American Journal of Law & Medicine

Procedural protections for patients in capitated health plans.(Health Care Capitated Payment Systems)


In the American health care system, payers are rapidly moving toward the use of capitation as the preferred method for paying for health care services for sponsored patients. In capitation, the payer pays a provider organization a set rate per patient to care for a group of patients. The provider organization assumes the risk of the actual costs of caring for these covered lives. The theory of capitation is that providers, by assuming risk, will have incentives to contain their costs.

The provider entity that provides the care can take many corporate forms. A capitated provider can be a small group of physicians with admitting privileges at a single hospital or a complex integrated delivery network comprised of hospitals, physicians, and other health care professionals and institutions with integrated case management and data systems. Currently such integrated delivery networks assume a variety of organizational forms, ranging from traditional staff model health maintenance organizations (HMOs) in which physicians are employees of the health plan to physician hospital organizations (PHOs) in which physicians and hospitals join together for purposes of contracting with payers.(1) Hospitals and physicians belonging to their medical staffs are motivated to form integrated delivery networks or other consolidated business organizations in order to contract with payers that seek providers willing to accept financial risk for the care of sponsored patients.(2) Providers join such arrangements out of fear of losing patients if they do not.

Private payers, generally employers or insurers on their behalf, have been moving aggressively toward contracting with provider groups and integrated delivery networks on a capitated basis for the nonelderly population for most of the 1990s. States have also moved toward capitation with managed care plans for Medicaid beneficiaries to control costs in escalating Medicaid program expenditures.(3) President Clinton proposed and the 103d Congress considered capitation as the major payment mechanism in the various proposals for comprehensive health reform.(4) The Republican proposals to reform the Medicare program now before Congress call for capitation as the means of paying for health care services to Medicare beneficiaries.(5) Even President Clinton's counterproposal on Medicare includes capitation as the predominant payment mechanism.(6) Finally, the growth in Medicare managed care through capitated health plans is increasing dramatically even without governmental intervention.(7)

Considerable evidence now shows this movement toward capitated managed care for the nonelderly population has slowed the overall increase in health system costs. Specifically, a recent survey of 376 HMOs nationwide reported declining premiums and utilization rates for the first time in the last four years.(8) Between 1992 and 1993, increases in health expenditures were 7.8%--one of the lowest rates of increase in thirty-three years.(9)

The use of capitation to pay for health care services raises important issues regarding the protection of the interests of individual patients in capitated health plans. Specifically, procedures are invoked in setting policies, including rates. Procedures are also necessary for resolving disputes between plans and consumers and, although not specifically discussed in this Article, between plans and providers. Further, affected parties dissatisfied with the policies, rates, and decisions made by capitated health plans may seek the review of state and federal courts. Consequently, an important issue is the appropriate oversight role, if any, for courts over capitated health plans.

Such procedural issues when they involve health plans for government benefit programs are the subject of administrative law. When they arise in the context of nonregulated private organizations, contract or simply private organizational policy handle these procedural issues. When government regulates private health plans and perceives the need, legislation may impose requirements on private health plans to make policy, set rates, and/or resolve disputes.

This Article analyzes the procedural issues raised by the need to protect patients in both public and private capitated health plans. Part II reviews the historical development of capitation in the American health care system. Next, Part III reviews the regulatory regimes that now govern capitated health plans in the United States and the implications for consumer protection with the spread of capitated health plans. Then Part IV reviews the constitutional and statutory law that govern or otherwise inform policy and rate making, dispute resolution, and judicial review for both public and private capitated health plans. The Article concludes with recommendations for appropriate procedural protections that should be required of capitated health plans with respect to rate setting, policy making, dispute resolution, and judicial review.


The theory of market economics in general is that the market will make appropriate allocation determinations consistent with consumer preferences. In a perfect market where consumers have complete information and suppliers face no barriers to entry, suppliers will compete to supply products and consumers will make decisions about those products based primarily on quality and price.(10)

However, the market for health care services does not work in this manner. Consequently. whether allocation decisions in the health care system should be made primarily through the market or through regulation has been a hotly debated issue since the maturation of the American health care system in the middle of the twentieth century. The peculiar historical development of the American private health insurance market and the introduction of government-sponsored health insurance for vulnerable groups into that market has shaped the terms of the debate then and now.

