The Sound Health Association: A Federally Qualified Health Maintenance Organization

Published by the Government Accountability Office on 1977-12-02.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                         DCCUMENT RESUME
04295 - fB3394623] (Restricted)
The Sound Health Association: A Federally Qualified Health
Maintenance Organization. HRD-77-119; B-164031(5). December 2,
1977. 26 pp. + 5 appendices (15 pp.).

Report to Rep. Paul G. Rogers, Chairman, House Committee on
Interstate and Foreign Commerce: Health and the Environment
Subcommittee; Son. Edward M. Kennedy, Chairman, Senate Committee
on Human Resources: Health and Scientific Research Subcommittee;
by Elmer B. Staats, Comptroller General.
Issue Area: Health Programs: Health Maint. Organization's
    Compliance with Law (1214). their Viability as A1ternative
    to fee-for-service mode of Producing Care
Contact: Human Resources Div.
Budget Function: Health: Health Care Services (551)}.
Organization Concerned: Department of Health, Education, and
    Welfare; Sound Health Association, Inc., Takora, WA.
Congressional Relevance: House Committze on IntDerstate and
    Foreign Commerce: Health and the Environment Subcommittee;
    Senate Committee on Human Resources: Health and Scientific
    Research Subcommittee.
Authority: Public Health Service Act (42 U.S.C. 246(e)). Health
    Maintenance Organization Act of 1973, as amended. P.L.
    94-63. 42 U.S.C. 242b (Supp. V). 42 U.S.C. 229b. 42 U.S.C.

          The Sound Health Association, Inc., of Tacoma,
Washington, is a consumer-owned, prepaid health plan and was the
 first health maintenance organization qualified by the
Department of Health, Education, and Welfare (HEW) under the
Health Maintenance Organization Act. The provision of health
care services on the basis of prepaid rates provides incentives
for the organization to emphasize preventive medicine to reduce
overall health care costs. Findings/Conclusions: The Sound
Health Association appears to be providing comprehensive prepaid
health care in accordance with the act. Although delays in the
publication of implementing regulations slowed the development
of the association and caused increased operational costs, it
should have enough operating income to meet operating costs by
the second quarter of calendar year 1979 provided that it meets
enrollment projections, improves marketing efforts, and controls
costs. The association requested a waiver of the open enrollment
requirement. HEW did not issue the waiver, but it has not forced
the association to have an open enrollment period. The
association is serving the indigent but has not actively so'nght
enrollment of high risk individuals. As of December 31, 1976, it
was providing comprehensive health care services to 6,016
members. The Federal Government requires employers to include a
health maintenance organization in their employees' health
benefit plans. For employees represented by a labor union, the
health maintenance organization alternative is subject to
collective bargining. Generally,   unioas have not offered the
plan as an option. (Author/SW)
        ESTytTrE     .          .    -  hoj r!!e,!ael outide the Genoral
                         A 4 :specific
                               "t   ft' 0          :' of        approval
      bah the            3a   a.*   C .. .; .@.   .i   .a$.onC


The Sound Health Association--
A Federally Qualified
Health Maintenance Organization

The Sound Health Association, Inc., of
Tacoma, Washington, is a consumer- owned,
prepaid health plan and was the first health
maintenance organization qualified by the
Department of Hrilth, Education and Wel-
fare under the law. As of December 31,
1976, the Sound Health Association was
providing comprehensive health care services
to 6,016 members.

HRD-77-119                                                       DECEMBER 2, 1977
                          WAIHINOTN D.C.       fhI


The Chairman and Ranking Minority Member
Subcommittee on Health and Scientific
Committee on Human Resources
United States Senate
The Chairman and Ranking Minority Member
Subcommittee on Health and the
Committee on Interstate and Foreign
House of Representatives
     This report discusses findings and conclusions on our
evaluation of Sound Health Association, Inc., of Tacoma,
Washington, a federally qualified health maintenance organi-
zation. A draft report was sent to Sound Health for review
and comment. Where appropriate, we have included its comments
in the report.

     This is the first in a series of 14 individual reports
to be issued in compliance with section 1314 of the Health
Maintenance Organization Act, as amended. An overall report
summarizing all our evaluations initiated under section 1314
will be submitted to the Congress by June 1978.

     As requested by the Chairman and Ranking Minority Member,
Subcommittee on Health and Sciertific Research, Senate Com-
mittee on Human Resources, we will be forwarding separate
reports on each health maintenance organization evaluation
to them and also to the Chairman and Ranking Minority Member,
Subcommittee on Health and the Environment, House Committee
on Interstate and Foreign Commerce.

     We are also sending copies of this report to the Depart-
ment of Health, Education, and Welfare. The Civil Service
Commission will receive copies of reports on health mainte-
nance organizations which participate in the Federal Employees
Health Benefits Program.
     While wehope that this and our subsequent
of federally qualified health maintenance organizations
be of use to the subcommittee(s) and the                   will
agencies, we believe that the public disclosure        Federal
                                                  of our dis-
cussion of several of the issues in the zeports
advertently and inappropriately have an adverse may in-
the health maintenance organizations' marketing effect on
and financial viability. Therefore, we
distribution of this report, and unless  have limited  the
subcommittee(s), we will restrict the public       by the
this and other reports in this series.        release o,

                               Comptroller General
                               of the United States

     REPORT OF THE                        THE SOUND HEALTH ASSOCIATION--

                 This report, on the Sound Health Association,
                 Inc., Tacoma, Washington, is one in a series
                 of evaluations of individual health mainten-
                 ance organizations. A health maintenance
                 organization provides health care services
                 to its members based on prepaid rates. This
                 provides incentive for an organization to
                 emphasize preventive medicine to reduce over-
                 all health care costs.
                 Sound Health appears to be providing compre-
                 hensive prepaid health care to its members in
                 accordance with the Health Maintenance Organi-
                 zation Act. Although delays in the publica-
                 'ion of implementing regulations by the De-
                 partment of Health, Education, and Welfare
                 (HEW) -lowed the development of Sound Health
                 and caused iiicreased operational costs,
                 Sound Health should have enough operating
                 income to meet operating costs by the second
                 quarter of calendar year 1979.
                Sound Health requested a waiver of the open
                enrollment requirement. HEW did not issue the
                waiver, but it has not forced Sound Health to
                have an open enrollment period.

                Sound Health is serving the indigent but has
                not actively sought enrollment of high risk
                individuals. Thus, its membership does not
                appear to represent the various age, social,
                and income groups in its service area.
                Sound Health will not have enough income to
                mee: operating expenses by the end of a
                36-month Federal loan subsidy period. Late
                publication of regulations by HEW delayed
                Sound Health's enrollment program, and member-
                ship has lagged about 6 months behind original
                projections. However, Sound Health should
                attain a brsak-even poirt--operational reve-
                nues will equal operatior   expenses--by

laor dats. Upon removal, the report
cover date should i notedhereon.      i                     HRD-77-119
the second quarter of calendar year 1979
provided that it
--meets enrollment projections,
-- improves marketing efforts, and
-- controls costs.
 Employers in the Sound Health service area
must include i health maintenance organiza-
 tion in their employees' health benefit
plans. Although some employers resent this
 Federal requirement, those contacted said
 the added administrative costs of offering
employees a health maintenance organization
were negligible. Sometimes employers paid
more for employee participation in the
Sound Health plan than in other health
benefit plans. However, in all cases, in-
creased employer contribution was volunt :y.
For employees represr.;Led by a labor union,
the health maintenance organization alter-
native is subject to collective bargaining.
Many employees in the Sound Health service
area receive health benefits through union
trust programs negotiated through collective
bargaining. Sound Health has generally
been unsuccessful in getting unions to
offer the health maintenance organization
as a health benefit plan option for
In commenting on this repcrt in July 1977,
Sound Health stated that they generally
agreed with GAO's conclusions. They point
out that the organization has grown to
9,200, the marketing system is better
organized, and controls imposed on health
services are working well.


