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
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.
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
($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
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?