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Health care economics is changing - the law is sure to follow.

Health care financing, as recently as a decade ago, was the domain of indemnity products. Consumers had unfettered choice of providers, and providers were paid their costs or their charges up to a liberally construed prevailing maximum. Today, health maintenance organizations (HMOs), which promise broad coverage and moderated pricing in return for limits on consumer choice, are a large part of the market, particularly in urban areas. HMOs pioneered the economic innovation we call integrated delivery--the merger of health care's financing and delivery components.

The need to achieve practice efficiencies, capture market share, and raise capital will continue to drive providers into economic integration. Payers of the future, fewer in number and (because of the pricing requirements of their private and quasi-public customers) more demanding of providers, will enhance this tendency. They will drive volume to provider systems that are willing to share insurance risk.

Provider Rights

To date, the courts have extended providers only limited relief when they have contested exclusions from managed care plans. The courts have been hesitant to "Monday morning quarterback" managed care organization (MCO) exclusion decisions alleged to be grounded in quality concerns. Likewise, case law has not favored claims contesting the ability of a payer to exclude providers on the basis of the MCO network's lack of a need for additional practitioners in the applicant's specialty. Court opinions on this subject often borrow rhetoric from the Seventh Circuit's Ball Memorial decision, to the effect that preferred provider networks are necessarily limited in size because of the need to trade price for volume.

Notable exceptions are cases involving the exclusion of an applicant from a network as a result of action by the applicant's competitors. However, in their pure form, these competition boycott cases are relatively rare. Provider-controlled networks are not in the majority, and, even where an exclusion is made by a network, the courts will uphold the action unless it is motivated by the controlling providers' interests as competitors in the applicant's market rather than their interests as directors of an entity competing in the market for the sale of services.

Of course, the case law to date has developed in a milieu where exclusion had limited effects on the applicant. The networks doing the excluding have not represented a crucial percentage of the applicant's business. Much of the private payer market was still available either because it was not network-based or because of the multiplicity of networks. Moreover, government business (Medicare, Medicaid, and CI-LA_MPUS) was still available to the applicant.

It doesn't take a rocket scientist to see how this is changing. As the managed care tidal wave grows, even private payers that have been the redoubts of open access are limiting enrollees to networks and are becoming more aggressive in economic profiling of providers seeking admittance. Federal and state governments are seeking to drive more Medicare, Medicaid, and CHAMPUS business through networks. If federal and state reform efforts reduce the number of payers, access to those payers' networks will become the only way a provider can secure core business.

Provider interest groups have, in the past, attempted to address this concern in state legislatures. Many insurance codes mandate that coverage be extended to services by various classes of providers. Recently, there has been a spate of "open pharmacy" laws. Finally, several states have "any willing provider" statutes. For the most part, however, the interpretation of these statutes has been favorable to restricted networks. Notwithstanding the recent Fourth Circuit Court of Appeals decision in Stuart Circle rejecting an ERISA preemption defense to the enforcement of Virginia's "any willing provider" law, networks usually are able to successfully defend exclusions by simply citing a lack of additional need. This has been the case even where a need rationale for exclusions was arguably not anticipated by the legislature.

As economic trends raise the stakes for health care providers, it will be surprising if providers do not require legislatures to address the issue in reform packages. It will also be surprising if provider groups do not demand a change in thinking on this score and seek laws requiring plans to deal with all providers exhibiting at least a minimum cost efficiency score. Likewise, one would expect to see provider associations urging the new purchasing coalitions ("alliances" in the language of the Clinton plan) to impose provider due process rights for their accountable health plan (AHP) contractors.

While new laws of this type would find a logical home in reform legislation, they are likely to develop on a freestanding basis even in the absence of such a vehicle. The economic squeeze on providers will be the compulsion. Once a new generation of statutes and regulations of this type are in place, a new body of AHP privileging case law can develop.

Joint Negotiations

The federal antitrust enforcement agencies-Federal Trade Commission (FTC) and Department of Justice (DOJ)--have long been suspicious of joint bargaining by health care providers. Since the Maricopa case in 1982, providers have struggled to collectively relate to managed care without straying into the territory of price fixing and boycotts.

Providers generally operate from informational and financial deficit positions when bargaining individually with payers. Moreover, while providers have been told that, if they transform themselves into joint ventures, the adoption of a collective bargaining strategy would be permissible, there is a dearth of guidance from the courts, FTC, and DOJ on the characteristics of a legitimate joint venture. Even the joint policy statement issued by FTC and DOJ on September 15, 1993, in an attempt to address provider concerns in advance of the President's health reform push, offered little solace, because it spoke only of safe harbors where a string of ameliorative facts were present. Thus, providers continue to struggle with "messenger model," "black box," "standing offer," and other preferred provider systems without any certainty as to their legality, at least in the enforcement agencies' view.

