Models of Physician-Hospital Organization: Possibilities and Pitfalls

Lawton R. Burns, Ph.D., M.B.A. LDI Senior Fellow, Associate Professor of Health Care Systems, The Wharton School, University of Pennsylvania

Volume 2, Number 7; November 1995

Increasingly, health care in the U.S. is brokered by managed care organizations. In response, providers (physicians and hospitals) are forming new organizations to increase their bargaining power and strengthen their competitive position. This Issue Brief explores the models of physician-hospital organization and analyzes their potential impact on physician practice patterns.

Economic forces are driving the health care industry to develop new models of physician-hospital relationships

Changes in physician and hospital payment, coupled with increased managed care penetration and increased competition in health care markets, are leading to new relationships between hospitals and physicians. These relationships are different in that they are formally organized, contractual or corporate in nature, and include physicians outside the hospital medical staff.

Physicians face limitations on practice revenues, but must contend with increasing practice costs. Today’s practice environment is characterized by administrative complexity which requires more sophisticated information and management systems to handle the dictates of managed care.
Hospitals are feeling the long-term effects of the prospective payment system and managed care: decreasing inpatient volume and a shift to ambulatory settings. To maintain and build their census, hospitals must protect and widen their physician referral base.

Physician-hospital arrangements have varying degrees of common ownership, governance, and management

There are at least four different models of new physician-hospital arrangements. Some evidence suggests that these arrangements develop from lower-order to higher-order models.

A physician-hospital organization (PHO) is a joint venture between one or more hospitals and a group of physicians. It acts as the single agent for managed care contracting, presenting a united front to payers. In some cases, the PHO provides administrative services, credentials physicians and monitors utilization.
A management services organization (MSO) is a freestanding corporation that is owned by a hospital or PHO. It provides management services to one or more medical practices and serves as a framework for joint planning and decision making. Often, the MSO employs all nonphysician staff and provides administrative systems, in exchange for either a flat fee or a set percentage of group revenues.
The foundation model is a corporation, usually non-prořt, that is either a subsidiary of a hospital or an affiliate with a common parent organization. The foundation owns and operates practices, including facilities, equipment and supplies. The foundation employs all non-physician personnel and contracts with a physician-owned entity to provide medical services for the practice.
An integrated health organization (IHO) is a single legal entity with three subsidiaries: a hospital corporation, a medical services corporation, and an educational and research foundation. Typically, the IHO and its subsidiaries are all tax-exempt, and nonprofit. The medical subsidiary has a physician-controlled board and employs physicians to provide patient services.
Other models not addressed here include physician ownership of hospitals, and hospital ownership of group practices. Relationships between the hospital and the physician- investors or employees vary in these models.

A PHO aligns the interests of hospitals and physicians, but each entity retains its autonomy

According to the 1995 Report of the Physician Payment Review Commission, 15-20% of all hospitals had a PHO in 1994, and most others reported plans for a PHO. PHOs are popular because they allow hospitals and physicians to join forces for managed care contracts, while maintaining separate lines of business.

The two parties can exert greater bargaining leverage and respond to purchaser preferences for a single, bundled price. To be seen as cost-effective by purchasers, the PHO must have active utilization management, sophisticated information systems, and intensive involvement of physicians in developing standards of care. PHOs have not yet developed this infrastructure.
To avoid concerns of antitrust, the PHO must entail significant elements of risk sharing for the both parties.

In an MSO, the risk of the entire practice is shared between the physicians and the owner of the MSO

An MSO usually owns the tangible assets of the physician's practice. This model entails closer ties between the two parties, but offers important advantages to physicians.

The MSO serves as a vehicle to transfer hospital capital to the group of physicians, which can be used to expand clinical services, staff or operations.
The MSO provides administrative systems that may not be affordable to the medical practices separately. It may also provide comprehensive patient services that manage care and assume financial risk.

The foundation model offers most of the advantages of an MSO, but also includes the availability of tax-exempt status.

A foundation typically owns both the tangible and intangible assets of the physician's practice. This arrangement comes with the possibility for tax-exempt status, which brings the foundation access to cheaper capital and exemption from sales and income taxes.

To qualify for tax-exempt status, foundations must primarily engage in activities that serve charitable purposes, such as provision of health care services regardless of ability to pay.
The foundation's net profits must not unduly benefit private shareholders or the physicians (also called the "private inurement proscription").
No more than 20% of the foundation's board of directors can be contracting physicians. Because physician participation in governance is limited, there is relative loss of physician control in the tax-exempt foundation model.

An IHO provides the highest degree of alignment of interests and incentives between physicians and hospitals

An ideal IHO merges the financing and delivery of health care, and offers many advantages to both physicians and hospitals.

An IHO allows the corporation to design and control its own delivery systems, benefit programs, and contracts. Coordination among hospital, physician and insurance activities is handled through internal transfer pricing, rather than through market transactions.
An IHO typically owns a managed care company and enjoys greater leverage over managed care contracts external to the system. This enables providers to compete with existing integrated systems.
An IHO has the best potential to develop a comprehensive, community-based system of care that is integrated in design and absent of duplication.

Closer integration of physicians and hospitals raises many organizational issues

The new physician-hospital models generate a number of managerial issues that need resolution.

In a single contracting unit of physicians and hospitals, two revenue streams are merged. The unit receives a capitated payment, which then must be split fairly between the two parties. The organization must determine the proper mix of fees and incentives that will encourage both parties to manage utilization effectively.
Adequate physician representation in governance is necessary to foster collaborative decision making in these new models. All parties should be sensitive to physician apprehension about bureaucratic control, declining autonomy, and practicing in unfamiliar, organized settings.

What are the potential effects of physician-hospital organizations on clinical care?

A recent study of obstetrical patients by Burns et al. (1994) found that physician practice factors explained much of the variability in the use of hospital resources. Physicians with larger practices and a higher share of managed care patients managed hospitalized patients more effciently, after controlling for severity of illness and other patient factors. Surprisingly, efficiency decreased as the concentration of a physician's practice at one hospital increased. These findings have implications for the new physician-hospital arrangements.

Previous research on physician practices suggest that physician-hospital arrangements may improve efficiency

The new physician-hospital networks will help to maintain and increase the patient volumes of physician members, thereby fostering practice efficiency.
Physician-hospital networks will increase the managed care caseload of both parties. As this happens, physicians will be subject to more cost-containment measures and risk sharing arrangements, which will foster efficiency.
Physicians will concentrate a greater share of their practice at one institution where they have contractual or salaried ties. This concentration may lower the efficiency of physician practice.

Policy Implications

Given the finding that the concentration of a physician's practice in one hospital has a negative impact on efficiency, physicians should be allowed to maintain multiple affiliations with multiple health plans in the community.
The new models of physician-hospital organization should clearly document the roles and expectations of both parties. The medical group’s control over medical practice and quality assurance should be respected.
Educators in medicine and health care should emphasize managed care contracting, utilization and quality management, the development of systems and networks, and the legal barriers to such arrangements.
Research is needed to document the processes and outcomes of these new models. It is important to determine which of the various models are most successful in delivering comprehensive care at the community level, and to identify specific characteristics of successful models.

This brief is based upon the following articles: L.R. Burns and D.P. Thorpe, Trends and Models in Physician-Hospital Organization, Health Care Management Review 1993; Fall:7-20; L.R. Burns, J.A. Chilingerian & D.R. Wholey, The Effect of Physician Practice Organization on Efficient Use of Hospital Resources, Health Services Research 1994;29:583-603.