In 1965, the Democratic administrations of Presidents Kennedy and Johnson in conjunction with a Democratic Congress enacted the Medicare program for the elderly and the Medicaid program for some poor.(11) It is important to appreciate that Congress deliberately designed these programs to look and function like private health insurance programs to gain cooperation of providers and also to minimize disruptions in the private markets for health care services and health insurance.(12) Nevertheless, this formidable public involvement in the markets for health care services and health insurance precipitated health care cost inflation based on increased demand and utilization of services often without genuine assessment of their benefits compared to costs. By 1990, medical prices had risen to 800% of their 1960 level-almost double the increase in the consumer price index generally.(13) National health expenditures moved from less than five percent of gross national product in 1960 to 13.9% in 1990.(14) The continuing problem of cost inflation is a major motivating force toward the use of capitated payment methodologies in today's health care system.

In 1973, Congress enacted the Employee Retirement Income Security Act (ERISA),(15) to regulate employer-sponsored benefit plans. By the 1970s, employers had extensive pension and health care plans and had become the predominant source of health insurance for the nonelderly population.(16) At the time of its enactment, most of the debate centered on ERISA's pension provision, and policy analysts saw ERISA primarily as a pension protection measure.(17) In response to pressures from labor that sought to minimize state regulation of employee benefits, Congress included a provision preempting state laws that might also affect employee benefit plans.(18) While expressly saving state insurance regulation from the preemption provision, Congress went further to provide that state insurance regulation would not cover employee benefit plans.(19) This preemption provision had an unanticipated affect on the market for health insurance of greatly increasing the proportion of employer, self-insured plans in the private health insurance market during the 1970s and 1980s.(20)

The enactment of Medicare, Medicaid, and later ERISA coincided with the revolution in constitutional law that changed the status and interests of beneficiaries of government programs. Specifically, the Supreme Court recognized that the beneficiaries of government programs had a constitutionally protected property or entitlement interest in the benefits that they received under the due process clause of the Fifth and Fourteenth Amendments.(21) During this period, courts and theorists wrestled with the implications of this recognition for public programs and private programs funded with public funds.(22) Not surprisingly, Congress incorporated many due process protections for consumers and providers in the Medicare and Medicaid programs(23) as well as consumer protections in ERIZA.(24)

Courts have long recognized that beneficiaries of the Medicare and Medicaid programs have a protected property interest in these programs, although providers have no recognized property interest in them.(25) Over the years, courts have outlined the contours of what due process means in the context of the Medicare and Medicaid programs.(26) However, the Supreme Court has ruled that due process procedural requirements are quite limited when legislative-type decisions are involved.(27) This distinction becomes crucial in affected capitated systems, because many issues are decided in a rate-setting context which is viewed in constitutional and administrative law jurisprudence as a legislative activity.(28) For example, the federal Administrative Procedure Act treats rate making as a rulemaking proceeding even when the rates of only one entity are involved.(29)

In the early 1970s, the federal government and states explored and adopted primarily regulatory strategies to address inflation in health care costs. Specifically, these strategies included hospital rate regulation, capital expenditure review for health care institutions, and utilization review for services ordered by physicians as means of controlling costs. This latter regulatory strategy, utilization review, was the precursor of managed care in that regulators sought to impose some oversight over the health care services ordered by physicians. These regulatory strategies persist today in some states and in the Medicare and Medicaid programs.

The early 1970s also witnessed considerable interest in HMOs as the means to control health system cost through nonregulatory means. HMOs, by definition, assume the risk of both providing as well as financing care for a preset monthly fee. By assuming risk for excess medical expenditures, HMOs and competitive health plans (CHPs) have the requisite incentives to control the costs of providers participating in the HMO. Some commentators have seen HMOs as more efficient and cost-effective vehicles for providing medical care because they emphasize preventive services and hold down utilization of inpatient hospitalizations and other expensive medical procedures.(30) In 1973, Congress inaugurated a federal program to promote the development of HMOs in the private market.(31) One benefit of being a federally-qualified HMOs was the requirement on employers with over twenty-five employees to offer an HMO option where federally-qualified HMOs were available to be eligible for favorable income tax treatment of the expenses of an employee health plan.(32) Congress ended the requirement that an HMO be federally qualified to entitle the employer for such favorable tax treatment in 1995.(33)

In the late 1970s and early 1980s, many theorists suggested that public policy should promote competition in the markets for health services and health insurance.(34) Many scholars argued that government's role in financing and regulating health care services should be minimized.(35) The basic concept in the competition strategy was to permit health plans to compete on the basis of price and quality. These theorists often touted the HMO as the predominant model of a competitive health plan that would achieve health system savings while preserving quality care.(36)

