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hospital services when, as, and if they can. The K-P program, however, makes a fundamentally different kind of commitment.

Our program undertakes not only to pay for medical and related services but also to assure that they will be available and actually rendered. Assumption of continuing responsibility for the actual rendition of health care services distinguishes our type of program from the bulk of the prepaid health care industry. Responsibility for actual provision of services underlies both the special advantages and the special problems inherent in such programs.

PERMANENTE MEDICAL GROUPS

To satisfy its obligations under membership contracts, the health plan allocates its responsibility by contract in two directions as indicated in Figure III-1. The Permanente medical group in the region undertakes comprehensive responsibility to provide or obtain all professional services of physicians, and paramedical services incidental thereto, necessary to assure the medical and related benefits to the members. The group's responsibility encompasses all medically appropriate services in the physicians' offices, in the hospital, and, to a limited extent, in the patient's home. Our concept of professional services is broad, including, for example, all of the hospitalbased specialty services-radiology, anesthesiology, pathology, and physiatry—as defined under Medicare.

Even though the Permanente medical groups have total responsibility for professional services to plan members, even the largest-the Permanente Medical Group in Northern California—is not totally self-sufficient in professional capability. The groups rely on community resources-especially medical schools-for certain infrequently used and highly specialized services.

There are six independent, legally separate medical groups. Four are organized as partnerships. One, in Hawaii, is an unincorporated professional association; and the most recent, in Colorado, is a professional corporation. These are professional organizations functioning to provide physicians within the groups with personal income from medical practice and their tax status is the same as that of any professional partnership, association, or corporation with no tax exemption or other special status.

KAISER FOUNDATION HOSPITALS

The principal remaining health care service responsibility is hospital care in a rather strict sense of the word-hospital room, dietary service, nursing care, and use of usual hospital facilities. Responsibility for this service is assumed by contract by Kaiser Foundation Hospitals, another corporation legally separate and distinct from, but closely associated with, the health plan.

This corporation is also responsible for providing medical center facilities—that is, inpatient hospital facilities, outpatient office facilities, and all other facilities, including land, buildings, and equipment required to constitute a modern medical center.

Kaiser Foundation Hospitals is also a California nonprofit corporation. In common with nonprofit hospitals generally it enjoys the so-called "charitable exemption"

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KAISER-PERMANENTE BASIC PHILOSOPHY AND ORGANIZATION

under Internal Revenue Code Section 501(c)(3) and corresponding provisions of applicable state laws. This exemption not only eliminates the great bulk of federal income tax on the organization's own income, but also qualifies it for tax-deductible donations under the federal income, estate, and gift tax laws. This is a matter of considerable significance, particularly in acquiring "seed money" to commence a new operation. As we interpret the law, the hospital corporation is exempt from most

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property tax on customary hospital facilities, but pays property taxes on outpatient medical offices.

Section 501(c)(3) tax status is generally applicable to nongovernmental universities and confers substantially the same benefits as the exemptions applicable to governmental universities.

Although beneficial in important respects, even the "charitable exemption” is not an unmixed blessing. Among other things it imposes an obligation to utilize resources for general public benefit in fields such as charitable care, education, and research. Kaiser's community service programs are generally carried out incident to the ongoing operations of Kaiser Foundation Hospitals. In addition, the Kaiser Foundation Research Institute, a separate accounting division within the hospital corporation, has been established as a vehicle for conducting major nonclinical research.

EMERGENCY SERVICES AND SERVICES TO NONMEMBERS

Two remaining responsibilities of the health plan deserve brief mention. Although the overwhelming bulk of health care services to the members is provided by or under the direction of the Permanente medical groups and is generally rendered at facilities operated by the program, plan coverage necessarily includes provision, on an indemnity basis, for accidental injuries and emergency illnesses occurring to members when traveling outside of our service areas. In addition, certain emergencies such as freeway accidents may require members, for reasons beyond their control, to be hospitalized at non-Kaiser facilities within our service areas. For such emergency care, the plan provides cash reimbursement.

