AHM 510 : Health Plans : Governance and Regulation

AHM 510
Health Plans: Governance and Regulation

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AHM 510: Syllabus

AHM 510 describes the formation, types, and structure of health plans. It also addresses
the role of health plans in government-sponsored programs, the impact of fraud and
abuse, how health plans make decisions about their purpose and overall direction, and
the role of public policy in health plans today.

Assignment 1: Environmental Forces

Reading A Environmental Forces

Assignment 2: Legal Organization of health plans

Reading A Legal Organization of health plans

Assignment 3: Formation and Structure of health plans

Reading A Corporate Restructuring and Corporate Transactions
Reading B Health Plan Structures and Arrangements

Assignment 4: Overview of Laws and Regulations

Reading A Perspective and Overview of State and Federal Laws
Reading B Regulatory Agencies and health plan

Assignment 5: State Regulation of Health Plans: Part 1

Reading A State HMO and Other Types of Health Plan Laws
Reading B State Mandates and Regulation of the Health Plan-Provider Relationship

Assignment 6: State Regulation of Health Plans: Part 2

Reading A Other Laws That Apply to Health Plans
Reading B Workers' Compensation Programs
Reading C Pharmacy Laws and Legal Issues
Reading D Market Conduct Examinations and Mechanisms for Enforcement

Assignment 7: Federal Regulation of Health Plans

Reading A Federal Regulation of Health Plans
Reading B Antitrust Concerns and Health Plans
Reading C ERISA and Health Plans

Assignment 8: Federal Government as Purchaser

Reading A Federal Government as Purchaser: Overview, TRICARE, and FEHBP
Reading B Medicare and Health Plans
Reading C Joint Federal-State Healthcare Programs (Medicaid, Programs of
AllInclusive Care for the Elderly, and the State Children's Health
Insurance Program)

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Assignment 9: Fraud and Abuse

Reading A Fraud and Abuse

Assignment 10: Governance: Structure and Strategy

Reading A The Components of Governance in a Health Plan
Reading B Strategic Planning in Health Plans
Reading C Key Strategic Issues for Health Plans

Assignment 11: Governance: Accountability and Leadership

Reading A Governance: Accountability and Leadership

Assignment 12: Key Legal Issues in Health Plan

Reading A Key Legal Issues in Health Plan

Assignment 13: Public Policy and Changing Environment

Reading A Public Policy from the Health Plan Perspective
Reading B Changing Environment and Emerging Trends in Health Plan Industry

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AHM 510: Course Objectives

This course describes the formation, types, and structure of MCOs. It addresses the role
of health plans in government-sponsored pro-grams, the impact of fraud and abuse, how
the purpose of an individual health plan is determined, and the role of public policy in the
health plan industry. You will learn:

Assignment 1: Environmental Forces

Reading 1A: Environmental Forces

• Name and describe several major factors shaping the environment of health
plans
• Describe the players in health plan and how their interests affect the way they
influence the healthcare environment
• Explain the influences accreditation organizations and the media exert over the
financing and delivery of healthcare
• Describe several possible governance responses that health plans make to deal
with their changing environment

Assignment 2: Legal Organization of Health Plans

Reading 2A: Legal Organization of Health Plans

• Explain the distinguishing features of a corporation and a limited liability company

• Describe the key features and differences between a for-profit company and a
not-for-profit company
• Describe the differences between a publicly traded stock company and a
privately held stock company
• Describe the key features and differences between a stock company and a
mutual company

Assignment 3: Formation and Structure of health plans

Reading 3A: Corporate Restructuring and Corporate Transactions

• Describe the options available to mutual companies seeking access to capital,

strategic partnerships, and other corporate transactions
• Describe the issues that a not-for-profit entity must address when converting to
for-profit status or when engaging in other transactions with for-profit entities
• Explain how health plans use reorganization and reengineering to improve
performance
• Distinguish between strategic partnerships, joint ventures, acquisitions, and
mergers

Reading 3B: Health Plan Structures and Arrangements

• Identify and describe the various types of sponsors of health plans

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• Discuss the objectives of providers in health plan structures and arrangements

• Discuss the impact of changes in health plan structures and arrangements on
regulation
• Differentiate between horizontal, vertical, and conglomerate integration
• Differentiate between structural, virtual, and operational integration
• Explain how strategic, marketplace, and regulatory issues can shape health plan
structures and arrangements
• Describe various arrangements employers use to provide healthcare benefit
plans for their employees

Assignment 4: Overview of Laws and Regulations

Reading 4A: Perspective and Overview of State and Federal Laws

• Describe the sources of law in the United States

• Explain the significance of the HMO Act of 1973 in the development of managed
care
• Name the federal laws that stimulated health plan participation in Medicare and
Medicaid
• Describe the provisions of the Health Insurance Portability and Accountability Act
of 1996 (HIPAA) of major interest to health plans
• Describe the aspects of a health plan on which state regulations usually focus

Reading 4B: Regulatory Agencies and Health Plan

• Explain the role of HCFA in regulating healthcare

• Describe the role of the Department of Labor in regulating health plans
• Explain the methods states use to delegate regulatory authority for health plans
to state agencies

Assignment 5: State Regulation of Health Plans: Part I

Reading 5A: State HMO and Other Types of Health Plan Laws

• Describe the major provisions of the NAIC HMO Model Act

• Describe the types of state regulation that apply to PPO, URO, TPA, PSO, and
POS products
• Explain the need for the Risk-Based Capital for Health Organizations Model Act
and the risk-based capital formula

Reading 5B: State Mandates and Regulation of the MCO-Provider Relationship

• Describe the difference between a mandated benefit and a mandated provider

law
• Give examples and explain the purpose of several mandated benefit laws
• Describe the problems with applying any willing provider laws to certain types of
health plans
• Explain why state mandates often increase the cost of healthcare services
provided by health plans

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Assignment 6: State Regulation of Health Plans: Part II

Reading 6A: Other Laws That Apply to Health Plans

• Describe the various types of state laws, other than HMO and insurance laws,
that apply to health plan products
• Explain how states regulate agent licensing, marketing activities, and advertising
• Describe common types of general insurance laws that apply to health plans

Reading 6B: Workers' Compensation Programs

• Describe the kinds of benefits injured employees receive under workers'

compensation
• List several ways in which workers' compensation differs from other types of
healthcare coverage
• Describe how state laws can limit the use of health plan to provide workers'
compensation benefits
• Describe some of the common features of workers' compensation managed care
plans
• Describe the features of an integrated health and disability plan

Reading 6C: Pharmacy Laws and Legal Issues

• Describe the various types of open pharmacy laws

• Describe how states regulate mail-order/ mail service pharmacy programs
• Describe how states regulate use of formularies and generic substitution
• Explain the benefit exclusions for an experimental drug, an investigational drug,
and the off-label use of a drug
• Describe how the Nonprofit Institutions Act applies to prescription drug pricing
• Describe how states regulate an health plan's use of drug utilization review
programs

Reading 6D: Market Conduct Examinations and Mechanisms for Enforcement

• List the operations that a state insurance department reviews in conducting a

market conduct examination
• Describe the enforcement mechanisms available to states to address violations
of law

Assignment 7: Federal Regulation of Health Plans

Reading 7A: Federal Regulation of Health Plans

• Describe some of the operational and quality requirements that federally qualified
HMOs must meet
• Explain some of the administrative burdens that the Health Insurance Portability
and Accountability Act of 1996 (HIPAA) imposes on health plans
• Describe the general provisions of the Mental Health Parity Act of 1996 and the
Newborns' and Mothers' Health Protection Act of 1996

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• Explain several typical applications to health plan of the Americans with

Disabilities Act

Reading 7B: Antitrust Concerns and Health Plans

• Describe the three major federal laws that regulate business activities to prevent
antitrust actions
• Describe the difference between the per se rule and the rule of reason
• Explain the applications of antitrust law in health plan-provider contracting
• Explain the relevance of antitrust in mergers and acquisitions
• Identify the issues that the 1994 DOJ and FTC guidelines addressed
• Explain the procedures the DOJ and FTC follow for their enforcement
proceedings

Reading 7C: ERISA and Health Plans

• Describe ERISA's documentation, reporting, and disclosure requirements

• Describe the minimum standards of conduct (the fiduciary duties) applicable to
ERISA plan fiduciaries
• Describe the claims procedures required under ERISA and the standards of
review that courts apply in deciding disputed claims
• Describe how ERISA preemption has been applied by the courts to: utilization
review and credentialing decisions made by health plans; mistaken verification of
eligibility by an employer or health plan to a healthcare provider; entities that perform
administrative functions under an ASO contract; and provider networks that contract
to provide healthcare services to either health plans or self-funded employers on a
capitated basis

Assignment 8: Federal Government as Purchaser

Reading 8A: Federal Government as Purchaser: Overview, TRICARE, and FEHBP

• Explain the government's dual role as purchaser and regulator of healthcare

services
• Describe the evolution of the military health services system from CHAMPUS to
TRICARE, and describe TRICARE's triple benefit structure
• List the primary features of the Federal Employees Health Benefits Program
(FEHBP)
• Describe how actions taken by the Office of Personnel Management (OPM) have
a positive influence on FEHBP

Reading 8B: Medicare and health plan

• Describe the types of Medicare health plan contracts

• Explain the certification process for a Medicare PSO
• List the three ways that payment rates will be determined for health plans under
Medicare + Choice
• Explain how a Medicare Medical Savings Account works
• Describe health plan contracting standards under the Medicare + Choice
program

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• Provide examples of Medicare marketing restrictions

Reading 8C: Joint Federal-State Healthcare Programs

• Explain the roles of the federal and state governments in the operation of the
Medicaid program
• Describe the Medicaid services mandated by the federal government
• Describe effects of the Balanced Budget Act 1997on regulation and operation of
Medicaid managed care programs
• Name the types of managed care entities that can contract to provide Medicaid
services
• Explain the purpose of Section 1915(b) and Section 1115 waivers
• Explain how states can mandate Medicaid managed care without obtaining a
waiver
• Explain the role of Programs of All-Inclusive Care for the Elderly (PACE)
• Discuss the purpose and options for implementation of the State Children's
Health Insurance Program (SCHIP)

Assignment 9: Fraud and Abuse

Reading 9A: Fraud and Abuse

• Define the terms fraud and abuse

• Describe how different types of compensation arrangements can lead to different
kinds of fraud and abuse
• List and describe the federal laws that regulate healthcare fraud and abuse, and
identify the federal agency responsible for enforcing them
• Describe the penalties that may be imposed for violating the federal fraud and
abuse laws
• Discuss some of the steps health plans can take to reduce fraud and abuse

Assignment 10: Governance: Structure and Strategy

Reading 10A: The Components of Governance in a Health Plan

• Explain the purpose of governance in a health plan

• Describe the roles and responsibilities of the board of directors
• Explain how organizational variations affect board structure and operation
• List the three steps in a board risk management program
• Describe the roles of shareholders/members and providers in governance
• Discuss the roles and responsibilities of the CEO and other senior management

Reading 10B: Strategic Planning in Health Plans

• Define strategic planning

• Explain why strategic planning is important to a health plan
• Describe the four primary activities in strategic planning
• Explain the importance of input and ownership in strategic planning

Reading 10C: Key Strategic Issues for Health Plans

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• Identify and describe the key strategic issues faced by health plans
• Give examples of how key strategic issues are interrelated in the strategic
planning process

Assignment 11: Governance: Accountability and Leadership

Reading 11A: Governance: Accountability and Leadership

• Discuss accountability among the stakeholders in managed care

• Explain several implications of accountability on health plan leadership and
governance
• Describe the essential elements of an effective health plan compliance plan
• Define medical necessity and describe how health plans address related
governance issues
• Describe quality and ethics programs and ombudsman programs

Assignment 12: Key Legal Issues in Managed Care

Reading 12A: Key Legal Issues in Managed Care

• Define breach of contract, negligence, medical malpractice, and punitive

damages
• Discuss the obligations that health plans owe to plan members in conducting
utilization management activities
• Describe the standard of care health plans must meet when they credential plan
providers
• Discuss two theories of liability that may make health plans liable for the medical
malpractice of plan providers
• Describe how ERISA affects the ability of plan members to bring legal actions
against health plans
• Identify and describe some legal issues that may arise between health plans and
plan providers
• Discuss some of the federal and state laws that regulate the business conduct of
health plans

Assignment 13: Public Policy and Changing Environment

Reading 13A: Public Policy from the Health Plan Perspective

• Explain some of the ways that health plans influence public policy
• Identify primary interest groups in each of the major healthcare sectors that
participate in efforts to affect health plan public policy
• Describe several types of advocacy and political activities undertaken by interest
groups in the health plan policy debate
• Discuss the role of litigation in determining health plan public policy
• Describe several techniques interest groups use to affect public opinion

Reading 13B: Changing Environment and Emerging Trends in the Health Plan Industry

• Identify several key environmental factors that affect health plans

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• Describe the underlying tension between universal healthcare coverage and

comprehensive healthcare benefits
• Explain how marketplace reform and regulatory reform have brought about
change in the health plan industry

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Chapter 1 A : Environmental Forces

To operate their businesses, health plans must navigate through a complex
environment. "Major players move into new markets in a matter of days. Market
segments unheard of just a few years ago-such as physician practicemanagement- get
major infusions of Wall Street capital and become forces to reckon with overnight.
Changes in policy emphasis from Washington create new forms of competition, such as
Medicare and Medicaid health plans."¹

Today, health plans must focus on raising capital, addressing competition, and helping
to shape or respond to healthcare public policy. In addition, health plans must cope with
a rapidly changing market that is regional and national as well as local in nature.
Mergers, acquisitions, and business alliances among health plan players who were once
avid competitors further complicate the environment. The increase in government
mandates dictating the healthcare services that must be covered by health plans drives
up costs for health plans. And these are just a few of the environmental forces present in
the industry today.

After completing this lesson, you should be able to:

• Name and describe several major factors shaping the environment of

managed healthcare
• Describe the players in health plan and how their interests affect the way they
influence the healthcare environment
• Explain the influences accreditation organizations and the media exert over
the financing and delivery of healthcare
• Describe several possible governance responses that health plans make to
deal with their changing environment

The board of directors and senior management of health plans must develop plans to
operate their businesses within this constantly changing environment. Business
practices that worked well yesterday may not be sufficient today. Healthcare public
policy in the form of regulation often impacts and sometimes constricts a health plan's
business plan for its operations. For example, health plans must meet state minimum
capital requirements in establishing and maintaining their business. In this way, state
and federal regulation affects executive management decisions concerning virtually all
aspects of a health plan. In addition, business decisions made by health plans may
trigger the enactment of new regulations to address new forms of business or new
business practices.

Governance is the vehicle health plans use to make decisions about the overall direction
or purpose of a company. In this course, we will define governance as the efforts by the
health plan's board of directors or other governing body, in conjunction with senior
management, to develop corporate policy, to create a corporate mission statement and
vision, and to develop strategies in order to achieve the organization's goals and
mission. We will discuss corporate vision and mission statements later in this lesson.

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Because regulation and health plan governance decisions share an interdependent

relationship, this course combines the presentation of governance issues faced and
managed by health plans and the regulations with which health plans must comply.

The environments in which health plans operate can be described as external or internal
as discussed in Figure 1A-1. In this lesson, we will discuss the factors that influence the
external environment of health plans and the internal responses that health plans make
to changes in the environment. Because the health plans' internal responses are
covered later in this course, this lesson focuses largely on the external environment
affecting health plans.

The Evolving Health Plan Market

The factors that drive the rapid change and shape the environment in the health plan
industry include:

• Extent and level of regulation and legislation (e.g., healthcare reform bills)
• Status of the economy
• Pace and number of mergers and acquisitions
• Changing structure of the health plan market
• Changing demographics (e.g., aging population)
• Consumer expectations for availability of and demand for new and better
products and services
• Entrepreneurial and technological innovation (e.g., advances in medical
technology including devices, surgical procedures and new pharmaceuticals)
• Politics and election cycles
• Media coverage
• Litigation developments and trends
• Changing interests or needs of the various health plab players (i.e.,
consumers, competitors, purchasers, providers, payors, etc.) in the
marketplace

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All the factors in the preceding list affect a health plan's business decisions and many
impact decisions related to formation, organization, and governance of the health plan.
In the following sections and throughout this lesson, we will examine how these factors
exert influence in the health plan marketplace.

Extent and Level of Regulation and Legislation

The health plan market is unique compared to many other business markets because of
the extent to which healthcare is regulated in the United States. For example, few other
industries are required to submit quality assurance plans with their applications to
operate in a particular state. In addition, few other industries must comply with state and
federal requirements regarding the minimum services a company must offer to its
customers. Ensuring compliance with regulations requires an allocation of resources and
capital to functional areas that would not otherwise need those resources and capital,
from a purely business operations standpoint.

Political pressures greatly impact both the regulatory and the legislative processes. In
addition, regulation is often the result of legislation. In recent years, the number of health
plan bills in the state and federal legislatures has dramatically increased. Legislators
have responded to their constituents' healthcare coverage concerns by proposing both
benefit mandates for specific healthcare services (e.g., maternity length-of-stay
mandates) and comprehensive bills that address numerous concerns (e.g., network
adequacy, mental health parity, external review, etc.).

Health plans have a great interest in legislation because of the impact it has on their
businesses. Each new mandate and administrative rule or regulation for coverage adds
to the health plan's costs for delivering and financing healthcare. These increased costs
may make premium hikes a necessity or cause the health plan to discontinue its
coverage of some of the "extras" (e.g., vision care or prescription programs) that make
health plans attractive to purchasers and consumers.

Status of the Economy

The state of the economy has a tremendous impact on the formation and operations of
health plans. Factors that reflect the state of the economy include the rate of a nation's
growth, employment levels, interest rates, spending, production, prices, housing starts,
and the money supply.

For health plans, economic factors can influence:

1. The availability of capital for business start-ups or expansions

2. The demand for healthcare services, or the type or amount of those services
desired
3. The accessibility of healthcare coverage

For example, as the United States comes closer to having full employment, the overall
population has greater access to healthcare coverage since most coverage is provided
through employment relationships. However, an increase in the number of mandates or
economic downturns can have a negative effect on the amount of employer-sponsored

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healthcare coverage because employers may buy less healthcare coverage in a period
of increased costs or economic instability.

Inflation also plays a role in the health plan environment by influencing the prices of
healthcare services, supplies, and coverage.

During an inflationary period, consumers may have less purchasing power because the
prices of goods and services increase more quickly than income. Economic factors also
influence employers' willingness to purchase coverage for employees and the amount of
the premium that employers are willing to pay. If the economy is experiencing increased
inflation, consumers and purchasers may choose not to purchase healthcare coverage.
During periods of inflation, costs for health plans usually increase more rapidly than the
health plan can increase premiums for purchasers to balance the increased costs. The
resulting downturn in premium revenue may cause health plans to cut back on
employment and/or to reduce expenses by cutting back on employment and/or offering
fewer services.

Fast Definition

Economic environment includes all the elements affecting the production, distribution,
and consumption of goods and services. 2

Fast Definition

Inflation-a prolonged rise in the average level of prices in an economy

Review Question

In the paragraph below, a statement contains two pairs of terms enclosed in

parentheses. Determine which term in each pair correctly completes the statement.
Then select the answer choice containing the two terms that you have chosen.

Inflation plays a role in the health plan environment by influencing the prices of
healthcare services, supplies, and coverage. During an inflationary period, consumers
typically have (more / less) purchasing power because the prices of goods and services
increase (more / less) quickly than income.

more / more
more / less
less / more
less / less

Incorrect. Because inflation increases the costs of goods and services,

consumers do not have more purchasing power.

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Incorrect. Because inflation increases the costs of goods and services,

consumers do not have more purchasing power.

Correct. Inflation typically increases costs, and reduces consumer purchasing

power

Incorrect. In an inflationary period, consumers have less purchasing power

because inflation increases the costs of goods and services, and consumers do
not have more purchasing power.

Mergers and Acquisitions

Mergers and acquisitions occur in almost every industry as companies identify business
opportunities that will enhance their market position. In the last few years, however, the
health plan industry has experienced a large proportion of mergers and acquisitions that
have changed the landscape of the market. On one hand, some industry observers
express concern that if the pace of consolidations continues there will be a substantial
lessening of competition in the health plan industry. For example, when two health plans
merge, the result may be a lessening of competition in some of the affected national,
regional, state, or local markets for managed healthcare. In addition, a merger may give
the newly formed health plan more market power than each participant had individually
prior to the merger. Each phenomenon raises antitrust issues.

On the other hand, a merger may result in a health plan being able to realize operational
synergies, reduce administrative costs, and expand and develop a better quality provider
network. However, health plans typically consider mergers with care because integration
of two formerly separate businesses requires a substantial amount of financial and other
resources.

Changing Market Structure

The geographical area of the health plan market has changed from a mostly local market
structure to a structure that frequently requires local, regional, and national market
presence. Employers with operations in multiple locations in different states or regions
often want to negotiate and enter into agreements with only one health plan that will
handle the financing and delivery of healthcare in all the employer's business locations.
Although enrollment in health plans has surged over the last 10 years, the rate of growth
varies among different geographical markets, and the strategies that work in one market
do not necessarily work in others.

Market maturity also affects business decisions. Market maturity is a measure of the
growth or development of a market in terms of the number and types of players present,
the relationships among those players, the products available, and consumer
acceptance of the products. Market maturity can affect how receptive consumers and
providers are to health plan programs, the extent to which employer healthcare
purchasing coalitions are present, the types of products the market demands, and the
level of competition among health plans in an area. For example, a health plan that
operates in a large metropolitan area may have to offer additional services to compete
with other health plans in that market. A health plan that is the only health plan available
in a rural community might not face the same market challenges. It is not necessarily
easy to assess market maturity in managed healthcare markets. Certain aspects of a
market may be in more mature phases than other aspects of the market. For example,

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there may be several health plan competitors in a market but the provider networks for
one or more of those competitors may be in the initial stages of development. Health
plans, therefore, must constantly assess each of the aspects of the market separately
and make business decisions based on the level of maturity of each market aspect.

Changing Demographics

Baby boomers are aging, and as they age they will require more healthcare services. As
a significant portion of the American population becomes eligible for Medicare,
opportunities for health plans to tap into this demographic market will grow. Recent
federal legislation expanded the types of health plans that can contract to serve the
healthcare needs of the Medicare population.

The increase in the U.S. population of members of certain ethnic groups or races is
another demographic factor that presents challenges and opportunities for health plans.
For example, some health plans are pursuing marketing programs that are targeted to
reach non-English-speaking potential enrollees. Other health plans are creating disease
management programs directed to age-based ethnic groups with a high incidence of
certain diseases.

Several health plans offer open access plans that allow members to choose in-network
coverage for a small copayment or out-of-network coverage that is generally more
expensive. In general, such plans are targeted to economically prosperous baby
boomers. In addition, women's healthcare issues and special needs have been the focus
of some purchasers, and legislative initiatives such as maternity length-of-stay laws and
mandated direct access to obstetricians/gynecologists reflect this concern. Health plans
may need to reassess their product and service offerings in light of these demographic
and associated regulatory changes.

Consumer Demand
The expectations of today's consumers continue to grow- and consumers are clamoring
for new and better healthcare products and services. Among these demands are:

• Direct access to specialists

• Increased efforts to ensure the delivery of quality healthcare (e.g., By
obtaining more information about plans and their providers)
• Coverage for more and different types of treatment (e.g., Experimental
treatments, alternative medicine, etc.)
• Free and open exchange about healthcare treatment options between
physicians and other medical personnel and the consumer
• Grievance and appeals procedures for claim denials, and health plan liability
for "bad outcomes"
• Convenience in the delivery of healthcare

Consumer demand has a significant effect on healthcare legislation. It also has an

impact on health plan operations. For example, most health plans use primary care
providers (PCPs) to manage and coordinate care. PCPs also act as conduits to
specialists to coordinate patient care and manage healthcare costs by eliminating

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unnecessary visits to specialists. Allowing consumers direct access to specialists

requires some modification in a health plan's procedures.

For example, in a direct access plan, usually the primary care provider (PCP) is still
responsible for coordinating patient care and monitoring the patient's health. A health
plan may notify (or regulators may require that the plan notify) the PCP about care from
specialists received without the PCP's knowledge. This notification may increase costs
by adding to administrative procedures, and if state-mandated, may subject a plan to
monetary or other penalties for noncompliance

Entrepreneurial and Technological Innovation

Entrepreneurs can claim credit for many of the innovations that exist in health plans
today. By identifying a market need, and finding a way to address that need,
entrepreneurs have established new standard industry practices or developed
alternative methods for providing healthcare. For example, entrepreneurs created the
concept of physician-hospital organizations, physician practice management companies,
and firms that offer disease management programs. Entrepreneurs change the way
healthcare is financed and delivered by creating new ways of fulfilling needs and
providing services. One way that entrepreneurs affect health plans is through the
establishment of unique strategic business alliances. We discuss strategic partnerships
in Formation and Structure of Health Plans.

Technological innovation is thriving on several fronts. From a clinical standpoint,

advances in healthcare abound- from the application of gene research in treating
diseases to breakthroughs in the early detection and treatment of certain forms of
cancer. New medical devices and new drugs have been created to treat illness and
disease.

From an information management standpoint, change is also flourishing. For example,

efforts by health plans to involve physicians in managing health risks require a great deal
of information technology support. In addition, recently enacted federal legislation
requires the Department of Health and Human Services to develop national standards
for the electronic transmission of health data. Information technology plays a pivotal role
in the maturation of health plans. Health plans are spending money to apply the findings
of outcomes research and evidenced-based medicine. Health plans that do not invest in
information technology find themselves at a competitive disadvantage.

Entrepreneurs in health plans have also had an impact on marketing. For example,
pharmaceutical companies now market new drugs directly to the consumer through
television, magazines, and other forms of advertising.

Evidence based medicine the conscientious, explicit, and judicious use of current best
evidence in making decisions about the care of individual patients. 5

Politics and Election Cycles

Because our legislative representatives are elected every two years, healthcare is a
public policy issue raised every two years in connection with political election
campaigns. Although voters do not vote on the issues considered by legislatures, they
do elect the representatives who vote on such matters. The elected representatives
usually feel compelled to try to implement into law the wants and needs of their

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constituents. As evidenced by the Clinton administration's healthcare reform proposal of

1992 and various patient bills of rights currently under consideration in the House,
Senate, and state legislatures, healthcare is an issue of some concern to legislators and
the voting public.

Litigation Developments and Trends

In addition to legislative and regulatory activity, court activity and decisions also impact
health plans. For example, consumers are bringing lawsuits against health plans as well
as providers for treatment decisions that result in bad outcomes. Court rulings often
result in precedents being set that are followed in subsequent court decisions. We
discuss key legal issues that impact health plans in Key Legal Issues in Health Plans.

Changing Interests of the Players

The main players in health plans are the consumers (the end users of the health plan
products and services), the purchasers (employers, unions, purchasing coalitions, other
large groups, government programs, and individuals), the providers (physicians,
hospitals, and other healthcare professionals), and the payors (health plans, insurance
companies, and certain self-funded employer groups).

The players in helath plans have diverse and sometimes conflicting interests. For
example, the payors and purchasers want to manage costs and deliver quality
healthcare, while the end-user consumers are usually concerned with obtaining the best
medical care without focusing on the cost. Physicians often want unlimited authority to
make decisions concerning patient care, while health plans must maintain utilization
management and quality assurance systems. For example, physicians who refer health
plan members to an out-of-network provider without obtaining plan approval may
undermine the plan's credentialing and quality programs and hamper the health plan's
ability to manage costs. In the following sections, we discuss the interests of the major
players and how they influence health plans. We will also discuss other stakeholders in
the health plan marketplace, such as vendors, the community, and patient advocacy
groups.

Consumers
Americans see healthcare as a social good and expect it to be available to all
individuals, whenever it is needed and in whatever quantity it is needed. In this way,
healthcare differs from almost every other product or service. Other products and
services are generally available only to those consumers who are able to pay for them.
Consumer expectations for healthcare services place burdens and unique
responsibilities on the suppliers or providers of such services. They also necessitate the
involvement of public policy in setting standards for the provision of healthcare services
to populations that are unable to pay the market price or even make any contribution to
the payment for those services. We will discuss the impact of the uninsured and
underserved populations later in this lesson. Let's now consider the end users who are
consuming health plan products and services and explore their impact on the health
insurance plan environment.

Consumers want affordable, quality healthcare available-where they need it, when they
need it. The influence of consumers can be seen in the number of legislative bills
concerning healthcare. For example, many states are considering mandating external
review for health plan decisions regarding exclusions from coverage to ensure protection

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of members' interests. Consumers are taking a more active role in their personal health.
In the past, a consumer may have hesitated to question the diagnosis or treatment
prescribed by a provider, but today such interaction is much more common. Consumers
are voicing and demonstrating their desires that certain aspects of healthcare be
available to them. The demand for greater choice of providers has encouraged health
plans to develop direct access plans. The increased interest in alternative medicine has
led some health plans to offer coverage for "non-traditional" providers and treatments.

Today's commercial health plan consumers are better educated and have higher
disposable incomes and higher standards of living than their predecessors. Employers
and other purchasers that buy the healthcare for these consumers are more attuned to
the consumer's needs and desires. In a booming economy with unemployment at a low
level, offering a generous package of healthcare benefits may make the difference
between hiring the candidate of choice or a less qualified substitute.

Purchasers
Employers and other purchasing groups have exerted tremendous influence on the
products and services offered by health plans. Employer initiatives that are shaping
health plans include an increased focus on quality as well as cost, as evidenced by the
formation of organizations such as the Foundation for Accountability (FACCT). FACCT is
a coalition of purchasers (mostly large employers) and consumer organizations founded
to make an outcome-oriented assessment of health plans' treatment of medical
conditions or diseases. Largely as a result of employers' focus on quality, there has been
an increase in the number of health plans that seek accreditation from nationally
recognized accreditation organizations. To prove that employers' dollars are being well
spent, health plans have begun devoting more time and money to outcomes research
and other quality-ensuring initiatives. Additionally, employers' efforts to curb the costs of
healthcare coverage, such as the establishment of on-site clinics for employees and the
creation of wellness programs, have caused health plans to innovate and expand their
product and service offerings.

Providers
Since providers actually supply the healthcare services that health plans deliver to their
customers, they are a crucial component of a health plan. A health plan must employ or
recruit and contract with many different types of providers for the provision of healthcare
services to the health plan's members. Health plans that strive to develop a relationship
with providers based on the exchange of mutual expertise are likely to be more
successful than health plans that have a less flexible approach. Providers' concerns
about the continued growth of health plans usually center on compensation and
autonomy issues. Because some physicians have concerns about losing their decision-
making autonomy to health plans, a number of physicians have joined physician groups
or created alliances with other providers to establish their own health plans, such as
physician-hospital organizations or provider-sponsored organizations. These
organizations sometimes become competitors of established health plans or insurance
companies by contracting directly with a purchaser and bypassing the health plan
entirely. Alternatively, they may present a different type of entity with which a health plan
or insurance company must negotiate to obtain provider services in a market. Health
plans that maintain strong and positive locally based relationships with providers are
more likely to prosper in today's environment. For example, providers have the clinical
expertise and supporting clinical data that health plans need to demonstrate to

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purchasers their commitment to quality. In addition, providers usually have great

influence with their patients. When these patients are members of a health plan, their
satisfaction is of prime importance to that health plan.

Payors
Insurance companies that offer a full range of healthcare products, including indemnity
products, compete with health plans. These same insurance companies are health plans
if they offer health plan products such as health maintenance organizations (HMOs),
preferred provider organizations (PPOs), POS options, etc. In certain instances, an
insurance company may have a slight advantage in establishing certain types of
managed healthcare product offerings. For example, an insurance company that forms
an HMO and also has experience in the fee-for-service arena may have an easier time
beginning a PPO or offering a POS option than an HMO that is not affiliated with an
indemnity insurer, because the indemnity insurer has the experience and ability to
process out-of-network claims and more accurately determine premium rates. The HMO
can build or acquire these assets and capabilities, but may take more time and use
substantial financial resources to do so.

Other Stakeholders
In the preceding sections, we have discussed some of the main players in the managed
healthcare marketplace; however, these are not the only participants in this market. The
community in which a health plan operates, the uninsured or underserved populations,
vendors, academic medical centers, patient advocacy groups, and the federal and state
government are also stakeholders in the health plan marketplace. Each of these
stakeholders is discussed in the following sections.

The Community

Although the markets for health plans may be expanding to regional or national markets,
most health plans are initially established to serve a local community. In addition, the
articles of incorporation and the mission statements of not-for-profits, established for
charitable purposes, reflect their commitment to provide benefits to the community.
Some state laws require community representation on the board of directors for health
plans.

Certain not-for-profit organizations are required to serve their community by making

membership available to individuals and small employers; by making services available
to low-income, high-risk, medically underserved, and elderly populations; and by using
community rating to determine their premiums. Other ways that health plans serve their
communities include: teaming up with community public health organizations to provide
demand management and health promotion activities, joining forces with academic
medical centers to perform education and research, and sponsoring community health
projects such as childhood immunization initiatives and health fairs. For example, some
health plans are partnering with community public health agencies to educate health
plan enrollees about the dangers of substance abuse or obesity. Since community public
health agencies often are already doing some of the promotion activities that a health
plan wishes to provide, a partnership between these two entities makes sense. In some
situations, the promotional activities of the public health agency are tailored for the

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health plan enrollee population; in others, the promotion is aimed at the geographic
population (which includes health plan enrollees) at large.

Health plans that are active participants in their local communities can gain many
benefits. From a public relations perspective, providing additional or tailored services to
meet needs in the local community can reap great rewards from increased enrollment in
plans to availability of funding sources for expansions. Additionally, individuals, the
community, and health plans all reap rewards when health plans participate in activities
to improve the health of their members.

Uninsured and Underserved Populations

The uninsured population in the United States is a significant social policy concern.
Federal and state governments often implement plans to extend insurance coverage or
health plan enrollment as an option for these populations. As we will discuss later in this
course, major reform initiatives to guarantee insurance for all citizens have not been
successful.

The uninsured population has a tremendous impact on the cost of healthcare services in
this country. Emergency-room treatment of conditions that would be better served by a
primary care provider costs a great deal. Costs of the uninsured cannot always be
expressed in monetary terms. For example, no amount of money can compensate the
parent of a child who dies after contracting a disease that could have been prevented by
an immunization. The basic tenets of health plan education and preventive services- are
a natural fit for this population; however, finding the public funding to finance such
endeavors is a challenge.

Recently enacted legislation (i.e., the Health Insurance Portability and Accountability Act
of 1996), which was intended to make great strides in guaranteeing access to health
insurance for some members of the uninsured population, does not seem to be
achieving that goal because the cost of coverage is being passed on to individuals. For
example, a recently released General Accounting Office report noted that individuals in
some states are paying premium rates 140% to 600% higher than standard premiums
for individual healthcare products. 6

Additional legislation to address this issue at either the state or federal level (or both) is
likely. Such legislation can sometimes increase a health plan's costs of providing
coverage to members. Health plans that remain active in this public policy debate may
be able to suggest solutions that benefit all the participants in this dilemma.

The underserved population in both rural and urban areas presents a somewhat different
problem than the uninsured population. Low-income residents in outlying rural
communities often suffer from lack of access to healthcare. There may be no hospital
and may be only one physician or other healthcare professional that visits such
communities once a week as part of a government outreach program. Sometimes, a
health plan or insurance company refrains from entering a rural market because there
are not enough potential members to make the market a viable business undertaking.
Additionally, health plans that desire to enter rural markets may meet resistance from the
local physicians or hospitals in those communities. Addressing the needs of underserved
markets is not an easy task, yet some health plan innovators have developed methods
of serving at least some of the underserved populations in rural areas. One health plan

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builds networks for medium-to-large employers with operations in rural areas across
broad geographic regions that allow the health plan to have a large enough potential
enrollee market to make the venture worthwhile. Although such a solution does not
address the communities where no healthcare facilities are available, it is a step toward
making health plans more accessible to a larger portion of the population. In addition, a
number of PPOs operate in rural markets.

In metropolitan or urban areas, meeting the needs of the underserved population is also
a challenge. For example, many urban Medicaid programs must address transportation
issues, lack of providers willing to serve this population, and long waits for care. Finding
ways to meet the needs of the uninsured and underserved populations is a responsibility
that health plans share with others in the healthcare industry and our country in general.

Vendors
Vendors, such as organizations that provide billing or other administrative services, can
play a significant role in the healthcare market. Companies that produce software for
contract or claims management or premium billing are essential to the operation of a
health plan. In addition, vendors may provide or manage clinical services such as
radiology, and disease management programs targeted to specific diseases such as
diabetes. Vendors may also arrange for and administer the provision of carve-out
healthcare services such as behavioral healthcare, radiology, chiropractic, oncology, etc.
In fact, some health plans have outsourced to vendors their entire information
technology function. A vendor often has expertise in a particular area that the health plan
has not developed or for which the cost of developing such expertise is not practical. In
the managed healthcare industry, there is increasing use of vendors to provide services
that are not cost-effective for the health plan to provide. For example, one health plan
has outsourced to a vendor its call center for customer service. As another example, an
HMO with little expertise in claim processing for a point-of-service product might
outsource this activity to a vendor.

As vendors become even more prevalent, they may impact the health plan market in
new ways. For example, there are increasing numbers of software firms that want to
meet the information needs of all stakeholders in the managed healthcare market.
Employers that self-fund their plans already use vendors to perform many functions that
are not cost-effective for the employer to undertake. Often the "vendor" to an employer is
a health plan; however, as more enterprising firms create market niches for their
services some health plans may lose some of their vendor contracts with employers. For
example, pharmacy benefit managers (PBMs) act as vendors to employers for
pharmaceutical products and services.

Academic Medical Centers

Another stakeholder in the health plan industry is the academic medical center.
Academic medical centers (AMCs), also known as academic health centers, are
healthcare institutions that offer physician residency programs and include medical
schools and other professional healthcare schools such as nursing and dental programs.
These institutions train healthcare professionals and perform various clinical and other
types of healthcare-related research. Teaching hospitals are usually part of an AMC.
Teaching hospitals are institutions that offer physician residency programs. In the past,
academic medical centers have had concerns about the growth of health plans. Some of
the reasons for this concern are as follows:

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• Often the physician billing practices of AMCs may not mesh with health plan
payment structures
• Lack of primary care providers on the staffs of AMCs (usually staffed by
specialists) may make such institutions unlikely candidates for health plan
approaches

At most teaching hospitals, the physician who supervises the resident bills for his or her
services, although it is the resident who provides all or some of the services. In addition,
the fee-for-service side of Medicare has largely subsidized AMCs. The proliferation of
Medicare health plans may eliminate some of that funding for AMCs. Also, policymakers
and legislators are reviewing many aspects of Medicare, including the fee-for-service
aspects, and have curbed some of the additional funds that were previously funneled
into AMCs.

The environmental pressures that have caused dramatic change in the health plan
industry are also impacting AMCs. Some AMCs have merged with other teaching
institutions or have entered into relationships with other hospital systems. Other AMCs
are beginning to enter into formal relationships with health plans. AMCs are purchasing
physician practices to gain access to patients, contracting with non-teaching hospitals to
become participants in Integrated Delivery Systems (IDS), or entering into partnerships
as providers with HMOs. Some AMCs are even becoming owners/investors in health
plans. AMCs can bring unique capabilities and resources to a health plan relationship.
Their expertise in education and research is a valuable tool in an era when the health
plan market focuses on information. Medical outcomes research and evidence-based
medicine are two areas in which AMCs may be able to help health plans.

Review Question

The Sawgrass Health Center is an institution that trains healthcare professionals and
performs various clinical and other types of healthcare-related research. Because
Sawgrass receives government funding, it is required to provide medical care for the
poor. Of the following types of health plans, Sawgrass can best be described as:

a medical foundation
an academic medical center (AMC)
a healthcare cooperative
a community health center (CHC)

Incorrect. A medical foundation is an entity that owns and manages all purchased
assets of physician practices, you will read more about this arrangement in the
lesson Health Plan Structure and Arrangements.

Correct. An academic medical center is an institution that trains healthcare

professionals, performs clinical and other types of healthcare-related research
and is required to provide medical care for the poor.

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Incorrect. A healthcare cooperative is a consumer-sponsored, physician-operated

medical facility that provides prepaid healthcare to members. You will read more
about this arrangement in the lesson Health Plan Structure and Arrangements.

Incorrect. A community health center is a medical facility that recieves federal,

state and private grant funding to provide primary care for medically underserved
populations. You will read more about this arrangement in the lesson Health Plan
Structure and Arrangements.

Patient Advocacy Groups

Patient Advocacy groups are consumer organizations that may provide patient
education, coordinate the delivery of or provide care, and/or represent the general
political interests of patients or those with certain illnesses. In addition, patient advocacy
groups often pursue legislation designed to further the interests of the patients in the
group (e.g., mandated coverage of benefits for experimental cancer drugs).

In the past, health plans' relationships with patient advocacy groups have sometimes
been adversarial. Health plans often only interacted with a patient advocacy group when
the health plan denied coverage for a treatment needed by a member the advocacy
group represented. Today, some health plans are partnering with patient advocacy
groups to provide certain aspects care. Some patient advocacy groups provide
psychosocial or holistic care in partnership with a health plan. A health plan may benefit
from such a partnership in several ways, including establishing a better reputation
among patients and actually lowering the long term cost of certain treatments by
providing care that more closely monitors and treats a patient's condition and over all
health.

Federal and State Governments

As we will describe throughout this course, federal and state governments exert
tremendous influence over a health plan's formation, operations, and governance. These
governments are stakeholders in the managed healthcare industry in two important
ways. First, such governments enact and enforce laws to protect and preserve the
public's interests.

The second way in which governments act as stakeholders is through their roles as
purchasers of healthcare services for government employees and government-
sponsored healthcare programs. From this perspective, their needs and concerns more
closely parallel those of purchasers described earlier. Governments, through their dual
roles as purchasers and regulators, affect the types of laws or regulations enacted or the
standards to compete in the marketplace. We will discuss governments' roles as
purchasers in more detail in Federal Government as Purchaser.

Review Question

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Regulatory and legislative bodies are among the important environmental forces in the
health plan industry. The following statements are about such regulation and legislation.
Select the answer choice that contains the correct statement.

Federal guidelines exist to direct health plans on compliance issues when a health
plan encounters conflicting state laws in a given service area.
Administrative rules and regulations do not carry the force of law.
As stakeholders in the health plan industry, federal and state governments exert
tremendous influence over a health plan's formation and operations.
In recent years, the number of health plan bills in the state and the federal
legislatures has decreased.

Incorrect. Healtrh plans often have to comply with multiple state laws while trying
to meet the needs of a single market.

Incorrect. Administrative rules and regulations, prescribed by a federal or state

administrative agency, carry the force of law.

Correct. Federal and state governments exert tremendous influence over health
plans' formation, operations and governance

Incorrect. In recent years the number of health plan bills in the state and federal
legislatures has increased.

Other Environmental Forces

In addition to the direct environmental forces that impact the market that we have just
discussed, other forces also shape health plans. Governments' roles as purchasers,
conflicting state and federal regulations, the increasing use of accreditation, and the
media all have an impact on health plans and their operations. We briefly discuss each
of these below.

1. Governments
2. Accreditation
3. The Media

We mentioned earlier that governments' dual roles as purchasers and regulators

sometimes affect the laws or regulations that impact managed healthcare. The dual roles
of governments sometimes affect the market in ways not necessarily intended. For
example, if the federal agency responsible for purchasing healthcare for federal
employees sets a standard that potential contractors must meet to be eligible for
consideration as a health plan for those employees, other purchasers in the industry may
demand a similar minimum threshold for the health plans with which they contract.

Governments also affect the managed healthcare regulatory environment in other

unintended ways. A health plan that serves a multistate community such as Memphis,

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Tennessee (portions of the Memphis metropolitan area are also in the states of
Mississippi and Arkansas), may be subject to several sets of state laws that sometimes
conflict. Offering the same product in the entire metropolitan area may become a
regulatory challenge since there are no guidelines for a health plan to follow to comply
with conflicting state laws in a service area. The health plan and its legal counsel must
comply with the laws of multiple states while trying to meet the needs of a single market.
In addition, there can be conflicts between state and federal laws. For example, a health
plan may have to meet a minimum federal standard for the provision of some aspect of
healthcare services, such as mental health in accordance with the federal Mental Health
Parity Act that we will discuss in Federal Regulation of Health Plans, and meet
additional requirements of a state that has regulations affecting the coverage for mental
health services.

Complying with regulations requires an allocation of time and money from a health plan.
The more complicated or burdensome the laws and regulations become, the more time
and resources are required to comply with such laws and regulations. Eventually, these
increased costs to the health plan are passed on to the purchaser in the form of increased
premiums.

Increased demands by purchasers and consumers for accountability in managed

healthcare have spurred growth of a competitive industry for accrediting health plans, the
health plans they sponsor, and the separate providers of specialized care within health
plans. Accreditation programs develop standards for health plan performance; conduct
reviews of the organization, its policies, and procedures; and gather data to determine the
extent to which the organizations meet the standards. Most accreditation programs were
initially developed by the providers in the industry they accredit in response to pressure
for accountability and the need for an independent third-party review. The major
accrediting programs for healthcare are now sponsored by independent not-for-profit
entities. These entities are governed by boards of directors with a broad representation of
providers, insurers, purchasers (private and public), and consumers to help ensure
independence, credibility, and responsiveness to the needs of major stakeholders.
Accrediting programs confer an accreditation status following their review but generally
do not attempt to establish rankings that directly compare health plans, their health plans,
or parts of their plans.
7

Many employers will not consider entering into a contract with a health plan that has not
been accredited by a nationally recognized accreditation program. In addition, some state
governments are requiring health plans to obtain accreditation from a nationally
recognized accreditation organization as a condition of licensure in a state. Other states
may not require accreditation for licensure but allow accreditation to suffice in place of a
mandatory external review for quality.

Today, it is hard to pick up any newspaper or magazine or to tune into network television
and not see managed healthcare mentioned. All too often, the articles are not positive.
The media has significant influence on public opinion in the choice of topics that it covers
and the manner in which the stories are covered. Since public opinion can have an
impact on a health plan's business, health plans must consider media coverage as a

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factor in their environment. Insight 1A-3 provides a brief overview of health plan's
relationship with the media.

Insight 1A-3. Does the media fuel health plan backlash?

A new survey on media coverage of health plan by the Kaiser Family Foundation points
to a significant increase in coverage of health plan issues over the past decade, much of it
critical of health plans. The study, which was published in the January/February 1998
issue of Health Affairs, finds that most, two-thirds, of 2,100 news stories that have
appeared in newspapers, business publications, and on network television since 1990 are
largely neutral in their coverage of health plan. A quarter were critical, whereas 11%
praised the system.

However, the more highly visible stories on network TV and in special newspaper series
have been much more negative, particularly in the last four years. Coverage involving
health plan in the early 1990s tended to emphasize the benefits of this emerging system
and its potential to reduce high healthcare costs. During the health reform debate of 1993
to 1994, health plan was the "savior," recalled reporter Susan Dentzer at a Kaiser forum
on media coverage of health plan. Competing health plans were going to improve quality
and lower costs.

More recently the media has highlighted patient "horror stories" and "high-drama"
anecdotes, particularly on TV and in newspaper series. Journalists acknowledge a "herd
instinct" among reporters in covering such issues as "drive-through deliveries" and gag
clauses. And some have found that editors are interested only in stories with health plan
victims and villains. To gain more balance, reporters cited a need for better data and hard
information on costs, enrollment, and benefits.

Health Plan Responses to Environmental Forces

We've discussed many of the external environmental forces at work in the health plan
industry and stated that health plans must make business decisions taking these factors
and forces into account. Now we'll briefly mention some ways health plans are
responding to the various forces in the health plan environment.

In our earlier discussion of the market for health plans, we touched upon many of the
ways health plans respond to changes in their environment or the market, such as
forming strategic business alliances and participating in mergers or acquisitions. To
ensure their survival in the rapidly changing health plan environment, health plans are
assessing their strategic options by reviewing their organizational structure, their
corporate values and mission, their product portfolio and development process, their
strategies to remain or become competitive in a particular market, and the way they
respond to consumers' demands.

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Most companies develop a corporate vision and a mission statement. Health plans are
no exception.

A mission statement is a statement that succinctly sums up the organization's reason

for existence and overall purpose. What is changing with health plans is the focus of
their corporate vision and mission statements. In the past, health plan mission
statements may have mentioned the customer, but meeting the customer's needs was
usually not the focus. Health plans now develop mission statements that center on
defining and meeting in an ethical and cost-effective manner the needs of the customer
and/or the community. To realize this overall goal of addressing the customer's needs,
health plans develop strategic plans. Strategic planning is the process of identifying a
company's long-term objectives. Companies use corporate strategies to achieve their
plans.

Changes in the environment of a health plan sometimes necessitate governance moves

that are not in the normal course of business. Occasionally, a change in a health plan's
environment makes it necessary for the health plan to restructure or reorganize its
business operations to remain competitive, become more competitive, or enter new
markets. A corporate reorganization or restructuring is the process of adjusting the
internal structure of an organization by changing reporting relationships; adding,
eliminating or changing the responsibilities of functional departments; moving from a
centralized to a decentralized business structure (or vice versa); or creating a new
subsidiary or holding company. For example, an insurance company that enters the
health plan arena may create a subsidiary HMO. Or, an existing health plan may change
the functional duties of departments or reporting relationships within its organization to
streamline its responses to customer needs or to reduce administrative expenses.

Fast Definition
Corporate vision an overall view of what the organization should achieve by its existence.

Fast Definition
Corporate strategies the methods a company plans to use to achieve its long-term
objectives.

Other ways that health plans respond to change include leadership changes, converting
from a not-for-profit or mutual organization to a for-profit organization, going public,
selling portions of their businesses, acquiring new or existing companies, entering new
business ventures, getting out of existing business ventures, or making major changes in
plan or product offerings. We will discuss each of these responses later in this course.
However, let's now consider an example of one of these environmental responses. See
Figure 1A-2.

As you can see, a health plan has many internal governance tools it can use to respond
to changes in its external environment. Throughout the remainder of this course, we will
discuss the legal and regulatory factors in the health plan environment, as well as the
governance planning and responses that allow health plans to thrive in the dynamic
environment of health plans today.

Figure 1A-2. An example of one health plan's response to its environment.

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After reviewing demographic characteristics and regulatory factors, the Livwel

Company, a health plan, identifies a new business opportunity in the Medicare market.
This health plan has ready capital, but no expertise in serving this market. The Livwel
Company decides to enter into a business venture with another health plan, called
Firstline, that has expertise in serving the Medicare market. This type of joint business
venture benefits Firstline by providing a ready source of capital, while the Livwel
Company gains expertise in serving this new type of market.

Chapter 2 A : Legal Organization of Health Plans

Because of the rapid pace of change in the health plan industry and the need to
constantly reassess strategic plans, determining a health plan's legal form is one of the
fundamental issues that must be addressed by the company's leaders. In this lesson, we
begin with an overview of the basic forms of legal organization available to health plans,
with a focus on corporations, the predominant form. We then examine the for-profit
health plan, the not-for-profit health plan, and the mutual insurance company. In this
discussion, we examine issues such as legal and formal requirements, owners' liability,
tax treatment, long-term stability, allocation of profits, and options for raising operating
funds.

After completing this lesson, you should be able to:

 Explain the distinguishing features of a corporation and a limited liability company

 Describe the key features and differences between a for-profit company and a not-
for-profit company
 Describe the differences between a publicly traded stock company and a privately
held stock company
 Describe the key features and differences between a stock company and a mutual
company

Basic Forms of Legal Organization

In the United States today, business entities can be established in any one of a number
of legal forms. For instance, most health plans are corporations, and many healthcare
providers and other vendors with whom health plans do business are sole
proprietorships, partnerships, or professional corporations. Figure 2A-1 provides an
overview of several forms of legal organization.

Corporations
Health plans are typically established as corporations. This legal form affords owners,
directors, and executives the greatest protection from individual liability. Also, in the case
of for-profit health plans, the corporation is the legal form that provides the greatest
flexibility for raising operating funds. In some states, an entity responsible for financing
healthcare, such as an insurance company, is required by law to be organized as a
corporation. In many states, however, a health plan, such as an HMO, is not required to
be a corporation; it can, for instance, be a limited liability company. Also, as we will see
later in this lesson, federal law now allows certain types of provider-owned
organizations, which are not all corporations, to operate as health plans in the Medicare
and Medicaid markets.

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Figure 2A-1. Sole Proprietorships, Partnerships, and Corporations.

Sole Proprietorships

A sole proprietorship is a business owned by one person. All the debts of the business
are the debts of the owner. Business profits or losses are treated as individual income
for tax purposes. Although the sole proprietor can leave the assets and liabilities of the
business to someone else, continuing the operation of a sole proprietorship after the
owner's death is often difficult.

Partnerships

A partnership is a business that has many of the same legal characteristics of a sole
proprietorship but is owned by two or more persons. The partners can be individuals or
legal entities, such as corporations. A partnership can be established by oral agreement
or through a formal partnership agreement. All states have laws that spell out the
requirements for establishing a partnership. A partnership can take any one of the
following legal forms.

A general partnership is owned by two or more general partners who share

responsibility for business operations. General partners, when they are individuals, are
responsible for the debts of the whole business and declare the appropriate share of
their partnership income or losses on their individual tax returns. The partnership itself
does not pay federal income tax, although it is required to file a return for information
purposes. A general partnership ends with the death or withdrawal of any general
partner; the remaining partners must form a new partnership if they want to continue the
business.

Partners can limit the liability of certain owner-investors by forming a limited partnership.
A limited partnership consists of limited partners and at least one general partner.
Limited partners, who cannot participate in the day-to-day management of the
organization, are at personal financial risk only for the amount of their investment in the
business. The general partners, on the other hand, have full liability, similar to the liability
of sole proprietors. Typically, limited partners can enter into and opt out of a limited
partnership with much greater freedom than can general partners, which is an
advantage for raising operating funds because the partnership can more easily attract
limited partners if it needs additional investors.

When the partners in a limited partnership are individuals, the profits and losses of the
business are treated as individual income, and the partners each declare the appropriate
share of their partnership income on their individual tax returns. The partnership itself
does not pay federal or state income tax. However, if the structure of the limited
partnership includes more corporate than partnership characteristics, it may be taxed as
a corporation.

Generally, a limited partnership continues upon the death or withdrawal of a limited

partner, but it ends with the death or withdrawal of a general partner. However, the
partnership agreement can place restrictions on a limited partner's right to withdraw, or
can allow for the partnership to continue beyond the withdrawal of a general partner.

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Another type of partnership, permitted by enabling statutes in some states, is the

registered limited liability partnership (LLP). A registered limited liability partnership
agreement eliminates a partner's personal liability for debts and obligations that result
from acts committed by another partner or a representative of the partnership while
conducting partnership business. A registered limited liability partnership is similar to a
general partnership in most other respects.

Corporations

A corporation, as defined in 1819 by U.S. Supreme Court Chief Justice John Marshall,
is "an artificial being, invisible, intangible, and existing only in contemplation of the law."

The owners, directors, and officers of a corporation, unlike the owners of a sole
proprietorship or a general partnership, are not individually liable for the debts of the
organization. Unlike sole proprietorships and partnerships, many corporations are taxed
twice. First, the corporation pays a corporate tax before it distributes earnings to its
owner-investors. Then the owner-investors pay individual income tax on the distributed
earnings. However, not all corporations are subject to this double-taxation. For example,
some smaller businesses can organize as a subchapter S corporation, which is not
subject to corporate taxes. To qualify as a subchapter S corporation, an entity must
file a formal election with the Internal Revenue Service (IRS) and must meet other
criteria, including requirements limiting the number of stockholders.

A corporation continues beyond the death of any or all of its owners. For example, the
individual investors in a for-profit corporation may change continually, but the entity itself
remains intact.

Review Question

The Surrey Medical Supply Company was formed as a limited partnership. In this
partnership, Victoria Lewin is one of the limited partners and Oscar Gould is a general
partner. This information indicates that, with respect to the typical characteristics of
limited partnerships,

Ms. Lewin has more freedom to opt out of the partnership than does Mr. Gould
Ms. Lewin has more liability for the debts of Surrey than does Mr. Gould
both Ms. Lewin and Mr. Gould participate in the day-to-day management of Surrey
the partnership will continue upon the death of Mr. Gould, whereas it will end with
the death of Ms. Lewin

Correct! In a limited partnership the limited partner can enter into and opt out of
the limited partnership with much greater freedom than the general partner.

Incorrect. In a limited partnership, the general partner has full liability, where the
limited partner is only at personal financial risk for the amount of their investment.

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Incorrect. In a limited partnership, the limited partner, Ms. Lewin, cannot

participate in the day-to-day management of the organization.

Incorrect. In a limited partnership, the partnership ends with the death of the
general partner

Legal Requirements and Governance

In each state, the authority to incorporate businesses is delegated to an administrative
agency, typically the Office of the Secretary of State. The exact requirements for
incorporating a business vary by state. The usual procedure is to submit proposed
articles of incorporation along with the required filing fee. The articles of incorporation
describe the essential features of the corporation, including its purpose, its name, the
location of its principal place of business, the type of business in which it will engage, the
names of the members of its initial board of directors, and whether it will be for-profit or
not-for-profit. The articles of incorporation usually describe in a limited way the proposed
governance structure of the company. For example, the articles might indicate that the
board of directors will be comprised of three or more members. Typically, more detailed
governance provisions are included in the corporate bylaws, which are required by state
law but do not have to be filed.

In most states, once all statutory incorporation requirements are met, the appropriate
state agency approves and maintains a record of the document that was submitted by
the company. This document grants the corporation its legal existence and right to
operate. In some states, the approved document is called a certificate of
incorporation; in other states and federally it is called a corporate charter.

Each state has laws regarding the governance of corporations. These laws generally
apply to all corporations, but additional provisions often apply to special types of
organizations, such as health plans. For example, laws might specify how health plans
can raise operating funds and invest their assets. Laws often stipulate that in order to
make certain changes in a corporation's structure, the individuals responsible for
governing the organization must comply with specific state requirements and must
obtain approval from the Secretary of State or the Attorney General. In most
circumstances, the approval of other state agencies is also required. For instance, laws
typically require HMOs, as well as corporations and mutual organizations that conduct
the business of insurance, to obtain Insurance Department approval.

A corporation's board of directors is composed of individuals- called directors- who

serve as the primary governing body of a corporation. Historically, directors of not-for-
profit corporations were called trustees, and their actions were governed by trust law.
Today, both not-for-profit and not-for-profit organizations are governed by corporate law,
but the term trustee is still sometimes used to refer to directors of not-for-profit
organizations.

Some laws require a health plan to be governed by at least a minimum number of board
members to help ensure a broad governance perspective. Others dictate that a specific
number of board members must reside in the state in which the health plan is
incorporated to increase the likelihood that the interests of state residents will be
represented. Others stipulate that the number of board members from the healthcare
industry must be limited to less than 50% to help ensure that interests other than those

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of providers will be represented. For similar reasons, some states require that
consumers make up a specified percentage of board members.

Typically, a health plan incorporates only once, in a state of its choosing. It is then said
to be domiciled in that state. Later, the company may file applications with other states to
do business in those states. In most cases, the health plan does not incorporate in those
states, although it is usually subject to applicable laws and regulations and is licensed in
those states. From the point of view of any state, a domestic corporation is one that is
incorporated under the laws of that state; a foreign corporation is one that is
incorporated under the laws of another state; and an alien corporation is one that is
incorporated under the laws of another country. For example, assume a health plan is
incorporated in New Jersey and does business in New Jersey and Georgia. From New
Jersey's point of view, this is a domestic corporation; from Georgia's point of view, it is a
foreign corporation. A company incorporated in Canada that does business in New
Jersey and Georgia is, from the point of view of both New Jersey and Georgia, an alien
corporation.

Review Question

The Tidewater Life and Health Insurance Company is owned by its policy owners, who
are entitled to certain rights as owners of the company, and it issues both participating
and nonparticipating insurance policies. Tidewater is considering converting to the type
of company that is owned by individuals who purchase shares of the company's stock.
Tidewater is incorporated under the laws of Illinois, but it conducts business in the
Canadian provinces of Ontario and Manitoba.

With regard to the state in which Tidewater is domiciled, it is correct to say that, from the
perspective of both Ontario and Manitoba, Tidewater is considered to be the type of
corporation known as:

a foreign corporation
an alien corporation
a sister corporation
a domestic corporation

Incorrect. A foreign corporation is incorporated under the laws of another state.

Correct. An alien corporation is one that is incorporated under the laws of another
country.

Incorrect. Sister corporations are two corporations having common or

substantially common ownership by the shareholders.

Incorrect. A domestic corporation is one that is incorporated under the laws of

that state.

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In some states, such as California and New York, all HMOs must be domestic
corporations. Therefore, an HMO that is domiciled in another state but wants to do
business in one of these states must incorporate a separate subsidiary in the applicable
state. Once established, this company can, at its discretion, also file for a license to do
business in other states. To illustrate, an HMO domiciled in Pennsylvania that wants to
do business in New York must incorporate a subsidiary in New York. If this same HMO
also wants to do business in Ohio, either the Pennsylvania company or the New York
company can file for a license to do business in Ohio as a foreign company.

Some states provide favorable tax treatment to domestic corporations. A health plan that
does business in one of these states as a foreign corporation may wish to voluntarily
incorporate a subsidiary as a domestic corporation to obtain the tax advantages.

When a health plan incorporates, it becomes subject to (1) its state of domicile's
applicable laws and regulations and (2) the jurisdiction of its state of domicile's courts.
State laws seek to ensure that domestic corporations are subject to the authority of the
courts by requiring the health plan to register the name and address of an individual the
corporation has appointed as its registered agent for purposes of service of process.
Service of process is the act of delivering to a party written notice that a lawsuit or other
legal action has been filed against that party. Foreign corporations may also be subject
to the jurisdiction of the courts of the states in which they do business.

Limited Liability of Owners

A corporation- apart from its owners, directors, or officers- can be considered a "person"
under the law and can be a party in a legal action. It can sue and be sued. Any legal
actions involving a corporation, however, affect only the assets and liabilities of the
corporation. If a corporation goes bankrupt, the organization's creditors must be satisfied
with the assets of the corporation only. The creditors cannot legally require the owners,
directors, or officers of the corporation to pay the organization's debt out of their own
individual property. This feature of limited liability is important to potential owners,
directors, or officers, especially if a company has to incur large debts in the course of
doing business.

On rare occasions, however, individuals can be held liable for the debts of the
corporation. A court that makes such a determination is said to be piercing the
corporate veil. Generally, this can happen if the owners, directors, or officers exhibit so
much control over the operations of the organization that a court finds it difficult to
distinguish between the interests and activities of the company and the interests and
activities of the individuals involved. In such cases, these individuals typically display a
blatant disregard for corporate formalities and largely ignore the corporate structure in
carrying out the business of the corporation. For example, these individuals may never
conduct board of director meetings or they may fail to maintain separate bank accounts,
expense records, and tax returns for the corporation. Insight 2A-1 reviews a court case
in which a plaintiff attempted to pierce the corporate veil of a pharmacy plan
administrator.

Insight 2A-1. Piercing the Corporate Veil.

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The United States Court of Appeals for the Second Circuit reversed a district court
decision and held that a pharmacy chain may not have been entitled to pierce a pharmacy
plan administrator's corporate veil in an attempt to recoup unpaid prescription claims.

The defendant in this case was a pharmacy plan administrator who entered into
agreements with "panel pharmacies" such as the plaintiff. Under these agreements,
eligible beneficiaries of ERISA welfare plans would have their prescriptions filled at
panel pharmacies. The panel pharmacies would accept only a small copayment from
beneficiaries, and would then submit the prescription claims to the pharmacy plan
administrator for reimbursement.

As a result of cash flow problems (due in part to loans to the sole stockholder of the
pharmacy plan administrator to pay personal expenses), the plan administrator failed to
reimburse one panel pharmacy for a number of prescriptions. The panel pharmacy sued
the plan administrator.

A district court ruled in favor of the panel pharmacy and determined that the pharmacy
plan administrator was liable to the panel pharmacy. After a subsequent bench trial, the
district court ordered that, under state law, the panel pharmacy could pierce the plan
administrator's corporate veil to recover its judgment from the assets of the
administrator's sole director and stockholder. In determining that the panel pharmacy
could pierce the corporate veil, the district court stated that "where the corporation in fact
is run by one person regardless of any corporate form, that person has to be responsible
for whatever debt the corporations have."

On appeal, the Second Circuit observed that in order to pierce the corporate veil: (1) the
owner must have exercised complete domination over the corporation with respect to the
transaction at issue; and (2) such domination was used to commit a fraud or wrong that
injured the party seeking to pierce the corporate veil. In this case, the court observed that
the first prong of the corporate veil test had been clearly satisfied. However, the district
court made no findings as to whether the executive's domination of the company was
used to commit a fraud or wrong against the panel pharmacy which resulted in the
pharmacy's injury. For this reason, the district court's judgment permitting the pharmacy
to pierce the pharmacy plan administrator's corporate veil and to recover damages from
its sole director and stockholder was declared legally void and sent back to the district
court with instructions to determine whether the second prong of the two-prong test was
satisfied.

Long-Term Stability
A corporation is the most permanent form of business organization. This feature gives a
corporation a stability that other legal forms cannot guarantee. Furthermore, a well-
managed corporation can survive the personal misfortunes of any of its owners,
directors, or officers. This fact is reassuring to the corporation's customers and, in the
case of a for-profit health plan, its investors.

Recently, new types of legal forms, such as limited liability companies, have emerged to
provide additional options for establishing a health plan. These organizational structures

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have certain characteristics of corporations and certain characteristics of limited

partnerships.

Limited Liability Companies

The limited liability company (LLC) is a relatively new type of legal entity that
combines features of both a partnership and a corporation. The owners, who can be
either individuals or companies, are called members. As in a partnership, when the
LLC's members are individuals, the business profits and losses are treated as individual
income for tax purposes. Similar to a corporation, the LLC makes available several
options for raising operating funds, and it limits the liability of its owners. When the LLC
members manage the organization themselves, the entity is called a member-managed
LLC. When the LLC members do not manage the organization, it is called a manager-
managed LLC.¹

Some provider groups are formed as limited liability companies, and although it is not
common, a health plan can be formed as a limited liability company or can enter a
specific business venture by forming a limited liability company with strategic partners.
For example, an insurer and a healthcare management company, both corporations,
might decide to launch a commercial health plan venture as an LLC. The LLC might
benefit from the financial stability and administrative expertise of the insurer and the
medical management know-how of the healthcare management company. Or a health
plan might decide to expand into a new market, such as Medicaid, and seek a partner
with familiarity in this market to jointly establish an LLC.

An LLC is usually established by filing a legal document, typically called articles of

organization, with the appropriate state agency. Typically, the LLC also draws up a
document, called an operating agreement- similar to a partnership agreement or
corporate bylaws- that provides more detailed information about governance issues,
such as voting rights, economic rights, and the steps to be taken if a member resigns.
LLC statutes provide a great deal of flexibility in these organizational matters, which
makes the LLC an attractive legal entity for attaining certain business objectives.

A health plan organized and operated in accordance with state LLC requirements can
obtain the benefits of organizational flexibility similar to a partnership, along with the
limited ownership liability of a corporation. In addition, for tax purposes, the profits and
losses of the business are treated as if it were a partnership; that is, the LLC itself does
not pay taxes. It is worth noting, however, that because LLCs are a fairly recent
development, many of the enabling state laws have not been reviewed by the Internal
Revenue Service (IRS) to determine if, in fact, the tax advantages are permitted.

An LLC is usually established for a limited period of time, such as 30 years, and typically
ends with the withdrawal, expulsion, or death of a member. However, the LLC can
remain in effect if there is a provision in the state law or the governing agreement that
allows for continuation upon approval by a majority of the remaining members

Professional Corporations and Professional Limited Liability Corporations

Certain "special-purpose" corporations, such as professional corporations and
professional limited liability corporations, are also available to some players in the
healthcare industry.

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For years, practitioners of the "learned" professions, such as law and medicine, were not
permitted to establish corporations. In the early 1960s, however, states began enacting
laws to permit and regulate professional corporations, and in 1969 the IRS granted
professional corporations the same tax status as other types of corporations. Physicians
and, in some states, other healthcare practitioners-such as registered nurses, physical
therapists, chiropractors, dentists, and pharmacists-may now establish professional
corporations. In some states, medical practitioners may also establish professional
limited liability companies.
3

Because of the variety of state approaches to regulation, it is difficult to generalize about

professional corporation laws; however, in almost all states professional corporations
differ from business corporations in at least three ways: 4

1. Ownership.
2. Directors and officers.
3. Liability.

Ownership.

A unique feature of professional corporations is that their shares of stock can only be
owned by individuals (and in some states, partnerships or other professional corporations)
licensed to practice that corporation's profession. Some states allow the owners to be
licensed practitioners in different areas of medicine, such as physicians and dentists. Any
sale or transfer of shares must be to a person or entity meeting this requirement. Also, if a
shareholder dies or is no longer a qualified shareholder, the stock must be transferred to a
qualified shareholder or it must be purchased by the corporation within a specified period
of time.

Directors and officers.

Another unique feature of professional corporations is the requirement in most states that
all directors and officers be licensed to practice the corporation's profession. In states
where nonprofessional directors are permitted, laws typically prohibit them from
exercising authority over professional matters.

Liability.

Under the professional corporation laws in most states, professionals who own shares of
stock in the corporation are individually liable for improper acts they perform or that are
performed under their supervision, but only if the act is related to their profession. In
other words, if a lawsuit arises concerning the corporation's purchase of office
equipment, the physician involved is not personally liable. However, if a lawsuit arises
concerning a medical service, then the physician who performed or supervised the service
can be held individually liable, although the risk can be insured against or financially
limited by the purchase of liability insurance. In a business corporation, the liability of
individual stockholders is limited in virtually all circumstances.

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Corporate Practice of Medicine Doctrine

Many jurisdictions have in place, either by specific statute or court decisions, a
prohibition against corporate practice of medicine. In general, the corporate practice of
medicine doctrine prohibits a physician from practicing medicine for a business
corporation. Where this doctrine applies, a physician can only practice medicine as a
sole proprietor, as a partner, for another physician, for a professional corporation, or for
a professional LLC. In other words, this doctrine prohibits a business corporation from
practicing medicine or from employing physicians to practice medicine on its behalf.

Corporate practice of medicine statutes arose largely out of the fear that business
organizations would unduly influence the professional judgment of physicians. Some
states also apply this doctrine to other healthcare practitioners besides physicians. The
corporate practice of medicine doctrine is often modified to allow certain types of
organizations to employ physicians when these organizations are licensed to employ
physicians, as is the case for hospitals and staff model HMOs.

The application of the corporate practice of medicine doctrine can impact the legal
structure of certain types of health plans. As insurers and health plans ally with
providers, they must ensure that such alliances are established so as not to invoke
corporate practice of medicine laws.

The application of the corporate practice of medicine doctrine varies by state. In practice,
only a small number of states have actually applied a prohibition against corporate
practice of medicine within the past 15 years, with California being a noteworthy
example. Many more states have applied this doctrine at least once, but not within the
past 15 years. Also, some states do not have a prohibiting statute, nor have they ever
applied the doctrine in court, although this is no guarantee that they never will. 5

For-Profit, Not-for-Profit, and Mutual Companies

A health plan's organizational structure strongly influences its approach to critical
business activities such as allocating profits, obtaining operating funds, and overall
governance. In developing a strategy to meet a health plan's mission and objectives, the
health plan's leaders must determine, among other things, whether the organization will
be a for-profit or not-for-profit company, and in the case of an insurer, whether it will be a
stock or mutual company.

For-Profit Health Plans

Profit can be defined as a health plan's total income (the amount of money it brings in)
minus its total expenses (the amount of money it spends). In this sense, it is possible for
a not-for-profit company or a mutual insurance company to make a "profit." However,
one feature that clearly distinguishes a for-profit health plan from a not-for-profit health
plan or a mutual insurer is the way the entity uses this excess of income over expenses.

A for-profit health plan conducts its business with the goal of making a profit to be
distributed to or shared by its owner-investors. A mutual insurance company distributes
"profits" to its policyowners. A not-for-profit health plan cannot distribute "profits" to
individuals for personal gain, but must instead use its profits to benefit the company and
its purpose.

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Obviously, any health plan, whether it is a for-profit company, a not-for-profit company,

or a mutual insurance company, seeks to have its income exceed its operating
expenses. The excess can be used to generate additional funds, and instills confidence
in potential investors and lenders who provide access to even more funds. If a health
plan is unable to convince investors, lenders, or donors of its ability to operate "in the
black," the health plan is likely to lose access to outside funds that are often critical to
continued operation in an increasingly competitive environment.

Stock Companies
Most for-profit health plans in the United States today are stock companies. A stock
company obtains the funds it needs to begin operations from investors who purchase
ownership shares of stock in the company. These owner-investors are called
shareholders. Although shareholders may receive a portion of the company's earnings
through periodic payments, known as dividends, historically health plans have elected
not to pay dividends. Shareholders realize capital gains or losses by selling their shares
of stock. If shares of stock are offered to the general public, the company is called a
publicly traded corporation. If shares of stock are not offered to the public, the
company is called a privately held corporation.

In a publicly traded corporation, certain shareholders, called common stockholders, vote

on company affairs and are ordinarily granted one vote per share of stock. Common
stockholders elect the company's board of directors and influence company operations
by voting on matters of company policy. One of the board's primary responsibilities is to
select senior management to operate the company. In this type of arrangement, the vast
majority of shareholders do not participate in the day-to-day operations of the business.
Ultimately, the board of directors and management of the company are accountable to
the shareholders for the profitability of the corporation.

Another class of stockholders is known as preferred stockholders. Preferred

stockholders must be paid their dividends before common stockholders are paid theirs,
but preferred stockholders generally do not have voting rights regarding the company's
directors or company policy.

Shares of stock in a privately held corporation are available only to a closed group. A
corporation may be privately held for any number of reasons. It may be too small to be
publicly traded, it may be a family business, or the owners may not want to give up
control and/or income by sharing ownership with outside investors. In these
corporations, the number of owner-investors may be small enough so that it is feasible
for all of the individuals to sit on the group's governing board. A privately held
corporation always has the option of "going public" if it decides this would be in its best
interest-for example, if the privately-held corporation needs to generate funds quickly for
expansion into new markets or if it seeks to improve its information management
capabilities by investing in new systems.

When a stock company is established, the articles of incorporation describe the number
of authorized shares of stock and the par value of those shares. Generally, a company
does not issue the total number of authorized shares. Instead, it retains some shares for
future investment purposes. The par value of the shares is established for state tax
purposes, but the actual investment is invariably greater than the par value.

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Governance of For-Profit Health Plans

A for-profit health plan is run strictly as a business focused on growth and generating
profits for its shareholders. This business focus and the ability to raise needed funds
through owner-investors are two primary reasons that for-profit health plans have
become more common in recent years. Another advantage that for-profit stock
companies have over not-for-profits and mutuals is the ability to attract executive-level
managers by offering shares of company stock as part of their compensation packages.

Some analysts believe that publicly traded corporations have a governance advantage
over other types of companies because their shareholders often take an active interest
in company operations. Shareholders, whose money is at stake, hold the board and
senior management accountable. Because of the scrutiny of shareholders, the
management of stock companies tends to be more aggressive, growth-oriented, and
adaptable to changes in the economy. However, some analysts consider this to be a
disadvantage, at times, because the desire for short-term financial results can
overshadow the need for long-term investments and strategies.

Regulation of For-Profit Health Plans

At one time, many states placed significant regulatory constraints on the formation of for-
profit HMOs, but today Minnesota and Vermont are the only states where for-profit
HMOs are prohibited. In other jurisdictions, for-profit health plans are subject to
comparatively fewer restrictions than mutual insurers and not-for-profit companies with
regard to how profits and surplus funds can be used, although they are often subject to
certain regulations, such as limitations on the types of investments they can make. A
large number of not-for-profit health plans are converting to for-profit status, a trend that
has prompted several states, as well as public interest groups, to pay closer attention to
regulation of "for-profit" transactions involving not-for-profit health plans (see Formation
and Structure of Health Plans).

Not-for-Profit Health Plans

The distinguishing characteristic of a not-for-profit health plan is that it has no owners or
owner-investors, as does a for-profit health plan, and therefore cannot distribute profits
for the benefit of individuals. Not-for-profit health plans typically use the term surplus to
refer to the excess of income over expenses. Depending on the stated purpose of the
health plan, surplus can be used for the benefit of the organization, the community, or a
charity, but not private individuals. If a portion of the net earnings of a not-for-profit
organization go to the benefit of private individuals, this is called private inurement.
Salary and benefits paid to employees of a not-for-profit health plan are part of the
organization's operating expenses and are not considered private inurement. However, a
not-for-profit company must be cautious in designing its compensation plan because if
regulatory authorities determine that the plan is not reasonable, the excess could be
deemed unlawful private inurement of profit.

Although one might think that not-for-profit health plans would be less "profitable" than
for-profit health plans, this has not been demonstrated. According to one study, the rates
of return on assets are not appreciably different between for-profit and not-for-profit
HMOs. 6

Taxable and Tax-Exempt Health Plans

Some not-for-profit health plans obtain tax advantages by qualifying for tax exempt

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status; however, not all not-for-profit health plans qualify as tax-exempt organizations. A
primary reason for tax-exempt status is that "charitable exemptions from income taxation
constitute a quid pro quo: the public is willing to relieve an organization from paying
income taxes because the organization is providing a benefit to the public." A complex
7

process that involves examination of sections of the Internal Revenue Code (IRC),
numerous IRS rulings, and applicable court decisions determine a health plan's federal
tax status.

The pertinent IRC sections for not-for-profits are 501(c)(3), 501(c)(4), and 501(m), not all
of which confer tax exemption. The most notable court decisions are Sound Health
Assn. v. Commissioner and Geisinger Health Plan v. Commissioner.

A health plan that qualifies as a 501(c)(3) charitable organization is tax-exempt on the

basis that it promotes health for the benefit of the community. In Sound Health, the court
held that an HMO can benefit the community, rather than solely private interests, if it
meets certain criteria, such as providing healthcare services and maintaining healthcare
facilities and staff, providing services to nonmembers on a fee-for-service basis,
providing care for the indigent at reduced rates, providing care for individuals on public
assistance programs, making emergency room facilities available to all members of the
community without regard to ability to pay, and appointing a board of directors that is
broadly representative of the community. Endnote Geisinger, the court further narrowed
8

the interpretation of the community benefit standard so that in essence the only types of
health plans that could qualify as 501(c)(3) organizations would be staff model HMOs or
HMOs owned and operated by providers or healthcare systems.

A health plan that qualifies as a 501(c)(4) social welfare organization is tax-exempt on

the basis that it is organized and operated exclusively to promote the general welfare of
certain people in the community it serves. A 501(c)(4) exemption is easier to obtain than
a 501(c)(3) exemption because 501(c)(4)s are allowed to benefit a comparatively smaller
group of individuals such as the members of an HMO. A 501(c)(3) exemption, on the
other hand, requires the organization to benefit the community at large. 9

A health plan that qualifies as a 501(c)(3) charitable organization can raise operating
funds through the sale of tax-exempt bonds and can accept tax-deductible donations. A
501(c)(3) designation can also help an organization establish exemption from state and
local property and sales taxes. Although a 501(c)(4) social welfare organization does not
have these advantages, it does have more flexibility in determining use of funds for
social or political activities. The choice of whether a health plan is established as a
501(c)(3) or 501(c)(4) organization is typically based on the organization's mission and
whether it intends to serve a charitable purpose. Few health plans have qualified as
501(c)(3) organizations.

The Tax Reform Act of 1986 included a provision, Section 501(m) of the IRC, that for
the most part eliminated the tax-exempt status for Blue Cross and Blue Shield plans,
which until then were typically established as 501(c)(4) organizations. As a result, these
plans were permitted to make tax deductions only for the portion of their earnings placed
in reserve funds. Although 501(m) has had the greatest impact on Blue Cross and Blue
Shield plans, the IRS also uses this section of the IRC in conjunction with sections
501(c)(3) and 501(c)(4) to determine the tax status of other types of health plans.

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Review Question

Some health plans qualify as tax-exempt organizations under Sections 501(c)(3) and
501(c)(4) of the Internal Revenue Code. One true statement regarding a health plan that
qualifies as a 501(c)(4) social welfare organization, in comparison to a health plan that
qualifies as a 501(c)(3) charitable organization, is that a

501(c)(4) social welfare organization is allowed to distribute profits for the benefit
of individuals, whereas a 501(c)(3) charitable organization can use surplus only for
the benefit of the organization, the community, or a charity
501(c)(4) social welfare organization can raise operating funds through the sale of
tax-exempt bonds, whereas a 501(c)(3) charitable organization does not have this
advantage
501(c)(4) social welfare organization has less flexibility in determining use of funds
for social or political activities than does a 501(c)(3) charitable organization
501(c)(4) exemption is easier to obtain than a 501(c)(3) exemption, because
501(c)(4) social welfare organizations are allowed to benefit a comparatively
smaller group of individuals

Incorrect. A not-for-profit entity cannot distribute profits for the benefit of

individuals.

Incorrect. A 501(c)(3)charitable organization can raise operating funds through the

sale of tax-exempt bonds, where a 501(c)(4) cannot.

Incorrect. A 501(c)(4) charitable organzation has flexibility in determining use of

fund for social or personal activities.

Correct. A 501(c)3(3) charitable organizaton must benefit the community, while a

501(c)(4) charitable organization promotes the general welfare of certain people in
the community it serves.

Section 501(m) denies tax-exempt status to any entity for which a "substantial part of its
activities consists of providing commercial-type insurance." Furthermore, according to an
IRS ruling, if a tax-exempt entity derives a portion of its income from operations that are
classified as commercial-type insurance, that portion of its income is treated as taxable
unrelated trade or business income. In distinguishing between HMOs and commercial
10

insurance companies, IRS rulings suggest that certain indemnity-type features of HMOs,
such as non-network emergency care or specialty care, are not considered commercial-
type insurance. However, other indemnity-type features, such as POS options, are
considered commercial-type insurance.

Some state requirements for tax-exempt status closely resemble federal requirements,
while other state requirements are more restrictive. For example, a Massachusetts court
ruled that a 501(c)(3) HMO was exempt from local real estate taxes because the HMO's
health promotion activities applied to a large enough class of persons to be considered a
benefit to the community at large. On the other hand, Maryland courts ruled that a
11

501(c)(3) HMO was not a charitable organization and was subject to state property

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taxes, finding that the provision of "high quality medical care to . . . members for a fee" is
not a charitable, benevolent, or educational activity. 12

In most cases, even when a health plan is tax-exempt it is still required to pay a state
premium tax, which is levied on premiums collected for certain types of insurance and
healthcare coverage. Whether a health plan is subject to state premium tax depends on
the type of health plan it is providing and the state in which it is doing business.
Typically, premiums for indemnity insurance and PPO plans are subject to premium tax.
In some states, POS options, exclusive provider only (EPO) plans, and HMO plans are
also subject to premium tax.

Fast Definition

Reserve funds are funds set aside and conservatively invested to enable a health plan
or insurer to pay claims as they come due.

Governance of Not-for-Profit Health Plans

In a not-for-profit health plan, governance comes from a board of directors or a board of
trustees appointed when the entity is established. In some organizations, directors are
replaced by board vote; in others, the board is elected by the health plan membership.
Some states require boards to be at least partly elected by members. In a not-for-profit
company, the directors or trustees are not accountable to voting shareholders or
policyowners, but rather, depending on the stated purpose of the health plan, to the
interests of the members, the community, or the charity the company serves.

Although the overall mission is different, the board of a not-for-profit health plan fulfills a
role and functions in a manner similar to the board of a for-profit health plan. In the past,
not-for-profit board members were often volunteers. Today, however, most board
members are paid fees, although the amount is typically less than the amount received
by for-profit board members. Later in this lesson, we will take a closer look at similarities
and differences between governance of for-profit and not-for-profit health plans.

Evolution of Not-for-Profit Health Plans

When Blue Cross and Blue Shield Plans and other prepaid health plans such as Kaiser
Permanente began to appear in America in the first half of the 20th century, the federal
government determined that these plans could be established as tax-exempt not-for-
profit organizations. In 1973, the federal HMO Act authorized grants and loans for
federally qualified HMOs that, at the time, were required to be "public or nonprofit
entities." These tax advantages and funding incentives accounted for the establishment
of a large number of not-for-profit HMOs. In the 1980s, however, government funding for
HMOs was phased out, and the industry- encouraged by the federal government- began
to demonstrate an increased ability to attract private investors.

Although not-for-profit health plans do not have access to shareholders, they do have
other alternatives for obtaining operating funds, especially if they are tax-exempt. These
alternatives include bond offerings, loans, private donations, surplus from business
operations, and, in some cases, funds from for-profit subsidiaries or joint venture
partners. It should be noted, however, that these funds are often more difficult to obtain
than funds from private investors.

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As Figure 2A-2 demonstrates, not-for-profit health plans are no longer the predominant
type of health plan in the United States; however, they remain a significant force.

Insight 2A-2. For-Profit and Not-for-Profit Health Plan Status in the United States.
Percentage of For-Profit and Not for Profit PPOs in the United States
For-Profit Not-for-Profit
1993 84% 16%
1996 88% 12%
Percentage of For-Profit and Not for Profit HMOs in the United States
For-Profit Not-for-Profit
1985 35% 65%
1990 66% 34%
1993 68% 32%
1996 74% 26%

Mutual Insurance Companies

Some health plans are organized as mutual insurance companies. The distinguishing
characteristic of a mutual insurance company is that technically it is owned and
governed not by investors, but by policyowners, and the board is ultimately accountable
to the policyowners who elect it. The policyowners elect the board of directors on the
basis of one vote for each policyowner, regardless of the amount of insurance or the
number of policies a person owns.

Mutual insurers can issue both participating and nonparticipating policies, but only
participating policyowners are eligible to elect board members. Participating
policyowners are also entitled to receive policy dividends, which are considered a return
of part of the premiums that were paid to keep the policy in force.

Most health plan policies issued by mutual companies are nonparticipating. However,
even when a health plan policy is participating, the covered individuals are seldom
eligible to participate in board elections or to receive policy dividends. Typically, covered
individuals do not have these rights because under group policies the empolyer, not
each covered employee, is the policy holder.

Review Question

The Tidewater Life and Health Insurance Company is owned by its policy owners, who
are entitled to certain rights as owners of the company, and it issues both participating
and nonparticipating insurance policies. Tidewater is considering converting to the type
of company that is owned by individuals who purchase shares of the company's stock.
Tidewater is incorporated under the laws of Illinois, but it conducts business in the
Canadian provinces of Ontario and Manitoba.

Tidewater established the Diversified Corporation, which then acquired various

subsidiary firms that produce unrelated products and services. Tidewater remains an
independent corporation and continues to own Diversified and the subsidiaries. In order

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to create and maintain a common vision and goals among the subsidiaries, the
management of Diversified makes decisions about strategic planning and budgeting for
each of the businesses.

Tidewater's participating policy owners have the right to

elect the board of directors on the basis of one vote per policy owner
elect the board of directors on the basis of one vote for each policy a person owns
participate in developing a corporate mission statement and strategic plans
receive stock dividends for each policy they own

Correct. Participating policyholders select the board of directors on the basis of

one vote per policyholder, regardless of the amount of insurance or the number of
policies owned.

Incorrect. Participating policyholders select the board of directors on the basis of

one vote per policyholder, regardless of the amount of insurance or the number of
policies owned.

Incorrect. Participating policyholders participate by electing a board, and by

receiving dividends.

Incorrect. Participating policyholders receive policy dividends, which are

considered a return of the part of the premiums that were paid to keep the policy
in force.

Similar to not-for-profit health plans, mutual insurers use the term surplus to refer to the
excess of income over expenses. The wealth of many mutual insurers lies largely in their
accumulated surplus. State regulations typically limit the ways that mutual insurers can
use or invest this surplus.

Health plans that are organized as mutual insurers have certain advantages. Similar to
not-for-profit health plans, mutual insurers are free from the pressures of stockholders
who, according to some analysts, may focus primarily on short-term profits at the
expense of long-term initiatives. Mutual insurers are also protected from unwanted
takeovers by outside interests because, unlike stock companies, they have no shares of
stock that can be acquired by other companies or investors. However, health plans that
are organized as mutual insurers also face certain disadvantages. These plans are more
difficult to establish and expand because, unlike stock companies, mutual insurers
cannot sell shares of stock to raise start-up funds, nor can they sell additional shares to
finance expansion or infrastructure improvements. Mutual insurers must raise capital
primarily from company operations- that is, by selling policies.

The inability to sell shares of stock also makes it more difficult for mutual insurers, as
well as not-for-profit companies, to take advantage of consolidation. Many players in the
health plan industry today consider consolidation to be a key strategic advantage. If two
for-profit health plans determine that it is in their best interest to merge, they can

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accomplish the transaction through an exchange of stock; however, if one of the entities
is a mutual insurer or a not-for-profit health plan, this option is not available.

Although some stock and not-for-profit health plans are converting to mutual insurance
companies (a process called mutualization), the trend over the past several years has
been for mutual insurers to convert to stock companies (a process called
demutualization). Also, some mutual insurers have created mutual holding companies to
address some of the difficulties associated with being a mutual company. We discuss
these topics in greater detail in Formation and Structure of Health Plans.

Health Plan Funding

In health plans, for-profit, not-for-profit, and mutual insurance companies compete in the
same marketplace for the same business. Yet each operates within a somewhat
different framework. Generating funds to establish, maintain, and expand operations is
critical for all health plans. Access to capital is essential for initiatives such as systems
upgrades, development of new products, expansion into new markets, and strategic
alliances. The way a health plan raises these funds, however, is strongly influenced by
how the health plan is organized. Although this text is not intended to provide a detailed
analysis of health plan financing, we will provide a brief review of how each type of entity
raises operating funds and a broad overview of funding sources.

A health plan can potentially obtain private sector operating funds from any number of
sources. For the purpose of this discussion, we will divide these sources into four
general categories: (1) internal sources, such as operating and investing activities; (2)
debt markets; (3) equity markets; and (4) donations. In other words, a health plan can:

• Generate funds by using its own resources, that is, its business operations
and investments (internal sources)
• Borrow from creditors (debt markets)
• Sell shares of ownership to owner-investors (equity markets)
• Solicit or receive funds (donations)

Different combinations of these options are available to each type of health plan.

All health plans have the potential to generate funds via internal sources of income. For
the purpose of this discussion, we have divided internal sources of income into operating
activities and investing activities.

1. Operating activities
2. Investing activities

A health plan's investing activities can be both long-term and short-term. Since
premiums are prepaid, the funds are available before expenses are incurred. Thus,
health plans can use premiums to make investments that can be used as a source of
income until the funds are needed to pay healthcare expenses.

Operating activities are those activities associated with a health plan's major lines of
business and involve transactions that directly determine the company's profits, including

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selling, administering, delivering, and designing managed healthcare products. 13

Generally, a health plan prefers to generate funds via operating activities. The health plan
invests in itself to improve its operations, which results in a healthier organization in
terms of funds on-hand, as well as future earnings potential. When it invests in operating
activities, a health plan does not have to take outside investment risk, pay interest on
debt, or pay the cost of issuing stock, as it might when seeking other sources of funds. At
the same time, it strengthens its ability to provide products and services. Of course, such
activities are not risk-free. There are no guarantees that a venture will succeed. Also, with
increased competition in healthcare, profits are slimmer, and many operating activities
require substantial capital investments. These challenges make it increasingly difficult for
health plans to generate sufficient income via operations. In addition, health plans must
adhere to all regulations governing investment in operating activities. For instance, a not-
for-profit health plan that seeks to enter a strategic alliance with a for-profit health plan
must comply with the requirements that apply to such transactions, and faces extensive
and protracted regulatory scrutiny.

Investing activities a health plan's other internal source of income, are transactions that
involve the purchase or sale of assets and the lending of funds to another entity. A health
plan's investing activities include (1) purchasing and selling bonds, mortgage loans,
stocks, real estate, equipment, certificates of deposit, and other assets, and (2) making
loans and collecting the principal and interest on those loans. 14

A company can also raise funds through the debt markets, which are sources of funds
loaned in exchange for the receipt of interest income and the promised repayment of the
loan at a given future date. Debt instruments, also known as bond issues, represent
debts that the issuing corporation owes to the bondholders. The debt markets are
available to all health plans, although mutual companies do not usually issue
conventional bonds. As we have seen, 501(c)(3) charitable organizations have access to
tax-exempt bond offerings and tax-free loans; for tax purposes, they can deduct both the
cost of generating a bond offering and the interest paid. Other types of health plans can
deduct only the interest payments.

Debt is the most expensive method of obtaining operating funds. Companies must pay
interest on debt, whether or not the company is making money. Typically, debt is utilized
by health plans that operate medical facilities, such as staff model HMOs, and is used in
connection with building or renovating facilities.

A for-profit company can also raise funds in the equity markets. The equity markets are
sources of funds obtained by issuing financial instruments that represent an ownership
interest (equity) in the issuing corporation. Shareholders invest in and own shares in the
issuing corporation. A publicly traded or privately held health plan can make a "public
15

offering" to obtain investors. In addition, a health plan that prefers not to "go public" can
raise private equity in the equity market. Many analysts consider access to equity
markets to be a significant advantage for a health plan. For instance, the cash that stock
companies receive from selling stock can be used to buy other companies or to pay for
expansion and improvements. Several not-for-profit and mutual companies have
converted to for-profit health plans in recent years to obtain access to equity markets.

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Health plans that pay dividends can also generate net income by reducing the dividend
amount they pay to their shareholders or policyowners.

Review Question

One way that a health plan can obtain operating funds is by issuing financial instruments
that represent an ownership interest in the issuing corporation. By raising funds in this
way, a health plan is accessing sources of funds called:

debt markets, which are available to all health plans

debt markets, which are available to for-profit health plans only
equity markets, which are available to all health plans
equity markets, which are available to for-profit health plans only

Incorrect. Debt markets are sources of funds loaned in exchange for the receipt of
interest income and the promised repayment of the loan at a given future date.
They are available to all types of health plans, although mutual companies do not
usually issue conventional bonds

Incorrect. Debt markets are sources of funds loaned in exchange for the receipt of
interest income and the promised repayment of the loan at a given future date.
They are available to all types of health plans, although mutual companies do not
usually issue conventional bonds

Incorrect. Equity markets are sources of funds obtained by issuing financial

instruments that represent an ownership interest (equity) in the issuing
corporation. They are not available to not-for-profit or mutual companies

Correct! Equity markets are sources of funds obtained by issuing financial

instruments that represent an ownership interest (equity) in the issuing
corporation. They are only available to for-profit companies.

Theoretically, any type of health plan can solicit and receive private donations. In
practice, however, donations are almost never made to health plans other than 501(c)(3)
organizations because only contributors to 501(c)(3) organizations can deduct qualified
donations from their taxable income.

Figure 2A-3 shows the options available to for-profit, not-for-profit, and mutual
companies for obtaining operating funds.

Insight 2A-3. For-Profit, Not-for-Profit, and Mutual Company Access to Operating Funds.

Type of Equity
Internal Sources Debt Markets Donations
Company Markets

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Available via funds Available, but almost

generated by never utilized because
For-Profit Available Available
opening activities there is no tax
and investments incentives for donors
Available via funds
Available, but almost
Not-for- generated by Not
Available never utilized except by
Profit opening activities available
501(c)(3) organizations
and investments
Available via funds Available, but Available, but almost
generated by mutuals do not Not never utilized because
Mutual
opening activities usually issue available there is no tax
and investments conventional bonds incentives for donors

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Chapter 3 A : Corporate Restructuring and Corporate

Transactions
After completing this lesson, you should be able to:

• Describe the options available to mutual companies seeking access to

capital, strategic partnerships, and other corporate transactions
• Describe the issues that a not-for-profit entity must address when converting
to for-profit status or when engaging in other transactions with for-profit
entities
• Explain how health plans use reorganization and reengineering to improve
performance
• Distinguish between strategic partnerships, joint ventures, acquisitions, and
mergers

In the 1990s, the managed healthcare industry experienced massive restructuring. The
unprecedented rate of corporate activities can be attributed to several factors. For
instance, health plans often seek to:

1. Generate funds.
2. Gain market share or offer new products.
3. Reduce expenses.
4. Integrate or improve functions.

The number and nature of strategies for realigning corporate structure and the reasons
for pursuing these strategies are virtually unlimited, as illustrated in Insight 3A-1 and
Figure 3A-1. In this lesson, we describe how health plans seek to improve their
performance through:

1. Corporate restructuring-such as demutualization, conversion from not-for-profit to

for-profit status, and reengineering
2. Corporate transactions-such as strategic partnerships, joint ventures, affiliations,
acquisitions, and mergers

Our discussion also examines key regulatory issues pertaining to corporate restructuring
and corporate transactions.

Fast Fact

1997 closed as a record year, with 1,183 mergers and acquisitions in the healthcare
industry, up 18.7% over 1996's 999 transactions. 1

Generate funds.

Managed healthcare is a capital-intensive business, and changes in corporate

arrangements can help generate funds needed for activities such as expanding service
areas, leasing facilities, purchasing equipment, paying off debt, adding to reserves to

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cover healthcare delivery costs, handling legal expenses, building information systems,
and improving key functions and capabilities.

Gain market share or offer new products.

In a rapidly evolving marketplace, health plans restructure or undertake corporate

transactions to capture a greater market share, enter new markets, or offer new products.

Reduce expenses.

Companies that restructure or combine organizationally often want to reduce the cost of
running the business. They do this by obtaining economies of scale, which means they
are able to perform functions on a larger scale and therefore at a lower unit cost than if
they operated independently, thereby reducing administrative and medical expenses.

Integrate or improve functions.

Operating a health plan requires integrating several diverse and challenging tasks, such as
arranging for the delivery and financing of healthcare, as well as performing many
closely regulated administrative, technical, and legal functions. Sometimes it is beneficial
for organizations to change structures and processes or join forces to more effectively
provide these key services to their customers.

Insight 3-1. Corporate Transactions in the Health Plan Industry.

Following is a "snapshot" of corporate transactions that took place during a period of just
one month, as reported in a health plan periodical:

Detroit, Mich.-based The Wellness Plan, which is formally incorporated as

Comprehensive Health Services Inc., and Troy, Mich.-based SelectCare HMO are
discussing the possibility of an affiliation or merger. The Wellness Plan, a not-for-profit
organization, is the Detroit area's third-largest HMO. For-profit SelectCare HMO is the
area's seventh-largest HMO.

Magellan Health Services and Merit Behavioral Care Corp. have signed a definitive
merger agreement under which Magellan will acquire Merit. The company will become
the nation's leading specialty health plan company. Under the agreement, Magellan will
purchase all of Merit's outstanding stock. Magellan will also refinance Merit's existing
debt.

Foundation Health Systems (FHS) Inc.'s Oregon HMO has completed its acquisition of
Clackamas, Oregon-based PACC HMO and PACC health plans. The combined
organization, called QualMed Plans for Health of Oregon Inc., serves about 180,000
members throughout Oregon and southwest Washington.

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Western Montana Clinic and Blue Cross and Blue Shield of Montana unveiled a new
HMO called Montana Health. Montana Health will emphasize preventative care and
freedom to choose providers, along with healthcare cost management.

Sutter Health and PacifiCare of California, the HMO subsidiary of PacifiCare Health
Systems, have signed a long-term agreement to create a "systemwide strategic alliance."
The agreement includes the FHP/Take Care members being absorbed into PacifiCare as
the result of the recent acquisition. The agreement is the first of its kind in Northern
California.

Ramsay Health Care Inc.'s managed behavioral care division, FPM Behavioral Health
(FPM), has signed a contract with PacifiCare of Utah and Talbert Medical Management
Corporation. Under the agreement, FPM will provide integrated behavioral healthcare
services to more than 193,000 of PacifiCare of Utah's Medicare and commercial
members.

Blue Cross and Blue Shield of Kansas City has acquired Overland Park, Kan.-based
Preferred Health Professionals. The acquisition will help Blue Cross and Blue Shield
offer health plan options to its 90,000 members. Preferred Health Professionals will retain
its name and location and will function as a subsidiary of Blue Cross and Blue Shield.
Source: Excerpted and adapted from NewsFurst (November 1997, III/10)

Figure 3A-1 Examples of Health Plan Realignment Strategies.

 A national health plan might decide to change its organizational structure by
consolidating its marketing and administrative support regions in an effort to improve
efficiency and reduce operating expenses.
 Two health plans might decide to join forces because their particular geographic
strengths complement each other, and by combining operations they can become a strong
regional or national health plan with significant market share.
 A national or regional health plan, which has been struggling to obtain market share
in a particular city, might decide to enter into a transaction with a local health plan, which
is also seeking greater market share; together they seek to significantly improve their
market position.
 A health plan might determine that it is "behind the curve" in developing a new
product critical to its customers-for example, a preferred provider organization or a
managed dental product. Rather than spend the time and money to develop the product
from the ground up, the health plan might enter into a transaction with a health plan that
has already developed such a product.
 One health plan may be expert at marketing and administration, another may be
expert at healthcare delivery. By combining resources and, in effect, drawing upon the
best of both operations, they seek to develop a more effective operation than either could
have built on its own.

 Two local health plans might decide to join forces because their provider networks
effectively complement each other; for example, one might have a strong primary care
physician panel and the other might have a strong specialist panel.

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Corporate Restructuring
Health plans, seeking to improve performance and respond to the multitude of
environment factors discussed in Environmental Forces, sometimes elect to change their
corporate structure. In this section, we describe several corporate restructuring options
available to health plans.

Parent Companies, Subsidiaries, Spin-offs, and Holding Companies²

The corporate structure of a health plan can take any of a number of forms, from a single
corporate entity to a complex arrangement of multiple entities. In this section, we briefly
describe the relationship between parent companies, subsidiaries, spin-offs, and holding
companies.

A parent company is a company that has a controlling interest in another company,

called a subsidiary. A subsidiary is a company whose controlling interest is owned by
another company, its parent. For example, some major insurance companies are parent
companies that have HMO subsidiaries. Two subsidiaries of the same parent company
are known as sister corporations.

Because a not-for-profit health plan cannot be owned, it cannot, technically, be a

subsidiary of a parent company. In some instances, however, a parent company controls
sole voting membership of a not-for-profit health plan, and the health plan is referred to
as an affiliate. In this context, affiliate means a company that is held, but not owned, by
a parent company.

In some situations, an organization actually lets a portion of its operations "spin off." A
spin-off is a former unit or department of a company that operates as a subsidiary or,
more often, as an independent company. If the company becomes completely
independent, it may be owned by the same shareholders as the original company, who
may be provided shares of the spin-off company's stock. In some cases, the spin-off is
sold to certain employees who then own and operate it; this is sometimes referred to as
a management buy-out. For example, a national multiline insurer with a health plan
division might decide to spin-off its health plan business unit, selling it to the health plan
division's senior management staff. Alternatively, the spin-off company's stock may be
sold to another company in the same line of business, thereby expanding the purchasing
company's business.

Sometimes the former parent company is the primary customer of a spin-off. However,
the spin-off can also offer services to other individuals or organizations. For example, a
health plan might develop a pharmacy management unit that it uses to provide services
to its covered individuals. Later it may decide to make this unit an independent company
(via spin-off) whose clients include the former parent company (the health plan from
which it was spun off), as well as other health plans. Such spin-offs are established
under the assumption that, freed from the restrictions of operating within a larger
company, a subsidiary tends to be managed in a more aggressive and competitive
manner and with lower administrative expenses. Spin-offs also may be designed to
utilize excess resources, to take advantage of unique expertise in a certain area, or to
pursue profit opportunities.

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When corporations wish to maintain a connection among a pair or group of separate

corporate entities, they often use the mechanism of a holding company system. A
holding company, which is a type of parent company, is an entity whose primary
business is the holding or "ownership" of controlling interests of other companies, which
are its affiliates or subsidiaries. A holding company arrangement can be used to control
a group of companies in the same or related lines of business to maximize expertise and
market presence in that field. A holding company arrangement can also be used to
control subsidiaries in widely differing industries. In this way, the holding company can
diversify its interests and protect itself from the risks involved in concentrating on just
one kind of business.

As illustrated in Figure 3A-2, there are two basic types of holding companies. A
downstream holding company is owned or controlled by the company that forms it. In
other words, the parent company establishes a holding company, which then creates or
acquires subsidiary firms. The parent that forms the holding company remains an
independent corporation and continues to own or control the entire holding company
system. Conversely, with an upstream holding company, the parent company forms a
holding company and is actually controlled by the holding company it forms. The holding
company is then in a position to create or acquire additional subsidiaries. The holding
company owns or controls the entire holding company system, including the company
that forms it.

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Most companies do not create downstream holding companies unless this is the only
option available due to regulatory requirements, as is the case for a mutual insurer.
Because a mutual insurer can only be owned and controlled by its policyholders, it
cannot form or be purchased by an upstream holding company. Some mutual insurers
determine that this restriction limits their ability to compete with other companies, a
factor that leads them to consider other alternatives, which we discuss later in this
lesson.

In pursuing a holding company arrangement, a not-for-profit health plan must be careful

to protect any charitable or community benefit interests in its stated purpose. If a not-for-
profit health plan creates an upstream holding company, there may be limits on the
assets that can be transferred. If a not-for-profit health plan establishes a for-profit
parent, this would likely be deemed a for-profit conversion, subject to applicable state
requirements. We discuss issues related to not-for-profit transactions later in this lesson.

In some jurisdictions, organizations have found that forming a holding company can
result in fewer restrictions on investments and greater flexibility in raising operating
funds. For example, regulations in New York limit the kinds of investments that can be
made by licensed insurance companies and their subsidiaries, although a parent
company or a holding company that owns or controls a licensed insurer is not subject to
the same investment rules, nor are its other subsidiaries. In this case, the holding

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company or one of its subsidiaries can make investments that an insurer cannot make.
However, regulators are particularly concerned with preventing a holding company
system from separating an insurer's assets and liabilities from that insurer's control.
Regulators are aware, for example, that a holding company could "raid" the capital and
surplus of an insurance subsidiary to provide funds for the holding company or another
subsidiary. State regulation of insurance holding company systems is therefore designed
to protect insurers and their customers from any such eventuality. 3

All states have enacted some type of holding company act, and most such acts are
based in whole or in part on the National Association of Insurance Commissioners'
(NAIC) Insurance Holding Company System Regulatory Act (Model Holding
Company Act). State holding company acts typically impose a number of registration
and reporting requirements on companies that are part of an insurance holding company
system. Also, most states have adopted regulations based on the NAIC's Insurance
Holding Company System Model Regulation with Reporting Forms and Instructions
(Holding Company Model Regulation). Such regulations specify requirements designed
to carry out the provisions of the state's holding company act. 4

Review Question

The Tidewater Life and Health Insurance Company is owned by its policy owners, who
are entitled to certain rights as owners of the company, and it issues both participating
and nonparticipating insurance policies. Tidewater is considering converting to the type
of company that is owned by individuals who purchase shares of the company's stock.
Tidewater is incorporated under the laws of Illinois, but it conducts business in the
Canadian provinces of Ontario and Manitoba.

Tidewater established the Diversified Corporation, which then acquired various

subsidiary firms that produce unrelated products and services. Tidewater remains an
independent corporation and continues to own Diversified and the subsidiaries. In order
to create and maintain a common vision and goals among the subsidiaries, the
management of Diversified makes decisions about strategic planning and budgeting for
each of the businesses.

In creating Diversified, Tidewater formed the type of company known as

a mutual holding company

a spin-off company
an upstream holding company
a downstream holding company

Incorrect. A mutual inurer cannot form or be purchased by an upstream holding

company, and can only create downstream holding companies.

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Incorrect. A spin-off is a former unit of department of a company that operates a

subsidiary

Incorrect. With an upstream holding company, the parent company forms a

holding company and is actually controlled by the holding company it forms

Correct. A downstream holding company is owned or controlled by the company

that forms it.

Mutualization and Demutualization

Mutualization is the process of converting a stock or not-for-profit company to a mutual
insurance company. Of particular note in the healthcare industry is the number of not-
for-profit Blue Cross and Blue Shield plans that have changed their legal structure to
become mutual insurers. Although the reasons for pursuing this strategy vary, a
common advantage is that mutual insurers are subject to fewer regulatory controls than
not-for-profit health plans. In addition, one Blue Cross and Blue Shield plan might seek
to mutualize to be able to merge with another mutual Blue Cross and Blue Shield plan.
Sometimes, mutualization allows a plan to expand its marketing territory into neighboring
states or to enter strategic alliances with providers that serve populations in bordering
states. Typically, when a Blue Cross and Blue Shield plan pursues mutualization, it must
obtain state insurance department approval. Also, because such a conversion involves a
change in the status of a not-for-profit health plan, it often raises issues of whether there
exists a public benefit or charitable trust (which we address later in this lesson).

Demutualization is the process of changing a mutual company to a stock company.

Often, companies that demutualize view this strategy as a way to compete with
shareholder-owned entities. Some mutuals, entering the process primarily out of
financial need, seek access to additional operating funds through the ability to sell stock.
Other mutuals, building on a position of financial strength, seek an organizational
structure that allows them to more quickly and easily pursue strategic options such as
acquisitions and mergers, which in turn provide greater access to new markets,
additional lines of business, and improved operational capacities. As we saw in Legal
Organization of Health Plans, a stock company has the ability to pursue consolidation
strategies using publicly traded stock as payment, and usually with less regulatory
scrutiny than a mutual.

Regulation of demutualization varies by state. Some states have no specific regulations

and guidelines for the process; others specifically prohibit it. A company that is
demutualizing must be sure to comply with all regulatory requirements. Because of the
changing business climate and legislators have been reviewing and in some cases
changing applicable mutual insurance laws to be less restrictive.

Demutualization requires the distribution of the company's surplus funds among its
policyowners. The company must find an equitable and efficient way to distribute this
surplus. The company must also seek the legal opinions of regulators and find answers
to several difficult questions. For instance, which policyowners should share in the
surplus? Should all living policyowners, as well as the heirs of deceased policyowners,
have rights to the surplus? Should only current or recent policyowners have these
rights? Once a company determines who is entitled to the surplus, it must also
determine how to make the distribution. Should policyowners receive cash, shares of

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stock in the converted company, or both cash and stock? Some consumer advocates
have challenged the way that mutual insurers have handled or proposed to handle
distributions that result from demutualization.
5

A company undergoing demutualization must be prepared to incur substantial legal,

accounting, printing, and postage costs as well as a decline in employee morale that is
likely to result because of uncertainty about the new direction of the company. 6

Recently, a new option has become available for mutual insurers seeking to change to a
corporate structure that enables them to compete more effectively with shareholder-
owned entities. The mutual holding company is a corporate structure under which the
mutual insurer can sell as much as 49% of its ownership to public shareholders. The
company gains access to capital markets, yet remains a mutual insurer because
policyowners retain majority ownership. A number of jurisdictions have passed new
mutual holding company laws or are considering new laws to allow mutual holding
companies.

Proponents of the mutual holding company structure contend that it is a valuable option
for mutual insurers that need access to capital and strategic alliances to compete with
stock companies, but want to preserve the mutual relationship with their policyowners.
On the other hand, some stock companies argue that this type of arrangement gives
mutuals an unfair advantage in that they can access capital markets and initiate strategic
alliances yet remain immune to takeover. In addition, some consumer advocates argue
that policyowners as a group suffer because they lose the full ownership available to
them under the traditional mutual insurance company structure.

Review Question

The Tidewater Life and Health Insurance Company is owned by its policy owners, who
are entitled to certain rights as owners of the company, and it issues both participating
and nonparticipating insurance policies. Tidewater is considering converting to the type
of company that is owned by individuals who purchase shares of the company's stock.
Tidewater is incorporated under the laws of Illinois, but it conducts business in the
Canadian provinces of Ontario and Manitoba.

Tidewater established the Diversified Corporation, which then acquired various

subsidiary firms that produce unrelated products and services. Tidewater remains an
independent corporation and continues to own Diversified and the subsidiaries. In order
to create and maintain a common vision and goals among the subsidiaries, the
management of Diversified makes decisions about strategic planning and budgeting for
each of the businesses.

In order to become the type of company that is owned by people who purchase shares
of the company's stock, Tidewater must undergo a process known as

management buy-out
piercing the corporate veil

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demutualization
mutualization

Incorrect. A management buy out is when a spin-off company is sold to certain

employees who then own and operate it.

Incorrect. Piercing the corporate veil is when a court determines that individuals
can be held held liable for the debts of the corporation.

Correct! Demutualization is the process of changing a mutual insurance company

to a stock company

Incorrect. Mutualization is the process of converting a stock, or not-for-profit

company to a mutual insurance company

Not-for-Profit Conversions and Other Transactions

A major trend in the healthcare industry today is for hospital systems and health plans,
including not-for-profit HMOs and Blue Cross and Blue Shield plans, to convert from not-
for-profit to for-profit or mutual status. In addition to outright conversions, not-for-profit
health plans sometimes enter into "for-profit-type" transactions, such as:

• Selling assets to raise funds

• Establishing for-profit subsidiaries
• Transferring assets into existing for-profit subsidiaries
• Entering into joint ventures or mergers with for-profit companies

As we noted previously, a key advantage of for-profit status is access to equity markets.

To compete effectively, a health plan must make significant investments in
administrative and medical management systems as well as in developing provider
networks, which might require expensive financial transactions such as the acquisition of
physician practices or hospital systems. For both business and regulatory reasons,
health plans do not want to carry large amounts of debt to fund these critical activities.
Therefore, the ability to raise equity capital becomes increasingly important. For those
7

companies that have already incurred these expenses, conversion to for-profit status or
a strategic alliance with a for-profit entity can help reduce or eliminate debt and meet
ongoing operating expenses. In some cases, an alliance with a for-profit entity can even
be used as a means to obtain funds for the not-for-profit charitable or community benefit
obligations.

Many not-for-profit health plans are finding that there are few business advantages to
retaining not-for-profit status in today's environment. Previously, there were tax
exemptions that in many cases are no longer available. In some jurisdictions- New York,
for example- not-for-profit health plans are subject to regulatory requirements and
restrictions that do not apply to for-profit health plans. Some not-for-profit organizations
convert to for-profit status or align with for-profit companies as a way to change the
overall governance or strategic focus of the organization.

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If a not-for-profit entity is converting to for-profit status, regulators in some states attempt

to apply a to apply a public benefit or charitable trust obligation and determine whether
(1) the sale price represents fair market value for the assets sold, and (2) the sale
proceeds will be used for charitable purposes. In some cases, the selling health plan
may be required to use its assets to establish a charitable foundation for a related
healthcare purpose such as provision of free medical care for residents in the
community.

If a not-for-profit health plan enters into a "for-profit type" transaction that might impact
its status as a not-for-profit entity, then the state Attorney General or the courts may
have to determine if the assets are being applied in a manner consistent with the
organization's stated purpose. Conversion activities raise concerns that the not-for-profit
entity is taking funds generated for charitable or social welfare purposes and putting
them into for-profit ventures that benefit individual owner-investors. For example, if a not-
for-profit health plan participates in a joint venture with a for-profit health plan, this might
raise questions about its ability to continue to fulfill its not-for-profit obligations. Such
participation might also raise questions about how the joint venture contributions made
by the not-for-profit organization will be used.

In some states, the Attorney General has the responsibility and authority to ensure that
any corporate transactions a not-for-profit organization undertakes or enters into are in
accordance with the organization's stated purpose. Some state Attorneys General, as
well as public interest groups, have attempted to either block not-for-profit transactions
or change the terms of the transactions. In effect, the states and public advocates,
through the court system, are attempting to become involved in the governance of not-
for-profit healthcare organizations, such as hospital systems and health plans. Figure
3A-3 lists some common issues that have arisen concerning not-for-profit transactions.

Figure 3A-3 Common Issues Concerning Not-for-Profit Transactions.

 Some states are concerned that not-for-profit entities are proceeding with conversions
to for-profit status without seriously considering other alternatives to the transaction
which might allow the entity to retain its not-for-profit status.
 Some Attorneys General want to require the not-for-profit organization to obtain a
court approval prior to proceeding with a transaction that could affect any not-for-profit
assets that are "impressed with a charitable trust." In other states, a court approval is
clearly required. For example, New York not-for-profit corporation law requires a court
order to authorize selling all or substantially all of the assets of a not-for-profit
corporation.
 A not-for-profit entity may be required to establish a charitable foundation with
certain of its public assets, or to donate those assets to an existing charitable foundation.
Several questions have been raised with regard to the transfer of assets to foundations. Is
the foundation's mission close enough to the not-for-profit entity's stated purpose? Is the
foundation far enough removed from the newly established for-profit entity? Is the not-
for-profit company undervaluing its assets, thereby donating less than fair market value
to the foundation?
 States are concerned that a transaction might result in personal financial gain for
directors or officers of the not-for-profit company. As we have seen, not-for-profit assets
cannot be used for individual gain.

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 Some Attorneys General have instituted court action when a not-for-profit entity
failed to respond in a timely or thorough manner to requests for information about a
transaction. Attorneys general also have expressed concern when a not-for-profit entity
failed to disclose the proposed transaction to the public.

In most states, HMO laws are silent on the subject of not-for-profit conversions. As of the
date of this writing, no jurisdictions, other than those that prohibit for-profit HMOs, have
proposed or enacted an outright ban on not-for-profit to for-profit conversions. However,
several jurisdictions have instituted or are considering closer regulatory scrutiny of health
plan conversions. In addition, the National Association of Insurance Commissioners
(NAIC) has focused on this issue, as have some federal legislators.

The type of legislation or proposed legislation governing conversions that has been
developed at the state level requires the health plan to submit an application to the state
Attorney General, a state agency, or both. This application is then reviewed to determine
that the transaction is in the public interest. In some jurisdictions, actual state approval
would be required for the transaction to proceed; in others, if the state does not respond
within the specified timeframe, the transaction would be deemed approved. 9

There is no consensus as to how to regulate not-for-profit transactions or even who

should regulate them. In a number of states, Attorneys General have not addressed
these transactions because they have taken the position that the laws in their states do
not give them authority to do so. Some analysts recommend federal legislation to
address this issue, but it appears federal legislation is not likely any time soon.

Insight 3A-2 provides an example of a not-for-profit transaction that illustrates several of

the issues discussed in this lesson.

Case Study: Not-for-Profit Conversions and Community Benefit

Insight 3A-2.
Issues.

In 1993, Blue Cross of California, a not-for-profit company, restructured itself to transfer

substantially all of its assets to a newly formed for-profit subsidiary, WellPoint Health
Networks. WellPoint includes both Blue Cross' HMO and its preferred provider network.
Blue Cross then raised $517 million when it sold a nearly 20% stake in WellPoint in an
initial public offering. California law required that the corporation converting from not-
for-profit to for-profit status make a financial contribution to charity equal to the value of
its assets. Initially, the California Department of Corporations determined that Blue Cross
would not have to make such payment because WellPoint is controlled by Blue Cross,
which had itself remained not-for-profit. In response, legislation was introduced that, if
enacted, would have required that a restructured not-for-profit public-benefit corporation
not only maintain, but also increase corporate charitable expenditures in proportion to
any increase in assets owned by the corporation. As a result of the introduction of this
legislation, Blue Cross agreed to make charitable contributions of $5 million annually for
the next 20 years. However, in late 1992, the Department of Corporations demanded that
Blue Cross make additional contributions. In an attempt to settle the matter, Blue Cross
of California agreed to donate $100 million in 1994 to healthcare charities and made a
tentative offer of donating a total of $500 million to charity. Source: Hall and Brewbaker, 1-122.

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Reengineering
In a rapidly evolving and increasingly competitive environment, some health plans seek
to improve their performance by changing their internal structures and processes
through corporate reengineering. Reengineering is defined by Michael Hammer and
James Champy as "the fundamental rethinking and radical redesign of business
processes to achieve dramatic improvements in critical, contemporary measures of
performance such as cost, quality, service, and speed." 10

Sometimes, reengineering focuses primarily on corporate structure and internal

organization and staffing; this process is also called reorganization as noted in
Environmental Forces. Often, however, the reengineering process goes beyond
organizational realignment to include a fundamental rethinking of the way the company
does business. In this more comprehensive approach to internal alignment, a health plan
closely evaluates and redesigns its technology, support systems (such as mechanisms
for hiring, training, and communication), competencies (such as the technical and
managerial skills of its employees), and overall work environment and ability to change. 11

In other words,

"Reengineering requires companies to look past existing models, assumptions, and

infrastructures to see the underlying key processes that bring value to the customer.
Cross-functional teams are assembled to ask the following question of each process:
'Would we do it this way if we could start from scratch tomorrow?' If the answer is no, the
process is a candidate for reengineering . . . The most successful health plans have
used the concepts of reengineering to establish large-scale, highly flexible, integrated
organizations that operate with a uniform set of work practices and information systems,
significantly lowering transaction costs. These centralized systems could not have been
created from existing systems that were built according to outmoded market
assumptions."

Typically, the reengineering process focuses on outcomes and results, rather than
specific tasks. For example, when looking at how to handle new business for group
purchasers, a health plan would not organize its reengineering process around separate
tasks performed for the purchaser by various departments. Instead, it would focus on the
specific items and services that are delivered to the purchaser (such as information kits,
premium notices, the group contract, and member booklets) and seek to find the most
effective ways to provide these "deliverables" to the customer. For example, the health
plan might decide to assign an employee to each new purchaser; this employee's job
would be to coordinate interdepartmental activities and to supply the various areas with
the information needed to produce the "deliverables" quickly and accurately.

Reengineering can result in restructuring of departments and job responsibilities,

consolidation and closing of work sites, or withdrawal from geographic markets or lines
of business. A health plan might decide to focus on its "core businesses" by investing
time, effort, and funds on what they do best. Or a health plan might decide that
environmental and competitive pressures require a focus on new markets and new lines
of business. One health plan might then embark on a reengineering process to develop
the required competencies from within. Another health plan might pursue a strategy that
involves an alliance with another company, and then utilize corporate reengineering to
combine the existing structures and operations of the previously separate entities into a
single organization.

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Corporate Transactions
In the first part of this lesson, we have seen how health plans change corporate structure
to respond to environmental factors and to improve performance. In this section, we
describe how health plans, for many of the same reasons, pursue corporate transactions
with other companies. Here are some examples of what health plans frequently hope to
gain from these transactions.

 An alliance with a well-financed company might enable a health plan to (1) meet the
demands of intense competition for capital and (2) invest this capital in key operational
and technological improvements to attract customers and generate revenue.
 A health plan can improve its overall financial strength and stability through an
effective alliance.
 The participants in an alliance can improve their ability to negotiate price with
national suppliers as well as local providers by delivering increased volume.
 If the participants are in different lines of business, they can diversify risk and be less
likely to suffer catastrophic loss in the event of a market downturn.
 Health plans can mesh geographical markets to obtain a broader presence. For
instance, one health plan might be well established in the east; the other might be well
established in the west. A combined broader geographical presence might generate
increased business with national employers that seek a single health plan for all of their
locations.
 Two health plans together might establish a more prominent position in a particular
market where each has been unable to make inroads on its own.
 Health plans can mesh product strengths and weaknesses to obtain a stronger product
mix. For example, one health plan might be strong in group HMO products, the other
might be strong in managed workers' compensation programs.
 The participants might have provider networks that effectively complement each
other and offer greater choice to members. For instance, one might have a strong primary
care physician panel, the other might have a strong specialist panel.
 An alliance can help obtain economies of scale to reduce operating expense.
 The participants might have functional strengths and weaknesses that complement
one another. For example, one might be proficient in marketing, claims, and member
services; the other might be proficient in provider contracting, provider relations, and
medical management.
 The participants might combine resources to make improvements in functions such as
medical management or marketing. For instance, they might combine their medical
outcomes databases to obtain a substantially larger pool of information; or they might
combine their marketing survey data to obtain similar advantages.

