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Legal issues in accepting capitation.

Shifting of legal responsibility and liability invariably accompanies financial risk shifting, and physicians taking such risk through capitation or otherwise have many of the same legal concerns that managed care organizations have faced. These key legal issues include those arising from:

* Utilization management/medical necessity decisions.

* Selection of other physicians to participate in a group, IPA, or other medical panel.

* Contractual responsibility to the managed care organization and the patient.

* Liability issues related to provider financial incentives.

* Antitrust concerns on pricing and participation decisions made by physician groups, IPAs, or other medical panels.

* Regulatory matters related to the acceptance of financial risk.

Contractual Issues

A physician accepting capitation must be concerned not only with the terms of the contracts to which he or she is a party but with every contract in the arrangement. For example, physicians who are accepting capitation cannot just be concerned with the terms of their contract with the managed care organization (MCO) because the physicians' interests are also affected by the actions and decisions of the other players in the arrangement (i.e., the MCO, the HMO or health plan, the employer, and the employees/enrollees) Thus, the physicians will want to ensure not only that the capitation payments they will receive are adequate, but also that the MCO has a marketing strategy that makes sense, that the plan educates employers who in turn educate employees about the plan.

Legal Issues Related to Delineation of

Services to Be Provided

Significant legal issues arise when physicians and other providers agree to accept capitation related to their contractual responsibilities. These issues give rise to four categories of potential liability or areas of contention: (1) allegations of breach of contract, (2) allegations of negligence or bad care, (3) disputes over the services to be provided by the physician who has accepted capitation or some other risk-shifting arrangement, and (4) disputes between providers over who is responsible for providing care in certain situations. Managed care contracts should prospectively address these issues, thereby solving as many of the disputes as possible before they actually occur.

A breach of contract dispute most commonly arises in one of two ways. First, a patient may claim breach of contract because a service is not provided or because a service is billed that the patient believed was covered under the plan. Alternatively, a physician may claim breach of contract because an MCO refuses to reimburse the physician for a service that the physician believed was outside the scope of services to be provided under the capitation payment. Both of these examples relate to the contractual definition of "covered services" in both the provider contract and the plan documents.

A clear delineation of the services, by CPT code or otherwise, is necessary to avoid confusion as to what services are to be provided in return for payments received. The physician must recognize one of the realities of risk shifting. When an MCO keeps the financial risk for the cost of medical services, it obviously has an incentive to clearly and nar-rowly define the services to be provided. However, once this financial risk is shifted to the physician through capitation, that incentive is no longer there. Therefore, it is incumbent upon the physician and his or her legal counsel to make sure that the provider agreement with the MCO clearly defines the services to be provided.

Disputes may also arise between primary care physicians and specialists as to who is responsible for a given service. The shift from fee-for-service reimbursement to capitation can cause tension in the relationship between primary care physicians and specialists. For example, an orthopedist may complain when a referral is made to him or her for a "sore shoulder," with the orthopedist taking the position that such a malady is really in the purview of the primary care physician. Obviously, this is a significant change from the fee-for-service environment, where minor aches and pains were readily accepted and paid for on a fee-for-service basis. The process of delineation of primary care versus specialty responsibility in a payment relationship where both the primary care physician and the specialist are at risk should be clarified and evolve over time, with an emphasis on establishing critical paths for care for as many areas as possible.

Perhaps the greatest source of liability exposure, however, is related to a claim for negligence when a patient is injured (or his or her condition worsens) because of a physician's failure to provide care in the belief that the services did not fall within the scope of services included in the capitation payment. Although a physician's medical ethics would ordinarily dictate the necessity of providing care, there are instances when there is no clear ethical duty (e.g., the use of less expensive diagnostic and treatment modalities, experimental treatments). A clear definition of covered services and of the responsibility for making medical necessity determinations can minimize the risk of negligence and possibly provide an affirmative defense against a negligence claim.

Marketing, Enrollment, and Enrollee


When a provider agrees to be paid on a capitated basis, enrollment, both the process and the strategy, becomes absolutely critical. The provider will want assurance that the enrollment process is made clear to the plan and plan members and that it is administered fairly and consistently. The plan should also have adequate enrollee identification and verification mechanisms in place.

