Big health care merger looms.

Health Systems International Inc. was created last year through a 1,000 mile-long link forged by the merger of Health Net in California and Qual-Med Inc. in Colorado.

That completed, the Woodland Hills-based HSI appears ready to make a much shorter trip experts believe will have far-reaching consequences for the local health care market: crossing Oxnard Street to merge with its Warner Center neighbor, WellPoint Health Networks Inc., the for-profit subsidiary of Blue Cross of California.

The deal - which observers say will challenge the hierarchy of California's health plans and place more financial pressure on hospitals and medical groups - appeared imminent last week, according to executives and a statement jointly issued by the companies.

But the deal is not without complications: San Francisco-based Blue Shield of California has apparently made two offers to acquire WellPoint last week, according to sources, with the latest a $48 a share, $4.8 billion offer that surfaced on Wednesday. A previous offer of $45 a share had been rebuffed, with sources indicating that the financing complications a not-for-profit like Blue Shield would have in consummating the deal makes it unattractive to WellPoint. A Blue Shield spokesman would not confirm or deny whether offers have been made.

"I think if you look at the combined company, it's a very powerful story," said HSI spokesman David Olson. "WellPoint is very strong in the (preferred provider organization) business, while we have the strongest model health maintenance organization in the state. You have everything that covers the waterfront, and very compelling financial characteristics."

Many observers agree.

"It will give them greater access to employers, as well as a larger critical mass in terms of being a market force," said Steven Valentine, a partner with Camden Group, a Torrance-based industry consultant.

"In the long run, it will cause premiums to go down, as redundancies among two companies are eliminated," said Ed Susank, a Los Angeles-based principal with benefits consultant William M. Mercer Inc.

Prospective giant looms

Olson noted the combined company would have 4.4 million members and pro forms revenues of more than $5 billion a year, making it the largest publicly owned health care carrier in the United States.

Aside from pruning costs, such a company would also butt heads with Oakland- and Pasadena-based Kaiser Permanente, California's largest health plan with 4.7 million subscribers, Susank said. And Kaiser would be at a distinct disadvantage: its dependence on internally run hospitals has added huge fixed costs that are hampering its need to maneuver in a rapidly changing market, observers say.

"Kaiser will not only be challenged by someone their size for the first time, they will be facing (a competitor) that will be much more flexible and quicker to adapt to market changes," said Peter Boland, president of Boland Healthcare, a Berkeley-based consulting firm.

Boland noted WellPoint and HSI have a business advantage in that they contract with hospitals rather then operate them, reducing costs and providing more marketing options. And Kaiser's not-for-profit status shuts it out from many capital markets open to for-profits.

WELLPOINT HEALTH NETWORKS INC.

(WLP/NYSE)

Full year:                        1994     1993

Sales                             $2.6     $2.4
Net income                      $213.2   $165.4
Average shares outstanding    99.6 mil.       -
EPS                              $2.14        -

Closing price: March 29

$34.875
Up $0.50

52-week

High
$36

Low
$24.25

All figures except EPS and stock price in millions.

Meanwhile, hospitals are also likely to feel more of a pinch when they negotiate rates with the new company.

Hospitals squeezed

"There is no question it will make things tougher," said David Langness, spokesman for the Healthcare Association of Southern California, a trade group that represents hospitals. Already squeezed by managed care cutting down their reimbursements, more than half of the state's hospitals are losing money, and experts project up to a third could close within the next decade.

"This deal will simply add to the pressure," said Susank, although he does not believe it will lead directly to hospital closures. "There are a lot of hospitals out there contracting with both (HSI and WellPoint), and once those contracts are consolidated, they will likely see the price of services reduced. The first decision to be made by them is whether or not to continue their contracts."

Valentine was less certain the merged company would drive harder bargains with hospitals. "I don't think they'll do that because (hospitals) are already getting squeezed pretty seriously. I would expect that the company-would be working instead to cut expenses by, eliminating duplicate services that add to overhead."

Physician groups could also be affected, but observers say they enjoy a tactical advantage not possessed by hospitals.

Doctors as guides

"Once the patient establishes a relationship with the physician, they will be guiding the patient on what hospital is needed - the physician is going to direct the patient to the hospital of choice, oftentimes ones where they practice," Susank said.

Langness believes there is an upside to carriers consolidating - less paperwork for hospitals.

"As the proliferation of insurers diminishes, they are going to institute more efficient methods of payments, and that's great for providers," he said. "Many hospitals now employ more people doing insurance and paperwork than in the emergency room."

Meanwhile, observers don't believe the merger will be the industry's last.

"The question that arises is what is the ideal number of large health care plans," Susank said. "I believe such a number exists, that market forces will balance out against the saving of overhead costs from these mergers. But it is our prediction that we will probably be reduced to a half-dozen large players by the end of the century."

HEALTH SYSTEMS INTERNATIONAL INC.

(HQ/NYSE)

Full year:                        1994     1993

Sales                           $2,300   $2,000
Net income                       $88.8    $53.5
Average shares outstanding        49.9        -
EPS                              $1.78        -

Closing price: March 29

$33.35
Down $0.05

52-week

High
$36.75

Low
$20.75

All figures except EPS and stock price in millions. 1993 figures
are pro forma, prior to 1994 merger of Qual-Med and Health Net

"There are a lot of people predicting that in eight or 10 years, there will be maybe a dozen (health carriers) in whole country," Langness agreed. "Many people have been expecting us to call foul, that this is undue pressure. We've been expecting it, and we've been arranging to meet the challenge."