Sorting through the options. (Physician/Hospital Business Relationships).

WHETHER THEY ARE ALREADY EMBROILED IN aggressively managed markets or are preparing for managed care dominance, providers agree that physician/hospital partnering is critical to success in the newly emerging health care system. But, local market characteristics determine, to a great extent, which physician/hospital business strategies and structures will be most successful. That is, one has to match strategies with specific market characteristics in order to achieve business goals.

During interviews conducted in the spring of 1997, 45 executives and physicians from hospitals, health care systems, physician/hospital organizations (PHOs.sub.), and management services organizations (MSOs) discussed strategies and structures being used in their markets. The authors have synthesized providers' comments and their own observations to provide a context for critical review of physician/hospital business relationships.

Options for physician participation

In most markets with 20 percent or more managed care penetration, successful hospitals and health care systems offer physicians a variety of participation packages. Frequently, using an MSO as the umbrella structure, these hospitals and systems typically offer multiple participation options such as the following:

* Practice acquisition. Often used as a market share building strategy by players with deep pockets and an under-supply of primary care physicians (such as tertiary centers), practice acquisition is also a defensive strategy by competitors. When properly structured, acquisition provides a long-term core of primary care and selected specialist physicians for managed care contracting, and offers capital and employment security for physicians. Issues include hospitals' desire for stronger financial performance (practices can lose upwards of $100,000 per physician per year if poorly structured) and physicians' calls for greater control.

* Shared ownership of practices or long-term management contracts in lieu of outright acquisition. This variant of acquisition has been used for years by physician practice management firms. Because shared ownership and long-term contracts can address ongoing financial performance and control issues, they are being implemented by physicians and hospitals in many advanced markets. These acquisition lookalikes allow physicians to receive a combination of equity, cash (with payments stretched over a number of years), and board representation, and to share directly in the practice's financial performance. Physicians. are attracted by ownership and governance positions, while hospitals/systems benefit from spreading cash distributions over a multi-year period (contingent on continued physician participation) and improved financial performance.

* Practice management services for owned practices and interested physician affiliates. The more financially successful services consolidate owned practices into groups of 15 or more and recruit experienced practice managers to achieve operating economies. Consistent billing and collection, quality monitoring, and information systems are established. Practice management services for solo and small groups are rarely successful financially, and tend to be provided only as recruitment and practice start-up tools. Most hospitals lose significant dollars with this strategy.

* Significant physician role in hospital/system governance and strategic planning. Some of the bolder health care systems have increased physician representation on system boards to 50 percent. A willingness to share control and truly partner with physicians is recognized by physicians (and many system CEOs) as critical to long-term business relationships. Physicians with significant governance roles often facilitate the development of win-win physician/hospital approaches to competition and community health care needs.

* Recruitment and practice start-up assistance. This option is particularly common in rural and medically under-served markets.

* Provider-sponsored managed care organizations (MCOs). A number of aggressive integrated delivery systems have formed HMOs/MCOs in partnership with other hospitals/systems, physicians, and/or an HMO. For the most part, these managed care organizations avoid head-to-head competition with regional insurers and are small players in the market, perhaps focusing on a specific payer group.

In the Southwest, however, one proactive provider made a preemptive strike by forming an HMO in the early stages of managed care development. It went head-to-head with the competition and now dominates the HMO market. The HMO has a mutually exclusive contract with an independent practice association (IPA) which determines its own physician panel and holds a minority equity position in the HMO. In the Northwest, similarly, a health care system purchased an HMO that has become the third largest in the state.

In markets where HMO payments to hospitals have dropped below financially viable levels (e.g., Philadelphia/southern New Jersey), provider systems may determine that "there's nothing left to lose" by competing directly with dominant HMO players.

* Joint contracting vehicles. The business goals and structures of joint contracting vehicles vary greatly based on local market characteristics. Business agreements range from take-it-or-leave-it arrangements with individual physicians to exclusive single-signature authority for global risk contracting with physician organizations. Among the participation options offered to physicians, none is more heavily influenced by local market dynamics than the models for joint contracting, as follows.

Joint contracting models: PHO and MSO definitions

Joint contracting strategies are frequently implemented using such models as PHOs and MSOs. The lack of standard industry definitions continues to muddy discussion of these models for physician! hospital business relationships. As the adage goes, if you've seen one PHO/MSO, you've seen one PHO/MSO. Below are definitions for the purposes of this article:

* PHO as a joint contracting vehicle.

