Managed care: the third generation.

For HMOs, rapid growth means rapid change, quick thinking, new strategies - and maybe a serious shakeout.

In 1995, 58 million people were enrolled in health maintenance organizations - almost 60 percent more than in 1990. By 2000, according to Thomas E. Hodapp and Michael Samols of brokerage firm Robertson Stephens & Co., HMOs will claim 113 million members. And revenues are expected to grow even faster, from premiums totaling $106 billion in 1995 to $252 billion in 2000. "The opportunities for managed care are staggering," say Hodapp and Samols.

Managed care is not only enjoying unprecedented popularity but, as the industry enters its third generation of growth, it's poised for even wider acceptance. The irony, however, is that this is also a time of unprecedented challenge for the men and women who run the industry - a time many of the current players will not survive. The pressures felt by every chief executive to select the right strategy are intensified in HMOs today. Appropriately enough, when CEOs from the field came together last November at the first annual Healthcare Leadership Forum, the kickoff address from consultant Peter Boland was entitled, "With Profits Up, Why Should CEOs Be Worried?" The answer: increasing demonization of the insurers by doctors, hospitals, politicians, and the press; increasing demands - for higher quality and lower costs - from the employers who select the coverage for their workers and pay the bills; and increasing economies of scale that put smaller players at a disadvantage as the big get bigger.

While there are a variety of viable strategies to turn an HMO into one of the long-term winners in the rapidly changing game of health-care delivery - with players that include not only HMOs but insurers that use preferred provider networks and utilization reviews - they all have certain common elements. One key to success is getting care truly integrated. This means goading disparate providers to agree on the proper technique for treating each patient and each condition and on giving up enough professional autonomy to go along with the plan. For efficiency, all these providers must work together on a patient's care - something that, given disparate egos and agendas, isn't always easy to orchestrate.

Coordinating care, in turn, means getting - and putting to use - the right data-management systems. "Ultimately, managed care is about changing behavior," asserts William M. McGuire, chairman, president, and chief executive of United HealthCare, the Minnetonka, MN, giant projected to have $10.4 billion in revenues this year. And that requires precise measurement of what each physician and facility is doing; how it relates to the patients' outcomes, and how that information, in turn, changes the treatment choices. The proper system can sharply reduce costs, especially if it allows doctors to make diagnoses from distant sites via computer imaging. But it takes a tremendous upfront outlay, and it won't work if it is not a system that providers actually will use.

Still, the best data systems in the world are useless unless managed-care companies pick the right partners. Few plans today try to go it alone. Stephen F. Wiggins, chairman and CEO of $3 billion Oxford Health Plans in Norwalk, CT, hinges his expansion plans on finding provider partners in each new market his company targets. Even enormous United HealthCare has moved into Virginia in a joint venture with the state medical society. In Washington, DC, the major HMOs are partnering with each other to save money by doing certain chores together; for instance, rather than each plan sending a representative to check out a doctor's office, "there's no reason why one site visit couldn't be done for all the members of the group," explains John Ott, CEO of George Washington University Health Plan.

The Past Is Prologue 

The idea that rather than paying for each episode of health care as it was delivered - the "fee-for-service" approach to health insurance - it would be effective and economical to charge a blanket price that would cover everything a patient needed was tied more to a social philosophy than an economic one a half century ago. At a time when what ordinary health insurance there was did not cover routine care, HMOs focused on wellness and prevention. The pioneers such as Kaiser Permanente and Group Health Cooperative of Puget Sound, generally nonprofits that employed the doctors rather than using those in private practice and often even owned their own hospitals, had their staunch backers. But they were little more than a bump on the national health-care landscape.

That changed dramatically in 1973, when Congress passed PL 93-222, specifically intended to "provide assistance and encouragement for the establishment and expansion of health maintenance organizations." This not only funneled federal money into feasibility studies for new HMOs, it also mandated that employers who offered health insurance had to include at least one HMO on their menu of choices if there were such an organization in their market, if it met federal standards, and if it formally asked to be included.

