[Federal Register Volume 63, Number 71 (Tuesday, April 14, 1998)]
[Rules and Regulations]
[Pages 18124-18135]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-9810]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF HEALTH AND HUMAN SERVICES

Health Care Financing Administration

42 CFR Part 422

[HCFA-1027-IFC]
RIN 0938-AI60


Medicare Program; Definition of Provider-Sponsored Organization 
and Related Requirements

AGENCY: Health Care Financing Administration (HCFA), HHS.

ACTION: Interim final rule with comment period.

-----------------------------------------------------------------------

SUMMARY: The Balanced Budget Act of 1997 establishes a new 
Medicare+Choice program that significantly expands the health care 
options available to Medicare beneficiaries. Under this program, 
eligible individuals may elect to receive Medicare benefits through 
enrollment in one of an array of private health plans that contract 
with HCFA. Among the new options available to Medicare beneficiaries is 
enrollment in a provider-sponsored organization (PSO). This interim 
final rule with comment period defines the term ``provider-sponsored 
organization'' for purposes of the Medicare program and establishes 
requirements related to meeting this definition.
    We believe that setting forth the definition of a PSO and the 
related requirements will facilitate the submission of applications to 
participate in the Medicare program as a PSO.

DATES: Effective date: This interim final rule is effective May 14, 
1998. Comment period: Comments will be considered if received at the 
appropriate address, as provided below, no later than June 15, 1998.

ADDRESSES: Mail written comments (1 original and 3 copies) to the 
following address: Health Care Financing Administration, Department of 
Health and Human Services, Attention: HCFA-1027-IFC, P.O. Box 26688, 
Baltimore, MD 21207.
    If you prefer, you may deliver your written comments (1 original 
and 3 copies) to one of the following addresses: Room 309-G, Hubert H. 
Humphrey Building, 200 Independence Avenue, SW., Washington, DC 20201, 
or Room C5-09-26, 7500 Security Boulevard, Baltimore, MD 21244-1850.
    Comments may also be submitted electronically to the following e-
mail address: [email protected]. E-mail comments must include the 
full name

[[Page 18125]]

and address of the sender and must be submitted to the referenced 
address in order to be considered. All comments must be incorporated in 
the e-mail message because we may not be able to access attachments. 
Because of staffing and resource limitations, we cannot accept comments 
by facsimile (FAX) transmission. In commenting, please refer to file 
code HCFA-1027-IFC Comments received timely will be available for 
public inspection as they are received, generally beginning 
approximately 3 weeks after publication of a document, in Room 309-G of 
the Department's offices at 200 Independence Avenue, SW., Washington, 
DC, on Monday through Friday of each week from 8:30 a.m. to 5 p.m. 
(phone: (202) 690-7890).

FOR FURTHER INFORMATION CONTACT: Maureen Miller, (410) 786-1097; Phil 
Doerr, (410) 786-1059.

SUPPLEMENTARY INFORMATION:

I. Background

A. Medicare+Choice Program

    Health care benefits covered under the Medicare program are divided 
into two parts: Hospital insurance, also known as ``Part A,'' and 
supplementary medical insurance, also known as ``Part B.'' Health care 
services covered under Part A include: inpatient hospital care, skilled 
nursing facility care, home health agency care, and hospice care. Part 
B coverage is optional and requires payment of a monthly premium. Part 
B covers physician services (in both hospital and nonhospital settings) 
and services furnished by certain nonphysician practitioners. It also 
covers certain other services, including: clinical laboratory tests, 
durable medical equipment, most supplies, diagnostic tests, ambulance 
services, prescription drugs that cannot be self-administered, certain 
self-administered anticancer drugs, some other therapy services, 
certain other health services, and blood not supplied by Part A.
    Section 4001 of the Balanced Budget Act of 1997 (BBA) (Pub. L. 105-
33), enacted August 5, 1997, adds sections 1851 through 1859 to the 
Social Security Act (the Act) to establish a new Part C of the Medicare 
program, known as ``Medicare+Choice.'' (The existing Part C of the 
statute, which included provisions in section 1876 of the Act governing 
existing Medicare health maintenance organization (HMO) contracts, was 
redesignated as Part D.) Under the new Medicare+Choice program, every 
individual entitled to Medicare Part A and enrolled under Part B, 
except for individuals with end-stage renal disease, may elect to 
receive benefits through either the existing Medicare fee-for-service 
program or a Part C Medicare+Choice plan.

B. Medicare+Choice Plan Options

    The Medicare+Choice plan options include both the traditional 
managed care plans (such as HMOs) that have participated in Medicare on 
a capitated payment basis under section 1876 of the Act as well as a 
broader range of plans comparable to those now available through 
private insurance. Specifically, effective January 1, 1999, section 
1851(a)(2) of the Act provides for three types of Medicare+Choice 
plans:
     Coordinated care plans, including HMO plans, provider 
sponsored organization (PSO) plans, and preferred provider organization 
(PPO) plans.
     Medical savings account (MSA) plans (that is, combinations 
of a high deductible, catastrophic insurance plan with a contribution 
to a Medicare+Choice MSA). This option is a demonstration.
     Private fee-for-service plans.

C. Statutory Requirements

    Section 1856(b)(1) of the Act directs the Secretary to publish by 
June 1, 1998, regulations necessary for overall implementation of the 
Medicare+Choice program. These regulations will establish a new Part 
422 in title 42 of the Code of Federal Regulations and will set forth 
the basic requirements for all Medicare+Choice plans.
    Additionally, section 1856(a) of the Act provides that the 
Secretary establish through a negotiated rulemaking process, the 
solvency standards (as described in section 1855(c)(1) of the Act) that 
entities will be required to meet if they obtain a waiver of the 
otherwise applicable requirement that they be licensed by the State. 
(For more information on the negotiated rulemaking process see the HCFA 
notices published on September 23, 1997, and October 28, 1997, 62 FR 
49649 and 62 FR 55773, respectively.)
    As we worked on developing procedures to allow PSOs to sign 
Medicare+Choice contracts in 1998, we determined that interested health 
plans needed to know the fundamental organizational requirements they 
had to meet as soon as possible. In addition, in the course of the 
negotiated rulemaking process, it has become clear to HCFA and the 
negotiated rulemaking committee that a clear definition of PSO was 
needed to establish solvency standards. Therefore, in order to assist 
entities considering applying to become PSOs under the Medicare+Choice 
program we have developed the definition of a PSO and related 
requirements for publication in this interim final rule with comment 
period.

II. Provider-Sponsored Organizations Under the Medicare+Choice 
Program

    In recent years, the term ``provider-sponsored organization'' has 
been one of several terms applied to health care delivery systems that 
are owned or controlled and operated by a provider or group of 
providers within a community. Such systems, also referred to as 
integrated delivery systems, are most commonly formed by physicians and 
hospitals and can provide an array of health care services to patients 
under a variety of payment mechanisms, including risk-sharing 
arrangements through contracts with HMOs. A few States have passed laws 
specifically recognizing these types of new entities, and some PSOs 
have undertaken direct contracting with employers and other payors. 
Until implementation of the BBA, these types of entities are eligible 
to participate in the Medicare program only if they meet the 
requirements for a risk contract under section 1876 of the Act.
    Section 4001 of the BBA established new sections 1851 through 1859 
of the Act. Section 1851(a)(2) of the Act now explicitly provides for 
participation of a PSO plan in the Medicare+Choice program. For the 
most part, a PSO plan is required to meet the same requirements as 
other coordinated care plans that participate in the program. However, 
the statute establishes two special rules for PSOs.
    First, a fundamental requirement of the Medicare+Choice program, as 
set forth under new section 1855(a)(1) of the Act, is that a 
Medicare+Choice organization must be ``organized and licensed under 
State law as a risk-bearing entity eligible to offer health insurance 
or health benefits coverage in each State in which it offers a 
Medicare+Choice plan.'' However, section 1855(a)(2) of the Act 
establishes an exception to this general rule by allowing a PSO to 
obtain a Federal waiver from the State licensure requirement if it 
meets one of three criteria specified in the Act. A PSO that files a 
request for a Federal waiver can qualify as a Medicare+Choice plan if 
the Secretary determines that any of the following criteria is met:
     The State failed to complete action on a licensing 
application within 90 days.
     The State denied the licensing application based on 
discriminatory treatment.
     The State denied the licensing application based on the 
organization's failure to meet solvency requirements,

[[Page 18126]]

and there is a difference between the State's solvency requirements and 
the Federal solvency requirements to be established through the 
negotiated rulemaking process mentioned above.
    Application for a waiver of the licensure requirement may be made 
until November 1, 2002, and the approved waiver is effective for a 
nonrenewable 36-month period. We will discuss the waiver criteria and 
application process in a separate rulemaking document on PSO Solvency 
Standards and Waiver.
    The other special rule for PSOs involves the minimum enrollment 
requirements set forth under new section 1857(b) of the Act. Section 
1857(b)(1) specifies that participating Medicare+Choice organizations 
must have at least 5,000 individuals receiving health benefits through 
the organization, or at least 1,500 if the organization primarily 
serves a rural area. For PSOs, though, these minimum enrollment 
requirements are set at 1,500 for urban areas and 500 for rural areas. 
These lower minimum enrollment requirements apply to entities that meet 
the Medicare definition and related requirements for a PSO, including 
State-licensed PSOs, in addition to PSOs that participate in the 
Medicare+Choice program under a Federal waiver of the State licensure 
requirement.