Equally important is the enrollment and marketing strategy. The plan and the provider must agree on a targeted population and eligibility criteria. It would be financially devastating if, after shifting financial risk to physicians and other providers, the MCO began underwriting individuals and groups that are poor risks and that would not previously have been issued policies. The development of a marketing and enrollment strategy must be a joint effort by the MCO and the providers - the irrational "take it or leave it" attitude prevalent in early managed care negotiations is no longer appropriate. Other marketing and enrollment provisions that should be contained in the contract include:

* Clear definition of enrollee.

* Procedure for verification of eligibility.

* Identification of enrollee (ID cards).

* Conditions on use of provider's name in marketing materials.

* Provider notice of new contracts and its terms.

* Informing enrollees of UR obligations and decisions.

* Administration of manual/policies/procedures/benefit plan descriptions.

* Ability to transfer or refuse enrollees under specific circumstances.

* Grievance procedures.

Once patients are enrolled in a managed care plan, they must be educated as to the plan's purpose and operation. The physician has the fight to expect that enrollees understand plan procedures and the consequences of not following them. Enrollees must be made aware of the different relationships in the managed care arrangement and know which parties are responsible for specific decision-making policies and procedures. Enrollees must also be educated regarding utilization management and the interplay between utilization management and quality assurance. The greatest internal UM program in the world is of little benefit if patients do not understand the importance of, and change their behavior toward, reducing utilization. Changing patients' behavior does not just mean requiring the use of a gatekeeper. It also means building incentives into the plan to encourage patients to make health-conscious decisions on a daily basis and to use efficient providers on an appropriate basis.

Data and Medical Records

The importance of data to a managed care system cannot be overstated. Physicians and the MCO need to develop and implement effective processes for data collection, analysis, and reporting. Data must be collected and manipulated in such a way as to track cost and outcomes information for specific illnesses; to monitor patient office visit rates. inpatient/outpatient utilization rates, and pharmacy prescription rates; and to monitor providers' practice and referral patterns. Reports showing such information must be produced on a periodic basis and be made available to all appropriate individuals. If physicians are organized in a group, IPA or otherwise, these data will be used to monitor the performance of all physicians in accordance with the performance requirements of the group and to measure actual costs versus projected costs of care.

Medical records must be maintained and made accessible in accordance with state regulatory requirements and physician office policy regarding confidentiality. The MCO should obtain written patient authorization for release of medical records, and access to data should be restricted to designated individuals.

Other Provisions

There is a seemingly endless list of additional issues that should be addressed in managed care contracts:

* Patient transfer policies.

* Reinsurance.

* Term and termination of agreement.

* Post-termination responsibilities (i.e., continuity of care).

* Patient referral limitations.

* General/professional liability insurance.

* Indemnification requirement.

* Prior approval for specified services.

* Payment methodology and time frame.

* Billing form.

* Payment appeals process.

* Risk of nonpayment (right to bill patient, limit on responsibility to provide services, right to receive charges actually made).

* Patient duties (e.g., copayments/deductibles/coinsurance, payment for noncovered services).

Again, physicians and other providers in a capitated environment become a managed care plan and have many of the same management issues with which to contend. At a minimum, the MCO's policies should be clarified and agreed to or changed so that physicians' policies do not conflict with the MCO's.

Physician Organizations

It is difficult for individual physicians negotiating a managed care contract to resolve many of the contractual and other issues discussed in this paper, or to otherwise develop a true partnership with an MCO. For that reason, and to spread the financial risk among several providers, many physicians are participating in physician organizations such as GPWWs, IPAs, MSOs or OWAs (other weird arrangements). The formation of a physician organization (PO) raises additional legal and operational issues. When a physician joins a PO for purposes of entering into managed care contracts, that physician's financial success is linked not just to his or her performance but to the performance of every provider in the organization. For this reason, a physician will want assurance that the PO has appropriate utilization management systems and credentialing policies in place. In addition, the PO must be cognizant of the liability issues related to provider financial incentives, as well as the antitrust, Stark II, and state insurance/regulatory implications of forming and operating an organization of physicians for purposes of taking risk.

