A Healing Process.

Tough underwriting, product and pricing decisions are the secrets to maintaining financial health in the managed-care industry.

The managed-care industry, on the critical list throughout the late 1990s, took a major step toward recovery last year as many of the leading publicly traded companies got up from their sickbeds and racked up healthy profits. Meanwhile, other managed-care organizations still find themselves in the financial doldrums. Just what are the successful organizations doing differently?

The move toward more conservative pricing and underwriting was perhaps the biggest dose of helpful medicine. Bringing premium rates to an adequate level is the most immediate way to improve profitability, and many of the now-profitable organizations took the plunge by introducing double-digit increases. These rate increases have held up for two reasons: reduced price competition as all carriers seek to improve margins and a tight labor market that makes employers unwilling to tamper with benefit programs.

Jettisoning lines of business that were either unprofitable or did not offer the health plan a particular advantage was also part of the cure. This pruning has been done both on a geographic basis and by product. Many health maintenance organizations, for instance, have boosted their profitability by trimming back participation in the Medicare+Choice program. Similarly, small-group and individual carriers have re-examined the regulatory and market environments in certain geographic areas and have chosen to focus their market activity in a more limited number of jurisdictions.

To address skyrocketing prescription drug costs, many carriers have modified their reimbursement agreements, often by changing pharmacy benefit managers to obtain a more favorable arrangement. In addition, they are altering their reimbursement formulas and forcing employers to migrate to a three-tier copay program that offers different copayments for generic, brand-name and brand with generic substitution available. Although these efforts have not curbed rising drug costs, they do provide a one-time shift in claims costs, thus partially mitigating rate increases.

Changes in provider contracts, while difficult to implement, are another remedy for sagging profits. In response to increased provider pushback, many plans are considering changes in managed-care contracts, such as excluding certain providers from their networks or offering multiple levels of networks. By excluding certain premier (and often expensive) facilities, the carrier, in effect, is trading market share for lower premiums or greater profitability.

In many cases, a smaller network has helped carriers to reduce the required rate increases. The danger is that it could inspire an adverse market reaction, offsetting the impact of lower prices and causing a loss of market share. This is because buying decisions are based not only on price, but also on the perceived quality and breadth of the network.

All of the remedies pursued by successful managedcare plans require isolating and addressing problem areas without doing unnecessary harm. In many cases, this requires complex information systems that allow the carrier to rapidly segment and examine various components of the business. Increasingly sophisticated reporting systems and data warehouses are giving managed-care plans the ability to compile ad-hoc information faster and more efficiently, enabling them to target product and price changes in specific problem areas.

Even thriving health plans face challenges. Politicians continue to bash managed care, and although a recent U.S. Supreme Court ruling allowed the industry to dodge a litigation bullet, class-action lawsuits continue to pop out of the woodwork. In the meantime, providers feeling the financial pinch are looking for increased reimbursement.

It is reasonable to expect fairly large cost increases as providers seek to recover from depressed reimbursement levels. Thus, insurers that have fallen behind in their pricing (relative to their costs) will need above-market increases to recover, and this will be very difficult to achieve. In addition, underperforming companies that could easily be improved also present a significant merger-and-acquisition opportunity to companies that are doing better. Ironically, an unprecedented number of plans are looking to exit the market at a time when prospects for profitability are better than they have been in many years.

To take advantage of this rate opportunity, however, a plan must be well managed. Achieving profitability requires strong information analysis capabilities and the willingness to make the tough underwriting, product and pricing decisions needed to cure the performance of ailing market segments.

Robert W. Stein, a Best's Review columnist, is national and global director of financial services for Ernst & Young, New York.