III. Provisions of the Interim Final Rule With Comment Period

A. Overview

    The requirements contained in this interim final rule represent the 
first set of published regulations applicable to the Medicare+Choice 
program. To accommodate the new regulations needed to implement this 
program, we are establishing a new Part 422--Medicare+Choice Program, 
in Title 42 of the Code of Federal Regulations. We intend to set forth 
the overall framework of part 422 in the comprehensive interim final 
rule scheduled to be published by June 1, 1998. At this time, we are 
establishing only Subpart H, the subpart necessary to address Provider-
Sponsored Organizations issues.

B. Discussion of PSO Definition and Related Requirements

    We are establishing a new Sec. 422.350 Basis, scope and 
definitions.
    Paragraph (a) states that the regulations set forth in subpart H 
are based on sections 1851 and 1855 of the Act. It also specifies that 
the scope of the subpart is to (1) authorize PSOs to contract with HCFA 
as a Medicare+Choice plan; (2) require that a PSO meet certain 
qualifying requirements; and (3) provide for waiver of State licensure 
for PSOs under specified conditions.
    Paragraph (b) of Sec. 422.350 sets forth the meaning of terms as 
they are used for purposes of subpart H. The terms defined here are 
discussed in logical order below; note that they appear in alphabetical 
order in the regulations text.
Provider-Sponsored Organization
    We define in regulations a PSO as it is defined in section 
1855(d)(1) of the Act. That is, a PSO is a public or private entity 
that--
    (1) Is established or organized, and operated, by a health care 
provider or group of affiliated (as defined in Sec. 422.354(a)) health 
care providers.
    (2) Provides a ``substantial proportion'' (as defined in 
Sec. 422.352(b)) of the health care items and services under its 
Medicare+Choice contract directly through the provider or affiliated 
group of providers. ``Substantial proportion'' is discussed below.
    (3) In the case of a group of affiliated providers, the providers 
share, directly or indirectly, substantial financial risk (as defined 
under Sec. 422.356(a)) for the provisions of items and services under 
its contract and have at least a majority financial interest (as 
defined under Sec. 422.356(b)) in the PSO.
    This definition focuses on the unique, provider-based nature of 
this type of entity and lays the groundwork for the requirements that 
follow. As set out in legislation, providers are the core of a PSO, and 
must establish, organize, and control the health plan. Further, the 
definition clearly establishes that providers must have a stake in the 
PSO enterprise by sharing in the financial risk passed to the health 
plan by HCFA.
    Control--As discussed below, section 1855(d)(4) of the Act sets 
forth a specific meaning of ``control'' for purposes of determining 
whether a provider is affiliated with another provider. For all other 
purposes related to PSOs, however, we define in Sec. 422.350(b) that 
control exists if an individual, group of individuals, or organization, 
has the power, directly or indirectly, ``to direct or influence 
significantly'' the actions or policies of an organization or 
institution.
    This definition is essentially the same as the long-standing 
definition of control that is used for purposes of providers in the 
Medicare fee-for-service programs (see 42 CFR 413.17.) The term 
``control'' is used in several contexts in relation to PSOs (aside from 
its specific meaning for purposes of determining affiliation under 
section 1855(d)(3)), and we believe that this general definition, which 
results in case-by-case determinations, is appropriate for all these 
uses.
    New section 1855(d)(5) defines the term ``health care provider'' 
for purposes of PSO requirements. This definition is much broader than 
the definition of ``provider of service'' found in section 1861(u) of 
the Act and the definition of ``provider'' found in Sec. 400.202 of our 
regulations (definitions specific to Medicare). Here, the term can 
apply to both individuals (such as physicians, nurse practitioners, 
physician assistants, etc.) and the entities commonly considered to be 
providers, as well as other types of health care entities.
    Pursuant to section 1855(d)(5) of the Act, we are defining ``health 
care provider'' as:
     Any individual who is engaged in the delivery of health 
care services in a State and who is licensed or certified by that State 
to engage in the delivery of such services in the State; and
     Any entity that is engaged in the delivery of health care 
services in a State provided, if required by the State, the entity is 
licensed or certified to engage in the delivery of such services in the 
State.
    To meet the terms of this definition, an individual health care 
practitioner must be licensed or certified by the State to be 
considered a provider for purposes of the PSO requirements. We believe 
this complies with the intent of section 1855(d)(5)(A) of the statute. 
Consistent with section 1855(d)(5)(B) of the Act, all entities that 
require licensure or certification must be in compliance with these 
State requirements. As contemplated by the statute, health care 
entities that are not required to be licensed or certified may meet 
this definition of ``health care provider'', although individual 
components of the entity may be required to be licensed or certified. 
An example, or hypothetical situation of this, is a health care system 
where, through merger or acquisition, a licensed hospital, a certified 
home health agency, a licensed rehabilitation facility, and a medical 
group consisting of individually licensed physicians have formed a 
corporate entity that provides a wide range of health care services. In 
this example, each of the component entities would be licensed, as are 
the individual physicians, but not the health care system as a whole. 
Thus, the corporate entity could be considered a ``health care 
provider'' even though it itself is not licensed.
    Given the evolving nature of the industry, we recognize that other 
types

[[Page 18127]]

of health care entities may exist that are not addressed by this 
regulatory definition. We welcome comments or suggestions on these 
types of arrangements, and will consider whether they would necessitate 
changes in the definition.
    We anticipate that the current requirement for Medicare-contracting 
HMOs and competitive medical plans to furnish services through 
providers that comply with conditions of participation and 
certification, as required by Sec. 417.416 of the regulations, will be 
incorporated (in the same or similar manner) into the Medicare+Choice 
standards to be issued June 1.
Engaged in the Delivery of Health Care Services
    This phrase is used in both contexts of the statutory definition of 
a health care provider, that is, both for individual providers and 
entities. Section 422.350(b) specifies that for an individual, 
``engaged in the delivery of health care services'' means that the 
individual directly furnishes health care services. For an entity, it 
means that the entity is organized and operated primarily for the 
purpose of furnishing health care services directly or through its 
provider members or entities.
    We are clarifying the meaning of this phrase in the definitions 
section of the regulations largely because of the new types of health 
care organizations that are continuing to be formed. For example, a 
number of provider entities or institutions that had been organized and 
operated to furnish health care services have added other types of non-
clinical health-related services, such as management services, 
utilization review services, electronic information services, etc. On 
the other hand, some health-related companies have ventured into areas 
associated with direct health care delivery. We believe that PSOs are 
intended to be established and operated by providers actively 
furnishing patient care. Thus, in this definition, we clarify the role 
and importance of furnishing health care services--for both individuals 
and entities--in order to be considered engaged in the delivery of 
health care services. If it is necessary for HCFA to make a 
determination whether an entity can be considered engaged in the 
delivery of health care services, we will consider the entity's 
organizational structure, (including lines of business), mission, 
bylaws and control to determine the predominant nature of the entity. 
Thus, for example, the extent to which physician members provide 
services and control an independent practice association (IPA) could be 
determining factors whether the IPA group is considered to be engaged 
in the delivery of health care services.

