Medicare Program; Waiver Requirements and Solvency Standards for Provider-Sponsored Organizations

SUMMARY: This interim final rule with a request for comments implements

authority to waive, in the case of provider-sponsored organizations

(PSOs) that meet certain criteria, the requirement that Medicare+Choice

organizations be licensed by a State as risk-bearing entities. The

waivers will be approved only under certain conditions where the State

has denied or failed to act on an application for licensure.

This rule also establishes solvency standards that certain entities

must meet to contract as PSOs under the new Medicare+Choice program.

These standards apply to PSOs that have received a waiver of the

requirement that Medicare+Choice organizations be licensed by a State

as risk-bearing entities.

DATES: Effective date: These regulations are effective on June 8, 1998.

Comment date: Comments will be considered if we receive them at the

appropriate address, as provided below, by 5 p.m. on July 6, 1998.

ADDRESSES: Mail an original and 3 copies of written comments to the

following address: Health Care Financing Administration, Department of

Health and Human Services, Attention: HCFA-1011-IFC, P.O. Box 26688,

Baltimore, MD 21207-5187.

If you prefer, you may deliver an original and 3 copies of your

written comments to one of the following addresses:

Room 309-G, Hubert H. Humphrey Building, 200 Independence Avenue, SW.,

Washington, DC 20201, or

Room C5-09-26, 7500 Security Boulevard, Baltimore, MD 21244-1850.

Because of staffing and resource limitations, we cannot accept

comments by facsimile (FAX) transmission. In commenting, please refer

to file code HCFA-1011-IFC. Comments received timely will be available

for public inspection as they are received, generally beginning

approximately 3 weeks after publication of a document, in Room 309-G of

the Department's offices at 200 Independence Avenue, SW., Washington,

DC, on Monday through Friday of each week from 8:30 a.m. to 5 p.m.

(phone: (202) 690-7890).

If you wish to submit comments on the information collection

requirements contained in this interim final rule, you may submit

comments to:

Health Care Financing Administration, Office of Information Services,

Information Technology Investment Management Group, Division of HCFA

Enterprise Standards, Room C2-26-17, 7500 Security Boulevard,

Baltimore, MD 21244-1850, Attn: John Burke, HCFA-1011-IFC

Office of Management and Budget, Room 10235, New Executive Office

Building, Washington, DC 20503, Attn: Allison Herron Eydt, HCFA Desk

Officer

FOR FURTHER INFORMATION CONTACT:

Aaron Brown, (410) 786-1033--general policy

Maureen Miller, (410) 786-1097--general policy

Philip Doer (410) 786-1059--program operations

Greg Snyder, (410) 786-0329--program operations

SUPPLEMENTARY INFORMATION:

I. Background

A. Current Medicare Contracting Program

Sections 1876 (g)(1) and (h)(1) of the Social Security Act (the

Act) authorize the Secretary to enter into risk-sharing and cost

contracts with eligible organizations to provide certain health

benefits to members. Section 1876(b) of the Act requires an eligible

organization, that may be a health maintenance organization (HMO) or a

competitive medical plan (CMP), to be organized under the laws of a

State. Additionally, section 1876(b) requires that such entities assume

full financial risk on a prospective basis for the provision of health

care services, and make adequate provisions against the risk of

insolvency.

B. Current Regulations

Regulations at title 42 of the Code of Federal Regulations (CFR),

Part 417, reflect the above requirement that Medicare contracting

organizations be organized under State law, and make adequate provision

against the risk of insolvency. Specifically, regulations at 42 CFR

417.120 require that Medicare contracting HMOs and CMPs have a fiscally

sound operation as demonstrated by the following:

Total assets greater than total unsubordinated

liabilities.

Sufficient cash flow and adequate liquidity to meet

obligations as they become due.

A net operating surplus or a financial plan.

An insolvency protection plan.

A fidelity bond or bonds, procured and maintained by the

HMO, in an amount fixed by its policy-making body but not less than

$100,000 per individual, covering each officer and employee entrusted

with handling of its funds. The bond may have reasonable deductibles

based upon the financial strength of the HMO.

Insurance policies or other arrangements, secured and

maintained by the HMO and approved by HCFA to insure the HMO against

losses arising from professional liability claims, fire, theft, fraud,

embezzlement and other casualty risks.

Since section 1876 of the Act requires that Medicare contracting

HMOs and CMPs be organized under the laws of any State, these entities

are subject to State laws regarding financial solvency. Many States

follow the financial solvency provisions of the HMO Model Act of the

National Association of Insurance Commissioners (NAIC). The financial

requirements of the Model HMO Act are distinct from those of the Health

Care Financing Administration (HCFA).

C. Balanced Budget Act of 1997

Section 4001 of the Balanced Budget Act of 1997 (BBA) (Public Law

105-33), enacted August 5, 1997, added new sections 1851 through 1859

to the Act. Those sections establish a new Medicare+Choice (M+C)

program under part C of title XVIII of the Act. Part C is designed to

give beneficiaries access to health plan choices that go beyond the

original Medicare fee-for-service program and existing Medicare HMOs.

Once the M+C program is implemented, an individual entitled to Medicare

Part A and Part B will be able to elect benefits either through

original Medicare or an M+C plan, depending on availability in their

area. Under Part C, the M+C plans that may be offered are coordinated

care plans (e.g., HMOs, provider-sponsored organizations (PSOs), and

preferred provider organizations (referred to as PPOs)), private-fee-

for service plans, and demonstration medical savings account (MSA)

plans (that is, a combination of a high deductible, catastrophic

insurance plan with a contribution to a Medicare+Choice account).

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Regulations for the overall implementation of the M+C program are

required by the BBA to be published by June 1, 1998. Those regulations

will be incorporated into Part 422 of title 42 of the CFR. Provisions

enacted by the BBA and the forthcoming M+C regulations establish broad

and comprehensive requirements for contracting as an M+C plan,

including basic benefits, payment, access to service, quality

assurance, beneficiary hold harmless, continuation of benefits, appeals

mechanisms, marketing and enrollment processes. Those overall M+C

regulations will apply to PSOs as well.

Section 1851(a)(2) of the Act explicitly provides for participation

of a PSO in the M+C program as a coordinated care plan. A PSO is

described in section 1855(d) of the Act as a public or private entity--

That is established or organized, and operated, by a

health care provider or group of affiliated health care providers;

That provides a substantial proportion of the health care

items and services directly through the provider or affiliated group of

providers; and

With respect to which the affiliated providers share,

directly or indirectly, substantial financial risk for the provision of

such items and services and have at least a majority financial interest

in the entity.

We recently published an interim final rule with an opportunity for

public comment setting out this definition, clarifying certain terms,

and establishing related requirements. (This PSO definitions rule

established 42 CFR Part 422 and, more specifically, Subpart H, which is

designated for the PSO provisions.) The terms and requirements related

to the definition of a PSO are now found at Secs. 422.350 through

422.356. Here, in this interim final rule with opportunity for public

comment, we focus on two more portions of the law established

specifically for PSOs and the M+C program: the Federal waiver of State

licensure and the solvency standards that will apply to PSOs that have

obtained such a waiver.

Section 1855(a)(2) of the Act establishes a special exception for

PSOs to the otherwise applicable requirement for State licensure if

certain conditions occur. This interim final rule implements the PSO

waiver provisions specified in the BBA, and makes clarifications. In

order to assist organizations that are considering applying to become

PSOs under the M+C program, we determined that the waiver provisions

should not be delayed until the June 1, 1998 regulation is published.

As with the PSO definitions rule mentioned above, early publication of

these PSO provisions is desirable because of requirements that must be

met before contract application.

Section 1856(a) of the Act provides that the Secretary establish

through a negotiated rulemaking process the solvency standards that

entities will be required to meet if they obtain a waiver of the

otherwise applicable requirement that they be licensed by a State. We

note here that based on Secs. 422.352(a) and 422.380, State-licensed

organizations that meet the PSO definition (see Secs. 422.350 through

356) may qualify for the minimum enrollment standards established under

Section 1857(b) of the Act but are not subject to these solvency

standards.

The solvency standards in this interim final rule with comment

period are a product of the negotiated rule making process. This rule

does not necessarily conclude the negotiated rulemaking process because

the Committee may be reconvened to consider public comments that are

received.

II. Waiver of State Licensure Requirement

A. Background

1. Statutory Basis

A fundamental requirement of the M+C program, as set forth under

new section 1855(a)(1) of the Act, is that an M+C organization must be

``organized and licensed under State law as a risk-bearing entity

eligible to offer health insurance or health benefits coverage in each

State in which it offers an M+C plan.'' However, section 1855(a)(2) of

the Act establishes an exception to this requirement by allowing

certain organizations established or operated and controlled by

providers, and known in the BBA as PSOs, to obtain from the Secretary a

Federal waiver of the State licensure requirement under certain

circumstances. This interim final rule with comment sets forth

regulations for implementing that waiver.

Unlike the regulations contained in this rule relating to PSO

solvency and capital adequacy, the waiver provisions were not developed

through the negotiated rulemaking process. The regulations described in

this section were developed by HCFA under its rulemaking authority.

2. State Licensure and the Medicare Program

Under section 1876(b) of the Act and implementing regulations at 42

CFR Part 417, Medicare contracting HMOs and CMPs must be organized

under the laws of a State. As used in section 1876 of the Act, the term

``HMO'' means a Federally qualified HMO and the term ``CMP'' means a

prepaid health plan that is likely regulated by the State as an HMO,

but is not Federally qualified. Thus a provider sponsored health plan

could apply to contract with HCFA as an HMO or a CMP if it became

Federally qualified or met the definition of CMP, and satisfied other

section 1876 requirements. In recent years, several States have adopted

licensure laws for PSOs (sometimes known as integrated or organized

delivery systems), thereby creating another licensure vehicle and

avenue for contracting with Medicare. (Some State PSO laws, however,

are limited in scope and licensed entities would not meet the CMP

requirements).

3. Federal Waivers and PSO Applications

As indicated above, section 1855(a)(1) requires that M+C

organizations be licensed as risk-bearing entities under the laws of

the State. Section 1855(a)(2) of the Act provides an exception to this

requirement for PSOs. PSOs are the only organization eligible to

participate in M+C without State licensure. It is clear from the

statute, however, that all organizations, including those established

by providers, must seek State licensure as the initial step toward an

M+C contract. Only under specific conditions, as described below, will

the organization be permitted to forego the preliminary and fundamental

requirement to be State-licensed as a risk-bearing entity.

If an organization believes that the circumstances of its State

application comply with one of the conditions for a waiver, it must

submit to HCFA a completed waiver request form. The request form, that

the Office of Management and Budget approved on April 2, 1998, (form

#0938-0722) is available through HCFA, and is posted on the HCFA web

site at http://www.hcfa.gov/Medicare/mplusc.htm. HCFA will make a

determination to approve or disapprove a waiver within 60 days of

receipt of a substantially complete request. If the waiver request is

approved, the organization will be considered eligible for a waiver,

and then may submit its contract application to HCFA. (The PSO

application form will be posted at the aforementioned Internet address

in the near future.) It is through the application process that the

organization must demonstrate to HCFA's satisfaction that it meets the

PSO definitions and requirements as set forth in 42 CFR 422.350 through

422.356, as well as the solvency standards established later in this

interim final rule. If it meets the

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definition, the organization will be considered a PSO and remains

eligible for a waiver.

Given the 60-day time period permitted HCFA to approve a waiver

request under section 1855(a)(2)(F) of the Act, we felt it would be

impossible in many cases to simultaneously process the waiver request

and determine whether an organization is a PSO as defined under

Sec. 422.350 through Sec. 422.356. This determination may require an

extensive review and verification of the organization's structure,

ownership or partnership arrangements, contracts and payment

arrangements. Therefore, as described above, the 60-day maximum time

period will apply to determining whether the organization is eligible

for a waiver, as required by law. The determination that the

organization is in fact a PSO will occur once it is eligible for a

waiver and has submitted an application for an M+C contract.

B. Waiver Provisions

In this interim final rule, we are establishing new provisions at

Sec. 422.370 through Sec. 422.378 for purposes of implementing section

1855(a)(2) of the Act. Because entities applying for a waiver as yet

will not have been determined to meet the PSO definition and

requirements of subpart H, the regulation text refers to these entities

as ``organizations.''

Section 422.370 implements the authority under section

1855(a)(2)(A) of the Act to waive the State licensure requirement for

M+C organizations contained in section 1855(a)(1) and restates the two

basic conditions for doing this. First, the rule requires organizations

interested in a waiver to file a request by no later than November 1,

2002, a time limit specified by the statute. Second, HCFA must

determine whether the organization meets one of the grounds for a

waiver listed in Sec. 422.372.

Section 422.372 of the rule establishes the basis for a waiver as

set forth in sections 1855(a)(2)(B), (C), and (D) of the Act. These

three conditions and a fourth condition identified by HCFA are

described below. In order for three of the conditions to be

effectuated, the organization must have applied for a State license

before requesting a waiver. By requiring that the organization apply

for ``the most closely appropriate'' license (or authority), we are

clarifying that the type of license must relate to the nature of M+C

coordinated care plans; that is, health plans providing coordinated,

comprehensive benefits through a health care delivery net work on a

fixed, prepayment basis. We are requiring this to ensure that

organizations requesting and obtaining waivers will likely meet the PSO

definition and M+C requirements during the application stage. We expect

that for most States the most appropriate license available will be an

HMO license, although this may change as States adopt PSO or modify

current licensure laws. It is very unlikely that we will approve a PSO

waiver based on an application for an indemnity insurance license, a

PPO license, any license or authority to provide limited health

services, or a limited license to bear risk for an HMO as a downstream

contractor.

Section 422.372(a) sets out the first basis on which an

organization may establish waiver eligibility, that is, the State

failed to complete action on the licensing application within 90 days

of the date the State received a substantially complete application.

(See section 1855(a)(2)(B).) The 90-day period may begin any time after

enactment of the BBA. It is counted from the date the State received a

``substantially complete application.'' In order to clarify the term

``substantially complete application,'' we consulted several parties

for technical assistance, and intend to make determinations as follows:

(1) If the State has notified the organization, in writing, that

the organization has submitted a substantially complete application,

the date of that notification will be considered the date the State

received a substantially complete application.

(2) If the State has not notified the organization, in writing, as

to the completeness of its application within 60 days of the date of

submission of an application, we will consider the date the

organization submitted its initial application to be the date the State

received a substantially complete application.

