Will HMOs in their current form survive into the new millennium?
Perhaps, but the managed-care model that has grown to dominate American healthcare, making millionaires of hundreds of industry executives along the way, could be headed for perilous times.
In fact, Bleeding Edge: The Business of Health Care in the New Century, a new book by medical economist J.D. Kleinke, argues that managed care in its current form is unsustainable and will "cease to exist within a few years."
"The profitability that gave rise to the big, national, for-profit managed-care companies was a one-time event, a temporary phenomenon designed to shake up the entire medical financing and delivery system," says Kleinke, formerly the vice president of corporate development for HCIA, a Baltimore-based healthcare information company.
Managed care worked as a transitional mechanism, Kleinke says. But now providers are learning to work the new system, consumers are becoming more sophisticated, and skeptics are questioning the huge chunk of healthcare premiums being gobbled up by managed-care companies for administrative expenses.
"We're seeing the beginnings of a fundamental breakdown. This is not just a one-year problem. This is a systemic problem," agrees Sheryl Skolnick, managing director of healthcare services for BancBoston Robertson Stephens in New York. She is one of the leading bears on the HMO front.
The depth of that breakdown will become apparent as managed-care companies report their financial results for the third and fourth quarters, Skolnick predicts.
System breakdown. The current model simply isn't working as well as it used to, as evidenced by a growing gap between premiums and medical costs, which over the past 18 months has left many HMOs posting big losses and exiting markets. Pressure from providers for higher rates and from consumers for more freedom and fewer restrictions are undercutting the price and utilization controls that kept healthcare costs in check throughout much of the decade.
"Managed healthcare, particularly the HMO version, is not a terribly sophisticated industry yet," says Peter Boland, a Berkeley, Calif.-based managed-care consultant. Boland says Wall Street is losing faith in the industry's ability to manage costs-let alone patient care.
The industry hasn't invested enough in critical information technology and has been "largely anti-customer in terms of practices and policies. That's just plain dumb," Boland says. And because managed-care plans haven't successfully differentiated their products from the competition, "what you get is price, price, price."
If even that advantage disappears, what's left? Boland asks.
A brake on inflation. Managed care got its impetus in the mid-1980s, when rapidly escalating healthcare inflation convinced employers that a middleman was needed to put the brake on costs.
But even with a large number of Americans now covered by some form of managed care-127 million out of the 225 million with health insurance, according to the Henry J. Kaiser Family Foundation-HCFA researchers predicted in a recent study that healthcare costs will double to more than $2.1 trillion by 2007. That's in large part because the one-time financial benefits of the conversion to managed care have already occurred.
Employers are beginning to realize that premiums are rising again, and they aren't happy about it.
"I've gotten calls from a number of employers who are outraged by the premium increases they're getting," says Steve McDermott, executive director of San Ramon, Calif.-based Hill Physicians Medical Group, one of the largest independent practice associations in Northern California.
Premium increases for many major employers will jump by as much as 8% to 10% next year, according to Larry Boress, vice president of the Chicago-based Midwest Business Group on Health, which represents 110 large employers in 11 Midwestern states. The group is strongly encouraging members to hold the line on premium renewals and to consider tactics such as freezing enrollment in plans with large rate increases, raising copayments and deductibles for employees, and warning employees that more drastic changes might be contemplated down the road.
"I'm surprised at how hard major employers are getting hit," Boress says.
Nationally, premiums are likely to increase at a 6% to 8% clip next year, according to surveys by Watson Wyatt Worldwide, William M. Mercer, Towers Perrin and other observers. That compares with a 3% to 4% increase this year. And even with the higher 1999 rates, HMOs are likely to face a tough operating environment because of rising pressures from providers.
"No one seems to have solved the cost problem," says Rob Mains, an Albany, N.Y.-based healthcare analyst for Advest.
Pharmaceutical costs are skyrocketing, and HMOs are having a tough time keeping the fees they pay to hospitals, doctors and other providers from doing the same.
Seeking answers. The only solution, according to some observers, is even more consolidation on the HMO side, until a small number of managed-care plans dominates the market and can squeeze excess capacity out of the system. But that could take another three to five years, Hill Physicians' McDermott predicts, and it's not clear the industry has that much time to prove its long-term worth.
If the managed-care model doesn't evolve in ways that make it more palatable to consumers and a less tempting target for politicians, managed care as we know it may soon be extinct, the analysts say.