Strategic Partnerships and Joint Ventures

In the course of doing business, all health plans conduct basic corporate transactions.
For example, through aggressive sourcing, health plans seek to obtain the best deals
from various vendors for equipment, supplies, and services such as telephones,
overnight mail, computer hardware and software, and copy machines. 12

Some health plans also choose to contract with vendors who provide specific functions
that would otherwise be performed in-house, such as paying claims. This type of

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corporate transaction, called outsourcing, typically requires more of an emphasis on

managing relationships and customizing processes than does aggressive sourcing. 13

Review Question

In the course of doing business, health plans conduct basic corporate transactions. For
example, when a health plan engages in the corporate transaction known as aggressive
sourcing, the health plan

chooses to contract with vendors who provide specific functions that would
otherwise be performed in-house, such as paying claims
seeks to obtain the best deals from various vendors for equipment, supplies, and
services such as telephones, overnight mail, computer hardware and software,
and copy machines
merges with one or more companies to form an entirely new company
joins with one or more companies, but retains its autonomy and relies on the other
companies to perform specific functions

Incorrect. Outsourcing is when the health plan chooses to contract with vendors
who provide specific functions that would otherwise be performed in-house, such
as paying claims.

Correct. Aggressive sourcing is when the health plan seeks to obtain the best
deals from various vendors for equipment, supplies, and services such as
telephones, overnight mail, computer hardware and software, and copy machines.

Incorrect. A consolidation is when the health plan merges with one or more
companies to form an entirely new company.

Incorrect. A stratgic partnership is when the health plan joins with one or more
companies, but retains its autonomy and relies on the other companies to perform
specific functions.

Another type of corporate transaction, which can be viewed as more reciprocal in nature
than either aggressive sourcing or outsourcing, is the strategic partnership. For the
purpose of this course, we use the term strategic partnership to mean an alliance
between two or more entities that are not directly involved in the other entities'
operations. Firms that enter into a strategic partnership often do not want to merge
operations with or acquire other companies. In fact, a strategic partnership is not the
same as the legal form of partnership we discussed in Legal Organization of Health
Plans.

Even though the participants in a strategic partnership are not directly involved in each
other's operations, the companies typically operate in accordance with a contract or
letter agreement. Rather than enter into a full-fledged joint venture (see below), the

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entities elect to retain their autonomy and enter into an arrangement in which they rely
upon each other for the specific functions needed.

For example, a physician-hospital organization might enter into a strategic partnership

with a management consulting company to gain the expertise needed to help bring a
new Medicare health plan product to market. Or an insurer might enter into a strategic
partnership with a hospital-physician network to develop a preferred provider
organization. We will take a closer look at specific health plan structures and
arrangements such as these in Health Plan Structures and Arrangements.

In a joint venture, a company is formed, owned, and operated by two or more entities
as a separate business or project for the mutual benefit of the participating entities.
Often, a joint venture is formed to share the risks and rewards in developing a new
product or entering a new market location, and the joint venture participants possess
resources and expertise that complement one another. In most joint ventures, a contract
spells out how each joint venture partner participates in the overall management and
operations of the venture. One joint venture partner may contribute more to the
operation of the venture or may have a greater economic interest in the venture than the
others; however, the arrangement is still considered a joint venture as long as no single
partner actually controls the venture. Often, the board of directors consists of an equal
number of representatives from each of the participating entities.

A national health plan and a local hospital system, which operates its own health plan
network, might enter a joint venture in which they share ownership of a newly created
health plan operation. The primary objective for the hospital system might be to shift its
focus back to hospital operations, while still obtaining patients from the health plan. The
primary objective for the health plan might be to gain market share in a geographical
area where in the past it has been unable to compete effectively. Eventually, the health
plan might buy the hospital system's share of the joint venture, or the companies might
merge some or all of their operations. The governance structure for the joint venture
would be described in an agreement that specifies the rights and responsibilities of the
participants, such as the percentage of the venture that each party owns, the
organizational structure, and the decision-making/approval process.

In an environment of constant change, strategic partnerships and joint ventures offer a

flexible and cost-efficient way of doing business. An entity can move quickly into a new
and potentially profitable endeavor without altering its legal form.

Acquisitions and Mergers

An acquisition occurs when one company purchases a controlling interest in another
company. Ownership of more than 50% of the stock generally gives the purchaser a
controlling interest. Practical control of a company's operations can take place with as
little as 10% of a company's stock, if the remaining stock is widely distributed. 14

One type of acquisition is called a stock purchase. In a stock purchase, a company

acquires 100% of the voting shares of another company's stock, thereby making the
acquired company a wholly owned subsidiary. All of the assets and liabilities of the
subsidiary, including those that were incurred prior to but not yet realized on the date of
the transaction, remain with the acquired subsidiary. 15

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Another type of acquisition is called an asset purchase. In an asset purchase a

company acquires all or certain operating assets of another company. The acquisition
agreement identifies the assets to be acquired and typically spells out any associated
liabilities that would be transferred. An asset purchase can be used when a for-profit
company acquires a business from a not-for-profit entity or a mutual company. It can
also be used when the company being acquired would otherwise carry with it substantial
liabilities such as financial problems or potential regulatory or legal problems.16

Review Question

In the paragraph below, a statement contains two pairs of terms enclosed in

parentheses. Determine which term in each pair correctly completes the statement.
Then select the answer choice containing the two terms that you have chosen.

One type of acquisition is called a stock purchase. In a typical stock purchase, a

company acquires (51% / 100%) of the voting shares of another company's stock,
thereby making the acquired company a subsidiary. The (acquired / acquiring) company
holds all of the assets and liabilities of the acquired company.

51% / acquired
51% / acquiring
100% / acquired
100% / acquiring

Incorrect. In a stock purchase, the acquired company becomes a wholey owned

subsidiary and retains all its assets and liabilities

Incorrect. In a stock purchase, the acquired company becomes a wholey owned

subsidiary, and the aquiring company does not take over the the assets and
liabilities of the aquired company

Correct. In a typical stock purchase, a company acquires 100% of the voting

shares of another company's stock, thereby making the acquired company a
subsidiary. The acquired company holds all of the assets and liabilities of the
acquired company.

Incorrect. While the company acquires 100% of the voting shares of another
company's stock, the aquiring company does not take over the the assets and
liabilities of the aquired company.

A merger occurs when two or more entities decide to pool their resources to form a
single legal entity. A merger can be transacted in any of a number of ways. For example,
one of the entities can merge into the other, or one of the entities can merge into a new
subsidiary formed by the acquiring entity. Frequently, the acquiring entity forms a new
subsidiary, which it then merges into the entity being acquired, leaving the acquired

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entity as the surviving entity in the merger. By having the acquired company survive as a
legal entity, the acquiring company can sometimes avoid requirements for obtaining new
licenses or other government approvals. When two or more companies merge to form
17

an entirely new company, and the original companies are dissolved, this type of
transaction is called a consolidation.

Because acquisitions and mergers are complex transactions that have the potential to
generate substantial financial and legal risks, health plans typically perform a due
diligence investigation before proceeding. When performing due diligence, a health
plan carefully examines a number of issues, such as potential transferred liabilities and
tax and accounting implications, that may determine the type of transaction and how it is
structured.

Besides conducting a due diligence investigation to minimize legal and financial risks, a
health plan also carefully considers whether a proposed corporate transaction actually
meets a strategic or business need. If the answer is yes and the health plan proceeds
with the transaction, then it is equally important for the health plan to perform effective
post-transaction management. Insight 3A-3 illustrates these points.

Insight 3A-3. Effective Corporate Transactions.

Consolidation in the health plan industry can create value. Yet evidence from the
healthcare marketplace and experience in other industries demonstrate that the chances of
gaining real value from a merger or acquisition are low unless firms pay careful attention
to why and how they pursue business combinations.

Specifically, effective merger management requires the ability to identify merger or

acquisition opportunities that fit a real strategic need and create economic value. This
means determining the real value of the merger or acquisition and not getting caught up
in the "chase" that allows the "purchase price" to reach astronomical levels that
exclusively benefit the acquired company's shareholders.

The second requirement for success is the ability to ensure that once the merger or
acquisition is consummated, strategic and economic value is captured through rigorous
post-transaction management. It is these two skills that are separating the winners from
the losers as health plan industry consolidation continues.

As in any other industry, a health plan company must evaluate a business combination
with a real eye to clarity of purpose and a hardheaded approach to determining the real
value of the merger.

The chance of gaining real value from a merger or an acquisition declines precipitously
when companies do not have a clear economic and strategic rationale for the deal. Thus,
merging companies need to systematically determine the actual value of each potential
synergy so that they can be very sure of not overpaying and then plan sufficiently for how
to capture the value through the post-merger integration process.

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Even management teams that have a good rationale for their business combination often
fail to capture the identified value after the merger has been consummated. This reflects a
fundamental axiom of mergers and acquisitions: Identifying synergy potential is a lot
easier than realizing it.

Those who have been most successful have done three things very well. They have:

(1) Planned for the integration and management of the merger or acquisition well before
the ink dried on the "deal" papers

(2) Moved quickly to achieve savings, focusing first on the administrative savings and
medical cost management areas. These savings include integrating the best approach in
the local markets where the networks overlap or leveraging lower HMO-negotiated
provider rates for such other products as their PPO

(3) Not let the merger or acquisition distract them from their growth agendas and the
value that can be created beyond the basic synergies. The successful mergers are
encouraging efforts on the "top-line" as well as the "bottom-line." Too often when a
merger occurs, executives focus exclusively on bottom-line savings and lose sight of how
much of the strategic and economic rationale for the merger was due to new revenue that
could be achieved by the merged entity (top-line growth)
Source: Vivian Riefberg, Susan Stock, and Cyrus Taraporevala, "Getting the Most from Your Health Plan Merger," Health Plan Week
(February 23, 1998): 6-7.

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Chapter 3 B

Health Plan Structures and Arrangements

After completing this lesson, you should be able to:

 Identify and describe the various types of sponsors of health plans

 Discuss the objectives of providers in health plan structures and arrangements
 Discuss the impact of changes in health plan structures and arrangements on
regulation
 Differentiate between horizontal, vertical, and conglomerate integration
 Differentiate between structural, virtual, and operational integration
 Explain how strategic, marketplace, and regulatory issues can shape health plan
structures and arrangements
 Describe various arrangements employers use to provide healthcare benefit plans for
their employees

In the United States today, as many as a million separate entities may be participating in
healthcare and health plans. This number includes organizations such as hospitals,
other healthcare institutions, various providers and provider groups, practice
management firms, manufacturers and suppliers, insurers, specialty health plans, PPOs,
and HMOs. As Charles G. Benda and Fay A. Rozovsky describe it:
1

"The phrase "managed health care" or "health plan" has been used in a variety of ways
and applied to a variety of organizations and activities. In the past, the term "health plan"
was often associated with a type of organization known as a health maintenance
organization or HMO. Currently, the term "health plan" has become a veritable circus
tent under which numerous and quite different organizational animals reside. Some
organizations, such as utilization review firms, do not deliver any type of care but their
activities are usually considered fundamental to health plans. Other organizations, such
as physician provider groups, appear to the patient to be delivering services in a manner
identical to that used in the past even though they may be sharing in the insurance risk
traditionally borne exclusively by insurance companies. In addition, there is a whole
assortment of health plans going under such acronyms as PPO, IPA, PHO, POS, and
the like.

Health plans are best understood as the result of a whole constellation of changes in
health care delivery, management, and financing. These changes have spawned a
variety of organizations and approaches, as businesses and professionals respond to
the changes and adapt to the new health care environment. . . Absent any government-
mandated approach that locks a particular program or structure into place, (these
changes) and the resulting variety of organizational forms (are) likely to continue."

A new type of health plan might appear when an unmet need is identified in the
marketplace. As the market changes, a health plan may decide to build upon a time-
tested strategy or to try something new, perhaps borrowing concepts from a number of
successful models to form a different type of health plan entity. Existing health plans are
constantly looking for new ways to operate and solidify their standing in a very
competitive environment. The participants in the health plan industry pay close attention

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to what succeeds and what doesn't, freely borrowing from one another and sometimes
forming "hybrid" business entities, further blurring the lines of distinction between the
various entities. Insight 3B-1 describes how the variety of health plan structures and
arrangements can impact industry researchers as well as participants.

In this lesson, we examine the variety of structures and arrangements in health plans,
focusing on who sponsors them, how they operate and interrelate, and the regulatory
and governance issues associated with their formation and evolution. Figure 3B-1
provides an overview of several organizational arrangements that have emerged to
address the changes, challenges, and opportunities in the healthcare environment.

Insight 3B-1. A Government Agency's Research Agenda for Health Plans.

Probably the greatest challenge to research on health plan is the fact that market realities
have evolved far more quickly than has our ability as researchers to conceptualize and
classify them. As a result, it is not clear how to isolate and measure those features of the
complex new healthcare organizations that are likely to be most important to use of
services, customer satisfaction, health status, or costs. The old alphabet soup
configurations of HMOs, IPAs, PHOs, and so on no longer do the job, but no generally
accepted alternative framework has emerged. To address this issue, the Agency for
Health Care Policy and Research (AHCPR) has been leading and encouraging the
development of new conceptual frameworks for analyzing the configuration, operation,
and impact of emerging health organizations and markets.
Source: Irene Fraser, "Research Agenda for Health Plans," U.S. Department of Health and Human Services, Public Health Service, Agency for
Health Care Policy and Research: 675.

Figure 3B-1. Types of Health Plans.

HMO. A health maintenance organization (HMO) is a system designed to deliver

healthcare to a voluntarily enrolled population in a particular geographic area, usually in
exchange for a fixed, prepaid fee. An HMO brings together the delivery, financing, and
administration of healthcare into a single integrated system.

PPO. A preferred provider organization (PPO) is an organization that offers a

healthcare benefit arrangement designed to supply services at a discounted cost by
providing incentives for members to use network providers, while also providing more
limited coverage for services rendered by providers who are not part of the PPO network.
Sometimes the product is called a preferred provider arrangement (PPA) to differentiate it
from the organization that offers it.

EPO. An exclusive provider organization (EPO), as its name suggests, only covers
healthcare rendered by participating providers, and does not cover most healthcare
rendered by nonparticipating providers. Typically, an EPO, as opposed to an HMO, is
regulated by state insurance laws and is subject to fewer licensing requirements.

Specialty health plans. A specialty health plan is an organization that uses an HMO or
PPO model to provide healthcare services to a subset or single specialty of medical care.

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Many states require a licensed HMO to provide a comprehensive set of services and
supplies. Some states regulate the establishment of single-service HMOs, such as dental
HMOs. Other states do not permit single-service HMOs, although organizers do have
other options for offering health plan specialty services, such as dental PPOs and dental
POS plans.

Utilization Review Organization. A utilization review organization (URO) is an

organization that conducts utilization review activities for health plans and purchasers. A
URO may offer medical cost management services in any number of areas, such as
inpatient review, outpatient review, and case management of high-risk conditions. Some
UROs have expanded their services to include additional functions, such as claims
administration, provider contracting, provider credentialing, medical outcomes
measurement, member satisfaction surveys, and plan design consulting.

Third party administrator. A third party administrator (TPA) contracts with insurers,
health plans, or employers to provide services to help administer healthcare benefits.
Because TPAs often perform insurance-like functions, such as claims administration,
they are regulated by the insurance department in many states.

At-risk provider organization. Broadly speaking, an at-risk provider organization, also

called a provider sponsored organization (PSO), also called a physician-owned
organization or provider-owned organization, is a health plan entered into or established
by providers to arrange for the delivery, financing, and administration of healthcare.
PSOs are often formed as a result of a state authorizing an alternative to securing an
HMO license. Typically, PSOs are subject to less rigorous solvency and licensing
requirements than HMOs, although regulators are considering changing these
requirements. The Medicare PSO, a specific type of PSO, is an entity entered into or
established by providers who deliver a substantial proportion of services under a
Medicare+Choice contract; these providers share substantial financial risk and have at
least a majority financial interest in the entity.

Independent practice association. An independent practice association (IPA) is an

association of individual physicians (or physicians in small group practices) that contracts
with a health plan to provide healthcare services.

Physician-hospital organization. A physician-hospital organization (PHO) is

structurally much the same as an IPA, except that it includes a hospital. The primary
purpose of a PHO is to contract with other health plans, payors, and purchasers on behalf
of its participating hospitals and medical practices.

Management service organization. A management service organization (MSO) is a

legal entity that provides a variety of management and administrative services for
participating physicians' practices. These services may include centralized purchasing,
administrative support, marketing, and practice management. With regard to these
primary functions, an MSO is similar to a physician practice management company (see
next item). Some MSOs have begun negotiating contracts with payors. For the most part,

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however, the MSO focuses on the "back office" (i.e., the administrative functions) to free
the physicians to focus on the clinical aspects of healthcare.

Physician practice management company. A physician practice management (PPM)

company is a legal entity that provides a variety of management and administrative
services for participating physicians' practices. Typically, a PPM accomplishes this by
purchasing the assets of the practices and entering into long-term contracts with those
physicians, often supplying capital for improving and expanding existing assets. The
services they provide may include centralized purchasing, administrative support,
marketing, practice management, and contract negotiations. Some PPMs perform payer
and utilization review/quality management functions; others have acquired HMOs.

Integrated delivery system. An integrated delivery system (IDS) is a combination of two

or more legally affiliated health plans, group practices, clinics, or hospitals that combine
their assets, efforts, risks, and rewards to deliver comprehensive healthcare and, in certain
instances, to arrange for the financing and administration of that care.

Medical foundation. A medical foundation is an entity that owns and manages all
purchased assets of physicians' practices. However, unlike an MSO or PPM, a medical
foundation is organized as a not-for-profit entity, rather than a partnership, professional
corporation, or other for-profit entity. A similar entity, the medical foundation IDS,
integrates a hospital and a tax-exempt physician practice, thereby producing tax-exempt
status for this organization as well. Typically, a medical foundation IDS consists of a
holding company and two not-for-profit subsidiaries: a hospital, and a medical
foundation. The medical foundation (not the holding company or hospital) enters into
contracts with payors and receives the negotiated fees.

Academic medical center. An academic medical center (AMC), also known as an

academic health center (AHC) is an institution that trains healthcare professionals and
performs basic and clinical research. In addition, because AMCs receive government
funding, they are required to provide medical care for the poor.

Cooperative. A cooperative, sometimes called a healthcare cooperative or a rural

cooperative, is a consumer-sponsored, physician-operated medical facility that provides
prepaid healthcare to members.

Community health center. A community health center (CHC) is a medical facility,

typically located in an inner city or a rural site, that receives federal, state, and often
private grant funding to provide primary care for medically underserved populations,
such as Medicaid recipients, Medicare recipients, or individuals who do not have health
coverage. The federal government first provided grants to establish these programs in the
1960s, at which time they were called neighborhood health centers, and then expanded
them to include rural areas, migrant farm workers, and homeless individuals.

The System in Health Plans

Despite the variety of participants in health plans, every entity we examine is involved in

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one or more functions comprising a system that delivers, finances, and administers
healthcare.

This system coordinates and manages a set of complex tasks or businesses that have a
well-established history of operating independently. When fee-for-service, third party
payment was prevalent, healthcare delivery and financing were at best only loosely
coordinated, and sometimes were at odds with each other because of different
perceived missions. Providers delivered healthcare. Insurers designed and administered
benefit plans that paid the healthcare bills. Both groups went about their business
separately, focusing on their particular areas of interest with limited coordination
between them.

Health plans brings together virtually the whole range of services that, in the indemnity
environment, were performed by separate businesses and professionals. The goal of
health plans is to streamline operations by integrating hospitals, physicians, various
other facilities and providers, payors, and administrators so that the various participants
can effectively share information, produce economies of scale, and provide continuity of
care- thereby improving quality, increasing access, and reducing cost.

The expertise required to operate a successful hospital or physician practice is

completely different from the expertise required to operate a successful insurance
company. Yet in health plans, these highly complex and diverse functions must work
together. What makes this an even greater challenge is the need for healthcare
professionals, who have a strong sense of autonomy of professional judgment, to buy in
to the health plan system. Thus, this system must combine "a collegium of professionals-
highly trained scientists delivering intimate human service- and a business- competitive,
entrepreneurial, preoccupied with the 'bottom line,' and therefore absorbed in all the
traditional problems of hierarchical organization of corporate authority. Both elements
must somehow be made to mesh." 2

The Role of Sponsors in Health Plans

A key factor in the development of health plans is how they are sponsored. A sponsor,
in this context, means an organization or group of individuals that pays for or plans and
carries out a health plan endeavor. Over the years, health plans have been established
or funded by many different kinds of sponsors. Figure 3B-2 shows the most common
types of sponsors in health plans. The presence of sponsors and the "depth of their
pockets" can play a major role in both the number of health plans that are established
and the mission of those health plans.

Although some sponsors view their participation primarily as an investment opportunity,

as is the case with investor groups, the motivation behind sponsorship often goes
beyond finances. The purpose of sponsorship might be to:

1. Improve the accessibility of health service in a local community

2. Control rising costs for health benefit plans
3. Achieve public policy goals
4. Compete effectively with other business entities

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For example, employers concerned about the cost of purchasing healthcare coverage
for their employees might consider sponsoring a health plan as a way to gain more
control over expenses. Insurance companies might see sponsorship of a health plan as
a relatively quick way to stay competitive in a rapidly changing environment. The federal
government or a state or municipal government might view sponsorship of health plans
as a way to meet a public policy need for affordable, accessible, quality healthcare.

Figure 3B-2. Sponsors in Manage Care.

Investor Groups
Government
Employers
Labor Unions
Consumer Groups
Insurance Companies and Blue Cross and Blue Shield Plans
Medical Schools and Universities
Hospital and Physician Groups
Other Health Plans

Types of Sponsors
In this lesson, we offer a brief overview of various types of sponsors.

1. Investor groups
2. Government
3. Employers
4. Labor Unions
5. Consumer Groups
6. Insurance Companies
7. Medical Schools and Universities
8. Hospital and Physician Groups
9. Other Health Plans

Investor groups.

Investors can invest in any type of health plan except a not-for-profit company or a
mutual company. Private sponsors have been a part of the health plan landscape since the
late 1970s and early 1980s when the federal government first began to encourage private
investment in HMOs. Various types of entities in the health plan industry continue to
obtain funds through investors. These include hospitals, physician groups, physician-
hospital organizations, physician practice management companies, HMOs, PPOs, and
insurers.

Government.

Over the years, municipal, state, and federal government entities have sponsored health
plans, sometimes directly founding health plans, sometimes playing a significant role as a

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purchaser or regulator. For example, the municipal government of New York established
the Health Insurance Plan of Greater New York (HIP), largely as an effort to put in place
a prepaid plan for city employees. Many of the HMOs for Medicaid recipients came
about largely as a result of state funding and initiatives to incorporate health plan into
Medicaid programs. And through the HMO Act, the federal government has played a
major role in the evolution of HMOs in many areas of the country.3

Employers.

Many employers pay a substantial portion of the cost of healthcare for their employees.
Consequently, they have a major financial stake in the system. Making premium
payments, however, does not constitute direct sponsorship of an insurance or health plan
organization. Sponsorship arises when employers accept the financial risk of providing
healthcare coverage for their employees. Often employers take on this risk by entering
into contractual arrangements with insurers, TPAs, or health plans for use of networks
and administrative services, or when employers, either on their own or through coalitions,
contract directly with providers. A well-known example of an employer-sponsored health
plan is the Kaiser Foundation health plans, established in 1937 when Kaiser, a
construction company, sought to finance medical care via a prepaid plan for its
employees working on a project in the southern California desert. Other employers, while
not sponsors of health plan entities, remain a major influence in the healthcare market by
participating in healthcare coalitions that contract with health plans or by contracting
directly with providers.

Labor Unions.

Labor unions today are not major sponsors of health plans; however, there was a time
when labor and cooperative movements were a driving force behind the establishment of
prepaid plans. The medical cooperative at Elk City, Oklahoma, was founded in the late
1920s with the support of the Farmers' Union. In the past, labor sponsored prepaid plans
in St. Louis, Detroit, and Providence.4

Consumer Groups.

Sometimes healthcare consumers decide to pool resources and form a health plan
organization for their mutual benefit. Members founded several early HMOs, sometimes
requiring that the governing board be comprised of a specified number or percentage of
consumer members. A well-known example of a consumer-sponsored health plan is the
Group Health Cooperative of Puget Sound, established in 1947 by consumers in Seattle
who organized 400 families, each of which contributed $100, to sponsor this group.

Insurance Companies.

Insurance companies, including Blue Cross and Blue Shield Plans and commercial
insurers, are major sponsors of health plans. These entities began sponsoring HMOs in
the late 1960s and early 1970s when public policymakers were considering a national

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health insurance program that might bypass or eliminate indemnity health insurance
plans. Insurers soon found other reasons to continue sponsoring health plans. For
instance, as healthcare costs rapidly rose, insurers saw health plans as a way to help
control costs for both their health plan and indemnity products. They also saw advantages
in diversifying their healthcare product portfolio. And, of course, they considered the
sponsorship of health plans to be a profitable business venture in its own right. 5

Medical Schools and Universities.

Universities with medical schools, a form of the academic medical centers (AMCs)
discussed earlier, must maintain a sufficient patient base to remain in operation. One way
they can do this is by sponsoring a health plan. For example, QualChoice of Arkansas,
Inc., is a health plan that is sponsored by Tenet Health Systems and the University of
Arkansas for Medical Sciences.

Hospital and Physician Groups.

Historically, when an HMO or other type of health plan was established in an area,
hospitals and/or fee-for-service physicians responded by sponsoring similar
organizations. Providers have formed some community health plans and Blue Cross and
Blue Shield Plans. Hospital and physician groups have established various types of
partnerships to sponsor health plans. Providers also sponsor health plans through
alliances with other types of entities. For example, in the 1970s, Rush Presbyterian
Hospital in Chicago started a group practice HMO, and in the 1990s became 50% owner
in the Rush Prudential Health Plan, a joint venture with Prudential. In addition, new types
of entities, such as physician practice management companies, have emerged, some of
which have gone on to sponsor health plan arrangements. In the past, activities such as
these have taken place mostly on a local basis, although multistate corporations and
physician practice management companies have recently begun sponsoring health plan
arrangements. Physicians and hospitals can also play a key role in the funding and
governance of health plans without actually acting as sponsors. For example, some
nonprovider sponsors of health plans may offer physicians or hospitals an ownership
interest in the health plan.

Other health plans.

Health plans are often sponsored by the expansion activities of existing health plans. For
example, a large, multistate HMO operating successfully in one region of the country
might establish, merge with, or acquire an HMO in another region.

Providers and Health Plan Structures and Arrangements

In Formation and Structure of Health Plans, we examined several factors that have
driven the restructuring initiatives and corporate transactions in health plans. In this
section, we look at another primary driver of change in health plans, the relationship-
strategic, financial, and operational-between health plans and providers. As Mark Hall
and William Brewbaker describe it,

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"The days of the free-standing hospital and the solo practitioner may soon be no more.
Significant pressures are transforming our traditional system of small, independent
professional practices and facilities into a competitive marketplace dominated by large
businesses consisting of hospitals, physicians, and other entities that have bonded
together to deliver broad regional health care services. The consolidation of the health
care delivery system in the United States has been brought about by a number of
important forces. Among the most significant have been the increasing attention given to
health care cost containment by employers (through whom most private health
insurance is purchased) and the simultaneous development of health plan entities which
blend health care delivery and finance. . . As more patients (and employers) have begun
buying their health care coverage through health plans that combine the delivery and
finance functions, the pressure on hospitals and physicians to join integrated networks
has intensified greatly."

Through consolidation and strategic alliances, hospitals and physicians seek a number
of competitive advantages. For example, many hospitals pursue alliances to access
health plan contracts and thereby reduce excess capacity of hospital beds, or to obtain
capital for investments in information management systems. Physicians often pursue
alliances to acquire leverage in negotiating with health plans. They can obtain access to
management expertise, advanced information systems, and nurse practitioners and
physician's assistants. Physicians can significantly reduce the cost and administrative
burden of operating a small practice by relying upon others to manage functions such as
tracking and registering patients, obtaining treatment approvals, and providing encounter
data. In addition, both hospitals and physicians are increasingly willing to accept a
6

portion of healthcare financing risk as a means of obtaining greater involvement in

developing and implementing medical management goals and decisions. Figure 3B-3
further explores these and other factors that have led to consolidation and strategic
alliances in healthcare.

Figure 3B- Factors Contributing to Consolidation and Strategic Alliances in

3. Healthcare.

Health plan contracting. When health plan patients represented a small portion of the
total patient population, providers were not particularly concerned with the impact of
health plan arrangements; from the providers' perspective, health plan patients brought a
slight increase in patient volume, but were not critical to maintaining a healthcare
practice. Today, providers that do not participate in health plan networks find it
increasingly difficult to market their services to an adequate volume of patients.
Consolidation and strategic alliances ease the burden of evaluating and entering into
contractual relationships.

Administrative complexity. Providers are less inclined or able to handle increasingly

complicated administrative functions such as electronic billing and collections from a
variety of payors. Consolidations and strategic alliances offer healthcare providers the
opportunity to access expertise and economies of scale in administrative functions.

Management expertise. Consolidation or strategic alliances enable providers to place

the business side of healthcare management with individuals who are more experienced
in these matters.

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Information technology. Consolidation or strategic alliances enable providers to obtain

access to information technology, which plays an increasingly important role in health
plan arrangements and in effectively linking with other components of the healthcare
delivery system.

Access to capital. Consolidation can provide greater access to capital. For physicians
practicing on their own or in small groups, obtaining operating funds can be difficult. For
hospitals, additional funds can be used for ongoing expenses, construction, and strategic
investments in medical and information technology.

Lifestyle preferences. Many younger physicians prefer a more stable work environment
and the security of working for a large organization.

Increased competition. Changes in the healthcare delivery environment such as the

emergence of ambulatory surgical centers and urgent-care centers have increased
competition, giving healthcare providers an additional reason to consider consolidation or
alliances.

Increased accountability. Providers are less inclined to handle the increasing demands
of quality improvement and utilization review processes. The specialization of functions
available through consolidations and strategic alliances can ease the burdens on
individual providers.

Positioning for the future. Consolidation and strategic alliances better position
providers for whatever lies ahead by enabling them to share skills, resources, expertise,
and strategies to face the unknown future.
Source: Excerpted and adapted from Hall and Brewbaker, 5-8 through 5-10.

Regulatory Issues from the Regulators' Perspective

The changing nature of the organizations and arrangements in the healthcare market is
of great concern to regulators, who monitor developments and formulate regulatory
responses, as necessary, to address their findings. The primary objective is to enhance
competition by accommodating various types of organizations that emerge and evolve,
while also applying relevant consumer protection standards for the benefit of the general
public.Insight 3B-1, from an article published by the Agency for Health Care Policy and
Research, gives an indication of how the variety of health plan structures and
arrangements impacts government agencies that monitor and regulate this rapidly
changing industry.

According to the National Association of Insurance Commissioners (NAIC), when

considering the wide variety of health plans in the market,

"The primary approach used by state insurance regulators is to regulate by function.

Almost all states regulate health plans performing similar functions through the same
laws. A few states have insurance laws that specifically apply to health plans owned or
controlled by providers. Most states do not directly regulate the contracts between health

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plans and providers. States do monitor these arrangements by imposing certain

requirements on the regulated health plan organization.

The states, through individual state initiatives and through the NAIC, are constantly
adapting to an evolving marketplace as part of the state regulatory process. The state's
tools for regulation continue to become more sophisticated. State insurance regulators
are reviewing the range of regulatory issues which have arisen from the growing
dominance of all forms of health plans in the health insurance market. In their review,
states focus on the insurance function performed. The development of a risk-based
capital formula (discussed in State Regulation of Health Plans) for health plans based on
the level of risk being assumed by a health plan, and the development of a uniform
licensing law for health organizations assuming insurance risk (also discussed in State
Regulation of Health Plans) are examples of the states' efforts to regulate by function
and adapt to an evolving marketplace." 7

With the emergence of various health plan structures and arrangements, federal and
state regulators have focused on issues such as solvency, quality assurance, benefits,
access to care, and provider contracting.

We examine these and other regulatory issues in greater detail later in this lesson.

Insight 3B-1. A Government Agency's Research Agenda for Health Plans.

Probably the greatest challenge to research on health plan is the fact that market realities
have evolved far more quickly than has our ability as researchers to conceptualize and
classify them. As a result, it is not clear how to isolate and measure those features of the
complex new healthcare organizations that are likely to be most important to use of
services, customer satisfaction, health status, or costs. The old alphabet soup
configurations of HMOs, IPAs, PHOs, and so on no longer do the job, but no generally
accepted alternative framework has emerged. To address this issue, the Agency for
Health Care Policy and Research (AHCPR) has been leading and encouraging the
development of new conceptual frameworks for analyzing the configuration, operation,
and impact of emerging health organizations and markets.
Source: Irene Fraser, "Research Agenda for Health Plans," U.S. Department of Health and Human Services, Public Health Service, Agency for
Health Care Policy and Research: 675.

Regulatory Issues from the Health Plan's Perspective

An existing regulatory framework can result in the evolution of different types of health
plan arrangements. For example, providers may be inclined to establish a PSO in a state
where PSOs are not subject to HMO licensing and solvency requirements. On the other
hand, providers may be more inclined to enter into strategic partnerships with licensed
HMOs in states where PSOs are required to comply with comprehensive HMO licensing
and solvency requirements. Also, as we saw in Legal Organization of Health Plans, laws
such as those relating to corporate practice of medicine and not-for-profit status have an
impact on the type of health plan that can be formed.

Although health plans are largely regulated at the state level, it is important to keep in
mind that federal regulation also plays a significant role in the evolution of health plan

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arrangements. As various entities consolidate, form strategic alliances, and do business

with one another, they must comply with federal laws, regulations, and related court
decisions that impact their business relationships.

Integration and Governance

Health plan structures and arrangements effectively deliver, finance, and administer
healthcare by employing varying degrees of integration. Integration is a combination of
two or more endeavors into a single endeavor that pursues common goals, which results
in previously separate entities sharing the risks and rewards of the combined endeavor.

According to antitrust law, the three basic types of integration are horizontal integration,
vertical integration, and conglomerate integration. Horizontal integration is a
combination of two or more entities in the same business segment that may directly
compete with one another. Examples of horizontal integration include the acquisition of
one HMO by another or a joint venture between two medical groups in the same market.
Vertical integration is a combination of two or more entities in different segments of the
same industry; the entities may be economically related, but they are dissimilar in nature
and do not substantially compete with each other. Examples of vertical integration
include a joint venture between an HMO, a hospital, and a medical group or the merger
of a hospital and a medical group. Conglomerate integration is a combination of
entities that produce unrelated products or services. An example of conglomerate
8

integration is the acquisition of a health plan by a holding company that owns various
types of businesses.

Structural and Virtual Integration

A single organization could integrate within it all the tasks that comprise a
comprehensive health plan system. This organization could own the healthcare facilities,
employ the physicians who provide the care, design the healthcare benefit and funding
arrangements, maintain the funds to pay for all covered healthcare expenses, market the
products and services, and employ the administrative staff responsible for functions such
as calculating and collecting the purchasers' bills, enrolling the members, and issuing
benefit description material.

However, as the health plan business becomes more complex, some health plans are
finding that they cannot excel at everything. As Derek F. Covert describes it,

"Health plans have been spinning off their provider units at a dizzying rate. FHP sold its
hospitals, Foundation Health sold its medical groups, CIGNA sold its medical groups,
and even Kaiser is positioning itself to move out of the hospital business. (It should be
noted that Kaiser does not own its physician groups, although they are very strongly
linked.) These health plans have determined that it is too difficult to effectively operate
both a health plan and a provider organization. The underlying operating principles are
very different, politics create hurdles effecting change, and the alignment of economic
incentives is always a challenge. In most of these transactions, it was determined that in
order for the provider organization to be economically feasible, it had to be able to enter
into agreements with other payors, and see patients other than those aligned with the
sponsoring health plan, which was deemed to be incompatible with the needs of the
health plan."9

Also, when staff model HMOs expand their product offerings to include out-of-network
features or when health plans move quickly to enter new geographic markets, they often

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find it necessary to enter into arrangements with other entities to bring their health plan
products to market. These arrangements and structures are established through the use
of many of the concepts we described in Formation and Structure of Health Plans. For
example, integration could be achieved through a strategic partnership, a joint venture,
an acquisition, or a merger.

Fast Definition

Span of Control an indicator of the number of people or activities being managed.

These different structures and arrangements result in varying degrees of management

control for the sponsors of the business venture. No degree of control is inherently better
or worse than another. Too great a span of control over a disparate, complex set of
functions can hinder effective leadership and management. Too little control can make it
difficult to develop and implement a common vision and strategy with focused business
objectives.

The type of integration that creates the joint ventures, acquisitions, and mergers
presented here and in Formation and Structure of Health Plans is called structural
integration. Structural integration, which can be horizontal, vertical, or conglomerate,
occurs when previously separate businesses create a legal entity that is either a single
organization or a combination of two or more organizations that are under common
ownership and control. 10

Some attempts at integration begin with structural integration. Others, such as strategic
partnerships and outsourcing, do not involve creating a single entity or affiliated
organizations under common ownership and control; instead, these arrangements are
contractual, and the entities remain separate. This type of arrangement is sometimes
called virtual integration.

Operational Integration
No integration process- whether horizontal, vertical, conglomerate, structural, or virtual-
is likely to succeed without operational integration. Operational integration occurs
when the various activities needed to design, sell, administer, and deliver health plans
are consolidated. As the term indicates, this consolidation does not have to be legal in
nature. Thus, recently merged organizations as well as separate business entities can
achieve operational integration. Depending upon the legal relationship between the
participants, operational integration may include joint strategic planning, the
consolidation of management, or the combining or developing of business systems and
processes. The purpose of operational integration is to create a common vision and
goals and to realize efficiencies by identifying and implementing best practices.

Health plans, which are a complex and diverse system of financing, administering, and
delivering healthcare, involves a certain amount of operational integration, whether it is
within a single entity or between separate entities. Greater operational integration is
achieved when an endeavor exhibits these characteristics:

• Operating all lines of business under a consolidated budget

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• Unifying governance and management functions and coordinating all lines of

business
• Coordinating and making compatible all business functions, such as
information systems, accounting, billing, utilization management, and quality
management
• Developing and implementing a common vision and common goals
• Implementing a unified strategic plan and marketing program designed to
further the best interest of the newly integrated organization as expressed in
its common vision and goals 11

The important issue to be decided by a health plan's leaders is not whether to pursue
structural integration or virtual integration, but to focus on how to deliver value to their
customers, and then, through operational integration, establish the structures or
arrangements that best support this focus. Insight 3B-2 illustrates the importance of
strategic focus in health plan arrangements.

Once a health plan's leaders have established objectives, they consider the functions
needed to accomplish those objectives. As part of the process, they might also
determine how critical a role each function plays in achieving the organization's major
strategic goals. The health plan's leaders then assess the organization's competencies
in the various functions compared to the availability and value of obtaining those
services from external sources. Put another way, the health plan's leaders might ask
questions such as these:

• What are we good at?

• What can we access and manage via a strategic partnership or outsourcing?
• Are there any functions that are so critical that we shouldn't depend upon
receiving them from someone outside the organization?
• What should we own and excel at? 12

Insight 3B-2. Strategic Focus in Health Plan Integration.

True integration is difficult to define because it is not an end point; rather, it is a

continuum- an ongoing process that varies with each organization. Consider, for example,
the different approaches of two hypothetical organizations. ABC Integrated Health
System might claim, "We have everything you need in health care- a hospital, physician
practices in various locales, home health services, and an HMO." This statement focuses
on structural integration. Premier XYZ Alliance might say, "Our goal is to provide the
patient with the highest quality health care as conveniently as possible. The patient enters
our system once, and we take care of everything after that."

Ultimately, integration is much more than an organizational chart; it is the result of a

philosophy. Regardless of the specific organizational model involved, true integration
embodies several core cultural attributes and operational approaches. It flows from shared
values and a common purpose that make up the cultural fabric of an organization.

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Sources: Excerpted and adapted from Suzanne T. Anderson, "How Healthcare Organizations Can Achieve True Integration," Healthcare
Financial Management (February 1998): 31-34.

Some health plans encounter difficulties trying to develop and implement effective
integration strategies. Difficulties can arise when a health plan's leaders either
overestimate or underestimate the organization's abilities to perform certain functions.
For example, senior management that has been with an organization for a number of
years might have a bias towards keeping functions "in-house" because "that's how we
built this company." Conversely, senior management that is new to an organization
might have a tendency to outsource or pursue strategic partnerships because these
executives lack familiarity with or confidence in the organization's internal capabilities.
Other factors that can cause problems for a health plan include a tendency for senior
management to simply mirror the latest industry trends, internal systems that support the
status quo, strong resistance from the workforce and middle management, and political
or community resistance. 13

Based on the unique capabilities of the organization and the market in which it operates,
the leaders of a health plan can choose from a virtually limitless mix of structures and
arrangements in pursuing an integration strategy. Each choice requires the organization
to apply a different combination of governance and management expertise and skills.
For example, the decision about how to structure or arrange the medical management
function is completely different from the decision about how to structure or arrange the
marketing function. However, one set of leadership characteristics required for all such
decisions is "the focus, toughness and courage to aggressively attack these issues
without bias, while maintaining the agility to modify structures as market dynamics
change." 14

Review Question

The Tidewater Life and Health Insurance Company is owned by its policy owners, who
are entitled to certain rights as owners of the company, and it issues both participating
and nonparticipating insurance policies. Tidewater is considering converting to the type
of company that is owned by individuals who purchase shares of the company's stock.
Tidewater is incorporated under the laws of Illinois, but it conducts business in the
Canadian provinces of Ontario and Manitoba.

Tidewater established the Diversified Corporation, which then acquired various

subsidiary firms that produce unrelated products and services. Tidewater remains an
independent corporation and continues to own Diversified and the subsidiaries. In order
to create and maintain a common vision and goals among the subsidiaries, the
management of Diversified makes decisions about strategic planning and budgeting for
each of the businesses.

By combining under Diversified a group of businesses that produce unrelated products

and by consolidating the management of the businesses, Tidewater has achieved the
type(s) of integration known as

conglomerate integration and operational integration

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horizontal integration and operational integration

horizontal integration and virtual integration
conglomerate integration only

Correct. Conglomerate integration is a combination of entities that produce

unrelated products or services. Operational integration occurs when the various
activities needed to design, sell, administer, and deliver health plans are
consolidated

Incorrect. While operational integration occurs when the various activities needed
to design, sell, administer, and deliver health plans are consolidated; horizontal
integration is a combination of two or more entities in the same business segment
that may directly compete with one another.

Incorrect. Horizontal integration is a combination of two or more entities in the

same business segment that may directly compete with one another. Vertical
integration is a combination of two or more entities in different segments of the
same industry; the entities may be economically related, but they are dissimilar in
nature and do not substantially compete with each other.

Incorrect. While conglomerate integration is a combination of entities that

produce unrelated products or services, there are other correct answers.

Other Governance and Strategic Issues

The strategic objectives of an organization's sponsors and executives invariably dictate
what type of health plan is formed and the arrangements it enters. For instance, a
hospital (or a joint venture between a hospital and physicians) sometimes sponsors an
MSO as a way to encourage formation of a physician medical group and to strengthen
the relationship between the hospital and physicians. Often the sponsors of an MSO
expect that at some point in the future the medical group will integrate with the hospital
to form an IDS. As a result, they may be willing to take a loss on the MSO venture so
they can realize a strategic gain later.

Historically, healthcare in the United States has been a local industry. In one location,
the bulk of the economic and political power with regard to healthcare issues may reside
with a hospital or a hospital system; in another location, this power may reside with the
physicians. In one area, an HMO may be dominant; in another area, the dominant entity
may be a large employer health plan that covers most of the residents. Or there may be
no single dominant entity. It follows, then, that the types of health plans and
arrangements that evolve in these various locations will vary depending upon the nature
of the market.

Some health plans offer ownership interests to participating providers. Ownership can
establish a strong financial incentive for providers to effectively manage care; it can also
enhance physician loyalty to the health plan. While this strategy can be advantageous to
both the health plan and providers, arrangements such as these are subject to
regulatory scrutiny, in part because of concerns that financial incentives might influence
the type and amount of healthcare services provided.

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The need to respond quickly to market conditions can also influence the form a health
plan takes. For example, a provider group may determine that it needs to enter into a
contract-based arrangement to respond to competition from other types of health plans.
Once it establishes a foothold, it may later decide to enter into a more structurally
integrated approach, such as a PHO or an IDS.

Employer-Sponsored Plans
As we mentioned in our discussion of sponsors, an employer's approach to providing
healthcare benefits for its employees plays a major role in determining the types of
health plan structures and arrangements utilized by health plans. Employers have four
options available to them with regard to structuring healthcare benefit plans for their
employees. They can

1. Purchase an insurance or prepaid product from an insurer or health plan

2. Self-fund a healthcare benefit arrangement and perform all associated
administrative services or obtain those services from an insurer, health plan, or
third party administrator
3. Contract directly with healthcare providers
4. Directly provide some or all of the healthcare services (e.g., employ company
healthcare providers to look after the healthcare needs of employees)

Employers can pursue each of these options (or a combination thereof) on their own or
collectively with other employers. In this section, we examine options 2 and 3, in which
employers move beyond the role of healthcare purchaser but stop short of the role of
healthcare provider. In other words, employers often assume the role of payor or take on
some of the functions typically performed by insurers and prepaid plans.

Self-Funded and Self-Administered Plans

As we discussed in Healthcare Management: An Introduction, self-funding (also called
self-insuring) is a method employers use to provide healthcare benefits to their
employees by funding the cost of the healthcare themselves, rather than through a
payor, such as an insurer or health plan. The employer, rather than the health plan,
assumes the financial risk. Figure 3B-4 shows the percentage of employers who provide
healthcare benefits to their employees through self-funded plans. Most employers that
decide to self-fund do so to improve finances and gain more control of benefit design.

Employers that decide not to self-fund typically do so because of (1) the financial risk of
having to pay for catastrophic healthcare costs and (2) the investment in time, effort, and
financial resources needed to establish a self-funded arrangement. Also, smaller
employers that cannot perform the necessary administrative functions on their own
sometimes find that the cost of contracting for these services eliminates many of the
financial advantages described above.

In a self-funded arrangement, employers use one of two funding vehicles. They either
obtain the funds from their general assets (this is called a nontrusteed plan), or they
use a trust to hold plan reserves. Employers that are concerned about claim fluctuation
or large-amount claims often minimize their financial risk by purchasing stop-loss
insurance. Stop-loss insurance places a dollar limit on the employer's liability for
paying claims. However, some states have maintained that in certain situations a self-

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funded plan with stop-loss insurance constitutes healthcare insurance, subject to state
regulation (see ERISA and Health Plans for more on this subject).

Self-funding
 Enables an employer to obtain immediate access to funds that would otherwise be
tied up in claim reserves held by the insurer or health plan
 Eliminates the need to pay the insurer's or health plan's risk charge, which is the
portion of the premium that is collected to cover the risk that the actual medical costs
might be higher than anticipated
 Has the potential to lower costs because state premium taxes (which may apply to
insured or prepaid plans in some states) do not apply to self-insured plans
 Significantly reduces the number of benefit and rating mandates that apply to the
employer's plan (see next section on ERISA), which means an employer can avoid the
cost of providing mandated benefits, retain control over plan design, and offer a uniform
plan in multiple jurisdictions; also, in a state that requires HMOs to be community rated,
an employer can, in effect, have an experience-rated HMO product

Review Question

The Wentworth Corporation uses a self-funded plan to provide its employees with
healthcare benefits. One consequence of Wentworth's approach to providing healthcare
benefits is that self-funding

requires that Wentworth self-administer its healthcare benefit plan

requires that Wentworth pay higher state premium taxes than do insurers and
health plans

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eliminates the need for Wentworth to pay a risk charge to an insurer or health plan
increases the number of benefit and rating mandates that apply to Wentworth's
plan

Incorrect. Often, an employer handles the administration of the self-funded plan

by hiring an insurer, a health plan, or a third party administrator (TPA) to provide
administrative services under the plan, while financial responsibility for funding
benefit payments remains with the employer.

Incorrect. Self funding has the potential to lower costs because state premium
taxes do not apply to self-insured plans

Correct. Self funding eliminates the need to pay the insurer's or health plan's risk
charge.

Incorrect. Self-funding significantly decreases the number of benefit and rating

mandates that apply to Wentworth's plan.

ERISA's Impact on Self-Funded and Self-Administered Plans

It is difficult to discuss self-funded plans without taking a quick look at the Employee
Retirement Income Security Act of 1974 (ERISA), which governs employee benefit
plans. We will do so here, saving a thorough analysis for ERISA and Health Plans.

ERISA is a federal law that regulates most employment-based health benefit plans, not
just self-funded plans. One effect of ERISA is that it preempts certain state laws with
regard to the regulation of most self-funded plans. In other words, state insurance laws
typically do not apply to self-funded plans. Currently, benefits are left largely unregulated
by ERISA, which gives employers who provide self-funded plans the freedom to design
plans without having to consider requirements that apply to insurance and HMO plans.
In addition, ERISA preempts state laws that allow covered individuals to sue their
employers and/or plan administrators, although the extent and limits of the ERISA
preemption, as interpreted by various court decisions, are not always clear.

ERISA's reach goes far beyond the issue of preemption. However, for the purpose of our
discussion of employer-based plans, one other provision is worthy of note. ERISA
imposes strict requirements on persons who are fiduciaries of employee benefit plans. A
fiduciary is defined under ERISA as a person, regardless of formal title or position, who
exercises discretionary authority and control over the operation or administration of the
plan, exercises any control over plan assets, or renders investment advice for a fee.
Individuals who have fiduciary responsibilities with respect to a self-funded plan and who
breach their trust are subject to personal liability to restore to the plan any resulting
losses and forfeit any profits. Generally, an insurer, health plan, or TPA has fiduciary
responsibility with respect to payment of claims under a self-funded plan, and the
employer has all other fiduciary responsibilities. There are, however, different views as
to which party has fiduciary responsibility for activities related to establishing and
operating a health plan network.

Administration of Self-Funded Plans

Self-funding eliminates or minimizes the employer's need to pay an insurer or health

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plan to assume financial risk. However, the employer must still have a way to administer
the healthcare benefit plan: determine eligibility, enroll members, review and pay claims,
and perform all the other administrative functions typically performed by a health plan.
Often, an employer handles this by hiring an insurer, a health plan, or a third party
administrator (TPA) to provide administrative services under the plan, while financial
responsibility for funding benefit payments remains with the employer. The contract that
describes this arrangement is called an administrative services only (ASO) contract. 15

Some employers choose to self-administer. A self-administered plan is a self-funded

plan that is also administered by the employer. Often a large employer can devote staff
to perform these administrative activities. An employer that self-funds or both self-funds
and self-administers a healthcare benefit plan is performing some or all of the major
functions of an insurer; however, it is not required to be licensed as an insurer or health
plan as long as it performs these functions only for its employees. 16

Self-administration is comparatively simple when the employer is providing an indemnity

health plan. A health plan, on the other hand, involves healthcare management functions
such as provider contracting, utilization review, and medical management, thereby
making the task of self-administration much more daunting and time-consuming.

When an employer decides to contract with a health plan to administer its health plan,
there are a number of ways to establish payment. For example, a health plan may set a
flat monthly fee for services. Or a health plan may identify specific services such as
network administration and utilization management for which it sets separate fees in
addition to a flat monthly fee.

A health plan also bills the employer for actual healthcare costs incurred by the covered
employees and dependents. Typically, at the end of the plan year, a final payment is
calculated to determine the employer's actual "claims" experience for the year. When the
healthcare providers are paid under special reimbursement arrangements, such as
capitation, the health plan must disclose to the employer that the employer's healthcare
payments are not necessarily the actual cost of providing care. This disclosure is
required by the Department of Labor in accordance with ERISA.

Employer Direct Contracting

Because large numbers of employers self-fund their health plans and because health
plans have become a dominant force in healthcare, it follows that some employers would
want to try their hand at direct contracting. Employer direct contracting is when
employers elect not to purchase a health plan product from a health plan, but instead
provide coverage for their employees by making arrangements directly with providers for
the delivery of healthcare. A large employer might structure an exclusive arrangement
with a network of providers, making the services of those providers available only to
employees of that employer. Or the employer might contract with providers who are also
entering into contracts with a number of other health plans and/or employers.

Because few employers have the expertise or resources to take on the complexities of
organizing and managing a healthcare network themselves, those that decide to enter
into a direct contracting arrangement typically contract with an already established
network of providers. However, some large employers do have the capability, not only to
contract directly with providers, but also to establish an exclusive or "captive" network

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when doing so. Insight 3B-3 provides an example of one such employer. Other
employers have achieved the capability to establish networks by joining with other
employers in coalitions, which we will discuss later in this section.

One other alternative available to some employers is the so-called "company clinic"
where employers develop their own primary care clinics and specialty care referral
networks. However, these types of arrangements will remain relatively few in number
because they can only be utilized by employers with large concentrations of employees
in a single location and because they are much more expensive to establish and operate
than any other type of network arrangement.

Insight 3B-3. Hershey Foods Corporation's "Captive Network."

Hershey Foods Corporation developed a captive network after spending two years
analyzing outcomes data for 55 diagnosis-related groups at 23 hospitals in central
Pennsylvania. Hospitals were ranked in such categories as length of stay, mortality and
morbidity rates, cesarean sections, back surgery, and inappropriate admissions, using a
formula of 70 percent quality and 30 percent cost. On the basis of these rankings and
certain ease-of-access criteria, Hershey established a point-of-service (POS) network that
includes nine hospitals, 180 primary-care physicians and 800 specialists. The company
gave employees a $150 bonus and a waiver of the first year's premium as an incentive to
choose the captive network.
Sources: J. Montague, Low Fat, Low Cost, Hospitals & Health Networks (Aug. 5, 1993), 76-78. Hall and Brewbaker, 4-5 through 4-6.

Purchasing Alliances
Employers have also exerted influence on health plan arrangements through purchasing
alliances, also known as employer coalitions, employer purchasing coalitions, or health
insurance purchasing cooperatives (HIPCs). A purchasing alliance is a collection of
employers and/or individuals (in some cases established and assisted by a
governmental or quasi-governmental agency) who employ a collective approach to
obtaining healthcare for their employees or themselves. Purchasing alliances can be
organized in any number of ways. In Other Laws that Apply to Health Plans, we will
examine state-initiated small group coalitions. Here we look at employer-sponsored
alliances.

One type of employer-sponsored alliance has as its primary objective increased

purchasing power when negotiating with health plans. A large number of small
employers can come together to form a healthcare benefit purchasing group that is in
many ways similar to a large employer. This arrangement gives the group increased
flexibility in negotiating plan features and premiums. In exchange, the health plan
obtains increased membership in its network. Although often used by small employers,
coalitions are also used by medium and large group employers. For instance, a group of
large, national employers, coordinated by a national consultant, can establish a coalition
to obtain price advantages, implement uniform administration, and standardize plan
features in multiple locations.

Another type of employer purchasing alliance, though not as common, involves

contracting directly with healthcare providers rather than health plans. Insight 3B-4

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describes one such coalition in Houston. Similar alliances have also been formed in
other locations such as Atlanta, Chicago, Cleveland, and Minneapolis.

As we have seen in this lesson, the complex relationships between employers, health
plans, hospitals, physicians, and other healthcare facilities and providers will continue to
evolve. The leaders of these groups, as well as regulators, will continue to closely
monitor the market, and as they do so a variety of health plan structures and
arrangements is likely to emerge, followed by a variety of regulatory responses.

Insight 3B-4. The Houston Health Purchasing Organization (HHPO).

"At the end of the day, you still have to go out and compete with the commercial
entities," says D. Rick Huntington, who administers the Houston Healthcare Purchasing
Organization (HHPO) with Ralph T. Smith, Jr. "It's a coalition that operates like a
business. I think that's the key to its success."

Five years ago, a survey of members of the Houston Area Health Care Coalition-all large,
self-funded firms-showed that many wanted the group to begin buying coverage. Others
argued that they were big enough to have ample bargaining clout on their own. After
much debate, Huntington and Smith, the corporate representatives who were most vocal
about the need for a purchasing group, got the coalition's blessing to forge ahead.

In 1994, the two men quit their jobs as benefits managers and launched a for-profit
operation, Business Health Companies (BHC). They also established the not-for-profit
HHPO, which they contracted to manage for the next 10 years under the auspices of a
BHC subsidiary.

HHPO set out to "take pricing out of the equation," says Smith, president of BHC. The
tactic: Come up with a schedule of payments and offer it to doctors and hospitals on a
take-it-or-leave it basis. Initially 15 companies-about a third of the employers in the
original Houston area coalition-agreed to go along. Participating companies now number
55.

The fees are discounted but generous enough so that all of Houston's hospitals and some
6,000 doctors-about three-quarters of those in the area-are on the HHPO list. "Our
experience really questions the design of narrow PPOs," Smith says. "By including
almost everybody, you end up saving more money" since there's seldom a need, even in
emergencies, to go out of network.

In 1996, providers under contract with HHPO collectively received $87 million, which
works out to 66% of billed charges. The discount was deepest (37%) for the biggest cost
component, hospital inpatient services. Doctors' services were discounted the least.

HHPO monitors how good a job the providers are doing. The idea is that eventually
employers will go with sub-networks comprising those with the best outcomes, rather
than offer the entire list of providers to their workers.

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Huntington and Smith have joined forces with Baltimore, Md.-based HCIA Inc. to collect
severity-adjusted data on the outcomes of HHPO patients. The coalition won provider
support for this portion of the undertaking by promising to keep the results confidential
for the first three years. The period of secrecy expires in 1998, but coalition members
have not specified how harsh they'll be with providers who don't measure up.

HHPO's direct payment concept works well for companies big enough to self-insure. But
its reach is much broader: John Alden Life Insurance Co. leases the network for an
insured product it sells to 5,000 smaller firms. In keeping with the coalition concept, all
5,000 have been required to join the not-for-profit HHPO.

HHPO's success has led to rapid growth. When members wanted to expand the plan to
other work sites, Huntington and Smith used the same model to put together a statewide
network. With 257 hospitals and 14,000 doctors outside of the Houston area, "We're in
every nook and cranny of Texas," Smith boasts.
Source: Excerpted and adapted from Daniel B. Moskowitz, "Going Entrepreneurial," Business and Health (January 1998): 42.

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Chapter 4 A
Perspective and Overview of State and Federal Laws
In Legal Organization of Health Plans and Formation and Structure of Health Plans, we
discussed many of the ways health plans are choosing to structure their organizations
from a business perspective. We also discussed, from a legal perspective, the forms of
organization a health plan can opt to use- i.e., corporation, partnership, limited
partnership, limited liability company, etc. In health plan, however, laws and regulations
affect much more than an organization's choice of legal structure. Because the
regulation of health plan evolved largely from a system designed to regulate indemnity
healthcare, there are many laws that may not be specific to health plan which affect the
formation and/or operation of health plans. In general, the term law refers to a system of
rules, enforceable by a controlling authority, that governs human conduct. Throughout
1

this lesson we use the term law to refer to statutes, rules, regulations, and court
decisions.

In this lesson, we will discuss laws and regulations affecting health plan. We begin our
discussion of laws and regulations affecting health plan in this assignment with a brief
review of the origin of laws, rules, and regulations in the United States.

After completing this lesson, you should be able to:

 Describe the sources of law in the United States

 Explain the significance of the HMO Act of 1973 in the development of healthcare
 Name the federal laws that stimulated health plan participation in Medicare and
Medicaid
 Describe the provisions of the Health Insurance Portability and Accountability Act of
1996 (HIPAA) of major interest to health plans
 Describe the aspects of a health plan on which state regulations usually focus

Sources of Law
Laws governing health plans come from a number of sources, including constitutions,
statutes, administrative rules and regulations, and case law. The following sections
describe each of these sources of law and introduce model laws.

Constitutions
A constitution sets forth in general terms the principles that form the legal foundation of
a government. It describes the structure of the government, defines the extent of its
powers, and outlines the principles on which it is to operate. In addition, a constitution
usually guarantees to citizens certain basic human rights. Because these principles are
intended to remain relatively stable and consistent over time, most constitutions include
safeguards designed to prevent frequent or ill-considered amendments. Changes to a
constitution that must be made to meet the needs of a changing society are generally
accomplished through interpretation of its terms by the courts, rather than by
amendment. The general language of a constitution makes this flexibility possible.

In the United States, there are two kinds of constitutions: the federal Constitution and the
state constitutions. The basic difference between the federal Constitution and a state
constitution is that power is delegated by the federal Constitution to the federal
government, whereas a state constitution defines and limits the already existing power of
the state government. The federal government has no power that is not given to it by the

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federal Constitution. A state government has all powers (i.e., "reserved powers") that are
not prohibited by the federal Constitution or by the constitution of that state.

Statutes
A statute, or act, is "an act of the legislature declaring, commanding, or prohibiting
something; a particular law enacted and established by the will of the legislative
department of government." Statutes enacted by Congress are called either federal
2

statutes or acts of Congress. Statutes enacted by state legislatures are called state
statutes. If it is not clear whether Congress or the state legislatures have the power to
legislate in a given area, the question can be referred to the courts for decision.

Fast Definition

Doctrine a statement of fundamental government policy. 3

Administrative Rules and Regulations

Both federal and state governments operate under a doctrine called separation of
powers. Separation of powers means that a government is divided into departments or
branches, each of which primarily performs a distinct function. Constitutions in the
United States provide for three branches of government-legislative, executive, and
judicial-and establish a system of checks and balances to guard against any branch
becoming too powerful. A branch of government performs a primarily legislative function
when it enacts, or makes, laws; a primarily executive function when it enforces, or
carries out, laws; and a primarily judicial function when it interprets laws and adjudicates
disputes under the law.

The complexities of modern business have necessitated some overlap among the three
branches. Legislators cannot have the necessary technical knowledge about every
business that must be regulated. Consequently, they have adopted the practice of
enacting regulatory statutes in general terms. They then authorize the administrative
officer having the duty of executing the law to fill in the details by enacting administrative
rules and regulations that have the force and effect of law. Courts have held that this
delegation of rule-making power to administrative officers does not violate the separation
of powers doctrine, as long as the rules so made are within the scope of the delegated
power, are made following specified procedure, and are subject to judicial review.
Administrative rules or administrative regulations are prescribed guides for conduct
or action created by an administrative agency that carry the force of law. For example,
the Centers for Medicare and Medicaid Services establishes rules and regulations for
health plans that wish to participate in Medicare. The agencies that regulate health plans
exert great power and influence over whether, and how, a health plan does business.

Administrative officers also perform judicial functions. They hold hearings, make
decisions, and impose penalties. Thus, administrative officers function in all three
spheres-executive, legislative, and judicial.

The commissioner, director, or superintendent of insurance is a state administrative

officer. Today, state legislatures have authorized such officers to adopt appropriate rules
and regulations to implement the provisions of the state insurance and health plan

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statutes. Often, such administrative rules and regulations constitute a major part of the
law governing the health plan industry. Similarly, Congress authorizes various federal
administrative officers to adopt appropriate rules and regulations implementing the
provisions of certain federal statutes that affect health plans. For example, the Centers
for Medicare and Medicaid Services creates and adopts administrative rules and
regulations to implement Medicare. Sometimes the rules and regulations issued by
administrative agencies do not provide enough detail for health plans. Often,
administrative agencies make informal policy documents available and provide guidance
to health plans trying to comply with such rules and regulations.

Model Laws
A model law is an act proposed by experts in a particular field for consideration by the
states that may be adopted and enacted, in whole or in part, by a state or that may serve
as the basis for state legislation, particularly in a technical area. The National
Association of Insurance Commissioners (NAIC), a nongovernmental association of
state insurance regulators, develops and adopts model laws and regulations for
consideration by legislators and regulatory agencies in developing particular state laws
and regulations. The model laws and regulations address subjects relating to health plan
financial requirements, quality assurance, utilization review, and statutory accounting
standards.

A model law or regulation itself is not a law and does not have the force or effect of law.
However, many of the NAIC's model laws and regulations directly impact health plans by
serving as the basis for state or federal legislation or regulations. For example, NAIC
model laws and regulations are often adopted in whole or in part by state legislatures or
state administrative agencies.

Another name for model law is uniform law. The term uniform law is sometimes used
because an important purpose of a model law is to promote uniformity among state laws.

Case Law
A court applies laws to resolve the controversies brought before it. In so doing, a court
interprets those laws and thus creates more law. In the United States, federal and state
court decisions form a vast and growing body of law called case law or common law.
Federal case law is made up of federal trial court decisions, federal intermediate court
decisions, and U.S. Supreme Court decisions. State case law consists of state
intermediate and supreme court decisions, because most state trial court decisions are
not published. The term common law is sometimes used to distinguish case law (court
decisions) from statutory or regulatory law. In that sense, the common law of a
jurisdiction is made up of the decisions of the courts, but not the enactments of the
legislature or administrative regulations.

Health plan case law has evolved from the decisions that state and federal courts have
made involving the laws and regulations that impact health plans. For example, case law
has been used to interpret how the provisions of the Employee Retirement Income
Security Act of 1974 (ERISA) should be applied to employee benefit plans that are
governed under ERISA.

History of Regulation of Health Plans

Earlier in this assignment we noted that regulation of health plans evolved from an

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environment designed largely to regulate indemnity insurance. It should be no surprise

that regulation of health plans also followed in the wake of traditional indemnity
insurance laws. In the absence of regulation specific to health plans, states and the
federal government have applied insurance and other applicable laws to health plans.

Federal laws that were passed to protect individual citizens or to protect the free market
economy in the United States were among the first noninsurance laws applied to health
plans. Antitrust laws are one example of this type of federal law. Antitrust became an
issue of national concern in the United States after the end of the Civil War. Using
4

pooling arrangements and trusts, "robber barons" created large companies that could
dominate a single industry. To curtail this type of activity that restrained trade and
5

competition, Congress passed the Sherman Act in 1890. The Clayton Act and the
Federal Trade Commission Act were both passed in 1914 to supplement and reinforce
the Sherman Act.

Historically, providers and provider groups asserted antitrust violations to combat the
development of prepaid group practices and other health plans that seemed to threaten
their livelihood. As health plans have evolved, entrepreneurs have created unique
partnerships and affiliations among providers, payors, and employers. The subsequent
mergers, acquisitions, and affiliations of these players have been subjected to antitrust
scrutiny. Antitrust laws and their application to health plans are discussed in Federal
Regulation of Health Plans.

Recall from Healthcare Management: An Introduction that prepaid group practices, a

forerunner to today's health plans, existed as early as 1910 (e.g., the Western Clinic in
Tacoma, Washington). At that time, prepaid group practices, cooperative health plans,
and other health plan-type organizations had to comply with state insurance regulations
and other state and federal laws that were not specifically designed to regulate such
entities. Prepaid group plans and their cost-saving components captured the attention of
the Nixon administration in the late 1960s. As described in the following section, health
plan-specific regulation was developed shortly thereafter.

Laws Enacted Specifically to Regulate Health Plans

HMO Act of 1973
The first major attempt by the federal government to influence the development of
managed care plans (now known as health plans) was the HMO Act of 1973. In the late
1960s and early 1970s, the Nixon administration was seeking ways to harness drastic
increases in healthcare costs. Initially proposed as a way to manage costs of Medicare
and Medicaid, health plans soon became a pivotal healthcare strategy for the Nixon
administration. Insight 4A-1 provides an explanation of the 1970s' vision of using health
plans to control healthcare costs in this country.

The Health Maintenance Organization Act of 1973 ("HMO Act"), Title XIII of the
Public Health Service Act, is a federal law that was designed to help contain spiraling
healthcare costs by encouraging the development of HMOs. The HMO Act was signed
into law on December 29, 1973, and provided requirements that health plans must meet
to obtain federal qualification. In addition, for a period of time, the HMO Act provided
federal funds for the establishment of HMOs. The HMO Act applied only to health plans
that chose to become federally qualified. Federal qualification is not a requirement and
state licensure is sufficient for a health plan to operate in a particular state. Initially, many

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health plans chose to become federally qualified because of the federal funds available
to establish and operate HMOs. Today, the majority of HMOs do not seek federal
qualification.

Insight 4A-1. The HMO Concept is Born.

According to the Consumer Price Index (CPI), from 1962 to 1975, medical costs rose 59
percent--more rapidly than any major category of personal expenses. Thus, both private
groups and public agencies looked for mechanisms that would reduce and contain costs.

Several national studies, in particular the 1967 Report to the President, recommended
group practice, and especially prepaid group practice, as possible solutions to the cost-of-
care crisis. The gestation period for the federal program was relatively short: by March 9,
1970, a position paper was completed by Paul M. Ellwood Jr., M.D., and his associates at
the American Rehabilitation Foundation (later to be called InterStudy) in which he coined
the phrase "health maintenance organization." As described in this paper, the HMO
concept was to become a major issue of the Nixon administration's health program.

First announced before an executive session of the House Ways and Means Committee
on March 23, 1970, and through a press release on March 25, 1970, Alternative C, as the
proposal was called, would authorize the Social Security Administration to contract with
HMOs to guarantee comprehensive health service for the elderly at a fixed rate. The
Nixon administration's bill, designed to help establish HMOs, was introduced in March
1971. Initially, the HMO concept was proposed by the Nixon administration as a way to
contain the costs of the Medicare and Medicaid programs. But, because of their cost-
saving potential and the increasing interest and acceptance of the concept, HMOs became
the central issue of President Nixon's health program.
Source: Used with permission, Robert G. Shouldice, An Introduction to Health Plans: HMOs, PPOs, and CMPs (Arlington, VA: Information
Resources Press, 1991), 29, 35.

The HMO Act contained provisions that:

• Made funds available for the formation and development of HMOs

• Preempted state laws that contained more stringent standards for HMO
development
• Required that employers with 25 or more workers offer a federally qualified
HMO as a choice for their employees if the HMO requested inclusion as a
choice for employees
• Gave the Department of Health and Human Services the authority to regulate
federally qualified HMOs to ensure that quality care was provided 6

Amendments to the HMO Act were passed from 1976 through 1995. These
amendments will be discussed in Federal Regulation of Health Plans. Currently, the
HMO Act is the only federal legislation enacted specifically to regulate health plans.
However, over the years other federal laws have been applied to the formation and
operation of health plans. Some of these laws even contain provisions specifically
directed at health plans.

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Other Federal Laws Applied to Health Plans

Federal laws that impact health plans are often found in broad legislation not specifically
enacted to regulate health plans. For example, portions of various budget acts contain
provisions that affect health plans. Additionally, amendments to the Social Security Act
established the federal programs Medicare and Medicaid; health plans that wish to
participate in such programs must comply with requirements set forth in that law. In the
following sections we explore several federal laws that contain provisions that are
applied to health plans' operations.

Employee Retirement Income Security Act (ERISA)

To help contain costs for financing healthcare for their employees or members,
employers and other large organizations began self-funding their own health plans. In
the early 1960s, the NAIC noted with growing concern the increase in the number of
self-funded plans in this country. At that time, self-funded plans were unregulated. In
7

1972, one state insurance department stepped forward to challenge a self-funded plan
sponsored by the Monsanto Company, alleging that the plan constituted an insurance
transaction and, therefore, should be subject to state regulatory requirements for
insurance. The Missouri Supreme Court ruled favor of the Monsanto Company in its
1974 decision on the case, and the challenge was unsuccessful. However, in that same
8

year a federal law was passed that addressed, among other things, the regulation of
self-funded employee benefit plans.

The Employee Retirement Income Security Act of 1974 (ERISA), a law whose
primary purpose was to prevent abuse of employer-sponsored pension benefit plans,
included a provision that subjects employment-based health benefit plans to regulation
under this act.

As noted in Health Plan Structures and Arrangements, ERISA does not directly regulate
health plans; instead it sets standards for most employment-based health benefit plans,
whether or not they are self-funded. The types of standards that ERISA imposes
9

include: documentation explaining benefits available under the plan and any
modifications to those benefits, reporting requirements, and procedures for appeals of
denial of claims. ERISA also sets standards that must upheld by anyone who acts as a
plan fiduciary. We discuss ERISA in more detail in Federal Regulation of Health Plans.

Omnibus Budget Reconciliation Act of 1981 (OBRA-81) and Medicaid

Amendments to the Social Security Act authorized Medicaid, a joint federal/state
program that provides medical assistance to low-income individuals. These provisions
required states to share the financial burden of this program and provided for matching
funds from the federal government. Although enrollment in health plan arrangements
was permitted almost from the inception of the Medicaid program in 1966, the Omnibus
Budget Reconciliation Act of 1981 (OBRA-81) was the true stimulus for increasing
participation by health plans in Medicaid. OBRA-81 amended the Social Security Act to
allow states to set their own qualification standards for HMOs that contracted with state
Medicaid programs and revised the requirement that participating HMOs have an
enrollment mix of no more than 50% combined Medicare and Medicaid members by
increasing that percentage to 75%. As you will learn later in this lesson, this 75%
10

requirement has been eliminated. OBRA-81 expanded the ability of the Centers for
Medicare and Medicaid Services (CMS), the federal agency in the Department of Health

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and Human Services that administers Medicaid, to grant waivers from the rules of the
Social Security Act. CMS could grant a waiver that allowed a state to develop a research
and demonstration project that served the particular needs of the Medicaid population in
that state. These Medicaid demonstration projects allowed states to try different
financing and delivery options, including health plan techniques, for serving their
Medicaid populations. The Balanced Budget Act of 1997, discussed later in this lesson,
includes amendments that streamline the waiver process and allow states to mandate
enrollment in health plans for most Medicaid beneficiaries.

Fast Definition

Medicare risk contract - A contract by which an HMO or CMP contracted with CMS to
assume the risk of providing medical services to Medicare beneficiaries. 11

Competitive medical plan - A federal designation that allowed a health plan to obtain
eligibility to receive a Medicare risk contract without having to obtain federal qualification
as an HMO; requirements for eligibility were somewhat less restrictive than for an HMO.
12

Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and Medicare
Just as OBRA-81 made it easier for health plans to serve the Medicaid population, the
Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 made it easier for HMOs to
enter into risk contracts to serve the Medicare population. Medicare, authorized by
amendments to the Social Security Act, is the federal government's hospital expense
and medical expense insurance plan for persons age 65 and older and certain other
qualified individuals. TEFRA also allowed competitive medical plans (CMPs) to
participate in Medicare risk contracting. As we discuss later in this lesson, the Medicare
program has been changed by recent legislation that eliminates CMPs and Medicare risk
contracting.

Prior to TEFRA, amendments to the Social Security Act contained provisions that
allowed prepaid plans to enter into a cost or risk contract for Medicare; however, only
federally qualified HMOs were allowed to participate. In the early stage of the Medicare
program, many plans participated through cost contracts. Under these contracts, HMOs
were reimbursed for all of their expenses, and although they could not profit, they could
cover a portion of their general overhead and were not at any risk. Many HMOs chose
not to participate in the Medicare program because the opportunities to make profits in
the Medicare program were limited. TEFRA addressed some of these obstacles to
participation in Medicare for HMOs.

Review Question

One federal law amended the Social Security Act to allow states to set their own
qualification standards for HMOs that contracted with state Medicaid programs and
revised the requirement that participating HMOs have an enrollment mix of no more than
50% combined Medicare and Medicaid members. This act, which was the true stimulus
for increasing participation by health plans in Medicaid, is called the

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Omnibus Budget Reconciliation Act of 1981 (OBRA-81)

Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)
Employee Retirement Income Security Act of 1974 (ERISA)
Federal Employees Health Benefits Act of 1958 (FEHB Act)

Correct. OBRA-81 made it easier for health plans to serve the Medicaid population

Incorect. TEFRA was a federal budget act that made it easier for HMOs to enter
into risk contracts to serve the Medicare population

Incorrect. ERISA's primary purpose was to prevent abuse of employer-sponsored

pension benefit plans.

Incorrect. FEHP established a voluntary program to provide health insurance to

federal employees, retirees and their dependents.

Fraud and Abuse Laws

In addition, the federal government has enacted laws and established regulations to
prevent fraud and abuse of monies paid for healthcare from the coffers of Medicare and
Medicaid. Since Medicaid is a joint federal-state program, states have also enacted and
created fraud and abuse laws.

Other Budget Acts

Legislation that affects health plans has often been included as part of other federal
budget acts as well. Insight 4A-2 describes some provisions of various budget acts that
affect health plans. The driving forces behind many of the provisions listed in the
following insight were:

• To protect seniors from becoming victims of misleading business practices

• To ensure continuation of health insurance coverage for certain populations
(i.e., employer-sponsored coverage upon termination of employment)
• To discourage discrimination in providing healthcare services to lower
socioeconomic populations
• To encourage communication of health plan benefits to
beneficiaries/members

Insight 4A-2. Budget Act Provisions Affecting Health Plans.

Omnibus Budget Reconciliation Act of 1985 (OBRA-85)

 Required that HMOs inform members of their rights when the members join the
HMO and annually thereafter
 Allowed Medicare HMO members to disenroll from a plan at Social Security offices

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 Required Quality Improvement Organizations (QIOs) to review HMO inpatient and

ambulatory care
 Mandated a study of physician incentive arrangements in hospitals reimbursed under
the Medicare prospective payment system

Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA-86)

 Required that group health plans allow employees and certain dependents to continue
their group coverage for a stated period of time following a qualifying event that causes
the loss of a person's group health coverage.
 Required that all Medicare marketing materials be approved by CMS before use

Omnibus Budget Reconciliation Act of 1987 (OBRA-87)

 Required that Medicare contracting plans which were terminating service in an area
or not renewing a contract arrange for Medigap coverage for affected Medicare
beneficiaries

Omnibus Budget Reconciliation Act of 1990 (OBRA-90)

 Imposed additional regulatory requirements on Medicare-contracting plans that have

incentive arrangements that put physicians at substantial risk for services the physicians
do not directly provide
 Required that health plans comply with Medicare rules to notify beneficiaries of
rights to use advance directives, such as living wills
 Allowed retroactive enrollment of retirees who enrolled in a Medicare contracting
plan through an employer-sponsored health plan
 Required Medicare-risk HMOs to make prompt payment on claims for services
provided by non-network providers [Note that the Medicare-risk program is being
replaced as of January 1, 1999, with a program called Medicare+Choice which will be
discussed in Medicare and Health Plans.
Source: Except as noted above, used with permission and adapted from Peter R. Kongstvedt, The Managed Health Care Handbook, Third
Edition (Gaithersburg, MD: Aspen Publishers, Inc., 1996), 721.

Americans with Disabilities Act (ADA)

The Americans with Disabilities Act (ADA), which was enacted in 1990 primarily to
ensure rights for people with disabilities, is being applied to the activities and facilities of
all types of health plans. For example, the ADA requires that a health plan facility must
be accessible to wheelchairs. Also, certain plan benefit exclusions have been challenged
in court as ADA violations. The health plan implications of the ADA are discussed in
Federal Regulation of Health Plans.

Health Insurance Portability and Accountability Act of 1996 (HIPAA)

After Congress failed to pass the comprehensive healthcare reform initiative
championed by the Clinton administration in 1994, a new approach to reform emerged.
Members of Congress began introducing healthcare bills that sought to reform only a
portion of the healthcare system in the United States. These efforts are commonly

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referred to as incremental reform bills. The Health Insurance Portability and

Accountability Act of 1996 (HIPAA) is an example of incremental reform legislation.

HIPAA affects health plans in many ways. In general, HIPAA contains provisions to
ensure that prospective or current enrollees in a group health plan are not discriminated
against based on health status (e.g., there are rules and limits on the use of pre-existing
condition exclusions). In addition, HIPAA generally requires guaranteed access to health
insurance for small businesses and certain eligible individuals that have lost their group
health coverage. HIPAA also generally requires guaranteed renewal of insurance once a
policy is sold to an individual or group regardless of the health status of the members. 13

Amendments to HIPAA relate to mental health benefits and maternity hospital length of
stays covered by insurers including health plans. We discuss HIPAA in more detail in
Federal Regulation of Health Plans.

Balanced Budget Act of 1997 (BBA)

The Balanced Budget Act of 1997 (BBA) has made significant changes to Medicare
and Medicaid health plan programs by making enrolling Medicare and Medicaid
beneficiaries in health plans easier. The BBA changes allow Medicare beneficiaries
14

more health plan options under the Medicare+Choice program. Beneficiaries can now
enroll in PPOs, POS options, medical savings account plans, provider-sponsored plans,
private fee-for-service plans as well as in HMOs. Payment reform provisions in the BBA
may encourage health plans to enter traditionally low-payment Medicare markets. 15

Funds for expanding health insurance for children whose parents cannot afford health
insurance were also allocated as part of the BBA. The Medicare Modernization Act of
16

2003 further encouraged health plans to re-enter the Medicare market, though the
creation of the more inclusive Medicare Advantage program (replacing M+C plans) a
competitive bidding processs and more favorable risk selection.

Federal Programs Established by Law that Incorporate Health Plans

As we discussed earlier in this lesson, both Medicaid and Medicare allow health
insurance plans to offer health plan products to eligible members of those populations. In
addition, two other federal programs established by law have significantly incorporated
health plans into their product offerings. The Federal Employees Health Benefits Act
of 1959 (FEHB Act of 1959) established a voluntary program to provide health
insurance to federal employees, retirees, and their dependents and survivors. The 17

program established by the FEHB Act of 1959 is called the Federal Employees Health
Benefits Program (FEHBP). FEHBP offers a choice of fee-for-service and health plans
to more than nine million beneficiaries. Many health plans participate in FEHBP and
18

must comply with rules and requirements for this program set forth by the Office of
Personnel Management (OPM).

Amendments to the Dependents Medical Care Act created the Civilian Health and
Medical Program of the Uniformed Services (CHAMPUS) in 1967. CHAMPUS 19

authorized a program of medical benefits for families of active-duty military members,

certain military retirees and their families, and certain former spouses of members of the
military. To incorporate health plans into CHAMPUS, the Department of Defense created
TRICARE. TRICARE is a health benefits program that has three options for eligible
members: an HMO-type option, a PPO option, or the traditional fee-for-service option.
Most of the care provided by TRICARE is through military facilities. The Department of

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Defense administers the TRICARE program and health plans bid to provide TRICARE
services in regions established by the DOD.

Figure 4A-1 provides an overview of the federal laws, listed in chronological order, that
we discussed in the preceding lessons. These are by no means all the federal laws that
impact the formation or operation of health plans, but they are key acts. Let's now
discuss how states regulate health plans.

Figure 4A-1. Major Federal Laws that Impact Health Plans.

Year
Name of Law Applies To
Enacted
Sherman Act 1890 All plans
Clayton Act 1914 All plans
FTC Act 1914 All plans
FEHB Act of 1959 1959 Plans that participate in FEHBP
CHAMPUS 1967 Plans that participate in CHAMPUS
HMO Act of 1973 1973 Federally qualified HMOs
ERISA 1974 Employer-sponsored plans*
OBRA-81 1981 Medicaid participating plans
Employer-sponsored plansand Medicare participating
TEFRA-82 1982
plans
OBRA-85, COBRA 1985, 1986 Varies by law and type of plan
OBRA-87, OBRA-
1987, 1990 Varies by law and type of plan
90
ADA 1990 All plans
HIPAA 1996 All plans
BBA 1997 Medicare and Medicaid participating plans

*Applies to employer-sponsored plans, excluding government-sponsored plans, in

varying degrees.

State Laws
The laws that we have discussed to this point are federal, but state laws provide the
primary basis for regulating most managed healthcare plans. States began regulating
insurance in the 1800s. As prepaid health plans emerged, state regulatory authorities
had the task of applying laws designed primarily for indemnity insurance to operations of
health plans. These laws are contained in state commercial insurance codes, not-for-
profit codes for health plans, and insurance holding company acts. In fact, many health
plans today form and operate their organizations pursuant to these codes that have
been amended over the years to include provisions that address health plans.

Although states had laws that regulated insurance, these laws did not readily address
features of the newly created HMO. To assist states in their development of laws and
regulations to regulate HMO plans, the National Association of Insurance
Commissioners (NAIC) stepped forward. As discussed earlier in this lesson, one of the
primary functions of the NAIC is to develop model laws and regulations to be considered

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for adoption by states. One of the most significant model laws developed by the NAIC in
20

conjunction with another association of state regulators, the National Association of

HMO Regulators (NAHMOR)--now the National Association of Health Plan Regulators--
is the Health Maintenace Organization Model Act (HMO Model Act). The HMO Model
Act, originally drafted in 1972 and modified subsequently as necessary, contains
provisions regulating major aspects affecting formation and operation of HMOs. There
are provisions in the HMO Model Act concerning licensing, solvency requirements,
quality assurance, enrollee information, grievance procedures, enrollment periods,
confidentiality of medical information, and reporting requirements. Most states have
some form of HMO law that closely mirrors the HMO Model Act.

While risk-bearing PPOs are typically regulated under state insurance law, some states
have enacted preferred provider organization (PPO) laws for nonrisk-bearing PPO
entities. Some states also regulate independent practice associations (IPAs). For
21

example, in New York, IPAs must have corporate purposes limited only to contracting
with HMOs. In addition, New York law subjects IPAs to review by the New York State
Department of Health. Many states have also enacted laws to regulate independent
functions performed by a health plan under contract to another organization. The most
22

common examples of these laws are utilization review and third party administrator
statutes.

A few states have enacted legislation or issued administrative rules that either create a
special licensure category for risk-bearing provider-sponsored organizations (PSOs) or
require such organizations to obtain a license as an HMO. However, most states do not
currently have specific laws or regulations that apply to at-risk provider organizations. In
those states that do not have specific PSO laws, such organizations often are required
to comply with the existing HMO or insurance laws that apply to the services or business
they are offering. To "level the regulatory playing field" among different types of health
plans, the NAIC is developing a model law called Consolidated Licensure for Entities
Assuming Risk (CLEAR). CLEAR would establish uniform licensing standards for all
health entities assuming insurance risk and is discussed in more detail in State
Regulation of Health Plans I.

The HMO Act of 1973 specified the services that a federally qualified HMO must provide
or cover. Many states have mirrored their benefit requirements on the federal HMO Act.
In addition, some states have passed laws mandating specific benefits to be covered by
health plans or mandating the providers who may deliver healthcare services to health
plan members. For example, states have enacted mandates that require health plans to
cover:

• Certain emergency room services

• A minimum hospital stay for mastectomy patients
• Certain benefits, such as alcoholism/substance abuse, mammograms, and
Pap smears

States have also enacted legislation to protect the rights of providers. Several years ago,
states began enacting any willing provider legislation. Any willing provider laws
generally allow any provider who meets the health plan's terms and conditions of
participation to become part of the network or receive payment from the health plan for

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covered services provided to health plan enrollees, whether the provider is a member of
the health plan network or not.23

Although quite a few states have any willing provider laws in their legal code, few states
have enacted this type of legislation in the last few years. Many of these laws are limited
to pharmacists or another specific category of provider.

In general, state and federal laws, rules, and regulations apply to a range of activities
performed by health plans. Insight 4A-4 discusses the scope of such regulation.

Review Question

Regulators of health plans have set standards in a number of areas of plan operations.
Requirements with which health plans must comply typically include

providing enrollees and prospective enrollees with detailed information about

various aspects of health plan policies and operations
maintaining internal grievance and appeals processes to resolve enrollee
complaints against the organization
maintaining quality assurance programs that reflect the plan's activities in
monitoring quality
all of the above

Incorrect. While providing enrollees and prospective enrollees with detailed

information about various aspects of health plan policies and operations is a
typical regulatory requirement, other answers are also correct.

Incorrect. While maintaining internal grievance and appeals processes to resolve

enrollee complaints against the organization is a typical regulatory requirement,
other answers are also correct.

Incorrect. While maintaining quality assurance programs that reflect the plan's
activities in monitoring quality is a typical regulatory requirement, other answers
are also correct.

Correct

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Chapter 4 B
Regulatory Agencies and Health Plans
The regulation of healthcare in the United States has developed in a piecemeal fashion
over the years. There has not been a master plan; instead, regulators have made
attempts to address problems or issues as they arise. This approach has resulted in a
patchwork (or segmentation) of regulations enacted by state and federal legislatures and
administrative agencies, often making it difficult for health plans to comply.

Rather than a single set of laws and regulations that apply to all health plans, there are
separate sets of regulations, both state and federal, applicable to different purchasers
(i.e., private employers, Medicare, Medicaid, FEHBP, TRICARE, etc.). Each federal
program in which a health plan chooses to participate has unique requirements. In some
states, a health plan may have different aspects of its plan regulated by the state
Medicaid agency, the state department of health, and the state department of insurance.
In some states, a health plan may have different aspects of its operations regulated by
the state Medicaid agency, the state department of health, and the state department of
insurance. In some states, these departments may regulate the same aspect of a plan
with differing standards. For example, a plan may have to meet different quality
standards set by each of the three agencies. Because of this regulatory complexity,
health plans often work closely with regulatory agencies to ensure compliance with all
applicable requirements.

The federal and state governments have created regulatory agencies to implement and
enforce federal and state laws and to establish additional rules and regulations, as
necessary, to ensure the legislative intent of such laws is put into practice. In addition,
some federal agencies provide education and training related to health plan. We discuss
several of these agencies and their responsibilities in the following sections.

After completing this lesson, you should be able to:

 Explain the roles of CMS in regulating healthcare

 Describe the role of the DOL in regulating health plans
 Explain the methods states use to delegate regulatory authority for healthcare plans
to state agencies

Federal Regulatory Agencies

Department of Health and Human Services
The Centers for Medicare and Medicaid Services (CMS) is a federal agency within the
Department of Health and Human Services that was created in 1977 to administer the
Medicare and Medicaid programs. 1

While CMS mainly acts as a purchaser of healthcare services for the Medicare and
Medicaid beneficiaries, it also:

 Assures that Medicare and Medicaid are properly administered by its contractors and
state agencies
 Establishes policies for the reimbursement of healthcare providers
 Conducts research on the effectiveness of various methods of healthcare
management, treatment, and financing

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 Assesses the quality of healthcare facilities and services

CMS's programs are administered by agency staff working in its Baltimore, Maryland,
headquarters and in 10 regional offices nationwide. The headquarters staff are
responsible for the national direction of the Medicare and Medicaid programs. The
regional office staffs provide CMS with the local presence necessary for quality customer
service and oversight.2

In addition, CMS and its sister agency, the Office of Inspector General, regulate federally
qualified HMOs and enforce the federal fraud and abuse laws that we will discuss later in
this lesson. See Figure 4B-1 for an overview of CMS's organizational structure and
3

specific information on the three centers that serve CMS's main customers.

Within CMS, the Center for Health Plans and Providers (CHPPs) handles the day-to-
day responsibilities of monitoring health plans and applying CMS's Medicare rules and
regulations to health plans. CHPPs issues operational policy letters addressing
4

Medicare issues and provides technical assistance to health plans in areas such as
guidelines for contracts with providers.5

Another office within CMS is the Center for Medicaid and State Operations. The
Department of Health and Human Services has delegated its responsibility for
development and oversight of regulations under the Health Insurance Portability and
Accountability Act (HIPAA) to CMS's Center for Medicaid and State Operations. The
provisions in HIPAA allow for a joint federal/state enforcement scheme to ensure
compliance with HIPAA regulations. If a state chooses not to enforce the federal
requirements and standards of HIPAA, that job will fall to the Center for Medicaid and
State Operations. Some states may choose to share the enforcement responsibilities
with the Department of Health and Human Services. In addition, if a state is not
adequately enforcing a specific HIPAA requirement, the Center for Medicaid and State
Operations can step in and enforce that HIPAA regulation. 6

The Center for Beneficiary Services is an office within CMS that provides Medicare
beneficiaries with support and information about health plans and other coverage
options. In addition, this office oversees health plan beneficiary appeals activities.
7

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Review Question

The Department of Health and Human Services (HHS) has delegated its responsibility
for development and oversight of regulations under the Health Insurance Portability and
Accountability Act (HIPAA) to an office within the Centers for Medicaid & Medicare
Services (CMS). The CMS office that is responsible for enforcing the federal
requirements of HIPAA is the

Center for Health Plans and Providers (CHPPs)

Center for Medicaid and State Operations
Center for Beneficiary Services
Center for Managed Care

Incorrect. The Center for Health Plan and Providers (CHPPs) handles the day to
day responsibilities of monitoring health plans and applying CMS' Medicare Rules
and Regulations to health plans.

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Correct. The Center for Medicaid and State Operations has responsibility for the
delegation and oversight of regulations under HIPAA.

Incorrect. The Center for Beneficiary Services provides Medicare beneficiaries

with support and information about health plans and other coverage options.

Incorrect. The Center for Managed Care falls under HRSA, another division of
HHS.

Health Resources and Services Administration (HRSA)

The Health Resources and Services Administration (HRSA) is another division of
HHS. HRSA assists in providing health resources for medically underserved
populations. Although HRSA does not regulate health plans, it provides resources and
8

performs activities that are designed to educate and train people about health plans and
underserved populations. Within HRSA, a Center for Managed Care has been
established. The Center's goals are:

• To ensure that trained primary care providers are available to serve the
needs of the underserved populations
• To educate the populations that HRSA serves about health plan systems and
encourage active participation in such systems
• To assist in building health plan systems that are responsive to the needs of
such underserved populations 9

Health and Human Services Office of Inspector General (OIG)

The Office of Inspector General (OIG) within HHS was established by the Inspector
General Act of 1978. The OIG's primary functions are to prevent fraud and abuse in HHS
programs, enforce sanctions for violations of HHS rules and regulations, and perform
audits of company practices to ensure compliance with HHS rules and regulations. The
OIG has three basic components or operational arms, the Office of Audit Services
(OAS), the Office of Evaluations and Inspections, and the Office of Investigations.

Department of Labor
Pension and Welfare Benefits Administration 10

The Pension and Welfare Benefits Administration (PWBA) of the Department of Labor is
responsible for administering and enforcing the fiduciary, reporting, and disclosure
provisions of Title I of the Employee Retirement Income Security Act of 1974 (ERISA).
Prior to January 1986, PWBA was known as the Pension and Welfare Benefits Program.
At the time of its name change, PWBA was upgraded to a sub-cabinet position with the
establishment of Assistant Secretary and deputy Assistant Secretary positions.

The administration of ERISA is divided among the Labor Department, the Internal
Revenue Service of the Department of the Treasury (IRS), and the Pension Benefit
Guaranty Corporation (PBGC). Title I- which contains rules for reporting and disclosure,
vesting, participation, funding, fiduciary conduct, and civil enforcement- is administered
by the Labor Department.

ERISA authorizes the Secretary of Labor, as well as plan participants and beneficiaries,
to bring a civil legal suit to enforce the terms of a health plan governed by ERISA. The

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Secretary of Labor may also seek injunctions barring future violations and may seek
criminal penalties for failure to comply with ERISA's disclosure and reporting
requirements. 11

Changes in legislation have expanded the DOL's scope of responsibility for ERISA. The
Omnibus Budget Reconciliation Act of 1989 contained provisions that require the
Secretary of Labor to assess a civil penalty equal to 20% of any amount recovered for
violations of fiduciary responsibility under ERISA.
12

In addition, the Department of Labor is authorized to enforce the provisions of the

Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA) and shares
enforcement of HIPAA with several other federal agencies. 13

Office of Personnel Management

The Office of Personnel Management (OPM) is the federal government's human
resources agency. OPM administers the Federal Employees Health Benefits Program
(FEHBP). The FEHBP is the largest employer-sponsored health insurance program in
the United States, serving federal employees, retirees, and their family members. To 14

provide federal employees with choices for their healthcare, OPM contracts with health
maintenance organizations, preferred provider organizations, plans offering point-of-
service products, and fee-for-service plans. OPM is responsible for setting standards for
plans that wish to participate in FEHBP. Such standards typically relate to the plan's
management experience, enrollment rates, network of providers throughout the
proposed service area, and ability to meet proposed budget projections. In addition to
15

setting standards for participation, the OPM conducts audits of health plans that
participate in FEHBP. These audits are designed to confirm that contracting health
16

plans use the appropriate rating method in determining the rates charged to FEHBP and
that the costs charged to the government are allowable.

Department of Defense (DOD) 17

The Department of Defense (DOD) administers the Military Health Services System
(MHSS), which provides medical care to active duty military personnel, their families,
and retirees who are not yet eligible for Medicare. (Because the MHSS covers Coast
Guard personnel and commissioned officers of the U.S. Public Health Service, DOD
consults with the Department of Transportation (DOT) and HHS on matters affecting
these two populations.) Within DOD, responsibility for administering this program has
been delegated to the Assistant Secretary of Defense for Health Affairs.

Much of the care is provided directly through government-owned military treatment

facilities (MTFs). This system currently includes about 115 hospitals and 471 clinics
around the world and employs more than 43,000 civilian and 103,000 active duty
personnel. MTFs are the core of the system. MHSS's recent TRICARE initiative- which is
intended to bring health plan principles to the military health services system- uses
several private plans to provide administrative services and back-up treatment facilities
on an exclusive basis in the 12 regions of the MHSS. For example, MHSS enrollees may
receive some care from MTFs and other care from providers under contract with a
private plan.

Department of the Treasury

Internal Revenue Service (IRS)

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The Internal Revenue Service (IRS) is the largest agency in the Department of the
Treasury. The IRS issues regulations to implement laws enacted by Congress in the
Internal Revenue Code. Tax implications affect the choice of forms of legal organization
for health plans. The IRS plays a part in many aspects affecting health plans' formation
and operations. For example, as we discussed in Legal Organization of Health Plans, a
not-for-profit health plan that applies for tax-exempt status must comply with many rules
and regulations set forth by the IRS. In addition, a health plan may have interaction with
the IRS in determining its federal income tax owed.

Often, tax laws passed by Congress contain provisions that affect many different
aspects of government. For example, TEFRA and OBRA-81 have provisions that apply
to Medicare and Medicaid as well as provisions that affect taxation. The IRS makes rules
and regulations to interpret and apply the tax portions of such laws while other federal
agencies, such as CMS in the case of Medicare and Medicaid, implement portions of the
law that apply to their particular area of expertise. In addition, the IRS can impose tax
penalties for failure to comply with certain laws.

Other Federal Agencies that Impact Health Plan Operations

There are many federal agencies that impact the operations of health plans. If a question
of job discrimination is raised about a health plan, the Equal Employment Opportunity
Commission (EEOC) or the National Labor Relations Board (NLRB) may be involved.
Healthcare plans must comply with rules and regulations made by the Immigration and
Naturalization Service (INS) concerning employment of illegal aliens. Moving closer to
the healthcare arena, the Food and Drug Administration (FDA) regulates
pharmaceuticals, and health plans must ensure that the pharmacy networks with which it
contracts comply with FDA rules and regulations. And the list goes on, depending on the
type of issue and the agency that is charged with implementing and enforcing federal
laws in that area.

Two other federal agencies that impact the formation and operation of health plans on
more regular basis. Those agencies are the United States Department of Justice (DOJ)
and the Federal Trade Commission (FTC). The U. S. Department of Justice is the
executive department responsible for enforcing federal laws, representing the United
States in federal cases, and providing legal advice to other federal officials and
departments. The U.S. Attorney General is responsible for directing the work of the
18

DOJ. Of particular interest to health plans is the DOJ's responsibility for enforcing
19

antitrust laws. As we will discuss in greater detail later in this course, antitrust laws can
affect formation, merger activities, or acquisition initiatives of a health plan.

Review Question

Antitrust laws can affect the formation, merger activities, or acquisition initiatives of a
health plan. In the United States, the two federal agencies that have the primary
responsibility for enforcing antitrust laws are the

Internal Revenue Service (IRS) and the Department of Justice (DOJ)

Office of Inspector General (OIG) and the Department of Defense (DOD)

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Federal Trade Commission (FTC) and the Department of Labor (DOL)

Federal Trade Commission (FTC) and the Department of Justice (DOJ)

Incorrect. While the DOJ does have antitrust enforcement responsibility, the IRS
focuses on enforcing the Internal Revenue Code

Incorrect. The OIG's primary function is to prevent fraud and abuse in HHS
programs, and the DOD is actually a purchaser of health plan services, but not an
enforcer of the antitrust laws

Incorrect. While the FTC does have an antitrust role, the DOL is focused on health
plans and ERISA

Correct! The FTC and the DOJ are responsible for enforcing antitrust laws.

The DOJ may also take a role in "qui tam" actions (commonly called "whistleblower"
actions) brought under the false claims act. "Qui tam" actions are legal actions brought
by private parties with direct knowledge of fraud. A private party makes a confidential
filing (often referred to as "a filing under seal") in federal court on behalf of the federal
government. The DOJ also receives a copy of this complaint. Generally, the DOJ has 60
days to decide whether it will pursue legal action based on the complaint. If the DOJ
decides to take action, it has primary responsibility for prosecuting the action. In addition,
if the government decides to take action the private party that filed the complaint is
usually allowed to share in a portion of the funds recovered from the party that
committed fraud. If the government elects not to take action, the private party can pursue
action on their own and receive a larger portion of the funds recovered from the party
that committed fraud.

The Federal Trade Commission (FTC) is a federal administrative agency, created by

the Federal Trade Commission Act, that helps enforce a variety of antitrust and
consumer protection laws. The Federal Trade Commission Act, passed in 1914,
authorized creation of the FTC and empowered it to work with the U.S. DOJ to enforce
the Clayton Act. In addition, the FTC enforces a variety of consumer protection laws,
20

such as laws pertaining to the interstate mailing of unfair or deceptive advertising

material by an insurer for solicitation purposes. The FTC defers to the states where
21

states have adequate laws to protect consumers against such unfair or deceptive trade
practices.22

Overlap sometimes exists in the responsibilities of federal or state agencies in enforcing

rules and regulations that affect health plan operations. Insight 4B-1 provides an
example of this type of agency overlap at the federal level.

Insight 4B-1. Overlap of Federal Agencies' Responsibilities.

The Health Insurance Portability and Accountability Act (HIPAA) relies on the
Department of Labor (DOL) and private parties to enforce its requirements that apply to
employee benefit plans and plan sponsors. However, HHS is responsible for enforcing
compliance of the insured product, purchased by an employment-based plan, with

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HIPAA and may take action against the product's issuer if a violation occurs. In such
cases, DOL becomes involved only if the plan or plan sponsor induces or otherwise
causes the issuer's violation-or engages in behavior that, in itself, is a violation. When a
group plan self-funds, however, DOL is solely responsible for enforcement. Tax penalties
may also be imposed by the IRS for HIPAA violations.
Source: Adapted and used with permission, American Association of Health Plans, 10.

State Regulatory Agencies 23

Health plans often are regulated by more than one agency in a state- usually the
department of insurance (which generally oversees the financial aspects of health plan
operations) and the department of health (which generally regulates the healthcare
delivery system, including oversight on access and quality of care). Because states are
also purchasers of healthcare for their own employees and through Medicaid programs,
other state agencies also may be involved in setting standards for HMOs.

In addition to the state agencies discussed above, a health plan may interact with a
state's secretary of state or similar agency responsible for incorporation issues; a state
attorney general for legal issues, such as not-for-profit issues, antitrust, or for-profit
conversions; the state social or human services department for Medicaid; and the state
department of revenue for taxation issues. Managed healthcare plans that offer workers'
compensation products are usually subject to regulation by the state Department of
Labor or similar state agency. 24

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Chapter 5 A
State HMO and Other Types of Health Plan Laws
When the federal HMO Act was passed, many state laws constrained or restricted the
development of HMOs. These state laws were designed to regulate insurance
companies, hospital and medical service corporations, or other entities- not health
plans. For example, some state laws required that an HMO be approved by a medical
1

society. Providers, who were the members of such societies, often saw HMOs as a
threat to their method of practicing medicine and put up roadblocks to deter HMO
formation. To encourage states to develop HMO-enabling laws in the early 1970s, the
now-defunct federal Office of Health Maintenance Organizations provided assistance
and conducted educational programs about the HMO Act for audiences of state
regulators.
2

Over time, almost every state in the United States developed its own HMO statute or
included HMO provisions in its general insurance code. Since it is not possible to
discuss every state's HMO laws in this assignment, we will use as a framework for our
discussion the National Association of Insurance Commissioners (NAIC) HMO Model
Act, which has served as the basis for many of the state laws that regulate HMOs.

After completing this lesson, you should be able to:

 Describe the major provisions of the NAIC HMO Model Act

 Describe the types of state regulation that apply to PPOs, UROs, TPAs, PSOs, and
POS products
 Explain the need for the Risk-Based Capital for Health Organizations Model Act and
the risk-based capital formula

NAIC HMO Model Act

In 1972, the NAIC adopted the Health Maintenance Organization Model Act (HMO
Model Act), a model law designed to regulate the licensure and operations of HMOs. In
the HMO Model Act, a health maintenance organization is defined as "any person that
undertakes to provide or arrange for the delivery of basic healthcare services to
enrollees on a prepaid basis, except for enrollee responsibility for copayments and/or
deductibles." Basic healthcare services are defined under the Model Act as "the
3

following medically necessary services: preventive care, emergency care, inpatient and
outpatient hospital and physician care, diagnostic laboratory services, and diagnostic
and therapeutic radiological services. It does not include mental health services or
services for alcohol or drug abuse, dental or vision services, or long-term rehabilitation
treatment." 4

Once it has been determined that an entity meets the definition of an HMO, the entity
must comply with the licensing requirements and all other applicable requirements of the
particular state's HMO statute.

The main purpose of the HMO Model Act is to provide consumer protection in two critical
areas: financial responsibility and healthcare delivery. In the rest of this section, we
discuss how the HMO Model Act regulates the licensure of HMOs, then we describe how
the HMO Model Act regulates financial responsibility, healthcare delivery, and several
other important operational issues with regard to HMOs.

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Obtaining a Certificate of Authority

Under the HMO Model Act and most state laws, an entity that wishes to operate as an
HMO must obtain a certificate of authority, often called a license. The process of
obtaining and maintaining a certificate of authority is often referred to as licensure. A
certificate of authority (COA) is a certificate issued by the state authority that regulates
HMOs, asserting that all requirements have been met for the establishment of an HMO
in accordance with the state's HMO laws. Generally, the purpose of licensing is to
ensure that an HMO is a solid, dependable organization, fiscally sound, and able to meet
specified quality standards for healthcare delivery.

As we discussed in Legal Organization of Health Plans, some states allow only domestic
corporations to obtain a certificate of authority, while others allow both domestic and
foreign corporations to obtain a certificate. To obtain a certificate of authority, an HMO
applicant must file an application form and additional information with the insurance
department or other state agency responsible for HMO regulation. Typically, the
submission must include these items.

In many states, the department of insurance and the department of health each have
specific responsibilities for regulating HMOs. For instance, the insurance department
might have responsibility for matters pertaining to solvency, financial statements, rate
filings, group contract filings, evidence of coverage filings, benefit mandates, and
member grievances; the health department might have responsibility for matters
pertaining to quality assurance, service area expansions, provider networks, and
provider relations. In some states, either the insurance department or the health
department has responsibility for all matters pertaining to regulation of HMOs. In other
states, regulation of HMOs is the responsibility of a different state agency, such as the
Department of Commerce in Minnesota.

 Organizational documents such as partnership agreements, trust agreements, or

articles of incorporation and bylaws, depending on the organizational form under which
the applicant operates
 Biographical information about the individuals who will be responsible for the
HMO's day-to-day operations and copies of all contract forms the HMO will use for
agreements with those individuals
 Current and historical financial statements and a financial feasibility plan detailing
projected enrollments, how the HMO will calculate premium rates, projected financial
statements, and sources of working capital or other funding resources
 A description of the procedures or processes the HMO will follow to meet the
protection against insolvency requirements in the HMO Model Act or state statute
 A description of the HMO's quality assurance program
 Contract forms the HMO will use for agreements with other parties providing
services, such as healthcare providers and third party administrators
 Copies of the evidence of coverage forms that the HMO will issue to enrollees
 Contract forms the HMO plans to use for group contracts with employers, unions,
trustees, or other organizations
 A description or map of the geographic area in which the HMO proposes to operate
 A list of the names, addresses, and license numbers of all providers in the HMO
network

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 A description of the internal grievance procedures the HMO will follow to investigate
and resolve enrollee complaints
 Other information required by the state regulatory authority to determine whether to
issue a COA

Financial Responsibility
HMO laws seek to apply appropriate net worth or capital requirements to help ensure
that members are enrolled in financially viable entities with the resources to pay for their
members' current and future healthcare needs. These requirements, along with
provisions for financial reporting, accounting, liquidity, investment practices, and related
matters, are often referred to as financial standards. HMO laws seek to ensure that
members are adequately protected in the event of insolvency, which is when an entity's
liabilities exceed its assets or when it is unable to meet its financial obligations on time.

Financial Standards
Adequate capital and surplus is essential to allow HMOs (as well as other types of health
plans) to withstand losses incurred due to unexpected fluctuations in operating costs. If a
health plan does not have a cushion to absorb such losses, its members may
experience adverse consequences. These consequences might include disruption of
care, having to pay for medical expenses that should have been covered by the health
plan (e.g., referral or out-of-network expenses for emergency or specialty care), or the
loss of any premium paid in advance. 5

The HMO Model Act requires an HMO seeking to obtain a COA to have an initial net
worth of $1,500,000 and to thereafter maintain the minimum net worth described in
Figure 5A-1. Net worth is an HMO's total admitted assets minus its total liabilities (its
debts and obligations, including obligations to pay for in-network and out-of-network care
for its members). Assets are all things of value owned by an individual or organization. 6

An admitted asset is an asset that state HMO or insurance laws permit on the Assets
page of a company's Annual Statement. Recall from Healthcare Management: An
7

Introduction that the Annual Statement is a financial report that most health plans have
to file to comply with state insurance regulations.

As the health plan industry has matured, the NAIC has developed additional capital
standards that were not contemplated in the original HMO Model Act. One example of
this type of regulatory evolution can be seen in the NAIC's recent efforts to develop a
formula for determining risk-based capital standards that will apply to all healthcare
organizations (not just HMOs). Risk-based capital refers to a method of taking into
account an organization's size, structure, and risk profile to set the minimum amount of
capital needed for that organization to support its overall business operations. The
NAIC's RBC formula for all healthcare organizations provides variable capital
requirements based on the nature and volatility of an organization's business. It is
expected that RBC will not replace, but rather complement, other state law financial
requirements. We address this regulatory initiative in greater detail later in this lesson.
8

Figure 5A-1. Minimum Net Worth Requirements in the NAIC HMO Model Act.

Section 13

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*****
A (2) Except as provided in Paragraphs (3) and (4) of this subsection, every health
maintenance organization must maintain a minimum net worth equal to the greater of:
(a) One million dollars ($1,000,000)
(b) Two percent (2%) of annual premium revenues as reported on the most recent
annual financial statement filed with the commissioner [director, superintendent]
on the first $150,000,000 of premium and one percent of annual premium on the
premium in excess of $150,000,000
(c) An amount equal to the sum of three months uncovered health care
expenditures as reported on the most recent financial statement filed with the
commissioner [director, superintendent]
(d) An amount equal to the sum of:
(i) Eight percent (8%) of annual health care expenditures except those paid on a
capitated basis or managed hospital payment basis as reported on the most recent
financial statement filed with the commissioner [director, superintendent]
(ii) Four percent (4%) of annual hospital expenditures paid on a managed hospital
payment basis as reported on the most recent financial statement filed with the
commissioner [director, superintendent].
Source: Section 13, Health Maintenance Organization Model Act (National Association of Insurance Commissioners, 1995).

Protections Against and in the Event of Insolvency

As we have seen, the HMO Model Act sets capital and surplus requirements to help
ensure that members are enrolled in financially viable entities that have the resources to
pay for their members' current and future healthcare needs. In addition, regulators can
use financial standards to help determine if a health plan is showing signs of
deteriorating financial condition. If the state insurance commissioner determines, after a
notice and hearing, that the financial condition of an HMO is such that its continued
operation might be hazardous to its enrollees, its creditors, or the general public, then
the commissioner may proceed with any of a number of interventions to protect against
insolvency. These interventions might include monitoring of a corrective plan developed
by the company, reducing the volume of new business being accepted, reducing
expenses by specified methods, suspending or limiting the writing of new business for a
period of time, selling the time or merging it with a financially sound company, or taking
over the management of the business.

Although financial standards provide a useful tool for state regulators to assess an
organization's financial viability and to intervene when necessary, they cannot
completely eliminate the possibility of insolvency. To further safeguard members, state
regulators rely upon other regulatory measures, such as deposit requirements, plans for
handling insolvency, replacement coverage requirements, administrative supervision
laws, receivership, assessments, and guaranty associations.

Deposit Requirements
The HMO Model Act requires that an HMO place a deposit in trust with the state
insurance commissioner that can be used to protect the interests of enrollees of an HMO
that becomes financially impaired. At the discretion of the insurance commissioner, the
deposit can be placed with an organization or trustee acceptable to the commissioner.
The deposit, regardless of where it is placed, must be in cash and/or securities and must

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at all times have a minimum value as specified by law. The amount deposited is treated
as an admitted asset for purposes of determining the amount of the HMO's net worth. 9

Sometimes an HMO must make an additional deposit in trust with the state insurance
department to protect members from creditors in the event of the HMO's insolvency. The
need for this deposit depends on the amount of the HMO's uncovered expenditures. An
expenditure is considered to be "covered" if it is the cost of a service provided by a
network provider that has a hold-harmless clause in its contract with the HMO. The hold-
harmless clause prevents a provider from trying to recover any outstanding payments for
covered services from HMO members. Although the HMO Model Act requires that
contracts between the HMO and healthcare providers include a hold-harmless clause,
not all healthcare expenses are subject to the clause, e.g., emergency services, out-of-
area care, and services provided by nonparticipating providers. Uncovered
expenditures are the costs to the HMO for healthcare services that are the obligation of
the HMO and for which an enrollee may also be liable if the HMO becomes insolvent.
Such expenditures are considered to be "uncovered" because if the HMO becomes
insolvent, the provider can seek to recover payment from the members. To prevent such
an occurrence, the HMO must make some other arrangements for covering those
expenses in the event of its insolvency.10

If an HMO's uncovered expenditures exceed 10 percent of its total healthcare

expenditures, then it must place a deposit in trust with the state insurance department.
This deposit is called an uncovered expenditures insolvency deposit. If the HMO
becomes insolvent, the uncovered expenditures insolvency deposit may be used by
the state insurance commissioner on behalf of enrollees in the state to pay claims for
uncovered expenditures. For purposes of determining the HMO's net worth, the amount
of the uncovered expenditures insolvency deposit is treated as an admitted asset. 11

Review Question

The National Association of Insurance Commissioners (NAIC) adopted the Health

Maintenance Organization Model Act (HMO Model Act) to regulate the development and
operations of HMOs. One true statement regarding the HMO Model Act is that the act

includes mental health services in its definition of basic healthcare services

authorizes only one state agency-the department of insurance-to regulate HMOs
requires HMOs to place a deposit in trust with the state insurance commissioner
for the purpose of protecting the interests of enrollees should an HMO become
financially impaired
requires HMOs that wish to offer a point-of-service (POS) product to contract with
a licensed insurance company to provide POS options to plan members

Incorrect. The HMO Model Act does not include, as part of basic healthcare
services, mental health services, or services for alcohol or drug abuse, dental or
vision services or long-term rehabilitation treatment.

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Incorrect. In many states, the department of insurance and the department of

health each have specific responsibilities for regulating HMOs.

Correct. The HMO Model Act does require HMOs to place a deposit in trust with
the state insurance commissioner in order to protect the interests of enrollees
should an HMO become financially impaired.

Incorrect. A standalone POS product is regulated under the state's HMO Act

Plan for Handling Insolvency

The HMO Model Act requires each HMO to have a plan for handling insolvency. If the
HMO becomes insolvent, this plan must allow for the continuation of benefits (1) for
contract periods for which it has received premium payments and (2) for enrollees who
are confined in an inpatient facility on the date of insolvency until they are discharged.
The state insurance department may require such a plan to include the following types of
features:

• Insurance to cover the expenses to be paid for continued benefits

• Provisions in provider contracts requiring healthcare providers to render
services the HMO is obligated to provide following an insolvency
• Insolvency reserves
• Acceptable letters of credit

Fast Definition

Reserves - Amounts of money set aside for the purpose of paying future business
obligations.

Letters of credit - Documents issued by a bank guaranteeing the payment of a

customer's bank drafts or other financial obligation up to a stated amount for a specified
period.

Replacement Coverage in the Event of Insolvency

In the NAIC HMO Model Act the term carrier is often used to refer to organizations or
entities that are responsible for paying for benefits or providing services under a group
contract. For example, such organizations include HMOs, insurers, and not-for-profit
hospital and medical service corporations. We will sometimes refer to carriers in our
12

discussion of the HMO Model Act.

The HMO Model Act prescribes additional regulatory actions to protect consumers in the
event an HMO becomes financially impaired or insolvent. For enrollees who were
covered under a group contract with an insolvent HMO, the insurance commissioner can
order all other carriers that participated in the group's most recent enrollment period to
offer their plan to the insolvent HMO's group enrollees. The insolvent HMO's group
enrollees are given a thirty-day enrollment period that begins on the date of insolvency
to enroll with another carrier. This offer must include the same coverages and rates that
were offered by the carrier during the last enrollment period. 13

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If no other carriers offered coverage to some groups enrolled in the insolvent HMO, or if
the insurance commissioner determines that the other health plans do not have sufficient
resources to assume responsibility for all of the group enrollees, then the commissioner
can allocate the insolvent HMO's group contracts among all HMOs that operate in the
insolvent HMO's service area. This allocation must be made equitably among all the
remaining eligible HMOs. In making the allocation, the commissioner considers the
healthcare delivery resources of each HMO. Each HMO must offer one of its current
benefit plans that provides coverage most similar to the coverage that each group had
with the insolvent HMO, at rates determined in accordance with the successor HMO's
existing rating methodology. 14

Similarly, the commissioner can allocate equitably the insolvent HMO's nongroup
enrollees among all HMOs that operate within a portion of the insolvent HMO's service
area, taking into account the healthcare delivery resources of each such HMO. Each
HMO is required to offer nongroup enrollees one of its current benefit plans that provides
individual or conversion coverage as determined by the type of coverage the enrollee
had with the insolvent HMO, at rates determined in accordance with the successor
HMO's existing rating methodology. Successor HMOs that do not offer direct nongroup
enrollment are permitted to include all of the allocated nongroup enrollees in one group
for coverage and rating purposes. 15

The HMO Model Act also requires a successor carrier to immediately cover all eligible
enrollees, regardless of any provisions in the carrier's contracts that might otherwise
deny eligibility due to an individual being hospital confined, pregnant, or not actively at
work. Further, a successor carrier cannot reduce or exclude benefits for an eligible
enrollee's pre-existing conditions.

Administrative Supervision Laws and Receivership

The HMO Model Act gives the insurance commissioner the authority to take action in
accordance with sections of the state rehabilitation, liquidation, and administrative
supervision laws that apply to insurance companies. Administrative supervision may
occur, by order of the insurance commissioner or consensual agreement, when an HMO
is in hazardous financial condition, has failed to comply with insurance laws, or for other
reasons.

When a state insurance commissioner judges that an HMO's financial difficulties are so
severe that more serious action than placing the HMO under supervision is warranted,
then the commissioner may choose to place the insurer in receivership. When an HMO
is placed in receivership, the state insurance commissioner, acting for a state court,
takes control of and administers the HMO's assets and liabilities. The receiver may
either try to rehabilitate the HMO or, if that is not possible, liquidate it by collecting the
HMO's assets and making sure that the HMO's obligations to customers are fulfilled as
much as possible. Rehabilitation occurs when an insolvent HMO continues in existence
under receivership; during this period state authorities try to find ways to return the
organization to normal operation. Liquidation occurs when the receiver either transfers
all of the HMO's business and assets to other carriers or sells the assets to satisfy the
HMO's outstanding obligations and terminates the HMO's business. 16

Assessments and Guaranty Funds

If a court declares an HMO to be insolvent, the HMO Model Act authorizes the insurance

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commissioner to levy an assessment on other HMOs that operate in the state. This
assessment goes towards paying (1) claims for uncovered expenditures of enrollees and
(2) continued coverage for a specified period of time for members who are not otherwise
eligible for continued coverage. In any one calendar year, an HMO's assessment cannot
be more than 2 percent of the aggregate premium written by the HMO in the state during
the previous year. An HMO that fails to pay an assessment within 30 days after notice is
subject to fines and/or suspension or revocation of its certificate of authority. The
insurance commissioner can waive an assessment of an HMO if the commissioner
determines that such an assessment would jeopardize the HMO's financial condition.
The HMO Model Act does not recommend that all states include this assessment
requirement in their statutes, especially if, in a particular state, the HMO premium
volume is small or the market is dominated by a few large HMOs.

Similar to the assessment provision in the HMO Model Act, a few states have adopted
HMO guaranty association requirements. These requirements, based on the life and
health insurance guaranty association requirements that are in effect in all states,
provide another way to safeguard consumers in the event of insolvency. As a condition
for obtaining an HMO license in these states, each HMO must participate in the HMO
guaranty association. This association is governed by a board composed of
representatives from all HMOs doing business in the state. If an HMO is declared
insolvent, the HMO guaranty association assesses the other HMOs in the amount
necessary to cover the failed HMO's responsibility to its members.

Healthcare Delivery
HMO members often rely exclusively on the HMO network for their choice of providers,
the quality of healthcare they receive, and their overall satisfaction with healthcare
services. To ensure that members are afforded appropriate consumer protections, HMO
laws pay particular attention to HMO healthcare delivery issues. Generally, with regard
to healthcare delivery, HMO laws focus on three key issues: network adequacy, quality
assurance programs, and grievance procedures.

• Network Adequacy
• Quality Assurance
• Member Grievances

Network Adequacy

As discussed earlier, the HMO Model Act requires an HMO seeking to obtain a
certificate of authority to file a description or map of the geographic area in which the
HMO proposes to operate and a list of the names, addresses, and license numbers of all
providers in the HMO network. Typically, state regulators examine this information to
ensure that providers are located within a reasonable distance of all locations in the
HMO's service area. In addition, regulators seek to ensure that the health plan maintains
adequate numbers of providers based on the number of members enrolled in the HMO.

As we mentioned in our discussion of financial responsibility, with the growth of the

health plan industry, the NAIC has developed additional standards that were not

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contemplated in the original HMO Model Act. In 1996, the NAIC adopted the Managed
Care Network Adequacy Model Act to establish network standards and to assure the
adequacy, accessibility, and quality of healthcare services offered under all health plans,
including HMOs. We describe the Health Plan Network Adequacy Model Act in more
detail later in this lesson.

Quality Assurance

The HMO Model Act also requires an HMO to file a description of its proposed program
for quality assurance. A quality assurance program establishes procedures to assure that
healthcare services provided to enrollees are rendered under reasonable standards of
quality of care consistent with prevailing professionally recognized standards of medical
practice. The procedures must include mechanisms to assure availability, accessibility,
and continuity of care.17 The purpose of the quality assurance program is to monitor and
evaluate the HMO's delivery of healthcare services. The HMO's quality assurance
program must include a statement of goals and objectives for evaluating the plan's quality
of care that emphasizes improving enrollees' health status. In addition, the program must
keep records of quality assurance program activities and make those records available to
the commissioner of health or other authorized regulatory official. The HMO Model Act
also requires that the HMO have a system for periodic reporting of program activities to
the HMO's board, its providers, and other organizational staff. Before a certificate of
authority is issued, the insurance department may confer with the health department to
assure that the HMO's proposed quality assurance program meets the standards set forth
in the HMO law. The NAIC has developed other model acts, such as the Quality
Assessment and Improvement Model Act and the Utilization Review Model Act to more
specifically regulate various aspects of quality assurance in all health plans, including
HMOs. We describe these model acts later in this lesson.

Member Grievances

In addition to requiring an HMO to file a description of the internal grievance procedures

that the HMO follows to investigate and resolve enrollee complaints, the HMO Model
Act requires the HMO to maintain records regarding all complaints received. These
records are subject to review by the appropriate regulatory authority. In addition, the
NAIC has developed the Health Carrier Grievance Procedure Model Act, discussed later
in this lesson, which more specifically addresses requirements concerning the handling of
member grievances.

Filing and Reporting Requirements

As we have seen, the HMO Model Act requires an HMO seeking to obtain a certificate of
authority to submit copies of its proposed provider and group contract forms, evidence of
coverage forms, and premium rate methodology. In most states, if an HMO wishes to
make changes to its group contract and evidence of coverage forms, it must file the
changes with the appropriate state agency. Some states also require HMOs to file
changes in premium rates. In many states, an HMO is not permitted to use new forms
(or rates, if rate filing is required) until the appropriate state agency reviews and
approves the filing. This is called prior approval. Some states, however, operate on a file

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and use basis, which means that the HMO must submit a filing, but prior approval is not
required for the HMO to begin using the forms (or rates), although the regulator may
later disapprove any forms or rates found to violate state laws.

