times the $5 discount per visit) depends on the behavior of all the other care givers in the IPA risk pool during the year. Why let one's economic fortunes depend on the vagaries of others'behavior? Each time this physician sees an IPA patient, a positive contribution of $16 accrues ($20 discounted price minus the $4 variable cost). The entire 6,000 discount could be recovered in 375 additional visits of IPA enrollees, even if the risk pool were totally depleted and no yearend distribution were forthcoming. Only 125 additional visits would lock in the equivalent of one-third of the risk pool distribution. And more generally, the additional economic return to the physician of seeing an IPA patient one more time is much larger than the cost to that physician of the resulting reduced distribution at yearend from the risk pool. Thus, even this risk pool mechanism does not protect the IPA from volume increases, a potentially fatal phenomenon for any prepaid arrangement. When prepayment and fee-for-service activity coincide in a practice, why not simply have separate income arrangements for each payment category? Why not pay a physician $50,000 to see all prepaid enrollees and $25/visit to see all fee-for-service patients? If by this we imply the identification of each patient by payment category, we could reasonably expect differential intensity to result between payment groups. If intensity were truly neutral as a causative factor in health outcomes, the resultant "classes of care" might be irrelevant. Fee- for-service patients would arguably be paying for some sort of psychological benefit associated with greater intensity that was nonmeasurable in terms of health outcomes.) But if intensity didn't matter, the whole point seems lost. Why give care at aH? And if intensity does matter, either positively or negatively, allowing measurably different classes of care creates the malpractice attorney's dream cases. The point might be trivial were medicine an exact science in which there was always a single, correct amount of care to be given, but this is not reality, and judgments as to more or less diagnosis and treatment are made in almost every case. Further, those judgments are made by physicians who are ordinary human beings subject to the economic realities of mortgage payments, college tuition, aged parents to support, etc. Economic pressures do influence the care judgments, if only subjectively, of even the most ethical and conscientious providers. The other reality is that no payment system is neutral; every system has the potential to affect care behavior. What, then, is the appropriate approach to income distribution within group practices under mixed payment modes? A variety of approaches are possible that bring individual and group interests into coincidence and that are consistent with uniform quality of care for patients. What is appropriate for a particular group will depend on a variety of factors, including the mix of payment categories, the stability of the mix, the consistency of the mix across the patient loads of individual physicians in the group, the extent to which the group has idle capacity, the cost sturcture fixed, variable, etc.) of the group, and the dynamics of the overall growth of services delivered by the group. General guidelines reflecting these and other factors are the subject of a current research project I am conducting, and win be the subject of a future column.