Utilization Management

Because physicians in the PO are accepting financial risk for providing medical care, the PO will want to take responsibility for providing or overseeing utilization management (UM) services. Utilization management has been an essential element of managing the cost of providing medical care. It allows a provider or a provider organization to coordinate patient treatment, monitor quality of care, minimize inappropriate use of services, track utilization patterns of providers, and make medical necessity determinations for purposes of claims payment. Utilization management comprises a multitude of functions, including utilization review, treatment and discharge planning, case management, physician profiling, and the development of clinical practice guidelines. Case management, an important component of utilization management, involves identifying at an early stage those patients who could be more cost effectively treated in an alternative setting or at a lower level of care without adversely affecting quality. Because all of these functions have some effect on level of care, payment for care, and possibly whether care is rendered at all, there are inherent liability risks associated with utilization management.

The issue of legal liability related to utilization management activities was first raised in the California case of Wickline v. State of California.[1] Wickline held that a third-party payer can be held legally responsible when medically inappropriate decisions result from defects in design or implementation of UM systems. Another California court held an insurance company liable for failure to make a complete investigation before denying care.[2] In determining that the investigation was defective, the court focused on the fact that the physician reviewer spent an average of only 12 minutes per claim and disclaimed responsibility for obtaining relevant records before making a recommendation. Litigation has also resulted from the failure to heed a physician's advice regarding the need for continued hospitalization,[3] failure to inform a patient of appeal rights,[4] failure to adequately communicate the reasons for denial,[5] misinforming patients,[6] improper standard of care,[7] improper personnel denying claims,[8] and even defamation.[9]

In setting up its UM system, a PO must bear in mind the lessons learned from the each of the above-mentioned cases. Physicians and patients must be educated regarding the standards and procedures for utilization management. Examples of what might be included in the UM system include:

* Definition of medical necessity must be clear and relate to the same definition in the plan document.

* Provider should only be required to provide medically necessary services.

* Denials should be reviewed by a UM physician and discussed with the attending physician.

* Verification of eligibility should be clear, as should be the process for preauthorization.

* Emergency care should be exempt from preauthorization requirements.

* Concurrent review process should limit access to patients and records to reasonable times that do not interfere with provider business and patient care

* Retrospective denial of claims should be limited.

* Appeals process should be expedited and the physician reviewer should not be the physician who made the initial determination.

* Should be determined whether provider receive indemnification for its participation in UM activities?

Rather than developing its own UM system, the PO may decide to contract with a utilization review organization (URO). Doing so, however, would not shield the PO from liability. A patient injured as a result of a utilization review decision, or merely dissatisfied with the basis or handling of the decision, may file suit against only the URO, may file suit against the URO and the PO for negligently selecting the URO, or may attempt to establish a legal relationship between the PO and the URO such that the PO can also be held liable for the URO's conduct.

Just as a PO has a duty to carefully select and monitor physicians, it has a duty to carefully select and monitor the URO with which it contracts, including ensuring that the URO's procedures are appropriate and its personnel are qualified before it hires the URO. After signing the contract, the PO must monitor the URO's performance and ensure that any operational problems are corrected.

Although the PO must monitor the URO's performance, it should not attempt to control the URO's policies and procedures. A PO's exertion of control over the URO's policies and procedures could create an agency relationship and potential liability under the legal theories of ostensible agency or vicarious liability.


A PO has a nondelegable duty to credential its physicians. Credentialing can be defined as the initial and ongoing process of investigating, verifying and evaluating a health care professional's competence and qualifications to provide medical care and to participate in an organization. Credentialing is a vital component of an PO's quality assurance efforts.

A PO's duty to credential its physicians creates two potential areas of liability risk. First, a PO can be held liable for the negligent acts of its physicians under such theories as corporate negligence, respondeat superior, and ostensible agency. Second, a PO faces potential liability from claims filed by physicians who have been denied participation or whose participation has been suspended, revoked, or not renewed.