The PHO is a joint contracting vehicle, typically initiated by a hospital and requiring little of its physician members in terms of financial commitment or medical management. Usually the PRO negotiates fee-for-service contracts and adds little value in terms of access to new purchasers, better prices, or greater efficiency.

A common PHO weakness is revealed in the phrase "typically initiated by a hospital." In the few PHOs described as successful by those executives interviewed, physicians led the charge or were quick to assume leadership positions. Further, executives usually defined success in modest terms such as "maintaining ties with primary care physicians" and "3,000 to 10,000 capitated lives." More aggressive measures of success, such as "increased market share," were not mentioned.

* Umbrella MSO, or MSO as an umbrella structure for physician participation options. Ownership of umbrella MSOs varies across markets. There appears to be a pattern of hospital/system development and initial ownership of the MSO; over time, most likely as the market consolidates and physicians become ready to commit to a particular institutional partner, ownership is shared with physicians. The umbrella MSO may include a PHO.

* Contracting MSO, or MSO as strictly a joint contracting vehicle. This MSO's purpose is to negotiate and manage risk contracts. It provides infrastructure for medical management and owns or outsources insurance-related functions. It does not manage physician practices.

* Practice MSO, or MSO as strictly a physician practice management organization. Practice management is frequently performed on a percent-of revenues basis, preferably with performance incentives. The success requirements for practice management are quite different from those for negotiation and management of joint contracts; hence, contracting and practice functions are best handled by different staffs.

* MSO as a risk contracting and practice management vehicle. An example from suburban New England is a for-profit MSO that is hospital funded. Physicians receive cash and equity in exchange for long-term management services agreements (a rigorous process is used for valuation of practice management rights and control of the revenue stream). Cash payments extend over several years, and physician risk contracting can be done only through the MSO. MSO governance is approximately 50-50. The hospital retains reserve powers, such as contracting veto. The model requires extensive capital outlay by the hospital; however, it secures long-term contracting relationships with primary care physicians and provides financial performance incentives to physicians. Physicians are attracted by cash, equity, and a degree of control.

Which model? Consider the market

Each of the joint contracting models described have succeeded somewhere, to some extent. The question, however, is, "Will it succeed for us in our market?" Three market features appear to greatly influence the success of providers' strategies and contracting models: market size, traditional market structure, and aggressiveness of care management.

Market size

In large urban markets, teaching hospitals and academic medical centers vie for dominance as hubs of integrated delivery systems; they tend to lead the market in practice acquisition, in order to develop primary care networks and secure "star" specialists. PHOs are too homogeneous to meet the variety of physician and payer requirements found in most large urban markets; they are more likely to succeed in small markets or those with only one hospital/system. Institutional members of large integrated delivery systems often use an MSO umbrella structure to offer multiple joint contracting options.

In a major Midwestern market, a multi-institutional system's MSO contracts on behalf of multiple physician groups, provides practice management services, performs medical management for risk contracts, and bears financial risk. Physicians commit to single-signature authority within agreed-upon parameters and select from a menu of risk-sharing options. These options include: equity position with full shared risk; contractual relationship with risk pool; and fee-for-service with an option to decline. (Under certain risk-sharing arrangements, it is possible to provide equity to physicians without an exchange of cash.)

A more narrowly structured model in the mid-Atlantic market is an MSO established by a major integrated delivery system expressly for global risk contracting. Extensive capital has been invested in management information systems, practice acquisition, and staffing. Physicians hold 20 percent equity and more than half the MSO board seats. The MSO has single-signature authority for owned and shared-equity practices, a primary care IPA, and a specialty IPA. As part of the agreement, IPA physicians receive cash and agree to exclusivity for five years. This model is in the start-up phase; its success hinges on expansion of Medicare HMO enrollment and local payers' willingness to share global risk.

Midsize markets are often characterized by consolidation into two to three systems, each with three to four hospitals and an array of non-acute services. Small urban markets may have only one or two systems. HMO penetration and payer willingness to share risk varies greatly in these markets. For example, in Portland, Maine, a market with only 15 percent HMO penetration, payers are willing to share risk with PHOs, whereas in Palm Beach County, Florida, a market with 30 percent penetration, payers are not.

