Legal implications of managed care arrangements.

Perhaps the biggest challenge facing the organizers of a managed care vehicle (MCV) is avoiding potential antitrust liability. On both the federal[5] and state[6] levels, laws prohibit any combination or conspiracy to restrain free trade. Three major antitrust issues that are Likely to have a significant impact on the organization and the operation of a MCV are price-fixing, group boycotts, and monopolization.

Price-fixing

Price-fixing arises when competitors come together to decide on the prices to be charged for their services (whether prices are raised, lowered, or stabilized). It is the only antitrust violation for which criminal conviction is a serious possibility. The price-fixing danger for managed care is that the MCV may be viewed as a mechanism for competing providers to agree on a price for their services. As a result, the MCV's organizers must devise a means for setting prices without engaging in price-fixing.

Isolation of the Competitors. The first method of reducing price-fixing exposure is to isolate all competitors involved in the MCV from pricing decisions. Five ways to accomplish this, beginning with the most conservative and concluding with the most aggressive, are:

* In the "messenger model" approach, the MCV serves merely as a conduit to pass along the prices individually set by the various member providers. Because each provider acts independently, there is no conspiracy or agreement among competitors. Unfortunately, this approach is also the least attractive to the market, because it does not provide price certainty. In addition, it makes negotiating with a large customer difficult, if not impossible.

* Individual providers set their own range of fees and authorize the MCV to negotiate fees with customers within the ranges. Some MCVs include opt-in and opt-out features for providers that are triggered at each end of the price range. These may create problems in the market. Others permit the MCV to bind all providers. In either case, the key is to isolate providers from access to pricing ranges submitted by competitors.

* The MCV retains a third party to set a fee schedule. The third party must be completely independent and given full authority to bind providers.

* In the "black-box approach," the MCV determines all contractual terms, including prices. The MCV then presents the contract to both customers and providers, each of whom must independently decide to accept or reject the contract. The MCV plays an active role as intermediary but must ensure that information is protected and that competitors are not given any access to pricing decisions.

* The "broker approach" is the most efficiently administered but is also the most aggressive. The MCV negotiates on behalf of individual providers who have designated the MCV as their negotiating agent. The MCV has full authority to accept or reject all customer proposals. Again, providers may not share fee information or influence the MCV's determination of individual prices.

Formation of "Integrated Joint Venture." The second way of reducing the price-fixing risk is to form the MCV as a new, separate, and integrated business in both the legal and the economic sense. This will solve the price-fixing issue, because there will be only one actor (the new MCV) and no conspiracy or agreement among competitors.

The critical issue will be whether the law views the MCV as an "integrated joint venture." It is the underlying reality, rather than the label, that determines antitrust liability. To be considered fully integrated, the MCV must share both the financial risk and the outcome risk of the business. Financial risk refers to being paid a fixed sum for services and bearing the risk in the event costs exceed the amount paid. Outcome risk refers to quality assurance, peer review, claims exposure, etc.

Although this structure is perhaps the safest way to avoid price-fixing exposure, ancillary legal issues may arise, including the corporate practice of medicine doctrine (discussed below) and licensing issues under state insurance or other regulatory laws.

Group Boycotts

Once the decision is made to form a MCV, the practical question of "who's in, who's out" inevitably arises. Unfortunately, the answer carries antitrust ramifications. Antitrust exposure exists because, in all MCVs, there is a risk that competitors will be making decisions about the size of practice areas and about which practitioners are excluded. This is called the "group boycott" or "excluded provider" problem. The first step to reduce this type of antitrust risk is to prevent practitioners from making decisions about their competitors. Competing specialists should not be allowed to make decisions about each other. For example, orthopedic surgeons should not decide how many or which podiatrists should be admitted in the MCV. Similarly, psychiatrists should not determine admission qualifications for psychologists.

The second risk reduction step is to document objective, rather than subjective, practitioner qualification information and criteria concurrently with preparation of the MCV's initial business plan. For instance, based on the business plan, the following issues should be considered, quantified, and documented:

* Beds per thousand and the market demands in terms of waiting time in days for procedures.

* Number of specialists needed to serve the targeted population.

* Professional qualifications for membership.

* Criteria for determining cost-effectiveness of providers.

* Utilization control.

Setting objective criteria before the selection decision is made will help the MCV answer "who's in, who's out" on grounds that are not anti-competitive.

Federal agency heads have expressed greater concern about "over-inclusion" of providers in health care delivery systems than about "under-inclusion." Over-inclusiveness "raises far more substantial competitive concerns in antitrust risks than does exclusion of providers."[7] However, the most likely practical exposure to an antitrust case probably comes from private suits by excluded providers.

