The Balanced Budget Act of 1997 – A Done Deal

On Tuesday, August 5, 1997, President Clinton signed into law the historic Balanced Budget Act of 1997 (the "Act"). While the focus of news reports has been on the tax and balanced budget provisions of the Act, the Act also contains numerous savings, spending and reform provisions pertaining to the Medicare and Medicaid fee-for-service and managed care programs, as well as to health care for uninsured children, all of which will have a profound impact on the nation's health care industry.

For example, the Act will enable Medicare beneficiaries to obtain their Medicare benefits directly from 46 provider-sponsored organizations" ("PSOs") that can now contract directly with the Medicare program on a risk basis. The Act also creates a new health insurance program designed to provide health benefits coverage to certain uninsured, low income children who are not eligible for the Medicaid program by providing billions of dollars in available funding over the next ten years to states in the form of grants under which the states will have a variety of options for providing the assistance called for by the Act. Furthermore, the Act contains provisions intended to improve the federal government's ability to rid federal health care programs of fraud, abuse and waste. This alert will focus on the PSO provisions, the children's health care provisions, and the fraud, abuse and waste provisions of the Act.

I. PSOs as Direct Medicare Risk Contractors

The Act includes provisions that will achieve the most significant structural change to the Medicare managed care program since the enactment of the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"). TEFRA generally established the current Medicare managed care program consisting in part of so-called "risk contractors" and "cost contractors" that contract directly with the Medicare program to provide Medicare-covered services to Medicare beneficiaries under various payment arrangements.1 As to risk contractors, TEFRA limited health plan eligibility to federally-qualified health maintenance organizations ("HMOs") and competitive medical plans ("CMPs"). "CMP" is a term used by the Medicare program essentially to refer to risk-bearing organizations that are not federally-qualified and for which a state license usually is required.

As a result of the Act, entities which meet the Act's definition of "PSO" also will be eligible to contract directly with the Medicare program on a risk basis.2 A PSO generally is defined under the Act as a public or private entity:

(A)that is established or organized, and operated, by a "health care provider," or group of "affil-iated" "health care providers;"

(B)that provides a "substantial proportion" of health care items and services through the provider or "affiliated" group of providers; and

(C)in which the "affiliated" providers share, directly or indirectly, substantial financial risk with respect to the provision of such items and services and have at least a majority financial interest in the PSO entity.3

The Act thus envisions the Medicare program entering into risk contracts directly with entities such as physician-hospital organizations ("PHOs"), hospital systems, medical groups, preferred provider organizations ("PPOs") and independent practice associations ("lPAs"), as long as these entities otherwise meet the new definition of "PSO" set forth in the Act.

A major reason why many entities which meet the Act's definition of "PSO" have not become Medicare risk contractors as CMPs under current law is because many PSOs cannot meet the administrative and solvency standards required by state law. To remedy this situation, the Act specifically authorizes PSOs to contract directly with the Medicare program on a risk basis and contains a special exception for PSOs from certain state organizational and financial requirements imposed on other "Medicare+Choice organizations." (Under the Act, entities that contract with the Medicare program are called "Medicare+Choice organizations." Thus, Medicare risk contractors generally will be referred to as "Medicare+Choice organizations" and the standard plans they offer will be called "Medicare+Choice plans").4

The Act requires that a Medicare+Choice organization be organized and licensed under state law as a risk-bearing entity eligible to offer health insurance or health benefits coverage. However, the Act directs that the Secretary of the U.S. Department of Health and Human Services (the "Secretary") shall waive this state-licensing requirement for a PSO if any of the following three grounds are met:

(A)the state has failed to complete action on the PSO's licensing application within ninety (90) days after the state's receipt of a substantially complete application;

(B)the state has denied the PSO's licensing application, and, as a condition for approval of the application, the state imposed material requirements upon the PSO (other than solvency requirements) that generally are not applicable to other entities engaged in a substantially similar business as the PSO, or, as a condition for approval of the application, the state required the PSO to offer any product other than a Medicare+Choice plan; or

(C)with respect to an application which is filed on or after the date that federal financial solvency and capital adequacy standards for PSOs are established by the Secretary, the state has denied the PSO's licensing application based upon the PSO's failure to meet the state's solvency requirements, and such requirements are not the same as the federal standards established by the Secretary for PSOs, or, as a condition for approval of the application, the state imposed documentation or information requirements relating to solvency or other material requirements, procedures, and standards relating to solvency that are different from the federal requirements, procedures, and standards applied by the Secretary to PSOs.

