[Federal Register Volume 63, Number 88 (Thursday, May 7, 1998)]
[Rules and Regulations]
[Pages 25360-25379]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-12058]



[[Page 25359]]

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Part III





Department of Health and Human Services





_______________________________________________________________________



Health Care Financing Administration



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42 CFR Part 422



Medicare Program: Waiver Requirements and Solvency Standards for 
Provider-Sponsored Organizations; Final Rule

  Federal Register / Vol. 63, No. 88 / Thursday, May 7, 1998 / Rules 
and Regulations  

[[Page 25360]]



DEPARTMENT OF HEALTH AND HUMAN SERVICES

Health Care Financing Administration

42 CFR Part 422

[HCFA-1011-IFC]
RIN 0938-AI83


Medicare Program; Waiver Requirements and Solvency Standards for 
Provider-Sponsored Organizations

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

ACTION: Interim final rule with comment period.

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

SUMMARY: This interim final rule with a request for comments implements 
authority to waive, in the case of provider-sponsored organizations 
(PSOs) that meet certain criteria, the requirement that Medicare+Choice 
organizations be licensed by a State as risk-bearing entities. The 
waivers will be approved only under certain conditions where the State 
has denied or failed to act on an application for licensure.
    This rule also establishes solvency standards that certain entities 
must meet to contract as PSOs under the new Medicare+Choice program. 
These standards apply to PSOs that have received a waiver of the 
requirement that Medicare+Choice organizations be licensed by a State 
as risk-bearing entities.

DATES: Effective date: These regulations are effective on June 8, 1998.
    Comment date: Comments will be considered if we receive them at the 
appropriate address, as provided below, by 5 p.m. on July 6, 1998.

ADDRESSES: Mail an original and 3 copies of written comments to the 
following address: Health Care Financing Administration, Department of 
Health and Human Services, Attention: HCFA-1011-IFC, P.O. Box 26688, 
Baltimore, MD 21207-5187.
    If you prefer, you may deliver an original and 3 copies of your 
written comments 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.

    Because of staffing and resource limitations, we cannot accept 
comments by facsimile (FAX) transmission. In commenting, please refer 
to file code HCFA-1011-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).
    If you wish to submit comments on the information collection 
requirements contained in this interim final rule, you may submit 
comments to:

Health Care Financing Administration, Office of Information Services, 
Information Technology Investment Management Group, Division of HCFA 
Enterprise Standards, Room C2-26-17, 7500 Security Boulevard, 
Baltimore, MD 21244-1850, Attn: John Burke, HCFA-1011-IFC
Office of Management and Budget, Room 10235, New Executive Office 
Building, Washington, DC 20503, Attn: Allison Herron Eydt, HCFA Desk 
Officer

FOR FURTHER INFORMATION CONTACT:

Aaron Brown, (410) 786-1033--general policy
Maureen Miller, (410) 786-1097--general policy
Philip Doer (410) 786-1059--program operations
Greg Snyder, (410) 786-0329--program operations

SUPPLEMENTARY INFORMATION:

I. Background

A. Current Medicare Contracting Program

    Sections 1876 (g)(1) and (h)(1) of the Social Security Act (the 
Act) authorize the Secretary to enter into risk-sharing and cost 
contracts with eligible organizations to provide certain health 
benefits to members. Section 1876(b) of the Act requires an eligible 
organization, that may be a health maintenance organization (HMO) or a 
competitive medical plan (CMP), to be organized under the laws of a 
State. Additionally, section 1876(b) requires that such entities assume 
full financial risk on a prospective basis for the provision of health 
care services, and make adequate provisions against the risk of 
insolvency.

B. Current Regulations

    Regulations at title 42 of the Code of Federal Regulations (CFR), 
Part 417, reflect the above requirement that Medicare contracting 
organizations be organized under State law, and make adequate provision 
against the risk of insolvency. Specifically, regulations at 42 CFR 
417.120 require that Medicare contracting HMOs and CMPs have a fiscally 
sound operation as demonstrated by the following:
     Total assets greater than total unsubordinated 
liabilities.
     Sufficient cash flow and adequate liquidity to meet 
obligations as they become due.
     A net operating surplus or a financial plan.
     An insolvency protection plan.
     A fidelity bond or bonds, procured and maintained by the 
HMO, in an amount fixed by its policy-making body but not less than 
$100,000 per individual, covering each officer and employee entrusted 
with handling of its funds. The bond may have reasonable deductibles 
based upon the financial strength of the HMO.
     Insurance policies or other arrangements, secured and 
maintained by the HMO and approved by HCFA to insure the HMO against 
losses arising from professional liability claims, fire, theft, fraud, 
embezzlement and other casualty risks.
    Since section 1876 of the Act requires that Medicare contracting 
HMOs and CMPs be organized under the laws of any State, these entities 
are subject to State laws regarding financial solvency. Many States 
follow the financial solvency provisions of the HMO Model Act of the 
National Association of Insurance Commissioners (NAIC). The financial 
requirements of the Model HMO Act are distinct from those of the Health 
Care Financing Administration (HCFA).

C. Balanced Budget Act of 1997

    Section 4001 of the Balanced Budget Act of 1997 (BBA) (Public Law 
105-33), enacted August 5, 1997, added new sections 1851 through 1859 
to the Act. Those sections establish a new Medicare+Choice (M+C) 
program under part C of title XVIII of the Act. Part C is designed to 
give beneficiaries access to health plan choices that go beyond the 
original Medicare fee-for-service program and existing Medicare HMOs. 
Once the M+C program is implemented, an individual entitled to Medicare 
Part A and Part B will be able to elect benefits either through 
original Medicare or an M+C plan, depending on availability in their 
area. Under Part C, the M+C plans that may be offered are coordinated 
care plans (e.g., HMOs, provider-sponsored organizations (PSOs), and 
preferred provider organizations (referred to as PPOs)), private-fee-
for service plans, and demonstration medical savings account (MSA) 
plans (that is, a combination of a high deductible, catastrophic 
insurance plan with a contribution to a Medicare+Choice account).

[[Page 25361]]

    Regulations for the overall implementation of the M+C program are 
required by the BBA to be published by June 1, 1998. Those regulations 
will be incorporated into Part 422 of title 42 of the CFR. Provisions 
enacted by the BBA and the forthcoming M+C regulations establish broad 
and comprehensive requirements for contracting as an M+C plan, 
including basic benefits, payment, access to service, quality 
assurance, beneficiary hold harmless, continuation of benefits, appeals 
mechanisms, marketing and enrollment processes. Those overall M+C 
regulations will apply to PSOs as well.
    Section 1851(a)(2) of the Act explicitly provides for participation 
of a PSO in the M+C program as a coordinated care plan. A PSO is 
described in section 1855(d) of the Act as a public or private entity--
     That is established or organized, and operated, by a 
health care provider or group of affiliated health care providers;
     That provides a substantial proportion of the health care 
items and services directly through the provider or affiliated group of 
providers; and
     With respect to which the affiliated providers share, 
directly or indirectly, substantial financial risk for the provision of 
such items and services and have at least a majority financial interest 
in the entity.
    We recently published an interim final rule with an opportunity for 
public comment setting out this definition, clarifying certain terms, 
and establishing related requirements. (This PSO definitions rule 
established 42 CFR Part 422 and, more specifically, Subpart H, which is 
designated for the PSO provisions.) The terms and requirements related 
to the definition of a PSO are now found at Secs. 422.350 through 
422.356. Here, in this interim final rule with opportunity for public 
comment, we focus on two more portions of the law established 
specifically for PSOs and the M+C program: the Federal waiver of State 
licensure and the solvency standards that will apply to PSOs that have 
obtained such a waiver.
    Section 1855(a)(2) of the Act establishes a special exception for 
PSOs to the otherwise applicable requirement for State licensure if 
certain conditions occur. This interim final rule implements the PSO 
waiver provisions specified in the BBA, and makes clarifications. In 
order to assist organizations that are considering applying to become 
PSOs under the M+C program, we determined that the waiver provisions 
should not be delayed until the June 1, 1998 regulation is published. 
As with the PSO definitions rule mentioned above, early publication of 
these PSO provisions is desirable because of requirements that must be 
met before contract application.
    Section 1856(a) of the Act provides that the Secretary establish 
through a negotiated rulemaking process the solvency standards that 
entities will be required to meet if they obtain a waiver of the 
otherwise applicable requirement that they be licensed by a State. We 
note here that based on Secs. 422.352(a) and 422.380, State-licensed 
organizations that meet the PSO definition (see Secs. 422.350 through 
356) may qualify for the minimum enrollment standards established under 
Section 1857(b) of the Act but are not subject to these solvency 
standards.
    The solvency standards in this interim final rule with comment 
period are a product of the negotiated rule making process. This rule 
does not necessarily conclude the negotiated rulemaking process because 
the Committee may be reconvened to consider public comments that are 
received.

II. Waiver of State Licensure Requirement

A. Background

1. Statutory Basis
    A fundamental requirement of the M+C program, as set forth under 
new section 1855(a)(1) of the Act, is that an M+C 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 an M+C plan.'' However, section 1855(a)(2) of 
the Act establishes an exception to this requirement by allowing 
certain organizations established or operated and controlled by 
providers, and known in the BBA as PSOs, to obtain from the Secretary a 
Federal waiver of the State licensure requirement under certain 
circumstances. This interim final rule with comment sets forth 
regulations for implementing that waiver.
    Unlike the regulations contained in this rule relating to PSO 
solvency and capital adequacy, the waiver provisions were not developed 
through the negotiated rulemaking process. The regulations described in 
this section were developed by HCFA under its rulemaking authority.
2. State Licensure and the Medicare Program
    Under section 1876(b) of the Act and implementing regulations at 42 
CFR Part 417, Medicare contracting HMOs and CMPs must be organized 
under the laws of a State. As used in section 1876 of the Act, the term 
``HMO'' means a Federally qualified HMO and the term ``CMP'' means a 
prepaid health plan that is likely regulated by the State as an HMO, 
but is not Federally qualified. Thus a provider sponsored health plan 
could apply to contract with HCFA as an HMO or a CMP if it became 
Federally qualified or met the definition of CMP, and satisfied other 
section 1876 requirements. In recent years, several States have adopted 
licensure laws for PSOs (sometimes known as integrated or organized 
delivery systems), thereby creating another licensure vehicle and 
avenue for contracting with Medicare. (Some State PSO laws, however, 
are limited in scope and licensed entities would not meet the CMP 
requirements).
3. Federal Waivers and PSO Applications
    As indicated above, section 1855(a)(1) requires that M+C 
organizations be licensed as risk-bearing entities under the laws of 
the State. Section 1855(a)(2) of the Act provides an exception to this 
requirement for PSOs. PSOs are the only organization eligible to 
participate in M+C without State licensure. It is clear from the 
statute, however, that all organizations, including those established 
by providers, must seek State licensure as the initial step toward an 
M+C contract. Only under specific conditions, as described below, will 
the organization be permitted to forego the preliminary and fundamental 
requirement to be State-licensed as a risk-bearing entity.
    If an organization believes that the circumstances of its State 
application comply with one of the conditions for a waiver, it must 
submit to HCFA a completed waiver request form. The request form, that 
the Office of Management and Budget approved on April 2, 1998, (form 
#0938-0722) is available through HCFA, and is posted on the HCFA web 
site at http://www.hcfa.gov/Medicare/mplusc.htm. HCFA will make a 
determination to approve or disapprove a waiver within 60 days of 
receipt of a substantially complete request. If the waiver request is 
approved, the organization will be considered eligible for a waiver, 
and then may submit its contract application to HCFA. (The PSO 
application form will be posted at the aforementioned Internet address 
in the near future.) It is through the application process that the 
organization must demonstrate to HCFA's satisfaction that it meets the 
PSO definitions and requirements as set forth in 42 CFR 422.350 through 
422.356, as well as the solvency standards established later in this 
interim final rule. If it meets the

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definition, the organization will be considered a PSO and remains 
eligible for a waiver.
    Given the 60-day time period permitted HCFA to approve a waiver 
request under section 1855(a)(2)(F) of the Act, we felt it would be 
impossible in many cases to simultaneously process the waiver request 
and determine whether an organization is a PSO as defined under 
Sec. 422.350 through Sec. 422.356. This determination may require an 
extensive review and verification of the organization's structure, 
ownership or partnership arrangements, contracts and payment 
arrangements. Therefore, as described above, the 60-day maximum time 
period will apply to determining whether the organization is eligible 
for a waiver, as required by law. The determination that the 
organization is in fact a PSO will occur once it is eligible for a 
waiver and has submitted an application for an M+C contract.