Monopolization

The third major antitrust concern, which may also arise in a group boycott or an excluded provider situation, is monopolization. The MCV will likely have a monopoly problem if it possesses sufficient market power to dictate prices and terms and willfully acquired or maintains such power. Market power is measured by both the relevant product and the geographic market. Generally, the larger the relevant product and the geographic markets are, the less likely it is that a competitor will have the requisite "market power." For example, a product market that is defined as the "health care financing market" will be broader than an "HMO market." The market power of an MCV will be diluted using broader product and geographic markets.[8] With respect to the provider segment of an MCV, unless providers making up more than 20 or 30 percent of the competing providers in the community (in any particular specialty) are committed to the network by exclusive contratcs for a substantial period, it is unlikely that the network will be found to have market power.[9] Particular attention will be paid to the degree to which the formation of the network inhibits the ability of payers to form competing panels of providers.[10]

Fortunately, it is very difficult for an excluded provider or other claimant to succeed in a monopoly claim against an MCV. Given the market and political pressures supporting MCVs, courts are generally unwilling to conclude that a MCV has sufficient market power. The courts are also quick to recognize the pro-competition benefits and often are unable to see any antitrust injury to the claimant.[11]

Managed care providers should always remember that, in the antitrust area, the ends do not necessarily justify the means. They must not assume that any MCV that results in lower prices in the market will be insulated from antitrust exposure.

Corporate Practice of Medicine

Doctrine

A possible impediment to adopting an integrated, risk-sharing MCV (which is one way to avoid antitrust price-fixing issues) is the corporate practice of medicine doctrine, which goes back decades in one form or another in a number of states. Under this doctrine, a corporation may neither practice medicine nor employ or retain a physician as its agent to practice medicine. The public policy behind this prohibition is that physicians should have absolute control over medical decisions and that there should be no arrangement that interferes with the physician-patient relationship.

This doctrine developed long before the time of MCVs and was originally directed at firms employing "company doctors" to treat workers. In today's favorable climate for MCVs, this doctrine is often overlooked and seldom enforced. In the event that a particular state enforces the doctrine, the typical solution involves an arrangement between physicians and the MCV in which each physician functions as an independent contractor. The physician maintains complete control over all medical decisions, fees, and records. In addition, the physician receives all monies generated from the delivery of medical services. If a particular state enforces the corporate practice of medicine doctrine, MCV organizers will need to either plan around it or determine whether the benefits of forming an "integrated joint venture" outweigh the risks of violating the doctrine.

Tax Considerations

Maintaining a Hospital's Tax-Exempt Status. The principal tax issue in a managed care arrangement is whether the involvement of a tax-exempt hospital will jeopardize the hospital's tax-exempt status. This, in turn, depends on the application of the "private inurement" and "private benefit" tests. Both tests are designed to ensure that the tax-exempt hospital operates to benefit the community rather than individuals.

The private inurement test mandates that the hospital's net earnings must be used to further the hospital's charitable purpose of providing health care to the community; the net earnings may not inure to or benefit private shareholders or individuals. For instance, there can be no dividends distributed by a tax-exempt hospital.

The concept goes far beyond the mere distribution of dividends, however. Any use of a tax-exempt hospital's funds or assets by certain private individuals raises an inurement issue. This includes granting physicians on a tax-exempt hospital's medical staff below-market leases in a medical office. As the variety of relationships between physicians and hospitals has grown, the Internal Revenue Service (IRS) has correspondingly expanded the concept of private inurement to apply to new situations.

Two additional features regarding private inurement should be noted. First, the concept only applies to a particular class of individuals, sometimes referred to as "insiders" of the hospital. These include members of the hospital's board of directors, officers, and physicians on the hospital's medical staff. Because most MCVs will involve all or some of these individuals, the IRS is likely to closely scrutinize the MCV. Second, any amount of private inurement can jeopardize the tax-exempt status of the hospital.

The related private benefit test is also designed to ensure that the assets and the funds of the tax-exempt hospital are used to further the hospital's charitable purpose. The major difference is that private benefit may exist where any private party receives a benefit, regardless of whether that person is considered an insider. A second difference exists, however, in that the IRS specifically permits a certain level of private benefit to occur without jeopardizing the hospital's tax-exempt status when such benefits are conferred on individuals who are not insiders. Unfortunately, the IRS has refused to quantify the permitted level of private benefits.

Given that the tax-exempt status of a hospital is such a sensitive issue and that the IRS has refused to provide any clear guidance, it is strongly recommended that a tax-exempt hospital get the IRS's approval prior to entering into an MCV arrangement. This can normally be done by requesting a private letter ruling from the national office of the IRS.

Tax-exempt Status of an MCV. A second tax issue that arises when forming an MCV is whether such an entity may itself qualify as a tax-exempt organization. Although this is a relatively new legal area, it may be possible to structure the MCV to accomplish this result. The IRS will focus primarily on whether the MCV is designed to deliver health care to a sufficiently broad cross-section of the community. An MCV that serves a limited number of companies in the community likely will not qualify as a tax-exempt organization.

A recent trend, reflected in most of the alternative health reform proposals before Congress, requires increased justification of a health care entity's tax-exempt status. The provision of health care will no longer be treated as an activity that accomplishes a charitable purpose unless the organization, at least annually, with the participation of community representatives, assesses the health care needs of its community and develops a plan to meet those needs.[12] Since February 1993, the IRS has issued five favorable tax-exemption determination letters to managed care vehicles created in connection with the formation of integrated delivery systems.[13] These letters reaffirm that the IRS's standard for exemption of an MCV will be based on an expansion of the community benefit standard.