From that beachhead, the new sort of HMO - usually using independent physicians who would contract to care for the HMO's patients for a set fee - slowly built a customer base. By the beginning of this decade, it was a standard way of delivering health care in some markets. Employers' sharpened awareness of the rapidly rising cost of their medical benefits had led to a search for a less expensive way of delivering quality care; to many, HMOs were the answer. It is not just the fact that HMOs were willing to negotiate bargain rates to get a big chunk of business. They also promised to manage care so that prevention could minimize later expenditures on care and to eliminate inappropriate referrals to expensive specialists, unnecessary procedures, and duplicative testing. And they developed a new kind of plan, called "point of service," which countered objections to the HMOs' limited provider choices by allowing enrollees to go to any doctor by paying somewhat more. The POS option attracted employers hesitant to force their worker - or the families of their top executives - to switch doctors, but kept intact the basic concept of the HMO, since the option is seldom exercised.

Now, says Alan Hoops, president and CEO of PacifiCare Health Systems of Cypress, CA, a $5.3 billion six-state HMO with 1.7 million members, "the legislative underpinnings of our business are beginning to change." Congress is rewriting the rules on Medicare, so that a major portion of the nation's senior citizens will be lured into HMOs. It's a huge market, and one that can provide companies an entry lever into new markets. The one-time novelty is about to become the dominant way of delivering and paying for health care. "Fee-for-service will be history, at least on the provider side, within the next four to five years," predicts W. Bruce Lunsford, chairman and CEO of Vencor, a $2 billion chain of long-term intensive-care hospitals headquartered in Louisville, KY.

But that doesn't automatically ensure prosperity for the managed-care companies now in the market and the networks of providers or hospitals that contract with them. The HMOs have been selling coverage primarily to those who have been persuaded that their way of delivering care is the best. As more and more employers force HMOs on their workers, the plans become subject to greater scrutiny and political attack. From newspaper articles detailing the cases of patients who died or were grievously injured allegedly because an HMO refused needed treatment, to moves in state legislatures to force plans to take any doctors that meet minimal standards, "a powerful, powerful reaction has set in against managed care," Boland warned the HMO CEOs at the Healthcare Leadership Forum in November. The survivors, says Lunsford, will be those with: a well-defined strategy, a good handle on controlling costs, and an effective way of communicating those cost-control measures.

Neither buyers nor the employees they are buying coverage for want cost curbs that are grounded simply on refusing to pay for needed services. "The basis of competition is shifting to quality," insists Karen Katen, president of Pfizer's U.S. Pharmaceuticals Group. The plan must be able to show via objective outcomes measures that it delivers good care. But that good care also has to be inexpensive care, with the cost savings coming from efficiencies, not from cutting corners on patients' true needs. As Victor Campbell, senior vice president of Columbia/HCA Healthcare of Nashville, TN, which, with expected revenues this year of $19.8 billion, is now the country's largest network of investor-owned hospitals, explains it, in negotiating a managed-care contract, "you get into a room based on your quality, then you spend the whole day talking price."

Size Matters

A core problem for the HMO CEO is that as the market grows, it becomes more attractive to bigger players, and there are escalating advantages of size. A plan with more members to offer can extract deeper price concessions - and better adherence to practice protocols - from doctors, hospitals, imaging centers, and other health-care providers. That, in turn, can lead to lower premiums, which attract more members, which gives the plan more negotiating clout. Moreover, the new opportunities to sign up Medicare beneficiaries can be tapped not by selling a corporate buyer coverage for a large group but by one-by-one customer sign-ups. That's a very expensive direct marketing effort where deep pockets are a vital asset.

There already has been much consolidation in the industry. Most dramatic: Metropolitan Life and Travelers put their health insurance businesses together into a new company, and within months that company was acquired by United HealthCare, turning it into a $10 billion operation, and giving it, says CEO McGuire, its first opportunity to land national accounts. All the analysts expect the trend toward plans gobbling up other plans to accelerate. Walter McNerney, a professor at Northwestern University's Kellogg Business School, who, as president of the Blue Cross/Blue Shield Association, was one of the shapers of the current health insurance system, predicts that in some markets only two or three plans will still be operating by the middle of the next decade.

