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Appendix B
Utilization Management and Quality Assurance in Health Maintenance Organizations: an Operational Assessment

Joan B. Trauner and Sibyl Tilson*

In the 1980s, health care payers in the public and private sectors have relied increasingly on utilization management to help control health care costs. As a result, the autonomy of health care providers—hospitals and professionals—has been curtailed as payers have applied predetermined criteria to judge the appropriateness of care. The medical community, in turn, has expressed concerns about the design of the clinical standards or algorithms governing utilization review decisions by health insurers, Blue Cross and Blue Shield plans, third-party administrators, and health maintenance organizations (HMOs). In particular, as payers seek to control costs more aggressively, physician organizations are seeking to review the criteria used for denial of services under second-opinion and prior authorization programs.1

At the same time, federal and state legislators, health policy analysts, and consumer groups are concerned about the impact of physician incentive plans on quality of care and accessibility to services in prepaid delivery systems. This concern was prompted, in part, by concerns about the quality of care delivered to Medicare beneficiaries enrolled in International Medical Centers Inc. (IMC), a for-profit HMO located in south Florida.2 The well-publicized IMC scandals raised a number of public policy issues, including enrollee understanding of benefit restrictions in HMOs,3 ineffective

*The authors are members of the accounting firm Coopers & Lybrand, San Francisco, Calif., and Washington, D.C.



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Page 205 Appendix B Utilization Management and Quality Assurance in Health Maintenance Organizations: an Operational Assessment Joan B. Trauner and Sibyl Tilson* In the 1980s, health care payers in the public and private sectors have relied increasingly on utilization management to help control health care costs. As a result, the autonomy of health care providers—hospitals and professionals—has been curtailed as payers have applied predetermined criteria to judge the appropriateness of care. The medical community, in turn, has expressed concerns about the design of the clinical standards or algorithms governing utilization review decisions by health insurers, Blue Cross and Blue Shield plans, third-party administrators, and health maintenance organizations (HMOs). In particular, as payers seek to control costs more aggressively, physician organizations are seeking to review the criteria used for denial of services under second-opinion and prior authorization programs.1 At the same time, federal and state legislators, health policy analysts, and consumer groups are concerned about the impact of physician incentive plans on quality of care and accessibility to services in prepaid delivery systems. This concern was prompted, in part, by concerns about the quality of care delivered to Medicare beneficiaries enrolled in International Medical Centers Inc. (IMC), a for-profit HMO located in south Florida.2 The well-publicized IMC scandals raised a number of public policy issues, including enrollee understanding of benefit restrictions in HMOs,3 ineffective *The authors are members of the accounting firm Coopers & Lybrand, San Francisco, Calif., and Washington, D.C.

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Page 206 quality assurance monitoring in HMOs (both internally by HMO staff and externally by regulatory agencies), and the impact of financial incentives on ordering of services and specialty referrals by HMO physicians.4 The intent of this paper is to describe the range of utilization management and quality assurance strategies that are used by HMOs and then to evaluate their actual implementation. The paper begins with a brief discussion of the methodology used in preparing this paper. The second section describes the organizational structure of existing HMOs, and the third discusses market, structural, and operational factors affecting HMO performance. The fourth section discusses the approaches to utilization management and quality assurance, and the fifth section evaluates the performance of utilization management and quality assurance programs in HMOs. In the sixth section, there is a review of existing research on physician risk incentives in HMOs, while the seventh section addresses some additional policy and research issues. The final section of this paper contains five condensed case histories. Except for the discussions on the organizational structure of licensed HMOs, the term HMO is generically in this paper to cover all closed systems in which physicians are partly or fully capitated for delivery of care and where enrollees may receive services only from contracting providers.5 All state-licensed prepaid medical plans are included in this definition, regardless of whether they are federally qualified and offer a full range of benefits. Methodology This paper reflects the authors' experience as health care consultants for an international accounting firm. During the past 3 years, we have had the opportunity to analyze the health benefits offered by numerous employers in both the public and private sectors and to help design their managed care programs. (By managed care, we refer to any program that channels patients to a specific set of health care providers.) During the same time, we and our associates have conducted operational reviews of over 20 HMOs, ranging from local to regional and multistate plans. In general, the HMO reviews have involved an analysis of financial, actuarial, enrollment, and utilization trends in the context of benefit design, premium pricing, marketing practices, claims processing procedures, contractual arrangements with providers, utilization review, and management reporting procedures. This managed care and HMO consulting experience provides the background for this paper. To supplement our experience, we reviewed the health services research literature for HMO-related studies. In describing

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Page 207 our personal experience, we do not purport to review a statistically representative sample of HMOs. In fact, because many of the plans that we studied are in transition, the paper may magnify some of the problems facing the HMO industry.6 The crucial advantage of an experiential analysis, however, is that it offers an internal view of HMO operations at all organizational levels that is not available through standard survey instruments or through a review of documents filed with regulatory agencies.7 In our HMO discussions, we do not refer to any plans by name, nor do we provide any information on exact plan size, geographic location, plan age, or precise sponsorship in order to preserve client confidentiality. The brief case histories for five plans that appear at the end of this paper do not include any plan identifiers, but do contain actual descriptions of the utilization management programs in place at the time that the operational reviews were conducted. We present these studies to show the range of operational problems that can undermine the structural design of utilization management and quality assurance programs. Hmo Organizational Structure According to the current InterStudy classification of HMOs, there are four types: staff, group, network, and individual practice association (IPA) model plans.8 Staff model HMOs deliver health services through physicians who are under salary to the plan. Group model HMOs contract with one independent multispecialty group practice, whereas network model HMOs contract with two or more multispecialty groups. IPAs contract with physicians in private practice, either as individuals, through their group practices, or through separate physician associations. Under the mandating process established by the HMO Act of 1973, an employer is required to offer only one group or staff model HMO and one IPA in a given service area. (The network classification did not exist under the original HMO Act.) In some geographic areas, HMOs have used a model designation that allows them to take advantage of the mandating process, rather than one that strictly corresponds to their underlying structure. For example, plans that contract almost exclusively with multispecialty groups have sought IPA designations to compete against long-established group or staff model plans. Therefore, any analysis of HMOs requires an assessment of the underlying contractual arrangement with physicians, rather than the plans own self-designation.9 More recently, ICF, Inc. has categorized HMOs as having two-tier or three-tier organizational structures.10 In the two-tier structure (Figure B-1), the HMO contracts directly with individual physicians; in the three-tier structure (Figure B-2), the HMO makes capitation or fee-for-service payments to the IPA or group, which, in turn, contracts with individual