HMOs must file with the state insurance department or appropriate state agency an
annual report detailing financial and operational information. This annual report must be
filed on a form approved by the state and must be verified by at least two of the HMO's
principal officers. Based on requirements set forth in the HMO Model Act, HMOs also
must file the following information each year:

• Audited financial statements

• A list of the healthcare providers who have executed a contract agreeing to
provide services to HMO enrollees
• A description of the HMO's grievance procedures, the total number of
grievances handled, a compilation of the causes underlying those grievances,
and a summary of the final disposition of the grievances

The HMO Model Act also gives the state the authority to require additional reports
deemed necessary and appropriate, such as reports that provide information on quality
assurance programs.

Note that each state may have in its reporting requirements some variation from the
items listed above. For example, some states do not require an annual filing of a list of
the HMO's contracted providers. Some states also require that material business
changes be reported more frequently than once a year. Such a filing may be required to
update the state's records of the HMO's enrollee materials, including the handbooks it
uses to describe coverage, provider lists, and sample member identification cards. In
addition, some states require regulatory approval of material business changes before
the changes are allowed. An HMO may also have to make a filing to obtain state
approval to expand its service area.

Enrollee Contracts
Under the HMO Model Act, HMOs are required to provide each group and individual
contract holder with a document that specifies the benefits and services available to
enrollees. For groups, the HMO typically provides a copy of the contract to the group
contract holder. The contract must contain a clear statement of this information.

Most of the foregoing information also must be included in a written statement, known as
an evidence of coverage (EOC), also called a certificate of coverage, that is provided
to individuals enrolled under group HMO contracts.

Individual HMO contracts also must provide for a 10-day period in which the enrollee
may examine and return the contract in exchange for a full premium refund. If an
enrollee receives services during the 10-day period and returns the contract for a
premium refund, then the enrollee must pay for all services received.

 The name and address of the HMO

 Eligibility requirements

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 Benefits and services within the service area

 Emergency care benefits and services
 Out-of-area benefits and services, if any
 Copayments, deductibles, or other out-of-pocket expenses
 Limitations and exclusions
 Enrollee termination procedures
 Enrollee reinstatement procedures, if any
 Claims procedures
 Enrollee grievance procedures
 Continuation of coverage
 Conversion
 Extension of benefits, if any
 Coordination of benefits, if applicable
 Description of the service area
 Entire contract provision
 Term of coverage
 Cancellation
 Renewal
 Grace period
 Conformity with state law

Disclosure Requirements
We have noted that the HMO Model Act requires HMOs to provide enrollees with
specific information about the HMO, its services, and its providers. Upon enrollment, an
enrollee must receive a list of the HMO's healthcare providers. Any "material change" in
the operation of an HMO affecting enrollees must be reported to enrollees within 30 days
of the change. For example, a major change in the provider network is considered a
material change that must be reported to enrollees. By contrast, the termination of one
medical care provider from the provider network would not qualify as a material change
unless that provider is a primary care provider. When a primary care provider is
terminated from the network, the HMO must notify all enrollees who receive primary care
from the terminated provider. In addition, the HMO must help those enrollees:

• Transfer to another primary care provider

• Obtain information about HMO services and notify them where additional
information on access to services can be found

The HMO must also supply a toll-free telephone number that enrollees can use to
contact the HMO. Newly enacted consumer protection laws contain additional disclosure
requirements intended to provide members with information about topics such as risk
arrangements, plan financial information, and prescription drug formularies.

Review Question

Greenpath Health Services, Inc., an HMO, recently terminated some providers from its
network in response to the changing enrollment and geographic needs of the plan. A

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provision in Greenpath's contracts with its healthcare providers states that Greenpath
can terminate the contract at any time, without providing any reason for the termination,
by giving the other party a specified period of notice.

The state in which Greenpath operates has an HMO statute that is patterned on the
NAIC HMO Model Act, which requires Greenpath to notify enrollees of any material
change in its provider network. As required by the HMO Model Act, the state insurance
department is conducting an examination of Greenpath's operations. The scope of the
on-site examination covers all aspects of Greenpath's market conduct operations,
including its compliance with regulatory requirements.

With respect to the type of change that constitutes a material change under the HMO
Model Act's disclosure requirements, the termination of one healthcare provider from
Greenpath's provider network

always qualifies as a material change in the plan, and Greenpath must report the
change to all plan enrollees
always qualifies as a material change in the plan, and Greenpath must report the
change to only those plan enrollees who have received care from the terminated
provider
qualifies as a material change in the plan only if the provider is a primary care
provider, and in such a case Greenpath must report the change to all plan
enrollees
qualifies as a material change in the plan only if the provider is a primary care
provider, and in such a case Greenpath must report the change to only those plan
enrollees who receive primary care from the terminated provider

Incorrect. Termination of one physician does not constitute a material change,

unless the physician is a primary care provider

Incorrect. Termination of one physician does not constitute a material change,

unless the physician is a primary care provider

Incorrect. While termination of a primary care provider is a material change, the

health plan does not have to notify all members

Correct. The HMO must only notify enrollees who receive primary care from the
terminated provider

Regulatory Supervision and Enforcement

To protect the interests of HMO members, the HMO Model Act authorizes the insurance
department to conduct an examination of each HMO's operations as often as is
reasonably necessary, but at least once every three years. Similarly, the HMO Model Act
authorizes the health department to conduct an examination of each HMO's quality
assurance program and its providers as often as is reasonably necessary to protect the
interests of the members, but at least once every three years. In lieu of conducting the
examination themselves, the insurance department and the health department have the
option of accepting the report of an examination made by another state. The insurance
department is authorized to take any of a number of actions, including suspending or

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revoking an HMO's certificate of authority, to enforce state laws and regulations and to
protect the public. We discuss market conduct examinations and mechanisms for
enforcement in more detail in Market Conduct Examinations and Mechanisms for
Enforcements.

Accreditation and HMO Regulation

Beyond the HMO Model Act requirements, a few states have made accreditation by an
external accreditation organization a requirement of licensure. For example, in Florida an
HMO must pass a quality-of-care assessment as a condition for doing business. In 18

some states, the state agency responsible for regulating HMO quality initiatives will
accept an accreditation by a nationally recognized accreditation organization in lieu of a
state-conducted quality review. Many states are moving toward adopting the same
standards for their quality assurance oversight responsibilities as those used by the
National Committee for Quality Assurance (NCQA) in their accreditation process;
however, these states are not planning to require accreditation as a condition for
licensure. Organizations from which health plans receive accreditation that may be
accepted by states in lieu of a state-conducted quality review include: the NCQA, the
American Accreditation Health Care Commission (The Commission/URAC-discussed
later), and the Joint Commission on Accreditation of Healthcare Organizations (JCAHO).
In general, accreditation organizations set minimum quality performance standards and
then measure health plans against those standards

Laws Regulating Other Types of Health Plans

The NAIC has developed and adopted a number of other model acts in addition to the
HMO Model Act to specifically address various aspects of health plans. These model
laws include the Health Care Credentialing Verification Model Act, the Quality
Assessment and Improvement Model Act, the Health Plan Network Adequacy Model
Act, the Health Carrier Grievance Procedure Model Act, and the Utilization Review
Model Act. Figure 5A-2 provides a brief description of these model acts.

Some states have specific regulations that address PPOs, TPAs, POS products,
utilization review, and PSOs. However, there is a movement at the NAIC to consolidate
licensure of all types of health risk-bearing entities into one regulatory act through the
CLEAR model act discussed in Overview of Laws and Regulations. Let's now look at
state regulation of preferred provider arrangements.

Figure 5A-2. NAIC Model Acts.

The NAIC defines the term "health carrier," used in the model acts described below, as
"an entity (subject to state insurance laws and regulations or to the insurance
commissioner's jurisdiction) that offers to contract to provide, arrange for, or reimburse
any of the costs of health care services." 19 Some provisions of the model acts apply only
to a "health plan," which is broadly defined as one that either requires an enrollee to use
or provides incentive to use certain providers. The model acts recognize that states can
exclude some plans with large networks and minimal restrictions from the definition of
health plan.

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Health Care Credentialing Verification Model Act: All health carriers that offer a
health plan are required to establish a comprehensive credential verification program that
verifies the credentials of all contracted health care professionals. Health carriers are
required to establish written credential verification procedures that they disclose upon
written request to any applying healthcare professionals. Health carriers must also allow
providers to review and correct any information they submit.

Quality Assessment and Improvement Model Act: This act requires that all health
carriers that offer a health plan must develop the systems necessary to measure and report
on quality of healthcare services. All health carriers that provide health plans must have a
quality assessment program. In addition, closed plans must have a quality improvement
plan.

Health Plan Network Adequacy Model Act: Health carriers offering a health plan must
meet general requirements pertaining to the provisions included in their provider
contracts. In addition, specific requirements related to notice of termination of contracts
are included for the plans and providers. Under this act, health carriers must notify a
provider's regular patients of the contract termination in writing within 15 business days
of the termination. Health carriers must establish provider selection standards and make
them available to all healthcare professionals. A prohibition on so-called "gag" clauses is
included in this act. Health carriers are required to maintain an adequate network
sufficient in number and types of providers. This act also requires the filing of sample
contract forms with the state regulatory agency and obtaining approval of any material
contract changes.

Health Carrier Grievance Procedure Model Act: Under this act, health carriers
offering a health plan must establish a second-level review panel (in addition to the
existing mechanism the plan has in place) for addressing grievances. Also, the health
carrier must allow members to review relevant information pertaining to their grievance,
attend the review panel meeting concerning their grievance, and have representation at
the panel meeting. Health carriers must develop written procedures for the expedited
review of any grievance where the normal timeframe would jeopardize the life or health
of the member. Health carriers must also use clinical peers "in the same or similar
specialty," that typically manage the situation under review, to perform expedited and
second-level review.

Utilization Review Model Act: Under this act, health carriers are required to cover
emergency services needed to screen and stabilize a member, without prior authorization,
if a prudent layperson acting reasonably would have believed that an emergency medical
condition existed. Health carriers must also cover an emergency visit to a non-contracted
provider if a prudent layperson would have believed that the delay in visiting a contracted
provider would worsen the emergency. Health carriers must provide written notice of
adverse determinations with instructions for filing appeals and for requesting disclosure
of the clinical rational, including the clinical review criteria used to make the
determination. Health carriers must also use clinical peers "in the same or similar

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specialty," that typically manage the situation under review, to perform expedited and
second-level review.
Source: "Key Issues: NAIC Health Plan Accountability Models," Washington Report 23-96, Issue Review, BlueCross BlueShield Association,
July 26, 1996, 1-8.

Preferred Provider Arrangements Laws

For regulatory purposes, a preferred provider arrangement (PPA) is a contract
between a healthcare insurer and a healthcare provider or group of providers who agree
to provide specified services to persons covered under the contract. The healthcare
insurer in a PPA can be either a licensed HMO or a licensed insurance company. The
providers who enter into such a contract with a healthcare insurer are known as
preferred providers or network providers. Providers who have not contracted with a
healthcare insurer are known as nonpreferred providers or nonnetwork providers. A
preferred provider organization (PPO) is one specific type of health benefit plan that
includes a preferred provider arrangement. 20

State regulation of PPOs is difficult to summarize primarily because PPOs are regulated
in different ways depending upon the state. In addition, the regulatory authority of each
state frequently is found in various statutes, rather than in a single statute. Nevertheless,
states tend to adopt at least one of the following general regulatory approaches. 21

Several states require PPOs to be licensed, registered, or certified. Requirements for

licensure may include solvency and grievance procedures or may be limited to
registering with state agency.

Other states require that an insurer (most often an indemnity plan) that contracts with a
preferred provider network submit documentation that the network is compliant with
certain state laws. These requirements may appear in a separate section of the
insurance code governing PPOs or they may be included in the carrier section of the
insurance code. In either case, this regulatory approach requires indemnity insurers that
contract with a PPO network to assure that the network complies with requirements,
such as network adequacy, timely claims processing procedures, and grievances and
appeals procedures.

In addition, some states require that risk-bearing entities meet specific solvency
standards. In other states, risk-bearing entities generally must meet the same solvency
standards as an indemnity plan or an HMO.

Many states have adopted laws or regulations that impose additional requirements on
preferred provider arrangements. The NAIC has adopted a Preferred Provider
Arrangements Model Act (PPA Model Act) that establishes minimum standards for
preferred provider arrangements and the health benefit plans that include such
arrangements. 22

The PPA Model Act permits healthcare organizations to develop health benefit plans that
include incentives for PPO members to use the services of preferred providers. Plans
must clearly identify the differences in benefit levels for services of preferred providers
and for services of nonpreferred providers. The amount of such differences in benefit
levels must be no greater than necessary to provide a reasonable incentive for members

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to use preferred providers. Some states prohibit a benefit differential greater than a
specified percentage. These plans must also provide benefits for emergency care for
covered services rendered by a nonpreferred provider when an insured cannot
reasonably reach a preferred provider. In such cases, the cost of emergency care must
be covered by the PPO as though the insured had been treated by a preferred provider. 23

The PPA Model Act requires a preferred provider arrangement to establish the amount
and manner of payment to the preferred providers. The PPA Model Act also requires
that the arrangement must include mechanisms designed to minimize the cost of the
health benefit plan. These mechanisms may include procedures for reviewing or
controlling utilization of healthcare services and for determining whether healthcare
services rendered are medically necessary. Preferred provider arrangements must
provide PPO members with reasonable access to covered services, and health benefit
plans that include a PPA must include an adequate number of preferred providers to
render those services. The PPA Model Act also prohibits preferred provider
arrangements from unfairly denying health benefits for medically necessary covered
services.24

Although only a few states have adopted requirements based closely on the PPA Model
Act, a number of states have adopted requirements to regulate PPOs. Also, a significant
number of preferred provider arrangements are offered as self-funded plans and, thus,
are not subject to state insurance law.

Utilization Review Laws

In addition to HMO and PPA laws, some states regulate certain functions that health
plans perform. Utilization review is one example of a health plan function regulated by
many states. Recall from Healthcare Management: An Introduction that utilization review
(UR) is the evaluation of the medical necessity, efficiency, and/or appropriateness of
healthcare services and treatment plans for a given patient. Utilization review may be
undertaken by an in-house department of a health plan or an external entity. External
entities that perform utilization review functions are called utilization review
organizations (UROs).

Utilization review laws in some states require any entity that performs UR functions to be
registered with the appropriate regulatory agency, such as the insurance department or
health department. Registration can be accomplished by simply filing some basic
information about the entity's structure and operations. In other states, full certification is
required. In these states, the personnel of any entity performing UR functions must meet
certain criteria with regard to experience, training, and education. For example, in
Maryland the physician performing utilization review must be in the same specialty as
the physician whose treatment plan is being reviewed. 25

Certification
Most states that require certification direct health plans and UROs to file a plan with the
appropriate state regulatory agency. This plan confirms that the entity's personnel meet
the requirements discussed above and provides information about the services to be
provided. In general, states require certification to keep track of the entities performing
UR services and to maintain an avenue for providers to question or appeal UR
decisions.

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Typically, state laws impose some requirements governing the accessibility of UR

personnel who make utilization review determinations. For example, most states require
that personnel be accessible by telephone during normal business hours, five days a
week. In addition, some states require that the entity performing UR establish a toll-free
telephone line, staff after-hours coverage for review determinations, and/or meet certain
response times for decisions. A typical required response time for UR decisions is two
days after receiving all information pertinent to the case.26

To protect the confidentiality of a patient's medical information, an entity performing

utilization review must also meet and uphold federal and state requirements concerning
the confidentiality of medical information standards. In addition, state laws usually
require the inclusion of an appeal procedure for adverse decisions or denials. Some
states require a written appeal procedure and set 30 days as the standard amount of
time for completing an appeal. A few states even have laws that ban the use of financial
incentives that might induce utilization review personnel to deny certain services, reduce
a length of stay in an inpatient facility, or otherwise impact a utilization review decision. 27

Licenses or certificates are usually valid for one to two years and are renewable. State
laws authorize officials to revoke an entity's license or certification and/or impose fines
and penalties for noncompliance with utilization review laws. In addition to requiring
28

that the entity obtain a license, some states also require that the personnel conducting
utilization reviews obtain reviewer licenses.

Accreditation
In lieu of following the requirements to obtain a certificate to provide utilization review
services, some states allow such entities to submit evidence of their accreditation by a
private accreditation organization. The accreditation organization must meet the
requirements of the state regulatory agency in charge of utilization review. Several
national organizations conduct accreditation programs. The most prominent accrediting
organization for utilization review programs is the American Accreditation Health Care
Commission (the Commission/URAC), formerly called URAC. The Commission/URAC
sets standards that UROs must meet and maintain to obtain accreditation. Standards for
accreditation focus on timely review of determinations, efficient and effective use of
information to make determinations, maintenance of confidentiality standards, training
and qualification of the UR staff, and specific requirements for the appeal process.

Third Party Administrator Laws 29

Another health plan function that has been the subject of state regulation is third party
administration of certain services, such as claims.

Most states have adopted laws and/or regulations to govern the activities of
organizations known as third party administrators (TPAs). As we described in our
discussion of self-funded plans, TPAs provide various administrative services to health
plans or employers or other large groups, such as unions, that provide health benefit
plans to their employees or members. Health plans and such employer groups often
obtain the services of TPAs to help administer health plan contracts. In such a case, the
health plan or group delegates some of its administrative duties to the TPA and agrees
to compensate the TPA for the services it provides. Because TPAs often perform
insurance functions-such as underwriting and claims processing-the states have
authority to regulate these activities.

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However, in some states, TPAs-using ERISA as the foundation-have challenged the

states' regulatory authority over TPAs that contract with self-funded plans. Courts have
taken both sides in this controversy so it is not yet clear whether TPA laws will be viewed
as preempted under ERISA in the future.

The NAIC Third Party Administrator Model Statute (TPA Model Law) is an NAIC
model law designed to regulate operations of third party administrators. Many state laws
that regulate TPAs are based on this model. We will base our description of TPA laws on
the provisions of this model law, which we refer to as the TPA Model Law.

Fast Fact

In addition to claims administration, some TPAs are offering services in disability

management, 24-hour coverages, vocational and physical rehabilitation, return-to-work
programs, employee assistance programs, mental health and crisis management,
benefit design, and plan document preparation. 30

Certificate of Authority
According to the TPA Model Law, a third party administrator subject to the law is any
organization that directly or indirectly solicits or effects coverage of, underwrites, collects
premiums from, or settles claims on residents of the state or on residents of another
state from offices in the state enacting the TPA Model Law. An organization may not act
as a TPA unless it has received from the state insurance department a certificate of
authority designating it a TPA. Thus, a certificate of authority is required from each state
that has enacted such a law and in which a TPA has an office or whose residents are
members of plans administered by the TPA. Note that some insurers act as TPAs for
self-funded employer plans. In those situations, the licensed insurer does not need to
seek additional certification. The TPA Model Law defines insurer as any person who
provides life or health insurance coverage in the state. Thus, for purposes of the TPA
Model Law, an insurer may be an HMO, an insurance company, or anyone who provides
insurance that is subject to state regulation.

To obtain a certificate of authority, a TPA must submit an application to the insurance

department and must provide information similar to the information an HMO must
provide for a certificate of authority. The state insurance department may also request
that a TPA provide additional information, and the TPA must make available documents
such as the written agreements it has entered into with health plans and employers.

When evaluating an application for a TPA's certificate of authority, the insurance

department will be concerned with ensuring that the TPA is solvent and that the
individuals responsible for conducting the TPA's affairs are competent, trustworthy,
financially responsible, and of good character.

Some states waive the application requirements for certain TPAs. Typically, a TPA may
obtain a waiver from such a state if the TPA has a valid certificate of authority from
another state that has similar certification requirements.

Written Agreement
Whenever a TPA enters into an agreement to provide administrative services, the
agreement must be put into written form. In most instances, a TPA enters into an

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agreement with an employer to administer a self-funded health benefits plan. The written
agreement entered into between the employer and the TPA must describe:

• The duties that the TPA will perform

• How the TPA will be compensated for its services-compensation may be
based on the amount of premium or charges the TPA collects or on the
number of claims it processes
• The health plan's or insurer's underwriting standards and any other standards
that pertain to the business the TPA will administer

Certain types of provisions may not be included in a TPA agreement. For example, the
TPA Model Law prohibits a TPA from entering into an agreement under which the
amount of the TPA's compensation is contingent upon savings the TPA is able to realize
from claims payments. Such prohibitions are designed to assure that the TPA is not
induced to place its own financial interests above the interests of plan members.

Both the TPA and the health plan or insurer must maintain the written agreement as a
business record through the term of the agreement. The insurance department has
authority to examine these business records, and the TPA's records of transactions
performed on behalf of a health plan or insurer must be made available to the health
plan or insurer.

With specific exceptions, the TPA Model Law requires the TPA to maintain such records
for at least five years after the termination of such an agreement. If a TPA agreement
terminates, however, the TPA and the health plan or insurer may agree for the TPA to
transfer all its records to a new administrator. In such a case, the TPA is not required to
maintain the records for an additional five years if the new administrator acknowledges
in writing that it is responsible for retaining the records for the required time.

Insurer Responsibilities
An insurer does not transfer its responsibilities for administration of its plan even if an
agreement between the health plan and a TPA specifies that the TPA will provide certain
administrative services. The health plan remains responsible for ensuring that its plans
are administered properly. The health plan must determine all premium rates, benefits,
underwriting criteria, and claims payment procedures for its plans, and it must provide
the TPA with written information on all such matters.

TPA's Responsibilities
When it acts on behalf of a health plan, a TPA acts in a fiduciary capacity. As a fiduciary,
a TPA must hold all funds it receives on behalf of a health plan in trust, must promptly
remit all such funds to the proper parties, and must periodically provide the health plan
with an accounting of all transactions the TPA has performed on behalf of the health
plan. The TPA Model Law also requires a TPA to:

• Provide a written notice, which has been approved by the health plan, to all
members identifying the health plan, policyowner, and TPA and describing
the relationship among these parties
• Identify all charges that it collects from covered individuals

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• Disclose to the health plan all charges, fees, and commissions the TPA
receives in connection with the services it provides to the health plan
• Promptly deliver to covered individuals any certificates, booklets, termination
notices, or other written communications that it receives from the health plan

A TPA is required to notify the state insurance department immediately following any
material change in its ownership or control. In addition, a TPA must notify the insurance
department if any material change occurs that might affect its qualification for a
certificate of authority. Each TPA is required to file with the insurance department an
annual report, which includes the names and addresses of all health plans that the TPA
contracted with during the preceding year.

Suspension or Revocation of Certificate of Authority

The TPA Model Law requires the state insurance department to suspend or revoke a
TPA's certificate of authority under certain specified conditions. The insurance
department must suspend or revoke a TPA's certificate of authority if the TPA (1) is
financially unsound, (2) is using practices that are harmful to insured persons or the
public, or (3) has failed to pay any judgment rendered against it in the state within 60
days after that judgment became final.

In addition, the insurance department has discretionary authority to suspend or revoke a

TPA's certificate of authority if, after notice and a hearing, the department finds such
action is warranted.

Review Question

Third party administrators (TPAs) provide various administrative services to health plans
or groups that provide health benefit plans to their employees or members. Many state
laws that regulate TPAs are based on the NAIC Third Party Administrator Model Statute.
One provision of the TPA Model Law is that it

prohibits TPAs from performing insurance functions such as underwriting and

claims processing
prohibits TPAs from entering into an agreement under which the amount of the
TPA's compensation is based on the amount of premium or charges the TPA
collects
requires TPAs, upon the termination of a TPA agreement with a group, to
immediately transfer all its records relating to the group to the new administrator
requires TPAs to notify the state insurance department immediately following any
material change in the TPA's ownership or control

Incorrect. The TPA Model Law regulates TPAs who peform insurance functions
such as underwriting and claims processing

Incorrect. Under the TPA Model Law the TPA is probibited from entering into an
agreement under which the amount of a TPA's compensation is contingent upon
savings the TPA is able to realize from claims payments

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Incorrect. The TPA Model Laaw requries a TPA to maintain records for five years
after the termination of an agreement, unless the TPA and insurer agree to
transfer all records to a new administrator

Correct! A TPA is required to notify state insurers immediately following a

material change in ownership

Laws Affecting Point-of-Service Products

Recall from Healthcare Management: An Introduction that with a point-of-service (POS)
product, when members need medical care, they choose, at the point of service,
whether to go to a provider within that plan's network or to seek medical care out of the
network. The regulatory requirements that apply to a POS product depend largely on the
way the product is structured. A POS product can be provided:

• Entirely by an HMO
• By an HMO and an insurer
• Entirely by an insurer

In the past, some states' statutes prohibited HMOs from being the sole sponsors of
point-of-service (POS) options. Recently, in response to consumer demand, states have
begun to allow HMOs to offer POS options without the involvement of a licensed
insurance company as long as the HMO meets certain requirements. Such requirements
may include having additional financial reserves related specifically to those services or
limiting the percentage of POS option products sold by the HMO to a specified
percentage of the overall products sold by the HMO. A few states have begun to
mandate that HMOs offer a POS option or product. When an HMO directly underwrites
healthcare services rendered by nonparticipating providers, this is sometimes called a
standalone POS product. The entire standalone POS product is regulated by the
state's HMO Act.

In states with laws that do not allow an HMO to directly underwrite healthcare services
rendered by nonparticipating providers, HMOs that wish to offer a POS product must
arrange for provision of the non-network care through an insurance contract. These are
sometimes referred to as wraparound POS products. An HMO may be a licensed
insurance company or may have a parent or sister corporation that is a licensed
insurance company, and can issue a separate insurance contract to provide non-
network care. Or, an HMO may enter into a contractual arrangement with an unrelated
insurer to provide non-network care. For a wraparound POS product, the HMO provides
the network benefits. Such benefits are subject to the laws that pertain to HMOs. The
non-network benefits for a wraparound POS product are provided by an insurer and are
subject to the state's insurance laws.

Sometimes an HMO chooses to develop a wraparound POS product even in a state

where it is permitted to provide these benefits entirely through the HMO. The HMO may
choose this approach to avoid having its financial condition negatively affected by non-
network claims. Since the financial viability of an HMO depends largely on its ability to

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manage costs by using network-based managed care techniques, an HMO that does not
want its financial condition impacted by "non-managed" non-network claims can offer a
wraparound POS product, where permitted by law.

A gatekeeper PPO, sometimes called an insured POS product, is like a POS product
except that the gatekeeper PPO provides network benefits through an insurance
contract. Insurers that offer this insured POS product develop provider networks in some
states that they use for several health plan arrangements, including POS products. The
insured POS looks almost identical to an HMO POS. The only differences result from
regulatory requirements; the network portion of the HMO POS product is subject to HMO
requirements, while the network portion of the insured POS is subject to state insurance
regulatory requirements.

Laws Regulating At-Risk Provider Organizations

Most at-risk provider organizations (sometimes called provider-sponsored organizations)
operate under a state HMO license; however, a few states have developed a special
licensure category for these entities. Georgia, Iowa, Kentucky, Minnesota, New Mexico,
New York, Oklahoma, and Texas all have separate laws for at-risk provider
organizations. Generally, these laws are patterned after state HMO laws, but some
contain different standards for solvency and quality assurance programs than their
existing HMO laws. For example, in Iowa an at-risk provider organization, called an
organized delivery system (ODS), does not have specific quality or access standards
that it must meet; however, an HMO in Iowa must have a quality assurance program. In
Oklahoma, the State Board of Health has the discretion to set standards for solvency to
ensure the at-risk provider organization's ability to deliver the services promised. For
HMOs, Oklahoma has set specific requirements for the amount of surety bonds or
deposits that must be furnished to the State Board of Health to ensure solvency. Idaho
reviews provider arrangements on a case-by-case basis, and North Dakota has a law
that allows healthcare provider cooperatives to contract with nonprofit health service
plans, HMOs, insurance companies, and the state Medicaid program on a capitated or
other risk-sharing basis. The Florida Commission on Integrated Health Care Delivery
Systems has recommended that at-risk provider organizations in that state meet the
same quality and solvency standards as HMOs.

Uniform Licensure
We mentioned in Overview of Laws and Regulations the NAIC's proposed model law
called CLEAR that seeks to reform state legislation by requiring that all health risk-
bearing entities that assume health insurance risk- for instance, HMOs, PPOs, and at-
risk provider organizations-be subject to the same regulatory licensing standards. Under
CLEAR, every health risk-bearing entity applying for licensure and meeting the
requirements of the model law would receive the same license as a health carrier.
Carriers would also have to meet additional requirements based on their activities or
plan design (e.g., plans that use contracted providers would have to meet provider
contracting standards).31

The NAIC has not yet adopted CLEAR and, therefore, no states have adopted CLEAR.
However, the state of Ohio has developed and passed its own uniform licensure law for
all health insuring corporations. The Ohio Health Plan Uniform Licensure Act (Ohio
MCULA) regulates health risk-bearing entities based upon how they function in the
health plan marketplace. For example, if a PHO meets the definition of a health insuring

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corporation based on the role it plays in the market, then it is required to obtain a license
under MCULA. An Ohio Department of Insurance policy statement describes the
purpose of MCULA this way: "MCULA was enacted to regulate risk-bearing entities on a
functional basis, regardless of the entity's acronym. In enacting MCULA, the
Department's goal was to fulfill its regulatory duty to regulate the 'business of
insurance.'" As regulators struggle to apply laws not designed to regulate many of the
32

recent innovative forms of health plans, uniform licensure acts, such as MCULA in Ohio,
may become more prevalent.

Capital Standards for all Health Plans

Given the diversity of organizations and arrangements that have emerged in the rapidly
changing healthcare marketplace, regulators have begun to address the original "one
size fits all" approach to healthcare financial regulation. As we discussed earlier in this
lesson, the HMO Model Act contains uniform solvency standards that all HMOs must
meet to obtain and retain a license. However, the nature and volatility of business can
vary significantly from one HMO to another. For instance, an HMO's capital and surplus
requirements can be affected by factors such as out-of-network coverage provisions and
provider compensation/risk-sharing arrangements.

In addition, some regulators and healthcare analysts maintain that because health plans
effectively reduce the risks assumed by traditional healthcare insurers, the capital and
surplus requirements for health plans should not be the same as those for indemnity
insurers. Further, the financial standards contained in the HMO Model Act and various
states' HMO and insurance statutes may not apply to at-risk provider organizations or
certain other health risk-bearing entities. Insight 5A-1 provides a brief discussion of the
evolution of solvency standards to apply to all health risk-bearing entities.

Recognizing the limitations of relying upon a single minimum fixed level of capital and
surplus requirements, the NAIC in the early 1990s began developing risk-based capital
(RBC)formulas for all life and health insurance companies. However, NAIC members
recognized that this formula did not adequately reflect the range of risks present in the
health insurance business. The NAIC then began a process to create a separate RBC
formula for all health insurers and health plans that accept risk. 33

History and Purpose of Risk-Based Capital Requirements for Health

Insight 5A-1.
Plans.

In the early 1990s, the NAIC began developing RBC formulas for life and health
insurance companies. The RBC concept differs from the regulatory approach previously
used in many states, which set a minimum fixed-level of capital and surplus requirements
for all insurers. NAIC members recognized that the current life and health RBC formula
did not adequately reflect the range of risks associated with the variety of coverages
available, funding approaches used, and organizational structures present in today's health
insurance business. To better reflect the full scope of health insurance risk characteristics,
the NAIC began a process to create a separate RBC formula that could be applied to all
health insurers and health plans that accept risk.
Source: Excerpted and adapted from "Health Organizations Risk-Based Capital (HORBC) National Association of Insurance Commissioners,"
information paper prepared by National Association of Insurance Commissioners staff, 1998, p. 1).

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The NAIC's approach to risk-based capital standards has two components: the RBC
formula and the enforcement model act. The RBC formula for health plans is a set of
calculations, based on information in the health plan's annual financial report, that yields
a target capital requirement for the organization. The health plan-RBC formula assesses
the risk profiles of specific health plans, gives credit for payment arrangements that
reduce risk, and determines appropriate capital requirements based on these risk
profiles. As a result, health plans that perform the same or similar functions with similar
types of assets, liabilities, and business profiles are subject to the same solvency
standards. 34

The health plan-RBC formula takes into account five different types of risk:

1. Affiliate risk
2. Asset risk
3. Underwriting risk (typically, the largest single determinant of a plan's RBC
requirement)
4. Credit risk
5. Business risk

Affiliate risk the risk that the financial condition of an affiliated entity causes an adverse
change in capital.

Asset risk the risk of adverse fluctuations in the value of assets.

Underwriting risk (typically, the largest single determinant of a plan's RBC

requirement) the risk that premiums will not be sufficient to pay for services or claims.

Credit risk the risk that providers and plan intermediaries paid by capitation will not be
able to provide the services contracted for and the risk associated with recoverability of
amounts due from reinsurers.

Business risk the general risk of conducting business, including the risk that actual
expenses will exceed amounts budgeted. 35

The second component of the NAIC's RBC regulatory framework is a model act that
gives regulators authority to take specific actions when the RBC level, as calculated by
the formula, reaches certain levels or has negative trends. The model act for the health
plan-RBC formula, which is virtually identical to the model act for other lines of
insurance, was not yet finalized at the time of this writing. It is titled the Health
Organizations Risk-Based Capital Model Act (HORBC), a reference to an earlier
version of the health plan-RBC formula. According to the provisions of HORBC,
regulators are to compare an organization's capital requirements (as determined by the
health plan-RBC formula) with the organization's total adjusted capital (the organization's
net worth as shown in the filing of its annual financial statements plus any other items
specified in the formula instructions). If the organization's total adjusted capital is
insufficient, then one of four levels of regulatory intervention may be triggered. These
four levels are (1) company action level, (2) regulatory action level, (3) authorized control
level, and (4) mandatory control level. These interventions range from requiring the

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submission of a corrective action plan to placing the plan under regulatory control of the
appropriate state agency.

In addition to serving as a tool for state regulators, the health plan-RBC formula provides
start-up companies with the information needed to estimate initial RBC levels based on
their operating projections for their first full year.

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Chapter 5 B
State Mandates and Regulation of the Health Plan-Provider
Relationship
After completing this lesson, you should be able to:

 Describe the difference between a mandated benefit and a mandated provider law
 Give examples and explain the purpose of several mandated benefit laws
 Describe the problems with applying any willing provider laws to certain types of
health plans
 Explain why state mandates often increase the cost of healthcare services provided
by health plans

State Mandates
Webster defines mandate as "an authoritative command." In a managed healthcare
1

context, state mandates are "authoritative commands" in the form of laws that require
health plans to provide coverage for specific treatments or benefits or that regulate
aspects of the health plan-provider relationship. In the last several years, many states
have enacted a variety of mandates that affect health plan operations. Although
mandates have been around for many years, the recent increase in such mandates may
be a response to a public perception that health plans are not providing coverage for
certain services seen as necessary and basic. In addition, some mandates are passed
because there are strong lobbying efforts made by various interested constituencies,
such as healthcare providers, patients with chronic diseases, etc. Regardless of the
motivation for their enactment, there are basically two types of state mandates:
mandated benefit laws and mandated provider laws. Other mandates that affect health
2

plans and do not fit into the two preceding categories include mandates concerning
utilization review activities, confidentiality of medical records, network adequacy, direct
access to providers, quality assurance, and external review of coverage decisions.

Mandated benefit laws or benefit mandates are laws that contain provisions which
require that health plans arrange for the financing and delivery of a particular benefit,
such as coverage for a stay in a hospital for a specified length of time. Mandated
provider laws are laws that relate to the health plan-provider relationship, including
decisions to engage or terminate providers, to include certain types of providers in
networks, and to establish certain financial arrangements between health plans and
providers.

Sometimes mandates are incorporated into a state's HMO statutes; other times
mandates are incorporated into the state insurance laws. Some mandates apply both to
entities that are licensed as an HMO and to entities licensed under state insurance law.
For the purposes of this lesson, we discuss state mandates in general and do not
distinguish between HMO and insurance laws.

In this lesson, we discuss some of the state mandates that affect health plans. Note that
not all plans must comply with state benefit mandates. Health plans provided by the
federal government and self-funded employee benefit plans are generally exempt from

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state benefit mandates because such plans are governed by federal, not state, law.
However, all health plans (including insurance companies), whether government-
sponsored, self-funded, or otherwise, must comply with the provisions in the Health
Insurance Portability and Accountability Act of 1996 (HIPAA). HIPAA, discussed in more
detail in Assignment 7, includes some federal mandates with which all health plans must
comply. Plans that are subject to state regulation must comply with both state mandates
and the federal mandates included in HIPAA. Such a regulatory system may create a
dual and sometimes potentially conflicting regulation of health plans.

In the remainder of this lesson, we discuss in more detail several types of mandates,
both benefit and provider, and look at other mandates that impact the benefits offered by
health plans. Figure 5B-1 shows a state-by-state comparison of some of the mandates
discussed in this lesson.

Mandated Benefit Laws

To attempt to list every mandated benefit that the states have passed would be a
daunting task. Figure 5B-2 shows a catalog of some different types of state benefit
mandates. Benefits have been mandated for illnesses, conditions, and diseases that
range from the diagnosis, treatment, and management of osteoporosis (California) to the
treatment of Lyme disease (Minnesota). We discuss a few of the newer types of
mandates appearing in state legislatures and mandates that have been passed by more
than a few states.

Figure 5B-2. Catalog of State Benefit Mandates.

This list provides a sampling of the types of mandates states have enacted:

• Mental health coverage

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• Length of stay for specific conditions/procedures (e.g., maternity, mastectomy)

• Infertility treatment
• Experimental treatments for cancer (e.g., bone marrow transplants for treatment
of cancer)
• Diabetes management
• Off-label uses for drugs to treat cancer and/or HIV/AIDS
• Hospice services
• Mammograms and pap smears
• Phenylketonuria and related metabolic disorders, sickle cell anemia, Lyme disease
• Services related to the diagnosis, treatment, and management of osteoporosis
Source: Centers for Medicare and Medicaid Services, Office of Health Plan "A Report to the Governor on State Regulation of Health
Maintenance Organizations," 16th ed., Prepared by Aspen Systems Corporation for CMS (Baltimore, MD: CMS, 1996).

Mental Health Coverage

Concern that coverage for mental illnesses was not being treated on a par with physical
illnesses motivated lawmakers to enact a mental health parity requirement that
subsequently was incorporated into HIPAA. The federal mental health coverage
requirements bar group health plans from having more restrictive annual and lifetime
limits or caps on mental illness coverage than for physical illness coverage if the health
plan has annual payment limits or aggregate dollar lifetime caps. The federal mental
health coverage law does not mandate coverage for mental illness; it seeks to ensure
that- if a health plan covers mental illness- the caps and limits are comparable to caps
and limits for physical illness. More than 15 states have enacted their own mental health
coverage laws. These laws, similar to HIPAA, vary from mandating coverage of
treatment for severe disorders or biologically based illnesses such as schizophrenia,
manic-depression, or bipolar disorder to mandating parity for coverage of mental
illnesses comparable to caps and limits for physical illnesses. Some state laws require 3

that all terms and conditions of coverage (i.e., copayments, deductibles, etc.) be the
same for both mental and physical illnesses.

Some state parity laws exclude substance abuse treatment from their mandates for
coverage of mental illnesses. Other state laws provide extensive coverage for mental
illnesses. For example, the Vermont mental health parity law, which includes in its
definition of mental illness any disorder listed in the International Classification of
Diseases Manual (ICDM), requires coverage for the treatment of a wide variety of mental
illnesses including substance abuse. In addition, as in several other state laws, the
Vermont law prohibits separate deductibles, copayments, coinsurance, and other similar
types of cost-sharing arrangements for mental and physical illnesses. In general, health 4

plans must ensure that they comply with the mental health parity requirements of the
federal law as well as any more stringent requirements imposed by the states in which
they operate.

Length of Stay Laws

Two types of length of stay (LOS) laws enacted by many states are maternity length of
stay and mastectomy length of stay. A federal maternity length of stay mandate was
enacted by passage of the Newborns' and Mothers' Health Protection Act of 1996
(NMHPA). The NMHPA was subsequently incorporated into HIPAA. The NMHPA
requires that health plans provide coverage for hospital stays for childbirth-at least 48
hours for normal deliveries and 96 hours for cesarean births. Prior to enactment of the

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NMHPA, more than half of the states had enacted maternity length of stay mandates. At
a minimum, a health plan must comply with the federal NMHPA law. If the health plan
operates in a state with a similar mandate that has more stringent requirements, it must
also comply with those additional requirements.

In addition, most states have considered and a number have enacted mastectomy
length of stay mandates. Some state mastectomy length of stay laws mandate a specific
hospital stay. For example, in New Jersey, health plans and insurers must cover hospital
stays for 72 hours for a radical mastectomy and 48 hours for a simple mastectomy. In
other states, such as Florida, health plans and insurers must cover the length of the
hospital stay as determined by the physician. 5

Emergency Care
In the past, some HMOs denied coverage for services provided in an emergency room if
it turned out that the illness or injury was not an actual medical emergency as defined by
the plan. State mandates for emergency care generally require that health plans cover
emergency room services if a "prudent layperson" would have assumed the illness or
injury to be an emergency.

Other Benefit Mandates

Although there are many state mandates that require coverage for specific diseases,
one of the newer types of mandates for a specific, prevalent disease is for diabetes.
About 23 states have passed mandates requiring health plans and insurers to cover
equipment, supplies, and self-care training for members with diabetes. Most of these
mandates have been passed in the last three to four years. Diabetes is a disease that
can have many complications and can be very expensive if left undetected or untreated
for a long period of time. It is estimated that the annual cost for the routine care of one
diabetic patient can be $5,000. Health plans have developed innovative strategies for
6

the management of diabetes, often incorporating disease management. Many health

plans voluntarily provide benefits for self-management of diabetes in the absence of
state mandates.

Other benefit mandates that have been enacted include coverage for:

• Experimental medical treatments for diseases such as AIDS and cancer

• Infertility treatments
• Contraceptives
• Chiropractic care

Some state laws have addressed the use of formularies for pharmaceutical
management. Mandates pertaining to prescription drugs are discussed in Pharmacy
Laws and Legal Issues.

State Benefit Mandates - Are They Free?

Most of the mandates that states enact come with a price tag. Some experts believe that
legislating coverage for certain procedures often translates into higher premiums that
purchasers or plan members ultimately have to pay. The reason for the increased costs
associated with mandates is threefold: (1) the health plan must pay for the additional
healthcare benefit, (2) the health plan must implement administrative procedures to

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assure that a mandated benefit is provided, and (3) the health plan may have to change
other plan policies or procedures to comply with mandates. Increased costs, resulting
from benefit mandates, may prompt health plans to raise premiums. In turn, purchasers
may raise the contributions required of plan members for participation in a plan. To
illustrate, assume that a state mandate requires that all impatient hospital stays for a
particular procedure, such as a simple mastectomy, be covered for a minimum of two
days. First, the health plan must pay for the hospital charges it might not have paid if the
stay was determined to be medically unnecessary. Second, the health plan must make
administrative changes to comply with the mandate. These administrative changes may
include changing plan literature for current or prospective enrollees, updating the health
plan's computer claims payment system to note coverage for that benefit, and amending
all existing contracts with purchasers to incorporate coverage for the documents. In
addition, the health plan will need to change it's treatment guidelines or medical
protocols to note this exception to its rules on medical necessity. Figure 5B-3 provides
an analysts perspective on the increase in costs triggered by different types of benefit
mandates.

Benefit mandates generally increase costs. One result of such increased costs may be
that employers drop healthcare coverage for their employees, which, in turn, may cause
the number of uninsureds to increase. States are recognizing the value of performing
cost-benefit analyses on proposed mandated benefits. For example, Colorado,
Kentucky, and Oklahoma have adopted laws that require an independent financial and
social impact study for all proposed mandated benefits bills before they can be passed
by the legislatures. Insight 5B-1 describes, from a cost perspective, some unintended
8

consequences of state health mandates.

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Insight 5B-1. Unintended Consequences of State Mandates.

Depending on their focus and approach, state healthcare mandates can make it difficult, if
not impossible, for health plans to arrange for the delivery of high quality, well-
coordinated, and affordable care. This, in turn hinders the ability of individuals and
employers to select and purchase benefits based on their healthcare needs and ability to
pay. A 1992 study in the Journal of Public Economics (Gabel and Jensen) estimated that
mandated benefits prevented one in five small firms that did not offer health insurance to
their employees from doing so.

Important, too, is the negative impact of state mandates on the state regulated insurance
market. Because self-funded health benefits plans are not subject to state mandates,
employers may have an incentive to self-fund to avoid these costs. According to
estimates from the Bureau of Labor Statistics, about half of the U.S. firms self-fund their
employee health benefits plans, rather than purchase a state regulated insurance product.

However, a more recent study indicated that although some companies chose to self-fund
to avoid mandates in the past, more recently self-funded companies are offering the same
or similar benefits as those mandated by the states in which they operate.

Ironically, the population most likely to be affected by mandate costs is also the most
vulnerable economically: persons working for small firms that are not self-funded; and
those who work part-time or are self-employed, who must purchase expensive, non-group
coverage.
Source: Adapted, with permission of the publisher, from BlueCross BlueShield Association, "Legislative Report: States Turning To Evaluation
Laws to Curb Mandated Benefits," Issue Review, April 18, 1997, 2-4.

Other Types of Mandates

As discussed in State HMO and Other Types of Health Plan Laws, all states have
comprehensive HMO licensure statutes and regulations that include protections in key
areas such as quality assurance, access to care (i.e., network adequacy, physician
credentialing, disclosure of health plan information, utilization review, grievance
procedures), coverage for basic health services, emergency services, and financial
solvency. In addition to these existing protections, several states have enacted or are
considering passage of specific mandates related to network access/adequacy and
quality assurance efforts. For example, New Hampshire now has a law that allows the
department of insurance to establish rules related to utilization review processes that
networks must develop, credentialing of network providers, ensuring the adequacy of
provider networks, and setting standards for quality assurance and improvement
programs. Sometimes quality assurance mandates are part of a larger health plan bill,
such as a consumer bill of rights, discussed later in this lesson.

External Review Mandates

One type of proposed legislation that is appearing frequently before state legislatures
mandates external review of a health plan's decisions to deny or limit benefits for
certain procedures or treatments. External review refers to a dispute resolution

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mechanism that involves review-by an individual or group of individuals not affiliated with
the health plan-of certain disputed decisions made by a health plan, which may include
what constitutes medically necessary treatment or denials for experimental treatments.
In most cases, the plan enrollee must exhaust the health plan's internal grievance
procedures before seeking external review. Some plans set a minimum dollar threshold
for the value of services for which coverage disputes can go to external review. In
general, external review laws may cover areas such as:

• Qualifications of external reviewers

• Who chooses the external review entity (i.e., the health plan or the state
agency responsible for ensuring compliance with the external review
mandate)
• The impact of external review determinations
• The type of decisions (i.e., experimental treatment or medical necessity)
subject to external review

All health plans have some type of formal, internal grievance procedure through which
enrollees can appeal coverage decisions. Some health plans also have less formal
processes to review complaints concerning issues that are routine or not as major as
coverage decisions. Formal grievance procedures are required by state and federal laws
for HMOs. Some health plans have also voluntarily implemented external review
programs to review complex coverage decisions (e.g., cases involving coverage for
experimental treatments). In addition, some health plans are establishing internal
ombudsman programs to resolve disputes between health plans and members regarding
benefits provided under a health plan. Ombudsman programs may also be created by
state agencies. We discuss ombudsman in more detail in Governance: Accountability
and Leadership.

Regulation of the Health Plan-Provider Relationship

Typically, the legal relationship between a health plan and its providers is based on the
contracts between these parties. State contract law governs many of the disputes that
may arise in relation to the health plan-provider relationship; however, states have also
passed health plan-specific laws regulating aspects of this relationship. For example, a
recent topic of considerable interest to consumers is the amount or type of any physician
financial incentives related to physician performance in meeting quality standards,
satisfaction rates of individual physicians' patients, and, in some cases, utilization of
certain services. Incentives could relate to underutilization (e.g., for preventive services
such as mammography or immunizations) as well as overutilization of some services.
Several states have enacted or are considering passage of laws that require disclosure
to health plan members of any physician financial incentives. As health plans become
more prevalent in the United States, consumers are demanding more information on
which to base decisions in choosing or changing health plans. To assist consumers in
this effort, legislators have introduced bills that seem to support the consumers' rights in
areas that affect the health plan-provider relationship. Thus, legislators have expanded
the legal authority over the health plan-provider relationship that was once based almost
exclusively on contract law to now encompass mandates that affect the health plans'
selection and compensation of providers. Some analysts argue that the purpose of
mandated provider laws is to protect the interests of providers, not to assist consumers.
Whatever the motivation behind these laws, they exist and affect the health plan's
operations. We discuss these types of mandates in the following sections. The elements

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of a contract between a health plan and its network providers will be explored in some
detail in the AHM Network Management in Health Plans dealing with network
management. We will discuss liability issues arising from this contractual relationship in
this lesson in Key Legal Issue in Health Plans.

Mandated Provider Laws

As mentioned earlier, mandated provider laws apply to the health plan-provider
relationship. The following sections discuss some of these laws.

Any Willing Provider Laws

We introduced the concept of any willing provider laws in Overview of Laws and
Regulations. Recall that such laws allow any provider who meets the health plan's terms
and conditions of participation to become part of the health plan's network or receive
payment from the health plan for covered services provided to enrollees, whether the
provider is part of the health plan network or not. However, not all state any willing
provider laws are alike. The definition of what constitutes a provider varies from state to
state. For example, in some states "provider" refers only to pharmacists, while in other
states the term "provider" includes non-physician healthcare providers and physicians.
The following discussion describes the differences among state any willing provider laws
and the groups that support and oppose such laws.

Of the 24 states with some type of any willing provider requirements, 22 apply such
requirements to PPOs or insurer-based provider networks. Seventeen states' any
11

willing provider laws apply to HMOs, and some of these laws provide exceptions for
staff/group-model or federally qualified HMOs. Also, since many of the laws were
12

enacted several years ago, it is unclear how they will affect new and developing health
plan arrangements, such as at-risk provider organizations.

The types of providers affected by any willing provider laws vary from state to state.
Pharmacy is the most common type of provider affected. More than 10 states' any willing
provider laws apply only to pharmacy providers. Some states, such as Arkansas, Idaho,
Kentucky, and Wyoming, include a wide variety of healthcare providers, including
physicians, in their any willing provider laws.13

The terms of the contract that a provider is required to meet to be considered a "willing"
provider also vary. Some any willing provider laws merely prohibit health plans from
"unreasonably discriminating" against providers, while others require that the provider
meet all of the health plan's qualifications for participation, or be appropriately licensed,
reputable, and in good standing. Some require that the provider be willing to meet more
specific standards, including those relating to the provision, utilization review, and cost-
containment procedures; the management and administrative procedures; and the
provision of cost-effective and clinically efficacious healthcare services. 14

The proponents of any willing provider laws all argue that selective contracting by health
plans reduces the number of providers, decreases competition, and could sever long-
standing relationships between patients and providers. The advocates further argue that
in the absence of any willing provider laws, health plans limit access to certain types of
providers. Proponents of any willing provider laws include members from pharmacy,
chiropractic, dental, home health, physical therapy, outpatient surgical, and clinical lab
associations.16

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Opponents of any willing provider laws include individual health plans and health plan
associations, the NAIC, the National Governors' Association, the FTC, employers, and
many policyholders. In many letters to state legislators, the Federal Trade Commission
has described any willing provider laws as anticompetitive. In addition, opponents argue
17

that any willing provider laws undermine the quality and affordability of healthcare and
limit consumer choice. Listed below are some of the chief reasons for opposition to any
willing provider laws. According to some analysts, these laws:

• Increase healthcare costs by eliminating incentives for providers to offer

discounts in exchange for patient volume 18

• Undercut the quality initiatives of health plans because such laws prevent
plans from choosing and contracting with only the most qualified providers
• May increase the number of uninsured Americans (i.e., as a result of the
increase in premiums that any willing provider laws bring, some employers
drop healthcare coverage for their employees)
• Limit consumer choice to coverage options much more costly than network-
based plans
• Decrease quality of care by requiring health plans to accept any provider
regardless of whether additional providers are necessary to meet the needs
of health plan members
• Allow providers to have mandatory contracting privileges that are not present
in any other industry or even elsewhere in the healthcare industry

Review Question

Any willing provider laws have their share of proponents and opponents. Arguments
commonly made in opposition to any willing provider laws include

that such laws reduce the number of providers in a health plan's network
that such laws limit consumer choice to coverage options that are more costly than
network-based plans
that such laws encourage providers to offer discounts in exchange for patient
volume
all of the above

Incorrect. Opponents argue that AWP laws decrease the quality of care by
requiring health plans to accept any provider regardless of whether they are
necessary to meet the needs of health plan members.

Correct. Opponents of AWP laws feel that they limit consumer choice to coverage
options more costly than network-based plans

Incorrect. Opponents feel the AWP laws increase healthcare costs by eliminating
incentives for providers to offer discounts in exhange for patient volume.

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Incorrect. Several of the responses listed above are incorrect

Direct Access Laws Direct access laws allow subscribers to have direct access to
certain specialists in the health plan's network without a referral from a primary care
provider (PCP). As of mid-1998, thirty-four states require direct access to some type of
provider. The vast majority of these direct access laws relate to access to
obstetricians/gynecologists. Interestingly, most health plans already provide direct
access to in-network obstetrician-gynecologists for routine gynecological and maternity
care. Florida and Georgia both have direct access laws that allow enrollees to visit a
dermatologist without referral from a PCP. Many states have mandates that require
coverage for chiropractic care. Recently, New York has mandated direct access to
chiropractors for health plan members. That law requires that plans cover at least 15
chiropractic visits without any ability to deny coverage for lack of medical necessity; after
the 15 visits have been made, HMOs and other health plans can deny coverage for
further treatment that they do not find medically necessary. Mandates such as direct
22

access laws may make it difficult for health plans to ensure the quality coordination of
healthcare.

Physician/Patient Communication
The term "gag" clauses, or "gag" rules as they are sometimes called, has been used to
refer to a statement in a health plan-provider contract that could restrict a provider from
discussing alternative treatment options with their patients. In 1996 the American
Medical Association (AMA) proposed a Patient Protection Act that among other
measures, prohibited health plans from using "gag-clauses" in provider contracts.
Shortly after, the General Accounting Office (GAO) studied 529 HMO's provider
contracts to determine the presence of these clauses. and they concluded that none of
the HMOs studeid used contract clauses that specifically restrict doctors from discussing
all appropriate medical treatment with their patients. Many states have enacted
legislation barring the use of so-called "gag" clauses in provider contracts. Health plans
do encourage physician/patient communication between their network providers and the
health plan enrollees. This physician/patient communication includes dialogues
between a provider and a health plan enrollee about diagnoses, treatment options,
physical examinations, laboratory tests, and other concerns that patient may have about
their healthcare.

The so-called "gag" clause mandates in most states bar health plans from including such
a provision in their provider contracts and from terminating a provider who violates such
a provision if one is included in the contract.

Review Question

Nightingale Health Systems, a health plan, operates in a state that requires health plans
to allow enrollees to visit obstetricians and gynecologists without a referral from a
primary care provider. This information indicates that Nightingale must comply with a
type of mandate known as a:

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direct access law

scope-of-practice law
provider contracting mandate
physician incentive law

Correct! Direct access laws allow subscribers to have direct access to certain
specialists in the health plan's network without a referral from a primary care
provider

Incorrect. Scope-of-practice legislation is legislation proposed by one type of

provider to amend state licensing laws to allow that type of provider to do a
procedure or set of procedures typically reserved only to another provider group

Incorrect. A provider contracting mandate requires that a health plan disclose its
criteria for selecting or deselecting providers

Incorrect! A physician incentive law requires a health plan to disclose to members

any incentive arrangements available to plan provicers, or the law bans types of
incentives that may encourage network providers not to refer members to
specialists for needed care.

Provider Contracting Mandates

Provider contracting mandates, also known as due process laws, require that a health
plan disclose its criteria for selecting or deselecting providers. In addition, such laws
usually contain certain procedural rules that must be followed when a provider is not
selected or is deselected from a health plan's network of providers. Typically, the
procedural rules that must be followed by health plans include notification of the
selection criteria for network providers, an explanation of the reason(s) that a provider is
deselected or rejected, and the provider's right to contest or challenge the health plan's
decision to deselect.23

To help standardize the process of credentialing that health plans use in selecting
network providers, the NAIC has developed and adopted a model act that sets
standards for credentialing efforts. The act is entitled the Health Care Credentialing
Verification Model Act. This model act calls for 24

 The creation of policies and procedures to be used by health plans to verify the
credentials of providers before contracting with them and for reverification every three
years
 Communication with potential participating providers of the applicable standards for
providers who wish to participate in the plan
 The creation of a committee comprised of healthcare professionals who would make
decisions setting the standards for verification of credentials

Physician Incentive Laws

There are actually two types of physician incentive laws enacted by states. One requires
only that health plans disclose to plan members any financial incentives available to

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participating providers in the health plan. The other type of law bans certain
compensation arrangements that regulators believe may encourage network providers to
not refer members to specialists as necessary or that encourages providers to not
provide the appropriate, medically necessary care to plan members. For example, an
Arizona law requires that health plans disclose any incentives or penalties that could
encourage participating providers to withhold healthcare services or minimize or avoid
referral to specialists. In addition, federal law provides specific guidelines regarding
permissible and impermissible incentive arrangements that apply to federally qualified
HMOs and other plans that provide coverage to participants in the Medicare program.

Mandating a Point-of-Service Option

Some states have adopted legislation requiring that certain health plans offer a point-of-
service (POS) option in addition to an HMO. Physicians who are not participants in
certain health plan networks generally support this type of legislation because it gives
them access to a patient base, members of health plans, that is otherwise not available
to them. A recent Johns Hopkins University study found that specialist utilization was no
higher in POS products than in closed-panel HMOs. The authors of the study suggested
25

that enrollment in a POS product was more for "peace of mind" than for changing actual
patterns of using specialists.

Market demand, not legislation, has given a boost to POS options in HMOs in many
markets. HMOs have realized the popularity of POS options with consumers and have
voluntarily offered POS options in many of their markets. While more than three-quarters
of all HMOs already voluntarily offer a POS option, only 22% of insured individuals are
enrolled in POS products. POS products typically cost more than a closed-panel HMO,
and consumers continue to choose HMOs as a high-quality, affordable healthcare
option.

States that mandate the provision of a POS option usually require a mandatory offering
by HMOs of a POS option to employers. Some states' POS mandates apply only to
employers that employ 50 or more employees or some other threshold number of
employees. There is some debate about the applicability of such mandates to group
plans governed by ERISA, but there is not yet a definitive answer on this issue.

Utilization Review Mandates

Some states (for example, North Dakota) have laws requiring that health plans disclose
to both providers and patients the criteria that they use in making utilization review
decisions. 27

Other states have laws that may require that:

• Only physicians be allowed to make utilization review (UR) decisions

• The physician making the UR decision must be in the same specialty as the
physician providing the care
• The physician performing UR be licensed in the state where the patient
resides

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In Texas, a law has been passed that establishes standard UR procedures and requires
that UR decisions be made only by licensed physicians, nurses, and physician
assistants.

Comprehensive Health Plan Legislation

Some states have taken the approach of rolling all their benefit mandates, mandated
provider laws, and other legislation pertaining to health plans into one comprehensive
piece of legislation. Comprehesive legislation may address issues such as:

• Grievance procedures
• Coverage of emergency room treatment
• External review
• Provider credentialing
• Direct access
• Physician/patient communication
• Disclosure of financial incentives
• Provider contracting
• Point-of-service option mandates
• Qualification standards for utilization reviewers
• Network adequacy and performance
• Confidentiality of medical records
• Use of drug formularies
• Continuity of healthcare coverage (e.g., laws similar to HIPAA and COBRA)

Many of the provisions included in comprehensive health plan laws are already covered
by existing law or regulations. Figure 5B-3 provides an overview of several states'
comprehensive health plan bills.

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Chapter 6 A
Other Laws That Apply to Health Plans
As we have seen, health plans, like other businesses, must comply with a variety of
local, state, and federal laws. Many of these laws do not pertain exclusively to health
plans or insurance companies. For instance, in some states, general consumer
protection laws apply to the claims payments that are made by health plans. Also,
because health plans are employers, they are subject to laws that govern all aspects of
the workplace, from employment and hiring practices to workplace health and safety
standards. In addition, health plans must comply with laws governing diverse issues,
such as civil rights, taxation, and zoning.

We begin this lesson with a brief overview of some of the healthcare-related and
antitrust laws that apply to health plans at the state level. We then take a closer look at
some of the more common types of insurance laws that apply to health plans yet do not
specifically address issues unique to health plans. These laws cover a wide variety of
subjects and often vary by state.

After completing this lesson, you should be able to:

 Describe the various types of state laws, other than HMO and insurance laws, that
apply to health plans
 Explain how states regulate agent licensing, marketing activities, and advertising
 Describe common types of general insurance laws that apply to health plans

Review Question

Certificate of need (CON) laws apply to health plans in a variety of ways, depending
upon the state. By definition, CON laws are laws that are designed to

regulate the construction, renovation, and acquisition of healthcare facilities as

well as the purchase of major medical equipment in a geographical area
protect commerce from unlawful restraint of trade, price discrimination, price fixing,
reduced competition, and monopolies
determine benefit payments when a person is covered by more than one plan,
such as two group health plans
license and regulate health plans that wish to establish and operate an HMO
Correct. Certificate of need (CON) laws regulate the construction, renovation, and
acquisition of healthcare facilities as well as the purchase of major medical
equipment in a geographical area. A primary objective of these laws is to contain
healthcare costs by reducing or eliminating unnecessary or duplicate services or
capital expenditures

Incorrect. Antitrust laws are designed to protect commerce from unlawful restraint
of trade, price discrimination, price fixing, reduced competition, and monopolies

Incorrect. Coordination of benefits (COB) laws are used to determine benefit

payments when a person is covered by more than one plan, such as two group

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health plans or a health plan and the medical benefits provisions of an automobile
policy.

Incorrect. Under the HMO Model Act, and most state laws, an entity that wishes to
operate as an HMO must obtain a certificate of authority.

State Antitrust Laws

Antitrust laws are designed to protect commerce from unlawful restraint of trade, price
discrimination, price fixing, reduced competition, and monopolies. As we saw in Legal
1

Organization of Health Plans, the health plan industry relies heavily on structural and
operational integration, strategic partnerships, mergers, and acquisitions. For this
reason, health plans must be particularly aware of antitrust laws. In addition to federal
antitrust laws, which we address in Federal Regulation of Health Plans, health plans are
subject to state antitrust laws. Most states have modeled their antitrust laws on the
Sherman Act and the Federal Trade Commission Act. The state antitrust laws apply to
all types of businesses, including health plans. In addition, many states address antitrust
issues through anticompetition provisions that are found in their insurance holding
company laws.

State attorneys general enforce both federal and state antitrust laws. State insurance
commissioners enforce insurance holding company laws. In looking at proposed
mergers and acquisitions, regulators determine if a particular transaction would result in
substantially reduced competition or a monopoly. Typically, they make this determination
by looking at the market shares of the entities involved, as well as other factors, such as
number of competitors in the market, volatility of ranking of market leaders, and ease of
entry into and exit from the market.2

General Insurance Laws that Apply to Health Plans

Some of the state laws that affect health plans may be found in general laws applicable
to all businesses, others may be found in general insurance laws, and others may be
found in HMO acts. At times, a state's general insurance code and HMO act will regulate
the same issue, and the requirements for HMOs may be different than the requirements
for other types of health plans. For example, some states have different insurance and
HMO benefit mandates for treatment of substance abuse. In other instances, statutes
from the insurance code apply to HMOs. For example, in some states HMOs are subject
to insurance regulations regarding payment of premium taxes, use of unfair trade
practices, rehabilitation and liquidation of insurance companies, and establishment of
holding companies. For the purpose of our discussion, we have organized general
insurance and HMO laws into the categories listed below, although the way these types
of laws are codified can vary by state:

• Sales and marketing

• Underwriting
• Records and privacy
• Claims and coordination of benefits
• Antifraud
• Continuation and conversion

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• Small group
• Individual healthcare (direct pay products for individuals)
• States as purchasers

Sales and Marketing

As competition in the health plan environment intensifies, marketing takes on an
increasingly important role. So, too, do state and federal laws that regulate marketing
and sales practices. Health plans that violate these laws can face liability for damages,
restitution, fines, or even criminal charges in cases of extreme misrepresentation or
deception. Therefore, it is important for health plans to be aware of the regulatory
requirements with regard to sales and marketing. In this lesson we discuss state sales
and marketing requirements; in Federal Regulation of Health Plans we address federal
requirements.

Typically, health plan products in the commercial market are sold by means of face-to-
face interactions between a sales representative or agent and a prospective purchaser,
often an employer. Health plan representatives also conduct marketing activities when
recruiting providers, such as healthcare practitioners and hospitals. Sales
representatives must comply with all applicable licensing requirements to be able to sell
the health plan's products. They must also conduct business in accordance with all
applicable laws and regulations, and must not engage in any prohibited sales practices.
In addition, any marketing and advertising material that a health plan uses must be
complete and accurate to comply with state and federal advertising requirements, which
are often very detailed.

Corporate Liability Based on Agency 3

A corporation can act only by delegating its authority to individuals, such as directors,
officers, and employees, who conduct the corporation's business. Because these
individuals act on behalf of the corporation, they are, in a sense, agents for the
corporation. Agency is a legal relationship in which one party, known as the principal,
authorizes another party, known as the agent, to act on the principal's behalf. (See Key
Legal Issues in Health Plans for a broader discussion of agency.)

As the principal in an agency relationship, a health plan has the right to determine the
scope of the agents' authority. Because agents who act within the scope of their
authority have the power to bind the principal, health plans are generally interested in
limiting the scope of such authority. For example, health plans want to ensure that their
sales representatives do not have authority to enter into binding insurance contracts on
the health plan's behalf. Sales representatives typically submit each contract application
for underwriting approval, and only specified employees- usually in the health plan's
home or regional office- have actual authority to approve an application and issue and
sign a contract that is binding on the health plan.

Licensing 4

The licensing requirements imposed on sales representatives allow the states to

oversee the activities of the individuals who engage in the sale of insurance and health
plan products. As with other regulatory requirements, specific licensing requirements
vary from state to state but are similar in many respects. We'll use the NAIC Agents

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and Brokers Licensing Model Act to illustrate state licensing requirements. Although
most states enacted their licensing laws before the NAIC adopted this Model Act, the
model illustrates features that are common to licensing laws.

Who Must Be Licensed?

Sales representatives must be licensed in each state in which they do business.
Although not all states define exactly what they mean by "doing business" in the state,
sales representatives are generally required to obtain a license in each state in which
they solicit or negotiate sales, deliver contracts, collect premiums, or have an office that
transacts insurance business. State laws typically list a number of individuals who are
not required to be licensed sales representatives. The Agents and Brokers Licensing
Model Act exempts certain individuals from the licensing requirements, such as:

• A health plan's or insurer's employees who do not negotiate or solicit

business
• Persons who assist in administering group health coverage and who do not
receive commissions for their services
• Employers that provide employee benefit plans, trustees of employee trusts,
and employees who administer such plans and who are not compensated by
the health plan or insurers that issued such plans

Agent and Broker Licenses

According to the Agents and Brokers Licensing Model Act, an insurance agent is an
individual, partnership, or corporation appointed by a company to solicit applications for
policies or to negotiate policies on the company's behalf. The Model Act defines an
insurance broker as a partnership, corporation, or individual who is compensated for
helping others to obtain insurance from a company that has not appointed that individual
as an agent. Note the distinction the Model Act makes between an insurance agent and
an insurance broker. An agent represents and acts on behalf of the health plan, whereas
a broker acts on behalf of the purchaser. Agents may place business with a health plan
only if they have been appointed as an agent with that company. By contrast, brokers
may place business with health plans they have not been appointed to represent.

Most states issue both agent's licenses and broker's licenses. States that do not issue
broker's licenses typically require individuals who act as brokers to obtain an agent's
license.

In most states, partnerships and corporations are eligible to be licensed agents and
brokers. Laws in these states usually require licensed partnerships to register with the
insurance department every partnership member and employee who personally engages
in the sale of insurance; licensed corporations must register every officer, director, and
employee who personally engages in the sale of insurance. In addition, these individuals
who are registered by a partnership or corporation must also be licensed as agents or
brokers.

Resident and Nonresident Licenses

Sales representatives typically conduct their business in the state in which they reside.
From the state's perspective, these individuals who reside and work in the state are

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known as resident agents and brokers, and the type of license they are required to
hold is known as a resident license.

Individuals who do not live in the state or whose principal place of business is located
outside the state are known as nonresident agents and nonresident brokers, and
must obtain a nonresident license before conducting business in the state. State laws
typically require applicants for a nonresident license to hold a similar license from
another state or country. In other words, sales representatives usually must hold a
resident's license from their home jurisdiction before being eligible to receive a
nonresident license from another jurisdiction.

Licensing Requirements
Individuals must comply with statutory requirements in order to be eligible to receive a
license. Figure 6A-1 lists the requirements from the Agents and Brokers Licensing
Model Act.

Once the insurance department receives a completed application and all applicable fees,
the department may conduct whatever investigation it deems necessary before acting on
that application. In most cases, the department approves the application and notifies
applicants of the dates and times on which they may take any required examination. If
the applicant passes the examination, then the department issues a license to the
applicant. If the department disapproves an application, it notifies the applicant of its
disapproval and gives the reasons for its decision.

Requirements for a nonresident license are generally the same as the requirements for a
resident license. Some states that issue nonresident licenses impose a
countersignature requirement under which applications solicited by nonresident sales
representatives must also be signed by an individual who holds a resident license.

Licensing Requirements from the Agents and Brokers Licensing Model

Figure 6A-1.
Act.
 The applicant must complete a written application on a form provided by the state
insurance department, which provides identifying information.
 An application for an agent's license must be accompanied by a written statement,
sometimes referred to as an appointment, made by an officer of an insurer or health plan
that is licensed to do business in the state. The appointment, made on a form prescribed
by the insurance department, indicates that an insurer or health plan appoints the
applicant as an agent for the products the applicant will be authorized to market. If a
health plan's corporate structure is such that it issues contracts through more than one
legal entity, then it must be sure to appoint the applicant for each entity. For instance, if
the health plan provides HMO coverage through one legal entity and PPO coverage
through another, then it must appoint its applicants for each entity.
 Individual applicants must be at least 18 years old.
 Applicants for a broker's license must have had at least two years' experience as an
insurance agent or in comparable employment with an insurer, health plan, agency, or
brokerage firm. This experience must have been during the three-year period before the
application.

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 An applicant must be competent, trustworthy, and financially responsible, and must

have a good personal and business reputation. The insurance department uses information
from the application to evaluate the applicant's character and fitness to hold a license. In
addition, the application typically includes a section that is to be completed by the entity
that has appointed the applicant as its agent. That entity certifies that it has investigated
the applicant's qualifications and background and believes the applicant is trustworthy
and competent.
 Applicants must pass a written examination in each line of business that they propose
to sell. Some states waive part of the examination requirement for applicants who have
successfully completed applicable courses of industry study. Many states require
applicants to complete a specified amount of prelicensing education before sitting for the
required written examination.
Source: Excerpted and Adapted form Harriet E. Jones, Regulatory Compliance: Companies, Producers, and Operations (Atlanta:
LOMA©1998), Used with permission; all rights reserved.

Review Question

State X issued a nonresident license to Tamara Pensky, a sales representative of the

Verity Health Plan. In doing so, State X imposed a countersignature requirement, which
requires that

an officer of Verity sign a written statement which indicates that Verity appoints
Ms. Pensky as an agent who is authorized to market Verity's products
an officer of Verity sign a written statement which certifies that Verity has
investigated Ms. Pensky's qualifications and background and believes she is
trustworthy and competent
applications solicited by Ms. Pensky must be signed by an individual who holds a
resident license
applications solicited by Ms. Pensky must be signed by an officer of Verity

Incorrect. In order to obtain an agent's license, the license must be accompanied

by a written statement from the health plan appointing the applicant as an agent
for the health plan's products

Incorrect. In order to obtain an agent's license, an officer of Verity sign a written

statement which certifies that Verity has investigated Ms. Pensky's qualifications
and background and believes she is trustworthy and competent

Correct. A countersignature requirement requires applications solicited by Ms.

Pensky must be signed by an individual who holds a resident license

Incorrect. Applications solicited by Ms. Pensky must be signed by someone other

than an officer of Verity

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Duration of License
In many states, as long as required renewal fees are paid, a sales representative's
license continues for an indefinite time, and expires only upon the occurrence of
specified events, such as termination of the individual's appointment with the health plan.
Other states issue a sales representative's license for a stated period, such as one or
two years. To renew the license, either the individual or the health plan must complete a
request for renewal and pay a renewal fee. In addition, the growing complexity of
products has led many states to require that licensed sales representatives complete
continuing education requirements in order to maintain their licenses.

The state insurance department has the authority to suspend or revoke a sales
representative's license. For example, suspension or revocation can occur when an
individual makes materially untrue statements in the license application, mishandles
funds, violates an insurance or HMO law, or is convicted of a felony or misdemeanor
involving moral turpitude, which is an act or behavior that gravely violates the moral
standards of the community. Typically, if the insurance department suspects a sales
representative of wrongdoing, it conducts a hearing at which the individual is given the
opportunity to present evidence. In the event of suspension or revocation, the insurance
department notifies the sales representative and all appointing entities. The insurance
department also notifies the NAIC and the insurance department of each state in which
the individual holds a license.

Marketing Activities 5

Most states have enacted a type of law typically known as an Unfair Trade Practices
Act. An Unfair Trade Practices Act defines certain practices as unfair and prohibits those
practices in the business of insurance if they are committed (1) flagrantly in conscious
disregard of the Act or (2) so frequently as to indicate a general business practice. Such
laws generally apply to all individuals and legal entities that engage in the business of
insurance, including sales representatives, insurers, third party administrators, and all
types of health plans ranging from medical and dental service plans to PPOs and HMOs.

Many such state laws are based on the NAIC Unfair Trade Practices Act, which lists
15 general practices that are prohibited; these prohibited practices are shown in Figure
6A-2.

Figure 6A-2. NAIC Unfair Trade Practices Act Defined.

Section 4. Unfair Trade Practices Defined

Any of the following practices, if committed in violation of Section 3, are hereby defined
as unfair trade practices in the business of insurance:

A. Misrepresentations and false advertising of insurance policies

B. False information and advertising generally
C. Defamation
D. Boycott, coercion, or intimidation
E. False statements and entries
F. Stock operations and advisory board contracts
G. Unfair discrimination

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H. Rebates
I. Prohibited group enrollments
J. Failure to maintain marketing and performance records
K. Failure to maintain complaint handling procedures
L. Misrepresentation in insurance applications
M. Unfair financial planning practices
N. Failure to file or to certify information regarding the endorsement or sale of
long-term care insurance
O. Failure to provide claims history
*Section 3 prohibits the practices listed in Section4 if committed (1) flagrantly and in
coscious disregard of the Act or (2) so frequently as to indicate a general business
practice.
Source: Unfair Trade Practices Act, Sections 3 and 4, National Association of Insurance Commissioners, 1993.

State unfair trade practices acts tend to contain broad prohibitions against certain unfair
practices; these laws do not attempt to identify every activity that is deemed unfair. Many
states have adopted regulations that supplement these acts. In addition, states have
enacted laws and regulations that govern specific activities of health plans and sales
representatives.

States often prohibit as an unfair trade practice the offering of inducements to enroll. For
example, some states would prohibit a health plan from giving out exercise equipment to
new members as part of a promotional campaign to increase membership.

State unfair trade practices laws may also pertain to activities between health plans and
prospective providers. For instance, a provider may be prohibited from offering the same
services at a price more favorable to one health plan than another. Or a health plan may
be prohibited from discriminating against a provider based on the types of services
typically rendered by the provider.

Advertising Requirements 6

A variety of state laws and regulations govern advertising by health plans. General
consumer protection statutes in many states regulate all types of advertisements,
including those generated by health plans. Unfair trade practices acts broadly prohibit
advertisements that are untrue, deceptive, or misleading. Many states' HMO laws have
similar prohibitions. The HMO laws in some states require that an HMO's application for
a certificate of authority include a description of the proposed method of marketing the
plan. Most states also have laws that specifically govern advertising of health coverage.

The NAIC Model Rules Governing Advertisements of Accident and Sickness

Insurance provide a good framework for discussing regulation of advertising for health
coverage. Most states have adopted rules based on the NAIC model, although there are
variations from state to state. The purpose of the model is to "assure the clear and
truthful disclosure of the benefits, limitations, and exclusions of policies sold as accident
and sickness insurance. This is intended to be accomplished by the establishment of
guidelines and permissible and impermissible standards of conduct in the advertising of
accident and sickness insurance." 7

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The NAIC rule define an advertisement to include:

• Printed and published material, audiovisual material, and descriptive literature

of an insurer used in direct mail, newspapers, magazines, radio scripts, TV
scripts, billboards, and similar displays
• Descriptive literature and sales aids of all kinds issued by an insurer, agent,
producer, broker, or solicitor for presentation to members of the insurance-
buying public, including but not limited to circulars, leaflets, booklets,
depictions, illustrations, form letters, and lead-generating devices of all kinds
• Prepared sales talks, presentations, and material for use by agents, brokers,
producers, and solicitors whether prepared by the insurer or by the agent,
broker, producer, or solicitor
8

The model act requires health plans to "establish and maintain a system of control over
the content, form, and method of dissemination of all advertisements of its policies. All
such advertisements, regardless of by whom written, created, designed or presented,
shall be the responsibility of the insurer whose policies are so advertised." Some states
9

require health plans to maintain an advertising file that contains copies of all advertising
pieces generated within a specified timeframe; this file indicates whether each piece was
reviewed for compliance with applicable requirements, how it was used, and whether it
remains in use. Advertising materials are subject to regulatory market conduct
examination.

The specific requirements imposed on any given advertisement depend on the type of
advertisement. According to the NAIC Rules, advertisements can be classified into three
types.
1. An institutional advertisement is one that is designed to promote either the
concept of health insurance or the insurer as a provider of health insurance.
Such advertisements do not refer to any specific product.
2. An invitation to inquire is an advertisement that is designed to induce the
audience to inquire further about a specific health policy and contains the policy
form number and a brief description of the coverage provided by the policy.
States typically prohibit invitations to inquire from referring to the cost of
coverage provided by the policy.
3. An invitation to contract is any health policy advertisement other than an
institutional advertisement or an invitation to inquire. Such an advertisement
contains fairly detailed information about a specific health policy and usually must
include the policy form number. Because invitations to contract are designed to
create consumer interest in purchasing a particular policy- so that a customer's
response to the ad is essentially an application for insurance- the states impose
a number of specific disclosure requirements on such ads. For example, if the
advertised policy contains exceptions, reductions, or limitations, the
advertisement must disclose those provisions. An exception is a policy provision
that eliminates coverage for a specific hazard. A reduction is a policy provision
that reduces the amount of the benefit payable for a specified loss. A limitation
is a provision, other than an exception or a reduction, which restricts the
coverage provided by the policy. Figure 6A-3 provides samples of an exception,
a reduction, and a limitation.

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Exceptions, reductions, or limitations must be placed conspicuously and in close

proximity to the statements to which they relate, or they must be put under prominent
headings, such as "Exceptions," "Exclusions," "Conditions Not Covered," or
"Limitations." Use of the words "only," "just," or "merely" to downplay the nature of
limitations or cost-sharing features is prohibited. For example, an advertisement cannot
state that "healthcare expenses are covered in full after you make a copayment of only
$15." State advertising regulations also prohibit exaggerated claims. For instance, an
HMO that requires members to file a claim form to be reimbursed for emergency care
rendered by a nonparticipating provider cannot state that "you never have to file a claim
form."

Figure 6A-3. Examples of an Exception, a Reduction, and a Limitation.

Exception: Charges for dental services are not covered.

Reduction: Charges for dental exams are limited to $40 per exam and not more than one
exam in any calendar year.
Limitation: Charges for dental services, other than treatment due to an accident, are not
covered.

Review Question

Indigo Health Plan advertised a specific individual health insurance policy through a
direct mail advertisement that provided detailed information about the product. In order
to comply with the NAIC Model Rules Governing Advertisements of Accident and
Sickness Insurance, Indigo must disclose whether the advertised policy contains any
exceptions, reductions, or limitations. Thus, Indigo disclosed in the advertisement that
one policy provision limits coverage for dental exams to $50 per exam and to one exam
per calendar year. This information indicates that, with respect to the definitions in the
NAIC Model Rules, Indigo's advertisement is an example of an

invitation to contract, and it discloses a policy provision known as an exception

invitation to contract, and it discloses a policy provision known as a reduction
invitation to inquire, and it discloses a policy provision known as an exception
invitation to inquire, and it discloses a policy provision known as a reduction

Incorrect. An invitation to contract is any health policy advertisement other than

an institutional advertisement or an invitation to inquire. An exception is a policy
provision that eliminates coverage for a specific hazard.

Correct. An invitation to contract is any health policy advertisement other than an

institutional advertisement or an invitation to inquire. A reduction is a policy
provision that reduces the amount of the benefit payable for a specified loss.

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Incorrect. An invitation to inquire is an advertisement that is designed to induce

the audience to inquire further about a specific health policy and contains the
policy form number and a brief description of the coverage provided by the policy.
An exception is a policy provision that eliminates coverage for a specific hazard.

Incorrect. An invitation to inquire is an advertisement that is designed to induce

the audience to inquire further about a specific health policy and contains the
policy form number and a brief description of the coverage provided by the policy.
A reduction is a policy provision that reduces the amount of the benefit payable
for a specified loss.

Most states require a health plan to disclose its legal entity name on all advertising,
applications, policies, and claim forms. In addition, most states prohibit advertisements
that disparage other insurers or health plans, or advertisements that provide unfair or
incomplete comparisons of plan provisions.

Some states have filing requirements for advertising material. These requirements vary
considerably by state. For instance, one state may require filing of all advertising
material for HMO products, but may not require filing of advertising material for PPO or
indemnity products. Another state may require filing for all small group advertising
material, whether the product is HMO, PPO, or indemnity. Some states establish a time
frame for health plans to file certain types of advertising. For example, a health plan
might be required to file each advertising piece at least 30 days prior to the date it
intends to use the piece; if the insurance department does not reply by that date, then
the filing is deemed approved.

Readability
Many states have readability laws, also called plain language laws or policy
simplification laws. The purpose of these laws is to simplify the language in the evidence
of coverage and make it easier for members to understand the plan provisions.
Readability laws require the health plan or insurer to issue documents that meet or
exceed a minimum readability score. This score is determined by a formula that includes
the average number of syllables per word and the average number of words per
sentence. Typically, the health plan calculates and certifies the score when it submits
forms to the state insurance department for approval.

Underwriting
Most state insurance laws contain provisions that in some way regulate the underwriting
practices of health plans. Often the purpose of these provisions is to protect consumers
from unfair discrimination. For example, most states require that any differences in
health plan benefits for members of employer groups must be based on conditions
pertaining to employment. An employer group would be permitted to have a $20 office
visit copayment for salaried employees and a $15 copayment for hourly employees
because these coverage classifications are determined by job-related factors. However,
an employer group would not be permitted to have a separate copayment for certain
employees listed in a memorandum sent by the company's human resources manager
to the health plan.

Many states prohibit discrimination in terms of denying coverage or charging higher

premiums based on factors such as race, national origin, marital status, gender, or

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sexual orientation. Some states prohibit such discrimination based on specified physical
or mental conditions.

Eligible Groups and Individuals

State group insurance laws specify the types of groups that can be issued group
coverage. The definition of an eligible group varies from state to state, but typically
includes the following:

• Single employers or trusts established by single employers

• Creditors
• Labor unions
• Trusts established by two or more employers or by employers and labor
unions
• Associations or multiple employer welfare groups

Some state insurance commissioners have the authority to approve other types of
groups that are substantially similar to those defined in the statute.

In addition to defining eligible groups, state insurance laws typically specify the
individuals who can or must be covered under a group policy. For example, eligible
employees in an employer group are often defined to include the officers, managers,
employees, and retired employees of the employer, a subsidiary corporation, or
companies under common control. Most health plans provide coverage for a member's
spouse and dependent children. Health plans often consider a spouse to be an
individual who is legally recognized as the employee's spouse, and a dependent child to
be a natural child, stepchild, or adopted child under a specified age, typically 19. Some
states have laws that specify whether or not domestic partners can be covered under a
health plan. Many states require a health plan to continue eligibility for handicapped
dependent children for as long as the child remains handicapped. Some states require
continued eligibility for college students up to a specified age. A number of states require
that newborn children of covered employees be provided automatic coverage for 31
days from the moment of birth, even if the coverage would require an increase in
contributions; the employee then has those 31 days to enroll the newborn child for
contributory coverage. If the employee fails to do so, then the child's coverage ends after
the 31-day period and the employee is liable for healthcare costs incurred after that date.

Records and Privacy 10

In the course of doing business, health plans gather a large amount of personal
information about individuals. General laws and court cases relating to confidentiality of
medical information apply to health plans and insurers. In addition, many states have
enacted laws designed to protect the privacy of individuals by establishing guidelines for
how health plans must treat such personal information. State privacy laws regulate the
ways in which companies collect, use, and disclose personal information. Many of these
laws are based on NAIC model acts. 11

For example, the NAIC HMO Model Act requires HMOs to protect the confidentiality of
information that would reveal the health status or treatment of members. HMOs may
disclose such information only in the following situations:

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• To carry out the purposes of the HMO Act

• With the express consent of the individual
• Pursuant to a statute or court order requiring the production of evidence
• In litigation between an enrollee and the HMO where the information or data
is relevant

In addition, the NAIC has enacted the Health Information Privacy Model Act. The model
act sets standards to protect health information from unauthorized collection, use and
disclosure by requiring carriers to establish procedures for the treatment of all health
information.

Aside from NAIC model acts, some states have enacted laws that:

• Prohibit health plans from selling for commercial purposes the names of their
enrollees
• Make all health plan documents and communications related to mental health
confidential
• Make all information derived from genetic testing confidential and authorize
release only with the consent of the individual tested

Some states also address procedures for maintaining health plan records. For instance,
they may require specific methods for filing and retrieving information and a specified
period of time for retaining files.

In addition to health plan information, health plans often need access to medical records
to perform utilization review and other medical management and quality assurance
activities. Recognizing this need, some states allow health plans limited access to
medical records. Typically, these laws require the health plan to obtain the appropriate
authorization from the member. Health plans often address this authorization
requirement by including a statement and signature line on the member enrollment form
which gives the member's approval for the health plan to access appropriate medical
records.

Several states that have enacted legislation or adopted constitutional amendments to

protect privacy of medical records have given patients access to their own medical
records, addressed procedures for maintaining health databases, and put in place strict
disclosure and authorization procedures.

Claims and Coordination of Benefits

State laws that address handling of claims set out a variety of improper claims practices
and prohibit health plans from engaging in those practices. The NAIC Model Unfair
Claims Settlement Practices Act defines improper claims practices as those
committed "flagrantly or in conscious disregard of this Claims Act" or so often as to
appear to be a general business practice. Figure 6A-4 provides some examples of acts
12

that would be considered unfair or improper according to the NAIC.

Coordination of benefits (COB) laws are used to determine benefit payments when a
person is covered by more than one plan, such as two group health plans or a health

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plan and the medical benefits provisions of an automobile policy. COB laws contain an
order of benefit determination to indicate which plan pays its benefits first (the primary
payor) and which plan pays its benefits second (the secondary payor). The primary
payor pays benefits as if the person had no other coverage. The secondary payor
reduces its benefits in a manner described by the COB provision in its contract and/or
according to the state's COB law, taking into account the benefits paid by the primary
payor.

COB provisions are relatively easy to administer for indemnity carriers. The individual
incurs the healthcare expenses and submits a claim to the primary payor, which
determines benefit payments; the individual then submits a claim to the secondary
payor, which reviews the primary payor's claim payment, then adjusts its payment
accordingly.

Figure 6A-4. Improper Claims Practices.

Following are some examples of acts that would be considered improper claims practices
according to the NAIC Model Unfair Claims Settlement Practices Act:

• Knowingly misrepresenting relevant facts or policy provisions

• Failing to acknowledge with reasonable promptness communications about claims
• Failing to adopt and implement reasonable standards for the prompt investigation
and settlement of claims
• Not attempting in good faith to effectuate prompt, fair, and equitable settlement of
claims
• Compelling insureds or beneficiaries to institute suits to recover amounts due by
offering substantially less than the amounts ultimately recovered in such suites
• Refusing to pay claims without conducting a reasonable investigation
• Failing to affirm or deny coverage of claims within reasonable time after having
completed an investigation
• Attempting to settle claims on the basis of an application that was materially
altered without notice to, or knowledge or consent of, the insured
• Making claims payments to an insured or beneficiary without indicating the
coverage under which each payment is being made
• Failing, in the case of claims denials or offers of compromise settlement, to
promptly provide reasonable explanations of the basis for such actions
Source: Excerpted and Adapted from Charles G. Benda and Fay A. Rozovsky, Liability and Risk Management in Health Plan (Gaithersburg,
MD: Aspen Publishers, Inc., 1998), p. 5:11.

Review Question

Determine whether the following statement is true or false:

Failing to adopt and implement standards for the prompt investigation and settlement of
claims is an example of an activity that would be considered an improper claims practice
according to the NAIC Model Unfair Claims Settlement Practices Act.

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True
False

Correct. NAIC Model Unfair Claims Settlement Practices Act defines improper
claims practices as those committed flagrantly or in conscious disregard of this
Claims Act or so often as to appear to be a general business practice

Incorrect. NAIC Model Unfair Claims Settlement Practices Act defines improper
claims practices as those committed flagrantly or in conscious disregard of this
Claims Act or so often as to appear to be a general business practice

COB provisions present more of a challenge for health plans. For instance, what is the
dollar amount of the "benefit" when an individual receives care from a capitated HMO
provider? Most COB laws state that when one plan uses capitation or similar
reimbursement provisions, then the "reasonable value" of the services will be used as
the basis for determining payment for COB purposes. For example, if an individual
obtains treatment from a capitated HMO physician and the HMO is the primary payor,
the secondary payor must determine the "actual charge" and the "benefit that was paid
by the HMO" in order to pay secondary benefits under the COB provision. The
secondary payor does this by assuming that the actual charge is the reasonable and
customary charge in the area for the care provided. It then determines the HMO "benefit"
by reducing the actual charge by the copayment made by the individual.

Another complicating factor arises when the health plan is the secondary payor, and the
covered individual obtains treatment from one of the health plan's participating providers.
If the provider is capitated, then the health plan has, in effect, already "paid the claim" at
the time of treatment, even though it is the secondary payor. The health plan must then
work with the primary payor to obtain a reimbursement in the amount that the primary
payor would have paid. The health plan, as secondary payor, then determines the total
benefit payable to the individual under the COB provision and, if applicable, reimburses
the individual. Typically, this means the health plan returns the member's copayment.
Health plans sometimes use the term "pay and chase" to refer to this method of handling
COB.

If a health plan determines prior to treatment that a member has primary coverage under
another plan, it might bill the patient and have the patient submit the bill to the primary
payor. After the primary payor pays the claim, the health plan can then determine the
total benefit payable under the COB provision and, if applicable, reimburse the
individual. However, in some states this practice is prohibited.

Antifraud
Because of the high cost to health plans, purchasers, and consumers, a number of
states have enacted legislation designed to reduce insurance fraud. These antifraud
laws vary a great deal from state to state, but they include a number of requirements
with which health plans must comply. For example, some states require health plans to
report all fraudulent activities-including all types of insurance fraud-that they discover.
Some states require health plans to establish special fraud units or systems that enable
them to detect fraudulent activity. Some states require health plans to include a fraud

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warning on applications for coverage and/or on claims forms. We discuss fraud and
abuse in more detail in Key Legal Issues in Health Plans.

Continuation and Conversion

When a person's eligibility under a group contract would otherwise end, a continuation
provision allows the employee and/or dependent to continue eligibility as if still covered
under the group contract. Except for the eligibility provision, all of the terms of the group
contract remain the same for the person who is continuing coverage. A conversion
privilege allows an employee or dependent to convert from or leave the group contract
to obtain similar coverage under a separate individual contract.

Several states have continuation laws that either (1) apply to groups not subject to the
COBRA continuation requirements or (2) require health plans to provide for continuation
not required by COBRA.

Many states have conversion laws that require health plans to offer a contract to
members whose eligibility under a group contract ends. Typically these laws specify the
circumstances under which the conversion contract need not be offered; for example, if
the member's coverage terminates for failure to pay premium contributions or if the
member has not been continuously covered under the plan for a minimum number of
months. If the member qualifies for and requests a conversion contract, then a contract
must be issued and the member does not have to submit evidence of insurability as is
typical in many other individual healthcare coverage transactions. The health plan can,
however, charge premiums in accordance with its individual rate structure, rather than its
group rates. Most states require the insurer or health plan to clearly disclose this
conversion right in the evidence of coverage and to issue a new contract to the member
upon conversion. If an individual also has a right to continue eligibility under the group
plan in accordance with COBRA or a state-mandated continuation law, then the
conversion right typically does not go into effect until after the continuation period has
ended. Some states, however, give an individual the right to decline the continuation and
immediately elect an individual conversion policy.

Fast Fact

According to the Employee Benefit Research Institute, 38 percent of the uninsured are
either self-employed, work for a private firm with 25 or fewer employees, or live in a
household headed by someone who is self-employed or who works for a small firm. 13

Small Group
A large segment of the U.S. population obtains healthcare coverage through employee
benefit plans, but historically many small employers have not offered healthcare benefits
to their employees. During the 1990s, in an attempt to increase access to healthcare,
many states enacted small group reform laws. Generally, these laws address two
major factors: (1) the cost of healthcare, which keeps many small employers and their
employees out of the marketplace, and (2) marketplace practices that deny small
employers and/or their employees access to coverage.

Although small group laws vary by state, they have certain features in common:

• Standardized benefit design

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• Restrictions on underwriting practices

• Restrictions on premium rating
• Requirements for disclosure of plan and rating information

Typically, states define a small group as an employer with as few as 2 or 3 employees

and as many as 49 or 50 employees, whether or not they enroll for coverage. Most
states have amended their small group laws to align with the guaranteed access
requirements of HIPAA. Some states have elected to apply an expanded definition. For
instance, some states consider a self-employed individual to be a small group, and other
states consider groups with as many as 99 employees to be a small group.

Uniform Benefit Design

Some states have developed standardized benefit designs that provide limited coverage.
Depending on the state, these plans are called low option, basic, essential, or bare
bone plans. They typically include features such as a high annual deductible, high
copayments, limits on lifetime and annual benefits, and a limited list of covered services
and supplies. To make healthcare coverage more affordable and thereby more
accessible to to small employers and their employees, a state might exempt small
groups from some of the regulatory benefit mandates that apply to other groups.

Many states have also developed standard plans that provide more comprehensive
coverage at benefit levels closer to large group products. In addition, some states allow
health plans to offer high option plans, which are benefit designs that are identical to
the health plans typically offered in the large group market. By allowing this increased
flexibility in plan design, states hope to attract small employers and their employees who
might be interested in more comprehensive coverage than the low option design
provides.

Recognizing health plan's success in controlling healthcare costs, most states have
included standardized benefit designs for HMO and PPO products in addition to
indemnity products.

Restrictions on Premium Rating

Another way that small group laws attempt to reduce the cost of healthcare coverage is
by placing restrictions on the rates that health plans can charge small employers.
Typically, these laws prohibit health plans from using experience rating and they
prescribe a method that limits the rate spread that health plans can use for all small
employer groups.

Many small group laws require health plans to use a rating method that is either pure
community rating or adjusted community rating. Other small group laws are based on
the rating method contained in the 1991 NAIC model small group laws and regulations.
This method allows health plans to use up to nine rating classes with prescribed
minimums and maximums in each class. Also, the average premium in each class
cannot be more than 120% of the average premium in any other class. The result of
these requirements is that the highest rate a health plan can charge a small employer
cannot be more than twice the lowest rate. The 1991 NAIC model was amended in 1995
to eliminate the class rating rules and require what the NAIC refers to as adjusted
community rating, which allows adjustments only for geography, family composition, and

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age. However, many state laws are based on the 1991 NAIC model and still allow rating
classes based on experience factors, subject to the requirements described above.

Restrictions on Underwriting Practices

Many small group laws seek to improve access to healthcare coverage by restricting the
underwriting practices that health plans can use to reduce their overall risk. Although
these restrictions actually increase the cost of providing healthcare coverage, they
directly improve access for groups and individuals who might otherwise be denied
coverage. Several of these features have been incorporated into the federal Health
Insurance Portability and Accountability Act of 1996 (HIPAA), which we describe in
Federal Regulation of Health Plans. These restrictions can be divided into two types,
those that apply to employer groups and those that apply to the individuals who are
members of the groups.

• Underwriting Practices for Employer Groups

• Underwriting Practices for Individual Members of Employer Groups

Another way that health plans can limit risk is by applying waiting periods and pre-
existing condition exclusions to individuals who are eligible for group coverage. Small
group laws seek to improve access to healthcare by placing restrictions on these
provisions.

Fast Fact

According to a 1996 survey, more than 16 million Americans under age 65 have
healthcare coverage through plans that are not provided through employer or
government programs. 14

Underwriting Practices for Employer Groups

Most small group laws contain a guaranteed issue provision, and HIPAA now mandates
guaranteed issue in the small group market. A guaranteed issue provision requires each
health plan that participates in a state's small group market to issue a contract to any
employer who requests coverage, provided that the employer meets the state's definition
of a small group. Typically, in the large group market an insurer or health plan can elect
not to issue a contract to a particular group if it determines that the group has had poor
claim experience or has a member who is suffering from a catastrophic illness or injury
that would result in substantial healthcare expenses. Small group laws prohibit this
underwriting practice. State and federal small group laws also contain guaranteed
renewal provisions, which prohibit health plans from canceling a group's coverage
because of poor claims experience or because of other factors that relate to group
underwriting, such as a change in health status of group members.

Underwriting Practices for Individual Members of Employer Groups

Before the small group reform initiatives of the 1990s, group insurance laws often set the
minimum number of employees in an eligible employer group at 10 or more. This meant
that employers with fewer than the specified number of employees were not considered

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employer groups for the purpose of applying group insurance laws. Therefore, insurers
used individual medical underwriting for individuals within these small groups. In other
words, insurers were able to accept an employer group for coverage, but determine that
certain individuals within that group could not enroll under the plan because of health
conditions. The small group reform laws typically changed the definition of an employer
group to include employers with as few as two or three emplyees, thereby subjecting each
individual in a small group to group, rather than individual, underwriting requirements.

Requirements for Disclosure of Plan and Rating Information

Small group laws typically include disclosure requirements to help acclimate purchasers
who are entering the group market for the first time and are unfamiliar with the issues
involved in purchasing group coverage. These requirements are intended to help
educate purchasers and enable them to make informed choices. They often require
marketing brochures to include information about rating criteria or about benefits that low
option plans do not cover.

Purchasing Alliances
The small group laws in some states establish purchasing alliances. A purchasing
alliance, also called a purchasing cooperative or a health insurance purchasing
cooperative (HIPC), is a means of increasing healthcare access for small employers by
(1) providing economies of scale in marketing and administrative activities and (2)
making it easier for small employers to purchase healthcare. In theory, by joining a
purchasing alliance, small employers gain purchasing power similar to that of a large
employer. The purchasing alliance acts as a liaison between the small employer and the
health plans. For example, the alliance might prescribe a uniform format for marketing
material and maintain copies of brochures from all participating health plans so that any
interested small employer can go to a single source (the purchasing alliance) to obtain
information about all available plans. The alliance might also coordinate billing and
enrollment activities between the small employer and the participating health plans.

Typically, the purchasing alliance is not a government agency; rather it is operated as a

not-for-profit entity that obtains its authority through state law but is governed by a board
made up of representatives from the community.

Individual Healthcare
Many states have laws intended to improve access and affordability in the individual
healthcare market. These laws often employ provisions similar to those found in small
group laws. In fact, certain small group laws that define a self-employed individual as a
"small group" are actually applying their small group laws to individuals.

A number of individual healthcare laws include guaranteed issue provisions, which

require health plans participating in the individual market to issue a contract to any
individual who requests coverage. In some states, the health plan is only required to
issue a contract to individuals who meet established criteria, such as individuals who
have had continuous healthcare coverage for the past 12 months or more. In a few
states, the health plan must agree to issue every product it markets in the state.
Elsewhere, the insurer or health plan must agree to issue at least one of the products it
markets in the state or to issue a standardized benefit design developed by the state. 15

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Individual healthcare laws in many states seek to improve access to healthcare by

placing restrictions on pre-existing conditions exclusions, similar to those found in small
group reform laws. To address the problem of affordability, several states apply rating
restrictions to limit variations in premium rates or to prohibit the use of rate factors, such
as health status, claims experience, age, or gender. For example, New York requires all
health plans to use community rating with variations based only on product, family
composition, and geographic location. In Washington, the highest rate a health plan can
charge an individual cannot be more than four times the lowest rate it charges, and rates
can vary based only on age and geographic location, but not health status or claims
experience. 16

Several states have not enacted any individual healthcare reform laws. In these states,
the only reforms that apply are those imposed by HIPAA.

Fast Definitions

Waiting period (also called probationary period, service waiting period, or

employment waiting period) - the length of time that a new member must wait before
becoming eligible to enroll in the plan.

Pre-existing condition exclusion - a policy exclusion that denies coverage for a

condition for which an individual received treatment during a specified period of time
prior to the effective date of his or her current plan. Although the individual is eligible to
enroll in the plan, the expenses relating specifically to the pre-existing condition are not
covered.

States as Purchasers
In their role as purchasers of healthcare, states also regulate health plans. For example,
states employ thousands of workers for whom they purchase group healthcare
coverage. Sometimes state employee healthcare plans are subject to unique bidding
and contractual requirements that are specified in laws, regulations, or administrative
guidelines. States also serve as purchasers of healthcare through their Medicaid
programs and the Children's Health Insurance Program (CHIP), both of which we
address in Federal Government as Purchaser. States arrange for workers' compensation
coverage for employees in their jurisdiction as well. These programs must comply with
unique requirements under workers' compensation laws that are enforced by state
Departments of Labor or similar agencies. We discuss Workers' Compensation in the
next lesson.

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Chapter 6 B
Workers' Compensation Programs
Before states required workers' compensation insurance, employees who were injured
on the job were not automatically entitled to receive compensation from their employers.
As a result, injured employees often had to sue their employers for their medical
expenses and lost wages. In 1911, Wisconsin became the first state to adopt a workers'
compensation law. Every state now has a workers' compensation law, and 47 states
require employers to offer workers' compensation benefits.

After completing this lesson, you should be able to:

 Describe the kinds of benefits injured employees receive under workers’

compensation
 List several ways in which workers’ compensation differs from other types of
healthcare coverage
 Describe how state laws can limit the use of health plans to provide workers’
compensation benefits
 Describe some of the common features of workers’ compensation health plans
 Describe the features of an integrated health and disability plan

Workers' compensation is a state-mandated insurance program that provides benefits

for healthcare costs and lost wages to qualified employees and their dependents. If an
employee suffers a work-related injury or disease, his or her employer will pay the cost
of the related medical expenses through workers' compensation. 1

The workers' compensation system is a compromise between the needs of injured

employees and the needs of employers. Workers' compensation protects employees
who are injured on the job by assuring that they will receive benefits for medical
expenses and lost wages. Workers' compensation also protects employers from lawsuits
by injured workers by imposing what is known as the exclusive remedy doctrine. The
exclusive remedy doctrine is a rule that states that employees who are injured on the
job are entitled to the benefits provided by workers' compensation but cannot sue their
employers for any additional amounts. In exchange for this protection, though,
employers are not allowed to deny liability for work-related injuries and must provide
benefits for work-related injuries even if the injuries are not their fault. As we will discuss
later in this lesson, the workers' compensation system also regulates how those benefits
must be provided.

In this lesson, we describe the ways in which workers' compensation differs from group
healthcare coverage and how workers' compensation plans have incorporated health
plan techniques. We conclude the lesson with a discussion of some of the challenges
facing the employers, insurers, and health plans involved in workers' compensation
programs.

How Workers' Compensation Differs from Group Healthcare

Although healthcare in workers' compensation programs and the group healthcare
market both provide medical benefits to injured or ill employees, there are many
differences between the two benefit systems. Some of these differences arise from the
fact that workers' compensation laws were first enacted decades ago- before managed

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healthcare became prevalent- and have not been revised to reflect modern ways of
providing healthcare. Some of the differences result from the compromises that were
built into the workers' compensation system when it was first designed. Understanding
these differences is important because they often affect the ability to use managed
healthcare techniques in providing workers' compensation benefits. These differences
are summarized in Figure 6B-1.

Free and Unlimited Coverage for All Employees

One of the basic distinctions between workers' compensation and group healthcare is
that employers in almost every state are required to provide workers' compensation
coverage for all employees, regardless of the number of hours worked. Group plans
typically limit coverage to eligible full-time employees.

Workers' compensation laws also require employers to provide coverage at no cost to

their employees. This means there can be no employee contributions and no cost-
sharing features, such as deductibles and copayments. In group healthcare, employees
often pay contributions toward the employer's total premium and share the cost of their
medical care by paying deductibles and copayments. Most use cost-sharing features to
help manage utilization, which can lower plan costs.

In addition, workers' compensation programs do not contain coverage restrictions, such

as those that specify an annual or lifetime benefit maximum or that limit benefits to a
predetermined number of days or visits. Workers' compensation laws require coverage
for as long as treatment is necessary. Many group plans limit benefits for certain types of
conditions or for certain services and supplies.

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Coverage for Work-Related Injuries

Another key difference between workers' compensation programs and group healthcare
is that workers' compensation provides benefits only if an injury or disease is work-
related. An employer or health plan, therefore, can contest a workers' compensation
claim if it feels that an injury or disease is not related to work. As we will discuss later,
employees sometimes fraudulently claim that their medical conditions are work-related
to gain access to workers' compensation benefits. Only a small percentage of workers'
compensation claims are contested, but resolving the contested claims can be
expensive and time consuming. Group healthcare plans, on the other hand, provide care
regardless of the cause of the injury or illness, although they typically exclude charges
for work-related injury or illness covered by any workers' compensation law.

Benefits for Lost Wages

Workers' compensation not only covers medical expenses resulting from work-related
injuries or illnesses, it also provides indemnity benefits. Workers' compensation
indemnity benefits are workers' compensation benefits that replace an employee's
wages while the employee is unable to work because of a work-related injury or illness.
Indemnity benefits are a concern for employers and workers' compensation carriers
because they account for almost half of all workers' compensation expenses. 2

Employees May Choose Providers

Most workers' compensation laws give injured employees a great deal of freedom to
choose their own medical providers. Injured workers frequently have the right to select
any provider they choose and to change providers whenever they like. Even in states
that allow employers to set up networks of providers to treat workers' compensation
patients, injured employees can usually opt out of the networks and obtain care from
providers of their own choice. In health plans, employees are often encouraged or
required to use providers who are part of the health plan network.

Fast Fact

By one estimate, employers in the United States spent over $90 billion to provide
workers' compensation benefits in 1996. 4

Cost Pressures on Workers' Compensation

Workers' compensation represents only a small portion of the total cost of providing
employee healthcare coverage, but employers still pay billions of dollars a year to
provide this coverage. Employers have become especially concerned about the
inflationary pressures that affect workers' compensation because the costs of providing
workers' compensation medical benefits have increased more quickly than the costs of
providing benefits under group healthcare plans. One reason for this is that injured
employees who do not have to pay deductibles or copayments have little incentive to
use cost-effective providers. Another reason for faster-rising costs for workers'
compensation is that workers' compensation coverage has grown in recent years to
include new types of injuries and illnesses. Today, workers' compensation often provides
benefits for conditions such as carpal-tunnel injuries and work-related stress disorders
that were not covered just a few years ago. Workers' compensation costs may continue
to increase even more quickly as the population continues to age, because older people
tend to require more time off the job when they are injured.

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The Cost of Employee Fraud

We have already learned that workers' compensation must be provided free to all
employees, with no deductibles or copayments, and that employees receive benefits for
lost wages in addition to health care. Some employees attempt to take advantage of this
generous coverage by claiming that their injuries are work-related when they are not. For
example, part-time employees who are not covered by group healthcare policies may
claim that their injuries are work-related so they can gain access to medical benefits they
would not otherwise receive. Employees who are covered by group healthcare policies
may claim that their injuries are work-related to avoid copayments and deductibles. And
since workers' compensation replaces lost wages while injured employees are out of
work, some employees receiving workers' compensation are able to obtain statements
from their physicians that allow them to stay off the job longer than necessary. Even
though most employees and physicians are honest, workers' compensation fraud costs
employers and insurers billions of dollars a year.
3

State Responses to Rising Costs

To help control workers' compensation costs, states commonly use fee schedules that
specify the maximum amount providers may charge for treating workers' compensation
patients. One advantage of fee schedules is that they can regulate increases in medical
costs by limiting how much medical fees may increase from year to year. Fee schedules
also help ensure that the fees paid by employers and health plans for medical
treatments are consistent from provider to provider. Most workers' compensation fee
schedules are based on the schedules used in Medicare and Medicaid.

As an additional way of controlling workers' compensation costs, several states have

adopted clinical practice guidelines, or treatment guidelines, for treating workers'
compensation injuries. A clinical practice guideline, or treatment guideline, is a
utilization management and quality management mechanism designed to aid providers
in making decisions about the most appropriate course of treatment for a specific case.
These guidelines help providers determine the most cost-effective methods of treating
work-related injuries.

In the next lesson, we discuss how some states are beginning to use health plans to
help control workers' compensation costs.

Review Question

Several states have adopted clinical practice guidelines for treating workers'
compensation injuries. Clinical practice guidelines can best be described as

fee schedules that specify the maximum amount providers may charge for treating
workers' compensation patients
a utilization management and quality management mechanism designed to aid
providers in making decisions about the most appropriate course of treatment for a
specific case
detailed plans of medical treatment designed to facilitate a patient's return to the
workplace
payment practices that might technically violate the provisions of the anti-kickback
statute but that will not be considered illegal and for which providers and health

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plans will not be subject to penalties

Incorrect. Clinical practice guidelines refer to the provision of approriate medical

services, not the payment of physicians

Correct! A clinical practice guideline, or treatment guideline, is a utilization

management and quality management mechanism designed to aid providers in
making decisions about the most appropriate course of treatment for a specific
case. These guidelines help providers determine the most cost-effective methods
of treating work-related injuries

Incorrect. A return-to-work protocol is a detailed plan of medical treatment

designed to facilitate the patient's return to the workplace

Incorrect. As you will learn in the lesson titled Fraud and Abuse, safe harbor
regulations describe payment practices that might technically violate the
provisions of the anti-kickback statute but that will not be considered illegal and
for which providers and health plans will not be subject to penalties

The Move to Managed Care

As the cost of providing workers' compensation benefits increases, employers and states
are looking to managed care way to help reduce expenses while ensuring quality. The
use of managed care not only helps control the cost of workers' compensation medical
benefits, it also helps reduce the cost of indemnity (wage replacement) benefits by
coordinating care to enable injured employees to return to work more quickly.

Until recently, workers' compensation laws often restricted the use of managed care
techniques, such as copayments and deductibles, or prevented employers from limiting
employees' choice of provider. Now, almost half the states allow managed workers'
compensation, and in a few states, the use of health plans are required. For example,
since January 1, 1997, Florida has required that all workers' compensation medical
benefits be provided using health plans. Many states have encouraged demonstration
projects to establish standards for new approaches to workers' compensation, including
the use of selective networks, utilization review, and case management.

Fast Fact

Using health plans can help employers save as much as 40% on workers' compensation
medical costs and 25% on costs for lost wages 5

Features of Managed Workers' Compensation

Describing the "typical" managed care workers' compensation product is difficult,
because like group healthcare plans, they may be structured in many different ways.
And because workers' compensation laws vary so much from state to state, a health
plan arrangement that is used in some states may not be allowed in others. In this
section, we discuss some of the most common characteristics of managed workers'
compensation and point out how state laws may affect their usefulness. These
characteristics are summarized in Figure 6B-2.

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Figure 6B-2. Common Characteristics of Managed Workers' Compensation.

 Use of preferred provider organizations (PPOs) to encourage employees to choose
providers who deliver affordable, quality care
 Use of utilization review and case management to ensure the most appropriate,
coordinated care
 Reliance on total disability management to control indemnity (wage replacement)
benefits
 Focus on occupational health services to return employees to work quickly

Review Question

While traditional workers' compensation laws have restricted the use of managed care
techniques, many states now allow managed workers' compensation. One common
characteristic of managed workers' compensation plans is that they

discourage injured employees from returning to work until they are able to assume
all the duties of their jobs
use low copayments to encourage employees to choose preferred providers
cover an employee's medical costs, but they do not provide coverage for lost
wages
rely on total disability management to control indemnity benefits

Incorrect. Managed worker's compensation programs use return to work

protocols, detailed plans of medical treatment designed to facilitate the patient's
return to the workplace. Case managers often find ways of returning employees to
work even if they cannot assume all the duties of their job.

Incorrect. Under workers' compensation copayments are not permitted

Incorrect. Workers compensation provides coverage for an employee's medical

cost as well as for lost wages

Correct! Managed workers compensation relies on total disability management to

control indemnity (wage replacement) benefits. Total disability management is a
type of case management that controls both medical and wage benefits by
developing treatment plans to emphasize the early return to work.

Use of Preferred Provider Organizations

In some states, workers' compensation laws allow insurers and health plans to direct
employees to certain providers. However, in many states, employees can seek care
from any provider they choose. The laws in these states prevent the use of some kinds
of health plans, such as HMOs and EPOs, which may require employees to use only
participating providers. Although HMOs are sometimes used in states that allow
employers to limit employee choice of provider, the most common type of health plan
used to provide workers' compensation benefits is the PPO.

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Under group healthcare plans using PPOs, the benefit incentives that encourage
members to use preferred providers include lower copayments and limits on the out-of-
pocket costs for in-network care. Under workers' compensation, however, copayments
are not permitted and employees are not responsible for out-of-pocket expenses, so
employers and health plans must rely on other incentives to encourage employees to
use preferred providers. For example, some employers give cash payments, while
others provide information about the high quality of in-network care.

Fast Fact

PPOs are used in 70% of all health plans providing workers' compensation benefits. 6

Reliance on Utilization Review and Case Management

Workers' compensation health plans often rely on utilization review techniques to help
manage cost and oversee quality. For example, plans that offer services through
provider networks can reduce unnecessary medical expenses through the use of
prospective review procedures, such as preadmission certifications and second opinion
requirements. They can also monitor ongoing treatment with concurrent review
procedures.

In managed workers' compensation, case management is especially important because

of the emphasis on returning injured employees to work quickly. To manage indemnity
(lost wages) benefits and medical benefits more effectively, managed workers'
compensation plans often practice total disability management. Total disability
management is a type of case management that controls both medical and indemnity
workers' compensation benefits by developing treatment plans that emphasize the early
return to work.

One way workers' compensation health plans enable their case managers to use total
disability management is to develop return-to-work protocols. Return-to-work
protocols are detailed plans of medical treatment designed to facilitate the patient's
return to the workplace. A skilled case manager can often find ways of returning
employees to work even if they are not able to assume all the duties of their jobs. A case
manager might develop a treatment plan, for example, that allows an employee to return
to work on a "light duty" or "limited hours" basis while still receiving treatment for an
injury.

Case management can also help control workers' compensation costs by reducing the
number of workplace accidents. By asking injured workers what caused their injuries,
case managers can aid in loss prevention by helping employers identify and correct
situations that contribute to workplace accidents.

Fast Definition

Case management - the process of developing healthcare strategies by assessing the

patient's needs and developing an appropriate plan of treatment and then monitoring
and coordinating care to achieve the optimum healthcare outcome in an efficient and
cost-effective manner.

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Focus on Occupational Health and Returning Employees to Work

Health plans that treat workers' compensation cases pay careful attention to selecting
providers who are trained in occupational health services. Occupational health
services are health services designed to protect the health and safety of employees at
work and, if necessary, to treat work-related injuries and illnesses. Some primary care
providers in group healthcare networks may not have a background in occupational
health services and may not be experienced in treating work-related injuries and
illnesses. Those providers may not place the same importance on returning employees
to work as providers who are experienced in treating workers' compensation cases, and
they may not be as aware of the different options for returning to work, such as the "light
duty" programs we mentioned earlier.

Challenges in Complying with State Regulations

Employers, insurers, and health plans face a difficult challenge in complying with the
state laws that regulate workers' compensation. Workers' compensation is closely
regulated, and the laws vary widely from state to state. The administrative costs of
ensuring compliance with these state regulations can be high, especially for health plans
that operate in several states. Many insurers and health plans find that they must add
staff to keep abreast of changing regulations.

Most states that allow the use of health plans in providing workers' compensation
benefits impose certification requirements on health plans to ensure that they provide
high quality care. Employers and health plans have developed national accreditation
standards for workers' compensation PPOs and workers' compensation utilization review
organizations through the American Accreditation Health Care Commission
(AAHCC/URAC). Several states that have certification requirements now allow health
plans to satisfy those requirements by achieving accreditation through the
AAHCC/URAC.

Integrating Workers' Compensation With Other Benefit Plans

We learned earlier that workers' compensation is similar to group healthcare plans
because it provides medical benefits to injured or ill employees. Worker's compensation
is also like short-term and long-term disability programs because it provides benefits for
lost wages. The key difference is that workers' compensation provides benefits only if an
injury or illness is work-related, and group healthcare plans typically exclude coverage
for work-related injury or illness.

Because of the similarities between workers' compensation, group healthcare, and

disability benefit plans, some employers are looking for ways to create integrated health
and disability plans. An integrated health and disability plan is a health plan that
provides medical or lost wage benefits to employees for all covered injuries or illnesses,
whether they are work-related or not. One reason for the interest in integrated health and
disability plans is that employers can reduce their administrative expenses if they
administer only one integrated benefit plan instead of several separate plans. In addition,
under integrated plans employers no longer have to devote time and resources
determining whether injuries are work-related as they do under workers' compensation.
Instead, they can focus their attention on promptly providing the care necessary to return
injured employees to work.

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24-Hour Coverage
One type of integrated health and disability plan is called 24-hour coverage. Under 24-
hour coverage, an employer's group health plan, disability plan, and workers'
compensation program are merged, integrated, or coordinated (depending on state
regulations) into a single health benefit plan that covers employees 24 hours a day.
Twenty-four-hour coverage provides all eligible benefits whether an illness or injury
occurs on the job or not.

The application of health plan principles to 24-hour coverage is called 24-hour managed
care. An advantage of 24-hour coverage or 24-hour managed care is the coordination of
claims processing. In some integrated plans, for example, claims examiners who are
trained in handling both healthcare claims and workers' compensation claims use their
knowledge and experience to select the most appropriate treatment for injured workers
from the wide range of treatment options that are available. Coordinating the claims
processing function also helps prevent situations in which plan members receive
duplicate workers' compensation and group healthcare benefits.

Obstacles to Developing Integrated Coverage

In large organizations, the administration of different health, disability, and workers'
compensation plans is often handled by more than one department. Integrating these
plans can require additional coordination between the employee benefits department,
which may oversee an employer's group health plan, and the risk management
department, which may oversee workers' compensation coverage. In addition, although
integrating the plans may result in administrative savings over the long run, the process
of initially designing and implementing an integrated program can be expensive. Finally,
until very recently, few insurance companies and health plans offered products that
combined group health, disability, and workers' compensation coverage. As illustrated in
Insight 6B-1 , however, more of these integrated products are now being introduced.

Insight 6B-1. Insurers Are Developing New Integrated Products.

Today health plans are offering innovative new programs that not only combine coverage
for workers' compensation and employee health benefits, but also provide top-notch care
for people with work-related injuries or illnesses. Two of these programs are discussed
below.

Kaiser Permanente's "Kaiser-on-the-job": This integrated health and disability plan was
recently introduced in the Pacific Northwest. "We're a health plan delivering preventive
and treatment services to injured workers," says Adrianne Feldstein, M.D., a Kaiser
Permanente physician who manages Kaiser Permanente's occupational medicine
operations. "We can provide integrated medical care-that is, care for injured or ill
workers and care for standard family practice patients-because we're one medical group.
We have one unified medical record, the same clinical guidelines covering both primary
care and occupational care-and we communicate."

Workers see physicians and nurses with full-time expertise in occupational medicine at
Kaiser Permanente's nine clinics-professionals who assess workplace risk, minimize
disability, and treat conditions common to workplace injury and illness every day. The
health plan sends its occupational care professionals through special training covering

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treatment protocols, with an emphasis on disability management-an important focus,

since in workers' compensation the big costs come not while the worker recovers from an
illness or injury, but later on, during disability.

"Although from Kaiser Permanente's overall perspective, workers' comp is only about 2%
of all medical care visits," Dr. Feldstein says, "to the employer who pays for both group
medical care and workers' comp, workers' comp is very important. In some high risk
areas, the cost of worker's comp, including indemnity costs, can come very near the cost
of [other] care."

Employers get consistent, quality care throughout the system, Feldstein says. Physicians,
nurses, and other professionals follow up-to-date treatment protocols, and the case
managers stay in touch with everybody concerned, including the employer, to get the
injured worker back to a productive life on the job as quickly as possible.

"And employers know they're saving money-something in the range of 30% to 50%
compared to unmanaged care," Feldstein says.

United Wisconsin Services' "United 24": United 24 is a "24-hour plan" that incorporates
all three health-related benefit programs offered by employers: health, disability (both
short-term and long-term), and workers' compensation. The plan is currently offered in
parts of Wisconsin by United Wisconsin Services (UWS), but may soon expand to other
parts of the country, according to Roger Formisano, executive vice president and COO of
UWS.

UWS is able to offer an integrated product like United 24 because it owns the three
insurers that offer the different kinds of coverage. Each of these insurers has its own case
managers, but all are cross-trained on the issues and approaches of the other insurers.
They meet weekly to discuss cases and coordinate care, regardless of whether the case
involves occupational or nonoccupational illness or injury. Employees have only one
point of contact, no matter which kind of coverage is involved.

Formisano explains that in traditional insurance settings, the health plan may prefer to
"go easy" on services so nature can take its course, while the disability plan may prefer to
see intensive services applied up front in order to spur an early return to work. But in
United 24, all care uses "medical management and back-to-work technology," he says.
Even the health plan is on the back-to-work track. The result, Formisano says, is that on
an injury, such as that resulting from a slip and fall, "all the physical therapy is done
quickly, to get the person back to work, regardless of where the fall occurred." If the
person can return to work only on a light-duty basis, the plan will arrange for it. This may
increase some of the healthcare costs, he concedes, but the program is managed with an
eye on the total dollars spent under all three insurance plans. The extra healthcare costs
may be more than offset by the savings on the disability side of the plan.

Because of regulatory boundaries between the three types of insurance coverage, the
insurance products are offered as individual modules, not one unified insurance contract.

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But Formisano says that United 24 functions in every other way as one product, managed
by a United 24 service team. There is one point of contact for claims, one toll-free phone
number, one enrollment person, one human resources training program, and one bill.
And, Formisano says, the integrated approach of United 24 is projected to save
employers something in the neighborhood of 15% over the cost of separate health,
workers' compensation, and disability policies.
Source: Adapted from Linda Koco, "24-Hour Plan Offers Health, Disability and Workers' Comp," National Underwriter, 2 March 1998, 29.
Reprinted with permission of the publisher.

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Chapter 6 C
Pharmacy Laws and Legal Issues
As the number of available medications has risen, the prescription drug benefit has
become an increasingly important part of health plans. Federal and state laws and
regulations address nearly every facet of drug therapy, including drug selection, pricing,
discounts, patient counseling, and utilization review. Further, states are regulating the
manner in which health plan entities administer the prescription drug benefit by
establishing legislative limits on the relationships between plans and pharmaceutical
providers in the form of open pharmacy laws. As health plans attempt to control costs by
streamlining the prescribing and dispensing process, state laws and regulations outline
which practitioners may prescribe and dispense medications. Each health plan offering a
prescription drug benefit must be closely familiar with federal and state laws and
regulations.

