February 1995

POs and PHOs—A Response to Manage Care (Part 1)

by Corena Peña Andorfer, Consultant for Health Policy

Health care providers may drive the health care industry, but managed care is changing the rules of the road. In the face of skyrocketing medical bills, payers have turned to managed care to reduce costs. In the process, the way in which these payers approach the health care system has changed. They now scrutinize hospital and physician services, negotiate lower fees, and force hospitals and physicians to compete for a limited number of contracts. In response, some physicians and hospitals have organized physician organizations (POs) and physician hospital organizations (PHOs) to help them react to the change. This Bulletin provides an overview of POs and PHOs. Next month we will take a more in-depth look at the key issues facing them.

Physician Organizations

Generally, a PO is defined as a "business [emphasis added] entity formed by a group of physicians to pursue managed care contracting opportunities and other cooperative ventures with other physicians." The main difference between a PO and a PHO is that the latter comprises hospitals as well as physicians; although the total number of such organizations is not known, anecdotal evidence suggests that both types of entities are gaining popularity in Michigan.

Robert Schwyn M.D., Ph.D., is president of a Dearborn-based PO—Southeast Michigan Physicians, P.C.—established more than a year ago. Although the organization is not yet completely operational, to date about four hundred physicians have signed up (two-thirds are specialists, and one-third are in primary care). Doctor Schwyn recognizes that over time there will be some attrition, but he believes that the number will not fall significantly. He maintains that POs are very attractive to many physicians: "We’re looking at a reorganization that will help us retain autonomy. We [physicians] can retain our independent practices for nonmanaged-care patients and have negotiating power for managed-care contracts."

For assistance with developing information systems, credentialing, and administrative functions, Southeast Michigan Physicians has contracted with PhyCorp, a Tennessee-based company. The PO that Dr. Schwyn heads is particularly fortunate in that PhyCorp has provided a certain amount of funding because it is testing its involvement in such projects; the doctor tells us that PhyCorp has invested in only one other PO in the nation. By finding a financial backer, the PO has scored a significant coup: According to one source, PO start-up costs (i.e., to create the PO on paper) vary, based on the type of services the organization will offer, but frequently begin around $50,000. Thus, seed money can be a major factor in the formation of POs, and lack of it may check the rate at which the number of such organizations increase.

While Dr. Schwyn indicates that the direction of the PO that he heads still is under review, he does not rule out the possibility that at some point the entity will develop into a PHO and may even accept financial risk for patient care, making it, in essence, a health maintenance organization in practice if not in name.

Physician and Hospital Organizations

Allegiance Corporation of Ann Arbor is an example of a PHO that has proven successful for physicians and hospitals. The union of Huron the Valley Physicians Association (having an active-physician membership of 500) and a local hospital system (owning three hospitals), Allegiance Corporation has several contracts as a preferred provider and accepts fully capitated risk for approximately 88,000 people.

According to a study sponsored in part by the Michigan State Medical Society (MSMS), Allegiance generated total revenue of $139 million in 1993. From the capitated risk segment of its business, the PHO reported a $4.8 million surplus in 1993, up from a loss of approximately $3 million in 1992, the first year it offered capitated risk.

As with POs, initial capitalization is key. Although all PHOs in the MSMS study are 50–50 ventures (that is, the hospitals and the physicians have an equal funding obligation), the hospitals have provided the bulk of the up-front costs, while physicians have paid a relatively low initial fee ($1,000–2,000), with the condition that over time they will pay the remainder. According to the study, this type of arrangement "seemed to be an essential ingredient in getting these PHOs off the ground, since most of the physicians indicated that their colleagues would not have been willing or able to fund a full 50 percent share of the venture with cash at the outset—either because of the risk involved or because of a limited access to capital."

While the number of PHOs in Michigan is not known, Brian Peters, Director of Health Care Futures at the Michigan Hospital and Health Association indicates that his organization plans to survey member hospitals and leaders in the physician community in this regard. He adds that currently, there is no clearinghouse for data on POs and PHOs, although "how-to" information is available.

Issues

The popularity of POs and PHOs is expected to climb, but there are some issues that can be expected to arise within the PO/PHO structure and with policymakers.

For the most part, the problems experienced by POs and PHOs will relate to holding costs in line, to enable them to operate within a budget. Currently, the majority of physicians are specialists, yet the more care that can be delivered through primary care, the more likely a group’s costs will be kept down; there doubtless will be tension between the need for and practicality of primary care and specialists’ need to maintain their practices.

Another difficulty will be that physicians generally are not negotiators, and because they are not, they may need to rely on outside entities to make the deal and then manage the PO or the PHO so that it is profitable. The latter point raises the issue of governance of the POs and PHOs, which also may be problematic.

As POs and PHOs gain in popularity, size, and number, their regulation likely will be important to policymakers. Currently, POs and PHOs generally are seen as a professional services corporations or limited liability companies, and as such they are regulated as regular corporations. However, if a group assumes risk, it will be regulated as a health insurer. Also, as POs and PHOs increasingly involve larger numbers of physicians and hospitals, antitrust could become an issue.

As mentioned at the outset, in the March Bulletin we will discuss these issues in more depth.

Conclusion

Part of the goal of health care reform is to reduce the amount of money spent on health care—as expenditures decrease, however, providers lose income. Physician organizations and physician hospital organizations are an effort by physicians and hospitals to retain a certain amount of financial and clinical control over the practice of medicine. As Tom Wolff, Chief of POs and PHOs and Legal Affairs for MSMS notes, "Managed care leaves everyone jockeying for position to see who will control the health care system."