HMOS' QUESTION: TO PAY AND DELIVER OR JUST PAY?
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January 22, 1996 12:00 AM

HMOS' QUESTION: TO PAY AND DELIVER OR JUST PAY?

Ira Studin
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    HMOs are quickly reaching a point where they will have to make a hard choice about their future. Will they pay for and deliver medical services or just pay for services?

    Historically, HMOs have both paid for and delivered medical care because their business linked prepaid premiums to a benefit design requiring nominal copayments for all the care enrollees received. Having to accommodate enrollee utilization within a prepaid budget, HMOs naturally assumed the responsibility for delivery-in some instances through staff and salaried group models, but in most instances by simply contracting with participating providers. Regardless of the type of HMO, however, their business model presupposed that HMOs by definition pay for and deliver healthcare.

    What stands out over the last 10 to 15 years is the decidedly pragmatic manner in which payment and delivery have been linked. Minimizing higher fixed costs, HMOs (with a few notable exceptions) embraced contracting with physicians in private practice as the dominant industry strategy. Certainly, this is not surprising.

    Since physicians have always zealously guarded their independence, the easiest way for HMOs to grow has been by signing up physicians, rather than hiring them. In addition, to avoid any association with "clinic" medicine, HMOs have tried to preserve the look and feel of private practice in their delivery systems. Participating provider arrangements, then, have typically been easier to establish than staff or salaried group models. They also required far less capitalization.

    HMOs now have to take the next step in their industry revolution. Rather than the pragmatic issues of market entry and consumer acceptance, the single most critical issue the industry faces is production-specifically at the clinical level. If HMOs are to continue paying for and delivering services, the production of clinical value has to become the primary focus.

    Three observations about current industry developments underscore why production should become the focal point of HMO strategy:

    The forces underlying healthcare inflation are invariant. High-tech medicine, aging, increasing chronicity and popular expectations for the best medical care possible are secular forces that will only increase the velocity and intensity of medical services in the future.

    As the demand for medical services increases, the dollars available to pay for that demand will not grow proportionately. The recurring complaint among physicians about having to work harder for less is a harbinger for the entire healthcare industry-a permanent tightening of the money supply in the medical economy signaling a need for greater value to be produced under a more or less fixed national budget.

    The pace of consolidation in virtually every healthcare sector-be it pharmaceutical, hospital, physician, nursing home, home infusion and health insurance-is unprecedented. With consolidation comes the drive for eliminating duplication and creating economies of scale. Industry sectors as well as competitors that successfully create economies of scale will capture more of the operating margin in the healthcare pie; those that do not risk mediocrity and eventual failure.

    Eliminating duplication and creating economies of scale, though, are entirely different. Creating economies of scale means changing the way activities are performed so products and services are produced more efficiently. Eliminating duplication simply allows fixed costs to be spread over greater volume. The latter amounts to one-time savings; the former will continue to throw off above-average margins so long as competitors don't match the particular economy of scale achieved.

    Wall Street's recent focus on HMO medical-loss ratios should not be viewed as just another spin on healthcare industry behavior. Nor should the Republicans' new-found focus on Medicare reform be viewed as some counterpunch in the game of partisan politics. Each is symptomatic of escalating pressures HMOs will have to contend with in the years ahead.

    HMOs now face a moment of truth. If they are to continue paying for and delivering health services they will have to produce greater clinical value in their delivery systems. To do that, however, requires

    re-engineering the day-to-day practice of medicine to build economies of scale that operate on multiyear productivity standards tied to wellness as well as illness. It also means relying much less on private practitioners who ply their trade according to the piece-rate logic of fee-for-service, and much more on staff and salaried group model platforms.

    This is not a question of right and wrong. It is a question of strategy and structure. Notwithstanding all of the overhead concerns attributed to staff and salaried group models, only those platforms allow direct control over medical practice so

    re-engineering and longer-term productivity standards can be achieved. HMOs built around contractual arrangements with participating providers in private practice can't re-engineer what they don't directly control. Consequently, they are precluded structurally from producing the additional clinical value needed to offset the inflationary forces endemic to the industry.

    Those HMOs would be better off saying they are now only in business of paying for healthcare services. They could then deploy resources to produce superior value in other parts of their overall business. Failing to make this admittedly tough decision will inevitably force HMOs to squeeze harder and harder on physicians through utilization review bureaucracies that extract their pound of flesh but contribute minimally to the value deficit the health insurance industry now faces.

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