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SPEAKER 1: I'm here with Professor Laurence Baker who's a professor here at Stanford Medical School, and what are we going to talk about? LAURENCE BAKER: Well, we pay physicians a lot of different ways in this country. And I thought it would be useful to spend a minute thinking about the different ways that we do that, the concepts, organizations, different practices that are out there. SPEAKER 1: So, literally, how do physicians receive their compensation? LAURENCE BAKER: Yes. SPEAKER 1: OK. LAURENCE BAKER: Yes. So we can go through this in a couple of different ways, but there are three ways that we can start out talking about, three general ways that we organize the payment of physicians. And they turn out to be fee for service-- SPEAKER 1: Fee for service. Let me write this. Fee for service. Keep going. I'll catch up. LAURENCE BAKER: Yes, sometimes we say FFS, Fee For Service. SPEAKER 1: FFS. OK. Makes sense. LAURENCE BAKER: Second one, we call capitation. And the third one, of course, salary. SPEAKER 1: Too close to decapitation for me, but maybe it's not related. But OK. And then salary. LAURENCE BAKER: And then salary. SPEAKER 1: OK. And so fee for service. That seems to be a little bit common sense. Is that literally it? LAURENCE BAKER: Fee for service. In a fee for service system, a physician gets paid a fee for every service that they do. It's kind of like going to a restaurant. You order the drink. You order a salad, maybe an entree, a dessert. The restaurant keeps a list of all the things that you ordered and, at the end of the night, there's a price associated with each one. And you add up the price associated with each of the things you got. That makes your total bill. That's the fee for service-- SPEAKER 1: I see. And so this is kind of what a doctor in private practice would face. LAURENCE BAKER: Well, doctors can be paid fee for service in a lot of different arrangements. So they might be in private practice paid this way. Some physician groups are paid this way, and fee for service concepts come up, even, in large organizations, like the Stanford Medical School where some people are sometimes paid for their work in a hospital according-- SPEAKER 1: I see. But the general idea is that if they're not providing service or if there's a slow day then they're not going to be making money that day. LAURENCE BAKER: Right. Right. The more services they do, the more expensive services they do, the more costly that they do, the more revenue that their practice will generate. SPEAKER 1: I see. And we'll talk later about whether that's a good idea. LAURENCE BAKER: Of course, that has implications for the way that physicians act and the way that they practice. SPEAKER 1: So what's capitation? Because I'm not familiar with that. LAURENCE BAKER: So capitation-- the general idea is to do something quite different than fee for service. The term capitation comes from the Latin, per head. SPEAKER 1: Oh so it is related to decapitation, literally, per head. [INTERPOSING VOICES] LAURENCE BAKER: So we're going to pay physicians per person that they have in their practice, and the kind of building blocks of a capitation system would be, one, a panel of patients who are assigned to a doctor. So the doctor might have 1,000 patients for which he or she is responsible. We'll call that group their members, their panel. Sometimes people call it their covered lives. Second piece of a capitation arrangement is an agreement about what the physician is going to be responsible for under the agreement. So we might say it's primary care services, all the office visits, and basic tests, and follow-ups that those patients might need, but maybe not their hospitalizations or their expensive surgeries, things like that. So you have some group of patients. You have some agreed set of services, and then you would define a payment, which in the jargon gets called the PMPM the Per-Member Per-Month. SPEAKER 1: Per-Member Per-Month. And who is making this payment? It is, I guess, the employer of the doctor. So this definitely would not be the case with a-- oh, go ahead. LAURENCE BAKER: So it would be the insurance company, generally, that's going to pay the doctor this payment. So when an insurance company, let's say Blue Shield Blue Cross, Aetna, Cigna, any number of different companies that might be out there, has an arrangement with a physician that they take-- some number of their insured people become part of the panel of that doctor, they could arrange to pay that doctor on a capitation basis, by saying, you've got 1,000 of our patients. Here's what we're going to pay you to take care of them. SPEAKER 1: I see. And it seems to make a lot of sense for the insurance company, because now you don't have this incentive for the doctor to-- LAURENCE BAKER: You change the way the whole incentive works. So now, if a physician gets, say, $25 per member per month for taking care of their 1,000 patients-- they get $25,000 a month-- they've got to do what needs to be done for those patients. But they don't get paid extra if they do something additional, if they do a more expensive test as opposed to a cheaper test, they get paid the same amount. So you