After completing this lesson, you should be able to:

 Describe the various types of open pharmacy laws

 Describe how states regulate mail-order/mail service pharmacy programs
 Describe how states regulate use of formularies and generic substitution
 Explain the benefit exclusions for an experimental drug, an investigational drug, and
the off-label use of a drug
 Describe how the Nonprofit Institutions Act applies to prescription drug pricing
 Describe how states regulate a health plan’s use of drug utilization review programs

Selecting Pharmacy Providers

Selecting a network of healthcare providers is a primary method of cost containment for
health plans. Many health plans have adopted benefit plans limiting or eliminating a
subscriber’s medication coverage if the patientdoes not purchase medications at a
pharmacy within a network of providers. These restrictions reduce drug benefit costs
because pharmacists who join a network accept a reduced reimbursement rate in return
for an anticipated increase in their volume of customers. In response, many states have
enacted legislation, either opening the networks to pharmaceutical providers who are
willing to participate, or prohibiting health plans from limiting a subscriber’s choice of
pharmacy. Some states have passed laws precluding the exclusive use of mail-order
pharmacies.

Health plans also may attempt to reduce administrative costs by allowing healthcare
providers to dispense drugs. These entities must observe state regulations concerning
the practice of pharmacy.

Open Pharmacy Laws

Open pharmacy laws are aimed at allowing health plan subscribers to choose their own
pharmacists. An any willing provider law requires health plans to allow any provider who
meets the terms and conditions of the health plan to participate in the plan. A typical
AWP law might state that any “pharmacy or pharmacist has the right to participate as a
contract provider under a plan or policy if the pharmacy or pharmacist agrees to accept
the terms and reimbursement set forth by the insurer.” Legislation also may effectively
1

ban preferred provider networks by prohibiting favorable reimbursements for

participating pharmacists, thus placing nonparticipating pharmacists on equal financial

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ground. In Alabama, for example, insurers may not reimburse pharmacists at a rate
lower than the “usual and customary rates.” 2

Freedom of choice laws focus on the patient, rather than on the pharmacists. Some
states have enacted broad statutes that allow health plan subscribers to choose even a
nonparticipating pharmacist without a monetary penalty. In Virginia, for example, no
insurer or corporation offering a preferred provider plan may require subscribers to pay
an additional copayment or penalty for choosing a nonpreferred pharmacy, as long as
the pharmacy provider is willing to accept reimbursement at preferred provider rates. 3

Some states have passed legislation that is a hybrid of any willing provider and freedom
of choice law. In South Carolina, a health plan must allow subscribers to choose any
participating pharmacy and must admit any eligible pharmacy into the network or plan. 4

State open pharmacy laws also vary in terms of the types of health plan entities they
regulate. Virginia freedom of choice law, for example, applies to preferred provider
organizations (PPOs) and health maintenance organizations (HMOs). Several states
5

exempt HMOs with in-house pharmacies from open pharmacy regulation. Health plans 6

should assess the open pharmacy laws of the states in which they practice to determine
whether the laws apply to various aspects of their operations.

The legality of some open pharmacy laws has been successfully challenged by health
plans on the grounds that these laws relate to employee benefit plans and, as such, are
preempted by ERISA. (See Federal Regulation of Health Plans for a detailed discussion
7

of ERISA preemption.) At least one state has attempted to resolve this problem by
excluding "health maintenance organizations which are both state-certified and federally
qualified and self-insured plans under the Employee Retirement Income Security Act of
1974" from its pharmacy choice statute. 8

Mail-Order and Out-of-State Pharmacies

Health plans often encourage subscribers to obtain certain "maintenance" medications
from mail-order pharmacies (also called mail service pharmacies). Contractual
provisions or monetary incentives favoring this practice may come under scrutiny,
however, as many states have enacted legislation proscribing this method of reducing
medication costs. Some states simply provide that health plans may not require
subscribers to obtain drugs from a mail order pharmacy as a condition of coverage. 9

Other state laws prohibit reimbursement schemes that induce subscribers to use mail-
order pharmacists. The Nebraska law provides an example:
A medical benefit contract . . . which provides reimbursement for prescription
drugs and other pharmacy services shall not impose upon any person . . . a fee
or copayment not equally imposed upon any party . . . utilizing a mail order
pharmacy, and no such contract shall provide differences in coverage or impose
any different conditions upon any person . . . not equally imposed upon any party
. . . utilizing a mail order pharmacy.
10

Some states have passed laws that apply only to out-of-state pharmacies (also called
nonresident pharmacies), allowing health plans to encourage the use of mail order within
the state. Many states have additional laws regulating the practice of out-of-state
11

pharmacists who provide medications to people in the state, mail order or otherwise.
These laws generally require the out-of-state pharmacy to register within the state. Many
states focus primarily on registration and disclosure requirements, but a few states also
require out-of-state pharmacies to be licensed in and to follow the drug laws of the state.

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This requirement poses a problem for a pharmacist with an interstate practice if the laws
of the state in which the pharmacist is located conflict with the laws of a state where
customers reside. Conflicts are more likely to occur in states with extensive out-of-state
pharmacy laws. Idaho, for example, requires out-of-state mail-order pharmacies to be
licensed in Idaho, as well as in the state where the facility is located, provide detailed
information on prescriptions or submit to inspection, identify all pharmacists, and comply
with Idaho substitution laws.12

Health plans with mail order pharmacies should be alert to patient counseling
requirements and ensure that mail-order facilities comply with the patient counseling
requirements of states in which customers are located. Some states have enacted
patient counseling laws specifically directed at mail-order pharmacies. Florida and
Kentucky, for example, require out of state mail-order pharmacies to provide a 40-hour-
per-week toll-free service to allow customers to speak with a pharmacist. California
13

requires mail-order pharmacies to satisfy the same standards as state pharmacies with
regard to patient counseling, except that face-to-face counseling is not required for mail-
order transactions. 14

Regulation of Pharmacy Personnel

State and federal authorities regulate the qualifications and permissible activities of
individuals participating in pharmacy practice. Violations of these laws and regulations
could lead not only to enforcement procedures by state and federal authorities, but also
to increased risk of liability, should a patient be injured by a medication error.
Pharmacists are licensed professionals who must meet state qualification requirements
in order to practice pharmacy lawfully. State laws specify the training and education
required for a pharmacist to be licensed. The appropriate designation for the licensed
pharmacists is "registered pharmacist." Licensing requirements generally include
minimum standards of education, training, and experience; and evidence of competency
through examination.

Drug Selection
Establishing a formulary, adopting a policy of substituting generic drugs for brand name
drugs, and excluding experimental and investigational drugs from coverage are common
methods of managing pharmacy benefits.

Formularies
A formulary is a list of drugs, classified by therapeutic category or disease class, that is
continually updated to represent the current clinical judgment of providers and experts in
the diagnosis and treatment of disease. A formulary can reduce costs by promoting a
15

uniform approach to prescribing and dispensing medication. Further, for health plans
that operate their own pharmacy, a formulary eliminates the costs associated with
stocking all available brands of a drug and permits economic savings associated with
large volume purchases from just one supplier. Formularies are not a recent
development; for years, they have been used by hospitals, government agencies, self-
funded employers, pharmacy benefit management companies, and health plans. In
2003, 97% of HMOs used formularies. Thus, the formulary plays an important role in
16

drug selection.

Federal law allows states to establish Medicaid drug formularies that identify
pharmaceuticals for which Medicaid will provide payment. A state formulary must be
17

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established by a committee that includes physicians and pharmacists. A drug may be

excluded from the formulary if, based on the labeling, it does not have a significant,
clinically meaningful therapeutic advantage over other drugs in the formulary. Medicaid
outpatient drug reimbursement plans may exclude or restrict coverage for anorectic
agents, fertility drugs, antismoking agents, drugs intended for cosmetic use, and certain
other substances. Many private health plans also exclude coverage for these
18

medications.

Health plans have taken a variety of approaches with regard to implementing

formularies. A health plan may cover only formulary drugs (known as a "closed
formulary"), present the formulary as a recommendation (known as an "open
formulary"), require preauthorization for nonformulary drugs, or offer financial incentives
for prescribers and patients to use listed drugs. Over the past several years, the number
of HMOs with closed formularies has increased significantly. Figure 6C-1 describes
19

three key areas that health plans address in developing formulary policy.

Figure 6C-1. Liability Issues in Developing a Formulary Policy.

When developing a formulary policy, health plans should be aware that liability may
arise in three areas:

1. Negligent Drug Selection: Traditionally, physicians have borne the responsibility for
drug product selection. If a health plan requires a physician to choose a medication from
a predetermined list of approved drugs, however, the plan injects itself into the drug
selection process and exposes itself to the liability that may result if a patient is harmed
by the formulary drug. Similarly, if a pharmacist substitutes a formulary drug for a
prescribed drug, causing a patient injury, the health plan could be liable not only on the
basis of the formulary policy, but also for the pharmacist's conduct. To reduce the
potential liability, health plans at the least should establish a procedure for allowing
physicians to prescribe medications outside the formulary and require pharmacists to
contact prescribing physicians before substituting. Correspondence between the health
plan and participating physicians and pharmacists should stress the medical, rather than
cost, effectiveness of formulary drugs and should indicate that drug selection is a matter
of the physicians' discretion. Health plans also should ensure that the formulary
committee updates the formulary regularly, makes decisions based on medical
effectiveness, and documents the decision process carefully.

2. Inadequate Disclosure: A patient not properly apprised of the scope of the drug benefit
may sue on the basis of fraud or breach of contract. Health plans should review
promotional materials and subscriber contracts to ensure that these materials are
consistent with reliance on a formulary. A health plan that promotes its full prescription
drug coverage, for example, may be open to suit if a patient is unable to obtain coverage
for a medication not included in the formulary.

3. Effective Exclusion of a Condition: When developing a formulary, health plans must

consider not only the effectiveness and cost of individual drugs, but also whether the
formulary as a whole adequately addresses the variety of conditions for which subscribers
will seek drug therapy. A health plan that does not cover the only drug therapy for a

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particular disease, for example, effectively excludes coverage for that disease and may be
liable for breach of contract. Further, offering a reduced form of coverage for certain
conditions by not covering drug therapy may run afoul of the Americans with Disabilities
Act a federal law prohibiting differential treatment on the basis of disability.

Therapeutic Substitution
Therapeutic substitution takes place when a pharmacist, with the prescribing physician's
approval, replaces the drug originally prescribed with a drug that is the therapeutic
equivalent. A drug is a therapeutic equivalent if it can be expected to produce an
identical level of clinical effectiveness and sound medical outcomes. The formulary itself
19

might list therapeutic equivalents. Or, to assess whether the medication prescribed is the
therapeutic equivalent of a formulary drug, the pharmacist might consult clinically based
prescribing guidelines developed and administered by a team of physicians,
pharmacists, and other medical practitioners who are experts in the diagnosis and
treatment of disease. Although state laws generally address only substitution of generic
drugs for brand name drugs (see discussion below), the practice of pharmacy has
included therapeutic substitution for many years, particularly in hospitals and HMOs. The
Delaware legislature has acknowledged the practice by defining the role of the
pharmacist to include therapeutic substitution20

Generic Substitution
A generic medication or generic drug is a chemically equivalent version of a brand
name drug. Substitution of generic medications for prescribed brand name drugs is a
widely used method of healthcare cost containment. Some 73 percent of HMOs required
generic drug substitution in 1993. At one time, pharmacists in every state were
21

prohibited from substituting one brand of a drug for another, unless the pharmacist
obtained the express consent of the prescriber. With the growth of the consumer
movement and the widespread view that antisubstitution laws were forcing the public to
pay unwarranted higher prices for brand name products, every state has enacted
legislation permitting pharmacists to disperse less expensive generic equivalents or, in
some cases, requiring the substitution.

Health plan pharmacy providers must determine whether generic substitution is

permissive or mandatory under state law. In Florida, substitution is mandatory, as the
law states that "A pharmacist who receives a prescription for a brand name drug shall,
unless requested otherwise by the purchaser, substitute a less expensive, generically
equivalent drug product . . . " Maine provides an example of permissive substitution
22

language: "Any pharmacist . . . may substitute a generic and therapeutically equivalent

drug for the drug specified on the prescription, provided . . . that the price of the
substituted drug does not exceed the price of the drug specified by the practitioner." 23

In every state, the prescriber can prevent the pharmacist from substituting a generic
drug, although the method varies. In many states, prescribers use a two line prescription
form. The prescriber signs the prescription on either a "substitution permitted" or "brand
necessary" line. In other states, a physician who wishes to prevent substitution must
hand-write a message such as "Do not substitute," or "Dispense as written" on the
prescription. Some states allow prescription forms on which a physician may check a
box prohibiting substitution.

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In most states, the pharmacist or a pharmacy employee must notify the patient or obtain
the patient's consent before substituting a generic drug. For example, in Oregon, "The
pharmacist, or the pharmacist's agent, assistant, or employee shall inform the person
receiving the drug pursuant to the prescription of the selection of a lower cost generically
equivalent drug, of the price difference between the brand name drug and the
generically equivalent drug, and of the person's right to refuse the drug selected." 24

Further, pharmacies must label drug containers with the name of the generic drug
dispensed, or risk violating misbranding provisions of the federal Food, Drug, and
Cosmetic Act (FDCA), and state drug labeling law. Under the FDCA, a drug is
misbranded if its label is "false or misleading in any particular." Violations of the FDCA
25

can lead to civil or criminal penalties. State laws may contain labeling provisions
26

specific to generic substitution. In addition to requiring labeling that reflects the name of
the substituted generic medication, some states require additional notations, such as
"Generic substitution made," or "Interchange."
27 28

As a result of generic substitution, pharmacists and health plans assume increased

responsibility, and increased potential for liability, as discussed previously in the context
of therapeutic substitution. In the case of generic substitution, however, more than half of
the state substitution statutes include language purporting to exempt the pharmacist
from liability for selecting a generic equivalent. The Illinois statute states:
The selection of any drug product by a pharmacist shall not constitute evidence
of negligence if the selected nonlegend drug product was of the same dosage
form and each of its active ingredients did not vary by more than 1% from the
active ingredients of the prescribed, brand name, nonlegend drug product or if
the selected legend drug product was included in the Illinois Drug Product
Selection Formulary at the time the prescription was dispensed. 29

At least one state court has held that a pharmacist who selected brands pursuant to the
state's generic drug law was not liable to a patient alleging injury as a result of taking the
medication selected by the pharmacist. The court stated that a pharmacist is not
30

negligent in selecting an alternate product unless an inferior or defective drug is

knowingly dispensed. Nevertheless, pharmacists and health plans should evaluate
substitution policies with an eye to potential liability that could result from a drug induced
patient injury.

Coverage for Particular Drugs

In addition to developing a drug selection process, health plans may control drug benefit
expenditure by limiting coverage of medications for which effectiveness has not been
proved conclusively. The conflict between a health plan's need to spend funds wisely
and patients' demand for promising innovative therapies requires careful drafting of the
benefit contract.

Experimental and Investigational Drugs

Insurance companies and health plans usually do not provide coverage for experimental
and investigational therapies. There is a fine line between experimentation,
investigational research, and treatment. Generally speaking, an experimental procedure
or experimental drug is one that has not been tested for safety or effectiveness, or is
being tested outside standard clinical trials. An investigational procedure or
investigational drug is one that is being tested in humans for safety and effectiveness,
in accordance with Food and Drug Administration requirements. Patients with life-
threatening medical conditions not likely to respond to conventional treatments are likely

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to consider experimental and investigational drugs to be medical treatment that should

be covered by their health plan. Although innovative drugs are extremely costly, and of
uncertain therapeutic value, a court faced with a coverage decision may have difficulty
denying a patient the only possibly successful treatment for a fatal condition. Thus,
health plans must draft subscriber contracts and other benefit description material
carefully to avoid litigation concerning coverage for experimental and investigational
"treatments."

One way to exclude coverage for questionable treatments is to specifically identify the
drugs that are not covered. Advancing technology makes it necessary to update the list
of exclusions continuously, however, making subscriber notification a daunting task.
Periodic lists of newly excluded treatments also may have a negative impact on
subscribers' perception of the plan's coverage.

Legal challenges to experimental exclusions have occurred, specifically in the area of

high dose chemotherapy and autologous bone marrow transplant (HDC/ABMT) as a
treatment for breast cancer. The particular treatments that lead to litigation change over
time, however. Advancing medical technology creates new treatments that will be sought
by subscribers before insurers and health plans are willing to provide coverage. Older
treatments lead to less litigation, as clinical data on the efficacy of a particular treatment
either results in increased coverage or less demand for the treatment. Further,
legislation may resolve disputes concerning the effectiveness of certain experimental or
investigational treatments by mandating coverage. For example, at least two states have
mandated coverage for high dose chemotherapy in conjunction with autologous bone
marrow transplant. Before denying coverage for an experimental drug, particularly for
31

terminal diseases such as cancer or AIDS, health plans should consult state law to
determine whether coverage is mandated.

Health Plans should assess not only contract provisions, but also the decision making
process involved in refusing coverage for an experimental drug. In addition to a suit for
breach of contract, a patient denied access to a particular drug may sue a health plan
based on negligent denial or bad faith denial of a claim. (See Key Legal Issues in Health
Plans for a discussion of these types of legal risks.)

Off-Label Uses of Approved Drugs

Even after a drug has been approved by the FDA, coverage disputes may arise when a
healthcare provider prescribes a drug for a use not approved by the FDA. This type of
prescription is known as an off label use (also called unlabeled or unapproved use). Off-
label use refers to the use of a drug for clinical indications other than those stated in the
labeling approved by the FDA. For example, using a drug for one form of cancer (e.g.,
prostate) when the drug had originally been approved by the FDA to treat other forms of
cancer (e.g., breast, lung, etc.) is an off-label use. The FDA's long standing policy has
been not to interfere with off label uses, citing a reluctance to interfere with the practice
of medicine.32

The Omnibus Reconciliation Act of 1990 (OBRA '90) allows states to exclude Medicaid
coverage of outpatient drugs when they are prescribed for a use other than a "medically
accepted indication." Similarly, many health plans exclude off label uses in the
33

subscriber contract. Health plans should be cautious when denying coverage for the off-
label use of approved drugs, however, as state law may mandate coverage. In

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Maryland, the law prohibits health insurance policies that provide drug coverage from
excluding coverage of an FDA approved drug on the ground that the drug has not been
approved for that particular indication, if medical literature recognizes the off label use. 34

Other states have enacted narrower statutes, requiring coverage of off label drug use for
treatment of cancer or AIDS only. 35

Review Question

The following statements describe various state benefit mandates. Select the answer
choice that describes a state law pertaining to off-label uses for drugs.

State A mandates that health plans provide benefits for experimental drugs for the
treatment of terminal diseases such as AIDS and cancer.
State B mandates that health plans have a procedure in place to allow a patient to
have a non-formulary drug covered under certain conditions.
State C mandates that, in dispensing generic drugs, pharmacies must label drug
containers with the name of the substituted generic medication.
State D mandates that health plans provide benefits for the treatment of one form
of cancer with specific drugs that had originally been approved by the Food and
Drug Administration (FDA) to treat other forms of cancer.

Incorrect. This type of mandate refers to experimental drugs

Incorrect. This type of mandate refers to therapeutic substitution

Incorrect. This type of mandate refers to generic substitution

Correct. Off-label use refers to the use of a drug for clinical indications other than
those stated in the labeling approved by the FDA.

Drug Pricing
Health plans have produced a heightened interest in the sales arrangements between
drug manufacturers and healthcare providers. The increased networking of caregivers
has resulted in a differential pricing structure. Entities that can engender competition
among drug manufacturers, for example through formulary inclusion, can purchase
medications at discounted prices.

Motivated in part by lobbying by retail pharmacists, legislatures at the state and federal
level have considered measures that would place regulatory controls on manufacturer
pricing practices. Litigation challenging differential drug pricing has also occurred as
retail pharmacies sue manufacturers under long standing federal antitrust laws, such as
the Robinson-Patman Act. (See Federal Regulation of Health Plans for a discussion of
federal antitrust laws.)

Not-for-Profit Exemption
The Nonprofit Institutions Act, an amendment to the Robinson Patman Act, allows
not-for-profit hospitals and other not-for-profit charitable institutions to purchase drugs

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and other supplies at a discount, for their "own use." The primary issue under this
36

exemption from antitrust/price discrimination enforcement is the definition of "own use."

The Supreme Court of the United States has considered the scope of this exemption
and determined that the following sales of drugs were not for a not-for-profit hospital's
own use (and therefore were subject to antitrust enforcement):

1. Sales to former patients of the hospital renewing prescriptions originally

dispensed when patients were discharged from the hospital.
2. Sales to nondependents, e.g., friends of employees or medical staff members.
3. Sales to walk in customers with no connection with the hospital, e.g., patrons of a
physician's office building. 37

Review Question

The Nonprofit Institutions Act allows the Neighbor Hospital, a not-for-profit hospital, to
purchase at a discount drugs for its 'own use'. Consider whether the following sales of
drugs were not for Neighbor's own use and therefore were subject to antitrust
enforcement:

• Elijah Jamison, a former patient of Neighbor, renewed a prescription that was

originally dispensed when he was discharged from Neighbor.
• Neighbor filled a prescription for Camille Raynaud, who has no connection to
Neighbor other than that her prescribing physician is located in a nearby
physician's office building.
• Neighbor filled a prescription for Nigel Dixon, who is a friend of a Neighbor
medical staff member.

With respect to the United States Supreme Court's definition of 'own use,' the drug sales
that were not for Neighbor's own use were the sales that Neighbor made to
Mr. Jamison, Ms. Raynaud, and Mr. Dixon
Mr. Jamison and Ms. Raynaud only
Mr. Dixon only
none of these individuals

Correct
Incorrect
Incorrect
Incorrect

Not-for-profit hospitals selling drugs to customers in those three classes must purchase
the drugs at the supplier's usual (not discounted) rate and must account separately for
the sales or they will be outside the protection of the Nonprofit Institutions Act and
subject to antitrust enforcement. 38

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A not-for-profit HMO may sell pharmaceuticals to its members at a discount under the
"own use" exemptions, the Ninth Circuit has held. The court cautioned, however, that
39

sales to walk in customers who are not members are not exempt. As not-for-profit
healthcare institutions move into related markets, such as home health agencies and
ambulatory surgicenters, new issues may arise concerning the applicability of the
exemption.

Other Drug Pricing Regulations

Pharmaceutical pricing practices are regulated by a variety of other laws, such as the
federal Prescription Drug Marketing Act, state and federal unitary pricing laws, and the
Medicare and Medicaid fraud antikickback statute. These laws are discussed in Figure
6C-2.

Figure 6C-2. Other Drug Pricing Regulations.

Prescription Drug Marketing Act. In 1988, Congress enacted the Prescription Drug
Marketing Act in response to concern that both public and private hospitals were
continuing to receive drug discounts and resell drugs at a profit, thus competing unfairly
with pharmaceutical retailers and wholesalers who are not entitled to such discounts. The
law forbids hospitals and other healthcare entities to resell prescription pharmaceuticals.
However, there are exceptions to the ban that allow resales under certain circumstances.
The Act does not apply to:

1. The sale or dispensing of a drug pursuant to a valid prescription.

2. The purchase of drugs for a provider's own use from a group purchasing
organization of which it is a member.
3. The temporary transfer of drugs to a retail pharmacy for a medical emergency.
4. Sales among facilities under common control.
5. Sales between nonprofit affiliates.

The Prescription Drug Marketing Act also prohibits the sale, purchase, and trade of
prescription drug samples. Drug samples are distributed without charge by manufacturers
to promote their sale. Licensed practitioners, as well as healthcare professionals and
hospital pharmacies acting at the direction of a licensed practitioner, may provide drug
samples to patients.

Unitary Pricing Laws. Not satisfied with the provisions of the Robinson Patman Act and
Prescription Drug Marketing Act, legislatures on the state and federal level have
attempted in the past to eliminate manufacturer price differentials by enacting laws that
directly mandate a single price for pharmaceutical sales. These statutes commonly are
known as "best price" or "unitary pricing" laws. As of the date of this writing, Maine is
the only state that has enacted such a law.

Federal Antikickback Law. The Medicare and Medicaid fraud antikickback statute
prohibits certain financial inducements to purchase medical goods and services. With
some exceptions, the law forbids offers and payments of remuneration (including rebates)

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made to induce any person to order, purchase, or recommend any good or service that
may be paid for, in whole or in part, directly or indirectly, by Medicare or Medicaid.

Although this broadly worded statute could encompass many discounting practices
common to prescription drug sales, the Department of Health and Human Services has
established "safe harbors" that outline legal procedures for discounting goods. Entities
complying with the safe-harbor requirements will not be subject to civil or criminal
penalties.

Prescription drug marketing has come under scrutiny recently, however. The Health and
Human Services Office of the Inspector General (OIG), responsible for prosecuting
Medicare and Medicaid fraud, has issued a "Special Fraud Alert" outlining prescription
drug marketing activities that the OIG may investigate under the federal antikickback
statute. The alert specifically identifies three marketing activities that may implicate the
antikickback statute:

1. Product conversion programs that offer cash rewards to pharmacies for switching
prescriptions from one drug to another
2. Frequent flier campaigns that give physicians credit toward airline mileage for
each new patient placed on a certain drug
3. Bogus research programs in which manufacturers pay physicians for providing
minimal information, sometimes a single word, concerning the treatment outcome
of patients placed on a drug

The OIG warns that violations of the antikickback law can result in exclusion from
Medicare and Medicaid participation, as well as criminal prosecution. According to the
alert, OIG investigation may be warranted based on the following marketing plan
features: a prize, gift, cash payment, coupon, or bonus based on choice of drug product;
cash or other benefits in exchange for pharmacist marketing activities under the guise of
"counseling"; grants for product-related research of questionable scientific value; and
payments to patients, providers, and suppliers for changing prescriptions. The alert urges
individuals to contact their local OIG regional office with any information concerning
possible violations.

Drug Utilization Review

In the past, pharmacy practice was focused primarily on the accurate delivery of drug
products as specified by prescribers. Today, the practice of pharmacy is patient oriented.
The pharmacist takes an active role in advising practitioners and patients about drug
therapy. This role expansion was facilitated by recent federal legislation. Specifically, the
Omnibus Budget Reconciliation Act of 1990 (OBRA '90) mandates prospective and
retrospective drug utilization review (DUR) for Medicaid providers of outpatient drugs. 40

Although OBRA '90 does not apply to hospitals (as long as the institutions use a
formulary system and do not bill Medicaid more than their purchasing cost for the drug)
or HMOs, it has brought DUR to the forefront.
Prospective drug utilization review (prospective DUR) focuses on the drug therapy
for a single patient, rather than on overall usage patterns. The purpose of prospective
DUR is to allow the pharmacist to intervene before a drug is administered or dispensed
to a patient, thus avoiding undesirable results. Although OBRA '90 mandated

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prospective DUR for Medicaid patients only, most states have extended the requirement
to all patients, either by statute or rule. Prospective DUR consists of three components:
41

documentation, screening, and counseling.

Documentation is a key component of prospective DUR because it serves as the basis

for both screening and counseling. Many states require pharmacists to maintain patient
profiles. In New Jersey, a broad statute requires all pharmacies to maintain patient
profiles that allow "immediate retrieval" of information including the patient's identity,
address, and telephone number, age, gender, known allergies, drug reaction, previously
prescribed drugs, dispensing dates, initials of dispensing pharmacist, prescription
number, prescriber, and drug dispensed. Massachusetts and Virginia require
42

pharmacists to make "reasonable efforts" to maintain a similar list of information for each
patient. By maintaining complete patient drug histories that include both prescribed and
43

over the counter medications, the pharmacist can improve the quality of drug therapy.
Failure to maintain proper patient documentation also may result in liability. A
Tennessee appeals court has ruled that failing to maintain and review drug profiles may
lead to liability.
44

The second component of prospective DUR is screening. If the pharmacist's review of

the patient's record yields problem findings or observations, they then are relayed to the
attending practitioner during consultation. A Florida regulation specifically identifies the
potential problems for which pharmacists should screen the patient profile:
overutilization, underutilization, therapeutic duplication, drug drug interactions, drug
disease contraindications, drug food interactions, incorrect dosage, incorrect duration of
drug treatment, drug allergies, and drug abuse or misuse. Facilities that maintain
45

records but fail to review them may be liable for failing to act. 46

Prospective DUR culminates with patient counseling. A pharmacist may make an offer of
counseling to a patient face to face, in writing, or by telephone, depending on both the
circumstances and state law. Virginia, for example, allows the pharmacist to choose
among face-to-face communication, a sign, a notation on the prescription bag or
container, or by telephone. Florida requires both a written and verbal offer to counsel for
47

patients present in the pharmacy, but allows a written offer for toll-free telephone
counseling for delivered prescriptions. Pharmacists should ensure that their procedures
48

comply with applicable state law.

The content of the counseling itself usually is left to the professional judgment of the
pharmacist, although state laws and regulations may list subjects that a pharmacist
might discuss. The pharmacist may address the name of the drug dispensed, dosage
and route of administration, expected effects, special directions and precautions,
potential interactions with other substances, common side effects, what to do in the
event of a missed dose, and storage instructions. Most states require that a pharmacist
meet face-to-face with the patient whenever possible. 49

The pharmacist also may consult directly with prescribers in the planning of drug
therapy, advising them on matters such as product selection, expected patient
responses, and drug interactions. Consultation with prescribers may be required by state
law if the pharmacist identifies a potential problem when screening a patient's drug
profile. In addition, pharmacists may provide consultative services to nurses and others
50

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as to the proper techniques to use in preparing injectables, the administration of drugs

requiring special handling, and other matters.

In addition to prospective review, focusing on each prescription for individual patients,

retrospective drug utilization review (retrospective DUR) is necessary to determine
whether a health plan is using drug therapy to its best advantage. For example, OBRA
'90 requires that each state establish a board to conduct periodic review of Medicaid
prescription drug claims. The goal of this retrospective review is to determine whether
51

covered outpatient drugs are being used efficiently and appropriately. Health plans also
conduct retrospective DUR to monitor practitioner prescribing practices and to determine
the expense of the prescription drug benefit. Although hospitals are exempt from OBRA
'90 requirements, Joint Commission standards now require a similar continuing review of
drug use in hospitals.
52

Review Question

The Good & Well Pharmacy, a Medicaid provider of outpatient drugs, is subject to the
prospective drug utilization review (DUR) mandates of the Omnibus Budget
Reconciliation Act of 1990 (OBRA '90). One component of prospective DUR is
screening. In this context, when Good & Well is involved in the process of screening, the
pharmacy is

updating a formulary to represent the current clinical judgment of providers and

experts in the diagnosis and treatment of disease
reviewing patient profiles for the purpose of identifying potential problems
consulting directly with prescribers and patients in the planning of drug therapy
denying coverage for the off-label use of approved drugs

Incorrect
Correct
Incorrect
Incorrect

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Chapter 6 D
Market Conduct Examinations and Mechanisms for
Enforcement
We conclude our review of state regulation of health plans with a discussion of market
conduct examinations and the enforcement mechanisms that are available to state
regulators to address violations of law.

After completing this lesson, you should be able to:

 List the operations that a state insurance department reviews in conducting a market
conduct examination
 Describe the enforcement mechanisms available to states to address violations of
law

Market Conduct Examinations

From a regulatory perspective, market conduct is one of the most critical issues facing
the insurance and health plan industries. A market conduct examination is a formal
review that is carried out by one or more state insurance departments and is designed to
determine whether a health plan's operations are conducted in compliance with
applicable state laws and regulations.

With regard to health plans, the NAIC Market Conduct Examiners Handbook states,
"Examinations are performed to determine treatment of enrollees, to measure the quality
of care procedures employed by an HMO in conjunction with any other appropriate
health regulatory agency, and to determine compliance with statutory provisions relating
to contractual arrangements for both providers and enrollees." 1

The states have developed procedures that insurance departments follow to examine
health plan operations to determine whether these operations are conducting business
in compliance with state laws and regulations. The procedures that are followed in
undertaking market conduct examinations are designed to provide state regulators with
information they can use to detect when a health plan is not in compliance with state
laws and regulations and, if necessary, to determine what enforcement action is
appropriate. Following some well-publicized cases of market conduct violations in the
insurance industry, the NAIC has developed a number of new model laws, and state
regulators have imposed new regulatory requirements on the activities of insurers and
health plans. Insight 6D-1 provides an NAIC view of the growth of market conduct
examinations for all risk-bearing entities in the United States.

Insight 6D-1. The Growth of Market Conduct Oversight in the 1990s.

By John C. Mancini
It has been said many times over the past few years: Market conduct is the issue of the
decade. In 1990, state insurance departments conducted 1,018 market conduct
examinations with 286 staff and 71 contract market conduct examiners. Contrast these
statistics to 1995 when state insurance departments conducted 1,511 market conduct
examinations with 364 staff and 85 contract market conduct examiners. Over this period,
the number of examinations increased 48% and the total number of market conduct

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examiners increased 26%. Clearly there has been increased attention to market conduct
because this growth occurred during a period when total state insurance department staffs
only grew 4.5%, from 9,323 to 9,751. In the 1990s, has greater attention been focused on
market conduct, consumer protection, and compliance? You bet it has. Are state
insurance departments, like most other business sectors, more efficient and productive
today than they were in 1990? Certainly.

What are the reasons for this growth? I think there are several reasons that stand out. In
the late 1980s and early 1990s, some members of Congress were espousing federal
regulation of insurance. This threat brought greater attention to several areas of state
insurance regulation, including consumer protection. A second reason for the increased
attention focuses on the methods used to sell insurance products. Recently, allegations of
churning and misrepresentation by agents and companies in the sale and marketing of life
insurance products have been in the forefront, including a number of nationwide class
actions. However, in the 1990s market conduct attention has been extended to all lines of
business and touched virtually every segment of the insurance industry. Problems with
the sale of Medicare supplement policies led to reforms in that area earlier this decade. In
the early and mid-1990s, state insurance regulators and other agencies, such as the U.S.
Department of Housing and Urban Development (HUD), investigated allegations of
redlining by property/casualty insurers, particularly in urban areas. Finally, the
information revolution and improved technology of the 1990s have changed the way that
the insurance business is conducted. There is more information available and it flows
much faster and more efficiently than it ever has. Regulators have had to keep up.

Not only has this heightened attention resulted in more examiners and more
examinations, but it has also resulted in increased attention to market conduct at the
NAIC. The NAIC's Market Conduct Examiners Handbook has been completely
overhauled since 1994. An annual Chief Examiners Forum is held to bring the top state
personnel working in the Market Conduct area together to discuss issues of common
concern. And, the amount of information in the NAIC's Market Information Systems
(MIS) is increasing proportionally. Today, the NAIC maintains market conduct databases
with over 100,000 regulatory actions and over 1.2 million consumer complaint records,
allowing insurance regulators and the public to get a good picture of the market behaviors
of agents and companies.

Where are we going from here? Many changes are likely to occur over the remainder of
the decade of the 1990s. These changes will take many forms, including information
technology improvements both by the insurance industry and by insurance regulators.
The Internet, expansion into new products and services, and financial services
modernization will all have a significant impact on the business of insurance and the
business of insurance regulation.
Source: John C. Mancini is Market Affairs Manager for the National Association of Insurance Commissioners.

To carry out a market conduct examination, representatives of a state insurance

department, called examiners, visit the insurer or health plan's home or regional office
and examine the business records of the company. The team of examiners is composed

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of specially trained insurance department employees or independent examiners hired by

the insurance department, or both. One individual functions as the examiner-in-charge
and is responsible for the conduct of the examination and supervision of the team of
examiners. The insurer or health plan usually appoints one of its employees to serve as
the examination coordinator, with responsibility for facilitating the examination. For
example, if the examiners have questions or need additional information, they make
those requests to the examination coordinator, who is responsible for obtaining the
information.

The specific types of business records the examiners review vary depending on the
scope of the examination. An on-site market conduct examination may be either a
comprehensive examination of all market conduct operations or a target examination of
one or only a few facets of a health plan's conduct operations. For example, a target
examination might focus on one line of a health plan's business or on specific functions
such as underwriting or claims. We describe the scope of a comprehensive market
conduct examination later in this lesson.

Many state insurance departments conduct a follow-up examination, known as a

reexamination, some time after the completion of a comprehensive or target
examination. An insurance department's focus in a reexamination is to determine
whether an insurer or health plan has complied with recommendations or directives
contained in a previous examination.

In addition to on-site examinations, state insurance departments sometimes conduct

desk examinations in which they review some of a health plan's business records in the
offices of the insurance department. A health plan that is the subject of a desk
examination is required to provide all necessary materials to the insurance department.
A desk examination is generally limited in scope as compared to an on-site examination.
For example, an insurance department might request that a health plan send a list of all
contract forms and evidence of coverage forms used within a specified time period to
determine if the health plan is in compliance with state filing requirements. Or an
insurance department may receive a series of consumer complaints about a specific
aspect of a health plan's operations. The insurance department then might require the
health plan to provide the department with its files and correspondence relating to those
complaints. The department would use those records to conduct a desk examination as
part of its investigation of the consumer complaints.

Multistate Cooperative Examinations

Every state in which a health plan is licensed to conduct business has authority to
examine the health plan's market conduct practices within its jurisdictional boundaries.
States cooperate extensively in performing financial examinations of insurers and health
plans to avoid duplication of effort. In the case of financial examinations, multistate
examinations are appropriate because the focus of each state's concern is the entity's
financial condition, and that condition does not vary from state to state. In addition,
regulatory requirements concerning a health plan's financial condition tend to be quite
similar from state to state.

In contrast, a health plan's market conduct practices may not be exactly the same in
each jurisdiction or geographic region in which it operates. A health plan, for example,
will likely sell different products in different geographic locations, and its market conduct

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practices might vary from product to product. Similarly, regulatory requirements

concerning market conduct vary from state to state more than do requirements
concerning solvency. Nevertheless, it may be appropriate in some cases for the
insurance departments of several states to perform a multistate cooperative
examination-that is, a market conduct examination performed on behalf of a number of
states that have agreed upon the standards against which the health plan will be
evaluated. The NAIC Market Conduct Examiners Handbook identifies three situations in
which an insurer or health plan is a candidate for a multistate cooperative examination:

1. Examination of an insurer's or health plan's group business. A multistate

examination is appropriate when an insurer or health plan maintains a sufficiently
large block of group insurance covering individuals in a number of jurisdictions.
2. Examination of an insurer's or health plan's national business. A multistate
examination is appropriate when an insurer or health plan issues large blocks of
business across the country using consistent underwriting, pricing, advertising,
and claims processing practices.
3. Examination of an insurer's or health plan's regionalized business. A
multistate examination is appropriate when an insurer's or health plan's regional
office conducts business in a number of states.

Examination Scheduling
Most states' laws require the state insurance department to perform periodic
examinations-including financial and market conduct examinations-of each insurer or
health plan licensed to conduct business in the state. The HMO Model Act requires the
state department of insurance to conduct a comprehensive examination of an HMO's
operations at least every three years. Many states require each licensed insurer to be
examined at least every three to five years. Other states conduct market conduct
examinations when they identify specific complaints about a health plan's market
conduct activities or have some specific concern about a health plan's operations. The
insurer or health plan is required to bear all costs of the examination.

The NAIC has developed an electronic system, known as the Examination Tracking
System (ETS), that enables the states to schedule and coordinate market conduct
examinations, as well as financial examinations. A state that plans to schedule an
examination may notify the other states by entering the information into the ETS. Other
states then have the opportunity to participate in the examination.

Review Question

Greenpath Health Services, Inc., an HMO, recently terminated some providers from its
network in response to the changing enrollment and geographic needs of the plan. A
provision in Greenpath's contracts with its healthcare providers states that Greenpath
can terminate the contract at any time, without providing any reason for the termination,
by giving the other party a specified period of notice.

The state in which Greenpath operates has an HMO statute that is patterned on the
NAIC HMO Model Act, which requires Greenpath to notify enrollees of any material
change in its provider network. As required by the HMO Model Act, the state insurance

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department is conducting an examination of Greenpath's operations. The scope of the

on-site examination covers all aspects of Greenpath's market conduct operations,
including its compliance with regulatory requirements.

From the following answer choices, select the response that identifies the type of market
conduct examination that is being performed on Greenpath and the frequency with which
the HMO Model Act requires state insurance departments to conduct an examination of
an HMO's operations.

Type of examination: comprehensive; Required frequency: annually

Type of examination: comprehensive; Required frequency: at least every three
years
Type of examination: target; Required frequency: annually
Type of examination: target; Required frequency: at least every three years

Incorrect. The HMO Model Act requires state insurance departments conduct a
comprehensive exam of the HMO's operations at least every three years

Correct! The HMO Model Act requires state insurance departments conduct a
comprehensive exam of the HMO's operations at least every three years

Incorrect. A target examination covers only a few facets of the health plan's
conduct operations. HMO Model Act requires state insurance departments to
conduct comprehensive market conduct examination every three years

Incorrect. While the HMO Model Act requires state insurance departments to
conduct comprehensive market conduct examination every three years, a target
examination covers only a few facets of the health plan's conduct operations.

A state insurance department that schedules a comprehensive examination typically

notifies the health plan in writing in advance of the examination to allow time to prepare.
The length of this notice period varies from state to state and ranges from a few weeks
to as much as 60 days. The notification letter, which can be several pages long, usually
includes the following types of information:

• A description of the scope of the examination, including the types of market

conduct activities and the time period that will be reviewed (for example, all
member and claims activities that took place from January 1, 2003 through June
31, 2004)
• The date the examination will begin and the date estimated for completion
• The estimated cost of the examination and how that cost will be billed to the
health plan
• Identification of the types of materials the insurer or health plan must provide,
such as its procedural guidelines, manuals, policy forms with notices of approval,
advertising materials, and sales representatives' records
• Requests for information that will take time for the insurer or health plan to
compile

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• Identification of the office space, supplies, and equipment the insurer or health
plan is to provide for the examiners

In some cases, an insurance department has the right to perform an examination without
giving prior notice. For example, if an insurance department has reason to believe that
the rights of a member might be harmed if it delays conducting an examination, then the
department is not required to provide advance notice of an examination. Similarly, if a
health plan has a valid reason for needing more time to prepare, state insurance
departments generally postpone the scheduled start date of an examination.

Examination Techniques
Before beginning an on-site market conduct examination, the team of examiners will
review a variety of documents to familiarize themselves with the health plan's operations.
Examiners generally review the results of previous examinations of the health plan and
note problem areas that should be reexamined. They also review the health plan's
Annual Statements so that they can assess its financial condition.

Once the examiners arrive at the health plan's offices, they begin to review the business
records. Because of the volume of those records, examiners usually are not physically
able to review them all. Instead, examiners use statistical sampling techniques that
enable them to review a representative sample of the records. For example, in order to
review a PPO's records concerning non-network claims payments, the examiners would
evaluate the total set of records and determine the appropriate method for selecting a
portion of those records to examine. The examiners' goal is to select a sample that will
lead them to the same conclusions about the PPO's claims payment procedures as they
would have reached had they evaluated all of the records.

Scope of Market Conduct Examinations

All nonfinancial aspects of a health plan's operations are considered within the purview
of market conduct. In this section, we identify and describe specific aspects of a health
plan's operations that may be the subject of a market conduct examination. Although we
describe the scope of a comprehensive market conduct examination here, keep in mind
that specific operations might be the subject of a target examination.

If a health plan is part of a legal entity licensed as an insurer, then the health plan's
operations might be included in a market conduct examination of the insurer's total book
of business. If a health plan is a separate legal entity, such as an HMO that is a
subsidiary of a parent insurance company, then that health plan would likely be subject
to a separate market conduct examination.

During review of each aspect of a health plan's operations, market conduct examiners
generally make the following determinations:

1. Has the health plan established standards to assure the activity is carried out
effectively?
2. Do the health plan's standards comply with applicable regulatory requirements?
3. Is the activity being carried out so as to meet the established standards?

Company Plan Structure and Management

In evaluating a health plan's plan structure, operations, and management, examiners are

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concerned with whether the health plan is structured and governed to assure regulatory
compliance. The types of records the examiners review include the certificate of
authority, structure and contractual arrangements, audit plan materials, computer
systems, and antifraud plans.

Certificate of Authority
Examiners typically evaluate whether the health plan's operations conform to its
certificate of authority. For example, they determine whether the entity is licensed as an
HMO, a PPO, or another type of health plan and then determine if it is has been
operating accordingly.

Structure and Contractual Arrangements

Examiners review the health plan's operations to determine if and how administrative
activities are delegated. They also examine other structural features, such as the fee
arrangements for reimbursing participating providers, provider referral procedures and
constraints, ratio of physicians to members, availability and choice of physicians, and
procedures for maintaining records.

Audit Plan Materials

Examiners will want to know whether the health plan has established an internal audit
system and/or compliance program by which it can detect and correct market conduct
problems. Businesses have long used audits-both internal and external-to review their
accounting and financial records for accuracy and appropriateness. Audits traditionally
have included an evaluation of the effectiveness of the organization's internal financial
control systems. Internal audit results are communicated to top management along with
recommendations, if necessary, for corrective action.

Market conduct examiners review the health plan's audit plan and all accompanying
procedures manuals. They also review audit reports to determine whether those reports
provide management with meaningful information about regulatory compliance issues.
Finally, examiners look at how management uses the information provided in audit
reports. For example, does management respond to audit recommendations by adopting
new procedures or modifying existing procedures? If not, then the examiners will want
an explanation of management's response.

Computer Systems
Health plans must keep a large volume of business records, and, thus, they have
developed computer systems to assist them in maintaining those business records.
Market conduct examiners evaluate the systems and procedures that are in place to
maintain data. Examiners evaluate whether there are adequate safeguards and controls
to assure the integrity of the information contained in the computerized records.
Examiners also evaluate the health plan's disaster recovery plans. Should a health
plan's records be lost following a disaster, the health plan must be able to recover the
information and continue operations without significant interruptions.
Antifraud Plan
Examiners determine whether the health plan has established any required antifraud
plan. Examiners then evaluate the plan to determine whether (1) it complies with
statutory requirements and (2) written antifraud manuals and procedures provide enough
detail for employees to understand how to perform their jobs in conformance with
management's intent.

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Complaints and Grievance Procedures

Most states have laws that require insurers and health plans to maintain marketing and
performance records, including complaint records. Examiners review the health plan's
complaint logs and make the following determinations about its complaint handling
procedures:

• Do the health plan's complaint records reflect all consumer complaints,

including those received by the state insurance department? Do complaint
records include all required information?
• Are there any patterns in the types of complaints received about the health
plan? For example, do a significant number of complaints concern a specific
product or are complaints concentrated in a specific geographic location? If
examiners detect a pattern in complaints, they will follow up to locate the
source of the complaints and may be required to broaden the scope of the
market conduct examination.
• Has the health plan handled the complaints adequately and in compliance
with regulatory requirements? For example, if the state imposes a time limit
within which health plans must respond to complaints, examiners will study
the health plan's response times.

In addition, many state HMO laws specify procedures for handling member grievances
or appeals. In reviewing a health plan's grievance procedures, examiners typically seek
to determine members' awareness of these procedures. They also review the health
plan's grievance process, the minutes of the health plan's Grievance Committee, and
other documentation supporting the process and the resolution of member appeals.

Marketing and Sales

All states impose regulatory requirements on the advertising and sales materials health
plans use to market their products. Market conduct examination of advertising material
includes comparing the materials to the policy forms they advertise to assure that the
materials accurately represent the terms of the policy forms and comply with the
applicable laws.

States hold health plans responsible for the content of all advertisements, whether the
advertisements originate from the company's home office, an individual agent, or even
an employer that is purchasing coverage from the health plan. A market conduct
examination includes a review of procedures and controls the health plan has in place
for reviewing all advertising and sales materials.

Sales Representative Licensing

Market conduct examinations include an evaluation of the health plan's compliance with
sales representative licensing requirements and whether or not outside brokers were
used. In this component of an examination, the health plan's records of licensing and
appointment are compared to the state insurance department's records to verify that the
records agree. The reasons for any discrepancies must be discovered to determine
whether regulatory requirements have been violated.

Review Question

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The following statements are about market conduct examinations of health plans. Select
the answer choice that contains the correct statement.

Multistate examinations are not appropriate for financial examinations, because

regulatory requirements concerning a health plan's financial condition tend to vary
from state to state.
Market conduct examinations of a health plan's advertising and sales materials
include comparing the advertising materials to the policies they advertise.
Once an examination report is provided to the state insurance department, a
health plan is not given an opportunity to present a formal objection to the report.
In imposing sanctions on health plans, state insurance departments are required
to follow federal sentencing guidelines.

Incorrect

Correct

Incorrect

Incorrect

Operations
Examination of health plan operations consists of evaluating compliance with regulatory
requirements regarding all policy transactions other than claims payments. Examiners
review files and periodic reports to evaluate how the health plan handled transactions
such as billing, member enrollment, and member termination. Examinations focus on
two primary issues:

1. Did the health plan handle policy transactions in a timely manner?

2. Did the health plan handle policy transactions in accordance with applicable
policy provisions and regulatory requirements?

Examiners may review the correspondence received by the health plan and the health
plan's responses to that correspondence to determine if the health plan responded in a
timely and appropriate manner.

Premium Rating, Underwriting, and Policy Forms

A market conduct examination typically includes evaluation of the health plan's practices
regarding premium rates and underwriting. In order to evaluate the health plan's rating
practices, examiners review a variety of materials, including rate manuals, rate cards,
and policy files. Examiners determine whether the health plan has filed premium rates, if
required, and is applying premium rates consistently and in accordance with filed rates
and its own rating methods. Examiners evaluate whether the health plan is charging the
proper premiums and implementing premium rate increases properly.

Examiners review the health plan's underwriting practices to assure that they are not
unfairly discriminatory and that they comply with applicable regulatory requirements.
This step includes a review of the underwriting files to assure that underwriting is being

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performed in accordance with the health plan's guidelines. If underwriting guidelines are
required to be filed with the state insurance department, examiners review the health
plan's records to verify that required filings were made.

Examiners also review the health plan's policy filings to verify that, where required, the
insurer has filed policy forms and received approval from the state insurance department
before using those forms.

Claims
Market conduct examiners review the health plan's claims handling practices to verify
that those practices comply with regulatory requirements and policy provisions.
Examiners review the health plan's claims systems, procedures manuals, and available
internal documents that describe claims handling practices. Then they review the
methods the health plan uses to process claims. Examiners also review claims files to
evaluate:

• The length of time required to investigate and settle claims

• Whether files contain adequate and accurate documentation
• Whether the amounts of claim payments made are accurately calculated
• Whether claims are paid to the correct payees

Examiners review the health plan's claim forms to verify that they are appropriate for the
product and are used appropriately. Claim forms should request only information the
health plan reasonably needs to evaluate the claim, and claimants should be able to
complete the forms without unreasonable hardship.

Market conduct examiners also review the health plan's files of litigated claims-that is,
claims that resulted in lawsuits. The focus of this review is to determine whether the
health plan has improperly denied claims. Examiners also look for patterns in how the
health plan handles claims and evaluate those patterns to verify that proper claims
handling procedures have been followed.

Quality Assurance and Utilization Review

Examiners determine the nature and scope of medical directors' responsibilities. They
also determine if the health plan uses a Peer Review Committee and a Professional
Review Committee and, if so, how frequently these committees meet, what activities
they oversee, and how they are operated. Examiners determine if the health plan has
established a system for medical audits and, if so, how management uses the
information provided in audit reports. Examiners also evaluate a health plan's utilization
review procedures by examining the appropriate information systems and by looking at
how the health plan reviews and acts upon physician practice patterns and hospital
utilization.

Anticompetitive Practices
In some states, the market conduct exam also includes a review of operating or
marketing practices that might have an anticompetitive impact. Whether or not an
insurance department conducts such a review depends largely on the scope of its
statutory authority.

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After the Market Conduct Examination

Market conduct examiners document their findings throughout an examination and
complete an exception form each time their findings indicate possible noncompliance.
Following completion of a market conduct examination, the team of examiners is
responsible for summarizing its findings into a written examination report. The report lists
the problems noted on all exception forms and makes recommendations as to steps the
health plan should take to comply.

The examination report is provided to the state insurance department and the health
plan. Although procedures vary from state to state, the health plan has the opportunity to
discuss the report with the insurance department and, where appropriate, the report is
corrected.

If the health plan objects to the report, it has the right to request a formal hearing before
a hearing officer who is authorized to evaluate testimony and make a decision as to the
contents of the final report. Once the report is finalized, the insurance department adopts
it and places it on file. In most instances, the filed examination report becomes a public
document. The insurance department typically provides a copy of the report to the
appropriate health regulatory agency in the state and to the NAIC, which maintains the
report in its information system.

Once an examination report is filed, the insurance department, where appropriate,

issues an order to the health plan. This order lists the recommendations contained in the
examination report and, in some cases, provides a date by which the health plan must
provide the department with evidence that it has complied with the order.

Mechanisms for Enforcement

At times, a market conduct examination reveals that a health plan has violated certain
insurance or HMO laws. Complaints from members, purchasers, or providers or an
investigation by other regulatory authorities could lead to similar findings. For example,
the office of the attorney general might receive a complaint from a competitor alleging
antitrust activities on the part of a health plan. When a state determines that a health
plan has violated a law or regulation, it has available to it several mechanisms for
enforcement.

Most state laws give the appropriate regulatory agency the authority to order a health
plan to "cease and desist" from violating a particular requirement. For example, if a
health plan is found to be using a television commercial prior to obtaining applicable
regulatory approval, the state can order the health plan to stop running that commercial.
In addition, regulators can sanction a health plan. Sanctions often take the form of fines.
The amount of the fine varies depending on the seriousness and frequency of the
violation. State laws sometimes provide the insurance department with guidance on the
amount of the fine that may be imposed for each specific violation. For example, the
NAIC Unfair Claims Settlement Practices Act recommends fines of $1,000 for each
violation up to a total limit of $100,000; in the event of a flagrant violation, the Claims Act
recommends fines of $25,000 for each violation up to a total limit of $250,000. In 2

extreme situations, a state might seek to suspend or revoke a health plan's certificate of
authority.

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Failure to comply with applicable regulatory requirements could also lead to civil
litigation, either as a breach of contract or a breach of a standard or duty of care, as
Insight 6D-2 illustrates.

Insight 6D- Failure to Comply with Advertising Requirements Can Lead to

2. Significant Liability for a health plan

An unreported Idaho court decision (Warne v. Lincoln Natl. Admin. Serv. Corp., No.
96932) illustrates a health plan's liability with regard to marketing activities. In this
situation, a health plan was sued for bad faith and fraud when it denied coverage for a
liver transplant. The plaintiff, relying on a brochure that indicated that organ transplants
were considered a covered benefit, was able to convince the jury that she had relied to her
detriment on the advertised coverage. The defense was unable to convince the jury that
other plan documentation, which denied almost all coverage for liver transplant
procedures, was controlling. The jury found for the plaintiff and awarded her $25 million
in punitive damages and $1.5 million for pain and suffering. In addition, the plaintiff was
awarded over $300,000 for the denied covered benefit.

Although this case was subsequently settled, it does paint a threatening scenario for
health plans that do not pay attention to the content of advertising and promotional
materials. Source: Liability and Risk Management in Health Plan, p. 12:5

State laws require health plans to oversee their operations to assure regulatory
compliance. In imposing sanctions on health plans, several state insurance departments
have followed the lead the federal government has taken in its sentencing guidelines.
Federal sentencing guidelines are used by federal courts to determine specific
punishments that are to be imposed on organizations and individuals who violate federal
laws. Note that state insurance departments are not required to follow the federal
sentencing guidelines; rather, they voluntarily follow some of the practices contained in
the guidelines. The primary influence of the federal sentencing guidelines on state
insurance departments has been the policy of assessing the degree of blame to place on
a company for allowing illegal activities to occur.

The guidelines recognize that all illegal behavior cannot be prevented, and they
recommend less severe punishments for companies that have taken steps to prevent
illegal activities. Thus, companies that have made good faith efforts to prevent
employees from engaging in illegal activities receive a lesser fine than do companies
that have not taken steps to assure regulatory compliance. We will examine the federal
sentencing guidelines in greater detail in Goverance: Accountability and Leadership.

Review Question

SoundCare Health Services, a health plan, recently conducted a situation analysis. One
step in this analysis required SoundCare to examine its current activities, its strengths
and weaknesses, and its ability to respond to potential threats and opportunities in the
environment. This activity provided SoundCare with a realistic appraisal of its
capabilities. One weakness that SoundCare identified during this process was that it

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lacked an effective program for preventing and detecting violations of law. SoundCare
decided to remedy this weakness by using the 1991 Federal Sentencing Guidelines for
Organizations as a model for its compliance program.

By definition, the activity that SoundCare conducted when it examined its strengths,
weaknesses, and capabilities is known as

an environmental analysis
an internal assessment
an environmental forecast
a community analysis

Incorrect
Correct
Incorrect
Incorrect

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Chapter 7 A
Federal Regulation of Health Plans
In Overview of Laws and Regulations, we introduced the HMO Act of 1973 and
described its history and its major provisions. In this lesson, we explore the major
amendments to the HMO Act and discuss the advantages and disadvantages of federal
qualification as well as the operational and quality requirements with which federally
qualified HMOs must comply. We conclude the lesson with an examination of Centers
for Medicare and Medicaid (CMS)'s role as the enforcer of federal HMO standards.

After completing this lesson, you should be able to:

 Describe some of the operational and quality requirements that federally qualified HMOs
must meet
 Explain some of the administrative burdens that the Health Insurance Portability and
Accountability Act of 1996 (HIPAA) imposes on health plans
 Describe the general provisions of the Mental Health Parity Act of 1996 and the
Newborns’ and Mothers’ Health Protection Act of 1996
 Explain several typical applications to health plans of the Americans with Disabilities Act

Federal Qualification and the HMO Act of 1973

The HMO Act, enacted in 1973, defined the standards for developing and operating
HMOs. The HMO Act also established the requirements necessary for HMOs to be
federally qualified. An HMO that applies for and meets the federal qualification
requirements whose application is approved becomes a federally qualified HMO.
Amendments to the HMO Act were made from 1976 to 1996. The 1976 amendments
allowed some flexibility related to community rating, open enrollment, and medical
staffing. Subsequent amendments addressed such issues as financial disclosure and
1

solvency protection. A 1986 amendment eliminated the federal grant and loan program,
created to encourage the development of HMOs. Amendments added in 1988 made
several significant changes to the HMO Act. These changes included:

• Allowing federally qualified HMOs to provide up to 10% of physician services

through nonaffiliated physicians and allowing reasonable deductibles for such
services
• Allowing federally qualified HMOs to establish non-federally qualifiable
separate lines of business
• Authorizing the repeal-effective in 1995-of the mandate requiring that
employers who offered a health insurance option also offer an HMO if one
was available in the geographic area (often referred to as the "dual-choice"
mandate)
• Expanding the definition of restrictive state laws that are preempted by the
HMO Act
• Requiring disclosure of the data and methods HMOs use to set their rates
• Addressing nondiscrimination in the financing of employee plans
• Eliminating the requirements that at least one-third of an HMO's policy-
making body be comprised of HMO members
• Abolishing the provision that required representation of underserved
communities on the HMO's policy-making body 2

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In 1996, another amendment to the HMO Act was included as a provision of HIPAA.
This amendment allows federally qualified HMOs to offer high-deductible plans. In the 3

following lessons, we will discuss the requirements for federal qualification and look at
the pros and cons of obtaining federal qualification. As described in the following
lessons, the federal qualification program played a much more important role for HMOs
in the past than it does today.
Operational Requirements for Qualification 4

HMOs sought federal qualification had to meet requirements in four basic operational
areas. First, the HMO had to offer a comprehensive basic benefits package that included
outpatient and inpatient services, unlimited home health benefits, and outpatient mental
health visits. HMOs could deliver these services through one of four permissible delivery
models: staff, group, individual practice association, or direct contract. Second, the HMO
had to enroll individuals eligible for group coverage without regard to health status and
established their prepayment charges on a community-rated basis with nominal
copayments by members.

Third, HMOs needed to have a fiscally sound operation and adequate protections
against the risk of insolvency. For example, one measure of fiscal soundness was for the
HMO to demonstrate that its total assets are greater than its total unsubordinated
liabilities. Finally, with respect to the quality of the care that federally qualified HMOs
provided, the HMO had arrangements for an ongoing quality assurance program that
met CMS (formerly HCFA) requirements, stressed outcomes, and provided for review by
physicians and other health professionals.

Fast Definition

Unsubordinated liabilities-A "subordinated liability" is a liability that is payable only after

all other liabilities hare paid. Unsubordinated liabilities are all other liabilities.

Review Question

Health maintenance organizations (HMOs) seeking federal qualification under the HMO
Act of 1973 and its amendments must meet requirements in four basic operational
areas. One operational requirement for qualification is that an HMO must

ensure that at least 1/3 of its policy-making body is comprised of HMO members
ensure that there is adequate representation of underserved communities on its
policy-making body
have an ongoing quality assurance program that meets the requirements of the
Centers for Medicaid & Medicare Services (CMS), stresses health outcomes, and
provides for review by health professionals
test, safeguard, and promote quality of care by following detailed programmatic
techniques that are explained in CMS's Federally Qualified HMO (FQHMO)
Manual

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Incorrect. While a basic qualification requirement is that an HMO must have a

fiscally sound operation, the make-up of the board is not specifically prescribed

Incorrect. While a basic qualification requirement is that an HMO must have a

fiscally sound operation, the make-up of the board is not specifically prescribed

Correct! A basic qualification requirement was that an HMO had arrangements for
an ongoing quality assurance program that met CMS (formerly HCFA)
requirements, stressed outcomes, and provided for review by physicians and
other health professionals.

Incorrect. The quality assurance program regulations adopted by HCFA at the

time focused on process, access, and continuity of care. These regulations are
explained further in the Federally Qualified HMO (FQHMO) Manual. In addition, the
FQHMO Manual provided detailed optional 'programmatic techniques' that HMOs
could use 'to test, safeguard, and promote quality of care.' While the techniques
are optional, the HMO had to meet underlying quality assurance requirements to
retain federal HMO qualification.

Quality of Care Requirements for Qualification 5

The quality assurance program regulations adopted by HCFA at the time focused on
process, access, and continuity of care. These regulations are explained further in the
Federally Qualified HMO (FQHMO) Manual. In addition, the FQHMO Manual provided
detailed optional "programmatic techniques" that HMOs could use "to test, safeguard,
and promote quality of care." While the techniques are optional, the HMO had to meet
underlying quality assurance requirements to retain federal HMO qualification.

Regarding process, federally qualified HMOs needed to have an ongoing quality

assurance (QA) program that

1. Stressed health outcomes to the extent consistent with the state of the art
2. Provided review by physicians and other health professionals of the process
followed to provide health services
3. Collected data on performance and patient results and provides interpretations to
its professionals and institutes change as necessary
4. Had written procedures to take appropriate remedial action whenever
substandard services are provided or whenever necessary care was not provided

Under the FQHMO Manual, the QA program needed a written plan that was reviewed
annually by the HMO's board. In addition, the program must be directed by an HMO
physician, be adequately staffed, and report regularly to the policy-making body of the
HMO about its activities and actions taken in response to its findings. Federally qualified
HMOs also needed to provide to enrollees services that were available and accessible
with "reasonable promptness" and "within generally accepted norms for meeting
projected enrollment needs." The HMO was explicitly required to make medically
necessary emergency services available 24 hours a day, seven days a week. With
respect to continuity of care, federally qualified HMOs required enrollees to use a single
health professional, usually known as a gatekeeper, to coordinate each enrollee's overall

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care. While this system is often seen as a utilization control, which it is, it began as (and
in its best iterations continues to be) a powerful technique to assure continuity in the
delivery system. The HMO also was required to keep necessary medical and
nonmedical records and assure their confidentiality.

Enforcement for Federally Qualified HMOs 6

CMS does not conduct regular surveys to assure that the HMO continues to meet
federal qualification standards; however, CMS will conduct necessary investigations,
generally in response to enrollee complaints. These complaints are brought to CMS's
attention through complaints by enrollees or competing health plans.

Federal Qualification: Then and Now 7

While federal qualification is entirely voluntary, HMOs that elected to meet federal
qualification requirements historically gained two basic advantages. First, HMOs were
eligible to participate in Medicare as risk or cost contractors without submitting additional
documentation to qualify as Medicare contractors. Second, certain employers used
federal qualification status to determine which HMOs to offer to their employees, viewing
federal qualification as a "stamp of approval" from the federal government.

The Balanced Budget Act of 1997 (BBA) made changes to the Medicare law that, in
effect, eliminate the first advantage cited above. As for the second advantage,
employers are increasingly looking to private accreditation status, rather than federal
qualification, as an indicator of a high quality health plan.

Until October 1995, the federal HMO law gave federally qualified HMOs the right to
require certain employers to offer the HMO as part of their health benefits program if the
employers were not already offering a federally qualified HMO. If the employer offered a
health insurance option and a federally qualified HMO was available in that area, the
employer had to offer it, too, through this "dual choice mandate" if requested by the
federally qualified HMO. Although the mandate lapsed, employers that contribute to the
cost of health insurance for their employees may not discriminate in the amount of the
contribution the employer will make toward health care costs if the employee selects a
federally qualified HMO as opposed to other plans offered by the employer.

In the past, the federal HMO Act gave federally qualified HMOs the right to require
certain employers to offer the HMO as part of their health benefits program if the
employers were not already offering a federally qualified HMO. If the employer offered a
health insurance option and a federally qualified HMO was available in that area, the
employer had to offer it, too, through this "dual choice mandate" if requested by the
federally qualified HMO. Although the "dual choice mandate" lapsed in 1995, employers
that contributed to the cost of health insurance for their employees may not discriminate
in the amount of the contribution the employer will make toward healthcare costs if the
employee selects a federally qualified HMO as opposed to other plans offered by the
employer.

The HMO Act initially required a federally qualified HMO to be a distinct legal entity and
not part of a non-federally qualified HMO. This requirement, which was repealed by
Congress in 1988, stifled the flexibility of HMOs that wanted to offer product lines that
were not federally qualified. Under current law, federally qualified HMOs can now market
nonqualified product lines separate and apart from the federally qualified HMO, with

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benefits and rates that would not be permitted for a federally qualified HMO. This change
allowed HMOs to offer benefit plans without conforming to the rigid benefit and
community rating requirements. Some HMOs viewed these requirements as
burdensome. Although federal qualification is voluntary, and newly created HMOs may
not seek federal qualification, about one third of the operational HMOs in the US
currently meet qualification requirements.

Health Insurance Portability and Accountability Act of 1996 (HIPAA)

A federal law that more significantly impacts health plans today is the Health Insurance
Portability and Accountability Act of 1996 (HIPAA). HIPAA is a federal law that
includes provisions designed to make healthcare coverage available and portable by
creating standardds applicable to access, portability, and renewability in both the group
and individual markets. As noted in Overview of Laws and Regulations, HIPAA affects
health plans in several ways, many of which are discussed in the following lessons.

Portability and Pre-Existing Conditions

HIPAA eliminates one obstacle for many individuals who desire to leave their current
jobs but who are concerned that a potential employer's health plan may exclude pre-
existing conditions. In effect, health coverage is made portable for individuals and their
dependents. Such individuals and their dependents are considered to be continuously
covered (as discussed below) under employer-sponsored plans.

The following federal requirements are related to health insurance portability. However,
these requirements serve as a "floor" for protecting individuals and groups seeking
insurance coverage. State law may be more protective, e.g., may require shorter periods
of pre-existing condition exclusion or may allow for longer breaks in coverage.

Group health plans and health insurance issuers offering group health coverage may
only impose pre-existing condition exclusions if the exclusion is related to a condition for
which medical advice, diagnosis, or treatment was given within the prior six months.
Under HIPAA, the term health insurance issuer means an insurance company,
insurance service, or insurance organization; insurance organizations include HMOs and
other risk-bearing health plans.

Pre-existing condition exclusions may only be applied for a period of 12 months, in the
case of employer group coverage-18 months for a late enrollee (defined below)-and the
period must be reduced by the length of the aggregate period of prior creditable
coverage. Creditable coverage is continuous healthcare coverage under a plan that
reduces the amount of time a pre-existing condition clause in a plan can apply to an
individual. Therefore, if an enrollee has 12 months of prior creditable coverage without a
significant break in coverage (or a late enrollee has 18 months of prior creditable
coverage without such a break), a plan may not impose a pre-existing condition
exclusion period. A break in coverage of more than 63 days is considered a significant
break in coverage. The following further clarify creditable coverage and the use of pre-
existing condition exclusions:

• Plans may not impose a pre-existing condition exclusion period on a

newborn, an adopted child, or a child under 18 placed for adoption as long as
the individual becomes covered under creditable coverage within 20 days of

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birth, adoption, or placement for adoption. Pre-existing condition exclusions

cannot apply to pregnancies.
• Creditable coverage includes coverage of the individual under a group health
plan, health insurance coverage, Medicare, Medicaid, military-sponsored
health care, an Indian Health Service program, a state risk pool, FEHBP, a
public health plan, or health plan under the Peace Corps.
• A late enrollee is a person who enrolls under an employer group plan other
than during the first period in which the person is eligible or other than during
a "special enrollment period" during which HIPAA requires a plan to accept
the person's enrollment.
• A person establishes creditable coverage through presentation of
certifications describing previous coverage or other procedures set forth in
the implementing regulations.

Health insurance issuers offering coverage in the individual market may not impose
exclusions for pre-existing conditions on eligible individuals. Individual-market-eligible
individuals are persons:

• With at least 18 or more months of aggregate creditable coverage

• With their most recent prior coverage from a group health plan, governmental
plan, or church plan
• Who are ineligible for Medicare Parts A or B and Medicaid
• Without any other health insurance coverag
• Who were not terminated from their most recent prior coverage for
nonpayment of premiums or fraud
• Who-if eligible for continuation coverage under COBRA or a similar state
program-elected and exhausted this coverage

States have flexibility in assuring this guarantee is met through a variety of mechanisms-
known as "alternative mechanisms"-including health insurance coverage pools or
programs, mandatory group conversion policies, open enrollment to individuals by one
or more insurers, or laws requiring guaranteed issue. If the state does not have a
mechanism to ensure group-to-individual portability, the federal requirement applies.

Affiliation Periods
An affiliation period is a period of time that must expire before coverage becomes
effective. A group health plan that offers coverage through an HMO may impose
affiliation periods of up to two months (three months for late enrollees) if the plan does
not impose a pre-existing condition limitation and the period is applied uniformly without
respect to any health status-related factors. An affiliation period is a period of time that
must expire before coverage becomes effective. During this period, no premium is paid
and no benefits or services are provided.

Administrative Requirements
Group health plans and health insurance issuers must provide each plan member with a
certificate of creditable coverage, a document that verifies the creditable coverage
earned by the member, at the time the member ceases to be covered under a plan or

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begins COBRA continuation coverage. Such certificates must also be provided when
COBRA coverage ends and at the request of a former enrollee if that request is made
within 24 months of the expiration of that enrollee's health coverage.
Guaranteed Issue
In general, HIPAA requires that issuers offering coverage in the small group market
(defined as employers with two to 50 employees) must guarantee issue of health
insurance to every small employer applying for coverage. An issuer cannot exclude an
employee or his or her dependents from coverage or discriminate with respect to
premiums on the basis of health status.

A network plan may limit employers that may apply for coverage to those in the plan's
service area or may deny coverage based on network capacity. A network plan may also
limit the individuals applying for coverage to those who live or work in the plan's service
area or deny coverage based on network capacity.

Issuers offering coverage in the individual market must guarantee issue to individual-
market-eligible individuals (discussed earlier).

Similar to the ban on imposing pre-existing condition exclusions on individual-market-

eligible individuals, the requirement that issuers guarantee issue to individuals only
applies in states that have not implemented "alternative mechanisms" to ensure group-
to-individual portability.

Guaranteed Renewal
With limited exceptions, issuers offering group health coverage must renew group health
policies in both small and large group markets, regardless of the health status of any
member. Issuers offering coverage in the individual market must also renew individual
policies, except in limited circumstances. This requirement applies regardless of whether
the state has implemented an "alternative mechanism."

Review Question

A federal law that significantly affects health plans is the Health Insurance Portability and
Accountability Act of 1996 (HIPAA). In order to comply with HIPAA provisions, issuers
offering group health coverage generally must.

A. Renew group health policies in both small and large group markets, regardless of
the health status of any group member
B. Provide a plan member with a certificate of creditable coverage at the time the
member enrolls in the group plan

Both A and B
A only
B only
Neither A nor B

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Incorrect. While HIPAA does require insurers offering group health coverage to
renew group health policies in small and large group markets, regardless of the
health status of any group member, it does not require the insurer provide a
certificate of creditable coverage when the member enrolls in the group plan.

Correct. HIPAA does require insurers offering group health coverage to renew
group health policies in small and large group markets, regardless of the health
status of any group member and does not require the insurer provide a certificate
of creditable coverage when the member enrolls in the group plan.

Incorrect. HIPAA does not require the insurer provide a certificate of creditable
coverage when the member enrolls in the group plan.

Incorrect. While HIPAA does require insurers offering group health coverage to
renew group health policies in small and large group markets, regardless of the
health status of any group member, it does not require the insurer provide a
certificate of creditable coverage when the member enrolls in the group plan.

Health Information Privacy

HIPAA required the Secretary to issue privacy regulations governing individually
identifiable health information, if Congress did not enact privacy legislation within three
years of the passage of HIPAA. Because Congress did not enact privacy legislation,
HHS promulgated regulations for individually identifiable electronic health information
that healthcare providers, health plans, and healthcare clearinghouses must follow. HHS
developed a proposed rule and released it for public comment on November 3, 1999.
The final regulation, the Privacy Rule, was published December 28, 2000 and final
modifications were published in final form on August 14, 2002.

Individually identifiable health information is information, including demographic data,

that relates to:

• the individual's past, present or future physical or mental health or condition,

• the provision of health care to the individual, or t
• he past, present, or future payment for the provision of health care to the
individual, and that identifies the individual or for which there is a reasonable
basis to believe can be used to identify the individual.

Individually identifiable health information includes many common identifiers (e.g., name,
address, birth date, Social Security Number).

A major purpose of the Privacy Rule is to define and limit the circumstances in which an
individual's protected health information may be used or disclosed by covered entities. A
covered entity may not use or disclose protected health information, except either: (1) as
the Privacy Rule permits or requires; or (2) as the individual who is the subject of the
information (or the individual's personal representative) authorizes in writing.

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Required Disclosures. A covered entity must disclose protected health information in

only two situations:

a. to individuals (or their personal representatives) specifically when they request

access to, or an accounting of disclosures of, their protected health information
b. to HHS when it is undertaking a compliance investigation or review or
enforcement action.

Permitted Uses and Disclosures. A covered entity is permitted, but not required, to
use and disclose protected health information, without an individual's authorization, for
the following purposes or situations:

1. To the Individual (unless required for access or accounting of disclosures) A

covered entity may disclose protected health information to the individual who is
the subject of the information.
2. Treatment, Payment, and Health Care Operations; A covered entity may use and
disclose protected health information for its own treatment, payment, and health
care operations activities. A covered entity also may disclose protected health
information for the treatment activities of any health care provider, the payment
activities of another covered entity and of any health care provider, or the health
care operations of another covered entity involving either quality or competency
assurance activities or fraud and abuse detection and compliance activities, if
both covered entities have or had a relationship with the individual and the
protected health information pertains to the relationship. Treatment is the
provision, coordination, or management of health care and related services for an
individual by one or more health care providers, including consultation between
providers regarding a patient and referral of a patient by one provider to another.
Payment encompasses activities of a health plan to obtain premiums, determine
or fulfill responsibilities for coverage and provision of benefits, and furnish or
obtain reimbursement for health care delivered to an individual and activities of a
health care provider to obtain payment or be reimbursed for the provision of
health care to an individual. Health care operations are any of the following
activities: (a) quality assessment and improvement activities, including case
management and care coordination; (b) competency assurance activities,
including provider or health plan performance evaluation, credentialing, and
accreditation; (c) conducting or arranging for medical reviews, audits, or legal
services, including fraud and abuse detection and compliance programs; (d)
specified insurance functions, such as underwriting, risk rating, and reinsuring
risk; (e) business planning, development, management, and administration; and
(f) business management and general administrative activities of the entity,
including but not limited to: de-identifying protected health information, creating a
limited data set, and certain fundraising for the benefit of the covered entity. Most
uses and disclosures of psychotherapy notes for treatment, payment, and health
care operations purposes require an authorization as described below. Obtaining
consent (written permission from individuals to use and disclose their protected
health information for treatment, payment, and health care operations) is optional
under the Privacy Rule for all covered entities.
3. Opportunity to Agree or Object; Informal permission may be obtained by asking
the individual outright, or by circumstances that clearly give the individual the
opportunity to agree, acquiesce, or object. Where the individual is incapacitated,

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in an emergency situation, or not available, covered entities generally may make

such uses and disclosures, if in the exercise of their professional judgment, the
use or disclosure is determined to be in the best interests of the individual.
4. Incident to an otherwise permitted use and disclosure; The Privacy Rule does not
require that every risk of an incidental use or disclosure of protected health
information be eliminated. A use or disclosure of this information that occurs as a
result of, or as incident to, an otherwise permitted use or disclosure is permitted
as long as the covered entity has adopted reasonable safeguards as required by
the Privacy Rule, and the information being shared was limited to the minimum
necessary as required by the Privacy Rule
5. Public Interest and Benefit Activities; The Privacy Rule permits use and
disclosure of protected health information, without an individual's authorization or
permission, for 12 national priority purposes.28 These disclosures are permitted,
although not required, by the Rule in recognition of the important uses made of
health information outside of the health care context. Specific conditions or
limitations apply to each public interest purpose, striking the balance between the
individual privacy interest and the public interest need for this information.
6. Limited Data Set for the purposes of research, public health or health care
operations. A limited data set is protected health information from which certain
specified direct identifiers of individuals and their relatives, household members,
and employers have been removed. A limited data set may be used and
disclosed for research, health care operations, and public health purposes,
provided the recipient enters into a data use agreement promising specified
safeguards for the protected health information within the limited data set.

Administrative Simplification
All healthcare providers and health plans that engage in electronic administrative and
financial transactions must use a single uniform set of national standards-to be
developed and adopted by CMS-for the electronic transmission of the following
information:
8

• Health insurance enrollment and eligibility

• Health insurance claims and equivalent information for encounters in health
plan settings
• Identification numbers for providers, health plans, employers, and individuals
• Health data codes and classification systems
• Security standards and safeguards

Electronic health information systems must meet security standards, which should result
in more cost-effective electronic claims processing and coordination of benefits. 9

Other Areas of Regulation

In addition to the provisions described above, HIPAA contains provisions concerning the
establishment of Medical Savings Accounts (discussed in Healthcare Management: An
Introduction), long-term care insurance, changes in the notice requirements associated
with benefit payments under Medigap insurance, and tax deductions for insurance costs
of self-employed individuals. HIPAA also amended the Employee Retirement Income
Security Act of 1974, which we discussed in ERISA and Health Plans.

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Some HIPAA provisions are of special interest to health plans. The provision that
requires health plans, as well as other payors, to develop information systems that
support electronic claims processing and comply with uniform national standards to be
established by the Department of Health and Human Services may require some
planning and additional allocation of resources. Note that CMS has experienced
11

substantial obstacles in developing a uniform numerical identifier for individuals for

electronic transactions due to concerns about confidentiality and, therefore, has delayed
implementation and enforcement of this requirement. However, CMS has recently taken
steps to propose a uniform numerical identifier for providers

A health plan or group plan also has to send a letter to inform newly enrolled plan
members about HIPAA's provisions and their rights under that law. Self-funded plans
may not pass their responsibility to issue certificates of creditable coverage to a TPA.
Even if they try, the self-funded plan retains ultimate responsibility for the issuance of
certificates under the law.12

HIPAA also requires special open enrollment periods for people who lose other health
coverage or when an individual becomes a dependent of an employee through marriage,
birth, or adoption. Health plans or employers must provide a notice of the special
enrollment rights to any individual who declines coverage. 13

One other area of regulation that HIPAA impacts is fraud and abuse. HIPAA
strengthened the existing fraud and abuse laws in a number of ways. We discuss these
changes in Fraud and Abuse.

Enforcement
States have primary responsibility to enforce the protections provided under HIPAA. If
states fail to act, the HHS Secretary can impose civil monetary penalties on health plans
or health insurance issuers who violate the provisions of HIPAA. HHS shares federal
14

regulatory responsibility for oversight and enforcement of HIPAA—with the Department

of Labor (DOL) and the Internal Revenue Service (IRS). For example, in addition to any
penalties or other enforcement actions taken by the DOL or HHS, the IRS may impose
tax penalties on employers or the employer’s benefit plans that do not comply with
HIPAA. The IRS may also impose tax penalties for violations of two other federal acts—
the Mental Health Parity Act of 1996 and the Newborns’ and Mothers’ Health Protection
Act of 1996—discussed in the following lessons.

Mental Health Parity Act

Amendments to HIPAA created the Mental Health Parity Act of 1996 and the Newborns'
and Mothers' Health Protection Act of 1996. Through these acts, HIPAA is the first law
that sets federal benefit mandates for group healthcare. In general, the Mental Health
Parity Act of 1996 (MHPA) prohibits certain group health plans that provide both
medical benefits and mental health benefits from imposing lower annual or lifetime dollar
limits or caps for mental illness than for physical illness, if the health plan has
established an annual payment limit or aggregate dollar lifetime cap for mental health
benefits.

Until September 30, 2001, the MHPA applies to both fully funded and self-funded group
health plans, but does not apply to group health plans for small employers (defined as
those with at least two but no more than 50 employees). The law also does not apply to
15

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substance abuse, often subject to stricter limits on annual and lifetime caps than mental
health.16

Under the law, group health plans cannot, for example, set a cap of $1 million for a
group member's lifetime medical health benefits while limiting the member's lifetime
mental health benefits to $50,000. Rather, plans must either (1) set one lifetime limit that
applies to both medical and mental health benefits or (2) set separate but equal lifetime
limits each for medical health benefits and mental health benefits or (3) set higher limits
for mental health benefits than for medical health benefits. These same requirements for
lifetime limits apply to annual limits for group medical and mental health benefits. 17

Fast Facts

In 1997, an estimated 168.5 million people had mental health benefits through a health
plan behavioral health program. 10

Note that the MHPA does not require group health plans to offer mental health benefits;
it imposes requirements on those plans that do offer mental health benefits. In addition,
18

the MHPA

• Does not prevent group health plans from imposing annual limits on the
number of outpatient visits and inpatient hospital stays for mental health
services. For instance, many group health plans limit group members to 20
outpatient visits and 30 days of inpatient hospital stays for mental health
services per year. The Act allows such limitations. 19

• Permits health plans to charge different copayments and deductibles for

mental health benefits than for medical/surgical benefits. "Different" may
mean higher copays and deductibles. 20

• Allows an exemption from compliance for employers who can prove (after six
months) that providing parity would result in an increase in costs under the
plan of at least 1 percent. As we mentioned earlier, there is also an
exemption for employers with at least two but no more than 50 employees.
• Does not ban limits on the number of days or visits for mental health
treatment, or place restrictions on medical necessity determinations. 21

• Does not preempt more stringent state mental health parity laws.
• Will sunset (i.e., the Act will no longer be effective) on September 30, 2001.*

The MHPA will require some employers to make difficult decisions regarding the mental
health benefits that they provide to their employees. Most health plans are not affected
by the MHPA because relatively few benefit plans are out of compliance with the law.
Those plans that are not in compliance are principally self-funded plans. Health plans
will be affected primarily if they are performing administrative services for a self-funded
plan.

* On January 10, 2002, President Bush signed legislation extending the sunset date on
the Mental Health Parity Act until December 31, 2002.

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Review Question

One provision of the Mental Health Parity Act of 1996 (MHPA) is that the MHPA prohibits
group health plans from

setting a cap for a group member's lifetime medical health benefits that is higher
than the cap for the member's lifetime mental health benefits
imposing limits on the number of days or visits for mental health treatment
charging deductibles for mental health benefits that are higher than the
deductibles for medical benefits
imposing annual limits on the number of outpatient visits and inpatient hospital
stays for mental health services

Correct. The MHPA prohibits certain group health plans that provide both medical
benefits and mental health benefits from imposing lower annual or lifetime dollar
limits or caps for mental illness than for physical illness, if the health plan has
established an annual payment limit or aggregate dollar lifetime cap for mental
health benefits.

Incorrect. The MHPA does not ban limits on the number of days or visits for
mental health treatment, or place restrictions on medical necessity
determinations.

Incorrect. The MHPA permits health plans to charge different copayments and
deductibles for mental health benefits than for medical/surgical benefits.
'Different' may mean higher copays and deductibles.

Incorrect. The MHPA does not prevent group health plans from imposing annual
limits on the number of outpatient visits and inpatient hospital stays for mental
health services. For instance, many group health plans limit group members to 20
outpatient visits and 30 days of inpatient hospital stays for mental health services
per year.

Newborns' and Mothers' Health Protection Act of 1996

The Newborns' and Mothers' Health Protection Act of 1996 (NMHPA) requires that
group health plans cover hospital stays for childbirth for both the mother and the
newborn for at least 48 hours for normal deliveries and 96 hours for cesarean births. An
attending physician is permitted to make a decision for an earlier discharge after
consulting with the mother. Similar to the MHPA, the NMHPA mandate applies only to
those group plans that provide benefits for childbirth-related hospital stays. The law does
not require plans to offer benefits for childbirth-related hospital stays.

Review Question

The Opal Health Plan complies with all of the provisions of the Newborns' and Mothers'
Health Protection Act of 1996 (NMHPA). Samantha Hill and Debra Chao are Opal

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enrollees. Ms. Hill was hospitalized for a cesarean birth, and Ms. Chao was hospitalized
for a normal delivery. From the following answer choices, select the response that
indicates the minimum hospital stay for which Opal, under NMHPA, must provide
benefits for Ms. Hill and Ms. Chao.

Ms. Hill: 72 hours; Ms. Chao: 24 hours

Ms. Hill: 72 hours; Ms. Chao: 48 hours
Ms. Hill: 96 hours; Ms. Chao: 24 hours
Ms. Hill: 96 hours; Ms. Chao: 48 hours

Incorrect. The NMHPA requires more thana 24 hour minimum for normal
deliveries, and more than a 72 hour minimum for cesareans.

Incorrect. While the NMHPA requires a minimum stay of at least 48 hours for
normal deliveries, it requires morre than a 72 hour minimum for cesareans.

Incorrect. The NMHPA requires a minimum stay of 96 hours for cesarean births,
and requires more than a 1 day stay for normnal deliveries.

Correct! The NMHPA requires a minimum stay of at least 48 hours for normal
deliveries and 96 hours for cesarean births.

Confidentiality Laws
Healthcare reform laws such as the MHPA and NMHPA reflect social concerns.
Technological advances in medicine and information systems that offer new options for
prevention and treatment of illnesses and disease are also drawing legislative attention.
For example, gene research is beginning to be used to identify individuals susceptible to
certain chronic or terminal illnesses. That information, along with the patient's medical
history, can be loaded into a computer database to assist in future diagnoses and
planning for preventive treatment. But many people are concerned about who will have
access to such confidential medical information. This concern has made assuring
confidentiality of medical records a top public policy priority as evidenced by the HIPAA
provision that allows HHS to develop regulations for health information privacy if
Congress does not enact such privacy legislation. HHS has made recommendations to
22

Congress regarding the privacy of confidential medical information, but, to date, no

legislation has been passed. Most states currently have in place confidentiality or privacy
laws. Federal confidentiality legislation will have to address these laws and resolve
potential conflicts. The question is: Will federal legislation preempt state laws on privacy
or will state laws with standards more stringent than the yet-to-be-enacted federal law be
allowed to prevail? Another major challenge to the drafters of federal confidentiality of
medical information legislation is balancing quality improvement and research with
privacy concerns. Figure 7A-1 illustrates the results of one consumer survey about the
confidentiality of medical information.

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Applications of the Americans with Disabilities Act to Health Plan Operations

The Americans with Disabilities Act (ADA) enacted in 1990 is a federal law that
addresses discrimination against people with disabilities in areas such as employment,
health services, access to public services, public accommodations, institutionalization,
education, vocational training, housing, communication, recreation, transportation, and
voting. The ADA expanded the nondiscrimination requirements of the Rehabilitation Act
of 1973. The Rehabilitation Act of 1973 was passed to prohibit discrimination against
disabled persons. Specifically, Section 504 of the 1973 Act requires agencies or
organizations that receive U.S. government money to open jobs, education, and services
to disabled persons. Health plans that have federal grants, loans, or contracts are
subject to the requirements of Section 504 of the Rehabilitation Act.

The ADA impacts health plans and their network providers mainly in the areas of health
services, public accommodation, and employment. Plaintiffs have brought lawsuits
against health plans for ADA violations in the following areas:

• Credentialing and/or termination of providers

• Reduction in plan benefits or denials of claims
• Access to provider facilities
• Employment-related claims of discrimination

In addition, the ADA has provisions regarding the confidentiality of medical records
maintained by employers. 23

Under the ADA, a disability is defined as a physical or mental impairment that

substantially limits one or more of an individual's major life activities. Major life
activities include communication, ambulation, self-care, employment, housing issues,

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socialization, education, vocational training, and transportation. The ADA provides

protections for any individual with a physical or mental impairment, anyone who has a
record of such impairment, or anyone who is regarded as having such an impairment. A
person does not have to currently have a disability or to ever have had a disability to be
covered under the ADA. In addition, the ADA protects people who live with someone
who has a disability.

A major area of interest for health plans is the application of the ADA in the area of
employment discrimination. The ADA applies to private sector employment organizations
that employ 15 or more employees. The Equal Employment Opportunity Commission
enforces the ADA, and other EEOC-related protections apply to persons covered under
the ADA.

Under the ADA, employers must reasonably accommodate the known disability of a
disabled person who is qualified to fill a position unless such accommodation represents
significant undue hardship for the employer. A qualified disabled person is one who
has the skills, experience, education, and other job-related abilities necessary for an
employment position, who can perform the essential duties of the position, and whose
employment does not pose a direct threat to the health and safety of other employees. A
qualified disabled person is protected by the ADA.

Employment activities that are subject to the ADA's provisions include job application
procedures, hiring, promotions, terminations, employee compensation, and training.

Outside the employment area, credentialing and termination of providers are two of a
health plan's activities most greatly affected by the ADA. These activities are discussed
in the following section.

Credentialing, Termination, and the ADA

A health plan or integrated delivery system must not discriminate against qualified
persons with disabilities through its credentialing program under the ADA, yet at the
same time the health plan or IDS must ensure patients of a high level of quality care.
The requirements of the ADA appear to be, in some instances, in conflict with this duty
to provide quality care. This is most evident in cases of providers with alcohol or drug
dependency. With respect to the ADA's application to credentialing, so long as the health
plan or IDS can show that the adverse employment (contract) action is directly and
necessarily related to quality of care issues, it may be able to reconcile its duty with the
ADA requirements. By questioning specific job-related functions rather than general
health status, the health plan or IDS should be able to achieve ADA compliance in its
application process.

Another health plan activity subject to ADA litigation is termination of providers or other
related action that may be viewed as ADA discrimination. A provider with a disability may
sue a health plan that terminates his or her contract without cause alleging ADA
discrimination. Health plans must carefully consider such decisions and document their
criteria for the termination. In lieu of termination, some health plans may require that a
provider disclose his or her disability to the provider's patients if the health plan
perceives a direct threat to patient care associated with the disability. For example, in
Pennsylvania, a health plan successfully required a surgeon to notify all his former and
potential patients of his HIV-positive status. This decision was upheld by a federal court

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on the grounds that the physician's disability posed a direct threat to his patients that
could not be solved by reasonable accommodation. 24

Reduction in Plan Benefits

Health plans that change the level of benefits for a specific disease and not for others
may find themselves the subject of ADA lawsuits. A plan that reduces benefits for a
certain service or treatment that does not discriminate against a certain group or class of
enrollees would generally not be in violation of the ADA. Also, a plan that does reduce or
eliminate benefits that impacts only individuals with a particular disease or disability may
not be in violation of the ADA if the health plan has a sound underwriting reason for
eliminating or reducing that benefit. For example, a plan that eliminates coverage for
allergy shots for asthmatics may be faced with a successful ADA lawsuit. However, if the
health plan reduces the benefits for prescription drugs that affects all classes of
enrollees, a successful ADA lawsuit would be unlikely.

Provider Facilities and the ADA

Another area in which health plans have faced litigation is access to provider facilities.
Since health plans contract with providers and have a duty to credential those providers,
access to the facilities of the provider becomes a responsibility of the health plan as well
as the provider. Most health plans include a site visit to a provider's facilities in their
credentialing processes to ensure that accommodations for people with disabilities are
available. In parts of New York, there have been demands by patients for the provider to
supply interpreters for deaf people under the ADA. It is not clear who should be
responsible for paying for these interpreters.

Federal Marketing Laws

Several federal laws have requirements that affect marketing. The Federal Trade
Commission Act (FTCA) focuses largely on antitrust issues, but it also prohibits unfair or
deceptive acts or practices related to commerce. Under this law, a marketing practice is
considered deceptive if it has the capacity or the tendency to deceive or mislead some
members of the public. One court has determined that the FTCA must be applied more
closely in the healthcare context than in business in general. In FTC v American Medical
Association, the court stated that "what may be false and deceptive for doctors may be
permissible for sellers of other products and services. Harmless puffery for a household
product may be deceptive in a medical context." Violations of the FTCA can result in a
cease-and desist-order, as well as fines, from the FTC. 25

Under the Lanham Act, a consumer or a competitor can sue for false advertising. The
party that files suit can recover compensatory or punitive damages if a court determines
that the advertising has deceived the public. 26

With limited exceptions, the Medicare law requires managed Medicare plans to submit
all advertising material to CMS for review and approval prior to use. In addition, federal
Medicaid law prohibits health plan entities from distributing marketing materials without
prior approval of the state. We discuss other regulatory requirements related to Medicare
and Medicaid marketing later in this lesson.

Other Federal Laws

There are other federal laws that affect healthcare benefits. In Healthcare Management:
An Introduction, we discussed that the Age Discrimination in Employment Act (ADEA),

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the Family and Medical Leave Act, COBRA, and Title VII of the Civil Rights Act all
contain provisions that affect the provision of healthcare benefits. In Overview of Laws
and Regulations, we described provisions of various federal budget and tax acts that
include provisions relating to healthcare that may impact health plans.

Some federal laws regulate activities associated with providers. The Health Care Quality
Improvement Act of 1986 provides rules that health plans must follow in peer review
activities to avoid antitrust violations. The Act creates a preferred set of provider
contracting procedures for peer review that, if followed, provides liability protection to
those conducting the peer review. The Act also requires the reporting of adverse peer
review determinations to state medical boards and the National Practitioner Data Bank.

In addition, government programs such as FEHBP, TRICARE, Medicare, and Medicaid

were all created by federal law and have federal regulation components. We discuss the
use and regulation of health plans in each of these programs in the next few lessons.

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Chapter 7 B
Antitrust Concerns and Health Plans
As we discussed in Overview of Laws and Regulations, antitrust laws emerged in the
late part of the 19th century to promote competitive business practices and to curb
efforts to restrain trade. Antitrust laws are laws that address competition, price fixing,
and monopolies in business practices. Insight 7B-1 describes how for many years the
healthcare industry was thought to be outside the reach of such laws.

Health plans now routinely consider the impact antitrust laws and regulations may have
on their businesses in the area of provider contracting. Regulators also scrutinize joint
ventures, mergers, and acquisitions that might create a monopoly or substantially lessen
competition in a given market. In addition, courts and other regulatory agencies
scrutinize the business practices of health plans or health plan business ventures that
have a sizeable market share to guard against potential monopolistic practices. In this
lesson, we describe the major federal laws that pertain to antitrust: the Sherman
Antitrust Act, the Clayton Act, and the Federal Trade Commission Act. Next, we explain
the standards used to review business practices to determine if antitrust violations have
occurred. Then, we look at the typical applications of antitrust laws in health plans.

After completing this lesson, you should be able to:

 Describe the three major federal laws that regulate business activities to prevent
antitrust actions
 Describe the difference between the per se rule and the rule of reason
 Explain the applications of antitrust law in health plan-provider contracting
 Explain the relevance of antitrust in mergers and acquisitions
 Identify the issues that the 1994 DOJ and FTC guidelines addressed
 Explain the procedures the DOJ and FTC follow for their enforcement proceedings

Insight 7B-1. Application of Antitrust Laws to Healthcare.

For a long time, the healthcare industry was widely believed to be exempt from antitrust
laws. The activities of individual healthcare providers, such as physicians, were
considered outside the scope of antitrust laws because they involved a "learned
profession," as distinguished from trade or business. Over the years, the scope of this
"exemption" was limited, and its validity often was challenged. The challenges reflected
a growing public perception that the activities of those in learned professions were not
entirely different from the activities of those in trade or business and that some such
activities were anticompetitive in purpose and effect. It was not until 1975, however, that
the Supreme Court, in Goldfarb v. Virginia State Bar, abolished any remnants of a
blanket exemption from the federal antitrust laws for the learned professions. Although
Goldfarb involved the activities of lawyers, its reasoning has been applied to other
professions, including healthcare.

Another reason the healthcare industry was thought to be exempt from the antitrust laws
was the tendency of courts to give broad construction to the McCarran-Ferguson Act
exemption for the "business of insurance." However, in 1979, the U.S. Supreme Court

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reversed that judicial tendency by narrowly construing the Act in Group Life and Health
Ins. Co. v. Royal Drug Co. In that case, the Court held that agreements between a health
plan and pharmacies that fixed prices but did not involve underwriting or the spreading of
risk did not constitute the business of insurance and therefore were not exempt from
antitrust scrutiny. A few years later, the Supreme Court ruled that the use of peer review
committees to determine reasonableness of chiropractic charges did not constitute the
business of insurance. Later cases reiterated that, for activities to be exempt under the
McCarran-Ferguson Act, challenged practices must constitute the "business of
insurance," must be regulated by state law, and must not amount to boycott, coercion, or
intimidation. The market for private healthcare financing, which embraces HMOs, PPOs,
and TPAs, generally is not considered to fall within the exemption.
Source: Jane Garwood et al., Managed Care Law Manual, vol. 1, 1998, "Antitrust", Supplement #1, April 1995, pp. 4-5 (Gaithersburg, MD:
Aspen Publishers, Inc.)

Determination of Antitrust Activities

Figure 7B-1 describes the three federal acts that govern antitrust activities-the Sherman
Act, the Clayton Act, and the Federal Trade Commission Act. An important test used to
determine if monopolization exists is the presence of market power. Market power is the
power to control prices or exclude competition in a given market. We will reference the
concept of market power throughout this lesson.

Antitrust activities are measured under two standards. One is the per se rule, which
applies to restraints of trade that are so obvious as to be presumed unreasonable and
therefore illegal. There is no requirement that harm to competition be proven for a per se
violation. Restraints of trade are not permitted regardless of the business justification or
pro-competitive effect. Included as per se illegal are price-fixing agreements among
competitors, horizontal division of markets.

The second standard is less onerous and uses a "rule of reason" analysis to
determine if the purpose or effect of the activity or agreement actually harms competition
or if the arrangement has redeeming economic benefits. A party must show actual and
unreasonable harm to competition under this standard. The existence of market power is
an essential ingredient in the analysis.

Figure 7B-1. Federal Acts that Impact Antitrust.

The Sherman Antitrust Act

The Sherman Antitrust Act prohibits actions that constitute unreasonable restraints of
trade. Section 1 of the Act provides that "Every contract, combination in the form of trust
or otherwise, or conspiracy, in the restraint of trade or commerce among the several
States, or with foreign nations, is hereby declared to be illegal." Section 2 of the Act
prohibits monopolization or attempts to monopolize and provides that "Every person who
shall monopolize, or attempt to monopolize, or combine or conspire with any other
person or persons, to monopolize any part of the trade or commerce among the several
States, or with foreign nations, shall be deemed guilty of a felony."

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The elements of restraint of trade under Section 1 of the Sherman Antitrust Act concern
(1) a concerted action by distinct entities (2) that has an unreasonable anticompetitive
effect (3) on interstate commerce.

The elements of monopolization under the Sherman Antitrust Act include (1) market
power and (2) the willful acquisition or maintenance of that power as distinguished from
growth or development arising from a superior product, business acumen, or historic
accident. Attempted monopolization under Section 2 of the Sherman Antitrust Act
includes intent to monopolize and actions in furtherance of that intent that have the
probability of success.

The Clayton Act

The Clayton Act addresses specific practices of single entities that would tend to lessen
competition or create a monopoly. Section 3 [15 USC § 14] prohibits exclusive dealing
arrangements, tying arrangements, and requirement contracts involving the sale of
commodities where the effect may be to substantially lessen competition. Section 7 [15
USC § 18] prohibits mergers, joint ventures, consolidations, or acquisitions of stock or
assets where the effect may be to substantially lessen competition or tend to create a
monopoly or to otherwise unreasonably restrain trade. In addition, Section 7a [15 USC §
18a], known as the Hart-Scott-Rodino Act of 1976, requires that certain proposed
mergers and acquisitions involving a specified level of stock/assets receive approval from
the FTC and the Justice Department before consummation. Section 2 of the Clayton Act,
which originally prohibited price discrimination in sales of commodities, was amended
by the Robinson-Patman Act and affects sales of products by nonprofit organizations.
The Robinson-Patman Act prohibits certain practices that result in discriminatory pricing.

Under the Sherman Act, an activity must have an actual adverse effect on competition
before it is considered illegal. Under the Clayton Act, if the activity might have an effect
on competition, it is illegal.

The Federal Trade Commission Act

The Federal Trade Commission Act (FTC Act) declares that unfair methods of
competition and unfair or deceptive acts or practices are illegal. The FTC Act's broad
proscription of unfair methods of competition was intended to ensure that antitrust
enforcement would not be limited to specific activities prohibited under the Clayton Act.
Consequently, the FTC Act is interpreted quite broadly, and violations of the Sherman
and Clayton Acts are also violations of the FTC Act.
Source: Excerpted and adapted, used with permission of the publisher, from Sheryl Tatar Dacso and Clifford C. Dacso, Managed Care Answer
Book, Second Edition (New York: Panel Publishers, 1997), pp. 5-3-5-4.

Review Question

The following situations illustrate per se violations of federal antitrust laws:

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• Situation A - Two groups of providers agreed among themselves that each

provider will do business with health plans only on a fee-for-service basis.
• Situation B - In order to avoid competing with each other, two independent,
competing physician-hospital organizations (PHOs) divide the geographic areas
in which they will market their services.

From the following answer choices, select the response that correctly identifies the types
of per se violations illustrated by these situations.

Situation A: price fixing; Situation B: horizontal division of markets

Situation A: price fixing; Situation B: tying arrangement
Situation A: horizontal group boycott; Situation B: horizontal division of markets
Situation A: horizontal group boycott; Situation B: tying arrangement

Correct. Price fixing involves the agreement by two or more independent

competitors on the prices or fees that they will charge for services. A horizontal
division of markets is when two or more independent competitors to agree not to
compete by dividing (a) geographic areas in which each will market and sell its
products, (b) the products that each will offer, or (c) the customers that each will
service.

Incorrect. While Situation A does describe price fixing, tying arrangements exist
when a competitor conditions the sale of one of its products or services, for which
it has market power, upon the purchase of a second.

Incorrect. While Situation B does describe a horizontal division of markets, a

horizontal group boycott occurs when two competitors agree not to do business
with another competitor or purchaser.

Incorrect. A horizontal group boycott occurs when two competitors agree not to
do business with another competitor or purchaser, and tying arrangements exist
when a competitor conditions the sale of one of its products or services, for which
it has market power, upon the purchase of a second.

Per Se Violations in Antitrust

As discussed earlier, some activities are per se (which means "taken alone") violations
of the federal antitrust laws. The four types of per se violations-price fixing, horizontal
group boycotts, tying arrangements, and horizontal division of markets-are discussed in
more detail below. The U.S. Supreme Court has ruled that tying arrangements and
horizontal group boycotts will be considered per se violations only if the entities under
scrutiny have market power. 1

Price Fixing
Price fixing involves the agreement by two or more independent competitors on the
prices or fees that they will charge for services. For example, independent physicians,
hospitals, or other healthcare providers may not agree on the fees they will individually
charge health plan providers. Nor may they agree on other practices that influence price.

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For example, it would be unlawful for two or more providers or groups of providers
(whether IPAs, PPOs, physician networks, PHOs, or hospitals) to get together and agree
among themselves that each will do business with health plan providers only on a fee-
for-service basis. This agreement would restrict the manner in which competitors
compete on the basis of price or fees and would have the same effect on competition as
an agreement on particular prices or fees. Nor may health plans agree among
themselves to accept only capitated contracts, or a certain level of reimbursement.

The principle here is that, for competition to work, buyers and sellers (providers and
health plans) must each bargain freely and independently based upon the particular
merits of the goods and services involved, and the economic needs of both parties. The
Department of Justice/FTC guidelines, discussed later in this assignment, provide
information regarding how these agencies analyze agreements related to price between
or among providers as part of physician or multiprovider joint ventures.

Horizontal Group Boycotts

A horizontal group boycott occurs when two competitors agree not to do business with
another competitor or purchaser. Horizontal group boycotts are almost always unlawful.
For example, two health plans may not agree to each refuse to do business with a
particular nonprofit hospital until that hospital ceases merger talks with a private hospital
corporation. Nor may a PHO deny membership to a physician solely because that
physician has admitting privileges at a competing hospital. This type of joint pressure
reduces the free market choices or disadvantages a competitor.

Tying Arrangements
In most cases, tying arrangements are unlawful. A tying arrangement exists when a
competitor conditions the sale of one of its products or services, for which it has market
power, upon the purchase of a second. This would force the purchaser to purchase an
unwanted product or service to obtain the desired product or service. For example, a
health plan with substantial market share may not require its contracting providers to
offer its health plan product to the provider's employees as a condition of contracting
with that provider. Each product or service must be permitted to compete on its own
merits. Likewise, a provider-owned IDS controlling most or all providers in a particular
specialty, for example, oncology services, will be vulnerable to an unlawful tying claim if
it refuses to reasonably contract (or to permit the specialty providers themselves to
contract) with competing provider networks or health plans that need the oncology
services, but not all of the services provided by the IDS.

Horizontal Division of Markets

It is unlawful for two or more independent competitors to agree not to compete by
dividing (a) geographic areas in which each will market and sell its products, (b) the
products that each will offer, or (c) the customers that each will service. The preceding
sentence describes a horizontal division of markets. For example, two competing
PHOs may not split the geographic areas in which they will market their services to
health plans. Nor may two health plans split large employer subscribers by agreeing that
one will market to certain employers and the second will market to different employers.
Horizontal division of markets represents an agreement not to compete and is thus, by
definition, anticompetitive.

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The Application and Elements of Market Power

We defined market power as the power to control prices or exclude competition in a
given market. Market power is used as a basis for evaluating a variety of potential
antitrust activities. First, market power is assessed to determine if certain businesses are
monopolies or certain business combinations are attempts to monopolize a market.
Second, in examining mergers and acquisitions for antitrust violations, market power is
an important factor. Third, market power is also examined in suits alleging illegal price
discrimination, illegal tying arrangements, exclusive dealing arrangements, and illegal
agreements that unreasonably restrain trade between or among two or more entities. To 2

determine if an entity or venture has market power, two elements must be assessed: (1)
the relevant product market and (2) the relevant geographical market.

The Product Market

The relevant product market for antitrust purposes consists of the product or service
under debate and all close substitutes. A close substitute is a product that is
reasonably interchangeable with the original product. The Managed Care Law Manual
explains the relevant product market for health plans in this way:
"The relevant product market for health plans is the market for healthcare
financing. Broadly defined, this market includes traditional insurers, HMOs,
PPOs, IPAs, etc., and their subscriber members. Participants in the market are
considered to be purchasers of healthcare benefit packages. Characteristics of
this market include few barriers to entry and great mobility. As a result, the
market share necessary to demonstrate market power is extremely high." 3

However, others dispute this broad market as the product market for health plans. These
opponents say that HMOs and/or health plans are a separate market from that of the
traditional insurers.

The Geographical Market

As explained in Tampa Elec. Co. v. Nashville Coal Co., the relevant geographical
market for antitrust purposes is the "market area in which the seller operates, and to
which the purchaser can practically turn for supplies." To determine the geographical
4

market, courts look at economic and physical barriers to expansion such as

transportation costs, delivery limitations, and customer convenience. Courts may use
5

other applicable factors to determine the geographical market. Once the relevant product
and geographical markets are confirmed, the market share can be determined and a
decision can be made as to the entity's market power.

Now that we know the elements and standards of antitrust regulation, we can examine
their application in health plan scenarios. First, we'll look at antitrust issues that arise in
provider contracting.

Antitrust Issues in Provider Contracting

Many antitrust issues in health plans involve providers and provider contracting. In
developing provider networks, health plans may be charged with excluding providers or
excluding specific groups of providers in violation of antitrust laws. In addition, a health
plan that enters into exclusive contracts with providers should be prepared for antitrust
scrutiny. Provider-controlled health plans such as PSOs may also have to contend with
price fixing allegations, discussed in DOJ/FTC guidelines later in this lesson.

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We introduced the concept of price fixing earlier in this lesson. However, not all joint
agreements related to price are considered anticompetitive or violations under antitrust
laws. The U.S. Supreme Court has ruled favorably on joint venture agreements among
competitors that pertain to price which are necessary for the creation of a new product. 6

In defined instances, courts will use the rule of reason instead of the per se rule to
analyze such joint ventures. For example, provider joint ventures that compensate their
providers by capitation enter into an agreement with those providers and pay a fixed rate
or price per member per month to all participating providers (who would normally be
competitors) in that market. However, courts do not view these types of agreements as a
violation of the per se rule because the independent providers share a substantial risk of
financial loss. As noted in the antitrust guidelines for healthcare (discussed later in this
7

lesson), such financial risk demonstrates integration that is likely to produce significant
efficiencies that benefit consumers.

Most-Favored-Nation Clauses
Most-favored-nation clauses are clauses sometimes found in contracts between health
plans and healthcare providers. Under a most-favored-nation (MFN) clause, if a
provider offers a price to any other health plan that is more favorable than the price
offered to the contracting health plan, then the provider must offer the same price to the
contracting health plan. The Seventh Circuit Court of Appeals ruled that MFN clauses
8

are not per se illegal and that they violate antitrust laws only if they have a predatory
purpose and an anticompetitive effect. If these clauses are not per se illegal, then the
9

other elements of antitrust behavior must be present for such a clause to violate antitrust
laws. Although MFN clauses included in health plan-provider contracts relate to price,
they do not involve decisions by providers concerning the level of fees to charge. Since
this is the case, such clauses are not per se illegal but should be reviewed under the rule
of reason analysis for antitrust purposes. The FTC takes a hard stand against MFN
10

clauses and there have been circumstances in which health plans have agreed not to
use them.

Review Question

Determine whether the following statement is true or false:

Although most-favored-nation (MFN) clauses in contracts between health plans and

healthcare providers are not per se illegal, they should be reviewed under the rule of
reason analysis for antitrust purposes.

True, because the Federal Trade Commission (FTC) ruled that MFN clauses are
not per se illegal and the FTC encourages health plans to include them in provider
contracts.
True, because although MFN clauses are not per se illegal, they violate antitrust
laws if they have a predatory purpose and an anticompetitive effect.
False, because MFN clauses involve decisions by providers concerning the level
of fees to charge, and thus they are per se illegal.
False, because MFN clauses are not per se illegal, and thus they are exempt from
antitrust laws and regulation by the FTC.

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Incorrect. The FTC takes a hard stance against MFN clauses, and there have been
circumstances where health plans have agreed not to use them.

Correct. The 7th Circuit Court of Appeals ruled that while MFN clauses are not per
se illegal, they violate antitrust laws if they have a predatory purpose and an
anticompetitive effect.

Incorrect. The 7th Circuit Court of Appeals ruled that MFN clauses are not per se
illegal

Incorrect. While MFN clauses are not per se illegal, the FTC takes a hard stand
against MFN clauses and there have been circumstances in which health plans
have agreed not to use them.

Provider Exclusion
In general, the federal regulatory agencies that enforce the antitrust laws recognize that
health plans may enter into selective or exclusive contracts with provider groups without
violating antitrust laws. Such arrangements result in greater competition among
providers. However, if the provider groups are required to contract with only one health
plan in an area, anticompetitive results may occur and antitrust claims may be made.
Antitrust claims relating to provider exclusion focus on the effect the exclusion has on
the relevant market (e.g., will the services offered to consumers be adversely affected),
not harm to providers. For example, a health plan may contract with only one hospital
and two IPAs in a market, excluding all other providers, with no antitrust effects.
However, if that same health plan requires those contracted providers to contract
exclusively with that health plan, competition may be adversely affected and antitrust
claims successfully made.

In some cases, certain groups of providers-such as podiatrists, chiropractors, or

psychologists-have alleged that health plan provider exclusion from a network results in
a group boycott of providers in those specialties. The decision as to whether antitrust
laws have been violated depends on the particular factors in the relevant case.
Generally, if there is no legitimate business purpose for the exclusion, a violation of
antitrust laws may be found.11

Antitrust Issues in Mergers and Acquisitions

Antitrust regulators scrutinize mergers and acquisitions in healthcare to ensure that no
one entity assumes too much market power as a result of such business activities. We
discussed mergers as a means of integrating business operations in Formation and
Structures of Health Plans and described the three basic types of organizational
integration: horizontal, vertical, and conglomerate. These three types of integration
strategies affect the type of antitrust standard used to evaluate each type of merger.
Regulators are concerned primarily with determining whether (1) the resulting entity in a
potential merger or acquisition will retain too much market power and (2) the merger or
acquisition will create market concentration. For antitrust purposes, market
concentration occurs when one independent competitor's business decision affects the
market interdependently, allowing all the competitors in that market to exercise collective
market power.

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The Antitrust Division of the Department of Justice (DOJ) has primary responsibility for
enforcing federal antitrust laws, which includes investigation of possible violations of
both the criminal and civil provisions of the Sherman, Clayton, and Robinson-Patman
acts. The Federal Trade Commission (FTC) enforces certain sections of the Clayton Act,
described in more detail later in this lesson, and a section of the FTC Act that prohibits
unfair methods of competition and unfair or deceptive acts or practices. In the following
sections, we describe the analysis the DOJ and the FTC undertake in reviewing
horizontal and vertical mergers for antitrust violations. Because conglomerate mergers
involve companies that produce unrelated products or services and there is little
integration, there is very little antitrust risk.
12

One part of the premerger regulatory filings that many health plans make is a Hart-Scott-
Rodino Act of 1976 (H-S-R Act) requires that certain mergers receive DOJ and FTC
approval before consummation. If a proposed health plan merger falls within the
parameters of the H-S-R Act, the parties to the transactions often make a filing with the
DOJ and FTC. This filing is made on forms provided by the DOJ and FTC and requires
supporting documentation detailing the particulars of the proposed transaction. The DOJ
and FTC review the H-S-R filing to determine if the proposed merger may create any
anticompetitive results. After a prescribed waiting period to allow for the agencies' review
of the filing, the parties to the proposed merger may proceed with the transaction as long
as neither the DOJ nor the FTC has intervened. However, a filing made under the H-S-R
Act does not preclude the DOJ and the FTC from subsequent investigation of any
anticompetitive behavior related to the merger or the merging parties.

Analysis for Horizontal Mergers

Market power and market concentration are two factors that regulatory agencies assess
in reviewing horizontal mergers for antitrust violations. In their examination of horizontal
mergers, such as the acquisition of one HMO by another HMO or one hospital by
another, the DOJ and the FTC follow their 1992 Horizontal Merger Guidelines,
updated in 1997. These steps that the DOJ and FTC take in analyzing a merger are
outlined in Figure 7B-2.

Figure 7B-2. DOJ and FTC 1992 Horizontal Merger Guidelines.

Overview: The Guidelines describe the analytical process that the DOJ (the Agency)
employs in determining whether to challenge a horizontal merger. First, the Agency
assesses whether the merger would significantly increase concentration and result in a
concentrated market, properly defined and measured. Second, the Agency assesses
whether the merger, in light of market concentration and other factors that characterize
the market, raises concern about potential adverse competitive effects. Third, the Agency
assesses whether entry would be timely, likely, and sufficient either to deter or to
counteract the competitive effects of concern. Fourth, the Agency assesses any efficiency
gains that reasonably cannot be achieved by the parties through other means. Finally, the
Agency assesses whether, but for the merger, either party to the transaction would be
likely to fail, causing its assets to exit the market. The process of assessing market
concentration, potential adverse competitive effects, entry, efficiency, and failure is a tool
that allows the Agency to answer the ultimate inquiry in merger analysis: whether the
merger is likely to create or enhance market power or to facilitate its exercise.

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In analyzing a horizontal merger, the Agency takes the following steps:

1. Define the relevant product market, especially from the perspective of the health
plans that purchase services from the merging groups.
2. Define the relevant geographic market.
3. Identify competitors in the relevant market.
4. Compute all competitors' market shares in each relevant market based on
capacity, sales, and production.
5. Compute the postmerger market share of the merging parties.
6. Apply the Merger Guidelines concentration standards to determine how serious a
problem, if any, the merger might raise.
7. Determine if the postmerger market share of the merging parties is more than 35
percent, which is the general benchmark used to determine market power.
8. If the level of concentration is significantly above Merger Guidelines levels or the
postmerger market share is above 35 percent, examine other factors.
9. Examine the level of entry barriers-that is, how difficult and likely would it be
that new entrants would enter the market if those already in the market attempted
to exercise market power by raising prices.
10. If the only issue is the group's postmerger market share, examine how difficult it
would be for competing groups in the market to increase their capacity and output
quickly if the merged firm increased prices.
11. Examine other factors suggesting whether collusion would occur and, if so,
whether it would be successful.
12. Examine the extent of efficiencies in the new, merged system.
13. Balance the procompetitive with anticompetitive effects.
Source: Excerpted from Sheryl Tatar Dacso and Clifford C. Dacso, MD, Managed Care Answer Book, Second Edition (New York: Panel
Publishers, 1997), p. 5-14

Analysis for Vertical Mergers

The same factors, market power and market concentration, used to analyze a horizontal
merger for antitrust violations are also used to analyze a vertical merger, such as the
merger of a hospital with an IPA. Particular antitrust concerns associated with vertical
mergers are: (1) that the merger will close off a large part of the market to competitors at
either the purchaser or seller levels, thereby creating market dominance for the merged
entity at one of those levels; (2) that it can create barriers to market entry because either
customers or suppliers will be unavailable to them as a result of the merger; and (3) the
number of competitors in the market may diminish. 13

Developments in Antitrust Regulation

In September 1993, the DOJ and the FTC issued the first healthcare-specific antitrust
guidelines. These guidelines set forth six policy statements regarding:

• Hospital mergers
• Hospital joint ventures involving high technology or other expensive medical
equipment
• Physicians' provision of information to purchasers of healthcare services
• Hospital participation in exchanges of price and cost information

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• Joint purchasing arrangement among healthcare providers

• Physician network joint ventures

In these guidelines, the DOJ and FTC established antitrust safety zones by describing
circumstances they would not challenge, absent extraordinary circumstances. In
addition, the statements provided an outline of the analysis the agencies would use to
review conduct falling outside the antitrust safety zones. The statements also committed
the agencies to respond to requests for business reviews or advisory opinions from the
healthcare community.

In 1994, the same regulatory agencies revised and expanded the 1993 policy
statements with superseding guidelines. The resulting guidelines cover:

• Hospital joint ventures involving specialized or expensive healthcare services

• Providers' collective provision of information about fees to purchasers of
healthcare services
• Analytical principles relating to multiprovider networks

The new multiprovider network statement applied to networks that include providers
other than physicians, such as multihospital systems or physician hospital organizations
(PHOs). However, the statement did not include antitrust safety zones for such
arrangements. In their revised guidelines, the agencies emphasized that just because
they have established safety zones, it doesn't mean that activity outside the safety zones
is likely to be challenged.

The most significant change in the new guidelines is the explicit statement that networks
that engage in joint pricing but do not involve shared risk may receive rule-of-reason
treatment. The old guidelines took a narrow approach to joint pricing among competitors
participating in multiprovider networks; such activities had to be related to significant
economic integration or were deemed per se illegal. The agencies took a broader
approach with physician networks, stating that they would review joint pricing among
physicians under rule-of-reason analysis either if the physicians in the joint venture
shared substantial financial risk or if the combining of physicians into a joint venture
enabled them to offer a new product producing substantial efficiencies.

Review Question

In 1994, the Department of Justice (DOJ) and the Federal Trade Commission (FTC)
revised their 1993 healthcare-specific antitrust guidelines to include analytical principles
relating to multiprovider networks. Under the new guidelines, the regulatory agencies will
use the rule of reason to analyze joint pricing activities by competitors in physician or
multiprovider networks only if

provider integration under the network is likely to produce significant efficiencies

that benefit consumers
the providers in a network share substantial financial risk

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the combining of providers into a joint venture enables the providers to offer a new
product
all of the above

Correct. The 1994 guidelines focus on the efficiencies produced that benefit
consumers.

Incorrect. The 1994 guidelines focus on physicians in the joint venture sharing
substantive risk, and the rule of reason will apply if the provider integration is
likely to produce significant efficiencies to benefit consumers.

Incorrect. The rule of reason will apply if combining providers into a joint venture
enables the providers to offer a new product that produces significant efficiencies
to benefit consumers

Incorrect. More than one of the responses above are incorrect.

The guidelines also apply the broader approach to multiprovider networks and explicitly
focus only on the efficiencies likely to be produced, rather than whether a new product is
created. The agencies now analyze joint pricing activities by competitors in physician or
multiprovider networks under the rule of reason if provider integration under the network
is likely to produce significant efficiencies that benefit consumers, and any price
agreements by providers are reasonably necessary to realize those efficiencies.

The guidelines provide that sufficient integration to produce efficiencies can be

demonstrated through an active and ongoing program to evaluate and modify the
participants' practice patterns and create a high degree of interdependence and
cooperation between participants to control cost and ensure quality, including:

• Establishing mechanisms to monitor utilization, control costs, and assure quality

of care
• Selecting network participants who are likely to further efficiency objectives
• Investing significant amounts of human and monetary capital in infrastructure to
achieve efficiencies, such as clinical information systems

The agencies' analysis focuses on substance, rather than form, in assessing a network's
likelihood of producing significant efficiencies. Networks whose purpose or effect are
little more than efforts to prevent or impede competition are not likely to produce
efficiencies and remain per se illegal according to the agencies.

The FTC and DOJ addressed some of the concerns about the balance of antitrust and
competititon in a July 2004 report described in Insight 7B-1.

Insight 7B-1 FTC-DOJ Report on Competition in the Health Care System

The Federal Trade Commission (FTC) and the Department of Justice (DOJ issued a
report on July 26, 2004 addressing the state of competition in the U.S. health care
system. This report was the result of numerous joint hearings the FTC and DOJ held

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over the past two years to examine the health care marketplace and issues relating to
competition, antitrust enforcement, and consumer protection. The report addressed two
basic questions. First, what is the current role of competition in health care, and how can
be enhanced to increase consumer welfare? Second, how has, and how should antitrust
enforcement work to protect existing and potential competition in health care?

Key recommendations from the report include:

• Payment methods should be developed for "aligning providers' incentives

with consumers' interests in lower prices, quality improvements and
innovation";
• Consumers should be provided with "more information on prices and quality"
and "greater incentives to use such information";
• Legislation should not be enacted to permit independent physicians to
collectively bargain; and
• Governments should consider whether coverage mandates serve consumers'
health care needs, given that "mandates are likely to limit consumer choice,
eliminate product diversity, raise the cost of health insurance, and increase
the number of uninsured Americans."

For more information and to retrieve a copy of the FTC-DOJ report, Improving Health
Care: A Dose of Competition, please access the FTC's website at www.ftc.gov/reports.
The 361 page report includes an executive summary.

Review Question

Antitrust laws can affect the formation, merger activities, or acquisition initiatives of a
health plan. In the United States, the two federal agencies that have the primary
responsibility for enforcing antitrust laws are the

Internal Revenue Service (IRS) and the Department of Justice (DOJ)

Office of Inspector General (OIG) and the Department of Defense (DOD)
Federal Trade Commission (FTC) and the Department of Labor (DOL)
Federal Trade Commission (FTC) and the Department of Justice (DOJ)

Incorrect. The IRS does not have primary responsibility for enforcing antitrust
laws

Incorrect. The OIG enforces fraud and abuse statutes, and the DOD is a purchaser
of healthcare services

Incorrect. The DOL does not have primary responsibility for enforcing antitrust
laws

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Correct. Both the FTC and the DOJ have primary responsibility for enforcing
antitrust laws.

