HEALTH REFORM: Alternative Provider Reimbursement Models — How Are They Treated Under MLR Rules?

Introduction

In a recent health reform alert, "New Rules Issued on Medical Loss Ratio Requirements,"[1] we described the rules issued by the Centers for Medicare & Medicaid Services ("CMS") and the U.S. Department of Health and Human Services regarding the calculation of the Medical Loss Ratio ("MLR") pursuant to the Patient Protection and Affordable Care Act (45 C.F.R. Part 158). Such rules require individual and group health plans (other than self-funded health plans) to spend a minimum percentage of premium towards medical expense or "medical loss" (or else provide rebates to enrollees). Other expenses are generally considered "administrative" and not counted toward such minimum. For purposes of this alert, "medical expense" (or "medical loss") is defined primarily as "incurred claims" and certain quality improvement activities ("QIAs").

The line differentiating administrative expense and medical expense can be difficult to determine. Historically, most health insurers (issuers) have reimbursed providers for clinical services rendered on a "fee for service" basis. Such fees clearly qualify as "incurred claims." Increasingly, however, alternative payment models are being used, including "pay for performance" bonuses that measure a provider's performance against quality and/or cost ("efficiency") criteria, bundled payment models, sharing "pools" of funds based on relative value units, and capitation models. Sometimes, these arrangements involve intermediary entities like independent practice associations ("IPAs") or pharmacy benefit management companies ("PBMs") that may also perform administrative services, such as utilization review and claims payment. This alert addresses whether such alternative reimbursement models qualify as "medical expense" for purposes of calculating MLR.

Regulatory Background — Incurred Claims and Quality Improvement Activities

Federal regulations define the term "incurred claims," which is a component of the numerator for determining MLR.[2] These regulations also permit activities that improve health care quality to be counted as "medical loss" for purposes of calculating MLR. The MLR regulations specify that QIAs must be designed to do the following:

• Improve health quality.  
• Increase the likelihood of desired health outcomes in ways that are capable of being objectively measured and of producing verifiable results and achievements.  
• Be directed toward individual enrollees or incurred for the benefit of specified segments of enrollees or provide health improvements to the population beyond those enrolled in coverage as long as no additional costs are incurred due to the non-enrollees. 
• Be grounded in evidence-based medicine, widely accepted best clinical practice, or criteria issued by recognized professional medical associations, accreditation bodies, government agencies, or other nationally recognized health care quality organizations.[3] 

In addition, the activities must be primarily designed to do the following:

• Improve health outcomes including increasing the likelihood of desired outcomes compared to a baseline and reduce health disparities among specified populations.  
• Prevent hospital readmissions through a comprehensive program for hospital discharge.  
• Improve patient safety, reduce medical errors, and lower infection and mortality rates.  
• Implement, promote, and increase wellness and health activities.[4] 

The regulations specifically exclude certain expenditures and activities from the definition of QIAs:

1. Those that are designed primarily to control or contain costs; 
2. The pro rata share of expenses that are for lines of business or products other than those being reported, including but not limited to, those that are for or benefit self-funded plans; 
3. Those which otherwise meet the definitions for quality improvement activities but which were paid for with grant money or other funding separate from premium revenue; 
4. Those activities that can be billed or allocated by a provider for care delivery and which are, therefore, reimbursed as clinical services; 
5. Establishing or maintaining a claims adjudication system, including costs directly related to upgrades in health information technology that are designed primarily or solely to improve claims payment capabilities or to meet regulatory requirements for processing claims (for example, costs of implementing new administrative simplification standards and code sets adopted pursuant to the Health Insurance Portability and Accountability Act (HIPAA), 42 U.S.C.1320d—2, as amended, including the new ICD—10 requirements); 
6. That portion of the activities of health care professional hotlines that does not meet the definition of activities that improve health quality; 
7. All retrospective and concurrent utilization review; 
8. Fraud prevention activities; 
9. The cost of developing and executing provider contracts and fees associated with establishing or managing a provider network, including fees paid to a vendor for the same reason; 
10. Provider credentialing; 
11. Marketing expenses; 
12. Costs associated with calculating and administering individual enrollee or employee incentives; 
13. That portion of prospective utilization that does not meet the definition of activities that improve health quality; and 
14. Any function or activity not expressly included in paragraph (c) of this section, unless otherwise approved by and within the discretion of the Secretary, upon adequate showing by the issuer that the activity's costs support the definitions and purposes in this Part or otherwise support monitoring, measuring or reporting health care quality improvement.[5]

As payors and providers or other entities enter into more complex arrangements that provide for compensation that is not solely based on the fee-for-service model, but include bonuses for medical cost reduction or payment for administrative services, consideration should be given to whether those payments to providers or other entities are treatable as QIAs for MLR purposes.

Consideration of Various Payment Options for Determining MLR

Pay-for-Performance Bonuses to Providers. Since activities designed primarily to control or contain costs are specifically defined by regulation as constituting administrative expense (not incurred claims or QIAs), any bonus paid to a provider based primarily on cost-saving measures is not likely to qualify as medical expense (although a fee schedule that gets "adjusted" retroactively or prospectively after measuring provider performance could arguably be considered to fall within the definition of "incurred claims"[6]). Therefore, a bonus paid to a hospital for reducing its average length of stay or to a hospital and/or physician group for reducing total claim costs for patients assigned to such providers would typically not qualify as medical expense (even if the patients receive an alternative and less costly type of service).

However, there appear to be at least two circumstances under which the payment of a "performance" bonus could justifiably be included in the MLR numerator: (1) where the payment is based on criteria that meet the definition of QIAs (as described above), and (2) if a bonus meets the four-part test for "clinical risk bearing entities," described below.