B. Waiver Provisions

    In this interim final rule, we are establishing new provisions at 
Sec. 422.370 through Sec. 422.378 for purposes of implementing section 
1855(a)(2) of the Act. Because entities applying for a waiver as yet 
will not have been determined to meet the PSO definition and 
requirements of subpart H, the regulation text refers to these entities 
as ``organizations.''
    Section 422.370 implements the authority under section 
1855(a)(2)(A) of the Act to waive the State licensure requirement for 
M+C organizations contained in section 1855(a)(1) and restates the two 
basic conditions for doing this. First, the rule requires organizations 
interested in a waiver to file a request by no later than November 1, 
2002, a time limit specified by the statute. Second, HCFA must 
determine whether the organization meets one of the grounds for a 
waiver listed in Sec. 422.372.
    Section 422.372 of the rule establishes the basis for a waiver as 
set forth in sections 1855(a)(2)(B), (C), and (D) of the Act. These 
three conditions and a fourth condition identified by HCFA are 
described below. In order for three of the conditions to be 
effectuated, the organization must have applied for a State license 
before requesting a waiver. By requiring that the organization apply 
for ``the most closely appropriate'' license (or authority), we are 
clarifying that the type of license must relate to the nature of M+C 
coordinated care plans; that is, health plans providing coordinated, 
comprehensive benefits through a health care delivery net work on a 
fixed, prepayment basis. We are requiring this to ensure that 
organizations requesting and obtaining waivers will likely meet the PSO 
definition and M+C requirements during the application stage. We expect 
that for most States the most appropriate license available will be an 
HMO license, although this may change as States adopt PSO or modify 
current licensure laws. It is very unlikely that we will approve a PSO 
waiver based on an application for an indemnity insurance license, a 
PPO license, any license or authority to provide limited health 
services, or a limited license to bear risk for an HMO as a downstream 
contractor.
    Section 422.372(a) sets out the first basis on which an 
organization may establish waiver eligibility, that is, the State 
failed to complete action on the licensing application within 90 days 
of the date the State received a substantially complete application. 
(See section 1855(a)(2)(B).) The 90-day period may begin any time after 
enactment of the BBA. It is counted from the date the State received a 
``substantially complete application.'' In order to clarify the term 
``substantially complete application,'' we consulted several parties 
for technical assistance, and intend to make determinations as follows:
    (1) If the State has notified the organization, in writing, that 
the organization has submitted a substantially complete application, 
the date of that notification will be considered the date the State 
received a substantially complete application.
    (2) If the State has not notified the organization, in writing, as 
to the completeness of its application within 60 days of the date of 
submission of an application, we will consider the date the 
organization submitted its initial application to be the date the State 
received a substantially complete application.
    (3) If the organization can demonstrate to HCFA that it has 
submitted all of the information requested in an incompleteness 
notification from the State and the State still regards the application 
as incomplete or fails to notify the organization as to the status of 
its application within 30 days from the date it receives the 
organization's submission of the additional information requested, then 
HCFA will consider the date the State received the additional 
information requested to be the date the State received a substantially 
complete application.
    (4) In a dispute between an organization and the State over whether 
the organization has submitted a substantially complete application or 
over the date the State received a substantially complete application, 
HCFA will make the final determination based on consultation with the 
organization and the State.
    We believe that this process for determining the date the State 
received a substantially complete application is consistent with 
Congressional intent that an organization must make an earnest attempt 
to become State licensed before requesting a waiver. This earnest 
attempt includes working with the State in good faith to submit all of 
the information necessary to have a license either approved or denied. 
At the same time, however, we also believe that State licensing 
agencies should be working in good faith with the organization to 
either approve or deny an application in a timely manner.
    We believe the process outlined above balances the concerns of the 
States and of the organization. However, given the complexity of 
implementing this provision, we invite comment on this approach.
    Paragraph (b) of Sec. 422.372 establishes the second basis for a 
waiver. Here, waiver eligibility results from the organization 
experiencing discriminatory treatment in the State's denial of its 
application. As provided in the statute, discriminatory treatment can 
occur in two ways, as follows:
     The State has denied the licensure application on the 
basis of any material requirements, procedures or standards (other than 
solvency requirements) that the State does not generally apply to other 
entities engaged in a substantially similar business.
     The State required, as a condition of licensure, that the 
organization offer any product or plan other than an M+C plan.
    Thus, an organization will be eligible for a waiver under this 
provision if the State imposes different requirements, and these 
different requirements are the basis of a license denial. In addition, 
the organization must demonstrate what requirement, procedure, or 
standard it failed to meet, and how this differs from what is generally 
applied to other similar plans. In order to demonstrate that the State 
does not ``generally apply'' the requirement on which the denial was 
made, the organization must show that the requirement is more of an 
exception and not usually applied to similar health plans. For example, 
if a pattern exists where most HMOs within a State are not held to a 
requirement, the PSO will be eligible for a waiver based on 
discriminatory treatment.
    By ``substantially similar business'' we mean entities that provide 
and manage a comprehensive set of health

[[Page 25363]]

care services, and are prepaid a fixed amount in advance and without 
regard to the frequency or cost of services when utilized. Such 
entities are likely to include HMOs, and may include certain PPOs and 
State-licensed PSOs. We do not anticipate considering indemnity 
insurers, PPOs reimbursed on a discounted fee-for-service basis, or 
``single-service'' managed care plans as being engaged in a 
``substantially similar business'' to the waiver-requesting 
organization.
    We considered a broader use of the term ``engaged in a 
substantially similar business'', but believe our interpretation is 
consistent with the PSO provisions in section 1855 of the Act. We 
believe an expanded interpretation, which includes all risk-bearing 
entities (for example, indemnity insurers) does not comply with the 
language of the statute. In processing waiver requests under this 
provision at this time, we anticipate looking to the requirements, 
procedures and standards that a State places on HMOs.
    The second criterion for discriminatory treatment, set forth in 
Sec. 422.372(b)(2), is that the State requires the organization to 
offer its health plan to other than the Medicare population. Here, an 
organization would have to demonstrate only that it was denied a 
license because the health plan would serve only Medicare 
beneficiaries. We believe this provision permits the establishment of 
Medicare-only PSOs, and establishes a Federal preemption over any State 
laws that would prevent it.
    Paragraph (c) of Sec. 422.372, the third basis for approving a 
waiver of the State licensure requirement, pertains to a State imposing 
different requirements related to financial solvency. Two conditions, 
or criteria are specifically addressed in this paragraph. (See 
1855(a)(2)(D)(i) and (ii).) Under Sec. 422.372(c)(1), a waiver may be 
granted if the State has denied the licensure application, in whole or 
in part, based on the organization's failure to meet solvency 
requirements that are different from those set forth in Secs. 422.380 
through 422.390. This provision incorporates the new regulatory 
citation for PSO solvency standards developed through negotiated 
rulemaking as established in this rule.
    An issue arose regarding waiver eligibility when a State has 
adopted the Medicare PSO solvency standards and denies a license based 
solely on a provision of the solvency standards that give the regulator 
discretion. For example, it is likely that while using the same 
solvency standards, HCFA and States could reach different decisions 
regarding the acceptance of administrative infrastructure to reduce the 
minimum net worth amount requirement. If a State does not permit such a 
reduction, the issue arose whether HCFA would consider this a basis for 
a waiver. We have decided to permit requests for waivers in these 
situations. As documentation, we will require organizations to submit 
all information relevant to the specific solvency requirement in 
question, including any State correspondence. As part of our review, we 
will likely seek input from the State. If we concur with the State's 
determination regarding the specific discretionary issue, the waiver 
request will be denied. However, if we make a decision, that differs 
from the State's, then the waiver will be approved and the organization 
may submit an M+C application. We considered acceding to States' 
decisions where a regulator's discretion is warranted under the PSO 
solvency rules, but concluded that this might overly restrict the 
availability of waivers.
    The second condition, for a waiver under Sec. 422.372(c) is that 
the State has imposed documentation or information requirements, or 
other requirements, procedures or standards related to solvency or 
other material requirements that are different from those imposed by 
HCFA in carrying out Secs. 422.380 through 422.390. As with the 
previous condition, we believe that a PSO may seek a waiver if a State 
denies a license based on its exercise of discretion in requiring 
different information or documentation than HCFA. Therefore, 
documentation, information, and other requirements which may stem from 
such discretion can be the sole basis for granting a waiver under this 
particular provision. Our position on this issue is based upon the 
intent of the Congress, as reflected in the Conference Report 
accompanying the BBA, that the State not impose documentation or 
information requirements ``that are dilatory or unduly burdensome and 
that are not generally applied to other entities engaged in a 
substantially similar business.'' (H.R. Rep. No.105-217, 105th 
Congress, Session 632 (1997))
    The fourth basis for approving a waiver of the State licensure 
requirement, paragraph (d) of Sec. 422.372, is that the appropriate 
State licensing authority has notified the organization in writing that 
it will not accept their licensure application. While this grounds for 
approval is not in the Act, we are using our authority under section 
1856(b)(1) to establish standards to add this provision based on 
concerns that the Act allows for a waiver only if the PSO submits an 
application to the State. We have identified a concern that some State 
agencies may refuse to accept licensing applications from PSO-like 
organizations, thus preventing these organizations from requesting a 
waiver until 90 days have transpired.
    We believe this provision facilitates the waiver process and 
conforms with the intent of section 1855(a)(2) of the Act. If it is 
clear that a State licensing agency will not act on an application as 
described here, both the State and the organization can save time and 
resources by permitting the organization to go directly to HCFA for a 
waiver.
    In Sec. 422.374 we clarify certain conditions and provisions 
related to the waiver request and approval process. Paragraph (a) 
clarifies section 1855(a)(2)(f) of the Act, which requires 
organizations seeking a waiver to submit a substantially complete 
waiver request. Section 422.374(a) specifies that to be substantially 
complete, a request must clearly demonstrate and document the 
organization's eligibility for a waiver. HCFA will notify the 
organization if the request is not complete, and will work with the 
organization to determine the information necessary to make a decision 
on the request. HCFA will have final discretion in determining whether 
a waiver request is substantially complete.
    Paragraphs (b) and (c) of Sec. 422.374 provide that HCFA will act 
promptly (within 60 days) to grant or deny a substantially complete 
waiver request and allow organizations that have been denied a waiver 
request to submit subsequent requests until November 1, 2002. (See 
section 1855(a)(2)(F).)
    Paragraph (d) of Sec. 422.374 establishes that the waiver will take 
effect upon the effective date of the M+C contract. We have added this 
provision to clarify that a waiver is linked to the contract and is not 
active, or operable, without an effective M+C contract. This provision 
helps organizations seeking a waiver, because the waiver is limited to 
a one-time, three-year period. If the waiver is made effective 
immediately upon approval of a waiver request and the approval of the 
M+C contract takes longer than anticipated, the three-year waiver 
period would be running and the organization could lose a significant 
amount of time that it is eligible to operate without a State license. 
If the contract application is denied, an even greater amount of time 
may elapse by the time the organization can develop, submit and gain 
approval of a revised contract application.
    Paragraph (e) of Sec. 422.374 gives HCFA the right to revoke a 
waiver if we

[[Page 25364]]

subsequently find that the organization's M+C application is 
significantly different from the application submitted to the State. 
Because Congress intended for organizations to make an earnest attempt 
to obtain a State license before applying for a Federal waiver, we 
believe that significant changes from the State application to the M+C 
waiver application could undermine this policy. We believe that 
requiring that the M+C contract application be very similar to the 
application submitted for a State license addresses two possible 
situations. First, it prevents organizations from circumventing the 
intent for them to achieve State licensure if possible. It also assures 
States the right to license an organization that has evolved or 
reorganized from the time of its first application; that is, the 
organization has undergone some significant changes and the application 
for all intent and purposes is ``new.''
    Organizations that reapply for an M+C contract because they were 
not successful M+C applicants do not have to reapply to the State or 
re-submit a waiver request as long as the revised application does not 
invoke paragraph (e) of Sec. 422.374.
    Section 422.376 is added to establish parameters of the waiver. 
Paragraph (a) of this section restates section 1855(a)(2)(E)(i) of the 
Act, the waiver is effective only for the particular State for which it 
is granted and does not apply to any other State. It also clarifies 
that an organization must be licensed or request and gain waiver 
approval for each State where it wishes to operate an M+C plan.
    Paragraph (b) of Sec. 422.376 incorporates section 
1855(a)(2)(E)(ii) of the Act by limiting the waiver to a 36-month 
period. We have modified this provision, however, to extend the period 
through the end of the calendar year in which the 36-month period ends 
unless the waiver is revoked based on paragraph (c) of this section. We 
made this modification because we were concerned about terminating the 
waiver and the M+C contract during the middle of a contract year. Such 
mid-year terminations are unreasonable, disruptive, costly, and could 
unnecessarily jeopardize the health care of beneficiaries enrolled in a 
PSO. By waiting until the end of the contract year to end a waiver (and 
thus the M+C contract), beneficiaries will be able to transition into 
other M+C plans through the annual enrollment process.
    Paragraph (c) of Sec. 422.376, mid-period revocation, was added to 
clarify that the waiver will cease before the end of the 36 month 
period if the organization's M+C contract is terminated or if the 
organization becomes State licensed. This provision emphasizes again 
the relationship between the waiver and the contract; namely that the 
waiver is not effective without a contract in effect, and the contract 
cannot be effective without the waiver. It also restates the Act by 
conditioning the waiver upon the organization's compliance with State 
consumer protection and quality standards as discussed further below.
    The last section of the waiver provisions, Sec. 422.378, addresses 
the relationship between State law and waivered organizations, or PSOs. 
These provisions are a codification of sections 1855(a)(2)(E)(iii) and 
(iv), and 1855(a)(2)(G) of the Act. Section 422.378(a) establishes a 
general Federal preemption of any State law related to licensing the 
organization that interferes with contracting under the M+C program. 
Section 422.378(b), on the other hand, establishes the State's right to 
require waivered organizations to comply with consumer protection and 
quality standards applicable to all other M+C plans in the State, as 
long as the standards are consistent with Medicare requirements. 
Paragraphs (c) and (d) of Sec. 422.378 establish processes for ensuring 
compliance with Sec. 422.378(b). We are developing a memorandum of 
understanding with the NAIC to implement Secs. 422.378 (b), (c) and 
(d).

III. PSO Solvency Standards

A. Background

1. Negotiated Rulemaking Act
    The Negotiated Rulemaking Act (Pub. L. 101-648), establishes a 
framework for the conduct of negotiated rulemaking. Negotiated 
rulemaking is a process whereby a rule (generally a proposed rule) is 
developed by a committee of representatives of interests that are 
likely to be significantly affected under the rule and includes a 
Federal government representative. The goal of the process is to reach 
consensus on the text or content of the rule and then publish that text 
for public comment. Consensus is defined in the Negotiated Rulemaking 
Act as unanimous concurrence among the interests represented. However, 
the committee could agree on another specified definition. The 
committee is assisted by a neutral facilitator.
    The agency responsible for the rule may use the services of an 
impartial convener to identify potential participants in the 
negotiation, determine whether they are willing to participate, inform 
them about the process, discuss issues with potential participants, and 
make recommendations regarding how to make the process work. The 
committee must be chartered under the Federal Advisory Committee Act 
(FACA) (5 U.S.C. App.2).
2. Establishing the Process
    To expedite the development of PSO solvency standards, Congress 
modified the negotiated rulemaking process by requiring that this rule 
be published as an interim final rule with comment, shortening the 
period for forming the committee, establishing a shortened period for 
committee negotiations, and setting a target date for publication of 
the interim final rule for April 1, 1998. (See section 1856(a) of the 
Act.)
    We selected the Department of Health and Human Services 
Departmental Appeals Board (DAB) to serve as the convener and 
facilitator for these negotiations because of their reputation for 
impartiality, as well as their experience and availability. The DAB has 
familiarity with HHS programs and experience convening and facilitating 
negotiated rulemaking on Medicare issues such as the Medicare Hospice 
Wage Index and the Shared-risk Exemption to Federal Health Care Anti-
Kickback Provisions. Further, a poll of parties interested in the 
development of PSO solvency standards indicated unanimous support for 
using the DAB to facilitate the negotiated rulemaking.
    During the convening process, the DAB interviewed over 50 
individuals from outside the Federal government, representing over 25 
different associations, coalitions or companies. On September 8, 1997, 
the DAB issued a convening report recommending participants for the 
negotiated rulemaking committee (the Committee). This recommendation 
was based on an evaluation of the potential effects of the rule on 
groups that indicated a desire to serve on the Committee. When any 
differences among groups were identified, the convener sought 
information about how these differences were relevant with respect to 
solvency standards, whether those differences could be adequately 
represented by other groups, and whether there had been demonstrated 
concern about solvency standards during the legislative debate. The 
report also identified issues to be negotiated and potential barriers 
to consensus.
    On September 23, 1997, we published in the Federal Register (62 FR 
49649) a notice of intent to form a negotiated rulemaking committee and 
notice of meetings. Based on the recommendations contained in the 
convener's report, the notice appointed

[[Page 25365]]

representatives of interests likely to be affected by PSO solvency 
standards to the negotiated rulemaking Committee. Committee members 
included the--

    American Association of Health Plans,
    American Association of Retired Persons,
    American Hospital Association,
    American Medical Association,
    American Medical Group Association,
    Blue Cross/Blue Shield Association,
    Consortium on Citizens with Disabilities,
    Federation of American Health Systems,
    Health Insurance Association of America,
    National Association of Insurance Commissioners,
    National Rural Health Association
    Coalition of the Catholic Hospital Association and Premier 
Health Care
    Coalition of the American Association of Homes and Services for 
the Aging, the American Health Care Association, the Home Health 
Services and Staffing Association, and the National Association for 
Home Care; and
    Coalition of the Independent Practice Association of America and 
the National Independent Practice Association.