DIGEST                                                    i

   1      INTRODUCTION                                    1
              Sound Health Association                    2
              Federal financial assistance                4
              Scope of evaluation                         5
            ACT?                                          7
              Open enrollment                             7
              Enrollment of members broadly represen-
                 tative of its service area               9
              Describing the community rating system     12
              Optimistic enrollment projections and
                marketing problems                       15
              Higher than anticipated utilization        18
              Audit of Sound Health                      19
              Our financial projection                   19
              Conclusions                                21
            PLOYERS AND SOUND HEALTH?                    22
              Economic impact on employers               22
              Employer reaction                          23
              Union resistance                           24
  5       QUALITY ASSURANCE PROGRAM                      25

       I   Letter :!ated Ma) 2' .376, from the
             Chairman and Ranking Minority Member,
             Subcommittee on Health, Senate
             Committee on Labor and Public Welfare         27

  II       Letter dated July 26, 1977, from the
             President, Sound Health Association           29

 III       Sound Health Association operating results
             for the quarters ended March 1975 through
             March 1976                                    31

  IV       Organizational and operating requirements
             for health maintenance organizations          32

       V   GAO actuarial projections for Sound Health
             Association                                   36


GAO        General Accounting Office

HEW        Department of Health, Education, and Welfare

HliO       health maintenance organization
                           CHAPTER 1

     The Health Maintenance OXganization (EMO) Act of 1973,
as amended, requires GAO to evaluate the operations of cer-
tain HMOs which hlave been certifie.; by the Department of
Health, Education, and Welfare (HEW) as complying wit;! the
dct's organizational and operational requizements and which
have received financial assistance under the act.

     Section 1314 of the act, as a,..-nded, requires us to
report to the Congress on the ability of these qualified HMOs

     -- to meet the requirements of the act regarding ;heir
        organization and operation, including the HMOs ability
        to include medically indigent and high risk individ-
        uals in their membership and to prc ide services to
        medically underserved populations, and

     -- to operate on a fiscally sound basis without continued
        Federal financial assistance.
       The act directs us to study and report tree economic
effects on certain employers required by section 1310 of the
act, us amended, to offer membership in qualified HMOs as an
c¢ptional health benefit plan, an option referred to as dual
r.ho ice.

     The act also requires us co evaluate (1) the operations
of distinct categories of HMOs in comparison with each other,
(2) HMOs as a group us compared with alternative forms of
health care delivery, and (3) the imyact that HMOs. individ-
ually, by category, and as a group have on the publIc health.
To the extent possible we will include such information in
our summary report to the Congress. However, as noted in our
September 3, 1976, report, "Factors That Impede Progress in
Implm.enting the Health Maintenance Organization Act of 1973,"
no state-of-the-art agreement exists on what methods have
been developed to provide comparative and health status
information to be used for such evaluations. For this
report we will describe the HMO's quality assurance program.

      This evaluation coicerns the Sound Health Association,
Tacoma, Washington, and is one in a series of evaluations
of IIMOs to be conducted in compliance with the act. At
the request of the Chairman and Ranking Minority Member,
Subcommittee on Health and Scientific Researcn, Senate

Committee on Human Resources (formerly the Subcommittee on
Health, Senate Committee on Labor and Public Welfare),
separate reports on each HMO evaluation wiUl be issued to
them and to the Chairman and Ranking Minority Member, Sub-
committee on Health ard the Environment, House Committee on
Interstate and Foreign Commerce. A report summarizing all
our audits initiated under section 1314, as amended, will be
submitted to the Congress *y June 1978.

     Sound Health was incorporated in June 1972 under
Washington State laws as a nember-owned nonprofit HMO and
began enrolling members and providing prepaid health services
in April :1974, before qual-ificati-on as an HMO by HEW.: Its-
board of directors, which is responsible for setting policyv
and guiding the affairs of the organization, is elected by
its membership.

     In June 1974 after publication of preliminary regula-
tions covering the HMO Act, the board of directors voted
to seek certification as a qualified HMO. Its original
health plan was revised to include preventive dental care
for children, outpatient mental health care, improved out-
of-area medical benefits, and liberalized hospital benefits.

     HEW certified Sound Health as a qualified HMO on
November 29, 1974--the first HMO to be certified in the
United states--and awarded the HMO a $1 million loan, the
first loan under this program.

     Sound Health provides health care services primarily
to members who live in Pierce County, Washington.   (See
page 3.) Sound Health furnishes outpatient health care
at its health center facility in Tacoma, but inpatient care
and specialized services, such as extended care and mental
health services, are supplied through contracts with
hospitals and other health care providers. The Sound
Health outpatient facility can provide health care services
for up to 12,000 members. Prospective enrollment groups
received information stating that other convenient health
care centers would he added as enrollment increases. The
Sound Health director stated that some plans and personal
contacts had been made to establish satellite health care
clinics in two additional areas. He estimated these would
be needed in the latter part of 1977.

                                   PIERCE COUNTY

                                   PIERCE COUNTY

Location of Sound Health farilty

      Federal financial assistance to prepaid hsl!th care
delivery programs was available before the HMO Act under
several sections of the Public Health Service Act (42 U.S.C.
246(e) (repealed Public Law 94-63), 42 U.S.C. 242b (1970 and
Supp. V, 1975), 42 U.S.C. 229b (1970), 42 U.S.C. 299j (1970)).
Between December 1971 and December 1974, Sound Health, or its
predecessor, the Puget Sound Health Care Association, received
three gran,'s totaling $428,382 under section 314(e) of the
Public Health Service Act (repealed by Public Law 94-63).
This section provides for grants to any putlic or nonprofit
private agency, institution, or organization to cover partially
the cost of (1) providing services to meet health needs which
are limited by geographic scope or specialized regional or
national significance or (2) initially developing and support-
ing new health services programs.

      In January 1972 the Puget Sound Health Care Association
received a grant of $100,000 to fund the initial planning
and developing of a hospital-based HMO. Unable to purchase
a hospital facility, the Puget Sound Health Care Association
changed the original concept of a hospital-based HMO to a
community-based organization, and a successor corporation,
Sound Health Association, was established. The grant was
transferred to Sound Health in June 1972.

     The HMO Act authorizes Fedaral financial assistance
through grants and contracts to public or private nonprofit
organizations for HMO feasibility studies, planning, and
initial development.

     The act requires each HMO to be fiscally sound. However,
because developing HMOs may have difficulty meeting operating
expenses, the act provides for Federal loans during their
first 36 months. Interest accrues from the date of the loan
closing and is to be paid in accordance with the loan agree-
ment, which requires repayment of the principal beginning
between the fourth and fifth anniversaries of the direct loan

     In June 1974, after 2-1/2 years of developmental activi-
ties supported by section 314(e) grants, Sound Health applied
under the HMO Act, for an operational loan of $563,000 and
an initial development grant of $124,520. HEW did not act on
the loan application because it had not published its final
HMO program regulations. As an interim measure, however,
HEW awarded Sound Health an initial development grant of

     Sound Health did obtain a Federal loan of $1 million,
effective November 1, 1974. The final amount of the loan was
larger than the original amount requested because during its
loan review process, HEW determined that Sound Health's lossts
would exceed its originally requested amount. Under the loan
conditions, Sound Hea!th must break even; that is, income must
equal expenses by November 1977 and must have sufficient cash
to begin loan principal repayment in July 1979.

     As shown below Sound Health has received 'Fe',dralfunds
totaling $1,733,0001 about 75 percent of the funds were pro-
vided under the HMO Act.

                           Federal Financial Assistance

Type           Authority         awarded        Amount        Purrose
Grant     Public Health                                    Planning and
            Service Act.            (a)    $     428,382     development
            section 314(e)                                   of a hospital-
                                                             based HMO
Grant     HMO Act                7/26/74         304,738   Initial develop-
Loan      HMO Act               11/29/74       1,000,000   Initial deficit
       Total                               $1,733,120
a/Represents three section 314(e) grants covering the period
  Dec. 16, 1971, to Dec. 15, 1974.