C. Basic Requirements for PSOs (Sec. 422.352)

    New Sec. 422.352 specifies that to be considered a PSO for purposes 
of the Medicare+Choice program, an organization must comply with the 
following general requirements.
    In paragraph (a) we require the organization to--
     Be licensed by the State or obtain a waiver of licensure 
as provided for under section 1855(a)(2) of the Act.
     Meet the definition of a PSO set forth in Sec. 422.350 and 
other applicable requirements of 42 CFR Part 422, subpart H.
     Be controlled by a health care provider or, in the case of 
a group, by one or more of the affiliated providers that established 
and operate the PSO.
    The requirement that an entity either be licensed by the State or 
have obtained a Federal waiver, basically restates the two ways in 
which a PSO can participate in the Medicare+Choice program, as spelled 
out under section 1855(a) of the Act. The general requirement 
concerning control explicitly incorporates into the regulations the 
underlying statutory intent that in PSOs, health care providers must 
have controlling authority over the organization. The joint conference 
committee report states: ``A PSO is a term generally used to describe a 
cooperative venture of a group of providers who control its health 
service delivery and financial arrangements.'' (emphasis added) (H.R. 
Report 105-217, Conference Report to accompany H.R. 2015, 630). As 
discussed above, control is defined in the same way as it is used in 
other Medicare settings, and we intend to make decisions about whether 
control exists on an individual case basis. In general, we believe that 
control implies that the providers or groups of affiliated providers 
that furnish health care services through a PSO must exercise control, 
not only over clinical decision-making and quality assurance, but also 
govern the PSO, e.g., direct the administration of the enterprise, 
maintain control of the governing body, and remain fully accountable 
for the organization. (See also the discussion of majority financial 
interest.)
    In paragraph (b) we include requirements concerning provision of 
services. We incorporate the general requirement that a PSO must 
demonstrate that it is capable of delivering to Medicare enrollees the 
range of services required under a contract with HCFA. This requirement 
currently applies to all managed care plans that contract with HCFA 
under section 1876 of the Act. We intend to establish a similar 
requirement for network-based organizations that enter into contracts 
under the Medicare+Choice program, in accordance with the general 
requirement for provision of services under section 1852(a)(1) of the 
Act. Thus, this requirement for PSOs will supplement the overall 
Medicare+Choice requirement that participating health plans (where 
applicable) be capable of providing all contracted services directly or 
through arrangement. (These organizations also are responsible for 
payment of out-of-plan emergency and urgently needed services, as well 
as care furnished in connection with point-of-service options.)
    Another key component of Sec. 422.352(b) involves the requirement 
that a PSO deliver a substantial proportion of the health care items 
and services through the provider or affiliated group of providers 
responsible for operating the PSO, as required under section 1855(d)(1) 
of the Act. Section 1855(d)(2)(A) of the Act then specifies that in 
defining what constitutes a ``substantial proportion,'' the Secretary 
is to take into account the need for a PSO to be responsible for 
providing ``significantly more than the majority'' of items and 
services under its contract through its own affiliated providers, with 
most of the remaining items and services to be furnished through 
agreements between the PSO and other nonaffiliated providers. The 
statute clarifies that the intent of the substantial proportion 
provisions is ``* * * to assure financial stability and to address 
practical considerations involved in integrating the delivery of a wide 
range of service providers.''
    In establishing the appropriate level for the substantial 
proportion requirement, our goal was to identify a threshold high 
enough to comply with the intent of the statute but not so high as to 
discourage participation in the program. A simple majority being 51 
percent, we determined that a PSO must directly provide significantly 
more than 51 percent of the items and services committed to under its 
contract in order to meet this requirement. We also recognize that some 
portion of services will be provided by nonplan providers on an 
emergency or urgently needed basis. In addition, we did not want to 
preclude the possibility of a PSO offering a point-of-service option. 
Therefore, we evaluated and modeled substantial proportion options 
between

[[Page 18128]]

60 and 80 percent of contractually required Medicare services.
    We considered both aggregate models, that is, comparisons of total 
services furnished by affiliated providers with total services 
furnished by the PSO, as well as hybrid models that compared services 
in various categories (for example, setting separate substantial 
proportion requirements for different types of care such as inpatient 
hospital services or physician services.) However, we determined that 
the hybrid models were unnecessarily complicated and administratively 
burdensome for both PSOs and HCFA, without contributing to the 
objective of assuring the financial stability of the organization. 
Based on our analysis, and consultation with health care industry and 
beneficiary representatives, we concluded that setting the substantial 
proportion requirement at 70 percent appropriately balances two key 
interests: (1) that we not set the proportion of services so high as to 
prevent participation by all but the most sophisticated provider 
organizations and (2) that the substantial proportion threshold be 
sufficient to ensure that a PSO have a well-developed capacity to 
deliver services, thus meeting the financial stability objective 
explicit in the statute and increasing the prospects for successful 
development and solvent operation of a PSO. Therefore, we are 
specifying under Sec. 422.352(b)(1) that in general a substantial 
proportion constitutes not less than 70 percent of Medicare items and 
services covered under a PSO's contract.
    Section 1855(d)(2)(C) of the Act provides that the Secretary may 
allow for variation in the definition of substantial proportion for 
rural PSOs. Consistent with this provision, and based upon 
consultations with rural health care industry representatives and 
beneficiary representatives, we have established under 
Sec. 422.352(b)(2), a substantial proportion threshold of 60 percent of 
Medicare items and services required under contract for rural PSOs. We 
believe that this requirement reflects the lower proportion of 
specialty and other medical services that are likely to be available in 
some rural areas and is necessary to foster the likelihood of PSO 
development and success in rural areas.
    Finally, along with the decision of how to define substantial 
proportion, we also needed to identify the best method for comparing 
the proportion of items and services furnished by a PSO's affiliated 
providers with the overall amount of items and services furnished 
through the PSO. The two possible approaches involved either the use of 
Medicare encounter data or Medicare expenditure data. During 
discussions with health care industry representatives, we learned that 
using expenditure data generally would not be burdensome for PSOs 
because it is commonly collected for internal financial management 
purposes. Furthermore, expenditure data may also produce a measurement 
more in line with the intent of the substantial proportion requirement. 
For example, the expenditures associated with an acute hospital visit 
would reflect a higher draw upon the PSO's resources than a physician 
office visit. Likewise, with expenditure data, the dollar amounts 
associated with each physician office visit, home care visit, etc., 
will reflect resource use and the ability of PSO providers to manage 
medical utilization. Therefore, based upon its immediate availability 
and superior meaningfulness, we concluded that use of expenditure data 
is the better approach at this time for determining compliance with the 
substantial proportion requirement. We intend to provide guidance on 
the calculation of substantial proportion in future documents 
concerning application and compliance procedures.
    Paragraph (c) discusses characteristics a PSO must have to be 
considered rural. For purposes of the substantial proportion 
requirement, we are adopting the language of current Sec. 412.62(f). 
This section references a widely accepted Office of Management and 
Budget methodology for identifying rural areas that is currently in use 
in the majority of HCFA programs. We considered several alternatives 
for defining rural areas including one that utilizes census tract data 
and another that utilizes a United States Department of Agriculture 
methodology whereby multiple levels of urban and rural definitions can 
be established through criteria. We concluded that the definitions set 
forth under Sec. 412.62(f) would appropriately identify those areas 
that may be eligible for the rural standard for substantial proportion 
and that this definition would provide consistency in the application 
of rural definitions among the majority of Medicare programs.
    Section 422.352(c) sets forth the standards for qualifying as a 
rural PSO, and allows non-rural providers to take part in the PSO as an 
affiliate or a subcontractor. The substantial proportion standards for 
rural PSOs recognize that non-rural providers are often an important 
source of care for residents of rural areas. Hence, the percentage of 
services that must be provided through affiliated providers of a rural 
PSO is less than the percentage required of a non-rural PSO. The 
exception for rural PSOs is intended to foster the development of 
capitated plans that can be available to residents of rural areas, and 
to permit rural providers to participate in the formation of such 
plans. Non-rural providers may be components of a PSO eligible for the 
rural exception to the substantial proportion standard, but we wish to 
ensure that such a PSO is primarily a rural-based plan, and that the 
arrangements such a plan makes for the provision of services is 
consistent with the patterns of care for the rural community. 
Beneficiaries who enroll in a rural PSO should enjoy the same level of 
accessibility and availability of care through local providers as non-
enrollees residing in the same area. Hence, we are requiring that the 
PSO must demonstrate that it can render, through affiliated providers 
located in the rural area, medical services commonly provided to 
beneficiaries by providers in the rural community. Services provided by 
providers located in the rural area generally should include primary 
care, emergency care, and commonly used types of specialty care 
available in the area, in order to ensure that a basic level of care is 
available to enrollees of the PSO at the local level. Patients may be 
referred to non-rural providers for more complex (e.g., tertiary-level) 
hospital care and for certain types of specialty care, and for other 
care, to the extent that the PSO can demonstrate that the use of non-
rural providers is consistent with referral patterns in the service 
area. As far as is practicable, services provided outside the rural 
area should be provided by affiliated providers or by providers that 
have contracts with the PSO, except for unusual or infrequently used 
health services.
    Another test as to whether the PSO qualifies as rural relates to 
the Medicare beneficiaries enrolling in the organization. A majority of 
the PSO's Medicare enrollees must reside within the rural area or areas 
served by the PSO. We considered higher thresholds for this standard, 
but, after consultation with rural health care and beneficiary 
representatives, determined that this was the most workable approach.
    We believe that this approach to rural PSOs is balanced. That is, 
the two standards (in conjunction with the 60 percent threshold for 
substantial proportion) validate that the PSO is indeed a rural-based 
health plan yet is flexible enough to promote the development of rural 
PSOs.

