Due Diligence and Financial Assessment: Selecting Rural Integrated Healthcare System Business Partners

by Mike Fadden, Rural Health Consultants

This is the second in a series of three articles concerning partnering relationships and the emerging rural Administrative Services Organization (ASO). The first article, published in the Spring/Summer 2000 DRIS newsletter, was devoted to issues of fit, "Finding the Right Business Partners", based on local values and expectations. In this second article, the focus is on the financial and due-diligence questions which should be asked in the process of choosing a business partner. In the third article, also published in this newsletter, we explore contracting issues to be considered when an ASO enters into a partnering relationship.

In this series of articles, business partners are those entities that the ASO contracts with:

1) to outsource services, such as claims administration, on behalf of a local provider-owned risk bearing network and/or self-insured employers;
2) to develop and/or provide locally-branded health care coverage using local and regional provider networks, such as health plans, insurance companies or other third party payers; and,
3) to have as a financial investment partner, such as a hospital or health system.

Background

As part of their managed care strategies, some DRIS communities chose to develop a community-owned, non-profit Administrative Services Organization (ASO), which is also referred to as a Community Health Organization (CHO). In the context of managed care, such an organization serves a variety of "customers" by providing value-added health plan administrative and medical management services designed to maintain local control of health care decisions. These customers may be health plans, insurance companies, self-insured employers or pr-ovider-owned risk-bearing entities such as a physician IPA or other form of provider network. ASO/CHOs do not assume financial risk for providing covered health care services to a defined population as do their potential customers. Rather, they provide services to assist these customers in managing such risk.

A community-based ASO/CHO can also perform other functions, depending on local needs, which may not directly relate to managed care. Such functions could include centralized provider credentialing, physician practice management services, and community health assessment and improvement programs. The scope of services undertaken by the ASO/CHOs at each of the DRIS sites varies, depending upon local community needs and what potential customers will purchase.

Why Develop a Partnering Relationship?

Unlike their urban MSO counterparts, a rural ASO/CHO will probably not perform all of the functions relating to managing care and insurance risk. For example, the smaller population base of most rural markets will require the ASO/CHO to outsource claims processing to a Third Party Administrator (TPA), at least initially. The ASO/CHO could arrange a straight -forward service contract with the TPA, or, with the right TPA partner, the ASO/CHO could negotiate a partnership arrangement where the TPA assists the ASO/CHO to incrementally develop its own in-house capacity to process claims for beneficiaries served by its own contracts.

In some instances, the rural ASO/CHO may want to find health plan partners that are willing to outsource local provider contracting, utilization management and quality review activities to the ASO/CHO in exchange for potential new business that may be attracted to a health plan that features local control of health care decisions. For other rural communities, it may be necessary to find a larger health system to be a financial partner in order to sustain their local health system. The ASO/CHO may be the appropriate intermediary to negotiate such a relationship on behalf of the community, seeking the right financial partner who will commit to keeping the local health system intact.

Advantages & Disadventages of a Partnering Relationship

Regardless of the ASO/CHO's purpose for seeking a partner, it should be aware of the potential advantages and disadvantages of a partnering relationship. Advantages include the following:

If with an HMO, the partnership can leverage the HMO's Knox-Keene License to locally market a product line designed to more appropriately meet local needs;
If with an HMO, the partnership can develop a risk sharing arrangement that more appropriately incentivizes local providers based on local market risk factors;
If with a TPA, the partnership can enable the ASO/CHO to process claims and provide effective management reports to clients while minimizing capital requirements; and
If with a larger health system, the partnership can leverage the health system's resources to improve existing services, increase access and develop new services that address local priorities.

The potential disadvantages of developing a partnering relationship with an HMO, TPA or larger health system include:

Some loss of local control over health care decisions and the deployment of health care dollars;
A potential dependency on the partner such that plans, programs and services developed by the partnership will fail if the partner pulls out of the market; and
Waning interest by the partner in continuing to invest resources into the partnership as market conditions and priorities shift over time.

Preparation & Due Diligence

An ASO/CHO should be concerned about the capacity of potential partners to contribute the resources and services needed to fulfill the purpose of the partnership, including the partner's financial viability and the quality and value of the services it can provide. An ASO/CHO should also be concerned about the extent of control a partner may wish to exercise over important issues. Preparation is the key to addressing these concerns. Before searching for a business partner, an ASO/CHO should carefully prepare an action plan, giving thoughtful consideration to the potential advantages and disadvantages.

This plan should:

Develop a clear and realistic purpose for the partnership;
Identify potential partners that may meet the ASO/CHO's requirements;
Develop a sound negotiating position which sets limits on what the ASO/CHO will and will not accept; and
Prepare a comprehensive Request for Information (RFI) to be forwarded to identified, potential partners.

The RFI should lay out the purposes of the ASO/CHO and of the partnership. It should clearly state the ASO/CHO's expectations and, in terms of due diligence, require the potential partner to answer questions and provide information covering the following areas.