take away the incentive that exists in a fee-for-service system that tends to get people to try to do more things, or at least creates a world in which it's possible to do more things and get paid for it. SPEAKER 1: And it's more predictable for the doctor, too. LAURENCE BAKER: Well, it could be predictable for the doctor. Although, in some sense, it's predictable. And in another sense, it's not. An important difference between fee-for-service and capitation, we'll say, in health policy, is associated with risk or this concept of risk. And when we talk about risk here, we mean financial risk associated with the health of the patients or variations in the needs of the patients in a given month. So if you're being paid fee-for-service, the doctor doesn't face any real risk. If it's a bad month, everybody's sick, everybody needs lots of care, they're going to get paid for delivering that care. Under capitation, the doctor does face more of that risk. They're getting paid a fixed amount. They've got to deal with whatever the patients need. SPEAKER 1: I see. In a high-volume month, the doctor takes the hit in capitation. But in a low-volume month, the insurance company takes the hit. So it goes both ways and kind of evens out. LAURENCE BAKER: Right. The doctor benefits in the low-volume months. Right? The doctor kind of averages out. In a good arrangement, this will be sort of even over time. The doctors will come out OK. But these risk issues have been problems in some capitation arrangements, especially if you're a small doctor practice and you've got a lot of variation from month to month. Maybe you're not a great manager. You can go out of business if you have a few bad months. SPEAKER 1: Who decides that it will be capitation or fee-for-service? Is it the doctor's choice or the insurance company says, you will do this? LAURENCE BAKER: So, over time, it's been a bit of negotiation back and forth. So insurance companies have preferences about how they do this, and doctors have preferences about how this happens. And so sometimes some of it's driven just by history. The Medicare program, for example, got started in the 1960s when fee-for-service was the most common way for physicians to be paid, and that's largely persisted in that program for historical reasons. It's just worked out that way. In the 1990s, a lot of health plans decided, the insurance companies decided, that, in the private market, they'd like to do more capitation, so they did. And they started pushing these arrangements, trying to get physicians to agree. They were successful for a while. And then, lately, it's been a little more-- physicians have said, we don't like capitation so well. We'd rather go back to fee-for-service. That's working better. So the negotiations have gone a little more the other way. SPEAKER 1: Have there been studies that showed when doctors who are compensated under capitation don't order as many services or perform as many services? LAURENCE BAKER: So the literature on this is pretty clear that it makes a difference. We would like to think that it doesn't make a difference. SPEAKER 1: Most of them are all about the health of the patient, but-- LAURENCE BAKER: Well, so there are hundreds of thousands of doctors in the country and, undoubtedly, out there are some that pay close attention to the financials. But I think, actually, you're right. Most of them probably don't, on a day-to-day basis, pay close attention. And at the end of year, they'll see the financials from their practice. Maybe they don't think it through. SPEAKER 1: But if you got to pay the college tuition, then all of a sudden, hey, maybe an MRI wouldn't hurt or a little extra this or that. LAURENCE BAKER: I think that's part of it. But the other thing that I think is going on in the background is the general, maybe almost subtle-- the things that you don't notice that create a system and let a system evolve in a particular way. So doctors like to do things for their patients. Patients like to have things done for them. A fee-for-service system creates a world in which everybody is fine with that. You can do that. And so, pretty soon, you get used to doing that. Which becomes the first thing you think of when you do these extra things. SPEAKER 1: Right. Neither party, neither the doctor nor the patient, has any incentive, really, of saying, wait. Who's paying for that? Oh no, someone else is. OK. LAURENCE BAKER: And it creates in the background these incentives for people who develop new products and services to develop them. And it makes it easy for a hospital, say, to put in a big new piece of equipment that they're pretty sure they can pay for. And once it's sitting there and you pass it every morning on your way into the hospital, it just becomes that much easier to use it. And so it sort of guides the evolution of our system in a way that has led us to a point now where we consume a lot of health care, maybe, sometimes, health care that we don't need. It's often health care that's beneficial, but it's all costly, and so that sets us up for the kind of dynamics and the challenges we have today. SPEAKER 1: How common is-- maybe we should talk about salary before we talk about how common they are. LAURENCE BAKER: