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Aligning incentives for success.

PROVIDERS ARE SCURRYING TO ACQUIRE PRIMARY care practices and develop physician networks. These activities are undertaken to complement the development of an integrated delivery system (IDS) that will be positioned to gain access to the covered lives necessary to effectively compete in a managed care environment. There is danger, however, that in the hurry to win the race in purchasing the practices, providers may agree to compensation arrangements that will actually slow the ability of the IDS to aggressively position for managed care.

It is a sellers' market right now for primary care physicians who, for the most part, can name their own price--and do. In negotiating compensation packages, the physicians are striving to protect their reimbursement systems of the past. Providers (hospitals, insurance companies, and the like) seem only too willing to enter into such arrangements and appease the physicians to obtain a desirable practice. However, in so doing, they may well be sacrificing long-term success for the perceived short-term gain of acquiring the practice. Practice acquisition, in and of itself, has only a transient placebo effect. But fundamental long-term changes in practice patterns are essential to success in a capitated environment. Financial incentives must be properly structured and aligned to drive and sustain the behaviors needed to prosper in a managed care environment.

Many organizations are struggling with the compensation issue in building their physician networks for an IDS. Unfortunately, with respect to most hospital-sponsored health care systems, they are not developing a managed care compensation strategy, let alone a positioning strategy. Rather, they are implementing a retrospective compensation model by focusing on productivity incentives. The prevailing attitude is "if you build it [the network], they will come [the covered lives]." To date, few integrated health care systems truly view themselves as in the business of delivering care to a population in a way that creates value for the employer (or government payer) by reducing the direct expenses of health care coverage, reducing future direct expenses through preventive and early intervention strategies, minimizing the indirect expenses of health problems caused by decreased productivity, and minimizing employee dissatisfaction. Most still perceive the IDS as a collection of independent providers that is capable of spreading the risk of managing the care of a given population, with the only value being created for the patient at the bedside.

Building on traditional productivity incentives

Most compensation packages resulting from practice acquisitions are heavily based on traditional productivity measures that encourage and provide financial rewards for increasing volume and maximizing reimbursement. Although effective at increasing revenue in a fee-forservice environment, such behaviors are potentially lethal in a managed care environment where maximizing the health of patients and optimizing resource consumption are the determinants of success. Such compensation measures are further complicated by stringent anti-referral laws such as the Stark bill and the Medicare/Medicaid fraud and abuse regulations.

Elements of a managed care compensation plan

Business strategy

To ensure that a physician compensation plan encourages behavior that will result in the achievement of business goals, an IDS must define the value it intends to deliver to the payer and the patient (i.e., covered life). The core value that the IDS will deliver defines the behaviors to be incentivized. There are three primary value areas in which a health care provider can excel in a managed care environment:

* Lowest Total Cost: An IDS that excels in providing the lowest total cost will deliver a combination of quality, price, and convenience that no one can match. This IDS offers the full continuum of care needed to address community needs with acceptable levels of quality in all areas. Such an IDS provides geographic coverage and a manner of service delivery that allows it to access a maximum number of covered lives.

The primary value lies in reducing the hassle for the covered lives in accessing, receiving, and obtaining payment for care. This IDS has developed the utilization, quality assurance/improvement, and information systems necessary to be extremely cost-efficient in managing care and administrative processes. A compensation system that furthers this business strategy rewards efficiency and cost-management behaviors. Most community-based health care providers today are attempting to excel in this value area.

* Service Leadership: An IDS that excels in service leadership provides superior quality medical services to the payer and the patient, with a focus on centers of excellence. Although this IDS must offer competitive pricing and develop a delivery system that will meet the convenience expectations of the payers and patients, the primary focus is on pushing the boundaries for achieving positive outcomes in complex areas of care. A compensation system that furthers this business strategy rewards innovation, superior results, and positive quality outcomes.

* Total Solution: An IDS that excels in providing a total solution focuses on tailoring its mix of services to deliver total health management to a payer or patients with unique needs. Examples are mental health and chronic disease management. A compensation system that furthers this business strategy rewards solution development, results and positive outcomes, and relationship management.