Beginning with Darling v. Charleston Community Memorial Hospital, courts have consistently held that a hospital has direct responsibility for the quality of care provided by independent staff members and a duty to exercise ordinary care in the selection of physicians.[10] Failure to meet these responsibilities is referred to as corporate negligence. The doctrine of corporate negligence applies equally to managed care entities. For example, McClellan v. HMO of Pennsylvania held that an IPA-model HMO had a nondelegable duty to select and retain competent providers.[11]

If a PO employs physicians, it can be held liable for the negligence of its employees under the doctrine of respondeat superior.[12] Under this doctrine, an employer is liable for the negligence of its employees if the negligent act was performed within the scope of the employee's duties. Simply stating in the provider contract that the PO and physician are independent contractors does not necessarily create such a relationship for liability purposes. The parties must truly be independent, i.e., the PO cannot be deemed to have control over the physician and the physician's medical decisions.

A PO may also be held liable for the negligence of a nonemployee physician under the theory of ostensible or apparent agency. This theory applies if a PO engages in conduct that leads a patient to reasonably believe that the entity, rather than the individual physician, is the provider of care.

A PO may also be exposed to potential liability from its credentialing decisions from claims filed by providers who allege that they have been unfairly denied participation in the PO. The liability exposure is generally centered around the criteria used for credentialing and the procedure followed in credentialing decisions. Although physicians wishing to participate in a PO are generally not given the same procedural rights as are afforded by hospitals in making credentialing decisions, a PO should utilize objective standards and a fair process in credentialing decisions.

A recent flurry of litigation and state legislation has arisen in the area of economic credentialing. Economic credentialing opponents assert that economic criteria have no relation to the quality of care provided and actually may undercut quality goals. Proponents of economic credentialing argue that efficiency is a legitimate criteria upon which to credential and, moreover, that quality and efficiency are inextricably related. Jurisdictions are split as to whether the use of economic criteria in credentialing process is appropriate and to what degree it is appropriate.

Liability Issues Associated with Provider

Financial Incentives

Capitation and other risk arrangements are intended to provide financial incentives to providers to choose the most appropriate level and most cost-effective method of providing care. However, there are inherent liability risks associated with these financial incentive arrangements. There have been a number of cases in which HMO subscribers have alleged that they had received inadequate medical care because a medical decision was adversely influenced by provider financial incentives.

In the 1979 case of Pulvers v. Kaiser Foundation Health Plan, a woman charged that an HMO's incentive plan was the reason her husband's condition was not diagnosed properly. However, the court ruled that the incentive plan was acceptable.[13] In Bush v. Dake, a patient alleged that an HMO's financial incentive arrangement caused a physician to delay in ordering a pap smear, which resulted in a missed diagnosis.[14] The court rejected a motion to dismiss and ruled that the case should go to trial. The case was ultimately settled out of court, so there was never a determination as to whether the financial incentives caused the allegedly improper medical decision.


Antitrust concerns arise during the formation of a PO when it possesses significant market power. In order to determine whether a PO has market power, one must first define the relevant market. This includes both the geographic market and the product market. Once the relevant market is defined, market power is determined by considering such factors as the percentage of participating providers, the number of competing organizations, exclusivity, and mitigating factors, such as the creation of efficiencies and whether or not providers are taking risk.

A PO's method or criteria for selecting participating providers may also raise antitrust concerns, i.e., a claim of provider exclusion or group boycott. POs must walk a fine line between overinclusion, whereby efficiencies are lost and participating providers cannot spread their risk, and exclusion, which provokes claims of group boycott. It is imperative that POs develop and maintain a credentialing plan and process focused on ensuring quality of care.

Finally, antitrust risks may also arise if a PO's conduct during implementation or operation is considered anticompetitive. The most commonly alleged form of anticompetitive behavior is price fixing. Price fixing can be an issue because a PO involves an agreement among otherwise competing providers on prices charged for health care services. However, courts have allowed providers to agree on prices when they are involved in a legitimate joint venture and the agreement on prices is ancillary to the joint venture. Factors that are considered in the determination of whether a PO is a legitimate joint venture include whether:

* Providers share substantial financial risk (e.g., through acceptance of capitation payments).