(3) If the organization can demonstrate to HCFA that it has

submitted all of the information requested in an incompleteness

notification from the State and the State still regards the application

as incomplete or fails to notify the organization as to the status of

its application within 30 days from the date it receives the

organization's submission of the additional information requested, then

HCFA will consider the date the State received the additional

information requested to be the date the State received a substantially

complete application.

(4) In a dispute between an organization and the State over whether

the organization has submitted a substantially complete application or

over the date the State received a substantially complete application,

HCFA will make the final determination based on consultation with the

organization and the State.

We believe that this process for determining the date the State

received a substantially complete application is consistent with

Congressional intent that an organization must make an earnest attempt

to become State licensed before requesting a waiver. This earnest

attempt includes working with the State in good faith to submit all of

the information necessary to have a license either approved or denied.

At the same time, however, we also believe that State licensing

agencies should be working in good faith with the organization to

either approve or deny an application in a timely manner.

We believe the process outlined above balances the concerns of the

States and of the organization. However, given the complexity of

implementing this provision, we invite comment on this approach.

Paragraph (b) of Sec. 422.372 establishes the second basis for a

waiver. Here, waiver eligibility results from the organization

experiencing discriminatory treatment in the State's denial of its

application. As provided in the statute, discriminatory treatment can

occur in two ways, as follows:

The State has denied the licensure application on the

basis of any material requirements, procedures or standards (other than

solvency requirements) that the State does not generally apply to other

entities engaged in a substantially similar business.

The State required, as a condition of licensure, that the

organization offer any product or plan other than an M+C plan.

Thus, an organization will be eligible for a waiver under this

provision if the State imposes different requirements, and these

different requirements are the basis of a license denial. In addition,

the organization must demonstrate what requirement, procedure, or

standard it failed to meet, and how this differs from what is generally

applied to other similar plans. In order to demonstrate that the State

does not ``generally apply'' the requirement on which the denial was

made, the organization must show that the requirement is more of an

exception and not usually applied to similar health plans. For example,

if a pattern exists where most HMOs within a State are not held to a

requirement, the PSO will be eligible for a waiver based on

discriminatory treatment.

By ``substantially similar business'' we mean entities that provide

and manage a comprehensive set of health

[[Page 25363]]

care services, and are prepaid a fixed amount in advance and without

regard to the frequency or cost of services when utilized. Such

entities are likely to include HMOs, and may include certain PPOs and

State-licensed PSOs. We do not anticipate considering indemnity

insurers, PPOs reimbursed on a discounted fee-for-service basis, or

``single-service'' managed care plans as being engaged in a

``substantially similar business'' to the waiver-requesting

organization.

We considered a broader use of the term ``engaged in a

substantially similar business'', but believe our interpretation is

consistent with the PSO provisions in section 1855 of the Act. We

believe an expanded interpretation, which includes all risk-bearing

entities (for example, indemnity insurers) does not comply with the

language of the statute. In processing waiver requests under this

provision at this time, we anticipate looking to the requirements,

procedures and standards that a State places on HMOs.

The second criterion for discriminatory treatment, set forth in

Sec. 422.372(b)(2), is that the State requires the organization to

offer its health plan to other than the Medicare population. Here, an

organization would have to demonstrate only that it was denied a

license because the health plan would serve only Medicare

beneficiaries. We believe this provision permits the establishment of

Medicare-only PSOs, and establishes a Federal preemption over any State

laws that would prevent it.

Paragraph (c) of Sec. 422.372, the third basis for approving a

waiver of the State licensure requirement, pertains to a State imposing

different requirements related to financial solvency. Two conditions,

or criteria are specifically addressed in this paragraph. (See

1855(a)(2)(D)(i) and (ii).) Under Sec. 422.372(c)(1), a waiver may be

granted if the State has denied the licensure application, in whole or

in part, based on the organization's failure to meet solvency

requirements that are different from those set forth in Secs. 422.380

through 422.390. This provision incorporates the new regulatory

citation for PSO solvency standards developed through negotiated

rulemaking as established in this rule.

An issue arose regarding waiver eligibility when a State has

adopted the Medicare PSO solvency standards and denies a license based

solely on a provision of the solvency standards that give the regulator

discretion. For example, it is likely that while using the same

solvency standards, HCFA and States could reach different decisions

regarding the acceptance of administrative infrastructure to reduce the

minimum net worth amount requirement. If a State does not permit such a

reduction, the issue arose whether HCFA would consider this a basis for

a waiver. We have decided to permit requests for waivers in these

situations. As documentation, we will require organizations to submit

all information relevant to the specific solvency requirement in

question, including any State correspondence. As part of our review, we

will likely seek input from the State. If we concur with the State's

determination regarding the specific discretionary issue, the waiver

request will be denied. However, if we make a decision, that differs

from the State's, then the waiver will be approved and the organization

may submit an M+C application. We considered acceding to States'

decisions where a regulator's discretion is warranted under the PSO

solvency rules, but concluded that this might overly restrict the

availability of waivers.

The second condition, for a waiver under Sec. 422.372(c) is that

the State has imposed documentation or information requirements, or

other requirements, procedures or standards related to solvency or

other material requirements that are different from those imposed by

HCFA in carrying out Secs. 422.380 through 422.390. As with the

previous condition, we believe that a PSO may seek a waiver if a State

denies a license based on its exercise of discretion in requiring

different information or documentation than HCFA. Therefore,

documentation, information, and other requirements which may stem from

such discretion can be the sole basis for granting a waiver under this

particular provision. Our position on this issue is based upon the

intent of the Congress, as reflected in the Conference Report

accompanying the BBA, that the State not impose documentation or

information requirements ``that are dilatory or unduly burdensome and

that are not generally applied to other entities engaged in a

substantially similar business.'' (H.R. Rep. No.105-217, 105th

Congress, Session 632 (1997))

The fourth basis for approving a waiver of the State licensure

requirement, paragraph (d) of Sec. 422.372, is that the appropriate

State licensing authority has notified the organization in writing that

it will not accept their licensure application. While this grounds for

approval is not in the Act, we are using our authority under section

1856(b)(1) to establish standards to add this provision based on

concerns that the Act allows for a waiver only if the PSO submits an

application to the State. We have identified a concern that some State

agencies may refuse to accept licensing applications from PSO-like

organizations, thus preventing these organizations from requesting a

waiver until 90 days have transpired.

We believe this provision facilitates the waiver process and

conforms with the intent of section 1855(a)(2) of the Act. If it is

clear that a State licensing agency will not act on an application as

described here, both the State and the organization can save time and

resources by permitting the organization to go directly to HCFA for a

waiver.

In Sec. 422.374 we clarify certain conditions and provisions

related to the waiver request and approval process. Paragraph (a)

clarifies section 1855(a)(2)(f) of the Act, which requires

organizations seeking a waiver to submit a substantially complete

waiver request. Section 422.374(a) specifies that to be substantially

complete, a request must clearly demonstrate and document the

organization's eligibility for a waiver. HCFA will notify the

organization if the request is not complete, and will work with the

organization to determine the information necessary to make a decision

on the request. HCFA will have final discretion in determining whether

a waiver request is substantially complete.

Paragraphs (b) and (c) of Sec. 422.374 provide that HCFA will act

promptly (within 60 days) to grant or deny a substantially complete

waiver request and allow organizations that have been denied a waiver

request to submit subsequent requests until November 1, 2002. (See

section 1855(a)(2)(F).)

Paragraph (d) of Sec. 422.374 establishes that the waiver will take

effect upon the effective date of the M+C contract. We have added this

provision to clarify that a waiver is linked to the contract and is not

active, or operable, without an effective M+C contract. This provision

helps organizations seeking a waiver, because the waiver is limited to

a one-time, three-year period. If the waiver is made effective

immediately upon approval of a waiver request and the approval of the

M+C contract takes longer than anticipated, the three-year waiver

period would be running and the organization could lose a significant

amount of time that it is eligible to operate without a State license.

If the contract application is denied, an even greater amount of time

may elapse by the time the organization can develop, submit and gain

approval of a revised contract application.

Paragraph (e) of Sec. 422.374 gives HCFA the right to revoke a

waiver if we

[[Page 25364]]

subsequently find that the organization's M+C application is

significantly different from the application submitted to the State.

Because Congress intended for organizations to make an earnest attempt

to obtain a State license before applying for a Federal waiver, we

believe that significant changes from the State application to the M+C

waiver application could undermine this policy. We believe that

requiring that the M+C contract application be very similar to the

application submitted for a State license addresses two possible

situations. First, it prevents organizations from circumventing the

intent for them to achieve State licensure if possible. It also assures

States the right to license an organization that has evolved or

reorganized from the time of its first application; that is, the

organization has undergone some significant changes and the application

for all intent and purposes is ``new.''

Organizations that reapply for an M+C contract because they were

not successful M+C applicants do not have to reapply to the State or

re-submit a waiver request as long as the revised application does not

invoke paragraph (e) of Sec. 422.374.

Section 422.376 is added to establish parameters of the waiver.

Paragraph (a) of this section restates section 1855(a)(2)(E)(i) of the

Act, the waiver is effective only for the particular State for which it

is granted and does not apply to any other State. It also clarifies

that an organization must be licensed or request and gain waiver

approval for each State where it wishes to operate an M+C plan.

Paragraph (b) of Sec. 422.376 incorporates section

1855(a)(2)(E)(ii) of the Act by limiting the waiver to a 36-month

period. We have modified this provision, however, to extend the period

through the end of the calendar year in which the 36-month period ends

unless the waiver is revoked based on paragraph (c) of this section. We

made this modification because we were concerned about terminating the

waiver and the M+C contract during the middle of a contract year. Such

mid-year terminations are unreasonable, disruptive, costly, and could

unnecessarily jeopardize the health care of beneficiaries enrolled in a

PSO. By waiting until the end of the contract year to end a waiver (and

thus the M+C contract), beneficiaries will be able to transition into

other M+C plans through the annual enrollment process.

Paragraph (c) of Sec. 422.376, mid-period revocation, was added to

clarify that the waiver will cease before the end of the 36 month

period if the organization's M+C contract is terminated or if the

organization becomes State licensed. This provision emphasizes again

the relationship between the waiver and the contract; namely that the

waiver is not effective without a contract in effect, and the contract

cannot be effective without the waiver. It also restates the Act by

conditioning the waiver upon the organization's compliance with State

consumer protection and quality standards as discussed further below.

The last section of the waiver provisions, Sec. 422.378, addresses

the relationship between State law and waivered organizations, or PSOs.

These provisions are a codification of sections 1855(a)(2)(E)(iii) and

(iv), and 1855(a)(2)(G) of the Act. Section 422.378(a) establishes a

general Federal preemption of any State law related to licensing the

organization that interferes with contracting under the M+C program.

Section 422.378(b), on the other hand, establishes the State's right to

require waivered organizations to comply with consumer protection and

quality standards applicable to all other M+C plans in the State, as

long as the standards are consistent with Medicare requirements.

Paragraphs (c) and (d) of Sec. 422.378 establish processes for ensuring

compliance with Sec. 422.378(b). We are developing a memorandum of

understanding with the NAIC to implement Secs. 422.378 (b), (c) and

(d).

III. PSO Solvency Standards

A. Background

1. Negotiated Rulemaking Act

The Negotiated Rulemaking Act (Pub. L. 101-648), establishes a

framework for the conduct of negotiated rulemaking. Negotiated

rulemaking is a process whereby a rule (generally a proposed rule) is

developed by a committee of representatives of interests that are

likely to be significantly affected under the rule and includes a

Federal government representative. The goal of the process is to reach

consensus on the text or content of the rule and then publish that text

for public comment. Consensus is defined in the Negotiated Rulemaking

Act as unanimous concurrence among the interests represented. However,

the committee could agree on another specified definition. The

committee is assisted by a neutral facilitator.

The agency responsible for the rule may use the services of an

impartial convener to identify potential participants in the

negotiation, determine whether they are willing to participate, inform

them about the process, discuss issues with potential participants, and

make recommendations regarding how to make the process work. The

committee must be chartered under the Federal Advisory Committee Act

(FACA) (5 U.S.C. App.2).

2. Establishing the Process

To expedite the development of PSO solvency standards, Congress

modified the negotiated rulemaking process by requiring that this rule

be published as an interim final rule with comment, shortening the

period for forming the committee, establishing a shortened period for

committee negotiations, and setting a target date for publication of

the interim final rule for April 1, 1998. (See section 1856(a) of the

Act.)

We selected the Department of Health and Human Services

Departmental Appeals Board (DAB) to serve as the convener and

facilitator for these negotiations because of their reputation for

impartiality, as well as their experience and availability. The DAB has

familiarity with HHS programs and experience convening and facilitating

negotiated rulemaking on Medicare issues such as the Medicare Hospice

Wage Index and the Shared-risk Exemption to Federal Health Care Anti-

Kickback Provisions. Further, a poll of parties interested in the

development of PSO solvency standards indicated unanimous support for

using the DAB to facilitate the negotiated rulemaking.

During the convening process, the DAB interviewed over 50

individuals from outside the Federal government, representing over 25

different associations, coalitions or companies. On September 8, 1997,

the DAB issued a convening report recommending participants for the

negotiated rulemaking committee (the Committee). This recommendation

was based on an evaluation of the potential effects of the rule on

groups that indicated a desire to serve on the Committee. When any

differences among groups were identified, the convener sought

information about how these differences were relevant with respect to

solvency standards, whether those differences could be adequately

represented by other groups, and whether there had been demonstrated

concern about solvency standards during the legislative debate. The

report also identified issues to be negotiated and potential barriers

to consensus.

On September 23, 1997, we published in the Federal Register (62 FR

49649) a notice of intent to form a negotiated rulemaking committee and

notice of meetings. Based on the recommendations contained in the

convener's report, the notice appointed

[[Page 25365]]

representatives of interests likely to be affected by PSO solvency

standards to the negotiated rulemaking Committee. Committee members

included the--

American Association of Health Plans,

American Association of Retired Persons,

American Hospital Association,

American Medical Association,

American Medical Group Association,

Blue Cross/Blue Shield Association,

Consortium on Citizens with Disabilities,

Federation of American Health Systems,

Health Insurance Association of America,

National Association of Insurance Commissioners,

National Rural Health Association

Coalition of the Catholic Hospital Association and Premier

Health Care

Coalition of the American Association of Homes and Services for

the Aging, the American Health Care Association, the Home Health

Services and Staffing Association, and the National Association for

Home Care; and

Coalition of the Independent Practice Association of America and

the National Independent Practice Association.