Enforcement of Antitrust Laws

The potential plaintiffs that must be considered in an antitrust suit include the DOJ, the
FTC, state attorneys general, and individuals harmed by anticompetitive actions. The
likelihood that either a government or private suit will be initiated depends on statutory
limitations or the degree of the potential plaintiff's interest in the particular activity. Thus,
each activity must be evaluated on the basis of its facts.

Justice Department
The Antitrust Division of the DOJ has primary responsibility for enforcing federal antitrust
laws, which includes investigation of possible violations of both the criminal and civil
provisions of the Sherman, Clayton, and Robinson-Patman acts.

The DOJ investigates possible criminal violations of antitrust laws by initiating a

proceeding before a grand jury. The grand jury has broad investigative powers; it may
compel witnesses to testify and may require the presentation of books, documents,
records, and other information. Unlike trial juries, which determine guilt or innocence, a
grand jury merely determines whether a party charged with violating an antitrust law
should stand trial. If, after the examination of witnesses, documents, records, and other
information, the grand jury finds probable cause to believe that a criminal antitrust
violation has occurred, it returns an indictment setting forth the practices alleged to be in
violation of the law. If no indictment is returned, the DOJ still may use the evidence
obtained by the grand jury in a civil action. 14

If the indictment results in a criminal conviction under the Sherman Act, a corporation
may be fined a maximum of $10 million. Individuals and representatives of partnerships
and unincorporated associations are subject to imprisonment not exceeding three years
and/or a maximum fine of $350,000. 15

The DOJ also may initiate investigations to determine whether a party has violated any
civil provision of the antitrust laws. If the civil investigation indicates that a violation has
16

occurred, the DOJ may bring a civil suit, seeking an injunction or damages. In such civil
actions, only actual damages may be recovered.

A defendant that loses in a government enforcement suit faces the possibility that a
private plaintiff will employ the decision in a subsequent treble damage action. Either a
criminal or civil conviction constitutes prima facie evidence of liability in such a suit. A
plaintiff will be required only to prove damages. In addition, almost any type of antitrust
legal action is lengthy and expensive to defend.

Fast Definitions

Actual damages - in legal terms damages refer to losses or injuries; courts award
actual damages to compensate for losses or injuries that have actually occurred (e.g.,
loss of income because of a medical injury, specific business losses due to a breach in a
contract, etc.).

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Treble damages - damages, in connection with certain types of wrongs, that by statute
are allowed to be multiplied by three to determine total damages payable.

Prima facie evidence - evidence sufficient to entitle the party presenting the evidence to
a verdict in that party's favor if the other party does not refute the evidence. 21

Divestiture - a remedy the court orders against the offending party to dispose of
property or assets before the party would normally have done so. 22

Interlocking directorates - the situation that occurs when an individual serves as an

officer or director of two or more competing corporations. 23

Because of this additional exposure, defendants often enter into a consent decree under
the Antitrust Procedures and Penalties Act. In essence, consent decrees are
17

negotiated settlements entered before any testimony is taken. These decrees not only
save both parties substantial time and expense, but also provide a wide range of
enforcement remedies, including divestiture or dissolution. Although consent decrees
18

are made without admissions by any party, once the court enters the final order, these
decrees have the same force and effect as decrees entered in litigated cases except 19

that they do not constitute prima facie evidence in any subsequent private treble
damages action.

The DOJ monitors compliance with antitrust judgments by means of the civil
investigative process. Through this process, it can compel a hospital against which an
antitrust judgment has been entered to produce records that indicate whether the
hospital is in compliance with the judgment. Noncompliance can result in the initiation of
contempt of court proceedings. 20

Federal Trade Commission

The FTC is authorized to enforce Section 5 of the FTC Act, which prohibits unfair
methods of competition and unfair or deceptive acts or practices. Together with the DOJ,
the FTC also enforces those sections of the Clayton Act that prohibit discrimination (e.g.,
in price), exclusive dealings and similar arrangements, certain corporate acquisitions of
stock or assets, and interlocking directorates.

The FTC may investigate an alleged antitrust violation on its own initiative or at the
request of the president, Congress, another government agency, the attorney general,
courts, or other persons. This broad investigative authority extends throughout FTC
25 26

activities, from investigations of alleged violations of antitrust laws to investigations of

compliance with antitrust decrees issued under the Clayton or FTC acts. 27

FTC enforcement proceedings begin in an administrative setting. A trial is held before an

administrative law judge. Both the FTC staff and the party sued have a right of appeal to
the full Commission. Decisions of the Commission that are adverse to the party can be
28

appealed to a federal appeals court, while decisions adverse to the FTC cannot be
appealed. If the Commission finds a practice to be unlawful, it enters a cease-and-desist
order that may require that the practice be stopped and also may require affirmative
action by the violator.

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Prior to adjudication on the case's merits, an FTC investigation may be terminated by the
entry of a consent order. Like consent decrees, consent orders that are entered before
29

adjudicative proceedings are conducted have the same force and effect as a court
order.30

The FTC also is authorized to institute civil penalty actions against those who knowingly
violate the FTC Act, and to petition a court for a temporary restraining order or a
31

preliminary injunction in appropriate circumstances. Courts generally have interpreted

32

this power as authorization for the FTC to seek any equitable remedy judicially
appropriate. The FTC does not, however, have the power to seek damages for antitrust
33

violations.

State attorneys general also have antitrust enforcement responsibility. State regulation
of antitrust, including enforcement mechanisms, was discussed in State Regulation of
Health Plans.

Fast Definitions

Temporary restraining order (TRO) - an emergency remedy that a court can grant,
without a hearing, to prohibit a person or entity from engaging in certain conduct that is
likely to cause irreparable harm to another party. A TRO is of short duration, and is
effective only until the court can determine what long-term relief, if any, may be
appropriate. 24

Preliminary injunction - a remedy that a court can grant, after a preliminary hearing, to
prohibit a person or entity from engaging in certain conduct that might harm another
party. The purpose of a preliminary injunction is to preserve the existing status of the
parties until the court can determine the merits of the controversy.

Private Enforcement
The universe of potential private plaintiffs is large, and the exposure to treble damages
can be disastrous. Hospitals and physicians, as well as vendors, are potential antitrust
plaintiffs. To assert an antitrust claim, a private party is required to demonstrate three
"standing" requirements:

• A violation of the antitrust laws

• Injury to its business or property or, in the case of injunction, threatened loss
or damage
• A causal relationship between the antitrust violation and the injury 34

Probably the most important of the three standing requirements is injury to business or
property, i.e., injury to commercial interests or enterprises. In actions for treble
35

damages, private parties' access to the courts is limited when they are injured only
indirectly by the antitrust activity. For example, a hospital that had a contract with a
36

mechanical contractor was found not to have standing to sue subcontractors for unlawful
price fixing when the hospital was not the direct purchaser of the subcontractor's goods. 37

When the injury is direct, however, courts have held that private parties have standing
under the antitrust laws in a variety of different situations involving diverse injuries,
including those that cause increases in the cost of doing business ; those that cause
38

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loss of business, including goodwill and reputation ; and those that frustrate a serious
39

potential competitor's attempts to enter the healthcare market.

Indeed, the Supreme Court held in Blue Shield of Virginia v. McCready that, as long as
the injury is direct and flows from that which makes the defendant's acts illegal, it is an
injury within the meaning of the antitrust laws even though the injury is not part of the
alleged anticompetitive effect. In McCready, the Supreme Court ruled that the patient
41

had standing to sue an insurer that had engaged in an unlawful boycott against
psychologists because the patient's injury was direct and provable. As a result of the
boycott, patients seeking treatment by psychologists were required to see a physician as
well. That discouraged the use of psychologists and increased the patients' out-of-pocket
costs.

In actions seeking injunctive relief, proof of a threatened injury loss may be sufficient to
constitute injury to business or property. Actual injury need not be shown; to obtain
42

relief, a private party need demonstrate only a significant threat of injury from an
impending, continuing, or recurring antitrust violation. In a unanimous decision in
43

California v. American Stores Co., the U.S. Supreme Court ruled that a private party,
including a state, can sue for injunctive relief against a merger. The Court held that
44

divestiture is a form of "injunctive relief" authorized by Section 16 of the Clayton Act.

The American Stores case also indicates that having a transaction approved by the FTC
or the DOJ (even by consent decree) will not eliminate all antitrust risks. A state or a
private litigant still may have grounds for pursuing a private right of action. On the other
hand, because of American Stores, hospitals can directly challenge and possibly prevent
a merger or seek divestiture of a completed merger.

Fast Definitions

Preliminary injunction - a remedy that a court can grant requiring a party to either
perform, or refrain from engaging in, certain conduct. Injunctive relief can be in the form
of a temporary restraining order, preliminary injunction, or a permanent injunction. A
permanent injunction is a final order that requires a party to do something or to refrain
from doing something.

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Chapter 7 C
ERISA and Health Plans
Few federal laws have a greater impact on the operations of health plans than the
Employee Retirement Income Security Act (ERISA) of 1974, as amended. Although 1

ERISA does not directly regulate health plans, it does regulate most employer-
sponsored employee benefit plans to which health plans market their products. ERISA
will affect the nature, design, and administration of such products by health plans.
Moreover, ERISA will determine what state laws can be applied to such products as well
as what legal challenges can be made to the administration of such products.

This lesson is designed to provide a working knowledge of the provisions of ERISA that
are likely to affect health plan operations. Topics addressed include ERISA's
documentation, reporting, and disclosure requirements; benefit plan design
considerations; the amendment of benefit plans; the duties of ERISA fiduciaries, which
may include health plans; challenges to benefit denials; ERISA's civil enforcement
scheme and remedies; and the effect of ERISA preemption of state laws and causes of
actions on health plans' operations.

After completing this lesson, you should be able to:

 Describe ERISA’s documentation, reporting, and disclosure requirements

 Describe the minimum standards of conduct (the fiduciary duties) applicable to
ERISA plan fiduciaries
 Describe the claims procedures required under ERISA and the standards of review
that courts apply in deciding disputed claims
 Describe how ERISA preemption has been applied by the courts to:
utilization review and credentialing decisions made by health plans; mistaken verification
of eligibility by an employer or health plan to a healthcare provider; entities that perform
administrative functions under an ASO contract; and provider networks that contract to
provide healthcare services to either health plans or self-funded employers on a
capitated basis

Documentation, Reporting, and Disclosure Requirements

A plan maintained by a nongovernment employer that provides healthcare or healthcare
benefits to employees (including plans providing coverage or benefits through a health
plan arrangement) generally constitutes an employee benefit plan subject to ERISA. 2

Such plans must meet the documentation, reporting, and disclosure requirements set
forth in ERISA.

Plan Document
Every employee benefit plan governed by ERISA is required to be set forth in a written
plan document (or documents) that detail the operative provisions governing benefits
under the plan. In the case of healthcare benefits that are provided through an
3

insurance contract or a contract with a health plan, the sponsoring employer might
maintain a simple plan document that describes certain of the plan's rules, such as a
description of the plan's eligibility and amendment provisions, but that otherwise refers to
the insurance or health plan contract for the description of plan benefits.

Summary Plan Description

A summary plan description (SPD) is a booklet that describes the operative provisions

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of a plan in lay language. The Department of Labor has prescribed the types of
information that are required to be included in the summary plan description. For insured
4

or health plans, employers often use the booklet published by the insurance company or
health plan as the basis for the summary plan description, although the employer
generally will have to add certain administrative information to comply with the
Department of Labor requirements concerning summary plan descriptions. In some
cases, a healthcare plan contains detailed benefit schedules that are difficult to
summarize. In lieu of repeating the benefit schedules, the summary plan description may
provide a general description of the types of benefits provided if the summary informs
participants that the complete schedules are available for their review. 5

As a result of the Health Insurance Portability and Accountability Act (HIPAA), other SPD
disclosure requirements were added. The SPD must include information on whether the
insurer, health plan, or third party administrator (TPA) is responsible for the financing or
administration of the plan. When this is the case, the SPD must show the name and
address of the insurer, health plan, or TPA, and must indicate to what extent, if any, the
benefits under the plan are guaranteed under an insurance or HMO contract. The SPD
must also indicate the nature of any administrative services provided by the insurer,
health plan, or TPA under an administrative services only (ASO) contract. In addition,
the SPD must include information about the HIPAA requirements for length of hospital
stay in connection with childbirth. Finally, the SPD must disclose the office of the
Department of Labor from which plan participants can obtain assistance regarding their
rights under HIPAA.

The summary plan description must be distributed to participants within 120 days after
the date on which the plan is adopted or made effective (or, in the case of an employee
who becomes a participant after the adoption or effective date of the plan, within 90 days
after the date on which the employee becomes a participant). In general, a new
6

summary plan description must be issued every five years, although if there have been
no amendments to the plan, distribution of a new summary plan description can be
made every 10 years. 7

Review Question

In the paragraph below, a statement contains two pairs of terms enclosed in

parentheses. Determine which term in each pair correctly completes the statement.
Then select the answer choice containing the two terms that you have chosen.

Every employee benefit plan governed by the Employee Retirement Income Security Act
(ERISA) must distribute a summary plan description (SPD) to participants within (90 /
120) days after the date on which the plan is adopted or made effective. Thereafter, if
the plan is amended, a new SPD must be distributed every (5 / 10) years.

90 / 5
90 / 10
120 / 5

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120 / 10

Incorrect. While when the plan is amended a new SPD must be distributed every 5
years, the first distribution can be made in a longer period of time than 90 days

Incorrect. When the plan is amended a new SPD must be distributed sooner than
every 10 years, and the first distribution can be made in a longer period of time
than 90 days.

Correct. Every employee benefit plan governed by ERISA must distribute a

summary plan description (SPD) to participants within 120 days after the date on
which the plan is adopted or made effective. Thereafter, if the plan is amended, a
new SPD must be distributed every 5 years

Incorrect. While the first distribution must be made in 120 days, subsequent
distributions need to be made sooner than every 10 years.

Summary of Material Modifications

If there are changes in the plan that affect the information provided in the summary plan
description at a time when the plan sponsor is not required to publish a new summary
plan description, the employer must publish a summary of material modifications. The 8

summary of material modifications (SMM) explains the plan changes and acts as a
supplement to the summary plan description until a revised summary plan description is
distributed. The summary of material modifications must be distributed to plan
participants within 210 days after the close of the plan year in which the plan
amendment is adopted. However, as a result of changes made by HIPAA and described
9

in interim final regulations (issued by the departments of Health and Human Services,
Labor, and Treasury), if there is a "material reduction in covered services or benefits
provided under a health plan," the plan sponsor must furnish a summary of material
modifications no later than 60 days after the adoption of the reduction. Alternatively, to
comply with the disclosure requirements for material reductions, the employer can
furnish SMMs at regular intervals of not more than 90 days. Also, the plan sponsor may
at any time publish an updated summary plan description in lieu of the summary of
material modifications.

The interim final regulations describe a material reduction as a modification that "would
be considered by the average plan participant to be an important reduction in covered
services or benefits under the plan," such as elimination of a benefit, increase in
deductible or copayment, or reduction of an HMO service area.

Discrepancies in Plan Documentation

Although the summary plan description and summary of material modifications are
intended, as their names suggest, as summaries of the actual plan document, some
courts have held that the summaries override the terms of the plan where the plan and
the summaries conflict. Thus, where the summary plan description provides for benefits
10

in a situation not covered under the formal plan document, the summary plan description
might govern, particularly if the participant or beneficiary is able to demonstrate reliance
on the faulty summary plan description.

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Government Reporting Requirements

The plan administrator of an ERISA welfare benefit plan (including plans that provide
benefits pursuant to a health plan contract) must file a variety of documents with either
the Department of Labor or the Internal Revenue Service. Each year, unless the plan is
exempt from filing, the plan administrator must file an annual return. The annual return
11

(form 5500) is a standard form that includes information pertaining to the plan, such as
plan year, plan number, employer identification number, type of coverage provided,
approximate number of plan participants, and financial information. The annual return is
due on or before the last day of the seventh month after the close of the plan year,
although certain extensions are possible. The return is filed with the Internal Revenue
12

Service and is provided by the IRS to the Department of Labor. The annual return is not
distributed to plan participants as a general matter, although a plan participant must be
allowed to review and make copies of the annual return. 13

Plan Design Considerations

Substantive Regulation under ERISA
ERISA provides little regulation of the content of employee welfare benefit plans (a
category that includes health benefit plans). In stark contrast to the regulation of pension
plans, where ERISA provides detailed requirements, the only areas in which ERISA
substantively regulates the terms and conditions of employer-sponsored health benefit
plans are as follows:

1. An employer-sponsored health plan is required to comply with the terms of a

qualified medical child support order. A qualified medical child support order
is a court order or court approved property settlement agreement that is entered
pursuant to state domestic relations law or certain state Medicaid laws and that
provides for health insurance coverage for a child of an employee. 14

2. A group health plan, if it otherwise provides coverage for dependent natural

children, is required to provide identical coverage for children who are placed for
adoption with the covered employee. 15

3. A group health plan may not reduce its coverage of pediatric vaccines below the
level of coverage that it provided as of 1 May, 1993. 16

4. A plan of an employer with 20 or more employees is required to provide

employees and their covered dependents whose coverage under the plan would
otherwise cease as a result of termination of employment or certain other
"qualifying events" the opportunity to purchase continued coverage under the
plan for a limited period of time.
17

5. An employer-sponsored health plan must comply with the requirements of

HIPAA, described earlier in this assignment.

Despite the limited regulation of the content of employee welfare benefit plans, ERISA's
impact is considerable.

ERISA Preemption of State Insurance Laws Affecting Plan Design

Generally
As is explained in more detail in the section of this lesson devoted to ERISA preemption,
ERISA broadly preempts all state law (and lawsuits under state law causes of action)
that relate to ERISA plans. Although limited exceptions exist for state laws that regulate
18

insurance, banking, or securities as well as for certain generally applicable laws,

ERISA's preemptive scope provides plan sponsors with great flexibility with respect to

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the design of their benefit programs, because ERISA generally will preempt state law
attempts to regulate the terms and conditions of ERISA plans.

Distinction between Insured and Self-Funded Plans

The exception for state laws that regulate the "business of insurance" creates an
interesting distinction between health benefit plans that purchase insurance and those
for which the plan sponsor self-insures (or self funds) the benefits. So-called mandated
benefits laws-that is, state laws that mandate that health insurance contracts subject to
the state's jurisdiction provide coverage or benefits for certain conditions or illnesses-
constitute laws that regulate the business of insurance, and are saved from preemption. 19

A self-funded plan does not purchase insurance, however, and a provision of ERISA
known as the "deemer clause" prevents a state from directly applying its insurance
regulation to the employee benefit plan. The result is a significant distinction between
20

insured and self funded plans. Although a state may not directly regulate an employee
benefit plan, the state may indirectly regulate the content of an insured plan by
regulating the terms and conditions of the insurance contract that the plan purchases. A
state may not, however, directly or indirectly regulate the terms and conditions of a self
funded plan.

When Is a Plan Self-Funded?

Historically, most health plan programs were insured arrangements, although today a
growing number of plan sponsors have adopted self-funded arrangements that
incorporate a preferred provider organization (PPO), point-of-service product, or other
feature generally associated within the rubric of health plans. Because of the
significance of the distinction between insured and self-funded plans, courts and state
regulators have been called upon to determine whether certain plans are insured or self-
funded.

This issue typically arises when the plan claims to be self-funded, but the plan or the
plan sponsor then purchases stop loss or excess loss insurance to protect the plan or
plan sponsor from large losses. Stop loss or excess loss insurance provides
reimbursement to the plan or plan sponsor in the event that benefits paid by the plan to
or on behalf of a plan participant or all plan participants as a group exceed thresholds
established in the insurance policy. Stop loss coverage is written with either or both a
specific or individual attachment point and an aggregate attachment point. Above the
specific or individual attachment point, the plan or plan sponsor is entitled to
reimbursement for claims paid during the policy year with respect to a single plan
participant. Above the aggregate attachment point, the plan or the plan sponsor is
entitled to reimbursement for claims paid during the policy year with respect to all plan
participants.

Plans that purchase stop loss or excess loss insurance coverage generally have been
considered self-funded for the purposes of the preemption rules described above, so
that a state is not allowed to regulate the plan indirectly through application of its
mandated benefit or other health insurance laws to the terms and conditions of the
insurance contract. Rather, the stop loss or excess loss contract typically is viewed as
21

property and casualty insurance that is subject to the state's rules and regulations for
such insurance. This characterization is subject to two caveats. First, the plan participant
should have no rights to claim benefits directly against the stop-loss or excess loss
insurer. Stop-loss or excess loss insurance is intended to provide reimbursement to the
plan or the plan sponsor for losses incurred beyond certain thresholds. If the plan

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participant has a direct claim against the insurer, however, the stop-loss or excess loss
contract arguably constitutes a direct health insurance contract that the state could
regulate as such.

Second, the thresholds at which the insurance company reimburses the plan or the plan
sponsor should be sufficient so that the plan or the plan sponsor bears substantial risk
for the provision of benefits under the plan (other than the risk of the insurance carrier's
bankruptcy). A number of courts have suggested that, if the thresholds are set so low
that they constitute a disguised deductible, the insurance contract, even though treated
by the parties as providing stop loss or excess loss coverage, might be treated as direct
health insurance. Similarly, several states have promulgated regulations to the effect
22

that stop-loss or excess loss policies with threshold points below certain amounts would
be regulated as direct health insurance contracts, allowing the state to assert the
applicability of its mandated benefit laws to the contract. More recently in 1995, the
23

National Association of Insurance Commissioners adopted a Stop-Loss Insurance Model

Act, under which a self-funded plan would be treated as having purchased health
insurance, which would be subject to all state insurance mandates, if the specific
attachment point is less than $20,000. Similar rules would apply with respect to the
aggregate attachment point. For groups of 50 or more, the plan will be treated as fully
insured if the aggregate attachment point is less than 110% of expected claims. For
groups of 50 or less, the aggregate attachment point must be at least equal to the
greater of $4,000 times the number of employees, 120% of expected claims, or
$20,000. 24

Limits on ERISA Preemption

ERISA's preemptive reach is extremely broad, although not all encompassing. For
example, a New York law that imposed surcharges on hospital bills was not preempted
by ERISA. Although the surcharges undoubtedly had an impact on a self-funded plan
25

by increasing the cost of the benefits provided by the plan, the New York surcharge
system did not relate to ERISA plans and therefore was not preempted. Although this
type of indirect impact law may survive preemption, a state law that attempts to regulate
the benefits provided by the plan will be preempted unless saved, in the case of an
insured plan, as a law regulating the business of insurance. Thus, plan sponsors have
significant flexibility with respect to the design of health benefit plans.

Also, as was noted in the section of this lesson that discusses documentation, reporting,
and disclosure requirements, ERISA does not apply to government plans, such as
municipal or county governments; thus, ERISA preemption of state law does not apply to
a government plan. Even if such a plan is self-funded, state laws that regulate "the
business of insurance" still apply.

Other Federal Laws Affecting Plan Design

Although ERISA grants plan sponsors considerable flexibility with respect to the design
of their healthcare plans, other federal laws may restrict a plan sponsor's discretion to
some extent. For example, a plan may not discriminate on the basis of age or other
protected classification. Moreover, a plan may not discriminate on the basis of disability
26

in a manner that violates the Americans with Disabilities Act (ADA). 27

Amendment of Plans

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ERISA requires that every employee benefit plan provide a procedure for amending the
plan and for identifying the persons who have authority to amend the plan. Generally, a
28

plan sponsor reserves to itself the power and authority to amend (or even terminate) a
plan. The employer's reserved amendment authority and the process by which the
employer exercises that authority have been the subject of considerable debate.

Benefit Reductions
Many employers provide health plan coverage to former employees who retired after
attaining a certain age and after completing a minimum period of service specified in the
plan (e.g., age 55 and 10 years of service). Traditionally, the employer had few retirees
relative to active employees, and healthcare costs were reasonable. As healthcare costs
escalated, however, and as the employer's population shifted to include a greater
number of retirees relative to active employees, employers began to modify (and in
some cases terminate) the coverage provided to retirees.

Predictably, retirees whose coverage was modified or eliminated challenged many of the
benefit cut-backs. Although early cases were far from uniform-some favoring the
employer, some applying a rebuttable presumption in favor of the retiree-more recent
cases, although still not entirely uniform, have become more homogenous in their
approach. In particular, the cases have rejected a per se rule and have instead viewed
the issue as a question of plan interpretation. Where the employer (plan sponsor) has
reserved to itself the authority to amend, modify, or terminate the plan, the employer's
exercise of that right has been upheld. Where the employer has not reserved to itself
29

the authority to amend, modify, or terminate the plan, however, or if the plan language is
ambiguous, the courts will seek to ascertain the parties' intent when creating the plan
(i.e., did the employer or, in the case of a collectively bargained arrangement, the parties
to the contract intend to create vested benefit rights that cannot thereafter be modified
by the employer?). The starting point, however, is the plan language concerning the
30

employer's right to amend the plan.

There is also a line of cases holding that, even where the plan documents reserve to the
employer the right to amend, modify, or terminate the plan, the employer might be
estopped from implementing the change as a result of prior assurances provided to plan
participants. For example, in Sprague v. General Motors Corp., the court determined that
General Motors had agreed to provide lifetime benefits as part of an early retirement
program, a commitment that in the court's opinion overrode the employer's rights under
the plan document. Similarly, in a case involving Unisys Corporation retirees, the U.S.
31

Court of Appeals for the Third Circuit permitted a retiree challenge to proceed based on
a breach of fiduciary duty theory (see "Fiduciary Duties" later in this lesson), despite the
fact that the plan document had at all times reserved to the employer the right to amend,
modify, or terminate benefits. The retirees alleged that plan fiduciaries had violated their
32

fiduciary duties by consistently misrepresenting to plan participants over a period of

years that retiree benefits were lifetime benefits.

Fast Definitions

Estop - a legal term meaning to stop, bar, prevent, or preclude.

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Amendment Procedure
Even where a plan document reserves to the employer the right to amend the plan,
employees and retirees have challenged the process by which amendments have been
adopted. In Schoonejongen v. Curtiss Wright Corp., the employer terminated a retiree
health insurance program. The plan reserved to the employer the right to amend or
33

terminate the plan but did not specify the process by which amendments could be
adopted or the persons or person with the authority to amend the plan. The U.S. Court of
Appeals for the Third Circuit held that the plan amendment procedure, and thus the
amendment terminating the plan, was invalid under ERISA.

The Third Circuit position was short lived. The U.S. Supreme Court reversed, holding
that the plan amendment procedure was valid even though it did not specifically identify
the person or persons with the authority to amend the plan. Also, the U.S. Court of
34

Appeals for the Seventh Circuit refused to set aside an amendment terminating a retiree
welfare plan even though the plan did not contain an adequate amendment procedure
under ERISA. It would thus appear that the courts will not easily set aside plan changes
35

communicated by the employer to plan participants. Nevertheless. a plan sponsor would

be well advised to avoid the issue altogether by specifying the amendment procedure in
the plan document and, having done so, to follow that procedure.

Fiduciary Duties
ERISA imposes special duties on plan fiduciaries. ERISA's definition of fiduciary is
functional, that is, a person, regardless of formal title or position, is a fiduciary to the
extent that he or she exercises discretionary authority and control over the operation or
administration of the plan, exercises any control over plan assets, or renders investment
advice for a fee. 36

ERISA prescribes the minimum standard of conduct applicable to fiduciaries, the so-
called fiduciary duties. A fiduciary with respect to a plan must discharge his or her
obligations with respect to a plan solely in the interests of the plan participants and
beneficiaries and for the exclusive purpose of providing benefits to plan participants and
their beneficiaries and defraying reasonable expenses of administering the plan. 37

Furthermore, the fiduciary must act in accordance with the plan documents (except to
the extent that the documents are themselves inconsistent with ERISA) and with the
care, skill, and diligence that a prudent person familiar with such matters would use in a
similar enterprise. Finally, if the plan is funded, plan investment must be diversified to
38

minimize the risk of large losses.39

Often, a plan fiduciary is also an officer of the sponsoring employer, raising the question
of when such a person is wearing his or her "fiduciary hat," and thus is required to act in
the sole interest of plan participants and their beneficiaries, and when the fiduciary is
wearing his or her "corporate hat," and thus is able to act in the best interests of the plan
sponsor. Although the distinction is not always clear, the authority to amend or even
terminate the plan is a "settlor function"; that is, an employer is not acting in a fiduciary
capacity when deciding to amend or terminate a plan. Thus, an employer might
40

prospectively amend its group health plan to eliminate certain coverages (assuming that
such elimination does not violate the ADA), and this action, although not in the best
interest of plan participants, does not implicate the fiduciary's obligations under ERISA.
Similarly, the decision to terminate a plan is a "settlor" or business decision of the plan

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sponsor. Although certain aspects of the termination process might constitute fiduciary
functions, the decision to terminate does not.

In addition to ERISA's general fiduciary responsibility rules, ERISA also prohibits a plan
fiduciary from engaging in a number of transactions known as prohibited transactions. 41

There are two sets of prohibited transactions. The first set prohibits a plan fiduciary
from causing a plan to engage in certain transactions (such as sale or lease of property
or extension of credit) between a plan and a party in interest. A party in interest
includes a fiduciary with respect to the plan, persons who perform services for a plan,
and other persons or entities related to such fiduciaries or service providers. Unless
42

advance approval is obtained from the Department of Labor, this type of related party
transaction is prohibited without regard to the economic benefits of the transaction to the
plan.

A second branch of the prohibited transaction rules proscribes a fiduciary from acting in
certain conflict-of-interest situations or from receiving compensation from a third party in
connection with a transaction involving the assets of the plan. For example, a fiduciary
with respect to the plan may not cause the plan to retain the fiduciary (or a related party)
to perform additional services for a fee. Where a fiduciary uses the authority, discretion,
and control that makes him or her a fiduciary to cause the plan to pay an additional fee
to the fiduciary, the fiduciary has engaged in a prohibited act of self-dealing. 43

Challenges to Benefit Denials

Claims Procedure
Every employee benefit plan under ERISA is required to establish a procedure whereby
a plan participant or beneficiary may challenge a denial of his or her claim for benefits. 44

A claims procedure will be deemed reasonable if a plan participant's or beneficiary's

claim is answered in writing, with explanation of the reasons for the decision and
references to pertinent plan provisions, within 90 days. If the claim is denied and the
plan participant or beneficiary wishes to pursue the matter further, an appeal may be
filed with the appropriate fiduciary designated by the plan. The appeal must be answered
in writing, again with explanation of the reasons for the decision and references to
pertinent plan provisions, within 60 days after the date on which the appeal is filed. In
certain cases, the 90-day and 60-day periods can be extended if the plan participant or
beneficiary is notified of the need for additional time before expiration of the initial
period.45

Standard of Review in Court Action

If the plan participant is not satisfied with the disposition of his or her claim at the plan
level, he or she can file suit in state or federal court. An important threshold question
involves the standard of review that the court will apply in reviewing the plan
administrator's denial of the plan participant's claim.

In Firestone Tire & Rubber Co. v. Bruch, the U.S. Supreme Court determined that, in
accordance with established principles of trust law, a plan participant's or beneficiary's
challenge to a denial of benefits is to be reviewed under a de novo standard- that is,
the court independently reviews and weighs the evidence and makes its decision
accordingly, with deference to the decision made by the plan administrator- unless the
plan document grants to the plan administrator or other appropriate fiduciary the
discretionary authority and control to determine eligibility for benefits or to construe the
terms of the plan. Where the plan grants the administrator such discretionary authority
46

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and control, the court is to review the benefit denial under the more deferential arbitrary
and capricious standard of review. Under this standard, the court reviews the evidence
but overturns the plan administrator's decision only if it represents a clearly
unreasonable interpretation or construction of the plan.

The Supreme Court's decision, although based upon principles of trust law, is a
puzzlement to many. Although the general rule is de novo review, the Supreme Court's
decision creates an exception that potentially eliminates the general rule. By including
appropriate language in the plan document, a plan sponsor changes the standard of
review that a court will apply in the event that a plan participant challenges a benefit
denial. More generally, why should a plan sponsor be allowed to select the standard of
review through its decision to include or not include certain language in the plan
document?

In the years after the Supreme Court's Bruch decision, the lower federal courts have
struggled with the implications of the decision. In a number of decisions, courts have
applied the de novo standard even though the document contained evidence that the
plan administrator (or other fiduciary) was intended to have considerable authority and
control with respect to the plan. For example, in Michael Reese Hospital & Medical
Center v. Solo Cup Employee Health Benefit Plan, even though the plan document gave
the administrator the authority to control and manage the operation and administration of
the plan, it was held that the plan demonstrated insufficient intent to grant to the
administrator discretionary authority to determine eligibility or to construe the terms of
the plan. Similarly, in Nelson v. EG&G Energy Measurements Group, the plan
47

document granted to the administrator the authority to "control and manage the
operation and administration of the plan and to promulgate rules and regulations as
deemed necessary and proper to interpret or administer the plan," yet the court applied
the de novo standard. Although it is not necessary that the plan document contain
48

"magic words" to demonstrate an appropriate grant of discretion, the arbitrary and

capricious standard will apply only if there is evidence to show that the administrator has
the power to construe uncertain terms or that eligibility and benefit determinations are to
be given deference. 49

In other cases, particularly those involving self funded arrangements for which benefits
are payable from the plan sponsor's general corporate assets, courts have focused on
the conflict of interest under which a plan fiduciary may operate because a denial of
benefits is directly beneficial to the plan sponsor's treasury. If a plan fiduciary with the
50

discretion to construe plan terms and make eligibility and benefit determinations also has
a conflict of interest, courts will apply a less deferential standard of review than the
arbitrary and capricious standard that would normally be applicable. 51

Right to Jury Trial

Most courts have held that ERISA does not provide a right to a jury trial, reasoning that
benefit claims under ERISA are equitable in nature. The decisions are not uniform,
however, and a minority of courts have found a right to jury trial.

Fast Definitions

Equitable relief - legal remedy available to a plaintiff who does not have an adequate
remedy in an action at law. The function of equity is to supplement, not to replace, the

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law. It can include legal principles such as a mandatory injunction (a command that a
person or entity do something) or a prohibitory injunction (a command that a person or
entity stop doing something).

ERISA'S Civil Enforcement Scheme And Remedies

In addition to suits for benefits brought by a plan participant or beneficiary, ERISA
authorizes a plan participant, beneficiary, fiduciary, or the secretary of the Department of
Labor to bring a variety of civil actions. Among the more important suits are those that
involve the right of a plan participant, beneficiary, fiduciary, or the secretary to bring an
action for breach of fiduciary duty under Section 502(a)(2) of ERISA. Also, a plan
54

participant, beneficiary, or fiduciary may bring an action under Section 502(a)(3) of

ERISA to enjoin any act or practice that violates (or to enforce the provisions of) Title I of
ERISA or the terms of the plan or to obtain other appropriate equitable relief. 55

Although ERISA authorizes a variety of civil actions, the remedies that are available to a
successful plaintiff have been quite limited. An action for breach of fiduciary duty under
Section 502(a)(2) of ERISA is an action brought on behalf of the plan and all recovery
runs in favor of the plan. Accordingly, the U.S. Supreme Court in Massachusetts Mutual
Life Insurance Co. v. Russell, held that a plan participant or beneficiary could not recover
extracontractual or punitive damages. Later, the Supreme Court in Mertens v. Hewitt
56

Associates held that Section 502(a)(3) authorizes only traditional forms of equitable
relief, not monetary damages. 57

The Supreme Court's restrictive interpretation of Sections 502(a)(2) and 502(a)(3) takes
on added significance in light of ERISA's preemption of state laws and state law causes
of action that relate to ERISA governed employee benefit plans. Because of ERISA's
preemptive reach, plaintiffs may not forego ERISA's civil enforcement scheme in favor of
state law remedies, which might, if not preempted, include punitive or extracontractual
damages. 58

After the Supreme Court's holding in Russell and Mertens, the lower federal courts have
struggled to attempt to provide meaningful remedies to plan participants and
beneficiaries in actions brought under Section 502(a)(3) of ERISA. For example, in
Watkins v. Westinghouse Hanford Co., the U.S. Court of Appeals for the Ninth Circuit
ruled that a plan participant could not recover under Section 502(a)(3) benefits allegedly
due the plan participant as a result of a misrepresentation. In other cases, such as
59

Howe v. Varity Corp., successful plaintiffs have recovered what are, in effect, monetary
damages by framing the action for benefits as a claim for restitution, an equitable
remedy. As a result, recovery under Section 502(a)(3) remains an open issue.
60

ERISA Preemption
Arguably, no provision of ERISA has more of an effect on the operations of health plans
than ERISA's preemption clause. This section explains the general principles of
preemption and discusses the impact of preemption on the following activities of health
plans: utilization review determinations; the establishment of provider networks; the
provision of healthcare services, either directly or by contract; representations of
eligibility and coverage to healthcare providers; and the provision of administrative and
other noninsurance services to ERISA plans.

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General Principles of Preemption

When Congress enacted ERISA, it intended to make the regulation of employee benefit
plans an exclusively federal concern. Congress, however, also did not want to divest the
states of their traditional power to regulate insurance. Pursuant to this scheme,
Congress enacted three clauses relating to the preemptive effect of ERISA:
1. The preemption clause-This clause provides that ERISA supersedes any and
all state laws insofar as they may relate to any employee benefit plan subject to
ERISA, except to the extent that such laws may be "saved" from preemption by
the savings clause. 61

2. The savings clause-This clause preserves from preemption any law of any
state that regulates insurance, banking, or securities except as provided in the
deemer clause. 62

3. The deemer clause-This clause provides that an employee benefit plan shall
not be deemed to be an insurance company or other insurer, bank, trust
company, or investment company or to be engaged in the business of insurance
or banking for the purposes of any law of any state purporting to regulate
insurance companies, insurance contracts, banks, trust companies, or
investment companies. 63

The Preemption Clause

As noted above, Section 514(a) of ERISA preempts "any and all State laws insofar as
they may now or hereafter relate to any employee benefit plan." A law relates to an
employee benefit plan if it has "a connection with or reference to such a plan." The 64

preemption clause is "conspicuous for its breadth," however, preempting not only state
laws that are specifically designed to affect employee benefit plans but also those that
may only indirectly affect such plans. Those state laws that courts have found not to
65, 66

be preempted under Section 514(a) are generally limited to laws of general applicability
that only tangentially affect ERISA plans. 67

The Savings Clause

A state law that relates to an ERISA plan may be saved from preemption if it falls within
Section 514(b)(2)(A), which excepts from preemption those state laws that regulate the
"business of insurance." In Pilot Life Insurance Co. v. Dedeaux, the U.S. Supreme Court
used a two-part analysis to determine whether a state law regulates the business of
insurance. First, the Supreme Court took a common-sense approach, determining
68, 69

that, in order to regulate insurance, a law must be specifically directed toward the
insurance industry. Second, the Supreme Court applied the three part test for
determining whether a practice constituted the business of insurance formulated for the
McCarran Ferguson Act, namely, whether the practice had the effect of transferring or
spreading a policyholder's risk, whether the practice was an integral part of the policy
relationship between the insured and the insurer, and whether the practice was limited to
entities within the insurance industry. Since Pilot Life, courts have recognized the
70

necessity of a state law meeting both parts of the test to fall within the protection of the
savings clause. 71

Review Question

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Congress enacted three clauses relating to the preemptive effect of the Employee
Retirement Income Security Act of 1974 (ERISA). One of these clauses preserves from
ERISA preemption any state law that regulates insurance, banking, or securities, with
the exception of the exemption for self-funded employee benefit plans. This clause is
called the

savings clause
preemption clause
deemer clause
de novo clause

Correct. The savings clause preserves from preemption any state law that
regulates insurance, banking or securities except as provided by the deemer
clause.

Incorrect. The preemption clause provides that ERISA supercedes any and all
state laws as they may be related to any employee benefit plan subject to ERISA,
except to the extent that such laws may be saved from preemption by the saving
clause.

Incorrect. The deemer clause provides that an employee benefit plan shall not be
deemed to be an insurance company or other insurer, bank, trust company or
investment company or to be engaged in the business of insurance or banking

Incorrect. A de novo standard is a standard of evaluating a plan administrator's

decision to deny benefits in which the court independently reviews and weighs
evidence and makes its decision accoridingly, with deference to the decision
made by the plan administrator.

The Deemer Clause

The deemer clause exempts from any direct or indirect state regulation self-funded
employee benefit plans. All power to regulate insurance reserved to the states under the
savings clause is taken away with respect to self-funded plans under the deemer
clause. The language of the deemer clause, according to the U.S. Supreme Court, is
72

either coextensive with or broader, not narrower, than that of the savings clause. Thus
73

state laws that relate to employee benefit plans but that are saved from preemption
under Section 514(b)(2)(A) are still preempted as applied to self funded ERISA plans.
Although, as discussed above in regard to the benefit design of ERISA plans, this
interpretation establishes a disparity between the regulation of insured and uninsured
plans, the U.S. Supreme Court has determined that such a dichotomy was the intent of
Congress when it enacted the statute.74

Utilization Review Decisions

The consensus among courts seems to be that utilization review decisions by health
plans, even when they involve medical decisions, are an integral part of the
administration of ERISA plans. Consequently, they relate to such plans and are
preempted by ERISA.

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The U.S. Court of Appeals for the Sixth Circuit recently had occasion to reaffirm this
conclusion. In Tolton v. American Biodyne, Inc., the coadministrators of the estate of a
mental patient who had committed suicide sued, among others, the patient's ERISA plan
administrator, the plan's mental health utilization review company, and the psychologists
performing utilization review on behalf of the utilization review company, alleging that the
plan administrator wrongfully denied benefits for inpatient psychiatric care based upon
the utilization review company's refusal to authorize such care. Plaintiffs' state law
75

claims based on such utilization review decision included wrongful death, improper
refusal to authorize benefits, medical malpractice, and insurance bad faith. The court
held that such claims clearly related to the ERISA plan and were preempted by ERISA.

In reaching its decision, the Tolton court relied on an earlier opinion of the U.S. Court of
Appeals for the Fifth Circuit, Corcoran v. United Health Care, Inc. In Corcoran, the
76

utilization review decision at issue was the refusal by the defendant utilization review
company to precertify hospitalization for a high risk pregnancy despite the
recommendation of the patient's physician. Instead, the defendant authorized 10 hours
per day of home nursing care. The patient, who had already been admitted to the
hospital, returned home when she learned that the expenses for her hospitalization
would not be covered. At a time when no nurse was on duty, her fetus went into distress
and died. The patient and her husband then sued the defendant, alleging wrongful death
and medical malpractice.

The Fifth Circuit Court acknowledged that utilization reviewers make medical decisions
despite any disclaimers to the contrary in policy manuals or promotional materials. The
court found, however, that the medical decisions made by the defendant were
inseparable from its determinations regarding what benefits were available under the
plan. The court found that the wrongful death claim related to a denial of benefits under
the plan and so was preempted by ERISA. Other courts have followed the reasoning of
the Corcoran case and have preempted claims arising out of utilization review
decisions.77

Credentialing Decisions
Like the analogous duty imposed on hospitals to exercise reasonable care in the
selection and granting of privileges to its medical staff, a health plan has a duty to
conduct a reasonable investigation of the qualifications and competence of the
healthcare providers to whom they refer patients. Courts have declined to describe
78, 79

what will constitute a reasonable investigation of a provider's credentials, stating that its
scope will vary from case to case. Recent cases have focused not on the nature or
80

extent of the investigation of a provider's qualifications, but on whether a claim that a

health plan did not conduct the requisite investigation is preempted by ERISA. Most
courts that have considered the issue have ruled in favor of ERISA preemption.

A representative case is Kearney v. U.S. Healthcare, Inc. In Kearney, plaintiff filed

81

wrongful death and survival claims against an HMO, alleging that decedent's primary
care physician failed to diagnose properly decedent's condition or to refer decedent to a
hospital for specialized treatment. Plaintiff claimed that the HMO breached its contract to
provide needed specialized care by limiting or discouraging the use of specialists,
hospitalization, and state of the art diagnostic procedures; misrepresented the primary
care physician's competence; and was negligent in selecting and supervising the primary
care physician. Plaintiff also claimed that the HMO was vicariously liable for the

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malpractice of the primary care physician. The court held that a "claim that an operator
or administrator of a plan failed to use due care in selecting those with whom it
contracted to perform services relates to the manner in which benefits are administered
or provided and is preempted." The court dismissed not only plaintiff's claims of
82

negligent selection but also the claim for misrepresentation and breach of contract. As
discussed further below, however, the court held that plaintiff's claim that the HMO was
vicariously liable for the malpractice of the primary care physician on ostensible agency
grounds was not preempted

Although the list of courts in agreement with the preemption of negligent selection claims
is impressive, there is some authority to the contrary. For example, in Jackson v.
83

Roseman, plaintiff brought a medical malpractice case against his physicians and the
HMO with which they contracted. Plaintiff alleged that the HMO was vicariously liable
84

for the negligence of his physicians in allowing the growth and ultimate metastasis of a
malignant cancer in his mouth. The court noted that the complaint could also be read as
asserting a claim of direct negligence on the part of the HMO for negligent hiring and
supervision of its contracting physicians. Although the court declined to address the
85

merits of whether a negligent hiring and/or supervision claim went to the heart of the
benefit plan's administration, the court indicated that it agreed with the reasoning of the
U.S. Court of Appeals for the Second Circuit in a case involving claims of negligent
hiring and/or supervision of a psychologist. In that case, the Second Circuit rejected
86

defendant's argument that claims of negligent hiring and supervision of healthcare

providers so resembled a denial of benefits or a denial of some other plan-created right
as to support the removal of such claims from state court to federal court. 87

Despite the cases to the contrary, a health plan can take some comfort from the
likelihood that a court will find that claims that a health plan has negligently selected or
retained a participating provider who committed malpractice are preempted. The same
court, however, may not preempt a claim against the health plan based on vicarious
liability for the malpractice of a provider, as discussed below.

Vicarious Liability for Medical Malpractice

Of the various tort theories used to impose liability on health plans for the medical
malpractice of healthcare providers to whom they refer patients, none has generated
more recent litigation than that of apparent or ostensible agency. Although the elements
of apparent or ostensible agency vary from jurisdiction to jurisdiction, a common
allegation is that the patient reasonably relied upon actions or representations of the
health plan, which "held out" the negligent provider as its employee or agent, the degree
of reliance required of the patient being subject to judicial debate. 88

As in the area of negligent credentialing, ERISA plays a crucial role in determining

whether a health plan will be vicariously liable for the malpractice of healthcare
providers. The courts have been sharply divided as to whether ERISA preempts such
claims, however.

Courts holding that medical malpractice claims against health plans are not preempted
have found that such claims do not sufficiently relate to the employee plan to warrant
preemption. Such courts point out that such claims do not involve the administration of
89

benefits or the level or quality of benefits provided under plan; they merely allege
negligence by a physician and an agency relationship between the physician and the

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health plan. Courts reaching the opposite conclusion have reasoned that a vicarious
liability malpractice claim concerns the delivery of benefits under the ERISA plan and
that the claim requires the examination of the terms of the ERISA plan to determine the
quality and quantity of services required of physicians and the relationship between the
ERISA plan and the physicians. 90

Fast Definitions

Tort - a violation of a duty to another person imposed by law, rather than by contract,
causing harm to the other person and for which the law provides a remedy.

Although the lower courts have been almost evenly split as to whether ERISA preempts
medical malpractice claims against health plans based on vicarious liability theories, two
recent Circuit Court decisions indicate that the trend may be against preemption. The
U.S. Court of Appeals for the Tenth Circuit in the case of Pacificare of Oklahoma, Inc. v.
Burrage identified four categories of laws that related to an employee benefit plan: laws
that regulated the type of benefits or terms of ERISA plans; laws that created reporting,
disclosure, funding, or vesting requirements for ERISA plans; laws that provided rules for
the calculation of the amount of benefits to be paid under ERISA plans; and laws and
common law rules that provided remedies for misconduct growing out of the
administration of ERISA plans. The Tenth Circuit held that a claim that an HMO was
91

vicariously liable for the malpractice of one of its primary care physicians did not involve
the administration of benefits or the level or quality of benefits promised by the plan; it
merely alleged negligent care by the physician and an agency relationship between the
physician and the HMO. The court pointed out that ERISA would not preempt the
malpractice claim against the physician and concluded that ERISA should similarly not
preempt the vicarious liability claim against the HMO if the HMO held the physician out
as its agent. Reference to the ERISA plan to resolve the agency issue did not "implicate
the concerns of ERISA preemption." 92

Review Question

In the paragraph below, a statement contains two pairs of terms enclosed in

parentheses. Determine which term in each pair correctly completes the statement.
Then select the answer choice containing the two terms that you have chosen.

In the case of Pacificare of Oklahoma, Inc. v. Burrage, the U.S. Court of Appeals for the
Tenth Circuit considered whether ERISA preempts medical malpractice claims against
health plans based on certain liability theories. In this case, the Tenth Circuit court held
that ERISA (should / should not) preempt a liability claim against an HMO for the
malpractice of one of its primary care physicians, and therefore the HMO was subject to
a claim of (subordinated / vicarious) liability.

should / subordinated
should / vicarious
should not / subordinated

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should not / vicarious

Incorrect. The Tenth Circuit Court did not hold that ERISA should preempt a
liability claim for the malpractice of one of its primary care physicians, and is not
subordinated.

Incorrect. While the Tenth Circuit court held that the HMO was subject to a claim
of vicarious liability, it did not hold that ERISA should preempt a liability claim for
the malpractice of one of its primary care physicians

Incorrect. While the Tenth Circuit court held that ERISA should not preempt a
liability claim against an HMO for the malpractice of one of its primary care
physicians, and is not subordinated.

Correct. In the case of PacifiCare of Oklahoma, Inc. v. Burrage, the Tenth Circuit
court held that ERISA should not preempt a liability claim against an HMO for the
malpractice of one of its primary care physicians, and therefore the HMO was
subject to a claim of vicarious liability.

In Dukes v. U.S. Healthcare. Inc., the U.S. Court of Appeals for the Third Circuit
addressed the issue of whether vicarious liability malpractice claims against the
defendant HMO could be removed from the state court to federal court. The lower
93

federal courts had allowed such a removal and then had dismissed the claims, holding
that they were preempted by ERISA. The Third Circuit reversed, noting that not all
claims preempted by ERISA were subject to removal. The court held that removal was
improper where plaintiffs were merely attacking the quality of the benefits received and
were not claiming that the ERISA plans had erroneously withheld benefits that were due
or were not seeking to enforce rights under the terms of their respective plans or to
clarify rights to future benefits. The court expressly distinguished the situation where the
HMO denied benefits in its utilization review role.94, 95

It should be noted that the Third Circuit's decision in Dukes was limited to the issue of
whether a defendant health plan can remove a medical malpractice claim from state
court to federal court. That court's discussion of the distinction between the quantity of
96

benefits due under an ERISA plan and the quality of the benefits provided under such
plan, however, will probably be cited by other courts as authority for a refusal to preempt
malpractice claims challenging the quality of services provided to plan participants and
beneficiaries.

Negligent Representations by Health Plans to Providers

Whether claims by a provider that a health plan misrepresented the existence or extent
of coverage is preempted by ERISA may hinge or whether the provider is suing in its
own capacity or as assignee of the health plan's insured or member. A majority of courts
have held that state law causes of action brought by a provider suing in its own capacity
are not preempted by ERISA, even though such causes of action would be preempted if
the provider was suing in a derivative capacity as assignee for the insured or member.

For example, in the influential case of Memorial Hospital System v. Northbrook Life
Insurance Company, the plaintiff hospital had treated a patient after the hospital had

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called the employer of the patient's husband and verified that the patient had coverage
for the hospital care under a group insurance policy issued and administered by
defendant. Subsequently, the patient and her husband assigned their benefits to the
97

hospital. Upon the hospital's request for payment, however, defendant informed the
hospital that the patient had not been eligible for benefits on the date of her
hospitalization and denied benefits. The hospital subsequently sued, alleging that the
employer acted as defendant's agent in verifying coverage and asserting state law
causes of deceptive and unfair trade practices under the Texas insurance code, breach
of contract, negligent misrepresentation, and equitable estoppel.

Fast Definitions

Equitable estoppel - a court's bar to a party from exercising a right or from asserting a
fact because of something the party said or did that misled a second party to act so that
harm resulted to the second party.

The lower court dismissed the hospital's claims for breach of contract and deceptive and
unfair trade practices, finding that those claims were brought by the hospital in a
derivative capacity, were related to a claim for benefits under an ERISA plan, and were
consequently preempted. The lower court reached the opposite conclusion with respect
to the claims of misrepresentation and estoppel, however, finding that those claims were
based on the hospital's independent position as a third party healthcare provider, were
not related to the ERISA plan, and thus "were not caught in the broad net of ERISA
preemption. 98

The hospital appealed the dismissal of the deceptive and unfair trade practices claim,
alleging that the lower court had mischaracterized it as a derivative claim for benefits.
The U.S. Court of Appeals for the Fifth Circuit agreed, holding that it was merely a Texas
codification of the common law doctrine of negligent misrepresentation. Nevertheless,
the Fifth Circuit felt "compelled to enter the preemption thicket" and determine whether
such cause of action was sufficiently related to the employee benefit plan at issue so as
to be preempted. The court ultimately held that it was not sufficiently related to be
99

preempted. It is worthwhile, however, to examine in some detail the court's analysis of

the policy issues involved in determining whether to preempt a provider's claims based
on an erroneous verification of a patient's eligibility and coverage because the same
reasoning has been adopted by courts in subsequent cases.

Before determining the legal issue of preemption, the court found it necessary to
examine the "commercial realities" of the hospital's position as a healthcare provider.
The scenario depicted in Memorial's appeal is one that is reenacted each day
across the country. A patient in need of medical care requests admission to a
hospital (or seeks treatment from a physician). The costs of medical care are
high, and many providers have only limited budget allocations for indigent care
and for losses from patient nonpayment. Naturally, the provider wants to know if
payment reasonably can be expected. Thus, one of the first steps in accepting a
patient for treatment is to determine a financial source for the cost of care to be
provided. 100

The court recognized that it was customary practice for a provider to communicate with
plan agents to verify eligibility and coverage and viewed the issue of a mistaken

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verification of eligibility and coverage by such plan agents as solely one of allocation of
risks, namely, whether the risk of nonpayment of the provider's costs "should remain
with the provider or be shifted to the insurance company, which through its agents
misrepresented to the provider the patient's coverage under the plan," noting that
enforcing "the allocation of risks between commercial entities that conduct business in a
state is a classically important state interest."
101

The court remained unconvinced that "either the commercial scenario described above,
or its state law vindication, raises any issue concerning the matters that Congress
intended to be regulated exclusively by ERISA." Moreover, the court was unpersuaded
102

that "insulating plan fiduciaries from the consequences of their commercial dealings with
third-party providers would further any of ERISA's goals." 103

According to the court, a one-time recovery by the hospital against the insurer or its
putative agent, the employer, would not affect the ongoing administration or obligations
of an ERISA plan. In addition, the court found that, if providers were held to have no
recourse under either ERISA or state law in situations where there was no coverage
under the express terms of the plan but providers had relied on assurances that there
was such coverage, providers would be understandably reluctant to accept the risk of
nonpayment and might require upfront payment by beneficiaries or impose other
inconveniences before treatment would be rendered: "This does not serve, but rather
directly defeats, the purpose of Congress in enacting ERISA." 104

Finally, noting that a healthcare provider did not have independent standing to seek
redress under ERISA, the Fifth Circuit found that, although employees had received
protection under ERISA in exchange for certain rights to sue under previous federal and
state law, the plaintiff and "the countless other healthcare providers were not a party to
this bargain." The court stated that it could not believe that "Congress intended the
105

preemptive scope of ERISA to shield welfare plan fiduciaries from the consequences of
their acts toward non-ERISA healthcare providers when a cause of action based on such
conduct would not relate to the terms or conditions of a welfare plan, nor affect-or affect
only tangentially-the ongoing administration of the plan." The court concluded that
106

ERISA's "preemption provision designed to prevent state interference with federal

control of ERISA plans does not require the creation of a fully insulated legal world that
excludes these plans from regulation of any purely local transaction." Other courts have
107

adopted the reasoning of the Memorial Hospital System case and refused to insulate
ERISA plans, their sponsors, or their administrators from liability when they mistakenly
verify eligibility or coverage to a healthcare provider. 108

Preemption of State Insurance Regulation

State insurance laws and regulations often expressly exempt ERISA employee benefit
plans from their application. In the absence of such express exemption, however, it has
109

been increasingly common for state insurance authorities to attempt to apply insurance
laws and regulations directly to noninsurance products of health plans as well as to
integrated delivery systems and other entities that have contracted to provide services to
ERISA plans. Whether state insurance laws and regulations are preempted by ERISA
depends on a combination of the nature of the state law or regulation at issue and the
nature of the services being provided to the ERISA plan.

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Under the traditional preemption analysis, the first issue to be addressed is whether the
state law or regulation relates to the ERISA plan. If so, the law or regulation will be
preempted unless it is "saved" from preemption because it regulates the "business of
insurance." The nature of the services being provided to the ERISA plan and that the
state is seeking to regulate, however, must constitute the "business of insurance"; it is
not sufficient that the services are being provided by an insurance company or other
entity subject to insurance regulation or that the state law or regulation is part of the
insurance code.

The U.S. Supreme Court has held that the underwriting or spreading of risk is an
indispensable characteristic of insurance. According to the Supreme Court, the
110

spreading of risk means that the entity engaged in the business of insurance accepts a
number of risks, some of which involve losses, and spreads such losses over all the
risks to enable the entity to accept each risk at a slight fraction of the possible liability
upon it. Courts also have held, however, that an incidental element of insurance in a
111

contract does not bring the contract within the regulatory power of the insurance laws. 112

Because some element of risk is inherent in any business transaction, the primary effect
of the contract at issue must be assumption and spreading of risk.

Administrative Services Only Contracts

In the situation where the entity contracting with the ERISA plan merely provided
administrative services to such plan, courts have determined that such services did not
constitute the business of insurance, and therefore ERISA preempted the application of
state insurance laws and regulations to such services. For example, the U.S. Court of
Appeals for the Fifth Circuit held that a third party administrator of an ERISA plan was
not engaged in the business of insurance where it performed no risk bearing function. 113

Consequently, ERISA preempted a Texas statute imposing regulations, fees, and taxes
to the extent that the statute applied to such third party administrator.

Similarly, the U.S. Court of Appeals for the Fourth Circuit held that, where an insurer
acted as a third party administrator, providing purely claims processing functions for an
ERISA plan pursuant to an administrative services agreement with the employer, the
insurer was not engaged in the business of insurance. According to the court, the
114

ERISA savings clause covered the same category of state insurance regulation as the
McCarran-Ferguson Act, which preserves to the states the right to regulate insurance,
115

and the McCarran-Ferguson Act did not "purport to make the States supreme in
regulating all the activities of insurance companies; … only when they are engaged in
the 'business of insurance' does the statute apply." 116

Finally, the U.S. Court of Appeals for the Third Circuit, in the often-cited case Insurance
Board of Bethlehem Steel Corp. v. Muir, found that the Pennsylvania Blue Cross and
Blue Shield (BCBS) plans were not engaged in the business of insurance where they
performed no underwriting function and received only an administrative fee based on the
number and type of plan participants, regardless of the fact that plan participants and
beneficiaries used BCBS claim forms, BCBS staff processed the claims, BCBS made
initial determinations regarding coverage, and BCBS paid plan participants and
beneficiaries directly and was reimbursed by the employer. According to the court,
117

because "ERISA creates a scheme in which any entity engaged in the business of
insurance, except an ERISA employee benefit plan, is subject to state insurance
regulation," the controlling question was whether BCBS was engaging in the business of

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insurance when it sold administrative services to the ERISA plan. The court held that it
118

was not because it did not assume any financial risk of a valid claim, it did not provide a
service that was an essential part of the insurance relationship but instead merely
provided administrative services, and other entities outside the insurance industry
provided the same administrative services provided by BCBS.

In summary, so long as the services being provided by contract to the ERISA plan do not
constitute the assumption and spreading of risk (i.e., "the business of insurance"), any
attempted state regulation of those services, including regulation under the insurance
code, will be preempted by ERISA. As the discussion below of the preemption of state
119

any willing provider (AWP) laws demonstrates, however, the dividing line between the
"business of insurance" and the provision of professional services is not always clear.

Any Willing Provider Laws

A key legal battle in the health plan arena is the fight between states and health plans
over the applicability of AWP laws to networks that contract with ERISA plans. Although
the terms of AWP statutes differ from state to state, in general AWP statutes require that
health plans and other entities establishing provider networks include the provider in the
network so long as the provider meets the network's general qualifications and is willing
to be compensated at the network's payment rate. Under some state statutes, patients
also cannot be penalized through reduced benefits if they seek treatment from providers
outside their designated network.

The debate over AWP statutes centers on ERISA and whether health plans that service
ERISA plans are subject to state AWP statutes. As explained above, under ERISA, any
state law that relates to an ERISA employee benefits plan is preempted. ERISA makes
an exception to its broad preemption provision, however, for any state law that regulates
the "business of insurance." Courts have interpreted that phrase to require a two part
analysis. First, courts look to whether common sense dictates that the state statute
regulates insurance. Then they decide whether a state statute affects a practice that has
the effect of transferring or spreading a policyholder's risk, is an integral part of the
relationship between the insurer and the insured, and is limited to entities within the
insurance industry. If it does, then the statute is not preempted by ERISA as applied to a
fully insured ERISA plan. As applied to a self funded ERISA plan, however, the statute is
still preempted.

The difference of opinion regarding the scope of ERISA with respect to AWP statutes
arises from the uncertainty as to whether regulating the identities of a network's
participating providers is a regulation of the business of insurance or a regulation of
noninsurance business.

Defenders of AWP statutes argue that AWP statutes regulate the business of insurance
because they define the type of policy that can be issued. HMOs and other health plans
that maintain closed provider networks increase the costs to patients who use
nonparticipating providers by reducing or eliminating benefits for services received from
those providers. An AWP statute allows a patient to obtain care from a provider who
might otherwise be excluded from a network without a reduction of benefits. This
prohibition on closed networks, it is argued, spreads the policyholders' risk insofar as it
shifts to health plans and physician groups the costs to patients of seeking treatment
from providers who otherwise would be excluded from a network.

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In addition to spreading policyholder risk, defenders of AWP statutes argue that such
statutes affect an integral part of the relationship between the insurer and the insured:
treatment and cost. AWP statutes help define the nature of the available services, who
can provide them, and how those providers will be paid. In this respect, AWP statutes
have been analogized to mandated benefits laws, which require insurers to include
certain types of benefits in their insurance policies. Mandated benefits laws were found
to be saved from ERISA preemption because they regulate the scope of the insurance
coverage and the availability of services. In the same manner, it is argued, AWP statutes
affect the type of benefits that an insured receives by determining who can provide
covered services and how those providers are selected. Opponents of preemption assert
that such regulation touches upon a vital part of the insurer insured relationship.

On the other hand, proponents of ERISA preemption contend that such statutes do not
regulate the business of insurance, although they may regulate the business of
insurance companies. They argue that the practice of limiting the providers with which a
health plan contracts does not spread policyholder risk. Instead, the practice is merely a
cost-saving mechanism. According to this argument, contracts between health plans and
providers, whereby the provider receives a reduced rate of compensation in exchange
for a certain volume of patients, are merely contracts for the purchase of goods and
services. The transfer of risk occurs when an HMO insures an ERISA plan, not when it
or another health plan attempts to minimize costs through its contracts with providers.
The provider contracts are seen as identical to many other arrangements whereby
health plans try to reduce costs.

Second, proponents of preemption argue that the practice of choosing the providers
through whom it will provide services does not affect an integral part of the relationship
between an insurer and the insured. The agreements at issue are between the insurer
and the providers. They do not affect the amount or the type of benefit that a patient
receives, only the vehicle through which such services are rendered.

Because of the runaway costs of healthcare and the concerted effort to find means by
which to curb healthcare expenses, there are also strong policy reasons for finding
ERISA preemption of AWP statutes. As discussed above, if health plans are prohibited
from closing their networks, they can no longer ensure a certain volume of business. In
this manner, AWP statutes eliminate any leverage health plans may have had to bargain
with providers for reduced rates of compensation, effectively eliminating the benefits of
establishing a provider network.

Thus far, courts have reached different conclusions as to whether particular AWP
statutes regulate "the business of insurance." One of the first AWP statutes to be
challenged by the health plan industry was in Virginia. Virginia's AWP statute allowed
120

insurers to form PPOs and establish terms and conditions that physicians, hospitals, or
other providers had to meet to qualify as a preferred provider. The statute, however,
prohibited insurers from both unreasonably discriminating against and among such
providers and from excluding providers willing to meet the terms and conditions for
participation in the PPO. The challenge to the Virginia statute arose after a PPO
established by Aetna, which provided services exclusively to employee benefit plans,
refused to allow a hospital to participate in its network. Instead, the PPO only contracted
with hospitals that were already participants in Aetna's HMO. The hospital sued Aetna
for failing to comply with the AWP statute and excluding it from the PPO network for the

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sole reason that it was not a member of Aetna's HMO. Aetna defended on the ground
that the statute was preempted by ERISA.

In the Virginia case, the court first found that the AWP statute related to ERISA plans.
The statute not only expressly provided that it applied to health benefit programs offered
or administered by insurers but also restricted the ability of an insurer to limit the choice
of providers that would otherwise confine the plan participants of an ERISA plan to those
preferred by the insurer.

Next, the court held that the statute was rescued from preemption because it regulated
the business of insurance and consequently fell under the ERISA savings clause.
According to the court, the statute spread policyholder risk because insureds whose
benefits otherwise would be reduced or denied if they sought treatment from
nonparticipating providers would receive full benefits under the statute. In addition, the
court asserted, the statute affected an integral part of the relationship between the
insured and the insurer because the statute affected the provision for treatment and
cost. Finally, the Virginia statute was explicitly limited to entities within the insurance
industry, thus satisfying the third McCarran Ferguson criterion. Consequently, the court
held that Virginia AWP statute was not preempted by ERISA. 121

A federal court in Louisiana reached the opposite conclusion in a challenge to

Louisiana's AWP statute. Like the Virginia court, it held that the Louisiana statute
122

related to ERISA plans. Indeed, the statute explicitly mentioned employee benefit plans.
In addition, the court found that application of the statute affected the employer's or plan
sponsor's discretion as to how health benefits could be structured under its employee
benefit plans, pointing out that the statute explicitly directed that it could not structure its
programs to exclude any provider willing and able to participate. The court then found,
however, that the Louisiana statute did not regulate the business of insurance. The
statute was not specifically addressed to the insurance industry but applied to entities
such as employers and Taft Hartley trusts. Consequently, the court held that it did not
meet the common definition of insurance test or the third prong of the McCarran
Ferguson test. The legal challenges to the application of state AWP statutes to networks
established by health plans and provided to ERISA plans are certain to increase.

Capitated Administrative Services Only Contracts

Another legal battle is brewing over the extent to which providers who have contracted to
provide healthcare services to either health plans or self-funded employers on a
capitated basis are subject to the insurance laws. The answer depends on whether such
capitated contracts are construed as insurance contracts.

In an opinion dated 19 June 1990, the Maryland Attorney General addressed whether a
third party administrator that had established a provider network and offered that
network to self-funded ERISA plans was engaged in the business of insurance and,
thus, needed an insurance license. The Attorney General opined that it was not. The
123

Attorney General warned, however, that the providers might need an insurance license if
they agreed to be paid on a capitated basis. The rationale for the Attorney General's
opinion was that, by agreeing to be paid on a capitated basis, the providers had
assumed risk and, therefore, were engaged in the business of insurance. The Attorney
General concluded that an employer's creation of a self-funded employee benefit plan,

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protected from state regulation by ERISA, did not also exempt the providers of services
to that plan from state insurance regulation.

On May 18, 1995, the Office of the Georgia Commissioner of Insurance notified a
physician-hospital organization that offered its services on a capitated basis that the
Georgia insurance statutes "do not permit a hospital or medical group or combination of
both to provide healthcare services or benefits directly to patients for a monthly
capitation fee unless fully licensed as an insurer by this department." The
124

commissioner ordered the immediate discontinuance of the physician-hospital

organization's healthcare program unless it was being underwritten by a licensed
insurer. With respect to the issue of ERISA preemption, the commissioner took the
position that the healthcare program at issue was being offered to multiple employers
but did not meet ERISA's definition of an employee benefit plan.

Similarly, the Virginia Bureau of Insurance notified the health plan industry that
healthcare providers and other entities that provide healthcare services to self-funded
employers on a capitated basis either would have to obtain insurance licenses or would
have to provide such services through licensed entities, such a HMOs. If the healthcare
125

services were provided on a capitated basis by means of a contract with a health plan
that in turn contracted with a self-funded employer for administrative services only (a so-
called capitated administrative services only contract), then the capitated administrative
services only contract would be considered an at-risk contract by the Bureau of
Insurance and would be subject to the full panoply of the insurance code, including
reserves requirements and assessments. The Bureau of Insurance took the position that
capitated administrative services only contracts were insurance contracts and, therefore,
were saved from ERISA preemption by the savings clause.

It seems likely that health plans and integrated delivery systems will seek both legislative
and judicial relief from insurance commissioners' efforts to regulate capitated
arrangements and that ERISA will continue to play a prominent role.

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Chapter 8 A
Federal Government as Purchaser: Overview, TRICARE, and
FEHBP
After completing this lesson, you should be able to:

 Explain the government's dual role as purchaser and regulator of healthcare services
 Describe the evolution of the military health services system from CHAMPUS to
TRICARE, and describe TRICARE's triple benefit structure
 List the primary features of the Federal Employees Health Benefits Program
(FEHBP)
 Describe how actions taken by the Office of Personnel Management (OPM) have a
positive influence on FEHBP

Role as Purchaser
In Overview of Laws and Regulations and Federal Regulations of Health Plans, we
discussed the federal government's role as a regulator of healthcare. The federal
government also acts as a purchaser of healthcare benefits by operating healthcare
programs that serve federal employees, the military, the poor, and the elderly. As we
discussed in Overview of Laws and Regulations, federal employees have healthcare
coverage options under the Federal Employees Health Benefits Program (FEHBP).
Through TRICARE, formerly called CHAMPUS, healthcare benefits are available to
families of active-duty service members of the military and certain other individuals who
have an association with the military. Medicaid is a joint federal-state program that
provides medical benefits for low-income individuals, and Medicare covers certain health
expenses and benefits for persons age 65 and older. All are government-sponsored
healthcare benefits programs in which the federal government is the purchaser of
healthcare benefits or services.

Because the federal government is such a large purchaser of healthcare benefits and
services, the standards and rules it sets for the health plans with which it contracts often
become industry standards for all health plans or a large portion of a company's
business. For example, in areas where federal employees make up a large part of the
population, the volume of business a provider gains by participating in a plan that serves
federal employees allows the health plan to negotiate with providers to form a more
extensive network. The health plan can often negotiate favorable rates from the
providers who will be able to spread their financial risk among a larger pool of health
plan participants.

Fast Fact

Forty-seven percent of the total healthcare spending in the United States can be
attributed to government purchasers. 1

Approximately 5.5 million people are eligible for TRICARE benefits. 2

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However, in February 1998, former President Clinton instructed the Secretaries of

Health and Human Services, Labor, Defense, and Veterans Affairs and the Director of
the Office of Personnel Management to determine the extent of their compliance with the
Consumer Bill of Rights and Responsibilities and to initiate actions consistent with the
Patient Bill of Rights. FEHBP was created by the Federal Employees Health Benefits Act
of 1958 and is administered by the Office of Personnel Management (OPM), the human
resources agency of the U.S. government. Subsequently, the following actions occurred:

• The Secretary of Health and Human Services notified all state Medicaid directors
that emergency room care protections should be consistent with the Consumer
Bill of Rights.
• The Secretary of Defense issued a policy directive to ban all so-called "gag"
clauses and to ensure that all patients in the military health system can fully
discuss all treatment options.
• The Secretary of Veterans Affairs ensured that a sufficient appeals process is in
place throughout the Veterans Health System.
• The Director of OPM issued regulations for plans that participate in FEHBP to
prohibit practices that restrict physician-patient communications about medically
necessary treatment options.
• In March 1998, the Director of OPM announced an initiative to bring FEHBP
plans into compliance with the Patient Bill of Rights within the next two years.
Plans were required to report on their current compliance with the standards and
submit a proposal describing how they will bring their plans into compliance.

The Federal Employees Health Benefits Program (FEHBP)

As we discussed in Perspective and Overview of State and Federal Laws, the Federal
Employees Health Benefits Program (FEHBP) was created by the Federal Employees
Health Benefits Act of 1959 (FEHB Act) and is administered by the Office of Personnel
Management (OPM), the human resources agency of the U.S. government. Through the
FEHBP, the U.S. government provides health benefits to federal employees, retirees,
and their family members. FEHBP is the largest employer-sponsored health benefits
program in the United States. Federal employees enjoy the widest selection of health
plans in the country. The choices that FEHBP offers include managed fee-for-service
(FFS) plans, plans offering point-of-service (POS) options, and health maintenance
organizations (HMOs). Eighty percent of the FFS plans in FEHBP offer participants a
preferred provider organization (PPO) option. Figure 8A-1 describes some features of
FEHBP for beneficiaries.

Figure 8A-1 Features of FEHBP

1. Voluntary, annual enrollment

2. No pre-existing conditions, physical exam, or age requirements
3. Choice of HMOs, POS options, and fee-for-service plans
4. Self-only or self-and-family coverage is available, and coverage begins
immediately upon enrollment
5. Payroll deduction for premium contributions

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To help employees select the right kind and quality of care at the right price, the OPM
develops and distributes an annual Guide to Federal Employees Health Benefits Plans
for Federal Civilian Employees. This Guide is a clear, well-written presentation of both
general information, such as the OPM's statement of commitment to its customers, and
specific plan report cards. The plan report cards include premium and deductible
amounts, information on accreditation, status designations from the National Committee
for Quality Assurance (NCQA), and the results of recent surveys measuring the
satisfaction of plan participants. In addition to examining overall customer satisfaction,
the surveys measure consumer satisfaction on a number of specific issues, such as
those listed in Figure 8A-2. The Guide indicates which plans have received an overall
satisfaction score that is significantly higher than other plans.

All prepaid plans offered by FEHBP have health plan features such as preadmission
certification, the use of primary care providers as gatekeepers to coordinate medical
care, and a network of physicians and other providers. The minimum benefits that
FEHBP plans provide include hospital benefits, surgical benefits, physician services
benefits, ambulatory patient benefits, supplemental benefits, and obstetrical benefits.

Figure 8A-2. Measures of Customer Satisfaction with FEHBP.

1. Ability to see the same doctor on most visits

2. Access to medical care (arranging for and getting care)
3. Access to medical care in an emergency (POS and HMO only)
4. Choice of doctors available through the plan (plan members' ability to find
doctors they are satisfied with)
5. Costs that beneficiaries personally have to pay (FFS only)
6. Coverage (range of services covered)
7. Explanation of care (what is wrong, what is being done, and what to expect)
8. Getting appointments when sick
9. How quickly claims are processed (FFS only)
10. Quality of care (from doctors and other medical professionals)
11. Results of care
Source: Adapted, with permission of the publisher, from 1998 Guide to Federal Employees Health Benefits Plans for Federal Civilian
Employees, 1997, online, United States Office of Personnel Management, Available: http://www.opm.gov/insure.

Preemption Issues
In drafting the FEHB Act of 1958, Congress took steps to protect the uniformity of
services provided under FEHBP. Concerned about the effect of requirements that differ
from state to state, Congress specified in Section 8902(m)(1) that FEHBP contract
provisions "which relate to the nature or extent of coverage or benefits" preempt any
inconsistent state law. The preemption provision allows the federal government to
preempt state laws that relate to (a) the nature or extent of coverage or benefits or (b)
taxes, fees, or other monetary payments, imposed on a carrier, when such state
requirements are inconsistent with the provisions of the FEHBP contract.

Congress intended for this preemption to be broad to cover state law requirements that
destroyed the uniformity of FEHBP benefits or any rates or taxes. However, no one
knows the absolute breadth of federal preemption of state laws. Case law generally
upholds the broad scope of the preemption.

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Funding for FEHBP

Like most employers, the U.S. government makes a monetary contribution for health
benefits for its employees. The FEHP Manual states the the Government pays "72
percent of the average premium" toward the cost of health insurance premiums, but not
more than 75 percent of the total premium for any plan. For example, in 2002, the
biweekly average premium amounts are $135.61 for self-only and $309.66 for self-and-
family coverage. Accordingly, the maximum biweekly Government contribution is $97.68
for self and $223.41 for family. For some plans the actual figure the government pays is
4

a lower amount, because the FEHB Act specifies that the government's contribution
cannot exceed 75 percent of a plan's total premium. Therefore, for some plans with
5

relatively inexpensive premiums, the government may have to pay less than it otherwise
would to keep from exceeding the 75% limit. Federal employees contribute their portion
of the premium through payroll deduction.

OPM Administration of FEHB Program

With an administrative staff of 150, OPM manages health benefits worth more than $16
billion at an administrative cost of $20 million. OPM is responsible for:
6

• Determining which plans will be part of FEHBP

• Communicating a wealth of information to plan members so plan members can
make informed choices and so participating plans will compete to offer the best
care to federal employees
• Requiring participating plans to perform a large share of the administrative tasks
• Demanding attractive premium rates and auditing the plans periodically to ensure
that premiums were properly developed

These tasks, plus the creation and administration of a reserve fund, allow OPM to keep
FEHBP premiums as low as possible.

Selecting Participants for FEHBP

OPM is responsible for determining which plans will be offered as part of FEHBP. By
law, OPM must offer any federally qualified HMO that meets its requirements. In
principle, OPM accepts any plan that can satisfy its requirements. To be eligible to
participate in FEHBP, a plan must:

1. Demonstrate financial stability and have a management team that has

experience pertinent to the prepaid healthcare provider industry
2. Possess an enrollment of at least 300 subscribers (exceptions are made for new
plans and plans in rural areas with limited numbers of government workers), and
sufficient subscriber income to operate within a budget
3. Have a healthcare delivery system that provides reasonable access to and
choice of quality primary care and specialty care throughout the service area
4. Be able to establish firm budget projections that can be met on a regular basis
5. Comply with OPM's minimum standards for benefit design

Once a plan is accepted, it can stay in FEHBP as long as it continues to meet the
minimum standards as they are specified each year. Each spring, OPM sends all plan
providers its call letter, a document that specifies, among other things, the kinds of
benefits that must be available to plan participants and cost goals and procedural

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changes that the plans need to adopt. Figure 8A-3 provides a list of examples of
expanded benefits or other benefit changes in the last few years.

Figure 8A-3. Expanded benefits/benefit changes to FEHBP.

1. Minimum of 48 hours inpatient care for normal childbirth and 96 hours of

inpatient care for Cesarean deliveries
2. Option of inpatient care with stay of at least 48 hours for mastectomy patients
3. Mammography screenings according to the National Cancer Institute's minimum
standard
4. The elimination of annual dollar limits on mental healthcare coverage, in
accordance with the new Mental Health Parity Act
5. Better access to specialists for treatment of complex or serious conditions, and
improved continuity of care for such conditions when either the participant or the
provider leaves the plan
Source: Eric Minton, "Purchasing Lessons From the Feds," Business & Health, February 1998, 21-28.

Setting Premium Rates and Auditing Plans

For FFS plans, including PPOs, OPM actuaries annually determine the lowest premium
that is actuarially sound, and then OPM negotiates to establish that premium rate. In
each instance, the negotiated premium rate allows the plan to earn a fixed profit for
every subscriber; however, that profit per subscriber is a fraction of 1% of the premium.
This profit structure gives the FFS plans an incentive to compete for subscribers.

For HMOs and POS options, OPM uses a different approach to set premium rates. If
OPM attempted to negotiate premium rates with every health plan with which it
contracts, the staff of OPM would have to be much larger than it is now. Instead, OPM
requires each health plan or plan with a POS product to use the same rating
methodology (adjusted for differences in benefits) for FEHBP members that it would use
to determine rates for other similarly sized subscriber groups (SSSGs). For a health
plan, similarly sized subscriber groups (SSSGs) are two employer groups with which
the health plan contracts that:

• Have similar numbers of enrolled members (as would enroll under FEHBP)
• Use any rating method other than retrospective experience rating
• Meet other OPM rate criteria for this classification

Review Question

The following statements are about the Federal Employees Health Benefits Program
(FEHBP), which is administered by the Office of Personnel Management (OPM). Three
of the statements are true and one statement is false. Select the answer choice that
contains the FALSE statement.

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For every plan in the FEHBP, OPM annually determines the lowest premium that
is actuarially sound and then negotiates with each plan to establish that premium
rate.
Once a health plan has submitted its rate proposals for a contract year to the
OPM, it cannot adjust its premium rate for any reason.
To cover its administrative costs, OPM sets aside 1% of all FEHBP premiums.
Each spring, OPM sends all plan providers its call letter, a document that specifies
the kinds of benefits that must be available to plan participants and cost goals and
procedural changes that the plans need to adopt.

Correct. If OPM attempted to negotiate premium rates with every health plan with
which it contracts, the staff of OPM would have to be much larger than it is now.
Instead, OPM requires each health plan or plan with a POS product to use the
same rating methodology (adjusted for differences in benefits) for FEHBP
members that it would use to determine rates for other similarly sized subscriber
groups (SSSGs).

Incorrect. It is true that once a health plan has submitted its rate proposals for a
contract year to the OPM, it cannot adjust its premium rate for any reason.

Incorrect. To cover administrative costs OPM DOES set aside 1% of all FEHBP
premiums

Incorrect. Each spring, OPM DOES sends all plan providers call letter, a document
that specifies the kinds of benefits that must be available to plan participants and
cost goals and procedural changes that the plans need to adopt.

Historically, OPM required participating plans (i.e., the nonexperience-rated plans) to

use prospective community rating to determine premium rates for FEHBP. There was
some confusion over the definition of a community rate and the way plans were to
determine such a rate. To simplify program administration, OPM shifted the focus of its
premium negotiations to SSSGs.

Health plans must be careful and accurate in setting premium rates for FEHBP. Once a
health plan has submitted its rate proposals, due annually by May 31 of the year
preceding the contract year, it cannot adjust its premium rate for any reason. In addition,
the OPM has the authority to conduct periodic audits of any health plans participating in
FEHBP. The purpose of these audits is to verify that the rate was determined in
accordance with FEHBP requirements and that any benefit or loading added to the
FEHBP premium rate was reasonable and appropriate. If OPM auditors determine that a
health plan’s premium development process was defective, the auditors will recommend
that the health plan refund any overcharges to FEHBP. If the auditors determine that a
health plan intentionally presented a false claim to the U.S. government, the health plan
could be liable for a substantial civil penalty, including treble damages for each violation.

Fast Definition

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Loading - The charge added to a net premium to cover the plan's or insurer's costs of
doing business. 14

Creating and Administering a Reserve Fund

OPM creates a special rollover reserve fund and uses the amounts in this fund either to
increase the benefits it offers or to decrease the premium that must be charged. The
money in this reserve fund comes from two primary sources:

• To cover its administrative costs, OPM sets aside 1% of all FEHBP premiums. As
a result of the money-saving strategies applied by OPM, the cost of administering
FEHBP is only about two-tenths of that 1%, and OPM puts the remainder in the
reserve fund. 8

• OPM sets aside 3% of every premium and specifically tags this money for the
carrier that collects that premium.
9

Each year at rate-setting time, OPM takes everything above two months of reserves and
uses this amount either to add an extra benefit to the coverage or to decrease the
premium for the plan.

TRICARE
The military health services system (MHSS) is a worldwide healthcare system comprised
of more than 500 medical and dental treatment facilities called military treatment
facilities (MTFs), including 124 hospitals, that provide medical care to people entitled to
such care as defined by the Department of Defense (DOD). People entitled to such
12

medical care include members of the armed forces on active duty, other armed forces
members, their dependents, and certain other persons specified as eligible by the DOD. 13

In addition to providing direct medical care for eligible participants, the DOD also offers
healthcare benefits to certain qualifying individuals under a program entitled TRICARE.
Qualifying individuals include:

• Families of active-duty service members

• Retired service members, their spouses, and certain unmarried children
• Certain former spouses of members of the military

TRICARE is a regional managed healthcare program available to eligible beneficiaries,

as defined by the DOD. Insight 8A-1 provides a brief history of the development of
TRICARE. TRICARE offers three options for healthcare services: TRICARE Prime,
TRICARE Extra, and TRICARE Standard.

1. TRICARE Prime
2. TRICARE Extra
3. TRICARE Standard

TRICARE is unique because it is not insurance and, therefore, is not subject to state
regulation of insurance. Under TRICARE, the federal government pays for healthcare
services delivered by authorized providers to eligible individuals except under the

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demonstration programs where TRICARE Management Activity (TMA), discussed in the

following section, contracts with health plans to finance and deliver care. 18

Insight 8A-1. The Development of TRICARE.

As early as 1884, Congress directed that "medical officers of the Army and contract
surgeons shall whenever possible attend the families of officers and soldiers free of
charge." This system remained in place with very little change for nearly 50 years.

World War II and the Korean conflict strained the ability of the military medical care to
meet the medical needs of family members of active-duty service members. In 1943,
Congress authorized the Emergency Maternal and Infant Care Program (EMIC). EMIC
provided for maternity care and the care of infants up to one year of age for wives and
children of service members in the lower four pay grades. It was administered by the
"Children's Bureau," through state health departments.

On December 7, 1956, the Dependents' Medical Care Act was signed into law. In 1966,
Congress proposed amendments to this act that created the Civilian Health and Medical
Program for the Uniformed Services (CHAMPUS). Beginning in 1967, active-duty
family members and retirees and their family members were all eligible for medical
treatment under CHAMPUS. The CHAMPUS budget for Fiscal Year (FY) 1967 was
$106 million. The MHSS has converted the CHAMPUS program to a program that
incorporates the use of a health plan, called TRICARE. In FY 1996, the TRICARE
budget was more than $3.5 billion, and more than 20 million claims were received.
Today, nearly 5.5 million people are eligible for TRICARE benefits.
Source: Adapted and used with permission, THE HISTORY OF CHAMPUS AND ITS EVOLVING ROLE IN TRICARE, online, Tricare
Management Activity, hp, Available: http://www.ochampus.mil/Fact_Sheets/Historyoftricare.htm, 11 Mar. 1998.

TRICARE Prime - a voluntary, annual enrollment option similar to a civilian HMO that
offers the full range of benefits formerly available under CHAMPUS plus additional
preventive and primary care services, such as physical screenings. A point-of-service
(POS) option is also available. If the beneficiary receives care from the civilian and
military providers who make up the Prime network, there are no deductibles to meet, no
claims filings, and cost-sharing is low. If the beneficiary receives care outside the Prime
network under the POS option, there are annual deductible requirements, claims must be
filed, and cost-sharing is 50% of the TRICARE allowable charge. Although active-duty
service members are automatically enrolled in the TRICARE Prime option, these
personnel are strongly encouraged to complete an enrollment form. Active-duty
dependents and eligible retirees and their families who wish to be covered under
TRICARE Prime must apply for enrollment. Active Duty service members and their
families pay no enrollment fee for TRICARE Prime. Retirees and their families pay an
annual enrollment fee to participate in TRICARE Prime. 15

TRICARE Extra - A Preferred Provider Organization (PPO) option that does not require
enrollment and offers low out-of-pocket costs for those beneficiaries who choose to
obtain care from network providers. There are annual deductible requirements but no
claims filings as long as the care is delivered by a PPO provider. 16

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TRICARE Standard - the same as the current CHAMPUS benefit and cost-sharing
structure. Under this option, TRICARE pays a share of the cost of covered health services
that are obtained from non-network providers. The cost-sharing for the beneficiary under
this option is higher than the other two options, but the beneficiary has the most freedom
to choose providers. No enrollment is required, but there are annual deductible and
claims filing requirements.
17

Review Question

TRICARE, a military healthcare program, offers eligible beneficiaries three options for
healthcare services: TRICARE Prime, TRICARE Extra, and TRICARE Standard. With
respect to plan features, both an annual deductible and claims filing requirements must
be met, regardless of whether care is delivered by network providers, under

TRICARE Prime and TRICARE Extra only

TRICARE Extra and TRICARE Standard only
TRICARE Standard only
none of these healthcare options

Incorrect. TRICARE and Extra offer no claims filings, and TRICARE Prime has no
deductible.

Incorrect. TRICARE Extra does not have claims filing

Correct. TRICARE Standard has both deductibles and claims filings

Incorrect. One of the three TRICARE options has deductibles and claims filing

Administration, Funding, and Benefits of TRICARE

Although three different cabinet secretaries-the Secretary of Defense, the Secretary of
Health and Human Services, and the Secretary of Transportation-share the regulatory
authority over TRICARE, the responsibility for providing policy guidance, management
control, and coordination for TRICARE belongs to the Assistant Secretary of Defense for
health affairs. TRICARE is administered by TRICARE Management Activity (TMA),
19

formerly called the Office of CHAMPUS (OCHAMPUS), and the TRICARE Support
Office (TSO).

Through its annual appropriations to the DOD and the Department of Health and Human
Services, Congress provides the funds used by TRICARE to pay benefits. Fiscal
intermediaries (FIs), who are disbursing agents under contract to the federal
government or TRICARE contractors, use these federal funds to pay TRICARE benefits
only; such funds are not used to pay claims under any other programs.

TRICARE benefits include most inpatient and outpatient health services, a large portion
of provider charges, medical supplies and equipment, and mental health services. In

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recent years, TRICARE benefits have been expanded to include liver, heart, lung, and
heart-lung transplants, as well as hospice care. Ambulatory surgical centers and free-
standing birthing centers have also been added to the list of authorized providers of care
for TRICARE. 20

Transition to TRICARE
Between 1985 and 1990, CHAMPUS expenditures and CHAMPUS claims more than
doubled. To address these factors, the DOD began several demonstration projects in
21

various parts of the United States through a project called the CHAMPUS Reform
Initiative (CRI). Each demonstration experimented with applying certain health plan
techniques to the services available under CHAMPUS.

Additionally, by enacting the National Defense Authorization Act for Fiscal 1994,
Congress directed the DOD to develop and implement a health benefit option under
CHAMPUS patterned after private-sector HMOs and other similar government health
insurance programs. Based on the demonstration programs initiated in the late 1980s
through CRI and following Congress' directive in 1994, TRICARE was developed.

Administration and Payment Mechanisms of TRICARE

Before attempting to implement TRICARE, the DOD divided the United States into 12
health services regions. Each health services region is administered by a Lead Agent
who works with the region's military treatment facility (MTF) commanders to develop an
integrated plan for the delivery of healthcare to eligible beneficiaries. A Lead Agent's
22

responsibilities include ensuring the appropriate referral of patients between the direct
care system and civilian providers, especially managing specialized treatment services.
The nature of the TRICARE program is regional as evidenced by the seven health
services regions. Due to its regional nature, some TRICARE features vary from one
region to the next, but other TRICARE features are the same in every region. Figure 8A-
4 describes features that are the same in every TRICARE region.

Figure 8A-4. Uniform TRICARE Features.

• Incentives based on enrollment status and network provider use—Beneficiaries

have financial incentives to enroll in managed care plans and to use network
providers. Such differentials are designed as incentives to use the system that
better ensures high-quality care and low costs.
• Primary care managers—MTF commanders have the flexibility to assign each
enrolled beneficiary to, or to allow each beneficiary to choose, a primary care
manager who has overall responsibility for managing the care provided to the
beneficiary and family.
• Greater uniformity in scope of covered services—To minimize beneficiary
confusion, the services covered under TRICARE will be as uniform as possible.
• Utilization management and quality assurance programs— Refinement and
expansions of existing utilization management and quality assurance policies
throughout the MHSS permit the DOD and the military service medical
departments to ensure quality improvement and cost effectiveness of TRICARE
within and among geographic regions.

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• Marketing strategies—A critical responsibility of managers at alllevels is to

communicate all changes in the way healthcare is delivered and received in the
TRICARE program to all those affected. An extensive education program for both
beneficiaries and healthcare providers is being [used to accompany the transition
from CHAMPUS to TRICARE.] This education program focuses on informing
beneficiaries of the options available in seeking healthcare and ensuring that
beneficiaries understand how they can maintain and improve their own health
status through family risk management, diet, exercise, and appropriate use of
health services.
Source: Reprinted from Peter R. Kongstvedt, MD, ed., The Managed Health Care Handbook, Third Edition, © 1996, p. 785, with permission
from Aspen Publishers, Inc., Gaithersburg, MD (1-800-638-8437).

Enrollment-based Capitation Capitation 23

A major component of TRICARE is the series of health plan support contracts that
supplement the capabilities of regional military healthcare delivery networks. These
contracts have been developed in coordination with the Lead Agents and procured by
the Department of Defense on a competitive basis. The TRICARE support contractors
develop networks of civilian providers around the MTFs and other prime service areas,
facilitate locating providers for beneficiaries, perform utilization management functions,
process claims, and provide beneficiary support functions. There are seven fixed-price,
at-risk contracts supporting the TRICARE regions.

Enrollment-based capitation (EBC) is being initiated throughout the MHSS to allow MTF
commanders full accountability for all resources used by the TRICARE Prime enrolled
populations. Under EBC, commanders commanders will know exactly which TRICARE
Prime patients they are responsible for and how much money they are being given to
care for these patients. There are essentially three components of EBC:

1. A per member per month (PMPM) “premium” earned by the MTF for each
TRICARE Prime patient enrolled
2. Additional revenues earned by the MTF for providing care for patients on a
space-available basis, as capacity permits
3. A system of referrals under which the referring institution is billed for the
treatment provided TRICARE Prime enrollees who are sent out for specialty care

This earning of revenues and purchasing of care will be reconciled on a monthly basis
and could result in a transfer of funds within and between the military departments.

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Chapter 8 B
Medicare and Health Plans
After completing this lesson, you should be able to:

 Describe the three major types of Medicare+Choice plans

 Explain the certification process for a Medicare PSO
 List the three ways that payment rates will be determined for health plans under
Medicare+Choice
 Explain how a Medicare Medical Savings Account works
 Describe health plan contracting standards under the Medicare+Choice program
 Provide examples of Medicare marketing restrictions

Editor's Note
On December 8, 2003, President George W. Bush signed into law the Medicare
Modernization Act of 2003 (MMA), taking steps to expand private sector health care
choices for current and future generations of Medicare beneficiaries. The MMA proposes
short-term and long-term reforms that build upon more than 30 years of private sector
participation in Medicare.

The centerpiece of the legislation is the new voluntary prescription drug benefit that will
be made available to all Medicare beneficiaries in 2006. Additional changes to the
Medicare+Choice (M+C) program include:

• Medicare+Choice program’s name is changed to Medicare Advantage (MA);

• Increased funding is provided for MA plans in 2004 and 2005;
• MA regional plans are established effective 2006.

On January 16, 2004 CMS announced new county base payment rates for the MA
program. Beginning March 1, 2004, all county MA base rates received an increase which
plans are required to use for enhanced benefits. Plans may use the extra money in one
of four ways:

• Reduce enrollee cost sharing;

• Enhance benefits for enrollees;
• Increase access to providers;
• Utilize the stabilization fund.

The short-term reforms have already improved benefits and reduced out-of-pocket costs
for millions of Medicare beneficiaries who are covered by health plans in the Medicare
Advantage program, previously known as the Medicare+Choice program. These
coverage improvements became effective on March 1, 2004.

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Beginning in 2006, the MMA will provide beneficiaries with a broader range of private
health plan choices similar to those that are available to working-age Americans and
federal employees. In addition to the locally-based health plans that currently cover more
than 4.6 million Medicare beneficiaries, regional PPO-style plans will be available as a
permanent option under the Medicare Advantage program.

Final regulations were released in January, 2005, and this chapter's content will be
updated in July, 2005 to reflect the new regulatory changes.

Overview and Background

In 1965, President Lyndon B. Johnson signed Medicare into law. Medicare is a federal
government hospital expense and medical expense plan for persons age 65 and older
and for certain other persons as specified by law. Under the Act that established
Medicare, the Medicare program was to be funded by payroll deductions, federal
subsidies, and (initially) $3.00 per month in individual premiums. In 1972, the Medicare
program was extended to include persons of all ages with end-stage renal disease and
those receiving Social Security disability payments. 1

Over the years since Medicare was initiated, a growing percentage of the nation's elderly
population has received health insurance through the program. Figure 8B-1 illustrates
the growth Medicare has experienced since its inception.

Originally, Medicare consisted of two parts: Hospital Insurance (Part A) and Medical
Insurance (Part B). Medicare Part A provides coverage of inpatient hospital services,
skilled nursing facilities, and hospice care. Medicare Part B helps pay for the cost of
2

physician services, outpatient hospital services, home health care, medical equipment,
and other health services and supplies.

In 1997, a Congressional budget act, entitled the Balanced Budget Act of 1997, added a
Part C (also called Medicare+Choice) to Medicare. Medicare+Choice is a portion of the
Medicare program, and is designed to (1) expand the healthcare coverage choices
available to Medicare beneficiaries by allowing more types of health plans to apply for
Medicare contracts, and (2) change the system for determining the rates that will be paid
to health plans with Medicare contracts. We will examine these changes in more detail
later in this lesson.

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Figure 8B-1. Medicare Enrollment Trends.

65+ Disability Total
Enrollment Enrollment Enrollment
July (In millions)
1966 19.1 -- 19.1
1970 20.5 -- 20.5
1975 22.8 2.2 25.0
1980 25.5 3.0 28.5
1985 28.2 2.9 31.1
1990 30.9 3.3 34.2
1991 31.5 3.4 34.9
1992 32.0 3.6 35.6
1993 32.4 3.8 36.3
1994 32.8 4.1 36.9
1995 33.0 4.3 37.3
1996 33.4 4.7 38.1
1997 33.6 5.0 38.6
1998 33.8 5.3 39.1

Source: CMS Statistics: Populations, Centers for Medicare and Medicaid Services, online, Available:
http://www.hcfa.gov/stats/hstats96/blustats.htm, 9 Sept. 1998.

Administration of the Medicare Program

As we discussed in Overview of Laws and Regulations, the Centers for Medicare and
Medicaid Services (CMS), a division of the Department of Health and Human Services
(HHS), administers the Medicare program. CMS is responsible for contracting with
health plans that wish to participate in the Medicare program. In addition, CMS develops
rules and regulations to implement various laws, such as the Balanced Budget Act of
1997, that impact the Medicare program. In a later section of this lesson, we will discuss
CMS's role in more detail.

Why Use Health Plans for Medicare?

Although Medicare covers hospitalization and many other medical services, it does not
usually pay the full costs of those services. Coverage is subject to both deductible and
coinsurance provisions. Also, a number of healthcare services are not covered under
Medicare. For example, fee-for-service (FFS) Medicare generally does not pay for
benefits such as prescription drugs, eyeglasses, hearing aids, routine physical exams,
and basic dental services. Medicare beneficiaries often purchase supplemental
3

insurance for healthcare expenses or services that are not covered by FFS Medicare.
This supplemental insurance is called Medigap. In the large majority of Medicare
markets where qualified HMOs have provided services, however, HMO enrollees have
seen a reduced need for Medigap insurance because HMOs offer more comprehensive
coverage to their Medicare enrollees than FFS Medicare.

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Another important reason the federal government has passed laws encouraging health
plans in the Medicare market is that, under the predominantly FFS system, Medicare
outlays have been growing rapidly. In fiscal year 1980, Medicare spending totaled $33.9
billion. By 1998, this amount had increased to $231.1 billion. With the baby-boomer
4 5

generation entering the Medicare program, many experts believe that without significant
reform Medicare Part A will become insolvent around the year 2010. Because health
plans have proven to be an instrumental tool in managing commercial healthcare costs,
the federal government is increasingly turning to health plans to help contain Medicare
costs.

Although the original Medicare law included opportunities for health plans to participate
in Medicare on a cost-reimbursement basis, in many markets this program was of limited
attractiveness to health plans. In 1972, Section 1876 of the Social Security Act was
enacted. Section 1876 allowed both cost-based and partial-risk Medicare health plan
contracts. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) amended
Section 1876 to include provisions that enabled health plans to participate in the
Medicare program on a full-risk basis. Figure 8B-2 describes the differences between
risk and cost contracts. Increasingly, Congress and CMS, in its role as administrator, are
focusing on a risk-based approach for the Medicare program. And, as described in
Figure 8B-2, cost contracts will be completely phased out of the program by the end of
the year 2002.

Figure 8B-2. Risk vs. Cost Contracts.

Since 1972, the federal government has provided payment to Medicare health plans
through two main types of contracts: risk contracts and cost contracts. Provisions in
Section 1876 of the Social Security Act allow for the formation of Medicare risk and cost
contracts. As a result, Medicare risk and cost contracts are sometimes referred to as
"Section 1876" contracts.

All Medicare-contracting health plans (both cost and risk plans) are required to provide
Medicare covered benefits. In addition, as an optional benefits package, services that are
not covered by Medicare may be offered by such plans. The plans may charge enrollees
an additional premium for those benefits packages.

Medicare Risk Contracts

Health plans with Medicare risk contracts are considered to be "at risk" because they are
financially responsible for providing beneficiaries with all necessary healthcare services
covered by Medicare. Risk plans receive a set amount of money from CMS each month
for each plan member, regardless of the amount of services the beneficiary requires in
any given month. The amount paid to the health plan varies depending on the category of
the enrollee, e.g., the enrollee's age, sex, institutional status, and Medicaid status.

Each year, a Medicare risk contracting plan is required to submit to CMS its adjusted
community rate (ACR). The ACR is the estimated premium that the plan would have to
charge Medicare enrollees for Medicare covered services, independent of Medicare
payments, less coinsurance and deductibles. The plan bases the ACR on the same rates it
charges to its non-Medicare enrollees, adjusting for Medicare enrollees' utilization.

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A risk contracting health plan may be required to offer "additional benefits" at no

additional charge or to lower its premium if the organization achieves a "savings" from
its Medicare payments. A savings is achieved when the plan's ACR is less than the plan's
average Medicare payment rate. A risk contracting plan may elect not to pass back all of
its savings to enrollees but to instead have the saving withheld and placed by CMS in a
benefit stabilization fund. A benefit stabilization fund is a fund established by CMS, at
the request of a risk HMO or CMP, to withhold a portion of the per capita payments
available to the HMO or CMP and to pay that withheld portion in a subsequent contract
period for the purpose of stabilizing fluctuations in the additional benefits the HMO or
CMP provides to its Medicare enrollees.

Medicare risk contracting health plans may also choose to offer mandatory supplemental
benefits, which are benefits that are not paid for by Medicare but that the plan requires its
members to accept and pay extra for as a condition of membership. Required
supplemental services must be approved by CMS. Unless an enrollee is enrolled in a
point-of-service (POS) plan, an enrollee of a risk contracting health plan is required to
obtain all Medicare services (except hospice, emergency, and urgently needed services)
from the plan. This is called the "lock-in rule." If the enrollee obtains such items or
services outside the risk plan's network, neither the plan nor Medicare is required to pay
for them. Electing a risk plan with a POS option provides enrollees with the right to
receive a limited amount of healthcare services outside the plan's provider network.

According to CMS statistics, as of July 1, 1998, risk contract plans accounted for 76.9%
of all Medicare health plans, and enrolled nearly 90% of those beneficiaries who were in
Medicare health plans.

On May 1, 1998, CMS discontinued accepting applications from plans to enter into
Medicare risk contracts because on January 1, 1999, the Medicare risk contracting
program will be replaced with the Medicare+Choice program, which we discuss later in
this lesson.

Medicare Cost Contracts

Organizations with cost contracts are reimbursed for health services by the government
using an allocation-of-costs system that is ultimately based on the amount of services
provided rather than on the number of enrollees served by the organization. (Health Care
Prepayment Plans--HCPPs--which cover part or all of the Medicare Part B services, but
not Part A services, also are reimbursed for health services on an allocation-of-costs
basis.) Administrative costs not related to health services are allocated based on the ratio
of the number of Medicare enrollees the plan serves to the number of total enrollees the
plan serves.

Enrollees of cost-based plans are not "locked in" to using the plan's network providers,
unless the enrollees elect to obtain non-Medicare covered supplemental benefits.
Enrollees of cost-based plans may receive services from non-network providers subject to
the usual Medicare deductible and coinsurance obligations.

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A provision of the Balanced Budget Act of 1997 calls for the phase out of cost contracts
by the end of 2002, and provides for the phase out of the HCPP program for health plans
by the end of 1998.

Medicare Choices Demonstration Project

Medicare Choices demonstration project was authorized by CMS in 1995. The project's
purposes were to provide Medicare beneficiaries with more delivery system choices and
to test alternative payment methods. Some of these payment methods involved risk-
adjusted payments, in which payments were adjusted to reflect diagnoses or the health
status of plan enrollees. In many particulars, these demonstration projects were a
precursor to the much broader changes in Medicare that came about through the
Balanced Budget Act of 1997, which we examine next.

Medicare and The Balanced Budget Act of 1997 (BBA)

The Balanced Budget Act (BBA) of 1997 (Public Law 105-33) has made the most
sweeping changes in federal healthcare programs since the inception of Medicare in
1965. The goal of the legislation is to reduce the federal budget by $115 billion over the
next 5 years and, in the process, protect the Medicare Part A fund to provide solvency
through at least the year 2007. 6

One of the most significant changes in Medicare brought on by the BBA is the creation
of Medicare+Choice. All individuals who are enrolled in Medicare Part B and are entitled
to benefits under Medicare Part A are eligible to enroll in any Medicare+Choice plan
available in their area or residence, except those people with end-stage renal disease
who were not already enrolled in a Medicare+Choice plan at the time of diagnosis. 7

Where Medicare Parts A and B address covered services under the traditional FFS
system, Part C addresses alternative methods of delivery of Medicare services and
increases beneficiaries' choices of Medicare delivery systems. A Medicare+Choice plan
can be any one of the following:
1. Coordinated care plan (i.e., an HMO with or without a point-of-service option, a
preferred provider organization [PPO], a provider sponsored organization [PSO],
or a plan offered by a religious/fraternal organization)
2. Private, fee-for-service plan
3. Combination of a medical savings account (MSA) plan and contributions to a
Medicare+Choice MSA

Major Provisions of the BBA under Medicare+Choice

Provisions of the BBA specify the types of organizations that are eligible to participate in
Medicare+Choice and outline the steps in the process by which health plans can seek
approval for participation in Medicare.

New Types of Contracting Entities

Under Section 1876 (prior to enactment of the BBA), a health plan had to qualify as a
competitive medical plan (CMP) or as a federally qualified HMO in order to participate in
the Medicare program as a Medicare risk entity. Through Medicare+Choice, the BBA
expanded the types of health plans that may qualify to contract with CMS for the
purposes of providing covered services to Medicare beneficiaries. As noted above,
organizations that may qualify for such contracts include, but are not limited to, HMOs,

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PPOs, PSOs, and religious/fraternal benefit societies that meet the requirements of the
law.

Requirements for Medicare+Choice Organizations

Many of the new provisions outlined in the BBA directly affect how health plans are
required to qualify and operate as Medicare+Choice providers. For example, the BBA
establishes new rules for qualifying for a Medicare contract as a coordinated care plan.
All Medicare+Choice coordinated care plans must comply with requirements for
Medicare benefit packages, marketing, enrollment, appeals and grievances, solvency,
quality assurance (QA), reporting, and other processes. Health plans with Medicare
contracts have always had to meet requirements in these categories, but in some cases
the Medicare+Choice requirements within specific categories have changed. For
example, health plans have always been subject to solvency requirements, but as we
will discuss later in this lesson, the solvency requirements have been changed for some
PSOs in specific situations defined under the Medicare+Choice program. The following
sections describe the requirements that contracting entities must meet to participate in
Medicare+Choice. Because the provisions in Medicare+Choice set forth provisions
specific to PSOs for the first time, later in this lesson we will also discuss some specific
requirements that apply to PSOs.

Health Plan Medicare+Choice Contracting

CMS oversees Medicare contracting with all Medicare+Choice organizations. All
Medicare+Choice coordinated care plans must comply with the interim final regulations
published by CMS in June 1998. These regulations are based on the regulations that
implemented Section 1876. Plans that had risk contracts in "good standing" before the
Medicare+Choice program and that submit the required supplemental information to
demonstrate compliance with Medicare+Choice requirements will be transitioned to the
Medicare+Choice program January 1, 1999.

Licensing
Coordinated care plans under the Medicare+Choice program must be state licensed as
risk-bearing entities. Medicare PSOs, however, may seek a waiver of this requirement
under certain conditions, which we will discuss later in this lesson. State licensure laws
govern the solvency standards that apply to such entities.

PSO Solvency and Licensure

A Medicare Provider-Sponsored Organization (Medicare PSO) is an organization
operated by hospitals or other affiliated groups of healthcare providers that provides a
substantial portion of healthcare treatments and services under its Medicare contract
through its affiliated providers. Medicare PSOs must also accept substantial financial risk
in delivering this healthcare, and the affiliated providers must have a majority financial
ownership in the PSO. PSOs "provide a way for doctors and hospitals to contract with
Medicare and to take capitated risk directly from Medicare for the patients to whom they
provide services. It is the combination of provider control and the direct provision of
services" by the owner-providers and affiliated providers that distinguishes PSOs from
many HMOs. 8

Medicare PSO Solvency Requirements

Medicare PSO solvency standards are divided into three parts: the (1) initial stage, (2)
ongoing stage, and (3) insolvency. In the initial stage, prior to CMS approval, the PSO
typically must have a minimum net worth of $1.5 million. CMS, however, may reduce this
required amount to $1 million if the PSO can demonstrate that its start-up costs will be

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reduced as a result of its administrative infrastructure. In addition, the PSO must have a
financial plan that demonstrates that it has sufficient resources to cover losses through a
period 12 months beyond its projected break-even point.

To meet the ongoing net worth requirements, the PSO must have a minimum net worth
that meets the greater of four amounts. Figure 8B-3 defines these four amounts.

To meet the liquidity requirements, the PSO must demonstrate that it can meet its
financial obligations as they come due and that it has the greater of $750,000 in cash or
cash equivalents or 40% of the minimum net worth required.

With regard to the insolvency portion of the requirements, the PSO must make a
$100,000 insolvency deposit in accordance with CMS instructions. In addition, consistent
with the NAIC HMO Model Act (see State HMO and Other Types of Health Plan Laws),
the PSO is obligated to have hold-harmless clauses in its provider contracts and have a
plan for the continuation of benefits for a specified period in the event of insolvency.

Review Question

Solvency standards for Medicare provider-sponsored organizations (PSOs) are divided

into three parts: (1) the initial stage, (2) the ongoing stage, and (3) insolvency. In the
initial stage, prior to CMS approval, a Medicare PSO typically must have a minimum net
worth of

$750,000
$1,000,000

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$1,500,000
$2,000,000

Incorrect. To meet the liquidity requirements, the PSO must demonstrate that it
can meet its financial obligations as they come due and that it has the greater of
$750,000 in cash or cash equivalents or 40% of the minimum net worth required

Incorrect. In the initial stage prior to CMS approval, a PSOs minimum net work
must be an amount greater than $1 million. CMS, however, may reduce this
required amount to $1 million if the PSO can demonstrate that its start-up costs
will be reduced as a result of its administrative infrastructure.

Correct. In the initial stage, prior to CMS approval, the PSO typically must have a
minimum net worth of $1.5 million

Incorrect. A Medicare PSOs net worth in the initial stage can be less than $2
million

Medicare PSO Licensure Requirements

As a general rule, Medicare PSOs must secure state licensure as risk-bearing entities.
However, the HHS Secretary may grant a PSO a waiver from this requirement through
November 2002 under certain conditions. The HHS Secretary will grant a waiver if the
state:
1) Fails to complete action on the PSO's licensure application within 90 days
2) Denies the PSO's application and the state standards or review process
imposes material requirements or procedures on PSOs that are not required of
other entities engaged in substantially similar business, or the state requires the
PSO to offer a product or plan other than Medicare+Choice
3) Denies the PSO's application based on the PSO's failure to meet solvency
requirements that are different from those developed and published by the HHS
secretary, or the state imposes documentation or information requirements
relating to solvency that are different from the standards promulgated by the HHS
secretary.

Under the BBA, a waiver is effective for a maximum of 36 months and is nonrenewable.
PSOs that submit a waiver request must do so no later than November 1, 2002. The
HHS secretary must grant or deny a waiver within 60 days of the time the PSO files a
substantially complete waiver application. PSOs that have received waivers must submit
an application to the secretary for certification (and periodic recertification) that the PSO
meets federal solvency standards. The secretary must act upon each of these
applications within 90 days.

As noted above, by the end of 2002, this waiver process will be discontinued.

Minimum Enrollment Requirements

New minimum Medicare+Choice enrollment requirements for PSOs are 1,500 members
in urban areas and 500 in rural areas. In certain circumstances, PSOs may request that
Medicare waive this requirement for the first three years. This enrollment standard for
PSOs differs from the Medicare+Choice enrollment standards for other plans, which are

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required to have a minimum enrollment of 5,000 (or 1,500 if the organization primarily
operates in nonurban areas). Under the BBA, the old "50/50" rule requiring that health
plans enroll 50% Medicare and 50% non-Medicare beneficiaries has been eliminated for
all health plans including PSOs.

Option to Use Medical Savings Accounts (MSAs)

The BBA also created the Medical Savings Account (MSA) national demonstration
project. The Medicare MSA demonstration project is limited to 390,000 beneficiaries,
with no new enrollment accepted after January 1, 2003. Medical Savings Accounts
9

(MSAs) are "health insurance arrangements that give consumers a financial incentive to
control their own healthcare costs by combining a high-deductible health insurance
policy with an individual savings account." A Medicare+Choice Medical Savings
10

Account is a tax-preferred account set up for individual Medicare beneficiaries and to

which CMS makes contributions on behalf of the beneficiary. Individuals who choose to
establish Medicare+Choice MSAs purchase a catastrophic MSA health policy with high
deductibles and out-of-pocket expenses of not more than $6,000 in 1999. After the
deductible and out-of-pocket expenses are met, Medicare covered services are paid at
100%.

Beneficiaries are not allowed to deposit their own funds in their MSA account. Instead,
Medicare+Choice MSAs may only receive funds from CMS. Deposits and earnings are
not taxable. Likewise, withdrawals are free from federal income tax if used for qualified
medical expenses, as defined by the Internal Revenue Code, for the beneficiary.
Withdrawals can be used to pay medical expenses that are not covered under the high-
deductible health insurance policy.

MSA plans are the high-deductible plans that beneficiaries must obtain in conjunction
with the establishment of an MSA. In general, MSA plans are subject to the same
requirements as other Medicare+Choice plans.

MSA plans are required to cover at least 100% of the cost of Medicare-covered items
and services or 100% of the amounts that would have been paid under Medicare, but
only after the enrollee incurs accountable expenses equal to the amount of the annual
deductible. If the Medicare+Choice payment exceeds the MSA plan premium, the
difference is deposited in the beneficiary's MSA.

Benefit Requirements
Coordinated care plans with Medicare contracts are required to offer members standard
covered items and services available in the basic fee-for-service Medicare benefit
package. Additional services may be offered as part of the benefit package, or as a
supplement for which members may be required to pay extra. Coordinated care plans
with Medicare contracts must also cover out-of-network services as follows:

1. Provide coverage of emergency services based on the "prudent layperson"

standard
2. Provide coverage of urgently needed services received outside the plan's
network when such services are medically necessary and immediately required
because of unforeseen illness or injury and it was not reasonable, given the
circumstances, to obtain the services through the plan

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3. Provide renal dialysis treatment to eligible members who are temporarily out of
the network area
4. Provide post-stabilization care covered under guidelines established by the HHS
secretary

The BBA expanded Medicare coverage of preventive benefits for members. Figure 8B-4
outlines the expanded coverage and the effective dates. The BBA also provides for
Medicare coverage of outpatient diabetes self-management training services and blood
glucose strips. In addition, the National Academy of Sciences has been directed to study
the desirability of requiring coverage for other preventive care benefits including
nutritional therapy, skin cancer screening, and additional coverage for
immunosuppressive drugs. 11

Figure 8B-4. New Preventive Health Benefits Requirements.

Benefit Effective Date
Annual Screening Mammography (for women over 40) January 1, 1998
Screening PAP Smear and Pelvic Exam (every 3 years) January 1, 1998
Colorectal Cancer Screening Exam January 1, 1998
Bone Density Measurement (to rule out osteoporosis) July 1, 1998
Diabetic Test Strips July 1, 1998
Prostate Cancer Screening Exam (for men over 50) January 1, 2000

Rate Determinations
Medicare reforms under the BBA make significant changes in payment rates to Medicare
coordinated care plans. Historically, payments to Medicare risk plans were based on
95% of the adjusted average per capita cost (AAPCC). The adjusted average per capita
cost (AAPCC) is the estimated cost, adjusted for certain demographic factors such as
age, gender, and health status, of covering Medicare beneficiaries under the fee-for-
service system in a particular county. In 1998, CMS implemented a new payment
methodology, authorized under the BBA for the Medicare+Choice program.

Changes in Payment Rates for Medicare+Choice Plans

In creating Medicare Part C, and eliminating the AAPCC, the BBA made several
significant changes in the way in which payment rates for Medicare health plans are
determined:

1. Payments in local markets will be based on the highest of three rates: a minimum
percentage increase over the previous year's rates; a blended rate using a
weighted average of the local rate and national rates; and a minimum rate that
sets a "floor" payment for markets with historically low rates. Figure 8B-5
describes this process.
2. Over time, Medicare payments for medical education costs will be carved out of
the new rate calculations
3. Beginning in 2000, the HHS Secretary must implement a risk adjustment
methodology to account for variations in per capita costs resulting from the health
status of enrollees

Figure 8B- Determining Medicare's Monthly Payment Rate under the

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5. Medicare+Choice Program.

Starting January 1, 1998, Medicare's payment rate for any given geographical area will
equal the largest of the following three amounts:

1. Blended rate (a rate determined by blending a weighted average of an area-

specific rate and a national rate)
2. A floor amount (a minimum monthly payment rate per enrollee) of $367 in
1998. In following years, this floor amount will equal the previous year's floor
amount increased by the national per capita Medicare+Choice growth percentage.
3. The previous year's rate increased by 2%.

For 1998 and 1999, the majority of plans will receive a 2% increase over the previous
year's rate. Additional BBA provisions stipulate that, over time, the calculation of
blended rates will change so that the national rate component will increase in weight
compared to the local rate component. Eventually the blended rate will move to a fifty-
fifty blend of national and local costs. For example, the blend will move from 90% local
and 10% national in 1998 to 50% local and 50% national by 2003.

States can also request a geographic adjustment to a Medicare payment area. These
adjustments can seek to create a single statewide payment area, metropolitan payment
areas, or consolidate into a single payment area noncontiguous counties within the
state. However, these adjustments in payment areas must be budget neutral.

One result of these changes in the ways that payment rates are determined is that
annual adjustments to the payment rates will no longer be based solely on Medicare
spending for fee-for-service beneficiaries in a given geographic area. Instead, as noted
above, in some cases national payment averages will affect local payment rates, some
local areas will be paid the "floor" rate, and some areas will be affected by the minimum
percentage increase rate. 12

Congress's intent in making the changes in payment methodology under the BBA as
described above and in Figure 8B-5 appears to have been to:

• Increase rates in rural, traditionally low payment areas

• Reduce, over time, geographic variations in payment rates

These changes have important implications for organizations with Medicare+Choice

contracts. The new BBA payment methodology narrows the geographic variations in
payments by both lowering the growth rate of payments in high-payment counties and
raising the rates in low-payment counties. As a result, the BBA reduces the growth in
rates in many markets relative to what the payment rates in those markets would have
been without BBA implementation. Furthermore, average payment rates for coordinated
care plans under Medicare+Choice will fall relative to payment rates in the fee-for-
service side of the program. The implementation of a risk adjustment methodology in
2000 is expected to further reduce Medicare+Choice payments relative to the FFS

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program. As a result of these constraints in Medicare+Choice payment rates, many

coordinated care plans may have to cut benefits, raise premiums, or do both.

The BBA also provides for testing of changes to payment methodologies in the future.
For example, Section 4012 of the BBA requires HHS to establish a Competitive Pricing
Advisory Committee (CPAC). CPAC will recommend geographic areas and will consult
with the HHS secretary to develop price-setting methodologies to be used in a
demonstration project that is designed to test competitive pricing. Other demonstration
13

projects and committees will be discussed in more detail later in this lesson

Review Question

The Balanced Budget Act (BBA) of 1997 created the Medicare+Choice plan. One
provision of the BBA under Medicare+Choice is that the BBA

requires health plans to qualify as either a competitive medical plan (CMP) or a

federally qualified HMO in order to participate in the Medicare program
eliminates funding for demonstration projects such as the Medicare Enrollment
Demonstration Project
narrows the geographic variations in payments to Medicare health plans by
lowering the growth rate of payments in high-payment counties and raising the
rates in low-payment counties
increases Graduate Medical Education (GME) payments to hospitals for the
training and cost of educating and training residents

Incorrect. Through Medicare+Choice, the BBA expanded the types of health plans
that may qualify to contract with CMS including, but are not limited to, HMOs,
PPOs, PSOs, and religious/fraternal benefit societies that meet the requirements
of the law.

Incorrect. In addition to the Medeicare Enrollment Demonstration Project, the BBA

funds several other demonstration projects

Correct. The BBA payment methodology narrows the geographic variations in

payments by both lowering the growth rate of payments in high-payment counties
and raising the rates in low-payment counties. As a result, the BBA reduces the
growth in rates in many markets relative to what the payment rates in those
markets would have been without BBA .

Incorrect. The BBA reduces these payments and limits the number of residents
supported by Medicare.

Provider Payment Reforms

In addition to significant changes in health plan payments under Medicare, the BBA also
changes some aspects of its fee-for-service provider payment systems. The BBA caps
the rate of growth in payments to hospitals that operate under the prospective payment
system (PPS). A PPS system will be applied for payments to skilled nursing facilities
(SNF) as well. The bulk of Medicare payments to SNFs in the past were made on a

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"reasonable cost" basis after the care was provided. Under the new PPS, these facilities
will be paid on a per diem basis.14

Graduate Medical Education Payments

Medicare provides financial support called Graduate Medical Education (GME)
payments to hospitals for the training and cost of educating and training residents. The
BBA reduces these payments and limits the number of residents supported by Medicare.
Payments are based on medical education factors, which are being reduced from 7.7%
to 7% in 1998, to 6.5% in 1999, to 6% in 2000, and 5.5% thereafter.

Plan Enrollment
In general, Medicare+Choice plans will be obligated to accept new members during
annual coordinated election periods, special enrollment periods, and a beneficiary's
initial election period. The annual coordinated election period is held each November,
during which time a Medicare beneficiary may choose to enroll in a Medicare+Choice
plan or change his or her election from one plan to another. Enrollment during the
annual coordinated election period becomes effective the following January 1. An initial
election period is the time period during which a person who is newly eligible for
Medicare benefits may elect to enroll in a plan.

In November 1998, CMS begins conducting an education and publicity campaign in

selected geographic regions aimed at those who are Medicare+Choice eligible. This
campaign's goal is to focus on informing beneficiaries of their options under
Medicare+Choice beginning in 1999.

Those who are eligible for Medicare+Choice will receive election forms, information on
disenrollment, member satisfaction data, health records, and compliance information
from CMS prior to their initial Medicare+Choice eligibility and prior to each annual
coordinated election period. Those eligible for Medicare+Choice will have the ability to
enroll and disenroll on a monthly basis until 2002. A beneficiary who fails to make a
choice will automatically be assigned to traditional FFS Medicare. Figure 8B-6 outlines
the disenrollment options available in 2002 and thereafter for those who are eligible for
Medicare+Choice.

Figure 8B-6. Medicare+Choice Disenrollment Options.