Developing a business strategy to provide a specific value to payers and covered lives naturally results in identifying the behaviors that should be rewarded when expectations are exceeded. Where is the traditional productivity incentive? Nowhere. It simply doesn't fit in a managed care environment.

Components of compensation plan

Generally, there are three major components of compensation:

1. Base Salary: Compensates for the core aspects of the job.

2. Incentive Compensation: Rewards special achievements beyond the base expectations and must be linked to achievement of specific business goals.

3. Bonus Compensation: Rewards participation in the overall performance of the IDS and is not linked directly to individual performance.

Base Salary

Base salary should be a fixed, not variable, annual amount and should have the effect of establishing the minimum level of performance required. The amount of base compensation must be sufficient to meet the physician's minimum financial security needs. In order to provide the necessary level of financial security, base compensation should at minimum be no less than two-thirds of total compensation available to the physician. Base compensation will need to be monitored against the market and adjusted to remain competitive in order to attract the caliber of physician desired within each specialty area.

Incentive Compensation. Incentive compensation should be designed to optimize the physician's performance, encourage the development of appropriate utilization patterns and productivity, and recognize outstanding patient care, quality, outcomes and/or practice administration. The behaviors to be rewarded by incentive compensation will vary depending on the value the IDS is delivering to its target market.

For example, the following types of incentives further a business strategy providing lowest total cost health care:

Utilization of Services:

* Achieving (within a range) estimates of service utilization for a particular physician or practice site based on an actuarial analysis of the physician's patient mix using the variables of sex, age, and severity of illness. Such incentive compensation should reward appropriate utilization and/or penalize for both over- and underutilization of services

* Practice guideline compliance

* Formulary compliance

* Avoidable use of the emergency room by patients treated by primary care physicians

Patient Satisfaction:

* Responses to patient surveys regarding physician performance

* Accessibility of physician to patients

* Adequacy of patient education

* Patient complaint analysis

* Patient retention rates

Preventative Services:

Physicians can receive incentive compensation based on their success and consistency in developing, implementing, and utilizing preventative services. Such measures might include:

* Immunization compliance

* Screening mammography

* Pap smear compliance

* Cholesterol screening

* Prenatal care

* Diabetic retinal exam


* Number of covered lives, adjusted for severity, under physician's care

* Physician's flexibility in accepting new patients and chronically ill or other time-intensive patient types

* Participating in the medico-administrative functions of the peer review, quality improvement, and utilization management systems

* Availability of evening and/or weekend office hours

* Managing office expenses below budgeted targets

* Achieving mutually-established annual objectives; and

* Supervising and using physician extenders and similar staff to provide certain selected services


* Clinical outcomes as compared to the peer average

* Obtaining special education related to the physician's practice area to increase physician's expertise or to enhance services

* Board certification

The successful incentive system includes developing clear, objective performance expectations annually and regularly (at least quarterly) measuring and communicating actual performance compared to target levels.

Using HEDIS indicators

Using HEDIS indicators can provide valuable information in the management of care. However, the factors on which compensation is based must be tailored to the specific strategy being pursued by the IDS, instead of based on a "standardized" approach. Specifically, health care is a local market and strategies for health care systems must be based on the local conditions. An IDS must develop a strategy that creates value for the customers in the given market, and the compensation system must encourage the behaviors necessary to create that value on a consistent basis. Depending on the strategy to be pursued by the health care system, the incentive structure will vary.

The problem with prescribing the HEDIS indicators is that they may or may not support the strategy and the population served. As such, these indicators may not be appropriate measures in the case of a "center of excellence" strategy, or the HEDIS measurement methodology may be inappropriately restrictive, thus limiting applicability to some populations the IDS wishes to study. For example, some HEDIS preventive services indicators require continuous enrollment for two to five years, thus making them inappropriate for a Medicaid population. While an IDS should consider the applicability of the HEDIS indicators and the report card concept to their compensation program, the first evaluation must be whether such indicators further the IDS's strategy and will encourage the behaviors necessary to create value for the target market.