In the 1980s, the federal government showed greater interest in promoting enrollment in Medicaid and Medicare beneficiaries in HMOs as a way of saving costs in these programs. In 1981, Congress expressly authorized the Medicaid program to accord states socalled freedom-of-choice waivers to enroll Medicaid beneficiaries into prepaid health plans with case managed primary care.(37) Although somewhat controversial at first,(38) by 1994, forty-five states had Medicaid managed care programs of which thirty-eight operated under (subsection] 1915 "freedom-of-choice" waivers.39 About 7.8 million Medicaid recipients (twentythree percent) are enrolled in HMOs and other managed care plans.(40)

In 1982, Congress authorized the Medicare program to establish HMOs for Medicare beneficiaries and to contract with qualified HMOs and also CHPs.(41) Specifically, Congress authorized the Health Care Financing Administration (HCFA) to enter into three types of contracts with Medicare HMOs-risk contracts which basically use capitated payment methods, cost contracts, and health care prepayment plans.(42) There was considerable concern about the appropriateness of HMOs for Medicare beneficiaries in the early years.(43) Even as late as 1992, the Administrator of HCFA publicly raised concerns about the performance of Medicare HMOs.(44) Nevertheless, the number of Medicare beneficiaries enrolled in HMOs had grown considerably from 2.9% in 1984 to 6.3% by 1992 and is still growing.(45)

By the 1990s, managed competition had become the established orthodoxy for accomplishing health reform.(46) In the early 1990s, President Clinton adopted managed competition as the principal approach for his comprehensive health reform proposal.(47) The Clinton health reform proposal promoted payment of health plans using the capitated payment methodology as the cardinal payment method.(48) The President's support for managed competition has spurred the private sector to move toward capitated systems independent of government-sponsored health reform proposals.

Indeed, by the mid-199Os, a sense of inevitability exists about the move toward organizing health care providers into integrated delivery networks and paying the networks and associated providers on a capitated basis. Even the Medicare program-the last bastion of fee-for-service (FFS) medicine and a reluctant player in the HMO approach to health care(49)--has moved toward capitation in recent years even without the legislative push contemplated by Medicare reform proposals before Congress.(50) No longer is the issue whether health care services in the United States will be paid for on a capitated basis. Rather, the issue is how and when.


The move toward capitation to pay providers and provider networks has important implications for the regulation of providers and payers in the health care system as well as for laws governing procedural protections for patients and providers.(51) This part describes these legal regimes. This part also addresses the difficult challenges facing health plans, plan sponsors, and regulators in terms of designing effective procedural arrangements for the protection of patients in today's changing health care delivery environment.

A dispositive issue in the regulation of risk is the location of the risk for health care expenditures. When an entity assumes the risk of providing health care for a fixed capitated payment of plan enrollees, that entity becomes in effect the insurer for the care of the enrollees. If a sponsor of a health plan purchases health care services for a group of patients on a capitated basis from a network or provider group, that sponsor transfers the risk of care and associated expenses to the entity accepting the capitated payment.

If the sponsor is an employee benefit plan, this transaction has very important implications for the locus of regulation for the health plan. Specifically, the question becomes what aspects of the plan are still regulated under ERISA and what aspects are now regulated under state insurance codes. The intersection of state insurance regulation and ERISA with respect to capitated health plans and providers poses new wrinkles in the regulation of capitated health plans, which in turn pose unanswered questions for health plans and providers as well as state and federal regulators.(52) Further, whether ERISA preempts state mandates regarding grievance procedures and other procedural protections is an important question.(53) Three major bodies of law currently regulate private health plans. First are state insurance and HMO regulation.(54) Second is ERIZA.(55) Third is federal regulation through participation requirements of public health insurance programs as well as direct regulation in the federal HMO program.(56) In addition, accreditation has become an important private regulatory force for managed care plans.(57) Finally, common law tort doctrines impose obligations on payers to deal with patients in good faith,(58) although these common law doctrines may not apply to ERISA plans.(59) Four important procedural protections exist for patients in capitated managed care plans. The first are procedures pertaining to the promulgation and, in particular, publication of coverage and other policies pertaining to plan benefits and services. While one would not expect consumers necessarily to participate in the formation of coverage and other policies, they should be informed of policies that would influence their decision to participate in the plan in the first instance or at least be informed of the extent of their benefits so that they could take steps to address deficiencies in the plan. …

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