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

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PSOs: Can they survive competition from Medicare HMOs?

From the October 1998 ACP-ASIM Observer, copyright 1998 by the American College of Physicians-American Society of Internal Medicine.

By Deborah Gesensway

Officials at St. Joseph Healthcare in Albuquerque, N.M., see HCFA's new Medicare+Choice program as a glass that is half full. That's why the organization was one of the first health systems in the country to apply to the federal government to operate its own managed care health plan for Medicare recipients as a provider-sponsored organization (PSO).

Medicare PSOs are a new type of health plan that promises to allow doctors to contract directly with the government and assume risk for Medicare patients. Optimists view this new breed of health plan as the latest way to cut out the middleman—commercial HMOs and insurers—and funnel health care dollars directly to physicians.

HCFA estimates that about 20 PSOs may apply and be approved for licensure under Medicare+Choice each year, although only three had applied at press time. The Congressional Budget Office estimates that about 1 million beneficiaries will have enrolled in PSOs by 2002.

Janice Torrez, president of St. Joseph's PSO, said that the ability to contract directly with Medicare will eliminate some of the layers of bureaucracy that are normally part of an HMO. She also said that officials at the health system are optimistic that building their own health plan for seniors will work because their hospitals and doctors already have a decade of experience in capitation from working with large HMOs. St. Joseph is part of Catholic Health Initiatives and includes three acute care hospitals, a rehabilitation hospital, a nursing home, several family health centers and a medical network.

Formidable barriers

Others in health care, however, are less sanguine about whether PSOs will succeed, mainly because this new type of health plan will have to operate largely like HMOs. In communities where powerful HMOs already have a lock on the Medicare market, the competition is likely to be brutal. And in areas where national HMOs haven't made a dent, PSOs will encounter low capitation rates, lack of adequate provider networks willing to accept deep enough discounts on fees, and even problems with patient resistance in this era of HMO-bashing. When some of the nation's largest, established HMOs this summer announced plans to abandon the Medicare market, Wall Street analysts and investors began to question whether covering Medicare patients can ever be profitable.

"My feeling is that PSOs do not have a chance because they are not well capitalized," said John M. Daniel, FACP, a general internist in Richmond, Va., who for much of the last decade has served as the medical director of Southern Health Services, a doctor-owned HMO. Federal regulations say that PSOs must have a minimum net worth of $1.5 million, half of which must be in cash. Sweat equity, which includes the providers' ability to give care even if the money runs out, may count for up to 20% of net worth if the PSO can show at least $1 million in cash reserves. Health care providers must own the majority of the PSO, and the PSO must assume full financial risk for all covered services. The PSO can provide the services itself or pay subcontractors to perform them.

Besides finding enough capital, Dr. Daniel said that start-up PSOs have to recreate all the functions of the managed care companies they will be competing with. "They have to do utilization management, quality assurance, claims management, marketing, plus everything else," he said. "So your administrative costs are going to be just the same as somebody else's."

Because of these challenges, John DuMoulin, the College's Director of Managed Care and Regulatory Affairs, predicted that many PSOs will go the same way of start-up physician-owned HMOs that attempted to get off the ground this decade. While some, like Dr. Daniel's, were able to succeed by carving out a niche for themselves, many more have gone under or have had to sell out to an insurance company or HMO. The key, Mr. DuMoulin said, is adequate capitalization. Unfortunately, he added, a group of doctors is unlikely to raise enough money on its own to develop enough of a cushion to cover the financial risk in treating Medicare patients. Rather, he said, doctors will have to find partners with deep pockets, such as hospital systems.

There is another complication: HCFA is rolling out a program to reduce some of the disparity in the capitation fees it pays to Medicare managed care plans. In areas where capitated payments are high, annual increases will be held to 2%, and efforts will be made to increase the amount of money paid in regions where the capitated amounts have historically been low. (Medicare's capitation rate is based on the amount of money that is spent on original, fee-for-service Medicare in that region.) Many question whether start-up PSOs and other health plans will be able to make it as HCFA cuts back on fees in high-paying areas.

"Real opportunity"

Despite these barriers, many physicians remain optimistic about the potential of PSOs. Plans that do succeed could present doctors with "a real opportunity" to regain "some of the autonomy that we've lost," said Donald T. (Ted) Lewers, FACP, a member of AMA's Board of Trustees. "The AMA has been saying for some time that the HMOs would be better off if they put practicing physicians into some of the decision-making roles in their organizations. I believe PSOs will create that opportunity."

Finally, PSOs are just one part of the new Medicare+Choice regulations that will affect physicians. Since Medicare+Choice will replace all of the current Medicare managed care program, its provisions promise to affect physicians who contract with any Medicare health plan.

Many of the provisions of the Medicare+Choice regulations have been supported by ACP and ASIM for years, Mr. DuMoulin said. They include banning gag clauses in HMO contracts so that physicians may not be restricted from advising patients about medical or treatment options even if the plan doesn't cover them as a benefit. Medicare+Choice will also require health plans to give participating providers written notice of terms of payment, credentialing, data reporting and utilization review. Health plans will not be allowed to deselect providers from their network without first giving the physicians a right to appeal the decision to a panel of peers. Health plans will also have to consult with physicians regarding their medical policies, quality assurance programs and medical management procedures, and they will have to develop guidelines in consultation with contracting health care professionals. Practice management or utilization management guidelines used by any plan must be based on reasonable medical evidence or a consensus of health care professionals in a particular field.

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