    In addition the Committee included a representative from HCFA.
    We requested public comment on whether we had identified the key 
solvency issues to be negotiated by the Committee; if we had identified 
the interests that will be affected by key issues listed; and whether 
the party we were proposing to serve as the neutral facilitator was 
acceptable. We also sought comments on several key definitions related 
to the negotiated rulemaking and the forthcoming rulemaking for 
Medicare+Choice organizations. In general, commenters supported the 
notice and as a result no changes were made to the Committee membership 
or issues to be discussed.
3. Summary of the Committee Process
    The Committee met seven times from October 1997 to March 1998. 
Notices of meetings were published in the Federal Register on September 
23, 1997 (62 FR 49649) and February 13, 1998 (63 FR 7359). Minutes for 
each of these meetings are posted on the M+C web page at http://
www.hcfa.gov/Medicare/mplusc.htm. At the first meeting, held October 
20, 21, and 22, 1997, business and health industry analysts made 
presentations that related to health plan solvency. Also the Committee 
discussed how to address the principle solvency issues and how to 
proceed in developing solvency standards. The Committee devoted the 
remaining series of 3-day meetings, and a final 1-day meeting, 
primarily to substantive discussion of solvency standards for Federally 
waived PSOs.
    The Committee's deliberations focused on the following issues: the 
stages at which to evaluate a PSO's financial solvency, the amount, 
composition, and location of assets and liabilities that PSOs must 
maintain to be considered financially solvent; the planning and data 
collection necessary to track PSO solvency; and the mechanisms needed 
to protect beneficiaries if a PSO becomes insolvent.
    On March 5, 1998, the Committee reached consensus on a PSO solvency 
standards proposal. All Committee members signed an agreement 
indicating unanimous concurrence with a written Committee statement of 
the Committee's recommendations for PSO solvency standards.
    In the agreement, HCFA agreed that, to the maximum extent possible 
and consistent with legal obligations, it will draft an interim final 
rule consistent with the Committee statement. We believe that the PSO 
solvency provisions of the interim final rule published herein are 
fully consistent with the Committee's recommendations, with some 
additional clarifications. Committee members have agreed not to submit 
negative comments on the interim final rule. If, however, a member 
believes any provision of this rule incorrectly reflects the Committee 
statement, the member may comment on the matter. If necessary, the 
Committee will be reconvened at a later date.
4. Summary of the Committee's Deliberations
    The Committee agreed that there are three stages at which to 
consider solvency standards: initially at start-up, as an ongoing 
business operation, and during insolvency. While these stages are only 
concepts that do not have exact starting or finishing points, the 
Committee felt that they are a useful framework for setting solvency 
standards at different stages of operation. These stages are translated 
in regulation to the application stage, the stage during which the M+C 
contract is in effect, and insolvency.
    The initial stage represents the period of activity prior to the 
first day of actual operation as an M+C contracting PSO. It includes 
the periods when an organization will request a Federal waiver of State 
licensure and will apply for an M+C contract. In this preamble and the 
regulation, the term PSO is reserved for organizations that are: 
approved for a Federal waiver, determined to meet the definition and 
related requirements of a PSO, and awarded a Medicare+Choice contract.
    The ongoing stage represents the period that begins when a PSO's 
M+C contract becomes effective. This is when a PSO will assume 
responsibility for providing services to Medicare beneficiaries for a 
fixed payment. During this stage, the appropriate solvency standards 
are affected by the number of Medicare enrollees for which a PSO is 
responsible. Lastly, the insolvent stage represents the period 
beginning when a PSO's total liabilities exceed its total assets.
    Using this three stage framework, the Committee developed alternate 
proposals regarding the amount, composition, and status of assets and 
liabilities that PSOs must maintain in order to be considered fiscally 
sound and financially solvent. The alternate proposals reflected the 
various interests of the Committee members and their constituencies. 
These proposals formed the basis for negotiations and the subsequent 
Committee statement and consensus agreement.
    To develop the solvency standards, the Committee considered what 
financial, capital and other factors must be present to assure that a 
PSO is fiscally sound. Specifically, the Committee considered 
requirements for net worth, financial plans, liquidity, financial 
indicators, and beneficiary protection.

B. Net Worth Amount Requirements

    The Committee considered the net worth requirements for the initial 
and ongoing stages. In each stage, the Committee deliberated on the 
appropriate amount and composition of assets to be counted toward the 
net worth requirement. The Committee agreed that in the initial stage 
an organization should have an initial minimum net worth amount of 
$1,500,000. This is the same minimum net worth amount that is specified 
in the HMO Model Act, with a significant difference. The Committee 
agreed to allow HCFA to reduce the net worth requirement by up to 
$500,000 if the PSO has available to it an administrative 
infrastructure that HCFA considers appropriate to reduce, control or 
eliminate start-up costs associated with the administration of the 
organization. Such infrastructure would include office space and 
equipment, computer systems, software, management services contracts 
and personnel recruitment fees. In recognizing a reduction of up to 
$500,000 for these costs, the Committee acknowledged that the minimum 
net worth drops from $1,500,000 to $1,000,000 as soon as the PSO is 
approved and that the $500,000 difference was to account for start-up 
costs. HCFA has the discretion to approve the administrative costs that 
an organization offers to obtain a reduction of up to $500,000.

[[Page 25366]]

    For the ongoing stage, the Committee agreed that the minimum net 
worth should be at least $1,000,000. This is the minimum specified in 
the HMO Model Act for the ongoing stage. The difference between the 
ongoing minimum net worth and the initial minimum net worth reflects 
the Committee belief that PSOs will incur administrative costs in the 
initial stage that will not be repeated in the ongoing stage. While the 
floor on the minimum net worth amount in the ongoing stage is 
$1,000,000, the Committee agreed to subject PSOs to a series of 
``greater of'' tests to determine an appropriate minimum net worth. The 
``greater of'' tests link the minimum net worth amount to the size of 
annual premium revenues, the amount of uncovered health care 
expenditures, and the amount of health care expenditures paid to non-
capitated and non-affiliated providers. These factors are indirectly 
related to the size of the plan (that is, number of enrollees) and the 
amount of risk being assumed.
    The Committee discussed whether to include, among the factors 
considered in setting the ongoing net worth amount for PSOs, the 
authorized control level (i.e., the point in a financial crisis where a 
State regulator is authorized to take control of an organization) 
capital requirement derived from the NAIC Health Care Organization Risk 
Based Capital (RBC) Formula. RBC is a new formula adopted by the NAIC 
to determine the minimum capital level that an organization should have 
before regulators become concerned about its solvency. The RBC level 
depends on the riskiness of the company's assets, investments, and 
products. RBC has several trigger points. As currently envisioned, if a 
company's actual net worth falls below the trigger point called the 
authorized control level, the State's insurance commissioner may take 
control of the company. The RBC for health organizations has not yet 
been adopted by States for setting minimum net worth requirements.
    The RBC formula by design will be used by States to monitor the 
financial viability of State-regulated managed care plans. It has not 
yet been adopted by States in setting the minimum net worth amount 
requirements. The Committee agreed that HCFA should consider adding 
that RBC authorized control level factor to the ongoing net worth 
amount requirements after evaluating whether the RBC is a valid 
indicator of Medicare PSO solvency and after considering the manner in 
which States have regulated managed care plans using the RBC authorized 
control level. In 1999, after PSOs have begun to operate and report 
financial data, HCFA will issue a notice requesting comment on adding 
this factor to the net worth calculation for PSOs. As part of HCFA's 
normal data collection process for all M+C plans, HCFA expects to be 
collecting information necessary to perform the RBC calculations.
    With regard to the composition of the minimum net worth amount, the 
Committee agreed upon the following requirements--
     At least $750,000 of the minimum net worth must be in cash 
or cash equivalents. After the effective date of the contract, however, 
the Committee agreed that $750,000 or 40 percent of the minimum net 
worth amount must be in cash or cash equivalents.
     Up to 10 percent of the minimum net worth amount can be 
comprised of intangible assets in the initial stage. However, in the 
initial stage, if a PSO keeps $1,000,000 in cash or cash equivalents 
and does not use the administrative reduction, then up to 20 percent of 
that PSO's minimum net worth can be comprised of intangible assets. In 
the ongoing stage, a PSO must keep the greater of $1,000,000 or 67 
percent of the ongoing minimum net worth in cash or cash equivalents to 
qualify for the 20 percent level on intangibles.
     Subject to the above provisions, health care delivery 
assets (HCDAs) may be admitted at 100 percent of their value according 
to generally accepted accounting principles (GAAP).
     Subject to the above provisions, other assets may be 
admitted according to their value under Statutory Accounting Practices 
(SAP).
     Subordinated debts and subordinated liabilities can be 
excluded from the calculation of liabilities for the purposes of 
determining net worth.
     Deferred acquisition costs are excluded from the net worth 
calculation.
    The Committee also agreed that HCFA will look at SAP codification 
upon its completion and will consider whether to adopt codification 
standards on the asset concentration and quality of HCDAs for waivered 
PSOs. SAP codification standards are currently being developed by the 
NAIC to make SAP more consistent among the States. HCFA will request 
public comment on whether to use any such standards in the notice on 
the NAIC RBC (see above). Meanwhile, HCFA may apply judgement in 
evaluating HCDAs for concentration and quality.
    In the Committee's deliberations the concepts of net worth and 
liquidity were closely related. Some Committee members suggested that 
because PSOs have the potential to provide ``sweat equity,'' these 
organizations could operate under different solvency standards for net 
worth and liquidity than might be acceptable for other forms of 
integrated delivery systems. The term ``sweat equity'' was used to 
represent the value of health services that a PSO could provide 
directly. One premise presented to the Committee was that PSOs could 
continue to furnish services during financial crises because the 
``owners'' actually provide health care services, whereas other managed 
care systems that contract for the delivery of care may not be able to 
continue to operate. In addition, PSOs could adopt contingent 
reimbursement arrangements with their providers. Under such 
arrangements, the affiliated providers' payments could be reduced until 
the PSO had weathered the financial crisis.
    The consensus was not to explicitly recognize sweat equity in the 
solvency standards. This position evolved because of the difficulty in 
developing an administrable solvency standard based upon sweat equity. 
Further, the solvency standards implicitly recognize sweat equity in 
other areas (e.g., the financial plan).

C. Liquidity Requirements

    In conjunction with a minimum net worth amount requirement, the 
Committee discussed a standard for meeting financial obligations on 
time. The Committee adopted, for both the initial and the ongoing 
stages, the liquidity standard that a PSO have sufficient cash flow to 
meet its obligations as they become due. Also, the Committee 
recommended that in the initial and ongoing stages HCFA should use the 
same factors to determine the ability of a PSO to meet the liquidity 
standard: (1) the timeliness of PSO payments of obligations, (2) the 
extent to which the current ratio is maintained at 1:1 or whether there 
is a change in the current ratio over a period of time, and (3) the 
availability to a PSO of outside financial resources to meet its 
obligations.
    The current ratio focuses on a period that is up to one year long. 
It compares all assets that are convertible to cash within that period 
with all liabilities that will come due in that same period using the 
following formula:
[GRAPHIC] [TIFF OMITTED] TR07MY98.000

    The Committee agreed that PSOs should maintain a current ratio of 
at least 1:1. That is, current assets should be equal to or greater 
than current liabilities. The Committee also agreed that the current 
ratio is a target rather than an absolute standard. This position

[[Page 25367]]

recognizes that valid reasons may exist for a PSO's current ratio to go 
below 1:1 for short periods of time. However, there were also concerns 
by some Committee members that the current ratio is an important 
indicator of an organization's condition and a current ratio of under 
1:1 should trigger some regulatory action. Therefore, the current ratio 
will be used to identify trends or sudden major shifts in a PSO's 
financial performance.

D. Financial Plan Requirements

    Several presenters before the Committee identified poor planning 
and management control as the primary reasons for the early HMO 
failures. As a standard to encourage good planning and strong 
management, the Committee agreed that a financial plan is essential for 
PSOs. Further, such plans should be prospective, reasonable, and 
consistent. The Committee used the financial plan standard for 
contractors under section 1876 of the Act to develop the PSO standard, 
but specified certain provisions differently. The specific requirements 
of the financial plan are presented in the discussion of provisions, 
below.
    The Committee believed that the financial plan standard they agreed 
to represents the minimum needed to monitor Federally waived PSOs. The 
Committee agreed that HCFA should have the discretion to modify the 
financial plan to require additional or different information as 
necessary to evaluate the financial position of a Federally waived PSO.
    The Committee agreed that in the initial stage, at the time of 
application, organizations must submit financial plans covering the 
period from the most recent financial audit until 12 months after the 
effective date of an M+C contract. If, however, a financial plan 
projects losses, then the time horizon must extend further, to 12 
months after the point that the financial plan projects two consecutive 
quarters of net operating surplus.