During 2002 - An individual may disenroll:

1. At any time during the first six months of the year or the first six months after
making an initial election if the individual has not previously changed his or her
election during this period
2. During the annual coordinated election period in November
3. At any time during a special election period

Beneficiaries first becoming eligible for benefits under Part A at age 65 may discontinue
their election and enroll under the traditional fee-for-service program at any time during
the 12-month period beginning on the effective date of enrollment.

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2003 and thereafter - An individual may disenroll:

1. At any time during the first three months of the year or the first three months after
making an initial election if the individual has not previously changed his or her
election during this period
2. During the annual coordinated election period in November
3. At any time during a special election period

Beneficiaries first becoming eligible for benefits under Part A at age 65 may discontinue
their election and enroll under the traditional fee-for-service program at any time during
the 12-month period beginning on the effective date of enrollment. (Sec. 1851[e][2]-[4])

Fast Definition

Special election period- Effective January 1, 2002, the time period during which a
currently enrolled Medicare+Choice enrollee may disenroll and make a new election.
Special election is allowed if

1. the enrollee loses eligibility because of a change in residence,

2. the plan violates terms or conditions of its contract or makes misrepresentations in
its marketing materials,
3. the plan loses its certification as a Medicare+Choice contractor or terminates the
plan, or
4. the enrollee meets other special conditions set by the HHS Secretary.

Marketing
CMS's The Medicare Health Plan National Marketing Guide contains rules related to
marketing products to Medicare beneficiaries. One CMS requirement is that health plans
submit proposed marketing materials to CMS for approval at least 45 days in advance of
dissemination. However, the guide provides for a "use and file" program for plans that
meet certain criteria. A use and file program allows health plans meeting specified
criteria that demonstrate ongoing compliance with marketing criteria to streamline the
market materials review process. Under the program, approved plans may use materials
marketing the plan to non-plan members without prior approval as long as they provide
CMS with copies of the materials within 10 days of their use. All other materials (e.g.,
those that describe membership rules and benefits such as member notices and the
member handbook) remain subject to prior approval. In addition, a "lead region" policy
guarantees that materials approved by a plan's lead CMS regional office automatically
meet approval in other CMS regions in which the plan contracts to provide Medicare
Coverage.

The Medicare Health Plan National Marketing Guide serves a number of purposes. Its
rules help to assure that beneficiaries receive current, accurate, and reader-friendly
marketing materials. It assists CMS in conducting uniform national marketing reviews.
Finally, it provides guidance for new health plan applicants submitting such materials to
CMS and for their overall marketing efforts. The guide addresses marketing activities
such as the following:

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1. Giveaways to potential enrollees may not have a value of more than $10 and
may not be conditioned upon enrollment (e.g., a coffee mug or day planner would
be acceptable). The goal of this rule is to prevent health plans from inducing
potential enrollees to join their plan with the promise of a gift.
2. Health plans may not advertise or provide "value-added services" (e.g. discounts
on health-related items such as over-the-counter medications and devices,
memberships in health clubs, etc.). However, in some circumstances, plans may
provide incentives to encourage preventative care. Again, CMS's goal is to
assure that an enrollee is making the decision to join a plan based on actual plan
merits.
3. No promotional language on quality rating may be used in any advertising efforts
conducted by the health plan without citing the source of the rating. CMS's
experience has shown that elderly beneficiaries are particularly susceptible to
false and/or misleading advertising.

In addition, marketing materials may not claim that the health plan is the "Centers for
Medicare and Medicaid Services" or the "Medicare Program," or that plan employees are
agents or employees of the federal government. For example, plans are not allowed to
15

describe their Medicare products as "a special contract with Medicare," or as "certified or
endorsed by Medicare," or as a "special plan for Medicare beneficiaries." A health plan
16

may tell its members it is:

• An HMO with a Medicare contract

• A Medicare-approved HMO
• A federally qualified HMO with a Medicare contract
• A federally qualified Medicare-contracting HMO 17

The Guide also contains model letters for routine communications between a plan and
its members. A "Must Use/Can't Use" chart of marketing language is also available for
health plans and covers subjects such as eligibility, benefits, premiums, providers,
enrollment periods, etc.

Quality Assurance
Quality improvement organizations are already in place to monitor quality issues relating
to health plans. Quality improvement organizations (QIOs) are organizations or
groups of practicing physicians and other healthcare professionals paid by the federal
government to review services ordered or furnished by other practitioners in the same
medical fields for the purpose of determining whether medical services provided were
reasonable and necessary, and of monitoring the quality of care given to Medicare
patients. 18

The BBA reinforces the changes that have occurred in the quality assurance monitoring
area, particularly under the purview of QIOs and CMS's Health Care Quality
Improvement Program. The Health Care Quality Improvement Program (HCQIP) is a
program initiated by CMS that seeks to improve the quality of care provided to Medicare
beneficiaries. Medicare+Choice coordinated care plans must have an agreement with a
QIO and undergo periodic quality reviews. The BBA allows external review requirements
to be waived if the plan has an excellent record of quality assurance (QA) and
compliance with other Medicare+Choice requirements. Furthermore, a plan may be

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deemed to have met requirements regarding confidentiality and accuracy of patient

records if the plan is accredited by a private organization approved by the state. 19

Review Question

From the following answer choices, choose the term that best corresponds to this
description. The SureQual Group is a group of practicing physicians and other
healthcare professionals paid by the federal government to review services ordered or
furnished by other practitioners in the same medical fields for the purpose of determining
whether medical services provided were reasonable and necessary, and to monitor the
quality of care given to Medicare patients.

Health insuring organization (HIO)

Independent practice association (IPA)
Physician practice management (PPM) company
Peer review organization (PRO)

Incorrect. A Health insuring organization contracts with state Medicaid agencies

as a fiscal intermediary.

Incorrect. An IPA is an association of individual physicians that that contracts

with health plans to provide healthcare services

Incorrect. A PPM is a legal entity that provides a variety of management and

administrative services for participating physicians' practices.

Correct. A PRO is an organization or group of practicing physicians and other

healthcare professioanls paid by the federal government to review services
ordered or furnished by other practitioners in the same medical field to determine
whether the medical services provided were reasonable and necessary.

The Medicare+Choice regulations identify five general requirements for a

Medicare+Choice plans quality assessment and performance improvement program.
Section 422.152(b) of the Medicare+Choice regulations identifies the following five
general requirements for a Medicare+Choice plan's quality assessment and
performance improvement program:

1. Meet the requirements contained in the rule concerning performance

measurement and reporting (including use of standard measures required by
CMS) and the requirements of the rule concerning the achievement of minimum
performance levels
2. Conduct performance improvement projects that achieve demonstrable and
sustained improvement in significant aspects of clinical care and nonclinical
areas

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3. Follow written policies and procedures that reflect current standards of medical
practice in processing requests for initial or continued authorization of services
4. Have in effect mechanisms to detect both underutilization and overutilization of
services
5. Make available to CMS information on quality and outcomes measures that will
enable beneficiaries to compare health coverage options and select among them

Medicare+Choice regulations require that the organization maintain a health information

system that collects, analyzes, and integrates the data necessary to implement its
program. Also, for each plan, a process for formal evaluation must take place at least
annually and it must address the impact and effectiveness of its quality assessment and
performance improvement program.

Appeals and Grievances

Issues subject to appeal include those involving a health plan's denial of payment or
reimbursement for provider services, or the health plan's refusal to provide medical
services that are covered by Medicare. The BBA and its implementing regulations
22

include a number of requirements regarding beneficiary appeals including:

• Explanations of appeal rights

• Provisions for expedited appeals

In general, when a party has made a request for a service, a Medicare+Choice

organization must notify the enrollee of its determination as expeditiously as the
enrollee's health requires, but not later than 14 days after the date the organization
receives the request. The BBA's language on expedited determination/reconsideration is
similar to the regulations already adopted by CMS. A Medicare+Choice organization
must provide an expedited appeal upon request by an enrollee if the organization
determines that the standard timeframe could seriously jeopardize the life or health of
the enrollee or the enrollee's ability to regain full function. The organization must grant
an expedited appeal upon the request of a physician if the physician indicates that the
above standard is met. Health plans must respond to such appeals within 72 hours. Any
notice of an adverse determination must include the reasons for the determination and
information on appeal rights and processes.

Health plans are also required to have grievance procedures for nonappealable
disputes. Instances of these grievance issues may include enrollment and disenrollment
practices, long waiting periods for appointment and referrals, care complaints, etc. 23

Anti-Fraud and Abuse Provisions

The BBA reinforces existing Medicare anti-fraud and abuse provisions and includes new
provisions such as giving HHS authority to refuse to enter into Medicare agreements
with providers who are convicted felons. In 1997, anti-fraud and abuse activities yielded
nearly $1 billion in savings and excluded more than 2,700 individuals and entities from
federal health care programs. Several new anti-fraud and abuse provisions affect
Medicare under Subtitle D, Section 4301 of the BBA. (See Fraud and Abuse for a
24

detailed discussion of fraud and abuse).

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CMS's Evolving Role under the Balanced Budget Act

As noted earlier, the Centers for Medicare and Medicaid Services (CMS) is the federal
agency that administers the Medicare program. CMS oversees and regulates health
insurance provided to over 74 million Americans through Medicare and other programs.
The majority of these individuals receive benefits through a traditional fee-for-service
plan. However, an increasing number are choosing health plans.

"The creation of the new Medicare+Choice program imposes substantial short-term and
ongoing burdens for CMS. These burdens are separate from the obligations placed on
the agency by other changes to Medicare made by the BBA. In addition to developing
new solvency requirements for PSOs and other nonsolvency standards as required
under Section 1856 of the Balanced Budget Act, CMS has to develop additional
regulations and guidance involving, among other things, enrollments and disenrollment
procedures; appeals and grievance procedures; rates and rate-setting mechanisms." 25

The BBA has created a number of initiatives that CMS must address as part of
implementing the Act. These key initiatives include the following:

• Medicare+Choice - As a result of the creation of the Medicare+Choice

program, CMS has had to issue hundreds of new Medicare regulations, such
as solvency standards for PSOs. Additionally, CMS has responsibility for
developing new Medicare+Choice contract documents. Existing Medicare
risk-based contractors transitioning to the Medicare+Choice organization
types are required to execute a new Medicare+Choice contract. These
contract documents will replace the current Section 1876 risk-based
contract.
26

• Medicare Beneficiary Information - To help meet the BBA's directive of

increasing beneficiary understanding of Medicare options, CMS is required to
coordinate a national educational and publicity campaign. This campaign
focuses on distributing comprehensive, user-friendly information about health
plans and other coverage options to every Medicare beneficiary.
• New Payment Requirements - The move to Medicare+Choice requires that
CMS develop risk adjusters to apply to the payment methodology used to
compensate health plans.
• Anti-Fraud Efforts - To continue its efforts to crack down on fraud and
abuse, CMS plans to increase claims reviews, screen home health agencies
more carefully, and encourage beneficiaries to phone in fraudulent activities. 27

• The "Quality Agenda" - CMS's Medicare Quality Improvement (QI) System

for health plans also require risk contractors to report performance data
according to standardized measures, to meet minimum specified
performance standards, and to develop internal QI programs." CMS is also
28

making efforts to put Medicare in compliance with the proposed Consumer

Bill of Rights and Responsibilities (discussed in Federal Government as
Purchaser) as far as the existing law allows

Operational Issues for Health Plans

Health plans in the Medicare market face unique challenges. To enter into and operate
within Medicare markets, health plans must "create the infrastructure and management
systems to effectively manage a very high-risk population represented by Medicare

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beneficiaries." This lesson provides a brief discussion of those operational areas. Figure
29

8B-7 offers some practical tips on developing a Medicare health plan strategy.
Figure 8B-7. Medicare Health Plan: Tips for Health Plans.

1. Be one of the first health plans in your market. Elderly patients are more likely to
switch to your plan from a FFS plan than from another health plan with which
they are satisfied.
2. Grow quickly after you start. A plan with 25,000 or more members has the best
chance for success.
3. Get your capital and marketing plans together. Expect to spend at least $500+ to
sign up each new enrollee. In addition, keep in mind that plans usually lose
money the first two or three years.
4. Hire additional support staff. You'll need extra staff to field questions from older
enrollees. They telephone more often and spend more time on the telephone when
they do.
5. Work closely with providers to help them succeed under capitation. Make sure
that both your health plan and those providing care have the same incentives to do
so cost-effectively.
6. Some plans find it more efficient to use internists sd primary care doctors for
seniors. Interists often are comfortable treating many chronic conditions and refer
patients less often to specialists than do other primary care physicians.
Source: Reprinted from Hospitals & Health Networks, vol. 71, no. 7, by permission, April 5, 1997, copyright 1997, American Hospital
Publishing, Inc.

Marketing and Education

A large portion of the start-up costs of a Medicare program go toward sales and
marketing, and these costs are significant. Health plans must also be aware of the new
rules and regulations for how plans are allowed to market Medicare. With increased
competition, marketing and sales are critical areas; it is generally agreed that success is
"typically bestowed on [plans] with a large enrollment....with those of at least 25,000 best
suited for survival." 31

Beneficiaries will be subject to a large amount of information regarding health plans,

Medicare, and Medicare+Choice. Therefore, education is an essential factor in attracting
and keeping Medicare beneficiaries in health plans. Beneficiaries are often skeptical of
health plans offering "zero premiums" since they may not understand that health plans
are able to offer these packages, not by offering an inferior product, but rather by
managing dollars. According to Kevin Shanklin, a practice director with the Blue Cross
32

and Blue Shield Association's Strategic Consulting Services, "The need for education is
critical. Health plan companies have to develop and, in fact, are developing major
educational programs in order to make their health plan programs work in the Medicare
and Medicaid markets."

Fast Definition

"Zero Premium" Plan - A plan that offers extra or supplemental benefit features (e. g.,
prescription benefits) at no additional cost to the Medicare health plan enrollee. 37

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Member Services and Benefits

Health plans have discovered a high volume of care is needed for an over-65 population,
not only in the provision of healthcare services, but also in member services. According
to Craig Schub, former president of Secure Horizons, a health plan in California,
"Whenever we announce a change in a Medicare plan, our phones light up. Seniors
want to understand those changes." Health plans need to consider their
34

communications and information systems and the personnel they currently have for
handling the increased demand for information.

Competition for the Medicare market means health plans need to develop flexible benefit
packages for seniors and the disabled. For example, Blue Cross and Blue Shield
(BCBS), among several other organizations, offers a portable Medicare health plan
product for their senior market. According to BCBS, this plan "has generated a lot of
excitement within the Association and among Plans because it's expected to meet an
important need of the senior market." 35

Studies also show that beneficiaries join health plans because of comprehensive benefit
packages. For example, according to a 1996 Physicians Payment Review Commission
(PPRC) survey, nearly half of beneficiaries polled cited the risk plan's reduced costs and
increased benefits as their primary reasons for enrolling. The second most common
36

reason was the plan's provider list.

The BBA seeks to expand Medicare coverage of preventative health care services.
While coverage of certain health screenings is required, health plans may wish to follow
the HMO industry's lead in creating Health Improvement Programs. These programs
provide help with managing member health and managing costs, and they are also
popular with senior members. These programs usually include senior seminars,
cholesterol and high blood pressure screenings, smoking cessation or weight loss
clinics, and other initiatives for members to maintain their health and quality of life.

Medical Management
It is generally agreed that seniors need two to three times the care of a commercial
member. As a result, plans will need more utilization management staff to manage this
care and more programs designed specifically for the healthcare needs of this
population.
Network Development and Provider Relations
One key to success for health plans in developing Medicare+Choice plans is
establishing and maintaining strong physician networks. Seniors tend to develop lasting
relationships with their physicians, and most seniors who have an established
relationship with a physician are not receptive to leaving that physician. In addition, plans
may need to increase their provider contracting efforts to include more physicians and
organizations that can manage chronic and terminal conditions, such as home health
care and cancer centers. A typical rule of thumb is, “a primary care doctor typically can
handle 2,000 patients under age 65, but only 800 over 65.” Another factor to consider is
38

that the scope of managed care contracting with physicians has changed significantly.
For example, physicians with health plan contracts rose from 61% in 1990 to 83% in
1995.

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With respect to provider relations, the BBA requires that health plans maintain certain
communications with their participating providers. For instance, health plans must supply
providers with Medicare+Choice participation rules and regulations. Health plans must
supply written notices of adverse participation decisions and the processes required to
appeal those decisions. Health plans must also have procedures and systems in place
to provide ongoing communications with providers regarding medical policies, quality,
and medical management.

Management Information Services (MIS)

The BBA requires the collection and reporting of encounter information, enrollment/
disenrollment information, HEDIS® and CAHPS information, among other data. Much of
this information must be collected, stored, and submitted electronically. Health plans will
need the information services equipment, personnel, and resources to maintainand
compete in the world of “electronic commerce.”

CMS requires its contracted health plans to transmit most data and information
electronically. CMS is encouraging contractors to adapt new and existing information
systems to prepare for Year 2000 programming changes. Though a costly and difficult
effort even for CMS, failure to do so could result in “massive breakdowns in information
flows” between health plans and CMS. CMS plans to provide health plans with
39

additional information on this issue in the future.

The National Bipartisan Commission on the Future of Medicare

The BBA includes provisions for a commission to monitor Medicare and develop
recommendations for ensuring the long-term financial reliability of the Medicare program.
This group, the National Bipartisan Commission on the Future of Medicare, is
composed of 17 members: 4 appointed by the President, 6 each appointed by the
Senate Majority Leader and the Speaker of the House (no more than 4 of whom are
from the same party), and an additional member who serves as Chairperson and was
jointly appointed by the President, the Majority Leader, and the Speaker of the House.
The commission's report is due in March of 1999.

The commission has created task forces to work on new program designs, build on the
system that is already in place, and examine the role Medicare plays in America's
healthcare system.

In addition to the National Bipartisan Commission, the BBA also established various
Demonstration Projects as outlined next.

Medicare Subvention Demonstration Project

The BBA authorized "six sites for Medicare health plan subvention demonstrations
between CMS and the Department of Defense (DOD)." Military retirees who are
40

Medicare eligible will be able to receive healthcare through military healthcare facilities.
Facilities must meet the same requirements as health plans that serve Medicare and will
be paid a percentage of Medicare reimbursement. Therefore, under military subvention
projects, the BBA gives veterans more freedom to choose where they receive their
medical care. 41

Military retirees in these areas are allowed to begin enrolling after the above healthcare
facilities are accepted into the Medicare program. A similar demonstration project has

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been proposed for the Department of Veterans Affairs (VA). Veterans would have a
choice of healthcare providers many do not currently have. "The three-year pilot,
designed to be at least cost-neutral, would cap Medicare payments to the VA at $50
million annually. The VA could determine which services it currently can make available
and target its service delivery to veterans who need them." 42

Fast Definition

Medicare subvention — a proposal that “would allow CMS to reimburse military MTFs
for the medical care provided to Medicareeligible beneficiaries.” 43

Medicare Enrollment Demonstration Project

The Medicare Enrollment Demonstration Project is a three-year project, authorized by
the BBA, that is designed to study the use of third-party contractors to oversee and
conduct Medicare+Choice enrollment and disenrollment. Third-party contractors will be
evaluated on their adherence to performance standards. If the contractor does not
comply with these standards, enrollment/ disenrollment functions will be carried out by
Medicare+Choice plans until a new contractor is secured.

Medicare Coordinated Care Demonstration Project

The Medicare Coordinated Care Demonstration Project is designed to study case
management and coordination of care for beneficiaries with chronic illnesses. The
project will be implemented in nine sites: five urban, three rural, and one within the
District of Columbia. If project components prove to be cost-effective while maintaining
quality and beneficiary satisfaction, they will be implemented for the Medicare program.

Privatization
The BBA has a tremendous capacity to lead Medicare toward privatization through the
availability of Medicare+Choice plans. The potential for increased enrollment by seniors
in large group healthcare plans could create competition among plans which, ultimately,
could lead to increased plan offerings to seniors. Therefore, privatization would benefit
the Medicare consumer as well.

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Chapter 8 C
Joint Federal-State Healthcare Programs (Medicaid,
Programs of All-Inclusive Care for the Elderly, and the State
Children’s Health Insurance Program)
After completing this lesson, you should be able to:

 Explain the roles of the federal and state governments in the operation of the
Medicaid program
 Describe the Medicaid services mandated by the federal government
 Describe the effects of the Balanced Budget Act of 1997 (BBA) on regulation and
operation of Medicaid health plan programs
 Name the types of health plan entities that can contract to provide Medicaid services
 Explain the purpose of Section 1915(b) and Section 1115 waivers
 Explain how states can mandate Medicaid health plans without obtaining a waiver
 Explain the role of Programs of All-Inclusive Care for the Elderly (PACE)
 Discuss the purpose and options for implementation of the State Children’s Health
Insurance Program (SCHIP)

In its efforts to ensure that needy populations have access to and coverage for
healthcare services, the federal government often enters into joint programs with state
governments. In this lesson, we discuss three joint federal-state programs that target
specific populations:

1. Medicaid. The Medicaid program targets the low-income population, including

certain aged and disabled individuals.
2. Programs of All-Inclusive Care for the Elderly (PACE). PACE is a combined
Medicaid and Medicare program that targets people aged 55 or older who require
a nursing-facility level of care.
3. State Children’s Health Insurance Program (SCHIP). SCHIP targets
uninsured, low-income children who traditionally have not been eligible for
healthcare coverage under Medicaid

Medicaid
The Medicaid program was established in 1965 as a joint federal-state matching
entitlement program under Title XIX of the Social Security Act (SSA) to provide
healthcare coverage to low-income families and certain categories of aged and disabled
individuals. Medicaid is the largest source of funding for medical and healthrelated
services for America’s poorest populations.

In this lesson, we discuss the purpose and operation of the Medicaid program and the
steadily increasing role of health plans in what was once almost entirely a fee-for-service
insurance program. Figure 8C-1 shows the breakdown of the Medicaid population by
fee-for-service (FFS) and health plans.

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This lesson includes the roles of the federal and state governments in establishing the
level of benefits, selecting and regulating health plan entities that contract to participate
in the Medicaid program, and determining eligibility for Medicaid benefits. As you will
learn, in recent years there have been a number of changes in the regulation of the
Medicaid program.

Fast Fact

In 1996, Medicaid provided healthcare assistance to more than 36 million individuals, at

a cost of $147.7 billion.1

Joint Federal-State Nature of Program

The Medicaid program is jointly financed by the federal and state governments. The role
of the federal government in Medicaid is to establish broad federal guidelines for the
program, to provide partial funding to the states, and to set minimum standards
regarding eligibility, benefit coverage, and provider participation and reimbursement. The
individual states administer the Medicaid program. The federal funds contributed to a
state Medicaid program are called federal financial participation (FFP), or the Federal
Medical Assistance Percentage. FFP ranges from 50 percent to 80 percent of the state’s
total Medicaid costs, with poorer states (based on per capita income) receiving a higher
percentage of federal matching funds. States have considerable latitude to expand the
benefits offered under Medicaid, as long as they meet the minimum federal standards.
Because states have the option to expand their programs beyond the minimum
standards set by the federal government, Medicaid programs vary from state to state.
Later in this lesson, we discuss how states determine eligibility and benefits for Medicaid
programs. First, we look at traditional Medicaid and examine why the Medicaid program
has embraced health plans in recent years.

Traditional Medicaid
Traditionally, Medicaid has operated as a fee-for-service insurance program. State
Medicaid agencies either (1) negotiate with physicians and other providers to render
care for a reduced fee for each service or (2) establish a fee schedule without
negotiation for the rates they will pay providers for each service rendered. These
providers are referred to as traditional Medicaid providers. Under Medicaid, a
traditional Medicaid provider is defined as one who has treated Medicaid beneficiaries
within the past year and has demonstrated expertise and experience in dealing with the
Medicaid population through participation in the Medicaid program.

The reduced FFS payment system established by the states has helped to manage the
costs of healthcare; however, the impact of the reduced FFS approach has presented
some difficulties in meeting the needs of certain Medicaid beneficiaries. State Medicaid
provider reimbursement rates have typically been lower compared to those of
commercial insurance plans. As a result, many medical providers have chosen not to
participate in the Medicaid program. Since there are fewer primary care providers willing
to treat Medicaid beneficiaries, the beneficiaries often have access to a limited selection
of providers. Frequently, this lack of providers leads Medicaid beneficiaries to use inner-
city hospitals (especially emergency departments), community health centers, public
health programs, and a sparse number of private practitioners for their medical care. As
a result, Medicaid beneficiaries may overuse emergency departments for routine care
rather than establish an ongoing relationship with a primary care provider.

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A large percentage of the Medicaid population consists of:

• Children under age 18 who have a need for well-child care

• Women of childbearing age who have a disproportionately high need for
obstetrical and perinatal services

The socioeconomic circumstances of this population often limit their access to a routine
source of care and their utilization of available services.

Determining Reimbursement for Providers and Medicaid Benefit Levels

Providers participating in Medicaid must accept Medicaid’s established payment rates as
payment in full for services rendered to Medicaid beneficiaries. Federal guidelines
require that payment rates be adequate to attract a sufficient number of providers to
serve the Medicaid population.

With a few exceptions, each state has relatively broad discretion (within federally
imposed upper limits and specific restrictions) to determine the reimbursement
methodology and resulting payment rates.

States may impose nominal deductibles, coinsurance, or copayments on some Medicaid

recipients for certain services. The state cannot, however, require copayments for
emergency services and family planning services. In addition, states may not require
cost-sharing by certain Medicaid recipients, who include:

• Pregnant women (for services related to pregnancy or another condition that

could complicate pregnancy)
• Children under age 18
• Hospital or nursing-home patients who are expected to contribute most of their
income to institutional care
• Individuals receiving hospice care

Review Question

States may impose nominal deductibles, coinsurance, or copayments on some Medicaid

recipients for certain services. Services for which states can require copayments from
Medicaid recipients include

A. Emergency services
B. Family planning services
Both A and B
A only
B only
Neither A nor B

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Incorrect. Services for which states can require copayments from Medicaid
recipients cannot include emergency services or family planning services.

Incorrect. Services for which states can require copayments from Medicaid
recipients cannot include emergency services

Incorrect. Services for which states can require copayments from Medicaid
recipients cannot include family planning services

Correct. Services for which states can require copayments from Medicaid
recipients cannot include emergency services or family planning services.

Health Plans Under Medicaid

Medicaid programs have faced financial crises over the past several years. As a result,
states have found it necessary to find ways to contain increases in expenditures. In an
effort to manage the costs and usage of Medicaid services and to make quality care
more accessible to beneficiaries, in the mid-1980s many states began applying health
plan techniques to their traditional Medicaid programs.

Almost from the beginning of the Medicaid program, states have had the option to enroll
Medicaid beneficiaries in a managed care plan on a voluntary basis. As we will discuss,
the need to manage costs and improve access to care have resulted in a move toward
mandatory enrollment of many beneficiaries in health plan programs. Under health
plans, the Medicaid program still covers the broad range of services previously covered,
with an emphasis on health maintenance and preventive care, especially for children
and pregnant women. The Balanced Budget Act of 1997 made several significant
changes to the Medicaid program.

Impact of the Balanced Budget Act of 1997 on Medicaid Health Plans

The Balanced Budget Act (BBA) of 1997 made sweeping changes in the ways states
contract with health plans and gave states greater flexibility in administering their
Medicaid programs. The BBA added Section 1932 to the Social Security Act (SSA).
Section 1932 of the SSA addresses virtually every area of Medicaid health plan
contracts, including definitions of Medicaid health plan entities, eligibility for benefits,
states’ ability to mandate health plans, regulation of MCE performance, marketing by
Medicaid MCEs, and protection of Medicaid enrollees’ rights. We will discuss some of
these changes in the following lessons.

Health Plans Eligible to Participate in the Medicaid Program

In Healthcare Management: An Introduction, we explained that there are three models
of health plans commonly used for Medicaid programs. These models are

1. Entities that contract with a state to provide or arrange for comprehensive

services on a risk basis—that is, health maintenance organizations (HMOs),
health insuring organizations (HIOs), and provider-sponsored organizations
2. Entities that contract for less than comprehensive services, contract on a nonrisk
or partial risk basis, or are otherwise exempt from the requirements a health plan
must meet to contract under Medicaid laws and regulations, i.e., prepaid health
plans (PHPs)

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3. Primary care case management programs (PCCMs), under which “freedom of

choice” of providers is restricted and all services must be approved by a primary
care provider or “gatekeeper”

In addition to HMOs, HIOs, PHPs, and PCCMs, the BBA amended Medicaid law to
explicitly allow states to enter Medicaid contracts with provider-sponsored organizations
(PSOs), discussed in Medicare and Health Plans. The BBA also created a new name or
term—health plan entities— for certain entities providing Medicaid health plan services.
As shown in Figure 8C-2, the term health plan entities refers to Medicaid health plans
(discussed in the following lesson) and PCCMs.

As we discussed earlier, health insuring organizations are one of the three main models
used in Medicaid health plan arrangements. Health insuring organizations (HIOs) are
entities that contract with the state Medicaid agency as a fiscal intermediary. The HIO
does not provide medical services but contracts with medical providers on behalf of the
Medicaid agency. In the states of California, Minnesota, and Washington, several HIOs
provide countywide healthcare coverage for all Medicaid participants. Since 1985,
Congress has subjected HIOs engaged in full-risk contracting to the same strict
regulatory standards as HMOs.

The BBA did not address the status of prepaid health plans (PHPs). Therefore, PHPs
are not subject to the Medicaid health plan contracting requirements found in section
1903(m) of the SSA, discussed in the following section. A prepaid health plan (PHP) is a
public or private entity under contract with a state Medicaid agency that provides a
noncomprehensive set of medical services to enrolled beneficiaries on either a capitated
risk or nonrisk basis or the entity provides a comprehensive set of medical services on a
nonrisk or partial risk basis. PHPs also include a few risk-comprehensive organizations
that have received statutory exceptions from section 1903(m).

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Review Question

From the following answer choices, choose the term that best corresponds to this
description.

Barrington Health Services, Inc. contracts with a state Medicaid agency as a fiscal
intermediary. Barrington does not provide medical services, but contracts with medical
providers on behalf of the state Medicaid agency.

Health insuring organization (HIO)

Independent practice association (IPA)
Physician practice management (PPM) company
Peer review organization (PRO)

Correct. Health insuring organizations (HIOs) are entities that contract with the
state Medicaid agency as a fiscal intermediary. The HIO does not provide medical
services but contracts with medical providers on behalf of the Medicaid agency.

Incorrect. An independent practice association is an assoication of physicians (or

physicians in small group practices) that contracts with a health plans to provide
healthcare services.

Incorrect. A physician practice management company is a legal entity that

provides a variety if management and administrative services for participating
physicians' practices.

Incorrect. PROs are organizations or groups of practicing physicians or other

healthcare professionals who review services ordered or furnished by other
practitioners in the same medical field to determine whether the medical services
provided were reasonable and necessary.

The following four types of entities meet the definition of PHP:

• Entities that do not accept risk for the comprehensive range of Medicaid services
• Entities that accept less than full risk for Medicaid services
• A narrow range of entities receiving Public Health Service Act grants since July
1, 1976, that contract with state Medicaid agencies to provide Medicaid services
on a risk basis
• Entities that contracted to provide Medicaid services (but not inpatient hospital
services) to Medicaid-eligible persons on a prepaid risk basis prior to 1970

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For example, a PHP may assume risk for only physician services or only ambulatory
care. PHPs are frequently clinics or large group practices that do not accept risk for
inpatient services or plans that provide only a single service, such as behavioral health.

Medicaid Health Plans

Medicaid Health Plans are entities qualified by either the federal or the state
government to contract on a prepaid, fully capitated basis to provide comprehensive
healthcare services to Medicaid beneficiaries. The Medicaid health plan determines the
reimbursement to be paid to providers. A Medicaid health plan integrates both the
contracting entity and the providers of medical services into one organization. Medicaid
health plans include HMOs, organizations with a current risk contract under Section
1876 or a Medicare+Choice contract, provider-sponsored organizations, or any other
managed care risk-bearing organizations. The term, Medicaid health plan, refers to
those managed care risk-bearing organizations that meet the requirements of Section
1903(m) of the SSA and that meet certain other regulatory requirements (e.g., relating to
solvency, access, coverage area, etc.) for contracting under the authority of the
Medicaid provisions in the SSA. To participate in the Medicaid program, a Medicaid
health plan must meet a broad range of standards set forth in the Medicaid law and
regulations. For example, a health plan’s services must be accessible to Medicaid
beneficiaries within a service area equivalent to that provided for Medicaid beneficiaries
not enrolled in the plan. Medicaid health plans, like commercial HMOs, must provide
safeguards against the risk of insolvency.

States have some flexibility in defining Medicaid health plans, but the definition must
require such health plans to give Medicaid enrollees the same access to care as the
health plan’s other plan participants. Medicaid health plans accept full risk for a
comprehensive range of healthcare services that they provide to enrollees. The benefits
provided by Medicaid health plans are often more extensive than those provided by
commercial HMOs because of the broad coverage mandated by the Medicaid program.
For example, Medicaid health plans almost always include pharmacy and vision
benefits, and may also provide dental benefits.

Primary Care Case Management Programs

Under a primary care case management program (PCCM program), states contract
directly with providers who serve as primary care case managers. Primary care case
managers (PCCMs) are responsible for locating, coordinating, and monitoring covered
primary care and other services to all their Medicaid enrollees. An MCE’s primary care
case management may be provided by a physician, a physician group practice, an entity 2

that contracts with or employs physicians or—at a state’s option —a nurse practitioner,
nurse midwife, or physician assistant. Usually, general practitioners, family practitioners,
internal medicine practitioners, obstetrician/gynecologists, or pediatricians serve as
PCCMs.

Most state PCCM programs pay the primary care provider a monthly case management
fee in addition to paying for medical services on a reduced FFS basis. PCCM programs
seek to reduce emergency room use and increase utilization of preventive care by
fostering ongoing interaction between PCPs and their Medicaid patients.

State contracts must require that the PCCM provide reasonable and adequate hours of
operation and a reasonable geographic location. The PCCM must have arrangements

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with, or the ability to refer to, a sufficient supply of providers other than the primary case
manager.

Who Is Eligible for Medicaid?

The Centers for Medicare and Medicaid Services (CMS), which we discussed in
Regulatory Agencies and Health Plans, is the federal agency that provides guidelines for
operating the Medicaid program. These guidelines include specific requirements for
Medicaid eligibility and covered benefits. The Balanced Budget Act of 1997 (BBA) and
the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) of
1996, a welfare reform law, have made recent changes in the categories of people
eligible for Medicaid. To understand how these laws affect eligibility for Medicaid, it is
helpful to have a general understanding of:

• Who was eligible for Medicaid prior to the passage of the BBA and welfare
reform
• Who is eligible for Medicaid now that the BBA and welfare reform are in place

It is important to keep in mind that rules and regulations for Medicaid eligibility frequently
change at the federal level. In addition, the states have flexibility in setting some
eligibility requirements for their Medicaid programs. The following information is intended
to give a broad overview of Medicaid eligibility. CMS or state Medicaid agencies can
provide more specific information on eligibility requirements.

Overview of Changes
Basically, prior to passage of the BBA, people who were eligible for welfare were eligible
for Medicaid benefits. Recently passed welfare reform laws unlinked the automatic
connection between these two programs. In some instances, it became more difficult for
certain categories of people to qualify for welfare assistance; however, most of these
people were still eligible for Medicaid.

Eligibility Before Welfare Reform and the BBA

Three broad categories of individuals were eligible for Medicaid prior to the BBA and
welfare reform:

• The categorically needy

• The medically needy
• “Expansion populations”

The Categorically Needy

Categorically needy individuals are those individuals who meet a state’s requirements
for certain categories that the federal and state governments have determined need
welfare coverage. Categorically needy individuals have Medicaid automatically because
they receive welfare (often called “cash assistance” or “cash-grants-in-aid”). Prior to the
passage of the BBA and welfare reform, there were two main welfare categories that
contained individuals considered to be categorically needy:
1. Individuals who qualified for a statefederal program called Aid to Families
with Dependent Children (AFDC). As a result of welfare reform laws, AFDC has

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been replaced with a new federal program called Temporary Assistance for
Needy Families (TANF); however, states still use the eligibility criteria in AFDC
to determine Medicaid eligibility for singleparent households. We discuss AFDC
and TANF in Figure 8C-3.

2. Individuals who qualified for a federal assistance program called

Supplemental Security Income (SSI). Figure 8C-4 describes individuals who are
eligible for SSI. Note that neither the BBA nor welfare reform laws currently
unlink the connection between eligibility for SSI and eligibility for Medicaid.
Welfare reform laws briefly unlinked this connection for certain categories of
immigrants, but that change was then reversed by provisions in the BBA, as we
discuss later in this lesson.

Figure 8C-3. Medicaid Eligibility and the AFDC and TANF Programs.

The Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) of

1996 (Public Law 104-193) was basically a welfare reform act. PRWORA established
time limits and work requirements for low-income individuals and families receiving
cash assistance. Signed into law on August 22, 1996, the PRWORA replaced several cash
welfare benefit programs. Aid to Families with Dependent Children (AFDC) was one of
the programs that was replaced. The AFDC program was a federally funded welfare
program that provided assistance to one-parent households with one or more children
which households met certain financial eligibility requirements.

AFDC was replaced with the Temporary Assistance for Needy Families (TANF)
program. Under TANF, each state receives a block grant for providing income support
and work programs to needy individuals. TANF gives states greater latitude than AFDC
did in determining who is eligible to receive cash grants. Because the purpose of
PRWORA is to encourage individuals to become self-supporting, the law generally limits
states to paying benefits to families for a maximum of five years; however, this limit does
not apply to Medicaid benefits.

Figure 8C-4. What is Supplemental Security Income (SSI)?

Supplemental Security Income (SSI) is an ongoing federal program that provides cash
assistance to the following groups:

• The aged (i.e., individuals aged 65 and older), called Old Age Assistance
• Individuals who are blind and/or permanently and totally disabled, called Aid to
the Blind and Aid to the Disabled, respectively

Individuals who qualify for SSI are also eligible for Medicaid benefits. The federal
government establishes income eligibility criteria for SSI benefits.

In addition to meeting the categorical requirements (e.g., single-parent household,

elderly, blind or disabled), individuals must meet certain financial resource requirements

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and monthly income requirements to be considered eligible as categorically needy for

Medicaid benefits. These financial eligibility criteria require that individuals’ financial
resources (assets) and monthly income not exceed specified limits, based on household
size. When the AFDC program was in effect, states set the resource and income limits
for the AFDC programs, subject to CMS approval. The Social Security Administration
sets the resource and income limits for the SSI program.

Medically Needy Individuals

The second group of people for which Medicaid benefits were available prior to the BBA
and welfare reform is the medically needy group. Medically needy individuals are
individuals who meet the categorical and financial resource requirements, described
above, to be deemed categorically needy—but whose income is too high to meet the
monthly income requirement. States can choose to provide Medicaid coverage to such
individuals and have the flexibility to provide such coverage to individuals whose
incomes are up to 100% of the federal poverty level. The federal poverty level (FPL) is
the income level at which an individual or family is considered “poor” by the federal
government. States may also choose to provide Medicaid coverage on a monthly basis
to individuals who “spend down” their excess income on medical care costs. The
“spending down” process works like a deductible; once an individual meets the threshold
maximum income level by incurring healthcare expenses, he or she becomes eligible for
Medicaid coverage as medically needy. Individuals can “spend down” by incurring
medical and/or remedial care expenses to offset their excess income. In this way,
individuals reduce their income to a level below the maximum allowed by a state’s
Medicaid program for eligibility under this category.

Expansion Populations
In the late 1980s, Congress expanded Medicaid coverage to certain populations—
children and pregnant women—who did not meet the requirements for the categorically
needy groups. The coverage for children includes all services available to children under
the AFDC program. The coverage for pregnant women is limited to pregnancyrelated
services throughout the pregnancy and continuing up through a 60-day postpartum
period. Congress later extended this coverage to include family planning services for a
period of one year after the birth of the child.

The laws that Congress passed to enact coverage for these “expansion populations” do
not require a financial resource test for eligibility; however, states can choose to impose
a financial resource test within specified limits. To be eligible for the “expansion
populations” category, an individual must meet an income test based on federal poverty
guidelines. Note that the income test sets a maximum income a household may earn to
be considered eligible for Medicaid under the “expansion population” category; however,
states may allow individuals or households with higher incomes to qualify for their state
Medicaid programs at their discretion. The standard income requirements, based on the
FPL, are as follows:

• For children up to age one and pregnant women, the household income level is
below 185% of the FPL guidelines
• For children aged one to five, the household income level is below 133% of the
FPL

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• For children aged six to 19, the household income level is below 100% of the
FPL guidelines

Dual Eligibles
Dual eligibles are people who are eligible for both Medicare and Medicaid benefits.
Almost 100% of people who are eligible for Medicaid because they receive Old Age
Assistance and approximately 40% of people who are eligible for Medicaid because they
receive Aid to the Blind/Aid to the Disabled also have Medicare coverage. For these
people, Medicare coverage is primary and Medicaid coverage is secondary, and
Medicaid pays the Medicare Part B premium. In addition, for a small group of dual
eligibles, Medicaid pays their Part A premium. Figure 8C-5 describes several categories
of dual eligibles and what the Medicaid program covers for these individuals.

Figure 8C-5. Medicaid-Eligible Medicare Beneficiaries.

State Medicaid programs are required to pay the Medicare premiums and the cost-sharing
(e.g., copayments, deductibles) on Medicare services for Medicare beneficiaries whose
income is below 100% of the poverty level and whose assets do not exceed two times
(200%) the amount allowed by the Supplemental Security Income program. The
Medicare beneficiaries who qualify for this costsharing are called qualified Medicare
beneficiaries (QMBs).

State Medicaid programs are also required to pay Part B premiums for individuals with
income between 100% and 120% of the FPL and whose assets do not exceed 200% of the
allowable SSI amount. These beneficiaries are known as specified low-income Medicare
beneficiaries (SLMBs). In general, SLMBs are people with slightly higher incomes than
QMBs.

States are also obligated to pay all or a portion of the Part A premium for a group of
beneficiaries known as called qualified disabled working individuals (QDWIs). QDWIs
are people who formerly qualified for Social Security disability income and have lost
eligibility but are exercising the option of keeping Medicare by paying the Part A
premium. These individuals have incomes of less than 200% of the FPL and assets that
do not exceed 200% of the allowable SSI amount. Medicaid pays the Part A premiums
for these individuals. QDWIs are a very small portion of the dual eligible population.

Medicaid Eligibility for Immigrants with Permanent Resident Status

Because we discuss changes that PRWORA and the BBA made in Medicaid eligibility
later in this section, it is important to note that prior to PRWORA, immigrants with
permanent resident status (i.e., “those who had qualified for and received a green card”)
had the same entitlement to Medicaid as did
U.S. citizens.

Eligibility After Welfare Reform and Passage of the BBA

As described in Figure 8C-2, PRWORA was basically a welfare reform act; Congress
chose not to deal with Medicaid reform directly. However, welfare reform had certain
impacts on the Medicaid program. In the final analysis some of the changes that

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PRWORA made on Medicaid eligibility were unintended. The BBA corrected some of
those changes and made further changes to eligibility for the Medicaid program.

Effects of Unlinking TANF and Medicaid

As we discussed earlier, PRWORA abolished the AFDC welfare entitlement program
and established TANF in its place. The link between welfare and Medicaid for the AFDC
population was broken. As we mentioned earlier in this lesson, being eligible for TANF
does not make an individual automatically eligible for Medicaid.

Unless the states choose to implement a single application and facilitate submission of
the application to both the TANF and Medicaid programs, eligible individuals have to
apply separately for benefits under TANF and Medicaid. Medicaid advocates have been
concerned that the separate application process will result in fewer eligible individuals
applying for Medicaid. For example, people who find out that they are not eligible for
TANF may assume that they are not eligible for Medicaid, or they just may not apply for
Medicaid benefits.

States' Flexibility to Change Eligibility Requirements

States still have to make Medicaid, not welfare, available to people who meet the AFDC
categorical and financial eligibility criteria in place as of July 16, 1996. However, states
have flexibility to adjust the financial eligibility criteria by one of two methods:

• Reducing the income standards to the levels they had in effect on May 1, 1988
• Increasing the income standards in accordance with changes in the Consumer
Price Index

In addition, the BBA offers states the opportunity to implement 12-month, rather than six-
month, continuous eligibility for children up to 19 years of age.

BBA Corrects Unintended Changes Made by PRWORA

As we discussed earlier, the BBA corrected some unintended effects of PRWORA. One
such change related to Medicaid coverage for disabled children. PRWORA changed the
disability determination criteria for children under the SSI program. This change could
have resulted in certain children losing their SSI welfare status and their Medicaid
benefits. The BBA softened the impact of the provisions of PRWORA by requiring that
states continue Medicaid coverage for children who were receiving SSI benefits on
August 22, 1996, and who subsequently lost those benefits as a result of the more
restrictive disability definition in PRWORA. The BBA also ensures that children who
began receiving SSI benefits after August 22, 1996, will be covered by state Medicaid
programs.

Medicaid Eligibility for Immigrants with Permanent Resident Status

As previously mentioned, prior to passage of PRWORA, immigrants with permanent
resident status were entitled to the same Medicaid benefits as U. S. citizens. PRWORA
contained provisions that

• Required that immigrants who attained permanent resident status after the
passage of PRWORA were subject to a five-year waiting period before becoming
eligible for any Medicaid benefits, with certain limited exceptions

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• Gave states the option not to provide Medicaid to immigrants—who had attained
permanent resident status prior to PRWORA—that met AFDC eligibility criteria
• Ceased cash grant assistance and Medicaid coverage to immigrants— who had
attained permanent resident status prior to PRWORA—that were receiving SSI.
However, the BBA restored SSI eligibility and Medicaid to this population

Dual Eligible
The BBA provided for additional allocations to the states in the form of five-year block
grants for paying Medicare Part B premiums for low-income, low-resource individuals
who do not qualify for Old Age Assistance under Medicaid. Unlike other Medicaid
eligibility categories, assistance funded by the block grants is available on a first-come,
first-served basis until the state allotment is depleted.

Medicaid Eligibility for Other Populations

In the preceding lessons, we have discussed Medicaid eligibility for certain populations;
however, the Medicaid program contains flexibility that allows states to cover other
populations outside the groups we discussed. There are three major populations for
which states have chosen to allow eligibility for their Medicaid program which we have
not discussed:

• States that have obtained waivers of Medicaid rules to extend eligibility to

populations that would not ordinarily be covered by Medicaid. Tennessee has a
Medicaid-waiver program called TennCare that is an example of such a waiver
program. The states that have these waivers determine the eligibility criteria,
subject to CMS approval, for the additional populations who will be eligible to
receive Medicaid benefits under their program.
• States that have chosen to implement the State Children’s Health Insurance
Program (SCHIP)—Title XXI of the Social Security Act, created by the Balanced
Budget Act—through their Medicaid programs. Eligibility criteria for these children
are determined by the state, subject to CMS approval. We discuss SCHIP later in
this lesson.
• States that provide health services to persons not eligible for federal Medicaid
through their Medicaid programs. The states set the eligibility criteria for these
individuals, who are often called Home Relief or General Relief recipients. These
criteria are not subject to CMS approval since there is no federal funding for the
services provided.

As mentioned above, we discuss SCHIP and how it can be implemented using an

existing Medicaid program or a separate non- Medicaid program later in this lesson.
Information on eligibility for Medicaidwaiver programs and programs for other
populations not ordinarily eligible for Medicaid can be obtained from state or county
Medicaid agencies or CMS.

States’ Responsibilities Under Medicaid Managed Care Programs

As we mentioned earlier in this lesson, the BBA made changes that allow states to
contract with additional types of MCEs, such as provider-sponsored organizations. The
BBA also lifted the need for states to obtain a waiver of certain requirements for state
Medicaid programs in order to implement certain mandatory health plan programs.

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However, states may still file a waiver to implement their Medicaid managed care
programs and must follow the rules for that process; such waivers must be renewed
every three years.

Under the nonwaiver option, states that file a satisfactory state plan amendment,
discussed later in this lesson, may continue their Medicaid managed care program
indefinitely. The following lessons describe waivers and the waiver process. Then we
focus on the role of the states in connection with Medicaid managed care initiatives.

Waivers
Initially, federal law prohibited states from making enrollment in health plans mandatory
for Medicaid beneficiaries without obtaining a special waiver of the Medicaid law and
regulations. By requiring beneficiaries to enroll in a health plan, their choice of providers
was effectively limited. Limiting choice of providers was considered a violation of
beneficiaries’ rights. Therefore, states were only allowed to encourage voluntary
enrollment in managed care programs. However, it became clear that PCCM programs
and voluntary enrollment were not going to stem the tide of increasing costs for the
Medicaid programs. The federal government encouraged states to apply for “waivers” of
certain requirements for state Medicaid programs. The requirements for such waivers
were already defined in Sections 1915(b) and 1115 of the SSA.

Section 1915(b) Waiver

Section 1915(b) of the SSA gives the Secretary of Health and Human Services (HHS
Secretary) authority to waive the requirements of the section of the SSA that sets forth
3

state plan requirements for Medicaid programs. Such waivers are very common and
obtaining them is routine. Exceptions can be allowed for any portions of the
requirements that prohibit a state from limiting the providers from whom a beneficiary
may choose to receive services. However, states are required to apply for a waiver to
require their Medicaid beneficiaries to enroll in health plans. The BBA amended
Medicaid law to provide that state Medicaid programs may mandate enrollment in a
health plan entity without seeking a Section 1915(b) waiver. 4

States must still obtain or renew an existing 1915(b) waiver to implement programs that
do not meet the 1915(b) requirements of the SSA. For example, those programs that
allow enrollment by special-needs children or Medicare beneficiaries or have default
enrollment processes (discussed later in this lesson) that give priority based on the
lowest cost provider must still obtain a waiver.

Many states have health plan Medicaid programs that currently operate under a Section
1915(b)(1) waiver known as a “freedom of choice” waiver. Figure 8C-6 describes the
1915(b)(1) waiver and several other types of 1915(b) waivers.

Figure 8C-6. Section 1915(b) Waivers.

Section 1915(b) has four subsections:

1. Subsection (1) is commonly referred to as the “freedom of choice” waiver. This

provision allows a state to restrict a Medicaid beneficiary’s choice of providers by
using a PCCM system or other arrangement. The beneficiary may also be offered

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a choice between enrolling in an HMO or choosing an independent practitioner or

clinic.
2. Subsection (2) permits a state to act as a central broker in helping Medicaid
clients to choose among competing health plans.
3. Subsection (3) allows the state to share with providers some of the savings from a
Medicaid health plan by providing coverage of enhanced services to Medicaid
beneficiaries. For example, Alabama has implemented a 1915(b)(3) waiver to
offer an enriched maternity benefit package to pregnant women.
4. Subsection (4) is commonly called the “selective contracting” section and allows
the state to limit eligible providers of a certain service to those who can
demonstrate effectiveness and efficiency. Some states have received 1915(b)(4)
waivers to contract for such services as inpatient maternity care, transportation
services, oxygen therapy, or mail-order prescription drugs.

To receive a Section 1915(b) waiver, a state is required, among other conditions, to

1. Demonstrate sufficient Medicaid health plan capacity

2. Show that Medicaid health plan payments did not exceed payments under the
state’s FFS plan
3. Comply with quality assurance and grievance requirements

The federal government monitors and evaluates states’ activities under Section 1115
waivers. Much of early Medicaid health plans evolved under Section 1115 waivers. As of
May 1998, seventeen states had received and implemented Section 1115 projects,
5

three additional states have received Section 1115 waivers but have not yet
6

implemented their programs; and one state has had its proposal approved in concept.
7

States often use a Section 1115 waiver to extend Medicaid eligibility to low-income
individuals not covered under federal Medicaid rules. Each waiver differs in the new
population covered, the scope of coverage, and the nature of the participating health
plans. The federal Medicaid requirements most commonly waived under Section 1115
are described in Figure 8C-7.

Figure 8C-7. Requirements Most Commonly Waived Under Section 1115.

The requirements of Title XIX of the SSA that are most commonly waived under
Section 1115 include the following seven categories:

1. Statewideness: A Section 1115 waiver can permit variations in the Medicaid

program in different areas of the state.
2. Comparability: A Section 1115 waiver can allow benefits to be provided to one
group and not to another and/or can permit the state to use different eligibility
methods and standards for different classes of beneficiaries.
3. Eligibility: A Section 1115 waiver can allow a state to revise its Medicaid
eligibility criteria and standards.

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4. Freedom of Choice: A Section 1115 waiver can allow a state to restrict

beneficiaries’ freedom of provider choice and can allow a state to make health
plan enrollment mandatory.
5. Health Plans: A Section 1115 waiver can allow Medicaid beneficiaries to receive
services through alternative delivery systems that otherwise would not meet
existing state and federal requirements.
6. Reimbursement: A Section 1115 waiver can allow reasonable alterations in
Medicaid payment requirements.
7. Benefits: A Section 1115 waiver can allow states to expand benefits beyond those
traditionally covered in the Medicaid program.

The Medicaid statute does not allow Section 1115 waivers to be used for the
following purposes:

1. To alter the medical assistance given to children and pregnant women

2. To change the drug rebate provisions that apply to drug manufacturers
3. To impose copayments on Medicaid-eligible individuals
4. To waive spousal impoverishment protections for institutionalized people
5. To change coverage of certain low-income beneficiaries or disabled individuals
who qualify for Medicaid assistance in paying the premiums for their Medicare
Part A or Part B premiums

Most statewide demonstration programs have attempted to expand Medicaid eligibility

and to increase the use of managed care in Medicaid programs. Some states have also
used Section 1115 waivers to move Medicaid beneficiaries with more complex
healthcare needs (e.g., the disabled or the elderly) into health plans. Arizona has
implemented the most comprehensive program of this type, encompassing all eligibility
groups and almost all services. Tennessee and Oregon have taken steps to cover their
entire Medicaid populations under health plans, although they specifically exempt
individuals who are residents in long-term care facilities.

States that currently operate Medicaid programs under Section 1115 waivers may
continue to do so. The BBA amended Medicaid law to create new authority to extend the
five-year waiver period. A state may submit a request for extension of a Section 1115
demonstration waiver 12 to 18 months before the waiver is due to expire. The extension
may be granted for up to three years. The HHS Secretary reviews requests and
approves or disapproves waiver extensions. If the HHS Secretary fails to respond within
six months, the request is automatically granted. All terms and conditions that applied to
the original waiver also apply to the extension.

Figure 8C-7. Requirements Most Commonly Waived Under Section 1115.

The requirements of Title XIX of the SSA that are most commonly waived under
Section 1115 include the following seven categories:

1. Statewideness: A Section 1115 waiver can permit variations in the Medicaid

program in different areas of the state.

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2. Comparability: A Section 1115 waiver can allow benefits to be provided to one

group and not to another and/or can permit the state to use different eligibility
methods and standards for different classes of beneficiaries.
3. Eligibility: A Section 1115 waiver can allow a state to revise its Medicaid
eligibility criteria and standards.
4. Freedom of Choice: A Section 1115 waiver can allow a state to restrict
beneficiaries’ freedom of provider choice and can allow a state to make health
plan enrollment mandatory.
5. Health Plans: A Section 1115 waiver can allow Medicaid beneficiaries to receive
services through alternative delivery systems that otherwise would not meet
existing state and federal requirements.
6. Reimbursement: A Section 1115 waiver can allow reasonable alterations in
Medicaid payment requirements.
7. Benefits: A Section 1115 waiver can allow states to expand benefits beyond those
traditionally covered in the Medicaid program.

The Medicaid statute does not allow Section 1115 waivers to be used for the
following purposes:

1. To alter the medical assistance given to children and pregnant women

2. To change the drug rebate provisions that apply to drug manufacturers
3. To impose copayments on Medicaid-eligible individuals
4. To waive spousal impoverishment protections for institutionalized people
5. To change coverage of certain low-income beneficiaries or disabled individuals
who qualify for Medicaid assistance in paying the premiums for their Medicare
Part A or Part B premiums

Section 1115 Waiver

Section 1115 of the SSA gives the HHS Secretary broad authority to waive provisions in
the Medicaid law in order to offer more comprehensive services for the following
categories:

• Aged individuals
• Blind individuals
• Dependent and crippled children
• Maternal and child welfare
• Public health

Although both the 1915(b) and 1115 waivers allow states to mandate enrollment in
Medicaid managed care plans, Section 1115 research and demonstration waivers allow
states more flexibility than Section 1915(b) waivers. Section 1115 allows the HHS
Secretary to waive compliance with sections of the SSA that establish basic
requirements for state Medicaid plans. In addition, Section 1115 allows the HHS
Secretary to approve and provide federal financial participation (FFP) for healthcare
coverage arrangements not ordinarily eligible for federal funds. States use Section 1115
waivers to test, or demonstrate, various innovative methods of covering uninsured

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populations and to test new healthcare delivery systems. These demonstration projects
can be statewide or can focus on a specific area of the state.

To receive a Section 1115 waiver, a state must demonstrate to the federal government
that the project will cost no more than the state’s current Medicaid program. The state
must also offer assurances that the demonstration project will maintain the quality of
care, prevent unnecessary utilization of services, and reimburse providers at adequate
rates, and that the participating health plans will meet the requirements of federal rules.

The federal government monitors and evaluates states’ activities under Section 1115
waivers. Much of early Medicaid health plans evolved under Section 1115 waivers. As of
May 1998, seventeen states had received and implemented Section 1115 projects,
5

three additional states have received Section 1115 waivers but have not yet
6

implemented their programs; and one state has had its proposal approved in concept.
7

States often use a Section 1115 waiver to extend Medicaid eligibility to low-income
individuals not covered under federal Medicaid rules. Each waiver differs in the new
population covered, the scope of coverage, and the nature of the participating health
plans. The federal Medicaid requirements most commonly waived under Section 1115
are described in Figure 8C-7.

Most statewide demonstration programs have attempted to expand Medicaid eligibility

and to increase the use of managed care in Medicaid programs. Some states have also
used Section 1115 waivers to move Medicaid beneficiaries with more complex
healthcare needs (e.g., the disabled or the elderly) into health plans. Arizona has
implemented the most comprehensive program of this type, encompassing all eligibility
groups and almost all services. Tennessee and Oregon have taken steps to cover their
entire Medicaid populations under health plans, although they specifically exempt
individuals who are residents in long-term care facilities.

States that currently operate Medicaid programs under Section 1115 waivers may
continue to do so. The BBA amended Medicaid law to create new authority to extend the
five-year waiver period. A state may submit a request for extension of a Section 1115
demonstration waiver 12 to 18 months before the waiver is due to expire. The extension
may be granted for up to three years. The HHS Secretary reviews requests and
approves or disapproves waiver extensions. If the HHS Secretary fails to respond within
six months, the request is automatically granted. All terms and conditions that applied to
the original waiver also apply to the extension.

Implementing State Mandatory Medicaid Managed Care Programs Without

Waivers
As we discussed earlier in this lesson, the BBA contains provisions to allow states to
implement a mandatory health plan program without obtaining a 1915(b) waiver. States
must file a state plan amendment (SPA) with the HHS secretary to make Medicaid health
plans mandatory. A state plan amendment (SPA) must describe how the state will meet
the requirements for mandating health plans. States may not require special-needs
children, dually enrolled Medicare and Medicaid beneficiaries, or native Americans (in
certain cases) to enroll in a health plan program unless they apply for a Section 1915(b)
waiver.

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To mandate health plan enrollment, states must offer enrollees a choice between at
least two MCEs, except in rural areas, where a state could offer beneficiaries a choice of
at least two providers in one MCE. The states must also give enrollees the right to
change plans or PCPs for cause at any time and without cause within the first 90 days
following enrollment. Enrollees must also have the opportunity to make a change in
plans at least once during any 12-month period. In effect, this allows states to limit
disenrollment from a health plan to only once per calendar year. Prior to the BBA,
enrollment could only be “locked in” for six months under a 1915(b) waiver.

States must establish an enrollment priority system that gives first choice for enrollment
to Medicaid beneficiaries who are currently enrolled in a health plan if the new plan that
they choose is full. States that implement programs to mandate health plan coverage for
Medicaid beneficiaries must ask beneficiaries to select a plan from the plans qualified by
the state.

If a beneficiary fails to select a plan or a PCP, the state is allowed to automatically

assign a beneficiary to a plan. States must establish a default enrollment process to
assign beneficiaries to a plan if they do not exercise their right to choose a plan or PCP.
This default process must attempt to maintain existing provider-beneficiary relationships
or relationships with traditional Medicaid pro-viders. If the default process cannot
maintain such relationships, the state’s process must try to equitably distribute
beneficiaries among the available health plans. Some states use criteria other than
provider relationships, such as plan quality performance, availability of additional
benefits, etc., to assign beneficiaries to health plans.

Requirements for Notices and Information

All notices and information provided to Medicaid enrollees by the states, its brokers, and
the health plan entities must be presented in a manner that is easily understood by
Medicaid enrollees and potential enrollees. For example, notices and information must
be written at no more than a sixth-grade reading level. The BBA requires MCES to
provide detailed information to prospective enrollees, including the following:

• The names of providers who are included in the entity’s network

• Enrollees’ rights and responsibilities
• Grievance procedures
• Covered items and services

Annually, or on the request of the enrollee, states must provide a list of available MCES,
including information about each entity’s benefits, service areas, and quality and
performance indicators. 8

Requirements for State Quality Assurance Programs

As we have seen, the Medicaid program seeks to manage the costs of healthcare. In
addition, the Medicaid program seeks to ensure the quality of healthcare provided to
Medicaid beneficiaries. Specifically, each state must develop and implement a quality
assessment and improvement strategy, applicable to contracting Medicaid MCEs, which
includes the following:

• Standards for access to care

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• Examination of other aspects of care and service directly related to quality such
as grievance procedures and marketing and information standards
• Procedures for monitoring the quality and appropriateness of care
• Requirements for providing quality assurance data to the state using the data
and information standards required by Medicare

CMS has been working closely with other federal and state officials, as well as
representatives of beneficiary advocacy groups and the health plan industry, to develop
quality standards that can better ensure that health plans which contract with CMS
protect and improve the health and satisfaction of their enrollees. The Quality
Assessment Performance Improvement (QAPI) is the product of these efforts. It builds
on a variety of recent CMS and state efforts to promote the assessment and
improvement of health plan quality. Once complete, QAPI will offer a uniform set of
quality assurance standards that can be used by CMS and the state Medicaid agencies
to determine whether a health plan can meet the quality assurance requirements
necessary to become and remain eligible as a Medicaid contractor.

Although the requirement for plans to undergo external quality review was in place prior
to passage of the BBA, the BBA requires that a standard protocol be developed for such
reviews. The HHS Secretary and the National Governor’s Association are charged with
contracting with an independent quality review organization to develop protocols to be
used in external independent reviews conducted on or after January 1, 1999. In addition,
the BBA gave states the authority to ensure that such external reviews do not duplicate
review activities performed by a private accreditation organization or a review under the
Medicare+Choice program. States may choose to “deem compliance” with the external
9

review requirement for Medicare+ Choice organizations that have had a Medicaid risk
contract in effect for at least two years.

The BBA also repealed a rule that required health plans to limit their Medicaid and
Medicare enrollment to less than 75% of total enrollment. This rule was intended to
ensure that Medicaid enrollees received the same level of quality healthcare that plans
provided to commercial enrollees. Since this rule has been repealed, Medicaid MCEs
are no longer required to serve commercial enrollees. The 75/25 composition rule, as
this rule was called, was repealed in part because new quality indicators have been
developed that help assure Medicaid managed care enrollees receive quality healthcare.
In addition, the composition rule was cumbersome to enforce and posed a problem for
health plans in areas with a large proportion of Medicaid recipients.

Oversight of Marketing Efforts

Although states had many regulatory requirements related to marketing prior to 1997,
there was very little federal regulation of Medicaid health plan marketing and enrollment
practices. Federal regulations did not require advance approval of marketing materials
and did not prohibit Medicaid HMOs from marketing door-todoor or from offering gifts or
payments to attract enrollees. Federal regulations addressed only general marketing
practices.

With passage of the BBA, the federal government demanded closer management of
Medicaid health plan marketing practices. For example, the federal Medicaid law now
prohibits health plans from distributing marketing materials without prior state approval.

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Medicaid marketing materials may not contain false or misleading information, and no
other insurance products may be marketed in conjunction with the health plan. Each
plan must distribute marketing materials to its entire service area. Both oral and written
marketing materials must conform to the standards of accuracy and understandability
set by the HHS Secretary so that enrollees can make an informed choice among health
plans. “Cold calls”—either door-to-door or by telephone—are prohibited.

The state must consult a medical care advisory committee as a part of the review of
marketing materials. In addition, states must distribute, either directly or through its
Medicaid MCEs, information in a chartlike format that compares the benefits,
costsharing, service area, and instructions on accessing any covered services not
included in the health plan benefit package.

If available, the comparative information must also include each health plan’s quality and
performance indicators. In addition, Medicaid marketing practices are heavily regulated
by state Medicaid agencies and, in some cases, the state agency responsible for
regulating commercial HMOs. State regulations specify where marketing activities may
take place and include provisions for certification and oversight of marketing agents.
Figure 8C-8 describes one state’s regulations for Medicaid marketing materials.

The Office of the Inspector General of the U.S. Department of Health and Human
Services, the U.S. General Accounting Office (on the request of a member of Congress),
the U.S. Attorney General, and in some states the State Attorney General and/or
Department of Insurance all can investigate Medicaid health plan marketing abuses.

Figure 8C-8. An Example of State Regulation of Marketing Materials.

The state of Tennessee has set the following standards for marketing materials used by
Medicaid managed care plans:

1. The state must preapprove written marketing materials.

2. Materials cannot mislead, confuse, or defraud.
3. Materials must be written on a reading level no higher than sixth grade.
4. Enrollment forms cannot be attached to marketing materials.
5. If the plan is advertising special benefits, it must explain clearly which health
services are required by the state and which are additional benefits.
6. Materials cannot give the appearance that the state endorses a particular plan. For
instance, plans cannot display the state seal on their materials.
7. Since Tennessee’s TennCare program requires certain people to pay premiums,
plans cannot use the word “free” on their marketing materials.
8. If plans fail to comply with these or other marketing restrictions, Tennessee may
suspend new enrollments, inform misinformed enrollees that they may disenroll,
and/or withhold capitation payments.
Source: Excerpted and adapted from Families USA Foundation, A Guide to Marketing and Enrollment in Medicaid Health Plan. June
1997, p. 9.

Determining Services to Be Offered

Each state determines the amount and duration of services offered under its Medicaid

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program, within broad federal guidelines (described later in this lesson). For example, a
state may limit the number of days of hospital care or the number of physician visits.
However, the limits must be sufficient to include a level of service to reasonably achieve
the purpose of the benefits. Limits on mandatory benefits may not be different for
different medical diagnoses or conditions.

States may also receive federal matching funds for providing certain optional services to
Medicaid recipients. The most common of the 34 currently approved optional Medicaid
services include the following:

• Diagnostic services
• Clinical services
• Intermediate care facilities for the mentally retarded
• Prescribed drugs and prosthetic devices
• Optometrist services and eyeglasses
• Nursing facility services for children under 21
• Transportation services
• Rehabilitation and physical therapy services
• Home and community-based care to certain persons with chronic impairments
(only 1915[b] waiver)

Role of State Regulatory Agencies

A survey of state insurance, Medicaid, and public health agencies conducted by the
National Academy for State Health Policy revealed that in a majority of states two or
more agencies have simultaneous regulatory authority over MCEs. State insurance and
health departments often regulate MCEs and publish review standards for purchasers to
consider. State Medicaid agencies have both regulatory and purchasing responsibilities.
Insurance departments typically monitor the financial aspects of MCE operations. Health
departments tend to monitor quality and consumer protection. Medicaid agencies are
more likely to monitor both the financial and quality assurance aspects of MCEs. The
Medicaid agencies’ dual responsibilities reflect their accountability to federal regulation
of the Medicaid program. If there are any gaps in a state’s oversight of its Medicaid
program, they tend to be in the area of quality assurance standards. The reason for this
gap is most likely the recent evolution of increasing emphasis on quality within the
healthcare industry and among consumer groups that demands more detailed oversight
of plans for quality assurance.

There are several approaches to the interagency division of responsibility for MCE
oversight. In one approach, the concurrent model, various state agencies exert authority
over similar aspects of MCE operations among the same group of MCEs. For example,
a state Medicaid agency and a state health department may both be responsible for
ensuring quality improvement programs are in place to meet each agency’s rules and
regulations for such programs. In this approach, there is considerable overlap of the
functions performed by the various agencies. States using this approach include New
Jersey, Rhode Island, and Vermont.

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Another approach is the parallel model, in which each agency regulates both financial
and quality aspects of MCE operations for distinctly different MCE types. For example,
one agency might focus on HMOs, the second on PCCMs, and the third on PHPs.

A third approach is the shared model, in which each agency focuses on its particular
area of expertise in regulating managed care. The health department focuses on quality
assurance; the insurance department focuses on financial operation; the Medicaid
agency focuses on those aspects of financial operation and quality assurance that are
beyond the expertise of the insurance or health department. Alternatively, the Medicaid
agency may focus more exclusively on program administration, including contracting,
rate-setting, and contract compliance. While this approach is still in development, the
states of Florida, Illinois, and Tennessee each have implemented a version of the shared
model. 10

Enforcement and Sanctions for Noncompliance

State Medicaid agencies must monitor MCEs and take action if MCEs fail to meet
Medicaid’s standards and requirements. However, states must allow MCEs due process
prior to terminating their participation in the Medicaid program. Federal law outlines the
intermediate sanctions a state may impose on an MCE. These sanctions may include
civil monetary penalties or other remedies. The state may impose sanctions if the MCE:

• Fails substantially to provide medically necessary items and services that are
required under law or under contract (penalty of up to $25,000 for each
determination)
• Imposes excessive premiums and charges (penalty is double the excess amount
charged)
• Acts to discriminate among enrollees on the basis of health status or other
requirements for health services except as permitted under applicable sections of
the SSA (penalty must not be more than $100,000 for each determination)
• Engages in a practice that reasonably could be expected to have the effect of
denying or discouraging enrollment by people who may need substantial future
medical services (penalty of up to $100,000 for each determination)
• Misrepresents or falsifies information furnished to the state, HHS, an enrollee, a
potential enrollee, or a provider (penalty of up to $100,000 for each
determination)
• Violates marketing requirements outlined in Section 1932(d) of the SSA (penalty
of up to $25,000 for each determination)

Review Question

There are several approaches to the interagency division of responsibility for managed
care entity (MCE) oversight. In State M, the state Medicaid agency, the state department
of health, and the state insurance department are all responsible for ensuring that quality
improvement programs are in place among the same group of MCEs and that these
programs meet each agency's rules and regulations for such programs. This information
indicates that State M uses the approach known as the

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parallel model
shared model
concurrent model
PACE model

Incorrect. The parallel model is when each agency regulates both financial and
quality aspects of MCE operations for distinctly different MCE types. For example,
one agency might focus on HMOs, the second on PCCMs, and the third on PHPs

Incorrect. The shared model is when each agency focuses on its particular area of
expertise in regulating managed care. The health department focuses on quality
assurance; the insurance department focuses on financial operation; the Medicaid
agency focuses on those aspects of financial operation and quality assurance that
are beyond the expertise of the insurance or health department

Correct. In one approach, the concurrent model, various state agencies exert
authority over similar aspects of MCE operations among the same group of MCEs.

Incorrect. PACE is a joint federal-state program that states have the option of
implementing to provide ann alternative to institutional care for persons age 55 or
older who require nursing facility levels of care.

In addition to, or instead of, imposing monetary penalties, a state may choose to take
any or all of the following actions:

• Permit beneficiaries to disenroll from the plan without cause

• Suspend default enrollment
• Suspend payment for individuals enrolled after the plan was notified of the
determination
• Appoint temporary management to oversee the plan (1) if there is a finding of
continued conspicuously bad behavior; (2) if there is a substantial risk to the
health of enrollees; or (3) to assure the health of enrollees while there is an
orderly termination or reorganization of the organization or while improvements
are made to remedy violations for which intermediate sanctions could be
imposed

Before imposing any sanctions other than termination, the state must provide the entity
with notice and any other due process protections that the state ordinarily provides. In
addition, before terminating a contract with an MCE, the state must grant the plan a
hearing. The state may notify plan enrollees of the hearing and permit them to disenroll
without cause.

Responsibilities of Health Plans Participating in Medicaid Programs

The following sections describe the services and certain protections that Medicaid health
plans must provide to beneficiaries. Requirements for quality assurance and prohibition
of certain marketing activities were discussed in the previous lessons.

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Scope of Services That Health Plans Must Provide

Federal law mandates that Medicaid programs provide certain basic services to most
categorically needy populations. Therefore, health plans that participate in state
Medicaid programs must be able to offer such services to Medicaid beneficiaries. In
general, these mandated services include the following:

• Inpatient hospital services

• Outpatient hospital services
• Prenatal care
• Vaccines for children
• Physician services
• Nursing facility services for persons 21 or older
• Family planning services and supplies
• Rural health clinic services
• Home health care for persons eligible for skilled-nursing services
• Laboratory and X-ray services
• Nurse-midwife services
• Pediatric and family nurse practitioner services
• Federally qualified health center (FQHC) services
• Ambulatory services of an FQHC that would be available in other settings
• Early and periodic screening, diagnostic, and treatment (EPSDT) services for
children under age 21. Figure 8C-9 describes EPSDT services.

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Protections for Medicaid Beneficiaries

Each Medicaid managed care plan contract must cover emergency services under the
“prudent layperson” standard without regard to whether prior authorization for such
services was obtained from the health plan. Health plans must also comply with
Medicare guidelines for coverage of post-stabilization care. To protect enrollee-provider
communications, under a health plan/Medicaid health plan contract, healthcare
professionals must not be restricted from advising a beneficiary about his or her health
status, medical care, or treatment, regardless of whether benefits for this care or
treatment are provided by the contract. In addition, each Medicaid managed care plan
must establish an internal appeals procedure by which an enrollee may appeal coverage
or payment decisions. Medicaid managed care plans must also provide the HHS
secretary and the state with assurances that the plan has the capacity to serve the
expected enrollment in the service area.

Medicaid managed care contracts must include a hold harmless provision that protects
enrollees against liability for payment. If the state does not make payment to a provider
or plan, in the event of the plan’s insolvency, the enrollee cannot be held liable for those
payments.

The plan must also offer an appropriate range of services, access to preventive and
primary care services, with a sufficient number, mix, and geographic distribution of
providers for those services.

New Programs Established Under the BBA

In addition to making changes to the existing Medicaid program, the BBA established
two new programs. One is an extension of a Medicare program and a demonstration
project serving the elderly poor; the other is an entirely new approach to providing
healthcare to uninsured low-income children.

Programs of All-Inclusive Care for the Elderly (PACE)

The BBA established Programs of All-Inclusive Care for the Elderly, which may be
implemented as a state option. This program has operated under demonstration waivers
in the past. Programs of All-Inclusive Care for the Elderly (PACE) provides an
alternative to institutional care for persons aged 55 or older who require a nursing-facility
level of care. PACE operates within both the Medicare and the Medicaid programs.
States may elect to provide PACE program services to individuals who are Medicaid-
eligible and are enrolled in PACE program. These individuals are not required to be
enrolled in Medicare to be eligible for a state’s PACE program.

To participate in PACE a public entity or private, not-for-profit organization that seeks to

provide, on a capitated basis, health and long-term care services to frail elderly people
who are at risk for institutional care files an application with the HHS Secretary. Upon
approval of such application, a PACE provider enters into an agreement with either:

• The state Medicaid agency responsible for administering the operation of the
PACE program
• The HHS Secretary

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This agreement, which defines the service area and describes other relevant information
related to the provision of PACE services, is called the PACE program agreement.
Each state determines eligibility for its PACE program in accordance with the PACE
program agreement. Individuals are eligible for PACE if they are 55 years of age or
older, require a nursing-facility level of care, reside in the service area of the PACE
program, and meet other requirements outlined in the agreement. An individual is
considered to be eligible for PACE if he or she could reasonably be expected to requalify
for a nursing-home level of care within the following six months if PACE services were
denied. The individual’s health status is determined using indicators such as medical
diagnosis, activities of daily living (ADLs), and cognitive impairment.

PACE enrollees must undergo an annual eligibility recertification to ensure that they are
being appropriately served in a PACE setting. Enrollees may voluntarily disenroll from
the program at any time. However, the PACE program may not disenroll individuals
except in cases of nonpayment of premiums (if applicable) or in cases where the
individual is engaging in disruptive or threatening behavior. Involuntary disenrollment is
subject to review by the HHS Secretary or the state Medicaid agency.

The individuals enrolled in PACE receive benefits solely through the PACE program.
Regardless of the source of payment (i.e., state Medicaid funds, matching Medicaid
funds, or Medicare funds), PACE providers receive capitated payment only through the
PACE program agreement. PACE providers must make available to PACE enrollees all
items and services covered under both Medicare and Medicaid, without limiting the
amount, duration, or scope of services, and without imposing on eligible enrollees any
deductibles, copayments, or other cost-sharing mechanisms that might otherwise apply
under Medicaid or Medicare. PACE enrollees must have access to benefits 24 hours a
day, every day of the year, and services must be provided through a comprehensive,
multidisciplinary system that integrates acute and long-term care services. The PACE
program agreement must include a written plan of quality assurance and improvement
and a set of written safeguards (including a patient bill of rights and procedures for filing
grievances and appeals).

During the initial three-year trial period of a state’s PACE program, the HHS Secretary
will conduct a comprehensive annual review of PACE providers to ensure compliance
with the requirements and regulations governing the program. The HHS Secretary may
terminate PACE provider agreements if this annual review identifies significant
deficiencies in the quality of care or if the provider is substantially out of compliance with
the conditions of the PACE program and fails to initiate a corrective action plan.

State Children’s Health Insurance Program (SCHIP)

In addition to making changes to Medicare and Medicaid, the BBA of 1997 established a
new title in the SSA: Title XXI. Title XXI of the SSA established the State Children’s
Health Insurance Program (SCHIP) to enable states to initiate and expand child health
assistance to uninsured, low-income children. Title XXI provides $47 billion in funding to
states over a tenyear period, $40 billion of which will be available in the form of matching
funds. Effective October 1, 1997, the states were charged with establishing programs in
one or both of the following ways:

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1. By establishing a separate program (in addition to an existing Medicaid program)

to provide health insurance coverage that meets the requirements of SCHIP.
These requirements relate to the amount, duration, and scope of benefits
2. By expanding eligibility for children under the State’s Medicaid program

State Children’s Health Insurance Program (SCHIP)

To be eligible for funds, states must submit a State Child Health Plan to the secretary
of HHS for approval. A State Child Health Plan must include general background on the
extent to which children currently have coverage, current state efforts to obtain
coverage, how the plan will be coordinated with other efforts, the proposed delivery
methods, and methods to assure quality and access to covered services. The plan must
describe standards and methods used to establish and continue eligibility and enrollment
for targeted low-income children. In addition, the plan must describe procedures for
outreach to inform and enroll families of children who are likely to be eligible for
assistance under the plan or under other public or private coverage.

Separate Program Option

If the state chooses to implement a separate, non-Medicaid option, the benefit package
must be structured in compliance with one of four options: benchmark coverage,
benchmark-equivalent coverage, existing comprehensive state-based coverage, or HHS
Secretary-approved coverage. Figure 8C-10 describes each of these options. States are
allowed to collect premiums consistent with the SCHIP guidelines for the separate
program option; however, the program’s cost-sharing must not favor higher-income
children over lower-income children. In addition, the State Child Health Plan may not
impose any pre-existing condition exclusions for covered benefits.

Figure 8C-10. SCHIP Separate Program Options.

Option 1/Benchmark Coverage

Benefit plans must be equivalent to one of the following healthcare plans:

1. The standard Blue Cross/Blue Shield Preferred Provider option offered under
FEHBP
2. A health benefits plan that is offered and generally is available to state employees
3. The HMO plan with the largest commercial enrollment in the state

Option 2/Benchmark- Equivalent Coverage

The health benefit coverage must have an aggregate actuarial value (determined by a
member of the American Academy of Actuaries) that is at least equal to one of the
benchmark coverage packages described above. The coverage under the benchmark-
equivalent package must include benefits in the following categories of basic services:

1. Inpatient and outpatient hospital services

2. Physicians’ surgical and medical services
3. Laboratory and x-ray services
4. Well-baby and well-child care, including age-appropriate immunizations

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If the state chooses to implement a benchmark-equivalent coverage package that includes

prescription drugs, mental health, vision, or hearing services, then the actuarial value of
each of these categories of service must be at least 75% of the actuarial value of the
benchmark package value. If the benchmark- equivalent package does not cover one of
the categories of services listed in the preceding sentence, then the equivalent plan may,
but does not have to, provide coverage for that category of service.

Option 3/Existing Comprehensive State-Based Coverage

Health benefit coverage under an existing comprehensive statewide program is defined as
a program that

1. Provides a range of benefits

2. Is administered by the state and receives state funds
3. Is offered in New York, Florida, or Pennsylvania
4. Was offered on the date of enactment of Title XXI
5. If modified, still includes a range of benefits and has an actuarial value equal to or
greater than either its value on August 5, 1997, or the value of one of the
benchmark packages

Option 4/HHS Secretary- Approved Coverage

Any health benefit coverage package that the secretary of HHS determines, upon
application by a state, provides appropriate coverage for targeted low-income children.

Medicaid Expansion Option

States may also choose to expand their Medicaid programs to meet the needs of
targeted low-income children. States that elect to expand children’s health insurance
through the Medicaid option are required to provide the state-mandated Medicaid benefit
package. If a state chooses to implement SCHIP by expanding its Medicaid program, the
state must submit a plan amendment, as well as submitting specified information
required by Title XXI. The advantage of choosing Medicaid expansion over a separate
program option is that even after the federal allocation of funds provided through SCHIP
is exhausted, states may continue to receive federal matching funds at their normal
Medicaid rate for children covered by a Medicaid expansion program.

Federal Funding for SCHIP

Under the law, a state must have an approved state plan for a fiscal year to receive an
allotment from SCHIP funds. Allotments are determined by a complex formula that takes
into account the total number of uninsured, low-income children in the state, multiplied
by a geographic cost factor. Like Medicaid, SCHIP is a matching program, under which
the states’ receipt of federal funds depends on state expenditures. As with the Medicaid
program, the federal percentage of contribution varies by state, based on the state’s
relative wealth. However, there is a cap on the federal contribution.

Administration of SCHIP
The Center for Medicaid and State Operations (CMSO) within CMS has primary
responsibility for administering the federal aspects of Title XXI. There is a team
composed of staff from other HHS offices providing support for the SCHIP program.
Among other coordination efforts, HHS works closely with states through the National
Governors Association.

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Eligibility for SCHIP Assistance

The SCHIP program is designed to assist targeted low-income children. A targeted low-
income child is considered to be a child who:

• Meets the eligibility standards set by the state

• Is under 19 years of age
• Is not currently eligible for Medicaid or covered under other health insurance
coverage
• Resides in a family with income below the greater of the following: 200% of the
FPL or, for states with Medicaid-eligible levels for children above 150% of the
FPL as of June 1, 1997, 50 percentage points above the state’s Medicaid
eligibility limit as of that date

One exception to these requirements is that the term targeted low-income child may
include children covered under a health insurance program in operation since before
July 1, 1997, that is offered by the state and receives no federal funds. Children who
might otherwise be included are excluded if they are inmates of public institutions,
patients in an institution for mental disease (IMD), or children whose families are eligible
for the state employee benefits plan.

Evaluation of SCHIP Programs

States must assess the operation of their plan, including progress made in reducing the
number of low-income children not covered by insurance, and report annually to the
HHS Secretary by January 1 of each year. By March 31, 2000, each state with an
approved State Child health plan must submit to the HHS Secretary an evaluation
addressing the effectiveness of the plan in a number of areas. The HHS Secretary will
submit to Congress by December 31, 2001, a report based on the state evaluations.

The Future of Medicaid Managed Care and SCHIP

Congress has targeted Medicaid spending for a $13 billion reduction between 1997 and
2002. The PRWORA and the BBA are the first steps toward achieving that goal.
Because of the extensive changes implemented by this legislation, it is logical to assume
that there will be additional legislation to fine-tune the operation of Medicaid health
plans. This prediction is supported by the fact that the BBA made several amendments
to the PRWORA.

Congress has not been concerned only with cost. The trend in government-sponsored
healthcare in the mid-to-late 1990s has been to give states greater flexibility and
accountability for providing medical care to their poor, with an emphasis on providing
care to poor children. The PRWORA has placed greater responsibility on poor adults to
improve their own situation, creating motivation for these individuals to become
selfsupporting. Yet, the federal and state governments have taken care not to
disenfranchise poor children, creating options for the well-being of the truly needy under
managed healthcare. MCEs must keep a watchful eye on what develops to remain
effective and competitive in Medicaid managed care.

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Chapter 9 A
Fraud and Abuse
The amount spent annually on healthcare in the United States now exceeds one trillion
dollars. With this amount of money at stake, it is not surprising that some of the players
involved in delivering, financing, or consuming healthcare engage in dishonest or even
criminal conduct to obtain money or other benefits to which they are not entitled. These
improper activities-known as fraud and abuse-not only make healthcare more expensive,
they also diminish its quality.

In this assignment, we describe the kinds of fraud and abuse that occur in managed
healthcare plans, both in federally funded programs such as Medicare and Medicaid and
in commercial plans. We also discuss the major federal laws that regulate healthcare
fraud and abuse and describe the penalties that can be imposed for violating them. We
end by examining some of the steps that health plans take to identify and reduce
healthcare fraud and abuse.

After completing this lesson, you should be able to:

 Define the terms fraud and abuse

 Describe how different types of compensation arrangements can lead to different
kinds of fraud and abuse
 List and describe the federal laws that regulate healthcare fraud and abuse, and
identify the federal agency responsible for enforcing them
 Describe the penalties that may be imposed for violating the federal fraud and abuse
laws
 Discuss some of the steps health plans can take to reduce fraud and abuse

What Is Fraud and Abuse?

The phrase fraud and abuse is used to describe a wide range of improper healthcare
activities. Fraud and abuse do have distinctive meanings, however. The more general of
the terms- abuse- is any improper practice that results in excessive or unreasonable
healthcare costs. Fraud, which is a specific kind of abuse, is a knowing and willful
deception or misrepresentation, or a reckless disregard of the facts, done with the intent
to receive an unauthorized benefit. The distinctive feature of fraud is the element of
misrepresentation or deception. For example, in a healthcare/health plan context, abuse
occurs when a doctor orders unnecessary tests, and fraud occurs when a provider
submits a bill to a managed healthcare plan or to the government requesting payment
for services that the provider knows were not actually provided.

Because of the element of deception or misrepresentation involved in fraud, it is usually

considered to be a crime. At the federal level, the Health Insurance Portability and
Accountability Act of 1996, which we will discuss in more detail later in this lesson,
makes it a federal crime to obtain money from a healthcare plan by fraud or false
pretenses. Penalties include fines up to $250,000 and terms in federal prison. Most
states also have laws that make healthcare fraud a crime, and in many states healthcare
fraud is considered to be a felony.

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We will use the phrase fraud and abuse in this lesson as it is commonly used-as a catch-
all way of describing the variety of improper activities that drive up the costs of
healthcare. You should keep in mind, though, that fraud often has a very specific
meaning under the criminal laws, while abuse describes conduct that is improper but not
necessarily criminal.

How Compensation Arrangements Affect Fraud and Abuse

You may recall from Healthcare Management: An Introduction that compensation
arrangements in health plans form a continuum, with fee-for-service (FFS) arrangements
at one end of the spectrum and capitation arrangements at the other. Under fee-for-
service compensation plans, providers are paid after the fact for services that have been
performed. Therefore, a provider's income increases with the volume and variety of the
services that he or she generates. Under capitation arrangements, on the other hand,
providers are paid in advance for all of the services that they have agreed to provide. A
provider is paid the same monthly amount for each member regardless of how often (if
at all) the member receives care during that month and regardless of the cost of that
care. The compensation arrangements used by a health plan can be at either end of this
continuum or somewhere in the middle, and the same health plan may use different
arrangements to pay for different services. Understanding these arrangements is
important, because the different types of arrangements generally lead to different kinds
of fraud and abuse. You may find it helpful to refer to Figure 9-1 as we discuss these
differences in the following lessons.

How Compensation Arrangements Affect Fraud and Abuse

You may recall from Healthcare Management: An Introduction that compensation
arrangements in health plans form a continuum, with fee-for-service (FFS) arrangements
at one end of the spectrum and capitation arrangements at the other. Under fee-for-
service compensation plans, providers are paid after the fact for services that have been
performed. Therefore, a provider's income increases with the volume and variety of the
services that he or she generates. Under capitation arrangements, on the other hand,
providers are paid in advance for all of the services that they have agreed to provide. A
provider is paid the same monthly amount for each member regardless of how often (if
at all) the member receives care during that month and regardless of the cost of that
care. The compensation arrangements used by a health plan can be at either end of this
continuum or somewhere in the middle, and the same health plan may use different
arrangements to pay for different services. Understanding these arrangements is
important, because the different types of arrangements generally lead to different kinds

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of fraud and abuse. You may find it helpful to refer to Figure 9-1 as we discuss these
differences in the following lessons.

Review Question

Arthur Dace, a plan member of the Bloom health plan, tried repeatedly over an extended
period to schedule an appointment with Dr. Pyle, his primary care physician (PCP). Mr.
Dace informally surveyed other Bloom plan members and found that many people were
experiencing similar problems getting an appointment with this particular provider. Mr.
Dace threatened to take legal action against Bloom, alleging that the health plan had
deliberately allowed a large number of patients to select Dr. Pyle as their PCP, thus
making it difficult for patients to make appointments with Dr. Pyle.

Bloom recommended, and Mr. Dace agreed to use, an alternative dispute resolution
(ADR) method that is quicker and less expensive than litigation. Under this ADR method,
both Bloom and Mr. Dace presented their evidence to a panel of medical and legal
experts, who issued a decision that Bloom's utilization management practices in this
case did not constitute a form of abuse. The panel's decision is legally binding on both
parties.

Different types of compensation arrangements in managed care plans, from fee-for-

service (FFS) arrangements to capitation arrangements, lead to different types of fraud
and abuse. From the answer choices below, select the response that identifies the form
of abuse in which Bloom is allegedly engaging, according to Mr. Dace's complaint, and
whether this form of abuse is more likely to occur in FFS compensation arrangements or
in capitation arrangements.

Type of abuse underutilization

Type of compensation arrangement FFS arrangement
Type of abuse underutilization
Type of compensation arrangement capitation arrangement
Type of abuse overutilization
Type of compensation arrangement FFS arrangement
Type of abuse overutilization
Type of compensation arrangement capitation arrangement

Incorrect. Underutilization occurs when services that are covered under a health
plan are provided to a lesser extent than was medically necessary. Plans with FFS
arrangements are not subject to this type of abuse.

Correct. Underutilization occurs when services that are covered under a health
plan are provided to a lesser extent than was medically necessary. Plans with
capitation arrangements may be subject to this form of abuse.

Incorrect. Overutilization occurs when services under a health plan are provided
at a greater extent than is medically necessary. Plans with FFS arrangements are
subject to this type of abuse.

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Incorrect. Overutilization occurs when services under a health plan are provided
at a greater extent than is medically necessary. Plans with capitation
arrangements are not subject to this type of abuse

Fraud and Abuse in Fee-for-Service Arrangements

In FFS arrangements, as healthcare services increase so do the incomes of providers.
With such strong financial incentives, there are typically more concerns regarding fraud
and abuse under plans with FFS arrangements than under plans with other types of
compensation arrangements. Also, plans with FFS arrangements seldom use health
plan techniques such as specialty referral or preauthorization requirements that can
sometimes prevent certain types of fraud. Because providers under FFS plans are paid
each time they submit a bill for services, much of the fraud and abuse under FFS plans
results from false billing practices. Most often, a false billing involves providers
submitting fraudulent bills for services that were not provided. False billing can also
involve upcoding.

Upcoding occurs when a provider requests payment for a service that has a higher
reimbursement to the provider than the service that was actually performed. For
example, upcoding occurs when a physician performs a minor nonsurgical procedure but
requests payment for surgery, or when a patient is seen by a nurse but the health plan is
charged for an office visit with a physician. In some cases, providers share the money
they receive from fraudulent claims with dishonest patients who provide them with the
insurance information they use to file the claims.

In addition to the fraud that results from submitting false claims, FFS arrangements can
also be subject to a form of abuse known as overutilization. Overutilization occurs
when services under a health plan are provided to a greater extent than is either
medically necessary or authorized by the plan. Overutilization may occur, for example,
when a physician sees a patient more often or provides for a certain condition a greater
number of treatments than are medically necessary. Providers under FFS arrangements
have an incentive to practice overutilization because their incomes increase with the
volume of services they provide.

Providers engage in underutilization when they undertreat the medical conditions of plan
members, either by providing fewer office visits than are medically necessary or by
providing substandard care. For example, some providers may improperly allow patients
to be examined by physician assistants or nurses when a higher level of care is needed.
Underutilization can also be practiced in more subtle ways, such as by delaying the
scheduling of appointments.

Another type of fraud and abuse that may occur under capitated fee arrangements is for
providers to overstate the number of patient encounters they have when they file
encounter reports with health plans. Health plans rely on encounter reports from
providers to establish how large future capitation payments will be. A provider who
overstates his or her encounters does not receive any additional income at the time, but
in the future may receive capitation payments that are larger than justified.

Fraud and Abuse by Health Plans

Because health plans often rely upon compensation arrangements as well as utilization

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review and quality assurance programs to help manage the delivery of healthcare, the
incidence of fraud and abuse is generally less frequent in health plans than in FFS
plans. However, one way that fraud and abuse can be committed by a health plan is
through the practice of underutilization, especially when the health plan shares part of
the financial risk. For example, a health plan might allow a large number of patients to
select a particular primary care physician, making it difficult for patients to make
appointments; or a health plan might try to limit patient access to high-cost treatments or
specialists by engaging in over-restrictive utilization management practices. We will
discuss the legal issues that can arise from inappropriate utilization management
practices in Key Legal Issues in Health Plans.

The Impact on Cost and Quality of Care

An enormous amount of money is lost to health care fraud and abuse each year. The
costs of fraud and abuse are felt both by health plans, which compensate providers for
services under health plans, and by the employers and individuals who ultimately pay
the premiums under those plans. And although the increased costs resulting from
fraudulent billing and overutilization may be easier to visualize, underutilization drives up
the cost of healthcare as well. When providers practice underutilization, plan sponsors
and members end up receiving fewer services than they pay for, so they pay more than
they should for the services they do receive.

Overutilization and underutilization can both be harmful to the health of plan members.
When providers practice overutilization, plan members may receive more extensive
treatment than is medically necessary or appropriate, and at times this can present
unnecessary health risks. When providers practice underutilization, plan members
typically receive fewer health services than they need, and as a result, their health can
be compromised.

Fast Fact

By some estimates, healthcare fraud amounted to $100 billion in 1997, or 10% of the
total national healthcare budget.1

Fraud and Abuse in Federal Healthcare Programs

As we mentioned in Federal Government as Purchaser, the federal government is a
purchaser of healthcare benefits for a significant number of Americans through the
Medicare and Medicaid programs. Because Medicare and Medicaid are still largely fee-
for-service (FFS) programs, they are subject to the same forms of fraud and abuse
present in other FFS plans. Much of this fraud and abuse is in the form of false billings
and overutilization. As Medicare and Medicaid continue to move toward health plans,
however, other kinds of fraud and abuse may become more common. To combat the
fraud and abuse in federally funded healthcare programs, Congress has enacted a
variety of laws that regulate the activities of participants in those programs. We discuss
the most important of these laws in this section. Other federal laws that do not apply
specifically to healthcare but that are sometimes used to fight healthcare fraud and
abuse are summarized in Figure 9A-2.

Figure 9A- Other Federal Laws That Can Be Used Against Healthcare Fraud and
2. Abuse.

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The False Claims Act makes it illegal to present a false, fictitious, or fraudulent claim
against the United States. Although the Act was not enacted specifically to combat
healthcare fraud, it has been used to prosecute fraudulent billings under FEHBP, the
Medicare and Medicaid programs, and other federal contracts as well. Sanctions include
fines and prison terms, plus additional penalties equal to three times the amount of the
false claim.

The mail fraud statute makes it illegal to use the mail to further a scheme to defraud.
This statute is especially useful in fighting healthcare fraud because healthcare fraud
often involves using the mail to submit false bills and invoices. Sanctions include fines of
up to $250,000 and prison terms.

The Racketeer Influenced and Corrupt Organizations Act (RICO) was originally
enacted to fight organized crime, but it has also been used against healthcare fraud. RICO
makes it illegal to associate with a criminal enterprise and participate in its activities.
Sanctions include fines of up to $25,000 and prison terms of up to 20 years.

The Anti-Kickback Statute

The federal anti-kickback statute, which is part of the Social Security Act, prohibits the
exchange of kickbacks in any federal healthcare program. The definition of kickback
under the federal anti-kickback statute is complex, but in general terms related to
healthcare a kickback occurs when one party directly or indirectly gives another party
money or some other benefit in exchange for receiving increased business under a
federal healthcare program. Kickbacks are undesirable because they may influence
providers and health plans to take actions that are not in the best interest of patients and
because they increase the costs of federal healthcare.

The anti-kickback statute applies to a wide variety of healthcare business activities, and
a comprehensive discussion of its provisions is beyond the scope of this lesson. By way
of example, however, illegal kickbacks may take the form of:

1. Payments or other benefits given to physicians or health plans in exchange for

patient referrals
2. Rebates and discounts given to health plans or providers to encourage them to
buy particular goods, services, or other items
3. Payments by drug manufacturers to physicians in exchange for prescribing the
manufacturers' drugs to patients

Safe Harbors
The Department of Health and Human Services (HHS) has issued regulations that
establish a number of "safe harbors" under the anti-kickback statute, which implement
the exceptions provided under the law and set forth additional exceptions. These safe
harbor regulations describe payment practices that might technically violate the
provisions of the anti-kickback statute but that will not be considered illegal and for which
providers and health plans will not be subject to penalties.

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The safe harbor regulations cover several types of conduct, a few of which have
particular application to health plans. For example, one of the safe harbors allows health
plans with Medicare or Medicaid contracts to offer increased benefits and reduced
copayments, deductibles, and premiums to Medicare and Medicaid beneficiaries
enrolled under the contracts, as long as the benefits and reductions are offered to all
such Medicare and Medicaid enrollees covered under the contract, and as long as any
other applicable requirements are met. Another safe harbor authorizes providers to give
health plans price reductions meeting the specific criteria of the safe harbor on
treatments and services provided to the plan's enrollees. A new provision enacted by the
Health Insurance Portability and Accountability Act of 1996 provides a few additional
exceptions to the anti-kickback law for certain provider contracting arrangements.

The safe harbor regulations are extremely detailed and describe many practices that do
not violate the anti-kickback statute, but they do not cover every type of permissible
conduct. Therefore, practices that are not specifically covered by the safe harbor
regulations are not necessarily illegal; they are simply not entitled to the automatic
protection provided by the regulations. To be safe, however, many health plans try to
structure their practices so that they fall squarely within one of the safe harbors.

The Ethics in Patient Referrals Act ("Stark laws")

The Ethics in Patient Referrals Act of 1989 and its amendments, commonly called the
Stark laws or Stark I and Stark II, prohibit a physician from referring Medicare or
Medicaid patients for certain designated services or supplies provided by entities in
which the physician or the physician's family member has a direct or indirect financial
interest. These designated services and supplies include but are not limited to laboratory
services, radiology, diagnostic services, physical therapy, home health services,
prescription drugs, occupational therapy, and durable medical equipment. Under the
Stark laws, there are two ways that a physician may have a financial interest in a
healthcare facility. First, a financial interest can arise if the physician has an ownership
or investment interest in a facility that provides services. A financial interest can also
result because there is some kind of compensation arrangement between the physician
and the healthcare facility. The definition of compensation arrangement is very broad,
and almost any kind of payment between the physician and the facility could be
considered to create a financial interest. For example, a physician might have a financial
interest in a clinic simply because the clinic leases office space or equipment from the
physician.

If a physician makes a referral that is prohibited by the Stark laws, the healthcare facility
receiving the referral may not present a bill to Medicare or Medicaid for the services that
were provided. In addition, a physician who violates the Stark laws may be required to
pay a penalty of up to $15,000 and be excluded from participating in the Medicare and
Medicaid programs.

The Stark laws were enacted to avoid the conflict of interest that might result when a
physician refers patients to healthcare facilities in which the physician has a financial
interest. The laws can also apply to a physician who belongs to a health plan network
and has a financial relationship with the health plan arising from the health plan's
compensation of the physician.

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There are numerous exceptions to the Stark laws, however, including an exception that
applies to prepaid health plans. This exception states that health services provided to
plan members by some prepaid healthcare plans, including federally qualified HMOs and
plans with Medicare contracts, are not subject to the ownership and compensation
prohibitions. Another important exception exempts certain physician incentive
arrangements complying with the Medicare/Medicaid physician incentive requirements.
This exception is important because it may protect health plan payment arrangements
for Medicare enrollees not covered under the Medicare Advantage program. Provider
compensation arrangements for services provided under the Medicare Advantage
program are exempt under the prepaid health plan exception. These exceptions
recognize that some referrals to services or laboratories in which the referring physician
has a financial interest are not necessarily fraudulent or abusive.

The Stark laws also impose reporting requirements on each entity that provides
Medicare or Medicaid services. The entities must provide the Department of Health and
Human Services with detailed information about the identity of all the physicians who
have an ownership interest in the entity or who have a compensation arrangement with
it. An entity that fails to comply with these requirements can be fined up to $10,000 per
day.

The Health Insurance Portability and Accountability Act

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) expands the
scope of the federal fraud and abuse laws by amending and strengthening existing law
and by creating a new category of federal healthcare crimes, called federal healthcare
offenses, that apply to private healthcare plans as well as federally funded health
programs. Under the provisions of HIPAA, it is now a federal crime to engage in a
scheme to defraud a healthcare plan or to obtain money from a healthcare plan under
false pretenses. This new law covers many of the fraudulent billing practices we
discussed earlier in this lesson. Some of the practices that are federal crimes under
HIPAA include:

• Requesting payment for services that were not provided

• Misrepresenting the nature of services that were provided
• Falsely certifying that provided services were medically necessary

Review Question

There are several exceptions to the Ethics in Patient Referrals Act and its amendments
(the Stark laws), which prohibit a physician from referring Medicare or Medicaid patients
for certain designated services or supplies provided by entities in which the physician
has a financial interest. Consider whether the situations described below qualify as
exceptions to the Stark laws:

• Situation A: Dr. Wong is a physician in the Marvel Health Plan's provider

network and has a financial relationship with Marvel arising from the health plan's
compensation for his services. Marvel is not a prepaid health plan.
• Situation B: Dr. Ryder is a physician in the provider network of the Glen Health
Plan, which is not a prepaid health plan. In situations of medical necessity, Dr.

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Ryder refers Glen patients to a physical therapy clinic that leases office space
from him.
• Situation C: Dr. Yost has a compensation arrangement with a health plan for
providing health services under the Medicare+Choice program.

An arrangement that is exempt from the Stark laws is described in

all of these situations
Situations A and C only
Situation B only
Situation C only

Incorrect. Stark allows an exemption that applies to prepaid health plans. This
exception states that health services provided to plan members by some prepaid
healthcare plans, including federally qualified HMOs and plans with Medicare
contracts, are not subject to the ownership and compensation prohibitions.

Incorrect. There are numerous exceptions to the Stark laws, however, including an
exception that applies to prepaid health plans. This exception states that health
services provided to plan members by some prepaid healthcare plans, including
federally qualified HMOs and plans with Medicare contracts, are not subject to the
ownership and compensation prohibitions.

Incorrect. There are numerous exceptions to the Stark laws, however, including an
exception that applies to prepaid health plans. This exception states that health
services provided to plan members by some prepaid healthcare plans, including
federally qualified HMOs and plans with Medicare contracts, are not subject to the
ownership and compensation prohibitions.

Correct. Provider compensation arrangements for services provided under the

Medicare Advantage program are exempt under the prepaid health plan exception

In addition to defining these new federal healthcare crimes, HIPAA provides additional
sources of funding for federal investigations into healthcare fraud and abuse. For
example, HIPAA provides that any fines and penalties recovered through regulatory
proceedings to enforce the federal fraud and abuse statutes will be turned over to
enforcement agencies to conduct additional investigations.

Section 231(h) of HIPAA amended the Social Security Act to prohibit offering or
transferring remuneration to a Medicare or Medicaid beneficiary when that remuneration
is likely to influence the beneficiary to order or receive from a particular provider a
Medicare- or Medicaid-reimbursable service. Under this law, remuneration includes the
waiver of all or part of coinsurance or deductible amounts, as well as transfers of items
or services for free, or for other than fair market value. Exceptions to the definition of
remuneration include differentials in coinsurance and deductible amounts as part of a
benefit plan if disclosed in writing in accordance with applicable standards, as well as

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incentives given to individuals to promote the delivery of preventive care in accordance

with applicable regulations. An important effect on the law has been with regard to the
offering of value-added services by health plans. As we saw in Medicare and Health
Plans, the law has been interpreted to prohibit health plans with Medicare contracts from
providing to enrollees value-added services such as discounted memberships to health
clubs or access to networks of discounted dental or optical providers.

Review Question

The following statements are about various provisions of the Health Insurance Portability
and Accountability Act of 1996 (HIPAA). Three of the statements are true and one
statement is false. Select the answer choice that contains the FALSE statement.

HIPAA permits group health plans that offer coverage through an HMO to impose
affiliation periods during which no benefits or services are provided to a plan
member.
HIPAA created a new category of federal healthcare crimes, called federal
healthcare offenses, that apply to private healthcare plans as well as to federally
funded healthcare programs.
One effect of Section 231(h) of HIPAA, which amended the Social Security Act,
has been to permit health plans with Medicare contracts to provide enrollees with
value-added services such as discounted memberships to health clubs.
HIPAA provides that any fines and penalties recovered through regulatory
proceedings to enforce the federal fraud and abuse statutes will be turned over to
enforcement agencies to conduct additional investigations.

Incorrect. Is is true to say that HIPAA permits group health plans that offer
coverage through an HMO to impose affiliation periods during which no benefits
or services are provided to a plan member.

Incorrect. It is true to say that HIPAA created a new category of federal healthcare
crimes, called federal healthcare offenses, that apply to private healthcare plans
as well as to federally funded healthcare programs.

Correct. One effect of Section 231(h) of HIPAA, which amended the Social Security
Act, has been to PROHIBIT health plans with Medicare contracts to provide
enrollees with value-added services such as discounted memberships to health
clubs.

Incorrect. It is true to say that HIPAA provides that any fines and penalties
recovered through regulatory proceedings to enforce the federal fraud and abuse
statutes will be turned over to enforcement agencies to conduct additional
investigations.

Enforcement Mechanisms
At the federal level, primary responsibility for enforcing the fraud and abuse statutes
rests with the Office of the Inspector General (OIG), which was established by Congress
in 1976 to assist federal agencies, including the Department of Health and Human

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Services (HHS). The OIG's mission is to identify and eliminate fraud and abuse in
programs administered by HHS, including Medicare and Medicaid. It carries out this
mission through a nationwide program of audits, investigations, and inspections. The
Department of Justice and the FBI also investigate violations of the federal fraud and
abuse laws that may result in criminal penalties.

One of the OIG's most effective initiatives in combating fraud and abuse is known as
Operation Restore Trust. The OIG started Operation Restore Trust in five states in 1995
to help identify providers who overbill the Medicare program and to recover fines and
other financial penalties from them. Operation Restore Trust has been very successful
during its first few years of existence, and the OIG now plans to expand it to other states
and eventually implement it nationwide.

At the state level, states have established Medicaid fraud control units. A Medicaid
fraud control unit (MFCU) is a state program, jointly funded by federal and state
money, established to investigate and prosecute fraud under the Medicaid program.
MFCUs have enforcement authority under the Medicaid program similar to the OIG's
authority under Medicare.

Fast Fact

In 1997, the Office of the Inspector General recovered $1.2 billion in fines and
settlements with healthcare providers that overcharged government insurance programs
such as Medicare. Operation Restore Trust identified $23 in fraud and abuse for every $1
3

it spent on investigation.
4

Criminal and Civil Penalties

Federal fraud and abuse laws provide a wide range of criminal and civil penalties that
can be imposed against individuals and organizations that violate those laws. The
criminal penalties are often severe. For example, an individual who violates the general
prohibition on defrauding any healthcare benefit program (Section 1347 added to Title
18, Chapter 63 of the U.S. Code by HIPAA) can be fined and sentenced to prison for up
to 10 years. If the violation causes someone to suffer a serious bodily injury, the
2

maximum prison sentence can be up to 20 years, and if the violation causes someone to
die, the maximum prison sentence can be life imprisonment.

The federal laws we discussed earlier also authorize the imposition of civil monetary
penalties. A civil monetary penalty (CMP) is a fine that may be imposed against
individuals and organizations for violating the federal fraud and abuse laws. One
important source for civil monetary penalties is the Balanced Budget Act of 1997 (BBA).
The BBA amended Medicare law to provide for civil monetary penalties of up to $50,000
for violations of the anti-kickback law. CMPs are in addition to the amounts assessed for
criminal fraud and abuse violations.

Another civil penalty that can be imposed under the federal fraud and abuse laws is
exclusion. For example, a provider or health plan that is convicted of a healthcare crime
may be excluded from participating in any federal healthcare program for up to five
years. Such an exclusion can have a serious financial impact on a health plan that
derives a significant portion of its income from federal programs.

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Health Plan Responses to Fraud and Abuse

We have discussed some of the adverse financial impacts that healthcare fraud and
abuse can have on health plans. Recall, for example, that fraud and abuse by providers
costs health plans billions of dollars a year. To help minimize these financial impacts,
many health plans are developing programs to detect and prevent fraud and abuse.

Because false billing practices represent the largest source of healthcare fraud, health
plans often focus their efforts on detecting fraudulent bills. An important part of this
process is auditing claims to identify those that might be questionable. Special training
can help claims examiners pick out suspicious claims, and many health plans employ
Certified Fraud Examiners, who have received specialized training in fraud detection, as
part of their programs. New fraud-detection software can also help health plans identify
suspicious billings and claims. Health plans that detect fraudulent billing practices often
share this information with law enforcement officials to assist in criminal investigations
and with other health plans and insurers to alert them to those practices.

Fast Fact

Health insurers reported total savings of $260 million, or an average of $2.3 million per
insurer, as a result of their antifraud efforts in 1995. They also reported savings of $7.50
for each dollar spent on fraud detection.5

Fraud and abuse resulting from underutilization are often harder to detect than fraud
resulting from false billings. Some health plans use statistical analysis to monitor
utilization levels and identify utilization rates that appear unusually low. Other health
plans rely on feedback from plan members to identify incidents of underutilization.
Underutilization might be suspected, for example, when plan members report that they
have difficulty getting appointments with providers or when a large number of plan
members want to drop a particular primary care physician. Performance information
gathered in the process of reporting on Health Plan Employee Data and Information Set
(HEDIS) measures (required by Medicare, by many states under Medicaid, and by many
employers) may highlight unusual practice patterns and help plans identify
underutilization.

Corporate Compliance Programs

Many health plans are instituting or enhancing compliance programs to help them avoid
the penalties that can result from violating the federal fraud and abuse laws. An
important feature of these programs is that they do not have to prevent all violations to
be beneficial. Even if a violation occurs, the penalties for violating the federal fraud and
abuse laws may be reduced if the health plan committing the violation has an effective
compliance program in place. We take a closer look at health plan compliance programs
in Governance: Accountability and Leadership.

We mentioned earlier that the Office of the Inspector General (OIG) enforces the federal
fraud and abuse statutes. In addition to conducting these enforcement activities, the OIG
administers programs that assist corporations in their voluntary programs to comply with
the federal fraud and abuse laws. Some of the OIG services that help health plans and
providers avoid violating the fraud and abuse laws include:

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• Issuing Special Fraud Alerts that identify segments of the healthcare industry that
are particularly vulnerable to abuse
• Issuing advisory opinions to providers who are seeking guidance on questions
arising under the federal fraud and abuse statutes
• Developing guidance for model compliance programs for hospitals and other
providers that health plans can customize to meet their individual needs

The advisory opinion process may be useful to a health plan in its compliance efforts, if
the health plan is seeking assurance that an activity in which it intends to engage won't
violate fraud and abuse prohibitions. However, the OIG is unlikely to be willing to issue a
favorable opinion regarding activities that are in the "gray area." To date, the advisory
opinion has not been a commonly used tool, likely due to the burden and expense
related to requesting such an opinion.

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Chapter 10 A
The Components of Governance in a Health Plan

After completing this lesson, you should be able to:

 Explain the purpose of governance in a health plan

 Describe the roles and responsibilities of the board of directors
 Explain how organizational variations affect board structure and operation
 List the three steps in a board risk management program
 Describe the roles of shareholders/members and providers in governance
 Discuss the roles and responsibilities of the CEO and other senior management

What Is Governance and Why Is It Needed?

In Environmental Forces, we defined governance as the efforts by the health plan’s
board of directors working with senior management to develop corporate policy, create a
corporate mission statement and vision, and develop strategies in order to achieve the
organization’s goals and mission. Simply put, governance guides a health plan’s
decisions about how to operate its business. A health plan’s board of directors provides
much of this guidance. The board and senior management are not the only participants
in governing a health plan. Shareholders, members, policyholders, consumers, and
providers may all have roles in the governance of a health plan.

A health plan’s board of directors plays a vital role in governing the organization’s
strategic operations. Senior management could make the decisions that boards typically
handle. But if senior management becomes too involved in “implementing” policies, they
may lose sight of strategic goals. The board provides valuable perspective on the health
plan’s business. Since the board as a whole is not involved in the day-to-day decisions
of operating the business, the board members have more objectivity to view the
organization’s efforts to meet the corporate mission or vision.

How Does Governance in Health Plans Differ From Governance in Other

Industries?
In the health plan industry, for-profit, not-for-profit, and charitable organizations work
alongside each other trying to achieve similar goals. Some of today's for-profit health
plans are subsidiaries of not-for-profit organizations or healthcare cooperatives. These
for-profit companies may face challenges in board establishment since they emerged
from a not-for-profit entity. They also may face challenges from state regulatory agencies
relating to the conversion of any charitable assets. Although the goals of for-profit and
not-for-profit health plans may be driven by different factors, the ultimate goal for both
types of organizations is often the same-to establish and maintain a successful health
plan. Figure 10A-1 provides an example of a business goal that illustrates one of the
unique governance relationships that a health plan must manage.

As described in Figure 10A-1, health plans govern multiple interdependent relationships.

A health plan, such as an HMO, combines all the functions that were present in the fee-
for-service healthcare system into one organizational structure. The HMO is responsible
1

for financing and ensuring the delivery of quality healthcare services for its members.
This combination of formerly separate functions into one organization can present

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governance challenges for a health plan. For example, an HMO that contracts with an
IPA must ensure that the IPA adheres to practices and procedures set by the HMO. The
IPA itself often has its own separate corporate vision, culture, and organizational goals
that may not be identical to the HMO's vision, culture, and goals.

One example of a governance challenge that some integrated delivery systems (IDSs)
face is the presence of a representational rather than an enterprise-focused board. IDS
directors usually include physicians or hospital representatives who may feel compelled
to represent a specific constituency or organization that is only one part of the IDS. This
may lead to representational governance-a situation in which the members of the
enterprise board focus on the best interests of component parts of the enterprise rather
than on the best interests of the enterprise as a whole. In addition, although constituent
1

interests can and should be represented by directors, a focus on representational

governance violates directors' fiduciary duty to represent the best interests of the entire
company. To overcome representational governance, a health plan must stress the
organization's mission and its identity as a whole unit instead of its separate
components. 2

Figure 10A-1. The Health Plan-Provider Relationship.

A specific goal developed by a health plan board may be to increase membership in the
health plan’s health plans. To achieve this goal, one action the health plan may need to
take is to provide purchasers with more detailed information about medical outcomes
data for its members. The health plan’s providers often have the raw data concerning
medical outcomes. To achieve its stated goal, the health plan needs to obtain this data
from providers. The health plan must have in place a system that fosters a cooperative
environment between the health plan and its providers that will allow the health plan to
obtain the needed information. Health plans constantly govern the interdependent
relationships they create among providers, other vendors, purchasers, and consumers.

Review Question

The board of directors of the Garnet Health Plan, an integrated delivery system (IDS),
includes physicians and hospital representatives who sometimes feel compelled to
represent a specific organization that is only one part of the IDS. Such a circumstance
can lead to ___________, which is a situation in which the members of the board focus
on the best interests of component parts of the enterprise rather than on the best
interests of Garnet as a whole.

an enterprise-focused board
representational governance
enterprise liability
boundary spanning

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Incorrect. An enterprise focused board centers its decision on the best interests
of the entire organization

Correct. Representational governance is a situation in which the members of the

board focus on the best interests of component parts of the enterprise rather than
on the best interests of Garnet as a whole.

Incorrect. Enterprise liability is a legal theory that creates a system where a health
plan is liable for any torts commited by plan providers against plan members
while they are enrolled in the plan, even if there is no employment or agency
relationship.

Incorrect. Boundary spanning is an aspect of leadership that requires an

individual to relate an organization or department to its environment.

The Board of Directors

In Healthcare Management: An Introduction, the variety in governance structures among
different types of health plans was discussed. For instance, most health plans have
established a board of directors (board) that is responsible for governance of the
organization. But not all health plans have boards. In health plans that have boards, the
number and types of board committees and board functions vary from one organization
to another. Further, regulations often require that certain groups or entities be
represented on the board or that board composition include those groups or entities. In
addition, the roles and responsibilities of senior management are not standard among
plans. In the following sections, we discuss some forms of board organization that are
found in many health plans and the duties and responsibilities of boards and board
members.

Board Organization
As we discussed in Legal Organization of Health Plans, a corporation’s board of
directors is composed of individuals—called directors— who serve as the primary
governing body of a corporation. A company’s articles of incorporation usually set a
minimum number of directors. State laws may also set a minimum. A chairperson is
often elected to facilitate direction of board activities; however, sometimes a chairperson
is appointed by the board and is paid additionally for his or her services. A chairperson’s
duties typically include scheduling board meetings, developing agendas, presiding at
meetings, overseeing the board evaluation process, and planning for leadership
succession. Sometimes the chairperson is also the CEO of the organization, but often a
5

separation of these two roles is desired, or even mandated by regulatory requirements.

Boards sometimes include both inside and outside directors. The proportion of inside to
outside directors varies from organization to organization.

Fast Definition

Inside directors — board members who hold positions with the company in addition to
their positions on the board.
3

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Outside directors — board members who do not hold other positions with the company. 4

Differences in Boards Based on Organizational Variations

Not all boards are alike. Boards vary in size and structure among different types of
organizations. The board structure and the board process are very similar between for-
profit and not-for-profit boards. However, one clear difference exists between for-profit
and not-for-profit boards. For-profit boards are accountable to shareholders, and at least
part of their corporate mission is to earn a return on shareholder investments. Not-for-
profit boards do not answer to shareholders, nor do their organizations have a corporate
mission focused on return on investment. However, not-for-profit boards may be
required to answer to health plan members, regulators, and/or the community if return on
assets is not adequate or if goals are not met; however, their duty is to the corporation
as a whole, not members or other interested parties. Figure 10A-2 describes some of the
differences between for-profit and not-for-profit boards.

Not only are there differences among boards based on their for-profit or not-for-profit
status, variations also occur based on who sponsors the organization. Provider-
sponsored organizations face some unique challenges in board operation because their
historical role as providers sometimes conflicts with their new role as managers of
healthcare. For example, for-profit PSO boards often have several provider directors, as
well as outside directors who are not providers. Sometimes, the provider directors want
to run the health plan like a medical institution, while the directors with a financial or
business background want to run the health plan like a business.

For-profit boards of organizations with a not-for-profit parent or an organization

established through a joint venture among for-profit and not-for-profit companies may
suffer governance growing pains. Although for-profit and not-for-profit boards operate
similarly, their cultures are often very different and their perspective on organizational
goals and strategic plans may clash.

Figure 10A- Typical Differences Between For-Profit and Not-For-Profit Boards of

2. Directors.

For-Profit Boards:

1. Elected by shareholders
2. Directly accountable to shareholders
3. Small in size
4. Highly structured
5. Directors’ terms of service often limited by age only
6. Directors compensated for board participation
7. Directors do not participate directly in raising capital

Not-for-Profit Boards:

1. Self-perpetuating or elected or approved by other organization members

2. Duty is to corporation as a whole, but may be accountable to members, regulators,
and/or the community

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3. Large in size
4. Loosely structured
5. Directors’ terms of service often preset by number of years and age
6. Directors compensated for board participation at lower rate than for-profit
counterparts
7. Directors may participate in raising capital themselves

Review Question

One typical difference between a for-profit health plan's board of directors and a not-for-
profit health plan's board of directors is that the directors in a for-profit health plan

can serve on the board for a period of no more than ten years, whereas the terms
of service for a not-for-profit board's directors are usually unlimited by the
director's age or by a preset maximum number of years of service
must participate in raising capital for the health plan, whereas a not-for-profit
board's directors are prohibited from participating directly in raising capital for the
health plan
are directly accountable to shareholders, whereas a not-for-profit board's directors
are accountable to plan members and the community
are not compensated for board participation, whereas a not-for-profit board's
directors are compensated for board participation

Incorrect. Terms of service for a not-for-profit board's directors are usually limited
by the director's age or by a preset maximum number of years of service. For-
profit board members face terms of service limited by age only.

Incorrect. For-profit boards do not participate directly in raising capital for the
health plan, whereas a not-for-profit board's directors may participate in raising
capital for the health plan.

Correct. For-profit boards are directly accountable to shareholders, whereas a

not-for-profit board's directors are accountable to plan members and the
community.

Incorrect. For profit board members are compensated for board participation,
whereas a not-for-profit board's directors are compensated for board participation
at a lower rate than for-profit board members.

Board Committees
To help the board fulfill its responsibilities for ensuring survival of the company, the
board is usually divided into a number of standing committees. These standing
committees can make decisions and take actions to recommend to the full board. Board
members may participate on more than one committee. Often, the background and
experience of directors dictate on which committees they will serve. Typical standing
committees for health plan boards include the executive committee (which may be
authorized to take actions between full board meetings), the finance committee, the audit

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or compliance committee, the compensation committee, a quality management

committee, a nominating committee, and a strategic planning committee. Figure 10A-3
provides a brief description of the purposes and responsibilities of each of these
committees.

In addition to standing committees, the board may be authorized by the bylaws to create
one or more special or ad hoc committees. Special committees may be composed of
board members and nonboard members. Members of a special committee usually have
expertise in a particular area. These committees may be standing or ad hoc entities. For
example, a special litigation committee may be temporarily established to oversee a
legal challenge regarding breach of fiduciary duty.

Figure 10A-3. Standing Committees of Health Plan Boards.

Members of standing committees of health plan boards are composed solely of board
members.

Executive Committee-handles issues related to overall policy for the organization

including such areas as the lines of business the organization participates in, employment
policies, locations in which the organization operates, etc. The executive committee often
acts on behalf of the full board between board meetings or when emergencies arise. This
committee may also be responsible for strategic planning for the organization if a
separate strategic planning committee does not exist.

Strategic Planning Committee - responsible for developing the strategic direction for
the health plan. This committee receives recommendations from management on the
strategic goals of the company and is responsible for reviewing and approving the
business plan. In addition, this committee considers proposed transactions such as
mergers and acquisitions.

Compensation Committee - handles issues related to compensation of the CEO and sets
general compensation and benefits policies for the organization. The compensation
8

committee may also function as the nominating committee for the board and executive
officers if a separate nominating committee does not exist.

Nominating Committee - responsible for annually recommending to the full board

nominations for the company officers as required in bylaws.

Audit and/or Compliance Committee -responsible for arranging for external audits of
the organization's operations and receiving regular reports from the external auditors. Its
duties may include review of regular reports by internal audit personnel to assess the
organization's various risks. The audit committee is responsible for reporting significant
risks to the full board. In some companies, this committee is also responsible for
compliance functions; in other companies, a separate compliance committee performs
compliance oversight. Compliance responsibilities include ensuring that a compliance
program is instituted and followed throughout the organization and that an annual review
of the effectiveness of the compliance program is conducted.