[[Page 18129]]

D. Requirements for Affiliated Providers (Sec. 422.354)

    The concept of affiliation is central to the organization of PSOs. 
Section 1855(d)(3) of the Act sets forth four criteria under which a 
provider can demonstrate affiliation with another provider for PSO 
purposes. In this interim final rule, we are incorporating the 
statutory provisions into Sec. 422.354 by specifying that a provider is 
affiliated with another provider if, through contract, ownership, or 
otherwise, any of the following criteria is met:
     One provider, directly or indirectly controls, is 
controlled by, or is under common control with the other.
     Each provider is a participant in a lawful combination 
under which each provider shares substantial financial risk (as set 
forth under Sec. 422.356 of this part) in connection with the PSO's 
operations.
     Both providers are part of a controlled group of 
corporations under section 1563 of the Internal Revenue Code (IRC) of 
1986.
     Both providers are part of an affiliated service group 
under section 414 of the IRC.
    As specified under section 1855(d)(4) of the Act, control is 
presumed to exist for purposes of the first criterion if one party, 
directly or indirectly, owns, or holds the power to vote, or proxies 
for, not less than 51 percent of the voting rights or governance rights 
of another. The second criterion (Sec. 422.354(a)(2)) contains a two-
pronged test. It requires that providers affiliate in a lawful 
combination, which we will interpret as meeting antitrust and other 
Federal guidelines, as well as applicable Federal and State statutes. 
However, HCFA's determination that providers are affiliated for 
purposes of the Medicare+Choice program does not constitute a 
determination that the arrangement among the affiliated providers is 
lawful under Federal or State antitrust law. (HCFA does not have 
authority to make such determinations, and will consult the Federal 
Trade Commission as necessary.) In addition, each affiliated provider 
must share substantial financial risk in the operations of the PSO. Our 
policy with respect to what constitutes substantial financial risk is 
discussed in detail below.
    The last two criteria are based on provisions of the Internal 
Revenue Code of 1986. We do not intend to make determinations as to 
whether or not a PSO meets either of these criteria, since this is 
outside our authority, but will look to evidence provided by the PSO as 
to its standing under the tax code. (When necessary, we will consult 
with appropriate officials within the Department of Treasury, as we 
have done in the development of this interim final rule.)
    In general, under these criteria, we believe that an affiliated 
provider could be, for example, a medical group, an IPA, a hospital, a 
nursing home, or a home health agency. (We note that an individual 
provider who is not part of a larger entity also could be considered an 
affiliated provider of the PSO if the individual provider meets all 
applicable requirements.) The purpose of these affiliation tests is to 
distinguish the PSO as an entity made up of separate providers who have 
combined in an acceptable manner and are bound together in order to 
contract with the Medicare program. These rules are not intended to 
limit the structuring, or even the payment arrangements, of 
individuals, facilities, or other providers who are components of the 
entity that is the affiliated provider. For example, these rules do not 
limit an IPA's flexibility in bringing together individual physicians, 
or its payment arrangements with those physicians. Likewise, if a 
hospital has purchased a medical practice and a nursing home, the 
hospital (now a health care system) is considered one affiliated 
provider of the affiliated model PSO. The concerns addressed in this 
portion of the regulation are with how the hospital or health care 
system in this example affiliates with other provider entities outside 
of its corporate structure for purposes of establishing and operating a 
PSO, not the individuals or component provider entities within the 
corporate structure.
    In addition to the organizational tests of affiliation under 
paragraph (a) of Sec. 422.354, paragraph (b) then specifies that a PSO 
must demonstrate that each of its affiliated providers share, directly 
or indirectly, substantial financial risk for the provision of items 
and services under the Medicare contract that are the obligation of the 
organization. Similarly, we include under Sec. 422.354(c) the 
requirement that affiliated providers, as a whole or in part, have at 
least a majority financial interest in the PSO. These requirements stem 
from section 1855(d)(1)(C) of the statutory PSO definition, and are 
included in Sec. 422.356 of the regulations, as discussed below.

E. Determining Substantial Financial Risk and Majority Financial 
Interest (Sec. 422.356)

    The term ``substantial financial risk'' is used twice in section 
1855(d) of the Act. First, section 1855(d)(1)(C) stipulates that, where 
affiliated providers have established the PSO, they must share 
substantial financial risk for the items and services provided under 
the contract. The term is used again in section 1855(d)(3)(C), which 
sets forth one of the four ways in which providers may demonstrate 
affiliation, i.e. providers must be in a lawful combination and share 
substantial financial risk in the operation of the PSO.
    In recent years, other legislation amending the Social Security Act 
has used the term ``substantial financial risk'' for purposes which 
differ from how the term is used here. Section 216 of the Health 
Insurance Portability and Accountability Act of 1996 (Pub. L. 104-191) 
requires the Secretary to establish, through a negotiated rulemaking 
process, a new safe harbor from the anti-kickback statute (section 
1128B of the Act, 142 U.S.C. 1320a-7b(b)) for certain risk-sharing 
arrangements that place an individual or entity at ``substantial 
financial risk for the cost or utilization'' of items or services 
furnished by those providers. Section 4204 of the Omnibus 
Reconciliation Act of 1990 (Pub. L.101-508) and the physician incentive 
plan under our regulations at 42 CFR 417.479 require managed care 
organizations that place physicians or physician groups at 
``substantial financial risk'' to assure that stop loss coverage is in 
place and to conduct beneficiary satisfaction surveys. Physicians are 
deemed to be at substantial financial risk if their risk for referral 
services exceeds 25 percent of the maximum potential payments under the 
contract (unless the entity serves more than 25,000 patients and 
certain pooling criteria are met). In addition, financial risk sharing 
as an indicator of integration among otherwise competing health care 
providers was addressed by the Federal Trade Commission (FTC) and the 
Department of Justice (DoJ) in antitrust guidelines issued in August, 
1996. Thus a regulatory clarification of this requirement as used for 
affiliated providers of PSOs is necessary.
    In both uses of ``substantial financial risk'' in section 1855(d) 
of the Act, a provider entity--such as a hospital or medical group--is 
required to be at financial risk for more than the provider's own items 
and services. That is, each affiliated provider must have a stake in 
the PSO. We considered defining a specific level of risk, such as a 
percentage, or categories of risk, but determined that this would not 
be workable given the numerous types of providers (ranging from large 
facilities to small speciality practices), varying capacities of the 
providers, and various