The need for a resolution of this issue is becoming more pressing as the number of provider-controlled managed care contracting vehicles spreads. What previously was a problem most acutely felt by provider-controlled individual practice associations (IPAs) and preferred provider organizations (PPOs) has become a mainstream issue with the proliferation of physician/hospital organizations (PHOs). While many would look at the advent of PHOs as a positive development facilitating the assumption of insurance risk by providers, this promise is continually threatened by unresolved antitrust issues.

The new federal policy statements create a safe harbor for risk assuming provider-controlled entities comprising no more than 20 percent of the providers in a market. Risk assumption is defined to encompass both withhold and capitation systems. While that surely represents some progress (extracted as a political concession for limited provider support of the Clinton plan), it will certainly create new anxiety for numerous procompetitive provider combinations that do not meet the size or risk assumption tests.

The system, with or without a kicker from reform, will require provider collaboration in the form of planning, the conduct of medical management, and participation in the risk. The State of Washington's health reform plan anticipated this and provided for a procedure through which the potential venturers could request state attorney general review of a proposed collaboration. The state's inquiry into the "whys and wherefores" of the collaboration and its continuing review of the rationale for the venture would strongly support claims for "state action" antitrust immunity. Eight other states have also enacted laws designed to create zones of state action immunity. We would anticipate a new legal specialty (a cousin of CON work) in assisting providers in making the case for antitrust immunity through these state processes.

Community Benefit

A related area of law that has hampered provider responses to payer demands for financial integration has been the Internal Revenue Service's (IRS's) positions with respect to physician influence on tax-exempt entities. First, it may be generally observed that the standards for exempt status for physician groups are significantly more stringent than those applied to hospitals. Hospital exempt status can be grounded in as little as an open emergency department or an open medical staff. In contrast, the exempt status applications of physician groups have required evidence that the applicant does more than simply provide health care-- they have demanded research and educational activity.

Impediments on access to tax-exempt financing are an interesting historical anomaly arising out of IRS suspicions toward physicians. In the current interest rate climate, this deprivation is not fatal. Of more concern is the IRS's policy, announced through private letter rulings, toward physician voting rights in the integrated delivery system context. The issue arises as physicians seek governance rights in economically integrated sy. stems involving tax-exempt hospitals. The IRS is reviewing these structures to satisfy itself that they do not result in any private inurement for "insiders" or create private benefit except as it may further the hospital's exempt purposes.

The Friendly Hills and Facey private letter rulings issued earlier this year established a 20 percent safe harbor for such involvement. The safe harbor was borrowed from IRS guidance in the tax-exempt financing area, and there is no direct statutory basis for this application. It is a remarkably strict standard, given the IRS's lenient treatment of large physician clinics and faculty practice plans over the years. Sadly, it presumes that a private inurement problem will exist wherever physicians are given input. Most important, it works at cross-purposes with federal policies designed to encourage physician/hospital integration as a way to reduce duplication and incentives for overutilization of inpatient settings.

The inappropriately restrictive safe harbor is illustrative of a problem of wider scope a narrow definition of community benefit. In its zeal to prevent exempt assets from benefiting insiders, IRS has taken a relatively narrow view of community benefit in the hospital context. Community benefit has focused on such things as the provision of indigent care and the development of a new service; efficiency has been lowly valued (see, e.g., IRS GCM 39862). In an era when we are seeking to reform the health care financing system to create new efficiencies, the community benefit standard should evolve. The IRS treatment of exempt entities should accommodate their need to "bond" with physicians, particularly where such bonding is motivated not simply by the need to secure sources of admissions but also by the desire to create an economically integrated unit that can have the right incentives for managing utilization of insured populations.

Professional Liability

MCOs have been concerned with two general categories of tort liability: the negligent acts of the corporation itself and liability imputed to the MCO for the negligent acts of its agents.

Direct Liability

Direct or corporate negligence has been viewed principally as being of three types: negligence in the selection and retention of network providers, negligence in plan design (e.g., provider compensation systems alleged to result in the denial of medically necessary care), and negligence in the administration of a utilization management program.

