HMO mega-merger poses threat to smaller firms.

Hospitals, small HMOs and physician networks, beware.

Health care industry experts believe those parties should be looking over their shoulders in the wake of Cypress-based PacifiCare Health Systems' announced mega-acquisition last week of Fountain Valley-based FHP International Inc.

The deal, if approved by stockholders and regulators, would create the largest publicly-traded HMO in the western U.S., with revenue of more than $8 billion and membership of 2.9 million. Experts said the combined health plan would be able to use size to its advantage when dealing with hospitals and physician groups.

"It certainly gives them more pricing leverages on contracting partners, particularly medical groups and hospital systems," said Peter Boland, president of Boland Healthcare, a Berkeley consulting firm.

Such developments could have a significant impact in the Los Angeles area, where nearly 20 percent of PacifiCare and FHP's combined enrollment - more than 531,000 members - are concentrated.

But Jim Lott, senior vice president of the Healthcare Association of Southern California, a trade group that represents hospitals and medical groups, does not believe PacifiCare will perform any blood-letting during price negotiations.

"Whenever the market gets smaller, we do expect greater pressure; that's a natural phenomenon," Lott said. "But Pacificare has a better reputation with providers than FHP. They've always been more fair."

Lott added, however, that FHP was more willing to contract with medical groups of fewer than 20 physicians, and that smaller players could find themselves squeezed out in future negotiations.

Smaller medical groups won't be the only ones at risk. Observers said that competing health plans will almost certainly be looking to merge among themselves in order to remain competitive.

"This will stimulate more mergers, and give more impetus for (smaller) health plans to get involved in more acquisition activity," Boland said. "They will need greater membership volume in order to exercise more leverage on pricing; at the same time, they are being pressed by the market and employers to have lower premiums. That puts pressure on the bottom line, and puts more weight on the value of merging and cutting costs."

But officials with PacifiCare and other health plans said that while costs would be cut on the hospital and physician end, that would not translate to lower premiums for policyholders - at least not in the short-term. Instead, they are expected to remain nearly flat.

"We have no intent to use our market (share) to increase prices; the market sets the price," PacifiCare CEO and president Alan Hoops said during a press conference last week. "But I would say that market information indicates that premiums are generally flat, with some upward movement in pricing."

Steve Valentine, president of the Camden Group, an El Segundo based consulting firm, said that it was a logical move for PacifiCare/FHP to keep premiums stable while reaping the benefits from post-merger streamlining.

"I think they will try and keep a hold on the premiums while cutting expenses. This will allow them to reinstate profits and have the stock price up," he said. "A lot of the HMO stocks have been doing poorly because of lower earnings."

At least one other large HMO, Woodland Hills-based Health Systems International Inc., hinted that it would follow in PacifiCare's footsteps on the premium issue.

"PacifiCare's plan is predicated on improving the pricing outlook, and that's good news for us and other health plans," said David Olson, HSI's vice president of investor and public relations.

Indeed, after weeks of erosion in the wake of weak earnings reports, local HMO stocks - all of them near their 52-week lows, rebounded last week. Health Systems was up $1.875 a share to $23.25 when the deal was announced Aug. 5, then climbed to $24.875 on Aug. 8. Woodland Hills-based WellPoint Health Networks Inc. climbed from $26.25 to $27.25. Los Angeles-based Maxicare Health Plans Inc. jumped from just under $15 a share to $16.75.

RELATED ARTICLE: Recent HMO Mergers

August, 1996: Cypress-based PacifiCare Health Systems Inc. agrees to acquire crosstown rival FHP International Inc. of Fountain Valley for $2.1 billion in stock and cash. The merger will create an HMO with membership of nearly 4 million in 15 states and annual revenue of more than $8 billion.

April 1996: Connecticut-based Aetna Life and Casualty agrees to acquire Pennsylvania-based U.S. Healthcare for $8.6 billion, creating a mega-health insurer with more than 10 million members throughout the U.S., including 1.2 million in California.

March 1994: After spurning an initial $829 million offer, Concord-based TakeCare Inc. agrees to a $1.09 billion cash and stock offer from FHP. The deal creates an HMO with 1.3 million members throughout the western U.S., although the bulk are in California.

January 1994: Woodland Hills-based Health Net and Colorado-based QualMed merge, creating Health Systems International Inc., an HMO conglomerate with more than 1.4 million members throughout the western U.S.