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Lab Test Revenue:

What Must You Know About The Economics Of Capitation?
(Part 1 of a 2-part series)

by Sheila Dunn, D.A.

Reprinted with Permission from Washington G-2 Reports, Physician Office Testing, August 1997

The more screening and diagnostic tests performed in your in-office laboratory, the more revenue generated--right? These days, that's not necessarily so. Managed care organizations (MCOs) increasingly are targeting lab services for cost-cutting. Thus, many physician office laboratories (POLs) have experienced either decreased test volume or payment reductions.

Physician practice managers and others who negotiate contracts with MCOs tend to concentrate on areas which represent the lion's share of practice revenue, such as office visits. The lab portion of the contract is often overlooked. Only a handful of POL managers negotiate managed care contracts, but given the clinical value of maintaining in-office testing capability, this situation must change.

For POL managers to secure contract concessions (that is, payment) from managed care plans, it's essential to have a thorough understanding of the economics of managed care. In this, the first of a two-part series, you'll learn how a common form of managed care payment--capitation--impacts your bottom-line.

Managed Care Payments To POLs
Some MCOs negotiate rock-bottom prices with large national or regional reference laboratories and require providers in their plan to forward patient specimens to these facilities. Some MCOs do pay for tests performed in the POL, but at greatly reduced rates. Others capitate provider payments and pay fee-for-service rates for lab tests. The most common variations in payments from MCOs are presented in Table 1.

Fee-For-Service vs. Capitation: What's The Difference?
Fee-for-service (FFS) payments represent "business as usual" in that POL profitability equals reimbursement minus the cost to produce a test result. Capitation, on the other hand, turns traditional concepts of profit and loss upside down, as illustrated below. Nationwide, capitation accounts for about 20% of total payments to providers for medical services.

Capitation is challenging because it is difficult to predict profitability. In a capitated environment, reimbursement per patient remains the same no matter how many times the patient utilizes services (such as having lab tests ordered); so, as utilization rises, payment per test decreases. If a disproportionate number of capitated plan members require more tests, revenue shrinks. For this reason, capitation requires accepting and managing risk.

Capitation Economics
Capitated payments consist of a fixed dollar amount per health plan member per month (PMPM). Take, for instance, payment for a medical practice which accepts a capitated rate of $12 PMPM for 1,000 patients. The formula is:

(PMPM payment) X (# of patients in the plan on any given month) or,

($12) X (1,000 patients) = $12,000/month or $144,000/year

How much of the above payment is allocated for laboratory testing? This must be proactively negotiated. As noted previously, some health plans in areas of heavy managed care penetration stipulate that all tests (or all but a few simple tests) be performed by outside reference labs which have contracted to furnish the tests at a very low PMPM fee. In this case, POLs can often negotiate the lab portion out of the contract and receive payment for tests on an FFS basis. Sometimes, the MCO prefers capitation to minimize claims submissions, so the worst outcome of a negotiation could be the acceptance of the same low capitated rate as the referral lab.

Often, mega-labs accept less than $1 PMPM. Those who don't fully understand the economics of capitation assume payment is less than $1/test and conclude no POL can stay in business at that rate! Yet, you need to look again at the numbers. For example, a POL capitated rate of $0.75 PMPM for 3,000 patients equals $2,250/month or $27,000/year. Table 2 offers an example of how a profit can be realized at this rate (in this example, the utilization data in the second column were provided by the MCO; if the plan isn't forthcoming with such data, estimate lab test usage from similar patient populations).

Consider another example (Table 3) where an MCO pays FFS for a few tests (urinalysis @$2, CBCs @$5, rapid strep @$4) and a capitated rate of $0.75 PMPM for some additional in-office testing. The physician provides services for 1,000 patients from this plan. The plan accounts for 20% of the total POL business. In Table 3, the utilization data are based on this percentage (as noted before, if the MCO doesn't provide utilization data, estimate lab usage from similar patient populations).

The total FFS payment for CBCs, urinalysis, and rapid strep testing is $6,260. The capitated managed care payment is $750/month ($0.75 x 1,000) or $9,000/year ($750 x 12). Total revenue from this mix of payment methods equals $15,260/year ($9,000 + $6,260) for 20% of POL test volume. Total costs from this mix equals $8,870. The profit equals $6,390/year.

In adapting the example in Table 3 to your own situation, it's important that you calculate your lab testing costs accurately (admittedly, this has confounded experts for years). If you don't know the cost-per-reportable-result for your POL, include only variable lab costs (such as reagents, controls, etc.) as well as a percentage of fixed lab costs (including personnel, proficiency testing, regulatory fees, overhead, etc.) that reflects the plan's portion of your POL business.

Determining true POL costs is tricky because new managed care contracts with lab provisions may increase POL volume significantly and enable the POL to achieve better economies of scale.

Armed with increased insight on how capitation can affect your bottom-line, you're ready for the next crucial step--calculating fair managed care payments for your POL's testing. In the overall healthcare equation, the value of point-of-care lab services is poorly understand by MCOs. Until we demonstrate this value, POLs will continue to be underfunded or ignored in managed care contracts. The real need is to convince MCOs that payment to POLs is money well spent.

>> Go to Part 2: What's a fair capitation rate for your POL?


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What's A Fair Capitation Rate For Your POL?

Table 1: Differing POL Arrangements With Managed Care
(Return To Text)

 Fee-For-Service (FFS)   Negotiating Strategy/Goal
All lab tests referred out; no POL testing reimbursed FFS reimbursement for POL tests
Discounted FFS for some tests Get additional POL tests reimbursed (such as urinalysis, rapid strep); all others referred out
Discounted FFS for all POL tests Evaluate payment; if needed, seek increase
 Capitated Plans  Negotiating Strategy/Goal
Discounted FFS for all POL tests Evaluate payment; if needed, seek increase
All POL tests referred out POL test payment on FFS or capitated basis
Added capitated rate for some POL tests (such as urinalysis, rapid strep); all others referred out FFS or capitated payments for all POL tests
Separate capitated rate for all POL tests (this is rare) Increase capitated rate, exclude more expensive tests from the rate

Table 2: Capitated Payments, Costs, Profit
(Return To Text)


 Est. Annual Utilization

 Lab's Cost

  Annual Cost

 CBC  1,000  $2.75  $2,750
 2 Chem tests  500  $4.30  $2,150
 Chem 12 panel  500  $8.30 $4,150
 Lipid panel  200  $6.85 $1,370
 Thyroid panel w/ TSH  250  $9.00  $2,250
 Strep screen  750  $3.00  $2,250
 Miscellaneous  500  Varies, $11avg  $5,500

                                                                                          Total Annual Cost $20,420

                                                                               Total Capitated Payment $27,000

                                                                                               Total after costs $6,580

Table 3: Mixed FFS & Capitated Payments To POLs
(Return To Text)

Test Est. Yearly Usage MCO (20%) MCO Payment Yearly Costs To Perform
 Urinalysis  5,000  1,000  $2/$2,000  $1,000
 CBC  2,500 500  $5/$2,500   $1,250
 Rapid strep  2,200  440  $4/$1,760 $1,320 
FFS= $6,260             3,570
 Diabetes panel  1,500  300  Capitated  $1,200
 Lipid panel  1,000  200  Capitated  $1,000
 Renal panel  1,000  200  Capitated  $1,600
 Hepatic panel  750  150  Capitated  $1,500
Cap= $9,000         $5,300

Total FFS, capitated revenue = $15,260 minus $8,870 in total costs = $6,390 profit.


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