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Page 208 Figure B-1 Organizational structures within HMOs: two-tier structures. Figure B-2 Organizational structures within HMOs: three-tier structures. physicians. ICF originally included only staff model plans and direct contract IPAs in the two-tier classification. In Figure B-l, we have added two additional categories: HMOs owned by group practices and HMOs in which physicians contract directly with the HMO but are arbitrarily grouped into risk-sharing pools or ''pods.'' As described in the literature, a two-tier structure may facilitate contracting in areas where physicians are geographically dispersed (that is, suburban or rural areas) or where physicians have not developed their own

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Page 209 IPAs. According to the literature, some HMOs elect to use a two-tier structure purposely to forestall physicians from creating IPAs, which, in turn, can function as bargaining units to provide physicians with higher fees.11 Lately, we have come across a new two-tier contractual arrangement involving those HMOs that contract directly with individual physicians and then create arbitrary physician risk pools, or pods. In these arrangements, the financial risk is shared with other providers with whom the physician may or may not have direct contact in daily practice.12 Depending upon the local market, pods may sometimes be organized by group practice or hospital affiliation; in other areas, physicians may be assigned to a pod solely on the basis of practice location. In this paper, we use the two- and three-tier structure as the basis for much of our analysis. This approach allows us to focus on where responsibility for utilization management decisions actually rests. For example, in two-tier IPA arrangement's, most decision-making resides at the HMO level, whereas in three-tier arrangements those entities that contract with the HMO (for example, IPAs and multispecialty groups) may take over many of these responsibilities. In determining how plans are classified, we ignore the self-designated HMO plan type and instead examine the underlying contractual relationship that exists with participating physicians. In this way, we can describe more precisely utilization management activities in those plans that have contractual arrangements with varying types of provider entities (for example, plans that have group-, staff-, and hospital-based IPA arrangements). Market, Structural, and Operational Factors Affecting Hmo Performance We believe that any review of HMO performance that focuses exclusively on structural measures will have serious limitations. The HMO market is in a state of flux. Not only are many plans reporting financial losses, but they are having to contend with employer demands regarding the provision of data and experience rating and with provider concerns about reimbursement rates and design of utilization review programs. In this section, we briefly describe the relationship of the health care marketplace to HMO structure and operations. The intent of the analysis is to show that plan performance, as measured by financial, utilization, and quality indicators, is a function of multiple variables, many of which are beyond the control of HMO management.

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Page 210 The Health Care Marketplace An HMO both reacts to and helps shape the health care market in which it operates. For example, the regulatory environment establishes parameters for benefit design, premium pricing, and marketing practices. The employment market determines eligibility for health benefits, level of employer contributions, and design and pricing of indemnity benefits. Demographic and geographic factors, such as the size of Medicare and Medicaid populations, the location of local industry, and commuting patterns, affect product development and the boundaries of HMO service areas. The use of a two- or three-tier contracting structure by an HMO is dependent upon existing alternatives to individual physician contracting, such as the presence of multispecialty group practices or hospital-sponsored IPAs, and the prior experience of local providers in working with other HMOs or managed care programs. Negotiation of reimbursement rates, capitation payments, and risk-sharing arrangements are dependent upon (1) hospital and physician supply, (2) the presence of competing HMOs and the design of their payment and risk arrangements, and (3) utilization and cost trends within the local market. In return, as an HMO becomes established, it will have an impact on the design and pricing of health benefits and health services in the local market, as well as on the structure of hospital and physician relationships (including the emergence of new IPAs, group practices, and joint ventures). Hmo Structure HMO structure, in part, reflects plan sponsorship, consumer orientation date of entry into the market, and short- and long-term financial goals. The adoption of nonprofit or for-profit status may reflect the history of the sponsoring entity, the availability of capital, and the marketability of the program to investors or joint venture partners. Management's perspective on provider behavior, plus the existence of other HMOs in the local market, help to determine the operating model (staff, group, network, IPA, or hybrid), the approach to contracting (direct contract versus three-tier arrangement), and the extent of any risk-sharing arrangements. Except in markets with a large oversupply of physicians and hospitals, there generally is some give and take in contract negotiations between an HMO and the provider community. While quality of care is always a concern in these negotiations, actual discussions usually end up focusing on economic considerations. As noted by Gnessin,13 there is an inherent conflict between the goals of any HMO's management and those of its participating physicians. Gnessin defines six goals for HMOs: (1) profit

