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Legal perils in risk pool participation

By Edward F. Shay, Esq.

Risk pools are a central element in the design of multi-provider compensation arrangements in risk contracting. Two years ago, a physician in Pennsylvania would only encounter risk pools in a discussion of managed care contracts with a colleague from California. Today, risk pools have become almost commonplace, and physicians everywhere are being asked to join in this type of incentive arrangement. Pennsylvania permits risk pools in managed care contracts after prohibiting them for almost fifteen years. In February 1997, New Jersey adopted regulations on risk transfer between HMOs and providers. Risk pools will become widespread in New Jersey.

Risk pools involve the pre-determined allocation of financial risk in managed care contracts. Risk pools also involve some significant legal risks to those who participate in them. In this changing environment, risk pools merit close examination in terms of how they work and what legal risks they may involve. The legal risks of joint and several liability and noncompliance with Medicare fraud should be carefully considered before entering a risk pool arrangements.

How Risk Pools Work

In its simplest form, a risk pool is usually an allocation method created by written agreement between an HMO, and intermediate entity (such as an IPA or a PHO) and each individual provider. The risk pool establishes a budgetary target—usually measured in claims expense or sometimes, inpatient days. Providers whose utilization and resource consumption are charged against the account have a financial incentive to meet or exceed their budgetary goals. Conversely, if resource consumption exceeds the allocated budget, the account will show a deficit and participating providers may be required to contribute funds to eliminate the deficit.

Commonly, risk pools are part of complex arrangements with interlocking financial incentives and disincentives. More sophisticated arrangements may involve contingency reserves, letters of credit, stop loss insurance and periodic reconciliations and budgetary adjustments to minimize the risk of a serious fund deficit.

A representative risk pool funding scheme would involve some or all of these relationships:

• An HMO will establish and administer the funding arrangements in trust and for the benefit of a network of providers. The funding arrangement will include a monthly payment based upon 77 percent of a the HMO’s premium per member per month multiplied by the total number of members.

• A hospital fund is budgeted at 47 percent of the monthly payment to provide claims payments to the hospital.

• A physician fund is budgeted at 35 percent of the monthly payment to pay primary care physicians, specialist physicians and hospital-based physicians.

• A special services fund is funded at 12 percent of the monthly payment to provide full risk, sub-capitated payments to vendors for all mental health and substance abuse, pharmacy and clinical laboratory services.

• An opportunity fund is budgeted at 6 percent of the monthly payment from which emergency payments will be made to cover a short-term deficit and to which payments will be made and distributed in the event that the hospital fund has a year-end surplus.

• On a quarterly basis, the HMO will reconcile the claims expense allocable to the hospital fund against the funds available in hospital fund. If the claims expense of the hospital fund exceeds the contributions to the fund, deficit contributions will be made to the hospital fund from the opportunity fund and the physician fund until the hospital fund has been restored to its budgeted level. Any surplus in the hospital fund will be paid into the opportunity fund and distributed at the end of the year to network providers.

In the above risk arrangement, a surplus will be distributed, or deficits contributed to or from the opportunity fund as follows. The hospital will receive 40 percent of the surplus. Sixty percent of the surplus will be divided among the physicians. One-half of the physician surplus will be divided per capita among all participating physicians. The other one-half of the physician surplus will be divided among the primary care physicians based upon their proportionate contribution to the hospital fund surplus and compliance with agreed upon quality factors. A deficit will be made up to the opportunity fund by applying in reverse the same methodology for contribution that would be followed for distribution.

Legal Risks in the Risk Pool

United by aligned financial incentives, physicians who participate in risks pools are also participating in an economic partnership. Their ability to achieve a surplus will be determined by their ability to achieve shared financial objectives upon which the risk pool design is predicated. In some instances, the economic attributes of partnership may also create the legal characteristics of a partnership. Importantly, where a legal partnership is found to exist, the legal responsibilities of partnership will apply. For physicians in a risk arrangement, the legal risk of partnership is joint and several liability for the obligations of the partnership.

The key legal components of a partnership consist of an agreement to form a partnership and the sharing of profits and losses. The agreement need not be written and can be inferred from the conduct of the partners. For example, a physician may enter into risk pool arrangement with a PHO. At the same time, the PHO (which may be the physician’s authorized agent) enters into identical agreements with other physicians. Among them, these participating physicians agree to form a risk pool arrangement and to share the surplus and deficits of the risk pool. Arguably, even though physician A does not enter into a written partnership agreement with physician B, they each agreed through their agent, the PHO, to the terms of a partnership. The risk pool formula for distribution of surplus and contribution for deficits involves the sharing of profits and losses. Courts have imputed the existence of a partnership on far thinner sets of facts than detailed managed care contracts.

Once a partnership has been established either expressly or by implication, legal partners may be held jointly and severally liable for the obligations of the partnership. Joint liability means that all partners are liable for the all obligations of the partnership. Several liability means that each partner is completely liable for the obligations of the partnership. For example, if through mismanagement a risk pool ran an otherwise unfunded deficit of $3 million, each individual partner would be severally liable for the entire $3 million and all partners would be jointly liable for the $3 million. Depending upon whom a judgment creditor chose to pursue to collect a debt of the partnership, an individual physician could be held accountable for the entire obligation of a risk pool arrangement.

The simple existence of a risk arrangement with risk pools does not consign participating physicians to a partnership and its legal risks. Quite commonly, the same managed care contract that creates the risk pool will have some safeguards built into it. For example, the contract may state that the parties are independent contractors with no intention of becoming partners. An independent contractor clause is an important first step to limiting liability exposure. However, the typical independent contractor clause does not address the relationship between non-party physicians who share in the surplus and deficits of the risk pool. Thus, an important second step is to extend the independent contractor disclaimer to all risk pool participants. The contract should provide for a waiver of claims by the parties against other participants and a disclaimer of all participants authority to represent themselves as partners for any purpose.

In addition to liability arising from implied partnerships, risk pools must comply with the anti-fraud and anti-referral laws if the risk arrangement involves funds for Medicare, Medicaid and related federal health programs. Both Medicare’s anti-kickback law and the Stark anti-referral law apply to Medicare risk arrangements and risk pools between HMOs and intermediate entities such as IPAs.

Under current law, many risk pool arrangements may be protected from Medicare’s antikickback law under a recent “safe harbor” adopted as part of the Health Insurance Portability and Accountability Act of 1996. However, at this writing, federal regulators have not provided any of the required details on what type of risk arrangements will be covered by the proposed safe harbor. Similarly, final regulations under the Stark anti-referral law have not been adopted to explain when a risk pool arrangement creates permissible compensation to exempt the referrals for services under the risk arrangement. Absent these two important sets of rules, definitive guidelines on acceptable risk arrangements are not available.

Notwithstanding the absence of final regulations on anti-fraud and anti-referral laws, two principles are clear from existing rules on these topics. First, a physician is safer in a risk arrangement where there is “substantial financial risk.” Substantial financial risk means that greater than 25 percent of the physician’s potential compensation will come from the contingent aspect of the risk arrangement. Second, the risk arrangement must be either developed and sponsored by the HMO, or the HMO should by contract agree to the terms of the risk arrangement.


Risk arrangements will become increasingly common in managed care contracting as more of the population moves into managed care and more managed care organizations seek to delegate performance responsibilities to physicians. These arrangements are new and sometimes complex ways to structure compensation and incentivize physicians. Risk pools which seek to align the incentives of many providers are not free from significant legal risks and merit careful scrutiny before they are accepted as a compensation model.

Edward F. Shay, Esq., is a member of Saul, Ewing, Remick & Saul’s Health Law Department in Philadelphia.

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