Capitation transfers insurance risks to health care providers. Insurance risk transfers are best done between when the entity accepting the risk is larger than the entity transferring the risk. This is trivially clear: Individuals do not accept insurance risks from insurers, insurers accept insurance risks from large numbers of individuals.

The Central Limit Theorem applies to insurance rate making and reserving, capitation contracting and statistical sampling theory. The difference is the size of the samples/portfolios. Everything else remains the same.

Small insurers produce annual loss ratios that are more distant from the population loss ratio than the loss ratios produced by large insurers. The relationship varies with the square root of the relative portfolio sizes. It is therefore very easy to quantify the inefficiency induced by capitation contracting.

Since capitation sub-portfolios are usually much smaller than the full portfolio of the risk transferring entity, the variation around the population loss ratio is larger for risk accepting health care providers than it would be if the risk transferring entity retained the risks.

Greater variation translates to much higher probabilities of extreme losses or profits; higher surplus requirements; and increased probabilities of insolvent insurance operations. Capitation increases inefficiency in every dimension of insurance operations: Marketing, claims adjustment, and risk management. The only way efficient providers could offset the adverse impact of insurance risk assumption is by systematically lowering the level/cost of the care they provide. By doing this they can reduce the probabilities of being unprofitable, incurring net losses, and the big one, reduce the probability that they will become insolvent because of their inefficient insurance operations.

The big myth is that the entities transferring these insurance risks play any roles as insurers. A fully capitated, managed care organization performs no insurance risk management function at all. Rather, these organizations are more like insurance brokers, selling insurance products on behalf of the real insurers, risk assuming health care providers.

In short, the only insurance function served by fully capitated managed care organizations is being a conduit for putting health care providers in the insurance business. All the benefits of insurance as a collective risk management system are destroyed when the risks are dis-aggregated and parceled out to smaller, risk assuming health care providers. But it gets worse. The portfolios transferred are not even random samples so each sub-portfolio produces a biased estimate of the population loss ratio. This adds to the risk assuming health care provider’s risk profile because the sub-portfolio they have may require far more care than the average for the full portfolio.

As well, compared to the large organizations transferring the risks, the risk assuming health care providers are also more geographically concentrated, increasing their conflagration risk exposure.

I call this “Professional Caregiver Insurance Risk.” In simple terms, for every dollar of care provided through a capitated finance system, less money is available at the point of care than in an equally clinically efficient indemnity insurance funded health care system. Since capitation is demonstrably more inefficient than indemnity insurance, what possible beneficial impact could it have on improving efficiency in the health care system? Inefficiency begets inefficiency, not efficiency.

Since providers have to act like the insurers they are, the impact at the point of care is dramatic. Millions of claims are being processed, every day in clinics, hospitals, and offices as health care providers, qua insurers, decide what claims to honor, what tests to offer/withhold, what treatments to offer/withhold, and in essence which claims they will delay, and deny.

The ethical and legal implications of health care providers’ undisclosed relationship as their patients’ insurers means that there are potentially hundreds of billions of dollars of unfunded litigation costs in the future. Since capitation could never work, even the protections afforded in ERISA are likely to be pierced eventually as quantitatively literate lawyers realize the magnitude of the flawed system and its legal implications.

Moreover, since benefit plan coverage varies greatly from patient to patient, an ‘efficient’ health care provider, qua insurer, is one who achieves a delicate balance. Being efficient means they cannot “over treat.” This need for caution reduces the level of service available to both capitated and non-capitated patients. Non-capitated patients wait alongside capitated patients in offices around the country, despite the higher costs of their insurance plans. Even when they are seen, the standard of care they are likely to receive is more likely to mirror that of capitated patients than it is to rise to the standards they are paying to receive.

This is not some esoteric result from actuarial risk theory that nobody can understand. “Professional Caregiver Insurance Risk” is Insurance 101 and Statistics 101.

Additional details are available at:

http://drtcbear.servebbs.net:81/~PCIR/