Although the K-P program is primarily focused on care for our enrolled population, we are also a community program and services are not restricted to our members. Figure III-2 depicts an additional set of relationships. At the top is the obvious fact that the health plan membership is drawn from the general population. Arthur Weissman will describe the characteristics of our membership as related to the general population. The heavy line depicts the flow of patients from the plan membership to the Permanente medical groups and to the various Kaiser Foundation hospitals.

The lighter line indicates a flow of patients from the general population to the medical groups and our hospitals. Nonmembers pay for professional services on the usual fee-for-service basis. However, revenue derived from such services flows to the group as a whole and does not directly affect the personal income of the individual physician rendering the service. Through our contractual, budgetary, and financial planning systems this revenue is integrated into the support of the total program. Similarly hospital services for nonmembers, or otherwise not within the scope of plan coverage, are charged on a basis similar to that used by other community hospitals. This revenue again contributes toward meeting the total financial requirements of Kaiser Foundation Hospitals and is integrated into support of the total program.

Revenue from nonplan sources does not bulk large in our total financial picture. There are significant regional variations, but overall revenue derived from nonplan services accounts for substantially less than 10 percent of program revenue.

There is an additional organizational feature, not important in magnitude but important in concept. As community institutions, the various Kaiser hospitals are

open to any professional qualified physician practicing in the surrounding area. In addition to the active medical staff, consisting primarily and often exclusively of Permanente physicians, each of our hospitals has a sizeable courtesy staff of community physicians privileged-within the limits of available capacity to admit patients.

FINANCIAL ARRANGEMENTS

As might be expected in a large and complex organization, the financial relationships are complicated. Both prepaid dues and other revenue from plan members are pooled in one category-Health Plan Revenue. From this pool the health plan covers

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its own operating needs-less than 5 percent of total program expenses-and applies the balance in payment for hospital, medical, and related services.

PLAN-HOSPITAl Reimbursement

Basically, the payment by the health plan to Kaiser Foundation Hospitals is a reimbursement of net financial requirements as tentatively established through a prospective budgeting process. I say "net" because the hospital corporation derives revenue from nonplan sources, and such revenue is applied to help meet hospital costs. I say "financial requirements" rather than "costs" because we believe that an organization responsible for providing and maintaining medical centers—to serve a growing population, to keep pace with escalating construction and equipment costs for health facilities, and to keep abreast of developing health care technology-must realize revenue substantially in excess of "costs" as usually defined. Thus significant earnings factors are built into our concept of "financial requirements." See Chapter VII.

PLAN-MEDICal Group ReiMBURSEMENT

The principal element of compensation paid by the plan to a medical group for professional and ancillary health care services to plan members is a per capita payment—a negotiated and contractually agreed amount per member per month. There is no element of fee-for-service compensation in this health plan-medical group financial relationship, nor are any individual physicians regularly associated with a Permanente medical group compensated on a fee-for-service basis.

Also, the plan pays the group on a cost-reimbursement basis for certain types of additional expenses, incurred in connection with group functions but not within the group's control. An example would be the cost of a union-negotiated wage and salary increase covering clerical employees of all organizations within the program and agreed upon by industrial relations representatives for the total program. The plan also sets aside funds to finance a retirement program for physicians in the Permanente groups. The last, and most complex, health plan-medical group payment is an incentive compensation arrangement.

THE INCENTIVE FORMULA

If the whole program in a region-health plan, hospitals, medical group and supporting services-has planned well and performed well, there will still be some revenue remaining in the plan's pool. One-half of this amount is distributed to the medical group as incentive compensation. The remainder is retained by the hospitals and health plan as additional earnings available for facility development, debt repayment, or other program purposes.

The amount of incentive compensation-which generally varies within fairly narrow limits--depends upon, and thereby constitutes an incentive for, the effective operation of the total program. It recognizes that the performance of individual physicians not only influences the efficiency of group operations as such but also influences the economy and effectiveness of the total program-hospitals, health plan, and supporting services as well as medical group. This incentive compensation system is now established only in the two large California regions. Other regions are working on development of similar arrangements.