In addition the Committee included a representative from HCFA.

We requested public comment on whether we had identified the key

solvency issues to be negotiated by the Committee; if we had identified

the interests that will be affected by key issues listed; and whether

the party we were proposing to serve as the neutral facilitator was

acceptable. We also sought comments on several key definitions related

to the negotiated rulemaking and the forthcoming rulemaking for

Medicare+Choice organizations. In general, commenters supported the

notice and as a result no changes were made to the Committee membership

or issues to be discussed.

3. Summary of the Committee Process

The Committee met seven times from October 1997 to March 1998.

Notices of meetings were published in the Federal Register on September

23, 1997 (62 FR 49649) and February 13, 1998 (63 FR 7359). Minutes for

each of these meetings are posted on the M+C web page at http://

www.hcfa.gov/Medicare/mplusc.htm. At the first meeting, held October

20, 21, and 22, 1997, business and health industry analysts made

presentations that related to health plan solvency. Also the Committee

discussed how to address the principle solvency issues and how to

proceed in developing solvency standards. The Committee devoted the

remaining series of 3-day meetings, and a final 1-day meeting,

primarily to substantive discussion of solvency standards for Federally

waived PSOs.

The Committee's deliberations focused on the following issues: the

stages at which to evaluate a PSO's financial solvency, the amount,

composition, and location of assets and liabilities that PSOs must

maintain to be considered financially solvent; the planning and data

collection necessary to track PSO solvency; and the mechanisms needed

to protect beneficiaries if a PSO becomes insolvent.

On March 5, 1998, the Committee reached consensus on a PSO solvency

standards proposal. All Committee members signed an agreement

indicating unanimous concurrence with a written Committee statement of

the Committee's recommendations for PSO solvency standards.

In the agreement, HCFA agreed that, to the maximum extent possible

and consistent with legal obligations, it will draft an interim final

rule consistent with the Committee statement. We believe that the PSO

solvency provisions of the interim final rule published herein are

fully consistent with the Committee's recommendations, with some

additional clarifications. Committee members have agreed not to submit

negative comments on the interim final rule. If, however, a member

believes any provision of this rule incorrectly reflects the Committee

statement, the member may comment on the matter. If necessary, the

Committee will be reconvened at a later date.

4. Summary of the Committee's Deliberations

The Committee agreed that there are three stages at which to

consider solvency standards: initially at start-up, as an ongoing

business operation, and during insolvency. While these stages are only

concepts that do not have exact starting or finishing points, the

Committee felt that they are a useful framework for setting solvency

standards at different stages of operation. These stages are translated

in regulation to the application stage, the stage during which the M+C

contract is in effect, and insolvency.

The initial stage represents the period of activity prior to the

first day of actual operation as an M+C contracting PSO. It includes

the periods when an organization will request a Federal waiver of State

licensure and will apply for an M+C contract. In this preamble and the

regulation, the term PSO is reserved for organizations that are:

approved for a Federal waiver, determined to meet the definition and

related requirements of a PSO, and awarded a Medicare+Choice contract.

The ongoing stage represents the period that begins when a PSO's

M+C contract becomes effective. This is when a PSO will assume

responsibility for providing services to Medicare beneficiaries for a

fixed payment. During this stage, the appropriate solvency standards

are affected by the number of Medicare enrollees for which a PSO is

responsible. Lastly, the insolvent stage represents the period

beginning when a PSO's total liabilities exceed its total assets.

Using this three stage framework, the Committee developed alternate

proposals regarding the amount, composition, and status of assets and

liabilities that PSOs must maintain in order to be considered fiscally

sound and financially solvent. The alternate proposals reflected the

various interests of the Committee members and their constituencies.

These proposals formed the basis for negotiations and the subsequent

Committee statement and consensus agreement.

To develop the solvency standards, the Committee considered what

financial, capital and other factors must be present to assure that a

PSO is fiscally sound. Specifically, the Committee considered

requirements for net worth, financial plans, liquidity, financial

indicators, and beneficiary protection.

B. Net Worth Amount Requirements

The Committee considered the net worth requirements for the initial

and ongoing stages. In each stage, the Committee deliberated on the

appropriate amount and composition of assets to be counted toward the

net worth requirement. The Committee agreed that in the initial stage

an organization should have an initial minimum net worth amount of

$1,500,000. This is the same minimum net worth amount that is specified

in the HMO Model Act, with a significant difference. The Committee

agreed to allow HCFA to reduce the net worth requirement by up to

$500,000 if the PSO has available to it an administrative

infrastructure that HCFA considers appropriate to reduce, control or

eliminate start-up costs associated with the administration of the

organization. Such infrastructure would include office space and

equipment, computer systems, software, management services contracts

and personnel recruitment fees. In recognizing a reduction of up to

$500,000 for these costs, the Committee acknowledged that the minimum

net worth drops from $1,500,000 to $1,000,000 as soon as the PSO is

approved and that the $500,000 difference was to account for start-up

costs. HCFA has the discretion to approve the administrative costs that

an organization offers to obtain a reduction of up to $500,000.

[[Page 25366]]

For the ongoing stage, the Committee agreed that the minimum net

worth should be at least $1,000,000. This is the minimum specified in

the HMO Model Act for the ongoing stage. The difference between the

ongoing minimum net worth and the initial minimum net worth reflects

the Committee belief that PSOs will incur administrative costs in the

initial stage that will not be repeated in the ongoing stage. While the

floor on the minimum net worth amount in the ongoing stage is

$1,000,000, the Committee agreed to subject PSOs to a series of

``greater of'' tests to determine an appropriate minimum net worth. The

``greater of'' tests link the minimum net worth amount to the size of

annual premium revenues, the amount of uncovered health care

expenditures, and the amount of health care expenditures paid to non-

capitated and non-affiliated providers. These factors are indirectly

related to the size of the plan (that is, number of enrollees) and the

amount of risk being assumed.

The Committee discussed whether to include, among the factors

considered in setting the ongoing net worth amount for PSOs, the

authorized control level (i.e., the point in a financial crisis where a

State regulator is authorized to take control of an organization)

capital requirement derived from the NAIC Health Care Organization Risk

Based Capital (RBC) Formula. RBC is a new formula adopted by the NAIC

to determine the minimum capital level that an organization should have

before regulators become concerned about its solvency. The RBC level

depends on the riskiness of the company's assets, investments, and

products. RBC has several trigger points. As currently envisioned, if a

company's actual net worth falls below the trigger point called the

authorized control level, the State's insurance commissioner may take

control of the company. The RBC for health organizations has not yet

been adopted by States for setting minimum net worth requirements.

The RBC formula by design will be used by States to monitor the

financial viability of State-regulated managed care plans. It has not

yet been adopted by States in setting the minimum net worth amount

requirements. The Committee agreed that HCFA should consider adding

that RBC authorized control level factor to the ongoing net worth

amount requirements after evaluating whether the RBC is a valid

indicator of Medicare PSO solvency and after considering the manner in

which States have regulated managed care plans using the RBC authorized

control level. In 1999, after PSOs have begun to operate and report

financial data, HCFA will issue a notice requesting comment on adding

this factor to the net worth calculation for PSOs. As part of HCFA's

normal data collection process for all M+C plans, HCFA expects to be

collecting information necessary to perform the RBC calculations.

With regard to the composition of the minimum net worth amount, the

Committee agreed upon the following requirements--

At least $750,000 of the minimum net worth must be in cash

or cash equivalents. After the effective date of the contract, however,

the Committee agreed that $750,000 or 40 percent of the minimum net

worth amount must be in cash or cash equivalents.

Up to 10 percent of the minimum net worth amount can be

comprised of intangible assets in the initial stage. However, in the

initial stage, if a PSO keeps $1,000,000 in cash or cash equivalents

and does not use the administrative reduction, then up to 20 percent of

that PSO's minimum net worth can be comprised of intangible assets. In

the ongoing stage, a PSO must keep the greater of $1,000,000 or 67

percent of the ongoing minimum net worth in cash or cash equivalents to

qualify for the 20 percent level on intangibles.

Subject to the above provisions, health care delivery

assets (HCDAs) may be admitted at 100 percent of their value according

to generally accepted accounting principles (GAAP).

Subject to the above provisions, other assets may be

admitted according to their value under Statutory Accounting Practices

(SAP).

Subordinated debts and subordinated liabilities can be

excluded from the calculation of liabilities for the purposes of

determining net worth.

Deferred acquisition costs are excluded from the net worth

calculation.

The Committee also agreed that HCFA will look at SAP codification

upon its completion and will consider whether to adopt codification

standards on the asset concentration and quality of HCDAs for waivered

PSOs. SAP codification standards are currently being developed by the

NAIC to make SAP more consistent among the States. HCFA will request

public comment on whether to use any such standards in the notice on

the NAIC RBC (see above). Meanwhile, HCFA may apply judgement in

evaluating HCDAs for concentration and quality.

In the Committee's deliberations the concepts of net worth and

liquidity were closely related. Some Committee members suggested that

because PSOs have the potential to provide ``sweat equity,'' these

organizations could operate under different solvency standards for net

worth and liquidity than might be acceptable for other forms of

integrated delivery systems. The term ``sweat equity'' was used to

represent the value of health services that a PSO could provide

directly. One premise presented to the Committee was that PSOs could

continue to furnish services during financial crises because the

``owners'' actually provide health care services, whereas other managed

care systems that contract for the delivery of care may not be able to

continue to operate. In addition, PSOs could adopt contingent

reimbursement arrangements with their providers. Under such

arrangements, the affiliated providers' payments could be reduced until

the PSO had weathered the financial crisis.

The consensus was not to explicitly recognize sweat equity in the

solvency standards. This position evolved because of the difficulty in

developing an administrable solvency standard based upon sweat equity.

Further, the solvency standards implicitly recognize sweat equity in

other areas (e.g., the financial plan).

C. Liquidity Requirements

In conjunction with a minimum net worth amount requirement, the

Committee discussed a standard for meeting financial obligations on

time. The Committee adopted, for both the initial and the ongoing

stages, the liquidity standard that a PSO have sufficient cash flow to

meet its obligations as they become due. Also, the Committee

recommended that in the initial and ongoing stages HCFA should use the

same factors to determine the ability of a PSO to meet the liquidity

standard: (1) the timeliness of PSO payments of obligations, (2) the

extent to which the current ratio is maintained at 1:1 or whether there

is a change in the current ratio over a period of time, and (3) the

availability to a PSO of outside financial resources to meet its

obligations.

The current ratio focuses on a period that is up to one year long.

It compares all assets that are convertible to cash within that period

with all liabilities that will come due in that same period using the

following formula:

[GRAPHIC] [TIFF OMITTED] TR07MY98.000

The Committee agreed that PSOs should maintain a current ratio of

at least 1:1. That is, current assets should be equal to or greater

than current liabilities. The Committee also agreed that the current

ratio is a target rather than an absolute standard. This position

[[Page 25367]]

recognizes that valid reasons may exist for a PSO's current ratio to go

below 1:1 for short periods of time. However, there were also concerns

by some Committee members that the current ratio is an important

indicator of an organization's condition and a current ratio of under

1:1 should trigger some regulatory action. Therefore, the current ratio

will be used to identify trends or sudden major shifts in a PSO's

financial performance.

D. Financial Plan Requirements

Several presenters before the Committee identified poor planning

and management control as the primary reasons for the early HMO

failures. As a standard to encourage good planning and strong

management, the Committee agreed that a financial plan is essential for

PSOs. Further, such plans should be prospective, reasonable, and

consistent. The Committee used the financial plan standard for

contractors under section 1876 of the Act to develop the PSO standard,

but specified certain provisions differently. The specific requirements

of the financial plan are presented in the discussion of provisions,

below.

The Committee believed that the financial plan standard they agreed

to represents the minimum needed to monitor Federally waived PSOs. The

Committee agreed that HCFA should have the discretion to modify the

financial plan to require additional or different information as

necessary to evaluate the financial position of a Federally waived PSO.

The Committee agreed that in the initial stage, at the time of

application, organizations must submit financial plans covering the

period from the most recent financial audit until 12 months after the

effective date of an M+C contract. If, however, a financial plan

projects losses, then the time horizon must extend further, to 12

months after the point that the financial plan projects two consecutive

quarters of net operating surplus.

E. Pre-Funding of Projected Losses

One area of the financial plan that the Committee discussed

considerably was a requirement that PSOs must identify all sources of

funding for projected losses (and in certain circumstances actually

have the cash available). A key issue in this discussion was if and how

to recognize such financing methods as guarantees and letters of credit

(LOC). Some Committee members expressed concern about quickly securing

money that was pledged to a PSO in a guarantee or letter of credit

during a financial crisis. For a PSO that is under financial strain,

the timely availability of cash is crucial to both the PSO and HCFA in

attempting to protect Medicare enrollees. A delay in securing needed

cash--if, for example, the guarantor stalls or reneges on its

obligation--could exacerbate a financial crisis and further threaten

the quality and continuity of care for enrollees.

Other Committee members contended that guarantees and LOC are a

common and accepted means of obtaining capital for integrated health

delivery systems. Furthermore, many providers who are candidates to

become Federally waived PSOs could not participate unless guarantees or

LOC, or both, are allowed. Advocates of guarantees and LOC felt that

they should be admitted for two purposes: meeting the net worth

requirements and funding projected losses.

As a compromise, the Committee agreed to accept guarantees, but

only for funding projected losses that are reported by a PSO in its

financial plan. As previously mentioned, the solvency standards

contained herein require PSOs to fund all projected losses in the

financial plan from the effective date of their M+C contracts until

they achieve two consecutive quarters of net operating surplus. The

Committee agreed that guarantees are an acceptable means to fund

projected losses provided certain conditions are met. Further, the

Committee agreed that each PSO's guarantee would be subject to a trial

period of one-year from the effective date of the PSO's M+C contract.

During this period, guarantees would be accepted, but cash or cash

equivalents equaling the obligations covered by the guarantee would

have to be on a PSO's balance sheet six months prior to the date

actually needed. After a year, assuming that the guarantee obligations

are met timely, the Committee agreed that a PSO should be permitted to

notify HCFA of its intent to reduce or eliminate the pre-funding

period. The Committee further agreed that HCFA should have up to 60

days after the receipt of such notice to exercise its discretion and

modify or reject the notice. However, if the guarantee obligations are

not properly met on a timely basis, the Committee agreed that HCFA

should have the discretion to require a PSO to fund projected losses

through other methods or further in advance.

