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Lab Test Revenue (part 2):

Mastering The New Math Of Capitated Payments
(Part 2 of a 2-part series)

by Sheila Dunn, D.A.

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

Last month, in the first of this series, we looked at differing financial arrangements--fee-for-service and capitation--that physician office laboratories (POLs) have with managed care organizations (MCOs), and you learned how capitation impacts your bottom-line. Capitated payments are a fixed dollar amount per health plan member per month (PMPM), requiring that you track service utilization and carefully manage risk.

This month, you'll learn how to calculate fair managed care payments for your POL. Most medical practices can successfully negotiate fee-for-service (FFS) payments for lab tests (for related tips, see POT, Dec. 1996, Jan. 1997, pp. 2-3). But sometimes, an MCO will take a tough stance with a POL, especially in areas of physician oversupply and high managed care penetration. Consider approaching MCOs proactively to learn their business goals and their expectations of providers. Often you can gain a competitive advantage by offering to be the first medical practice to work with an MCO that intends to transition physician payments to capitation.

What if the best you could accomplish in negotiations was this: "If you're willing to accept the capitated payment we've negotiated with ABC mega-lab, then you can do the tests in your POL"? How can you tell if a particular capitated rate will be profitable, allow you to break even, or be a sure road to the poor house? Will $0.50 PMPM suffice or does your POL need as much as $3 PMPM?

The four steps that follow will help you answer such questions. Table 1 illustrates the process. Use it as a guide in devising your own POL's calculations.

Step 1
List the POL tests you wish to perform in Column 1. In Column 2, list their reimbursement. Select your usual and customary fees, the Medicare fee caps, or your actual average receipts for each test as a benchmark to compare to the calculated capitated rate. In Column 3, list the number of times each test is performed annually.

Step 2
Determine your average test reimbursement by dividing the total income for all codes (Column 4 total) by the total number of times the tests were performed per year (Column 3 total):

Avg. Reimb./Test: $71,962.50 ­ 9,050 = $7.95

Step 3
Request the annual lab test utilization rate (usually expressed by MCOs as the rate per 1,000 members) for the tests you've listed in Column 1. Utilization of lab services by plan members is the most important number in this equation and may only be available for total lab services.

Annual Lab Utilization Rate Per 1,000 Members = 1,500 (data provided by MCO)

This indicates that the average patient in this managed care plan utilizes 1.5 lab tests/year. Remember, this number may be falsely high if it includes all lab tests, not just those your POL performs.

Step 4
Multiply your average test reimbursement (Step 2) by the managed care plan's average utilization rate per 1,000 members (Step 3) and divide by 1,000 to find the per member per year (PMPY) average. Then divide by 12 for the per member per month (PMPM) rate.

Average Charge PMPM: $7.95 x 1,500 =$11,925 ­ 1,000 ­ 12 = $0.99 PMPM capitated rate

Assuming that MCO utilization statistics are accurate and that utilization does not change appreciably, a $0.99 PMPM capitated rate should be an approximate equivalent to current receivables (or whichever benchmark you chose for Column 2).

Utilization: The Most Critical Variable

The reason capitation is risky is that if only a few patients are tested, profit ensues; if many are tested, losses may be incurred. Patient health, i.e., how often patients seek medical attention, and whether the physicians in your practice rely heavily on lab results for patient diagnosis and treatment, are big factors in the capitation equation.

Examine utilization statistics provided by the MCO carefully because they could underestimate actual utilization. Can one successfully predict how often patients will undergo testing? Is there a difference if the patient copay is $2 vs. $25? What about college-age males vs. women of childbearing age vs. Medicare beneficiaries? Finally, what about healthcare professionals vs. business executives vs. asbestos plant workers? Access to healthcare services, age, gender, and occupation all influence lab test utilization.

As lab utilization rises, the payment per test from a capitated plan decreases (Table 2).

What Capitated Payments To Negotiate
Once you've determined a reasonable capitated payment for your POL, try to negotiate at least two times what you are willing to accept. How can you negotiate $2 or $3 PMPM for just a few tests when mega-labs often accept less than $1 PMPM for all lab tests? One reason is because mega-labs may be tacking on hefty fees for STAT tests or transportation costs for remote specimen pickups. A POL can often perform certain tests for much less than referral labs because specimen handling/transport costs are not a factor.

