American College of Physicians: Internal Medicine — Doctors for Adults ®

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State regulators causing problems for risk-bearing PSOs

Despite physician protests, legislators want to regulate risk-bearing physician groups as HMOS

From the April 1997 ACP Observer, copyright © 1997 by the American College of Physicians.

By Michael J. Werner, JD

As managed care becomes a dominant player in health care, physicians and other health providers have sought to organize networks and health plans. One response to physicians' desire to integrate has been the birth of provider sponsored organization (PSOs), which deliver care through affiliations of providers.

Some PSOs accept global capitation and bear full risk, while others enter into risk-sharing arrangements. Some PSOs contract with licensed health plans to provide benefits through a capitated contract, while others obtain an HMO license and directly compete with insurers.

Before physicians or groups of physicians attempt to organize into any type of PSO, however, they should first consult their state's insurance laws. Each state regulates provider networks differently, and how a state treats a network will greatly influence its structure and contractual arrangements with other entities.

ACP supports PSOs as an alternative to traditional insurers because they have the potential to improve care and reduce costs by increasing physician autonomy.

What states can do

Regulators in many states are focusing on PSOs because of concerns about protecting patients from the excesses of managed care. Many state officials are concerned that risk-sharing may give physicians an incentive to undertreat; they argue that increased regulation is needed to ensure that patients receive top quality care and are protected if a plan or provider group becomes insolvent. These regulators use the laws that govern HMOs to regulate risk-bearing PSOs.

Because most states do not have distinct legal requirements for PSOs, they require that PSOs participating in the “business of insurance” be licensed as HMOs. This is significant because most states require HMOs to have extensive reserves, capital and deposits to reduce the chances that a health plan will go bankrupt and leave its enrollees without health care coverage. Most PSOs, however, don't have the same financial backing and argue that holding them to the same standards as HMOs is unfair.

To avoid being licensed as an HMO, then, PSOs operating in these states cannot engage in the business of insurance. State regulators make this determination primarily by examining the PSO's payment mechanism. Regulators are likely to find that the PSO is engaged in the business of insurance if it accepts a premium, assumes risk and then spreads that risk over a population of insured individuals. In most states, therefore, PSOs cannot accept a capitated premium or assume risk for a full range of services without an HMO license. Instead, they must use alternatives like fee withholds or “global payments” that cover a patient's overall course of treatment.

Some states apply less stringent rules for PSOs by either licensing them under other existing laws (Michigan) or developing laws specifically for PSOs (Iowa). Other states such as Illinois have indicated that they will likely not regulate PSO arrangements at all.

Federal government weighs in

Although states have jurisdiction over insurance regulation, legislative changes may soon allow federal law to apply to PSOs in certain circumstances.

For example, federal regulations may supersede state law in regulating PSOs that contract with Medicare. Continuing a debate that began in 1995, Sen. John Rockefeller (D-W. Va.) and Sen. Bill Frist (R-Tenn.) have introduced legislation that would authorize PSOs to accept full or partial risk from Medicare to care for Medicare patients. The Clinton administration has included this idea in its Medicare proposal. In general, federal rules governing structure, solvency and quality assurance would apply to such PSOs.

In addition, PSOs that contract directly with employer-based health plans will probably not be governed by state regulations. Under the provisions of the Employee Retirement Income Security Act, employee benefits plans are not considered the business of insurance for the purposes of state regulation. At least seven states have said they will not regulate PSOs that contract with self-funded plans sponsored by employers.

Apart from these exceptions, however, state rules will prevail in regulating PSOs. Physicians interested in organizing a PSO, therefore, should be careful to check the insurance laws in their state before moving ahead with their integration efforts.

Michael J. Werner is Senior Associate for Government Relations in ACP's Washington, D.C., office.


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