HCFA presented the Committee with draft standards on guarantees.

The Committee generally supported the draft with some revisions, but

did not officially adopt the standards as part of the Agreement before

needing to vote on consensus.

The Committee agreed that it should recognize LOC as a means to

fund projected losses. To be accepted, LOC must be irrevocable, clean,

and unconditional. Additionally, LOCs must be capable of being promptly

paid upon presentation of a sight draft under the LOC without further

reference to any other agreement, document or entity. The Committee

also agreed that beginning one year after the effective date of an M+C

contract, a PSO should be allowed to use the following other means to

fund projected losses: (1) lines of credit from regulated financial

institutions, (2) legally binding capital contribution agreements, and

(3) other legally binding contracts of similar reliability.

The Committee recognized that HCFA should have discretion regarding

the acceptance of guarantees, LOCs and other means to fund projected

losses. Accordingly, use of these vehicles is subject to an

appropriateness standard. That is, guarantees, LOCs and other means of

funding projected losses may only be used in a combination or sequence

that HCFA determines is appropriate.

F. Reporting

The Committee agreed that PSOs must meet HCFA requirements for

compiling, maintaining and reporting such financial information as the

agency determine is necessary. HCFA should have the discretion to

specify the contents, method of calculation, and the schedule for

reporting such financial indicators. We believe that this discretion is

necessary for proper oversight of Federally waived organizations as

they evolve and as market conditions evolve. The Committee recommended

that the general reporting format be the NAIC's Official Annual

Statement Blank--HMO Edition (the Orange Blank). HCFA will modify data

obtained from this form for application to PSOs. Use of this form will

not prohibit HCFA from requesting additional information if the agency

determines that such information is necessary to accurately assess a

PSO's financial condition.

The Committee agreed that the common practice should be to require

quarterly or annual reports. If a PSO has not achieved a net operating

surplus, the Committee felt that HCFA could require financial reporting

as frequently as monthly. Monthly reporting would be necessary to

enable HCFA to maintain better oversight of PSOs that are at heightened

financial risk.

[[Page 25368]]

G. Insolvency Protections

The Committee's deliberation in the area of insolvency focused upon

protecting beneficiaries. The Committee considered five issues

regarding insolvency: an insolvency deposit requirement, a hold

harmless requirement, a continuation of coverage provision, reserves

for uncovered expenditures, and termination of an M+C contract.

The Committee agreed that an insolvency deposit should be required.

The insolvency deposit would be used to pay for the costs associated

with receivership or liquidation. Committee discussions focused on the

amount of the insolvency deposit rather than the need for a deposit.

For the insolvency deposit requirement, the Committee considered a

range between $100,000 and $300,000. Committee members supporting a

$300,000 deposit contended that a lower deposit would be quickly

exhausted and inadequate in a financial crisis. Committee members who

supported the $100,000 deposit countered that a higher deposit would be

too onerous when combined with the cash reserves required to meet the

minimum net worth amount. The consensus position was to allow the lower

insolvency deposit of $100,000, provided that the requirement for the

cash portion of the minimum net worth amount be set at $750,000.

Additionally, the Committee agreed that the insolvency deposit would be

counted toward the minimum net worth requirement although not toward

the $750,000 cash requirement.

With regard to uncovered expenditures, the Committee adopted the

HMO Model Act standard. The Model Act requires that whenever uncovered

expenditures exceed 10 percent of total health care expenditures, an

entity must create a deposit equal to 120 percent of outstanding

liabilities for uncovered expenditures. Rather than being available for

a State insurance commissioner, the deposit would be restricted for

HCFA's use in the event of an insolvency to pay claims and

administration costs.

While the Committee discussed the issues of Federal bankruptcy/

State receivership, hold harmless, and continuation of coverage, they

concluded that these issues were beyond the scope of the negotiations.

Further, Federal bankruptcy and State receivership matters are not

within the purview of HCFA. The hold harmless and continuation of

benefits provisions will be considered as part of the overall M+C

regulation due to be published later this year.

H. Solvency Standards for Rural PSOs

In pre-consensus Committee discussion, there was vigorous

discussion of separate solvency standards for rural PSOs. (See

Sec. 422.352(c) for a definition of rural PSO.) Some Committee members

contended that rural providers would find it particularly difficult to

meet the solvency standards, especially the cash requirements. Rural

providers, as compared to their urban counterparts tend to have high

portions of their assets concentrated in health care delivery assets

and intangible assets. To rural PSOs, an excessive cash requirement may

amount to an undue barrier to entry.

The Committee's consensus on this issue was to develop one solvency

standard for all PSOs. The underlying premise was that the experience

of an unexpected, major claim would harm rural PSOs more because rural

PSOs tend to have smaller enrollments than urban PSOs, and therefore a

smaller revenue base for absorbing sudden financial fluctuations. The

Committee believed that financial instability in a rural PSO could be

more easily triggered by lower solvency standards.

However, recognizing the unique needs of rural communities, the

Committee directed HCFA to solicit public comment on the issue of

separate solvency standards for rural PSOs. Thus, we are hereby seeking

comments on this matter, particularly on the appropriateness of the net

worth and liquidity requirements of this interim final rule for rural

PSOs. HCFA is interested in the merit and appropriateness of separate

standards, alternative proposals, relevant analysis, and administrative

simplicity.

I. Credit for Reinsurance

As directed by the BBA, the Committee considered whether to allow a

credit for reinsurance. Several Committee members advocated that

reinsurance reduces the risk that PSOs will have to bear and would be

particularly valuable during the initial stage where PSOs are likely to

have fewer enrollees and claims are harder to predict. Committee

members who opposed reinsurance argued that many HMO reinsurance

contracts contain termination clauses that are triggered once an

organization starts losing money. Underlying this contract issue is a

broader problem; namely there would need to be provisions developed for

Federal regulation and oversight of PSO reinsurers given the Federal

waiver of State licensure. Without proper regulation and safeguards,

reinsurance policies could not be relied upon to protect beneficiaries

in the event of a financial crisis. Opponents also indicated that

reinsurance is an essential part of a sound business plan. Therefore,

it should not be treated as an optional credit against the minimum net

worth amount. Lastly, to the extent that reinsurance will reduce a

PSO's current and projected losses, reinsurance is implicitly

recognized in the financial plan. The consensus was not to admit

reinsurance as a credit against the minimum net worth amount. The

Committee felt that to the extent that reinsurance reduces projected

losses, it is implicitly recognized in the financial plan.

J. Financial Solvency Standards Provisions

The requirements of this interim final rule are found in 42 CFR

Part 422, Subpart H, Provider-Sponsored Organizations. Here we set

forth the solvency requirements for organizations that are applying for

and are operating under an M+C contract.

Section Sec. 422.350, Basis, Scope and Definitions, is amended to

include definitions and terminology for new terms related to the

solvency standards for PSOs.

Section Sec. 422.380 sets forth the general requirement that a PSO

must have a fiscally sound operation that meets the requirements of the

following provisions.

Section 422.382 sets forth the minimum net worth amount

requirements. There is a minimum net worth amount requirement for

organizations that are in the process of applying for a PSO M+C

contract, and another for organizations that are operating as a PSO

under an M+C contract.

Paragraph (a) of Sec. 422.382 sets forth the requirements that must

be met at the time of application. An organization must have a

$1,500,000 minimum net worth amount. This is the same amount that is

specified in the HMO Model Act, except that under this regulation, HCFA

has the discretion to reduce this amount by up to $500,000 for

organizations that at the time of application have available

administrative infrastructure that will reduce, control or eliminate

administrative costs.

Paragraph (b) of Sec. 422.382 sets forth the requirements that must

be met after the effective date of an M+C contract. A PSO must have a

minimum net worth amount of at least $1,000,000. The minimum net worth

amount is determined by a ``greater of'' test. The

[[Page 25369]]

``greater of test'' requires a PSO to have a minimum net worth amount

equal to the greater of--

$1,000,000;

Two percent of annual premium revenues up to and including

the first $150,000,000 of annual premiums and 1 percent of annual

premium revenues on premiums in excess of $150,000,000;

An amount health care expenditures; or

An amount equal to the sum of 8 percent of annual health

care expenditures paid on a non-capitated basis to non-affiliated

providers, and 4 percent of annual health care expenditures paid on a

capitated basis to non-affiliated providers plus annual health care

expenditures paid on a non-capitated basis to affiliated providers.

Annual health care expenditures that are paid on a capitated basis to

affiliated providers are not included in this calculation. In essence,

the ``greater of'' test establishes a minimum net worth requirement

above $1,000,000 that varies in proportion to the size of the PSO's

operation.

Section 422.382(c) establishes the composition of assets that are

needed to meet the minimum net worth requirement. The objective of the

minimum net worth requirement is to enable PSOs to avoid a financial

crisis or to mitigate the effects of a crisis. To achieve this,

organizations applying to become PSOs are required to have on their

balance sheets a minimum level of cash or cash equivalents. In

paragraph (c)(1) of Sec. 422.382, the minimum cash requirement is set

at $750,000 at application, and at $750,000 or 40 percent of the

minimum net worth amount after the effective date of the contract.

After the effective date of an M+C contract the cash requirement above

$750,000 is proportional to the minimum net worth amount. Lower cash

requirements were proposed, but the Committee was unable to reach

consensus on them. As discussed below, organizations that maintain a

higher cash level are permitted to use a greater proportion of

intangible assets to meet the minimum net worth requirement.

Other provisions of the paragraph address assets besides cash or

cash equivalents that may be included in determining the minimum net

worth, and limitations. Paragraph (c)(2) of Sec. 422.382 establishes

the proportion of the minimum net worth amount that may be comprised of

intangible assets, depending on an organization's cash level.

Intangible assets can comprise up to 10 percent of the minimum net

worth amount, at the time of application for an organization with

$750,000 (and less than $1,000,000) in cash or cash equivalents.

However, an organization that has $1,000,000 in cash or cash

equivalents at application can satisfy up to 20 percent of its minimum

net worth amount requirement with intangible assets. After the

effective date of the contract, an organization must maintain the

greater of $1,000,000 or 67 percent of the minimum net worth amount in

cash or cash equivalents to qualify for the admission of intangible

assets up to 20 percent of the minimum net worth amount.

Under paragraph (c)(3) of Sec. 422.382, HCDAs are admissible to

satisfy the minimum net worth amount requirement, subject to the cash

requirement. They are valued at 100 percent of their value according to

GAAP. Section 1856(a) of the Act directed the Secretary to take into

account ``the delivery system assets of [provider sponsored

organizations].'' The recognition of HCDAs under GAAP, that often times

is limited under SAP, was adopted to recognize that large portions of

PSOs' assets are HCDAs. The Committee agreed that if the cash

requirement were set at the appropriate level, then any perceived risk

from recognizing HCDAs was reduced.

Under paragraph (c)(4) of Sec. 422.382, other assets that are not

used in the delivery of health care are admissible to satisfy the

minimum net worth amount. However, they are admitted at their value

according to State SAP which generally are more conservative than GAAP.

Because SAP are determined at the State level, organizations will have

to follow the accounting methodology approved by the insurance

commissioner in the State in which they operate.

As set out in paragraph (c)(5) of Sec. 422.382, an organization

does not have to include subordinated debts or subordinated liabilities

for the purpose of calculating the minimum net worth. (Subordinated

liability is a new concept that the Committee defined to mean claims

liablities otherwise due to providers that are retained by the PSO to

meet the net worth requirements.) The Committee discussed this

provision in the context of provider reimbursement arrangements that

withhold a portion of payment contingent upon certain budget or

utilization targets being met. The Committee agreed that if these

payments are fully subordinated to all other creditors, then they

should not be included in the calculation of a PSOs net worth for the

purpose of meeting the minimum net worth amount requirement. We believe

that this provision is another example how the concept of sweat equity

is implicitly considered in these solvency standards.

In paragraph (c)(6) of Sec. 422.382, deferred acquisition costs are

not permitted to be included in the calculation of the minimum net

worth amount. The Committee believed that in an insolvency situation,

these would have little or no value.

Paragraphs (a) (b) and (c) of Sec. 422.384 sets forth the financial

plan requirement. The same documents required of Medicare contracting

HMOs and CMPs under section 417.120(a)(2) of the Medicare regulations

are required here; namely marketing plans, statements of revenue and

expense, statements of sources and uses of funds, balance sheets,

detailed justifications and assumptions supporting the financial plan,

and statements of the availability of financial resources to meet

projected losses.

PSOs should anticipate the need to utilize the services of

qualified actuaries (e.g., a member in good standing with the American

Academy of Actuaries) in (a) the preparation of financial plans

consistent with the PSO's business plan, (b) the development of claim

costs for the benefits to be offered by the PSO and (c) the analysis of

claim liabilities and the necessary liquid assets to meet obligations

on a timely basis. Accordingly, the Committee agreed that the financial

plan must be satisfactory to HCFA. HCFA expects and, at its discretion,

will ascertain that the information contained in the financial plan has

been certified by reputable and qualified actuaries.

Paragraph (d) of Sec. 422.384 sets forth the requirement that

organizations that are projecting a loss must have the resources to

fund those projected losses. This section also defines the conditions

under which HCFA will recognize various arrangements as acceptable

funding of projected losses. The general rule is that organizations

must have on their balance sheets assets that they identify to fund

projected losses. Exceptions are made for guarantees, LOCs, and other

means provided that certain conditions are met.

Paragraph (e) of Sec. 422.384 sets forth the exception to the ``on

the balance sheet'' requirement that applies when guarantees are used

to fund projected losses. Guarantees are permitted, but they are

subject to a trial period. For the first year after the effective date

of an M+C contract any organization using a guarantee must have from

the guarantor, in cash or cash equivalents, funds to cover projected

losses six months in advance of when needed. For example, prior to the

effective date of an M+C contract, a PSO must have funding from

[[Page 25370]]

the guarantor equal to the projected losses for the first two quarters

(6 months) of the contract. Before the start of the second quarter,

funding of projected losses through the third quarter must be added to

the balance sheet of the PSO. Because of the time it takes to bring a

new contractor onto the HCFA systems, the first two quarters funding

will need to be in the PSO, that is, on its balance sheet at least 45

days before the effective date of the contract. Quarters, or 90-day

periods, will be counted from the effective date of a PSO's M+C

contract.