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Page 211 maximization; (2) capital appreciation; (3) enrollment growth; (4) shift of financial risk to third parties; (5) maximum utilization control with minimum malpractice exposure; and (6) control over all components of HMO operations, including the actual health care delivery system. For physicians, Gnessin defines five goals: (1) maximum autonomy in the practice of medicine; (2) minimal loss of existing patient base or patient volume; (3) expansion of patient base and volume; (4) minimal financial risk; and (5) increased income from new revenue sources (other than the direct provision of health services). It is the tension between these two perspectives that establishes the setting for the negotiation and implementation of financial incentives. According to Gnessin's "fairness doctrine," at any given time either HMO management or HMO providers may be in a superior bargaining position. However, when the dominant party imposes its will unilaterally on the other, this strategy usually proves successful only in the short term; in the long term the imbalance in power will result in acrimony and disintegration of the relationship. In other words, a plan that transfers risk to providers without reimbursing them adequately or providing them with data to manage their practices runs the risk of losing physician participation in the long run. Conversely, a plan that accedes completely to physician demands and pays them market rates without changing practice patterns may price itself out of the marketplace or require the plan sponsors to absorb large operating losses. Hmo Operations An HMO cannot transfer risk fairly to providers and deliver quality care in a cost-effective manner without (1) effective management information systems for tracking enrollment, premiums, and utilization and for providing usable and timely reports to management and participating providers; (2) efficient claims processing procedures to ensure prompt payment to providers and the accurate capture of procedural and diagnostic data; (3) accurate actuarial and underwriting procedures for reliable projection of utilization and delivery costs by provider class (hospital, primary care provider, specialist, and other ancillary providers); (4) representation of professional staff and/or a medical director at the HMO's upper management level; and (5) adequate professional staffing to support a utilization management and quality assurance program. In Figures B-1 and B-2, we described two- and three-tier physician contracting arrangements, as first defined by ICF. There is considerable variation within these two- and three-tier arrangements, however, depending upon how much control any HMO wishes to retain for itself or to

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Page 212 delegate to contracting providers. Broadly speaking, there are three issues that influence the HMO's decision-making process: (1) how physician groups and IPAs are organized in the local market in terms of the cost-effectiveness of their delivery networks, the design of their data systems, and their management capabilities; (2) how institutional and professional providers are reimbursed and whether the HMO wishes to retain control over the claims payment process; and (3) whether the HMOs believe that the physicians can discipline themselves effectively through the utilization review and peer review process. As shown in Table B-1, which describes operational responsibilities, there are two control models for two-tier organizations and three control models for three-tier organizations. Responsibilities for utilization management and financial operations may rest almost entirely with the HMOs (Model 1), may be shared between the HMOs and providers (Model 2), or may be assumed largely by providers (Model 3). In two-tier arrangements, in which the physicians either are not independent contractors (for example, staff model, group-owned, or affiliated HMOs) or are fee-for-service providers contracting directly with the HMO, an arrangement like that in Model 3 is not feasible. Moreover, any sharing of services with providers is more limited in two-tier plans than it is in three-tier plans. Typically, sharing of services involves those utilization management and claims payment activities that revolve around the gatekeeper role of contracting primary care physicians (for example, preadmission authorizations and specialty referrals). In pod-type situations in which primary care physicians are capitated, the physicians may review claims from specialty providers before authorizing them for payment. In rare cases, when providers are individually capitated and have direct control over their own specialty funds, they may actually pay for specialty claims. In three-tier organizations, HMOs are usually not responsible for physician selection and peer review, as these responsibilities rest with contracting IPAs or groups. In Model 1, the IPA or group may share limited utilization review functions with the HMO. For example, an IPA may receive utilization and financial reports from the HMO's claims system; the IPA, in turn, uses these reports as the basis for remedial action against errant providers. In Model 1, all physician payments and all risk incentives are calculated by the HMO. In Model 2, the HMO creates a medical (physician) fund, which is then handled by the IPA or groups; this fund may represent a capitated payment or a budget allocation based upon anticipated fee-for-service charges. The IPA or group then processes and pays claims for services rendered by its member physicians, while the HMO continues to pay for hospital services and emergency and out-of-area claims. The IPA or group provides feedback on utilization patterns to contracting providers and provides encounter data

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Page 213 TABLE B-1 Operational Responsibilities in Two- and Three-Tier Organizational Structures by Control Model   Two-Tier Organizations (with Pods)   MODEL 1   MODEL 2   HMO MD   HMO MD Marketing X     X   Enrollment/underwriting X     X   Utilization review X     X   Claims payment X     X X Encounter data         X Data analysis X     X   Provider feedback X     X   Peer review X     X   Quality assurance X     X     Three-Tier Organizations   MODEL 1 MODEL 2 MODEL 3   HMO IPA/Grp HMO IPA/Grp HMO IPA/Grp Marketing X   X   X   Enrollment/underwriting X   X   X   Utilization review X X X X   X Claims payment X   X X X X Encounter data       X   X Data analysis X   X X   X Provider feedback X   X X   X Peer review   X   X   X Quality assurance X X X X X X NOTE: MD indicates physician; Grp indicates group practice. on medical services to the HMO itself. In Model 2, the HMO may also be responsible for utilization review for services covered by the medical fund (for example, specialty referrals and diagnostic testing). In Model 3, the HMO largely assumes the role of a broker; it markets benefits to employers, enrolls members, and pays claims for noncapitated services. Otherwise, the IPA or group is given complete responsibility for all utilization review and data analysis. In the case studies, we have provided examples of one two-tier, Model 1 plan (Case 5), three three-tier, Model 1 plans (Case Studies 1, 3 and 4), and one three-tier, Model 3 plan (Case Study 2).