Bonus Compensation

Bonus compensation should be designed to allow the physician to participate in the improved performance of the IDS and the achievement of stated business goals. In for-profit health care systems, this often takes the form of profit-sharing or granting stock options, provided such a plan satisfies the exceptions under the Stark Bill and the safe harbors under the Medicare/ Medicaid fraud and abuse laws. Because net earnings of the organization may not in any way inure to the benefit of a private person, a tax-exempt IDS must be more creative in designing bonus compensation formulas.

A tax-exempt health care IDS excelling in providing the lowest total cost can allow physicians to participate in the system's overall performance as follows:

* Revenue Growth: Indexing bonus compensation based on IDS achieving revenue growth projections.

* Market Share: Indexing bonus compensation based on increasing the IDS' market share penetration as measured by the number of covered lives.

* Utilization Control: Indexing bonus compensation based on IDS achieving overall utilization management objectives.

* Total Quality Management: Indexing bonus compensation based on IDS achieving of total quality and outcome targets.

Non-Employed Physicians

These same incentive concepts can apply to physicians who are not employees of the IDS. Variable rate reimbursement can serve as an incentive for physicians who are under a personal service arrangement. Specifically, if the physician is paid according to a fee-for-service reimbursement schedule, the fee can be varied according to multipliers that take into account the behaviors to be discouraged or rewarded. For example, a physician whose performance mirrors the desired behaviors may be paid 10 percent over the standard fee schedule. This same variable formula can be applied to the capitation rate paid to a physician.


Although there are few situations where the compensation plan has been fully integrated as a management tool for accomplishing the IDS's strategic objectives, individual compensation incentives outlined earlier have been used on an isolated basis to modify behavior.

Established HMOs provide the strongest examples. In particular, one large regional HMO in the Midwest adjusts the base rate of capitation individually using strategically selected performance factors. A national managed care company uses a bonus compensation system that rewards the provider for performance consistent with objectives for cost effectiveness, compliance with quality and preventive indicators, and patient satisfaction.

Several health care systems are developing full compensation models as incentives for providers to achieve targeted treatment objectives in managing specific conditions, such as diabetes, asthma, and other chronic conditions. Moreover, as health care systems truly focus on managing the health of a community, building the information systems that provide the tools for managing care, and developing the technology and infrastructure necessary to support the delivery of care, compensation systems are being designed based on establishing team objectives for the management and delivery of care, with incentives for team members to achieve such objectives.

With respect to PPOs specifically, most serve as a vehicle for joint contracting and do not engage to any substantial degree in the management of care. Accordingly, most PPOs still reimburse on a fee schedule, but could successfully apply the type of compensation system described earlier. This approach is also applicable in the staff or group model setting. For example, one PHO contractual network that is the integrating unit of an IDS is developing such an incentive compensation system. As presently conceived, the compensation system will include a base capitation rate or fee for each specialty or service. The base rate will be subject to modification (both up and down) based on the physician's individual performance in meeting or exceeding certain objectives with respect to utilization, quality, patient satisfaction, and compliance with practice protocols and clinical pathways. In addition, physicians will be entitled to a bonus based on the overall performance of the PHO.

Transitioning to a managed care compensation system

It is critical that proper incentives be designed and in place prior to the time the IDS is required to perform under a capitation arrangement. One way to educate physicians and accomplish such a transition is to track performance as if the physician were operating in a capitated environment while continuing to compensate on a fee-for-service basis. This can be accomplished by establishing a "shadow capitation" program based on claims paid information for a physician's covered population. Under such a plan, each physician receives information on his or her actual billings, as well as what the earnings would have been under capitation compared to his or her peer group for a demographically comparable patient population. A component of such physician's incentive compensation could be based on an analysis of the variation between actual and expected resource utilization.

Based on the results of the study, the IDS can implement a compensation system that will enable it to succeed in a managed care environment. Such a plan is most effective if it is implemented 12 to 18 months before the IDS accepts its first capitated or similar risk arrangement.