[[Page 18130]]

financial concerns. Establishing categories or levels of risk was too 
arbitrary given the extent of potential affiliates, and 
administratively burdensome for us and the health plans. Because each 
PSO will be unique, we decided that a case-by-case determination would 
be needed. Thus, in this interim final rule, we establish that HCFA 
will determine whether the affiliated providers demonstrate substantial 
financial risk for purposes of section 1855(d)(1)(C) of the Act and for 
purposes of affiliation in section 1855(d)(3)(C).
    To help us provide regulatory clarification on risk-sharing, we 
looked to the health care provider antitrust guidelines mentioned above 
for guidance. The antitrust guidelines and the requirement for 
substantial financial risk in the BBA have different purposes: The 
antitrust guidelines are concerned with the extent of economic 
integration among otherwise independently competing health care 
providers, while the BBA's requirement addresses the extent of the 
affiliated providers' stake in, and commitment to, the successful 
operation of the PSO. Because of the different contexts and purposes of 
the two provisions, we have not adopted the risk-sharing mechanisms 
outlined in the antitrust guidelines in total for this interim final 
rule with comment. We adopted with modifications three of the four 
examples of mechanisms identified by the FTC and DoJ. Through our 
analysis, we determined that the fourth, global payment rates for 
certain complex cases, or for case management, was not evidence of an 
affiliated provider's risk in the overall enterprise of the PSO.
    One mechanism that may be acceptable for demonstrating financial 
risk is capitation; i.e., agreement by an affiliated provider (such as 
a medical group or IPA) to provide services at a capitated rate of 
payment from the PSO. A capitated rate is a preset, fixed payment per 
enrollee in exchange for the provision of a set of services without 
regard to frequency of use, intensity, or cost of such services for a 
specified time period. In these regulations, we are not concerned with 
the capitation or other payments to individual providers within the 
provider entity, but only the capitation arrangement between the PSO 
and the affiliated provider. The capitation arrangement must 
demonstrate that the affiliated providers share significant risk for 
the PSO enterprise. For example, we may consider a comprehensive, 
capitated payment rate that covers hospital and physician services as 
demonstrating substantial financial risk. In this case, a capitated 
health care system that is providing the bulk of commonly used services 
to a significant portion of PSO's enrollment would be viewed as sharing 
in the financial risk of the PSO enterprise. However, more typical 
capitation arrangements (e.g. whereby an IPA is capitated for the 
primary and specialty care of its associated physicians) usually will 
not be adequate to demonstrate that an affiliated provider shares 
substantial financial risk in the PSO. In the latter case, another 
mechanism that links the affiliate financially to the overall health 
plan will likely be necessary because the capitated affiliated provider 
(such as an IPA or medical group) must demonstrate that it holds risk 
in the PSO, and is not at risk just for its own services. An example of 
what may be permissible here is the withholding of a significant amount 
of an affiliated provider's capitation, to be used to cover the losses 
of the PSO, if such occur, or to distribute back to the affiliated 
provider(s) if cost-containment and utilization management goals are 
met. Another example could be a significant capital investment in the 
PSO on the part of the capitated affiliate. The amount or level of 
financial risk borne by each affiliated provider may vary based on 
factors such as the size or capacity of the provider, the nature of 
services provided, and financial strength. For example, a well-
capitalized hospital affiliate will bear more risk than a nursing home, 
home health agency, or federally qualified health center affiliates.
    In addition to capitation, other possible risk-sharing mechanisms 
drawn from the antitrust guidelines include agreement by an affiliated 
provider to provide services for a predetermined percent of the PSO's 
premium (or revenue), and certain financial incentives considered to be 
significant, e.g., withholds and preestablished, fixed budgets or 
utilization targets for the affiliated provider. Again, the PSO must 
demonstrate that the affiliated provider shares risk in the PSO 
enterprise through these risk-sharing mechanisms.
    We have included also a provision that allows HCFA to consider 
other means of demonstrating ``substantial financial risk'' in the PSO. 
This approach allows us the flexibility to consider other financial 
commitments that could be submitted for consideration, such as 
significant ownership in a for-profit PSO, significant investments from 
the affiliated provider, or a guarantee by an affiliated provider to 
cover the debt or operating expenses of the PSO.
    We believe that the approach chosen for this regulation, a 
determination by HCFA as to the demonstration of substantial financial 
risk sharing and the outline of mechanisms that will be considered in 
the assessment, is appropriate at this early stage in the PSO program. 
We also believe that this approach will work for both provisions 
regarding the substantial financial risk in section 1855(d). As our 
experience evaluating risk-sharing arrangements, contractual 
agreements, and organizational structures for PSOs increases, we may 
provide further guidance through program issuances.
    Paragraph (b) of Sec. 422.356 reflects the requirements of section 
1855(d)(1)(C) of the Act that the affiliated providers in a PSO have a 
majority financial interest in the organization. We considered 
requiring that all affiliated providers have an ownership interest, 
membership interest, or voting rights in the PSO. We rejected this 
alternative because we believed it would unnecessarily restrict the 
formation and development of PSOs. In addition, such a requirement 
could result in a nominal ownership interest, such as a $1 stake in the 
PSO, rendering the requirement meaningless. We also considered 
establishing thresholds of financial interest, but determined this 
method to be too arbitrary. We believe, that by nature of the 
requirement that PSOs must be effectively controlled by the affiliated 
providers, the affiliated providers must have a majority financial 
interest in the PSO. Even where one or a portion of the affiliated 
providers control the PSO (this is permissible under the regulations), 
we believe that the requirement that all affiliated providers share 
substantially in the risk borne by the health plan--taken together with 
the requirements for affiliation--provides the appropriate incentives 
for provider ``buy-in'' to the PSO as envisioned by the statute. 
Therefore, Sec. 422.356(b) simply states that majority financial 
interest means maintaining effective control of the PSO.
    Following are two examples of how this requirement may be met:

    Example 1. In a for-profit PSO, the affiliated providers (either 
all or some portion of the affiliated providers) both own(s) not 
less than 51 percent of the organization and maintain(s) control, 
including a majority position, in the governance of the PSO (such as 
control of the board of directors).
    Example 2. In a not-for-profit, member-model PSO, the affiliated 
providers (either all or some portion of the affiliated providers) 
both control(s) not less than 51 percent of the membership and 
maintain(s) control,

[[Page 18131]]

including a majority position, in the governance of the PSO.

    The requirement concerning majority financial interest does not 
preclude either providers not affiliated with the PSO (but who could 
have another arrangement to provide services) or nonproviders from 
ownership, membership, or other formal position in the PSO's 
organizational structure. However, any restrictions are intended to 
ensure that effective controlling authority rests with the affiliated 
providers.

IV. Applicability of These Rules

    As noted above, the definition and requirements set forth in this 
interim final rule pertain only to PSOs and do not apply to any other 
type of coordinated care plan. However, in order to contract with the 
Medicare program, a PSO also must meet the general Medicare+Choice 
program requirements that will be established under Part 422. Until 
these requirements are established, we suggest that interested parties 
consult the current Medicare risk contract requirements under Part 417, 
in the managed care section on HCFA's Homepage on the Internet, in 
combination with the statutory requirements under the BBA, for 
guidance. An organization interested in entering into a contract with 
Medicare as a PSO must first apply to its State for licensure. Only a 
PSO that is denied licensure by the State based on any of the three 
criteria set forth under section 1855(a)(2) of the Act may obtain a 
waiver from HCFA. Following either State licensure or approval of a 
Federal waiver, the organization then applies to HCFA to participate in 
the Medicare+Choice program as a PSO. We will review the application 
first to determine whether the organization meets the PSO definition 
and related requirements set forth in this interim final rule. We then 
will determine whether the organization meets the general 
Medicare+Choice requirements.
    An organization that applies under the Federal waiver provision 
also needs to meet the solvency standards established in regulations in 
compliance with new section 1856 of the Act. Again, this entire process 
will be discussed in greater detail in another interim final rule with 
comment period. This rule also will be used for entities that are 
licensed by the State but wish to avail themselves of the lower minimum 
enrollment standards for PSOs. In this situation, no waiver request and 
only that portion of the PSO application related to this interim final 
rule will be applied.