If guarantee funding is timely during the first year, a PSO may

reduce or eliminate the period of pre-funding in future years by

providing notice to HCFA. Upon receipt of such notice, HCFA will have

up to 60 days in which to modify or reject any changes in the period of

prefunding. If the guarantee funding is not timely, then HCFA may take

appropriate action including requiring an organization to use other

methods or timing to fund projected losses. Lastly, guarantors and

guarantees must meet the requirements specified under Sec. 422.390,

discussed below.

Paragraph (f) of Sec. 422.384 sets forth the exception to the ``on

the balance sheet'' requirement that applies when LOCs are used to fund

projected losses. LOCs are admissible to fund projected losses on the

condition that they are provided by a high quality source and be

irrevocable, unconditional and satisfactory to HCFA. Additionally, LOCs

must be capable of being promptly paid upon presentation of a sight

draft under the LOCs without further reference to any other agreement,

document or entity. The Committee agreed that HCFA should have the

discretion to accept or reject a letter of credit.

Paragraph (g) of Sec. 422.384 sets forth the exception to the ``on

the balance sheet'' requirement that applies when other means are used

to fund projected losses. Other means of funding such as LOCs credit,

legally binding capital contribution agreements, and other legally

binding contracts of similar quality are admissible to fund projected

losses. However, these methods are available only after an organization

has had an M+C contract for at least one year.

Paragraph (h) of Sec. 422.384 sets forth the general rule that HCFA

will have the discretion to decide whether a PSO is using guarantees,

LOCs or other means in a combination or sequence that HCFA deems

appropriate. We note here that the BBA directed the Secretary to take

into account alternative means of protecting against insolvency

including guarantees, LOCs and other means. The Committee considered

whether to admit guarantees, LOCs, and other means to reduce the

minimum net worth amount, as well as to fund projected losses. However,

the consensus was to recognize them only toward meeting the requirement

to fund projected losses.

Section 422.386(a) sets forth the general liquidity requirement

that a PSO must have sufficient cash flow to meet its financial

obligations as they become due and payable. This requirement is

consistent with the standard that is applied to Medicare contracting

HMOs and CMPs under 42 CFR Sec. 417.120.

Paragraph (b) of Sec. 422.386 contains three tests to determine

whether an organization is able to meet its financial obligations as

they become due and payable: (a) history for timeliness in meeting

current obligations, (b) the extent to which a PSO maintains a current

ratio of 1:1, and (c) the availability of outside financial resources

to the PSO. The Committee adopted (a) because such a history is a

strong signal of management's commitment to maintaining a fiscally

sound organization.

The second test requires more discussion. We define ``current

ratio'' as total current assets divided by total current liabilities,

where the word ``current'' means less than one year. A current ratio of

1:1 means that an organization's current assets are sufficient to meet

its current liabilities. The possibility exists that in the course of

normal business operations PSOs may miss the current ratio slightly for

short, nonrecurring periods of time. In light of this, HCFA is using a

1:1 current ratio as a target rather than as an absolute standard.

Accordingly, HCFA will monitor PSOs that drop below the 1:1 ratio and

act where a PSO experiences a long-term, declining trend or a sudden,

large decline in its current ratio.

The use of trends in the current ratio allows HCFA to recognize

certain situations where current assets do not have to equal or exceed

current liabilities. For HMOs and PSOs in their early years, the

reported current ratio results will likely produce misleading trends.

The amount of pre-funding of projected losses ``within'' versus

``outside'' the organization may change over time, distorting trends.

Changing patterns of liabilities (for example, 30-day business expenses

unpaid or estimates of unreported claims) can also distort the current

ratio from one based on consistent underlying data. Consequently, the

PSO has an obligation to monitor underlying true trends and to provide

such information, together with a projection of continuing current

liabilities consistent with its business plans. The information should

be certified by a qualified actuary and presented to HCFA prior to the

filing of a timely financial report with a current ratio below

standard.

The third test for evaluating liquidity highlights in several ways

the importance of having outside financial resources available to a

PSO. First, such resources fill a practical role by providing a cushion

in the event of a financial crisis. Second, if such resources are

available from a parent or affiliate organization, it signals a

continuing commitment to the PSO. Third, the availability of such

resources from outside the corporation, either from a private or a

commercial source, indicates continuing market confidence that the

organization is a viable ongoing business concern.

Paragraph (c) of Sec. 422.386 requires that if HCFA determines that

an organization is not in compliance with the liquidity requirement, it

will require the organization to initiate corrective action to pay all

overdue obligations.

Paragraphs (d) and (e) of Sec. 422.386 specifies that corrective

action can include requiring the organization to change the

distribution of its assets, reduce its liabilities, secure additional

funding, or secure funding from new funding sources.

Section 422.388 sets forth the deposit requirements to provide

protection in the event of an insolvency. Paragraph (a) of Sec. 422.388

establishes an insolvency deposit that organizations are required to

make at the time of application and maintain for the duration of the

M+C contract. The insolvency deposit is $100,000. The deposit must be

restricted to use in the event of insolvency to help assure

continuation of services or pay costs associated with receivership or

liquidation. At the time of application and thereafter, upon HCFA's

request, the organization must provide HCFA with proof of the

insolvency deposit, in a form that HCFA considers appropriate.

Paragraph (b) of Sec. 422.388 establishes an uncovered expenditures

deposit requirement. The amount of uncovered expenditures that a PSO

experiences will vary, and this deposit is required any time that they

exceed 10 percent of the PSO's total health care expenditures. The

deposit must at all times have a fair market value of an amount that is

120 percent of the PSO's outstanding liability for uncovered

expenditures for enrollees, including incurred, but not reported

claims. The deposit must be calculated as of the first day of each

month required and maintained for the remainder of each month required.

If a

[[Page 25371]]

quarterly report is not otherwise required, a report must be filed

within 45 days of the end of the calendar quarter to demonstrate

compliance. The deposit must be restricted for HCFA's use to protect

the interests of the PSO's Medicare enrollees and to pay the costs

associated with administering the insolvency. The deposit is restricted

and in trust and may be used only as provided in Sec. 422.388.

Under paragraph (c) of Sec. 422.388 the deposits may be used to

satisfy the organization's minimum net worth requirement. Under

paragraph (d) of Sec. 422.388 all income from the deposits or trust

accounts are considered assets of the organization. Upon HCFA's

approval, the income from the deposits may be withdrawn.

Paragraph (e) of Sec. 422.388 sets forth requirements that upon

HCFA's written approval, the income from the deposits may be withdrawn

if a substitute deposit of cash or securities of equal amount and value

is made, the fair market value exceeds the amount of the required

deposit, or the required deposit is reduced or eliminated.

The deposit requirement for uncovered expenditures is triggered by

a historical trend analysis that indicates such expenditures are

comprising an increasing portion of total health care expenditures. The

Committee adopted the HMO Model Act language for the uncovered

expenditures deposit.

Section 422.390 sets forth the requirements for guarantors and

guarantees, which under Sec. 422.384(e), above, can be used to fund

projected losses. We are exercising caution in the use of guarantees

because we will have to monitor the financial viability of the PSO and

the guarantor as well. We believe we have selected a screening approach

that recognizes financially strong guarantors and protects Medicare

enrollees, yet permits affiliated providers or parent organizations to

support the PSO with financial backing.

Paragraph (a) of Sec. 422.390 vests HCFA with the discretion to

approve or deny the use of a guarantor. Paragraph (b) of Sec. 422.390

initiates the approval process with a request from the PSO, including

financial information on the guarantor.

Paragraph (c) of Sec. 422.390 sets forth the requirements that a

guarantor must meet to be licensed and authorized to conduct business

within a State or territory of the United States. The guarantor must be

solvent and not be under any Federal bankruptcy or State proceedings,

and have a net worth of at least three times the amount of the

guarantee.

A distinction is made between guarantors that are and are not

regulated by a State insurance commissioner. If regulated by a State

insurance commissioner, the guarantor's net worth calculation need only

exclude from its assets the value of all guarantees, investments in and

loans to organizations covered by guarantees. But, if a guarantor is

not regulated by a State insurance commissioner, then it must also

exclude the value of guarantees, investments and loans to related

parties (i.e., subsidiaries and affiliates) from its assets to

calculate its net worth. We believe these requirements ensure the

stability and financial strength of the guarantor without being overly

restrictive.

Paragraph (d) of Sec. 422.390 contains provisions for the guarantee

document to be submitted to HCFA by the PSO, and signed by the

guarantor. This document is the written commitment of the guarantor to

unconditionally fulfill its financial obligation to the PSO on a timely

basis.

In paragraph (e) of Sec. 422.390, the PSO is required to routinely

report financial information on the guarantor.

Paragraph (f) of Sec. 422.390 sets forth the requirements for

modification, substitution, and termination of the guarantee. A PSO

must have HCFA's approval at least 90 days before the proposed

effective date of the modification, substitution, or termination;

demonstrate to HCFA that insolvency will not result; and demonstrate

how the PSO will meet the requirements of this section within 15 days,

and if required by HCFA, meet a portion of the applicable requirements

in less than the time period granted.

Paragraph (g) of Sec. 422.390 establishes conditions that must be

met if the guarantee is nullified. If at any time the guarantor or the

guarantee ceases to meet the requirements of Sec. 422.390, HCFA will

notify the PSO that it ceases to recognize the guarantee document. In

the event of nullification, a PSO must meet the applicable requirements

of this section within 15 business days and if required by HCFA, meet a

portion of the applicable requirements in less than the above time

period. These requirements and conditions are not only good business

practices, but also protect Medicare enrollees by ensuring that a PSO's

financial backing is sound.

IV. Applicability of These Rules

The provisions of this rule apply only to certain PSOs and do not

apply to any other type of Medicare applicant or contracting entity.

Organizations that may be considered PSOs and that meet any of the

criteria as set forth in Sec. 422.372 may be eligible for a waiver of

State licensure. As discussed earlier, an organization interested in

entering into a contract with Medicare as a PSO must first contact the

appropriate State agency and, in most cases, submit an application for

a State license, or authority. A PSO that is denied licensure (and the

denial is related to any of the criteria cited) or is denied the

opportunity to apply for licensure, should submit a request for a

waiver to HCFA. Organizations that have their waiver request approved

by HCFA may then submit a PSO application. The PSO application contains

provisions for demonstrating compliance with the PSO definitions and

solvency requirements in addition to other contracting requirements (a

supplemental application may be necessary after the June regulation is

published). It is during the application process that an organization

will be determined to qualify as a PSO for purposes of Medicare

contracting under Part C of the Act. The waiver will take effect with

signing of the M+C contract.

The solvency standards established in this rule apply to

organizations which have had a waiver approved, as described above, and

are applying for a Medicare PSO contract, as well as waivered PSOs with

a Medicare contract in effect. These rules were developed through

negotiated rulemaking specifically for risk-bearing entities that will

enroll primarily beneficiaries of the Medicare program. Federal and

State government agencies that may contemplate use of these solvency

standards for other purposes or other populations should review them

carefully, and consider the nature of the health plans and the

populations they will serve.

Provider-sponsored managed care plans that obtain a State license

should apply directly for an M+C contract by completing the application

for HMO/PPOs/State-licensed PSOs (i.e., this is the same application as

used by HMOs). These entities, whether licensed as a PSO or HMO or

other managed care plan recognized by the State, will not have to

demonstrate compliance with the PSO definitions in Sec. 422.350 through

356, or with the PSO solvency standards. However, State-licensed PSOs

or State-licensed managed care plans that wish to meet the lower

minimum enrollment standard will have to meet the definitions criteria

of the PSO application. These ``State-licensed PSOs'' must meet the

solvency standards as required by their State, not the Medicare PSO

solvency standards as established in this interim final rule.

[[Page 25372]]

V. Regulatory Impact Analysis

A. Introduction

We have examined the impact of this interim final rule as required

by Executive Order 12866 and the Regulatory Flexibility Act (RFA)

(Public Law 96-354). Executive Order 12866 directs agencies to assess

all costs and benefits of available regulatory alternatives and, when

regulation is necessary, to select regulatory approaches that maximize

net benefits (including potential economic, environmental and public

health and safety effects; distributive impacts and equity). The

Regulatory Flexibility Act (RFA) requires agencies to analyze options

for regulatory relief for small businesses, unless we certify that the

regulation would not have a significant economic impact on a

substantial number of small entities. Most hospitals, and most other

providers, physicians and health care suppliers are small entities

either by non-profit status or by having revenues of less than $5

million annually. The impact of this regulation will be to create a new

business opportunity for such small entities to form provider sponsored

organizations to contract with the Medicare program.

Section 1102(b) of the Act requires us to prepare a regulatory

impact analysis if a final rule may have a significant impact on the

operations of a substantial number of small rural hospitals. This

analysis must conform to the provisions of section 604 of the RFA. For

purposes of section 1102(b) of the Act, we define a small rural

hospital as a hospital that is located outside a Metropolitan

Statistical Area and has fewer than 50 beds. We are not preparing an

analysis for section 1102(b) of the Act because we have determined, and

we certify, that this final rule will not have a significant impact on

the operations of a substantial number of small rural hospitals.

We prepared this impact analysis because of the probability that

these waiver requirements and solvency standards may have an impact on

certain hospitals, physicians, health plans and other providers. We are

preparing to publish a regulation outlining the overall provisions of

the M+C program. That regulation will consider the impacts of PSOs and

other new provider types in greater detail than is provided in this

regulation. The following analysis, in combination with the rest of

this interim final rule with comment period, constitutes a regulatory

impact analysis and a regulatory flexibility analysis.

B. Background

While the term ``provider sponsored organization'' has been used

generally in reference to health care delivery systems that providers

own or control and operate, the term has a more specific meeting for

purposes of the M+C program. Accordingly, we defined, by regulation,

the fundamental organizational requirements for entities seeking to be

PSOs. These definitions are set forth at 42 CFR 422.350. Organizations

that meet these definitional requirements can apply for a Federal

waiver and a M+C contract. Having defined the term PSO in earlier

regulation, this rule has two broad purposes: (1) To establish the

requirements and process necessary for organizations to obtain Federal

waiver of license requirements for risk-bearing entities; and (2) to

establish standards for financial solvency to which such Federally

waived organizations must adhere.