Negligence in selection has, to date, been overrated as a theory of recovery. The chain of causation has been difficult to establish, and there are no widely accepted standards for credentialing that a plaintiff could point to as being followed by all reasonably prudent managed care companies. Accreditation by the National Committee for Quality Assurance (NCQA) is in greater demand by purchasers and will be one source of a standard of care upon which future litigation will be based. A reform proposal is also likely to lead to credentialing standards being imposed on AHPs by purchasing alliances.

In such an atmosphere, the National Practitioner Data Bank (NPDB) will grow in importance. As AHPs become the predominant buyers of physician services, an adverse NPDB report that leads to the applicant's rejection or termination could be career limiting. If the current lack of a de minimis exemption to the reporting obligation persists, nuisance settlements might become extinct. Also possible is a new tribunal to consider the appeals of physicians seeking to avoid a report.

In contrast, the claim of negligence in plan design is not likely to grow in importance. Plan designs may be dictated by statute or by alliances. If so, all AHP plan designs would, ipso facto, be operating under community standards.

The tort of negligence in utilization management may have greater legal significance for several reasons. First, where state tort reform has limited recoveries from providers, the managed care organization has become an increasingly attractive "deep pocket." Tort reform enacted in conjunction with a federal managed competition program may have a similar effect.

Second, utilization review may become even more prevalent as pricing pressures on payers increase. On the other hand, the tort will fade in significance in those parts of the delivery system where providers are at risk and do not employ precertification, concurrent review, and other currently fashionable techniques.

Finally, in the course of federal reform, Section 514 of the Employment Retirement Income Security Act (ERISA) is likely to be amended to allow state reforms to proceed unfettered by ERISA preemption and to restore the remedy of extracontractual damages for bad faith claim denials that Pilot Life and its progeny destroyed. At that time, the ERISA defense to the negligent utilization management claim also may be eliminated, thus increasing activity in this area of tort law.

Vicarious Liability

The second major category of liability in managed care arrangements is imputed or vicarious liability. A managed care entity may be held to be vicariously liable for the actions of contracting providers on one of several theories. One is the theory of respondeat superior ("let the master answer"). Another is that of the "ostensible agency." In ostensible agency cases, the managed care entity is held liable on the ground that the consumer reasonably perceived the health care provider to be acting under the direction of the managed care entity.

As health care purchasing alliances place new pricing pressure on AHPs, we expect health care financing and delivery to become ever more tightly entwined. As this occurs, vicarious liability claims, which to date have had a limited record of success, will be strengthened. The integrated managed care entity will become more involved in the delivery of care in some cases through provider ownership and in other cases simply through new activism in the development of care protocols and outcomes-based decision making. This new involvement will make the entity more like the "master" upon whom liability is traditionally fixed under respondeat superior. At the same time, the consumer may become more aware of the managed care network as a provider of services. When that occurs, ostensible agency claims will be strengthened.

Other Liability Fallout

The development of integrated networks may also reduce the number of physicians who approach risk management on an individual basis. Physician/hospital aggregations are likely to purchase coverage as a group when new products become available or purchase systemwide professional liability coverage. What has initially been the creation of hospital-sponsored malpractice programs for physicians as a "bonding" tool is likely to evolve into systemwide risk management programs. These programs may be built on systemwide patient management protocols. Thus, the managed competition program may, quite aside from its express malpractice provisions (such as caps on attorneys' fees), gradually reshape the professional liability landscape.

As this occurs, many vestiges of the old system will need to redesigned. One such component is the Health Care Quality Improvement Act (HCQIA) and the National Practitioner Data Bank that it created. At the outset, HCQIA's immunity provisions must be extended to cover professional review of all forms of AHPs. A related concern is the need to modify NPDB reporting requirements so that they do not impede the assumption of liability by managed care entities. Under current law, a claim made jointly against a provider and the managed care system could not be settled by the system without producing a data bank entry report on the provider on whose behalf the settlement was in part made. The potential inability to settle claims without besmirching a provider's record could impede the evolution of entity risk management.

Physician Incentive Systems

Managed care is premised on the belief that the best way to control utilization is to provide incentives for physicians not to perform or order unnecessary care. These incentive systems vary greatly in scope and effect. They have been most widely employed in HMOs not using salaried physicians. However, if health reform aggregates purchasing power and limits price increases, physician incentive systems are likely to become more widespread.

On the one hand are the so-called "withhold incentive systems," wherein a percentage of the provider's fee is withheld and used to fund deficits in the budgets for the services that the provider orders, such as specialty physicians, hospitalizations, or lab services. Also used are capitation payments, where the provider receives a fixed monthly payment for each patient in an assigned population no matter how many or how few services are provided. A key issue is what services the capitation is meant to cover--the physician's own services only or including a number of ordered services. Many times, the systems use capitation for physician services net of a withhold to create incentives for the physician's ordering of referral services.

