Provider-sponsored networks are babes in managed-care land.
Except for a few mature, sophisticated organizations like Detroit's Henry Ford Health System or Geisinger in Danville, Pa., few provider networks have risk-bearing experience or track records. Revenues from prepaid risk contracts account for a scant percentage of most PSNs' total revenues.
In anticipation of marketplace changes, many PSNs are daring to embark on the very grown-up business of bearing financial risk for patients' healthcare coverage.
As an example, Medalia HealthCare, a primary-care company sponsored by Sisters of Providence Health System, Seattle, and Franciscan Health System, Tacoma, Wash., began providing fully capitated healthcare coverage for 28,000 Boeing Co. enrollees in July.
"It was a situation where Boeing decided to bypass the insurance industry and deal directly with providers," said Raymond F. Crerand, chief executive officer of Providence. Medalia, which represents 300 primary-care physicians and other ancillary providers, entered the direct-contracting business at Boeing's request and expects to respond to similar requests from other local businesses, he said.
Another example is Hackensack (N.J.) University Medical Center. Through its management services organization, Hackensack expects to enter its first capitation contracts before the end of the year. John P. Ferguson, Hackensack's president and CEO, believes it will be the first Garden State PSN to directly assume financial risk for covered lives.
"We're doing it now because the volume is small and we want to put our foot in the water and understand how to do it," Ferguson said.
Risk contracting is a whole new ball game for most healthcare providers. Are PSNs ready?
Hospital Research and Educational Trust, an arm of the American Hospital Association, is studying how PSNs assess, assume and manage financial risk, but it won't complete its report for several months. Gloria Bazzoli, HRET vice president for research, declined an interview request.
Many industry observers doubt that PSNs are up to the challenge.
"There are some who are (ready)," but the industry as a whole isn't prepared, said Peter Kongstvedt, M.D., Ernst & Young's national practice leader for managed-care strategy and medical management. "A number of these organizations don't take it seriously yet."
From February to April of this year, Ernst & Young surveyed 202 "integrated delivery and financing systems." It defined an IDFS as a provider-controlled organization that can accept a variety of financial arrangements directly from an employer or from an insurer through a "downstream" contract in exchange for providing an array of services (See definitions, this page).
According to the survey, IDFS's are generally young organizations with limited infrastructure and rudimentary information systems. Many lack a complete continuum of care, a clear commitment from management and well-defined long-term goals.
Ernst & Young's report depicts a nascent industry scrambling to respond to market forces. About 71% of the 202 responding organizations were 3 years old or less. Just 22% said they had an HMO license. And 14% had 100,000 or more covered lives.
Financially, provider-controlled organizations underperform the HMO industry. Some 21% of respondents reported a loss, and 22% said they didn't know their financial status.
As an anecdotal observer of the industry, James Forbes, a director in the New York office of Merrill Lynch & Co.'s healthcare department, has seen very limited success among provider-sponsored organizations. "You really have to (operate like) an insurance company," he said. Like insurers, providers need the requisite information systems, reserves and management expertise, he added.
Many new risk-contracting opportunities are expected to emerge as more states put their Medicaid business up for bid and employers seek to extract additional savings by cutting out HMOs and dealing directly with providers. Payers are turning to PSNs, hoping they will manage healthcare benefits more cost-effectively, focusing on preventive care, for example. By directly contracting with PSNs, they also expect to trim a layer of administrative expense.
Medicare, the biggest payer of all, also is beginning to test risk-based contracting. Twenty-five managed-care plans, including nine PSNs, will participate in a demonstration called Medicare Choices, which is set to begin early next year. The participants are located in Atlanta; Columbus, Ohio; Houston; Jacksonville, Fla.; New Orleans; Orlando, Fla.; Philadelphia; San Diego; and five rural areas.
One participant, Saint Joseph's Care Management Corp., a subsidiary of Saint Joseph's Health System of Atlanta, will be required to have an initial net worth of $1 million. Tom Flora, vice president of managed care and a former executive with Portland, Ore.-based Legacy Health System, has major questions about the future of PSNs. But he's committed to making Saint Joseph's risk-contracting arrangement work. If it doesn't, Flora jokingly told his board he'll shave his beard and move back to the West Coast.
Congress also is expected to reconsider legislation next year allowing PSNs to accept full risk for Medicare beneficiaries. The controversial proposal, which failed to make it through Congress this year, would place PSNs squarely in competition with HMOs for Medicare beneficiaries. What angered insurers were the accommodations made for PSNs.
"We welcome provider-sponsored networks," said Donald White, a spokesman for the American Association of Health Plans. "In fact, some 15% of HMOs are provider-sponsored networks, so the issue is how will those networks be regulated." All the consumer protection regulations that apply to HMOs ought to apply to similar types of plans, he said.