Yeah, we can pick that up as we go along. Fee-for-service and capitation have been ebbing and flowing. Frankly, in the US at the moment, fee for service is a very common way for people to be paid. Capitation is declining. There are still places-- SPEAKER 1: So even though fee for service was where everyone started, capitation kind of went a little bit [INAUDIBLE] and then no one's really a fan of it. Or the doctors aren't a fan of it. LAURENCE BAKER: Picked up. The doctors were less of a fan, and so the arrangements have been shifting more toward-- insurance arrangements that would use more fee-for-service these days. So the US is, definitely, I think, majority fee-for-service. SPEAKER 1: Who decides what the panel-- because it sounded like the insurance companies would pay for part of the panel of a doctor who would be under capitation. LAURENCE BAKER: So these kinds of arrangements can, in practice, get kind of complicated. So the concept of paying per head is clear, but there will be variations that go on. So if you change the scope of services, you change the arrangement-- If you have a primary care arrangement for capitation, that's one piece but, of course, it leaves off the MRI or the surgery. And what would happen in those cases is the health plan would have an arrangement for primary care services with some doctors under capitation. Then they would have other arrangements with other doctors. They might, say, have a capitated arrangement with some cardiologist to do the cardiology. Or they might have an arrangement with some cardiologists to pay fee for service to those cardiologists, so when the-- SPEAKER 1: I see, so it's a big mix-up, but obviously there's an incentive. If you are being paid capitation, you want the healthiest people in that capitation panel. LAURENCE BAKER: So there's another incentive that's in the background. And that's a selection kind of incentive. So it's, again, a thing where I think doctors probably don't think about this, most doctors, on a day-to-day basis. But it's a subtle force operating in the background. If you're getting capitation and you can take actions that would get you a healthier patient bunch for that same $25,000, say, you end up a little bit ahead at the end of the month. And doctors don't, I think, like to shift patients off. And there's laws that prevent certain kinds of activities. But, subtly in the background, it helps the system evolve in that direction. And so we would probably see some of that kind of thing happen. SPEAKER 1: OK. And salary is what we imagine. This is how most of us get paid. LAURENCE BAKER: Salary is what you imagine. It's an agreement to be paid a certain amount per year for some amount of work [INAUDIBLE]. SPEAKER 1: This would be from the insurance companies, wouldn't it? LAURENCE BAKER: So what happens-- we talk about these three as being different things, but when you get to the real-world interpretation, or real-world looking at systems that are out there, what you'll see is often mixes between these. And so one of the pieces of disentangling this is multilevel systems. And that's where salary becomes kind of important to think about. So one common thing that happens is physicians group together into larger practices. And that larger practice collects the activity of all the doctors that work in that practice, bills for that from an insurance company, and then disseminates or distributes the money among the doctors. And so what you will often see in real life-- and that complicates the inference here-- is, say, a large practice that billed an insurance company on a fee-for-service basis for the collective activity of all the doctors, takes that resulting pool of money and divides it up. Maybe pay some of the doctors a salary. Maybe pays them a salary with some sort of bonus that depends on how much work they did. And does other things. And so sometimes the incentive that an individual doctor, sitting in a room with a patient is looking at, might be different than the incentive based on the managers of that practice who might then want to get the doctors to do something that's different than-- SPEAKER 1: But the general idea is that-- I mean, the only way to get a salary is if there's some organization between the doctor and the insurance companies to kind of-- LAURENCE BAKER: Yes. SPEAKER 1: --insulate the doctor. LAURENCE BAKER: So one of the important pieces here that we think about is that fee-for-service works in almost any physician practice, a solo practitioner, one person working by themselves, or two together could do this. Capitation almost always works in any kind of physician practice, with the exception that, if you're a very small practice, the risk you face from month to month, depending on the sickness of your patients, might put you out of business if you're not really on top of it. So we like to think capitation could work in any practice, but really only larger ones. And salary is a nice incentive in a lot of ways but requires you to have a big organization to be able to do this. And so some of the differences you see in how physicians get paid have a lot to do with the size of the organization they work in. SPEAKER 1: Makes complete sense. Well, thanks for that.