With regard to the impact of the waiver requirements and process,

we emphasize three important underlying factors. First, waivers cannot

exceed 36-months in duration and are not renewable. Second, the

Secretary's authority to grant waivers ends November 1, 2002. Finally,

the Secretary can grant waivers only to organizations that have first

applied for a State license as a risk bearing entity, but were denied

by virtue of three things: (1) States' failure to act timely on the

license application; (2) States' denial of the application for

``discriminatory'' reasons; or (3) States'' denial for failure to meet

different solvency standards than are promulgated here. The first two

factors (i.e., the duration of the waiver and the waiver authority) are

important to this impact analysis because they indicate that, under

current law, no organization will operate under a Federal waiver after

November 1, 2005. The third fact regarding eligibility for a Federal

waiver may have an effect on the waiver application rate.

The solvency standards have an even narrower focus than the waiver

requirements because the former only effect organizations that have

received a Federal waiver and are either applying for or actually have

received an M+C contract. Within this smaller population, organizations

will be affected differently or not at all depending upon the status of

the solvency standards in their respective States. It is likely that

waiver activity will be greater in States that have solvency standards

that differ significantly from the standards developed in this

regulation. Below we consider the anticipated impact of this rule.

C. Anticipated Effects

1. Effects on Providers

HCFA discussion with the industry as part of the negotiated rule

making process suggests widespread interest in the benefits of becoming

a PSO (i.e., waiver of State licensure and lower minimum enrollment

standards). This regulation benefits certain health services providers

that have been denied a State risk-bearing license by creating an

opportunity for them to obtain a Federal waiver of the State license

requirement and participate in the M+C program as contractors. As such,

this regulation provides means for such providers to gain access to a

market from which they otherwise would be excluded. While clearly not

possible to predict how many organizations will attempt to take

advantage of this new opportunity, we have seen estimates that the

first year application rate will be between 25 and 150 organizations.

For several reasons, we estimate between 25 and 50 organizations will

apply. In the first year many organizations will be interested, but we

expect that the ``learning curve'' necessary to gain familiarity with

this new program will restrain the first year application rate. Second,

the waiver process, which for this discussion includes the prerequisite

State application process, and M+C application process, are time

intensive steps. At a minimum, these steps could take up to 6 six

months to complete. After the first year, however, the number of

applicant organizations will increasingly be a function of PSOs'

performance and their reception in the market place.

We do not expect that the waiver process will create a substantial

additional burden for organizations. For one thing, the waiver process

is not a mandatory burden. The waiver process affects only

organizations that affirmatively choose to become Federally waived

PSOs. For those organizations that apply, we estimate that the waiver

application will require less than 20 hours to complete. However, we do

believe that waiver applicants will face the additional task of

documenting their denial of a State license.

Regarding the application for an M+C contract, there are existing

application requirements for organizations that seek to contract with

Medicare under section 1876 of the Act. We do not believe that the M+C

application process, which will be essentially the same, will be any

[[Page 25373]]

more burdensome than an application under section 1876 of the Act. To

the extent that organizations that previously have not contracted with

the Medicare program choose to seek an M+C contract, the application

will be a new task. Given the new provider focus of this initiative, it

is plausible to expect that many applicants have not previously

contracted directly with Medicare. However, we believe that the benefit

to Medicare beneficiaries gained by screening potential contractors

outweighs the burden associated with having a reasonable application

process in place.

2. Effects on the Market Place

We expect that the advent of PSOs will increase market competition

among health care service providers, albeit only slightly. The increase

in competition is expected to be limited for four reasons. First, since

Federally waived PSOs are limited to serving Medicare enrollees, any

changes in competition will be primarily concentrated in the Medicare

sector of the health services delivery market. We note that there may

be crossover effects to the extent that service providers' success with

Medicare may affect their success generally.

Second, we believe that this rule, primarily concerns the structure

of entities that can participate in the market for Medicare enrollees.

We expect transfer effects; that is, existing providers changing

corporate form in order to avail themselves of PSO status. However, we

do not anticipate a significant increase in the aggregate market place

capacity of providers or health service delivery assets. The providers

and hospitals that will form PSOs are coming from the same pool that

are currently providing services. In addition, the principle effect on

revenues will be a change in the source of payment from Medicare parts

A and B to the new part C.

Third, to the extent that these solvency standards are similar to

existing standards, the potential transfer effect will be limited.

Since standards vary greatly by State, and State standards are

evolving, it is difficult to assess the relative effect of the instant

standards. We note, however, that with several key exceptions (e.g.,

different initial minimum net worth requirement and a lower insolvency

deposit) the instant standards track the HMO Model Act. Therefore, we

do not believe there will be a significant transfer due to the

existence of an unlevel playing field between PSOs and other entities.

We believe that establishing standards of financial solvency is

necessary to insure that PSOs have the financial resources to provide

adequate quality care and to reduce the possibility of disrupting

beneficiary care.

Finally, in the preamble to this regulation, HCFA agreed that it

will consider the NAIC's Risk Based Capital formula as well as the

codification of Statutory Accounting Practices when these methodologies

become available. If one or both of these methodologies are adopted for

the PSO solvency standards, it would help to narrow any existing

differences between State-level and Federal solvency standards.

3. Effects on States

This regulation will affect States in several ways, some of which

are offsetting. First, we expect that a few States may have to reduce

their application turnaround times in order to avoid tolling the 90-day

limit for State review of a waiver application. However, based upon

conversations with State insurance commissioners, we believe in many

States the application turnaround time is at or near the 90-day limit.

The second effect will be a reduction in States' oversight burden.

For PSOs that obtain a Federal waiver, responsibility for monitoring

their financial solvency will be transferred from the States to HCFA.

This is a temporary reduction, since waivers last only 36 months and

the Secretary's authority to grant waivers ends on November 1, 2002. By

the end of a PSO's waiver, it will need a State license in order to

continue its M+C contract. Therefore, to ease the transition from a

Federal waiver to a State license, we encourage PSOs to establish a

relationship with regulators in their respective States soon after

receiving a waiver. To minimize the chances of a gap in financial

oversight, HCFA is negotiating with the State Insurance Commissioners

via the NAIC to develop a Memorandum of Understanding regarding sharing

information on the financial solvency of PSOs.

Lastly, it has been suggested that this interim final rule may

pressure States to adopt solvency standards that mirror the Federal

standards. Currently, we do not have a good measure of the extent to

which this will occur. However, we emphasize that the negotiated

rulemaking committee developed these solvency standards solely in the

context of Federally waived PSOs that will provide services under an

M+C contract. States are cautioned not to adopt these standards for

general application without first considering their affect on the

overall health services delivery market in their jurisdictions.

4. Effects on Beneficiaries

We expect that this regulation will have a positive effect on

Medicare beneficiaries since it creates a new managed care option. We

expect that the principle source for enrollees for newly formed PSOs

will be current Medicare fee-for-service enrollees. We expect that the

advent of PSOs and M+C in general will have the effect of further

mainstreaming managed care plans among Medicare enrollees. We do not

anticipate an increase in the potential for service interruptions

because these new PSOs will be subject to the same beneficiary hold-

harmless provisions and continuation of benefits requirements as all

M+C organizations. Lastly, section 1855(a)(2)(G) of the Act requires

PSOs to comply with all existing State consumer protection and quality

standards as if the PSO were licensed under State law.

D. Conclusion

By enacting the BBA provisions related to PSOs, Congress has

indicated its belief in the potential for provider controlled

organizations to improve the delivery of services to Medicare

beneficiaries. While expanding the options available to Medicare

beneficiaries, we believe that this regulation provides an opportunity

for providers to test their ability to manage the delivery of health

care services. The negotiated rulemaking Committee, which included

representatives from the entire range of interested parties, reached

consensus on provisions that were acceptable when considered as a

whole. It is safe to say that Committee members considered the impact

of these provisions on their respective constituencies during the

negotiating process.

We conclude that this regulation will have an undeterminable impact

on small health service providers. However the provisions of this

interim final rule are expected to be favorable for the managed care

community as a whole, as well as for the beneficiaries that they serve.

We have also determined, and the Secretary certifies that this proposed

rule will not result in a significant economic impact on a substantial

number of small entities and would not have a significant impact on the

operations of a substantial number of rural hospitals. In accordance

with the provisions of Executive order 12866, this regulation was

reviewed by the Office of Management and Budget.

[[Page 25374]]

VI. Collection of Information Requirements

Emergency Clearance: Public Information Collection Requirements

Submitted to the Office of Management and Budget (OMB)

In compliance with the requirement of section 3506(c)(2)(A) of the

Paperwork Reduction Act of 1995, the Health Care Financing

Administration (HCFA), Department of Health and Human Services (DHHS),

has submitted to the Office of Management and Budget (OMB) the

following request for Emergency review. We are requesting an emergency

review because the collection of this information is needed prior to

the expiration of the normal time limits under OMB's regulations at 5

CFR, Part 1320. The Agency cannot reasonably comply with the normal

clearance procedures because of the statutory requirement, as set forth

in section 1856 of Balanced Budget Act of 1997, to implement these

requirements on June 1, 1998.

HCFA is requesting OMB review and approval of this collection

within eleven working days, with a 180-day approval period. Written

comments and recommendations will be accepted from the public if

received by the individual designated below, within ten working days of

publication of this notice in the Federal Register.

During this 180-day period HCFA will pursue OMB clearance of this

collection as stipulated by 5 CFR. 1320.5.

In order to fairly evaluate whether an information collection

should be approved by OMB, section 3506(c)(2)(A) of the PRA requires

that we solicit comment on the following issues:

The need for the information collection and its usefulness

in carrying out the proper functions of our agency.

The accuracy of our estimate of the information collection

burden.

The quality, utility, and clarity of the information to be

collected.

Recommendations to minimize the information collection

burden on the affected public, including automated collection

techniques.

Therefore, we are soliciting public comment on each of these issues

for the information collection requirements discussed below.

Section 422.374(a), requires an organization to submit a waiver

request if it has been denied licensure as a risk-bearing entity by the

State in which it operates or wishes to operate. To facilitate the

implementation of the requirements of this section we developed a model

waiver request form and submitted it to OMB for emergency clearance in

compliance with section 3506(c)(2)(a) of Paperwork Reduction Act of

1995. OMB has concurred with the model request form, and the form and

instructions are currently on view on the HCFA web site, the address of

which is provided in section II.A.3 of this document. The OMB approval

number is 0938-0722 and is referenced on the document.

A modification of this waiver request form is necessary to

incorporate the fourth criterion for a waiver of State licensure as

established in this interim final rule. The additional criterion allows

a PSO-type organization to forego a lengthy application process with

the State if the State informs the organization in writing that such an

application will not be reviewed. As part of the waiver request, the

organization will be required to submit a copy of the written

communication from the State. This criterion is mentioned in the

purpose section of the form, and, with publication of this rule, we can

add it to the check list in section III, Waiver Eligibility. We intend

to submit this modification to OMB in the near future.

Section 422.382(c) establishes the composition of assets the

organization must have at the time it applies to contract with HCFA as

a PSO. The organization must demonstrate that it has the required

minimum net worth amount as determined under paragraph (c), demonstrate

that it will maintain at least $750,000 of the minimum net worth amount

in cash or cash equivalents, and demonstrate that after the effective

date of a PSO's M+C contract, a PSO will maintain the necessary minimum

net worth.

Section 422.384 requires that at the time of application, an

organization must submit a financial plan acceptable to HCFA. The

financial plan must include a detailed marketing plan; statements of

revenue and expense on an accrual basis; a cash flow statement; balance

sheets; the assumptions in support of the financial plan; and if

applicable, statements of the availability of financial resources to

meet projected losses. The financial plan must cover the first 12

months after the estimated effective date of a PSO's M+C contract; or

if the PSO is projecting losses, cover 12 months beyond the period for

which losses are projected. Except for the use of guarantees, LOC, and

other means as provided in paragraphs (e), (f), (g) and (h) of

Sec. 422.384, an organization must demonstrate that it has the

resources for meeting projected losses on its balance sheet in cash or

a form that is convertible to cash in a timely manner, in accordance

with the PSO's financial plan.

Guarantees will be an acceptable resource to fund projected losses,

provided that the guarantor complies with the requirements in paragraph

(e)(2) of this section, and the PSO, in the third quarter, notifies

HCFA and requests a reduction in the period of advance funding of

projected losses.

Section 422.386 sets forth the general liquidity requirement that

at the time of application the PSO must demonstrate that it has

sufficient cash flow to meet its financial obligations as they become

due and payable. To meet this requirement HCFA will consider: the PSO's

timeliness in meeting current obligations, the extent to which the

PSO's current ratio of assets to liabilities is maintained at 1:1 and

whether there is a decline in the current ratio over time, and the

availability of outside financial resources to the PSO.

Section 422.388 sets forth the deposit requirements to provide

protection in the event of an insolvency. At the time of application,

an organization must demonstrate that they have deposited $100,000 in

cash or securities (or any combination thereof) into an account in a

manner that is acceptable to HCFA, and demonstrate that the deposit

will be restricted only to use in the event of insolvency to help

assure continuation of services or pay costs associated with

receivership or liquidation.

At the time of the PSO's application for an M+C contract and,

thereafter, upon HCFA's request, a PSO must provide HCFA with proof of

the insolvency deposit, such proof to be in a form that HCFA considers

appropriate.

If at any time uncovered expenditures exceed 10 percent of a PSO's

total health care expenditures, then the PSO must demonstrate in a

manner acceptable to HCFA that it has placed an uncovered expenditures

deposit into an account with an organization or trustee.

The PSO must also demonstrate that, at all times the deposit will

have a fair market value of an amount that is 120 percent of the PSO's

outstanding liability for uncovered expenditures for enrollees,

including incurred, but not reported claims; the deposit will be

calculated as of the first day of each month required and maintained

for the remainder of each month required; if a PSO is not otherwise

required to file a quarterly report, it must file a report within 45

days of the end of the calendar quarter with information sufficient to

demonstrate compliance with this section; the deposit required under

this section will be restricted and in trust and may be used only as

provided under this section.

