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by Will Farnham



  The PHO is an entity that, at a minimum, allows a hospital and its physicians to negotiate with third party payers.  PHOs may do little more than provide for such a negotiating vehicle, although this could raise the risk of antitrust.  PHOs may actively manage the relationship between the providers and MCOS, or they may provide more services, to the point where they may more aptly be considered Management Service Organizations (MSOs).

  In its weakest form, the PHO is considered a messenger model.  This means that the PHO analyzes the terms and conditions offered by an MCO and transmits its analysis and the contract to each physician, who then decides on an individual basis whether to participate.

  In its simplest and more common version, the participating physicians and the hospital develop model contract terms and reimbursement levels and use those terms to negotiate with MCOs.  The PHO usually has a limited amount of time to negotiate the contract successfully (e.g., 90 days).  If that time limit passes, then the participating physicians are free to contract directly with the MCO; if the PHO successfully reaches an agreement with the MCO, then the physicians agree to be bound by those terms.  The contract is still between the physician and the MCO and between the hospital and the MCO.  In some cases, the contract between the physicians and the MCO is relatively brief and may reference a contract between the PHO and the MCO.

  PHOs are generally considered the first step on the evolutionary ladder in vertical integration with respect to practitioners and facilities.  They often form as a reaction to market forces from managed care.  PHOs are considered the easiest tvpe of vertically integrated system to develop, although they are not actually that easy, at least if done well.  They also are a vehicle to provide some integration while preserving the independence and autonomy of the physicians.

  By definition, a PHO requires the participation of a hospital and at least some portion of the admitting physicians.  Often, the formation of the PHO is initiated by the hospital, but unless the leadership of the medical staff is also on board it is unlikely to get far.  It is not uncommon for a PHO to be formed primarily as a defensive mechanism to deal with an increase in managed care contracting activity.  It is also not uncommon for the same physicians who join the PHO already to be under contract with one or more managed care plans.

  The PHO is usually a separate business entity, such as a for-profit corporation.  This requires thorough legal analysis for the participating not-for-profit, tax exempt hospital because the hospital could lose its tax exempt status if access to tax exempt financing confers an advantage to the PHO's balance.

  Initial capitalization and ownership occur with varying formulas, but most strive toward equal ownership between the physicians and the hospital.  The hospital may put up the majority of the cash, however.  For the sake of practitioner motivation, physician equity is considered a desired feature.

  Ongoing revenue to the simplest form of PHO may be a non-item because the entity could serve only as a cost center for the hospital.  As the PHO takes on various MSO functions, however, participating providers pay a fee for those services.  Third party payers also may pay an access fee.

  Governance can evolve similarly.  That is, in its simplest form hospital administrators may run the entity.  Most PHOs are establishing formal governing boards, however.  Board composition is usually equally divided between hospital administrators and physicians, with attention being given to primary care representation within the physician component.

  PHOs fall into two broad categories: open and closed.  These are described separately because MCOs often view them that way.

Open PHOs

  The open PHO is one that is open to virtually any member of the medical staff of the hospital.  There will often be minimum credentialing requirements (see Chapter 8), but not necessarily even that.  Open PHOs are almost universally specialty dominated; in other words, there are disproportionately more specialists in the PHO than there are PCPS.  The creators of the open PHO are often the specialists themselves, who become concerned that MCOs are selectively contracting, thereby reducing the amount of business that the specialists (as a group) are doing.  The medical staff then approach the hospital administration to form the PHO primarily to allow all the members of the medical staff to participate with MCOS.  In this situation, PCPs are usually courted but may still be relegated to secondary citizenship, even if unconsciously.

  Some open PHOs claim that, although their genesis is an open format, the ultimate goal will be to manage the membership and remove those physicians who are unable to practice cost effectively.  MCOs view such claims with skepticism, although it is certainly possible.  The political reality of an open PHO is that it is quite difficult to bring sufficient discipline to bear on medical staff members who wield a high level of influence.  This is currently complicated by the continued dichotomy of payment mechanisms, in which a certain portion of reimbursement to the hospital rewards cost effectiveness (e.g., prospective payment, capitation, and package or bundled pricing), whereas other forms of reimbursement reward the opposite (e.g., fee for service and simple discounts on charges).  Finally, one must never underestimate the influence of the medical staff, particularly when they are united; failure to attend to the needs of the medical staff may be a serious career limiting move on the part of the hospital chief executive officer (CEO).  In light of this, some PHOs have featured hospital CEOs permitting more than half the board seats to be occupied by physicians, although some are hospital-based physicians; in the case of not-for-profit PHOS, however, physicians may not represent more than 20 percent of the governance, regardless of the hospital's desire.

  One last note regarding PHOs: The "PO" portion of a PHO may be a different model entirely.  As an example, a GPWW or an IPA could represent the physician portion of the PHO.  Although the most common model is one in which the physicians remain independent and contract individually with the PHO, it is by no means the only method of organization.

Closed PHOs

  The primary difference between a closed PHO and an open one is the proactive decision to limit physician membership in the PHO.  This is clearly more difficult politically than an open model, but it carries greater potential for success.  The two general approaches to limiting membership are by specialty type and by practice profiling.

