Human Capital & Careers

Power to the Providers

Hospitals, doctors, and some health care purchasers are finding ways to bypass the HMOs in the middle.
Joseph McCaffertyJanuary 1, 1998

For years now, physicians and hospitals have been talking about, and to some extent creating, their own organizations to do an end-run around health maintenance organizations (HMOs). These so-called physician hospital organizations (PHOs) have had some success, but they have failed to attract employers in large numbers, because they are often poorly capitalized and too small to have much of an impact.

But that hasn’t stopped providers from merging, forming alliances, and forging joint ventures at a feverish pace. A 1996 survey by Deloitte & Touche LLP revealed that in only two years, the number of hospitals that belonged to larger health care organizations had grown from 24 percent to 40 percent. Only 21 percent of respondents said their hospitals will remain stand-alone facilities through the next five years. “The last 18 months have been pretty frenzied,” says Thomas C. Billet, vice president, national practice, for The Medstat Group Inc., an Ann Arbor, Michigan-based health care consulting firm. “And the phenomenon has by no means run its course.” Ultimately, Billet believes, providers that don’t affiliate with the megaplexes may be forced to close down.

The largest of these provider-sponsored networks (PSNs) offer medical services that cover every need, from brain surgery to pediatrics, and they have supplemented their capabilities with such ancillary health care components as specialized clinics, rehabilitation centers, and home health care units. Detroit’s Henry Ford Health System, for example, has assembled a system in southeastern Michigan that includes six hospitals, four affiliated hospitals, and 30 ambulatory-care centers. The physicians are all employees of the system, which also owns a managed-care organization. Ultimately, Ford could compete directly with traditional HMOs for premiums, says Thomas McNulty, CFO and senior vice president.

Ford has emerged as a model for the health care organization of the future: a single entity that not only provides all medical services, but also administers, markets, and insures those services.

Left unanswered is the question of how these new models will affect the cost and quality of health care. McNulty believes that by directly contracting with purchasers, he can cut costs by 3 to 5 percent. “Your whole cost structure changes because you’re removing an entire layer.” On the other hand, by placing the financial incentives to cut costs into the hands of providers, these structures may actually work against patient interests.

Meanwhile, corporate purchasing groups are finding their own ways to bypass the HMO in the middle.

Creating a Market In Minneapolis

In the Minneapolis/St. Paul area, one corporate purchasing group could not wait for health care providers to take the next step, so it forced the issue. Last year, with only three managed-care companies–Allina Health System, Blue Cross and Blue Shield of Minnesota, and HealthPartners Administrators Inc.–dominating the metropolitan area, purchasers had few options. So the Buyers Health Care Action Group (BHCAG), which purchases health care for 26 companies, including 3M Co., Norwest Bank, and General Mills Inc., went directly to providers and asked them to organize into what it calls “care systems” and submit proposals. From the 19 it received, BHCAG selected 15 as health care options for the more than 100,000 employees it covers. The BHCAG contract encouraged many of the care systems to organize specifically for the bid. In order to create physician accountability and reduce redundancy in provider networks, BHCAG specified that no primary-care physician could belong to more than one network.

The purchasing group says the arrangement aligns incentives with those that provide medical services. “In the past, [employers] tried to hold a health plan responsible for care that was delivered by someone else,” says Ann Robinow, executive director of care systems and finance at BHCAG. Now the responsibility lies directly with those who provide care.

BHCAG hasn’t altogether eliminated the need for a middleman. It turned to HealthPartners, a Minneapolis/St. Paul health plan, which also owns an HMO, to be its third-party administrator. For a monthly, membership-based fee, HealthPartners takes care of record keeping, claims processing, and other services. The employers are all self-insured, and they do not ask providers to share insurance risk. That, says BHCAG’s executive director of policy and public affairs, Steve Wetzell, insulates members from the dangers of a care system becoming insolvent.

The program has transformed the dynamics in the Twin Cities market. Instead of kowtowing to the demands of a few large managed-care organizations, BHCAG has created its own market for health care at the provider level. “We went from being a market taker to a market maker,” says Wetzell. “As buyers, we want to make sure there is enough competition.” Minneapolis has long been ahead of the curve in the development of health care systems, but Wetzell believes employers in any other market can also organize to create the same sort of system. “If you give physicians incentives to manage their own business and to be more accountable to consumers, they will respond.”

