Why Investors Are Taking Notice of Healthcare Capitation Models

Although fee-for-service (FFS) is the most common payment model in healthcare, payers, providers and investors are increasingly interested in capitation.

Skyrocketing healthcare costs have helped fuel the interest in capitation as investors look for innovative ways to provide services more efficiently. At the same time, valuations for capitated physician groups have soared. In many instances, these groups trade on revenue multiples—a measure of a company’s value based on its net sales or gross revenue—that are often seen for tech company valuations.

Interest is also rising because investors now have more options to enter the capitated sector. For years, one large, private company was the only major player in the market. Now, there are two publicly traded capitated physician companies, and more are expected to enter the space.

If you’re considering capitation—whether as a physician, hospital administrator or investor—here are several key factors to keep in mind.

How Capitation Works

In a capitated arrangement, the physician receives a set monthly payment for each patient. If the cost of care exceeds the contracted monthly payment amount, the physician is typically responsible for the overage. If the cost of care is below the monthly capitation payment, the physician typically keeps the difference.

FFS vs. Capitation

In an FFS system, providers are paid for every service they perform. This can create an uncertain revenue stream because the number of patients they see and services they provide can vary widely from month to month. With payments tied to services, FFS systems create an incentive for providers to order more procedures—driving up healthcare costs across the board.

In capitation, providers receive a flat monthly fee for every patient enrolled, regardless of the cost of treatment or whether a patient receives care. These consistent payments give providers more financial certainty, which makes it easier to budget and control costs. Patients also benefit because capitated systems have built-in health metrics, with an emphasis on preventive care.

For example, if you treat a chronic disease now with inexpensive medication and regular check-ups, you may avoid a costly hospital stay down the road. Because hospital fees can cut into profit margins, capitated physician groups have a greater incentive to make sure their patients stay healthy and out of the emergency room.

The end result? A well-run capitated practice could provide better care at lower costs.

Going Beyond Medicare Advantage

Americans 65 and older account for the vast majority of U.S. healthcare dollars spent. But compared with other high-income countries, the U.S. is getting less bang for its healthcare buck.

The U.S. consistently ranks among the lowest in healthcare outcomes and efficiency. According to The Commonwealth Fund, which used data from the Organisation for Economic Co-operation (OECD), the U.S. spends the most on healthcare as a share of its economy—but has the lowest life expectancy among peer nations.

Capitation provides a chance to improve outcomes and rein in costs, particularly for primary care practices that treat many Medicare Advantage patients. Physician groups focused on Medicare Advantage patients make up the bulk of capitated practices and are expected to see the largest growth in capitation in the future.

Capitation can work for other types of practices as well. Some primary care groups have implemented capitated payments for Medicaid patients, while a few specialists have successfully moved to a capitated payment model.

Looking Ahead

If personal habits are hard to break, business habits are even harder. And that’s one of the biggest challenges of moving physician groups to a capitated system: Many doctors have only worked in an FFS environment.

For investors, it may make more sense to focus on practices that already use capitation. There’s no need to educate physicians on how to work in the system, and the potential payoffs could come quicker.

Investors may also begin to eye groups with younger physicians who may not be as attached to an FFS model and have fewer old habits to break. These doctors may be looking 10, 20 or 30 years down the road and suspect the current FFS system is not the future of healthcare. Their outlook aligns well with forward-thinking investors.

Assessing and Managing Risk

Success in capitation comes down to risk assessment and management. A properly assessed patient population and well-managed capitated system may provide a higher reward for physicians, hospital systems and outside investors. A poorly assessed and ill-managed system, however, may result in costly overruns and substandard health outcomes.

With such high risk-reward levels, it’s crucial that you understand all the complexities of capitation. At J.P. Morgan, we’ve been working with capitated physician groups for years, and we led the recent IPOs of two publicly traded capitated physician companies. We have experience in the sector, and we can help providers and investors navigate capitation financing and banking challenges.

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