Traditional market structure

In markets traditionally dominated by large physician groups, hospital equity in large physician groups may improve the hospital's market access. A 20 percent equity investment has yielded one mid-Atlantic hospital a preferred-provider position for cardiac services, along with reserve powers, such as veto in contracting decisions.

In markets traditionally dominated by one or two payers, the payers establish the contracting climate and providers must adapt their contracting models accordingly. In Philadelphia, for example, despite HMO penetration over 30 percent, little risk sharing has been permitted by the two dominant payers. As an initial step, one payer offered a "blind capitation" arrangement to major tertiary-based systems. Systems must contract with individual primary care physicians (who are capitated for primary care only) to place their patients in the system's risk pool; the systems have minimal control over patient flow. In essence, joint contracting models must be formed specifically in response to this contracting opportunity.

Aggressiveness of care management

The stages of managed care are often measured by "percent HMO penetration;" however, HMO penetration does not always correlate with how aggressively care is managed. Use rates, such as acute inpatient days per thousand population over/under age 65 and ambulatory surgical procedures per thousand Medicaid enrollees, indicate how aggressively providers and payers are managing care; use rates also suggest how few revenue dollars must be shared among hungry providers. To illustrate, compare the Philadelphia market to the Fort Wayne, Indiana, market in 1995:

* In Philadelphia, managed care penetration was over 30 percent, but the over-65-years population used more than 3,000 inpatient days per thousand population.

* In Fort Wayne, with only 16 percent managed care penetration, the over-65 population used about 1,350, or less than half as many, inpatient days per thousand. (Denver, generally considered a benchmark city, was at about 1,800.)

The few PHOs breaking even on risk contracts are located in markets where use rates are still high (e.g., Michigan, New York, and New England). Characterized by strong physician leadership and shared control by hospital partners, these PHOs amicably distribute risk pools and modest profits.

However, when government payments decrease or national HMOs enter the market and drop prices to gain market share, significant losses may be incurred. When global capitation payments drop by $50 per member per month, who decides who will absorb the loss? Actuaries can help, but will not calm physicians' worry and anger over declining incomes. Capitated PHOs in these markets must quickly develop mechanisms to reduce per capita costs and resolve disputes over allocation of fewer premium dollars. Most likely, these organizations will require restructuring, either to separate physicians and hospitals, or to merge them into single entities strong enough to withstand the market's tornadoes.

Retooling and restructuring

Many hospitals and physicians have found that industry "templates," such as PHOs and MSOs, are not solving their problems. As Diane Bissonnette, attorney with the Boston firm Foley, Hoag & Eliot, LLP, has said, "the MSO-versus-PHO issue is a red herring." Bissonnette emphasizes the need to clearly define the entity's business goals before deciding upon a structure and to customize the entity's organizational structure to support achievement of its business goals.

Understandably, physicians and hospitals may be reluctant to dismantle a PHO or MSO in which they have invested considerable resources. It is possible, and often preferable, to retool and restructure an existing PHO or MSO while retaining the core partnerships. In other words, many or all of the original business partners renegotiate their partnership agreements to yield a "cleaner" structure that is streamlined toward achieving measurable business objectives. Retooling and restructuring may involve changes in corporate and governance structures, in equity positions (please see sidebar entitled, "Physician Equity in MSOs"), and in management roles. In any retooling effort, clear lines of financial accountability, performance standards and corresponding financial consequences, exit provisions, and dissolution thresholds should be defined.

Whether evaluating, retooling, or developing physician/hospital business relationships is being undertaken, the following steps can maximize both physician and hospital return on these critical investments:

* Assess the foundation of mutual trust and respect. Successful businesses require strong foundations; physician/hospital trust and respect must be developed prior to joint financial investment.

* Assess organizational resources, with attention to capital and physician leadership. During interviews, management information systems (MIS) and medical management infrastructure were cited as the greatest challenges for risk-bearing organizations, particularly in terms of capital and physician leadership requirements. With growth in covered lives, MIS and medical management requirements expand and access to capital can remain a critical issue.

* Assess local market characteristics. Market size, traditional market structure, and aggressiveness of care management must be assessed, as well as physician, payer, and competitor initiatives.