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Page 214 Approaches to Utilization Management and Quality Assurance As previously noted, responsibility for specific aspects of an HMO's operations vary by control model. Understanding where the locus of control rests is particularly important when evaluating those cost-containment approaches that affect patient care decisions. For this analysis, we have divided utilization management into its underwriting benefits, delivery of health services, and quality assurance components. Underwriting Benefits Almost always, benefit design and development of underwriting guidelines remain the responsibility of HMO management, not providers. (An exception occurs when providers require the use of copayments for office-based care to control unnecessary demand for services.) These functions can be described as follows. Enrollment criteria are underwriting guidelines by industry or service class and by group size. Premium pricing and marketing practices also affect enrollment patterns and are included in this subcategory. There has been a growing body of literature on enrollment patterns in HMOs to study the issue of selection bias. These analyses have been prompted, in part, by employer concerns that HMOs have attracted a disproportionate share of young and presumably healthy employees. In an analysis of 21 studies on self-selection, Wilensky and Rossiter concluded that most of the recent studies have shown HMOs to be enrolling a lower risk population. However, only rarely have any studies examined the impact of enrollee continuity on utilization rates.15 Benefit design relates to (1) the extent of coverage for specific services, drugs, and supplies; (2) any required copayments, coinsurance and/or deductibles; (3) level of services offered (for example, for mental health, the availability of individual or group therapy); (4) number of visits per condition; (5) out-of-pocket maximums; and (6) lifetime dollar benefits. Federally qualified HMOs have historically offered a more comprehensive set of benefits than have nonqualified prepaid plans or exclusive provider arrangements that are indemnity-based. With the recent growth of non-qualified plans and the move away from community rating and defined benefit packages to experience rating and negotiated benefits, there has been increased emphasis on benefit design as a cost-containment mechanism within HMOs.

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Page 215 Delivery of Health Services The delivery component of utilization management involves seven subcategories, as follows. Utilization review is usually administered under the auspices of a medical director and includes one or more of the following services; (1) preadmission review; (2) concurrent hospital review; (3) second surgical opinions; (4) specialty and/or out-of-network referral authorizations; (5) high-cost case management; (6) retrospective review of services; (7) bill audit; and (8) remedial action for providers suspected of fraud or noncompliance with utilization review or referral procedures. Clinical protocols or guidelines are used for medical decision-making. Formal protocols exist in writing and define the exact procedures to be followed for specific clinical conditions. There are also informal guidelines that represent a consensus of the participating providers about delivery of care. Protocols and guidelines may define, for example, when it is clinically appropriate for a patient with a specific condition to undergo a surgical or diagnostic procedure; they may also define the types of services to be rendered to a patient with a given medical condition and the appropriate setting where these services should be provided. The development of formularies to control the dispensing of pharmaceuticals also falls into this category. Patient flow procedures are used to control the scheduling and timing of patient services across the entire HMO physician network. Included in this category are the assignment of patients to "gatekeepers" for primary care services, guidelines for scheduling of visits by patient class (for example, acute-care patients, physical examinations, and follow-up visits), time allocated per appointment, access to specialists and tertiary providers, maintenance of telephone lines, office hours, and facility location. Development of staffing ratios for professional and administrative personnel represents another form of control over patient flow. Physician selection involves an assessment of a physician's technical capabilities and practice style. In medical groups and staff model HMOs, the selection process begins at the initial time of hire and continues through a probationary period. In IPAs, the process is more limited and often focuses on establishing criteria for physician participation, such as a medical license in good standing, adequate malpractice coverage, local medical staff affiliation, and board certification or eligibility. For some community-based IPA HMOs, participation is on an "every willing provider" basis, with the intent of providing as widespread a geographic distribution of physicians as possible. Data analysis involves a review of financial and utilization trends by practice site, by primary care or specialty service, by member class (for

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Page 235 was provided to the group physicians or their support staffs. Thus, there was no consensus among the group physicians and the referral clerks as to which local providers were the most cost-efficient, in terms of future referrals. Medical Director and Utilization Management Support Staff Both of the medical directors devoted approximately 50 percent of their time to their clinical practices and appeared to have taken on the management role with some reluctance. Neither had worked with their medical staffs to develop referral protocols or had undertaken any educational efforts to make them aware of referral costs by specialty. Moreover, both medical directors were extremely fearful about undertaking any program that would antagonize local physicians; thus, they did not encourage any claims review that would result in fee cutbacks by eliminating billing abuses or by using a fee schedule. Rather, the intent of the medical directors was twofold: to initiate preferred provider contracting with the specialists identified as being the most cost efficient and to internalize the high-volume specialties as quickly as possible to control the dollar outflow. However, the plan's ability to recruit specialty staff was dependent, in part, on its ability to expand its existing facilities and/or develop new clinical sites. Case Study 3: Carrier-Sponsored Hmo Background In the mid-1980s, a carrier took over an existing IPA model HMO operation that had a number of start-up sites. The computer system that was in place was inadequate to handle the variations in benefit packages across sites, as well as the different payment mechanisms used to reimburse hospitals and physicians. Because of the losses sustained at most of the HMO sites and the costs associated with upgrading the HMO software and developing new products (that is, triple option or a point-of-service HMO), the carrier decided to evaluate the future of each HMO site. The following description relates to one of the sites with fewer than 25,000 enrollees. Control Type Three-tier, with control resting with the HMO (Model 1).

