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Industry Outlook -- Services: HEALTH CARE
The emergency surgery-raising premiums and balancing budgets-was a success. HMOS have a bloom in their cheeks again. But hospitals and doctors are winning more power
The managed-care balloon burst spectacularly last July. In one week, four publicly traded health-maintenance organizations reported profits sharply lower than Wall Street had figured on. Pop! Giants United Health Care Corp. and Humana Inc. fell from grace. Pop! Earnings at smaller Mid-Atlantic Medical Services Inc. and Physicians Health Services Inc. tanked. HMO shares on average shed nearly a quarter of their value.
Managed care quickly set to healing itself--and the hurried operation has been a success. Insurers are winning higher premiums from employers and fixing the cost problems that brought unwelcome surprises. Average HMO earnings should jump by at least 20% in 1997 from last year's depressed results, analysts say. And managed-care stocks have rebounded to pre-July levels.
PREMIUM HIKES. Indeed, much of the health-care sector is poised for a robust year. It's not that revenues are soaring: The $700 billion industry should grow only 6.5% in 1997. Rather, HMOs should score by fixing past mistakes. And big hospital companies, nursing-home chains, and powerful new physician organizations are reaping the rewards of efficiency that managed care always promised. Sheer scale and better management are lowering costs and lifting profits.
HMOs, for their part, have negotiated premium increases for 1997 of 2% to 5%. Humana told analysts in November that it was cutting off customers who refused to pay an average 3% premium hike. "They're not completely out of the woods, but [pricing] is getting better," says Salomon Brothers Inc. analyst Robert J. Hoehn.
The gains barely match medical inflation, but they're a welcome tonic after two straight years of flat prices or actual declines. HMOs tolerated stagnant premiums because enrollment was soaring and strategies to limit costs in hospitals and doctors' offices appeared to be working. "They were getting a little fat and happy," says analyst Stephen Hodapp at Robertson, Stephens & Co. But insurers' earnings got socked in July when outpatient and pharmaceutical claims came in above budgets.
HMOs have imposed new controls on drug costs, and their ratios of medical costs to premiums have begun to drop. But their longer-term prospects look gloomier. Last summer's stock market debacle indicated that the days of simply beating profits out of doctors and hospitals are coming to an end. "The easy pickings are out of the system," says consultant Michael A. Sachs.
In this view, doctors, hospitals, and other providers are strengthening their hand against insurers. The nation's biggest hospital chains, for example, continue to consolidate for efficiency and pricing power. Tenet Healthcare Corp., the nation's second-largest hospital chain, agreed in October to pay $3.1 billion for OrNda HealthCorp, which is No.3. Columbia/HCA Healthcare Corp., which grew by mergers to become by far the largest U.S. hospital chain, should win profit gains of 15% to 20% in 1997.
How? Size and breadth mean clout. "This is a struggle for leverage," says Ronald J. Del Mauro, president of St. Barnabas Health Care System. A year ago, St. Barnabas ran two hospitals and four nursing homes in New Jersey. Since then, it has purchased six big New Jersey hospitals. It also runs 20 outpatient centers, a psychiatric facility, and two more nursing homes. Four or five more hospitals could join by March.
Del Mauro, like many hospital executives, argues that providers that blanket a region with a range of high-quality services--such as outpatient surgical centers, skilled nursing facilities, and the like--will command more and better contracts from insurers and employers. Aetna Life & Casualty Co., for example, aims to establish long-term relationships with as many as 25 integrated regional provider systems within five years.
There's plenty of room left for rationalization. Hospitals fill just 60% of their beds on any given night, and their productivity is falling. Overcapacity will intensify as more Medicare recipients go to managed care, which has reduced hospitalization of older patients. Consultant Sachs estimates that demand for hospital beds could drop 46% by 2000. As hundreds of institutions close, those remaining--increasingly in the hands of for-profit chains--will have more bargaining power.
Physicians, meanwhile, are recapturing leverage with the emergence of so-called physician practice management companies. Some PPMs buy medical practices outright, while others just handle administration and contract negotiations for a fee. Certain companies, such as industry leader MedPartners Inc., administer thousands of practices in different regions and specialties; many groups focus on regional markets or on specialties such as coronary care.
This year physician practice management companies' growth may stall. True, PPMs control less than 10% of U.S. practices. Yet William B. Hanlon III, a principal at investment bankers Shattuck Hammond Partners Inc., which has advised on PPM deals, says the easily acquired clinics already have been bought up, leaving a massive number of scattered solo physicians and small groups.
Still, PPMs already have brought both bulk and management savvy to a highly fractured industry. "Today, if you negotiate with any physician group, it's almost guaranteed you'll have a lawyer and an accountant and an actuary there," says Joseph Lynaugh, chief executive officer of NYLCare Health Plans.
The challenge to HMOs from physicians' groups isn't just a matter of pricing. Increasingly, managed-care companies are negotiating so-called capitated contracts that pay providers a flat monthly or annual fee per patient, no matter how much care is given. Related contracts pay providers a set rate for treating certain diseases or disorders--say, a heart attack. By doing so, insurers pass on all or most of the risk to doctors. They also pass on control over managing the care involved.
EFFECT ON QUALITY. Physicians, then, practice with stronger incentives to reduce costs than ever before. Many analysts believe doctors so motivated will, in fact, be better at rooting out ineffiencies in medicine than insurers have been--although the effect on quality is troublingly uncertain. But the most intriguing question is this: As providers, by taking on risk, become more like HMOs, what role will HMOs serve? "HMOs are not going to disappear," says Tenet CEO Jeffrey C. Barbakow. But their value could become limited to marketing and back-office operations: If doctors figure out how to find their own customers, insurers may find themselves simply processing claims--a low-margin affair.
In coming years, insurers may also become vulnerable simply by virtue of their success. More Americans than ever--perhaps 150 million--have entered some form of managed care. But that success has a downside: HMOs no longer can win one-time savings by converting large numbers of patients from more expensive indemnity plans. And since nearly all physicians have contracted to accept patients from several rival HMOs, managed-care plans look more and more alike to consumers and their employers--except for the premiums they charge. Health insurance, in other words, is becoming a commodity.
In fact, more health-care buyers are starting to think they can do the job better themselves. Sophisticated employer groups in Des Moines, Minneapolis, St. Louis, and other cities are attempting to bypass insurers altogether, negotiating contracts directly with doctors and hospitals. Such steps threaten insurers. For them, 1997 will be a year of healing. After that, there could be more bumps and bruises.By Keith H. Hammonds in New YorkReturn to top