October 20, 2019

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New Regulation Clarifies DMHC’s Position Regarding Knox-Keene Licensing

After a protracted comment period, the California Department of Managed Health Care (the “Department”) formally adopted its much anticipated “global risk” regulation (the “Regulation”), which will go into effect on July 1, 2019. As more specifically set forth in Section 1300.49 of the California Code of Regulations (“CCR”) and as described below, the Department has formalized its long-standing policy that any person that assumes “global risk” must obtain a license to operate a health care service plan and has added a process whereby such a person can seek an exemption from such licensure. As a result of new definitions for the terms “global risk” and “prepaid or periodic charge,” the Regulation marks a significant expansion of the Department’s oversight activity, and is likely to have a substantial impact on a variety of entities and arrangements in the State.

Scope of Knox-Keene Act Licensure Statutes and Regulations

Historically, the Knox-Keene Health Care Service Plan Act of 1975 and the regulations promulgated thereunder (collectively, the “Knox-Keene Act”) established a framework for licensing health care service plans. The Knox-Keene Act defines a “health care service plan” as “[a]ny 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.” The Regulation builds on other provisions of the Knox-Keene Act by providing that “any person who assumes global risk shall obtain a license to operate a health care service plan.” Assuming “global risk” has been defined as accepting a prepaid or periodic charge from or on behalf of enrollees in return for the assumption of both professional and institutional risk.

Prepaid or Periodic Charge

The Department broadly defines a “prepaid or periodic charge” 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.” This means that whether an agreement is for a fixed amount or a percentage, a savings or a loss, at the start of a period or at the end, it can qualify as a prepaid or periodic charge. However, as noted in the definition above, acceptance of a prepaid or periodic charge alone does not trigger the Knox-Keene Act licensure requirements. There must also be an assumption of both professional and institutional risk.

Professional and Institutional Risk

The Regulation essentially defines professional risk as financial responsibility for the cost of the provision of professional medical services, and institutional risk as financial responsibility for the cost of the provision of hospital inpatient, hospital outpatient, or hospital ancillary services (to the extent not provided pursuant to the person’s own license).

This expansive definition of “global risk” could bring a variety of arrangements under the regulatory purview of the Department, such as shared savings arrangements and hospital risk pool arrangements. Numerous commentators encouraged the Department to narrow the definition and/or explicitly carve out certain arrangements in order to avoid the Regulation having a chilling effect on the health care market. However the Department consistently replied that the requirement for reviewing and potentially licensing entities engaged in a “global risk” arrangement would not be disruptive, and instead would provide greater consumer protections; and further that any entity that desires to avoid the regulatory requirements could seek exemption, which will be discussed further below.

Restricted Health Care Service Plans

The Regulation codifies the Department’s position regarding “restricted” health care service plans, a category of licensure previously acknowledged and granted by the Department, but not explicitly defined in the Knox-Keene Act. Under the Regulation, a restricted health care service plan is defined as “a person with a health care service plan license issued by the Department for the provision of, or the arranging, payment, or reimbursement for the provision of, health care services to subscribers or enrollees of another full service or specialized health care service plan under a contract or other arrangement whereby the person assumes both professional and institutional risk but does not directly market, solicit, or sell health care service plan contracts.” Stated more simply, a restricted health care service plan is a person that contracts with a fully licensed health care service plan to assume global risk with respect to subscribers or enrollees of the fully licensed plan (effectively a risk intermediary).

Pursuant to the Regulation, a person seeking licensure as a restricted health care service plan must file the following with the Department:

  • an application for licensure in accordance with section 1351 of the Health and Safety Code and rule 1300.51 of the CCR (the application for licensure includes all exhibit types);
  • all contractual agreements between the applicant restricted health care service plan and the full service health care service plan, or specialized health care service plan; and
  • a Restricted Health Care Service Plan Responsibility Statement (an item not previously required under the restricted license application process), which Statement will describe the obligations of both the applicant restricted health care service plan and its fully licensed plan partner (i.e., a delineation of responsibility).

Exemption Process

The Regulation provides an exemption process for persons that wish to be excluded from the license application process and ongoing compliance obligations under the Knox-Keene Act. Specifically, the Director of the Department is required to grant an exemption upon review and a finding that the action is in the public interest and not detrimental to subscribers, enrollees or other persons regulated under the Knox-Keene Act.

To apply for an exemption, a person must submit the following information for consideration:

  • financial statements related to the applicant’s viability;
  • the total percentage of annualized income of institutional risk the applicant will assume;
  • the contract(s) for the assumption of risk;
  • the estimated number of subscribers and enrollees;
  • the geographic service area under consideration; and
  • any other information the applicant believes to be appropriate or relevant for the Department to consider.