     Our review was done at the Sound Health Association,
Tacoma; HEW's Health Services Administration Headquarters,
Rockville; and HEW's region X offices, Seattle. We also inter-
viewed employer representatives at their offices in Tacoma
and Pierce County.

     To determine Sound Health's ability to be fiscally sound
without continued Federal financial assistance, we

       -- compared Sound Health's financial history to its ini-
          tial financial projection s,bmitted when applying for
          qualification and also for a Federal loan;

     -- reviewed the actuarial projections used by Sound
        Health and prepared new projections from data ob-
        tained during our reviews and
     -- reviewed Sound Health's marketing program, its finan-
        cial operations, and its systems to control ovrer-
        utilization of services.
      To evaluate Sound Health's ability to meet the other
requiremrents and purposes of the act, we
     -- compared its organizational structure and its level
        of health services provision to the requirements of
        the HEW regulations which had been used in qualifying
        Sound Healthy and
     -- evaluated Sound Health's health services programs to
        medically underserved areas, high-risk individuals,
        and nthe indigent.
     Summarized in appendix IV are our determinations on
Sound Health's compliance with the act.
                          CHAPTER 2


     The HMO Act directs qualified HMOs to be fiscally sound;
offer specified health benefits; and meet certain other
organizational and operational requirements, including use
of a community rating system to develop premium rates.   (See
app. IV.) Sound Health's financial viability is discussed in
chapter 3. Sound Health offers the specified health benefits,
meets the organizational requirement, and generally satisfies
the operating requirements of a federally qualified HMO.
     Provisions not met include

     -- the open enrollment requirement which Sound Health
        never fully implemented and which was never formally
        waived by HEW; and

     -- the broadly representative n;embership requirement,
        which we believe could be better satisfied by Medicare

     HEW has not published program guidelines for interpreting
some operational requirements. For example, although HMOs
must establish a community rating system for fixing periodic
payments, HEW has not published guidelines to be used in devel-
oping such a system (see p. 13).

     HEW encourages an HMO to implement certain other program
objectives of the act but does not require it. Guidelines
have not been established, thus leaving the interpretation
to each HMO. An example of such an objective would be in the
ways services should be directed toward medically underserved


     P:ior to being amended section 1301(c)(4) of the HMO Act
of 1973 stated that each HMO shall

        "* * * have an open enrollment period ofnot
        less than thirty days at least once during each
        consecutive twelve-month period during which en-
        rollment period it accepts, up to its capacity,
        individuals .n the order in which they apply
        for enrollment."
Sound Health was subject to this requirement during its first
year of operation.

     Exceptions to the open enrollment requirement could be
authorized by the Secretary if the HMO demonstrated, to HEW's
satisfaction, that it had enrolled or would be forced to
enroll a disproportionate number of individuals who were
likely to make excessive use of its services and that enroll-
ing more such individuals would jeopardize the financial via-
bility of the HMO.

     In 1975 Sound Health held an 8-day open enrollment
period in which 40 members were enrolled. Sound Health re-
quested a waiver of the remaining 22 days for 1975 because:

        "Continuation of this open enrollment period would
        attract more people who are extremely ill and thus
        put our organization into a questionable financial
        position because of assumed risk. We believe it
        would be beyond what this organization could

     Sound Health also requested a waiver of the entire 1976
open enrollment period.  The 1976 request noted that about
75 percent of the members who had joined during the 1975
open enrollment period had preexisting and/or chronic medical
conditions. These conditions included hypertension, cancer,
cardiac problems, diabetes, cataracts, arthritis, and alcohol-
ism. Data maintained for these 40 enrollees showed that their
rate of utilization of services had exceeded the average for
total enrollees as shown below:

                      Utilization Comparison
                   (October 1974 - March 1976)

                             Enrollees' annualized rates
  Services         5pe   i1ent     pri    ---     Totai
Office visits             6.9 per member          5.9 per member
X-ray                      .95 per member          .9 per member
Hospital days            1,350 per               495 per
                           1,000 members           1,000 member

     The Sound Health director mated that Sound Health had
received many inquiries from persons with severe or chronic
medical problems as to the date of the next open enrollment.
He said that Sound Health cannot afford to accept high-risk
individuals--at least not until the membership is large enough
to absorb the high per capita costs for such individuals.
     Regional HEW and Sound Health officials said that both
requests for waiver had been tacitly approved by HEW, but
no documentation was available to show the requiremen* itad
been waived. HEW headquarters officials have not issued a
formal waiver, but neither have they forced Sound Health to
have an open enrollment period.
     HEW has not issued final criteria for considering re-
quests for waivers. The amendments to the HMO Act changed
the open enrollment requirements jo that open enrollment is
now required for only those HMOs which
    -- have been providing comprehensive health services on
       a prepaid basis for 5 years or have 50,000 members

    -- did not incur a financial deficit in their most recent
       fiscal yeat.
     Because of these amendments, Sound Health will not have
to have an open enrollment in the near future.  It will not
have been operating for 5 years as a qualified HMO until
late 1979; it had 6,000 members as of December 31, 1976;
and it continues to incur deficits.


     Section 1301(c) of the act requires an HMO to enroll
persons broadly representative of various age, social, and
income groups within the area served. Federal implementing
regulations provide no guidelines defining a "broadly repre-
sentative" membership. Sound Health is serving the indigent
(Medicaid) but has not actively sought enrollment of high-
risk (Medicare) individuals. This suggests that Sound
Health's membership doas not represent various age, social,
and income groups in its service area.

Medicare enrollees
     In its application for qualification as an HMO, Sound
Hel1th indicated that its health professionals and contract
providers were eligible to serve Medicare beneficiaries.
Sound Health offers a Senior Plan, which supplements the
Federal Medicare program anc provides the same health ser-
vices and benefits available to othe: Sound Health members.
As of April 1, 1976, only 30 members were enrolled under
the Senior Plan. The Sound Health director stated that Medi-
care beneficiary enrollments have not been actively sought
because Sound Health would have to act as a fee-for-service
provider, which must obtain payment from Medicare.
Medicaid enrollees
     Sound Health has contracted with the Washington Depart-
ment of Social and Health Services to provide health ser-
vices to Medicaid beneficiaries.   The Sound Health contract
became effective July 2, 1975, and was subsequently amended
to include the following conditions:
     -- Enrollment by Medicaid beneficiaries will be voluntary.
     --Sound Health will enroll eligible Medicaid recipients
       throughout the year.
     -- The Department of Social and Health Services will
        approve Sound Health's marketing plans, procedures,
        and materials used to recruit Medicaid enrollees.
     -- The Department of Social and Health Services will be
        able to inspect and evaluate the quality, appropriate-
        ness, and timeliness of contract services and to audit
        and inspect books and records.
     -- Within 2 years after the contract effective date, no
        more than 50 percent of the Sound Health members may
        be Medicare or Medicaid beneficiaries.
     Sound Health negotiated an increase in the monthly Medi-
caid premium--from $17.20 to $20 per enrollee--effective
February 1, 1976. Health care benefits provided to Medicaid
members are essentially comparable to those provided to
regular members, except that Sound Health is not required to
provide mental health and alcohol and drug abuse health care
services to Medicaid members.

     To attain its goal of 1,000 members from the Aid to
Families with Dependent Children program, Sound Health acted
as follows to increase Medicaid enrollment. It sent mailings
to Medicaid recipients, conducted training sessions for Depart-
ment of Social and 1':alth Services staff, provided information
to social and health service agencies, and evaluated the
recruiting program.
     Monthly enrollment statistics of Medicaid beneficiaries
for Februr-y through May 1976 were:

                        Medicaid Enrollment
     Date         Added             Lost          total
  January 31        -                 -            319
  February 1       33                24            328
  March 1          22                16            334
  April 1         219                49            504
  May 1           525                46           983
     Total        799               135
     A continuing program provides for mailing information
to Aid to Families with Dependent Children program partici-
pants every 6 months.

