WHAT IS AN HMO?

By Richard C. Miller
rmiller@monseesmayer.com

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I. The Development of Managed Health Care and HMOs

A. Traditional Model of Healthcare Before the Emergence of HMOs

Though Congress passed the first statute dealing with Health Maintenance Organizations (“HMOs”) in 1973 the development and dominance of HMOs and other Managed Health Care Organizations (“MCOs”) is a recently new phenomenon in the United States. Until the late 1980’s, the typical model of healthcare in the United States was the fee-for-service model. Under this plan, a patient was permitted to see any physician he/she desired, and the insurance company would either pay that physician for services rendered, or reimburse the patient for any medical costs incurred in connection with the physicians services. Primarily, the physician and the patient were in control of the treatment plan and together they would determine the course of treatment for the patient, with the insurance company simply paying for the medical care received. The fee-for-service model was blamed for the increase in the cost of medical care in the United States, due to the potential for abuse by physicians providing too much or unneeded care in order to increase the payments they received from the insurance companies. As there was no limit on the amount of care to be provided to patients, physicians had an incentive to provide more care in order to receive more money from insurance companies.

B. HMO Defined

In response, HMOs began to develop around the United States, promising to dramatically decrease the cost of medical care, particularly winning over employers who provided costly medical insurance to its employees. By providing incentives for physicians and applying case control management and review, HMOs attempt to achieve economic efficiency. While “HMO” is now a common term in homes throughout the United States, with over 70 percent of the workforce and their families enrolled in some type of HMO plan, the legal aspects of HMOs are still unclear to many.

Generally, HMOs provide healthcare to participants (enrollees) in their healthcare plan. In most situations, the employer (on behalf of his employee) pays a fixed monthly sum to the plan and in return, the HMO pays for the medical care received by the enrollee. The enrollee must choose a physician who has contracted with the HMO to provide services, usually at a reduced price or at a fixed rate.

Put another way, “An HMO is a group that contracts with medical facilities, physicians, employers, and sometimes individual patients to provide medical care to a group of individuals. This care is usually paid for by an employer at a fixed price per patient. Patients generally do not have any significant out-of-pocket expenses.”

1. Types of HMO Models Utilized to Provide Services

The relationship between the provider and the HMO usually fits under one of five models: the staff model, the group model, the direct contract model, the Individual Practice Association Model, or the network model.

Under the staff model, the HMO employs physicians to work and provide healthcare services directly to the patients from HMO-owned facilities. Physicians are employed by and paid a salary by the HMO. This type of relationship is similar to any other employee-employer relationship, with the physician/providers answering directly to the HMO. If a situation arises in which the HMO cannot provide all of the necessary services in-house, they contract with outside physicians and specialists for services.

Under the group model, the HMO contracts with physician groups to provide services to the enrollee, including both primary and specialty services. Under this model, the physician group employs their own physicians and the HMO has no control or influence over their selections. Services by the physician groups are provided in either private facilities or HMO facilities.

If a direct contract model is utilized, private physicians and specialists contract directly with the HMO. Enrollees are then required to choose a primary care physician from a list of physicians provided to them by the HMO. The primary care physician provides general healthcare services to the enrollee, and if necessary, refers the enrollee to HMO approved specialists.

An Individual Practice Association (IPA) is a separate legal entity, made up of a group of physicians. The individual physicians/members of the IPA provide services to enrollees directly out of their own personal offices, and are not limited to providing services only to the HMO enrollees, but can contract with other facilities as well. Under this type of model, the IPA is paid a certain sum directly by the HMO, which is then distributed among the physician/providers. An Individual Practice Association “offsets losses and encourages risk sharing among physician members by withholding a portion of the HMO’s payment to encourage a common fund. This fund is extinguished and paid to the IPA members only if expenses have not exceeded a certain level.”

