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Network Development - Legal and Regulatory Issues
Network Development - Legal and Regulatory Issues

Richard Krohn
In previous installments of this series the focus of discussion has been the development of a market driven network strategy. During the planning stage of the physician network it is vital to carefully consider the legal and regulatory dimensions of network organization and operations. The local legal and regulatory environments play a central role in determining the market impact and economic potential of the network. Further, with the advent of Federally and State mandated programs like Medicare and Medicaid, the scope of regulatory and legal oversight of health care has expanded dramatically. And, in keeping with a proud tradition, the legal environment of network development and operations is remarkably complex. Confusing and often murkily defined legal statutes leave many physicians constantly wondering if they are in violation of hidden or broadly defined legal prohibitions against physician activities. Federal and State scrutiny of physician integration initiatives have amply reinforced this concern. Attempts by physician to collaborate with their peers, short of full asset mergers, have traditionally been viewed with suspicion by the Federal and State governments, ostensibly to prevent the inclination of business savvy physicians to "game the system" in order to reap a personal benefit. The perception of government hostility towards physician integration is reinforced by strongly worded antitrust, anti?kickback, anti?price?fixing, anti?self referral, anti self?inurement and other statutes which have effectively barred physicians from creating even modest economic alliances. Throughout this decade, while the other service sectors of healthcare ? the insurers, the hospitals, pharmaceuticals, long term care facilities, practice management companies, and others, have experienced a consolidation and merger frenzy, physicians have been actively discouraged from executing their own advanced managed care strategies. Recognizing this imbalance in the competitive position of physicians, the government has recently relaxed its restrictions on the types of physician integration allowable under Federal statutes. The intent is to expand the acceptable parameters of physician integration short of full asset mergers, in direct response to the economic demands of managed care.

Legal Prohibitions Governing Physician Networks

Unlike the legal issues associated with a practice merger or acquisition, (which include due diligence, tax, and market valuation issues) the issues surrounding physician network development tend to be more focused on the economic impact of network activities. Unfortunately, there is not a wealth of case law that clearly defines the limits of regulatory compliance. Additionally, individual state laws must be considered. Generally speaking, however there are several key areas of physician network activity that have become lightning rods for federal and state regulatory scrutiny.

Federal law prevents physician combinations that restrain competition. The major concern stems from the degree of physician joint marketing. Issues include:

Price fixing - agreements on price among competitors are illegal. The network may be considered to be in violation if it engages in joint marketing activities that do not meet legal criteria for sharing of contractual risk or substantial economic integration.

Market Power - a combination of competitors into a single business unit, such as a joint venture, is illegal if it gives the combination the ability to restrict output and raise prices. The network could be in violation if its' membership is sufficiently large enough to have achieved market power.

Horizontal Division of Markets - the network is in violation of Antitrust if it enters an agreement to segment the market in collusion with a separate business combination of physicians.

Group Boycotts - agreements among competitors not to sell to a purchaser that refuses to pay the prices desired by the competitor are illegal, as are agreements among competitors to prevent another competitor from entering the market.

Tying Arrangements - compelling purchasers to buy an undesirable product as a condition of purchasing a desired product is illegal.

Exclusion - Under some circumstance it may be illegal to exclude membership in the network to providers, particularly if the network has sufficient market power to make membership essential to remain competitive.

In evaluating the antitrust implications of physician network development, the strategic framework and operational capabilities of the proposed organization should be measured against several key criteria.

a). Degree of Integration - Generally speaking, the greater the level of pooling of economic resources and the sharing of risk, the lesser is the risk of running afoul of Antitrust statutes.

b). Degree of Exclusivity - A network is considered to be exclusive if it does not allow participating physicians to belong to competing networks, or does not allow physicians to contract with payors on terms the network itself will not accept.

c). Market Power - Networks, which are able to restrict output and raise prices due to their sheer size, may be considered in violation of antitrust laws.

d). Market Demographics - In the past, networks were considered to be in violation of antitrust if their size exceeded a fixed benchmark (usually 20% of available resources for exclusive networks and 30% for nonexclusive networks) in a defined market area. This restriction has been modified, and now larger networks may be permissible if they are necessary for a payer to gain entry to a rural market.

Fraud and Abuse

Physician networks are subject to scrutiny for possible violations of illegal compensation arrangements and self-referral prohibitions. Three specific areas of concern addressed by these statutes are compensation arrangements, practice acquisitions, and physician recruitment arrangements. The major legal statutes covering this issue are the Medicare Anti-Kickback Statute, Stark I and II, and multiple statutes regarding underutilization.

Anti-Kickback Statute - This statute prohibits the knowing or willful solicitation or acceptance of any remuneration, cash or otherwise, in return for the referral of a patient which results in a payment for services by Medicare. This is a broad statute, and necessarily "safe harbors" have been created to exclude arrangements in areas such as price discounts, payments to employees, group purchasing agreements, and space/equipment rentals.