Service to medically underserved areas

     The Secretary of HEW may designate areas which have a
shortage of personal health services as medically underserved.
HMOs are not required to serve such areas, but HEW encourages
them to do so.

     HEw classified 10 census tracts in Pierce County as
medically underserved areas, each within the Sound Health
immediate service area. The Sound Health clinic is in an
area classified as medically underserved.

     Sound Health officials stated it has not emphasized serv-
ice to underserved areas becauo · , except for Medicaid bene-
ficiaries, marketing is conducted through employee qooups
without regard to the residence of prospective members. Al-
though some Sound Health members are in medically underserved
areas, this has occurred by accident rather than design.


     Originally section 1301(b)(1) of the act requires that
payment for basic health services provided by the HMO be
fixed under a community rating system. Section 1302(8) of
the HMO Act, as amended, defines a community rating system as

     "* * * a system of fixing rates of payments for
     health services. Under such a system rates of
     payments may be determined on a per-person or
     per-family basis and may vary with the number
     of persons in a family, * * *.

     * * * such rates must be equivalent for all in-
     dividuals and for all families of similar com-

     Nominal differentials in payment rates are permitted
for certain categories of members to reflect the different
administrative costs of collecting payments. Differentials
may also be established for members enrolled under contract
with a governmental authority or any health benefit program
for employees of Stater, political subdivisions of States,
and other public entities.

     Sound Health officials said its premium rates are an
adjusted experience rate for the entire membership. In deter-
mining the premium rates, Sound Heal'h divides the total
budgeted costs by the forecasted member months. In addition,
the rates are partially determined by local competition.
Our comparison of rates for competitive health benefit plans
suggests Sound Health could raise rates 10 percent above
projections and still be competitive with other plans.
(See p. 19.)

    As of July 1, 1976, Sound Health premium rates were:

    Coverage                           Monthly premium
    Employee                              $27.00
    Employee and spouse                    54.00
    Employee, spouse, and child(ren)       79.51
    Employee and child(ren)                52.81
    Employee (Medicare supplement)         13.50

     HEW has not published, nor has it any specific plans
for publishing, program guidelines to interpret how community
rating should translate into a premium structure. As a result
we could not determine if Sound Health's rate structure com-
plies with act requirements for a community rating system.
The HMO amendments have changed application of the community
rating requirement to after the HMO has been qualified for
48 months.

                           CHAPTER 3
     As stated in chapter 1, the HMO Act requires each
qualified HMO to be fiscally sound. 8owever, because a devel-
oping HMO may have difficulty in meeting initial operating
expenses, section 1305 of the act, as amended, provides for
Federal loans, not to exceed $1 million in any fiscal year
or $2.5 million in total, to assist during its first 36 months
of operation. HMOs eligible for loans must be certified as
qualified. However, to become qualified, an HMO must be
fiscally sound. For Sound Health the Federal loan establishes
fiscal soundness.

      Sound Health obtained a Federal loan of $1 million ef-
fective November 1, 1974. We question Sound Health's ability
to break even by November 1977, as planned. However, our
actuarial projections indicate that even though Sound Health
will not break even as planned, its cash flow will permit
payments on the loan principal to begin in July 1979 as sche-

     According to the loan agreement, Sound Health will pay
only interest until July 1979 when it must begin principal
repayment. Projections prepared by Sound Health with HEW
assistance in June 1976 showed Sound Health having sufficient
operating revenues to meet operating expenses by November
1977. However, Sound Health
     -- has failed to meet enrollment projections in the past--
        partially due to Federal delays in publishing dual-
        choice regulations,

     --cnntinues to have marketing problems, and

     -- has experienced unnecessary and unanticipated costs.
Sound Health must overcome these difficulties to continue with-
out Federal financial assistance. Changes in rates charged
by Sound Health, reductions in planned overhead costs, or
other organizational changes could significantly improve
Sound Health's financial position.

     The enrollment projectionr from sound Health, submitted
with its application Lof ajalification in 1974, was revised
in June 1976. This re-,ision predicts an enrollment increase
from 3,048 in March 1976 to 13,931 in November 1977--an aver-
age increase of 544 members a month. This increase appears
overly optimistic in light of past performance. Sound
Health's average monthly increase was 292 and 257 members
during the third and fourth quarters of 1975, respectively,
and 249 members per month during the first 6 months of 1976.
The 1976 figures included a Medicaid enrollment increase
of 525 during May. During the quarter ended Marcn 1976, about
76 percent of Sound Health's revenue was from membership dues.
The remainder was generated through copayments, fee-for-.
service income, and interest income. Sound Health expel s
to obtain over 90 percent of its revenue from membershi, :.ues.

     Our actuarial assessment of the future financial vi&-
bility of Sound Health suggests that improved marketing i-
crucial for Sound Health's success. Even assuming an
improvement in marketing, we believe the Sound Health enroll-
ment projections may be overstated unless additional member-
ship sources are identified.

     The enrollment projections submitted with Sound Health's
qualification application in 1974 have proven overly optimis-
tic, as shown on the following chart.



14,000                                                                                   /-


                                   SOUND HEALTH                                 /
10,000                             1974 ENROLLMENT                         //
            ~~~~10,000      -PROJECTION

                                     8 0              o            /,,     PROJECTION

                                                          /   ,/         SOUVD HEALTH

                                      /     ACTUAL ENROLLMENT

 2,000 -

    12/74         6/75     12/76          6/76            12/76           6/77                12/77

     Federal delays in the HMO qualification and certification
process and in publishing regulations and guidelines to imple-
ment the dual-choice provisions of the act have contributed
to Sound Health's failure to meet enrollment expectations.
However, several other factors have contributed and continue
to contribute to this condition, including

    -- Sound Health's lack of organization in its marketing
    -- employer resistance to the act (see ch. 4), and

     -- local union resistance to Sound Health (see ch. 4).
     An HEW official conducted a marketing assessment of
Sound Health in 1974 and reported that, "I was surprised
to find that the basic data essential to make intelligent
marketing decisions has not been acquired in spite of 3
years an.d $700,000 of involvement to date." Our actuarial
review showed that, even assuming an improvement in mar-
keting, Sound Health enrollment projections may be substan-
tially overstated unless additional membership sources are
identifies.   (See app. V, p. 36.)

     Sound Health's success in enrolling employee groups has
been mixed. The first year rate of penetration--that is,
the percentage of employees who chose to enroll during the
first year the plan was offered to their respective employer--
was 3.1 percent. Enrollment efforts in April 1976 included
failure to enroll anyone in a company with 1,100 eligible
employees. The plan also enrolled only 10 in a company with
985 employees, 1 in a group of 170, and none out of 150.
In commenting on our draft report, a Sound Health official
pointed out these failures were due to problems with union
acceptance and inability to obtain access to employees.
However, as noted on page 11, Sound Health did have signifi-
cant Medicaid enrollment.

     Recently, the Sound Health director moved to organize the
marketing function, including establishing a data base on
Pierce County emplovL8s.