Buying at the provider level is the second step of BHCAG’s move away from HMOs. In 1993, the purchasing group left an insured HMO for a self-insured preferred provider organization (PPO), and, Wetzell says, premiums dropped by 11 percent. Last year’s bids from care systems, he adds, were 9.5 percent lower than BHCAG would have paid if it had continued with the PPO.

Another benefit, Robinow says, is that BHCAG can assess quality more effectively. “One of the advances we’ve made is that we now measure performance at the care-system level, not at the plan level,” she says. BHCAG is positioned to evaluate individual services from each hospital, clinic, and physician group.

Still, BHCAG has not been exempt from price increases. “We saved a lot of money in 1997, but we don’t operate in a vacuum,” says Robinow. “There is a lot of underlying upward pressure [on prices] that we have to deal with.” New medical treatments and technology are always expensive. Furthermore, Robinow says, because some care systems bid too aggressively for last year’s contracts, she expects contract costs to rise this year, too.

Back to Basics In the Southeast

Piedmont Health Coalition Inc., in Burlington, North Carolina, also contracts directly with providers. But the group, which covers 13,000 people locally, asks health care systems to assume a portion of the risk. “The people who write the checks wanted to be in a closer relationship with the people who write the prescriptions,” says coalition president Gregory Walters. And, he says, health care providers would rather work directly with employers, because the providers resent being forced to drive down costs without having an equitable share in the subsequent gains. “Piedmont makes the hospitals more accountable for managing health care costs,” says Walters. “The insurance market is not happy with what we’re doing.”

The coalition, which includes Glen Raven Mills Inc., a private textile company in Burlington; and Laboratory Corp. of America, a clinical testing company also in Burlington, negotiates fixed rates per-employee at local care systems, including Alamance Regional Medical Center and Duke Medical Center. The third-party administrator for the coalition is a unit of Glen Raven, which has self-administered its own plan for 22 years. Walters says Glen Raven and Lab Corp. reduced their health care expenditures by 30 percent last year, and the relationship between the providers and the purchasers is more durable. “In a world where employers change their insurance carrier every few years, this lends itself to strengthening relationships among payers and providers,” says Walters. “Every quarter, we have eight or so physicians sitting around a table with eight CEOs discussing the issues.”

Walters believes that direct contracting will improve quality, by making it easier to measure. “We have one data repository where we can measure quality and eventually measure clinical quality,” says Walters. Quantitative assessment of clinical outcomes–say, patient recovery rates rather than test delivery rates–has long been the Holy Grail of health care. Experts say that the ability to evaluate medical care at the provider level rather than at the plan level brings employers a step closer to that goal.

While Piedmont transfers risk using a hybrid system based on fixed rates for specific ailments, most PSNs shoulder financial risk through contractual agreements known as capitation arrangements. Under capitation, employers or buyers’ coalitions pay providers a fixed monthly fee for each person who has access to the system. Health care industry observers maintain that capitation transfers the incentive to more-closely manage care and cut costs to those with the most power to do so–hospitals and doctors. “Instead of trying to keep the beds full, the goal [of the hospital] is to get patients in and out as quickly as possible,” says Todd Swim, in the Chicago office of benefits consultants William M. Mercer Inc.

Others, however, say that putting the financial incentives in the hands of doctors can be dangerous. Patients don’t want to have to worry that their doctors are making medical decisions that might affect their own paychecks. “People do what they are paid to do,” says David Friend, a physician and managing director of the eastern region of benefits consultancy Watson Wyatt & Co. “Just because they’re doctors doesn’t mean they’ll act any differently than administrators.” Only now, the healthy tension created by administrators trying to cut costs and doctors fighting for needed procedures is removed.

The Regulation Debate

Direct contracting also introduces some thorny regulatory issues. Critics say that when health care providers take on risk through capitation and other agreements, they are acting as insurers and, therefore, should be subject to the same regulations. But the long and expensive process of securing HMO licensing could devastate PSNs. Many have neither the capital nor the infrastructure to qualify.