  Limitations by specialty type are most common and most easily done.  The most common limitation is the number of specialists, to address the imbalance of PCPs and specialists found in an open PHO.  In fact, it is not uncommon to find closed PHOs having a disproportionate number of PCPs on the governance board as well as in the membership of the PHO.  Although an extreme demonstration of this concept is the primary care-only PHO that simply subcontracts with certain specialists, the PHO usually places limits on the number of specialists of any given specialty type beyond primary care for equity sharing and/or membership status.  This limitation on the number of specialists is most often accomplished by projecting the enrollment (or covered lives) that the PHO is expected to cover over the next several years and then recruiting specialists according to predetermined ratios of specialists needed for that enrollment.

  The second type of limitation involves practice profiling and is more difficult to carry out for technical reasons.  This type of limitation requires the PHO to examine some objective form of practice analysis (it could be a subjective analysis, but that would probably raise a restraint of trade issue).  Based on that analysis, physicians are invited to join the PHO or not.  This is difficult to accomplish unless the PHO has access to adequate data, which is most uncommon.  The closed PHO may be impeded in its quest to demonstrate selectivity by those states enacting any willing provider legislation and needs to be aware of any possible antitrust issues.

  As part of ongoing recredentialing, the PHO also regularly reevaluates the number of physicians required in each specialty.  If the PHO has the ability to capture and analyze data regarding practice behavior and clinical quality, those data may be used in managing the physician membership and, ultimately, in ending the participation agreement with any physicians who repeatedly depart from the PHO's practice guidelines.  Such analyses are difficult to perform properly.  It is important for the PHO (or for any type of IDS, for that matter) that accepts full risk to negotiate the right to receive claims data on all members for whom the PHO has the full capitated risk because otherwise the PHO will not have sufficient data to analyze all medical costs.

Advantages of a PHO

  The primary advantage of a PHO is its ability to negotiate on behalf of a large group of physicians allied with a hospital.  This advantage can be ephemeral if no MCO wishes to negotiate, but it may be very real if the hospital and key members of the medical staff are attractive to MCOs and are not already under contract.  Closed PHOs are more attractive to MCOs than open ones.  Of course, if the providers have already contracted with the MCO and threaten to pull out (i.e., boycott the MCO) unless the MCO uses the PHO, a serious antitrust problem may arise.  If the MCO has not already contracted with the providers, the PHO may be an expeditious route to developing a delivery system capability.  Even in those situations where a contract already exists, contracting through the PHO may represent a sufficient improvement in terms such that an MCO will be willing to switch from direct contracting to using the PHO; for example, the PHO may be willing to provide performance guarantees.  Finally, physicians may view the PHO as a facilitator in landing direct contracts with self-insured employers, with the Health Care Financing Administration for Medicare risk contracts, and with the state for managed Medicaid contracts.

  A second advantage of a PHO is its theoretical ability to track and use data and to manage the delivery system, at least from the standpoints of UM and quality management.  Once again, this advantage is more likely to be found in a closed PHO than in an open one, primarily because a closed PHO has a greater concentration of events over fewer physicians.

  The third advantage of a PHO is that it is the first step to greater integration between a hospital and its medical staff.  Although a PHO by itself may result in improved relations, those relations can quickly sour if the PHO consumes time, energy, and money but fails to yield results.  If the PHO does result in a better ability to contract or yields economic rewards, then its mission is successful, at least for the near term.  If the PHO does not succeed, or if success appears to be short lived, then the PHO may be the base from which a more integrated model may be built.

Disadvantages of a PHO

  The chief disadvantage of a typical PHO is that it often fails to result in any meaningful improvement in contracting ability.  In many cases, MCOs already have provider contracts in place and see little value in going through the PHO.  Even worse, an MCO may see the PHO as little more than a vehicle for providers to keep their reimbursement high.

  Open PHOs are at a significant disadvantage if the MCO (or employer, in the event that the PHO chooses to contract directly with employers) does not want all the physicians in the PHO to be participating with the health plan.  MCOs often want the right to select the providers and are unlikely to give up that ability.  Even closed PHOs may suffer from this problem if the MCOs specifically wish to avoid contracting with certain physicians who are members of the PHO.

  MCOs may view the PHO as a barrier to effective communication with the physicians and a hindrance to fully effective UM.  Unless the PHO has a compelling story to tell regarding its ability to manage utilization, the MCO may believe that it can do a better job without the PHO's interference.  Alternatively, if the health plan has relatively unsophisticated UM capabilities, or if the plan is too small to be able to devote adequate resources to UM, the PHO may represent an attractive alternative.

  Because PHOs are relatively loose in their structure, and because the physicians may still be completely independent, the PHO's ability to affect provider behavior is rather limited.  This can have an impact not only on UM but also on getting the entire organization to make necessary changes.

  Regrettably, there have been a few cases where a hospital and medical staff with existing managed care contracts formed a PHO with the intent of using the PHO to improve their negotiating strength, only to lose the existing managed care contract and be unable to replace it with anything better.  In other words, the PHO actually harmed them because it was considered undesirable by the MCO.  Because PHOs do allow the participating physicians to contract directly with the MCO in the event that the MCO does not offer terms agreeable to the PHO, this risk is usually minimal.

Specialist PHOs

  A recent variant of the PHO has emerged over the past few years.  The specialist PHO has taken the general closed PHO concepts down to the level of a single specialty.  Common specialties involved are cardiology and pediatrics; psychiatric PHOs also have existed for many years.  Their track record is too brief in most cases for definitive observations, but the value placed on them by the market should follow the logic described above under specialist PPMS, except that this entity brings with it an expensive facility.


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