V. Regulatory Impact Statement

A. Introduction

    Section 804(2) of Title 5, United States Code (as added by section 
251 of Pub. L. 104-121), specifies that a ``major rule'' is any rule 
that the Office of Management and Budget finds is likely to result in--
     An annual effect on the economy of $100 million or more;
     A major increase in costs or prices for consumers, 
individual industries, Federal, State, or local government agencies, or 
geographic regions; or
     Significant adverse effects on competition, employment, 
investment, productivity, innovation, or on the ability of United 
States-based enterprises to compete with foreign-based enterprises in 
domestic and export markets.
    As discussed throughout this interim final rule, the establishment 
of PSOs should promote competition in the managed care industry and 
thus will not produce cost or price increases. Although the definitions 
being established through this rule do not lend themselves to a 
quantitative impact estimate, we do not believe that they are likely to 
produce an annual effect on the economy of $100 million or more. 
Therefore, we have determined that this interim final rule does not 
constitute a major rule as defined in Title 5, United States Code, 
section 804(2).
    We have examined the impacts of this interim final rule under 
Executive Order 12866, the Unfunded Mandates Act of 1995, and the 
Regulatory Flexibility Act (RFA) (Public Law 96-354). Executive Order 
12866 directs agencies to assess all costs and benefits of available 
regulatory alternatives and, when regulation is necessary, select 
regulatory approaches that maximize net benefits (including potential 
economic, environmental, and public health and safety effects; 
distributive impacts; and equity). The RFA requires agencies to analyze 
options for regulatory relief for small businesses and other small 
entities. For purposes of the RFA, most hospitals, and most other 
providers, physicians, and health care suppliers are small entities, 
either by nonprofit status or by having revenues of less than $5 
million annually. Most coordinated care plans are not considered to be 
small entities within the meaning of the RFA.
    The Unfunded Mandates Reform Act of 1995 requires that agencies 
prepare an assessment of anticipated costs and benefits for any rule 
that may result in an annual expenditure by State, local, or tribal 
governments, in the aggregate, or by the private sector, of $100 
million. This rule has no consequential effect on State, local, or 
tribal governments. We believe that the private sector costs of this 
rule also fall below the $100 million threshold.
    Also, section 1102(b) of the Social Security Act requires us to 
prepare a regulatory impact analysis for any rule that may have a 
significant impact on the operations of a substantial number of small 
rural hospitals. Such an analysis must conform to the provisions of 
section 603 of the RFA. For purposes of section 1102 of the Act, we 
define a small rural hospital as a hospital with fewer than 100 beds 
that is located outside a Metropolitan Statistical Area.
    Although we do not believe the aggregate impact of the PSO 
definitions and requirements set forth in this interim final rule will 
approach $100 million annually, it is clear that they may have a 
significant economic impact on certain hospitals, physicians, health 
plans and other providers. Thus, we have prepared the following 
analysis that, in combination with the rest of this interim final rule 
with comment period, constitutes a combined regulatory impact analysis 
and regulatory flexibility analysis.

B. Background

    As discussed in section I of this preamble, we believe that issuing 
these definitions as an interim final rule at this time is a necessary 
precursor to the establishment of solvency standards for PSOs through a 
negotiated rulemaking process, as required under section 1856(a)(1). In 
addition, publishing the definitional requirements at this time will 
allow time for interested entities to meet the requirements before 
submission of a PSO waiver and application in the spring of 1998. This 
sequence of events is necessary to ensure that all administrative 
systems will be in place to allow PSOs to begin health care operations 
by January 1, 1999.
    The PSO definition and requirements set forth in this interim final 
rule incorporate all statutory requirements set forth in section 
1855(d) of the Act. In those areas where further clarification of the 
statute is necessary, we have established requirements consistent with 
the statutory intent, that is, in a manner that will foster the 
development of PSOs as a distinct health care option for Medicare 
beneficiaries without inappropriately limiting competition among the 
various organizations that can offer Medicare+Choice plans. We have 
attempted to achieve a balance between these two goals in choosing the 
best alternative for several of the key issues discussed below.

[[Page 18132]]

C. Major Issues

    As discussed in section II of this preamble, the statute 
establishes two exceptions for PSOs to the requirements that apply to 
other Medicare+Choice organizations. Clearly, the primary benefit to an 
organization that can meet the definition of a PSO is that for 3 years, 
a PSO can qualify for a Federal waiver from State licensure 
requirements. In addition, PSOs are subject to lower minimum enrollment 
requirements than other Medicare+Choice organizations. We believe that 
the purpose of these exceptions is to encourage the development of a 
significantly different health care option for Medicare beneficiaries. 
Under the PSO option, providers are intended to bear a more direct 
responsibility for the delivery, management, and associated financial 
risks of a patient's health care than that borne by providers in other 
coordinated care plans. Establishing requirements in this interim final 
rule that allow health plans that are not significantly different from 
other Medicare+Choice options to contract as PSOs would undermine the 
intent of the statute by allowing organizations to receive the 
competitive advantage afforded by a waiver of state licensure and lower 
minimum enrollments without increasing options for beneficiaries.
1. Definition of a PSO
    Section 422.350(b) sets forth the statutory definition of a PSO, 
including the requirement that a PSO be established or organized, and 
operated, by a health care provider or group of affiliated providers. 
We are also including under Sec. 422.350(b) the statutory definition 
(from section 1855(d)(5) of the Act) of a health care provider, which 
specifies that a health care provider must be ``engaged in the delivery 
of health care services.'' We are clarifying in this section that for 
an individual, ``engaged in the delivery of health care services'' 
means that the individual directly furnishes health care services. For 
an entity, it means that the entity is organized and operated primarily 
for the purpose of directly furnishing health care services.
    We believe that this requirement will ensure that PSOs consist of 
providers that are actively delivering patient care, without 
arbitrarily prohibiting participation of entities that combined direct 
patient care services with other nonclinical health-related services. 
Under this definition, organized groups of providers, such as 
individual practice associations, physician practice management 
companies, or multi-specialty medical groups could fall within the 
definition of a provider, if they meet related requirements concerning 
affiliation, substantial risk, etc.
2. Substantial Proportion
    Section 1855(d)(1)(B) of the Act states that a PSO must provide a 
``substantial proportion'' of health care services directly through the 
provider or affiliated group of providers. Section 1855(d)(2) then 
provides specific further direction on what the Secretary should take 
into account in order to define ``substantial proportion'' so as ``* * 
* to assure financial stability and to address the practical 
considerations involved in integrating the delivery of a wide range of 
service providers.'' In particular, the statute directs that a PSO 
provide ``significantly more than the majority'' of the items and 
services required under the contract through its own affiliated 
providers.
    In defining the level of services that should constitute a 
substantial proportion of items and services under section 1855(d) of 
the Act, we attempted to identify a proportion that would achieve a 
balance between two competing interests. First, we did not want to set 
a proportion so high as to preclude participation by all but the most 
integrated provider organizations. At the same time, we wanted to set a 
requirement that would ensure that a PSO had a sufficiently well-
developed capacity to deliver services so as to meet the intent of the 
BBA both in terms of (a) providing a distinct and viable health care 
option for individual beneficiaries and (b) increasing the prospects 
for successful development and solvent operations of PSOs in general. 
Another consideration related to the establishment of the substantial 
proportion threshold percentage surfaced through our discussions with 
physician groups. They raised the possibility of establishing PSOs 
without hospitals as affiliates, and suggested that a 60 percent 
threshold might be low enough to allow such an organization. Finally, 
we had to take into account the fundamental requirement under section 
1855(d)(2)(A)(I) that a substantial proportion consist of 
``significantly more than a majority'' of items and services.
    Given all these considerations, we evaluated substantial proportion 
options between 60 and 80 percent of contractually required services. 
As part of this evaluation, we modeled the various service mixes to 
attempt to identify the types of provider combinations that might be 
possible at these various substantial proportion percentage levels. We 
came to the conclusion that it would be very difficult, if not 
impossible, to meet the substantial proportion percentage under any of 
these scenarios (that is, substantial proportion threshold of anywhere 
from 60-80 percent of services) without some combination of physician 
and hospital participation in the direct delivery of services as an 
affiliated provider of the PSO. Thus, under Sec. 422.352(b)(1), we are 
establishing the substantial proportion threshold at 70 percent of all 
health care items and services. We believe that this percentage on its 
face constitutes significantly more than a majority and achieves an 
appropriate balance among the objectives discussed above, in particular 
the requirement that the definition of substantial proportion achieve 
the objective of assuring the financial stability of the PSO. As 
required by section 1855(d)(2)(A)(ii), the PSO must provide most of the 
remainder of items and services not provided by the PSO and its 
affiliates directly through contracts with other health care providers.
    We also considered the possibility of specifying the composition of 
providers constituting the affiliated group of providers as a means of 
defining substantial proportion. Instead, we opted for the much more 
flexible approach of allowing PSO organizations to determine service 
mix within the constraint of meeting the overall substantial proportion 
requirement.
    Section 1855(d)(2)(C) of the Act provides that the Secretary may 
allow for variation in the definition of substantial proportion for 
rural PSOs. Consistent with this provision, and based upon consultation 
with rural health care industry representatives, we have established 
under Sec. 422.354(b)(2), a substantial proportion threshold of 60 
percent of items and services required under contract. We believe that 
this requirement reflects the lower proportion of specialty and other 
medical services that are likely to be available in some rural areas 
and is necessary to promote the likelihood of PSO development and 
success in rural areas. Consistent with most other Medicare programs 
(and current Sec. 417.1 of the regulations), we are adopting the widely 
accepted Office of Management and Budget definition of a rural area.
    As noted above, we recognize that the economic effects of the 
requirements set forth in this interim final rule concerning the 
substantial proportion threshold will be to require some combination of 
physician and hospital affiliation in most if not all PSOs. To the 
extent that this assumption is true, an

