What went wrong with PSOs?

THE BALANCED BUDGET ACT OF 1997 MADE IT POSSIBLE for provider sponsored organizations to contract directly with HCFA, serving Medicare beneficiaries much in the same way as traditional Medicare HMOs. Many heralded the change as an opportunity for physicians and hospitals to be the local owners of provider- and patient-friendly managed care organizations providing services to Medicare eligibles. By controlling care locally, providers reasoned they could deliver better service, grow their market share, and enhance their income.

HCFA also had high hopes. The agency thought the legislation would bring about an increase in the number of Medicare + Choice plans, not to mention improvements through competition and increases to market penetration (currently about 15 percent of all Medicare eligibles).

But two years later, HCFA has approved fewer than a handful of PSO applications as Medicare + Choice plans. In addition, the 13 demonstration projects, originally approved before the BBA as models by HCFA never started, went out of business, or lost large amounts of money. What went wrong?

* Poor timing. At a time when providers are being encouraged by the federal government to start up managed care organizations, HMOs have been announcing their departure from the market. They have cited as the reason big financial losses caused by inadequate reimbursement and expensive government mandates. The rural and suburban areas, where HCFA was especially interested in seeing new Medicare managed care options, were the first markets from which the HMOs departed. On July 15, 1999, HCFA announced that 41 health plans would be quitting Medicare + Choice in 2000, requiring 327,000 Medicare enrollees to look for different options. Not surprisingly, providers have been asking themselves, if the HMOs can't be successful, how can we?

* Large financial risk. The start-up costs for a PSO can conservatively be expected to range from $6 million to $10 million. In addition, the organizations must maintain reserves of at least $1.5 million. The Medicare demonstration projects lost substantial amounts of money, usually because the amount paid by HCFA to the Medicare + Choice PSO was not sufficient to cover the costs of medical care and administration. For 2000, the basis for per member per month payment (PMPM)--the average adjusted per capita cost (AAPCC)--will range, depending on the county, from $401 to $814. The AAPCC rates tend to be lowest in the areas HCFA is most interested in seeing PSOs form, such as rural communities. Providers, especially those who have had bad experiences with capitated health plans, see PSOs as creating great and unwanted financial risks.

* Unclear strategic direction. There is not much difference between a PSO and an HMO. In fact, the short-term duration of the legislation--three years--may mean that PSOs will have to become licensed as HMOs in order to operate long term. Many providers believe that operating an insurance company is not their mission or strength and could hurt their relationships with their patients, physicians, and other health plans. While patients may love their physicians or their hospitals, they usually feel differently about their HMOs, even when they are provider-owned.

* Uncertain regulatory and administration issues. HCFA's oversight and reporting requirements are considerable. Because the rules regarding compliance change frequently, providers constantly require new administrative expertise and information systems in order to comply with the agency's regulations. Beginning in 2000, health plan and provider reimbursement models will be based on a new risk adjustment methodology. Meeting the data collection and administrative requirements necessary for the changed methodology is a daunting task for providers. Many providers, even those who are well-capitalized, have decided that the challenge is just too great.

Faced with few PSO applications and many HMO market withdrawals, the feds will have to consider whether additional incentives are needed to sustain their policy of encouraging Medicare managed care growth. It is likely, however, that any plans to motivate providers differently will still tempt only the most risk-oriented or well-capitalized provider groups, and that the near future will see few new applications. Despite this prediction, 50,000 Medicare eligibles still join Medicare + Choice plans every month. So while few provider groups are expected to own and operate new Medicare PSOs, the small number of national HMOs are positioned to benefit from this growth, and providers will have to learn how to succeed at contracting in order to serve this population.

Phil Dalton, vice president of The Camden Group in El Segundo, California, provides strategic business advice to health care organizations.