1. History & Background of the Potential Business Partner

The RFI should request general background information about the formation, tax status, control, strategic direction, products and/or services, target markets, market penetration and financial history of the business partner. It should also request information regarding its licensing status, if applicable, and any legal or regulatory problems it has experienced. If publicly held, the RFI should request a copy of the most recent S-10 filing with the Securities and Exchange Commission. Organ-ization and management structure, including biographical sketches of key corporate board members and officers, would also be helpful. For all potential business partners, examples of any experience or expertise in rural health care issues should be requested.

2. Business Partner's View of Rural Health and the Future of Health Care

The RFI should ask the potential business partner to describe its major strategic initiatives for the next five years, including its rural strategy, if any. It should also request a description of its assessment of the future of health care service organizations, delivery and financing, including its view of rural health care.

3. Financial Viability of the Business Partner

If not provided by the potential partner's S-10 filing, the RFI should specifically request financial information, including detailed financial statements and a statistical summary of the entity's financial performance over the last three years.

4. Services and/or Resources Requested

The RFI should clearly state the specific services and/or resources the ASO/CHO is seeking from the business partner and the potential benefits that the business partner may gain as a result of the partnership. If the ASO/CHO's purpose is to develop a locally appropriate line of health plans with an HMO partner, the RFI should seek to determine:

The willingness of the potential HMO partner to offer a private label product or to market existing or amended health plan products in the service area;
The HMO's premium costs, as well as its willingness to delegate medical management functions to the ASO/CHO;
That portion of the premium dollar the ASO/CHO can retain to cover the costs of the administrative and medical management services it provides to the partnership;
The potential HMO partner's approach to marketing a locally branded product line and whether or not it is willing to contract with local insurance brokers; and
The HMO's provider networking strategy, including how it develops access to provider networks in other rural and upstream markets and, specifically, how it plans to develop a rural appropriate risk sharing strategy with the ASO/CHO's provider network. This will, undoubtably, be tied to the degree of control the ASO/CHO and its provider network wish to exercise over administrative and medical management functions, including provider credentialing.

5. Claims Processing

If the ASO/CHO's purpose is to provide value-added plan administration and medical management services to provider-owned risk bearing entities and/or self-insured employers, without the use of a Knox-Keene License, it will want to specify the claims processing, member services and management reporting services a TPA partner should provide, including potential fees the TPA may charge for these services. In addition, the RFI should seek to determine:

The experience and quality of the TPA's services, including client satisfaction and performance measurements, such as claims turnaround, claims error rates and grievance rates. Samples of weekly, monthly and annual management reports for clients should be requested;
The extent of the TPA's access contracts with various local, regional and national provider networks, and the fees these networks charge the TPA for network access;
Additional capabilities such as benefit design and administration of other employee benefits such as dental and vision care, disability coverage and worker's compensation; and
The RFI should request the TPA to provide at least five client references.

If the purpose of the partnership is to leverage the resources of a larger health system to improve existing services, develop new services or increase access to services, the RFI should specify the program and services development assistance requested, including the nature of any financial investment. In addition, the RFI should seek to determine:

The health system's experience in assisting other rural health systems, and the specific benefits that accrued to both parties and the rural community, including how these benefits were measured. If the health system has experienced failed partnering relationships with other rural health systems, information as to why these partnerships failed should be requested;
The strengths of the health system relevant to the specific program and service objectives of the ASO/CHO; and
The RFI should request the health system to provide at least three references of other rural health systems with whom it has partnered in the last three years.

As complex and dynamic as the health industry is today, the ASO/CHO will often require the services of more than one type of entity. For example, an HMO or insurance company may be interested in partnering even if it provides an "administrative services only" (ASO) contract. In this case, the HMO or insurance company is playing the role of a TPA. On the other hand, some health systems have developed their own in-house TPA capabilities.

6. Business Partner's Capacity to Serve the ASO/CHO and its Rural Market

The RFI should address the potential business partner's capacity to invest the effort and dollars to work with the ASO/CHO. If the partnership's purpose is to market a line of locally branded health plans, the potential HMO partner must demonstrate that it has the capacity to take on additional covered lives and perform all the administrative functions not delegated to the ASO/CHO, likewise for a potential TPA partner. For all potential partners, capacity should include adequate field personnel to support the partnership's activities as well as the assignment of an appropriate manager or executive to the project.

7. Community Education and Health Improvement

To the extent that the ASO/CHO desires to develop and implement community health improvement programs, it should request information about the potential partner's experience in developing, implementing and measuring the performance of community-wide health improvement programs in rural communities. It should also determine whether or not the entity is willing to work with the ASO/CHO and its provider network to develop such programs.

Once the RFI has been completed, it should be forwarded to the identified potential partners along with a cover letter that summarizes the purpose and goals of the partnership and outlines the requirements that must be met in responding to the RFI. These requirements should include a deadline for returning a completed RFI. The deadline should be reasonable, such as 30 days.

Continuing Due Diligence

When the RFIs have been returned, ASO staff should review them for completeness and obtain additional information from the respondent if necessary. ASO staff and a Board level committee should be appointed to grade each RFI in accordance with the criteria previously established by the Board during the planning process. ASO staff and committee members should keep in mind that the negotiating process will reveal additional information that may significantly impact a final decision. The due diligence efforts of the ASO should continue throughout the selection, negotiation and contractual development process, as well as after a partnership has been formed.

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