[[Page 18133]]

argument can be made that in setting the 70 percent substantial 
proportion threshold, we may be closing off market opportunities for 
physician groups by in-effect precluding them from establishing PSOs 
without hospital participation. However, we believe that, in most 
service areas, sufficient competition exists in the hospital industry 
to ensure hospital interest in engaging in a risk relationship with 
physician groups under a PSO; thus, physician groups should not be at 
an economic disadvantage. For rural areas, where such competition among 
hospitals is least likely to exist, we have established a lower 
substantial proportion threshold. We welcome comments on the economic 
effects of the substantial proportion threshold, particularly any data 
or statistical analysis relevant to this requirement.
3. Affiliation Status
    As described in detail in section II.B.6 of this preamble, section 
1855(d)(3) of the Act provides clear direction on the four possible 
meanings of the term ``affiliation'' as it applies to PSOs. We have 
adopted the statutory language under Sec. 422.354 of the regulations, 
and do not believe there is any reasonable alternative to this 
approach. (See below for related discussions of the meaning of 
``substantial risk'' and ``majority financial interest.'')
    We considered whether providers would be required to affiliate 
individually with other providers of the PSO or whether they could 
affiliate as a group through organizations such as physician practice 
management companies or individual practice associations. We concluded 
that such group affiliation arrangements are acceptable where the group 
is controlled by providers and where all other requirements are met. 
Requiring individual affiliation would be overly burdensome and could 
have the effect of unnecessarily restricting the development of, and 
availability of care under, PSO plans. Thus, as noted above, we believe 
that an affiliated provider could be a medical group or an independent 
practice association , as well as a hospital, nursing home, or home 
health agency, as long as the affiliation tests are met.
    In general, the affiliation rules are not intended to constrain the 
internal organizational structuring of the components of the entity 
that is the affiliated provider. For example, these rules do not limit 
an individual practice association's flexibility in bringing together 
individual physicians or its payment arrangements with those 
physicians. Similarly, if a hospital has purchased a medical practice 
and a nursing home, the hospital (in effect, now a health care system) 
is considered one affiliate provider. The affiliation tests apply to 
how this hospital or health care system affiliates with other provider 
entities outside of its corporate structure.
4. Substantial Financial Risk
    The term ``substantial financial risk'' is used in two contexts in 
section 1855(d) of the Act. First, section 1855(d)(1)(C) requires that 
all affiliated providers within a PSO share substantial financial risk 
in the provision of health care services. In addition, under section 
1855(d)(3)(C), one basis for demonstrating provider affiliation is the 
sharing of substantial financial risk in connection with the 
organization's operations. In order to provide additional guidance to 
organizations considering applying for PSO status, we have clarified 
the meaning of these terms in this interim final rule. We believe that 
both of these provisions share the common statutory intent of ensuring 
that affiliated providers have a financial interest in seeing the PSO 
and its affiliated providers achieve operational and financial success. 
This could serve to differentiate PSOs from other coordinated care 
options because providers in PSOs would have a more direct economic 
incentive to improve the PSO's delivery of health care.
    To satisfy this intent, we needed to determine both what type of 
financial arrangements were appropriate and whether the same set of 
arrangements should be considered substantial financial risk for both 
purposes. We considered allowing only those arrangements where 
affiliated provider income was based directly on the PSO's performance 
(for example, the ability of the PSO to ``withhold'' a significant 
amount of affiliated provider compensation to help pay other expenses). 
However, we determined that this option would unnecessarily restrict 
PSO development because a variety of arrangements may exist where 
affiliated providers have a financial interest in the PSO's 
performance. Therefore, we decided to consider a wide range of 
financial arrangements as constituting financial risk, as set forth 
under Sec. 422.356(a). We believe that this approach can achieve the 
statutory objective that affiliated providers are financially motivated 
to improve and maintain PSO performance. At the same time, PSOs can 
retain sufficient flexibility to tailor their financial arrangements 
with affiliated providers according to their particular circumstances.
    We also considered using different interpretations of substantial 
financial risk for the two applications of the term. We concluded that 
the identical use of the term in the statute provides a clear 
indication that a similar meaning is called for in both applications.
    We welcome comments on the potential effects of our interpretation 
of the term substantial financial risk.
5. Majority Financial Interest
    Section 1855(d)(1)(C) of the Act concludes with the requirement 
that the affiliated providers in a PSO have at least a majority 
financial interest in the organization. As discussed in detail in 
section III.E of this preamble, we believe the intent of this 
requirement is to ensure that affiliated health care providers maintain 
effective control of the PSO. However, the statute does not specify 
whether the affiliated providers that are required to have at least a 
majority financial interest in the PSO must constitute the identical 
group of affiliated providers that is required to provide a substantial 
proportion of services as discussed above.
    Thus, we considered two basic policy alternatives:
    (a) All affiliated providers used for purposes of complying with 
the substantial proportion requirement must individually meet the 
majority financial interest requirement. That is, all affiliated 
providers must have a financial interest in the PSO.
    (b) The majority financial interest requirement can be met under 
any combination of the affiliated providers. That is, at least one of 
the affiliated providers (or any combination of those providers) must 
maintain a majority financial interest in the PSO.
    We believe that the first option creates unnecessary restrictions 
on the development of the PSO option and could inhibit the ability of 
PSOs to compete effectively with other Medicare+Choice plans. In 
addition, mandating that each affiliated provider maintain a financial 
interest in the PSO is not practical in view of the dynamic nature of 
affiliated provider group relationships. Therefore, we are implementing 
the second and less restrictive option through Sec. 422.356(b), in 
combination with Sec. 422.354(c). We believe this option meets the 
intent of the statute by ensuring that PSOs develop a key 
distinguishing characteristic, provider control, from other 
Medicare+Choice coordinated care plans, while allowing sufficient 
organizational flexibility to foster PSO development.

[[Page 18134]]

D. Conclusion

    Overall, we believe that this interim final rule, as a complement 
to the statutory provisions regarding PSOs, can ensure that PSOs become 
a distinct and viable health care option under Medicare+Choice. Thus, 
this interim final rule should have beneficial effects in terms of 
providing additional coverage choices for Medicare beneficiaries. 
However, we are unable to quantify the economic effects of these 
provisions and recognize that not all of the potential effects can be 
anticipated. Therefore, we welcome comments on all aspects of this 
impact analysis, including the degree to which these definitions should 
promote availability of PSO plans, any effects of these definitions on 
the amount of interest among beneficiaries in joining these plans, and 
likely competitive effects (for example, whether the definitions set 
forth in this rule will promote competition or, alternatively, will 
unnecessarily created or close off opportunities in the health care 
market). Given the necessarily subjective nature of much of this impact 
analysis, we particularly solicit comments offering empirical data on 
the likely economic impact of the policies discussed here both on PSO 
health care plans and on competing Medicare+Choice plans.
    In accordance with the provisions of Executive Order 12866, this 
interim final rule with comment period was reviewed by the Office of 
Management and Budget.

VI. Waiver of Notice of Proposed Rulemaking

    We ordinarily publish a notice of proposed rulemaking in the 
Federal Register to provide a period for public comment before the 
provisions of a rule are made final. However, section 1871(b) of the 
Act provides that publication of a notice of proposed rulemaking is not 
required before issuing a final where ``a statute specifically permits 
a regulation to be issued in interim final form.'' Section 1851(b)(1), 
as added by section 4001 of the BBA, expressly authorizes the Secretary 
to issue standards, other than the PSO solvency requirements, as 
necessary to carry out Part C and to accomplish this through interim 
final rulemaking with public comment. We are exercising this authority 
in issuing this interim final rule with comment on PSO definitions and 
related requirements.
    In addition, we may waive publication of a notice of proposed 
rulemaking if we find good cause that prior notice and comment are 
impractical, unnecessary, or contrary to public interest. As discussed 
in section I of this preamble, HCFA and the negotiated rulemaking 
committee developing the solvency standards believe that we needed to 
establish a clear definition of a PSO and the fundamental 
organizational requirements that a PSO must meet as a prerequisite to 
the development of appropriate solvency standards. The PSO solvency 
regulation has a statutory deadline for publication of April 1, 1998. 
Further, we determined that entities considering applying to become 
PSOs under the Medicare+Choice program need to know whether and how 
they can qualify to participate in the program in order to establish 
the complex organizational structures necessary under the law prior to 
application. Many of these entities also need to seek State licensure 
or a federal waiver. Given the time required for these events, and the 
clear impetus from Congress for implementation of the Medicare+Choice 
program, we believe that it is impractical and contrary to the public 
interest to publish a notice of proposed rulemaking before establishing 
the PSO definitions and related requirements set forth in this interim 
final rule. We are providing a 60-day period for public comment.

