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Changes Ahead for California’s Managed Care Regulatory Scheme                                        
May 16, 2019

California’s Department of Managed Health Care (“DMHC”) recently finalized regulations that significantly expand what it means to take on “global risk,” which triggers the requirement to obtain a Knox-Keene license or an exemption. Historically, the requirement to obtain a Knox-Keene license has been reserved for health maintenance organizations (“HMOs”) or other organizations that are paid on a capitated basis in exchange for providing or arranging health care services.

The new regulation will disrupt this status quo by sweeping in a range of value-based payment arrangements – potentially including independent practice association (“IPA”) participation in hospital risk pools and some accountable care organizations (“ACOs”) – that providers have historically entered into without needing to be licensed as a Knox-Keene plan. California-based providers that engage in these types of payment arrangements should therefore pay special attention to these new rules as they are implemented.

Though the rules technically take effect July 1, 2019, the Department recently released draft guidance indicating that the licensure requirement will be phased in such that prior approval will not be required during the second half of 2019, and for the time being, certain arrangements will not be subject to the licensure requirement at all – including bundled payments, arrangements under the purview of the California Department of Insurance, and ACOs regulated by the Centers for Medicare & Medicaid Services (“CMS”). However, while the guidance remains in draft form, providers should pay close attention to this shifting regulatory landscape.

The Current Regulatory Framework

The Knox-Keene Health Care Service Plan Act of 1975 (the “Knox-Keene Act”) was enacted to “promote the delivery and the quality of health and medical care to the people of the State of California who enroll in, or subscribe for the services rendered by, a health care service plan …” Accordingly, the focus of the law is “health care service plans.” These are defined in the statute to include “any person who undertakes to arrange for the provision of health care services to subscribers or enrollees, or to pay for or to reimburse any part of the cost for those services, in return for a prepaid or periodic charge paid by or on behalf of the subscribers or enrollees.” Health & Safety Code § 1345. Under the law, a license issued under the Knox-Keene Act is generally required in order to operate a health care service plan.

Historically, the term “prepaid or periodic charge” has been widely understood to describe capitation, or a per-member, per-month payment made in advance to an organization for providing or arranging for health care services for those members. A fully-licensed plan enrolls its members directly (as individuals or groups) and provides or arranges for those members to receive services in exchange for a premium, while a restricted plan contracts with a fully-licensed plan to arrange for or provide services to that plan’s members.[1]

The statute does not require any other type of organization to be licensed as a health plan. After several large medical groups that accepted capitation from health plans faced financial collapse in the 1990s, however, the Department began regulating these groups indirectly, requiring the licensed Knox-Keene plans that contracted with them to ensure that they had sufficient capitalization to take on financial risk. These medical groups are referred to in the regulations as “risk-bearing organizations” (“RBOs”). Because these groups only take risk for services that are within the scope of their professional licenses, they have traditionally been considered exempt from the requirement to obtain a full or restricted Knox-Keene license.[2]

Setting the Stage for New Rulemaking

Until now, the Department has not sought to regulate other provider types – including hospitals – that take on significant financial risk in their arrangements with health plans or employers. The new regulation represents a step in that direction, though it is not entirely clear why the Department decided to engage in new rulemaking.

Several recent developments may provide insight into the Department’s decision-making. First, in a 2015 decision, Hambrick v. Healthcare Partners Medical Group, Inc., the California Court of Appeal invited the Department to determine “the level of financial risk… that causes [an organization]… to become a ‘health care service plan,’ ” because that “is precisely the type of regulatory determination involving complex economic policy that should be made by the DMHC in the first instance.”[3]   This may have encouraged the Department to engage in rulemaking to provide guidance on the types of activities for which it considers a license to be necessary.

Second, the Department has indicated that it is uncomfortable with the amount of risk-taking by certain provider groups, including those that contract directly with employers that self-insure and are not regulated by the Department. This suggests that the new regulation was specifically intended to allow the Department to oversee these activities. Finally, the Department has expressed a desire to provide clarity around certain concepts, like “restricted” or “limited” licenses, that are not currently described in the Knox-Keene Act or its implementing regulations.

Expanded Licensure Requirement Under the New Regulation

The regulation echoes the statutory requirement that a license is required in order to take on “global risk” (subd. (b)(1)) which is defined as “The acceptance of a prepaid or periodic charge from or on behalf of enrollees in return for the assumption of both professional and institutional risk” (subd. (a)(1)).[4]

This aligns closely with the language of the statute, which requires a health plan to obtain a Knox-Keene license to accept a “prepaid or periodic charge” in exchange for providing or arranging health care services. While this has historically been understood to refer to capitation, the new regulation departs from this traditional interpretation in how it defines a “prepaid or periodic charge,” which is defined under subdivision (a)(4) as “any amount of compensation, either at the start or end of a predetermined period, for assuming the risk, or arranging for others to assume the risk, of delivering or arranging for the delivery of the contracted-for health care services for subscribers or enrollees that may be fixed either in amount or percentage of savings or losses in which the entity shares.” (Emphasis added.)

This new definition changes the historical understanding of a “prepaid or periodic charge” in two key ways. First, the reference to payments made at the “start or end of a predetermined period” departs from the traditional understanding that only organizations that charge advance payments for providing or arranging for health care services – that is, capitation – would be subject to licensure.