Keep Track Of Capitated Payments
Since utilization fluctuates as new groups of people join health plans, it's essential to monitor capitated payments against actual test utilization as well as against a benchmark. Many practices use the Medicare fee caps for this purpose. A good tracking system allows POL managers to determine which managed care plans are profitable and which are not, and provides solid documentation for renegotiating contracts.

Changing The Shape Of Money
Avoid the temptation to take a parochial view of your POL's bottom-line without realizing the importance of testing to the entire episode of patient care. Maybe a managed care plan only pays $5 for a rapid strep test (it may cost $3.50 and many POLs are accustomed to a reimbursement of about $20), but if a nurse saves 10 minutes, a doctor saves 5 minutes, and a patient is spared hours of hassles and time away from work, the savings generated for the practice by doing the test in-house is worth a bundle (Table 3)!

Consider how much the following are worth to your practice and attempt to quantify where possible:

  • A dissatisfied patient switches to a health plan to which your practice does not belong because he or she must go elsewhere to have blood drawn.
  • A more accurate diagnosis is made when some test results are available at the time of the patient visit (define which tests/which type of patients).
  • For capitated plans where each patient visit costs money, can in-house testing help avoid a second visit? An extra visit to the pharmacy?
  • The time it takes your staff to choose the correct blood tubes, log, package, store, and locate the proper container for referred tests.
  • A patient's condition worsens because lab tests were delayed (define which tests and the circumstances).
  • An unnecessary emergency department visit, a hospital admission, or an expensive, unnecessary procedure is performed.
  • Rescheduling patients or changing their treatment plans after learning of lab results days after the patient visit.

Do More With Less
Total POL revenue is derived from a mix of FFS, discounted FFS, and capitated payments. When determining POL profitability, don't forget to include test revenue from sources outside managed care, such as Medicare, Medicaid, and private payers. Calculate the exact percentage of each type of payment by examining each payer agreement and determining the percentage of total revenue derived from each source.

To increase POL profitability, consider the following tactics:

  • Encourage efficient test ordering (redesign requisition slips, develop reflex testing protocol, etc.) in order to better control utilization.
  • Reduce the cost to perform each test (consolidate vendors, purchase in bulk for lower prices).
  • Carve out as many tests as possible from the capitated payment. Negotiate FFS payment for expensive POL tests and those that can be justified on a STAT basis.
  • Be sure the capitated payment for POL tests lists the tests included by CPT code.
  • Minimize risk by adding a stop-loss/safety net clause to capitated contracts to guard against overutilization. Specify the maximum expenditure per individual member (stop-loss) or for the group (safety net). If utilization is exceeded, specify that capitated payment defaults to FFS.


Table 1: How To Estimate A Capitated Rate
(Return to text.)

 Test/CPT Code  Reimbursement*  Frequency/Yr Total Income Per Code,
Per Yr
 Chem 6
 $11.00  750  $8,250
 Chem 12
  12.50   225  2,812.50
 Lipid panel
 20.00  225  4,500
 Thyroid panel (80092)  38.00   100  3,800
4.50   2,000  9,000
 Urine HCG
10.00  1,200  12,000 
11.50  1,000   11,500
 10.00 750  7,500 
 Rapid strep
13.50  400   5,400
3.00  2,400   7,200

                                  Total 9,050       $71,962.50

*Average, near Medicare fee cap

Table 2: Effect Of Utilization On Capitated Payments Per Test
(Return to text.)

 PMPM/PMPY  1 Test PMPY  2 Tests PMPY  3 Tests PMPY  4 Tests PMPY
 $0.75/$9.00 $9.00  $4.50  $3.00  $2.25 
 1.00/12.00 12.00  6.00  4.00  3.00 
 2.00/24.00 24.00  12.00  8.00  6.00 
 3.00/36.00 36.00  18.00  12.00  9.00 
 4.00/48.00 48.00  24.00  16.33  12.00 

Table 3: The New Language of POL Testing Benefits
(Return to text.)

Managed Care Speak Translation
Increases patient satisfaction Patients continue to see that doctor and stay enrolled in that MCO. Retaining patients saves money.
Decreases employee absenteeism Saves money for the MCO's customer, the employer
Increases physician practice efficiency, productivity Saves money for your practice
Better patient outcomes Patients get better quicker which saves money for the entire healthcare system

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