E. Pre-Funding of Projected Losses

    One area of the financial plan that the Committee discussed 
considerably was a requirement that PSOs must identify all sources of 
funding for projected losses (and in certain circumstances actually 
have the cash available). A key issue in this discussion was if and how 
to recognize such financing methods as guarantees and letters of credit 
(LOC). Some Committee members expressed concern about quickly securing 
money that was pledged to a PSO in a guarantee or letter of credit 
during a financial crisis. For a PSO that is under financial strain, 
the timely availability of cash is crucial to both the PSO and HCFA in 
attempting to protect Medicare enrollees. A delay in securing needed 
cash--if, for example, the guarantor stalls or reneges on its 
obligation--could exacerbate a financial crisis and further threaten 
the quality and continuity of care for enrollees.
    Other Committee members contended that guarantees and LOC are a 
common and accepted means of obtaining capital for integrated health 
delivery systems. Furthermore, many providers who are candidates to 
become Federally waived PSOs could not participate unless guarantees or 
LOC, or both, are allowed. Advocates of guarantees and LOC felt that 
they should be admitted for two purposes: meeting the net worth 
requirements and funding projected losses.
    As a compromise, the Committee agreed to accept guarantees, but 
only for funding projected losses that are reported by a PSO in its 
financial plan. As previously mentioned, the solvency standards 
contained herein require PSOs to fund all projected losses in the 
financial plan from the effective date of their M+C contracts until 
they achieve two consecutive quarters of net operating surplus. The 
Committee agreed that guarantees are an acceptable means to fund 
projected losses provided certain conditions are met. Further, the 
Committee agreed that each PSO's guarantee would be subject to a trial 
period of one-year from the effective date of the PSO's M+C contract. 
During this period, guarantees would be accepted, but cash or cash 
equivalents equaling the obligations covered by the guarantee would 
have to be on a PSO's balance sheet six months prior to the date 
actually needed. After a year, assuming that the guarantee obligations 
are met timely, the Committee agreed that a PSO should be permitted to 
notify HCFA of its intent to reduce or eliminate the pre-funding 
period. The Committee further agreed that HCFA should have up to 60 
days after the receipt of such notice to exercise its discretion and 
modify or reject the notice. However, if the guarantee obligations are 
not properly met on a timely basis, the Committee agreed that HCFA 
should have the discretion to require a PSO to fund projected losses 
through other methods or further in advance.
    HCFA presented the Committee with draft standards on guarantees. 
The Committee generally supported the draft with some revisions, but 
did not officially adopt the standards as part of the Agreement before 
needing to vote on consensus.
    The Committee agreed that it should recognize LOC as a means to 
fund projected losses. To be accepted, LOC must be irrevocable, clean, 
and unconditional. Additionally, LOCs must be capable of being promptly 
paid upon presentation of a sight draft under the LOC without further 
reference to any other agreement, document or entity. The Committee 
also agreed that beginning one year after the effective date of an M+C 
contract, a PSO should be allowed to use the following other means to 
fund projected losses: (1) lines of credit from regulated financial 
institutions, (2) legally binding capital contribution agreements, and 
(3) other legally binding contracts of similar reliability.
    The Committee recognized that HCFA should have discretion regarding 
the acceptance of guarantees, LOCs and other means to fund projected 
losses. Accordingly, use of these vehicles is subject to an 
appropriateness standard. That is, guarantees, LOCs and other means of 
funding projected losses may only be used in a combination or sequence 
that HCFA determines is appropriate.

F. Reporting

    The Committee agreed that PSOs must meet HCFA requirements for 
compiling, maintaining and reporting such financial information as the 
agency determine is necessary. HCFA should have the discretion to 
specify the contents, method of calculation, and the schedule for 
reporting such financial indicators. We believe that this discretion is 
necessary for proper oversight of Federally waived organizations as 
they evolve and as market conditions evolve. The Committee recommended 
that the general reporting format be the NAIC's Official Annual 
Statement Blank--HMO Edition (the Orange Blank). HCFA will modify data 
obtained from this form for application to PSOs. Use of this form will 
not prohibit HCFA from requesting additional information if the agency 
determines that such information is necessary to accurately assess a 
PSO's financial condition.
    The Committee agreed that the common practice should be to require 
quarterly or annual reports. If a PSO has not achieved a net operating 
surplus, the Committee felt that HCFA could require financial reporting 
as frequently as monthly. Monthly reporting would be necessary to 
enable HCFA to maintain better oversight of PSOs that are at heightened 
financial risk.

[[Page 25368]]

G. Insolvency Protections

    The Committee's deliberation in the area of insolvency focused upon 
protecting beneficiaries. The Committee considered five issues 
regarding insolvency: an insolvency deposit requirement, a hold 
harmless requirement, a continuation of coverage provision, reserves 
for uncovered expenditures, and termination of an M+C contract.
    The Committee agreed that an insolvency deposit should be required. 
The insolvency deposit would be used to pay for the costs associated 
with receivership or liquidation. Committee discussions focused on the 
amount of the insolvency deposit rather than the need for a deposit. 
For the insolvency deposit requirement, the Committee considered a 
range between $100,000 and $300,000. Committee members supporting a 
$300,000 deposit contended that a lower deposit would be quickly 
exhausted and inadequate in a financial crisis. Committee members who 
supported the $100,000 deposit countered that a higher deposit would be 
too onerous when combined with the cash reserves required to meet the 
minimum net worth amount. The consensus position was to allow the lower 
insolvency deposit of $100,000, provided that the requirement for the 
cash portion of the minimum net worth amount be set at $750,000. 
Additionally, the Committee agreed that the insolvency deposit would be 
counted toward the minimum net worth requirement although not toward 
the $750,000 cash requirement.
    With regard to uncovered expenditures, the Committee adopted the 
HMO Model Act standard. The Model Act requires that whenever uncovered 
expenditures exceed 10 percent of total health care expenditures, an 
entity must create a deposit equal to 120 percent of outstanding 
liabilities for uncovered expenditures. Rather than being available for 
a State insurance commissioner, the deposit would be restricted for 
HCFA's use in the event of an insolvency to pay claims and 
administration costs.
    While the Committee discussed the issues of Federal bankruptcy/
State receivership, hold harmless, and continuation of coverage, they 
concluded that these issues were beyond the scope of the negotiations. 
Further, Federal bankruptcy and State receivership matters are not 
within the purview of HCFA. The hold harmless and continuation of 
benefits provisions will be considered as part of the overall M+C 
regulation due to be published later this year.

H. Solvency Standards for Rural PSOs

    In pre-consensus Committee discussion, there was vigorous 
discussion of separate solvency standards for rural PSOs. (See 
Sec. 422.352(c) for a definition of rural PSO.) Some Committee members 
contended that rural providers would find it particularly difficult to 
meet the solvency standards, especially the cash requirements. Rural 
providers, as compared to their urban counterparts tend to have high 
portions of their assets concentrated in health care delivery assets 
and intangible assets. To rural PSOs, an excessive cash requirement may 
amount to an undue barrier to entry.
    The Committee's consensus on this issue was to develop one solvency 
standard for all PSOs. The underlying premise was that the experience 
of an unexpected, major claim would harm rural PSOs more because rural 
PSOs tend to have smaller enrollments than urban PSOs, and therefore a 
smaller revenue base for absorbing sudden financial fluctuations. The 
Committee believed that financial instability in a rural PSO could be 
more easily triggered by lower solvency standards.
    However, recognizing the unique needs of rural communities, the 
Committee directed HCFA to solicit public comment on the issue of 
separate solvency standards for rural PSOs. Thus, we are hereby seeking 
comments on this matter, particularly on the appropriateness of the net 
worth and liquidity requirements of this interim final rule for rural 
PSOs. HCFA is interested in the merit and appropriateness of separate 
standards, alternative proposals, relevant analysis, and administrative 
simplicity.

I. Credit for Reinsurance

    As directed by the BBA, the Committee considered whether to allow a 
credit for reinsurance. Several Committee members advocated that 
reinsurance reduces the risk that PSOs will have to bear and would be 
particularly valuable during the initial stage where PSOs are likely to 
have fewer enrollees and claims are harder to predict. Committee 
members who opposed reinsurance argued that many HMO reinsurance 
contracts contain termination clauses that are triggered once an 
organization starts losing money. Underlying this contract issue is a 
broader problem; namely there would need to be provisions developed for 
Federal regulation and oversight of PSO reinsurers given the Federal 
waiver of State licensure. Without proper regulation and safeguards, 
reinsurance policies could not be relied upon to protect beneficiaries 
in the event of a financial crisis. Opponents also indicated that 
reinsurance is an essential part of a sound business plan. Therefore, 
it should not be treated as an optional credit against the minimum net 
worth amount. Lastly, to the extent that reinsurance will reduce a 
PSO's current and projected losses, reinsurance is implicitly 
recognized in the financial plan. The consensus was not to admit 
reinsurance as a credit against the minimum net worth amount. The 
Committee felt that to the extent that reinsurance reduces projected 
losses, it is implicitly recognized in the financial plan.

J. Financial Solvency Standards Provisions

    The requirements of this interim final rule are found in 42 CFR 
Part 422, Subpart H, Provider-Sponsored Organizations. Here we set 
forth the solvency requirements for organizations that are applying for 
and are operating under an M+C contract.
    Section Sec. 422.350, Basis, Scope and Definitions, is amended to 
include definitions and terminology for new terms related to the 
solvency standards for PSOs.
    Section Sec. 422.380 sets forth the general requirement that a PSO 
must have a fiscally sound operation that meets the requirements of the 
following provisions.
    Section 422.382 sets forth the minimum net worth amount 
requirements. There is a minimum net worth amount requirement for 
organizations that are in the process of applying for a PSO M+C 
contract, and another for organizations that are operating as a PSO 
under an M+C contract.
    Paragraph (a) of Sec. 422.382 sets forth the requirements that must 
be met at the time of application. An organization must have a 
$1,500,000 minimum net worth amount. This is the same amount that is 
specified in the HMO Model Act, except that under this regulation, HCFA 
has the discretion to reduce this amount by up to $500,000 for 
organizations that at the time of application have available 
administrative infrastructure that will reduce, control or eliminate 
administrative costs.
    Paragraph (b) of Sec. 422.382 sets forth the requirements that must 
be met after the effective date of an M+C contract. A PSO must have a 
minimum net worth amount of at least $1,000,000. The minimum net worth 
amount is determined by a ``greater of'' test. The

[[Page 25369]]

``greater of test'' requires a PSO to have a minimum net worth amount 
equal to the greater of--
     $1,000,000;
     Two percent of annual premium revenues up to and including 
the first $150,000,000 of annual premiums and 1 percent of annual 
premium revenues on premiums in excess of $150,000,000;
     An amount health care expenditures; or
     An amount equal to the sum of 8 percent of annual health 
care expenditures paid on a non-capitated basis to non-affiliated 
providers, and 4 percent of annual health care expenditures paid on a 
capitated basis to non-affiliated providers plus annual health care 
expenditures paid on a non-capitated basis to affiliated providers. 
Annual health care expenditures that are paid on a capitated basis to 
affiliated providers are not included in this calculation. In essence, 
the ``greater of'' test establishes a minimum net worth requirement 
above $1,000,000 that varies in proportion to the size of the PSO's 
operation.
    Section 422.382(c) establishes the composition of assets that are 
needed to meet the minimum net worth requirement. The objective of the 
minimum net worth requirement is to enable PSOs to avoid a financial 
crisis or to mitigate the effects of a crisis. To achieve this, 
organizations applying to become PSOs are required to have on their 
balance sheets a minimum level of cash or cash equivalents. In 
paragraph (c)(1) of Sec. 422.382, the minimum cash requirement is set 
at $750,000 at application, and at $750,000 or 40 percent of the 
minimum net worth amount after the effective date of the contract. 
After the effective date of an M+C contract the cash requirement above 
$750,000 is proportional to the minimum net worth amount. Lower cash 
requirements were proposed, but the Committee was unable to reach 
consensus on them. As discussed below, organizations that maintain a 
higher cash level are permitted to use a greater proportion of 
intangible assets to meet the minimum net worth requirement.
    Other provisions of the paragraph address assets besides cash or 
cash equivalents that may be included in determining the minimum net 
worth, and limitations. Paragraph (c)(2) of Sec. 422.382 establishes 
the proportion of the minimum net worth amount that may be comprised of 
intangible assets, depending on an organization's cash level. 
Intangible assets can comprise up to 10 percent of the minimum net 
worth amount, at the time of application for an organization with 
$750,000 (and less than $1,000,000) in cash or cash equivalents. 
However, an organization that has $1,000,000 in cash or cash 
equivalents at application can satisfy up to 20 percent of its minimum 
net worth amount requirement with intangible assets. After the 
effective date of the contract, an organization must maintain the 
greater of $1,000,000 or 67 percent of the minimum net worth amount in 
cash or cash equivalents to qualify for the admission of intangible 
assets up to 20 percent of the minimum net worth amount.
    Under paragraph (c)(3) of Sec. 422.382, HCDAs are admissible to 
satisfy the minimum net worth amount requirement, subject to the cash 
requirement. They are valued at 100 percent of their value according to 
GAAP. Section 1856(a) of the Act directed the Secretary to take into 
account ``the delivery system assets of [provider sponsored 
organizations].'' The recognition of HCDAs under GAAP, that often times 
is limited under SAP, was adopted to recognize that large portions of 
PSOs' assets are HCDAs. The Committee agreed that if the cash 
requirement were set at the appropriate level, then any perceived risk 
from recognizing HCDAs was reduced.
    Under paragraph (c)(4) of Sec. 422.382, other assets that are not 
used in the delivery of health care are admissible to satisfy the 
minimum net worth amount. However, they are admitted at their value 
according to State SAP which generally are more conservative than GAAP. 
Because SAP are determined at the State level, organizations will have 
to follow the accounting methodology approved by the insurance 
commissioner in the State in which they operate.
    As set out in paragraph (c)(5) of Sec. 422.382, an organization 
does not have to include subordinated debts or subordinated liabilities 
for the purpose of calculating the minimum net worth. (Subordinated 
liability is a new concept that the Committee defined to mean claims 
liablities otherwise due to providers that are retained by the PSO to 
meet the net worth requirements.) The Committee discussed this 
provision in the context of provider reimbursement arrangements that 
withhold a portion of payment contingent upon certain budget or 
utilization targets being met. The Committee agreed that if these 
payments are fully subordinated to all other creditors, then they 
should not be included in the calculation of a PSOs net worth for the 
purpose of meeting the minimum net worth amount requirement. We believe 
that this provision is another example how the concept of sweat equity 
is implicitly considered in these solvency standards.
    In paragraph (c)(6) of Sec. 422.382, deferred acquisition costs are 
not permitted to be included in the calculation of the minimum net 
worth amount. The Committee believed that in an insolvency situation, 
these would have little or no value.
    Paragraphs (a) (b) and (c) of Sec. 422.384 sets forth the financial 
plan requirement. The same documents required of Medicare contracting 
HMOs and CMPs under section 417.120(a)(2) of the Medicare regulations 
are required here; namely marketing plans, statements of revenue and 
expense, statements of sources and uses of funds, balance sheets, 
detailed justifications and assumptions supporting the financial plan, 
and statements of the availability of financial resources to meet 
projected losses.
    PSOs should anticipate the need to utilize the services of 
qualified actuaries (e.g., a member in good standing with the American 
Academy of Actuaries) in (a) the preparation of financial plans 
consistent with the PSO's business plan, (b) the development of claim 
costs for the benefits to be offered by the PSO and (c) the analysis of 
claim liabilities and the necessary liquid assets to meet obligations 
on a timely basis. Accordingly, the Committee agreed that the financial 
plan must be satisfactory to HCFA. HCFA expects and, at its discretion, 
will ascertain that the information contained in the financial plan has 
been certified by reputable and qualified actuaries.
    Paragraph (d) of Sec. 422.384 sets forth the requirement that 
organizations that are projecting a loss must have the resources to 
fund those projected losses. This section also defines the conditions 
under which HCFA will recognize various arrangements as acceptable 
funding of projected losses. The general rule is that organizations 
must have on their balance sheets assets that they identify to fund 
projected losses. Exceptions are made for guarantees, LOCs, and other 
means provided that certain conditions are met.
    Paragraph (e) of Sec. 422.384 sets forth the exception to the ``on 
the balance sheet'' requirement that applies when guarantees are used 
to fund projected losses. Guarantees are permitted, but they are 
subject to a trial period. For the first year after the effective date 
of an M+C contract any organization using a guarantee must have from 
the guarantor, in cash or cash equivalents, funds to cover projected 
losses six months in advance of when needed. For example, prior to the 
effective date of an M+C contract, a PSO must have funding from