Congress had proposed looser regulations, because the risk being assumed would only be for Medicare beneficiaries. The legislation would have allowed states and HHS to set insolvency protection standards that are less restrictive than HMO requirements.
According to the National Association of Insurance Commissioners, which represents state insurance regulators, most states license PSNs as HMOs. More than half have laws based on the NAIC's HMO Model Act, which requires plans to have an initial net worth of $1.5 million and maintain a minimum net worth of $1 million.
When a PSN accepts full risk from an employer group or governmental payer, it agrees to provide all necessary and appropriate healthcare services to insured members of a group in exchange for a prepaid monthly fee per member. To make a profit, the PSN has to keep costs below budget. If future costs or utilization exceed actuarial predictions, the PSN eats the loss, at least up to a specified amount. Stop-loss insurance would cover any extraordinary losses.
Some PSNs also are beginning to accept downstream risk from HMOs, when HMOs will agree to it. In these arrangements, the HMO bears full risk for a group of patients and pays the provider network on a capitated or percent-of-premium basis to provide certain services. With hospitals in oversupply, HMOs generally don't need to enter subcapitation arrangements. They save money by squeezing discounts from hospitals that will agree to do business.
By getting their feet wet now, PSNs hope to respond more aggressively to growing employer and governmental demands for cost savings.
In the insurance industry, PSNs' rapid entry into the risk-bearing business has triggered a flurry of regulatory action. The NAIC has spent two years studying the issue and developing a white paper.
The association believes any organization engaging in the insurance business must be regulated by the states and be made subject to solvency and other consumer protection standards. Insurance regulators also believe PSNs should play by the same basic rules as other risk-bearing entities. For example, some states require the entity assuming the risk to hold the capital. That rule works against PSNs whose riches are tied up in hospitals.
Because every state establishes its own licensing and solvency standards, the rules differ dramatically. Nine states-Colorado, Georgia, Iowa, Kentucky, Michigan, Minnesota, New York, Oklahoma and Texas-have passed provider-specific laws or regulations.
Iowa, the first state to enact licensing requirements for provider networks, requires "organized delivery systems" to maintain $1 million or three times their average monthly claims for third-party providers, whichever is greater. To date, SecureCare of Iowa, an affiliate of Mercy Hospital Medical Center in Des Moines, is the only organization in the state licensed as an ODS.
At the other extreme, a handful of states-Idaho, Illinois, Ohio and South Carolina-have said they're unlikely to regulate PSNs that enter risk arrangements with employers, the NAIC said. Idaho said it's up to self-funded employers and insurers to protect enrollees. South Carolina believes the federal ERISA law may pre-empt it from regulating provider networks that contract with self-insured plans.
For self-insured employers and union-sponsored benefit plans covered under the Employee Retirement Income Security Act of 1974, state insurance law takes a back seat to the federal act. ERISA enables these plans to design and administer their own benefits packages.
But if states insist on requiring PSNs to be licensed as insurers, ERISA plans will not achieve anticipated savings, according to some observers.
"Allowing the provider-sponsored organizations to assume risk only from licensed health plans creates a market for licensed insurers that is protected by regulation," according to an article by Edward Hirshfeld, associate general counsel for the American Medical Association in Chicago.
In the Fall 1996 issue of Health Affairs, Hirshfeld writes: "If ERISA plans want the low costs of risk assumption, they must purchase a health plan from a licensed insurer that transfers risk to provider-sponsored organizations." He says that raises costs because the licensed insurer must pay its own administrative costs and make a profit, and it prevents ERISA plans from avoiding the costs of state regulation.
Providers say that's a cover. What insurers fear is getting cut out altogether. One harbinger is the Bloomington, Minn.-based Buyers Health Care Action Group, a coalition of 24 large employers that has bypassed HMOs to contract directly with providers. Effective Jan. 1, the buyers group will enter 14 contracts with hospitals, physicians and clinics that have organized into systems that can provide a continuum of services.
But insurers say the regulation is needed to ensure that PSNs don't go belly up. "They especially seek to avoid the recurrence of HMO bankruptcies that occurred in the 1980s," according to a draft white paper issued in September by the Risk-Bearing Entities Working Group of the NAIC's State and Federal Health Insurance Legislative Policy Task Force.
The NAIC's Health Organizations Risk-Based Capital Working Group, with help from the American Academy of Actuaries, has developed a risk-based capital formula for ensuring healthcare organizations' solvency. The proposed formula, which is being tested by more than 600 HMOs and other insuring entities, links the amount of capital required to the amount of risk assumed.