Stark I and II - The Stark prohibitions relate to physician referrals to entities in which they have a financial interest. Originally aimed at referrals to physician owned labs, the prohibitions have been expanded to include referrals to durable medical equipment suppliers, home health services, physical therapy, occupational therapy, radiology, MRI, prosthetics, prescription drugs, inpatient and outpatient services, and others. Again, exceptions have been made for referrals within group practices, ownership of or investment in publicly traded companies, hospital ownership, employment and personal service arrangements, physician incentive plans, physician recruitment, among others.

Corporate Practice of Medicine

This statute prohibits the employment of physicians or the practice of medicine by lay corporations. Generally, there is an exception for medical corporations (which are owned exclusively by physicians). The prohibition makes it difficult for networks organized as medical corporations to raise money from lay investors.


Networks that accept risk directly may expose themselves to licensure and reserve requirements applied to health plans. If so designated, networks must meet minimum solvency requirements - typically of $1.5 million, just to receive a license. In addition, networks must then comply with reporting and accounting principles of health plans, and adopt procedures and policies which govern health plans. The key qualifier for the designation of the network as a health plan is the type of risk being assumed. The network is not necessarily considered to be a health plan if it accepts "upstream" risk, meaning risk transferred directly from a self insured employer to the network, but may be considered to be in the business of insurance if it accepts "downstream" risk, which is transferred from a health plan to the network and effectively creates an insurer-equivalent obligation on the part of the network.

Tax Issues

In general, physician networks do not seek tax exempt status unless they are organized as a medical foundation to meet state corporate practice of medicine criteria. To gain tax exempt status, an organization must be operated exclusively for religious, charitable, scientific, or educational purposes. It cannot transfer income or assets to "insiders" (employees, investors). These restrictions are usually inconsistent with the central purpose of the physician network, and commonly prevent the network from seeking tax exempt status. However, physician networks often ally with a non profit hospital as a capital partner. A potential conflict can occur in the creation of this joint venture if the hospital has non profit status and the joint venture network is a for profit organization. Sources of concern in these business combinations include:

joint ventures between physician networks and tax exempt hospitals;
integration with tax exempt hospitals;
insurance risk in such joint ventures.(1)

1996 Reinterpretation of the Antitrust Statute

On August 29, 1996 the Department of Justice and the Federal Trade Commission jointly issued statements which significantly revised the interpretation of the Antitrust statutes. The effect of these revisions has been to allow providers more flexibility in creating and operating networks. The major feature of this revised interpretation is that provider networks are not considered per se to be in violation of Antitrust if their members jointly contract but do not share substantial financial risk. This ruling is significant because it clears the way for physicians to form networks in which they do not share financial risk, subject to certain conditions. The mechanism by which this new standard is being applied is the so-called "rule of reason". The rule of reason applies to the treatment of networks that generate significant consumer benefit, even if they do not share substantial financial risk. Under the previous interpretation, physician networks that engaged in fee for service contracting on behalf of members were considered per se in violation of Antitrust statutes. As a result of the 1996 interpretation, and subject to the rule of reason, physician networks are not considered anti competitive if they promote:

utilization management and quality assurance programs;
practice standards and protocols;
management information systems;
a credentialling plan;
significant investment to realize efficiencies (as evidenced by improved cost controls, case medical management, and economies of scale).
Further, networks may qualify under rule of reason review if it can be demonstrated that pro-consumer efficiencies outweigh anti competitive effects. Criteria includes:
the number, types, and size of managed care plans operating in the market;
the degree of network member exclusivity;
the degree to which physicians participate in and derive income from outside plans or networks;
the availability of suitable providers to form competing networks;
the degree of network exclusivity as a matter of contract or practice;
the degree of cost control objectives and programs;
the degree to which the network was formed in response to payer demand.(2)

The ruling creates a distinction between physician networks and multi-provider networks. In addition to the qualifiers already described, multi-provider networks may be held to be in compliance if they achieve substantial clinical integration, even if there is no substantial risk sharing among physicians. Examples of clinical integration include case management, pre admission authorization, concurrent and retrospective review, practice standards and protocols, and investment in information systems.

The interpretation of laws and regulations that govern network operations is trending favorably towards physicians, although many restrictions remain. The degree to which physicians can achieve a shared economic benefit is often a function of their formal asset integration, operational integration, or risk sharing arrangements. Subsequently, it is vital that the activities of the network correspond to the legal limits of the network structure.

Richard Krohn is a member and contributor of HealthBond. View his expert page on HealthBond.

Richard Krohn is President of HealthSense. Krohn is a widely-published managed care expert as well as a dynamic speaker providing in-depth, practical and timely information on topics such as managed care contracting, strategic positioning for provider organizations, building new provider alliances, reengineering practice operations, developing market driven products, and creating equitable physician compensation plans.

1. Hirshfeld, Ed and Kolb, Frank, Avoiding Antitrust and Legal Stumbling Blocks When Developing PSNs, American Medical Association, Chicago, IL, 1997, pp. 3-55.
2. Katten Muchin and Zavis, Provider Networks Enjoy Greater Leeway Under Revised Antitrust Policy Statements, Client Advisory, September 1996, Chicago, IL.

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