As stated above, the burden associated with these provisions will

be

[[Page 25375]]

captured as part of the M+C PSO application and/or quarterly financial

reporting processes, similar to section 1876 HMO and CMP contractor

applications and quarterly financial reporting processes. Based on

section 1876 of the Act, we estimate the burden associated with the

submission of the application to be 100 hours per application and 62

annual hours per organization to submit their quarterly financial

report. Based upon the current volume of waiver reporting workload, we

estimate that on an annual basis, we will receive 25 to 50 applications

and 25 organizations will contract with us and will be required to

submit quarterly financial reports.

Under Sec. 422.388(d) PSOs may submit a written request to withdraw

income from the solvency deposits. We anticipate that, on an annual

basis, we will receive less than 10 requests. Therefore, these

requirements are not subject to the Paperwork Reduction Act as defined

in 5 CFR 1320.3(c).

Under Sec. 422.388(e) a PSO may submit a written request to

withdraw or substitute a deposit. We anticipate that, on an annual

basis, we will receive less than 10 requests. Therefore, these

requirements are not subject to the PRA as defined in 5 CFR 1320.3(c).

Under Sec. 422.390(b), in order to apply to use the financial

resources of a guarantor, a PSO must submit to HCFA, documentation that

the guarantor meets the requirements for a guarantor under paragraph

(c) of this section; and the guarantor's independently audited

financial statements for the current year-to-date and for the two most

recent fiscal years. The financial statements must include the

guarantor's balance sheets, profit and loss statements, and cash flow

statements. We believe that the initial burden associated with this

activity is most likely incurred during the application process, for

which we have previously estimated the aggregate burden. We expect that

less than 10 PSOs per year will incur this burden in subsequent years.

Therefore, these requirements are not subject to the Paperwork

Reduction Act as defined in 5 CFR 1320.3(c).

Under Sec. 422.390(d), if the guarantee request is approved, a PSO

must submit to HCFA a written guarantee document signed by an

appropriate authority of the guarantor. The guarantee document must

state the financial obligation covered by the guarantee; agree to

unconditionally fulfill the financial obligation covered by the

guarantee and not subordinate the guarantee to any other claim on the

resources of the guarantor; declare that the guarantor will act on a

timely basis (that is, in not more than 5 business days) to satisfy the

financial obligation covered by the guarantee; and meet other

conditions as HCFA may establish from time to time. We believe that the

initial burden associated with this activity is most likely incurred

during the application process, for which we have previously estimated

the aggregate burden. We expect that less than 10 PSOs per year will

incur this burden in subsequent years. Therefore, these requirements

are not subject to the PRA as defined in 5 CFR 1320.3(c)

A PSO must submit to HCFA the current internal financial statements

and annual audited financial statements of the guarantor according to

the schedule, manner, and form that HCFA requests.

A PSO cannot modify, substitute or terminate a guarantee unless the

PSO requests HCFA's approval at least 90 days before the proposed

effective date of the modification, substitution, or termination;

demonstrates to HCFA's satisfaction that the modification,

substitution, or termination will not result in insolvency of the PSO;

and demonstrates how the PSO will meet the requirements of this

section.

The public will be afforded several subsequent comment periods in

future publications of Federal Register notices announcing our

intention to seek OMB approval for the application and quarterly

reporting information collection requirements, including a modified

version of the National Data Reporting Requirements (the Orange Blank),

that will be submitted to OMB in the near future.

We have submitted a copy of this rule to OMB for its review of the

information collection requirements above. To obtain copies of the

supporting statement and any related forms for the proposed paperwork

collections referenced above, E-mail your request, including your

address, phone number and HCFA regulation identifier HCFA-1011, to

P[email protected], or call the Reports Clearance Office on (410) 786-

1326.

As noted above, comments on these information collection and record

keeping requirements must be mailed and/or faxed to the designee

referenced below, within ten working days of publication of this

collection in the Federal Register:

Health Care Financing Administration, Office of Information Services,

Information Technology Investment Management Group, Division of HCFA

Enterprise Standards, Room C2-26-17, 7500 Security Boulevard,

Baltimore, MD 21244-1850. Attn: John Burke HCFA-1011. Fax Number: (410)

786-1415, and,

Office of Information and Regulatory Affairs, Office of Management and

Budget, Room 10235, New Executive Office Building, Washington, DC

20503, Attn: Allison Herron Eydt, HCFA Desk Officer. Fax Number: (202)

395-6974 or (202) 395-5167

VII. Waiver of Notice of Proposed Rulemaking

We ordinarily publish a notice of proposed rulemaking in the

Federal Register to provide a period for public comment before the

provisions of a rule are made final. Section 1871(b) of the Act,

however, provides that publication of a notice of proposed rulemaking

is not required before issuing a final rule where a statute

specifically permits a regulation to be issued in interim final form.

Section 1856(a)(1) of the Act, as added by section 4001 of the BBA,

directs the Secretary to establish the solvency standards for PSOs on

an expedited basis using a negotiated rulemaking process. Section

1856(a)(8) provides for the publication of solvency standards as an

interim final rule, with an opportunity for comment to follow. Under

section 1856(a)(3), the ``target date'' for publication of this rule

was April 1, 1998. We are promulgating the solvency provisions in this

rule according to the expressed interim final rule authority in section

1856(a)(8).

Section 1856(b)(1) also provides for the publication of other

standards implementing the new M+C program in Part C on an interim

final basis, with an opportunity for comment to follow. The PSO waiver

provisions in this rule are being promulgated according to this latter

expressed interim final rule authority. In addition, we may waive

publication of a notice of proposed rulemaking if we find good cause

that prior notice and comment are impractical, unnecessary, or contrary

to public interest. As discussed earlier in this preamble, HCFA and the

Committee believe that we need to establish the PSO waiver process

early in order to allow the sequence of waiver request, application,

and contract signing to occur, and to have PSOs initiate operations

upon implementation of the M+C program. Further, we determined that

entities considering applying to become PSOs under the M+C program need

to know whether and how they can qualify to participate in the program

in order to establish the complex organizational structures necessary

under the law prior to application. Many of these entities also need to

seek State licensure or a Federal waiver.

[[Page 25376]]

Given the time required for these events, and the clear impetus

from the Congress for implementation of the M+C program, we believe

that it is impractical and contrary to the public interest to publish a

notice of proposed rulemaking before establishing the Federal waiver

and solvency standards set forth in this interim final rule. We are

providing a 60-day period for public comment.

VIII. Response to Comments

Because of the large number of items of correspondence we normally

receive on Federal Register documents published for comment, we are not

able to acknowledge or respond to them individually. We will consider

all comments we receive by the date and time specified in the DATES

section of this preamble, and, when we proceed with a subsequent

document, we will respond to the comments in the preamble to that

document.

List of Subjects in 42 CFR Part 422

Health Maintenance organizations (HMO), Medicare+Choice, Provider

sponsored organizations (PSO).

42 CFR Part 422 is amended as set forth below:

PART 422--MEDICARE+CHOICE PROGRAM

Subpart H--Provider-Sponsored Organizations

1. The authority citation for Part 422 continues to read as

follows:

Authority: Secs. 1851, 1855 and 1856 of the Social Security Act

(42 U.S.C. 1302, 1395w-21 through 1395w-27, and 1395hh).

2. Section 422.350(b) is amended by adding the following

definitions in alphabetical order:

Sec. 422.350 Basis, scope, and definitions.

* * * * *

(b) * * *

Capitated basis is a payment method under which a fixed per member,

per month amount is paid for contracted services without regard to the

type, cost or frequency of services provided.

Cash equivalent means those assets excluding accounts receivables,

which can be exchanged on an equivalent basis as cash, or converted

into cash within 90 days from their presentation for exchange.

* * * * *

Current ratio means total current assets divided by total current

liabilities.

Deferred acquisition costs are those costs incurred in starting or

purchasing a business. These costs are capitalized as intangible assets

and carried on the balance sheet as deferred charges since they benefit

the business for periods after the period in which the costs were

incurred.

* * * * *

Generally accepted accounting principles (GAAP) means broad rules

adopted by the accounting profession as guides in measuring, recording,

and reporting the financial affairs and activities of a business to its

owners, creditors and other interested parties.

Guarantor means an entity that--

(1) Has been approved by HCFA as meeting the requirements to be a

guarantor; and

(2) Obligates its resources to a PSO to enable the PSO to meet the

solvency requirements required to contract with HCFA as an M+C

organization.

Health care delivery assets (HCDAs) means any tangible assets that

are part of a PSO's operation, including hospitals and other medical

facilities and their ancillary equipment, and such property as may be

reasonably required for the PSO's principal office or for such other

purposes as the PSO may need for transacting its business.

* * * * *

Insolvency means a condition where the liabilities of the debtor

exceed the fair valuation of its assets.

M+C stands for Medicare+Choice.

Net Worth means the excess of total assets over total liabilities,

excluding fully subordinated debt or subordinated liabilities.

* * * * *

Qualified Actuary means a member in good standing of the American

Academy of Actuaries or a person recognized by the Academy as qualified

for membership, or a person who has otherwise demonstrated competency

in the field of actuarial determination and is satisfactory to HCFA.

Statutory accounting practices means those accounting principles or

practices prescribed or permitted by the domiciliary State insurance

department in the State that PSO operates.

Subordinated debt means an obligation that is owed by an

organization, that the creditor of the obligation, by law, agreement,

or otherwise, has a lower repayment rank in the hierarchy of creditors

than another creditor. The creditor would be entitled to repayment only

after all higher ranking creditors' claims have been satisfied. A debt

is fully subordinated if it has a lower repayment rank than all other

classes of creditors.

Subordinated liability means claims liabilities otherwise due to

providers that are retained by the PSO to meet net worth requirements

and are fully subordinated to all other creditors.

Uncovered expenditures means those expenditures for health care

services that are the obligation of an organization, for which an

enrollee may also be liable in the event of the organization's

insolvency and for which no alternative arrangements have been made

that are acceptable to HCFA. They include expenditures for health care

services for which the organization is at risk, such as out-of-area

services, referral services and hospital services. However, they do not

include expenditures for services when a provider has agreed not to

bill the enrollee.

3. A new Sec. 422.370 is added to read as follows:

Sec. 422.370 Waiver of State licensure.

For an organization that seeks to contract as an M+C plan under

this subpart, HCFA may waive the State licensure requirement of section

1855(a)(1) of the Act if--

(1) The organization requests a waiver no later than November 1,

2002; and

(2) HCFA determines there is a basis for a waiver under

Sec. 422.372.

4. A new Sec. 422.372 is added to read as follows:

Sec. 422.372 Basis for waiver of State licensure.

In response to a request from an organization and subject to

paragraphs (a) and (e) of Sec. 422.374, HCFA may waive the State

licensure requirement if the organization has applied (except as

provided for in paragraph (d) of this section) for the most closely

appropriate State license or authority to conduct business as an M+C

plan as set forth in section 1851(a)(2)(A) of the Act and any of the

following conditions are met:

(a) Failure to act timely on application. The State failed to

complete action on the licensing application within 90 days of the date

the State received a substantially complete application.

(b) Denial of application based on discriminatory treatment. The

State has--

(1) Denied the licensure application on the basis of material

requirements, procedures, or standards (other than solvency

requirements) not generally applied by the State to other entities

engaged in a substantially similar business; or

(2) Required, as a condition of licensure, that the organization

offer any product or plan other than an M+C plan.

(c) Denial of application based on different solvency requirements.

(1) The State has denied the licensure

[[Page 25377]]

application, in whole or in part, on the basis of the organization's

failure to meet solvency requirements that are different from those set

forth in Secs. 422.380 through 422.390; or

(2) HCFA determines that the State has imposed, as a condition of

licensure, any documentation or information requirements relating to

solvency or other material requirements that are different from the

requirements, procedures, or standards set forth by HCFA to implement,

monitor and enforce Secs. 422.380 through 422.390.

(d) The appropriate State licensing authority has notified the

organization in writing that it will not accept their licensure

application.

5. A new Sec. 422.374 is added to read as follows:

Sec. 422.374 Waiver request and approval process.

(a) Substantially complete waiver request. The organization must

submit a substantially complete waiver request that clearly

demonstrates and documents its eligibility for a waiver under

Sec. 422.372.

(b) Prompt action on waiver request. The organization will be

notified in writing within 60 days of having submitted to HCFA a

substantially complete waiver request whether the waiver request has

been granted or denied.

(c) Subsequent waiver requests. An organization that has had a

waiver request denied, may submit subsequent waiver requests until

November 1, 2002.

(d) Effective date. A waiver granted under Sec. 422.370 will be

effective on the effective date of the organization's M+C contract.

(e) Consistency in application. HCFA reserves the right to revoke

waiver eligibility if it subsequently determines that the

organization's M+C application is significantly different from the

application submitted by the organization to the State licensing

authority.

6. A new Sec. 422.376 is added to read as follows:

Sec. 422.376 Conditions of the waiver.

A waiver granted under this section is subject to the following

conditions:

(a) Limitation to State. The waiver is effective only for the

particular State for which it is granted and does not apply to any

other State. For each State in which the organization wishes to operate

without a State license, it must submit a waiver request and receive a

waiver.

(b) Limitation to 36-month period. The waiver is effective for 36

months or through the end of the calendar year in which the 36 month

period ends unless it is revoked based on paragraph (c) of this

section.

(c) Mid-period revocation. During the waiver period (set forth in

paragraph (b) of this section), the waiver is automatically revoked

upon--

(1) Termination of the M+C contract;

(2) The organization's compliance with the State licensure

requirement of section 1855(a)(1) of the Act; or

(3) The organization's failure to comply with Sec. 422.378.

7. A new Sec. 422.378 is added to read as follows:

Sec. 422.378 Relationship to State law.

(a) Preemption of State law. Any provisions of State law that

relate to the licensing of the organization and that prohibit the

organization from providing coverage under a contract as specified in

this subpart, are superseded.

(b) Consumer protection and quality standards. (1) A waiver of

State licensure granted under this subpart is conditioned upon the

organization's compliance with all State consumer protection and

quality standards that--

(i) Would apply to the organization if it were licensed under State

law;

(ii) Generally apply to other M+C organizations and plans in the

State; and

(iii) Are consistent with the standards established under this

part.

(2) The standards specified in paragraph (b)(1) of this section do

not include any standard preempted under section 1856(b)(3)(B) of the

Act.

(c) Incorporation into contract. In contracting with an

organization that has a waiver of State licensure, HCFA incorporates

into the contract the requirements specified in paragraph (b) of this

section.

(d) Enforcement. HCFA may enter into an agreement with a State for

the State to monitor and enforce compliance with the requirements

specified in paragraph (b) of this section by an organization that has

obtained a waiver under this subpart.