* Make explicit assumptions regarding future market characteristics. Once momentum begins to build (e.g., as HMO competition heats up in a discounted-fee-for-service market), market dynamics will shift suddenly and dramatically. New risk contractees will not enjoy the gentle learning curve of their earlier counterparts. More likely, national HMOs will enter "ripe" markets en masse, quickly forcing down prices in attempts to destroy local HMOs. To maintain profit levels, HMOs will reduce payments to providers, who may be forced to price "on the margin" until bed closures reduce the oversupply of beds. Price cuts for physician services will follow, after the desired panels have been established,

* Clearly identify and prioritize business objectives in light of the anticipated future market environment, Is the core objective to increase market share? To gain market leverage? It is useful to distinguish among physician, hospital, and joint physician/hospital objectives?

* Define measures of success for each business objective. Maintain organizational discipline by assigning accountability for evaluating success and ongoing redirection of efforts.

* Customize your organizational structure. Examine models that are succeeding (and those that have failed) in markets with low premiums and low use rates. Use successful models as a platform, but customize your organization's structure to support achieving your specific business objectives and to provide flexibility as the market continues to evolve.

Rapid change continues to be the one constant we face--we can count on it. And while the profusion of options available for physician/hospital relationships can be mind-boggling, they also show great promise that the health care system is reinventing itself with a foundation of partnerships and a commitment to providing affordable, accessible, and quality care.

RELATED ARTICLE: Is Your Organization Ready for Risk Sharing?

Many providers are facing the critical decision of whether to go after risk contacts. Prior to pursuing risk, determine payer willingness to share risk and compare your PHO, IPA, or MSO to the following success features:

* A history of strong physician/hospital relations and high trust levels

* Strong physician leadership, preferably with medical management experience

* Predominantly physician board representation, with at least 50 percent primary care (FP, IM, peds)

* Recognition that the revenue pie will shrink when HMOs compete on price

* MIS for medical management and for claims and other administrative processing

* An executive director experienced in managed care

* Peer review and medical management system in place, with financial consequences

* Physician partner(s) organized as physician organizations (POs or IPAs) which serve as a structure for physician decision-making and discussion

* Participation by multiple hospitals and physician organizations as required to achieve:

1. Geographic coverage as required by purchasers

2. Market leverage, i.e., "indispensable provider in the market"

3. Capital reserves to fund potential losses (requirements vary from state to state)

4. Access to capital for development of management information systems and medical management infrastructure

Most PHOs/MSOs are unprepared to shift to risk contracting without significant retooling. Organizations that aren't ready for such a change are characterized by:

* Hospital-dominated or specialty-dominated governance and/or management

* Uncommitted physicians who joined to hedge their bets, rather than manage risk and price services competitively

* Political priorities, rather than business development priorities

* Lack of preparation for medical management (e.g., little protocol development, weak peer review, little managed care education)

Melinda Zipin and Nathan Kaufman

Physician Equity in MSOs: Issues to Consider

* Physicians want a voice in policy and management decisions. Many want an ownership position as a means to gain control. But many joint equity MSOs are in financial distress and physicians must either provide additional capital or lose both ownership and control. However, board seats and management influence do not usually require an ownership position.

* Hospitals may view physician equity positions as a way to ensure physicians' financial accountability, for example, a commitment to efficient medical management However there are other ways to align physician/hospital financial incentives and gain accountability.

* Medical management services, with their considerable information system overhead, are loss leaders. Owners of these services will lose money for the first several years.

* If physicians insist on ownership they will expect a reasonable return on investment, so leadership would do well to consider restructuring to remove medical management services from the entity in which physicians invest.

* Hospitals may need to provide medical management services and absorb the loss. However, this is permissible for non-profit hospitals only if providing medical management services is integral to fulfilling the hospital's mission to the community, if services are available to all physicians, and if services are provided at market rates.

Melinda Zipin and Nathan Kaufman

References

(1.) Superior Consultant Company, Inc., Chi Systems Division, 1997.

(2.) Indiana Hospital & Health Association.

Melinda Zipin is a Senior Consultant with the Chi Systems Division of Superior Consultant Company, Inc., in Charlotte, North Carolina, a health care consulting firm. She can be reached by calling 704/364-3440 or via fax at 704/364-9606.

Nathan Kaufman is President of The KAUFMAN Group Division of Superior Consultant Company, Inc., in San Diego and is the primary author of Building Better Relationships with Physicians, published by the American Academy of Family Physicians. He can be reached by calling 619/4879771 or via fax at 619/487-3476.