[[Page 25370]]

the guarantor equal to the projected losses for the first two quarters 
(6 months) of the contract. Before the start of the second quarter, 
funding of projected losses through the third quarter must be added to 
the balance sheet of the PSO. Because of the time it takes to bring a 
new contractor onto the HCFA systems, the first two quarters funding 
will need to be in the PSO, that is, on its balance sheet at least 45 
days before the effective date of the contract. Quarters, or 90-day 
periods, will be counted from the effective date of a PSO's M+C 
contract.
    If guarantee funding is timely during the first year, a PSO may 
reduce or eliminate the period of pre-funding in future years by 
providing notice to HCFA. Upon receipt of such notice, HCFA will have 
up to 60 days in which to modify or reject any changes in the period of 
prefunding. If the guarantee funding is not timely, then HCFA may take 
appropriate action including requiring an organization to use other 
methods or timing to fund projected losses. Lastly, guarantors and 
guarantees must meet the requirements specified under Sec. 422.390, 
discussed below.
    Paragraph (f) of Sec. 422.384 sets forth the exception to the ``on 
the balance sheet'' requirement that applies when LOCs are used to fund 
projected losses. LOCs are admissible to fund projected losses on the 
condition that they are provided by a high quality source and be 
irrevocable, unconditional and satisfactory to HCFA. Additionally, LOCs 
must be capable of being promptly paid upon presentation of a sight 
draft under the LOCs without further reference to any other agreement, 
document or entity. The Committee agreed that HCFA should have the 
discretion to accept or reject a letter of credit.
    Paragraph (g) of Sec. 422.384 sets forth the exception to the ``on 
the balance sheet'' requirement that applies when other means are used 
to fund projected losses. Other means of funding such as LOCs credit, 
legally binding capital contribution agreements, and other legally 
binding contracts of similar quality are admissible to fund projected 
losses. However, these methods are available only after an organization 
has had an M+C contract for at least one year.
    Paragraph (h) of Sec. 422.384 sets forth the general rule that HCFA 
will have the discretion to decide whether a PSO is using guarantees, 
LOCs or other means in a combination or sequence that HCFA deems 
appropriate. We note here that the BBA directed the Secretary to take 
into account alternative means of protecting against insolvency 
including guarantees, LOCs and other means. The Committee considered 
whether to admit guarantees, LOCs, and other means to reduce the 
minimum net worth amount, as well as to fund projected losses. However, 
the consensus was to recognize them only toward meeting the requirement 
to fund projected losses.
    Section 422.386(a) sets forth the general liquidity requirement 
that a PSO must have sufficient cash flow to meet its financial 
obligations as they become due and payable. This requirement is 
consistent with the standard that is applied to Medicare contracting 
HMOs and CMPs under 42 CFR Sec. 417.120.
    Paragraph (b) of Sec. 422.386 contains three tests to determine 
whether an organization is able to meet its financial obligations as 
they become due and payable: (a) history for timeliness in meeting 
current obligations, (b) the extent to which a PSO maintains a current 
ratio of 1:1, and (c) the availability of outside financial resources 
to the PSO. The Committee adopted (a) because such a history is a 
strong signal of management's commitment to maintaining a fiscally 
sound organization.
    The second test requires more discussion. We define ``current 
ratio'' as total current assets divided by total current liabilities, 
where the word ``current'' means less than one year. A current ratio of 
1:1 means that an organization's current assets are sufficient to meet 
its current liabilities. The possibility exists that in the course of 
normal business operations PSOs may miss the current ratio slightly for 
short, nonrecurring periods of time. In light of this, HCFA is using a 
1:1 current ratio as a target rather than as an absolute standard. 
Accordingly, HCFA will monitor PSOs that drop below the 1:1 ratio and 
act where a PSO experiences a long-term, declining trend or a sudden, 
large decline in its current ratio.
    The use of trends in the current ratio allows HCFA to recognize 
certain situations where current assets do not have to equal or exceed 
current liabilities. For HMOs and PSOs in their early years, the 
reported current ratio results will likely produce misleading trends. 
The amount of pre-funding of projected losses ``within'' versus 
``outside'' the organization may change over time, distorting trends. 
Changing patterns of liabilities (for example, 30-day business expenses 
unpaid or estimates of unreported claims) can also distort the current 
ratio from one based on consistent underlying data. Consequently, the 
PSO has an obligation to monitor underlying true trends and to provide 
such information, together with a projection of continuing current 
liabilities consistent with its business plans. The information should 
be certified by a qualified actuary and presented to HCFA prior to the 
filing of a timely financial report with a current ratio below 
standard.
    The third test for evaluating liquidity highlights in several ways 
the importance of having outside financial resources available to a 
PSO. First, such resources fill a practical role by providing a cushion 
in the event of a financial crisis. Second, if such resources are 
available from a parent or affiliate organization, it signals a 
continuing commitment to the PSO. Third, the availability of such 
resources from outside the corporation, either from a private or a 
commercial source, indicates continuing market confidence that the 
organization is a viable ongoing business concern.
    Paragraph (c) of Sec. 422.386 requires that if HCFA determines that 
an organization is not in compliance with the liquidity requirement, it 
will require the organization to initiate corrective action to pay all 
overdue obligations.
    Paragraphs (d) and (e) of Sec. 422.386 specifies that corrective 
action can include requiring the organization to change the 
distribution of its assets, reduce its liabilities, secure additional 
funding, or secure funding from new funding sources.
    Section 422.388 sets forth the deposit requirements to provide 
protection in the event of an insolvency. Paragraph (a) of Sec. 422.388 
establishes an insolvency deposit that organizations are required to 
make at the time of application and maintain for the duration of the 
M+C contract. The insolvency deposit is $100,000. The deposit must be 
restricted to use in the event of insolvency to help assure 
continuation of services or pay costs associated with receivership or 
liquidation. At the time of application and thereafter, upon HCFA's 
request, the organization must provide HCFA with proof of the 
insolvency deposit, in a form that HCFA considers appropriate.
    Paragraph (b) of Sec. 422.388 establishes an uncovered expenditures 
deposit requirement. The amount of uncovered expenditures that a PSO 
experiences will vary, and this deposit is required any time that they 
exceed 10 percent of the PSO's total health care expenditures. The 
deposit must at all times have a fair market value of an amount that is 
120 percent of the PSO's outstanding liability for uncovered 
expenditures for enrollees, including incurred, but not reported 
claims. The deposit must be calculated as of the first day of each 
month required and maintained for the remainder of each month required. 
If a

[[Page 25371]]

quarterly report is not otherwise required, a report must be filed 
within 45 days of the end of the calendar quarter to demonstrate 
compliance. The deposit must be restricted for HCFA's use to protect 
the interests of the PSO's Medicare enrollees and to pay the costs 
associated with administering the insolvency. The deposit is restricted 
and in trust and may be used only as provided in Sec. 422.388.
    Under paragraph (c) of Sec. 422.388 the deposits may be used to 
satisfy the organization's minimum net worth requirement. Under 
paragraph (d) of Sec. 422.388 all income from the deposits or trust 
accounts are considered assets of the organization. Upon HCFA's 
approval, the income from the deposits may be withdrawn.
    Paragraph (e) of Sec. 422.388 sets forth requirements that upon 
HCFA's written approval, the income from the deposits may be withdrawn 
if a substitute deposit of cash or securities of equal amount and value 
is made, the fair market value exceeds the amount of the required 
deposit, or the required deposit is reduced or eliminated.
    The deposit requirement for uncovered expenditures is triggered by 
a historical trend analysis that indicates such expenditures are 
comprising an increasing portion of total health care expenditures. The 
Committee adopted the HMO Model Act language for the uncovered 
expenditures deposit.
    Section 422.390 sets forth the requirements for guarantors and 
guarantees, which under Sec. 422.384(e), above, can be used to fund 
projected losses. We are exercising caution in the use of guarantees 
because we will have to monitor the financial viability of the PSO and 
the guarantor as well. We believe we have selected a screening approach 
that recognizes financially strong guarantors and protects Medicare 
enrollees, yet permits affiliated providers or parent organizations to 
support the PSO with financial backing.
    Paragraph (a) of Sec. 422.390 vests HCFA with the discretion to 
approve or deny the use of a guarantor. Paragraph (b) of Sec. 422.390 
initiates the approval process with a request from the PSO, including 
financial information on the guarantor.
    Paragraph (c) of Sec. 422.390 sets forth the requirements that a 
guarantor must meet to be licensed and authorized to conduct business 
within a State or territory of the United States. The guarantor must be 
solvent and not be under any Federal bankruptcy or State proceedings, 
and have a net worth of at least three times the amount of the 
guarantee.
    A distinction is made between guarantors that are and are not 
regulated by a State insurance commissioner. If regulated by a State 
insurance commissioner, the guarantor's net worth calculation need only 
exclude from its assets the value of all guarantees, investments in and 
loans to organizations covered by guarantees. But, if a guarantor is 
not regulated by a State insurance commissioner, then it must also 
exclude the value of guarantees, investments and loans to related 
parties (i.e., subsidiaries and affiliates) from its assets to 
calculate its net worth. We believe these requirements ensure the 
stability and financial strength of the guarantor without being overly 
restrictive.
    Paragraph (d) of Sec. 422.390 contains provisions for the guarantee 
document to be submitted to HCFA by the PSO, and signed by the 
guarantor. This document is the written commitment of the guarantor to 
unconditionally fulfill its financial obligation to the PSO on a timely 
basis.
    In paragraph (e) of Sec. 422.390, the PSO is required to routinely 
report financial information on the guarantor.
    Paragraph (f) of Sec. 422.390 sets forth the requirements for 
modification, substitution, and termination of the guarantee. A PSO 
must have HCFA's approval at least 90 days before the proposed 
effective date of the modification, substitution, or termination; 
demonstrate to HCFA that insolvency will not result; and demonstrate 
how the PSO will meet the requirements of this section within 15 days, 
and if required by HCFA, meet a portion of the applicable requirements 
in less than the time period granted.
    Paragraph (g) of Sec. 422.390 establishes conditions that must be 
met if the guarantee is nullified. If at any time the guarantor or the 
guarantee ceases to meet the requirements of Sec. 422.390, HCFA will 
notify the PSO that it ceases to recognize the guarantee document. In 
the event of nullification, a PSO must meet the applicable requirements 
of this section within 15 business days and if required by HCFA, meet a 
portion of the applicable requirements in less than the above time 
period. These requirements and conditions are not only good business 
practices, but also protect Medicare enrollees by ensuring that a PSO's 
financial backing is sound.

IV. Applicability of These Rules

    The provisions of this rule apply only to certain PSOs and do not 
apply to any other type of Medicare applicant or contracting entity.
    Organizations that may be considered PSOs and that meet any of the 
criteria as set forth in Sec. 422.372 may be eligible for a waiver of 
State licensure. As discussed earlier, an organization interested in 
entering into a contract with Medicare as a PSO must first contact the 
appropriate State agency and, in most cases, submit an application for 
a State license, or authority. A PSO that is denied licensure (and the 
denial is related to any of the criteria cited) or is denied the 
opportunity to apply for licensure, should submit a request for a 
waiver to HCFA. Organizations that have their waiver request approved 
by HCFA may then submit a PSO application. The PSO application contains 
provisions for demonstrating compliance with the PSO definitions and 
solvency requirements in addition to other contracting requirements (a 
supplemental application may be necessary after the June regulation is 
published). It is during the application process that an organization 
will be determined to qualify as a PSO for purposes of Medicare 
contracting under Part C of the Act. The waiver will take effect with 
signing of the M+C contract.
    The solvency standards established in this rule apply to 
organizations which have had a waiver approved, as described above, and 
are applying for a Medicare PSO contract, as well as waivered PSOs with 
a Medicare contract in effect. These rules were developed through 
negotiated rulemaking specifically for risk-bearing entities that will 
enroll primarily beneficiaries of the Medicare program. Federal and 
State government agencies that may contemplate use of these solvency 
standards for other purposes or other populations should review them 
carefully, and consider the nature of the health plans and the 
populations they will serve.
    Provider-sponsored managed care plans that obtain a State license 
should apply directly for an M+C contract by completing the application 
for HMO/PPOs/State-licensed PSOs (i.e., this is the same application as 
used by HMOs). These entities, whether licensed as a PSO or HMO or 
other managed care plan recognized by the State, will not have to 
demonstrate compliance with the PSO definitions in Sec. 422.350 through 
356, or with the PSO solvency standards. However, State-licensed PSOs 
or State-licensed managed care plans that wish to meet the lower 
minimum enrollment standard will have to meet the definitions criteria 
of the PSO application. These ``State-licensed PSOs'' must meet the 
solvency standards as required by their State, not the Medicare PSO 
solvency standards as established in this interim final rule.

[[Page 25372]]

V. Regulatory Impact Analysis

A. Introduction

    We have examined the impact of this interim final rule as required 
by Executive Order 12866 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, to select regulatory approaches that maximize 
net benefits (including potential economic, environmental and public 
health and safety effects; distributive impacts and equity). The 
Regulatory Flexibility Act (RFA) requires agencies to analyze options 
for regulatory relief for small businesses, unless we certify that the 
regulation would not have a significant economic impact on a 
substantial number of small entities. Most hospitals, and most other 
providers, physicians and health care suppliers are small entities 
either by non-profit status or by having revenues of less than $5 
million annually. The impact of this regulation will be to create a new 
business opportunity for such small entities to form provider sponsored 
organizations to contract with the Medicare program.
    Section 1102(b) of the Act requires us to prepare a regulatory 
impact analysis if a final rule may have a significant impact on the 
operations of a substantial number of small rural hospitals. This 
analysis must conform to the provisions of section 604 of the RFA. For 
purposes of section 1102(b) of the Act, we define a small rural 
hospital as a hospital that is located outside a Metropolitan 
Statistical Area and has fewer than 50 beds. We are not preparing an 
analysis for section 1102(b) of the Act because we have determined, and 
we certify, that this final rule will not have a significant impact on 
the operations of a substantial number of small rural hospitals.
    We prepared this impact analysis because of the probability that 
these waiver requirements and solvency standards may have an impact on 
certain hospitals, physicians, health plans and other providers. We are 
preparing to publish a regulation outlining the overall provisions of 
the M+C program. That regulation will consider the impacts of PSOs and 
other new provider types in greater detail than is provided in this 
regulation. The following analysis, in combination with the rest of 
this interim final rule with comment period, constitutes a regulatory 
impact analysis and a regulatory flexibility analysis.