The network model is a combination of the prior four models, in that IPA’s, medical groups and private physicians contract with network HMO’s to provide services to enrollees. In addition, providers that do not have a contract with the HMO can provide services to enrollees. A situation in which a non-contracted physician may provide services to an enrollee is in an emergency situation. If an enrollee is faced with an emergency situation and needs care immediately, they are likely to go to the closest hospital, regardless of whether that hospital or its physicians are contracted to provide services to enrollees. Similarly, a primary care physician may not have the experience and skills to provide specialty services to the enrollee so they refer the patient to a specialist who is not contracted to provide services. In these situations, the non-contract physicians submit their bills directly to the HMO for payment.

II. The Money Saving Techniques of HMO’s

A. Shifting the Risk of Loss

There are many ways that HMOs attempt to shift the risk of financial loss away from the itself and directly to another, generally the physician/provider. Generally, an HMO enrollee pays a fixed fee to the HMO, and in return, the enrollee receives unlimited healthcare provided by the HMO. It is similar to an insured paying premiums to an insurance company, the main difference being that instead of receiving cash reimbursement from the HMO the enrollee receives healthcare services. Under this contract providers are required to provide “medically necessary care”.

With this framework in mind, one way in which an HMO shifts the risk of loss to others is through “hold harmless” clauses. These clauses place the risk of non-payment by the HMO on the physicians by providing that in the event the HMO refuses to pay the physician for the services provided to the enrollee, or the HMO is insolvent and cannot pay for the services, the physician is not able to seek payment directly from the enrollee. Thus, in any situation in which the HMO does not pay the physician, the physician is stuck with the loss and cannot be reimbursed by the enrollee.

HMO’s also shift the risk of loss by contracting with IPA groups. This works in the following manner: “IPA groups withhold a portion of the HMO payments and place them in a separate fund. This fund is paid to the IPA members only if expenses do not exceed a certain level during the year. If an HMO becomes insolvent and is unable to pay the IPA groups, then the fund will not be paid out but rather will be used to offset unreimbursed expenses.”This setup removes the burden of loss from the HMO by shifting it to the IPA.Ultimately, it is the individual physician/providers who bear the burden of loss, because they are the ones who do not get full reimbursement for services they provided to enrollees.

It is important to note that there are some situations in which the HMO is not able to shift the risk of loss. One example of this is when a non-contract provider provides services to an enrollee. The non-contract provider has no contract with the HMO, thus if the provider is not reimbursed for his services by the HMO, he can seek reimbursement/payment directly from the enrollee, which causes the HMO to bear the risk of insolvency.

B. Other Methods of Achieving Economic Advantage

One very common method utilized by HMO’s to achieve an economic advantage is to pay physicians less than their normal fee in exchange for membership in the HMO network. The HMO’s then persuade their enrollees to seek healthcare services from a network physician by refusing to provide full payment unless a network physician provides the enrollee’s healthcare.Further, HMO’s may encourage network providers to order few tests or services by providing bonuses to the physicians at the end of the year if they have limited the number of referrals to specialists and/or the number of specialized tests for their patients. This practice of bonus payments shifts the burden of loss to the physicians. If they provide more specialized tests or services to the enrollees than the HMO deems appropriate through a “quota”, the individual physicians are the ones who don not get paid.

Other HMO’s may simply withhold a portion of the provider physician’s payments until the end of the year, and will pay that portion to the physician only if he has limited the number of referrals and orders for specialized testing. This provides great incentives for providers to provide less services to the enrollees, ultimately placing the enrollee’s needs below the provider’s incentives to provide less care and the HMO’s profit margin.

One other method utilized by HMO’s to limit their costs, and the amount of healthcare provided to a patient by a provider physician is simply to pay the provider a certain amount of money each month, regardless of the amount of healthcare provided to each enrollee. When this method is utilized, the provider has an incentive to provide less care to patients, due to the fact that he receives a certain sum each month, regardless of the true cost of his services to the enrollee. In other words, the provider is given an incentive not to provide “unnecessary” medical care, and as a result, HMOs “enable employers who offer healthcare benefits to their employees to save money” on healthcare costs. This method is formally called the “capitation method.”