In a 1996 landmark ruling, the federal government held that physicians and hospitals united in a network can avoid antitrust regulation if they bring “efficiencies” to the market. Exactly what that means, however, remains unclear, and regulators in individual states, which have jurisdiction over HMO licensing, are considering their next moves. Perhaps the biggest question is how much cash from premium payments a PSN must keep on reserve. In Colorado, for example, risk-bearing PSNs are required to keep a reserve of only $100,000, while Georgia requires provider groups to maintain reserves of $1 million. By contrast, most states require HMOs to keep reserves of $3 million.

In North Carolina, which to date has imposed little regulation, Walters says a reserve requirement of $3 million would kill Piedmont’s current arrangement. “There should be some level of review, but [PSNs] should not be under the same level of scrutiny as HMOs,” Walters maintains. “Most provider systems are community-based and are not in the business of insurance.” Indeed, many PSNs are not licensed as HMOs. A recent survey by Ernst & Young LLP found that 72 percent of the PSNs that receive premium payments do not have HMO licenses.

Some provider groups–Seattle First Choice, for example–have applied for and received HMO licenses in anticipation of increased regulation. “It has resulted in the creation of a different type of HMO, one that is doctor-driven and doctor-owned,” says Ned Goodhue, president of Avandel Healthcare Inc., a catastrophic health-care coverage provider in Lynnwood, Washington.

Insurers’ Big Checks

Are PSNs prepared to support the level of risk they are pursuing? Clearly, some of the smaller groups are not. It’s not surprising, then, that many industry observers question PSNs’ ability to bypass traditional insurance. “Insurance companies are not going anywhere,” asserts Friend. “They may have a diminished role, at least in the short term, but they will continue to be claims payers, technology providers, and underwriters. Insurance companies are very good at writing large checks.”

Still, other experts question whether providers can further reduce costs without the strong-arm tactics of managed-care overseers. After all, PSNs won’t be reducing costs by introducing administrative economies of scale. They can reduce costs only through real integration achieved through reducing overlapping layers of care. A PSN, for example, needs only one cardiac center in its network. Skeptics doubt that providers will be amenable to true integration. “The theory is well meaning,” says Helen Darling, manager, international compensation and benefits, at Xerox Corp., in Stamford, Connecticut. “But it’s not clear that hospitals have been able to achieve the transition to an integrated system. They are no better off than before.”

Indeed hospitals have had a difficult time carving away the dead wood. Friend compares them to “sinking ships that tie themselves together.” Hospitals have been eager to merge, but they have been slow to eliminate inefficiencies.

Some hospital executives admit that there are barriers to reducing costs. “In industry, if a plant no longer serves its purpose, you blow it up and build a new one,” says Henry Ford’s McNulty. “But hospitals are different. Taking a charge against earnings doesn’t help us much.” Part of the problem, he says, is that practitioners guard their territories ardently. At most hospitals, physicians are independent contractors, and even those who work at the same hospital compete. The power struggle between physicians and hospitals continues to threaten the success of PSNs.

But it’s way too early to count managed-care companies out of the equation. The emergence of integrated delivery systems has provided even managed-care companies with an opportunity. Much of the consolidation among hospitals and physician groups is capital-intensive, and many insurers have struck agreements to shoulder some of the load. For now, the pendulum might be swinging toward the providers, but what happens next depends on how well providers can integrate health care services.

The advent of PSNs has added to the complexity of the health care picture. “There are more entry points to service,” says Friend. The new provider groups are still immature. So, he points out, “there is a bigger possibility of getting a bad deal.”

Managed-care companies were the first to emphasize reducing costs and eliminating health care inefficiencies. Now, however, PSNs give providers themselves incentives to cut costs, and the most promising way to reduce health care costs may be to bypass managed-care organizations. Still, most employers are cautious. “There’s a lot of dialogue going on now,” says Ken Francese, executive director, compensation and benefits, at Chrysler Corp., in Auburn Hills, Michigan. Direct purchase “could lead to removing a layer of cost, which we could consider.” However, he says, “there are a lot of unknowns with it. We need to see it take more shape before we see the relative benefits.”

Joseph McCafferty is an associate editor at CFO.