Hospitals, Faced With Rising Costs,
Are Re-examining Managed-Care Deals
Like rolling blackouts or lake-effect snow, hospital networks walking away from certain HMO contracts seems to be a regional phenomenon, but that could change as the trend seeps from California to regions with less HMO penetration.
Several hospital-HMO contract disputes have flared up in California in recent months, notably St. Joseph Health System’s highly publicized trimming of its HMO network from 17 to five carriers in the fall. PacifiCare of California, the Cypress-based subsidiary of Santa Ana-based PacifiCare Health Systems Inc., first announced that it was among the plans dropped from St. Joseph’s HMO network. PacifiCare officials said their relationship ended because St. Joseph wanted rate increases that local employers were not willing to absorb. St. Joseph officials, on the other hand, said the breakup came about because PacifiCare was unwilling to shoulder more of the risk of paying for rising healthcare costs.
St. Joseph later said it was contracting with just the five “partner health plans,” including Aetna, Cigna, Health Net, Blue Cross and Blue Shield. Orange-based St. Joseph cited several reasons for the reshuffling, including heavy losses.
Linked to Capitation
“Clearly, in my mind, this is a state situation, not a national one,” said Don Goldmann, president of the Orange County Association of Health Underwriters. Goldmann links the contract cancellation issue to California’s common HMO business model, which until recently relied on fixed-payment, or capitated, contracts.
Under capitation, hospitals and medical groups receive a set amount of money per patient for providing healthcare, regardless of how much care the patient actually uses. If the cost of providing healthcare, however, exceeds the capitated rate, the hospitals and doctors’ groups absorb the excess.
Even though experts often cite the St. Joseph situation and a contracting breakup between Sutter Health and Blue Cross of California in the north, such scenarios aren’t narrowly confined to California.
Partners HealthCare Inc., a large Boston hospital system, walked away from negotiations with Tufts Health Plan Inc. late last year rather than lose money on a deal with Tufts. Some have said the Partners-Tufts situation is an example of large hospital networks, not insurers, calling the shots on contracts,leading to a likely outcome of significantly higher healthcare premiums for employers.
Market Differences
Kenneth Kaufman, principal of Kaufman Hall, a Chicago-based financial and capital consulting firm, believes hospital systems outside California are considering dropping their contracts on a case-by-case, regional basis.
“While I think this is a national concern, (action) reflects markets’ differences,” Kaufman said. “Some will not hesitate (to drop contracts). Others won’t do it.”
For example, Kaufman said, Chicago isn’t experiencing many managed care contract dumps by hospitals because businesses mainly offer healthcare through preferred-provider organizations and restrictive, capitated benefits weren’t well received by employers or workers.
“We’re a freedom-of-choice market. Enforced reimbursement never took in Chicago,” Kaufman said.
The Northeast, on the other hand, has a high HMO penetration, like California.
Dr. Jack Thomas, family practice residency director of Pacific Hospital in Long Beach, tends to agree with Kaufman.
“Things started here in terms of managed care. We initiate trends. More and more hospitals will do what St. Joe’s did,” said Thomas, who formerly practiced at Unicare in Garden Grove. He added that he believes contract dropping has hit Los Angeles County much harder because of its larger population and a troubled infrastructure, including several struggling government-owned hospitals.
Sheryl Skolnick, a healthcare analyst formerly with the Robertson Stephens investment banking firm, said the situation is part of a structural change in the underlying economic market for healthcare services. “Health plans are having a hard time getting permission from the politicians and the employers” to behave as they did in the past, said Skolnick, who spoke on the subject at the recent Health Care Forecast Conference at UC Irvine.
“They can’t globally capitate. They must bear insurance risks,a novel concept for some payers,” Skolnick said.
Hospital contract shedding “is something that’s becoming almost commonplace in California and the rest of the nation,” said Steve Richter, healthcare practice leader in the Southern California office of the Watson Wyatt Worldwide consulting firm. “Hospitals, especially those in California, are facing financial pressures.”
Hospitals’ Costs Rising
Such pressures are “a real severe nursing shortage,” increasing numbers of uninsured patients, complying with new state seismic standards and reimbursement freezes imposed by the Balanced Budget Act of 1997, according to Richter.