     For employees represented by a labor union, the offer
of the HMO alternative is subject to collective bargaining.
Sound Health's entrance into the health benefit programs of
local unions has been very limited, and Sound Health faces
strong union resistance. However, both Sound Health and
union officials told us this resistance stemmed from conflicts

between them rather than weaknesses in the Sound Health plan
or the HMO Act. (See ch. 4.)
     Publication of the dual-choice guidelines and regulations
in October 1975 and Sound Health's certification for dual-
choice in January 1976 should inprove Sound Health's marketing.
Also, the Civil Service Commission has approved Sound Health
to participate in the Federal Employees Health Benefits Pro-
gram beginning January 1, 1977. The Sound Health director
said that over 10,000 Federal civilian employees live in
Pierce County, making the Federal Government one of the lar-
gest area employers.
     Sound Health has operated at a deficit since it became-
operational in April 1974. During calendar year 1975, it
incurred an operating loss of $549,169, or $108,645 more
than anticipated. Much of this loss can be attributed to
Sound Health's failure to meet enrollment expectations.
However, some of the loss resulted from higher than anti-
cipated costs, particularly in health service payments
to providers who are not on the Sound Health staff (referral
costs). Referral costs incurred during 1975 exceeded Sound
Health's cost projection by more than $67,000.
     Sound Health also underestimated and underbudgeted for
these costs during the first quarter of 1976. Referral costs
exceeded the budget by $50,978. The Sound Health director
said that about $15,000 of the first quarter 1976 referral
costs were avoidable because services could have been provided
by Sound Health. He stated that controls on referrals had
been implemented in April 1976. For example, X-rays and
laboratory tests are now performed by Sound Health, and plan
approval iL required before members may be hospitalized.
Referral costs were reduced from $80,456 in the first quarter
of 1976 to $49,178 in the second quarter.
     In commenting on our draft report, Sound Health's execu-
tive director clarified the point on referral costs. He
stated that beginning in April of 1976, "we instituted more
strict controls over referrals to all outside specialists
in the areas of ;i-b and X-ray. Whenever possible we also
control the tests being done prior to hospitalization by
having them done at our health center."
     The director told us that because an HMO cannot refuse
to enroll individual members of a group covered by other
health plans offered by the employer, some employees with

preexisting health care needs convers to HMO coverage during
group enrollment periods when it is economically advantageous
for them. According to the director, Sound Health has been
adversely affected by many group enrollees with preexisting
cardiac, cancerous, orthopedic, and other conditions requiring
extensive treatment. Similarly, the director said that from
December 1975 to May 1976, Sound Health enrolled 30 pregnant
members. Th- Sound Health finance director said that mater-
nity costb account for $3.66 of the monthly premium rate.

     Sound Health's 1974 and 1975 financial statements were
audited by a certified public accounting firm and found in
order. The HEW Audit Agency performed a quick assessment
audit of Sound Health in August 1974 and a followup audit in
August 1975. The 1974 quick assessment audit disclosed
several weaknesses which Sound Health needed to correct
to provide proper management of and accountability for grant
funds. The HEW followup audit reported that most of the
deficiencies had been corrected or resolved. Deficiencies
reported in August 1974 which we still found in April 1976
included untagged nonmedical equipment and a statement by
the financial officer that a physical inventory of equipment
had never been taken. Two deficiencies noted in the 1975
audit report had been referred to the region X HMO branch
but had not been resolved at the time of our review. The
report states that:
     -- Sound Health inappropriately allocated about $13,000
        ($11,766 Federal share) in costs to its HMO develop-
        ment grant.
     -- Sound Health had inappropriately applied $58,830 in
        operating costs to the HMO development grant. It
        then used loan funds to replace the grant funds.
     Sound Health's comments on our draft report acknow-
ledged a need for a more up-to-date physical inventory and
affirmed plans for an annual inventory.
     Our analysis of the future financial viability of Sound
Health indicated that proposed premium rates must be increased
for Sound Health to break even. Appendix V contains our
actuarial assumptions and projections. A comparison of
rates for competitive plans suggests Sound Health could raise

rates 10 percent above its already projected increase and
still be competitive with other plans.
     In commenting on our draft report, Sound Health said
some difference may exist in the competitive health ;lans
that were compared. We agree that differences in health
benefits offered ray exist. However, the rates below were
offered to the sal, group which required a set of minimum
benefits to be included in the four health plans.
               Comi-arison of Sound Health Monthl
           Premium Rates With Competitive Plans note a)
                        Sound         Blue       Group       Western
Pecsons under 65        Health        Cross      Health      Clinic
Employee               $27.60         $ 41.90    $29.83      $53.64
Employee and spouse     55.20           83.15        58.53    63.13
Employee, spouse,
  and child(ren)        81.25          118.00        84.68    89.25
Employee and
  child(ren)            53.70           76.75        53.76    61.76
i/Rates offered to Washington State employees in 1976 as
  obtained from a brochure entitled "State Employees Insur-
  ance, Board Approved Medical Plans."
     With a 10-percent increase, we project operating profits
for Sound Health during the second quarter of 1979 when its
membership approaches 20,000. The following schedule shows
our projections.
          Enrollment     Income     Expenses     Loss(-)
1976           5,293     1,003,734       1,545,547     -541,813
1977         10,772      3,244,022       3,666,889     -422,867
1978         16,363      5,899,639       6,193,692     -294,053
1979         21,626      8,875,044       8,821,019       54,025
1980         25,000     11,650,968      11,130,115      520,853

      For Sound Health to become financially viable without
continued Federal financial assistance, we believe it needs
increased premium rates and more members. Although
tion Sound Health's ability to break even within the we36-month
subsidy period prescribed in the HMO Act, we believe they
can accomplish this within 5 years.

                           CHAPTER 4

     Section 1301 (the dual-choice provision) of the HMO
Act, as amended, provides that every employer, which (1) has
at least 25 employees in the HMO's service area, (2) is
required to pay the minimum wage, and (3) provides health
benefits to employees, must offer employees the option of
joining a qualified HMO. The act relieves an employer from
contributing more to the cost of the HMO plan than it con-
tributes to other health benefits plans.

     We contacted 16 employers, 3 labor representatives,
and an insurance consulting firm in the Sound Health service
area to determine

     -- the economic effect on employers of offering Sound
        Health membership to employees as an optional
        health plan in compliance with the HMO Act,
     --employer rea-ction to the act,

     -- how Sound Health has used dual choice and its effect
        upon Sound Health, and
     -- union response to Sound Health and the HMO Act.

     The employers contacted in the Sound Health service
area reported no significant economic impact from the require-
ment that Sound Health membership be included as an option
to employees in their health benefit programs, and none of
the employers had measured the effects of Sound Health mem-
bership on the health of their employees. Employer attitudes
toward the act ranged from lack of concern to strong resent-
ment of Federal interference in their business.


     Employers which offered Sound Health membership as a dual-
choice option to their employees said the effect on administra-
tive costs was negligible. The employer contributions for
employee health benefits generally remained the same. However,
some employers said that they had voluntarily changed their
contributions but had not measured the cost differences. For
example, one employer's contribution amounted to 10 percent
of employee health plan premium costs for each year of

 employment with the firm, regardless of the health
 selected. Another employer, a self-insurer, contributed
 up to $36 a month for health benefits for an employee
 dependents under the company's indemnity plan.          and his
                                                  The employer
 agreed to pay the same amount toward Sound Health
 In addition, this employer agreed to pay the entiremembership.
 Health premium up to $36 a month for individuals      Sound
 pendents, even though premium costs for such employees      de-
 the company's plan is only $21 a month. The employee     under
 fits director said that generally high health service bene-
 tend to select an HMO to avoid the deductibles and      users
 required in the company plan. Therefore,
 premiums may be slightly higher, costs to while
                                                  Sound Health
 self-insurer may be lower because of the high medical as a
 zation costs shifted to Sound Health. However,
 has not measured or studied the effect of this   the  employer
     Employers also said the dual-choice provision
noticeably affected their relationships with other has not
plans or representatives of these health plans.


     Several employers contacted expressed resentment
the HMO Act; others said they were indifferent.       about
said their resentment stems from the level of Federal
ference" in their businesses, not from Sound Health.  "inter-

      Employer representatives said, and Sound
that it has not emphasized the employer's legalHealth agreed,
to offer Sound Health's benefit plan. The marketing
used has been to explain the benefits of the plan
employer support. Through trade associations,      and  request
professional organizations, and sources         publications,
                                         other than Sound
Health, many employers we contacted became aware
legal obligation to offer an HMO. Sound Health of their
                                                 has sent
written dual choice notifications to those employers
(1) initially refused to offer dual choice, (2)
written notification, or (3) strongly resisted requested
                                                the program.
qound Health had sent such letters to 69 employers
first 4 months of 1976.                             in the

     The Sound Health director said
offered the Sound Health plan until several employers had not
                                    implementing regulations
had been published and Sound Health was qualified
                                                  for dual
choice. The qualification delay contributed
failure to meet enrollment projections. Based Sound Health's
with local employers, we believe Sound Health on our contact
to enroll more employer groups because of the will be able
regulations.                                  dual choice

     Three employers said they were uncertain if they were
obligated to offer the Sound Health plan if most of their
employees were receiving health benefits from union health
and welfare trusts.