B. Background

    While the term ``provider sponsored organization'' has been used 
generally in reference to health care delivery systems that providers 
own or control and operate, the term has a more specific meeting for 
purposes of the M+C program. Accordingly, we defined, by regulation, 
the fundamental organizational requirements for entities seeking to be 
PSOs. These definitions are set forth at 42 CFR 422.350. Organizations 
that meet these definitional requirements can apply for a Federal 
waiver and a M+C contract. Having defined the term PSO in earlier 
regulation, this rule has two broad purposes: (1) To establish the 
requirements and process necessary for organizations to obtain Federal 
waiver of license requirements for risk-bearing entities; and (2) to 
establish standards for financial solvency to which such Federally 
waived organizations must adhere.
    With regard to the impact of the waiver requirements and process, 
we emphasize three important underlying factors. First, waivers cannot 
exceed 36-months in duration and are not renewable. Second, the 
Secretary's authority to grant waivers ends November 1, 2002. Finally, 
the Secretary can grant waivers only to organizations that have first 
applied for a State license as a risk bearing entity, but were denied 
by virtue of three things: (1) States' failure to act timely on the 
license application; (2) States' denial of the application for 
``discriminatory'' reasons; or (3) States'' denial for failure to meet 
different solvency standards than are promulgated here. The first two 
factors (i.e., the duration of the waiver and the waiver authority) are 
important to this impact analysis because they indicate that, under 
current law, no organization will operate under a Federal waiver after 
November 1, 2005. The third fact regarding eligibility for a Federal 
waiver may have an effect on the waiver application rate.
    The solvency standards have an even narrower focus than the waiver 
requirements because the former only effect organizations that have 
received a Federal waiver and are either applying for or actually have 
received an M+C contract. Within this smaller population, organizations 
will be affected differently or not at all depending upon the status of 
the solvency standards in their respective States. It is likely that 
waiver activity will be greater in States that have solvency standards 
that differ significantly from the standards developed in this 
regulation. Below we consider the anticipated impact of this rule.

C. Anticipated Effects

1. Effects on Providers
    HCFA discussion with the industry as part of the negotiated rule 
making process suggests widespread interest in the benefits of becoming 
a PSO (i.e., waiver of State licensure and lower minimum enrollment 
standards). This regulation benefits certain health services providers 
that have been denied a State risk-bearing license by creating an 
opportunity for them to obtain a Federal waiver of the State license 
requirement and participate in the M+C program as contractors. As such, 
this regulation provides means for such providers to gain access to a 
market from which they otherwise would be excluded. While clearly not 
possible to predict how many organizations will attempt to take 
advantage of this new opportunity, we have seen estimates that the 
first year application rate will be between 25 and 150 organizations. 
For several reasons, we estimate between 25 and 50 organizations will 
apply. In the first year many organizations will be interested, but we 
expect that the ``learning curve'' necessary to gain familiarity with 
this new program will restrain the first year application rate. Second, 
the waiver process, which for this discussion includes the prerequisite 
State application process, and M+C application process, are time 
intensive steps. At a minimum, these steps could take up to 6 six 
months to complete. After the first year, however, the number of 
applicant organizations will increasingly be a function of PSOs' 
performance and their reception in the market place.
    We do not expect that the waiver process will create a substantial 
additional burden for organizations. For one thing, the waiver process 
is not a mandatory burden. The waiver process affects only 
organizations that affirmatively choose to become Federally waived 
PSOs. For those organizations that apply, we estimate that the waiver 
application will require less than 20 hours to complete. However, we do 
believe that waiver applicants will face the additional task of 
documenting their denial of a State license.
    Regarding the application for an M+C contract, there are existing 
application requirements for organizations that seek to contract with 
Medicare under section 1876 of the Act. We do not believe that the M+C 
application process, which will be essentially the same, will be any

[[Page 25373]]

more burdensome than an application under section 1876 of the Act. To 
the extent that organizations that previously have not contracted with 
the Medicare program choose to seek an M+C contract, the application 
will be a new task. Given the new provider focus of this initiative, it 
is plausible to expect that many applicants have not previously 
contracted directly with Medicare. However, we believe that the benefit 
to Medicare beneficiaries gained by screening potential contractors 
outweighs the burden associated with having a reasonable application 
process in place.
2. Effects on the Market Place
    We expect that the advent of PSOs will increase market competition 
among health care service providers, albeit only slightly. The increase 
in competition is expected to be limited for four reasons. First, since 
Federally waived PSOs are limited to serving Medicare enrollees, any 
changes in competition will be primarily concentrated in the Medicare 
sector of the health services delivery market. We note that there may 
be crossover effects to the extent that service providers' success with 
Medicare may affect their success generally.
    Second, we believe that this rule, primarily concerns the structure 
of entities that can participate in the market for Medicare enrollees. 
We expect transfer effects; that is, existing providers changing 
corporate form in order to avail themselves of PSO status. However, we 
do not anticipate a significant increase in the aggregate market place 
capacity of providers or health service delivery assets. The providers 
and hospitals that will form PSOs are coming from the same pool that 
are currently providing services. In addition, the principle effect on 
revenues will be a change in the source of payment from Medicare parts 
A and B to the new part C.
    Third, to the extent that these solvency standards are similar to 
existing standards, the potential transfer effect will be limited. 
Since standards vary greatly by State, and State standards are 
evolving, it is difficult to assess the relative effect of the instant 
standards. We note, however, that with several key exceptions (e.g., 
different initial minimum net worth requirement and a lower insolvency 
deposit) the instant standards track the HMO Model Act. Therefore, we 
do not believe there will be a significant transfer due to the 
existence of an unlevel playing field between PSOs and other entities. 
We believe that establishing standards of financial solvency is 
necessary to insure that PSOs have the financial resources to provide 
adequate quality care and to reduce the possibility of disrupting 
beneficiary care.
    Finally, in the preamble to this regulation, HCFA agreed that it 
will consider the NAIC's Risk Based Capital formula as well as the 
codification of Statutory Accounting Practices when these methodologies 
become available. If one or both of these methodologies are adopted for 
the PSO solvency standards, it would help to narrow any existing 
differences between State-level and Federal solvency standards.

3. Effects on States

    This regulation will affect States in several ways, some of which 
are offsetting. First, we expect that a few States may have to reduce 
their application turnaround times in order to avoid tolling the 90-day 
limit for State review of a waiver application. However, based upon 
conversations with State insurance commissioners, we believe in many 
States the application turnaround time is at or near the 90-day limit.
    The second effect will be a reduction in States' oversight burden. 
For PSOs that obtain a Federal waiver, responsibility for monitoring 
their financial solvency will be transferred from the States to HCFA. 
This is a temporary reduction, since waivers last only 36 months and 
the Secretary's authority to grant waivers ends on November 1, 2002. By 
the end of a PSO's waiver, it will need a State license in order to 
continue its M+C contract. Therefore, to ease the transition from a 
Federal waiver to a State license, we encourage PSOs to establish a 
relationship with regulators in their respective States soon after 
receiving a waiver. To minimize the chances of a gap in financial 
oversight, HCFA is negotiating with the State Insurance Commissioners 
via the NAIC to develop a Memorandum of Understanding regarding sharing 
information on the financial solvency of PSOs.
    Lastly, it has been suggested that this interim final rule may 
pressure States to adopt solvency standards that mirror the Federal 
standards. Currently, we do not have a good measure of the extent to 
which this will occur. However, we emphasize that the negotiated 
rulemaking committee developed these solvency standards solely in the 
context of Federally waived PSOs that will provide services under an 
M+C contract. States are cautioned not to adopt these standards for 
general application without first considering their affect on the 
overall health services delivery market in their jurisdictions.
4. Effects on Beneficiaries
    We expect that this regulation will have a positive effect on 
Medicare beneficiaries since it creates a new managed care option. We 
expect that the principle source for enrollees for newly formed PSOs 
will be current Medicare fee-for-service enrollees. We expect that the 
advent of PSOs and M+C in general will have the effect of further 
mainstreaming managed care plans among Medicare enrollees. We do not 
anticipate an increase in the potential for service interruptions 
because these new PSOs will be subject to the same beneficiary hold-
harmless provisions and continuation of benefits requirements as all 
M+C organizations. Lastly, section 1855(a)(2)(G) of the Act requires 
PSOs to comply with all existing State consumer protection and quality 
standards as if the PSO were licensed under State law.

D. Conclusion

    By enacting the BBA provisions related to PSOs, Congress has 
indicated its belief in the potential for provider controlled 
organizations to improve the delivery of services to Medicare 
beneficiaries. While expanding the options available to Medicare 
beneficiaries, we believe that this regulation provides an opportunity 
for providers to test their ability to manage the delivery of health 
care services. The negotiated rulemaking Committee, which included 
representatives from the entire range of interested parties, reached 
consensus on provisions that were acceptable when considered as a 
whole. It is safe to say that Committee members considered the impact 
of these provisions on their respective constituencies during the 
negotiating process.
    We conclude that this regulation will have an undeterminable impact 
on small health service providers. However the provisions of this 
interim final rule are expected to be favorable for the managed care 
community as a whole, as well as for the beneficiaries that they serve. 
We have also determined, and the Secretary certifies that this proposed 
rule will not result in a significant economic impact on a substantial 
number of small entities and would not have a significant impact on the 
operations of a substantial number of rural hospitals. In accordance 
with the provisions of Executive order 12866, this regulation was 
reviewed by the Office of Management and Budget.

[[Page 25374]]

VI. Collection of Information Requirements

Emergency Clearance: Public Information Collection Requirements 
Submitted to the Office of Management and Budget (OMB)

    In compliance with the requirement of section 3506(c)(2)(A) of the 
Paperwork Reduction Act of 1995, the Health Care Financing 
Administration (HCFA), Department of Health and Human Services (DHHS), 
has submitted to the Office of Management and Budget (OMB) the 
following request for Emergency review. We are requesting an emergency 
review because the collection of this information is needed prior to 
the expiration of the normal time limits under OMB's regulations at 5 
CFR, Part 1320. The Agency cannot reasonably comply with the normal 
clearance procedures because of the statutory requirement, as set forth 
in section 1856 of Balanced Budget Act of 1997, to implement these 
requirements on June 1, 1998.
    HCFA is requesting OMB review and approval of this collection 
within eleven working days, with a 180-day approval period. Written 
comments and recommendations will be accepted from the public if 
received by the individual designated below, within ten working days of 
publication of this notice in the Federal Register.
    During this 180-day period HCFA will pursue OMB clearance of this 
collection as stipulated by 5 CFR. 1320.5.
    In order to fairly evaluate whether an information collection 
should be approved by OMB, section 3506(c)(2)(A) of the PRA requires 
that we solicit comment on the following issues:
     The need for the information collection and its usefulness 
in carrying out the proper functions of our agency.
     The accuracy of our estimate of the information collection 
burden.
     The quality, utility, and clarity of the information to be 
collected.
     Recommendations to minimize the information collection 
burden on the affected public, including automated collection 
techniques.
    Therefore, we are soliciting public comment on each of these issues 
for the information collection requirements discussed below.
    Section 422.374(a), requires an organization to submit a waiver 
request if it has been denied licensure as a risk-bearing entity by the 
State in which it operates or wishes to operate. To facilitate the 
implementation of the requirements of this section we developed a model 
waiver request form and submitted it to OMB for emergency clearance in 
compliance with section 3506(c)(2)(a) of Paperwork Reduction Act of 
1995. OMB has concurred with the model request form, and the form and 
instructions are currently on view on the HCFA web site, the address of 
which is provided in section II.A.3 of this document. The OMB approval 
number is 0938-0722 and is referenced on the document.
    A modification of this waiver request form is necessary to 
incorporate the fourth criterion for a waiver of State licensure as 
established in this interim final rule. The additional criterion allows 
a PSO-type organization to forego a lengthy application process with 
the State if the State informs the organization in writing that such an 
application will not be reviewed. As part of the waiver request, the 
organization will be required to submit a copy of the written 
communication from the State. This criterion is mentioned in the 
purpose section of the form, and, with publication of this rule, we can 
add it to the check list in section III, Waiver Eligibility. We intend 
to submit this modification to OMB in the near future.
    Section 422.382(c) establishes the composition of assets the 
organization must have at the time it applies to contract with HCFA as 
a PSO. The organization must demonstrate that it has the required 
minimum net worth amount as determined under paragraph (c), demonstrate 
that it will maintain at least $750,000 of the minimum net worth amount 
in cash or cash equivalents, and demonstrate that after the effective 
date of a PSO's M+C contract, a PSO will maintain the necessary minimum 
net worth.
    Section 422.384 requires that at the time of application, an 
organization must submit a financial plan acceptable to HCFA. The 
financial plan must include a detailed marketing plan; statements of 
revenue and expense on an accrual basis; a cash flow statement; balance 
sheets; the assumptions in support of the financial plan; and if 
applicable, statements of the availability of financial resources to 
meet projected losses. The financial plan must cover the first 12 
months after the estimated effective date of a PSO's M+C contract; or 
if the PSO is projecting losses, cover 12 months beyond the period for 
which losses are projected. Except for the use of guarantees, LOC, and 
other means as provided in paragraphs (e), (f), (g) and (h) of 
Sec. 422.384, an organization must demonstrate that it has the 
resources for meeting projected losses on its balance sheet in cash or 
a form that is convertible to cash in a timely manner, in accordance 
with the PSO's financial plan.
    Guarantees will be an acceptable resource to fund projected losses, 
provided that the guarantor complies with the requirements in paragraph 
(e)(2) of this section, and the PSO, in the third quarter, notifies 
HCFA and requests a reduction in the period of advance funding of 
projected losses.
    Section 422.386 sets forth the general liquidity requirement that 
at the time of application the PSO must demonstrate that it has 
sufficient cash flow to meet its financial obligations as they become 
due and payable. To meet this requirement HCFA will consider: the PSO's 
timeliness in meeting current obligations, the extent to which the 
PSO's current ratio of assets to liabilities is maintained at 1:1 and 
whether there is a decline in the current ratio over time, and the 
availability of outside financial resources to the PSO.
    Section 422.388 sets forth the deposit requirements to provide 
protection in the event of an insolvency. At the time of application, 
an organization must demonstrate that they have deposited $100,000 in 
cash or securities (or any combination thereof) into an account in a 
manner that is acceptable to HCFA, and demonstrate that the deposit 
will be restricted only to use in the event of insolvency to help 
assure continuation of services or pay costs associated with 
receivership or liquidation.
    At the time of the PSO's application for an M+C contract and, 
thereafter, upon HCFA's request, a PSO must provide HCFA with proof of 
the insolvency deposit, such proof to be in a form that HCFA considers 
appropriate.
    If at any time uncovered expenditures exceed 10 percent of a PSO's 
total health care expenditures, then the PSO must demonstrate in a 
manner acceptable to HCFA that it has placed an uncovered expenditures 
deposit into an account with an organization or trustee.
    The PSO must also demonstrate that, at all times the deposit will 
have a fair market value of an amount that is 120 percent of the PSO's 
outstanding liability for uncovered expenditures for enrollees, 
including incurred, but not reported claims; the deposit will be 
calculated as of the first day of each month required and maintained 
for the remainder of each month required; if a PSO is not otherwise 
required to file a quarterly report, it must file a report within 45 
days of the end of the calendar quarter with information sufficient to 
demonstrate compliance with this section; the deposit required under 
this section will be restricted and in trust and may be used only as 
provided under this section.
    As stated above, the burden associated with these provisions will 
be