A tax-exempt MCV would have to abide by other restrictions as well, such as the requirement that no dividends may be paid to private shareholders. These burdens must be balanced against the benefits of tax-exempt status by those forming the MCV. An organization that wishes to apply for recognition as a tax-exempt organization must generally do so within 15 months after the date it is created.

Fraud and Abuse Laws

The IRS has recently asserted that any arrangement that violates the Medicare/medicaid fraud and abuse statute will automatically result in loss of the hospital's tax exemption. This makes the necessity for considering the fraud and abuse issues even more important where a tax-exempt hospital is involved.

Parties to any health industry business arrangement must be sensitive to federal and state fraud and abuse issues whenever dollars flow in one direction while referrals, or even the ability to influence referrals, flow in the other direction. The primary source of concern is the Medicare antikickback statute, which makes it illegal to receive or pay remuneration for benefits of any kind in exchange for the inducement of referrals that may be paid by the Medicare/Medicaid program. In addition, the "Stark Bill" and its extension, "Stark II" (which becomes effective on January 1, 1955), generally prohibit referrals from a physician to a clinical laboratory or one of 11 other "designated health services," including physical therapy services, occupational therapy services, durable medical equipment, and home health services, in which the physician has either an investment interest or a compensation arrangement.[14]

Participation in a managed care arrangement can be characterized as acceptance of a discounted charge or fee for services in exchange for a stream of referrals. Consequently, the essential elements of a violation of the fraud and abuse laws are present: remuneration in the form of accepting less than normal charge in exchange for a stream of referrals. Partially because MCVs are a politically favored means of health care cost containment, amendments to the "Safe Harbor Regulations" were issued in November 1992 that outline managed care situations and arrangements in which the federal fraud and abuse laws do not apply. Exceptions to the Stark rule against self-referral generally conform to the Medicare antikickback safe harbor rules. In light of such regulations, the risks of violating federal fraud and abuse laws can be reduced, if not eliminated.

Conclusion

Given the economic and political pressures surrounding the health care industry, two things are certain. First, managed care arrangements, which have had unprecedented growth over the past few years, are certain to be a large part of the nation's health care system in the future. Second, legal issues that have the potential to significantly affect managed care arrangements will continue to develop and evolve. Organizers of a managed care arrangement must address these issues in a proactive, rather than a reactive, manner. Their only chance to do so is by addressing the issues before the business plan is finalized. At the very least, timely consideration of the issues will allow the individuals involved to weigh the risks and make informed business decisions.

References

[1.] Kaiser Family Foundation/KPMG Peat Marwick survey, July 15, 1994.

[2.] KPMG Peat Marwick Study, "Health Benefits in 1992," Nov. 5, 1992.

[3.] Governor Bill Clinton, "Putting People First - a National Economic Strategy for America. ("Consumers will be able to select from among a variety of local health networks, made up of insurers, hospitals, clinics, and doctors. The networks will receive a fixed amount of money for each customer, giving them the necessary incentive to control costs.")

[4.] This article is based in part on a comprehensive analysis of the legal aspects of managed care presented at the 25th Annual Meeting of the Academy of Hospital Attorneys by Jerry A. Bell Jr. and Jeffrey M. Sconyers.

[5.] Sherman Act (15 U.S.C. [sections] 1,2); Clayton Act (15 U.S.C. [sections] 14, 18, 18a); Federal Trade Commission Act (15 U.S.C. [section] 45).

[6.] Every state except Pennsylvania has a counterpart to the Sherman Act. State laws also have counterparts to the other federal antitrust statutes.

[7.] Letter from Anne K. Bingaman, Assistant Attorney General, Antitrust Division, Dept. of Justice, to J. Bert Morgan (Nov. 17, 1993) at 8-12.

[8.] U.S. Healthcare Inc. v. Healthsource Inc., No. 91-113D (D.N.H. Jan. 30,1992).

[9.] Dept. of Justice and FTC Antitrust Enforcement Policy Statements in the Health Care Area, 4 CCH Trade Req. Rep. [para.] 13,150 (Sept. 15, 1993).

[10.] Mark J. Horoschak, Director, Bureau of Competition, Federal trade Commission, "Joint Ventures in Evolving Health Care Matters," remarks before Washington State Hospital Association (Sept. 25, 1993) at 14.

[11.] Grady, K. "Antitrust Health Care Developments." Antitrust Law Journal 59:405, 419-20, 1991.

[12.] Health Security Act [section] 7601(a), H.R. 3600, 103rd Congress, 1st Session (1993).

[13.] The Friendly Hills Determination Letter, the Facey Foundation Determination Letter, the Billings Medical Clinic Determination Letter, the Harriman Jones Medical Foundation Determination Letter, and the Rockford Memorial Health Services Corporation Determination Letter.

[14.] The Omnibus Budget Reconciliation Act of 1993, Pub. L. 103-66, 107 Stat 31.