VII. Response to Comments

    Because of the large number of comments we normally receive on 
Federal Register documents published for comment, we are not able to 
acknowledge or respond to them individually. We will consider all 
comments we receive by the date and time specified in the DATES section 
of this preamble and will respond to them in a forthcoming rulemaking 
document.

List of Subjects in 42 CFR Part 422

    Health Maintenance organizations (HMO), Medicare+Choice, Provider 
sponsored organizations (PSO).

    For the reasons set forth in the preamble, 42 CFR chapter IV is 
amended as set forth below:
    A new Part 422 is added to read as follows:

PART 422--MEDICARE+CHOICE PROGRAM

Subparts A--G [Reserved]

Subpart H--Provider-Sponsored Organizations

Sec.
422.350  Basis, scope, and definitions.
422.352  Basic requirements.
422.354  Requirements for affiliated providers.
422.356  Determining substantial financial risk and majority 
financial interest.

    Authority: Secs. 1851 and 1855 of the Social Security Act.

Subparts A-G-[Reserved]

Subpart H--Provider-Sponsored Organizations


Sec. 422.350  Basis, scope, and definitions.

    (a) Basis and scope. This subpart is based on sections 1851 and 
1855 of the Act which, in part,--
    (1) Authorize provider sponsored organizations, hereinafter 
referred to as PSOs, to contract as a Medicare+Choice plan;
    (2) Require that a PSO meet certain qualifying requirements; and
    (3) Provide for waiver of State licensure for PSOs under specified 
conditions.
    (b) Definitions. As used in this subpart (unless otherwise 
specified)--
    Control means that an individual, group of individuals, or entity 
has the power, directly or indirectly, to direct or influence 
significantly the actions or policies of an organization or 
institution.
    Engaged in the delivery of health care services means--
    (1) For an individual, that the individual directly furnishes 
health care services, or
    (2) For an entity, that the entity is organized and operated 
primarily for the purpose of furnishing health care services directly 
or through its provider members or entities.
    Health care provider means--
    (1) Any individual who is engaged in the delivery of health care 
services in a State and is licensed or certified by the State to engage 
in that activity in the State; and
    (2) Any entity that is engaged in the delivery of health care 
services in a State and is licensed or certified to deliver those 
services if such licensing or certification is required by State law or 
regulation.
    Provider-sponsored organization (PSO) means, for purposes of 
Medicare Part C, a public or private entity--
    (1) That is established or organized, and operated, by
    (i) A health care provider, or
    (ii) Group of affiliated health care providers;
    (2) That provides a substantial proportion (as defined in 
Sec. 422.352(b)) of the health care items and services under the 
Medicare+Choice contract directly through the provider or affiliated 
group of providers; and
    (3) In the case of paragraph (1)(ii) of this definition, the 
affiliated providers

[[Page 18135]]

    (i) Share, directly or indirectly, substantial financial risk (as 
defined in Sec. 422.356(a)) for the provision of items and services 
that are the obligation of the PSO under the Medicare+Choice contract, 
and
    (ii) Have at least a majority financial interest in the PSO.


Sec. 422.352  Basic requirements.

    (a) General rule. An organization is considered a PSO for purposes 
of a Medicare+Choice contract if the organization--
    (1) Is licensed by the State or has obtained a waiver of such 
licensure as provided for under section 1855(a)(2) of the Act;
    (2) Meets the definition of a PSO set forth in Sec. 422.350 and 
other applicable requirements of this subpart; and
    (3) Is effectively controlled by the health care provider or, in 
the case of a group, by one or more of the affiliated providers that 
established and operate the PSO.
    (b) Provision of services. A PSO must demonstrate to HCFA's 
satisfaction that it is capable of delivering to Medicare enrollees the 
range of services required under a contract with HCFA. Each PSO must 
deliver a substantial proportion of those services directly through the 
health care provider or the affiliated providers responsible for 
operating the PSO. Substantial proportion means--
    (1) For a non-rural PSO, not less than 70% of Medicare items and 
services covered under the contract.
    (2) For a rural PSO as defined in Sec. 422.354, not less than 60% 
of Medicare items and services covered under the contract.
    (c) Rural PSO. To qualify as a rural PSO, a PSO must demonstrate to 
HCFA that--
    (1) It has available in the rural area (as defined in 
Sec. 412.62(f) of this chapter) routine services, including but not 
limited to primary care, routine specialty care, and emergency 
services, and that the level of use of providers outside the rural area 
is consistent with referral patterns; and
    (2) As the PSO enrolls Medicare beneficiaries, a majority of these 
enrollees reside within the rural area served by the PSO.


Sec. 422.354  Requirements for affiliated providers.

    A PSO that consists of by two or more health care providers must 
demonstrate to HCFA'S satisfaction that it meets the following 
requirements:
    (a) The providers are affiliated. For purposes of this subpart, 
providers are affiliated if, through contract, ownership, or 
otherwise--
    (1) One provider, directly or indirectly, controls (as defined in 
paragraph (d) of this section), is controlled by, or is under common 
control with another;
    (2) Each provider is part of a lawful combination under which each 
shares substantial financial risk (as defined in Sec. 422.356(a)) in 
connection with the PSO's operations;
    (3) Both, or all, providers are part of a controlled group of 
corporations under section 1563 of the Internal Revenue Code of 1986; 
or
    (4) Both, or all, providers are part of an affiliated service group 
under section 414 of that Code.
    (b) Each affiliated provider of the PSO shares, directly or 
indirectly, substantial financial risk (as defined in Sec. 422.356(a)) 
for the provision of items and services under the Medicare contract 
that are the obligation of the PSO.
    (c) Affiliated providers, as a whole or in part, have at least a 
majority financial interest (as defined in Sec. 422.356(b)) in the PSO.
    (d) For purposes of paragraph(a)(1) of this section, control is 
presumed to exist if one party, directly or indirectly, owns, controls, 
or holds the power to vote, or proxies for, not less than 51 percent of 
the voting rights or governance right of another.


Sec. 422.356  Determining substantial financial risk and majority 
financial interest.

    (a) Determining substantial financial risk. The PSO must 
demonstrate to HCFA's satisfaction that it apportions a significant 
part of the financial risk of the PSO enterprise under the 
Medicare+Choice contract to each affiliated provider. The PSO must 
demonstrate that the financial arrangements among its affiliated 
providers constitute ``substantial'' risk in the PSO for each 
affiliated provider. The following mechanisms may constitute risk-
sharing arrangements, and may have to be used in combination to 
demonstrate substantial financial risk in the PSO enterprise.
    (1) Agreement by a health care provider to accept capitation 
payment for each Medicare enrollee.
    (2) Agreement by a health care provider to accept as payment a 
predetermined percentage of the PSO premium or the PSO's revenue.
    (3) The PSO's use of significant financial incentives for its 
affiliated providers, with the aim of achieving utilization management 
and cost containment goals. Permissible methods include the following:
    (i) Affiliated providers agree to a withholding of a significant 
amount of the compensation due them, to be used for any of the 
following:
    (A) To cover losses of the PSO.
    (B) To cover losses of other affiliated providers.
    (C) To be returned to the affiliated provider if the PSO meets its 
utilization management or cost containment goals for the specified time 
period.
    (D) To be distributed among affiliated providers if the PSO meets 
its utilization management or cost-containment goals for the specified 
time period.
    (ii) Agreement by the affiliated provider to preestablished cost or 
utilization targets for the PSO and to subsequent significant financial 
rewards and penalties (which may include a reduction in payments to the 
provider) based on the PSO's performance in meeting the targets.
    (4) Other mechanisms that demonstrate significant shared financial 
risk.
    (b) Determining majority financial interest. Majority financial 
interest means maintaining effective control of the PSO.

(Catalog of Federal Domestic Assistance Program Nos. 93.778, Medical 
Assistance Program; Program No. 93.773, Medicare--Hospital 
Insurance; and Program No. 93.774, Medicare--Supplementary Medical 
Insurance Program)

    Dated: February 25, 1998.
Nancy-Ann Min DeParle,
Administrator, Health Care Financing Administration.

    Dated: March 27, 1998.
Donna E. Shalala,
Secretary.
[FR Doc. 98-9810 Filed 4-13-98; 8:45 am]
BILLING CODE 4120-01-P