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Is There a Perfect ACO Legal Entity?

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Gary J. McRay & Nicole E. Stratton
Foster Swift Health Care Law Report
June 30, 2011


On April 7, 2011, the Centers for Medicare and Medicaid Services ("CMS") published proposed rules to implement Section 3022 of the Affordable Care Act which contains provisions concerning accountable care organizations ("ACOs") and the Medicare Shared Savings Program for ACOs.  An ACO is defined in the proposed regulations as (1) a legal entity that is recognized and authorized under applicable state law, (2) is identified by a taxpayer identification number ("TIN"), (3) comprised of an eligible group of ACO participants that work together to manage and coordinate care for Medicare fee-for-service beneficiaries, and (4) has established a mechanism for shared governance, providing all ACO participants with proportional control over the ACO's decision making process. 

CMS has requested comments on its proposed regulations by June 6, 2011 and many organizations, including the Michigan Health and Hospital Association ("MHA"), filed by the deadline.  However, given the industry's general displeasure with the regulations, there likely will be vast changes to the proposed regulations and additional chances to comment on ACO structure.

This article is a follow-up to an earlier article in April (Accountable Care Organizations ("ACO") Analysis) where we discussed various issues facing three likely entities that might take the lead in creating an ACO.  Again, the "three candidates" are:  (i) integrated delivery systems, (ii) insurers and (iii) physician hospital organizations ("PHOs").  This article outlines some of the April 7, 2011 proposed regulations, how certain entities might meet the regulation requirements, and other issues with the proposed regulations.

General Requirements 

Under the proposed Rules at 42 CFR ยง425.5(d)(7), the legal structure of the ACO must allow:  (1) receiving and distributing ACO shared savings; (2) repaying ACO shared losses; (3) establishing reporting and ensuring provider compliance with health care quality criteria; and (4) other ACO functions identified in the proposed rules.  All three candidates can meet these several requirements.  However, some of the entities will face more difficulties than others in meeting the more specific requirements.

Shared Governance and Leadership Structures

One specific requirement is that each ACO establish and maintain a governing body (such as a board of directors) with adequate authority to execute the functions of the ACO.  In particular the governing body must have the ability to promote evidence based medicine and patient engagement, report on quality and cost measures, and coordinate care.

The governing body, according to the proposed regulations, must be comprised of the following:

  1. ACO participants or their designated representatives;
  2. Medicare beneficiaries served by the ACO who do not have a conflict of interest with the ACO and who have no immediate family member with a conflict of interest with the ACO; and
  3. at least 75% control of the ACO's governing body must be held by ACO participants (i.e. providers such as physicians or suppliers).

The governing body must have and possess broad responsibility for the ACO's administration, fiduciary and clinical operations.

Since there must be widespread physician involvement in ACO governance, it is understandable why PHOs are seriously being considered as the ACO entity of choice.  However, hospitals that are tax-exempt health care systems will in all likelihood not be able to use their existing boards which reflect an IRS mandate that encourages a majority of independent community members on the board of directors.  See Rev. Rule 69-545 and Form 990.  Hospitals or health care systems, therefore, will most likely be required to form a new entity to serve as the ACO unless there is an existing PHO or an independent physician association ("IPA") readily available.  Profit insurers may be able to meet the governance requirement but adding the ACO federal regulatory requirements on top of state insurance regulations will deter most from using this entity.

The ACO process also demands a certain leadership and management structure.  For example, the application process requires demonstration of:

  1. a leadership and management structure that supports the Shared Savings Program goal (which includes better health care for populations and lower growth in expenditures);
  2. management by an executive, officer, manager or general partner whose appointment and removal is under the control of the ACO's governing body;
  3. clinical management and oversight managed by a full-time senior level medical director who is physically present on a regular basis at the ACO location;
  4. participants and providers having a meaningful commitment to the ACO's clinical integration program so that the potential loss of the investment will motivate the participant to ensure clinical integration success (meaningful commitment can include a meaningful financial investment in an ACO such as ownership or a meaningful human investment such as time and effort in the ongoing operations of the ACO);
  5. a physician-directed quality assurance and process improvement committee that oversees ongoing action-oriented quality assurance and improvement programs;
  6. evidence-based medical practice or clinical guidelines and processes for delivering care constraints with the goals of better care, better health and lower growth in health care expenditures;
  7. participants and providers agreeing to comply with these guidelines and being subject to performance evaluations; and
  8. an infrastructure that enables the ACO to collect and evaluate data and provide feed back to ACO participants and providers.1

Supporting materials to demonstrate the ability to provide shared governance should include all of the ACO documents such as participation agreements with the providers, employment contracts, operating policies and other documents that describe the scope and scale of the quality assurance and clinical integration program documents.