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Page 236 Financial Incentives Participating primary care providers received a monthly age- and sex-adjusted capitation payment for a CPT-coded list of services; this payment was subject to a 20 percent withhold (that could be increased to 30 percent, under specific conditions). Primary care physicians retained the right to self-refer for services not covered under the capitation agreement. The individual PCPs were then grouped into pods or arbitrary physician incentive pools with a minimum of at least 1,000 members; the withholds of all PCPs in each pod were then combined. For each pod, there was a separate referral services budget to cover the costs for specialty, hospital, and ancillary services; this payment was based upon the number of members in the pod, adjusted for their age and sex mix. Specialists were paid out of the referral services budget, according to the 70th percentile of usual and customary rates, subject to a withhold. Hospitals were paid according to diagnosis-related groups (DRGs) or discounted charges, but not per diems. During the calendar year, if there were deficits in the referral services fund, the overrun was to be made up first through withholds in the specialist pool and then through withholds in the primary care pool, and finally, any remaining deficits were the responsibility of the carrier. Individual stop-loss coverage from the carrier protected the PCP from responsibility for charges in excess of $7,000 per calendar year. Despite the ability of the HMO to penalize physicians for poor performance, there was a strong fear by plan management of antagonizing primary care doctors and losing their participation in the plan. Thus, for calendar years 1986 and 1987, a corporate decision was made to return 75 percent of the physician withholds at each of the HMO sites, regardless of the extent of deficits in the referral services funds. Design of Mis System The hardware and software were inadequate to support membership size, leading to a backlog of claims in excess of 20 days for the HMO site as of December 31, 1987. Moreover, at any given time, the number of unentered claims and their dollar value were unknown. Once a claim was entered into the system, there were minimal edits to allow processors to detect inappropriate or unnecessary services or unusual billing practices by referral physicians. From a statistical perspective, the information that came off the claims system was suspect. For example, if a PCP submitted a bill that included both capitated services and specialty care (for a self-referral), two encounter numbers had to be generated; if supplies, reimbursable on a cost basis, were also included in the billing, a third encounter form was generated. Thus,

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Page 237 the reports on cost per PCP encounter were unreliable. Another example related to classification of claims by location of service. All claims had to be grouped into one of three categories: inpatient, outpatient, or other. As a result, nursing home expenses could not be easily separated out from hospital expenses, while home health care expenses, for example, could not easily be separated from those for physical and occupational therapy. As reported by the executive director at the local site, the system was designed strictly to allocate costs to the pods and to calculate withholds. Utilization Management There were no data by pod on patient demographics and no analysis of utilization patterns within pods to determine where or why deficits were occurring. In effect, there was no way to evaluate the performance of individual PCPs, except in terms of expenditures for self-referrals and outside referrals. Yet, the physicians in the pod were supposed to be self-disciplining. Their contract, however, did not specify the mechanics of any review process, nor did it define how a poorly performing physician could be removed from a pod. Medical Director and Utilization Management Support Staff At the local level there was a part-time medical director who largely handled physician and hospital contracting. Utilization review was handled by three nurses who functioned as patient care coordinators. They received all incoming calls for the authorization of hospital admissions, and depending upon the case and available time, they were responsible for conducting on-site concurrent review. The three nurses were also supposed to authorize referrals for some 20 high-cost diagnostic tests and procedures, such as use of magnetic resonance imagers and lithotripters. However, a number of PCPs regularly ignored this requirement, knowing that the plan had no intent of closely monitoring their behavior. In fact, other than the initial credentialing process, there was no quality assurance program in place. Case Study 4: Carrier-Sponsored Hmo Background A carrier established an IPA model HMO which then contracted with a series of open panel IPAs. Each IPA was responsible for delivering care in one or two counties of the state. The HMO provided all marketing, administrative, enrollment, accounting, financial, claims processing, and

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Page 238 MIS services for the IPAs. Under its contract, it was also responsible for supplying the IPAs with necessary data and reports to enable the IPAs to perform peer review, to operate a quality assurance program, and to determine the status of withhold accounts. Problems arose when one of the IPAs discovered that it was operating at a deficit and requested an increase in its monthly capitation rate. The physicians in this IPA were convinced that the deficits were attributable to three problems: (1) the HMO's use of outmoded actuarial information, leading to an underestimation of outpatient costs and a miscalculation of the capitation payment to the IPA; (2) the miscoding or misclassification of claims data, preventing a meaningful comparison between capitated payments and actual claims costs; and (3) the failure of the HMO to provide the IPA with detailed financial and utilization reports on a timely basis. This case study examines the experience of this one IPA. Control Type Three-tier, with control resting with the HMO (Model 1). Financial Incentives The HMO allocated to the IPA capitation on a per-member, per-month basis (not adjusted by age or sex), with the HMO processing all hospital and professional claims. Claims from participating IPA physicians were to be paid by the HMO according to the lesser of billed charges or a maximum fee schedule. This schedule was approximately 10 percent higher than the sponsoring carrier's schedule for its standard business. Twenty percent of all physician's fees were to be withheld and placed in a risk account. The IPA required enrolled members to sign up with a primary care physician, but did not actively support a gatekeeper system. Patients could self-refer to participating specialists. Authorizations for hospital admissions could be requested by primary care physicians or treating specialists. Moreover, there were no built-in financial incentives for performing the gatekeeper function. For example, the IPA did not allocate any percentage of funds in the withhold to primary care physicians, but distributed the funds on a pro-rata basis across the entire IPA membership. Design of Mis System Only management reports, not claims processing procedures, were reviewed. By April 30 of each year, an annual financial accounting was due, showing all capitation payments to the IPA for covered services and all billed and paid services adjusted for incurred but not reported claims;