What can go wrong? In most PSN risk-contracting disasters, in which providers incur big losses, "the critical issues have not been addressed up front," said J. Bruce Ryan, executive vice president in the Atlanta office of Jennings, Ryan & Kolb, a healthcare consulting firm.
Ryan has seen his share of missteps by PSNs. He agreed to share some examples without disclosing the networks' identities:
In one example, two hospitals agreed to consolidate and seek joint capitation contracts. One is a teaching hospital; the other a low-cost community provider. Ordinarily you would expect low-intensity patients to be routed to the community hospital where it costs less to treat them. But in this case the teaching hospital wouldn't allow it, mistakenly believing those capitation dollars should be allocated to support the hospital's teaching costs.
Such an arrangement, which smacks of a "fee-for-service mentality," would harm both parties by failing to consolidate services in a manner that makes financial sense, Ryan said. He said the parties are still negotiating referral patterns.
In another instance, a hospital entered a multiyear risk contract with minimal regard for the kinds of structural and utilization controls needed to ensure success. "Our advice was, stay away from this. You're nowhere near ready," Ryan said. But the hospital felt it was more important to charge ahead and ended up losing "hundreds of thousands" on the contract.
Sometimes physicians fail to understand the risks of capitation. Ryan once attended a physician-hospital organization meeting in a major city in the Southeast where a specialist refused to share risk with any other specialists except his partners. In other words, the physician felt more comfortable bearing the entire risk for a smaller group of patients, say 10,000, than sharing risk for the entire covered population of some 100,000 patients.
If only the doctor understood the "law of large numbers," he would have known that insurance risk becomes increasingly more predictable with larger groups, Ryan said. The physician might have jumped at the chance to hedge his bet by contracting with other specialists for all the covered lives.
Typically, PSNs that have suffered significant losses on capitation contracts fail to assess their operating efficiencies, establish utilization and reimbursement targets, and create a physician incentive program consistent with those targets, said Bruce Pyenson, a consulting actuary with Milliman & Robertson's New York office. Some systems haven't even set up the structures to know whether they've made or lost money.
In its 1994 report titled Capitation Strategy, the Washington-based Advisory Board Co., a membership organization that conducts healthcare research, said it had identified hospitals and health systems that lost "millions of dollars" in the early years of capitation. It's typical for most providers to lose money and stumble upon actuarial errors in the first two years of a full capitation contract, it said.
The report draws no single conclusion but recommended full-risk capitation above other contracting models, believing that hospitals are better positioned "for success and profitability" if they go at risk.
To credit-rating agency analysts who rate health system bonds, risk assumption is a double-edged sword.
"In many respects, it's the right business decision because there's a lot of money to be made if you do it right," said Martin Arrick, a director with Standard & Poor's Corp., New York. On the other hand, he said, it is very risky.
Since few PSNs are generating significant capitated revenues at this time, there hasn't been a perceptible impact on ratings, analysts said. But that could change.
PSN losses from downstream risk contracts also have been limited because many insurers have been "unwilling to cede control" over the capitation payment, said Kevin Ramundo, a vice president in the healthcare ratings group of Moody's Investors Service, a New York-based credit rating agency. Instead, HMOs subcontract with providers on a discounted fee-for-service or per-diem basis.
But having an HMO license doesn't ensure ratings stability. In January, Moody's lowered Harris Methodist Health System's bond rating to A from A1. The agency cited continuing losses posted by the Houston system's HMO as one reason for the downgrade. Harris Methodist Health Plan's $20 million loss for 1995 exceeded a budgeted loss of $10 million.
The problem? Rapid enrollment growth. The expansion "overloaded" the plan's computer capacity, requiring a $2 million investment in new equipment, Moody's said. It also led to increased overhead, advertising costs and staffing levels.
And for many PSNs, just amassing enough capital to meet solvency standards will emerge as an important challenge.
Providence Health Plans, the risk-bearing entity for Seattle-based Medalia HealthCare, is attempting to set aside enough capital to cover 1 million lives in risk products by 2002, said Providence Health System's Crerand. Meeting capital requirements-about 14% of annual revenues-while growing the number of capitated lives and maintaining good facilities requires a delicate balancing act, Crerand acknowledged.
In Washington state, any risk-bearing entity is required to maintain the reserves itself, "so a PSN sponsored by a not-for-profit has certain hurdles to cross," he said.
To clear those hurdles, Providence Health System may need to reduce its days in cash or allow its AA credit rating to slip and pay more interest on its bonds. "That can be a short-term strategy," he said.
But to succeed over the long haul, the not-for-profit system hinted that its insurance arm may need to merge or sell. Providers who move into the insurance business need to carve out a significant presence in the market and raise sufficient capital, Crerand said. "If you can't do that, then maybe the insurance business is not for you.
"I think we learned this as we went along," he said. "There's no rulebook."