* The organization offers a new product that offers substantial efficiencies (e.g., guaranteed comprehensive physician services for a prepaid premium).

* The organization dictates what participating providers can charge to nonplan patients.

* Participants have substantially integrated their businesses, thus generating procompetitive efficiencies

Stark II

Although a thorough discussion of the Stark II legislation is beyond the scope of this article, a general explanation of the law and its possible effect on capitation is appropriate. Stark II generally prohibits physicians from referring Medicare patients for designated health care services to persons or entities with which the physicians have "compensation arrangements." The term "compensation arrangement" is defined so broadly that virtually any type of arrangement is prohibited unless it specifically falls under one of the Stark exceptions.

While there is not an exception for capitation arrangements per se, an exception for nonemployee physician incentive plans, which applies to physician compensation arrangements between entities and physicians that directly or indirectly have the effect of reducing or limiting services (but not medically necessary services) provided to individuals enrolled with the entity. An argument can be made that capitation qualifies under this exception because it is intended to reduce the number or level of services provided. However, there is some uncertainty as to the scope of the exception. For example, some commentators take the position that the exception only applies to HMOs.

Despite the lack of clear direction from the text of the legislation, it is unlikely that Stark II will be interpreted to prohibit physicians from taking financial risk for providing medical services or from entering into arm's-length relationships with hospitals, through physician-hospital organizations or otherwise, to manage risk.

State Insurance Regulatory Issues

To the extent physicians or Pos take financial risk beyond the services they are actually providing (e.g., ancillary services, durable medical equipment), they must be sensitive to state insurance regulations. Insurance regulators are voicing a concern over the potential insolvency of groups taking risk. Regulators of every state have horror stories of IPAs becoming insolvent and leaving members holding the bag. Therefore, many state regulators have suggested the development of model acts to be adopted by states that would serve to regulate IPAs and other organizations that take financial risk for the cost of providing medical services. It is likely that these laws, if enacted, would require the maintenance of financial reserves or set forth business and management criteria for qualifying to accept financial risk.


[1.] Wickline v. State of Cal., 239 Cal. Rptr. 810 (Cal. App. 1986), review dismissed, remanded, 741 P.2d 613 (Cal. 1987). [2.] Hughes v. Blue Cross of N. Cal., 245 Cal. Rptr. 273 (Ct. App. 1988). [3.] Salley v. E.I duPont de Nemours & Co., 966 F.2d 1011 (5th Cir. 1992). [4.] Davis v. Blue Cross of N. Cal, 600 P.2d 1060 (Cal. 1979). [5.] Kent v. Central Benefits Mut. Ins. Co., Civ. Act. No. 88 AP-758 (Ohio Ct. App. Feb. 9, 1989). [6.] Aetna Life Ins. Co. v. Lavoie, 470 So. 2d 1061 (Ala. 1984). [7.] Hughes v. Blue Cross of N. Cal., 245 Cal Rptr. 272 (Cal. App. 1988). [8.] Linthicum v. Nationwide Life Ins. Co., 723 P.2d 675 (Ariz. 1986). [9.] Slaughter v. Friedman, 185 Cal. Rptr. 244 (Cal. 1982), surgeon sued dental director for defamation for a letter stating that a number of claims were unnecessary and that the surgeon had overcharged. [10.] Darling v. Charleston Community Memorial Hosp., 211 N.E.2d 253 (1965), cert denied, 383 U.S. 946 (1966). [11.] McClellan v. HMO of Penn., 604 A.2d 1053 (Pa. Super. 1992). [12.] Sloan v. The Metropolitan Health Council of Indianapolis, Inc., 516 N.E.2d 1104 (Ind. App. 1987). [13.] Pulvers v. Kaiser Foundation Health Plan, 99 Cal. App. 3d 560 (1979). [14.] Bush v. Dake, No. 86-25767-NM (Mich. Cir. Ct., filed on June 1, 1987).
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Author:Hynes, Daniel W.
Publication:Physician Executive
Date:Jul 1, 1995
Previous Article:The marriage of risk management and the process of patient care.
Next Article:Capitation and informatics.

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