While PHOs are a likely entity to provide the required shared governance, CMS may consider ACO management structures not meeting these requirements.  Therefore, some of the other entities such as hospitals or health systems may be able to use alternative governance and still be approved as ACOs.

Distribution of Savings

In addition to demonstrating the requirements listed above, the ACO must describe how the ACO plans to use shared savings payments, including how it will distribute the savings among its physicians and hospital providers.  The fundamental concept of an ACO is that it is an entity that will be financially and clinically integrated with both tax-exempt organizations and taxable providers (i.e. physicians, physician assistants, nurses and other health care providers).  Consequently, the ACO may very well be a non-profit but ultimately a taxable corporation, the tax result of many PHOs.  The IRS will most likely view the ACO's goal of providing better care for Medicare enrollees at reduced costs as laudatory but not charitable.  Therefore, an ACO may not qualify for its own federal tax exemption.

Nonetheless the IRS, in separate guidance issued in Notice 2011-20 on March 31, 2011, made it clear that under certain circumstances a tax-exempt organization's participation in an ACO will not result in impermissible private inurement or private benefit to the tax-exempt participant.  The IRS notice, however, did not go any further in describing under what circumstances an exempt organization's participation in activities beyond serving Medicare enrollees through an ACO will be consistent with the organization's tax exemption.

Therefore, unless more guidance is given there can be no guarantees that owning and operating an ACO that delivers coverage beyond Medicare enrollees is a protected activity for exempt owners.

Antitrust Review

In addition to tax issues with ACO entities, there are also antitrust considerations.  In accordance with the Antitrust Policy Statement issued by the Federal Trade Commission ("FTC") and the Department of Justice ("DOJ") on March 31, 2011, each ACO will need to analyze the market share for its physician groups, hospitals and other ACO participants in order to determine whether the safety zone applies or whether there has to be a mandatory review by one of the two agencies.  It is important to remember that if only one common service provided by two or more independent ACO participants exceeds 50% of any participant's primary service area ("PSA") and the PSA is not in a rural county, the ACO will be required to obtain an antitrust review from one of the agencies before even participating in the CMS Shared Savings Program. 

This Antitrust Policy Statement allows exclusive participation among primary care physicians, but would prohibit exclusive participation with hospitals, ambulatory surgery centers, and many specialty groups who have a potentially significant market share.  In connection with the antitrust review, organizations that employ physicians still have an antitrust advantage of not having to worry that the employment by itself is going to create an antitrust review.  However, all potential ACO organizations will need to do an extensive antitrust analysis to determine if they need to file with one of the two agencies a market review of their ACO participants. (For a more in depth analysis see Antitrust Enforcement Policy Statement.)

Limited Stark, Anti-Kickback and Civil Monetary Penalties Waivers

Waivers from compliance with Stark, the Anti-Kickback Statute and the Civil Monetary Penalties law were also published on March 31, 2011 and do give some limited guidance for potential ACO entities. For example, CMS would waive any applicability of the provisions of Stark to distributions of shared savings received by ACO participants.  The intent of this Stark waiver is to protect financial relationships (between physicians and hospitals) created by the distribution of shared savings within the ACO.  However, if physicians have an ownership interest in the ACO there will need to be a different Stark exception to avoid Stark law prohibitions.  Since physicians are encouraged to have some type of financial or clinical integration with the ACO entity, CMS needs to provide additional waivers and/or guidelines in this regard.

