Moment of truth arrives for potential PSO suitors with HCFA announcement
Moment of truth arrives for potential PSO suitors with HCFA announcement
Read on to see if your group is in luck
It was five weeks later than expected, but HCFA finally published its long-awaited solvency standards for future provider-sponsored organizations (PSOs) in the May 7 edition of the Federal Register. Last year's federal budget legislation created the opportunity for physician and hospital organizations to form PSOs, allowing them to contract directly with Medicare beneficiaries and thus take on many of the characteristics of private insurers.
"Based on my first read, it doesn't look like HCFA made any significant changes from the March 5th negotiated rule-making agreement it developed with the provider and health plan community," notes Michele Manfreda, an analyst in Ernst & Young's Washington, DC, office. (For more details on these agreements, see Physician's Payment Update, May 1998, p. 73 and April 1998, p. 53.)
According to an analysis prepared by Richard Ramsey, JD, with Proskauer Rose in Washington, DC, providers wishing to contract as a PSO must demonstrate strength in the following areas before being licensed by HCFA:
1. Minimum net worth. Potential PSOs wanting to enter into a Medicare+Choice contract with HCFA must have a minimum net worth of $1.5 million. HCFA may reduce this to a $1 million minimum based on a business plan that demonstrates the PSO has, or has available to it, an administrative infrastructure that will reduce start-up costs.
To value assets included in net worth, HCFA may use 100% of book value, based on generally accepted accounting principles (GAAP), of any tangible asset that is part of the PSO operation. Tangible assets apparently include the real property of the hospital and medical facilities, as well as ancillary equipment and any other property as may reasonably be required for the PSO's principal office.
The PSO may include intangible assets in its net worth, but intangible assets cannot exceed 20% of the minimum net worth (i.e., $300,000). These intangible assets may be included only if at least $1 million of the initial minimum net worth requirement is met by cash or cash equivalents.
There is a chance that the intangible assets maximum may change, however. HCFA may require this value to have a cap of 10% of the minimum net worth if one of two things occurs:
- less than $1 million of the initial minimum net worth requirement is attributed to cash or cash equivalents;
- HCFA reduces the initial net worth requirement to less than $1.5 million.
2. Detailed financial plan. When a PSO submits an application to contract with HCFA, it must submit a financial plan for the first 12 months of operation. The plan must include:
- a detailed marketing plan;
- statements of revenue and expense on an accrual basis;
- a cash flow statement;
- balance sheets;
- assumptions in support of the financial plan;
- if applicable, the availability of financial resources to meet projected losses.
Although HCFA expects that the financial resources requirement must be met with cash or cash equivalents, HCFA may accept a guarantee under certain circumstances. Likewise, with HCFA's approval, an irrevocable, unconditional letter of credit may be used. Finally, after the first year, a PSO may fund projected losses with a line of credit from a regulated financial institution, a legally binding agreement among the PSO's owners for capital contributions, or other legally binding contracts of a similar level of reliability.
3. Liquidity. The PSO's projected cash flow must be sufficient to meet its debts as they become due. However, HCFA will consider the timeliness of payment, whether the current ratio of debt to assets is maintained at 1:1, and the availability of outside financial resources when reviewing the PSO's cash flow status.
To stay in good standing after the PSO starts operating in the black, it must maintain a net worth equal to the greater of:
- $1 million;
- 2% of premiums;
- the sum of three months' uncovered health expenditures;
- the sum of 8% of noncapitated payments made to nonaffiliated providers, plus 4% of expenditures paid on a capitated basis to nonaffiliated providers and noncapitated payments to affiliated providers alike.
"You are still going to need cash - a lot of cash - to meet these initial solvency requirements," points out Patrick O'Hare, partner in the Washington, DC, offices of McDermott, Will & Emery.
Like many experts, O'Hare says most PSOs will be a joint venture between a local hospital or hospitals and a group of physicians, with the hospital side providing most or all of the start-up financing and projected loss guarantees.
However, such issues as the legal, organizational, and tax status of participating providers could create potential problems affecting how the entity will be structured, says O'Hare.
Governance will be a major issue, for instance. Most physician participants will want to control at least half of the PSO's board. Yet, "if a nonprofit hospital puts up 100% of the capital needed to launch the PSO but ends up sharing 50% of the governing authority with its physician partners, this vehicle will probably fail the IRS' joint venture test, which says the nonprofit hospital putting up most of the money must have most of the votes on the board," says O'Hare.
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