The Department is required to issue a decision regarding a request for exemption within 30 days of receipt of the request. In reviewing the above-described information, the Director is required to consider the following factors:

  • the person’s portion of contracted global risk when compared to the person’s overall business;
  • the portion of market share the person assumes for global risk in the geographical region compared to the market share assumed by other persons within the region, and whether disruption will occur in the marketplace if the person fails to maintain financial solvency;
  • the financial capacity to assume a portion of global risk without jeopardizing enrollee access to basic health care services in the geographical region;
  • the potential impact on the health care marketplace in the geographical region in which the person operates, including the impact on contracted institutional and professional providers, if the person is unable to maintain financial solvency; and
  • whether the issuance of an exemption will negatively impact public interest or protection of the public, subscribers, enrollees, or persons subject to the Knox-Keene Act, if the person assumes global risk.

Although the exemption application process has yet to be implemented, it stands to reason that an applicant would be well advised to submit supplementary materials and information – as permitted under the Regulation – that would support a positive finding with respect to the above factors.

Legacy Agreements

The Regulation only affects contracts issued, amended, or renewed on or after July 1, 2019. Beyond granting a temporary reprieve from potential licensure, this limitation enables existing persons or arrangements within the scope of the Regulation to apply for licensure or an exemption before their existing contract is amended or renewed.

The Regulation also allows limited health care service plans and restricted health care service plans licensed by the Department or its predecessor as of July 1, 2019 to continue to engage in business as limited health care service plans or restricted health care service plans, as applicable.

Interaction with Other Programs

The Department stated during the public comment period that the Regulation will not affect products that are licensed by the California Department of Insurance or the Centers for Medicare and Medicaid Services. However, this statement is murky since entities that assume “global risk” from Medicare Advantage plans must be licensed as health care service plans. Additionally, the Department noted that “the proposed regulation may impact Accountable Care Organizations or other arrangements that, considering the proposed regulation, meet the definition of a health care service plan […] [though] such entities may always seek exemption from licensure.” In its Final Statement of Reasons, the Department estimates that it may license up to two-thirds of the estimated 67 ACOs in California – which we believe could include Medicare ACOs.

Providers that assume only professional risk will not be required to apply for licensure as a health care service plan (rather, historical regulations relating to risk-bearing organizations (RBOs) would govern). However, the assumption of any portion of institutional risk could subject such providers to licensure requirements under the Regulation, including, but not limited to, participation in a hospital risk pool.

Given its significant reach and its potentially wide-ranging implications, the Regulation has garnered significant attention from industry participants. Providers and other organizations that assume risk in California would do well to take advantage of the interim period prior to the Regulation’s effective date to assess their existing contractual relationships and develop strategies to ensure post-implementation compliance.

Copyright © 2019, Sheppard Mullin Richter & Hampton LLP.

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About this Author

Eric Klein, Legal Specialist, Sheppard Mullin, national healthcare practice
Partner

Eric Klein leads the 95 attorney national healthcare practice, and is a partner in the Century City office, of Sheppard Mullin Richter & Hampton LLP, a full service AmLaw Global 100 law firm with offices throughout California, New York, Chicago, Washington, D.C., London, Brussels, Beijing, Seoul and Shanghai. With over thirty years of practical legal and business experience, his practice focuses on the healthcare, technology and related industries. Known in the business community for his creative solutions and deal-making ability, Eric uses deep industry knowledge, entrepreneurial...

310-228-3728
Lynsey Mitchel, Attorney, Sheppard Mullin, Corporate Practice
Asssociate

Lynsey Mitchel is an associate in the Corporate Practice Group in the firm's Century City office and is a member of the firm's healthcare practice team.

Areas of Practice

Lynsey represents hospitals, managed care organizations, medical groups, pharmacies, home health providers, medical device retailers and other health care entities and providers. 

Lynsey has deep expertise in HMO regulatory matters and has assisted numerous clients to obtain HMO licensure as health care service plans under California’s Knox-Keene Health Care Service Plan Act. Lynsey has represented approximately half of all currently licensed restricted Knox-Keene HMO license holders in California in their licensure process. Lynsey has worked on HMO licensure and other matters for Medicare Advantage, commercial and Medicaid health plans.  Lynsey also assists health plans with regulatory compliance matters, material modifications, growth strategies, acquisitions and training. 

310-228-3745
Matthew Goldman, Corporate Attorney, Sheppard Mullin Law Firm
Associate

Matthew Goldman is an associate in the Corporate Practice Group in the firm's Century City office and is a member of the firm's healthcare practice team.

Areas of Practice

Matthew’s practice blends the regulatory and transactional components of healthcare law, and includes representation of hospitals, managed care organizations, medical groups, and other healthcare entities and providers. On the regulatory side, Matthew’s practice is focused on licensing, regulatory compliance, and managed care arrangements. Matthew has extensive experience preparing Knox-...

310.228.2285
John Tilton Corporate Attorney
Associate

John M. Tilton is an associate in the Corporate Practice group in the firm's Century City office.

Education

  • J.D., University of California, Los Angeles, 2018

  • B.A., Hillsdale College, 2014

Admissions

  • California

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