The next year or two will be "a major decision point" for the industry, says Joseph Coyne, chief executive officer of Healthcare Databank, a Sonoma, Calif.-based research firm that tracks the managed-care industry. Unless health plans can improve service at the same pace at which they raise rates, they are likely to face further legislation and litigation that will "significantly restrict their autonomy in the marketplace," Coyne predicts.
Paul Hofmann, senior vice president at Aon Consulting in San Francisco, believes market pressure, along with political pressure on the state level from legislators, attorneys general and other regulators, will force HMOs to do a better job of documenting value than they have in the past. It may even compel them to "make some accommodations" on patient-protection legislation, access and other consumer issues.
The American Association of Health Plans is putting its faith in quality improvement and in convincing consumers that new regulatory burdens will make things worse, says Karen Ignagni, the trade association's president and CEO. But more broadly, Ignagni expects to see a "continued evolution" that puts consumers in the driver's seat by giving them more choice of providers and benefits.
More choice could mean higher medical costs-a tough trade-off for HMOs that are already struggling to make a profit. And if the evolution of the HMO weakens the elements that made managed care appealing in the first place, some observers say participants could be back in a world that looks a lot like the 1980s-with high medical inflation, less coordination of care and growing demand for a governmental solution.
In such an environment, "many of managed care's virtues could be washed away," says industry consultant Doug Sherlock of Gwynedd, Pa.
Managed-care bull Peter Kongstvedt of Ernst & Young disagrees with counterparts like Skolnick that the industry is "in crisis," but he acknowledges managed-care companies are getting squeezed and are unlikely to see the huge profit margins of the mid-1990s in coming years.
"The times of giant margins are probably done," he says, "but they'll still make a margin."
Missteps. So far this year, that hasn't been the case for many major industry players.
Highlighted by major missteps at United HealthCare Corp., Oxford Health Plans and Kaiser Permanente in recent months, the industry has seen its financial results slump dramatically.
Minneapolis-based United and Norwalk, Conn.-based Oxford wrote off $900 million and $508 million, respectively, in the second quarter, and Oakland, Calif.-based Kaiser last year posted its first loss ever, totaling $271 million. Overall the industry lost $768 million in 1997, according to a recent report by Weiss Ratings, and it could fare even worse this year.
Kaiser, for example, is still losing money, according to industry insiders, and soon could be faced with selling non-California operations or instituting tough systemwide budget cuts. Some sources say Kaiser is on track to post 1998 losses that top 1997's (Oct. 12, p. 28).
The managed-care giant lost just $31 million over the first two quarters of this year but was bailed out by investment income prior to the market's recent plunge. On operations, its first-half losses were a hefty $162 million.
Oxford's woes also continue to mount. A Sept. 23 report by Moody's Investors Service changed the firm's outlook on Oxford's bonds to negative, indicating that uncertainties surround its turnaround plan. Continued operational difficulties could result in a further decline in Oxford's "already significantly depleted cash position," Moody's says.
Although Wall Street's expectations of the managed-care industry are dropping, pressure on margins is forcing companies to shelve strategies that focus on gaining market share. Generating higher profits is becoming king.
But employers won't pay more just to boost the HMOs' earnings. "We're concerned about plans shifting from developing market share to developing (higher) profits," says Boress of the Midwest Business Group on Health. Employers look at health plans as vendors, he says, and they are looking for vendors that can keep their costs down.
Chaotic market. Adding to the uncertainties is the chaotic state of the Medicare HMO market.
United has blamed many of its recent woes on payment and cost problems involving its Medicare HMO products in 35 markets nationwide. Since last spring, the company and a host of other health plans have announced plans to exit selected Medicare-risk markets. Only about 400,000 enrollees have been affected so far, but Medicare-related questions continue to concern some analysts.
"A lot of people are questioning the future of (the Medicare HMO program)," says Advest's Mains.
Even though pharmaceutical and other medical costs are skyrocketing, HCFA has limited Medicare HMOs to reimbursement increases of 2% per year. In conjunction with low reimbursement rates in many rural and suburban counties around the country, that has prompted many HMOs to take a second look at the Medicare market. Managing an HMO "on an ongoing basis at 2% is virtually impossible," says John Bertko, a San Francisco-based managed-care consultant with the Reden & Anders consulting firm.
In any case, the numbers this year have been brutal, and tumultuous times on Wall Street could make it tough for health plans to make up in investment income what they lose on operations.
A mid-September study by Healthcare Databank found that one-third of all California HMOs lost money last year, despite declining medical-loss ratios in the state. The ratios measure the amount of money being spent directly on medical care.
Studies in New England and New York have produced similar results.