[[Page 25375]]

captured as part of the M+C PSO application and/or quarterly financial 
reporting processes, similar to section 1876 HMO and CMP contractor 
applications and quarterly financial reporting processes. Based on 
section 1876 of the Act, we estimate the burden associated with the 
submission of the application to be 100 hours per application and 62 
annual hours per organization to submit their quarterly financial 
report. Based upon the current volume of waiver reporting workload, we 
estimate that on an annual basis, we will receive 25 to 50 applications 
and 25 organizations will contract with us and will be required to 
submit quarterly financial reports.
    Under Sec. 422.388(d) PSOs may submit a written request to withdraw 
income from the solvency deposits. We anticipate that, on an annual 
basis, we will receive less than 10 requests. Therefore, these 
requirements are not subject to the Paperwork Reduction Act as defined 
in 5 CFR 1320.3(c).
    Under Sec. 422.388(e) a PSO may submit a written request to 
withdraw or substitute a deposit. We anticipate that, on an annual 
basis, we will receive less than 10 requests. Therefore, these 
requirements are not subject to the PRA as defined in 5 CFR 1320.3(c).
    Under Sec. 422.390(b), in order to apply to use the financial 
resources of a guarantor, a PSO must submit to HCFA, documentation that 
the guarantor meets the requirements for a guarantor under paragraph 
(c) of this section; and the guarantor's independently audited 
financial statements for the current year-to-date and for the two most 
recent fiscal years. The financial statements must include the 
guarantor's balance sheets, profit and loss statements, and cash flow 
statements. We believe that the initial burden associated with this 
activity is most likely incurred during the application process, for 
which we have previously estimated the aggregate burden. We expect that 
less than 10 PSOs per year will incur this burden in subsequent years. 
Therefore, these requirements are not subject to the Paperwork 
Reduction Act as defined in 5 CFR 1320.3(c).
    Under Sec. 422.390(d), if the guarantee request is approved, a PSO 
must submit to HCFA a written guarantee document signed by an 
appropriate authority of the guarantor. The guarantee document must 
state the financial obligation covered by the guarantee; agree to 
unconditionally fulfill the financial obligation covered by the 
guarantee and not subordinate the guarantee to any other claim on the 
resources of the guarantor; declare that the guarantor will act on a 
timely basis (that is, in not more than 5 business days) to satisfy the 
financial obligation covered by the guarantee; and meet other 
conditions as HCFA may establish from time to time. We believe that the 
initial burden associated with this activity is most likely incurred 
during the application process, for which we have previously estimated 
the aggregate burden. We expect that less than 10 PSOs per year will 
incur this burden in subsequent years. Therefore, these requirements 
are not subject to the PRA as defined in 5 CFR 1320.3(c)
    A PSO must submit to HCFA the current internal financial statements 
and annual audited financial statements of the guarantor according to 
the schedule, manner, and form that HCFA requests.
    A PSO cannot modify, substitute or terminate a guarantee unless the 
PSO requests HCFA's approval at least 90 days before the proposed 
effective date of the modification, substitution, or termination; 
demonstrates to HCFA's satisfaction that the modification, 
substitution, or termination will not result in insolvency of the PSO; 
and demonstrates how the PSO will meet the requirements of this 
section.
    The public will be afforded several subsequent comment periods in 
future publications of Federal Register notices announcing our 
intention to seek OMB approval for the application and quarterly 
reporting information collection requirements, including a modified 
version of the National Data Reporting Requirements (the Orange Blank), 
that will be submitted to OMB in the near future.
    We have submitted a copy of this rule to OMB for its review of the 
information collection requirements above. To obtain copies of the 
supporting statement and any related forms for the proposed paperwork 
collections referenced above, E-mail your request, including your 
address, phone number and HCFA regulation identifier HCFA-1011, to 
P[email protected], or call the Reports Clearance Office on (410) 786-
1326.
    As noted above, comments on these information collection and record 
keeping requirements must be mailed and/or faxed to the designee 
referenced below, within ten working days of publication of this 
collection in the Federal Register:

Health Care Financing Administration, Office of Information Services, 
Information Technology Investment Management Group, Division of HCFA 
Enterprise Standards, Room C2-26-17, 7500 Security Boulevard, 
Baltimore, MD 21244-1850. Attn: John Burke HCFA-1011. Fax Number: (410) 
786-1415, and,
Office of Information and Regulatory Affairs, Office of Management and 
Budget, Room 10235, New Executive Office Building, Washington, DC 
20503, Attn: Allison Herron Eydt, HCFA Desk Officer. Fax Number: (202) 
395-6974 or (202) 395-5167

VII. 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. Section 1871(b) of the Act, 
however, provides that publication of a notice of proposed rulemaking 
is not required before issuing a final rule where a statute 
specifically permits a regulation to be issued in interim final form. 
Section 1856(a)(1) of the Act, as added by section 4001 of the BBA, 
directs the Secretary to establish the solvency standards for PSOs on 
an expedited basis using a negotiated rulemaking process. Section 
1856(a)(8) provides for the publication of solvency standards as an 
interim final rule, with an opportunity for comment to follow. Under 
section 1856(a)(3), the ``target date'' for publication of this rule 
was April 1, 1998. We are promulgating the solvency provisions in this 
rule according to the expressed interim final rule authority in section 
1856(a)(8).
    Section 1856(b)(1) also provides for the publication of other 
standards implementing the new M+C program in Part C on an interim 
final basis, with an opportunity for comment to follow. The PSO waiver 
provisions in this rule are being promulgated according to this latter 
expressed interim final rule authority. 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 earlier in this preamble, HCFA and the 
Committee believe that we need to establish the PSO waiver process 
early in order to allow the sequence of waiver request, application, 
and contract signing to occur, and to have PSOs initiate operations 
upon implementation of the M+C program. Further, we determined that 
entities considering applying to become PSOs under the M+C 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.

[[Page 25376]]

    Given the time required for these events, and the clear impetus 
from the Congress for implementation of the M+C program, we believe 
that it is impractical and contrary to the public interest to publish a 
notice of proposed rulemaking before establishing the Federal waiver 
and solvency standards set forth in this interim final rule. We are 
providing a 60-day period for public comment.

VIII. Response to Comments

    Because of the large number of items of correspondence 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, when we proceed with a subsequent 
document, we will respond to the comments in the preamble to that 
document.

List of Subjects in 42 CFR Part 422

    Health Maintenance organizations (HMO), Medicare+Choice, Provider 
sponsored organizations (PSO).
    42 CFR Part 422 is amended as set forth below:

PART 422--MEDICARE+CHOICE PROGRAM

Subpart H--Provider-Sponsored Organizations

    1. The authority citation for Part 422 continues to read as 
follows:

    Authority: Secs. 1851, 1855 and 1856 of the Social Security Act 
(42 U.S.C. 1302, 1395w-21 through 1395w-27, and 1395hh).

    2. Section 422.350(b) is amended by adding the following 
definitions in alphabetical order:


Sec. 422.350  Basis, scope, and definitions.

* * * * *
    (b) * * *
    Capitated basis is a payment method under which a fixed per member, 
per month amount is paid for contracted services without regard to the 
type, cost or frequency of services provided.
    Cash equivalent means those assets excluding accounts receivables, 
which can be exchanged on an equivalent basis as cash, or converted 
into cash within 90 days from their presentation for exchange.
* * * * *
    Current ratio means total current assets divided by total current 
liabilities.
    Deferred acquisition costs are those costs incurred in starting or 
purchasing a business. These costs are capitalized as intangible assets 
and carried on the balance sheet as deferred charges since they benefit 
the business for periods after the period in which the costs were 
incurred.
* * * * *
    Generally accepted accounting principles (GAAP) means broad rules 
adopted by the accounting profession as guides in measuring, recording, 
and reporting the financial affairs and activities of a business to its 
owners, creditors and other interested parties.
    Guarantor means an entity that--
    (1) Has been approved by HCFA as meeting the requirements to be a 
guarantor; and
    (2) Obligates its resources to a PSO to enable the PSO to meet the 
solvency requirements required to contract with HCFA as an M+C 
organization.
    Health care delivery assets (HCDAs) means any tangible assets that 
are part of a PSO's operation, including hospitals and other medical 
facilities and their ancillary equipment, and such property as may be 
reasonably required for the PSO's principal office or for such other 
purposes as the PSO may need for transacting its business.
* * * * *
    Insolvency means a condition where the liabilities of the debtor 
exceed the fair valuation of its assets.
    M+C stands for Medicare+Choice.
    Net Worth means the excess of total assets over total liabilities, 
excluding fully subordinated debt or subordinated liabilities.
* * * * *
    Qualified Actuary means a member in good standing of the American 
Academy of Actuaries or a person recognized by the Academy as qualified 
for membership, or a person who has otherwise demonstrated competency 
in the field of actuarial determination and is satisfactory to HCFA.
    Statutory accounting practices means those accounting principles or 
practices prescribed or permitted by the domiciliary State insurance 
department in the State that PSO operates.
    Subordinated debt means an obligation that is owed by an 
organization, that the creditor of the obligation, by law, agreement, 
or otherwise, has a lower repayment rank in the hierarchy of creditors 
than another creditor. The creditor would be entitled to repayment only 
after all higher ranking creditors' claims have been satisfied. A debt 
is fully subordinated if it has a lower repayment rank than all other 
classes of creditors.
    Subordinated liability means claims liabilities otherwise due to 
providers that are retained by the PSO to meet net worth requirements 
and are fully subordinated to all other creditors.
    Uncovered expenditures means those expenditures for health care 
services that are the obligation of an organization, for which an 
enrollee may also be liable in the event of the organization's 
insolvency and for which no alternative arrangements have been made 
that are acceptable to HCFA. They include expenditures for health care 
services for which the organization is at risk, such as out-of-area 
services, referral services and hospital services. However, they do not 
include expenditures for services when a provider has agreed not to 
bill the enrollee.
    3. A new Sec. 422.370 is added to read as follows:


Sec. 422.370  Waiver of State licensure.

    For an organization that seeks to contract as an M+C plan under 
this subpart, HCFA may waive the State licensure requirement of section 
1855(a)(1) of the Act if--
    (1) The organization requests a waiver no later than November 1, 
2002; and
    (2) HCFA determines there is a basis for a waiver under 
Sec. 422.372.
    4. A new Sec. 422.372 is added to read as follows:


Sec. 422.372  Basis for waiver of State licensure.

    In response to a request from an organization and subject to 
paragraphs (a) and (e) of Sec. 422.374, HCFA may waive the State 
licensure requirement if the organization has applied (except as 
provided for in paragraph (d) of this section) for the most closely 
appropriate State license or authority to conduct business as an M+C 
plan as set forth in section 1851(a)(2)(A) of the Act and any of the 
following conditions are met:
    (a) Failure to act timely on application. The State failed to 
complete action on the licensing application within 90 days of the date 
the State received a substantially complete application.
    (b) Denial of application based on discriminatory treatment. The 
State has--
    (1) Denied the licensure application on the basis of material 
requirements, procedures, or standards (other than solvency 
requirements) not generally applied by the State to other entities 
engaged in a substantially similar business; or
    (2) Required, as a condition of licensure, that the organization 
offer any product or plan other than an M+C plan.
    (c) Denial of application based on different solvency requirements. 
(1) The State has denied the licensure

[[Page 25377]]

application, in whole or in part, on the basis of the organization's 
failure to meet solvency requirements that are different from those set 
forth in Secs. 422.380 through 422.390; or
    (2) HCFA determines that the State has imposed, as a condition of 
licensure, any documentation or information requirements relating to 
solvency or other material requirements that are different from the 
requirements, procedures, or standards set forth by HCFA to implement, 
monitor and enforce Secs. 422.380 through 422.390.
    (d) The appropriate State licensing authority has notified the 
organization in writing that it will not accept their licensure 
application.
    5. A new Sec. 422.374 is added to read as follows:


Sec. 422.374  Waiver request and approval process.

    (a) Substantially complete waiver request. The organization must 
submit a substantially complete waiver request that clearly 
demonstrates and documents its eligibility for a waiver under 
Sec. 422.372.
    (b) Prompt action on waiver request. The organization will be 
notified in writing within 60 days of having submitted to HCFA a 
substantially complete waiver request whether the waiver request has 
been granted or denied.
    (c) Subsequent waiver requests. An organization that has had a 
waiver request denied, may submit subsequent waiver requests until 
November 1, 2002.
    (d) Effective date. A waiver granted under Sec. 422.370 will be 
effective on the effective date of the organization's M+C contract.
    (e) Consistency in application. HCFA reserves the right to revoke 
waiver eligibility if it subsequently determines that the 
organization's M+C application is significantly different from the 
application submitted by the organization to the State licensing 
authority.
    6. A new Sec. 422.376 is added to read as follows:


Sec. 422.376  Conditions of the waiver.

    A waiver granted under this section is subject to the following 
conditions:
    (a) Limitation to State. The waiver is effective only for the 
particular State for which it is granted and does not apply to any 
other State. For each State in which the organization wishes to operate 
without a State license, it must submit a waiver request and receive a 
waiver.
    (b) Limitation to 36-month period. The waiver is effective for 36 
months or through the end of the calendar year in which the 36 month 
period ends unless it is revoked based on paragraph (c) of this 
section.
    (c) Mid-period revocation. During the waiver period (set forth in 
paragraph (b) of this section), the waiver is automatically revoked 
upon--
    (1) Termination of the M+C contract;
    (2) The organization's compliance with the State licensure 
requirement of section 1855(a)(1) of the Act; or
    (3) The organization's failure to comply with Sec. 422.378.
    7. A new Sec. 422.378 is added to read as follows:


Sec. 422.378  Relationship to State law.

    (a) Preemption of State law. Any provisions of State law that 
relate to the licensing of the organization and that prohibit the 
organization from providing coverage under a contract as specified in 
this subpart, are superseded.
    (b) Consumer protection and quality standards. (1) A waiver of 
State licensure granted under this subpart is conditioned upon the 
organization's compliance with all State consumer protection and 
quality standards that--
    (i) Would apply to the organization if it were licensed under State 
law;
    (ii) Generally apply to other M+C organizations and plans in the 
State; and
    (iii) Are consistent with the standards established under this 
part.
    (2) The standards specified in paragraph (b)(1) of this section do 
not include any standard preempted under section 1856(b)(3)(B) of the 
Act.
    (c) Incorporation into contract. In contracting with an 
organization that has a waiver of State licensure, HCFA incorporates 
into the contract the requirements specified in paragraph (b) of this 
section.
    (d) Enforcement. HCFA may enter into an agreement with a State for 
the State to monitor and enforce compliance with the requirements 
specified in paragraph (b) of this section by an organization that has 
obtained a waiver under this subpart.
    8. A new Sec. 422.380 is added to read as follows:


Sec. 422.380  Solvency standards.