Legal restrictions on compensation arrangements with physicians

Structuring a compensation system to encourage the behaviors necessary to manage health care delivery in a managed care environment will largely avoid violating Stark and the fraud and abuse laws. However, it is still important to understand and appreciate the regulatory limitations that can affect the design of a compensation system by an IDS.

Anti Referral Statutes. The Medicare fraud and abuse statute criminally punishes any provider who, with respect to a Medicare or Medicaid patient, "offers or pays any remuneration ... directly or indirectly, overtly or covertly, in cash or in kind to any person to induce such person to refer an individual" [42 U.S.C. 1320a-7b(b)]. The focus of this statute is to prevent providers from receiving compensation for referrals to other providers that would encourage the provider to increase the number of procedures and cost of care.

Similarly, the Stark Bill provides that "if a physician has a financial relationship with an entity ... the physician may not make a referral to the entity" [42 U.S.C. 1395nn(a)(1)]. This restriction applies to referrals for "designated" health services (as defined in the Stark Bill), that include clinical laboratory services and inpatient and outpatient hospital services. If there is a prohibited referral, the entity may not bill for the services provided, and the entity and the physician are subject to fines, criminal prosecution, and other sanctions.

Productivity formulas that provide compensation for volume of patient procedures or billings generated risk violating Stark and the fraud and abuse laws as they may take into account prohibited referrals. Similarly, profit-sharing formulas that include profits generated from billings for designated health services also risk violating these statutes. Accordingly, compensation arrangements that include a productivity or profitability component must meet the statutory exceptions for group practices or employment.

Incentive and bonus compensation based on factors that measure success in a managed care environment largely avoid the over-utilization concerns of the Stark and fraud and abuse laws, giving the IDS and physicians increased flexibility.

Tax Exemption Restrictions. With respect to tax exemption restrictions, the key requirement is that the total compensation package be reasonable. Reasonableness can be established to the extent that external surveys can demonstrate that the compensation is competitive. However, the compensation package must also further the IDS' charitable purposes. Accordingly, for a tax-exempt IDS, it is essential that the incentives be aligned to achieve business goals to avoid private inurement concerns. In addition, a tax exempt IDS should establish a maximum limit on the annual amount of incentive and bonus compensation that can be earned by a physician.


Rarely are physicians or hospitals with experience limited to the fee-for-service arena prepared to jump into a managed care or capitated compensation system. Nevertheless, it is essential to have such a compensation system in place to ensure successful fiscal management of an IDS under such a capitation or similar risk arrangement. The transition to a compensation system can be eased by implementing a "shadow" capitation or similar arrangement that will test physician performance under a risk arrangement in advance.

Information resulting from the shadow capitation test should then be used in restructuring the compensation system to ensure that the behaviors being encouraged will promote successful care and fiscal management. Horror stories abound about providers that have failed to modify their incentive systems in advance and have exhausted their annual capitation budget in the first six months of the plan year. Aligning the business strategy and financial incentives in advance is the best way to ensure that your IDS' transition to capitation is a success story.

Linda Koeppen, MHA, FACHE, Chief Executive Officer of Hospice of Dayton, Inc., Dayton, Ohio, has more than 20 years of experience as a clinician and health care executive in community and tertiary health care settings. She can be reached at 513/2564490.

Mike Mess, JD, is a

Principal of HealthServe, Inc., a Columbus, Ohio-based strategic advisory and management services firm. He specializes in developing and managing physician-driven health care systems. He can be reached at 614/442-2431.

Kara Trott, JD, a Principal of HealthServe, Inc., focuses on developing and managing physician-driven health care systems. She can be reached at 614/442-2431.

Linda Yazvac,MD, has more than 15 years of experience practicing in a variety of settings, including six years with the Ochsner Clinic, and four years with CIGNA HealthCare of Ohio, Inc. She is a full-time quality improvement and managed care consultant and can be reached at 614/848-4942.
COPYRIGHT 1997 American College of Physician Executives
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1997, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Transition To Capitation
Author:Yazvac, Linda S.
Publication:Physician Executive
Geographic Code:1USA
Date:Jan 1, 1997
Previous Article:Core competencies for physician practice success.
Next Article:Capitation conundrum.

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