Applications for a waiver from the state-licensing requirement must be filed by PSOs with the Secretary by November 1, 2002.5 The Secretary must grant or deny a waiver application within sixty (60) days after the date the Secretary determines that a substantially complete waiver application has been filed. If granted, the waiver is good only for a period of thirty-six (36) months and cannot be renewed.

Several observations on the waiver process can be made. First, mere inaction by a state on a PSO's substantially complete application for a license will support a federal waiver from the state-licensing requirement. In many states, it is unheard of to complete an HMO license process in only ninety (90) days. Thus, many PSOs seeking Medicare risk contracts may be eligible for a waiver of the state-licensing requirement simply because the state is understaffed to process license applications.

Second, a state's requirement that a PSO offer a product other than a Medicare+Choice plan as a condition for licensure also will support a federal waiver from the state-licensing requirement. Ironically, until now, it has been federal law that generally has required Medicare contractors to offer non-Medicare products through the so-called "50150 enrollment mix rule." In this regard, the Act substantially changes, and eventually sunsets, the existing 50150 rule that requires a Medicare risk contractor to have an enrolled membership, at least one half (1/2) of which consists of individuals who are not entitled to Medicare or Medicaid benefits. Effective immediately, a Medicare risk contractor can count Medicaid members with commercial members for purposes of complying with the amended 50/50 rule. The Act further authorizes the Secretary to waive the amended 50150 rule entirely during the phase-out time period. The amended 50/50 rule will not apply to any Medicare risk contractor with a contract whose period begins on or after January 1, 1999.6

Third, the state's imposition of material requirements upon a PSO (other than solvency requirements) that generally are not applicable to other entities engaged in a "substantially similar business" as the PSO as a condition of licensure may be waived by the Secretary. The phrase "substantially similar business" is not defined by the Act and could raise potential issues under various interpretations of state licensure laws.

Fourth, even with a state law waiver, PSOs still will have to meet federal standards for organization and administration, as well as federal financial solvency and capital adequacy standards, to qualify for Medicare risk contracts. In this regard, the Act directs the Secretary to establish federal financial solvency and capital adequacy standards for PSOs through a negotiated rulemaking process by April 1, 1998, the target date set by the Act. If, after attempting to use a negotiated rulemaking process, this process is deemed by the committee established by this process to be unlikely to result in the publication of such federal standards by April 1, 1998, then the Act permits the Secretary to establish the federal standards for PSOs through such other method as the Secretary may provide.7

PSOs that are granted a waiver from the state-licensing requirement by the Secretary also will have to meet all consumer protection and quality standards which would apply to the PSOs if they were state-licensed, which generally are applicable to other Medicare+Choice organizations in the state, and which otherwise are consistent with the federal standards of the revised Medicare managed care program. Yet, the Act provides that these con-sumer protection and quality standards do not include state standards relating to: (1) benefit requirements; (2) requirements relating to inclusion or treatment of providers; or (3) coverage determinations (including related appeals and grievances processes).8 It is unclear whether state requirements relating to administrative capacity and other operational requirements still will apply to Medicare risk contractors.9

There is another federal standard which also is different for PSOs under the Act. Specifically, PSOs seeking to offer a Medicare+Choice plan generally must have at least 1,500 individuals who are receiving benefits through the PSO before contracting with the Medicare program, whereas other Medicare+Choice organizations seeking to offer Medicare+Choice plans must have at least 5,000 individuals who are receiving benefits through the organization before contracting with the Medicare program.10

With respect to the timeline for PSOs obtaining Medicare risk contracts, the Act is unclear. The Act pro-vides that the special minimum enrollment rule of 1,500 members for PSOs applies to contract years beginning on or after January 1, 1998. Also, as discussed above, the Act requires PSOs that are granted a waiver from the state-licensing requirement to meet federal financial solvency and capital adequacy standards, which are not even targeted for publication until April 1, 1998. Obviously, PSOs cannot satisfy this requirement, and thus may not obtain a Medicare risk contract, until these federal standards have been promulgated. Thus, there is a significant question as to when PSOs truly can take advantage of the special provisions of the Act, and it remains to be seen how many PSOs will do so.