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Page 239 from this accounting, the HMO would determine whether any or all of the physician withhold would be available to the IPA for distribution to participating physicians. The reports received from the HMO in April 1986 indicated that the IPA did not have an operational deficit, and, therefore, the 1985 withhold was returned and the amount of the withhold was decreased from 20 to 10 percent. IPA leadership continued to believe that the IPA was operating profitably until the end of the year, when the HMO reported a substantial deficit in the IPA account, requiring an increase in the withhold. Apparently, during the year the HMO had experienced a buildup in unpaid claims, resulting in a miscalculation of the incurred but not reported claim and a restatement of the IPA's financial position. At the same time, the IPA was not receiving adequate information from the HMO to develop any estimates of its own performance. For example, while the HMO provided monthly totals on admissions per 1,000 members and the average length of stay per discharge, there was no financial information on average cost per patient-day or per discharge, by type of service, or by diagnosis. Detailed information on cost per patient visit and average cost per procedure was not provided to the IPA prior to the announcement of the IPA's operational deficit. The capitation shortfall was attributed in part to the fact that the HMO was predicating utilization rates on statistics presented by outside actuarial consultants; however, the data classification system in place at the HMO did not correspond to that used by the outside consultants. For example, laboratory and x-ray costs were allocated differently in the two systems, resulting in an underestimation of the cost of outpatient services in the capitation payment. Utilization Management and Support Staff For all hospital admissions, the admitting physician was to call the utilization review department at the HMO for preauthorization. The appropriateness of the admission and the site (inpatient versus outpatient) was not questioned initially by the staff, but rather was reviewed retrospectively. Nurses at the HMO were responsible for conducting concurrent utilization review by phone and/or handling on-site reviews. An additional team of one physician and two nurses handled all psychiatric admissions. For outpatient services, the claims were screened by processors at the HMO by using a series of routine edits to detect duplicate billings, noncovered services, medically outmoded services, and services covered by total charges. Otherwise, there were no screens to review the frequency of services or upgrading of procedure codes. Individual claims were not subject to special review unless physicians contested not getting paid for all

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Page 240 services rendered. There were no reports issued on a regular basis (that is, monthly or quarterly) listing physicians who routinely billed for more services per visit or had higher costs per visit than the IPA average—or the average across all participating IPAs. There was no separate tracking of ancillary services with respect to volume and dollar amounts, by referring or treating physician. Approximately every 6 months, on an "as-needed basis," there was a joint meeting of IPA leadership and the HMO medical director and review staff to resolve outstanding problems. Actions of that committee typically included a determination of which physicians were utilizing nonparticipating providers and/or failing to notify the HMO of inpatient admissions. The IPA was then authorized to levy a $100 fine against noncomplying physicians; over a 2-year period, approximately 12 fines were issued. Otherwise, the combined HMO-IPA review team, which theoretically was responsible for quality assurance activities, did not undertake any analysis of member grievances, incident reports, admissions by diagnosis, or mortality rates. Medical Director and Utilization Management Support Staff There was a nominal flow of information down to the IPA from the medical director and his support staff at the HMO. As a result, physicians participating in the IPA continued to practice under fee-for-service incentives. The medical director of the IPA, along with the leadership of the IPA, had never supported an active utilization management program. For example, using annual information produced by the HMO on the distribution of office visits by specialty, the medical director had never sought to review the practice patterns of individual physicians identified as being in the top 25 percent by cost per visit. He had not worked with IPA leadership to develop protocols to curb unnecessary ordering of ancillary services and diagnostic testing or to foster the use of outpatient surgery. Rather, the focus of the IPA's management—and the medical director—had been directed to renegotiation of the capitation payment to eliminate the IPAs operational deficit. Case Study 5: Physician-Sponsored Ipa Background A physician-owned IPA model HMO with under 25,000 members and a panel of more than 1,000 physicians had consistently reported operating losses since its founding in the mid-1980s. In 1987, it was reported to be out of compliance with the capital reserve requirements of the state's insurance department. Accordingly, the IPA sought to determine how best to obtain

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Page 241 an immediate infusion of funds. Two primary sources had previously been identified: additional contributions from participating physicians or a loan from one or more local hospitals. However, the analysis revealed that the physicians were quickly becoming disenchanted with the plan and were unlikely to contribute additional monies, while the hospitals were not anxious to loan money unless the operational expenses of the plan could be brought under control. Control Type Two-tier, with control resting with the HMO (Model 1). Financial Incentives The physician shareholders in the plan each originally contributed between $600 and $1,750 to finance the plan's start-up. The HMO has operated on a discounted fee-for-service basis, with reimbursement predicated upon the 85th percentile of the customary and reasonable rates used by carriers operating in the local market. After the first full year's experience, these rates were reviewed and adjusted downward to control operating costs. In addition, the plan retained 20 percent of paid charges as a withhold; this withhold was not returned after the initial year of operation, but was returned after the second year as a good faith effort on the part of the IPA leadership. There were no other incentives in this plan other than the discounted fees and the withhold. Participating physicians who were interviewed felt that the withhold had no impact on utilization patterns in terms of frequency of office visits, ordering of ancillary services, or use of referrals. In fact, with the discounted fee arrangement, some primary care physicians noted that it was more cost-efficient to refer difficult or time-consuming patients to a specialist in order to maintain the patient flow within their own offices. Because of the failure of the withhold to control utilization, plan management is now considering a preestablished budget by practice type or specialty; under this approach, a percentage of the premium will be designated to cover specific services (for example, family practice, obstetrical care, surgery, and allergy), with a reserve fund created from the premium allocation. Payback of this withhold would be based upon the combined experience of the specialties covered under each withhold. Design of Mis System The claims processing section was originally under the jurisdiction of the chief financial officer, who had no previous experience with a claims