8. A new Sec. 422.380 is added to read as follows:

Sec. 422.380 Solvency standards.

General rule. A PSO or the legal entity of which the PSO is a

component that has been granted a waiver under Sec. 422.370 must have a

fiscally sound operation that meets the requirements of Secs. 422.382

through 422.390.

9. A new Sec. 422.382 is added to read as follows:

Sec. 422.382 Minimum net worth amount.

(a) At the time an organization applies to contract with HCFA as a

PSO under this part, the organization must have a minimum net worth

amount, as determined under paragraph (c) of this section, of:

(1) At least $1,500,000, except as provided in paragraph (a)(2) of

this section.

(2) No less than $1,000,000 based on evidence from the

organization's financial plan (under Sec. 422.384) demonstrating to

HCFA's satisfaction that the organization has available to it an

administrative infrastructure that HCFA considers appropriate to

reduce, control or eliminate start-up administrative costs.

(b) After the effective date of a PSO's M+C contract, a PSO must

maintain a minimum net worth amount equal to the greater of--

(1) One million dollars;

(2) Two percent of annual premium revenues as reported on the most

recent annual financial statement filed with HCFA for up to and

including the first $150,000,000 of annual premiums and 1 percent of

annual premium revenues on premiums in excess of $150,000,000;

(3) An amount equal to the sum of three months of uncovered health

care expenditures as reported on the most recent financial statement

filed with HCFA; or

(4) Using the most recent annual financial statement filed with

HCFA, an amount equal to the sum of--

(i) Eight percent of annual health care expenditures paid on a non-

capitated basis to non-affiliated providers; and

(ii) Four percent of annual health care expenditures paid on a

capitated basis to non-affiliated providers plus annual health care

expenditures paid on a non-capitated basis to affiliated providers.

(iii) Annual health care expenditures that are paid on a capitated

basis to affiliated providers are not included in the calculation of

the net worth requirement under paragraphs (a) and (b)(4) of this

section.

(c) Calculation of the minimum net worth amount--(1) Cash

requirement. (i) At the time of application; the organization must

maintain at least $750,000 of the minimum net worth amount in cash or

cash equivalents.

(ii) After the effective date of a PSO's M+C contract, a PSO must

maintain the greater of $750,000 or 40 percent of the minimum net worth

amount in cash or cash equivalents.

(2) Intangible Assets. An organization may include intangible

assets, the value of which is based on Generally Accepted Accounting

Principles (GAAP), in the minimum net worth amount calculation subject

to the following limitations--

[[Page 25378]]

(i) At the time of application. (A) Up to 20 percent of the minimum

net worth amount, provided at least $1,000,000 of the minimum net worth

amount is met through cash or cash equivalents; or

(B) Up to 10 percent of the minimum net worth amount, if less than

$1,000,000 of the minimum net worth amount is met through cash or cash

equivalents, or if HCFA has used its discretion under paragraph (a)(2)

of this section.

(ii) From the effective date of the contract. (A) Up to 20 percent

of the minimum net worth amount if the greater of $1,000,000 or 67

percent of the minimum net worth amount is met by cash or cash

equivalents; or

(B) Up to ten percent of the minimum net worth amount if the

greater of $1,000,000 or 67 percent of the minimum net worth amount is

not met by cash or cash equivalents.

(3) Health Care Delivery Assets. Subject to the other provisions of

this section, a PSO may apply 100 percent of the GAAP depreciated value

of health care delivery assets (HCDAs) to satisfy the minimum net worth

amount.

(4) Other assets. A PSO may apply other assets not used in the

delivery of health care provided that those assets are valued according

to statutory accounting practices (SAP) as defined by the State.

(5) Subordinated debts and subordinated liabilities. Fully

subordinated debt and subordinated liabilities are excluded from the

minimum net worth amount calculation.

(6) Deferred acquisition costs. Deferred acquisition costs are

excluded from the calculation of the minimum net worth amount.

10. A new Sec. 422.384 is added to read as follows:

Sec. 422.384 Financial plan requirement.

(a) General rule. At the time of application, an organization must

submit a financial plan acceptable to HCFA.

(b) Content of plan. A financial plan must include--

(1) A detailed marketing plan;

(2) Statements of revenue and expense on an accrual basis;

(3) Statements of sources and uses of funds;

(4) Balance sheets;

(5) Detailed justifications and assumptions in support of the

financial plan including, where appropriate, certification of reserves

and actuarial liabilities by a qualified health maintenance

organization actuary; and

(6) If applicable, statements of the availability of financial

resources to meet projected losses.

(c) Period covered by the plan. A financial plan must--

(1) Cover the first 12 months after the estimated effective date of

a PSO's M+C contract; or

(2) If the PSO is projecting losses, cover 12 months beyond the end

of the period for which losses are projected.

(d) Funding for projected losses. Except for the use of guarantees,

LOC, and other means as provided in Sec. 422.384(e), (f) and (g), an

organization must have the resources for meeting projected losses on

its balance sheet in cash or a form that is convertible to cash in a

timely manner, in accordance with the PSO's financial plan.

(e) Guarantees and projected losses. Guarantees will be an

acceptable resource to fund projected losses, provided that a PSO--

(1) Meets HCFA's requirements for guarantors and guarantee

documents as specified in Sec. 422.390; and

(2) Obtains from the guarantor cash or cash equivalents to fund the

projected losses timely, as follows--

(i) Prior to the effective date of a PSO's M+C contract, the amount

of the projected losses for the first two quarters;

(ii) During the first quarter and prior to the beginning of the

second quarter of a PSO's M+C contract, the amount of projected losses

through the end of the third quarter; and

(iii) During the second quarter and prior to the beginning of the

third quarter of a PSO's M+C contract, the amount of projected losses

through the end of the fourth quarter.

(3) If the guarantor complies with the requirements in paragraph

(e)(2) of this section, the PSO, in the third quarter, may notify HCFA

of its intent to reduce the period of advance funding of projected

losses. HCFA will notify the PSO within 60 days of receiving the PSO's

request if the requested reduction in the period of advance funding

will not be accepted.

(4) If the guarantee requirements in paragraph (e)(2) of this

section are not met, HCFA may take appropriate action, such as

requiring funding of projected losses through means other than a

guarantee. HCFA retains discretion to require other methods or timing

of funding, considering factors such as the financial condition of the

guarantor and the accuracy of the financial plan.

(f) Letters of credit. Letters of credit are an acceptable resource

to fund projected losses, provided they are irrevocable, unconditional,

and satisfactory to HCFA. They must be capable of being promptly paid

upon presentation of a sight draft under the letters of credt without

further reference to any other agreement, document, or entity.

(g) Other means. If satisfactory to HCFA, and for periods beginning

one year after the effective date of a PSO's M+C contract, a PSO may

use the following to fund projected losses--

(1) Lines of credit from regulated financial institutions;

(2) Legally binding agreements for capital contributions; or

(3) Legally binding agreements of a similar quality and reliability

as permitted in paragraphs (g)(1) and (2) of this section.

(h) Application of guarantees, Letters of credit or other means of

funding projected losses. Notwithstanding any other provision of this

section, a PSO may use guarantees, letters of credit and, beginning one

year after the effective date of a PSO's M+C contract, other means of

funding projected losses, but only in a combination or sequence that

HCFA considers appropriate.

11. A new Sec. 422.386 is added to read as follows:

Sec. 422.386 Liquidity.

(a) A PSO must have sufficient cash flow to meet its financial

obligations as they become due and payable.

(b) To determine whether the PSO meets the requirement in paragraph

(a) of this section, HCFA will examine the following--

(1) The PSO's timeliness in meeting current obligations;

(2) The extent to which the PSO's current ratio of assets to

liabilities is maintained at 1:1 including whether there is a declining

trend in the current ratio over time; and

(3) The availability of outside financial resources to the PSO.

(c) If HCFA determines that a PSO fails to meet the requirement in

paragraph (b)(1) of this section, HCFA will require the PSO to initiate

corrective action and pay all overdue obligations.

(d) If HCFA determines that a PSO fails to meet the requirement of

paragraph (b)(2) of this section, HCFA will require the PSO to initiate

corrective action to--

(1) Change the distribution of its assets;

(2) Reduce its liabilities; or

(3) Make alternative arrangements to secure additional funding to

restore the PSO's current ratio to 1:1.

(e) If HCFA determines that a PSO fails to meet the requirement of

paragraph (b)(3) of this section, HCFA will require the PSO to obtain

funding from alternative financial resources.

12. A new Sec. 422.388 is added to read as follows:

[[Page 25379]]

Sec. 422.388 Deposits.

(a) Insolvency deposit. (1) At the time of application, an

organization must deposit $100,000 in cash or securities (or any

combination thereof) into an account in a manner that is acceptable to

HCFA.

(2) The deposit must be restricted to use in the event of

insolvency to help assure continuation of services or pay costs

associated with receivership or liquidation.

(3) At the time of the PSO's application for an M+C contract and,

thereafter, upon HCFA's request, a PSO must provide HCFA with proof of

the insolvency deposit, such proof to be in a form that HCFA considers

appropriate.

(b) Uncovered expenditures deposit. (1) If at any time uncovered

expenditures exceed 10 percent of a PSO's total health care

expenditures, then the PSO must place an uncovered expenditures deposit

into an account with any organization or trustee that is acceptable to

HCFA.

(2) The deposit must at all times have a fair market value of an

amount that is 120 percent of the PSO's outstanding liability for

uncovered expenditures for enrollees, including incurred, but not

reported claims.

(3) The deposit must be calculated as of the first day of each

month required and maintained for the remainder of each month required.

(4) If a PSO is not otherwise required to file a quarterly report,

it must file a report within 45 days of the end of the calendar quarter

with information sufficient to demonstrate compliance with this

section.

(5) The deposit required under this section is restricted and in

trust for HCFA's use to protect the interests of the PSO's Medicare

enrollees and to pay the costs associated with administering the

insolvency. It may be used only as provided under this section.

(c) A PSO may use the deposits required under paragraphs (a) and

(b) of this section to satisfy the PSO's minimum net worth amount

required under Sec. 422.382(a) and (b).

(d) All income from the deposits or trust accounts required under

paragraphs (a) and (b) of this section, are considered assets of the

PSO. Upon HCFA's approval, the income from the deposits may be

withdrawn.

(e) On prior written approval from HCFA, a PSO that has made a

deposit under paragraphs (a) or (b) of this section, may withdraw that

deposit or any part thereof if--

(1) A substitute deposit of cash or securities of equal amount and

value is made;

(2) The fair market value exceeds the amount of the required

deposit; or

(3) The required deposit under paragraphs (a) or (b) of this

section is reduced or eliminated.

13. A new Sec. 422.390 is added to read as follows:

Sec. 422.390 Guarantees.

(a) General policy. A PSO, or the legal entity of which the PSO is

a component, may apply to HCFA to use the financial resources of a

guarantor for the purpose of meeting the requirements in Sec. 422.384.

HCFA has the discretion to approve or deny approval of the use of a

guarantor.

(b) Request to use a guarantor. To apply to use the financial

resources of a guarantor, a PSO must submit to HCFA--

(1) Documentation that the guarantor meets the requirements for a

guarantor under paragraph (c) of this section; and

(2) The guarantor's independently audited financial statements for

the current year-to-date and for the two most recent fiscal years. The

financial statements must include the guarantor's balance sheets,

profit and loss statements, and cash flow statements.

(c) Requirements for guarantor. To serve as a guarantor, an

organization must meet the following requirements:

(1) Be a legal entity authorized to conduct business within a State

of the United States.

(2) Not be under Federal or State bankruptcy or rehabilitation

proceedings.

(3) Have a net worth (not including other guarantees, intangibles

and restricted reserves) equal to three times the amount of the PSO

guarantee.

(4) If the guarantor is regulated by a State insurance

commissioner, or other State official with authority for risk-bearing

entities, it must meet the net worth requirement in Sec. 422.390(c)(3)

with all guarantees and all investments in and loans to organizations

covered by guarantees excluded from its assets.

(5) If the guarantor is not regulated by a State insurance

commissioner, or other similar State official it must meet the net

worth requirement in Sec. 422.390(c)(3) with all guarantees and all

investments in and loans to organizations covered by a guarantee and to

related parties (subsidiaries and affiliates) excluded from its assets.

(d) Guarantee document. If the guarantee request is approved, a PSO

must submit to HCFA a written guarantee document signed by an

appropriate authority of the guarantor. The guarantee document must--

(1) State the financial obligation covered by the guarantee;

(2) Agree to--

(i) Unconditionally fulfill the financial obligation covered by the

guarantee; and

(ii) Not subordinate the guarantee to any other claim on the

resources of the guarantor;

(3) Declare that the guarantor must act on a timely basis, in any

case not more than 5 business days, to satisfy the financial obligation

covered by the guarantee; and

(4) Meet other conditions as HCFA may establish from time to time.

(e) Reporting requirement. A PSO must submit to HCFA the current

internal financial statements and annual audited financial statements

of the guarantor according to the schedule, manner, and form that HCFA

requests.

(f) Modification, substitution, and termination of a guarantee. A

PSO cannot modify, substitute or terminate a guarantee unless the PSO--

(1) Requests HCFA's approval at least 90 days before the proposed

effective date of the modification, substitution, or termination;

(2) Demonstrates to HCFA's satisfaction that the modification,

substitution, or termination will not result in insolvency of the PSO;

and

(3) Demonstrates how the PSO will meet the requirements of this

section.

(g) Nullification. If at any time the guarantor or the guarantee

ceases to meet the requirements of this section, HCFA will notify the

PSO that it ceases to recognize the guarantee document. In the event of

this nullification, a PSO must--

(1) Meet the applicable requirements of this section within 15

business days; and

(2) If required by HCFA, meet a portion of the applicable

requirements in less than the time period granted in paragraph (g)(1)

of this section.

(Catalog of Federal Domestic Assistance Program No. 93.773,

Medicare--Hospital Insurance; and Program No. 93.774, Medicare--

Supplementary Medical Insurance Program)

Dated: April 20, 1998.

Nancy-Ann Min DeParle,

Administrator, Health Care Financing Administration.

Dated: April 28, 1998.

Donna E. Shalala,

Secretary.

[FR Doc. 98-12058 Filed 5-4-98; 11:09 am]

BILLING CODE 4120-01-P