     Local union officials said unions in Pierce County have
expressed strong resistance to Sound Health. This stemmed
from conflicts between Sound Health and union officials,
not weaknesses in the Sound Health plan or the HMO Act.
Only two unions in the area signed group sponsorship contracts
with Sound Health, and only about 600 members were eligible
under these contracts. Union officials said they knew of no
restrictions that would prevent them from offering an HMO
option to their members.

     Union officials also said that one union had presented
the Sound Health plan at a membership meeting. After being
told by a local union leader that only one health plan could
be selected by the group, the membership, by majority vote,
chose their present carrier.

                          CHAPTER 5


     Section 1301(c)(8) of the act requires each HMO to
establish an ongoing quality assurance program which stresses
health outcomes and provides for review by physicians and
other health professionals of processes for providing health
services. HEW regulations state that each HMO shall have a
quality assurance program which
    -- collects systematic data on performance and patient
       results and
    -- is designed -to meet t-he professional standards review
       established under the Social Security Act for services
       provided by hospitals and the operating health care
       facilities or organizations.
     The Sound Health quality assurance program adopted in
February 1974 included the following policies and Sound Health
implementing actions:
    Qualification of medical group members
          The Sound Health medical director stated that all
     its staff physicianc arc board certified or board eligible.
    Management information system
        Elements of the management information system are
    examined to identify real or potential problems.
    Management information system data shows the number of
    encounters by each Sound Health provider, referrals
    to outside providers, and quantitative use of other
    medical services. For example, the finance director
    said analysis of the system had alerted Sound Health
    to an increase in referral costs during the first quar-
    ter of 1976. (See p. 18.)
    Member relations
        Sound Health surveyed members in 1975 and 1976 to
    obtain opinions on its health services. Generally,
    members were asked if such items as waiting time, medi-
    cal staff competence, and medical facilities were
    satisfactory or unsatisfactory. Sound Health also
    established committees to deal with health benefits
    and member grievances.

      Medical audit
     The Sound Health medical director stated
     of the limited number (three) of Sound    that because
                                            Health physi-
     cians, no systematic peer review of medical
     exists. However, he told us the medical      procedures
     weekly. Sometimes the procedures prescribed     meets
     fic cases are discussed, but no documentation for speci-
     for these informal case reviews. Region        is kept
     stated they are helping Sound Health     X HEW officials
     peer review program.                 develop  a systematic

     Continuing education
         Many (12 out of 29) professional staff
     in the Sound Health continuing education
     1974-75.                                 course 3 during

     HEW, in its review of the Sound Health
application, noted the Sound Health quality HMO qualification
continuing education programs followed      assurance and
                                       the regulations.
      We were told that all hospitals under
                                            contract with Sound
Health have State-approved utilization
The Professional Standards Review Organization procedures.
performs peer review activities in short-term, in this region
hospitals only and has yet to implement         acute care
review in facilities such as Sound Health's          care peer
                                             outpatient clinic.
     In our opinion Sound Health should establish
                                                    a more
formal peer review system to insure the
administered by its providers. Such      quality of care
                                      a system
documented regular review of systematically    should include
                                             selected cases.

         APPENDIX I                                                                              APPENDIX I

          N           &US#
                      A. wua      Jm, N.J.,     .      .N
jUwU RUat5H. W. V.                  JAlo N,.. VW.       N.Y.
e-             - "X .1,            jA         W,h    UWIM.     PA.
                                        1.mm.       T, 4C..                        A

W*UWIAM NAl             UMW
                         .A   M           A
                        M~ir.   A P. E, 1.MSiLB.
                                           Bu     ,O.¢.,                               1.
              A,WLD    M WNI*   J&
                                 I*I     BOAU.,JA.LlC                ,AOMCANO   WI.I   AR,

                                                                      May 24, 1976
          -May              (5)                                           24031

         The Honorable Elmer B. Staats
         Comptroller General of: the United States
           General Accounting Office
         441 G-Street, N.W. :
     -   Washington, DC.= 2 48                                                               X

         Dear Mr. Staats:
               In April, members of your staff provided information to
         our staff regarding the General Accounting Office's initital
         reviews of HeaLth Maintenance Organizations under section
         1314(a) of the Health Maintenance Organization Act of 1973.
         In addition to expressing the Subcommittee's appreciation for
         the assistance your staff has provided the Subcommittee in
         exercising its oversight responsibility and in its deliberation
         on S.1926, the purpose of this letter is to confirm the review
         approach presented by your staff.
              We understand that GAO has started a review of two
         qualified HMOs as a beginning point for meeting its require-
         ments under section 1314(a) as it would be amended by S.1926.
         Mr. James Martin's November 21, 1975 testimony before the
         Subcommittee has indicated that the slow rate of progress in
         establishing "qualified" HMOs along with the lack of an accepted
         or generally agreed upon methodology for evaluating the impact
         of HMOs on the health of the public would prevent GAO from
         meeting the reporting deadline (December 29, 1976) for the
         evaluations called for by sections 1314(b) and 1314(c). The
         Subcommittee acknowledges that in view of the unanticipated
         delays in implementing the HMO Act of 1973, the 36 month
         reporting requirements for sections 134(b) and (c) now appear
         unrealistic and are virtually moot. However, the Subcommittee
         is pleased to note that GAO is planning to include elements of
         subsections (b) and (c), in its reviews of the individual
         "qualified" HMOs, specifically: (1) evaluations of the economic
         effects of section 1310 upon the employers that have included
         the "qualified" HMO in their employee health benefit programs
         and (2) descriptions of the quality of care assessments and
         evaluations in each lIMO.

APPENDIX I                                                 APPENDIX I

      As yc4r staff complete the reviews
 like reports on each review forwarded to ofus each HMO, we would
                                                (and as previously
 discussed with our staff, copies to the Chairman and
 Minority Member of the House Subcommittee               Ranking
                                             on Health and Public
 Environment, Interstate and Foreign Commerce Committee).
 may supply copies of ti.e individual reports to DHEW         You
                                                        and to the
 Civil Service Commission to assist them in the performance
 of their regulatory and monitoring duties over HMOs.
 report to the Congress would be submitted by June        A summary
  or by section 1314(a) as amended by S.1926.         1978 as called

     Again, the work by your Manpower and
staff on the implementation of the HMO Act Welfare
                                               by  DHEW
                                                         and the
GAO questionnaire survey of prospective HMO grant applicants
have greatly assisted us in our d eli-bera-t-i-ons-on
amendments of 1975. We look forward to receiving the          :::-::   ::
report on this effort as well as the reports on         the final
reviews on HMOs.                                      your planned

      Qg             ;             Sincerel

Richard S. Schweiker                        ar    Kennedy
Ranking Minority Member                 Chairmr
Senate Subcommittee on                  Senate ,..hco  ftee on
  fHealth                                 Hiealth

                                                        APPENDIX IX

                        SOUND. HEALTH ASIOCIATION
                                i.'- . L · . .: . ;I

                                    July 26,   1977

 Mr. Gi gory
 United StatesJ.General
                 Ahart, Director
                        Accounting Office
 Human Resources Division
 Washington, D. C. 20548
  Dear Mr. Ahart:
 We ha\ reviewed the draft of
                                a proposed report prepared by
 the Comptroller General of the
 of Sound Health Association,    United States on the evaluation
                               a federally qualified HMO.
 We are attac.ing a list of corrections
 made prior to publication of the         that we think should be
 Generally the report is a fair
                                 and accurate expression of the
 position of Sound Health Association
 The report succinctly reported        as it was in June 1976.
 to its present status.          the evolution  of our organization
As the letter indi.cates the study
great deal has happened since        is late in being published. A
our organization haw reached a  the  original Study. For example,
better organized marketing cystemmembership  of 9_00. It has a
within the year on the operational and we have matured considerably
imposed on health services are        levels. The controls we
ways to control other expenses   working  well and we are seekirq
                                 as effectively.
We invite you to return and do
explore some other aspects of a follow-up assessment and perhaps
                               HMO development such as manpower
development in the i!MO movement
process itself.                   or evaluation of the development

                               Sincerely yours,

                               Robert E. Huesers, President
cc: Lou Smith, GAO, Seattle

APPEhbIX     It                                   APPENDIX II

 GAO note:    The attachment pertains to material that was
              included or deleted from the report.

