PSOs: A New Opportunity for Providers

For many years, hospitals and physicians have been lobbying to be able to contract directly with Medicare beneficiaries, arguing that provider directed care would produce better results than HMO directed care. Finally, as the result of the passage of the Balanced Budget Act of 1997 (the "Act"), they are going to have that opportunity. The Act establishes a new program called the Medicare + choice Program (the"Program"). The Program significantly expands the health plan options available to Medicare beneficiaries, providing as many as eight different choices. One of those choices is revolutionary, enrollment in a provider-sponsored organization ("PSO"). If the Medicare beneficiary elects the PSO alternative, the PSO will be capitated, and thus will bear direct risk for the health needs of the person – global capitation for all Part A and Part B Medicare services – with all the attendant risks and rewards that goes with it. However, a PSO is not a classic HMO or insurance company, and a majority of its equity must be owned by health care providers. The Health Care Financing Administration ("HCFA") is scheduled to begin licensing PSOs in November, and will allow them to contract for patients beginning in 1999. This schedule leaves little time for preparation for providers.

The term PSO has been used for many years in the health care arena to describe an entity controlled by health care providers. Under the Act it now has a specific meaning. The definition of PSO set forth in the Act, however, left room for interpretation. On April 14, HCFA published an interim final rule (the "Rule") which clarifies some of the ambiguities.

The Act requires a PSO to be "established or organized, and operated by a health care provider or group of affiliated health care providers". The term "health care provider" ("Provider") includes any licensed health care practitioner who directly furnishes health care services. The Rule clarifies that integrated delivery systems, such as physician hospital organizations or other physician/hospital controlled entities, are able to qualify as Providers and thus are in a position to own and operate a PSO.

The Providers must provide "a substantial portion" of the health care items and services under the Medicare + Choice contract, whether it provides them directly or pays subcontractors to provide them, and must share "substantial financial risk." The term "substantial portion" is defined in the Rule as 70% (60% in a rural area) of all health care items and services. As a practical matter, this means that both hospitals and physicians must be among the PSO's Providers or affiliated Providers. Otherwise, there is no way to meet this definition. Those same Providers must share "substantial financial risk." Under the Rule, such risk includes acceptance of capitation payments or a predetermined percentage of the premium, or withholds of a "significant amount of the compensation" due the Providers. This is intended to effectively tie the Providers together economically.

The Act also requires that Providers have a "majority financial interest" in the PSO. The rule provides some leniency, mandating only that at least one affiliated Provider (or any combination of them) must have such interest. This is a good development, as it was thought that HCFA might adopt a narrower, less flexible rule requiring that all affiliated Providers included for the "substantial portion" test have a financial interest as well.

Generally, a PSO must be licensed under State law, as a risk-bearing entity in each state where it intends to offer a Medicare + choice plan. However, under certain circumstances, HCFA will grant a waiver from this requirement. A waiver will be necessary in Florida, as there is currently no Florida law licensing PSOs. A bill to create such authority was debated in the 1998 legislative session, but was not passed. However, even if the waiver is obtained, the Act imposes certain financial solvency standards. These standards were shaped by a "blue ribbon" HCFA committee which met monthly from October, 1997 through March, 1998. At the application stage a $1.5 million net worth is required, with at least $750,000 to be in cash, and the remainder allowed to be through tangible assets.

An entity desiring to qualify as a PSO is required to file an application to HCFA. While the form of application is still being prepared, it is expected to be detailed, lengthy and costly to complete. Among other things, it will require a financial plan covering the first 12 months of operations (longer if the plan projects losses during that time) and a d3tailed marketing plan. The PSO must also show to HCFA's satisfaction that it will have sufficient cash flow to meet its financial obligations as they come due.

On the surface, it would seem that PSOs look particularly attractive in South Florida. Dade County has one of the highest Medicare payment rates in the country, and Broward and Palm Beach Counties are not far behind. Nevertheless it will be a significant challenge for a PSO to cause its providers to care for patients effectively, and still earn a profit. Many Medicare patients will not be interested in the PSO option. PSOs will have to compete with other competitors, like Medicare HMOs, who will fight to retain their business. All of an HMO's typical expenses, like administrative costs and additional benefits which must be offered for the product to be competitive (e.g., dental, eyeglasses, deductible waiver), will have to be borne by the PSO before paying physicians and, hopefully, the investors. It will be imperative that the PSO physicians and hospitals share risk, establish effective protocols, and address clinical resource consumption.

Despite all these difficulties and risks, many providers throughout the country will seek licensure as a PSO.