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Finance Committee - determines the broad investment policy of the organization and is
responsible for approval of budgets, review of health plan financial results, review of the
annual audit, approval of outside funding sources, and determination of the types of
investments in which the organization will place its funds. 9

Quality Committee - health plan boards usually establish a standing quality management
committee (QM committee) to put in place and oversee companywide quality
improvement programs and receive reports on quality initiatives from staff-level
committees.

Many health plans have a staff-level quality management committee that works closely
with the plan's medical director and makes regular reports to the full board. Staff-level
quality management committees are usually composed of staff members, outside
physicians, and sometimes board members.

Fast Definition

Standing committee — permanent committees that are used by company executives and
the board as sources of continuing advice. 6

Ad hoc committee — a non-permanent committee that is established for a specific

purpose or project.7

Legal Requirements Affecting Board Structure

Federally qualified HMOs must meet requirements for board composition set forth in the
HMO Act of 1973 and related regulations. As we discussed in State Regulation of Health
Plans, some state laws require representation of health plan members, consumers, or
providers on boards of directors or limit the number of providers on a board. For
example, in California a task force formed to make recommendations related to health
plan laws has developed guidelines for board composition for health plans. Arkansas
has a law that requires that certain categories of providers and consumers be
represented on HMO boards.

Board Duties and Responsibilities

The board exercises control over the company by approving or not approving actions
performed or proposed by the executive officers. Most health plan boards, whether for-
profit or not-for-profit, perform the following functions:

• Participate in developing the overall corporate strategic plan

• Set major policies for the company (e.g., Assuring high customer satisfaction,
employee morale, and quality performance goals)
• Evaluate the results of the company's operations (the methods used for
evaluation differ between not-for-profit and for-profit companies)
• Authorize major transactions, such as mergers and acquisitions
• Appoint and evaluate the performance of the executive officers (including the
chief executive) who actually operate the company
• Hire external auditors

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• Recruit and orient new board members and assess board performance 10

Individual Directors' Roles and Responsibilities

Corporate directors are bound by several specific legal duties and obligations as defined
in the state corporate codes, the corporation's articles of incorporation, bylaws, and in
other governing rules. As a threshold matter, corporate directors are required to act
within the scope of the corporation's and their own authority. They must act only within
the particular power and authority of their positions as directors. Corporate management
is the responsibility of the entire board; individual directors generally do not have
independent legal authority to govern the corporation. Rather, the board's combined
judgment is to be relied upon to protect the corporation from unwise decisions.

Directors, as a group, can be held liable for the decisions of the board. In unusual
circumstances, directors can be held individually liable for board decisions; however,
most state laws and corporate charters limit directors' individual liability. To minimize the
risk of such liability, individual directors must exercise good faith business judgment. To
meet this requirement of exercising good faith business judgment, directors must
demonstrate their compliance with three duties in all their decisions: the duty of care, the
duty of loyalty, and the duty to supervise.

The Duty of Care

Both for-profit and not-for-profit corporate law in most states requires that directors
exercise their duties in good faith and with the same degree of diligence, care, and skill
that an ordinary, reasonable person would be expected to display in the same situation. 11

This is known as the duty of care. Figure 10A-4 describes some key criteria that are
used by regulators to evaluate meeting the duty of care.

Figure 10A-4. Key Criteria to Evaluate Meeting the Duty of Care.

 The director's exercise of independent business judgment (e.g., did the director
critically evaluate the recommendations of the corporation's officers and employees and
make an independent decision, or did he or she simply follow the recommendations of
another without independent thought?)
 The director's decision-making based on knowledge of the facts and circumstances
related to the issue under consideration (e.g., was the director's decision based upon a
consideration of the facts relevant to a particular issue, or was it based upon other
factors?)
 The director's attendance at meetings at which a decision was to be made, and other
relevant meetings and activities that were required for an informed decision (e.g., did the
director attend meetings at which relevant information was presented and discussions
held, or was he or she chronically absent?)
Source: Excerpted and adapted from Bruce A. Johnson, JD, MPA, Gerald A. Niederman, JD, Managed Care Legal Issues (Englewood, CO:
Medical Group Management Association, 1996), 238. Reprinted with permission from the Medical Group Management Association, 104
Inverness Terrace East, Englewood, Colorado 80112-5306; 303-799-1111. Copyright 1996.

The Duty of Loyalty

Because directors hold positions of special trust and confidence (i.e., they act as
fiduciaries), they have certain special obligations to the company. Fiduciaries must carry

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out their duties by acting in the best interests of the organization. That is, a director must
put the interests of the organization before his or her personal interests. In this way, a
director meets the duty of loyalty. For example, directors may not use their roles as
directors to further their personal business interests to the detriment of the organization.
In addition, directors may not try to win business away from the organization to further
their personal business or interests. These types of situations are generally referred to
as conflicts of interest.

To uphold their duty of loyalty, directors must notify the organization of potential conflicts
of interest that arise and may have to abstain from participation in board decisions on
such matters. Many boards develop policies that address conflicts of interest. In addition,
some state laws allow boards to excuse themselves from obligations made by a director
who had a conflict of interest and did not disclose that conflict to the board, unless the
action is shown to be fair despite the conflict of interest. 12

The Duty to Supervise

A board of directors cannot undertake every action to manage and operate the
organization's business and affairs, but must necessarily rely on the actions of others.
Accordingly, directors also have a duty to supervise. If the board is notified that its
officers or outside advisers (e.g., accountants, attorneys, or others) may not be
adequately performing their duties, then the board must use reasonable care to
investigate and correct such conduct. The board must exercise its duty of care to
supervise the corporation's officers and others who act on the corporation's behalf.

A corporate board of directors can also delegate some powers to executive or other
committees. Provisions of state law, the corporation's articles, or bylaws typically provide
for committees that have the power to exercise the authority of the board except with
respect to certain substantial matters (e.g., a committee may generally not authorize
distributions, approve proposed shareholders, fill board vacancies, amend the articles or
bylaws, or undertake certain other actions). The board and its committees can also use
and rely upon the advice provided by lawyers, accountants, and others to assist in the
exercise of their authority. The creation of a committee and the delegation of authority
does not, however, relieve the board or any of its members from their ultimate
responsibility as the corporation's governing body.

Excerpted and adapted from Bruce A. Johnson, JD, MPA, Gerald A. Niederman, JD, Managed Care Legal Issues (Englewood,
CO: Medical Group Management Association, 1996), 240. Reprinted with permission from the Medical Group Management
Association, 104 Inverness Terrace East, Englewood, Colorado 80112-5306; 303-799-1111. Copyright 1996.

Review Question

Directors on a health plan's board must demonstrate their compliance with three duties
in all their decisions. Directors who exercise their duties in good faith and with the same
degree of diligence and skill that an ordinary, reasonable person would be expected to
display in the same situation are meeting the duty known as the

duty of loyalty
duty to supervise

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duty of care
trustee duty

Incorrect. The duty of loyalty dictates that a director must put the interests of the
organziation before his or her personal needs

Incorrect. The duty to supervise states that the board of directors, if aware that its
officers or advisors may not be adequately performing their duties, they must use
reasonable care to investigate and correct such conduct

Correct. The duty of care states that the director exercise their duties in good faith
and with the same degree of diligence and skill that an ordinary, reasonable
person would be expected to display in the same situation

Incorrect. This term refers to the duties of a not-for-profit board member.

Liability Issues for Board Members

Increased board responsibility and accountability bring increased exposure to liability.
The liability of the governing board and the company's officers is called directors' and
officers' liability, and there are two separate categories: (1) the organization's liability
for the actions of its governing board and/or officers and (2) the personal liability of
individual board members and/or officers. There are four types of protection from
directors' and officers' liability:

1. Indemnification provisions in bylaws

2. Liability insurance
3. State statutory limitations on liability
4. Corporate risk management

Figure 10A-5 shows the type of liability (organization or individual) to which each
protection applies.

An indemnification provision in the healthcare organization’s bylaws may provide that

board members will be compensated by the organization for losses that board members
are legally obligated to pay and that are related to their being members of the board, as
well as legal defense costs.

Adapted and reprinted from Robert J. Taylor and Susan B. Taylor, editors, The AUPHA Manual of Health Services Management,
© 1994, p. 177, with permission from Aspen Publishers, Inc., Gaithersburg, MD (1-800-638-8437).

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An indemnification provision in the healthcare organization's bylaws may provide that

board members will be compensated by the organization for losses that board members
are legally obligated to pay and that are related to their being members of the board, as
well as legal defense costs.

In addition to the indemnification provision, most organizations purchase liability

insurance for their directors and key officers. As with most insurance policies, these
policies contain coverage limitations and exclusions. Therefore, such insurance is not
total protection for board members.

States often provide some protection for director liability. Many states have passed
legislation to provide immunity from liability for directors of nonprofit organizations.
However, many state statutes contain limitations and exclusions, vague language, and
loopholes.

The fourth method of protecting boards and trustees from liability is corporate risk
management. Corporate risk management consists of a series of activities designed to
minimize the corporation's and the board's liability exposure and reduce the risks of
lawsuits, while enabling the board to govern the organization effectively. A corporate risk
management program usually has three steps: (1) determine potential areas of board
liability exposure, (2) assess the degree of liability exposure in each area, and (3)
implement actions to minimize liability exposure in high-risk areas.

Effective Boards
Simply establishing a board of directors for a health plan does not ensure successful
governance. A board that exists only to comply with regulatory requirements or as a
figurehead does not help a health plan meet its goals. To be useful to the health plan, a
board must be effective in its duties. Characteristics of effective boards include: 13

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• A commitment to the continuing education of board members, including

information about the health plan, the industry, and the board's duties and
responsibilities within that framework
• A self-evaluation process for improvement of individual board members
• An effort to develop itself and act as a single governing body, not just component
parts
• The ability to analyze and dissect complex problems and develop appropriate
responses
• An understanding of the environment in which the board and the organization
operate
• A vision of where the organization stands and where it is headed in the industry
• The ability to keep the organization on course in meeting its goals, using the
corporate mission as a guide

Shareholders' Role in Governance

As we discussed in Legal Organization of Health Plans, many health plans are legally
organized as for-profit, stock corporations. In exchange for their purchase of a share or
shares of ownership of a health plan, most shareholders obtain voting rights that allow
them to exercise a voice in the governance of a health plan.

Common shareholders participate in health plan governance by electing the board of

directors. Shareholders may also call for a vote for termination of the current board if
they are dissatisfied with the company's performance. Another way that shareholders
participate in health plan governance is by approving board actions at annual or special
meetings of the shareholders. Shareholders also have the right to approve mergers and
acquisitions by vote.

Members' and Providers' Roles in Governance

Members of health plan health plans often sit on the health plan board to represent
customers' interests. Many states have laws that require representation of members on
health plan boards. In addition, most health plans have consumer representatives on
their grievance and appeals committee.

Members have a less direct, but possibly greater, influence on governance through their
buying power. The needs and desires of members often drive governance decisions
made by health plans. State laws often require representation of key constituencies on
health plan boards of directors. Providers constitute a key constituency. As we
discussed in Legal Organization of Health Plans, some state laws also limit the amount
of provider representation on boards.

Overview of Executive Leadership

We have used the term governance throughout this lesson to refer to actions taken by
boards to steer health plans in achieving their corporate mission. Sometimes, the terms
governance and management are used interchangeably, but they are not the same.
Recognizing the distinctions between these two terms makes it easier to understand the
roles and responsibilities of the board versus the roles and responsibilities of the chief
executive officer (CEO) and senior management team of an organization.

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Governance is frequently equated with policy development, and management is equated

with the implementation of policy. Put another way, the board decides if an organization
will do something, and management decides how it will be done. Does this mean that
management does not participate in policy development or that the board does not
monitor the implementation of the policy or occasionally fine-tune it? No, there is rarely
an absolute division of these two intertwined functions. The practical distinction between
governance and management must be tailored to fit each individual organization, and it
must be revisited and revised as new circumstances and issues arise.

Recall that one of the primary responsibilities of a board of directors is hiring a chief
executive officer. The chief executive officer (CEO), called chief operating officer
(COO) in some companies, is the officer of an organization that the board of directors
entrusts with broad administrative powers. The CEO is also the primary liaison between
the board and other members of management and is responsible for leading the
organization in the pursuit of the goals outlined in the strategic plan. The CEO is
responsible for recruiting and developing a management team that can successfully
implement the policies created by the board. CEO's duties vary by organization but
many of their concerns are the same.

Choosing the right CEO for a particular organization depends on the type of organization
and the maturity of the organization. For example, a start-up IDS requires a different kind
of chief executive officer than an established HMO. The start-up company often needs a
leader who can make decisions with no precedents to rely on, build the business, and
build coalitions with groups who are resistant to change and new approaches. 14

The Roles and Responsibilities of Senior Management

Choosing a senior management team for a health plan can be a challenging task. We
noted that it is the board's responsibility to select the chief executive officer. It is also
crucial for health plans to select the right candidates for other senior management
positions.

One of the most important responsibilities of the key officers and senior management of
a health plan is the duty to report information to the board of directors. Presenting
relevant, concise reports to the board on strategic issues affecting the organization aids
a health plan in meeting its corporate goals.

In most companies, the board hires the chief executive officer (CEO) and annually
appoints the officer positions of president, treasurer, and secretary. The CEO hires and
appoints other officer positions in the organization. These key officers include vice
presidents, a chief financial officer (CFO), a chief information officer (CIO), chief medical
officer (CMO), and general counsel.

In Healthcare Management: An Introduction, we introduced the key management

positions in a health plan. Figure 10A-6 outlines some of those roles and responsibilities
for your review. Although titles and duties vary from one organization to another, senior
management is a crucial link in the management chain descending from the board and
the CEO.

Figure 10A-6. Key Management Positions.

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MEDICAL DIRECTOR - Almost by definition, health plans will have a medical

director. Whether that position is a full-time manager or a community physician who
comes in a few hours per week is determined by the needs of the plan. The medical
director usually has responsibility for provider relations, provider recruiting, quality
management, utilization management, and medical policy.

FINANCE DIRECTOR - In free-standing plans or large operations, it is common to

have a finance director or chief financial officer. That individual is generally responsible
for oversight of all financial and accounting operations. In some plans, that may include
functions such as billing, management information services, enrollment, and underwriting
as well as accounting, fiscal reporting, and budget preparation. This position usually
reports to the executive director, although once again some national companies use
vertical reporting.

MARKETING DIRECTOR - This person is responsible for marketing the plan.

Responsibility generally includes oversight of marketing representatives, advertising,
client relations, and enrollment forecasting. A few plans have marketing generating initial
premium rates, which are then sent to finance or underwriting for review, but that is
uncommon. This position reports to the executive director or vertically, depending on the
company.

OPERATIONS DIRECTOR - In larger plans, it is not uncommon to have an operations

director. This position usually oversees claims, management information services,
enrollment, underwriting (unless finance is doing so), member services, office
management, and any other additional backroom functions. This position usually reports
to the executive director.
Source: Reprinted from Peter R. Kongstvedt, MD, ed., Essentials of Managed Health Care, Second Edition, © 1997, pp. 73–74, with
permission from Aspen Publishers, Inc., Gaithersburg, MD (1-800-638-8437).

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Chapter 10 B
Strategic Planning in Health Plans
What Is Strategic Planning? 2

As we saw in the lesson Environmental Forces, strategic planning is the process of

identifying an organization’s long-term objectives and the broad, overall courses of
action that the company will take to achieve those objectives. Strategic planning forces a
company to look beyond tomorrow or next year and establish a long-term plan. Most
companies today develop a long-term strategic plan for at least the next three to five
years as well as a short-term tactical or business plan (with measurable objectives) for
the first one or two years of the strategic plan.

Effective strategic plans are developed to accommodate change and to be revised as

circumstances warrant. The farther a company plans into the future, the less exact its
planning can be because of unanticipated changes that may occur both within the
company and in its external environment. Therefore, it is important for a health plan to
re-evaluate corporate goals on a regular basis to determine whether the goals remain
valid. Health plans must also re-evaluate corporate strategies to determine whether
these strategies can still achieve a company's long-term goals. Consequently, each year
when a company develops its business plan, it usually conducts a strategic review of
current long-term objectives and strategies. Many companies update their strategic
plans by first evaluating the past year (comparing the actual results to the business
objectives), and then adding a new "final" year to the long-term plan. This annual review
process keeps the strategic plan current on a "rolling basis." 3

Strategic planning is conducted by the board of directors, senior executives, or the board
and executives working together. Sometimes the board establishes a long-term planning
committee as a way to maintain board involvement in the planning process and to keep
the board apprised of the organization's progress in attaining its goals. Typically, these
committees report on a regular basis at board meetings.

When strategic planning is driven by senior management, control of the process resides
with the chief executive officer (CEO) and key senior executives, who may work with a
few members of the board of directors or with a board planning committee. This group
develops a strategic plan that it presents to the full board for review and approval. Some
CEOs choose to work alone on a preliminary draft of the strategic plan and then obtain
input from key board members and executives. Others schedule a few days or a week-
long "retreat" devoted exclusively to strategic planning with senior executives and/or
board members where they develop or update the organization's plan for presentation to
the full board.4

In contrast to a senior-management-driven approach, some health plans engage in a

strategic planning process that is more participatory in nature by involving most, if not all,
of the board members as well as key senior management staff. This group conducts an
in-depth analysis of market conditions, organizational strengths and weaknesses, and
resource requirements before coming together as a complete or representative group to
develop an overall plan. Often the task of developing the written plan is assigned to a
work group and the draft plan is presented at board and senior management meetings
for review and revision.5

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The time required to effectively complete the planning process and develop a written
strategic plan varies, depending on the type of plan and the manner in which it is
conducted. Obviously, an initial strategic plan requires more time to complete than an
update to an existing plan. Also, a plan developed solely by the CEO, which is then
revised based on input from key senior management and board members, takes less
time to complete than a plan developed in a participatory manner. Some health plans
take several months or as long as a year every three to five years to update their overall
strategic plans. Others, as we have mentioned, allocate intensive time to the planning
process and can update a plan in a few days or weeks.

Why Is Strategic Planning Important?

At first glance, it might seem that long-term planning makes little sense in the rapidly
changing environment of health plans. Urgent, day-to-day business pressures can easily
push aside a long-term planning process. An organization may slip into a reactive rather
than a proactive approach to the challenges it faces, and may simply follow the
competition or the latest industry trends. A health plan's leaders may decide that the
results of strategic planning just don't justify the time and effort it takes to complete a
formal plan. Or they may conclude that it is pointless to prepare for five years in the
future when marketplace and regulatory uncertainties make it difficult to predict what will
happen in the next five months, let alone five years.

However, the sense of urgency and uncertainty in healthcare today is all the more
reason that successful health plans choose to devote their time and efforts to strategic
planning, which can be used as a "compass" to maintain the right direction in an
environment of constant change. Effective strategic planning often brings about practical
business decisions and improved results. For example, in response to the need for
greater choice, health plans developed out-of-network options and direct access to
specialists, and they provided more flexibility with regard to the number and types of
healthcare providers available within their networks. Studies have shown that when
health plans implement a strategic planning process, their results are typically better
than the results of health plans that do not use strategic planning or that do not follow
through with implementation. For example, according to a 1998 study, health plans that
are actively involved in strategic planning are more likely to have lower administrative
costs than health plans that are not involved in strategic planning.6

Strategic planning can also produce other tangible benefits for an organization. Potential
board members and executives, as well as investors or donors, sometimes examine a
health plan's strategic plan before deciding to become involved with the organization.
They review the plan to find out the organization's mission and how it is implemented.
The presence of a well-thought-out strategic plan can help a health plan recruit key
personnel or obtain important funding. 7

Strategic planning can "translate" the goals of the organization into specific day-to-day
actions and objectives for each employee in the organization. If done in a participatory
manner, strategic planning can enhance teamwork and morale. Some organizations use
strategic planning as a way to not only focus on challenges, objectives, and actions, but
to shape organizational culture. Organizational culture, also called corporate culture, is
"a collection of shared values, beliefs, and language that creates a common identity and

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sense of community among organization members." A health plan's culture can have a
8

subtle but significant influence on the results the organization achieves.

The Strategic Planning Process 9

As illustrated in Figure 10B-1, the strategic planning process includes four primary
activities:
1. Defining or redefining the company mission
2. Conducting a situation analysis
3. Establishing or revising corporate objectives
4. Developing or revising corporate strategies

As shown in the figure, each activity performed in the strategic planning process
provides input for the activities that follow, and the entire strategic planning process
provides the basis for tactical planning.

Defining or Redefining the Company's Mission 10

As we noted in Environmental Forces, a mission statement is a statement that succinctly

sums up the organization’s reason for existence and overall fundamental purpose. A
mission statement defines the scope or domain of an organization’s activities and
answers the question, “What business are we in?” Although a company is not likely to
change its mission regularly, a company still needs to consider making such a change
each time it conducts strategic planning. As we saw in Formation and Structure of
Health Plans, some notfor- profit health plans in effect changed their mission when they
converted to for-profit status.

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Many organizations develop formal mission statements to provide all employees with a
clear, unified sense of the organization’s purpose and direction. According to marketing
expert Peter Drucker, a mission statement should answer the following questions:

(1) What is our business?

(2) Who is our customer?
(3) What constitutes value for our customer?
(4) What will our business be?
(5) What should our business be? 11

An effective mission statement is broad enough to encompass the types of business a

company is engaged in, but specific enough to provide a meaningful focus for the
company’s activities. A mission statement also defines the scope and nature of a
company’s business, both as it is today and as it could be in the future, yet it is realistic
about the company’s ability to enact the mission statement. In some companies, each
functional area develops its own mission statement based on the organization’s overall
mission.

Most companies today are moving toward a market-oriented philosophy. To help

transition to a market-oriented philosophy, companies often develop a mission statement
that focuses on the customer needs that the company plans to satisfy, not just on the
products that the company plans to sell. For example, a product-oriented health plan in
the early 1990s might have focused its mission on “striving to be a market leader by
managing the quality and cost of healthcare through strong group model HMOs.” Such a
mission may have been effective at one time, but if a health plan neglected to adjust its
focus as healthcare consumers and purchasers began to seek additional choice of
providers in health plans, that health plan might have run into difficulties during the next
few years. A health plan that focuses its mission on “striving to be a leading health plan
by meeting the needs of midsize employers and their employees and families with
products and delivery systems that provide healthcare quality and value” is more likely to
attract and keep customers and to maintain the flexibility to refocus its mission as
products and needs change.

Market-oriented mission statements also carefully define their markets in terms of

customers who value the abilities and strengths of the company. Companies must attract
customers whom they can satisfy and be willing to turn away customers whose
patronage will not be cost-effective for the company. A company that tries to serve all
potential consumers will spend too much money trying to attract and keep consumers
that it will not be able to satisfy in the long run anyway.

For example, a health plan that is successful in the small-employer market where
purchasers typically select healthcare based on cost would find it difficult to attract and
retain large national employers that expect customized reports and similar services. An
effective mission statement recognizes its most suitable market segments.

To be effective, a mission statement should not only define the scope of a company's
operations, but should also be motivating and relevant to employees. Often motivation
results from defining the company vision. A vision is an ideal that a company would like
to achieve and what it would like to be. A vision is intended to inspire enthusiasm and
commitment in employees. Such energy is needed for a company to make the vision

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become a reality. An example of a company mission statement is shown in Figure 10B-

2.

Figure 10B-2. Mission Statement: QualChoice of Arkansas, Inc.

QualChoice of Arkansas, Inc. is a full service health plan dedicated to delivering

affordable, high quality, patient-centered healthcare to its members. We are committed
to:

1. superior service to members

2. active partnership with providers
3. accountability for the cost and quality of care
4. developing and recognizing employees

Central to achieving our mission is our partnership with the University of Arkansas for
Medical Sciences, the state’s only academic health center.
Source: Reprinted with permission from QualChoice of Arkansas, Inc.

Situation Analysis 12

After a company has focused its operations on a specific mission, the company
ordinarily conducts a situation analysis. Situation analysis, which involves examining
the environments that affect a company, provides many of the assumptions an
organization needs to develop its strategic plan. The primary steps involved in situation
analysis are (1) conducting an environmental analysis, (2) developing an environmental
forecast, and (3) conducting an internal assessment.

Environmental analysis is the ongoing compilation and examination of information

about events and relationships in the external environment, and the ways these events
and relationships are likely to affect a company. Since monitoring and analyzing the
whole environment would be a monumental task, most companies concentrate their
efforts on specific areas they know are relevant to their business activities. These
specific external areas might include (1) the company's current target market, (2)
competitors' activities, (3) legal and regulatory developments, and (4) other major
environmental factors that affect purchaser behavior, such as demographic changes,
attitudes/beliefs about the healthcare and health plan industry and products, economic
conditions, and technological advances. Many of the topics addressed in Environmental
Forces are examples of events and relationships that would be examined in a health
plan's environmental analysis.

Information gained in the environmental analysis is used to develop an environmental

forecast, which is a prediction of the major environmental trends that will affect a
company's business activities. By conducting an environmental analysis and developing
an environmental forecast, a company can reduce uncertainty and risk by estimating the
character, magnitude, and timing of anticipated environmental changes and predicting
the effects those changes may have on the company's performance and operations.

For example, changes in the environment that result from mergers or acquisitions might
mean that a health plan is faced with a new competitor that has different strengths and

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weaknesses than existing competitors. The newly formed entity might offer a popular
product that was previously not available in the market, requiring the health plan to
adjust its strategic plan by introducing new products or perhaps seeking a strategic
alliance of its own to meet the challenge of new and more formidable competition

To further illustrate this point, consider how changes in laws and regulations might
present a health plan with new and different competition. As we discussed in Federal
Government as Purchaser, recent changes in Medicare now allow PSOs to contract with
the federal government to offer health plan products for Medicare beneficiaries. For a
health plan that contracts with Medicare, an environmental analysis and forecast might
lead the senior management team to address this new type of competition by re-
examining the organization's current products and services. Or the health plan might
seek a strategic alliance or identify a new business opportunity such as offering
administrative services to PSOs that are unfamiliar with the managed Medicare
business. However, before senior management seriously considers responses to
environmental factors, they typically conduct an internal assessment to realistically
determine the organization's capabilities in the changing external environment.

A company analyzes its internal environment by conducting an internal assessment. An

internal assessment is an examination of a company's current activities, its strengths
and weaknesses, and its ability to respond to potential threats and opportunities in the
environment. Determining its strengths and weaknesses helps a company develop
corporate objectives that will allow it to take advantage of its strengths and to avoid or
remedy its weaknesses. Examples of strengths might include efficient billing and
eligibility processes, underwriting expertise, a productive sales force, and knowledgeable
and responsive member services staff. Examples of weaknesses might include
insufficient financial resources and outdated computer systems.

Review Question

SoundCare Health Services, an MCO, recently conducted a situation analysis. One step
in this analysis required SoundCare to examine its current activities, its strengths and
weaknesses, and its ability to respond to potential threats and opportunities in the
environment. This activity provided SoundCare with a realistic appraisal of its
capabilities. One weakness that SoundCare identified during this process was that it
lacked an effective program for preventing and detecting violations of law. SoundCare
decided to remedy this weakness by using the 1991 Federal Sentencing Guidelines for
Organizations as a model for its compliance program.

By definition, the activity that SoundCare conducted when it examined its strengths,
weaknesses, and capabilities is known as

an environmental analysis
an internal assessment
an environmental forecast

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a community analysis

Incorrect. An environmental analysis involves examining the environments that

affect a company

Correct. An internal assessment is an examination of a company's current

activities, stengths and weaknesses and ability to respond to potential threats and
opportunities.

Incorrect. An environmental forecast is a prediction of environmental trends that

will affect a company's business activities

Incorrect. A community analysis is the process that allows not-for-profit health

plans to gather informion and evaluate trends related to chartiable mission or
community benefit

Among the internal factors that have a significant impact on a health plan's strategic
planning are the company's mission and vision, governance and leadership capabilities,
financial condition, product portfolio, sales and marketing capabilities, provider networks,
medical management techniques, claims and member services capabilities, and
technological resources.

Tools of Analysis
Gathering the enormous quantity of information required to conduct a situation analysis
is only half the process. If the information is not organized in a useful manner, it is
worthless. In this case, "useful" means in a way that will help the senior management
team decide where and how to focus efforts and resources. In the next lessons, we
describe several methods used to highlight information so senior management can gain
useful insights and not be burdened with irrelevant data.

SWOT Analysis
The acronym SWOT stands for strengths, weaknesses, opportunities, and threats. As
we discussed, companies undergoing a situation analysis attempt to identify their
strengths and weaknesses as well as the current and upcoming opportunities and
threats posed by environmental forces. SWOT analysis is a means of organizing this
information so planners can easily identify matches between a company's strengths and
specific marketing opportunities. A marketing opportunity arises when the right
combination of circumstances occurs to allow a company to use its strengths or
capabilities to take advantage of an environmental opportunity. The term strategic
window is often used to describe the time period during which an optimum "fit" exists
between a company's distinctive capabilities and the key requirements of an opportunity.
Use of SWOT analysis helps a company identify the best possible places to devote
resources so strategic windows are exploited before they begin to close.

Business Portfolio Analysis

Companies that engage in more than one business or offer more than one product line
can use business portfolio analysis when conducting an internal assessment. For
example, this tool might be valuable to health plans that provide health plan products in
the commercial market and in government programs such as Medicare, Medicaid, or
workers' compensation.

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Business portfolio analysis is a process that allows a company to evaluate its

individual business units according to their potential contribution to the firm, given their
strengths and weaknesses in comparison to trends in their markets. Business portfolio
analysis helps senior management determine each unit's potential for (1) generating
financial resources for the firm and (2) requiring financial resources from the firm.
Generally, companies will want to invest more of their resources in units that are already
profitable or that have the potential to grow and become more profitable. Companies
usually will want to withdraw from units that lack such potential.

To conduct business portfolio analysis, a company typically must identify its major
business units. In this text, we use the term strategic business unit to refer to these units.
A strategic business unit (SBU) is an area of business that is distinct from other areas
within a company in that it:

• Is operated as a separate profit center

• Has its own separate set or share of customers and competitors
• Generally has its own management
• Is capable of having its own marketing strategy

Not all companies label their organizational units as SBUs. Other labels that are
commonly used are profit centers, divisions, subsidiaries, product lines, teams, or lines
of business. An SBU may be an entire company, a division, a product line, a single
product department, or a major market. For example, a health plan's sub-business units
might consist of several divisions organized according to geographic markets (e.g., west,
central, and east), demographic markets (e.g., employer groups, Medicare beneficiaries,
and the Medicaid population), or products and services (e.g., HMO/PPO, third party
administration, pharmacy management, and behavioral healthcare). Although SBUs are
separate profit centers, they are usually dependent on their parent company for
allocation of their financial resources.

Once a company's SBUs have been identified, a business portfolio analysis considers
factors related to (1) the market in which the SBU competes and (2) the strength of the
SBU in that market. With regard to the market, the portfolio analysis might examine
market growth rate, market size, government regulation, market stability, competitive
intensity, and technological requirements. With regard to the SBU, the portfolio analysis
might examine relative market share, price competitiveness, product quality, customer
loyalty, technological and financial resources, and management effectiveness.

Based on this analysis, the senior management team is in a position to determine the
role each business unit will play in the company's future. Although a company can
seldom do much to affect the market's growth rate, it can take action to improve a
business unit's market share in a particular market. A company can follow four basic
strategies with a business unit:
1. Build strategy. Under a build strategy, a company seeks to increase a
business unit's market share. This strategy usually requires that a company
sacrifice immediate earnings in order to fund the growth required to improve a
business unit's market position.
2. Hold strategy. When following a hold strategy, a company tries to maintain a

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business unit's market position. The company generally invests only enough to
hold promotional activities and customer services constant, though occasionally
a company will increase short-term investment in the business unit in an attempt
to enhance profits.
3. Harvest strategy. Under a harvest strategy, a company seeks to maximize a
business unit's short-term earning and cash flow. Usually, the harvest strategy
entails reducing the amount of resources expended on the business unit and,
thus, allowing its market share to decline. For example, a company may stop
allocating money to the business unit for promotional activities, or it may cut the
staff serving the business unit.

4. Withdrawal strategy. Under a withdrawal strategy, a company sells or

discontinues a business unit because the resources required to support it can be
more profitably employed elsewhere.

Review Question

After conducting a business portfolio analysis, the Acorn Health Plan decided to pursue
a harvest strategy with one of its strategic business units (SBUs)-Guest Behavioral
Healthcare. By following a harvest strategy with Guest, Acorn most likely is seeking to

maximize Guest's short-term earnings and cash flow

increase Guest's market share
maintain Guest's market position
sacrifice immediate earnings in order to fund Guest's growth

Correct. A harvest strategy maximizes Guest's short-term earnings and cash flow.

Incorrect. Under a harvest strategy a plan reduces the amount of money expended
on the business unit, allowing its market share to decline.

Incorrect. Under a harvest strategy a plan reduces the amount of money expended
on the business unit, allowing its market share to decline

Incorrect. A build strategy sacrifices immediate earnings to fund growth required

to improve a business unit's market position.

Community Analysis
In the case of many not-for-profit health plans, an additional element in strategic
planning is the community analysis. Community analysis is a process that allows a not-
for-profit health plan to gather information and evaluate trends related to charitable
mission or community benefit. Community analysis helps the board and senior
management team determine demand for services and programs, environmental forces
that may have an impact on demand, and the emergence of additional opportunities for
the health plan to fulfill its charitable/community benefit mission.
13

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Establishing and Revising Corporate Objectives 14

After developing the company mission statement and conducting a situation analysis,
the next step in the strategic planning process is to establish specific goals for
addressing the threats and opportunities uncovered during the situation analysis.
Corporate objectives, also known as organizational objectives or corporate goals, are
statements that describe the long-term results that a company plans to achieve in
carrying out its mission. Corporate objectives add a sense of purpose to the activities
undertaken by the organization and, in turn, increase employee motivation. Corporate
objectives also increase the consistency with which decisions are made throughout the
company and, thus, increase management control over operations.

Corporate objectives, which normally cover a period of three to five years, are
established for a whole company. Such objectives often deal with profit, growth, use of
technology, quality of services, and sales and market share; in the case of not-for-profit
health plans, the objectives might also focus on any community benefit or charitable
purpose. Effective corporate objectives are (1) clearly stated, (2) specific and
measurable, and (3) realistic. Whenever possible, each objective specifies in quantifiable
terms what is to be accomplished and the time period over which the objective is to be
achieved. For example, rather than stating, "To increase sales" as a goal, an effective
corporate objective makes a quantitative statement such as "To increase total corporate
sales by 10% within four years" or "To achieve a market share of 20% within the next
four years." Figure 10B-3 provides some examples of corporate objectives health plans
might develop.

Figure 10B-3. Examples of a Health Plan Corporate Objectives.

1. Obtain full NCQA accreditation within three years

2. Increase the percentage of preventive health interventions for total eligible
membership during each of the next three calendar years for the following
services: mammography, Pap smears, immunizations, and first trimester visits for
prenatal mothers
3. Improve high-impact health and satisfaction outcomes during each of the next
three calendar years for the following medical conditions: asthma, depression,
cardiovascular disease, diabetes, and end-stage renal disease
4. Improve customer satisfaction on an annual basis for each of the next three
calendar years, as measured by satisfaction surveys for members, providers, and
employer groups
5. Attain top three market share position within the next three years
6. Increase by 30% the number of claims processed by the automated claims
payment system and reduce by 10% the cost of paying claims during the next
three years
7. Reduce overall administrative expenses by 10% over the next three years
8. Reduce voluntary turnover to less than 9% for all employees each calendar year

Review Question

The following statements appear in the Twilight Health Plan's strategic plan:

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• Increase the percentage of preventive health interventions for total eligible

membership during each of the next three calendar years for the following
services: mammography, Pap smears, immunizations, and first trimester visits for
prenatal mothers
• Improve customer satisfaction on an annual basis for each of the next three
calendar years, as measured by satisfaction surveys for members, providers,
and employer groups
• Increase by 30% the number of claims processed by the automated claim
payment system and reduce by 10% the cost of paying claims during the next
three years

These statements are examples of Twilight's

corporate objectives
company mission
company vision
corporate strategies

Correct. Corporate objectives, also known as organizational objectives or

corporate goals, are statements that describe the long-term results that a
company plans to achieve in carrying out its mission.

Incorrect. A corporate mission succinctly sums up the organization's reason for

existence and overall fundamental purpose

Incorrect. A company vision is an ideal that the company would like to achieve

Incorrect. Corporate strategies define long-term methods by which an

organization plans to achieve its corporate objectives.

Corporate objectives form the basis for the objectives of each functional area of the
company. For example, a health plan's marketing objectives are based on overall
corporate objectives, as are the objectives of accounting, claims, finance (investments),
human resources, information systems, legal, member services, provider relations,
underwriting, and other functional areas. As corporate objectives are translated into
functional area objectives, they become more specific and more short-term and are,
thus, easier to plan and control.

In light of increased attention in the area of market conduct, most health plans today are
including objectives related to market conduct and compliance in their strategic plans. In
Governance: Accountability and Leadership, we take a closer look at how health plans
approach compliance.

Developing and Re-evaluating Corporate Strategies 15

After a company has established its corporate objectives, the next step in strategic
planning is to develop the corporate strategies required to achieve those objectives.
Corporate strategies define the long-term methods by which an organization plans to
achieve its corporate objectives.

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Companies generally can choose among several alternative strategies to accomplish

their objectives. Further, companies can apply different strategies to different SBUs. In
our discussion of business portfolio analysis, we discussed the strategies associated
with the development of business units. The combination of strategies required by one
company may be different from the combination of strategies required by another
company, even when both are trying to reach the same or similar goals. In addition, the
combination of strategies that is best for a company today may not be the best
combination in the future. Consequently, companies regularly re-evaluate their strategies
to make sure that their present strategies are still appropriate in the context of their
current environments. In addition, organizations often establish contingency plans for
use in the event that current conditions radically change.

In the next lesson, we discuss overall corporate strategies that focus on growth.

Corporate Strategies That Focus on Growth

Although most companies develop corporate strategies that seek growth, a company
can pursue a number of different strategies to attain their objectives. These strategies
are categorized as:
(1) Intensive growth strategies
(2) Integrated growth strategies
(3) Diversified growth strategies

Intensive growth strategies are those available to a company that has not yet exhausted
the sales or market potential in its current products or current markets. Intensive growth
strategies focus on market penetration, market development, and product development.
These strategies require significant financial capital.

1. Market penetration focuses on increasing sales of current products to current

purchasers. A company using a market penetration strategy usually increases its
sales by increasing its promotion efforts significantly. For example, as a market
penetration strategy, a health plan can simultaneously increase its advertising in
business periodicals, increase the size of its sales force, and offer additional
incentives to its sales associates.
2. Market development focuses on increasing sales of current products by
introducing them in new markets. This type of strategy often involves expansion
into new geographic areas. In recent years, several health plans that established
themselves in one region of the country have sought new markets by setting up
operations in other regions.
3. Product development focuses on increasing sales by modifying current products
or developing new, but related, products for current markets or segments within
current markets. When a health plan develops a new type of health plan product
and then markets that product to its current customers, the company is following a
product development strategy. For example, a health plan that decides to offer an
open access plan or a managed dental plan is following a product development
strategy.

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Integrated growth strategies are strategies that involve taking over or entering a
strategic alliance with another area or level of a company's industry. Integrated growth
strategies include horizontal integration and vertical integration, as discussed
inFormation and Structure of Health Plans.

Diversified growth strategies are strategies that require companies to venture outside the
industry in which they conduct business to seek growth opportunities in industries that
produce products or services unrelated to their existing business. Diversification can be a
risky strategy because a company must employ knowledge, skills, and processes that are
substantially different from those with which it is generally familiar, but diversification
can soften the blow of a dramatic downturn in a market.

Review Question

In developing its corporate strategies, the Haven Health Plan decided to implement a
growth strategy that is focused on increasing the percentage of preventive health office
visits from its current plan members. To accomplish this objective, Haven will send a
direct mail kit to existing plan members to remind them of the variety of preventive health
services that Haven currently offers, including physical exams, cholesterol tests, and
mammograms. This information illustrates Haven's use of

an intensive growth strategy known as market penetration

an integrated growth strategy known as product development
an integrated growth strategy known as market development
a diversified growth strategy known as market penetration

Correct

Incorrect. Product development is considered an intensive growth strategy.

Product development focuses on increasing sales by modifying current products
or by developing new products for current markets.

Incorrect. Market development is considered an intensive growth strategy. Market

development focuses on increasing sales of current products by introducing them
to new markets.

Incorrect. Diversified growth strategies are strategies that require companies to

venture outside the industry in which they conduct business to seek growth
opportunities in other markets.

Linking Corporate Strategies with Tactical Planning

As noted earlier in this lesson, strategic planning focuses on a health plan’s long-term
corporate goals and the broad, overall courses of action that the company will follow to

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achieve those goals. These longterm goals provide a framework for developing a tactical
plan with short-term objectives that are tied to the corporate strategy. This framework
helps coordinate the efforts of the health plan’s various functional areas and strategic
partners in implementing the organization’s overall strategy. Each functional area within
the health plan (and ideally, each strategic partner outside the health plan) develops
specific plans based on the health plan’s overall strategic goals and business objectives.

A comprehensive discussion of all functional area plans in a health plan is beyond the
scope of this lesson. From a governance perspective, however, an important point to
keep in mind is that strategic planning must be integrated and coordinated with tactical
planning in the various functional areas. Each functional area determines what its role is
in the overall corporate strategic plan and then sets its own objectives, strategies, and
tactics accordingly.

It is also important to keep in mind that for the purpose of this discussion, we have
classified strategic planning and tactical planning as distinct and separate processes. In
reality, however, these planning processes often overlap. For example, marketing is a
functional area with activities that are typically a major focus in a health plan’s strategic
plan. Because marketing forms a health plan’s primary link to potential customers, the
strategic planning process relies heavily upon input from marketing. Without marketing
input, the board and senior management would have no way to realistically estimate
future revenue, nor would they be able to estimate future workloads in each of the
functional areas to help plan for equipment purchases and staffing. Figure 10B-4
illustrates how corporate strategy can be linked to tactical planning.

Figure 10B-4. Linking Corporate Strategy and Tactical Planning.

A provider group developing a corporate strategy for building a preferred
provider organization will give careful consideration to the overall effort
involved, which should be broken down into tasks and subtasks. The major tasks
in the corporate strategy might include:
1. Developing the provider network and negotiating provider contracts
2. Establishing a sales and marketing organization
3. Developing a utilization management and quality assurance capability
4. Developing a management information system
5. Establishing an organizational infrastructure
Each of these major tasks then would be broken down into individual subtasks
(i.e., tactical planning in the appropriate functional areas). The major task of
developing a provider network (item 1 above) could be further broken down into
subtasks that might include:
1. Analyze provider admission and cost information
2. Identify desired providers
3. Develop model provider contract
4. Negotiate provider contracts
5. Establish ongoing provider relations function
Source: Reprinted from Peter Boland, editor, Making Managed Healthcare Work, © 1993, p. 219, with permission from Aspen
Publishers, Inc., Gaithersburg, MD (1-800-638-8437).

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Corporate Strategies: Resource Requirements and Project Management Tools

The implementation of a health plan strategy can be labor intensive and slow to produce
results. Therefore, the board and senior management pay close attention to the
resources that will be needed in terms of capital investment, areas of expertise, staffing
allocations, and management oversight. Strategic planners resist the tendency to
underestimate needed resources. They try to anticipate problems and build flexibility into
their planning.

Corporate strategies include specific action plans identifying who will do what and when.
These strategies include cost and staffing projections for start-up activities as well as
ongoing activities. The projections are reviewed and approved by the board of directors
and/or senior management to assure that adequate funds and staff are appropriated for
successful implementation of the plan. These projections are typically integrated into the
annual budgeting process to assure that needed resources are available to the
appropriate functional areas. Strategic planners typically use project management tools
to plan and monitor progress and to report results to the board of directors and senior
management. These tools help coordinate efforts and also identify problems that the
original plan may not have anticipated.

Risk Assessment in Corporate Strategies

Senior management, recognizing that there is no such thing as a risk-free strategy, tries
to anticipate (1) the likelihood that a strategy will create problems and (2) the
consequences of such problems. Sometimes the negative consequences can be
quantified. For example, a health plan might determine that failure to successfully
develop a new POS product would result in the loss of the startup capital required to
launch this project. Other times the risk may be difficult to quantify. For example, a
strategy to contract with a new physician group could seriously damage a health plan’s
existing relationship with its providers. Once the board and senior management have
assessed the risk, they re-examine the strategy and determine whether the potential
rewards justify the risk.
16

The “Human Element” in Corporate Strategies

As we have seen, strategic planners often link corporate strategies to tactical planning
and allocate the necessary financial and staffing resources to improve the chances for
success. However, effective planners also realize that the “human element” is critical to
the success of any strategy. Some organizations develop a formal human resource
strategy to help determine the number of associates and the types of skills that will be
needed to successfully implement the corporate strategy. A human resource strategy
might specify ways to retrain existing staff or to hire additional staff from outside the
organization. A carefully developed human resource strategy helps ensure that the
organization is staffed with associates who have the necessary skills and motivation to
support the goals of the strategic plan.
17

Successful implementation of a strategic plan not only requires the commitment of key
associates such as board members, senior management, and middle management, it
also requires an organizational climate in which as many associates as possible
understand the reasons behind the strategy and their individual roles in implementing it.
One of the keys to obtaining this understanding is effective communication.

The need for effective communication is particularly important when health plans pursue
aggressive strategies such as joint ventures, mergers, vertical integration, and targeting

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of new markets. Strategies such as these in an environment that has become

increasingly competitive and uncertain can directly impact the jobs and personal lives of
many of a health plan’s associates as well as its strategic partners.

For example, a not-for-profit health plan that is seeking access to equity markets by
converting to for-profit status will improve its chances for success if it has the
cooperation and commitment of the many people who will be involved in or affected by
this strategic initiative. Some associates might view the overall strategy as a mistake.
Others might understand the business need, but have concerns that their departments
will have to reassign associates from critical day-to-day operations to help implement the
strategy. Others might view the strategy and the associated changes as a threat to their
current jobs, or they might be concerned that their salary and benefit packages will be
affected.

Often when a health plan decides to pursue a market-driven strategy, its associates
have to make significant changes in the way they approach their jobs. A company, which
in the past has been successful with a product-oriented focus, may have difficulty
shifting to an organizational culture that focuses on customer needs. Some companies
have decided to change from a traditional top-down structure organized in separate
functional areas to a matrix management system that relies upon much more
communication and cooperation than associates may be accustomed to. Changes such
as these are often unsettling to employees. If the board and senior management do not
attempt to gauge the impact and plan appropriately, many associates within the
organization will not respond well to the new strategy.
18

A carefully considered strategic plan recognizes that associates will perform in a more
positive and effective manner if they understand the reasons for change and they have
an opportunity to provide input and ask questions about their new or changing
responsibilities. An effective strategic plan provides for frequent communication in as
many ways as possible, such as in newsletters, electronic-mail messages, “town hall
meetings,” work group meetings, and individual objective-setting sessions that link each
employee’s compensation level and performance review to the strategic plan. These
efforts to communicate and encourage participation help build consensus and increase
the likelihood of obtaining “buy-in” from the many associates responsible for
implementing the corporate strategy on a daily basis.

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Chapter 10 C
Key Strategic Issues for Health Plans

After completing this lesson, you should be able to:

 Identify and describe the key strategic issues faced by health plans
 Give examples of how key strategic issues are interrelated in the strategic planning
process

As we have seen, an effective board of directors and senior management team (1)
define the organization’s mission, (2) assess the external environment and the
organization’s own capabilities and limitations, (3) establish corporate objectives, and (4)
develop strategies to meet the objectives. Although the strategic planning process for
each health plan is based on a unique blend of corporate mission and objectives,
internal capabilities, and external environmental factors, there are several key issues
that most health plans consider when developing a strategic plan. These key strategic
issues are:

• Markets and product portfolio

• Pricing
• Financial management
• Provider networks
• Medical management
• Customer services
• Information technology
• Corporate transactions

In this lesson, we provide a brief overview of each of these issues. As we do so, keep in
mind that the overall objective of the strategic planning process is to assemble these
separate but interrelated issues into a cohesive and effective corporate strategy. When
the board and senior management consider one key issue, they often must consider
other related issues. For instance, a health plan’s market strategy can be significantly
influenced by its capabilities to perform certain types of functions such as medical
management and member services. Also, in the “information age” there are few
operational issues that are not in some way impacted by information technology. For
example, a health plan’s ability to provide effective member services is closely related to
the effectiveness of its supporting systems. Finally, although we have not listed
legislative and regulatory activities as a separate strategic area, the regulatory issues
associated with markets and products, pricing, provider networks, medical management,
customer services, information technology, financial management, and organizational
structure require careful attention because they can have a significant impact on a health
plan’s strategic plan.

Markets and Product Portfolio

An effective strategic plan includes an assessment and selection of target markets.
Health plans can target any one or a combination of the following markets: non-
government groups, government employee groups, government- sponsored programs,

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and individual purchasers. Within each of these larger markets are market segments.
For instance, a health plan that is considering nongovernment groups can target
singleemployer groups, multiple-employer associations, or certain sized groups, such as
large, midsize, or small employers. A health plan that is considering government
employee groups might target municipal entities, state employee plans, FEHBP, or
TRICARE. When considering government-sponsored programs, a health plan might
target workers’ compensation plans, Medicaid, or Medicare.

To effectively determine market strategies in the planning process, a health plan looks at
both the external and internal environment. The board and senior management team
consider external issues such as the needs and buying behavior of the purchasers,
medical needs that may be unique to a particular population, the amount and nature of
the competition in the market, and any state and federal regulatory requirements. For
example, many large employers expect a health plan to duplicate product features that
they had under a prior plan. Also, large employers often expect customized contracts,
benefit description material, and year-end reports. Small employers, on the other hand,
typically purchase healthcare based on price, and do not expect customized products
and services. When considering target markets, a health plan must determine what the
market expects and then realistically assess the organization’s abilities to deliver on
those expectations. If a health plan does not have the personnel or information systems
needed to provide the customized products and services that large employers demand,
then its strategic plan would likely focus on the small and midsize employer markets.

As this example demonstrates, the strategic issues involved in a health plan’s choice of
markets can touch upon several other key areas such as customer services, pricing, and
information systems.

Closely related to a health plan’s assessment of its markets is an assessment of its

product portfolio. A product portfolio (also called lines of business or health plan
products) is the number and variety of product designs or plans that the health plan
makes available to its customers. The only constraints on a health plan’s product
portfolio are regulatory requirements and the organization’s ability to effectively deliver
and administer the products to its customers. Some of the issues health plans address in
developing their product portfolios are the:

• Number and types of healthcare services and supplies that will be covered
• Benefits or cost-sharing features, such as deductibles, copayments, coinsurance,
limitations, and maximums
• Protocols for delivery of healthcare services and supplies (for example, which
healthcare services and supplies require preauthorization)
• Out-of-network coverage, if any, including the number and types of healthcare
services and supplies that will be covered and the applicable benefits or cost-
sharing features
• Breadth of the product portfolio (the number of “plans” that will be standardly
offered to the health plan’s customers, based on variations of the above features)
• Willingness to customize products at the request of specific customers

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Some health plans develop products that are based on the networks or delivery systems
available within a particular geographic area. For example, a health plan might offer two
types of HMO products: one that delivers healthcare services via a network that consists
solely of group model practices and another that delivers healthcare services via a
network of both group model practices and individual practices.

To effectively address product issues in its strategic plan, a health plan looks at the
external environment by conducting market research and considering the strengths and
weaknesses of its competitors. The objective of this external assessment is to develop a
strategy that meets the customers’ needs and differentiates the company from the
competition. Because the results of this assessment can vary, depending upon the
location, a health plan that operates in multiple locations may develop different products
or product features in different markets. In addition to this external assessment, a health
plan evaluates its internal strengths and weaknesses to determine the number and
variety of products it is capable of delivering effectively and at a competitive price.

For example, as a result of its environmental assessment a health plan might conclude
that purchasers and members consider “easy access to specialty providers” to be a
valuable plan feature. The health plan would then determine the number of competitors
that offer this type of plan and the actions it must take to be capable of providing a
competitively priced product that offers open access to specialists. This decision might
be based in large part on the organization’s relationship with and confidence in its
network specialists as well as its ability to monitor the frequency and cost of specialty
care. Using this internal and external assessment, the health plan can then determine
whether to include an open access plan in its product portfolio.

A health plan’s structure and the applicable regulatory requirements can also affect the
organization’s product strategy. State or federal regulations can require certain types of
health plans to offer certain healthcare services or benefits, sometimes subject to
specified rating requirements. As we saw in Federal Regulation of health plans, federally
qualified HMOs are subject to benefit requirements that do not apply to other types of
health plans. Another example that illustrates this point is the variation in plan design
between POS and PPO products. These products are similar in that they each provide
in-network and out-of-network benefits. However, the product design varies depending
on the regulations that apply to the offering health plan. For instance, the in-network
benefits provided by an HMO’s POS product are subject to the requirements of that
state’s HMO act. However, in the same state, the in-network benefits provided by a PPO
organization are subject to the requirements of that state’s insurance code. Differences
in benefit and rating mandates in the state’s HMO act and the insurance code could
result in a difference in premiums, covered services, and benefit levels—all of which
could result in a product that would be more or less likely to generate business. Yet the
product concept—in-network and out-of-network benefits—is the same for both the HMO
and the PPO.

Similarly, a traditional HMO product and an EPO product both require members to obtain
in-network services, for the most part, but the benefit mandates that apply to the HMO
are typically found in the state’s HMO act, whereas the benefit mandates that apply to
the EPO are often found in the state’s insurance code. Entities that offer an EPO product
are sometimes preferred provider organizations that are competing with HMOs. These
PPOs develop a strategy to offer both the EPO product and a PPO product. In this way,

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a PPO organization can offer two health plan products, one of which is a less expensive
“network only” product (the EPO) that competes directly with similar HMO products in
the marketplace.

Pricing
Basically, when a health plan considers a pricing strategy it tries to determine the
market’s perception of value. In other words, how much are customers willing to pay for
the health plan’s products and services? Included in this assessment is a determination
of competitive pricing pressures. Once this marketplace evaluation is complete, the
health plan performs an internal assessment to determine the cost of providing these
products and services.

Health plans typically divide their costs into medical and administrative expenses.
Medical expenses are payments to providers for the delivery of healthcare.
Administrative expenses are all other costs associated with providing healthcare
coverage, such as office leases, equipment costs, sales and marketing costs, and
salaries and benefits for executives and for all functional areas.

Review Question

Health plans typically divide their costs into medical and administrative expenses.
Examples of medical expenses are.

equipment costs
salaries and benefits for executives and for all functional areas
sales and marketing costs
payments to providers for the delivery of healthcare

Incorrect. Equipment costs would be an example of administrative costs

Incorrect. Salaries and benefits would be an example of administrative costs

Incorrect. Sales and marketing costs would be an example of administrative costs

Correct! Medical expenses are payments to providers for the delivery of

healthcare.

Once a health plan knows how much the market is willing to pay and how much the
organization must spend to provide the proposed products and services, it has the
necessary information to establish a pricing strategy. Often, health plans base premiums
on the estimated cost of providing the product and services, plus a targeted profit margin
(or, in the case of a not-for-profit health plan, the excess of income over expenses).
Figure 10C-1 examines two other types of pricing strategies that are used by health
plans: buying market share and market skimming.

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Pricing is not always controlled by the health plan. For example, the health plan does not
determine the rates for Medicare and Medicaid products. However, for these products, a
key strategic issue for the health plan is to determine whether it can provide the products
and services at the established price.

Figure 10C-1. Pricing Strategies.

Buying Market Share

Many health plans have used a strategy of buying market share, also called
penetration pricing, by setting a low price in a highly price-sensitive market to
stimulate revenue growth. The objective of this strategy is to sacrifice near-term
profits for fast growth as a means of quickly building critical mass and
establishing a market position. This is a relatively high-risk strategy, and careful
consideration must be given to determining capital requirements and ensuring that
capital is available to sustain the organization organization through this high-
growth, low-profit stage. However, caution must be exercised to avoid a price war
in which the competition simply matches the low price and thus lowers the price
level of the entire industry at the expense of industry profits.

Market Skimming

Another pricing strategy frequently used is market skimming, also called price
skimming. Under this strategy, the highest price possible is established given the
comparative benefits of the product versus those of the competition. Even at this
relatively high price, certain segments of the market will still buy the product.
Each time sales slow down, the price is lowered to draw in the next price-
sensitive layer of customers. This strategy results in slower growth. The
significant risk inherent in this type of strategy is the limited market available to
the product. Clearly, the product must be substantially differentiated from that of
lower-priced competitors to justify its higher price in the eyes of the consumer.
Source: Reprinted from Peter Boland, editor, Making Managed Healthcare Work, © 1993, pp. 225–226, with permission from
Aspen Publishers, Inc., Gaithersburg, MD (1-800-638-8437).

Review Question

The Westchester Health Plan is using a pricing strategy that involves setting a low price
in a highly price-sensitive market to stimulate revenue growth. In following this strategy,
Westchester is sacrificing short-term profits for fast growth in selected markets. This
information indicates that Westchester is following the pricing strategy known as

market skimming
buying market share
price skimming

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unitary pricing

Incorrect. Under this strategy, the highest price possible is established given the
comparative benefits of the product versus those of the competition.

Correct. Buying market share is a strategy where health plans set a low price in a
highly price-sensitive market to stimulate revenue growth.

Incorrect. Under price skimming, also called market skimming, the highest price
possible is established given the comparative benefits of the product versus
those of the competition

Incorrect. One of the responses above is the correct choice.

Financial Management
A strategic plan that recognizes the importance of timely and accurate financial data can
significantly improve a health plan’s chances for success. Basically, when a health plan
considers financial management issues, its goal is to obtain information to determine
past and current expenses and revenues, to project future expenses and revenues, and
to effectively evaluate and utilize this information in developing its overall strategy.

If financial management systems are unable to detect (or do not detect quickly enough)
that revenues are outpacing expenses, a health plan might miss an opportunity to
pursue a key strategic initiative. For instance, on the mistaken notion that they do not
have access to needed capital, the board and senior management might decide to delay
pursuing a market expansion initiative or delay developing a new product that might
have provided a competitive advantage. Conversely, if a health plan’s financial
management systems are unable to detect (or do not detect quickly enough) that the
health plan has been operating at a loss, the board and senior management might
overextend the organization by pursuing a strategy they otherwise might not have
considered. For example, on the mistaken notion that they have access to needed
capital, a health plan might decide to invest in a new technology without adequate funds
to support such an investment.

Further, if a health plan fails to develop effective financial management systems, it can
waste critical time needed to redirect its strategies to reduce exposure to loss or to
support growth. For example, suppose a health plan begins losing money on a particular
market segment (such as large self-funded plans) or a particular product line (such as
managed dental).

If this information is not made available in a timely manner, the health plan’s board and
senior management team might not be able to make the necessary adjustments to turn
things around or to prevent additional losses that otherwise might have been prevented.
Alternatively, if a health plan is experiencing a period of rapid growth, but its financial
management systems cannot effectively evaluate the impact of the projected growth on
the organization’s capital requirements, the health plan will be unable to support the
infrastructure it will need to maintain its customers.

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Effective financial management strategies rely heavily upon information captured and
monitored by the various functional areas within the health plan, particularly areas such
as medical management, claims, and provider contracting. It is important for the medical
1

management and claims areas to effectively communicate to the financial management/

accounting area the actual and estimated medical costs based on claims paid, claims
reported but not paid, and claims incurred but not reported. It is also important for the
2

financial management/accounting area to be aware of potential expenses resulting from

provider reimbursement arrangements such as physician and hospital withholds. 3

A key component of effective financial management is the ability of a health plan to

analyze financial requirements/results for each of its market segments and product lines.
This information enables a health plan to determine specific strategic initiatives. For
instance, based in part on information obtained through its financial management
systems, a health plan might decide to withdraw from a particular market or it might
decide to redirect resources to bolster a particular market or product that has excellent
long-term prospects.

Provider Networks
When a health plan’s strategic planners prepare to address provider networks, they
consider the geographic coverage of the network and the number and types of providers
to be included. In most cases, their objective is to obtain a full continuum of healthcare
services, from acute care hospitals and physicians to outpatient care to various
specialties such as rehabilitation services, home healthcare, mental health and chemical
dependency services, and vision care. They often decide on first choices and back-up
choices for each type of provider or service.
4

Recognizing the importance of providers, many health plans make a concerted effort to
recruit and retain quality providers who will reflect favorably on the health plan in both
the way that they deliver healthcare and their attitude toward the plan. Many health plans
approach provider recruitment as they would an important customer. For example, they
market their health plan to providers by stressing that when providers become part of
their organization they realize an increase in patient volume and prompt provider
reimbursements.

To strengthen ties with providers, health plans might pursue strategies that involve
increased sharing of data with providers or seeking ways to help providers improve the
quality and effectiveness of their practice. Some health plans involve providers in the
strategic planning process as they would an important strategic partner. At a minimum,
they communicate promptly and effectively to keep providers apprised of important
governance decisions.

Medical Management
An effective strategic plan also establishes objectives and strategies for medical
management that monitor and address the utilization and quality of healthcare services.
These strategies recognize the need for clinical quality measures and performance
improvement, as well as the need for quality medical personnel to oversee the medical
management programs and processes. These strategies also incorporate the use of
state-of-the-art information systems to facilitate processes such as authorizations, large
case management, and discharge planning. In addition, these strategies recognize the
need to respond quickly and effectively to the rapidly changing healthcare environment.

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A health plan must develop the capability to address a complex array of medical issues,
such as treatment of new diseases and the appropriate use of newly developed
prescription drugs, medical technologies, and medical procedures.

Some health plans do not have the resources to develop the medical or systems
expertise and equipment needed for an effective medical management program. Other
health plans have the resources but decide to outsource this function. In both instances,
these health plans develop a strategy to provide medical management services by
contracting with a third party vendor. As the health plan business becomes increasingly
complex and competitive, more health plans include outsourcing in their strategies, and
more vendors emerge to provide services such as claims payment, systems support,
and medical management. Many third party utilization and quality management
organizations offer experienced personnel, tested medical protocols, and large
databases of information that enable them to perform this critical function more
effectively and at a lower cost than it can be performed within some health plans. 5

Customer Services
Because most healthcare is provided through group plans, marketing and sales
strategies initially focus on group purchasers and the brokers and consultants that
support group purchasers. However, many employers provide their employees with
more than one healthcare option, and in this situation health plans must make a “second
sale” to the employees at enrollment meetings and through the services provided to
members throughout the year. Even in the case of a health plan that is the sole
healthcare plan for an employer, health plans seek to keep member trust and
satisfaction high as part of their strategy to conserve business. Many group purchasers
solicit input from their employees about their health plans. If member satisfaction is low,
the health plan could lose the business.

One way that health plans seek to retain members is by ensuring timely and efficient
service through their member services functions. An effective strategic plan considers
the staffing, training, and equipment necessary to ensure that phone calls will be
answered promptly, hold times will be kept to a minimum, and concerns will be resolved
to the members’ satisfaction. In addition, health plans seek to maintain the trust of their
members through a complaint and appeals process that handles member grievances in
a timely and impartial manner.

Information Technology
Most health plans have developed unique information systems within their organizations;
like most other businesses, health plans have become increasingly dependent on
information technology. In a worst-case scenario, a strategic plan that does not
adequately consider information technology can result in catastrophic operational
problems. In a best-case scenario, a strategic plan that takes full advantage of advances
in information technology can deliver world-class service in all aspects of its operations.
For example, with the right information systems the member services function can
quickly access the specific plan information needed to provide telephone support to
members. Member enrollments and claims, provider reimbursements, and purchaser
billing can all be handled more quickly and accurately.

Effective use of information technology can also extend outside the organization through
information sharing with strategic partners. For example, medical outcomes can be

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tracked and applied by medical management and providers to improve the quality of
healthcare. In addition, a health plan with effective information systems can produce the
types of reports that purchasing groups, particularly large employers and government
purchasers, often require as a condition for doing business with a health plan.

Corporate Transactions
Many health plans use corporate transactions such as strategic partnerships, joint
ventures, mergers or acquisitions to achieve the strategic objectives related to the issues
we have examined in this lesson.

For example, a health plan that is considering adding an open access HMO plan to its
product portfolio has several options. The health plan can develop the product internally,
utilizing its existing resources, or it can look outside the organization, perhaps forming a
strategic partnership with a provider network or perhaps merging with a health plan that
already has an open access product in its portfolio.

A health plan that has a strategic goal to enter new markets might consider an alliance
as a means of attaining that goal, particularly when the new markets differ significantly
from the organization’s existing markets in areas such as buying behavior, medical
needs, administrative demands, and regulatory requirements.

For example, consider a commercial health plan that plans to enter the Medicare market
within a specified period of time. Based on a situation analysis, the strategic planners
conclude that:

• Existing provider networks and medical management functions are not in a

position to handle the unique needs of a large elderly population
• Existing member services staff would require considerable training to be able to
effectively handle the types of issues and questions typical of a Medicare
population
• The compliance area does not have enough familiarity with Medicare filing
procedures to obtain the required regulatory approvals within the proposed
timeframe

Before abandoning a promising strategic option, however, this health plan might
consider whether it can proceed by way of a strategic partnership, joint venture, merger,
or acquisition. If the health plan merges with or acquires a health plan that is already
established in the Medicare market, not only does it gain the expertise it previously
lacked, but also it immediately acquires a Medicare book of business.

As this example illustrates, the right alliance can result in “instant expertise” and “instant
market share” for a health plan that is considering a new market, whether that market is
Medicare, Medicaid, workers’ compensation, small employer groups, or large employer
groups with locations in several different states or regions of the country.

The right alliance can also increase an health plan’s ability to address a number of other
key strategic issues we have examined in this lesson. For example, a health plan that
wants to become more competitive in a price-sensitive market might determine that a

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merger or acquisition could produce economies of scale that would better enable it to
meet this strategic objective. A health plan that determines the need to offer a wider
choice in terms of the number or types of providers in its network could pursue a
strategic partnership with a health plan or provider group that provides a good match. A
health plan seeking to improve its medical management or member services functions
might consider an alliance with a health plan that has demonstrated strengths in these
areas.

As we mentioned at the beginning of this lesson, each health plan addresses a unique
combination of key strategic issues depending on the organization’s mission, objectives,
external environment, and internal capabilities. However, there are several issues that
are common to the strategic plans of most health plans.

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Chapter 11 A
Governance: Accountability and Leadership

After completing this lesson, you should be able to:

 Discuss accountability among the stakeholders in health plans

 Explain several implications of accountability on health plan leadership and
governance
 Describe the essential elements of an effective health plan compliance plan
 Define medical necessity and describe how health plans address related governance
issues
 Describe quality and ethics programs and ombudsman programs

Accountability in Health Plans

A primary driver of leadership and decision- making in health plans today is the demand
for accountability. Indeed, the demand for accountability “has become one of the
mantras of the 1990s in health care.” Accountability is the process by which one party
1

is required to justify its actions and policies to another party. Healthcare analysts
2

sometimes describe accountability as a “motivational state” to emphasize the

expectation that accountability will motivate behavior to ensure certain minimal
standards of quality.

To examine accountability in the world of health plans, we begin by considering these

questions:

• Who is accountable?
• To whom are they accountable?
• What behaviors are being examined?
• What standards of performance apply?

Who Is Accountable and to Whom Are They Accountable?

We address these questions together because we can answer both with the same set of
parties or stakeholders. In the context of health plans, stakeholders are any individuals
or institutions with whom an health plan interacts. Many of these stakeholders can be
held accountable and can hold others accountable. The accountable stakeholders in
health plans include :
3

• Health plans
• Hospitals and other institutional providers such as skilled nursing facilities
• Physicians and nonphysician healthcare providers
• Professional medical associations
• Purchasers
• Private investors in for-profit health plans
• Individual members

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• Lawyers and courts

• The government

What Behaviors Are Being Examined and What Standards of Performance Apply?
Each accountable stakeholder has accountability in one or more of the following areas:

• Professional competence (how well the stakeholder does the job)

• Legal and ethical conduct (the stakeholder’s adherence to legal and ethical
standards)
• Financial performance (obtaining a return for investors)
• Equity of access (giving equal opportunity to obtain healthcare)
• Public health promotion (making a contribution to prevention of illness and
accidents)
• Community benefit (being a good “corporate citizen” and, in the case of certain
not-for-profit health plans, adhering to a charitable or community benefit mission) 4

Within each of these areas of accountability are a number of sets of behavioral or quality
standards against which performance is measured. Within a particular area for a
particular stakeholder, there may be multiple sets of behavioral standards for
accountability, each tied to a different stakeholder. For example, in the area of
professional competence for health plans, there is one set of performance standards
established by the courts (see Key Legal Issues in Health Plans), another established by
employers (directly through their agents or through the accreditation organizations), and
yet another established by the government (in the form of state and federal regulatory
oversight of health plan quality).

Creating Balanced Accountability Systems

The challenge for health plans is to meet the need for organizational control in a way
that fosters, rather than erodes, personal responsibility. Traditional notions of
accountability tend to emphasize external control. Under this view, as long as the
standards are high and individuals are held accountable to their superiors for meeting—
or failing to meet—those standards, people will be motivated to perform. The problem
with this approach is that people who work in an organization they perceive as
unsupportive or for leaders they perceive as unfair tend to shrink their self-definition of
the job and are less likely to engage in helpful behaviors outside their perceived job
descriptions. The results are similar when work is too structured or too formal. Figure
5 6

11A-1 provides a few examples to illustrate this point.

Leaders of a health plan need to balance the way they structure expectations for
employees and other stakeholders: too much or too little structure will reduce individuals’
levels of perceived responsibility, while balanced structure will increase those levels.
They need to increase employees’ sense of control over their ability to meet
expectations, their resources, and their choice of methods of task production. Finally, the
health plan’s leaders need to structure stakeholders’ activities so that stakeholders see
the importance of what they are doing. 7

Figure 11A- The Need For Organizational Control that Fosters Personal

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1. Responsibility.

As the following examples illustrate, health plans need their employees and others who
work for the health plan to define their jobs broadly and operate flexibly across
departments, functions, and roles.

An employee of a health plan’s marketing department defines the job so narrowly (“Sell,
sell, sell!”) as to ignore the need to run a change in benefit design by the legal department
to obtain regulatory approval (“Compliance is the legal department’s job, not mine!”).
This practice could result in fines or even a cease-and-desist order from the state
insurance department.

A lawyer charged with assuring that customer service representatives give the proper
description of how the health plan is complying with a newly enacted benefit mandate
simply photocopies the law and sends it to the director of the customer service
department (“It’s their job to train their staff, not mine!”). This approach could result in
noncompliance and possible fines or a cease-and-desist order. A physician in a health
plan’s network views the responsibilities of a participating provider as being limited to
treating patients, not responding to the health plan’s practice patterns survey or providing
requested encounter data. This behavior impairs the health plan’s quality improvement
efforts and perhaps its legal reporting requirements.

Models of Accountability
Outside the world of healthcare, organizations typically establish accountability through
selection, training, job design, goal setting, performance development/appraisal, and
corporate climate. However, these challenges are made more complex within the
healthcare environment because accountability has typically been defined by the
professional model of accountability. The professional model of accountability,
designed for individuals and focused on the relationship between a physician and a
patient, relies extensively on personal relationships and trust. This paradigm does not
work well with large institutions, yet most participants in the healthcare system have
8

been raised on that professional model. These providers often perceive the network of
external controls imposed by health plans, government regulators, private accreditation
organizations, hospital or physician practice risk management policies, and payment and
reimbursement decisions as interfering with professional accountability and eroding the
clinical and ethical quality of care.9

As an alternative to the professional model of accountability, health plans and other

participants in health plans are turning to the economic model of accountability and
the political model of accountability. The economic model of accountability suggests that
the delivery of healthcare should be more like a business—patients are just specialized
consumers, shopping for some optimal combination of price and quality. Under this
model, the primary mechanisms for accountability are the mechanisms of the
marketplace; failure to meet standards will result in a loss of demand for services. In10

other words, patients are “cost-conscious buyers shop[ping] for the lowest price,” and
the health plans are “the provider community… divided into competing economic units.” 11

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Review Question

In examining accountability in the current managed care environment, one is likely to

find that combinations of various models of accountability are in operation. Under one
model of accountability, the primary mechanisms for accountability are the mechanisms
of the marketplace-failure to meet standards will result in a loss of demand for services.
By definition, this model of accountability is called the

professional model of accountability

political model of accountability
due diligence model of accountability
economic model of accountability

Incorrect. The professional model of accountability, designed for individuals and

focused on the relationship between a physician and a patient, relies extensively
on personal relationships and trust.

Incorrect. The political model of accountability is achieved, not through exit, as is

the case in the economic model, but through voice.

Incorrect. There are only three models of accountability, professional, political

and economic

Correct. The economic model of accountability suggests that the delivery of

healthcare should be more like a business.

The political model of accountability, on the other hand, sees the health plan as less
of a business and more a community of stakeholders. In this view, accountability is
achieved, not through exit, as is the case in the economic model, but through voice. In
other words, instead of withdrawing business from a stakeholder who does not meet the
standards (exit), the other participants can complain, protest, and offer an alternative
(voice). Note that political does not necessarily mean governmental—under this model,
stakeholders can express themselves through a variety of mechanisms, only one of
which is governmental. Community boards, physician committees, and citizen advisory
groups are other mechanisms for the expression of this voice and the exercise of
organizational control.
12

All three of these models of accountability are in operation in the current healthcare
environment; various stakeholders, whether organizations or individuals, have some
level of influence over the models and systems of accountability under which they
operate. For example, health plans can choose a primarily economic model of
governance through a shareholder-dominant board of directors or they can elect a
political model of governance through member and provider participation on the board of
directors and advisory committees. 13

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It is unlikely, however, that an entire health insurance plan system —including all its
stakeholders —can operate under a single model of accountability. The advantages and
disadvantages of each of the models vary from one set of accountability relationships to
the next. Most healthcare systems feature some combination of two or even all three of
these models of accountability. However, some health plans, recognizing for the first
time that they have choices about models of accountability, are modifying their
structures of organizational control to optimize the strengths of each model in particular
settings. For example, it may be in a hospital-based health plan that quality improvement
efforts are better served by the inclusion of physicians in governance than by the
inclusion of senior management in that governance, as is suggested in a recent study. 14

On the other hand, it seems likely that the economic model of accountability will continue
to be the optimal model in the relationship between investors and health plans. In other
words, by recognizing that they have choices regarding models and structures of
accountability, and by developing rational methods of assessing the appropriateness of
particular models for particular relationships, health plans and other participants are
moving toward a more informed selection among organizational control systems.

Leadership in Health Plans

Leaders of organizations have a special function. Some analysts maintain that
“executive work is not that of the organization, but the specialized work of maintaining
the organization in operation.” As one healthcare CEO recently put it, “My job is to
15

create a milieu in which other people can function. I do very little when you get right
down to it. But I create an environment that’s conducive to people doing their thing.” 16

This view of executive leadership, however, paints only a part of the picture, that of the
internal management of the company. Some analysts view organizations as open
systems whose fates are intertwined with their environments; these analysts focus on
the boundary-spanning functions of leaders. Boundary-spanning requires an individual
17

to relate an organization or department to its environment. Boundary-spanning

18

leadership functions include such roles as “scout,” “ambassador,” “sentry,” and “guard.”
One cannot overstate the importance of these functions. There is growing support that
the external leadership functions are more closely related to organizational success than
the internal administrative functions. The extent to which any of these functions is
19

necessary for leadership of a particular organization depends largely on the nature of the
environment in which the organization operates. 20

Most modern models now assume both the internal and boundary-spanning functions of
leadership. This dual-orientation view applies to leaders at all levels organization. The
21

nature of their functions, however, may vary depending on their within the organization. 22

All leaders, regardless of organizational level, engage in direction setting ( setting,

planning, envisioning) and boundary spanning. The qualitative nature direction setting
does not vary substantially with organizational level. Further, nature of boundary-
spanning activities differ from one level to the next, remain an essential component of
leadership. For example, while a director of information services department need to
span the health plan’s boundary great frequency, this individual much involved in
negotiating the environment in which the department is embedded, spanning the
boundary of the department to negotiate for resources and accountability relationships.
The the other hand, is more likely to engage activities that relate to the management the
health plan’s boundary, such as negotiations with business partners, regulators, external

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stakeholders. This boundary-spanning function may even extend to managing the

boundary of the industry as Public advocacy on behalf of the care industry, which we
discuss in Public Policy and Changing Environment, is the responsibility of in many
organizations.

In addition, all leaders, regardless of level, are responsible for “operational maintenance
and coordination within the organization.” Where there is accountability, there is a
23

leader charged with designing or maintaining the organizational control structures by

which that line of accountability is managed.

What kinds of skills, then, are important for a health plan executive? In short, leaders
must have a high ability to process and respond to environmental complexity. As S. J.
Zaccaro explains in Models and Theories of Executive Leadership,

[the] operating environment for organizational leaders becomes increasingly

complex at higher levels. . . . The different internal and external stakeholders to
whom the executive is beholden, as well as the range of dynamic environmental
forces and influences (e.g., economic, political, legal, technological...) acting on
the organization, virtually guarantee that top organizational executives will have
to generate, attend to, and choose from multiple solution paths. Further, the
diversity within and between constituencies and the fluid character of most
organizational environments create multiple outcome possibilities, conflicting or
interconnected solution paths, and ambiguous associations between defined
solution paths and organizational outcomes. These characteristics of executive
work result in higher information-processing demands and hence greater
complexity.24

The environmental factors that increase the need for these skills are very much present
in the health plan industry. The first of these factors is environmental munificence.
Environmental munificence is the degree of richness or scarcity of resources in the
environment; it is important because executive mistakes are less critical in a
resourceabundant environment than in a resourcescarce environment. In the past,
25

health plans operated in an abundant environment where the primary competitors were
traditional, fee-for-service indemnity carriers, but this is no longer the case in most
regions of the country. Mistakes in a highly competitive environment can be catastrophic,
as profit margins shrink or, in some cases, are replaced by losses.

A second environmental factor weighing heavily on health plan leaders is environmental

complexity. Environmental complexity is the degree of complexity in an organization’s
internal and external environment in terms of stakeholders, markets, and geography.
Few modern economic environments are as complex as the health plan industry today.
Similarly, environmental dynamism, or the rate of change in an industry, can place
great demands on an organization’s leaders in terms of the need for effective strategic
planning. Dynamism in the managed care environment is pervasive—the entire
landscape of health plans, including competition, regulation, purchasing, the provider
sector, and consumer involvement, is in a constant state of flux. For example, many
entities that are part of the healthcare delivery system today are downsizing or “right-
sizing.” Flexibility is becoming the watchword in the structure of entities, whether they
are health plans or companies that provide services under a broader healthcare system.

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Some nearly inevitable consequences of downsizing are that employees operate with
reduced managerial supervision and less specific job descriptions. In addition,
employees are expected to exhibit greater flexibility in the face of unpredictable
demands on their time and skills. This environment expands the need for approaches to
accountability that promote diverse and creative responses, rather than “by the book”
solutions.
26

This consequence of downsizing—the increased need for flexibility and broad skill sets
—argues for the expanded use by health plan leaders of cross-training and
interdisciplinary teams in the performance of essential health plan functions.
Increasingly, health plans are creating teams that span closely related departments,
such as customer service, utilization review, and claims processing. Not only do these
highly interdependent teams possess an expanded ability to address multidimensional
issues raised by members, but the individual members of the teams see a broader set of
solutions they can apply to particular member issues. Over time, cross-functional
learning occurs, providing the health plan with employees who are more capable and
willing to take flexible approaches to organizational problem solving.

Another leadership challenge posed by the rise in downsizing in the health plan industry
is the need for the senior executive to respond to the inevitable shock and grief that
follows downsizing, even among the “survivors” of the layoffs. The complex
organizational and interpersonal needs of an organization that has been through the
shock of a downsizing process expand the requisite skills of health plan executives to
include emotional leadership skills, introspection, and an enhanced ability to learn. 27

Systems of Organizational Control

Because health plans function within a complex web of accountabilities to a wide array
of stakeholders, their leaders must rely upon systems of organizational control. Such
systems allow health plans to:

• Maximize individual initiative and creativity yet create a climate for cooperation
toward common goals 28

• Ensure that all participants in the organization follow a coordinated agenda in the
face of the various pulls and pushes stemming from the disparate and often
conflicting goals of multiple stakeholders29

• Enhance predictability so that the organization can meet its social, legal, and
fiduciary responsibilities and requirements 30

In this lesson, we examine a few of the more prominent health plan control systems:
compliance programs, utilization review and quality oversight programs, ethics
programs, and ombudsman programs.

Compliance Programs
As we have seen, health plan structures are quite complex and the industry must comply
with a large number of complicated state and federal laws and regulations. Not
surprisingly, compliance presents a substantial management challenge. Therefore, many
health plans today have established compliance programs to prevent, detect, and
address conduct by the health plan and its agents that violates legal requirements.

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The Office of Inspector General’s (OIG’s) Compliance Program Guidance for Hospitals
defines a corporate compliance program as, “Effective internal controls that promote
adherence to applicable federal and state law, and the program requirements of federal,
state and private health plans.” An effective compliance program uses employee
31

education, training, and oversight to ensure compliance with laws and regulations
applicable to the ongoing operation of an organization. A compliance program can be all-
encompassing—covering all lines of business in which an organization is involved—or it
can be limited in scope to one or more specific lines of business.

Why Implement a Corporate Compliance Program?

A compliance program is not just good corporate practice, it is a necessity. Healthcare
misconduct is clearly the focus of increased attention by the government and the media.
In the 1980s, the federal government began to intensify its efforts to address criminal
activity and misconduct in the delivery of healthcare. This trend has continued to the
present with a daunting assortment of federal and state agencies engaged in the
investigation and prosecution of healthcare wrongs.

Obviously, it is better to prevent adverse events than to have to respond to them.

Although the OIG is expected to eventually publish compliance guidelines for health
plans, there are no such guidelines at the time of this writing, and there are few laws that
explicitly require that a company establish a compliance program. However, in the
absence of clear guidance outside the realm of fraud, prosecutors and practitioners alike
turn to the 1991 Federal Sentencing Guidelines for Organizations (“Guidelines”) and
comparable state laws for direction.

The Guidelines can be a valuable tool for establishing and maintaining an effective
compliance program. Also, federal prosecutors now routinely insist that a company
seeking to settle a fraud case set up a corporate compliance program modeled on the
Guidelines. Further, entities that have a compliance plan can sometimes lessen potential
penalities by voluntarily reporting a criminal offense to the government.

The Guidelines, which became effective November 1, 1991, furnish a strong incentive
for companies to develop compliance plans. By establishing a compliance program that
incorporates the features required by the Guidelines, an organization diminishes the
potential for criminal activity by its employees and agents. It also reduces the potential
criminal and civil consequences of criminal conviction should an employee commit a
crime despite the compliance program.

The Guidelines, which became effective November 1, 1991, furnish a strong incentive
for companies to develop compliance plans. By establishing a compliance program that
incorporates the features required by the Guidelines, an organization diminishes the
potential for criminal activity by its employees and agents. It also reduces the potential
criminal and civil consequences of criminal conviction should an employee commit a
crime despite the compliance program.

The Guidelines govern the sentencing of all organizations, including corporations,

partnerships, joint-stock companies, union, trusts, pension funds, unincorporated
organizations, and nonprofit organizations. They impose severe economic sanctions on
organizations convicted in federal courts of criminal offenses. Several mitigating factors
can temper the severity of the sanctions imposed by the Guidelines. The most significant

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mitigating factor is the maintenance of a corporate compliance program. The Guidelines

describe the essential features that a compliance program must include to be considered
“effective” and thereby qualify as a mitigating factor during sentencing.

Criminal and civil liability may attach to the directors and officers of the company as well
as the corporation itself. An officer “may be convicted for the criminal acts of lower level
company employees simply because of the officer’s responsible relation to the situation
and failure to correct or prevent the criminal violations.” Certainly, under this theory an
32

officer or director would be more vulnerable in the event he or she did little or nothing to
prevent the employee misdeeds by way of establishing an effective corporate
compliance program. Still further, one easily could argue that shareholders’ civil actions
against directors and officers that failed to take reasonable steps to prevent employee
misconduct would be seriously considered by the courts. 33

It is important to note that it will not be enough for a corporation to plead in its defense
that it did not sanction the illegal activities of its employees. There is no requirement in
the law that there be a finding of corporate willfulness or fault. Rather, the law-breaking
employee’s intent will be attributed to the corporation, as long as it involves conduct that
is within the ordinary duties of employment and will inure to the benefit of the
organization.34

Obviously, an organization would prefer to discover an internal problem before

regulators and prosecutors do. Besides mitigating any penalties ultimately imposed,
such discovery could avoid a costly investigation. In addition, self-policing through use of
a compliance plan can avert the possibility of a lawsuit being filed against the health plan
under the False Claims Act. Under the False Claims Act, introduced in Fraud and Abuse
any person having knowledge of a false or fraudulent claim, or the use of a false record
or statement to obtain government payment or approval, may bring a “qui tam” action (as
described in Regulatory Agencies and Health Plans) in federal district court on behalf of
himself and the government. If the government proceeds with the action, or if the
35

individual elects to continue it, the person is entitled to share in a portion of the proceeds
or settlement of the action. The “whistleblower” is entitled to costs, expenses, and
attorney fees.

Virtually anyone can file a qui tam suit: a disgruntled current or former employee,
competitors, physicians, or patients. People who may potentially bring a “qui tam” action
are called relators. A corporate compliance program can heighten employee awareness
of fraud and abuse concerns and thus may expand the pool of potential qui tam relators.
This places an even greater premium on self-policing to avoid improper activities and,
when necessary, to detect improper activities at an early stage and undertake remedial
action as soon as possible.

Some states have adopted requirements similar to those found in the Guidelines. For
example, Maryland’s insurance laws and regulations specifically require every
authorized insurer to “institute, implement and maintain an insurance antifraud plan” that
it must file with the State.
36

Developing a Corporate Compliance Program

As we discussed earlier, the Guidelines can provide a framework for the development of
a health plan’s compliance program. The Guidelines include seven minimum objectives

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that an organization must meet for its corporate compliance program to be considered
an effective program to prevent and detect violations of law. This framework requires an
organization to exercise due diligence in attempting to deter and, if a violation occurs,
detect misconduct. Recall that in Health Plan Structure we discussed due diligence in
relation to acquisitions and mergers. In an organization’s compliance effort, exercising
due diligence requires, at a minimum, these actions.

1. Putting in place written standards and procedures for the corporation’s employees and
other agents that could reduce the prospect of criminal conduct.

2. The assignment of high-level personnel to oversee compliance with such standards and
procedures.

3. The use of due care to avoid the delegation of substantial authority to persons whom
the corporation knows, or reasonably should know, have a propensity to engage in illegal
activities.

4. The effective communication of the corporation’s standards and procedures to its

employees and agents (e.g., through training programs or publications that explain in
practical terms what the company requires).

5. The implementation of reasonable measures or steps to achieve compliance with the

corporation’s standards (e.g., establishing a monitoring or auditing system designed to
detect misconduct, establishing and publicizing a reporting system by which employees
and agents could report misconduct without fear of retribution).

6. Consistent enforcement of the corporation’s standards through appropriate disciplinary

mechanisms, including, as appropriate, discipline of individuals responsible for the
failure to detect an offense. Adequate discipline of individuals responsible for an offense
is a necessary component of enforcement; however, the form of discipline that will be
appropriate will be case-specific.

7. When and if the entity detects misconduct, taking all reasonable steps to respond
appropriately and prevent further misconduct, including modifying the corporation’s
compliance program. 37

The nature and complexity of a compliance program depends on several factors. These
factors include: (1) the size and financial condition of the organization, (2) the
vulnerability of the organization to misconduct, and (3) whether the organization has a
history of being a party to or the victim of fraud or other misconduct. In addition, answers
to the following important questions help establish the scope of the compliance effort:

1. Is the organization primarily engaged in government contracting, Medicare

contracting, or Medicaid?
2. Is the organization in a growth phase, i.e., actively acquiring physician practices
and other network providers?
3. Are there problems that require immediate review and corrective action or is the
organization taking a proactive approach to its compliance efforts?

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Enlisting the support of essential employees is important to a successful compliance

effort. Depending upon the scope of the program, the organization can best develop the
compliance program through a committee of individuals with diverse views of the
company’s business, e.g., operations, finance, human resources, marketing, medical
management, claims, internal audit, and legal. This group could include directors,
executive officers, managers of important operating units or divisions, and legal counsel.
By participating in such a work group, employees not only feel a part of the process, but
help create companywide support for the compliance program.

The following lessons describe important elements of an effective compliance program.

Establishment of Legal Standards and Procedures

Effective standards and procedures that govern a compliance program are tailored to the
particular industry. Therefore, the team or work group formulating such standards and
procedures typically begins the process by taking an inventory of all laws and
regulations that govern the business. For example, a health plan hospital will examine
such regulations as those promulgated by CMS, the state health department, or the
state insurance department. Although not all of these regulations carry criminal
penalties, the organization usually incorporates all of them into the organization’s
standards so that one integrated document governs all corporate conduct. Finally,
besides these industry-specific standards, the organization’s compliance standards
might also include workplace standards that are generally applicable to all businesses.
For example, these might include standards governing use of company property and
proprietary information, accuracy in recordkeeping, and company policies regarding
harassment and discrimination.

The organization can use the inventory for two purposes: (1) to identify those
departments and departmental activities likely to fall within the reach of each particular
law or regulation, and (2) to conduct a comprehensive internal evaluation of each key
department.

Review Question

SoundCare Health Services, a health plan, recently conducted a situation analysis. One
step in this analysis required SoundCare to examine its current activities, its strengths
and weaknesses, and its ability to respond to potential threats and opportunities in the
environment. This activity provided SoundCare with a realistic appraisal of its
capabilities. One weakness that SoundCare identified during this process was that it
lacked an effective program for preventing and detecting violations of law. SoundCare
decided to remedy this weakness by using the 1991 Federal Sentencing Guidelines for
Organizations as a model for its compliance program.

With respect to the Federal Sentencing Guidelines, actions that SoundCare should take
in developing its compliance program include

creating a system through which employees and other agents can report
suspected misconduct without fear of retribution
holding management accountable for the misconduct of their subordinates

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assigning a high-level member of management to the position of compliance

coordinator or administrator
all of the above

Incorrect. With respect to the Federal Sentencing Guidelines, actions that

SoundCare should take in developing its compliance program should include
creating a system through which employees and other agents can report
suspected misconduct without fear of retribution, as well as other actions listed
on this page.

Incorrect. With respect to the Federal Sentencing Guidelines, actions that

SoundCare should take in developing its compliance program should include
holding management accountable for the misconduct of their subordinates, as
well as other actions listed on this page.

Incorrect. With respect to the Federal Sentencing Guidelines, actions that

SoundCare should take in developing its compliance program should include
assigning a high-level member of management to the position of compliance
coordinator or administrator, as well as other actions listed on this page.

Correct! With respect to the Federal Sentencing Guidelines, actions that

SoundCare should take in developing its compliance program include all of the
above

Initial Internal Departmental Evaluation and Monitoring Procedures

The group creating the compliance plan may conduct a comprehensive internal audit at
the time it develops the compliance program. After the company has identified the
relevant legal standards with which the company must comply, the next step is to
conduct a thorough self-evaluation.

This self-evaluation can be accomplished by asking that the group members use the
inventory of applicable laws and regulations as a resource to review all of the functions
and procedures in their departments and to identify those risk areas where misconduct
could occur. For example, such risks could relate to billing for items and services not
provided, improper diversion of payment intended for compensating a provider, and
misrepresentation of types of services provided. By identifying risk areas, each
department can develop monitoring procedures that specifically address the risk areas of
that department, and design specific procedures to detect misconduct unique to that
department.

Detection/Reporting System
To satisfy the Guidelines, a company generally does more than establish compliance
standards and procedures; it takes steps to achieve actual compliance with those
standards and procedures. The Guidelines expressly recommend the creation of a
system through which employees and other agents can report suspected misconduct
without fear of retribution.

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An internal detection/reporting system benefits the company in at least two ways. First, it
provides constant evaluation of the company by its own employees and agents. Second,
it encourages employees and agents, who might otherwise go directly to governmental
authorities, to report suspected misconduct to the company instead.

In an effective internal detection/reporting system, the company conveys to all personnel

its ongoing genuine interest in operating a legal and ethical business. The company also
designs a system that fosters a sense of confidence in the system. Finally, the
procedures for detecting and reporting misconduct are not so intricate and detailed that
they are difficult for individuals to follow consistently.

Sometimes, there is a mechanism for anonymous reporting, which makes it much more
likely that employees will report suspected misconduct. In addition, an anonymous
reporting system shows that the company is more interested in learning about
misconduct than about the identity of the person reporting it. Mechanisms for creating
such a system can include a standard reporting tool, a toll-free hotline number, and a
mail-drop for those individuals who want to report incidents of suspected misconduct but
wish to maintain anonymity.

Besides providing this information to its employees and agents, the organization may
distribute this information to enrollees and participating providers. The reason for
extending the reporting system to include enrollees and participating providers is
twofold; it conveys (to enrollees and providers) the organization’s interest in operating a
legal and ethical business, and it provides an additional avenue for learning about
suspected misconduct before governmental intervention.

In the end, health plans generally cannot guarantee anonymity even to those who report
misconduct through an apparently anonymous procedure. At some point, the company
may need to reveal the identity of the person who initiated the complaint, or that identity
may become obvious. Typically, health plans strive to assure discretion, but also
endeavor not to mislead individuals with promises of absolute anonymity. Some health
plans address this issue before the onset of an investigation by sending a formal notice
to the department from which a complaint has originated. Among other things, this notice
includes a statement that the law may require that the organization reveal the identity of
the individual who reported the misconduct. The organization can also incorporate a
similar statement into the company’s standard reporting tool or in the taped message on
the toll-free hotline.

Program Oversight
Under effective compliance programs, a high-level member of management is
responsible for overseeing the company’s compliance program. The Guidelines
expressly state that this compliance coordinator or administrator must be a “director; an
executive officer; an individual in charge of a major business or functional unit of the
organization; or an individual with a substantial ownership interest.” To strengthen the
compliance officer’s ability to carry out the duties of the position and assure a
commitment to this effort, the individual reports periodically to the company’s board of
directors, preferably, or at minimum to the company’s chief executive officer. The
Inspector General and a number of commentators have recommended that the chief
compliance officer neither be the general counsel nor report to the general counsel. 38

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A typical compliance program includes the establishment of a formal compliance

committee to oversee its implementation. Such a committee, chaired by the compliance
officer, often consists of individuals selected from major departments. Under such a
structure the committee is responsible for coordinating the detection, referral, and
investigation of all suspected misconduct that occurs against or by the company. Among
other things, the committee is responsible for reviewing all complaints to decide whether
they warrant a full fraud investigation. The committee also maintains a database that
tracks all incidents of suspected misconduct and the disposition of each complaint, and
considers whether mandatory reporting requirements (to the appropriate regulatory or
law enforcement agency) apply.

Investigations
Once an organization becomes aware that misconduct may have been committed, the
Guidelines require the organization to respond appropriately. While the Guidelines do
not state specifically what an appropriate response to suspected misconduct would be, it
is clear that the organization must begin by conducting a thorough internal investigation.

An organization can obtain mitigation credit, in addition to the credit available for
maintaining a corporate compliance program, if it voluntarily reports a criminal offense to
the government and subsequently reveals the results of the internal investigation.

Some states have similar provisions. For example, Maryland’s fraud statute provides
that “if an insurer, in good faith, has cause to believe that insurance fraud has been or is
being committed, the insurer shall report the suspected fraud to the Insurance Fraud
Division or to the appropriate federal, State or local law enforcement authority.” 39

The benefits of internally investigating possible misconduct extend beyond reducing the
organization’s ultimate fine, if any. Through the internal investigation, the company gains
an understanding of the facts, which it can then use to prevent further similar offenses.

An effective compliance program includes extensive fraud investigation procedures.

Under one popular model, the compliance committee refers those complaints that
warrant a full investigation to an investigation unit. That unit will then investigate the
complaint and submit a written report of its findings to the committee. Several days
before an investigation begins, the investigation unit sends a memorandum to the
appropriate department head, which includes the following:

• Notification that the unit will conduct a full investigation of a complaint

• The duration of the investigation
• The nature of the complaint
• A statement that the investigators may interview and ask departmental personnel
to provide information (which will be considered confidential)
• A statement that the unit may refer the matter to federal, state, or local regulatory
or law enforcement officials, and that cooperation with such officials, which may
include court room testimony, may be a result of the investigation

Finally, if the investigation unit determines that fraud has been or is being committed, the
compliance committee reports the incident to the applicable federal and/or state
governmental agency within fifteen days of receiving the investigation unit’s report.

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Auditing System
The Guidelines also suggest that an effective compliance program include an auditing
system that will ensure that the company has followed its policies and procedures.
Ideally, someone independent of line management conducts the audits.

A sound compliance program might include a two-tiered auditing system that includes
annual and random audits. The compliance program could require each department to
conduct its own internal audit at least once a year. The purpose of the audit is to: (1)
decide whether fraud has been or is being committed by or against the organization, (2)
assess whether the department’s current monitoring procedures adequately detect fraud
committed by or against the organization, and (3) assess the department’s current
functions and systems to decide if they adequately deter misconduct committed by or
against the organization.

Effective compliance programs also typically provide for random audits. The compliance
committee oversees such audits and establishes guidelines and procedures for the
conduct of the audits. One ground for the initiation of an audit would be if a department
has a high incidence of misconduct or is a department in which the committee
determines that misconduct is most likely to occur.

Disciplinary and Corrective Action

The Guidelines require organizations to discipline individuals who violate compliance
standards. The Guidelines do not mandate, however, specific sanctions that the
company must apply. An organization, therefore, has discretion to decide the nature and
severity of the discipline depending on the facts and circumstances, as long as it applies
the sanctions consistently. For an unintentional and minor infraction, an informal
reprimand often is an appropriate sanction. Such a reprimand puts the employee on
notice that the conduct engaged in is a violation of the company’s compliance standards
and that further misconduct may lead to more severe sanctions.

For serious, intentional violations of the company’s compliance standards, firings and
referrals to the relevant governmental agency or law enforcement unit are appropriate.
For violations that fall between these two extremes, the company may discipline an
employee by demoting or transferring the employee, or suspending the employee
without pay. Effective but less severe sanctions might include financial penalties, such
as a temporary salary reduction, a denial of a salary increase, or denial of a bonus or
incentive compensation.

The Guidelines also specifically state that management must be accountable for the
misconduct of their subordinates. Managers are subject to discipline for failure to detect
compliance violations that occur within their departments. If a manager’s negligence,
carelessness or inattention facilitates or prolongs misconduct within an operating unit,
the organization disciplines that manager in a way that is commensurate with the
seriousness of the violation that has occurred.

The compliance committee notifies the human resources department (HRD) of every
instance of employee misconduct. The committee’s notice includes a description of the
misconduct and a recommendation of the appropriate sanction warranted. Although
most HRDs have much discretion over the imposition of sanctions against employees,

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the compliance program usually provides that the HRD confer with the employee’s line
manager and/or department head before imposing a sanction.

Employees are not the only individuals against whom health plans can take disciplinary
actions. Others in this category include enrollees, agents, and participating providers,
under the contractual arrangements between the health plan and such individuals. In
such a case of disciplinary action, the compliance committee sends a notice to the
applicable department head, including a recommendation as to the appropriate sanction
warranted. The department head would then have discretion over the type of sanction
imposed against the enrollee, agent, or participating provider. For example, if a
participating provider is found to have violated the company’s compliance standards, the
compliance committee would send to the applicable department head—perhaps the
director of provider relations—a notice that would include a description of the misconduct
and a recommendation of the appropriate sanction.

Finally, it is particularly important that the organization handle any disciplinary actions in
a way that affords the individual some form of due process, i.e., advance notice, and an
opportunity to respond to the charges, and the availability of any appeal procedures
previously established by the organization for terminating or suspending employees,
agents, enrollees, and providers.

Incentive Program
To encourage the reporting of suspected misconduct, some organizations maintain a
program that gives recognition to employees whose reports of suspected misconduct
lead to the successful detection, investigation, and referral of misconduct. A compliance
program might also include an employee reward program that disburses a cash award
for each well-founded complaint of fraud or serious misconduct that is made to the
compliance committee.

Education and Training

Once the company has developed and written compliance standards and procedures, it
typically distributes them to all employees and agents of the company. The organization
can include these standards and procedures in a separate compliance manual or as an
additional section in the company’s employee handbook. Either way, many health plans
require all employees who receive a copy of the company’s compliance standards and
procedures to sign a written certification that they have received, read, and understood
them. In addition, the company generally gives all employees and agents updated and
new material whenever a change in law or a change in compliance standards or
procedures makes it necessary.

Distribution of written compliance standards and procedures, however, is not enough. An

effective compliance program uses a variety of training and other interactive activities to
communicate the company’s policies and procedures. New employees receive a copy of
the company’s compliance standards and procedures immediately upon hiring with the
same certification requirements described above. The company typically requires that
new employees attend an introductory training session that:

• Presents an overview of the applicable laws and regulations that regulate the
company

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• Addresses the specific aspects of fraud associated with the company’s various
lines of business, if applicable
• Thoroughly educates all personnel about the company’s compliance program,
including a review of all standards and procedures. More specifically, the training
sessions will ensure that employees and agents (a) know how to report
misconduct, anonymously or otherwise, (b) know what happens to complaints
after the initial report, and (c) know what happens to people who use the
reporting system

The sound compliance program includes an annual “refresher course” for all current
employees and agents. Such a course reviews the company’s standards and
procedures, highlights any particular problems or concerns in the company or in the
industry generally, and explains any changes to the applicable laws or changes in
company procedures that employees need to know to ensure compliance.

Trainers for the introductory training sessions and the refresher courses can be internal
or external. Large, well-developed HRD training programs can usually accept this
responsibility. In any event, an effective program includes documentation and
maintenance of records of attendance. Maintaining records of attendance by topic and
date ensures that all personnel receive sufficient compliance training and creates a
record of the company’s efforts to carry out an effective compliance program.

Periodic Compliance Program Reviews

Nothing in the world of health plan compliance is static. Laws, regulations, and court
decisions affecting health plans, both state and federal, are in a constant state of flux.
Thus, corporate compliance programs designed to remain useful require a regularly
scheduled, reasonably frequent, and comprehensive review of the law. This will typically
involve both an ongoing monitoring of state and federal developments and an annual or
biannual audit of the adequacy of the compliance standards.

Changes in law are not the only source of potentially hazardous change. Company
practices and products, if anything, are changing even more rapidly than laws and
regulations. Health plans are creating new contractual relationships with provider
organizations, designing new products that involve radically different operational
approaches than typical health plan products, and making a host of other operational
changes that can have profound legal implications. Compliance officers must ensure that
the business changes that the organization undertakes are handled in compliance with
existing laws.

Governing the Compliant Health Plan: The Role of Leadership

A health plan can follow every recommendation of every compliance expert, develop a
plan that anticipates every regulator’s and every prosecutor’s objections, and create a
structure that the authors of the Guidelines themselves could have written, and still fall
short. The essential ingredient to any compliance plan is that the company’s leadership
—from the board of directors to the CEO and president on down—must be committed to
compliance and fully aware of the risks involved in noncompliance. For example, they
must take care not to be too single-minded in their oversight of the company’s bottom
line that they neglect to calculate compliance risks. Executives sometimes face

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situations that call for a choice between maximizing a business opportunity or strictly
complying with the demands of regulation, as Insight 11A-1 illustrates.
Insight 11A-1. Business Opportunity and Compliance Risk.

A new product is ready to be launched. The state requires a health plan to obtain
insurance department approval of policy forms before issuing any new product. If the
health plan unveils this product by the first of the next month it will (1) have the first
such product in the market and (2) be just in time to offer the product to a large employer
coalition that is putting its healthcare benefit business out to bid. The competitive
advantage could be worth millions of dollars, but only if the product “hits the streets”
next month. Regulators have approved all but a single, minor aspect of the policy form,
but will not grant approval in time for the product to be available for the client. In short,
to comply with the law is to hand millions of dollars of business over to competitors,
miss corporate profit targets, and cost many employees of the company a year-end bonus.

Obviously, the executive’s question to the compliance officer will be “what are the costs
of noncompliance?” If the issue were one of public safety, the commission of a
fraudulent act, or some act of similar severity, it is likely to be an easier issue for the
executive than the above example. Few people will risk imprisonment, a corporate death
sentence, or injury to life or limb for profits. Yet, this example, with neither life nor limb
nor criminal statutes at stake, illustrates the type of issues a health plan’s leaders must
sometimes address.

Compliance officers who are asked to assess the risk of noncompliance can shrug their
shoulders and say, “This is too subjective to predict.” Alternatively, they can hazard a
guess. Or they can perform some sort of rigorous analysis to formulate an educated
guess. While some might argue that regulatory penalties are too arbitrary for an outsider
to calculate, there is evidence to the contrary. A recent analysis of one state’s market
conduct administrative penalties assessed against HMOs over a 10- year period was
able to explain, with a rather simple formula, nearly 96 percent of the variance among
those penalties. That formula was based in large part on a calculation of maximum
40

penalty allowed by law per violation that the HMO was alleged to have committed.

However, regulatory standards of punishment have been on the rise as public scrutiny of
both health plans and regulators has grown in intensity. Calculations based on even
recent regulatory experience may not predict regulatory penalties in the future as well as
they would have, absent this elevated scrutiny. Furthermore, regulators sometimes react
quite strongly to the idea that corporate executives would calculate the cost of
noncompliance, then decide it was worth it. A health plan’s leaders must consider the
risk of fines or a cease-anddesist order from regulators. Also, a health plan’s leaders
must consider the risk of damage to its client relationships and of negative publicity.

As we have seen, compliance programs are a critical system of organizational control for
health plans; in the remainder of this lesson we examine several other systems.

Utilization Review and Quality Oversight Programs

One of the most sensitive issues in the world of health plans is the question of medical
necessity as a condition for covering a medical service or supply. Most health plans

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exclude from coverage any service or supply that is not medically necessary. Therefore,
the notion of medical necessity comes up in the context, not of clinical decisions about
treatment alternatives (which are made by the healthcare practitioner), but of coverage
decisions (which are made by the health plan). In other words, medical necessity is a
contractual issue; the health plan must decide whether the service or supply is covered
under the terms of the contract’s medical necessity requirement.

While medical necessity has been defined in a number of ways, most definitions include
requirements that the proposed treatment be (1) medical (provided or ordered by a
licensed healthcare practitioner), (2) effective (supported by scientific literature that
suggests the treatment will result in a benefit to the patient), (3) individualized (likely to
be effective for this particular patient, given that patient’s clinical indications), and (4)
economical (as compared to other available, equally effective treatment alternatives).

Returning to our earlier analysis of accountability in health plans, we may ask,

• “Who is accountable for decisions of medical necessity?

• To whom are they accountable?
• In what domains are they accountable?
• Who establishes the standards for accountability?”

The mechanisms and structures employed by health plans to make determinations of

medical necessity vary from organization to organization.

However, we can generalize about the most common structures. Typically, medical
management is under the supervision of a medical director, assisted in larger plans by
assistant medical directors or local medical directors who report to a national medical
director. Other licensed healthcare professionals, notably nurses, are typically quite
heavily involved, at least initially, in reviewing claims for determining the medical
necessity of the treatment.

Accountability for decisions of medical necessity is owed to several stakeholders. First,

the medical director typically reports to the chief executive officer of the health plan.
Furthermore, state law often requires not only that each health plan have a medical
director, but that the medical director be a physician licensed in the health plan’s state,
raising the specter of accountability not only to professional medical societies but also to
the state medical board or other state regulator. Many health plans have utilization
review committees, to whom the medical director brings questions such as those of
medical necessity. Increasingly, as health plans grow and as public demands for
accountability increase, health plans are using specialized utilization review panels; for
example, pediatricians are assisting the medical director in difficult cases involving
pediatric medical necessity, cardiologists are assisting with cardiological medical
necessity, and so on. Additionally, state and federal governments increasingly demand
some form of external review of such decisions. Finally and most significantly, health
plans are accountable to their members—the patients—for their determinations of
medical necessity.

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A number of areas of accountability are involved in determining medical necessity.

Certainly, the primary area is professional competence. Another significant area of
accountability in determining medical necessity is financial performance, i.e., the
economic obligations of the participants in the decision. The interest of government and
the relevance of ethical questions to the decision also bring that area of accountability
into the fray. Even access is an issue, particularly in the face of behavioral health
professionals who charge that the standard of medical necessity is an inappropriate
standard for judging coverage for behavioral healthcare treatments. 41

As we have seen, within each of these domains, each stakeholder has a separate claim
on establishing the standards for performance. For example, professional organizations
may attempt to assert jurisdiction over medical directors’ professional competence in
making determinations of medical necessity. Chief executives may establish economic
targets that affect assessments of the economic portion of the medical necessity
determination.

Related to the issue of utilization review and medical necessity is the overlapping issue
of clinical quality management. As we saw in Healthcare Management: An Introduction,
clinical quality management has traditionally been defined in terms of:
(1) assessing a healthcare organization’s structure (whether the entity is capable
of delivering quality care by means of certification, licensure, recordkeeping, etc.)
(2) process (whether the way care is provided is consistent with quality)
(3) outcomes (whether the end result of treatment is consistent with standards of
quality healthcare delivery).
42

Essentially, the same stakeholders and areas of accountability apply in quality

management as apply in determining medical necessity, since medical necessity is a
component of quality management. The greater breadth of the subject matter involved in
quality management, however, brings into play additional mechanisms of organizational
control. Quality committees, which oversee clinical quality, and perhaps include
questions of peer review and provider credentialing, are a common mechanism for the
exercise of health plans’ organizational control. Such committees typically set standards,
provide feedback and administer sanctions to providers, and advise the medical director
and the management team on clinical quality improvement initiatives

An important and relatively recent development has been the systematic development of
clinical practice guidelines. As we discussed in Workers' Compensation Programs, a
clinical practice guideline is a utilization management and quality management
mechanism designed to aid providers in making decisions about the most appropriate
course of treatment for a specific case. Clinical practice guidelines are a particularly
powerful tool in establishing accountability for relatively specific behaviors of providers.
Indeed, the specificity of the standards may make it particularly important that providers
who are accountable to those standards feel that the standards have been arrived at by
competent, unbiased parties. Clinical practice guidelines that are so developed,
preferably by or in consultation with providers themselves, are more likely to be
accepted by physicians than those perceived to be designed and imposed by the health
plan.

To date, over 1,800 guidelines have been catalogued, although a complete assessment
of their impact on cost and quality of healthcare services has yet to be conducted. 43

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While over 82% of HMOs claimed in a recent survey to use clinical practice guidelines to
reduce variability in practice patterns of participating providers, there is still a great deal
of uncertainty as to the extent these patterns actually represent optimal clinical practice
or have been diluted with considerations of patient preferences and socioeconomic
factors. In any event, clinical practice guidelines are just that— guidelines, which may
44

be modified to meet the special circumstances of a patient.

Ethics Programs
Biomedical ethics, a field with a long and respected history, recently has gained a
specific focus—the ethics of health plans. Rather than the exclusive domain of
academics and consultants, the field has taken up residence in the form of health plan
ethics committees. Ethics committees review health plan policies for consistency with
principles of ethics and recommend changes where needed. Accepted in hospitals the
45

1980s, ethics committees are emerging in health plans. They can provide valuable
assistance to health plan executives by providing forum for the discussion of difficult
issues, reviewing or generating statements health plan policy, and assisting in the
education of health plan employees and participating providers. 46

Ethics committees are only one component of a broader corporate commitment to

ethical organizational behavior, sometimes described as ethics programs. Ethics
programs represent an across-the-board effort to foster exemplary ethical behavior
throughout the health plan by seeking to:

• Continuously improve efforts to communicate the health plan’s mission and core
values
• Train executives and staff on how to weave ethical behavior into daily
organizational activities, including all organizational meetings
• Develop tools and techniques for using ethical considerations as a criterion in
selection processes for hiring, promotion, and training 47

• Codify and measure standards of ethical behavior 48

• Recognize health plans’ clinical responsibilities in addition to their business

obligations49

Some analysts have expressed concerns about the ethical problems specific to
managed care. These concerns involve the potential for conflict—apparent or real—
between the financial objectives of the health plan and the health interests of the patient.
In other words, the concern is over the collision between medical ethics and business
ethics. The distinction between the business world generally and the world of health
50

plans specifically is that the product— healthcare—suggests the need for a higher
standard of ethical behavior, and the providers of care—physicians and other
51

professionals—operate under their own sets of ethical standards. The challenge, then, is
for health plans to adopt ethics systems in a highly competitive environment. 52

Another concern has to do with the privacy of the traditional doctor-patient relationship,
and the potential impact of managed care programs, such as utilization review and
member appeals, which rely upon the sharing of patient-specific medical information. 53

This concern suggests that an important task of health plan ethics programs is to assure

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that health plan employees preserve patient privacy as a top priority throughout the
organization.

Ombudsman Programs
As we have seen, the ombudsman program is a method to have complaints against an
health plan investigated by a neutral third party, thereby helping to ensure health plan
accountability to healthcare consumers. Webster defines ombudsman as “a public
official appointed to investigate citizens’ complaints against the government.” Common
54

usage and the practice of governments and nongovernmental organizations have

expanded the definition to include any official appointed to investigate complaints
against the official’s organization.

Analysts disagree as to the precise role an ombudsman plays. They have described an
ombudsman in a number of ways:

• A neutral, third-party fact-finder

55

• A person who helps the aggrieved person gather information in preparation for
an appeal 56

• A person who is not necessarily neutral as he or she helps the aggrieved party
pursue justice 57

One can see legislators’ affinity for ombudsman programs in healthcare laws approved
by legislatures at all levels. For example, the Congress, in funding activities to protect
the rights of vulnerable elderly users of long-term care, saw state and local ombudsman
programs as being an essential component of that program. Indeed, ombudsman
58

programs can be found throughout the U.S. Code.

Similarly, states have turned to ombudsman programs to help consumers of healthcare

services. States, responding to the federal government’s invitation to establish longterm
care ombudsman programs, have gone well beyond the domain of long-term care in the
establishment of such programs. For example, Florida has a Statewide Managed Care
Ombudsman Committee, charged with acting “as a consumer protection and advocacy
organization on behalf of all healthcare consumers receiving services through health
plan programs in the state.”59

Healthcare entities of all sorts have established ombudsman programs. For example,
Pennsylvania’s public health department has established such a program throughout its
mental hospitals. Health plans are employing psychiatrists as ombudsmen. Some
60 61

health organizations have established specialized ombudsman programs targeting

specific types of grievances, such as sexual harassment. 62

Experience in HMOs and other healthcare organizations have left practitioners with a
number of guidelines on how to operate such programs:

1. Establish a clear mission and objectives

2. Empower the program to resolve problems other departments cannot
3. Build programs on existing resources, using available skill sets

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4. Empower the program with independence and the authority to identify the root of
and facilitate the resolution of the problem
5. Gain the buy-in of all the relevant stakeholders within and outside of the health
plan
6. Use documentation of accomplishments to build confidence in stakeholders
7. Use the program to identify organization developmental needs
8. Keep an eye on cost effectiveness of the program
9. Maintain a client-centered focus 63

Ombudsman programs are seen as yet another tool for creating organizational control,
emphasizing the organization’s accountability to the clients of the programs, whether
they are health plan members, employees, providers, or other stakeholders. Their
flexibility makes them uniquely adapted to a variety of accountability domains and sets of
performance standards. Insight 11A-2 describes one health plan’s ombudsman program.

Insight 11A-2. An Ombudsman Program at BCBSMA.

Ask Ron Romano of Blue Cross Blue Shield of Massachusetts (BCBSMA) how his role
as ombudsman works for health plan members, and he’ll tell you the story of Peter.

Peter (not his real name), a member of HMO Blue, BCBSMA’s principal managed health
care plan, was a man with a serious alcoholism problem. Peter had shown signs of
alcohol-based impairment at work and home, causing concern to friends, family, and
colleagues, but he had always denied his problem.

Finally, one day earlier this year, Peter became irate and started smashing furniture at the
small business he owns. Panicked and unsure what to do, his coworkers called a
detoxification and rehabilitation center. The center urged the coworkers to get Peter into a
car and drive him over immediately. Fortunately, after intensive detoxification and
rehabilitation, Peter overcame his alcoholism and has been sober for over a year.

Unfortunately, the center turned out not to be part of HMO Blue’s provider network, and
when the facility submitted claims to the plan, they were denied. Any of BCBSMA’s
customer service reps could have explained the plan’s policies in this case, but none were
authorized to override them. Ron Romano is authorized and empowered to use his
experience-based judgment (he’s been in the position for seven years and with the
company for nearly 17) to resolve cases just like Peter’s.

Romano, in his role as ombudsman, is one example of a creative, flexible strategy that’s
being employed to help health plan members navigate the system that delivers their care.

When Peter was referred to Romano on appeal of his claims denial, Romano sat down
with him, heard his story, and realized that there was excellent precedent for paying this
claim based on a case from several years ago. Peter “didn’t realize he was in crisis, and of
course, his coworkers didn’t know what his health plan covered,” Romano notes. Even
more importantly, he says, here was a plan member who took responsibility for his

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situation, and for whom the clinical treatment worked. It wasn’t difficult for Romano to
make a judgment in Peter’s favor.

Nor did Romano have to ask permission, which is another key aspect of his role. While
customer service representatives are empowered to make certain exceptions, Romano, as
ombudsman, has no contractual, procedural, or financial limit.

His role is also different from the kind of proactive patient advocacy naturally practiced
by physicians and other clinicians in their day-today provision of patient care. In contrast
to providers, his involvement is usually retrospective; most of his interventions come
about as the result of a plan member’s appeal for coverage denied. In making his
judgments, Romano says he has a single criterion: What is the most reasonable solution
to a disagreement or confusion between the plan and a member, and the closest to a win-
win for both parties possible?

And that explains the core of the ombudsman’s role as it’s evolving in managed health
care, as a goodfaith mediator between members and health plans, someone who uses his
or her judgment to find the best answers to questions about coverage issues, and who is
able to bring knowledge, experience, and resources to such problems. Though
ombudsmen differ widely in their affiliation (some are set up by health plans themselves;
others by external agencies), funding, scope of authority, and scope of practice, all focus
on educating health plan members about their rights and responsibilities, and resolving
issues to achieve the best outcomes for plan members and health plans alike.

At BCBSMA, the ombudsman program actually began in the early 1970s, when the
company was primarily fee-for-service, but in the past decade it has shifted almost
entirely over to the company’s health plans, primarily HMO Blue. This is a natural
response, Romano says, to the fact that more and more people are choosing HMOs and
thus many plan members are new to managed care. In a sense, the ombudsman’s role is
helping people navigate in a changing health care system.

The same phenomenon has helped spur the creation of ombudsman programs in other
venues, primarily for Medicaid managed care plan members in states where large
numbers of (or even almost all) Medicaid recipients have switched to health plans in
recent years. Gradually, the whole ombudsman phenomenon is moving into the spotlight.
Source: Adapted from Mark Hagland, “Seven Lessons of the Ombudsman,” Healthplan (July/August 1997): 70–71. Used with permission; all
rights reserved.

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Chapter 12 A
Key Legal Issues in Health Plans
In previous lessons, you learned about many of the federal and state regulations that
govern the activities of health plans. These regulations impose obligations that health
plans must satisfy to remain qualified to operate under federal and state law. In
administering health plans, however, health plans also have legal obligations to
members who receive plan services, as well as obligations to physicians and others who
provide services under the plan. And like all businesses, health plans are subject to
antitrust laws and other business regulations that govern how they may interact with
their competitors. In this lesson, we discuss some of the key legal issues that arise from
these obligations.

After completing this lesson, you should be able to:

 Define breach of contract, negligence, medical malpractice, and punitive damages

 Discuss the obligations that health plans owe to plan members in conducting
utilization management activities
 Describe the standard of care health plans must meet when they credential plan
providers
 Discuss two theories of liability that may make health plans liable for the medical
malpractice of plan providers
 Describe how ERISA affects the ability of plan members to bring legal actions
against health plans
 Identify and describe some legal issues that may arise between health plans and
plan providers
 Discuss some of the federal and state laws that regulate the business conduct of
health plans

An Overview of Contract and Tort Law

Many of the legal issues that health plans encounter in administering health plans arise
from contracts. A contract is a binding promise or an agreement enforceable at law. For
example, the terms and provisions of a healthcare plan are considered to form a contract
that creates obligations on the part of the health plan that are enforceable by plan
members. Health plans also enter into contracts with healthcare providers and others,
such as pharmacists, who provide services to plan members. A health plan may be
required to pay money damages if it commits a breach of any of these contracts. A
breach of contract is the failure of a party to perform a contract according to its terms
without a legal excuse.

In addition to liabilities arising from breach of contract, health plans may be liable for
damages if they commit a tort. A tort is a violation of a duty to another person imposed
by law, rather than contract, causing harm to the other person and for which the law
provides a remedy. One type of tort is known as negligence. Negligence is the failure to
exercise the amount of care that a reasonably prudent and careful person would
exercise under similar circumstances.

The duty to exercise reasonable care applies both to individuals and corporations, such
as health plans, and both individuals and corporations are liable for damages when their
negligence harms someone.

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One type of negligence most of us are familiar with in the field of healthcare is medical
malpractice. Medical malpractice is a type of negligence that occurs when a patient is
harmed because a healthcare provider failed to exercise reasonable care in providing
medical treatment.

We mentioned that health plans may be required to pay damages if they commit a
breach of contract or a tort. Damages are the sum of money that the law awards as
compensation for a legal wrong. In most contract and tort cases, damages are the
amount of money that will compensate the injured party for his or her injuries. In some
tort cases, however, courts may also award the injured party a kind of damages known
as punitive damages. Punitive damages are damages awarded to punish and make an
example of the wrongdoer and not to compensate the injured party for an injury. They
are usually permitted only when a tort is outrageous or intentional. Because punitive
damages are intended as punishment and not as compensation, they are typically
awarded in very large amounts—sometimes in the millions of dollars.

Fast Fact

Medical malpractice costs account for as much as 5% of the total healthcare bill in the
United States. These costs include direct costs resulting from malpractice lawsuits and
indirect costs resulting from doctors practicing unnecessary “defensive medicine.” 1

Between 1990 and 1994, there were at least 33 awards of punitive damages against health
insurers and health plans, and almost half of these awards were for $1 million or more. 2

Issues That Can Be Raised by Plan Members

Plan members can raise a number of legal issues, including claims that result from
utilization management decisions, claims that arise from credentialing decisions,
vicarious liability, and ERISA claims. In this section, we take a look at each of these legal
issues. We also look at arbitration as an alternative to litigation.

Claims Resulting from Utilization Management Decisions

Recall that a key feature of health plans is utilization management, which is the process
of managing the use of medical services so that patients receive necessary, appropriate,
high-quality care in a costeffective manner. Utilization management may be performed
either by healthcare professionals who are employees of the health plan or by outside
organizations, such as utilization review organizations (UROs), who are under contract
with the health plan. In this section, we discuss some of the ways that a health plan’s
utilization management activities can give rise to liabilities to plan members.

Breach of Contract Claims

Managed healthcare contracts contain exclusions and other provisions limiting the kind
of benefits that are available to plan members. Some of these limits are clear and
specific, such as limitations on the number of covered home health visits. Others require
the exercise of judgment, such as when covered treatments are limited to those that are
medically necessary. These determinations are made through utilization management
activities.

In exercising sound utilization management practices, health plans sometimes find it

necessary to deny coverage for some treatments or services. A common example

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occurs when a contract excludes coverage for experimental or investigative medical

treatments. Medical advances sometimes produce new treatments that may be
requested by plan members before they are proven to be effective. When a health plan
denies coverage for those treatments, a plan member might bring a lawsuit claiming that
the healthcare contract requires the health plan to cover the treatments. In that type of
lawsuit, the court must determine whether the health plan properly excluded the
treatment from coverage under the policy.

