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Testimony on Provider-Sponsored Organizations by Kathleen A. Buto
Associate Administrator for Policy
Health Care Financing Administration
U.S. Department of Health and Human Services

Before the House Ways and Means Subcommittee on Health
April 24, 1997


Mr. Chairman, I am pleased to be here today to discuss the Administration's proposals regarding provider-sponsored organizations (PSOs). In other hearings this year, we have spoken about PSOs as one part of our Medicare managed care proposals, but this is our first opportunity to focus more closely on this important, new, managed care option.

In my testimony, I have been asked to discuss general areas of agreement regarding PSOs in the President's fiscal year 1998 budget, the Balanced Budget Act (BBA) of 1995, and a bipartisan bill recently introduced in the House by Representatives Greenwood and Stenholm, the Medicare Provider Sponsored Organization Act of 1997. 1 should note that Senators Frist and Rockefeller also introduced a bill which is very similar to the Greenwood-Stenholm bill. I will highlight the different approaches that each of these bills take in four key areas related to fiscal soundness and solvency, private enrollment requirements, State licensure requirements, and the ability to offer a point-of-service (POS) option. Finally, I will present our experience to date with PSOs in the Medicare Choices demonstration.


Currently, the Health Care Financing Administration (HCFA) can contract with Federally- qualified health maintenance organizations (HMOs) and competitive medical plans (CMPs) to enroll Medicare beneficiaries. The Administration believes that Medicare beneficiaries should have more managed care choices. Thus, the President's budget would expand managed care options to include preferred provider organizations (PPOS) and PSOS. On this point, there is general agreement between Congress and Administration with both the BBA and the Greenwood-Stenholm bill permitting beneficiaries to enroll in PSOs.

We believe that direct contracts with alternative managed care models such as PSOs are the key to expanding managed care, particularly in rural areas. Currently, there are twenty-five States that have Medicare HMOs serving rural areas. As of March 1996, sixty-eight Medicare HMOs (fifty eight risk plans and seventeen cost plans) served beneficiaries in rural areas- only 79,000 enrollees out of a possible I million beneficiaries in these rural regions enrolled in Medicare HMOs. Coupled with revisions to the managed care payment methodology under which rural areas would be paid either a minimum payment amount ($350 per month in 1998) or a blended payment rate, we believe that the establishment of a PSO option would have a positive impact on managed care enrollment in rural areas.

There is also agreement that, with a few exceptions, PSOs should be required to meet the same standards as Medicare HMOs. Under the President's budget and the BBA, PSOs would be held to all of the same standards related to quality, access, marketing, beneficiary liability, benefits, and appeals and grievances. Under the Greenwood-Stenholm bill, PSOs would meet all the same standards as HMOs.


Although there is general agreement on PSOs as a new managed care option for beneficiaries, the various bills have somewhat different approaches on four issues -- (1) fiscal soundness and solvency, (2) private enrollment requirements, (3) state licensure requirements for PSOs, and (4) the ability of the PSO to offer a point-of-service (POS) option. Hearings like this one today will allow us to listen to all viewpoints -- from the States, managed care plans, providers, and beneficiaries and their advocates -- and to debate the merits of the various approaches.

In developing a consensus on these issues, I believe we would all agree that our primary focus should be what is best for the Medicare beneficiary. We all want to provide beneficiaries with new managed care choices. However, to ensure continuity and quality of care for our beneficiaries, we also want to be certain that such choices are sufficiently capitalized and have adequate protections against insolvency. We want to be certain that these new entities have experience managing risk and are appropriately certified and monitored for compliance with Medicare's requirements.

Fiscal Soundness and Solvency Standards

Since all Medicare HMOs are licensed by the State, all Medicare HMOs also meet State standards for fiscal soundness and solvency, which in many instances are more stringent than Federal standards. For example, Medicare's regulations require only that plans have a positive net worth, while States may require that plans maintain a minimum net worth.

Medicare also requires that contracting HMOs must also have a plan for handling insolvency that allows for continuation of benefits (for inpatients until they are discharged and for all enrollees for the remainder of the contract period for which payment has been made) and arrangements to protect members from incurring liability for payment of any fees which are the legal obligation of the HMO. To satisfy these requirements, the HMO must demonstrate that it has arrangements in place to cover at least two months of health care expenses, in the event the HMO becomes insolvent. The arrangements to cover health care expenses could include insolvency insurance, "hold harmless" provisions in provider contracts, continuation of benefits provisions, letters of credit, restricted State reserves, guarantees from the financially sound parent corporation, and net worth.