Capitation Payments to Physicians and Non-Physician Clinical Providers. The regulations only mention capitation payments to physicians, but CMS has provided the following technical guidance with respect to capitation payments to non-physician clinical providers:

The answers to questions 8 and 9 are important for a number of reasons. First, the guidance recognizes that even though a component of the capitation payment does, in some cases, cover a portion of the provider's administrative expenses, the entire capitation amount will be treated as incurred claims. Secondly, although the regulation specifies capitation payments to physicians, the intention is to recognize capitation payments to all providers appropriately licensed or otherwise authorized to provide clinical services.

Payments to Third Parties.

a. "Payments to Clinical Risk Bearing Entities."CMS recently issued additional guidance for payments made to "clinical risk bearing entities."[8] Questions and answers ("Q&As") 20, 21, and 22 attempt to clarify treatment of such payments. Question 20 addresses whether payments to third parties, such as IPAs, physician hospital organizations, and accountable care organizations ("ACOs"),[9] constitute incurred claims.

The guidance provides that payments to such entities will generally be treated as incurred claims, where each component of a four-pronged test is satisfied. The four factors are:

1. The entity contracts with an issuer to deliver, provide, or arrange for the delivery and provision of clinical services to the issuer's enrollees but the entity is not the issuer with respect to those services;
    
2. The entity contractually bears financial and utilization risk for the delivery, provision, or arrangement of specific clinical services to enrollees;
    
3. The entity delivers, provides, or arranges for the delivery and provision of clinical services through a system of integrated care delivery that, as appropriate, provides for the coordination of care and sharing of clinical information, and which includes programs such as provider performance reviews, tracking clinical outcomes, communicating evidence-based guidelines to the entity's clinical providers, and other, similar care delivery efforts; and
    
4. Functions other than clinical services that are included in the payment (capitated or fee-for-service) must be reasonably related or incident to the clinical services, and must be performed on behalf of the entity or the entity's providers.

If the entity satisfies this four-part test, payments for clinical services for which the entity takes on the financial risk for utilization as provided in prong two above will be considered incurred claims. Conversely, when an entity takes on only pricing risk, Question and Answer 19[10]... applies. Q&A #19 addresses payments to third party vendors who pay others (not employees) to provide clinical services to enrollees and perform administrative functions. It provides that the entirety of the payment by an issuer to an entity that only takes on pricing risk (e.g., payments to pharmacy benefit managers (PBMs) for retail pharmacy claims) should not be reported as incurred claims.[11]

The four-part test attempts to delineate the requirements through which payments to clinical risk-bearing entities qualify as incurred claims. The elements provide interesting asides (for example, it appears that the entity can be an insurer, but only where the entity "is not the issuer with respect to those services"). The term "financial and utilization risk" (in factor (2) above) is not defined in the guidance (this creates some confusion given that activities designed primarily to control or contain costs are specifically treated as administrative expense per the definition of QIAs. In addition, any functions that are not clinical services must be "reasonably related or incident" (a term not defined) to the medical services being provided in order to qualify as incurred claims. The guidance distinguishes this model from an arrangement whereby the entity takes on only pricing risk. As an example, the guidance notes that payments to PBMs for retail pharmacy claims are not to be treated as incurred claims.   The regulations do not define what constitutes "pricing risk." The reference to Q&A 19 at the end of Q&A 20 seems to imply that Q&A 19 applies to clinical entities that do not take on financial risk for utilization, but Q&A 19 applies to third-party vendors that pay others to provide clinical services, which implies that such vendor is not a clinical entity itself. Thus, there appears to be no clear guidance on how payments to clinical entities that do not take on "financial and utilization risk" are treated for MLR purposes. 

Q&A 21[12] addresses the scenario where the payment to the clinical risk-bearing entity includes payment for administrative functions performed on behalf of the entity's providers. Under those circumstances, the payment will constitute incurred claims if the four factors previously mentioned are established. However, per Q&A 22,[13] if the administrative functions are performed on behalf of the issuer, the portion of the payment attributable to such administrative functions is not includable as incurred claims.

b. Payments to Non-Clinical Entities. When a third-party entity is not a clinical entity, Q&A 12 in the May 13, 2011, guidance and Q&A 19 in the July 18, 2011, guidance apply. Q&A 12[14] addresses third-party vendors that provide clinical services to enrollees through employees. The guidance provides that the entire portion of the payment to the vendor for the provision of clinical services constitutes incurred claims, even if some of the payment is attributable to the vendor's administrative costs, as long as those cost are directly related to the provision of clinical services. It is important to note that contracted providers do not constitute employees, limiting the reach of this exception.

Q&A 19[15] addresses payments to third-party vendors that pay others (not employees) to provide clinical services to enrollees and perform administrative functions. Also, Q&A 19 provides that the entirety of the payment by an issuer to an entity that only takes on pricing risk (e.g., payments to PBMs for retail pharmacy claims) should not be reported as incurred claims.[16]

Bundled Payments to Providers. Bundled payments are payments made to a group of providers for an "episode of care" and are used in place of separate fee-for-service payments to each such provider, and thus would be considered incurred claims since they are "direct claims paid to providers."

Payments to Members. Some health plans have experimented with paying members to go to providers that charge less for particular services. Assuming such payments are made to members of health plans subject to the MLR rules, such payments are not "incurred claims" or QIAs. It is unclear if such payments could constitute QIAs if they were based on quality measures and not "designed primarily to control or contain costs" (the latter being a specific exclusion to the definition of QIAs).

Conclusion

The guidance issued to date answers many questions as to how various alternative provider reimbursement models should be treated for purposes of MLR but leaves a number of questions unanswered. Because of the rapidly changing legal and business landscapes, counsel working on such arrangements should stay tuned for further insight and guidance from CMS as such models continue to evolve.

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Endnotes

Resources