II. Health Care Assistance for Uninsured, Low Income Children

The Act creates the State Children's Health Insurance Program ("SCHIP"). SCHIP is authorized through the year 2007 during which billions of dollars in funding will be available to states. States may use this funding to provide health care assistance to uninsured, low income children under the age of nineteen (1 9) who are not eligible for the Medicaid program. A state may access this funding as early as October 1, 1997, if the state's plan has been filed and approved by the Secretary.

States that choose to participate in the program will receive federal matching funds from each state's allotment through a formula specified in the Act. The Act gives states significant flexibility in spending these funds. States' options for providing health care assistance to the targeted children include:

(A)expanding the states' Medicaid programs;

(B)providing coverage that meets the requirements of the Act; and

(C)a combination of these options.

While the Act provides the states with three benchmark benefits plans from which to choose, the Act also allows states to design their own benefit plans, so long as the benefit plan has an equivalent actuarial value to the bench-mark plans.

SCHIP does not provide for substantial safeguards to prevent employers from dropping dependent coverage. It also is unclear how many states will elect to participate in the program.

III. Anti-Fraud, Abuse and Waste Provisions

The Act supplements the additional legal weapons against fraud, abuse and waste in federal health care pro-grams already gained by the federal government with the recent enactment the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). Specifically, the Act contains the following additional anti-fraud, abuse and waste provisions:

(A)"Three Strikes and You're Out"--This provision requires the mandatory, permanent exclusion from federal health care programs of individuals convicted of three offenses for which exclusion must be imposed by the Secretary.

(B)"Individuals or Entities Convicted of Felonies"--This provision permits the Secretary to refuse to enter into an agreement, or to terminate or refuse to renew such an agreement, with a provider of services, if the provider has been convicted of a felony for an offense which the Secretary determines is "detrimental to the best interests" of the Medicare program or Medicare beneficiaries. This provision also applies to Medicare participating physicians.

(C)"Information Included in Explanation of Benefits Forms and Itemized Bills"--These provi-sions require that each explanation of benefits form provided to Medicare beneficiaries contain a statement that Medicare fraud, abuse and waste is a significant problem, as well as a toll-free number for persons to report information about fraud, abuse and waste in the Medicare program. These provisions also include requirements relating to a beneficiary's right to a review of an itemized bill for Medicare-covered services.

(D)"Exclusion of Entities Controlled by Family Members and Members of the Same Household of Sanctioned Individuals"--These provisions authorize the Secretary to exclude an entity from participating in federal health care programs if a person transfers an ownership or control interest in the entity to an immediate family member or to a member of the individual's household in anticipation of, or following, a conviction or exclusion against the person.

(E)"Civil Money Penalties"--These provisions create a new civil money penalty for cases in which a person contracts with a provider for the provision of services covered by federal health care programs, when the person knows or should know that the provider is excluded from participating in a federal health care program. These provisions additionally create a new civil money penalty of $50,000 for each violation of the federal health care program anti-kickback statute. Finally, the Act creates a civil money penalty of up to $25,000 for health plans that fail to report adverse actions as required under the health care fraud and abuse data program created by HIPAA.

(F)"Information and Surety Bonds"--These provisions require durable medical equipment ("DME") suppliers to provide the Secretary with information as to persons with an ownership or control interest in the supplier, or in any subcontractor in which the supplier has a five percent (5%) or more ownership interest. The Secretary may impose this requirement on any provider of items or services under Part A. These provisions also require home health agencies, comprehensive outpatient rehabilitation facilities, and rehabilitation facilities, to provide a surety bond of at least $50,000 to the Secretary.

(G)"Advisory Opinions"--This provision requires the Secretary to issue advisory opinions as to whether a referral relating to a designated health service is prohibited under the Medicare/Medicaid Physician Self-Referral Law, also known as the Stark Law.

(H)"Fraud and Abuse Control Program"--This provision requires the U.S. General Accounting Office ("GAO") to issue a report on the operation of the Medicare fraud and abuse control program by June 1, 1998.