Under the President's budget, PSOs would be subject to different fiscal soundness and solvency standards than HMOs because of differences between their delivery systems. Unlike most HMOs which provide services through contracts, PSOs would provide a substantial proportion of services directly through their own physicians and hospitals. These fiscal soundness and solvency standards for PSOs are not specified in the President's budget bill. Instead, these standards would be carefully developed through regulation so that we could consider input from all parties on this complicated, evolving issue. Likewise, the BBA also would have permitted PSOs to meet solvency standards that are different than those applied to HMOs. The BBA also specified that in developing solvency standards for PSOS, the Secretary would take into account alternative means of protecting against insolvency. The Greenwood-Stenholm bill takes a somewhat different approach. While special solvency standards would be developed for PSOS, the bill specifically establishes such standards. As noted above, because of the complexities associated with this issue, the Administration would prefer that fiscal soundness and solvency standards for PSOs be developed in regulation rather than statute.

Private Enrollment Requirements

Under current law, to ensure that HMOs enrolling Medicare beneficiaries have sufficient experience managing risk, Medicare HMOs must have a minimum commercial enrollment of 5000 members in urban areas and 1500 in rural areas. In addition, a Medicare HMO's Medicare and Medicaid enrollment cannot exceed 50 percent of its total enrollment. This requirement is often referred to as the 50150 rule. The 50/50 rule is considered by many as a "proxy for quality."

The President's budget would maintain the 50/50 rule for all managed care plans until a new quality measurement system is finalized. However, the rule would be modified by excluding Medicaid enrollees from the calculation, thus an HMO's Medicare enrollment only (not Medicare and Medicaid) could not exceed its commercial enrollment. In addition, before the quality measurement system is implemented, the Secretary would have additional authority to waive the 50/50 rule for managed care plans serving rural areas, for plans with good track records and in other circumstances the Secretary deems appropriate. The President's plan would also maintain the minimum private enrollment requirements for all managed care plans. However, the President's plan would allow PSOs to meet the 50/50 rule and the minimum private enrollment requirement in a different way than HMOs. The PSO could "count" as commercial enrollees individuals for whom the PSO providers were at substantial financial risk. For example, if the physician group of a PSO had received capitated payments from an HMO for a number of the HMO's enrollees, those individuals would count towards meeting the 50/50 and minimum private enrollment requirement for the PSO.

Under the BBA, the 50/50 rule was repealed for all managed care plans, including PSOs. The Administration believes that the 50/50 rule should not be eliminated until it can be replaced with a quality measurement system. Under the Greenwood-Stenholm bill, PSOs would be deemed to meet the 50/50 rule if they had experience providing coordinated care and if they met "higher" quality assurance standards. I would like to note that while the Greenwood-Stenholm bill considers the standards fisted in the bill as more rigorous than current law standards for HMOs, the Administration believes that these standards are similar to current statutory, regulatory and administrative requirements for Medicare-contracting HMOs, with the exception of the requirement to provide comparative outcome data. HCFA now requires all Medicare HMOs to submit HEDIS performance measures, and we will disseminate this comparative information to beneficiaries in the future. We believe it is important that outcome data for all managed care plans, not just PSOS, be provided to our beneficiaries so they can make informed decisions. To that end, under our Choices demonstration, we will be developing and testing quality outcomes that use encounter data.

Both the BBA and the Greenwood-Stenholm bill would permit PSOs to meet lower minimum enrollment requirements compared to current law. Under these bills, the Secretary could not enter into a contract with a PSO unless the PSO had at least 1500 -enrollees in urban areas and 500 enrollees in rural areas. These minimum membership requirements, however, would not apply for the first three years of the PSO's contract. The Administration has concerns that these enrollment requirements would not ensure that PSOs' providers had sufficient experience managing risk before the PSO began enrolling Medicare beneficiaries.

Licensure Requirement for PSOs

There are different perspectives regarding whether PSOs should be required to be licensed by the State. Some assert that State insurance departments (who license HMOs in addition to other insurers) may impose unnecessarily stringent requirements, particularly fiscal soundness and solvency requirements, that would effectively prohibit PSOs from entering the managed care market. Consequently, they argue that the Federal government's standards for PSOs should pre-empt the State's licensing requirements. Alternatively, State insurance officials, HMOs and others argue that since PSOs would accept the same degree of risk as HMOs, in the form of capitate payments for their enrollees, both should be subject to the same State-determined standards.