Second, the regulation’s reference to charges of amounts “fixed either in amount or percentage of savings or losses in which the entity shares” establishes that payment arrangements involving fee-for-service payments, with an opportunity to share savings if the total amount of payments made under the arrangement is under budget, are also considered a “prepaid or periodic charge.” This upends the capitation concept entirely: take, for example, a contract by which a provider is paid for health care services using a fee schedule, but is entitled to 50% of any savings the provider can achieve against a target budget. The provider would be accepting compensation at the “end of a predetermined period” that is “fixed” in the “percentage of savings… in which the [provider] shares.” This common arrangement, which is currently used by many IPAs in their risk pools, and by accountable care organizations (“ACOs”), would require a Knox-Keene license under the new regulation.

The New Scheme Will Be Phased In Over the Second Half of 2019

The new regulation expressly applies to contracts “issued, amended, or renewed” on or after July 1, 2019. (Subd. (e).) As a result, payment arrangements between providers and payors that satisfy the new definition of a “prepaid or periodic charge” do not require a license on July 1, 2019, – if the arrangement is already in place as of that date.

Instead, the regulation requires a license (or exemption) for any payment arrangements that are entered into, amended or renewed on or after July 1. The Department’s recently-issued draft guidance indicates that the Department is thinking of phasing in the licensure requirement, giving providers more time to comply with the new rules.

First, the draft guidance indicates that arrangements entered into, amended or renewed in the first six months after the rule is in effect will be deemed exempt from the licensure requirement. An organization would not need to seek prior approval from the Department for arrangements entered into, amended or renewed in the first six months the regulation is in effect. Rather, an organization can simply submit a request for an expedited exemption within thirty days of entering into, amending or renewing the arrangement or beginning to perform under it (whichever is earlier), and the Department will deem the arrangement to be exempt. This six-month phase-in will significantly ease the burden for providers that are establishing new payment relationships, or amending or extending existing relationships, in the latter half of 2019.

Second, the draft guidance document indicates that the Department will consider certain payment arrangements to be entirely outside of the scope of the licensure requirement for now. These include bundled payments, case rate, diagnosis-related group payments, and per diem arrangements; ACOs regulated by CMS; and arrangements where the payor is an insurer licensed by the California Department of Insurance.

If the draft guidance is finalized as currently written, this means that providers will have more time to comply with the new rules, and that certain providers might not need to seek an exemption from the Department at all.

Compliance in 2020 and Beyond

Although the grandfathering and phase-in provisions contemplated by the regulation and draft guidance, respectively, provide some much-needed relief from the immediate need to obtain a license or exemption, many organizations will eventually need to pursue one of these paths. While providers can seek a Knox-Keene license in order to comply with the new rules, this is probably an unrealistic and undesirable option for many providers. Obtaining and maintaining a Knox-Keene license involves complying with a host of complex requirements that are aimed at traditional HMOs and are simply inappropriate for providers whose only risk-bearing activities involve entering into value-based payment arrangements with health plans and other payors. For these providers, obtaining an exemption from the Department will likely be the most efficient way to comply with the new rule in the long term.

The regulation provides some insight into how the Department will respond to exemption requests. First, the regulation identifies materials that should be submitted to the Department by an organization seeking an exemption, including contracts for the assumption of risk, financial information, and information about the patient population affected by the arrangement for which an exemption is being sought. (Subd. (b)(2).) The regulation also specifies the criteria the Department considers in determining whether to grant an exemption, including information related to the applicant’s financial wherewithal and market conditions. (Subd. (b)(3).) During informal conversations with stakeholders, the Department has signaled that it is more likely to grant exemptions for relatively low-risk arrangements entered into by well-established organizations that have greater financial resources. Under the new regulation, the Department must respond to requests for exemption within thirty days of receipt of the request. (Subd. (b)(4).)

Another path forward is to enter into only payment arrangements that are not subject to the new rule. Providers could redesign existing payment arrangements to avoid falling within the scope of the new rule; for example, providers that currently share in a payor’s savings or losses may redesign those agreements to incorporate different incentives for providing efficient, effective care. Moreover, according to the draft guidance, the Department will not apply the licensure requirement to certain common payment arrangements (such as bundled payments, Medicare ACOs, etc.), though it is unclear how long the Department will take that position.

As July 1 approaches, California providers should develop a strategy for complying with the new rule. Unless and until the Department’s draft guidance is finalized, providers should not rely on draft guidance and should be prepared to comply beginning July 1.

To discuss whether the new rule impacts your organization and explore paths forward, please contact Stephanie Gross in San Francisco, Charles Oppenheim in Los Angeles, or your regular HLB contact.


[1] Until now, restricted (or limited) plans have never been described in statute or regulation, and the Department issued licenses to these plans with waivers from the various requirements under the Knox-Keene Act that are only appropriate for plans that market directly to individuals and groups.

[2] Professional corporations, independent practice associations (IPAs) and medical foundations can also be RBOs.

[3] 238 Cal.App.4th 124, 149.  While this case dealt squarely with the amount of risk-taking that requires an RBO to obtain a license, it raised questions regarding the level of risk-taking that requires an organization to obtain a Knox-Keene license generally.

[4] All references are to a new regulatory section, section 1300.49 of title 28 of the California Code of Regulations.

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