(1)"Disclosure of Interest"--This provision requires a hospital's discharge plan to identify a provider to whom an individual is referred in which the hospital has a financial interest or which has such a financial interest in the hospital.

(J)"Inherent Reasonableness"--This provision requires the Secretary to describe by regulation the factors to be used in determining cases in which application of the payment rules under Medicare Part B (other than for physician services) results in a determination that an amount is not inherently reasonable. However, under this provision, the factors provided by the Secretary can not decrease payment amounts by more than fifteen percent (I 5 %) from the preceding year's amount.

(K)"Competitive Acquisitions"---These provisions authorize the Secretary to conduct five (5) demonstration projects in competitive acquisition areas established by the Secretary for furnish-ing Part B services (except physician services) under guidelines set forth by the provisions. One demonstration is to be for oxygen and oxygen equipment.

As you can see, the Act's provisions relating to Medicare risk-contracting PSOs, to health benefits coverage for uninsured, low income children, and to federal health care program fraud, abuse and waste, constitute a com-prehensive package of savings, spending and reform provisions that will leave few in the health care market place untouched. Epstein Becker & Green is prepared to assist our clients in interpreting these provisions, as well as the other significant health care provisions included in the Act.

If you would like additional information regarding the Balanced Budget Act of 1997, please contact Lynn Shapiro Snyder, Stuart Gerson in our Washington, D.C., office at (202) 861-0900, William Helvestine or Margaret Reynolds in our San Francisco office at (415) 398-3500, or the member of the firm who normally handles your legal matters.


1 Under the Act, Medicare beneficiaries choosing to access their benefits through the revised Medicare managed care program will not be able to access their Medicare benefits through cost contractors as of the year 2002. Back to Article

2 The Act also specifically identifies preferred provider organizations (PPOs) as an option for Medicare beneficiaries. However, the Act provides little guidance as to the qualifications that will be needed by PPOs to obtain contracts with the Medicare program on a risk basis. Back to Article

3 The Act directs the Secretary of the U.S. Department of Health and Human Services to issue regulations to further explain the definition of the term "PSO" and provides the Secretary with guidelines for developing the definition of the key term "substantial proportion" which is used within the definition of the term "PSO." The Act also sets forth the definitions for the key terms "affiliated," "control" and "health care provider" which are used within the definition of the term "PSO." See Section 1855(d) of the Social Security Act created by the Act. Back to Article

4 Pursuant to the Act, Medicare+Choice organizations may also offer "Medicare+Choice private fee-for-service plans," as well as "MSA plans," i.e., "medieval savings account plans." Back to Article

5 The Act directs the Secretary to submit a report regarding whether the waiver process should continue after December 31, 2002, to the appropriate Congressional committees by no later than December 31, 2001. In making such a recommendation, the Act directs the Secretary to consider, among other factors, the impact of such process on Medicare beneficiaries and on the long-term solvency of the Medicare program. Back to Article

6 The Act repeals the so-called "75/25 enrollment mix rule" which applies to Medicaid risk contracts effective June 1, 1996. Back to Article

7 IN established the federal financial solvency and capital adequacy standards for PSOs through the negotiated rulemaking process, the Act directs the Secretary to consult with interested parties and to take certain enumerated factors into account, including any standards developed by the National Association of Insurance Commissioners ("NAIC") specifically for risk-based health care delivery organizations. Back to Article

8 Under the Act, state standards relating to: (1) benefit requirements; (2) requirements relating to inclusion or treatment of providers; or (3) coverage determinations will not apply to any "Medicare+Choice organizations." Back to Article

9 The Secretary may enter into an agreement with a state under which the state monitors and enforces compliance of a PSO with the state consumer protection and quality standards which PSOs must meet. Back to Article

10 For PSOs primarily serving individuals residing outside of urbanized areas, the Act requires these PSOs to have at least 500 individuals who are receiving health benefits through the organization before contracting with the Medicare program. Other Medicare+Choice organizations primarily serving individuals residing outside of urbanized areas must have 1,500 such individuals before contracting with the Medicare program. The Act permits the Secretary to waive these minimum enrollment requirements during the first three (3) contract years with respect to any Medicare+Choice organization. Back to Article