In effect, by guiding and controlling the patient’s course of healthcare, from “the scope of covered services to the length of stay in hospitals, and controlling the physicians ability to refer the patient to specialists or authorize medical tests, HMO’s have shifted the control of healthcare decisions from the patient and physician to the HMO.

C. Prospective Utilization Review

One of the most effective, and probably most controversial ways in which an HMO controls costs and achieves economic efficiency is by using a methodology termed “prospective utilization review.” A healthcare provider who works under this type of HMO model must obtain permission from the HMO before a certain procedure or service is administered. This review plays a very “important role in the cost containment function of HMO’s.”“Prospective utilization review enables a third-party payor to ascertain whether a proposed treatment is medically appropriate before the care is provided and valuable resources are needlessly expended.”

In performing the review, the HMO is attempting to determine whether a more cost-effective treatment is available that would accomplish the same thing that the proposed treatment by the physician is purporting to accomplish. The end result of prospective utilization review is that HMOs are able to control overall healthcare costs by denying unnecessary treatment or higher cost treatment in favor of less expensive treatment that will provide the same end result.

III. Conclusion

Since their introduction and development in the late 1980’s, HMO’s have been criticized for putting their own economic interests ahead of patient’s health and well-being. As the industry grows to command more patient lives, physicians have no choice but to join and patients have no other options for their healthcare needs. But in their fight for economic efficiency, patients complain that their healthcare needs are being ignored in order to help HMOs cut costs. Physicians complain that the HMOs are taking important decisions away from the doctors and patients by making their own determinations, in order to further save money. Physicians are caught in a catch-22 situation, with financial incentives to provide the least amount of care as possible opposing patient demands for ethical and sound medical decisions.

Courts and legislatures are attempting to balance patients’ rights to adequate medical care with the HMO’s duties to provide professional care . The debate over who can sue whom, when they can sue, in what court the action must be brought, and what damages can be recovered continues. New HMO legislation continues to be tested in state courts throughout the United States while Congress continues to debate a “Patient’s Bill of Rights.” Only time will tell whether our healthcare system will mature into one that is fair and equitable for all concerned or stagnates in the present polarized debate.


See 42 USC § 300e, et seq. (1973).

Because the terms are often treated as synonymous the terms will be used interchangeably throughout this paper.

Patricia Mullen Ochmann, Comment, Managed Care Organizations Manage to Escape Liability: Why Issues of Quantity vs. Quality Lead to ERISA’s Inequitable Preemption of Claims, 34 Akron L. Rev. 571, 572 (2001).

Id.

Id. at 573.

Id.

Id. at 574.

Kevin J. Smith, Article, Power and Control of Managing Medicine: Recent Developments, 33 UWLA L. Rev. 191, 194 (2001).

See Ochmann at 574.

Gayle L. Holland, Commentary, Health Maintenance Organizations, Member Physicians Assuming the Risk of Loss Under State and Federal Bankruptcy Laws, 15 J. Leg. Med. 445, 446 (September 1994).

Id. at 446-47.

Id. at 447.

Smith, supra note 8 at 194.

Holland, supra note 10 at 447-48.

Id. at 447.

Christine E. Brasel, Comment, Managed Care Liability: State Legislation May Arm Angry Members with Legal Ammo to Fire at Their MCOs for Cost Containment Tactics…But Could it Backfire?, 27 Capu. L. J. 449, 451 (1999).

Holland, supra note 10 at 447.

Id.

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Id. at 447-48.

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Holland, supra note 10 at 451.

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Brasel, supra note 16 at 451.

Holland, supra note 10 at 451.

Id.

Id.

Id. at 451-52.

Id.

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Smith, supra note 8 at 194.

Id.

Id. at 195.

Id.

Id.

Id. at 196.

Id.

Brasel, supra note 16 at 451.

Smith, supra note 8 at 194.

Id. at 197.

Brasel, supra note 16 at 452.

Id. at 453.

Id.

Id.

Id.