APPENDIA.    T                                                               APPENDIX III

                   QUARTERS ENDED MARCH 1975 THROUGH MARCH 1976

                                                  Qu    arter Ended
                            MarCh           June.....     september
                                                                 'e     Dcmbe-r    ...     iFc
                            1975            1975            1975         1975              1976
Member dues               $45,532       $54,177            $72,528     $117,028
Copaymente                                                                               $154,433
                              351           900                399        1,365             2,950
ree for service
  and other
  income                   20,348       15,312              18,286        30,396
Interest income                                                                            32,290
                           20,284       .2,513               3699         31,566           13,419
   Totall ineome          -0$6,517      72,900             $S94,912 ;$180,355        S1203089
Physicians               $ 23,864     $ 18,676           $ 23,533      $ 41,95!
Health center                                                                            $ 30,851
  operations               35,632       52,759             49,593        33,593
Hospital care                                                                              73,187
                            8,142        4,631             23,248        53,081            79,022
Drugs and
  vision care               4,399            5,545          7,904          9,361
Other contracted                                                                           13,781
  health services          16,851            8,256         29,249        63,900
Reinsurance and                                                                            801456
  out of area               1,183            2,046          2,539         5,831
Facilities and                                                                              5,989
  equipment                19,056       21,940             25,053        12,198
Administration                                                                             20,819
                           37,472       32,824             32,846        47,583            47,184
Enrollment                 18,076       29,379             19,584        24,793
Business taxes                                                                             24,420
                              908        1,113              1,524         2,165             2,768
Interest                   24,076       23,426             23,606        26,796
Authorization                                                                              25,698
  and develop-
  ment costs             _8            _8393
                                         8393                           _8393            _8,393
   Total expenses       $198j052      $208,988           $247,072      $329,739      Si4         6
   Revenue Loss(-)     -$111,535     -$13               -$152,160     -149,384     -$209,479
Average number
  of members              877           1,008              1,468         2,180           2,944

 APPENDIX IV                                          APPENDIX IV



                                             In          Not in
                                         compliance    compliance
The HMO shall be a legal entity
which provides:                               X
  Basic health services for a basic           X
  health service premium which is:
    -- paid on a periodic basis               X
       without regard to the dates
       health services are provided
    -- fixed without regard to the            X
       frequency, extent or kind of
       health services actually
    -- fixed under a community rating         X (as defined by
       system                                   Sound Health; see
                                                ch. 2)
    -- may be supplemented by                 X
       additional nominal payments,
       except that such payments
       may not serve as a barrier
       to delivery of health services.
  Supplemental health services for a          X
  supplemental health service payment
  which is fixed:
    -- on a prepayment basis,                X
    -- under a community rating              X (as defined by
       system.                                 Sound Health; see
                                               ch. 2)
The services of health professionals         X
which are provided as a basic health
service shall be provided through
health professionals who are members
of the staff of the HMO, through a
medical group or individual practice
association unless the health pro-
fessiona:q services are unusual or
infrequently used or the basic health
service was provided because it was

                                                         APPENDIX IV

                                                In           Not in
                                            compliance     compliance
 medically necessary and could not be          X
 provided by such a health professional.
Basic and Supplemental Health Services         X
shall be available, accessible and be
provided in a manner that assures con-
tinuity and when medically necessary be
available and accessible twenty-four
hours a day and seven days a week.
A member of an HMO shall be reimbursed         X
by the organization for his expenses
in securing basic or supplemental- health
services other than through the organi-
zation if it was medically necessary.
An HMO should have a fiscally sound            X (with some
operation and adequate provision against
the risk of insolvency which is satis-           changes neededt
factory to the Secretary.                        see ch. 2)

An HMO should assume full financial            X
risk on a prospective basis for the
provision of health services, except
that the HMO may obtain insurance or
make other arrangements.
An HMO shall enroll persons who are
broadly representative of the various                         X
age, social and income groups within
the area it serves.
An HMO shall have an open enrollment
                                               X (During our review,
period of not less than thirty days
at least once during each consecutive            Sound Health was not
twelve month period during which en-             in compliance. How-
                                                 ever the act, as
rollment it accepts, up to its capacity,
individuals in the order in which they           amended, does not
apply, (Unless] the HMO demonstrates             require open enroll-
to the Secretary the need for a waiver.          ment until certain
                                                 criteria are met;
                                                 see p. 9)

 APPENDIX IV                                            APPENDIX IV

                                               In           Not in
                                           compliance     compliance
Ali HMO shall not expel or refuse to re-      X
enroll any member because of his health
status or his requirements for health
An HMO shall be organized in such a           X
manner that assures that at least one-
third of the membership of the policy-
making body of the HMO be members of
the organization and there shall be
equitable representation on the
member portion of the policymaking
body of members from the medically
underserved populations in proportion
to their enrollment relative to the
entire enrollment.
An HMO shall be organized in such a           X
manner that provides a meaningful pro-
cedure for hearing and resolving griev-
ances between the HMO and the members
of the organization.
An HMO shall have an organizational           X (some improve-
arrangement for an ongoing quality              ments are neededt
assurance program which stresses                see ch. 5)
health outcome and provides review
by physicians and other health pro-
fessionals of the process followed in
the provision of health services.

An HMO shall provide for its members:
     -- medical social services               X
     -- encourage and actively provide        X
        for its members' health
        education services.
An HMO shall provide or make arrange-         X
ments for continuing education for its
health professional staff.

An HMO shall provide for an effective
procedure for developing, completing,
evaluation, and reporting to the
Secretary statistics and other

APPENDIX IV                                          APPENDIX IV

                                            In           Not in
                                        compliance     compliance
     -- cost of operations                 X
     -- patterns of utilization of
        services                           X
     -- availability, accessibility,
        and acceptability of its
        services                           a/
     -- to the extent practical
        developments on the health
        status of its members              a/
     -- such other matters as the
        Secretary may require.             a/

a/HEW has not completed reporting requirements.

APPENDIX V                                         APPENDIX V

     Our analysis of the Sound Health financial outlook
indicates it is unlikely to succeed under the rate structure
proposed by Sound Health's finance director. A comparison
of rates for competitive plans suggests Sound Health could
raise rates 10 percent above those projected and still be
competitive with the other plans. We made a second pro-
jection, assuming Sound Health would increase premiums 10
percent above projected amoutLs as of January 1977. Under
this assumption the plan would begin to have operating pro-
fits during the second quarter of 1979.  C 3h flow problems
will probably not occur if the HEW loan to Sound Health
is increased to $2 million, as expected by Sound Health,
and if the loan period is extended beyond 3 years, as author-
ized in the 1976 amendments to the HMO Act. The first pay-
ment on the principal is scheduled for July 1979.

      For Sound Health to succeed it must improve its
marketing significantly. The executive director of Sound
Health has expressed willingness to move toward achieving
this.   Even assunLing an improvement in marketing, we
believe that Sound Health enrollment projections may be
substantially overstated, unless additional membership
sources are identified.

     The major differences in assumptions used in the Sound
Health projection (showing a fourth quarter 1977 break-even
point) and our projections are summarized as follows.