And a recent report by InterStudy, a Minneapolis-based HMO research group, illustrates that declining profitability is part of a broader industry trend that began in 1994 and has continued despite huge enrollment increases over the past three years. HMO enrollment jumped to 66.8 million in January 1997, compared with 45.4 million in January 1994, according to InterStudy.
Since 1995, HMO premiums have not increased in real terms (using inflation-adjusted dollars), according to InterStudy, and attempts by managed-care companies to broaden their appeal with expanded product lines, including open-access or point-of-service plans, have had mixed results.
Casualties. As a result, costs are jumping faster than premiums in many markets, and Skolnick and other pessimists warn that additional physician practice management and provider groups are likely to collapse in the near future, causing further financial distress for HMOs.
Such failures as San Diego-based FPA Medical Management, which filed for federal bankruptcy protection in July, will likely mean more financial losses for HMOs, more chaos and uncertainty, and less credibility for an industry that is already suspect in the eyes of the public.
In many cases, HMOs have an ownership stake in the PPMs, while in other cases, they are left holding the bag for loans and other contractual obligations to the physician groups.
FPA's financial woes translated into losses of more than $38 million each for Foundation Health Systems, Oxford and WellPoint Health Networks.
Similarly, the Chapter 11 bankruptcy filing in late July by Pittsburgh-based Allegheny Health, Education and Research Foundation, one of the nation's most aggressive not-for-profit healthcare systems, forced Bethesda, Md.-based Coventry Health Care HMO to take a $55 million charge.
A good deal of the remaining dirty laundry is likely to come out in the next few months, as companies take advantage of Wall Street's current doldrums to announce as much bad news as possible while their stock prices "are in the dumps," Skolnick says.
Greg Crawford, a healthcare analyst at Fox-Pitt, Kelton brokerage firm in New York, isn't as bearish as Skolnick, but he agrees that managed-care organizations will have to slash benefits and dramatically raise copayments to make it in the near future.
"Maybe not this year, but next year," says Crawford, who argues that current benefits are far too generous for HMOs to maintain healthy bottom lines.
Large copayments and deductibles may come back into fashion, he says, as managed-care companies look to employers-and consumers-to bear more of the financial burden.
"You'll see employers becoming much more active," he says. "You'll see some pretty large benefit adjustments."
Objections. The problem with slashing benefits, of course, is that both the public and the politicians-who are constantly checking the public's pulse-already object to the restrictions that managed care imposes on enrollees. Further limitations would likely stoke their dissatisfaction.
Fortunately for HMOs, patient-protection laws have been stymied by Washington's focus on President Clinton's scandals. But under the surface, the pressure for further regulatory restrictions on HMOs is still there.
Managed-care companies continue to face pressure in the marketplace to offer greater access to physicians and fewer restrictions on consumer choice.
But if HMOs open up formerly closed panels of physicians and loosen up financial and utilization controls, they will lose many of the features that allowed them to control costs and to "manage" medical care in the first place, some industry experts say.
"If you keep chipping away, you'll be back to the `good old days' of indemnity," says Cora Tellez, president of Prudential Health Plan of California and a former Kaiser Permanente and Blue Shield of California executive.
Or as Skolnick says, "once HMOs lose the ability to ration, the game is over."
In the long run, many observers believe the solution is to wring more "excess capacity" out of the healthcare system by effectively forcing numerous doctors to stop practicing medicine and by closing more hospitals.
So far, however, that has proved to be a tough task, even in California, where managed care has held sway for many years. The solution is a hard sell politically for an industry that has more than its share of public perception problems (Aug. 17, p. 30).
No alternative. The best thing going for managed-care companies, some analysts say, is the lack of a credible alternative on the horizon-other than some form of government-run, single-payer system.
The AAHP's Ignagni wonders aloud whether the public sector "is prepared to pay what it takes to meet its objectives?" She points to consumer surveys that show the public is in favor of overturning the managed-care apple cart-until it discovers the cost of doing so. Recent polling on various "patient protection" proposals shows that many consumers want to pile restrictions on HMOs until they learn the cost, in terms of premium increases.
So managed care may not be dead, but it's clearly ailing and in need of a burst of creativity and energy.
If the industry doesn't heed its wakeup call, observers such as Kleinke say, providers and employers-likely led by coalitions such as the Midwest Business Group on Health and the San Francisco-based Pacific Business Group on Health-will take matters into their own hands and move more boldly toward direct contracting.
According to Kleinke, a pattern of more mergers and more premium increases won't do the trick for the HMO industry.
If that's the case, "they'll become victims of their own success and their own hugeness," he predicts.