The Administration wants to ensure that PSOs would not face unreasonable barriers to entering the managed care market place, while also ensuring that they are financially sound entities with the ability to manage risk. We do not believe that a broad pre-emption of State licensing requirements is necessary and that pre-emption of State licensing requirements should be limited to the extent possible. This approach is similar to that taken under Title XIII of the Public Health Service Act, also know as the HMO Act. Under the HMO Act, federally qualified HMOs are required to be organized under the laws of the State. However, the HMO Act also exempts federally qualified HMOs from any law or regulation that would prohibit the health plan from doing business in the State as an HMO.

The President's budget would provide Federal pre-emption of State licensing requirements in limited circumstances. Prior to approval of a State's certification and monitoring program for PSOs, the Medicare program would not require PSOs to be State-licensed in order to obtain a Medicare contract. State licensing requirements would be preempted unless the State's requirements are identical to Federal contracting standards. However, after the State has a certification and monitoring program approved by the Secretary based on its standards being substantially similar to Federal standards, PSOs would be required to obtain a license from the State. After 2000, the State could impose more stringent standards, but these standards would have to be approved by the Secretary.

The BBA utilizes a somewhat different approach, but we believe that the overall goal is the same. Like the President's budget, the BBA wants to ensure that PSOs are treated fairly compared to other managed care plans and that no PSO faces unreasonable barriers to entering the market. Under the BBA, PSOs would be required to apply for a license from the State. However, PSOs could seek a waiver of the licensing requirement from the Secretary if the State does not act on the licensing application within 90 days or the State denied the application and one of the following applied: the State's standards were not the same as for other entities in substantially the same business; the State applied solvency standards but did not have its program approved by the Secretary (to be approved, the, State's solvency standards must be identical to Federal standards); or the PSO has been reviewed by the Secretary and determined to meet Federal standards, but the State has denied the license based on the PSO's failure to meet its solvency standards.

We believe that the "substantially similar" criteria used to evaluate State programs used in the President's budget is more reasonable than the "identical" standards criteria in the BBA and Greenwood-Stenholm bill, since minor differences between State and Federal standards should not result in exemption from State licensure.

The Greenwood-Stenholm bill offers yet a third approach on this issue and appears to permit broader pre-emption of State licensing laws than under either the President's budget or the BBA. Under the Greenwood-Stenholm bill, before 2002, PSOs would not need to be licensed by the States. After 2002, PSOs will be required to have a license only if the State's solvency standards are identical to Federal standards and non-solvency standards are substantially equivalent. PSOs could request waiver of the licensure requirement if the State took more than 90 days to act on licensing application or if the State imposed unreasonable barriers to entry.

Point of Service Option

Under the President's budget, PSOs would be prohibited from offering a point-of-service (POS) option. We believe that if the PSO wants to offer an insurance product and accept risk beyond its own providers it should be treated as a Medicare HMO and meet the corresponding State licensure and Medicare contracting requirements. Neither the BBA or the Greenwood-Stenholm bill would prohibit PSOs from offering a POS option.


As you know from our past appearances before this Committee, the objective of the Medicare Choices demonstration is to test a broad range of managed care delivery systems, such as PSOS, and to evaluate the suitability of such options for the Medicare program. As a result, the Medicare Choices demonstration will give HCFA a " head start" on developing solutions to a wide range of implementation issues with respect to PSOs.

Of the seventeen sites in the Medicare Choices demonstration, eleven are PSOS. Of the eleven PSOs, four have received final awards and we have completed negotiations and certified the sites, which have started, or are about to start, enrollment under the demonstration. The remaining seven PSOs are completing developmental activities in preparation for site awards. Following is information about the eleven PSO Choice participants, including a description of the provider network, whether or not the PSO has received or will receive licensure from the State, the current status of the award and enrollment to date.

Mount Carmel Health System in Columbus, Ohio, is a PSO of physicians and three hospitals. The final demonstration award was made February 28, 1997. This PSO has an HMO license from the State. The PSO initiated enrollment March 1, 1997 and has enrolled 530 beneficiaries.

Florida Hospital Healthcare System in Orlando, Florida, is a P SO associated with the Adventist Health System. The plan will offer a basic HMO benefit in three counties in the Orlando area. The final demonstration award was made December 26, 1996. This PSO received special permission from the State to operate without a license for purposes of the demonstration. The PSO initiated enrollment January 1, 1997 and enrolled over 4,000 beneficiaries during the first 3 months.

Memorial Sisters of Charity in Houston, Texas, is a PSO sponsored by the Memorial Healthcare System and the Sisters of Charity of the Incarnate Word. The final demonstration award was made December 26, 1996. This PSO has an HMO license. The PSO initiated enrollment in mid-February 1997 and reports 547 enrollees to date.