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Page 242 operation. As a result, the operation was poorly managed find understaffed, resulting in low morale, high employee turnover, and periodic claims lags. As for the claims system, the existing hardware was adequate to support the membership size, but the software lacked the necessary edits to detect unusual physician billing practices as well as a flexible report writer to produce reports according to management specifications. Utilization Management The primary care physician functioned as a gatekeeper and in that capacity was responsible for completing referral forms for all specialty, ancillary, and hospital services. Once an authorization was entered into the system, all claims were automatically paid without review, except for emergency room visits, mental health services, physical therapy, speech and occupational therapy, out-of-area claims, and out-of-plan referrals. Because the IPA was originally established by the leaders of several local medical societies and/or hospital boards and because these individuals collectively represented the medical establishment in their communities, there was a reluctance on the part of the nurse reviewers to challenge participating physicians regarding their practice patterns. This problem was further compounded by the fact that there were few or no data with which to document consistent patterns of overutilization of services or unnecessary admissions. The plan had two medical directors; one was largely responsible for utilization review and the other was responsible for physician relations and for recruiting primary care physicians for outlying areas. To date, the approach to utilization management has been through gentle persuasion, rather than tightly written protocols. However, the failure of the plan to bring utilization rates down (for example, to lower hospital utilization under 375 days per 1,000 members for the under age 65 population) has resulted in a decision to implement a more stringent review process. Ipa Management The same chief executive officer has remained in place since the plan was founded. However, within the first year of its operations, the plan lost its original chief financial officer, its director of management information systems, its director of claims, its nursing supervisor (who was responsible for quality assurance), and several other key administrative staff. There continues to be a high degree of tension between the physician leadership of the IPA and its lay management. One area of major conflict has been over underwriting practices. Plan management had established a policy of not accepting groups with fewer than 25 employees because of potential high

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Page 243 utilization. However, the IPA board of directors overruled management and decreed that participating physician offices and families were eligible for HMO membership. The offering was also extended to members of the local medical societies. Despite evidence to show that the physician offices had been high utilizers, the IPA physicians continued to overrule plan management. Notes and References 1. Page, Leigh, ''New Era in Utilization Review,'' American Medical News, Vol. 1, December 9, 1988, pp. 48-49. (See also Scheier, Ronni, "Medicine by the Book," American Medical News, January 6, 1989, pp. 1, 20). 2. U.S. General Accounting Office, Medicare Issues Raised by Florida Health Maintenance Organization Demonstrations, Report to Congress, GAO/HRD-86-97, Washington, DC, July 1986. 3. U.S. Congress, House, Maintaining Medicare's HMOs: Problems, Protections, and Prospects, Hearing before the Select Committee on Aging, 100th Congress, First Session, Washington, DC, June 11, 1987. 4. U.S. General Accounting Office, Medicare: Physician Incentive Payments by Hospitals Could Lead to Abuse, Report to the Chairman, Subcommittee on Health, Committee on Ways and Means, U.S. House of Representatives, GAO/HRD-86-103, Washington, DC, July 1986. 5. Trauner, Joan B., "The HMO Identity Crisis." Best's Review 87, April 1987, pp. 60-70. 6. The Group Health Association of America's 1988 analysis of HMO industry performance, using 1986 survey data, showed that 39.2 percent of 181 plans submitting financial data had a profit or surplus. Of the HMOs that we reviewed, 25 percent were profitable in 1986. See Group Health Association of America, Inc., HMO Industry Profile: Financial Performance, Vol. 3, Washington, DC, September 1988. 7. In a study of physician incentives in HMOs, ICF researchers noted that they were unable to check the consistency or accuracy of information supplied by the plans. They also noted that information on file at the federal Office of Prepaid Health Care (OPHC) was not always reliable; in some cases, financial incentive arrangements contained in applications for federal qualification had never become operational, and in other cases, design of incentives had changed without being reported to OPHC. ICF, Inc., Final Report: Study of Incentive Arrangements Offered by HMOs and CMPs to Physicians, Submitted to the Office of the Assistant Secretary for Planning and Evaluation, Department of Health and Human Services, Washington, DC, May 18, 1988, p. II21. 8. InterStudy, The InterStudy Edge, Excelsior, MN, Spring 1988, p. 54. 9. For a different approach, when traditional community- or foundation-based IPAs are contrasted with newer group-based IPAs, see Welch, W. P., "The New Structure of Individual Practice Associations, Journal of Health Politics Policy and Law, Vol. 12, Winter 1987, pp. 723-739. 10. ICF, Inc., Final Report, p. IV-6 (see note 7 above). 11. Gnessin, Alan M., "Physician Incentive Payment Systems and Risk Sharing Alternatives," in Group Health Association of America, Inc., Physician Incentive Programs: Defining the Risk, Washington, DC, October 28-30, 1987. 12. For a description of an HMO in which individual physician incentives are used within pods, see the statement by Jerome Beloff, Corporate Medical Director, Av-Med Health