CMS also waives application of the Anti-Kickback Statute to shared savings received by ACO participants under the Shared Savings Program.  In similar fashion, CMS would also waive application of the Civil Monetary Penalties law to the distributions made from a hospital to a physician as part of the Shared Savings Program, provided that (a) the payments were not made knowingly to induce the physician to reduce or limit medically necessary items or services, and (b) the hospital and the physician are ACO participants.  (For a more in depth discussion see CMS Finally Proposes to Waive Certain Fraud and Abuse Laws for ACOs.)

Beneficiaries May Leave the ACO

Besides containing vague and potentially narrow exceptions, the proposed regulations also contain some risks for providers.  Specially, beneficiaries may opt out of being treated by ACO providers.  Each provider who is associated with an ACO will have to notify the Medicare beneficiaries of their ACO affiliation, the financial incentives that exists in connection with the ACO participation, and the possibility of beneficiaries choosing non-ACO providers.  This notice of the potential to opt out of the ACO provider network is given at the time the beneficiary seeks care from the provider.  CMS clearly wants beneficiaries to have the flexibility to seek care from any provider.  The challenge of an open and flexible network of providers for enrollees is increased financial risk to the ACO due to movement of beneficiaries during the year of treatment.

Retroactive Assignment

Another risk component relates to CMS retroactively assigning beneficiaries to the ACO.  CMS does an analysis at the end of each year to determine where Medicare beneficiaries receive the plurality of their primary care services during the previous year.  Then CMS allocates the beneficiary to the physician who provided this plurality of care.  This creates a challenge for all ACOs since they have based their operating budgets on their projection of the number of Medicare beneficiaries they will treat with their provider network based upon historical patterns of care provided by their primary care providers.  The ACO budget could have much less revenue since the ACO payment will be based on the actual number of enrollees calculated retroactively at the end of the year.  Plus, ACO programs to target high risk populations may be hindered since the assigned and identified population will only be known long after such programs should have begun.  This creates significant additional risk for ACOs that are trying to budget and manage the health care of a shifting target.

Risk Sharing

The amount of risk assumed by an ACO provider depends on the model it chooses.  CMS is proposing a phase-in of mandatory financial risk-sharing by all ACOs.  In the first round of ACO contracts, an ACO may elect the one-sided model that for the first two years is risk-free with only a percentage of shared savings being paid to the ACO.  Then in year three of this model, the ACO can incur potential losses.  The one-sided model will share up to a 50% savings after certain adjustments.

Alternatively, an ACO may instead elect to participate in a two-sided model that allows the ACO to share in both savings and losses for all three years.  The advantage to this two-sided model is that the ACO may keep potentially 60% of the savings in all three years, subject to certain quality scores.

The financial risk under both models is linked to 65 proposed quality measures which are aggregated into five domains of ACO performance.  ACOs that are able to manage and properly report their success in these quality areas will be successful, but the potential loss in year three or over all three years in the two-sided model is reducing the enthusiasm of many potential ACO sponsors.

CMS has estimated it may cost $1.8 Million to create and operate an ACO for one year.  MHA has reported much higher estimates.  Despite these high capital costs, CMS has also required (i) a 25% withhold on all shared savings bonuses to offset potential losses and (ii) at least 50% of its primary care physicians become meaningful users for the Medicare or Medicaid EHR Incentive Programs by the beginning of the second ACO year.  Both requirements exacerbate the capital necessary to operate the ACO.


The proposed regulations demonstrate certain conclusions:  the ACOs' organization and management structure is complex, intensely regulated and financially risky.  These challenges favor (1) large organizations who have already managed risk through delivery of insurance products, (2) organizations who have existing provider networks, and (3) large organizations with the technology and resources to determine compliance with quality goals and measurements.  Other less experienced healthcare organizations will have a harder time meeting all the proposed ACO standards without any managed care infrastructure currently in place.

With many in the industry worried about the risk and uncertainty found in current regulations, the industry commentary directs CMS to revise its proposed rules.  One can only hope that the complexity of the proposed ACO regulations do not overwhelm the health care industry so that the ACO goals of better care at a more reasonable cost are forgotten.

1This infrastructure may include electronic health records ("EHR") technology certified to the standards and specifications adopted by CMS for the purpose of meaningful use in connection with the EHR incentive program.