    General rule. A PSO or the legal entity of which the PSO is a 
component that has been granted a waiver under Sec. 422.370 must have a 
fiscally sound operation that meets the requirements of Secs. 422.382 
through 422.390.
    9. A new Sec. 422.382 is added to read as follows:


Sec. 422.382  Minimum net worth amount.

    (a) At the time an organization applies to contract with HCFA as a 
PSO under this part, the organization must have a minimum net worth 
amount, as determined under paragraph (c) of this section, of:
    (1) At least $1,500,000, except as provided in paragraph (a)(2) of 
this section.
    (2) No less than $1,000,000 based on evidence from the 
organization's financial plan (under Sec. 422.384) demonstrating to 
HCFA's satisfaction that the organization has available to it an 
administrative infrastructure that HCFA considers appropriate to 
reduce, control or eliminate start-up administrative costs.
    (b) After the effective date of a PSO's M+C contract, a PSO must 
maintain a minimum net worth amount equal to the greater of--
    (1) One million dollars;
    (2) Two percent of annual premium revenues as reported on the most 
recent annual financial statement filed with HCFA for up to and 
including the first $150,000,000 of annual premiums and 1 percent of 
annual premium revenues on premiums in excess of $150,000,000;
    (3) An amount equal to the sum of three months of uncovered health 
care expenditures as reported on the most recent financial statement 
filed with HCFA; or
    (4) Using the most recent annual financial statement filed with 
HCFA, an amount equal to the sum of--
    (i) Eight percent of annual health care expenditures paid on a non-
capitated basis to non-affiliated providers; and
    (ii) Four percent of annual health care expenditures paid on a 
capitated basis to non-affiliated providers plus annual health care 
expenditures paid on a non-capitated basis to affiliated providers.
    (iii) Annual health care expenditures that are paid on a capitated 
basis to affiliated providers are not included in the calculation of 
the net worth requirement under paragraphs (a) and (b)(4) of this 
section.
    (c) Calculation of the minimum net worth amount--(1) Cash 
requirement. (i) At the time of application; the organization must 
maintain at least $750,000 of the minimum net worth amount in cash or 
cash equivalents.
    (ii) After the effective date of a PSO's M+C contract, a PSO must 
maintain the greater of $750,000 or 40 percent of the minimum net worth 
amount in cash or cash equivalents.
    (2) Intangible Assets. An organization may include intangible 
assets, the value of which is based on Generally Accepted Accounting 
Principles (GAAP), in the minimum net worth amount calculation subject 
to the following limitations--

[[Page 25378]]

    (i) At the time of application. (A) Up to 20 percent of the minimum 
net worth amount, provided at least $1,000,000 of the minimum net worth 
amount is met through cash or cash equivalents; or
    (B) Up to 10 percent of the minimum net worth amount, if less than 
$1,000,000 of the minimum net worth amount is met through cash or cash 
equivalents, or if HCFA has used its discretion under paragraph (a)(2) 
of this section.
    (ii) From the effective date of the contract. (A) Up to 20 percent 
of the minimum net worth amount if the greater of $1,000,000 or 67 
percent of the minimum net worth amount is met by cash or cash 
equivalents; or
    (B) Up to ten percent of the minimum net worth amount if the 
greater of $1,000,000 or 67 percent of the minimum net worth amount is 
not met by cash or cash equivalents.
    (3) Health Care Delivery Assets. Subject to the other provisions of 
this section, a PSO may apply 100 percent of the GAAP depreciated value 
of health care delivery assets (HCDAs) to satisfy the minimum net worth 
amount.
    (4) Other assets. A PSO may apply other assets not used in the 
delivery of health care provided that those assets are valued according 
to statutory accounting practices (SAP) as defined by the State.
    (5) Subordinated debts and subordinated liabilities. Fully 
subordinated debt and subordinated liabilities are excluded from the 
minimum net worth amount calculation.
    (6) Deferred acquisition costs. Deferred acquisition costs are 
excluded from the calculation of the minimum net worth amount.
    10. A new Sec. 422.384 is added to read as follows:


Sec. 422.384  Financial plan requirement.

    (a) General rule. At the time of application, an organization must 
submit a financial plan acceptable to HCFA.
    (b) Content of plan. A financial plan must include--
    (1) A detailed marketing plan;
    (2) Statements of revenue and expense on an accrual basis;
    (3) Statements of sources and uses of funds;
    (4) Balance sheets;
    (5) Detailed justifications and assumptions in support of the 
financial plan including, where appropriate, certification of reserves 
and actuarial liabilities by a qualified health maintenance 
organization actuary; and
    (6) If applicable, statements of the availability of financial 
resources to meet projected losses.
    (c) Period covered by the plan. A financial plan must--
    (1) Cover the first 12 months after the estimated effective date of 
a PSO's M+C contract; or
    (2) If the PSO is projecting losses, cover 12 months beyond the end 
of the period for which losses are projected.
    (d) Funding for projected losses. Except for the use of guarantees, 
LOC, and other means as provided in Sec. 422.384(e), (f) and (g), an 
organization must have the resources for meeting projected losses on 
its balance sheet in cash or a form that is convertible to cash in a 
timely manner, in accordance with the PSO's financial plan.
    (e) Guarantees and projected losses. Guarantees will be an 
acceptable resource to fund projected losses, provided that a PSO--
    (1) Meets HCFA's requirements for guarantors and guarantee 
documents as specified in Sec. 422.390; and
    (2) Obtains from the guarantor cash or cash equivalents to fund the 
projected losses timely, as follows--
    (i) Prior to the effective date of a PSO's M+C contract, the amount 
of the projected losses for the first two quarters;
    (ii) During the first quarter and prior to the beginning of the 
second quarter of a PSO's M+C contract, the amount of projected losses 
through the end of the third quarter; and
    (iii) During the second quarter and prior to the beginning of the 
third quarter of a PSO's M+C contract, the amount of projected losses 
through the end of the fourth quarter.
    (3) If the guarantor complies with the requirements in paragraph 
(e)(2) of this section, the PSO, in the third quarter, may notify HCFA 
of its intent to reduce the period of advance funding of projected 
losses. HCFA will notify the PSO within 60 days of receiving the PSO's 
request if the requested reduction in the period of advance funding 
will not be accepted.
    (4) If the guarantee requirements in paragraph (e)(2) of this 
section are not met, HCFA may take appropriate action, such as 
requiring funding of projected losses through means other than a 
guarantee. HCFA retains discretion to require other methods or timing 
of funding, considering factors such as the financial condition of the 
guarantor and the accuracy of the financial plan.
    (f) Letters of credit. Letters of credit are an acceptable resource 
to fund projected losses, provided they are irrevocable, unconditional, 
and satisfactory to HCFA. They must be capable of being promptly paid 
upon presentation of a sight draft under the letters of credt without 
further reference to any other agreement, document, or entity.
    (g) Other means. If satisfactory to HCFA, and for periods beginning 
one year after the effective date of a PSO's M+C contract, a PSO may 
use the following to fund projected losses--
    (1) Lines of credit from regulated financial institutions;
    (2) Legally binding agreements for capital contributions; or
    (3) Legally binding agreements of a similar quality and reliability 
as permitted in paragraphs (g)(1) and (2) of this section.
    (h) Application of guarantees, Letters of credit or other means of 
funding projected losses. Notwithstanding any other provision of this 
section, a PSO may use guarantees, letters of credit and, beginning one 
year after the effective date of a PSO's M+C contract, other means of 
funding projected losses, but only in a combination or sequence that 
HCFA considers appropriate.
    11. A new Sec. 422.386 is added to read as follows:


Sec. 422.386  Liquidity.

    (a) A PSO must have sufficient cash flow to meet its financial 
obligations as they become due and payable.
    (b) To determine whether the PSO meets the requirement in paragraph 
(a) of this section, HCFA will examine the following--
    (1) The PSO's timeliness in meeting current obligations;
    (2) The extent to which the PSO's current ratio of assets to 
liabilities is maintained at 1:1 including whether there is a declining 
trend in the current ratio over time; and
    (3) The availability of outside financial resources to the PSO.
    (c) If HCFA determines that a PSO fails to meet the requirement in 
paragraph (b)(1) of this section, HCFA will require the PSO to initiate 
corrective action and pay all overdue obligations.
    (d) If HCFA determines that a PSO fails to meet the requirement of 
paragraph (b)(2) of this section, HCFA will require the PSO to initiate 
corrective action to--
    (1) Change the distribution of its assets;
    (2) Reduce its liabilities; or
    (3) Make alternative arrangements to secure additional funding to 
restore the PSO's current ratio to 1:1.
    (e) If HCFA determines that a PSO fails to meet the requirement of 
paragraph (b)(3) of this section, HCFA will require the PSO to obtain 
funding from alternative financial resources.
    12. A new Sec. 422.388 is added to read as follows:

[[Page 25379]]

Sec. 422.388  Deposits.

    (a) Insolvency deposit. (1) At the time of application, an 
organization must deposit $100,000 in cash or securities (or any 
combination thereof) into an account in a manner that is acceptable to 
HCFA.
    (2) The deposit must be restricted to use in the event of 
insolvency to help assure continuation of services or pay costs 
associated with receivership or liquidation.
    (3) At the time of the PSO's application for an M+C contract and, 
thereafter, upon HCFA's request, a PSO must provide HCFA with proof of 
the insolvency deposit, such proof to be in a form that HCFA considers 
appropriate.
    (b) Uncovered expenditures deposit. (1) If at any time uncovered 
expenditures exceed 10 percent of a PSO's total health care 
expenditures, then the PSO must place an uncovered expenditures deposit 
into an account with any organization or trustee that is acceptable to 
HCFA.
    (2) The deposit must at all times have a fair market value of an 
amount that is 120 percent of the PSO's outstanding liability for 
uncovered expenditures for enrollees, including incurred, but not 
reported claims.
    (3) The deposit must be calculated as of the first day of each 
month required and maintained for the remainder of each month required.
    (4) If a PSO is not otherwise required to file a quarterly report, 
it must file a report within 45 days of the end of the calendar quarter 
with information sufficient to demonstrate compliance with this 
section.
    (5) The deposit required under this section is restricted and in 
trust for HCFA's use to protect the interests of the PSO's Medicare 
enrollees and to pay the costs associated with administering the 
insolvency. It may be used only as provided under this section.
    (c) A PSO may use the deposits required under paragraphs (a) and 
(b) of this section to satisfy the PSO's minimum net worth amount 
required under Sec. 422.382(a) and (b).
    (d) All income from the deposits or trust accounts required under 
paragraphs (a) and (b) of this section, are considered assets of the 
PSO. Upon HCFA's approval, the income from the deposits may be 
withdrawn.
    (e) On prior written approval from HCFA, a PSO that has made a 
deposit under paragraphs (a) or (b) of this section, may withdraw that 
deposit or any part thereof if--
    (1) A substitute deposit of cash or securities of equal amount and 
value is made;
    (2) The fair market value exceeds the amount of the required 
deposit; or
    (3) The required deposit under paragraphs (a) or (b) of this 
section is reduced or eliminated.
    13. A new Sec. 422.390 is added to read as follows:


Sec. 422.390  Guarantees.

    (a) General policy. A PSO, or the legal entity of which the PSO is 
a component, may apply to HCFA to use the financial resources of a 
guarantor for the purpose of meeting the requirements in Sec. 422.384. 
HCFA has the discretion to approve or deny approval of the use of a 
guarantor.
    (b) Request to use a guarantor. To apply to use the financial 
resources of a guarantor, a PSO must submit to HCFA--
    (1) Documentation that the guarantor meets the requirements for a 
guarantor under paragraph (c) of this section; and
    (2) The guarantor's independently audited financial statements for 
the current year-to-date and for the two most recent fiscal years. The 
financial statements must include the guarantor's balance sheets, 
profit and loss statements, and cash flow statements.
    (c) Requirements for guarantor. To serve as a guarantor, an 
organization must meet the following requirements:
    (1) Be a legal entity authorized to conduct business within a State 
of the United States.
    (2) Not be under Federal or State bankruptcy or rehabilitation 
proceedings.
    (3) Have a net worth (not including other guarantees, intangibles 
and restricted reserves) equal to three times the amount of the PSO 
guarantee.
    (4) If the guarantor is regulated by a State insurance 
commissioner, or other State official with authority for risk-bearing 
entities, it must meet the net worth requirement in Sec. 422.390(c)(3) 
with all guarantees and all investments in and loans to organizations 
covered by guarantees excluded from its assets.
    (5) If the guarantor is not regulated by a State insurance 
commissioner, or other similar State official it must meet the net 
worth requirement in Sec. 422.390(c)(3) with all guarantees and all 
investments in and loans to organizations covered by a guarantee and to 
related parties (subsidiaries and affiliates) excluded from its assets.
    (d) Guarantee document. If the guarantee request is approved, a PSO 
must submit to HCFA a written guarantee document signed by an 
appropriate authority of the guarantor. The guarantee document must--
    (1) State the financial obligation covered by the guarantee;
    (2) Agree to--
    (i) Unconditionally fulfill the financial obligation covered by the 
guarantee; and
    (ii) Not subordinate the guarantee to any other claim on the 
resources of the guarantor;
    (3) Declare that the guarantor must act on a timely basis, in any 
case not more than 5 business days, to satisfy the financial obligation 
covered by the guarantee; and
    (4) Meet other conditions as HCFA may establish from time to time.
    (e) Reporting requirement. A PSO must submit to HCFA the current 
internal financial statements and annual audited financial statements 
of the guarantor according to the schedule, manner, and form that HCFA 
requests.
    (f) Modification, substitution, and termination of a guarantee. A 
PSO cannot modify, substitute or terminate a guarantee unless the PSO--
    (1) Requests HCFA's approval at least 90 days before the proposed 
effective date of the modification, substitution, or termination;
    (2) Demonstrates to HCFA's satisfaction that the modification, 
substitution, or termination will not result in insolvency of the PSO; 
and
    (3) Demonstrates how the PSO will meet the requirements of this 
section.
    (g) Nullification. If at any time the guarantor or the guarantee 
ceases to meet the requirements of this section, HCFA will notify the 
PSO that it ceases to recognize the guarantee document. In the event of 
this nullification, a PSO must--
    (1) Meet the applicable requirements of this section within 15 
business days; and
    (2) If required by HCFA, meet a portion of the applicable 
requirements in less than the time period granted in paragraph (g)(1) 
of this section.

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

    Dated: April 20, 1998.
Nancy-Ann Min DeParle,
Administrator, Health Care Financing Administration.

    Dated: April 28, 1998.
Donna E. Shalala,
Secretary.
[FR Doc. 98-12058 Filed 5-4-98; 11:09 am]
BILLING CODE 4120-01-P