               Sound Health
Assumption      projection               GAO projection
Inflation    10-percent simple     10 percent compound rate,
  factor     rate (not com-        20-percent effective rate
             pounded)              for malpractice insurance,
                                   and 10 percent additional
Hospital     450 days per 1,000    480 days per 1,000
  utiliza-   members a year        members a year

 APPENDIX V                                            APPENDIX V

 Facility     Delay adding facili-    Lease second facility
   expan-     ties. It is unclear     when enrollment reaches
   sion       from projection work-   12,500. Stop enroll-
              sheets where members    ment activities when
              are to be cared for     membership approaches
              after original          the 25,000 limit of 2
              facility is out-        facilities.
 Enrollment    Initial penetration     Accepted Sound Health pro-
               rates of 5 percent      jected Medicaid and non-
               for some specific       group enrollment increases.
              major employers          Assumed enrollment increases
               (Federal, and State     for 25 or fewer employment or
              Government, Boeing,      less approximately equal the
              etc.).   It is un-       increase between 3/1/75 and
              clear what enrollment    3/1/76. Initial penetration
               increases were as-      rate of 3.8 percent for large
              sumed to be.             groups with semiannual
              Approximately            increase for 3 years
              straight line in-       of 1.5 percent (3 per-
              creases in nongroup     cent annual increases
              enrollment, and          for Federal employees).
              Medicaid enrollment     Peak penetration after
              spurts for Medicaid     the fourth year of 12.8
              in April and October    percent. Used specific
              after semiannual        enrollment drives planned
              mailings.               by Sound Health when
                                      available. Assumed
                                      drives in 10 firms per
                                      quarter averaging 75 em-
                                      ployees for remaining
                                      months through end of
                                      1979, when all major
                                      employers will have
                                      been contacted. Assumed
                                      2.3 plan members per

     We accepted the 10-percent rate used by
but applied as a compound rate. A 10-'- cent Sound Health
Cused by Sound Health) results in a 50-percent simple rate
after 5 years. A 10-percent compound rate       increase
results in a 6 1-percent increase after 5 years. by us)
  Feb. 1976 Seattle area medical expense consumer
  index - 169.6

APPENDIX V                                           APPENDIX V

   Feb. 1972 Seattle area medical expense consumer price
        index -    122.9

        Annual effective rate of increase        -    8.4%

                                       100   =   Jan. 1967
   Feb. 1976 national hospital charges consumer price
        index = 144.1

   Jan. 1972 national hospital charges consumer price
        index = 100.0

        Annual effective rate of increase        =    9.6%

                                       100   -   Jan. 1972
"Jan./Feb. 1975 Malpractice Digest" published by St. Paul
Fire and Marine Insurance quotes malpractice premium in-
creases over the previous 5 years as 154-percent for low-
risk doctors (non-surgeons) and 172 percent for high-risk
doctors--effective annual rates of about 21 and 22-percent,

     For Sound Health to become viable under our assumptions,
a 10-percent rate increase above that projected by Sound
Health would be required. A premium comparison, based on
a chart in the brochure "State Employees Insurance, Board
Approved Medical Plans" (see p. 20 of report), indicates
that such an increase would leave Sound Health rates com-
petitive with all listed plans except Blue Cross low option
(benefits not comparable) Kaiser (not available in Tacoma)
and well below Blue Cross high option rates.

     The finance director of Sound Health said he assumed
the hospital utilization rate could be reduced to 450 days
for 1,000 members by postponing elective surgery (such as
vasectomies) until fewer than a prescribed number of Sound
Health members were hospitalized. We don't believe Sound
Health can achieve the dramatic enrollment improvement
needed for success and also refuse to provide benefits as
promised. Therefore, GAO used a utilization rate closer
to actual hospital use.

APPENDIX V                                            APPENDIX V

     Hospital utilization for the let quarter of 1976s

2,855 members in Jan. x 533 annual days
     per 1,000                        - 1,522 annual days
2,929 members in Feb. x 524 annual days
     per 1,000                        - 1,535 annual days
3,048 members in Mar. x 429 annual days
     per 1,000                        - 1,307 annual days
     Total                                4,36
   Total member months (2,855 + 2,929 +
                                3,048)      . 8,832,000 members
                                                 494 annual days
                                                     per thousand

     The original projection of the Sound Health finance
director showed a second facility would have to be leased
when enrollment approached 12,500 and a third facility would
be needed at a membership of 25,000. He then revised his
projection, eliminating the lease expense for additional
facilities and adding a variable expense when membership
exceeds 14,000. We know of no way of adding parts of
facilities as each new member joins.  The only alternative
is to add a new facility when the existing one is outgrown.
Adequate facilities are crucial to a successful marketing
program. We, therefore, used Sound Health's original
projection. Since our projection indicated that membership
would peak at around 26,000, we assumed a cutoff of enroll-
ment activity at the 25,000 level, which would be the
capacity of the 2-facility operation. Sound Health stated
that our assurption could apply within the initial period
of Sound Health development, but they expect to have other
facilities in a larger capacity in years to come.


     A 3.8 percent first year penetration rate, that is,
the percentage of employees enrolled during the first
year the plan was offered to respective employers would be
a significant improvement over recent Sound Health experi-
ence. The calculations below show a first year rate as
of March 1, 1976, following the initial offering and may

APPENDIX V                                           APPENDIX V

reflect some reenrollments and the initial enrollments. The
first year rate for the period ended March 1, 1976, was 3.1
percent. Sound Health's April 1976 enrollment drives included
such failures as Pacific Northwest Bell--10 out of 985,
Tacoma Housing Authority--0 out of 150, Boeing--0 out of
1,100, Pierce County Health Department--l out of 170. A
Sound Health official pointed out that these failures were
due to problems with union acceptance and inability to
obtain access to employees. Projected improvement is hoped
for because of the apparent willingness of Sound H-alth's
executive director to improve Sound Health's marketing
department and to finalize dual-choice regulations.
     The Community Health Care Center Plan of New Haven,
Connecticut, opened in October 1971. Its penetration rates
have averaged 5.9 percent for the first year and 14.3 percent
for the fourth year, and have leveled off in the fifth.
The straight-line rate of penetration increase has been
14.3-5.9 = 2.8%. We assumed a 3-percent rate of increase
for Sound Health since it is starting from a lower initial

                Penetration Rate Computed for
             Groues Under Contract as o   3-T1/76
3/1/76 - Employees in Sound Health from firms with
           24 of fewer employees                          161

3/1/75 - Employees in Sound Health from firms with
           24 or fewer employees                           99

         Increase in employees enrolled                    62

              x 2.3 average members per employee         x2.3

         Increase in membership                         142.6
                .12                                        12

         Monthly membership increase                       12

 APPENDIX V                                          APPENDIX V

 Firms of 25 employees                  First-year   Penetration
       or more            Employees     enrollees       rate
 Under contract as of
   3/1/75                   5,889          307          5.2%
 Contracted 3/1/75 through
   3/1/76                  11,467          358          3.1%
 Combined                  17L356          665         3.8%
     Omitted from this calculation were Sound Health, which
has 100-percent penetration; a bank corporation (Sound Health
advised us that it expects very little success with banks);
and the State of Washington (which had had no enrollment
drive as of March 1976).

     We obtained a schedule of enrollment
1976 through September 1977 and noted that drives for December
                                            the Civil Service
Commission had approved offering Sound Health to 10,000
Federal employees effective January 1977. For those months
for which no enrollment drive information was available, we
assumed that 10 firms could be contacted a month, averaging
75 employees a firm,   The average number of employees came
from a listing provided by Sound Health. We eliminated
firms with fewer than 25 employees and firms already Li der
contract or scheduled for enrollment drives. The remaining
351 firms on the list had 26,292 employees (an average of
75 a firm). In addition to the firms on the list, we in-
cluded 13 firms not listed, each averaging 75 employees.
These assumptions result in no additional major employers
to enroll after December 1979. We also assumed neither
substantial increases nor decreases of employment will
occur in the Tacoma area.

     HEW's HMO Reporting System Report on "Membership per
Contract for Federally Qualified Health Maintenance
Organ:zations" for the quarter ended December 1975 shows
that Sound Health had averaged 2.3 members per contract
for all contracts and 2.2 members per contract for group
contracts. We used the higher average.