When the language in a health plan contract is unclear or ambiguous, a court will
interpret the language against the party that selected the language and wrote the
contract —in this case, the health plan. As we noted in Pharmacy Laws and Legal
Issues, health plans must pay careful attention to drafting their contracts to ensure that
they clearly and unambiguously specify what types of treatments are excluded, because
ambiguities will be interpreted in favor of plan members. Some health plans define
coverage for drugs based on whether treatment has been approved by the Food and
Drug Administration, for example, because determining whether a treatment is FDA-
approved is an objective decision and leaves little room for ambiguity. Some plans also
voluntarily seek third party review of these claims to assure plan members that the
decisions are objective.

Negligence Claims
In addition to claims for breach of contract, health plans may also face negligence claims
as a result of their utilization management activities. Recall that negligence is the failure
to exercise the amount of care that a reasonable person would exercise under similar
circumstances. Plan members have sometimes claimed that health plans are negligent
for designing utilization management systems in such a way that they result in decisions
that are not in the best interests of plan members. For example, a plan member might
argue that a health plan is negligent because its utilization review program is designed
so that physicians are not allowed to have input into coverage issues regarding
treatments they feel are medically necessary for their patients.

Plan members have also claimed that the process of making utilization management
decisions is subject to a standard of care and that the failure to meet that standard
constitutes negligence. To help minimize the risk of such claims, health plans adopt
processes to assure that decisions are made by personnel who are competent to make
them and only after gathering the information necessary to reach a sound medical
judgment. Figure 12A-1 contains a checklist of some other steps health plans can take
to help ensure that they minimize the risk of liability from their utilization management
processes.

Figure 12A- Ways to Help Minimize Liability Risks from Utilization Management
1. Decisions.

1. Develop clear utilization management policies and procedures and follow them
consistently.
2. Make sure that cases are reviewed by proper personnel. For example, if the initial
reviewer is a nurse, have denials reviewed by a physician reviewer as well.

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3. Make sure that physician reviewers practice in areas of medicine relevant to the
cases they review.
4. Discuss cases with the patient’s physician before issuing a denial.
5. Document the basis for all denials.
6. Allow patients and physicians to appeal denials.
7. Communicate denials to patients and inform them of their rights.
Source: Adapted from Mark Hagland, “Seven Lessons of the Ombudsman,” Healthplan (July/August 1997): 70–71. Used with permission; all
rights reserved.

If a health plan’s utilization management is performed by an outside organization such

as a utilization review organization, the health plan must use reasonable care in
selecting and monitoring the performance of the URO to ensure that the URO’s
procedures are appropriate and that its personnel are qualified to conduct utilization
review. The health plan should also ensure that the URO is properly licensed and
accredited. The leading organization that accredits UROs is the American Accreditation
Health Care Commission/ URAC (the Commission/URAC).

Claims for Bad Faith

Some courts have held that health plans owe plan members a duty to act in good faith
when making utilization management decisions. The duty to act in good faith means that
an health plan may not act maliciously, recklessly, or purely in its own economic self-
interest when it denies coverage for a treatment or service. If a health plan violates this
standard of conduct, a court may find that the health plan is liable for the tort of bad faith
rather than only for breach of contract or mere negligence. This distinction is significant
because the tort of bad faith—unlike the breach of contract and negligence liabilities we
discussed earlier—can justify an award of punitive damages. Recall that punitive
damages are intended to serve as punishment and are often awarded in large amounts.
Some states also have laws that impose monetary penalties in addition to punitive
damages against insurers that are guilty of bad faith.

In deciding whether a health plan acted in bad faith in denying coverage, a court will
determine from the terms of the plan whether the health plan had a reasonable basis for
the denial. If the health plan’s interpretation of the plan is not reasonable, the court is
more likely to find that the health plan acted in bad faith. The court may also examine the
health plan’s conduct for evidence of bad faith. Courts are especially likely to find bad
faith when a health plan allows its own financial selfinterest to outweigh the welfare of
plan members or considerations of medical necessity. Other conduct that might indicate
that a health plan acted in bad faith includes:

• Unreasonably delaying a decision on a request for coverage until the plan

member dies or is no longer eligible for coverage
• Denying a request for coverage without observing the health plan’s own
utilization management policies and procedures
• Misleading a plan member about the reasons for denying coverage or about the
procedures the health plan used in reaching a decision

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To avoid the potential liability for punitive damages and other penalties that can result
from a finding of bad faith, health plans should scrupulously avoid conduct that might
appear to be self-serving or indifferent to the medical needs of plan members. Health
plans should also comply with state laws regulating the handling of claims. For example,
most states have adopted variations on the Unfair Claims Settlement Practices Model
Regulation, drafted by the National Association of Insurance Commissioners (NAIC).

As we saw in Market Conduct Examinations and Mechanisms for Enforcement, this

model regulation specifies how insurers should process claims and notify beneficiaries of
claim determinations. The regulation requires that claims be evaluated in a fair and
timely manner and provides that when a claim is denied, the denial should be in writing
and give a reason. Health plans can help establish that they did not act in bad faith by
showing that they complied with laws modeled on this regulation.

Claims Arising from Credentialing Decisions

An important feature of many health plans is that health plans either limit plan members’
choice of provider or provide incentives for plan members to select from panels of
preferred providers. Because plan members may be injured if a health plan selects
providers who are incompetent or unqualified to provide quality care, courts have held
that health plans have a duty to use reasonable care in credentialing providers. Recall
that credentialing is a review process conducted to determine the current clinical
competence of providers and to ensure that providers meet the organization’s criteria. If
a plan member is injured because a health plan fails to exercise reasonable care in
credentialing providers, the health plan may be required to pay damages for negligence.

Various organizations, including the National Committee for Quality Assurance (NCQA)
and the American Association of Preferred Provider Organizations (AAPPO), have
adopted standards for conducting provider credentialing. The NCQA standards list the
kinds of information health plans should obtain about providers during the initial
credentialing process and suggest that health plans recredential all providers every two
years. These standards are not mandatory for health plans, but courts sometimes find
that health plans have satisfied their duty to use reasonable care in their credentialing
activities if they comply with them. In addition, some states have enacted laws that
specify the criteria health plans should consider in making credentialing decisions.
Compliance with these laws may help a health plan show that it has satisfied its
standard of care.

Health plans sometimes delegate the credentialing of providers to a third party known as
a credential verification organization (CVO). When contracting with a facility, such as
a hospital, the health plan may delegate credentialing of the hospital’s staff to the
hospital administration, which must credential its staff to obtain Joint Commission on
Accreditation of Healthcare Organizations (JCAHO) accreditation. The NCQA has
certified a number of CVOs that have met NCQA’s requirements for performing certain
activities of the credentialing function.

Refer to Figure 12A-2 for the standards that the NCQA has established for delegated
credentialing. The Commission/URAC has also established guidelines for delegation of
credentialing.

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When a health plan delegates credentialing activities to a third party, the health plan
typically agrees to assume the following responsibilities:

• Review the third party’s credentialing policies and procedures for compliance
with the health plan’s standards, state and federal laws, and accreditation agency
regulations
• Provide the third party with the health plan’s credentialing policies and
procedures
• Maintain the confidentiality of the third party’s files, reports, and
recommendations, and permit access only to authorized parties
• Share with the third party any utilization management (UM), quality management
(QM), member satisfaction, and member complaint information that relates to the
delegated credentialing or recredentialing activities
• Retain the right to approve, reject, suspend, or terminate any individual provider
or healthcare delivery site not in compliance with the health plan’s policies and
procedures
• Notify the third party prior to the termination of a provider or site
• Determine the effective date and the termination date of all providers added to
the network by the third party
• Perform an annual audit of the third party’s credentialing and recredentialing
program and records to assess effectiveness and compliance with regulations

The third party generally accepts the following responsibilities under the delegation
agreement:

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• Review the health plan’s policies and procedures and conduct the delegated
credentialing and recredentialing activities in accordance with these policies and
procedures
• Provide the health plan with the third party’s policies and procedures
• Maintain the confidentiality of documents, reports, and other information provided
by the health plan, and permit access only to authorized parties
• Allow the health plan to review the minutes from meetings of the third party’s
credentialing committee or other designated decision-making body
• Provide specific information on all individual providers in the network and revise
the information on a monthly basis
• Notify the health plan immediately of any provider who has been terminated or
placed on probation, or whose practice has been restricted in any way
• Notify the health plan immediately of any provider who fails to meet credentialing
or recredentialing standards, or who has been sanctioned by a hospital, licensing
board, professional association, or regulatory agency
• Share with the health plan any information on UM, member satisfaction, claims,
or other functions that may be relevant to the health plan’s QM program

Although health plans sometimes delegate their credentialing decisions to third parties,
many states consider a health plan’s duty to use reasonable care in credentialing
providers and monitoring their performance to be a nondelegable duty. A nondelegable
duty is a duty that cannot be assigned or entrusted to someone else. If the duty is
nondelegable, a health plan that relies on a third party for credentialing might still be
liable to plan members who are injured by the third party’s negligent credentialing
decision.

Vicarious Liability
A patient who is injured by medical malpractice can bring a claim for damages against
the individual provider whose negligence caused the injuries. When the negligent
medical treatment was provided under a health plan, however, the injured patient may
also be able to present a claim against the health plan that administers the plan. One
reason patients find such claims advantageous is that health plans are usually
corporations, so they often have more resources from which to pay damages than the
individual provider who committed the malpractice.

The legal basis for a claim against a health plan for the negligence of a plan provider is
known as vicarious liability. Vicarious liability is a kind of liability that arises when one
party is held responsible for the actions of another party because of the existence of a
special relationship between those two parties. The key characteristic of vicarious
liability is that it makes a health plan liable for a plan member’s injuries not because of
any negligence committed by the health plan, but simply because of the relationship
between the health plan and the negligent provider. This means that a health plan can
be responsible for medical malpractice committed by a plan physician even if the health
plan had no direct involvement in providing the medical treatment that caused the
injuries.

Review Question

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The Hanford Health Plan has delegated the credentialing of its providers to the Sienna
Group, a credential verification organization (CVO). If the contract between Hanford and
Sienna complies with all of the National Committee for Quality Assurance (NCQA)
guidelines for delegation of credentialing, then this contract

A. Transfers to Sienna all rights to terminate or suspend individual practitioners or

providers in Hanford's provider network
B. Describes the process by which Hanford evaluates Sienna's performance in
credentialing providers

Both A and B
A only
B only
Neither A nor B

Incorrect. When a health plan delegates credentialing activities to a third party, the
health plan retains the right to approve, reject, suspend, or terminate any
individual provider or healthcare delivery site not in compliance with the health
plan’s policies and procedures.

Incorrect. When a health plan delegates credentialing activities to a third party, the
health plan retains the right to approve, reject, suspend, or terminate any
individual provider or healthcare delivery site not in compliance with the health
plan’s policies and procedures.

Correct. When a health plan delegates credentialing activities to a third party, the
health plan typically agrees to review the third party’s credentialing policies and
procedures for compliance with the health plan’s standards, state and federal
laws, and accreditation agency regulations.

Incorrect. When a health plan delegates credentialing activities to a third party, the
health plan typically agrees to review the third party’s credentialing policies and
procedures for compliance with the health plan’s standards, state and federal
laws, and accreditation agency regulations.

Claims Based on the Respondeat Superior Doctrine

Health plans may be liable for the actions of their employees under a doctrine of
vicarious liability called respondeat superior, which is a Latin term meaning “let the
master answer.” Respondeat superior stands for the principle that an employer is
responsible for torts its employees commit in the course of their employment and within
the scope of their authority. The rationale for this rule is that because an employer has
the right to control the conduct of its employees, the employer should be responsible for
the employees’ actions.

Respondeat superior applies only when there is an employment relationship between

the health plan and the provider who committed the medical malpractice. Traditionally,
physicians have been considered to be independent contractors rather than employees

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because of their high degree of skill and the independence they exercise in making
medical decisions. However, some kinds of health plans such as staff-model HMOs
have formal employment relationships with physicians. When such an employment
relationship exists, the health plan is responsible if a physician-employee commits a tort
that injures a plan member.

Respondeat superior may apply even when there is no formal employment relationship
between the physician and the health plan if the circumstances show that the health plan
actually treated the physician like an employee. One important consideration in making
this determination is the amount of control the health plan exercises over the physician’s
medical decisions and judgments. Other considerations include whether the physician
controls the financial and operational aspects of his or her practice and whether the
physician also treats patients who are not enrollees of the health plan. We mentioned
earlier that physicians have traditionally been considered to be independent contractors
because they exercise independence in doing their work. If that traditional independence
in making medical and other decisions is not present because the health plan exercises
too much control, the physician might be considered to be the health plan’s employee.

Claims Based on Agency

A health plan may also be subject to vicarious liability under principles of agency. As we
saw in Other Laws that Apply to Health Plans, an agent is someone who acts on behalf
of another person (known as the principal) in dealings with third parties. For example, an
insurance agent acts on behalf of an insurance company (the principal) in dealing with
clients who are buying insurance. Under the laws of agency, the principal is responsible
for actions the agent takes while acting within the scope of the agency relationship. A
health plan may be liable for the negligence of a plan provider if the provider is
considered to be the health plan’s agent. Ordinarily, an agency relationship arises only if
the principal and the agent mutually agree that there will be such a relationship. In the
case of an insurance agent, for example, the insurance company and the agent typically
sign a written contract that establishes the agency relationship, and both parties intend
that an agency relationship will come into effect.

Another type of agency, called ostensible (or apparent) agency, may occur even when
there is no agency agreement and the principal does not intend to create an agency
relationship. Ostensible (or apparent) agency is a type of agency that occurs when
one party negligently or intentionally creates the impression that another party is its
agent. Ostensible agency can arise in the health plan context when a health plan
somehow gives plan members the impression that plan providers are its agents. An
health plan can be responsible for injuries committed by a plan provider if the health plan
causes a plan member to reasonably believe that a provider is the health plan’s agent
and the plan member is injured by the provider’s malpractice.

As with respondeat superior, the element of control is important in determining whether a

health plan is liable under principles of ostensible agency, because plan members are
more likely to believe that providers are agents of the health plan when the health plan
exercises significant control over the providers’ activities. A plan member might also get
the impression that providers are agents of the health plan from statements in the health
plan’s advertising or marketing brochures indicating that healthcare is being provided by
the health plan and not the individual providers. In one case, for example, a health plan’s
advertising materials stated that the health plan itself provided healthcare, that the health

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plan guaranteed the quality of the care, and that the health plan provided the physicians,
hospitals, and other healthcare professionals needed to maintain good health. The court
found that these statements could reasonably create the impression in plan members
that the providers under the plan were acting as the health plan’s agents. Figure 12A-3
lists some steps health plans can take to avoid creating the impression that plan
providers are its agents.

Figure 12A-3. Avoiding Liability Under Ostensible Agency.

A health plan can reduce the likelihood of being liable for provider negligence under the
theory of ostensible agency by

1. Developing ways to put members on notice that providers are independent

contractors and not health plan employees
2. Making no guarantees of the quality of medical care provided to members
3. Adding disclaimers to written materials indicating that only physicians and not
the health plan provide care and make medical decisions
4. Avoiding terms such as “our doctors” or “our providers” in advertising materials
5. In advertising and marketing documents, characterizing the health plan’s role as
“arranging for healthcare” rather than “providing physicians, hospitals, and other
healthcare professionals”
Source: Adapted and reprinted from Barbara J. Youngberg, editor, Managing the Risks of Managed Care, © 1996, p. 97, with permission from
Aspen Publishers, Inc., Gaithersburg, MD (1-800-638-8437).

Review Question

Brighton Health Systems, Inc., a health plan, wants to modify its advertising and
marketing materials to avoid liability risk under the principle of ostensible agency. One
step that Brighton can take to reduce the likelihood of being liable for provider
negligence under the theory of ostensible agency is to

guarantee the quality of medical care provided to Brighton members

use advertising materials which state that Brighton itself provides healthcare
add disclaimers to advertising materials indicating that only physicians and not
Brighton make medical decisions
use advertising materials to characterize Brighton's role as providing physicians,
hospitals, and other healthcare professionals rather than arranging for healthcare.

Incorrect. Brighton should not make any guarantees of the quality of medical care

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Incorrect. A health plan does not provide healthcare itself, but contracts with
providers to provide the healthcare

Correct. Because Brighton does not provide healthcare, Brighton shoild make it
clear that the physicians are ultimately responsibile for medical decision-making,
not the health plan.

Incorrect. Brighton should have materials stating that it arranges for healthcare,
rather than providing physicians, hospitals and other healthcare professionals

Statutes Affecting Vicarious Liability

In some states, health plans receive protection from vicarious liability claims by laws that
exempt health plans from responsibility for medical malpractice. For example, some
states have laws stating that furnishing healthcare under a health plan is not considered
the practice of medicine. Courts have sometimes decided that these laws mean that a
health plan cannot be sued for medical malpractice. Other states have laws that prohibit
corporations from practicing medicine, and courts in these states sometimes apply the
corporate practice of medicine doctrine. As we discussed in Legal Organizations of
Health Plans, the corporate practice of medicine doctrine is a rule stating that a
corporation cannot legally engage in the practice of medicine.

On the other hand, the legislature in one state has enacted a law that makes it easier to
sue health plans for medical malpractice, and several other states are considering
enacting such laws. In 1997, Texas enacted a law providing that health plans have a
duty to exercise ordinary care when making healthcare treatment decisions and
providing that health plans are liable for damages if their failure to exercise ordinary care
causes harm to plan members. More importantly, the law also allows plan members to
sue a health plan for damages if they are harmed by the negligence of the health plan’s
employees, agents, ostensible agents, or representatives who are under the health
plan’s control.

In such a lawsuit, a health plan cannot use the corporate practice of medicine doctrine
as a defense.

Enterprise Liability
The two theories of vicarious liability we have discussed so far—respondeat superior
and ostensible agency—depend on the existence of an employment or agency
relationship as the basis for making a health plan liable for a provider’s negligence.
Some people have argued for a theory of liability that would make health plans
responsible for the actions of plan providers regardless of the existence of such a
relationship. This theory, known as enterprise liability, would create a system in which
a health plan is liable for any torts committed by plan providers against plan members
while they are enrolled in the plan, even if there is no employment or agency relationship
between the health plan and the providers.

Statutes that would impose enterprise liability on health plans have been proposed at the
federal level. Enterprise liability was part of the unsuccessful Clinton administration
healthcare reform plan of the early 1990s, for example. Recent bills in Congress do not

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provide for this type of liability. Instead, those bills take away ERISA preemption of state
law for wrongful coverage decisions. None of these proposals has yet become law.

ERISA’s Impact on Claims by Plan Members

Recall that most employer-sponsored health plans are governed by ERISA. As we
discussed previously, one of the most significant features of ERISA is that it contains a
preemption provision, which means that the terms of ERISA generally take precedence
over state laws that regulate employee welfare benefit plans, including most employer-
sponsored health plans. When a state law is preempted by ERISA, a person may not
seek a remedy or file a lawsuit under state law, but must rely instead on the remedies
provided by ERISA. The remedies under ERISA are less generous in some ways than
those allowed under state law. For example, ERISA does not permit the recovery of
compensatory or punitive damages, which are often permitted by state law.

In 1987, the U.S. Supreme Court decided in Pilot Life Insurance Co. v. Dedeaux that 3

ERISA preempts state lawsuits claiming that an employer-sponsored benefit plan acted
in bad faith in denying benefits. Under ERISA, therefore, state law claims based on the
denial of a plan benefit are preempted.

With regard to state lawsuits seeking to recover for plan negligence, however, lower
courts have issued conflicting rulings when applying the Pilot Life decision. Under some
of these decisions, claims that an health plan was negligent in credentialing providers or
performing utilization review are preempted. Other decisions have held that these kinds
of claims are not preempted. Similarly, it is not clear whether ERISA preempts state
claims seeking to hold health plans liable for the negligence of their providers under
principles of vicarious liability. The courts that have addressed this issue have reached
conflicting results, but the trend seems to be that ERISA does not preempt vicarious
liability claims.

Overall, recent court decisions have tended to reduce the protections provided to health
plans by the preemption doctrine. Federal legislation has also been proposed (but not
yet passed) that would remove ERISA as an obstacle to bad faith denial claims against
health plans. As the protections afforded by ERISA preemption continue to erode, health
plans can expect to face greater exposure to liability for state law claims.

Even when state claims are preempted by ERISA, plan members may still bring claims
against health plans under the provisions of ERISA itself. Although some kinds of
damages that are available under state law are not available in ERISA actions, a health
plan that loses an ERISA claim may still be required to pay damages to the plan member
who brought the claim. For example, the plan might have to pay the value of any
services or benefits that were improperly denied to the plan member, and it may be
required to pay any attorney’s fees and expenses the plan member incurred in bringing
the claim.

Arbitration as an Alternative to Litigation

Traditionally, parties who were unable to settle legal disputes themselves had little
choice but to go to court to seek a resolution. Using litigation to resolve disputes can be
time consuming and expensive, however, because court proceedings often take months
or years to conclude and the attorney’s fees for such prolonged proceedings can be
substantial. Litigation also involves a great deal of uncertainty because it is difficult to

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predict how a jury will rule in any given case or what damages it will award. And in cases
involving physical injuries, such as medical malpractice, juries can sometimes be
affected by feelings of sympathy toward the injured party and award damages that seem
out of proportion to the party’s injuries.

In an attempt to resolve disputes with plan members more quickly and with less expense
and uncertainty, some health plans are using alternative dispute resolution (ADR)
methods such as arbitration. Arbitration is a method of dispute resolution in which the
dispute is submitted to a person or panel of persons, known as arbitrators, who are
either chosen by the parties or selected as provided by law. After conducting a
proceeding in which the parties are allowed to present their evidence, the arbitrator
issues a decision. This decision is usually binding on both parties, although some
arbitration procedures permit a party who is dissatisfied with the arbitrator’s decision to
seek further review in court.

Review Question

Arthur Dace, a plan member of the Bloom Health Plan, tried repeatedly over an
extended period to schedule an appointment with Dr. Pyle, his primary care physician
(PCP). Mr. Dace informally surveyed other Bloom plan members and found that many
people were experiencing similar problems getting an appointment with this particular
provider. Mr. Dace threatened to take legal action against Bloom, alleging that the health
plan had deliberately allowed a large number of patients to select Dr. Pyle as their PCP,
thus making it difficult for patients to make appointments with Dr. Pyle.

Bloom recommended, and Mr. Dace agreed to use, an alternative dispute resolution
(ADR) method that is quicker and less expensive than litigation. Under this ADR method,
both Bloom and Mr. Dace presented their evidence to a panel of medical and legal
experts, who issued a decision that Bloom's utilization management practices in this
case did not constitute a form of abuse. The panel's decision is legally binding on both
parties.

This information indicates that Bloom resolved its dispute with Mr. Dace by using an
ADR method known as:

corporate risk management

an ombudsman program
an ethics committee
arbitration

Incorrect. Corporate risk management is a series of activities undertaken by an

organization to minimize the organization's and board's liability exposure and to
reduce the risk of lawsuits.

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Incorrect. An ombudsman program is a mechanism of ensuring accountability to

healthcare consumers by providing members with methods of having complaints
against a health plan investigated by a third neutral party.

Incorrect. An ethics committee reviews health plan policies for consistency with
principles of ethics and recommends changes where needed.

Correct. Arbitration is a method of dispute resolution in which the dispute is

submitted to a person or panel, called arbitrators, who are either chosen by the
parties or selected by law. The arbitrators weigh evidence and produce a (usually)
binding decision.

A key feature of arbitration is that arbitrators are often medical experts, retired judges, or
lawyers. Using arbitrators to resolve disputes can help ensure that decisions are
reached rationally and based on the facts, without the emotional influences that can
sometimes affect the decisions of juries. In addition, arbitration is quicker and less
expensive than litigation, so it can be beneficial to plan members as well as to health
plans.

Health plans have established arbitration procedures to resolve both medical

malpractice claims and disputes involving utilization management decisions. In some
states, health plans are allowed to require plan members to use arbitration to resolve
those disputes, while in others health plans may offer arbitration as an option but may
not require plan members to use it. Insight 12A-1 illustrates how one health plan uses
arbitration to resolve disputes with plan members.

Insight 12A-1. Arbitration: A New Approach to Dispute Resolution.

Kaiser Permanente’s Southern California Region has used binding arbitration to resolve
disputes for almost 20 years.

Under this system, claimants choose one arbitrator, respondents choose another, and
those two agree on a third, neutral arbitrator. Hearings are much like a trial, with expert
as well as factual witnesses. The decision of the three arbitrators is final, with extremely
limited statutory grounds (such as a failure to hear relevant evidence) for overturning an
award.

“In general, this system is costeffective and works extremely well,” says Trischa
O’Hanlon, senior counsel for the region. “Cases are resolved much more quickly than in
the courts—typically in about 19 months, compared to an average of 33 months for
malpractice lawsuits handled by the court system.”

“In emergency situations we have gotten cases to arbitration within a week. For example,
in one instance a cancer patient wanted a bone marrow transplant, and she needed it very
quickly if she was going to have it at all. In this particular situation it wasn’t clear
whether the procedure was experimental or not, so we went to arbitration very quickly—

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and ended up paying for the treatment.” Kaiser probably ends up paying more judgments
than it would in court, O’Hanlon says, but the judgments are lower than jury awards.

“In arbitration you don’t have these enormous, irrational awards. Arbitrators will give a
lower amount, but they will give something.”
Source: Adapted from Elaine Zablocki, “Tort Reform,” HMO Magazine (May/June 1994): 74–77. Used with permission; all rights reserved.

Issues That Can Be Raised by Plan Providers

In addition to the issues that arise in dealing with plan members, health plans also
encounter legal issues when dealing with entities that provide benefits or services to
plan members. These entities include healthcare professionals, physicians, hospitals,
and others who contract with health plans to provide medical treatment or benefits to
members. As in any contractual relationship, care must be taken in drafting these
contracts to ensure that they comply with applicable laws and regulations and
appropriately define the obligations of all parties. When these obligations are not clearly
defined, disputes may arise. For example, providers may claim that the health plan is not
paying them for their services in the way their contracts require.

Claims Arising from Selection and Termination Decisions

As we discussed earlier, health plans owe plan members a duty to use reasonable care
in selecting providers. Health plans also have other legal obligations when selecting
providers. Some of these obligations are imposed by antitrust laws. A provider who is
excluded from a health plan network may claim that the exclusion is a violation of these
laws if the exclusion adversely affects competition.

A provider who is excluded or terminated from a healthcare network may also bring a
claim against the health plan under state law for the tort of defamation. A defamation is
a false communication that tends to harm the reputation of the defamed person so as to
lower the defamed person in the estimation of others and to deter others from
associating or dealing with that person. A provider might bring a claim for defamation, for
example, if a health plan damages the provider’s reputation or ability to attract referrals
by communicating the reason for the exclusion to the provider’s patients or peers.

Without-Cause Terminations and Obligations of Fair Process

Contracts between health plans and healthcare providers sometimes contain “without
cause” or “at will” termination provisions. A “without cause” (or “at will”) termination
provision states that a party can terminate the contract at any time, without providing
any reason for the termination, simply by giving the other party a specified period of
notice. One reason these provisions are used by health plans is that they allow health
plans to terminate providers in response to the changing enrollment and geographic
needs of the plan. Historically, courts found that “without cause” termination provisions
were enforceable, reasoning that parties should be bound by agreements they freely
entered into.

More recently, some providers who have been terminated under “without cause”
termination provisions have claimed that because of the financial impact termination will
have on their practices, they should have the right to receive a reason for the termination
and a chance to present information relevant to the termination decision. Other providers
have claimed that they were terminated for reasons that might violate public policy. For

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example, some providers have claimed that they were terminated for advocating for their
patients during utilization review or for advising patients about alternative treatment
options.

In response to these claims, courts in a few states have ruled that providers who will
suffer an adverse financial impact from termination or who claim that their terminations
are based on reasons that violate public policy may not be terminated from health plan
networks without receiving what is known as “fair procedure” or “due process.” Although
the courts have not always defined specifically what “fair procedure” is, in this context
fair procedure (or due process) typically means that a provider who is being
terminated from a health plan has the right to receive an explanation for the termination
and an opportunity to present reasons that the termination should not take place. Some
states have enacted laws that restrict the use of “without cause” termination provisions.

Generally, these laws require health plans to give a terminated provider written notice of
the termination, to provide a written list of reasons for the termination, and to allow the
provider to respond to the allegations or to appeal an adverse decision. Some laws
prohibit health plans from basing termination decisions on reasons that violate public
policy, such as for engaging in patient advocacy. Other laws regulate the use of
economic credentialing in making termination decisions. Economic credentialing is
credentialing that considers economic factors (such as the provider’s utilization rate and
cost-effectiveness in providing care) in determining whether the provider meets the
health plan’s selection criteria.

Some states prohibit health plans from terminating or excluding providers for purely
economic reasons, while other states that permit the use of economic credentialing
require health plans to share with providers the economic criteria that will be used to
make credentialing decisions.

Review Question

Greenpath Health Services, Inc., an HMO, recently terminated some providers from its
network in response to the changing enrollment and geographic needs of the plan. A
provision in Greenpath's contracts with its healthcare providers states that Greenpath
can terminate the contract at any time, without providing any reason for the termination,
by giving the other party a specified period of notice.

The state in which Greenpath operates has an HMO statute that is patterned on the
NAIC HMO Model Act, which requires Greenpath to notify enrollees of any material
change in its provider network. As required by the HMO Model Act, the state insurance
department is conducting an examination of Greenpath's operations. The scope of the
on-site examination covers all aspects of Greenpath's market conduct operations,
including its compliance with regulatory requirements.

The contracts between Greenpath and its healthcare providers contain a termination
provision known as

an 'economic credentialing' termination provision

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a 'breach of contract' termination provision

a 'fair procedure' termination provision
a 'without cause' termination provision

Incorrect. Economic credentialing is credentialing that considers economic

factors (such as the provider’s utilization rate and cost-effectiveness in providing
care) in determining whether the provider meets the health plan’s selection
criteria.

Incorrect. Breech of contract is the failure of a party to perform a contract

according to its terms without a legal excuse

Incorrect. Fair procedure (or due process) typically means that a provider who is
being terminated from a health plan has the right to receive an explanation for the
termination and an opportunity to present reasons that the termination should not
take place

Correct! A 'without cause' (or 'at will') termination provision states that a party can
terminate the contract at any time, without providing any reason for the
termination, simply by giving the other party a specified period of notice.

Federal laws also impact the use of “without cause” terminations. For example, the
Medicare+Choice health plans, created by the federal Balanced Budget Act of 1997, are
required to give providers notice of adverse selection decisions and must allow hearings
so that providers can appeal unfavorable decisions. The law also prohibits these plans
from excluding providers simply because they advise patients about alternative
treatment options. Another federal law, the Health Care Quality Improvement Act
(HCQIA), exempts some health plans from liability arising from the credentialing and
peer review process. To receive the benefits of this exemption, however, health plans
must adhere to certain due process standards. For example, a health plan that declines
to retain a physician in its provider network—because of the physician’s professional
misconduct or incompetence, which could adversely affect patient health—must provide
the physician with timely notice of its decision so the physician can prepare a response.

Business Conduct Issues

In Antitrust Concerns and Health Plans, you learned about some of the federal antitrust
laws that have been enacted to help maintain a competitive business environment.
Health plans must ensure that their business activities do not result in anticompetitive
activities that might violate these laws. Health plans must use special care to avoid
violating the federal antitrust laws because violations can result in large awards of
damages. And because the laws are so complex, professional legal advice is often
necessary to ensure compliance. As we discussed in Medicare and Health Plans,
federal regulatory agencies establish rules and regulations that also affect business
conduct of health plans (e.g., the Medicare marketing guidelines).

As we saw in Other Laws that Apply to Health Plans, state laws also impose restrictions
on the business conduct of health plans. For example, most states have laws that
prohibit unfair or deceptive trade practices. The business practices prohibited by these

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laws vary widely from state to state, but many states prohibit unfair marketing practices
such as false advertising and making misrepresentations in promotional materials. More
than half the states have adopted variations of the National Association of Insurance
Commissioners (NAIC) Health Maintenance Organization Model Act, which provides that
an HMO’s certificate of authority may be suspended or revoked if it advertises its
services in an “untrue, misrepresentative, misleading, deceptive, or unfair” manner.

In some states, health plans are also subject to laws that specifically regulate other
types of business conduct by insurance companies or health plans. Several states
prohibit as an unfair trade practice the offering of inducements to enroll in a health plan,
for example. A health plan might violate this kind of restriction by giving out items of
more than nominal value, such as bike helmets or exercise equipment, as part of a
promotion to increase membership. As with federal antitrust law, health plans must rely
on professional legal advice to avoid violating these laws.

The Importance of Risk Management

We have discussed some of the legal damages and financial penalties that can result
when claims are asserted against health plans. It is important to remember, however,
that health plans may suffer other indirect consequences, such as action by regulatory
agencies and adverse public relations, when dissatisfied plan members or providers
bring claims against them. A health plan that is accused of negligence or other
wrongdoing may also suffer damage to its reputation and, as a result, find it more difficult
to secure business from employers and other plan sponsors. For all these reasons,
many health plans are relying more heavily on risk management programs to help
prevent claims from occurring and to minimize the damage from claims that do occur.

We have already discussed some of the steps health plans can take to help avoid claims
by plan members and providers. In addition to these steps, as we saw in Governance:
Accountability and Leadership, health plans have implemented compliance programs to
help ensure compliance with regulatory requirements and to monitor member
satisfaction. An important goal of compliance programs is to identify and correct potential
liabilities before they result in claims or litigation. As part of the compliance process,
health plans rely on legal counsel to help them keep abreast of court decisions and
proposed legislation that may affect the legal relationships between health plans and
their members and providers.

As we discussed in The Components of Governance in a Health Plan, health plans can

obtain insurance to protect them against many of the risks we have discussed in this
lesson. Insurance is available that will protect health plans against liability for breach of
contract and negligence, for example, and some insurers offer policies that will protect
against vicarious liability claims, including those that arise as a result of medical
management activities. Health plans in many areas can also obtain insurance against
punitive damages, although some states prohibit on public policy grounds insurance
against punitive damages.

The Importance of Risk Management

We have discussed some of the legal damages and financial penalties that can result
when claims are asserted against health plans. It is important to remember, however,
that health plans may suffer other indirect consequences, such as action by regulatory
agencies and adverse public relations, when dissatisfied plan members or providers

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bring claims against them. A health plan that is accused of negligence or other
wrongdoing may also suffer damage to its reputation and, as a result, find it more difficult
to secure business from employers and other plan sponsors. For all these reasons,
many health plans are relying more heavily on risk management programs to help
prevent claims from occurring and to minimize the damage from claims that do occur.

We have already discussed some of the steps health plans can take to help avoid claims
by plan members and providers. In addition to these steps, as we saw in Governance:
Accountability and Leadership, health plans have implemented compliance programs to
help ensure compliance with regulatory requirements and to monitor member
satisfaction. An important goal of compliance programs is to identify and correct potential
liabilities before they result in claims or litigation. As part of the compliance process,
health plans rely on legal counsel to help them keep abreast of court decisions and
proposed legislation that may affect the legal relationships between health plans and
their members and providers.

As we discussed in The Components of Governance in a Health Plan, health plans can

obtain insurance to protect them against many of the risks we have discussed in this
lesson. Insurance is available that will protect health plans against liability for breach of
contract and negligence, for example, and some insurers offer policies that will protect
against vicarious liability claims, including those that arise as a result of medical
management activities. Health plans in many areas can also obtain insurance against
punitive damages, although some states prohibit on public policy grounds insurance
against punitive damages.

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Chapter 13 A
Public Policy and Changing Environment
After completing this lesson, you should be able to:

 Explain some of the ways that health plans influence public policy
 Identify primary interest groups in each of the major healthcare sectors that
participate in efforts to affect health plan public policy
 Describe several types of advocacy and political activities undertaken by interest
groups in the health plan policy debate
 Discuss the role of litigation in determining health plan public policy
 Describe several techniques interest groups use to affect public opinion

Public Policy from the Health Plan Perspective

How do we expand health benefit coverage to include more medical conditions and
more treatment alternatives? And, how do we continue to improve the quality of
healthcare delivered in this country? On the other hand, how do we control costs and
make coverage available to the roughly 42 million Americans who currently lack health
insurance coverage. How do we slow (or even halt) the growth of the uninsured
population? How do we make the healthcare system easier to navigate?

Each side of this healthcare dilemma has its own supporters, and those supporters have
varying political resources and constraints that affect their abilities to influence policy.
These resources and constraints change over time with changes in market, budgetary,
and political conditions. Some of these issues are at center stage in health care public
1

policy; other issues are in the wings. In this lesson, we define what public policy is and
examine some of the major factors that influence the public policy process.

What Is Public Policy?

For purposes of this discussion, we define public policy as any law, regulation,
principle, or plan established by an agency, arm, or branch of government. It can apply
at the federal, state, or local level. Most often, public policy involves action and is shaped
by many players, including privatesector entities, interested in its outcome. However, the
choice not to act is also an element of public policy, as “absence of action is not the
absence of policy.”2

Governments have six types of tools they can exercise in the domain of public policy:
legislation, regulation, taxation, funding of public programs, purchase of services, and
collection and provision of information. Historically, they have used these tools within the
3

realm of two broad categories of public policy—allocative policies and regulatory

policies.

Types of Public Policy

In the context of public policy, allocative policies are those that determine the allocation
of public funding. Regulatory policies include all other policies that affect the delivery
and financing of healthcare in both the public and private sectors.

At the broadest level, Medicaid and Medicare are examples of allocative policies—
government programs that allocate public funds to members of the population eligible for

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such programs. Medicare laws have always recognized that health plans were
fundamentally different modes of financing healthcare and provided that health plans
could receive payment for services on a basis other than standard fee-for-service. Over
time, the federal government has enacted a number of laws designed to attract health
plans into the Medicare market. These laws, ranging from amendments to the Social
Security Act (Section 1876 of the Social Security Act) to the Balanced Budget Act of
1997, are discussed in earlier assignments in this course manual. All of these laws are
allocative in that they change how health plans participating in the Medicare program do
business and they shift the way public money is spent in the provision of healthcare.

Similarly, the federal and state governments, acting in loose concert, have adopted a
number of allocative laws and regulations affecting health plans by switching state
Medicaid systems from fee-for-service to health plans. As we have seen, Congress laid
the groundwork for this series of laws in 1981 by expanding the authority of the Centers
for Medicare and Medicaid Services (CMS), formerly known as the Health Care
Financing Administration, to grant waivers to states seeking to experiment with ways of
providing healthcare to the indigent. Arizona was the first state to create a health plan
Medicaid system, and dozens of states have followed suit in the intervening years. While
these laws and regulations affect how health plans operate, they are essentially
allocative in their purpose and content, since they modify how public funds are spent in
the financing of healthcare.

Although most allocative policy is set by the legislature, the legislature is not the sole
government agency that is engaged in such allocative actions. For example, when
former President Clinton announced an Executive Order expanding federal efforts to
enroll children in Medicaid, he proposed a public policy action that will change the
allocation of public resources devoted to healthcare.

Other laws and regulations, which are regulatory in nature, control how health plans do
business. State and federal officials, both legislative and regulatory, have been engaged
in a nearly constant process of adopting new regulations in the last few years. Laws
ranging from the Health Insurance Portability and Accountability Act (HIPAA) of 1996—
that contains provisions designed to ensure access to portability of healthcare coverage
—to laws affecting health plan quality oversight and how health plans may contract with
providers fall into this category of regulatory policy. Examples of regulatory policy include
mandated healthcare benefits, laws specifying procedures for health plan handling of
consumer appeals and grievances, and laws and regulations addressing the solvency of
health plans.

Allocative policy is limited because only a portion of the population receives direct
benefit from the allocation of public funds for healthcare. In contrast, regulatory policy is
nearly unlimited in its range. The regulation of the financing and delivery of healthcare
affects nearly every American. Health plans have their greatest impact on public policy in
the arena of regulatory policy where they help set legislative agendas and develop laws.

Review Question

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The government uses various tools within the realm of two broad categories of public
policy-allocative policies and regulatory policies. In the context of public policy, laws that
fall into the category of allocative policy include

the Balanced Budget Act (BBA) of 1997

the Health Insurance Portability and Accountability Act (HIPAA) of 1996
laws affecting health plan quality oversight
laws specifying procedures for health plan handling of consumer appeals and
grievances

Correct. Allocative policies are those that determine the allocation of public
funding.

Incorrect. HIPAA is an example of regulatory policy.

Incorrect. Laws that affect health plan quality oversight are examples of regulatory
policy

Incorrect. Laws specifying consumer appeals and grievance procedures are

examples of regulatory policy

How Health Plans Exert Influence on Agenda Setting

Health plans help set the agenda for regulatory policy in a variety of ways. At the passive
end of the spectrum, a health plan can simply comply with the laws and regulations that
apply to its organization. At the active end of the spectrum, health plans can choose to
devote resources in a variety of ways to influence the content of the relevant laws and
regulations. Even the most passive health plans can influence the course of public policy
through their day-to-day operations. The failure to act can also shape policy. An
omission so seemingly minor as a failure to train health plan employees to properly
answer members’ questions about how the health plan is complying with a new state law
can inadvertently trigger legislative and regulatory activity. In addition, much of today’s
legislative and regulatory activity seems to be driven more by politics than by the actions
or nonactions of health plans.

One example of the influence of individual health plans on regulatory policy relates to so-
called “gag” clauses. In 1996, a few reports of the presence of these clauses in some
contracts led to state and federal government action. In a span of a few months, state
and federal governmental bodies prohibited such clauses. In November 1996, CMS sent
a letter to health plans explaining that federal law prohibited the restriction of a
physician’s responsibility to explain all treatment options. By the end of 1997, over 40
4

states had adopted laws or regulations prohibiting or limiting the use of these clauses.
Yet, despite this nearly universal public policy activity in opposition to such clauses, the
U.S. General Accounting Office’s examination of the issue found that the clauses were
virtually nonexistent in provider contracts.5

Health plan public policy activity, especially in the last few years, also has broader roots.
That portion of policy activity that is responsive to broad changes in the market is

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growing rapidly, as government becomes increasingly responsive to constituencies

injured or fearing injury by changes in the health plan market. 6

Exerting Influence Through Policy Modification

As we discussed in the preceding lesson, health plans can influence public policy
through acts or omissions at the policy or operational level. They also influence public
policy by modifying their policies or practices. A recent example illustrates this point. In
1995, the Maryland General Assembly threatened to force health plans to pay for all
medical care provided to health plan members in Maryland emergency rooms, even
when the condition underlying the care was not considered an emergency under the
state’s “reasonable layperson” standard. Legislators were particularly interested in
situations in which the member’s primary care physician referred the member to the
emergency room. Reports indicated that some health plans were not covering medical
care administered in emergency rooms after such a referral. Health plans argued that
such policies denying coverage for emergency room referrals may have existed in the
past, but no longer existed. By surveying its members, the Maryland Association of
Health Maintenance Organizations (MAHMO) confirmed that no members of MAHMO
had such a policy, blunting the pressure for the General Assembly to act on the subject.

One observer explains health plans’ ability to anticipate the issues that will be the
subject of policy debate and perhaps shape that policy in this way:
Federal policy is often mentioned as an important force behind increasingly
competitive health care markets. But if this is the case, it is not through policies
that have been enacted, but through a process of market participants taking
anticipatory steps to prepare for policies that might be enacted. 7

In the wake of the Clinton administration’s healthcare reform initiatives in the 90s and the
more recent Republican initiatives for Medicare in 2004, health plans anticipated and
shaped public policy on those issues. 8

Exerting Influence in the Development of Legislation

Health plans have an even greater impact on public policy when they participate in the
process of developing legislation. This participation can be formal or informal, and
includes bill drafting and voicing opinions on legislation through written or oral testimony,
informal advocacy, or undertaking grassroots efforts. In the following lesson we discuss
these methods of influencing legislation. Later in this lesson we discuss influences on
overall public policy that are not necessarily limited to specific legislation.

Drafting Legislation
When a health plan or an association of health plans wants government to take a
specific action, they may actually write the proposed law and present it to one or more
legislators for introduction. The chief advantage to this approach is that it provides the
drafting organization with an opportunity to start the policy discussion with its own
language, so that any subsequent versions will simply be amendments to the
organization’s starting position. In some situations, the final product may be closer to the
health plan’s position than it would have been if others initially drafted the bill.

A bill drafted by a health plan may also be easier to implement than a similar bill drafted
by legislators and their staffs. Health plan employees often have a greater understanding
of operational nuances than do legislators. While this may not be an important
consideration when the time comes to pass or reject a bill, it could be vital at the point of
implementing the law.

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One argument against health plan bill-drafting is the assumption that the drafting is
driven by self-interest. However, the health plan can argue that while its proposed
changes certainly are in its own best interests, a health plandrafted bill also serves the
public interest. The success of this argument depends on the nature of the proposal
itself, the credibility of the organization, and the political climate in the state or the nation.
Proposals to change health plan laws vary based on the extent to which other groups
and the public would be affected by the change. Some proposals impact the relationship
between health plans and all their members, suppliers, and providers—impact many
people and/or many interest groups. Other proposals impact only the relationship
between the government and health plans. For example, proposals such as those to
simplify the procedure for market conduct impact only regulators and health plans.

Similarly, the credibility of the health plan introducing the proposal will affect its ability to
persuade legislators that its proposal is in the public interest. This credibility is a product
of many factors. One factor is the organization’s reputation with legislators. If the health
plan and its representatives are perceived by legislators as providing objective
information about the industry and their operations, their credibility will be high.
Credibility can also be affected by the health plan’s behavior in the marketplace. In
general, health plans that serve their members well will have greater success
persuading legislators that their proposals are in the public interest. Another factor that
affects credibility is personal relationships between legislators and the health plan’s
leaders and lobbyists.

The political climate surrounding the introduction of the health plan’s proposal also
influences the likelihood that the health plan’s proposal will lead to legislation. In some
markets, the history of healthcare issues is so contentious that no health plan’s proposal
is accepted, no matter how limited the proposal or how credible the organization.

If an individual health plan has credibility problems with legislators, it can ask an industry
trade association to sponsor legislation that the health plan supports. A health plan that
wants an industry trade association to sponsor legislation generally participates on the
association’s legislative committee. Such committees, typically composed of public
policy specialists from each of the member organizations of the association, make all
recommendations concerning legislative matters for the association. Health plan
association legislative committees are good venues for the drafting of legislation
because of the diverse expertise of the committee members. If an entire industry has
credibility problems with legislators, the industry participants may ask another
organization or group of organizations outside the industry to sponsor legislation or to
work jointly to secure passage of specific legislation.

Voicing Opinions on Legislation

Health plans that wish to express their opinion on their own or other proposals may
express their views through both formal and informal processes. The most formal
method of voicing opinions is through the submission of written and oral testimony in a
legislative hearing. A health plan faces several decisions in pursuing this approach.

First, it must decide whether to submit that testimony on its own or through its
association or other interested parties. The health plan’s credibility with legislators,
discussed in the previous section, affects this decision. Second, if the health plan
decides to present its own testimony, it must decide who should present that testimony.

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Most often, the choice is between a medical director or a government relations

professional.

The decision depends on both the position and the individual, and in both cases the
issue is credibility. Some professional occupations lend more credibility than others,
particularly on certain issues. For example, for issues concerning how an health plan
makes medical necessity decisions, a good argument could be made that the health
plan’s representative should be its Chief Medical Officer.

While legislators, like their constituents, are influenced by the credibility of physicians,
they are also influenced by other issues —such as the expertise of the witness. In
optimal testimony, this expertise should be both substantive and procedural. Certainly,
the health plan’s witness should have unquestionable understanding of the subject of the
proposed legislation. Additionally, the witness should have a solid understanding of the
legislative process generally and the legislative committee hearing process specifically.
Not only should the witness understand what is going on, he or she should be
comfortable as a participant in the process.

In general, it may make sense to have the medical director testify at more technical, less
emotional hearings and the government relations professional testify at less technical,
more heated hearings. Sometimes, however, health plans are faced with an acute need
for substantive expertise found only among its senior management and medical directors
on an issue over which emotions are inflamed. Most health plans train their executives
and clinical professionals to present oral legislative testimony in a hostile environment.
While many health plans and trade associations have the expertise in-house to provide
such training, many are turning to a growing body of consultants who specialize in
preparing employees for legislative committee hearings.

Many experts, however, question the value of appearing before a legislative committee
to make one’s case. Some believe that a health plan or its association can accomplish
much more through informal advocacy. Informal advocacy which is a form of lobbying
(discussed later in this lesson) involves the promotion of a position in ways other than
providing formal legislative testimony. Such advocacy may be limited by state open
meeting laws. These laws, present in most jurisdictions, place some restrictions on the
ability of advocates to present their case to groups of legislators behind closed doors.
However, some forms of informal advocacy are still permitted under these laws.

The most commonly used type of informal advocacy is the face-to-face meeting between
the health plan’s representative and a legislator and his or her staff. Such encounters
between lobbyists and legislators occur while the legislature is in session. Sometimes
health plans bring a clinical leader or senior executive to such meetings to provide
substantive information. Usually, the health plan’s lobbyist accompanies the health plan
executive, to provide an interpersonal liaison between the legislator and the executive
and to help provide political context to which the executive may not be privy.

Grassroots lobbying efforts can have a substantial impact on the development of

legislation. For purposes of our discussion, a grassroots lobbying campaign is a
connected series of efforts or actions directed at generating public support on a
particular issue which an organization or group supports. We discuss this concept in
more detail later in this lesson.

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A variation of the face-to-face meeting between health plan executives and legislators is
the “lobby day.” Typically coordinated through a trade association, lobby day is an all-
day affair during which health plan employees at all levels and from all departments
move from appointment to appointment with individual legislators, accompanied where
possible by a lobbyist or other government relations professional. The value of such a
series of meetings is that the legislators meet their constituents in the health plan
industry and can develop a better understanding of their needs and the challenges they
face.

A similar form of advocacy is the “site visit.” In a site visit, an individual legislator, a
legislative subcommittee, or even a full committee pays a visit to a major facility of the
health plan. During the visit, the legislators meet with employees at all levels of the
company, both at their desks and in open meetings. Where a lobby day allows a health
plan to put a handful of its employees in front of the legislators, a site visit can put
hundreds of employee-voters in face-to-face contact with lawmakers, for a longer period
of time than is usually available on a lobby day. The site visit is also a forum that is
amenable to highlighting some of the pro-consumer achievements of the health plan,
such as a disease-management program, a high-achieving quality improvement
department, or community service.

Effective advocacy does not start or end with legislators. Legislative staff may be an
even more important audience for the advocacy methods described in this section. As
translators and interpreters for legislators and committees, legislative staff members
spend time reading testimony, listening to detailed concerns about bill drafting, and
balancing competing interests. They often serve as the “gatekeeper” to the legislator.

In addition to face-to-face meetings, the written word is influential in the legislative

process. Individual letters, including electronic mail, from constituents are often effective
in making a case for or against legislation. health plans can seek participation in their
letter-writing campaigns to legislators from their enrollees and other interested parties.

Exerting Influence in Rulemaking

As we have seen, much of the regulatory policy that affects health plans stems from
administrative rules and regulations, discussed in Overview of Laws and Regulations,
rather than laws. Rulemaking and regulation drafting offer health plans an opportunity to
shape health plan policy.

Most state legal codes include an administrative procedures act, which establishes
the requirements that agencies must follow to establish and enforce regulations. They
also often mandate that certain procedures must be established through formal
rulemaking or regulation as outlined in the administrative procedures act, to prevent
agencies from circumventing the guidelines set forth in the act. In general, rulemaking
requirements are designed to ensure adequate public notice and opportunity for public
comment prior to the finalization of a proposed rule or regulation.

Administrative procedures acts typically require administrative agencies to take the

following steps to establish rules or regulations:

• Notify a central state agency (such as the Office of the Secretary of State) of the
agency’s intent to promulgate a rule or regulation

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• Publish in the official state administrative publication (usually known as the

Register) and/or in a newspaper of general circulation, and notify any parties that
have requested notification, of the agency’s intent to promulgate a rule or
regulation, the text of the proposed rule or regulation, and the date or dates of
public hearings
• Prepare (and perhaps publish) an analysis of regulatory impact
• Allow oral and written testimony to be submitted to the agency, either in the
public hearing(s) provided for such purpose or directly in writing to the agency
• Decide whether to adopt, amend, or withdraw the proposed rule or regulation
• Publish (as described above) notice of adoption or amendment of the proposed
rule or regulation

In most states, interested parties may influence the process at several points along the
way. The first opportunity is in the decision to promulgate. If, for example, a state agency
is engaged in a regulatory practice that, in the view of a health plan, would not withstand
the public scrutiny that is built into the formal promulgation process, it might seek to
induce the agency to promulgate a rule or regulation that formalizes that practice. It may
use informal direct persuasion in discussions with regulators, exert pressure on
regulators through other public officials in the legislative or executive branches, or
threaten or even bring litigation to force the initiation of the statutory rulemaking process.

If relationships between a health plan and its regulators are sufficiently positive, a health
plan can provide technical assistance to the regulators as they draft the proposed
regulation. Most states do not prohibit such informal consultations, although state law
should be consulted. In some cases, informal participation prior to the initiation of formal
rulemaking procedures is encouraged by regulators through the formation of informal
working groups and advisory committees. The drafting stage of the rulemaking process
is a good opportunity to anticipate and avoid potential technical problems that may be
difficult to address in a more formal process. It is also the last opportunity for a health
plan to participate informally in the rulemaking process. Once the process has begun,
and notice of intent to establish rules is published, there is substantial pressure on
interested parties to participate exclusively through the statutory process. If the agency
accepts input through avenues other than those specified in the governing statutes, the
legality of the process may be threatened.

The formal rulemaking process is very much like the legislative hearing process
described earlier in this lesson except that the hearing is before an administrative law
judge rather than a legislative committee.

Health plans participating in the formal hearings on a proposed rule or regulation face
the same questions of mode of testifying, who should testify, and whether to involve
allied organizations. The primary difference between hearings in the two settings is that
the regulatory hearing is likely to be more substantive and less emotionally charged,
because most regulators have more expertise in the particular area of regulation than
most legislators. A health plan typically will send its most technically proficient experts to
regulatory hearings, paying less attention to the public relations and oratorial skills than it
would pay in connection with a legislative hearing.

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Once the regulators adopt a rule or regulation, health plans can continue to participate in
the process by appealing the decision. In some states, the first appeal after the formal
adoption of a rule is to the same agency, in the form of a request for reconsideration. In
others, the first appeal is to an external agency, either executive (such as to a
commission that oversees the regulatory agency), legislative (to a special committee that
oversees the state’s administrative process), or judicial (either an administrative law
judge whose jurisdiction is primarily over such appeals from regulatory bodies, or to a
court of general jurisdiction). Generally, the grounds for such an appeal are limited either
to procedural grounds or jurisdictional grounds. Procedural grounds for appeal are
usually in the form of objections to the process by which the rule or regulation was
adopted, such as a claim of inadequate opportunity to be heard, improper publication of
the notice of intent to establish rules, or some other nonsubstantive objective.
Jurisdictional grounds for appeal generally are objections that the subject matter is
outside the realm of issues that are legal for inclusion in that agency’s rules or
regulations, or that the regulations are contrary to or inconsistent with the law.

Beyond procedural and jurisdictional grounds, bases for appeal are usually extremely
limited. Those states that do permit appeals on other grounds than these limit the
grounds for appeal to a claim that the regulatory agency abused its discretion and
imposed substantial burden-of-proof requirements on the party appealing the regulatory
decision.

Review Question

Health plans are allowed to appeal rules or regulations that affect them. Generally, the
grounds for such appeals are limited either to procedural grounds or jurisdictional
grounds. The Kabyle Health Plan appealed the following new regulations:

• Appeal 1 - Kabyle objected to this regulation on the ground that this regulation is
inconsistent with the law.
• Appeal 2 - Kabyle objected to this regulation because it believed that the subject
matter was outside the realm of issues that are legal for inclusion in the
regulatory agency's regulations.
• Appeal 3 - Kabyle objected to the process by which this regulation was adopted.

Of these appeals, the ones that Kabyle appealed on jurisdictional grounds were

Appeals 1, 2, and 3
Appeals 1 and 2 only
Appeals 1 and 3 only
Appeals 2 and 3 only

Incorrect. Jurisdictional grounds for appeal generally are objections that the
subject matter is outside the realm of issues that are legal for inclusion in that

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agency’s rules or regulations, or that the regulations are contrary to or

inconsistent with the law.

Correct! Jurisdictional grounds for appeal generally are objections that the
subject matter is outside the realm of issues that are legal for inclusion in that
agency’s rules or regulations, or that the regulations are contrary to or
inconsistent with the law.

Incorrect. Jurisdictional grounds for appeal generally are objections that the
subject matter is outside the realm of issues that are legal for inclusion in that
agency’s rules or regulations, or that the regulations are contrary to or
inconsistent with the law

Incorrect. Jurisdictional grounds for appeal generally are objections that the
subject matter is outside the realm of issues that are legal for inclusion in that
agency’s rules or regulations, or that the regulations are contrary to or
inconsistent with the law.

Appeals of regulations are relatively rare. First, as we have just seen, the grounds for
appeal are usually limited to procedural and jurisdictional grounds, providing potential
appellants with a narrow target for an appeal. Second, courts are reluctant to impinge on
the ability of regulators to exercise their legal discretion in establishing rules and
regulations. Third, interested parties—particularly those, like health plans, who have an
ongoing relationship with regulators and therefore an ongoing need for the continued
good will of the regulators —are generally reluctant to threaten the regulators’ good will
by appealing a regulatory decision.

Exerting Influence at the Stage of Policy Operation

Policymaking does not end with adoption of a law or regulation. It extends into the
administration of the policy as well. Most laws and regulations are vaguely written to
garner broad-based support, allow for contingencies, and reduce the threat of challenge.
This drafting ambiguity gives regulators enormous flexibility in administering laws that
apply to health plans. It also gives health plans opportunity to influence administrative
decisions.

Frequent contact between regulators and health plan employees tends to increase
familiarity and can help the health plan in its effort to make an impact on how a law is
administered by regulators. If it appears that the health plan can bring substantial
9

expertise in a hearing before an administrative law judge, and is likely to prevail in that
hearing on the basis of that expertise, the regulator is more likely to be responsive to the
health plan’s arguments.

A health plan’s direct influence over regulators is augmented by its ability to take its case
elsewhere. Regulators do not operate in a policy vacuum, despite the presence of a
wide variety of legal mechanisms to ensure their independence from the influence of
other branches of government, or even other parts of the executive branch of
government. Regulators make their decisions about how to implement health plan laws
and regulations with an eye on the governor, other regulators, the legislature, and the
courts.

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Most state health plan regulators, whether in insurance departments, health

departments, or elsewhere, are accountable to the state governor. Only a dozen
insurance commissioners are elected directly by the people, and fewer chief health
regulators are elected. Most of the chief regulators are appointed by the governor. When
the actions of regulators seem grossly unfair, health plans have the option of pleading
their cases with the governor. While this avenue is rarely pursued except in situations
where the stakes are high and the regulatory conduct is extreme, the existence of this
option helps to temper regulatory conduct to some extent. While not all health plan
regulators report to the state’s governor, all are accountable to legislatures for their
authority, funding, and staffing. This means the legislature is also a potential forum for a
health plan to air disputes with a regulator. However, the regulators can also appeal to
the legislature for support or the passage of further legislation to bolster their position.

Regulators are also accountable to the judicial branch of state government. This
accountability provides health plans with another forum for appeal of perceived
regulatory abuses. Judicial appeal is the most direct route for a health plan to seek
redress for grievance it may have against a regulator, but it is often the least likely to
succeed and the slowest. Regulators have a great deal of legal discretion in the
administration of the laws within the scope of their jurisdiction. As a result, courts are
reluctant to overturn regulatory judgments except in cases of clear abuse of that
discretion or a reasonably clear showing that the regulators misapplied the law or
regulation.

Health plans rarely seek any of these avenues of relief from regulatory burdens. An
appeal is likely to diminish good will between the health plan and its regulators, good will
that the health plan needs to function in a highly regulated environment. For the most
part, health plans rely on their expertise and the good will of regulators in its exercise of
influence on policy.

Participation on Government-Sponsored Task Forces

When government officials face a difficult challenge, they often advocate the creation of
task forces to research and resolve the issue. A task force is a special, ad hoc
committee established to research and report on a specific problem or issue. A task
force typically consists of multilevel and/or crossfunctional personnel.

The Formation and Purposes of Task Forces

Policy makers can form task forces in a number of different ways. The variety can be
attributed to differences in state laws, disparate political dynamics in various legislative
and regulatory environments, and differing levels of interest among members of the
executive and legislative branches. For example, a governor or the President can call for
a task force to be formed. In addition, the legislature sometimes convenes a task force to
deal with complex or volatile issues.

Task forces are formed for a variety of purposes. For example, a task force can be
formed to address broad issues, such as health plan accountability, the costs and
benefits of expanding a health plan’s tort liability, or reviewing various proposals for
mandates and determining if mandates are the best way to ensure access and quality
care.

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Alternatively, a task force can focus on narrower issues, such as ways to amend state
laws to allow plan members to bring suit against the health plan for tort liability. In cases
such as this, the basic issue has been decided in advance (e.g., plan members must be
able to bring suit for tort liability against a health plan), leaving the task force to decide
only on its implementation.

Composition of Task Forces

The composition of a task force can often determine the outcome of the process. The
interests and policy preferences of the participants on a task force, as well as the
number of representatives from each viewpoint, may decide the task force’s ultimate
results. For example, a task force that is formed to address health plan issues, and that
has minimal representation from the health plan industry may make recommendations
that are not practical to implement. health plans often work to assure representation on
task forces.

Work Structure
Task forces may structure their duties in at least two different ways. They may form
subcommittees and delegate specific tasks enumerated in the task force’s purpose to
each subcommittee for research and recommendation to the full task force. On the other
hand, the task force may operate as a group to perform the research and make
recommendations to its founders. The timeframe and number of participants on a task
force may determine the work structure.

Insight 13A-1 describes two task forces that were created to address health plan public
policy.

Insight 13A-1. Examples of a Federal and a State Task Force.

In the following examples, the clamor in the Congress and the California legislature,
respectively, for changes in health plan law induced the president and California's
governor to move the proposed changes into task forces that could consider all the issues
together.

The President's Advisory Commission on Consumer Protection and Quality in the

Health Care Industry

President Clinton established the Advisory Commission on Consumer Protection and

Quality in the Health Care Industry (President's Commission) by Executive Order 13040
on March 26, 1997. Because he established the commission by executive order, he had
complete discretion over the Commission's composition, purpose, and work plan.

Purpose: The president's task force focused on implementing a public policy directive
(i.e., to make recommendations concerning consumer protection and quality in
healthcare). The objectives of the president's commission were to:

1. Review the available data addressing consumer information and protection for
health plan members and to recommend any necessary improvements

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2. Review existing and proposed efforts to define, measure, and promote healthcare
quality, and attempt to build consensus on approaches to promote healthcare
quality
3. Collect and evaluate information on changes in the availability of healthcare
treatment and services and to recommend any necessary improvements

Composition: The president's commission was comprised of 32 members drawn from a

broad array of stakeholders: seven members that represented academics, foundations, and
experts, one consumer advocate, three representatives of labor unions, two lawyers, five
representatives from health plans, four private purchasers, eight providers, one research
organization, and one representative of state government officials.

Work Structure: This commission held public hearings, took testimony, and reviewed
and commissioned extensive research. It conducted the bulk of its work through
subcommittees.

The California Managed Health Care Improvement Task Force

The California task force was produced through actions of the governor and the
legislature. California Governor Pete Wilson expressed his opposition to piecemeal
reform of the health plan industry by threatening to veto most health plans legal reform
bills in 1996. This led the legislature to approve Assembly Bill 2343, to require the
governor to create a task force on health plans to research and report on certain aspects of
the effect of healthcare plans. During the year while the task force met, the governor
continued to veto legislation aimed at health plan practices, citing his desire to await the
recommendations of the task force.

Purpose: This task force took a broad-based approach and focused on establishing the
policy itself. Its objectives were to research and report on:

1. An overall descriptive analysis of the world of health plans, including a review of

the types, modes of operation, and structure of health plans, health plan
regulation, the trends and changes in healthcare and their impact on the economy,
academic medical centers, and the education of healthcare professionals
2. Whether health plans are succeeding in controlling costs and improving quality
and access to care
3. An examination of the impact of provider financial incentive systems on the
delivery of healthcare
4. The effect of health plans on the patient-physician relationship, if any, and on
academic medical centers and health professions education

Composition: Twenty of the California Task Force's 30 members were gubernatorial

appointees - four representatives of each of five groups: healthcare plans, employer
purchasers, healthcare plan enrollees, providers of healthcare, and consumer groups. The
Senate Rules Committee and the Assembly Speaker each had five appointments, one

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from each of these groups. The governor also appointed five ex-officio members and the
Senate appointed two ex-officio members.

Work Structure: The California task force held public hearings, with agendas posted,
and minutes and transcripts made available to the public. The task force itself consulted
with experts, reviewed existing policy research, and conducted a public opinion survey.

Other Participants in Policymaking

So far, we have discussed the influence that health plans have on the development and
implementation of public policy. In this section, we address the roles of two other major
participants in the policy making process: organized interest groups and politicians.
Organized interest groups are groups that “have discernible stakes in or positions on
the policy status quo or policy alternatives to it. They each naturally wish to manipulate
policy making to the advantage of their group or clients.” Politicians “are the elected
10

officials who possess the formal public authority to decide the course of government
policy and who regularly suffer the consequences of their decisions by standing for
reelection in their constituencies.
11

Interest Groups
In the context of health plan policy, interest groups consist of payors, providers,
purchasers, and consumers. Each group is typically motivated by some blend of self-
interest and the public interest. In addition, each group vies to be heard in the health
plan policy discussion.

Payors
Health plans are payors, as are indemnity insurers and self-funded employer groups that
provide healthcare coverage. (Self-funded employer groups can be either payors or
purchasers depending on which tasks they perform themselves and which tasks they
contract to third parties.) Although payors as a group would seem to have the same
interests in health plan policy, this is not always the case. For example, a substantial
number of individuals in group plans still are not covered under health plans. Employees
in these plans receive their coverage from indemnity carriers. Indemnity carriers
sometimes find themselves opposing health plans on policy positions that would alter the
way health plans and indemnity carriers are regulated relative to one another. An
example of such an issue would be a law specifying that the state employees’ health
benefit plan contract only with health plans accredited by a national accreditation
organization. Such a decidedly pro-managed care slant would split traditional allies
within the payor community.

Often, indemnity carriers are organized separately from health plans into trade
associations restricted to representing the interests of these indemnity carriers. For
example, in Maryland you will find both the Maryland Association of Health Maintenance
Organizations and the Maryland League of Life and Health Insurers. However, in many
cases, insurers that provide traditional indemnity coverage also provide PPO, point-of-
service, and HMO options. What’s more, companies that traditionally offered only “pure”
HMO products are now offering a full line of health products including indemnity, PPO,
and point-of-service products. As a result, the lines between health plans and indemnity
payor trade associations become increasingly blurry each year. On the national level,
trade associations that represent the interests of health plans include the America's

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Health Insurance Plans (AHIP) and the Blue Cross and Blue Shield Association
(BCBSA).

Employers that offer self-funded plans to their employees have policy interests distinct
from indemnity carriers, and other employers that purchase healthcare coverage from
indemnity carriers and health plans. As we discussed earlier in this lesson, the most
significant policy distinction is that self-funded plans are not subject to state insurance
laws. ERISA’s preemption of such state insurance laws has profound consequences in
the area of health plan policy. For example, if a state’s oversight of health plans
becomes so rigorous that it imposes an undue burden or cost on health coverage,
employers may decide to selffund and thereby escape the regulatory burden.

Similarly, self-funded employers often have an entirely different reaction to state

legislative proposals affecting health plans (which laws would not apply to them) than the
employers that purchase health coverage from regulated carriers and health plans.
Finally, while a state-regulated health plan could conceivably support some forms of
federal regulation of health plans if the law helped to level the competitive playing field
without damaging its ability to operate profitably, it is less likely that self-funded
employers would support an expanded federal regulatory role that subjects them to
additional regulation.

Fast Fact

In 2003, HRET/KFF estimated that only 7% of covered employees were still in

conventional indemnity plans. 12

The government also acts as a payor for healthcare programs such as Medicare,
Medicaid, CHAMPUS, and FEHBP. However, the government is a different kind of payor
than those we have already discussed. Unlike other payors, government can—for the
most part—unilaterally change the terms under which it operates as a payor. One of the
few constraints on this power, other than traditional mechanisms of accountability to the
public, is the extent to which a state is constrained in some important respects by federal
Medicaid law.

Providers
As we discussed earlier in this lesson, increasing numbers of physicians and hospitals
have begun to band together to create risk-bearing entities similar to health plans. This
blurring of roles in the healthcare market has had an impact on health plan politics and
policy. Providers that once opposed all policies that furthered the spread or enhanced
the operations of HMOs may now support such policies. Indeed, state health plan
associations are finding that traditional political opponents are taking different political
stands than they did only a couple of years prior, and these former opponents are now
becoming members of the health plan association.

However, it is still valid to consider providers as a separate interest group with policy
interests that are often in direct opposition to health plan policy interests. Increasingly,
employers that are demanding more services for a lower cost have health plans
searching for ways to cut costs while continuing to deliver a quality healthcare product.

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Providers
Like health plans, providers operate in the policy arena both as individuals and as
institutions. The most visible provider policy participants are the physician professional
associations, such as the American Medical Association (AMA) and the National Medical
Association (NMA). Specialists such as obstetricians, pediatricians, and emergency
physicians are also represented by national and state professional associations.

Physician societies often face challenges in representing the interests of all of their
members. For example, some physician members have fared well in the modern
healthcare marketplace while others have not. Reaching a consensus on a medical
society legislative committee or executive committee on health plan policy issues can be
challenging. As a result, some societies have lost members, and societies tend to take
the middle road in policy positions. These same issues are also present in the
organizations representing other providers, such as hospital or nurse associations.

Specialty physician organizations provide an opportunity to pursue specialty-specific

issues that may not be the priority of a broader organization. For example, while only a
small minority of the overall physician population is concerned with questions involving
compensation for emergency services, these issues can be pursued with single-minded
intensity by the American College of Emergency Physicians (ACEP) and its state
affiliates.

Additionally, not all health plan policy issues are provider-versus-payor issues.
Sometimes, they pit providers against each other. For example, scope-of-practice
legislation can be both a health plan issue and a clear provider-versus-provider issue.
Typically, scope-of-practice legislation is an attempt by one type of provider (not
necessarily a physician) to amend state healthcare licensing laws to allow another type
of provider to do a procedure or set of procedures typically reserved only to another
provider group. One example is chiropractors’, psychologists’, and podiatrists’ efforts to
expand their domain into areas previously thought to be the domain only of physicians.
On the surface, these appear to be turf issues among providers. However, when coupled
with state laws that prohibit health plans from discriminating among healthcare
professionals that are licensed to provide a service covered by the health plan, these
issues also become managed care policy issues.

Another example of a provider-versus-provider dispute can be found in health plans’ use

of preferred pharmacies. Drug manufacturers, chain pharmacies, and locally operated
pharmacies have often found themselves with opposing viewpoints or interests
pertaining to health plans and pharmacy benefit managers (PBMs). For example, chain
pharmacies have challenged local pharmacies over the ability of health plans to
selectively contract with some pharmacies and exclude others—the any-willing-provider
dispute. More recently, the use of formularies by health plans and PBMs has given rise
to efforts to curb or eliminate their use. These issues have split the pharmacy world, with
the chain pharmacies and manufacturers siding with the health plans and PBMs against
the efforts of the local pharmacies.

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One advantage provider interest groups have over payor organizations is the number of
providers represented by interest groups. The majority of people employed in the
healthcare industry are engaged in the provision of healthcare, not the financing of it.
The impact in terms of numbers of constituents that can become involved in an effort to
lobby legislators translates directly into a larger number of:

• Votes, phone calls, and letters to legislators

• Face-to-face meetings between constituents and legislators
• Campaign contributions

Purchasers
Typically, purchasers of health plans are strong allies of health plans. The business
community has been supportive of health plans, both in purchasing decisions and in the
political domain. One major reason for this support is the ability of health plans to help
13

purchasers contain the increase in costs for healthcare coverage for their employees.
Inflation in health plan premiums has been in the low- to mid-single digits for the last
several years due largely to the rise of health plans as the dominant means of
healthcare financing. Purchasers’ satisfaction with health plans and a fear of a return to
rampant inflation fuel purchasers’ political support for health plans.

Political support for health plans often stem from organizations supported by large
corporations. State and national chambers of commerce frequently have served as the
coordinating bodies for business efforts to provide political support to health plans. Other
organizations with substantial membership in large companies that have been important
pro-health plan players have included the National Association of Manufacturers, the
Health Benefits Coalition for Affordable Choice & Quality, and the The Washington
Business Group on Health (WBGH). These organizations are all composed of payors
and purchasers supportive of the health plans’ position in the public policy debate.

Small businesses sometimes have different concerns than large businesses when it
comes to health plans. Small businesses may place more emphasis on aspects of health
plans, such as accessibility and renewability, than larger corporations

Fast Fact

From 1993–1996, health insurance premiums lagged behind the rise in consumer prices. 18

Consumers
All the players in the public policy process contend that their positions are in the best
interests of consumers. On one hand, the supporters of health plans claim, with some
legitimacy, that:

• Health plans are pro-consumer because they have increased the affordability
of health coverage for the average consumer
• Health plans, especially HMOs, are actively engaged in quality initiatives and
support preventive care

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• Health plans slowed the tendency of employers to shift the cost of that
coverage to employees
• Health plans established accountability for healthcare providers that was
largely absent in the pre-health plan era

On the other hand, health plan opponents argue that:

• Health plans have restricted consumers’ ability to go to any healthcare provider

they desire and have that visit covered by their health plans
• Government oversight of health plans is not uniform across the nation and
suffers from serious gaps

The arguments about the consumer-friendliness of health plans have ample support on
both sides. There are basically two types of organizations that seek to represent
consumer interests: unaffiliated consumer groups and consumer advocacy
organizations. Unaffiliated consumer groups consist of consumer advocacy
organizations, such as the Consumers Union (CU), the Consumer Federation of America
(CFA), Community Catalyst, and Public Citizen, that have a long history across a broad
array of issues. These groups are less likely to represent a single special interest than
consumer advocacy organizations. Consumer advocacy organizations are consumer
organizations created by special interests with a more direct stake in the outcome of
particular policy issues. For example, the American Association of Retired Persons
(AARP) seeks to represent the consumer interests of retired persons. In addition, patient
advocacy groups, discussed in Environmental Forces, can have an impact on healthcare
public policy by advocating for the passage of laws to protect their members’ interests.

Government
As we discussed previously, government acts as both a purchaser and regulator of
healthcare services. In its role as a purchaser, government is a stakeholder in the health
plan public policy debate. As a regulator, it has information often gathered through
government-sponsored healthcare programs (e.g., Medicare and Medicaid) that impacts
public policy for health plans.

State public officials are often members of not-for-profit organizations of state officials,
divided along lines of job description. The oldest of these state associations, the National
Association of Insurance Commissioners (NAIC), is a key participant in managed care
debates because of the central role played by most insurance regulators in the oversight
of health plans. The National Conference of State Legislatures (NCSL), representing
over 8,000 state legislators across the nation, has a very active health policy component
that often influences managed care issues. The National Governors Association (NGA)
has taken positions on health plan issues such as any-willing-provider laws and
consumer disclosure laws. 15

Federal government officials are less likely than state public officials to be informally
organized in not-for-profit associations. The need for organization at the federal level is
filled by more formal governmental structures (e.g., the Department of Health and
Human Services and the Department of Labor). However, one vehicle for participation of
federal officials that is specifically focused on health plans is the National Association for

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Managed Care Regulators. The members are both state and federal officials involved in
health plan oversight. Most of these officials are employees of the federal Centers for
Medicare and Medicaid Services (CMS) and state insurance and health departments.

These organizations of state and federal officials participate in the health plan policy
process primarily as experts. This has been particularly true in the 1990s, as the federal
government has expanded its jurisdiction into areas, such as health insurance regulation
for non-government programs, that have typically been the nearly-exclusive domain of
state regulators.

Influences on Policymaking
In this lesson we examine several ways that healthcare policymaking can be influenced.
These influences are lobbying, political activities, litigation, and public opinion.

Lobbying
Lobbying, which we mentioned in our earlier discussion of informal advocacy, is the act
of “communicating with public policymakers for the purpose of influencing their decisions
to be more favorable to, or at least consistent with, the preferences of those doing the
lobbying.” A lobbyist is a person employed or retained by a client to perform lobbying
16

for compensation.

Both state and federal laws address lobbying. For example, federal lobbying laws do not
consider a person a lobbyist if less than 20 percent of his or her time over a sixmonth
period is spent lobbying. For the most part, federal and state lobbying laws exclude
certain activities from the definition of lobbying, such as presenting testimony,
participating in advisory commissions, and advocating on behalf of one’s own personal
interests that are exclusive to that person.

Lobbyists play important roles in policy debates. They serve as educators, mediators,
bill-drafters, facilitators, advocates, and fundraisers, to mention just a few of their roles.
While many lobbyists are lawyers (legal training may assist their billdrafting), the number
of nonlawyer lobbyists has grown over time.

Lobbying is big business. In the first six months of 1997, federal lobbying alone involved
over 7,000 organizations spending an annual sum of $1.2 billion on over 9,000
lobbyists. Although it is difficult to assess what portion of these organizations performed
17

lobbying on health plan issues, 2,531 organizations listed health issues as a subject on
which they lobbied Congress— ranked third among all issues. Insurance issues were
listed by 558 organizations, ranking 24th on the list of issues. 18

Health plan lobbyists typically work for the health plans directly or for trade associations
of health plans, or both. It is common practice in both the state legislatures and the
Congress for health plan lobbyists to work in tandem with health plan association
lobbyists. In some states, the association lobbyist will coordinate the efforts of the
lobbyists representing the individual health plans. In other states, the lobbyists operate
more independently of each other.

Most health plan lobbying efforts are coordinated through the relevant health plan
association’s legislative committee. Such committees are typically populated by in-house
government relations specialists from the member health plans who (1) lobby directly

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and (2) oversee the activities of outside lobbyists representing their respective health
plans.

Political Activities
Interest groups can influence policy making by participating in the political election
process. Most organizations, like health plans, that are profoundly affected by policy,
participate in campaign financing to the extent permitted by law. American politics has
always been dominated by money, and most of that money has come from organized
groups, such as social, political, and business organizations. Institutional interests and
many wealthy individuals typically finance the bulk of American electoral campaigns.

Before 1972, restrictions on campaign contributions were few. In the post-Watergate

reform, however, Congress and a number of state legislatures began to limit
substantially the extent to which organizations, both for-profit and not-for profit, could
contribute to campaigns out of general organizational funds. Instead, political action
committees (PACs) became the funding vehicle of choice for interest groups. Political
action committees (PACs), organized under various state and federal laws, allow
individuals and organizations to pool their resources to contribute to electoral
campaigns. The laws under which these state and federal PACs operate usually limit or
even prohibit certain kinds of organizational contributions, and usually establish
incentives for funding to come from individuals rather than corporate or union treasuries.
Organizations, therefore, fund the PACs they sponsor through individual, voluntary
contributions from their employees, members, or other individual stakeholders.

PAC dollars go directly to candidates’ campaign committees, and, along with other
contributions made directly to campaigns, are known as hard money. In contrast to hard
money, soft money is not subject to state and federal restrictions on campaign financing.
The U.S. Supreme Court drew this distinction in a 1976 decision that declared
unconstitutional a federal effort to limit “independent expenditure” or soft money. Soft
money is money used in connection with a candidate’s election but not contributed
directly to the campaign or controlled by the campaign. As a result of the Supreme
19

Court ruling, attempts to constrain soft money to fund independent efforts— that have an
increasing impact on electoral politics—have been challenged based on freedom of
expression conferred by the Bill of Rights.

Health plans, like other organizations greatly impacted by changes in the political arena,
must decide whether it makes good economic, legal, and ethical sense to be involved in
financing campaigns for public office. Those that choose to participate have a number of
options. The more limited level of participation is to encourage employees to contribute
to already-existing PACs, or to encourage employees to donate to a particular candidate
or set of candidates deemed to be supportive of the organization’s interests. Greater
involvement might take the form of establishing a PAC for employees’ contributions.
Even greater involvement might involve soliciting outside the organization for
contributions to the PAC (to such groups as the organization’s vendors), or to use
corporate or individual funds to support soft-money efforts.

The importance of a health plan’s employees in the legislative process is often

overlooked. As mentioned above, employees are frequently encouraged to participate in
the legislative process by contributing to PACs and/or by writing letters to their
representatives to support the health plan’s positions on policy issues. Many health

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plans invest a considerable amount of time and resources to educate their employees
about the policy issues that impact their business.

Litigation
Most discussions about public policy revolve around the executive and legislative
branches of government. However, the judiciary also plays an important role in the
public policy process.

Litigation has both a direct and an indirect impact on public policy. Direct impact can be
seen in the changes in law brought about by appellate court rulings on sub-stantive
issues. Indirect impact can be seen when litigation or the threat of litigation influences
public officials’ decisions about public policy development and/or implementation.

One of the central functions of courts is to interpret the laws approved by the legislature.
An additional function for courts is to test laws against the standard of the federal and
state constitutions. Because legislation often deals with broad concepts instead of the
details required for implementation, courts have had the task of interpreting the policy
intended to be contained in legislation.

Where statutes are vague or too sparsely written, the courts must work especially hard.
For example, the ERISA preemption clause gives rise to much court involvement in
interpretation of ERISA. As we have seen, the preemption does not apply to “any law of
any State which regulates insurance.” The question of “what constitutes the business of
20

insurance” defines the boundary between whether state insurance laws or federal laws
under ERISA apply to the particular case. The courts, almost exclusively, have dealt with
this question with little or no help from Congress.

Shaping Public Opinion

Public opinion is one of the more potent influences on policymaking. However, as we
saw at the beginning of this lesson, public understanding of many healthcare issues is
sometimes low, at least in the view of many policymakers and academics.For example,
public support for the Clinton administration’s failed healthcare reform plan dropped from
a high of 59 percent in September 1993 to 43 percent in April 1994, a 16-point drop in
only six months. While members of the public may not have been particularly well
21

informed on the details of the plan, it is undeniable that this collapse of support
contributed to the political failure to act.

There are two basic approaches to lobbying through the vehicle known as public
opinion: grassroots lobbying and media relations. A grassroots lobbying campaign
includes a set of activities designed to encourage people or entities who share that same
“desired” public opinion to contact key decision makers and voice their support for the
opinion. In many instances, the “desired” public opinion is representative of the actual
majority public opinion on an issue. Media relations, on the other hand, involve a direct
effort to change public opinion through the vehicle of a wide variety of media, both paid
and free.

There is an important distinction between these two concepts. While grassroots lobbying
campaigns may have an impact on public opinion, those efforts are generally designed
to give exposure to a public opinion that may or may not reflect the actual majority
opinion on an issue. However, interest groups can broaden their efforts beyond

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straightforward grassroots tactics to try to influence public opinion at large. For the most
part, this broader approach involves the use of mass media.

In a grassroots lobbying campaign, an organization has a number of potential sources of

sympathetic individuals to tap. They include the organization’s employees, vendors,
customers, business partners, and other stakeholders. In the case of a health plan, the
array of potential contacts includes not only the company’s employees and vendors, but
that part of the provider network that might be favorably inclined toward the health plan
side of policy issues (e.g., primary care providers) and members and insureds of the
health plan.

Grassroots efforts involve a variety of techniques. Direct mail, telephone banks,

announcements in company literature, advertisements in the popular press are all
means of attempting to mobilize grassroots activity. The activity that the health plan
wants to mobilize might be related to specific policy issue (e.g., “call your legislators
today and tell them to vote no Senator Smith’s anti-health plan bill”) or to more general
issue (e.g., “call your legislators today and tell them to draw the on all the anti-health
plan legislation pending the legislature”). A grassroots campaign may target all
employees, or all vendors, or may be more narrowly targeted geographically to focus
resources on a few legislators (e.g., health committee chairpersons), depending on the
organization’s available resources.

If there is time and money to do so, ambitious health plan or association might try sway
public opinion. This is a difficult thing to do once people have made up their minds on an
issue. However, on many issues, public’s level of awareness of, understanding of, or
involvement with the issue is low that there is still an opportunity to move public opinion.
Under the best of circumstances, such an effort involves a significant expenditure of time
and money.

Review Question

The following answer choices describe various approaches that a health plan can take to
voice its opinions on legislation. Select the answer choice that best describes a health
plan's use of grassroots lobbying.

The Delancey Health Plan is launching a media campaign in an effort to persuade

the public that proposed health care legislation will increase the cost of healthcare.
The Stellar Health Plan is using direct mail and telephone calls to encourage
people who support a patient rights bill to contact key legislators and voice their
support for the bill.
The Bestway Health Plan is encouraging its employees to contribute to a political
action committee (PAC) that is funding the political campaign of a pro-health plan
candidate.
A representative of the Palmer Health Plan is attending a one-on-one meeting with
a legislator to present Palmer's position on pending managed care legislation.

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Incorrect. Public opinion lobbying can be done through grassroots lobbying, or

media relations. Media relations goes beyond grassroots lobbying by trying to
influence public opinion at large.

Correct. A grassroots lobby campaign includes a set of activities designed to

encourage people or entities that share the same desired public opinion to
contact key decision makers and voice their support for their opinion.

Incorrect. PAC donations are used by health plans to donate money to canditate's
campaigns, where those canditates are deemed to be supportive of of the
organization's interests.

Incorrect. Health plans use lobbyists to meet with legislators to present the health
plan's position on pending legislation.

Traditionally, media relations are divided into “paid media” and “free media.” Paid media
or advertising is any form of promotion or media exposure that is generated and
controlled by a paying sponsor and presented by the mass media. The most famous use
of paid media in connection with healthcare policy is the campaign featuring a fictional
couple known as “Harry and Louise.” This couple’s concerned chats over the breakfast
table about their objections to the Clinton administration’s healthcare reform effort of
1993 and 1994 have been credited with a substantial portion of the decline in public
support for the proposal.

Free media or publicity is any form of promotion or media exposure that is transmitted
by the mass media but is not directly generated, controlled, and paid for by a sponsor.
Free media campaigns involve using the media to persuade the public. The tools of such
campaigns are news releases, news conferences, speeches covered by the media,
media “events” such as protests or demonstrations, and visits with the editorial boards of
media organizations. The use of “free” is a misnomer in the sense that such campaigns
can involve substantial amounts of time and money. Nevertheless, they are generally
only a fraction of the cost of paid media campaigns.

One advantage of free media over paid media is that of credibility. While Americans may
have an inherent suspicion of such obviously self-interested modes of communications
as paid advertising, they are less suspicious of information delivered through
presumably independent third parties such as journalists. The chief disadvantage of free
media, on the other hand, is that the organization has substantially less control over the
content of the message.

Like other forms of communications efforts, paid and free media campaigns can be
made more efficient through the use of public opinion polling, focus groups, and
targeting. Through polls and focus groups, media professionals are increasingly
proficient at identifying the themes that will be most persuasive to the target public—the
so-called “magic bullet” themes that may make the difference in public opinion.

Targeting subsets of the population can also improve the efficiency of the media
campaign. Such targeting can be geographically based, focusing on important legislative
districts or media markets. An alternative targeting method is demographically based,
allowing certain “narrow-band” messages to be delivered to certain audiences. For

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example, if a specific message is more effective for certain age, gender, or

socioeconomic groups, advances in direct mail now allow organizations to deliver that
message only to the receptive group.

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Chapter 13 B
Changing Environment and Emerging Trends in Health
Plans
In Environmental Forces, we examined the current environment in health plans and the
ways that health plans respond to the many challenges and opportunities in their
environment. In the assignments that followed, we addressed topics such as formation
and evolution of health plans, regulations, government programs, governance of health
plans, key legal issues, and public policy. In our last lesson, we focus exclusively on
changes and emerging trends. We begin with a look at the overall environment within
which all healthcare organizations, including health plans, must operate, and we
examine some of the underlying tensions that drive change in health plans. We then look
at recent events in healthcare reform and provide an overview of emerging trends.

After completing this lesson, you should be able to:

 Identify several key environmental factors that affect health plans

 Describe the underlying tension between universal healthcare coverage and
comprehensive healthcare benefits
 Explain how marketplace reform and regulatory reform have brought about change in
the health plan industry

Changing Environment and Underlying Tensions in Health Plans

Healthcare is inextricably woven into the economic and social fabric of the United States,
and over the past several years health plans have played an increasingly important role
in healthcare. It stands to reason, then, that changes in society will affect the health plan
industry, and vice versa.

In this lesson, we look at some of the overriding factors and underlying tensions that are
driving change in the environment in which health plans operate.

Demographics Aging Population

The cost of providing healthcare for the aging population is exerting considerable
financial pressure on America’s healthcare system. According to the Bureau of Labor
Statistics,
A major component of spending among the elderly is for health care. In general,
those age 75 and older are presumably at the greatest risk for incurring health
care costs. The overall increase in real total health care expenditures from 1984
to 1995 is much higher for older consumers than for younger ones. For example:
the overall increase in real total health care expenditures from 1984 to 1995 is
much higher for older consumers than for younger ones. Expenditures rose
about 8% for the younger group, while the older groups each increased their
health care expenditures by more than 20%.

Between 1984 and 1986, shares for health insurance for all groups decreased.
They then began to increase and have done so more or less continuously…. The
rate of increase in the share for the oldest group (75 and older) has been steeper
than for the 65- to 74-year-old group in the last few years. 1

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Many health plans, which now have a relatively high percentage of younger, healthier
members, will face rising healthcare costs as their membership ages. The Medicare
program will have to address an even greater challenge, since it will not only have to
provide coverage for an aging population, but will have to do so with a decreasing tax
base because of the lower birthrate in the “post-baby boom” generation.

The aging population and the American Association of Retired Persons (AARP) will have
a lot to say in the healthcare policy debate. As the “baby boomers” encounter the
inevitable health problems associated with aging, they are likely to focus intently on
healthcare as a public policy issue. With their economic and political power, this group
will be a key participant in the public dialogue that shapes the future of healthcare.

Fast Fact

By 2030, the proportion of people over age 65 will reach 20% of the population, up from
13% today, and the 85- and-older group will be the fastest growing segment of the
population. 2

Diversity
As minority and immigrant populations continue to make up a greater percentage of the
U.S. population, racial and ethnic diversity will present an increasing challenge for health
plans. Because racial and ethnic groups sometimes have unique sets of health factors,
medical conditions, and healthcare access issues, successful health plans will need to
develop “cultural competency” to recognize and respond to an increasingly complex
variety of member needs. In addition, health plans, in their role as employers, will have
to address the cultural and language issues associated with employing a diverse
workforce.

The Role of Women

For a number of reasons, women are likely to become an increasingly important
constituency for health plans. Because women as a group have a higher incidence of
illness and a longer life span than men, they receive more healthcare and interact more
often with health plans over the course of a lifetime. Women are also more likely than
men to coordinate healthcare for other family members. Also, because large numbers of
women have entered the workforce during the past two decades, a greater percentage
of the subscribers in employee group health plans are women. These demographic
factors indicate that health plans, as part of their efforts to compete effectively, are likely
to focus more of their marketing, customer service, and healthcare efforts on women.

Review Question

Health plans should monitor changes in the environment and emerging trends, because
changes in society will affect the managed care industry. One true statement regarding
recent changes in the environment in which health plans operate is that

women as a group receive more healthcare and interact more often with health
plans than do men over the course of a lifetime

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the focus of healthcare during the past decade has shifted away from outpatient
care to inpatient hospital treatment
the uninsured population in the United States has been decreasing in recent years
the decline in overall inflation in the 1990s failed to slow the growth in healthcare
inflation

Correct. Women, as a group, have a higher incidence of illness and a longer life
span than men, and are more lkely than men to coordinate healthcare for other
family members.

Incorrect. The focus of healthcare has shifted from inpatient to outpatient care

Incorrect. The uninsured population has continued to increase in recent years

Incorrect. The decline in overall inflation in the 1990s has contributed to an

impressive reduction in healthcare inflation.

Consumer Attitudes
Since most health plans operate in the group market, in the past they looked upon the
employer as their primary customer. Recently, however, health plans have begun to pay
closer attention to the individual consumer. The focus has shifted, in part, because
health plans need to educate a large number of individuals who are new to health plans
and unfamiliar with network protocols, such as PCP authorizations, referrals, and
emergency procedures. However, as we pointed out in Environmental Forces, this shift
in focus is also due to the growing influence of consumerism among plan members,
legislators and regulators, and public interest groups.

Members now expect more from their healthcare providers and their health plans. In
response, health plans, policymakers and the government agencies that regulate health
plans have tried to anticipate and address consumer needs and concerns. Health plans
are developing member material that is easier to read and understand. They are
emphasizing excellent customer service to assure that questions are answered quickly
and correctly and that appropriate action is taken on member requests. Like other
businesses, the health plan industry increasingly refers to “delighting the customer” by
providing responsive service, high quality, and competitive prices.

On the legislative and regulatory front, a large number of laws and regulations have
been proposed and enacted in the name of consumer, member, and patient satisfaction
and rights. Government agencies have established consumer “hotlines,” which members
can call to register complaints and ask questions. Government programs, such as
Medicare, are making a concerted effort to improve beneficiary education and
communication.

Public interest groups and the media have also focused on consumerism in healthcare.
Some consumer “watchdog groups” have made healthcare a top priority in their
advocacy efforts. Several periodicals now evaluate and rank hospitals and health plans
on a variety of consumer-oriented criteria.

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In the future, health plans will continue to be challenged by the increasing influence of
consumerism and the importance of adjusting products and services to meet the needs
of the individual healthcare consumer. Insight 13B-1 illustrates how some of these trends
are taking shape.

Insight 13B-1. A Consumer “Voice” Will Drive Health Plans as a Service Industry.

Consumers have a growing influence on the healthcare industry, according to a study by

KPMG Peat Marwick. Furthermore, consumer satisfaction and preferences drive product
design, development, and innovation.

“New Voices: Consumerism in Healthcare” examines the impact of consumers on the

healthcare industry and the industry’s response. Eighty-three percent of healthcare
executives in all segments of the industry “agreed” or “strongly agreed” that consumers
influence the policy, strategy, operations, and investment decisions of healthcare
organizations.

“While health plan companies still view large employers as their primary customers, they
are more often looking to reach out to individual consumers to pull them through the
system,” says Richard A. D’Amaro, national managing partner, healthcare, at KPMG
Peat Marwick.

“The growth of ‘choice-enhancing’ products such as point-of-service plans is a direct

manifestation of this, as are the growth in consumer- focused advertising, interactive
websites, and health information services,” he adds.

Consumerism in many ways is the root cause of much of the regulation or pending
regulation that has and will continue to impact health plans, such as 48-hour maternity-
stay requirements, antigag- rule regulations and, perhaps most visibly, the Patient Bill of
Rights.

In touch with consumers. Virtually all of the healthcare organizations surveyed will
increase investments in feedback mechanisms to assure they are “in touch” with
consumer needs. For example:

1. 99% of the healthcare organizations responding referred to new services as

indications of consumer influence, including facility renovations, improved
patient access, and new informational/ educational services.
2. 95.7% of organizations responding have at least one patient satisfaction initiative.
3. 72.9% report going beyond conventional patient feedback mechanisms, such as
questionnaires, patient and member surveys, and toll-free numbers.

“Health plan companies cannot be held exempt from a movement that is sweeping every
other sector of the economy,” D’Amaro says. “For years, many health plans and
providers operated under the premise that simple customer service could be sacrificed as
long as the medical care was good. Now they are realizing that both are required to
maintain retention and customer loyalty.”

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Most health plan companies are starting only now to make organizational and operational
changes to address these problems, according to D’Amaro. These changes, most of which
already have been implemented in other service industries, include empowering front-line
workers, providing more detailed and meaningful customer service training, linking
everyone’s compensation to customer service, and undertaking more rigorous hiring and
recruiting to identify people who are more apt to be successful in a “customerinterface”
position.

“The lessons that health plan can learn from other service industries should have
tremendous benefit,” he says.
COPYRIGHT NOTICE:
Reproduced with permission of the publisher, from Tracey Walker, “Health Maintenance Organizations Can Run, But They Can’t Hide: A
Consumer ‘Voice’ Will Drive Health Plan as a Service Industry,” Managed Healthcare, (Vol. 8, Number 3, March 1998), pp. 13, 15. Copyright
by Advanstar Communications Inc. Advanstar Communications Inc. retains all rights to this material.

The Economy
Healthcare and the health of the economy are closely interrelated. The decline in overall
inflation in the 1990s has contributed to the impressive reduction in healthcare inflation,
while the success of health plans in controlling runaway healthcare costs has contributed
significantly to lowering the overall inflation rate and improving the economy. Simply
stated, changes in the economy are bound to affect the healthcare industry, and
changes in the healthcare industry are bound to affect the economy.

One way to view the impact healthcare has on the economy is to look at it from the
employer/industry perspective. Since a large percentage of the healthcare bills are paid
by employers, a rise or decline in the cost of healthcare can affect the wages paid by
employers, which impacts the ability of most Americans to make purchases. Also, a
change in the cost of healthcare can impact the cost of producing products and providing
services, which in turn affects prices. In a global marketplace, where many competitors
are not funding employee healthcare coverage, the cost of healthcare is a critical
competitive issue for U.S. employers.

Fast Fact

The United States has “the most costly health delivery system in the world. Health care
consumes 14% of the gross domestic product, or almost oneseventh of the nation’s
output, a percentage that has remained unchanged for four years.” 3

Growth in the nation’s healthcare spending reached a 37-year low in 1996. 4

Healthcare inflation during the past few years has been as low as it has been in
decades, but there are signs that prices may not hold much longer. During the past
several years, as health plans have replaced traditional fee-for-service insurance, it has
achieved significant cost reductions. Recently, however, factors such as advances in
medical and pharmaceutical treatments, increased competition among health plans,
benefit mandates, and consumer and purchaser demand for better benefits and greater
choice in providers have led to reduced profits and even significant losses for many
health plans. These factors combine to create price pressures on the cost of healthcare
and healthcare coverage.

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Advances in Information Management

Information management is critical to an health plan’s ability to operate effectively. It can
be used to improve functions as diverse as maintaining eligibility lists, authorizing
medical procedures, paying member and provider claims, issuing contracts, measuring
customer service and satisfaction, analyzing medical outcomes, and monitoring medical
and administrative costs. Information management can be used to improve a health
plan’s ability to meet the demands of purchasers, consumers, regulators, and accrediting
agencies, all of which require accurate information about quality, cost, responsiveness,
and customer satisfaction to help evaluate health plans. In fact, “Of all the truths that
have emerged from managed care’s evolution in recent years, one clearly stands out:
Information management has moved from the basement to the boardroom. The ability of
health plans to manage this strategic resource is fast becoming a fundamental driver of
care quality and industry performance.” 5

Unfortunately, because technology typically changes faster than laws, there is often a
period of time during which existing regulations do not address issues that arise as a
result of new technologies. Therefore, as health plans employ the latest information
management tools to maintain a competitive edge, they must be well versed in the
associated regulatory and liability issues.

A case in point is the increased use by health plans of electronic data interchange
(EDI), which is the computer-to-computer exchange of data between two or more
organizations. Although health plans must comply with all applicable federal and state
regulations regarding privacy, specific compliance issues may not always be clear
because most existing privacy laws address presentation in the paper medium, but do
not yet address the specific intricacies of EDI.

Changes in the Practice of Medicine

The practice of medicine is changing at an amazing rate. For example, researchers are
developing new types of imaging technology for diagnostic use, improving laser and
radio-frequency technology for surgery, producing new drugs, and making advances in
genetics that could lead to enhanced diagnosis and treatment capabilities. This rapid
rate of change presents a variety of challenges for health plans, purchasers, regulators,
and society as a whole.

In the United States, we sometimes take for granted the availability of state-of-the-art
medical treatments, but since most advances come with a high price tag, they exert
considerable cost pressures on the financing and delivery of healthcare. As we have
seen, healthcare inflation has a negative impact on the overall economy, and high costs
make it difficult or impossible for some purchasers and consumers to obtain healthcare
coverage.

Advances in medicine present non-economic dilemmas as well. For instance, when

researchers develop a promising new treatment for a life-threatening illness, health
plans, purchasers, and regulators face intense public pressure to immediately begin
paying for the treatment, regardless of whether it has been proven to be safe and
effective.

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Health plans and regulators often have to scramble to keep up with changes in medical
technology, as was demonstrated by the debate over coverage for treatment of
impotency using the prescription drug Viagra. Another example of the impact of
advances in medical technology was when the medical community began to use high-
dose chemotherapy and autologous bone marrow transplants (ABMT) as a method for
treating cancer. Some state insurance departments struggled to develop regulatory
requirements to effectively address this complex medical issue. Florida, for example,
convened a statewide task force to decide questions about the medical appropriateness
of ABMT for specific types of cancer. Health plans had to contend with these same
issues.

Advances in medical technology also raise ethical issues. Medical practitioners

sometimes use extraordinary measures to keep patients alive. The cost of these life-
prolonging procedures is often enormous, and some analysts contend that healthcare
dollars would be better spent on patients who are more likely to survive.

The practice of medicine is also changing due to the influence of health plans. For
instance, during the past decade, the focus of healthcare has shifted away from inpatient
hospital treatment to outpatient care and demand management, in which the patient
obtains decision-making information, designed to reduce the overall need for healthcare
services.

Review Question

One example of health plan's influence on the practice of medicine is that, during the
past decade, the focus of healthcare has moved toward __________________, which is
designed to reduce the overall need for healthcare services by providing patients with
decision-making information.

demand management
managed competition
comprehensive coverage
private inurement

Correct. Demand management is when the patient obtains decision-making

information designed to reduce the overall need for healthcare services.

Incorrect. Managed competititon tries to keep healthcare coverage largely in the

private sector to achieve the benefits and efficiencies of marketplace
competititon.

Incorrect. Universal coverage provides healthcare benefits to the entire population

Incorrect. Private inurement is the net earnings of a not-for-profit organization that
go to the benfefit of a private individual.

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Role of the Media

According to a survey conducted by the Kaiser Family Foundation, media coverage of
health plans increased sevenfold during the period from 1990 through mid- 1997, while
the media’s portrayal of HMOs and the health plan industry became increasingly
negative.

The increasingly negative coverage has contributed to an explosion of proposed and

enacted legislation at the state and federal level to regulate health plans. Along with this
increase in legislative activity has come an increase in media coverage of legislative
activity. The Kaiser Family Foundation survey indicated that in 1990 only 3% of health
plan stories in the media covered regulatory issues, but the number jumped to 16% by
mid-1997.

Universal Coverage vs. Comprehensive Healthcare Benefits

Some people might describe the “ideal” healthcare system as one that provides both
universal coverage and comprehensive healthcare benefits. In other words, it would
protect the entire population (universal coverage) and give all individuals complete
choice of healthcare practitioners and facilities, while providing full, unlimited benefits for
every medical condition and every type of service or supply that patients and providers
deem necessary (comprehensive healthcare benefits). However, the purchasers and
taxpayers who pay for healthcare in America would likely be reluctant to finance such a
system.

Today the majority of Americans have some form of healthcare coverage, through
individual policies, group plans, or public health programs. However, 42 million
Americans do not have healthcare coverage.

With the rise in healthcare costs, many employers are now requiring their employees to
pay a larger percentage of group healthcare premiums. A number of employees, who
can’t afford the contributions or don’t think they need coverage, are choosing not to
participate. Americans often do not obtain individual coverage because they can’t afford
the premiums. As a result, many Americans tend to seek coverage only when they are
seriously ill or expecting a serious illness, driving the cost of healthcare coverage even
higher.

Even if policymakers were to agree that healthcare coverage should be provided to all
Americans, they would have to determine a system for achieving that goal. The
alternatives proposed so far are controversial. Greater coverage could be achieved
through an employer-sponsored system, such as the one in place now, by mandating
that all employers provide coverage. This approach, however, would leave many of the
unemployed without coverage. Another option would be to implement a national
program, such as Medicare, for all Americans. Recently, some analysts have proposed
an individual voucher system for healthcare. Beyond this, policymakers would have to
agree on whether to mandate a minimum level of benefits. If benefits were not sufficient,
all Americans might be eligible but coverage for many of their medical conditions would
be limited or excluded. On the other hand, with comprehensive healthcare benefits, the
cost of providing healthcare to all Americans might be prohibitive. Since there are only
so many dollars available to pay for healthcare, a key issue in the public policy debate is
to determine how those funds will be spent. Over the years, this underlying tension

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between the desire for universal coverage and the desire for comprehensive healthcare
benefits has been behind many legislative initiatives, such as Medicare, Medicaid,
HIPAA, and SCHIP.

Regulatory Reform vs. Marketplace Reform

Proponents of increased regulation contend that the business of health plans and
insurance is a business affected with a public interest. In other words, “insurance is of
such importance to so many people that it is in the public interest to enact whatever laws
are necessary to assure that the great trust vested in insurers is not abused.” 7

These analysts contend that the rapid rate of change in the industry requires new
regulations to oversee evolving entities and practices, and to ensure fairness and
adequate access to healthcare coverage for all Americans.

Few, if any, analysts would argue that managed care should be completely free of
regulation. However, proponents of marketplace reform argue that too much regulation
hampers competition and makes it difficult for businesses to operate efficiently. In a
competitive environment, these analysts contend, the health plans that are most capable
of providing high quality and competitively priced services will find ways to do so. 8

Often the goals of regulators and the managed care industry are the same, but the
industry believes it can attain these goals voluntarily. Industry advocates maintain that
new mandates and the diversity of mandates among the state and the federal
governments often have unintended consequences, placing a cumulative burden on
health plans by stifling innovation, causing confusion and delays in service, and
increasing medical, administrative, and compliance costs. Also, proponents of less
regulation point to federal and state agencies that have recognized the success of
managed care innovation in managing healthcare costs and improving quality, and have
turned to the private sector to improve government- sponsored programs, such as
Medicare, Medicaid, workers’ compensation/ programs, and coverage for government
employees. Insight 13B-2 describes the “blend” of regulatory and marketplace influence
that makes up the healthcare system in the United States today.

Insight 13B-2. Healthcare in America.

Back in 1960, nearly one of every two dollars spent on health care (49.2 percent) came
from the pockets of private individuals. Doctors charged higher fees to patients who
could afford it and lower fees to those who couldn’t. As a nation, we could have
continued this direct economic relationship between doctor and patient. Or we could have
adopted an insurance system with large deductibles and copayments, meant to protect
against “catastrophic” medical expenses.

Instead, we built a system of relatively generous private and public insurance. One
compelling reason was that this type of insurance encouraged the spread of lifesaving but
expensive medical innovations.

By 1993, total health care expenditures were 33 times their level in 1960, but less than
one dollar in five (17.8 percent) came from private pockets. (These figures come from the
Congressional Budget Office and the Centers for Medicare and Medicaid Services.)

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At some point we might have phased out most private health insurance and instituted a
nationalized system such as those of almost all other Western nations. Medicare and
Medicaid could have been (as many expected) the first step towards comprehensive,
government- financed health coverage.

But, again, we did not take that route, nor did we embrace the private- public solution
—“managed competition”—proposed by the Clinton administration.

What we as a nation have chosen, instead, is to let the marketplace determine the shape of
our health care system. To be sure, there is still state regulation of insurance companies,
both from a fiscal and consumer-rights perspective. Nonetheless, the present system is
neither as neat and centralized, nor as political and bureaucratic, as a federally directed
solution would be. It is a kind of “unmanaged” competition. Unlike a “single-payer”
system, in which one organization has responsibility for all medical spending, hundreds
of health plans do much the same thing on a smaller scale for their own members.
Source: Michael L. Millenson, The New American Health System (Washington, DC: American Association of Health Plans, 1997), 19.

Federal vs. State Regulation

Although the authority for regulating insurance rests with the federal government, the
McCarran-Ferguson Act gives states the authority to regulate insurance as long as
Congress considers regulation to be adequate and in the public interest. “By leaving the
door open to federal oversight of insurance, the McCarran-Ferguson Act created a
certain tension between the federal and state governments. The Act gives the states an
incentive to oversee the insurance industry adequately and fairly; that incentive is the
threat of federal legislation. Thus, historically, when specific concerns have been raised
about state regulation of industry practices, the states have increased their efforts to
regulate in the areas affected by those concerns. As a result, the regulation of insurance
continues to reside with the states, but that situation could change at any time.” 9

From the time the McCarran-Ferguson Act became effective in 1945, Congress has
enacted a growing body of legislation to regulate healthcare coverage. Also, the topic of
sweeping national healthcare reform is almost always on the agendas of at least a
handful of federal legislators, and at times it has received considerable attention.

Insight 13B-3 presents arguments in favor of comprehensive federal regulation and in

favor of continued state regulation.

Insight 13B-3. Federal vs. State Regulation of Healthcare Coverage.

Why Federal Regulation?

People have a variety of reasons for wanting to shift the regulation of healthcare coverage
to the federal government. A reason that has been stated for many years is that federal
regulation would result in uniformity. Health plans would no longer be required to
comply with laws that vary from state to state, and consumers in all states would have the
same legal rights and the same access to quality medical services at an affordable price.

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The increasing complexity of the healthcare industry has led some people to support
federal regulation.

The healthcare industry today is characterized by intense competition. health plans must
find new ways to attract and satisfy customers and bolster profits. Some companies have
increased the amount of risk they are willing to take in order to meet their objectives. The
increased risk causes some people to worry that these companies either will not be able to
pay benefits when due or will not be able to stay in business. Many companies have
undertaken efforts to cut costs, often resulting in the downsizing of their operations. The
industry has seen a flurry of mergers and acquisitions between companies seeking to
improve their solvency and profitability. All of this activity has led some to conclude that
the states are unable to effectively regulate the solvency of an industry undergoing this
level of change.

Why State Regulation?

Proponents of state regulation believe that the states have been relatively effective in
regulating the insurance and health plan industries, and that federal regulation is not
always in the public interest. The states have many years of experience in overseeing
insurance.

The states continue to respond to the changing environment in which the industry
operates by escalating their regulatory efforts. For example, the NAIC is now taking a
more active role in encouraging states to enact laws based on NAIC model bills. Risk-
based capital requirements have strengthened the states’ ability to make sure that insurers
and health plans remain solvent. State regulators are also placing increasing emphasis on
market conduct examinations.
Source: Excerpted and adapted from Harriett E. Jones, Regulatory Compliance: Companies, Producers, and Operations (Atlanta: LOMA, ©
1998), 10–11. Used with permission; all rights reserved.

Recent Events and Emerging Trends in the Health Plan Environment

In the early 1990s, healthcare premiums had been rising for years and healthcare
inflation seemed to be a problem that might never be solved. The federal budget and
most state budgets were running deficits, and many Americans lacked confidence in the
U.S. economy. In this climate of economic uncertainty, healthcare became an important
“security” issue for many voters, worried that if they lost their jobs they would have no
coverage. Against this backdrop, national healthcare reform became a high-profile issue,
but then faded. Seemingly overnight, health plans came to prominence. Meanwhile,
incremental reform continued in the marketplace and in state legislatures, and soon
emerged again at the federal level in the form of new and proposed regulations. Today
most experts agree that the American healthcare system is in the midst of significant
change (some would say revolution); however, there is no consensus on where this
change will lead.

National Healthcare Reform

In 1993, the Clinton administration proposed a national system of managed
competition to address the issues of rising medical costs, the uninsured, and the quality
of healthcare. The goal of managed competition is to keep healthcare coverage largely
in the private sector to achieve the benefits and efficiencies of marketplace competition.

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However, to ensure consistency, fairness, and effective communication, this competitive

environment is “managed” by the government or a government- sponsored entity, similar
to the way the market is managed in states that sponsor small group purchasing
coalitions (see Other Laws that Apply to Health Plans).

Recognizing the successes of health plans in the marketplace, the Clinton proposal
relied heavily upon the participation and innovation of health plans. As a result, managed
care received a great deal of attention, and “[w]ith health reform seemingly inevitable,
enrollment in HMOs and other managed care plans surged. HMOs alone added more
than seven million new members between July 1, 1994 and July 1, 1995, a record
increase.” Yet, around the time that managed care enrollments were soaring,
10

Americans made it clear that they did not intend to support national healthcare reform.
Why? Although, there are rarely simple answers to complex policy issues, analysts point
to several key factors:

• When it became apparent that there were no easy solutions to obtaining

universal coverage, Americans chose to keep the status quo
• Americans were worried about placing their healthcare coverage in the hands of
a federal bureaucracy
• As the economy improved and managed care reined in healthcare inflation,
Americans were less concerned about losing healthcare
• Americans were worried their choice of providers might be restricted

Although the Clinton administration’s proposal for national healthcare reform was never
sent to Congress, it did succeed in placing healthcare issues in the public spotlight. As
the next round of the public policy debate began, the healthcare landscape was in the
process of changing in three significant ways: (1) healthcare inflation was coming under
control, (2) health plans were replacing fee-for-service as the main system for financing
and administering coverage, and (3) purchasers were becoming more informed and
aggressive in their approach to obtaining healthcare coverage. Increasingly, the
successes and shortcomings of the American healthcare system became, in the eyes of
much of the American public and many politicians, the successes and shortcomings of
health plans. This was the beginning of what some analysts call the health plan
“backlash.”

The Health Plan “Backlash”

In some ways, health plans became a victim of their own success. Once consumers,
purchasers, policymakers, and other healthcare players were no longer occupied with
the problem of rising costs, they started to focus on other problems, many of which were
laid at the doorstep of health plans. Several of the factors that contributed to this health
plan “backlash” are listed below. Some of these factors had also contributed to the
rejection of managed competition, while others were unique to managed care:

• Members became concerned about losing their ability to choose providers and
the procedures covered by their plans, as employers increasingly switched from
indemnity to managed care plans.

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• Doctors and hospitals were concerned about the increasing number of patients
covered by health plans and the potential for reduced income as a result of
reimbursement agreements with health plans.
• Hospitals were concerned about losing inpatient revenues due to an increased
focus on outpatient care.
• Specialists were concerned about fewer referrals as a result of tighter utilization
review procedures.
• Primary care doctors were concerned that they would lose their autonomy if they
participated in health plans.
• The media—picking up on anecdotal complaints from patients, consumers,
consumer groups, providers, and their lobbyists—started to focus on concerns
with (rather than benefits of) health plans.
• Politicians began proposing legislation to address concerns they were hearing
from constituents, lobbyists, and the media.

Marketplace Reform
Although large-scale national healthcare reform was dormant, incremental reform
continued in the marketplace, as managed care evolved as the predominant system for
healthcare financing and delivery. Health plans, competing on cost and quality, quickly
replaced most of the fee-for-service healthcare business in the commercial market.

Health plans also made impressive gains with health plans that covered state and
federal government employees, and with government purchasing programs, such as
Medicaid and Medicare. The cost of healthcare coverage remained level, and
competition among health plans became more intense. Increased competition drove
health plans to seek new ways to attract and retain purchasers and consumers. Before
long, health plans were providing plan features such as outof- network options and direct
access to specialists, and they were providing more flexibility with regard to the number
and types of healthcare providers available within their networks.

As we noted in Formation and Structure of Health Plans, the participants in the health
plan marketplace also changed dramatically. Large health plans moved quickly into new
markets, often establishing a local or regional presence by merging with or acquiring
other health plans. New competitors, such as physician practice management
companies, appeared seemingly out of nowhere and became major players, due in part
to large capital infusions from the stock market. Employers became more informed and
aggressive in their negotiations with health plans, focusing increasingly on measurement
and quality issues and applying vendor management techniques to their purchasing
decisions.

In some mature health plan markets, employers even formed purchasing coalitions to
contract directly with providers. Accreditation organizations, which for years were part of
the healthcare marketplace, became an important participant in the health plan industry
and a way for purchasers to determine the quality of health plans. More recently, some
states have turned to accreditation organizations for regulatory purposes.

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Regulatory Reform
Reform continued in state legislatures in an explosion of healthcare legislation. From
1994 through 1996 more than a thousand bills to regulate health plans were introduced
into state legislatures, and many were enacted into law. States initiated special task
11

forces to investigate problems in healthcare and to recommend solutions. At the federal

level, the President appointed an advisory commission out of which came a Consumer
Bill of Rights and Responsibilities, which now applies to all federal employee healthcare
plans (such as FEHBP and CHAMPUS) and to federal healthcare programs (such as
Medicare). Congress passed HIPAA, MHPA, NMHPA, and SCHIP all of which seek to
reform particular aspects of healthcare coverage. In addition, numerous proposals have
been introduced or proposed by federal legislators.

Recently, Congress’ focus has been on providing coverage for specific segments of the
population, such as uninsured children (SCHIP) or individuals who are between jobs
(HIPAA). These laws outline general requirements and authorize a federal agency to
establish specific national standards. However, rather than preempt state law, these
federal laws have established national standards as a “baseline” and given each state
the option to decide whether to (1) defer regulation to the federal government, (2)
enforce the federal standards themselves, or (3) develop their own standards, using the
federal standards as a foundation. In the case of HIPAA, over forty states elected the
third option (the “acceptable alternative mechanism”) to avoid transferring state authority
to the federal government.

Legislators and policymakers are also looking closely at ERISA. Those who contend that
ERISA should be amended point out that it “is a law enacted before the advent of health
plans and is being used by the courts in a way Congress never intended.” Proponents
12

of change argue that ERISA does not go far enough to protect the rights of members
and patients. They point out that ERISA’s disclosure requirements apply to the
relationship between members and employers, not health plans.

Also, although ERISA requires health plan sponsors to act solely in the interest of their
employees, many analysts contend that this fiduciary duty is weakly enforced. In
addition, under ERISA, plaintiffs who challenge benefit denials must meet a far more
stringent standard to demonstrate harm than plaintiffs in most other types of civil cases.
Perhaps the most contentious issue with ERISA is that it generally does not allow
patients to recover punitive or compensatory damages.

Those who contend that ERISA should not be amended point out that ERISA “has
played a key role in making health care coverage available to millions of Americans.” 13

These analysts point out that the American healthcare system is based largely on
employer-sponsored benefit plans. The premise of ERISA, they argue, is that employers
voluntarily sponsor benefit plans for their employees in exchange for limiting the
employer’s risk to whatever benefits should have been provided.

If this protection is removed, then employers will be less inclined to provide coverage for
their employees. In addition, ERISA’s defenders point out that this federal law allows
multistate employers to provide uniform benefits to their employees through self-funded
plans that are exempt from state benefit mandates. ERISA’s defenders argue that
weakening the law would do nothing to improve the quality of healthcare, it would only
encourage costly lawsuits, increase the cost of healthcare, and reduce the number of

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Americans able to afford coverage, all for the financial benefit of a small number of
plaintiffs and their attorneys. They contend that a major restructuring of ERISA would
endanger America’s employer-based healthcare system that provides coverage to the
majority of the population.

One key element that has largely been missing from the recent round of proposed
legislation and enacted laws is any attempt to address the cost of healthcare.
“Unfortunately, much of the public believes that more care equals better care. Yet health
plans cannot just loosen cost controls, because the public is not prepared to accept the
fiscal consequences of its demands, that is, higher taxes, higher health insurance
premiums, or lower wages. Given global economic pressures, corporate purchasers
aren’t about to let healthcare costs slip out of control, either.” With healthcare costs and
14

premiums starting to exert upward pressure, it’s only a matter of time before cost again
becomes an issue, particularly if reform policy is to address the continuing problem of
the uninsured. It remains to be seen if these difficult issues will be addressed from a
regulatory standpoint.

Emerging Trends
Recognizing that in health plans, this morning’s “emerging trends” are often this
afternoon’s “recent history,” we now briefly examine some of the issues that are likely to
trigger change. Many industry experts believe that issues important to consumers are at
the top of the list: choice of plans, choice of providers, access to providers and
healthcare services, affordability, and customer service in both the delivery and
administration of healthcare.

Consumer groups, health plans, and regulators all agree that it is critical for a healthcare
system to give purchasers and consumers useful information to make informed choices.
This information enhances competition and is likely to lower costs and improve quality
and customer service. Also, with the advent of automated medical records, we can
expect to see legislative activity as well as voluntary industry initiatives concerning
methods for disclosure and communication of medical information.

Surprisingly, quality of healthcare is not a major factor in a large number of healthcare

purchasing decisions. In part, this may be because existing information on quality of care
is not always adequate for purchasers and consumers to make choices. Increasingly,
however, employers are using HEDIS® and other data about quality to make and guide
purchasing decisions. Because this is an area where there is opportunity for
improvement, we are likely to see increased activity to develop meaningful healthcare
quality criteria through a combination of industry-initiated efforts and regulatory
requirements. 15

Issues important to the provider community will be another important source of change.
Providers, especially physicians, have a lot to say about the future of healthcare in
America. “If everyone seems to be trying to control the actions of physicians, that is
because doctors’ orders determine where 80 cents of each healthcare dollar is spent—
or roughly $800 billion a year.” With the rapid shift from a fee-forservice to a health plan
16

system, hospitals and physicians have seen their roles change quickly and dramatically.
Both are working hard to regain the leadership position that was theirs before the
ascendance of health plans. For instance, providers have become increasingly willing to

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take on the risk of financing healthcare coverage, and advocacy efforts by the AMA have
been behind many recent regulatory reform initiatives.

Recently, physicians have shown an increased interest in organizing through labor

unions to strengthen their bargaining position with health plans. Typically, they are taking
this step with the goal of obtaining a stronger, more united voice in healthcare policy
discussions. As we saw in Formation and Structure of health plans, the consolidation of
healthcare providers through various types of business entities is likely to continue. This
consolidation has the potential to make the delivery of healthcare more efficient and cost
effective through economies of scale. Conversely, it has the potential to increase
healthcare costs by reducing competition and giving providers greater leverage in
negotiating price with health plans.

In addition, issues important to purchasers are likely to continue producing change. In

some markets, intense competition and increased merger and acquisition activities have
narrowed the playing field to a few dominant health plans. Employers, concerned that
less competition among health plans will lead to rising prices and less product
innovation, have joined forces to contract directly with providers. So far, the results of
these initiatives are mixed. Some analysts doubt that employer purchasing coalitions will
succeed nationwide because the markets where they have been implemented are
mature health plan markets with many large employers, a combination that is not typical
in most locations.

The intense competition in health plans has forced health plans to operate more like
entrepreneurial small companies in terms of efficiency, innovation, and responsiveness
to the marketplace. At the same time, competition has placed substantial pressures on
health plans to enter joint ventures and mergers and acquisitions to obtain economies of
scale, “instant” local market share, and the additional capital needed to improve
infrastructure and enter into new ventures. The successful health plans of the future will
likely be those that efficiently address these critical governance issues, while meeting
the expectations of consumers and purchasers through effective partnerships with
providers.

Conclusion
As we have seen, healthcare reform has come about through a combination of
government regulation and marketplace innovation. Since the majority of patients are
now covered under health plans, “the call for more regulation of managed care is
tantamount to asking…government to step in and expand regulation of the entire health
care system.” 17

Legislators and health plans frequently have the same goals, but the industry prefers to
attain these goals voluntarily. Through the marketplace, new initiatives have emerged
such as HMO report cards to provide more information to purchasers and consumers in
selecting health plans, ombudsman programs to assist members with problems they
encounter within their health plans, and adoption of patient-oriented principles and
practices. Referring to health plan’s early days as a largely not-for-profit industry, some
analysts point out that the perspective of health plans has shifted from doing “social
good” to “consumer good.”

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In this lesson, we have examined two different but closely related aspects of the health
plan industry. First, the structure, governance, and leadership of health plans constitute
the internal environment within which health plans operate. Second, regulatory, legal,
and marketplace realities make up the external environment. We have seen the way that
each can affect the other. Regulations and laws often impact how health plans are
structured and governed, and health plans often exert influence on public policy and
regulations through marketplace innovations and advocacy efforts.

No one can say for sure what the future holds for health plans. It is virtually impossible to
predict the types of entities that will emerge in the marketplace, the focus and degree of
legislation that will come from federal and state government, or the rulings that the
courts will make in their interpretation of health plan-related laws and regulations. Almost
everyone agrees, however, that the industry will continue to undergo dramatic change,
either through marketplace innovation, regulation, or a combination of the two.

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