Blended FFS and Capitation: Healthcare’s “Protective Collar” Paradox

Over a couple of posts I’ve discussed how difficult risk contracts can be for healthcare systems transitioning from fee-for-service.

There are three main problems for systems trying to blend FFS and capitation-payment systems.  Two have been the subjects of earlier posts:

  1. Systems growing risk capability need to make big investments in population health and have to tolerate a transitional “straddle” period where the margins from FFS fall and the performance in risk hasn’t yet caught up with the cost of the risk infrastructure.
  2. Systems that take on a blend of FFS and risk contracts are generally loathe to differentiate services on the basis of insurance status.  This means that FFS patients receive receive care management interventions available to all patients but funded by risk dollars.  The improved wellness of the group’s FFS patients accrues to the insurer.

There’s a third problem, something I’m calling the “protective collar” paradox, which is the subject of this post.

Here’s the problem:

One of the neat things about risk is that incentives are 180 degrees different than those in FFS.  A filled bed, or sick patient represents revenue in FFS but represents expense in capitation.  Investments in population health, primary care and wellness are investments that generate value in risk; they are expenses without financial rewards in FFS. Volume, then, is a pure revenue driver in FFS and pure expense driver in risk.

All is well when you live in an exclusively FFS or capitated environment.  But, when you live in both worlds the problems begin.   Risk and FFS are essentially chiral versions of the other, reversed mirror images.

This creates a real problem: efforts to improve performance in either risk or FFS (so long as they are applied to all patients) theoretically decrease performance among patients in the other payer pool.

I was thinking about this problem when I recently came across a financial/ investment analog, called a “protective collar.”  Here’s the idea:

For years, investment firms have offered their clients a stock options strategy called a “protective collar”  The collar is designed to shield investors from volatility and is a way of locking in a particular value on a security without selling it. 

To buy a collar, buyers invest in two types of options:  A call is an options contract that gives the owner the right to purchase an underlying security at a specified strike price at any point up until expiration. A put is an options contract that gives the owner the right to sell an a security at a specified strike price at any point up until expiration.

To implement a collar, investors buy equal amounts of call and put options, each at the same strike price and with the same time horizon.  The maximum loss is capped by the put’s strike price, and the maximum gain is capped by the call’s strike price.  The breakeven is the net minus costs/fees. Here is a better explanation.  The takeaway: increasing stock prices are mitigated by the call, and decreasing stock prices are mitigated by the put.  You’ve locked in a value.



Imagine a health system making money from FFS patients on an expensive (but no better) proton-beam therapy, while losing money by stimulating demand for the procedure among capitated patients.  Or one that doubles down by investing heavily in diabetes management interventions only to see diabetic hospitalizations fall and revenue from FFS patients erode.

Just as a protective collar protects investors from changes in performance, a 50/50 FFS/capitation mix will theoretically keep health systems from benefitting from financial performance improvements in both their risk and FFS patients.   You don’t want to bake this collar into your system.

For executives, there seem to only be two ways out of this pickle: either segregate patients by payment type (which is unethical, displeasing to patients and hard to do).  Or, double down on a payment methodology and design a strategy and system of care around how you’re paid.  Ripping off the band-aid is hard but being in a collar-contrained environment is worse.



Image: Scotttade, Doc Searls via Flikr, cc.