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Page 244 Plan of Florida before the Physician Payment Review Commission, Washington, DC, July 15, 1988. 13. Gnessin, Alan M., "Physician Incentive Payment Systems and Risk Sharing Alternatives," 1987 (see note 11 above). 14. Wilensky, Gall R., and Rossiter, Louis E, "Patient Self-Selection in HMOs," Health Affairs, Vol. 5, Spring 1986, pp. 66-80. For a more recent study showing the impact of dependents' claims on health plan selection see Lairson, David R., and Herd, J. Alan, "The Role of Health Practices, Health Status, and Prior Health Care Claims in HMO Selection Bias," Inquiry, Vol. 24, Fall 1987, pp. 276-284. 15. Neipp, Joachim, and Zeckhauser, Richard, "Persistence in the Choice of Health Plans," Advances in Health Economics and Health Services Research, Vol. 6, 1985, pp. 47-72. 16. Borok, Gerald M., "Appropriate Utilization of Resources Program," Quality Assurance and Utilization Review, Vol. 2, May 1987, pp. 57-61. 17. Donabedian, Avedis, "Explorations in Quality Assessment and Monitoring," The Definition of Quality and Approaches to Its Assessment, Vol. I, Ann Arbor, MI: Health Administration Press, 1980. 18. Mosser, Gordon, "Quality Assurance in HMOs," Presentation to Management and Physician Orientation Program, Group Health Association of America, Inc., New Orleans, December 9-11, 1987. 19. For a discussion of 15 ways in which out-of-plan use may occur, see Mott, Peter D., "Hospital Utilization by Health Maintenance Organizations: Separating Apples from Oranges," Medical Care, Vol. 24, May 1986, pp. 398-406. 20. For a discussion of the process used by the Rand Corporation to impute mental health visits and expenditures at one large HMO (Group Health Cooperative of Puget Sound), see Wells, Kenneth, Manning, Willard Jr., and Benjamin, Bernadette, "Comparison of Use of Outpatient Mental Health Services in an HMO and Fee-for-Service Plans: Sensitivity to Definition of a Visit," Medical Care, Vol. 25, September 1987, pp. 894-903. 21. Joint Commission on Accreditation of Health Care Organizations, Report of the Findings of the Joint Commission's Quality Assurance Evaluation and Medical Records Audits of Health Maintenance Organizations in Ohio under the Medical Assistance Program, Submitted to the Bureau of Alternative Delivery Systems, Ohio Department of Human Services, December 1987. 22. Conversation with Jo Ellen Ross, Chief Executive Office, California Medical Review Inc., San Francisco, January 17, 1989. 23. U.S. General Accounting Office, Medicare: Physician Incentive Payments, Washington, DC, July 1986. 24. Mathematica Policy Research, Inc., National Medicare Competition Evaluation, Final Analysis Report: The Structure of Quality Assurance Programs in HMOs and CMPs Enrolling Medicare Beneficiaries, Washington, DC, February 1987. 25. Gold, Marsha and Reeves, Ingrid, "Preliminary Results of the GHAA-BC/BS Survey of Physician Incentives in Health Maintenance Organizations (HMOs)," Group Health Association of America, Inc., Research Briefs, Vol. 1, November 1987, pp. 1-15. 26. Findings from the BC/BS survey have been used to augment the GHAA survey, with duplications removed. For the BC/BS results, see Blue Cross and Blue Shield Association, "A Survey of Physician Financial Payment Arrangements in Blue Cross and Blue Shield Plan HMOs," Chicago, January 1987. 27. Hillman, Alan, "Sounding Board: Toward Full Disclosure of Referral Restrictions and Financial Incentives by Prepaid Health Plans," New England Journal of Medicine, Vol. 317, December 31, 1987, pp. 1743-1748.

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Page 245 28. ICF, Inc., Final Report (see note 7 above). 29. Memorandum from Lewin/ICF, Inc. and Group Health Association of America to Chris Bladen, Division of Health Financing Policy, U.S. Department of Health and Human Services, Washington, DC, June 24, 1988. 30. For a review of early research studies on utilization rates in HMO and fee-for-service settings and across HMOs, see Luft, Harold S., Health Maintenance Organizations: Dimensions of HMO Performance, New York: Wiley, 1981. 31. See, for example, Yelin, Edward H., Henke, Curtis J., Kramer, Jane S., Nevitt, Michael C., Shearn, Martin, and Epstein, Wallace V., "A Comparison of the Treatment of Rheumatoid Arthritis in Health Maintenance Organizations and Fee-for-Service Practices," New England Journal of Medicine, Vol. 312, April 11, 1985, pp. 962-967. Also see Quick, Jonathan D., Greenlick, Merwyn R., and Roghmann, Klaus J., "Prenatal Care and Pregnancy Outcome in an HMO and General Population: A Multivariate Cohort Analysis," American Journal of Public Health, Vol. 71, April 1981, pp. 381-390. 32. For a study that assumed that the differential use of diagnostic testing was due to its increased profitability to fee-for-service providers, see Epstein, Arnold M., Begg, Colin B., and McNeil, Barbara J., "The Use of Ambulatory Testing in Prepaid and Fee-for-Service Group Practices: Relation to Perceived Profitability," New England Journal of Medicine, Vol. 314, April 24, 1986, pp. 1089-1094. 33. Scovern, Henry, "Hired Help: A Physician's Experiences in a For-Profit Staff-Model HMO," New England Journal of Medicine, Vol. 319, September 22, 1988, pp. 787-790. 34. For an example of a discussion on referral patterns, see Piland, Neil E, White, Robert E., and Smith, Howard L., "Physician Referral Patterns: Implications for Group Practice," GHAA Journal, Vol. 7, Winter 1986, pp. 4-12. For an example of a discussion on provider feedback, see Berwick, Donald M., and Coltin, Kathryn L., "Feedback Reduces Test Use in a Health Maintenance Organization," Journal of the American Medical Association, Vol. 255, March 21, 1986, pp. 1450-1454. See also Braham, Robert L, and Ruchlin, Hirsch S., "Physician Practice Profiles: A Case Study of the Use of Audit and Feedback in an Ambulatory Care Group Practice,'' Health Care Management Review, Vol. 12, 1987, pp. 11-16.