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Limitations of PSOs in Medicare risk contracts

By Mark Stadler, Esq.

The Balanced Budget Act of 1997 established the Medicare + Choice Program as a new Part C of Medicare. The intent of the Medicare + Choice Program is to offer private health choices to Medicare beneficiaries in addition to traditional fee-for-service benefits under Parts A and B. These choices include coordinated care plans (HMOs, PPOs and POS plans), medical savings account plans and private fee-for-service plans. In the eyes of HCFA, “the introduction of the Medicare Choice + Program represents what is arguably the most significant change in the Medicare Program since its inception in 1965.”

Under the coordinated care plan option, the Medicare + Choice Program provides for the creation of provider sponsored organizations (PSOs). Consisting of a group of affiliated health care providers, a PSO is empowered to contract directly with Medicare for the provision of managed care services to Medicare beneficiaries. In other words, through a properly structured PSO, providers (i.e., physicians and hospitals) can now directly undertake Medicare risk contracts without the intervention of a commercial health plan or outside insurer. In theory, this would appear to create a significant opportunity for providers. In reality, it seems likely that few if any PSOs will be capable of exploiting this opportunity.

A PSO is defined a public or private entity (1) that is established or organized and operated by a health care provider or group of affiliated health care providers (2) that provides a substantial portion of the health care items or services provided under its Medicare + Choice contract directly through the provider or an affiliated group of providers and (3) in the case of affiliated providers, in which such affiliated providers share, directly or indirectly, substantial financial risk for the provision of items and services under its contract and have at least a majority financial interest in the entity.

Providers affiliated with the PSO must own at least 51 percent of the venture. In addition, the providers affiliated with the PSO must directly deliver at least 70 percent (60 percent in rural areas) of the Medicare medical services provided to member beneficiaries. For the most part, this 70 percent provision effectively precludes physicians from creating a PSO without a hospital partner and vice-versa.

Substantial Regulation

This past summer HCFA published over 150 pages of regulations applicable to the Medicare + Choice Program and PSOs. If nothing else, this amount of regulatory verbiage clearly establishes that the organization and operation of a PSO will be a highly complex and heavily regulated endeavor. Among other things, these regulations:

• Establish significant beneficiary protections, many of which are based on the recent Consumer Bill of Rights and Responsibilities legislation, e.g., mandatory care including baseline health assessments, direct access to specialists under certain circumstances, expanded beneficiary appeals rights, etc.

• Address numerous provider issues, including expanded physician participation requirements, anti-gag rule provisions and the like.

• Impose significant quality assurance and quality improvement requirements.

• Create many new and expanded compliance oversight, audit, certification and related requirements.

State Law Waiver and Minimum Enrollment Requirements

PSOs are treated differently from other Medicare Choice Plans in two key regards.

Generally, Medicare + Choice Plans must be organized and licensed under applicable state law as risk bearing entities eligible to offer health insurance or health benefits coverage. However, PSOs are eligible to receive a waiver of the state licensure requirement under certain circumstances. The effect of this waiver is to provide PSOs with relief from state requirements (solvency, net worth, liquidity, etc.) in excess of those imposed by federal regulations and the failure of state agencies to act promptly on licensure applications.

The minimum enrollment for PSOs is 1500 individuals (500 in rural areas), with the Secretary of HHS being authorized to waive these requirements during the first three contract years. For non-PSO Medicare + Choice organizations a minimum enrollment of at least 5000 individuals must be met. This provision could potentially provide PSOs with a competitive advantage in areas that have been undesirable because of a paucity of potential enrollees.

It bears noting that the benefits of the state law waiver may be illusory since all PSOs must first seek state licensure and the waiver is limited to a period of 36 months without opportunity for extension. Hence, all PSOs will have to apply for and ultimately secure state licensure.

Startup Costs, Payment Rates and Return on Investment

Projected PSO startup costs range from two million to seven million dollars. The PSO application/approval process (from initial development to final approval) is estimated at between 18 and 24 months. In addition, it is anticipated that the typical PSO will incur losses of between eight and 15 million dollars during its first three years in business. By any measurement, a significant amount of cash and resources will have to be devoted to the establishment of a PSO. This begs the question as to whether this investment can be justified.

Medicare managed care has not been a lucrative endeavor for most commercial insurers, many of which would like to drop these products unless and until payment rates improve. Under the Medicare + Choice Program, it is expected that urban rates and rural rates will become more closely aligned. A blended rate will be used taking into account regional and national cost data.

Under any circumstance, we are unlikely to see a significant increase in rates given the ongoing push to control, if not shrink, program expenditures. Assuming that a PSO could operate just as efficiently as a commercial insurer, (perhaps a large assumption given their startup nature), there is no indication that the Medicare payments received by the PSO will provide enough of a return to justify the significant startup investment.

HCFA has projected that as many as 800 to 1000 PSOs could be operational within three years. This may be an unrealistic projection. While the notion of contracting directly with HCFA without the costs of a health insurance intermediary is attractive, it cannot be denied that the infrastructure and services typically provided by the insurer have some value. Whether a newly formed PSO can replicate this infrastructure at an acceptable price without actually decreasing the amount ultimately paid to its providers is a major question.

At best, formation of a PSO will be a high-risk, high-expense proposition involving massive regulation and no guarantee of viable payment rates. Likely components of success will include:

• A large, well-established integrated delivery system or group practice comfortable with risk contracting.

• A strong financial partner with deep pockets who is willing to own 49 percent or less of the PSO.

• A well-developed Medicare risk infrastructure (i.e. information systems, sales and marketing forces and the like), either independently developed or acquired through contracts with effective providers of these services.

Even with these components in place, success is not assured. The guess here is that PSOs will meet the same fate as medical savings accounts. When originally authorized, Congress imposed a 750,000 cap on the number of accounts which could be created in anticipation of a rush to create these accounts. As of October 1, 1998 (eighteen months after these accounts were authorized) Americans had created fewer than 55,000 medical savings accounts.

Mark Stadler, Esq. is with the Cohen and Grigsby law firm in Pittsburgh.

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