Although risk systems are central to health care delivery under a managed care approach, they have received little regulatory attention. State HMO laws and PPO-authorizing statutes are largely silent on the subject. Similarly, federal qualification rules for HMOs have not placed any constraints on incentive systems. The one exception to this trend has been the statutory language in Section 9313(c) of OBRA '86 that prohibits payments to physicians as an inducement for them to reduce or limit services to Medicare or Medicaid recipients. That statute, to this day, does not have implementing regulations--in large part because the Department of Health and Human Services (HHS) is perplexed by how to define the physician incentive system problem, if such a problem exists.

When the Government Accounting Office and Physician Payment Review Commission studied the issue, they noted that a multiplicity of factors affect whether a physician incentive plan might go too far and actually result in the denial of medically necessary care. Those factors probably include:

* The amount of risk shifted to the physician.

* The number of physicians whose cost performance is used to determine the size of the incentive pool available.

* Whether incentive payments are based on a percentage of provider savings or profits.

* The length of time over which cost performance is measured.

The draft regulation for HHS (57 Fed. Reg. 59024) did not attempt to deal with the multivariate nature of physician incentives. It simply aggregated bonuses, withholds, and capitation amounts and established limitations on the risk that could be taken by the physician for services not provided.

That regulation is subject to criticism for being myopic in its approach to managed care quality assurance. The regulation doesn't take into account such important variables as the percentage of the physician's total income the plan's risk payments constitute; the sufficiency of the actual price paid, exclusive of the at-risk money; whether distribution of surplus is based on individual or group performance; the size of the group; the size of the population across which the risk is being spread; and the quality assurance systems in place.

As the delivery system evolves to place more and more groups and individual physicians at risk for the delivery of services, these concerns are likely to be taken up by state as well as federal regulators. Should a managed competition scheme take effect, regional alliances are likely to require their suppliers (AHPs) to conform their risk-shifting systems to certain requirements. In the process, policymakers will have to grapple with questions concerning how to put enough price pressure on physicians so that they order only necessary tests while at the same time not creating a system where the transfer of inappropriate amounts of financial risk to providers leads to unacceptable quality and access compromises.


Managed competition's emphasis on provider incentives to manage health care utilization of populations draws attention to an unresolved issue in managed care regulation concerning appropriate limits to the assumption of risk by entities other than licensed insurers. Historically, indemnity companies and service benefit plans did not share risk with intermediary organizations. HMOs broke this pattern with what was perceived to be a restrained amount of risk shifting to aggregations of physicians. Sometimes, these aggregations were economically integrated (a medical group), but, in certain instances, IPAs were at best partially integrated. In the years subsequent to the failure of the International Medical Centers health plan in Florida, state regulators have felt that this risk shifting created system vulnerability. However, there is, to date, no uniform state response for managing this exposure.

The promise of PHOs as managed care contracting vehicles is likely to remain unfulfilled unless state law evolves to permit the assumption of risk by these organizations both in the HMO and the non-HMO payer contexts. Currently, in some states, PHOs will be unable to accept capitation from HMOs for the combination of hospital and physician services. The situation is even bleaker with respect to compensation arrangements for other payer entities. For example, the capitation of non financially integrated provider groupings by self-funded payers is problematic in most jurisdictions. While many jurisdictions tolerate the operation of withhold systems by self-funded and indemnity company payers, it is not clear that these systems sufficiently encourage cost-effective treatment patterns.

If the promise of managed competition is to be realized, state regulators must come to terms with assumption of risk by provider groupings without imposing prohibitive net worth requirements on such entities. Currently, insurance and HMO net worth requirements are barriers to effective participation by provider entities in managed care delivery and financing. Moreover, such barriers are many times disproportionate to the risk being managed. They should be scaled to reflect the actual financial exposure to the risk-assuming entity and offset by the availability of the reserves from, and the net worth of, the risk-ceding plan. Absent state accommodation in this regard, a federal statute creating appropriate models may be required.

Mark Lutes, Esq., is a partner with the law firm of Epstein, Becker and Green, Washington, D.C.
COPYRIGHT 1993 American College of Physician Executives
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Author:Lutes, Mark E.
Publication:Physician Executive
Date:Nov 1, 1993
Previous Article:Building a vertical provider system.
Next Article:Quality improvement in the era of health reform.

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