But in many cases, the disconnect between hospitals and health plans was fueled by the growth of strict capitated contracts, especially in California.
Evan Moore, head of the healthcare practice at Houlihan Lokey Howard & Zukin, a Los Angeles investment banking firm, said, “The rates came down a lot more here. Other (markets) have not embraced managed care, at least not to the same degree of risk as here.”
Moore said California hospitals and doctors’ groups took to capitation at first.
“Whether it was from force-feeding or competition, hospitals embraced taking risks,” Moore said. “They said give me the money, I’ll manage the care and make more money.”
But the scenario did not work because physicians and hospitals lacked the infrastructure, particularly computer systems, to actually track how healthcare dollars were being spent, Moore said. “That’s why you saw MedPartners and a number of large physician entities go belly up.”
Another example of that was last year’s failure of Anaheim-based KPC Medical Management Inc., which imploded after management problems and protracted battles with health plans over payments. KPC eventually shuttered its 38 clinics, pink-slipped its 2,000-plus employees and filed for bankruptcy.
“Hospitals signed aggressive contracts with health plans in the 1990s, in order to grow or preserve their market share,” Richter said. “They signed capitated contracts and they found they were losing their shirts. A lot of them had reimbursements that didn’t even cover their marginal costs and weren’t viable long-term.”
“Hospital administrators have always believed that if you achieved a high enough occupancy level, the finances would work out,” said Ron Mason, a consultant in Towers Perrin’s Costa Mesa office. But with capitation, “even with 85% or more of their beds occupied, their bottom line’s still not good.”
Hospitals now are willing to either terminate contracts or take a harder negotiating line with managed care companies, Mason said, “because they can do something about them. You can’t yell at Medicare or fire the Medicare system. You can fire some payers.”
UCI Led the Way
St. Joseph, though its move was highly public and is often cited, was not the only or first Orange County hospital to disassociate itself from HMO contracting. The first shot was fired around two years ago, when UCI Medical Center quietly re-evaluated its dealings with managed care.
Dr. Ralph Cygan, the Orange teaching hospital’s chief executive, has said that HMOs weren’t paying enough to cover the costs of expensive treatments. “The problem is you get the same amount of money whether the patient is sick or the patient hasn’t seen the doctor in 10 years.
“The economics do not work out, unless you can dilute that one sick person’s healthcare costs against literally thousands of other patients who don’t access healthcare on a regular basis,all those healthy young twenty-something who never see the doctor,” Cygan said. “We just could not make ends meet when we were receiving un-risk-adjusted capitation.”
Richter said another factor affecting the issue is the fact that contract negotiations, on both sides, have come out into the open. As examples, he cited the breakup between Sutter, a dominant not-for-profit provider in Northern and Central California, and Blue Cross of California, and tensions between Blue Cross and Good Samaritan hospitals in Los Angeles County.
Specifically, Richter said it is now “mainstream” for hospital systems to cancel HMO contracts and then see if the health plans will come to the table to renegotiate.
Meanwhile, health plans, besides hospitals, also have to deal with employers’ possible concerns about narrower provider networks, experts said.
“It puts a lot of pressure on them,” Richter said about contracting fissures. “St. Joseph is a very prestigious hospital network. If you don’t have them, it’s very difficult to sell your product.”
Such situations, Richter said, makes it even more important for managed care plans to make sure they have other hospital systems lined up to take their patients. In PacifiCare’s case, it recently signed a long-term agreement with Tenet Healthcare Corp., Orange County’s largest hospital operator, and it renegotiated its contract with Memorial Health Services, which has three Orange County hospitals.
Goldmann, on the other hand, said that his clients have taken the shifts as part of doing business. “Generally, the employer is reasonably astute and understands,” Goldmann said, adding that California employers have purchased network-based benefits for 40 years.
“From a broker (perspective), as long as the carrier makes a good-faith effort to communicate, you see very little fallout. We don’t see a whole clamoring of people trying to move because of a public spat.”
Moore predicted that the fallout would include more shifting of risks to the patient and a move by employers to give their workers money and allow them to select their own healthcare benefits plans.
“What I see is that the employer wants to get out of the middle,” Moore said. n