Crozer-Keystone Health System in Media, Pennsylvania, is a PSO based in Delaware County. The final demonstration award was made December 26, 1996. This PSO has a risk-bearing PPO license. The PSO initiated enrollment around March 1, 1997 and has over 405 Medicare enrollees to date.

Georgia Baptist Health Care System, Inc., in Atlanta, Georgia, is a PSO with its flagship hospital in inner-city Atlanta. This PSO would allow Medicare beneficiaries to select a specialist as a primary care physician. The plan will be available in the four counties encompassing Greater Atlanta. The plan has received a State PSO license but, the State has not yet completed its certification of the plan's delivery system. The PSO plans to initiate enrollment this summer.

Baptist/St. Vincent's Health System in Jacksonville, Florida, is a PSO which will offer benefits to Medicare beneficiaries in Duval and Na ssau Counties. The PSO, which assumed the lead on this demonstration site foll owing the withdrawal of the original HMO applicant (Healthcare USA), plans to submit revised application documents this summer in order to initiate enrollment in early 1998. This PSO will probably need and receive permission from the State to operate without a license for purposes of the demonstration

Mercy Health Corporation in Bala Cynwyd, Pennsylvania, is a PSO proposing a managed care product, "Liberty ElderCare", for Medicare beneficiaries including those beneficiaries qualifying for Medicaid. The delivery system will provide full Medicare benefits, including supplemental services, in medically underserved area s of Philadelphia and Delaware Counties. The plan is currently discussing the structure of its dual-eligible benefit design with the State and is exploring licensing options, including a joint venture with Keystone East HMO. The issue of licensure is still to be determined for this PSO. The plan hopes to initiate enrollment late this year.

People's Health Network in Kenner, Louisiana, is a P SO established by Tenet Healthcare in March 1994 as a management services organization whose members are the New Orleans area Tenet hospitals and their affiliated Independent Practice Associations (IPAs). This PSO has an HMO license from the State. The HCFA certification site visit is scheduled for this month, and the plan hopes to start enrollment this summer.

The Morgan Health Group, Inc., in Norcross, Georgia, is a PSO organized as a physician-led primary care management organization. Morgan will serve beneficiaries in the 16 counties currently served by the Morgan Health Group. The plan has applied for a PSO license from the State of Georgia and hopes to initiate enrollment this summer.

University Of California at San Diego (UCSD) Healthcare Network in San Diego, California, is a PSO originally organized to manage commercial HMO risk agreements with the UCS provider network. This PSO has a modified Knox-Keene license from the State which the State has stated is sufficient for the Medicare Choices demonstration. The HCFA site visit is scheduled for this month, and the plan hopes to start enrollment this summer.

St. Joseph's Health System in Atlanta, Georgia, is a PSO of 18 hospitals led by St. Joseph's Hospital of Atlanta. The plan will offer a full range of Medicare services in a 36-county service area in northern Georgia. The plan h as applied for a PSO license from the State of Georgia and hopes to initiate enrollment this summer or next fall.

Because only one PSO has been in operation for more than 3 months, and most have not yet started to enroll beneficiaries, experience under the Medicare Choices Demonstration at this time is still quite limited. Nonetheless, we have made some observations.

First, the PSO is an attractive option for Medicare beneficiaries. While enrollment rates vary among plans, all seem to be attracting beneficiaries. Florida Hospital reported receiving 5,500 calls during its first week of operation and enrolling 400 beneficiaries in those first few days. Of the 4,000 Medicare enrollees to date, 60 percent are from the fee-for-service market while 40 percent are transferring from HMOs. In a survey of 120 of those enrollees, the primary reason for joining the Florida Hospital plan was the hospital's reputation followed by the quality of the physician network. Over 80 percent of the respondents rated the fact that the plan was operated by a local hospital and physicians as very important. Over 90 percent also considered as very important the fact that the plan was locally headquartered.

Second, PSOs have been able to develop administrative capabilities in order to qualify for a contract with Medicare. While most of the PSOs in the demonstration have had some experience in providing health care under a capitate payment arrangement, few of the plans had experience as primary contractors responsible for all administrative functions. Although the plans remain at various stages of development, several of the plans have been able, quite expeditiously, to design marketing plans, establish enrollment procedures, and develop claims processing operations.


Despite our different approaches regarding financial standards, minimum private enrollment requirements, State licensure requirements for PSOs and the ability to offer a point-of-service option, there appears to be widespread bipartisan agreement that Medicare beneficiaries have the option of enrolling in PSOs. In resolving these differences, our overall goal should be to craft PSO legislation that best serves our Medicare beneficiaries. I am confident that working together we will accomplish this important objective..

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