So growth, like demonstrable quality, is part of everyone's strategy. For some, that means breaking through the traditional definitions of what part of the industry a company is in, shedding the old, self-imposed restrictions that defined the company's business. Even the pioneers are changing. Blue Cross/Blue Shield now is allowing its affiliates to switch to for-profit status. Kaiser Permanente, the granddaddy of the "pure" HMO that strictly required members to go only to its own facilities, is easing up on that approach.

Or take $250 million HealthCare Compare of Downers Grove, IL, the largest nationwide preferred provider organization, with 2,100 hospitals and 180,000 providers of outpatient care in its vast network. It made its mark selling that network to employers, unions, and insurers, offering them management services that could cap health-care outlays. But it had nothing to offer potential customers who wanted the tighter controls of an HMO. So on November 29, 1995, HealthCare Compare bought an insurance company, giving it licenses in 26 states to sell health coverage for which it assumes all financial risk. President and CEO James C. Smith's strategy is to design a plan that allows enrollees to go to doctors outside the network but provides strong incentives not to, and then offer it not to HealthCare Compare's current customers but to nationwide companies that currently buy an HMO policy from one of the big insurers. The lure: a guaranty of what total costs will be for three years. From that launching platform, he'll go after small groups and Medicare beneficiaries with the same product. The PPO side of the business will continue to dominate the company, but Smith expects what he calls the "HMO-like" line to provide "substantial" income by 1998.

But such category blurring is not without problems. At the Healthcare Leadership Forum, Paul Ginsburg, executive director of the Center for Studying Health System Change, pointed out that just as health-care companies are buying suppliers or customers, "there's a strong trend in other industries to get away from vertical integration."

Oxford's Wiggins is one CEO who is rethinking some of his HMO's integration. It owns 47 percent of a business management firm that runs the practices for 531 doctors but that has found resistance among many customers to letting an HMO have that much control over operations with which it contracts. For the practice management business, "recently it's been more of a problem than a help to be part of Oxford," Wiggins says. On his agenda this year is a decision on whether to spin off the holding.

Similarly, $4.2 billion FHP International of Fountain Valley, CA, is narrowing its product line. FHP began in the HMO business 35 years ago with the staff model: Its enrollees went to doctors and hospitals owned by the plan. Then it expanded to offer services as well through independent facilities that contracted with the insurer. Now it is shedding its original business, selling off its hospitals and transferring the leases of two subacute care facilities it operates but does not own. The company already has reorganized its staff doctors and dentists into a big group practice, dubbed the Talbert Medical Group, and is weighing either spinning off that entity to its stockholders or selling its holdings to the public. The goal, says President and CEO Westcott W. Price III, is to get assets and income in line: The staff providers were serving 20 percent of FHP members, but consuming 70 percent of the assets.

Sticking To The Last

To avoid such problems, other companies are defining their growth strategy as more of the same, achieving increasing clout in a particular niche. That niche may be in services. For instance, $668 million PhyCor of Nashville plans to stay with its core business of putting together networks of physicians and then selling those networks to managed-care plans as their core providers.

For others, the niche is geographic. While getting into position to shed its doctor management business, Oxford Health Plans has been deliberately expanding from its key market: New York City. It has moved north into Connecticut and south into New Jersey and, with the recent acquisition of the 42,000-member OakTree Health Plan, into the Philadelphia market. Similarly, $350 million Sierra Health Services of Las Vegas, whose 330,000 managed-care enrollees in Nevada make it the dominant player in its headquarters area, is moving to lock up other markets in the state. Last June, it got government approval to sell coverage in three northern counties. The same month, it bought Northern Nevada Health Network, a PPO sold to self-insured employers. And it acquired CII Financial, a workers' compensation insurer, because, explains Chairman and CEO Anthony M. Marlon, "more and more employers are looking to managed-care companies to reduce workers' compensation costs."

The ultimate lesson is, as Kenneth B. Pitts, executive vice president of OrNda HealthCorp, a $1.9 billion Nashville hospital chain, puts it, "there is no one model." Different strategies for coping with the current changing conditions will work in different markets and for different companies. But expecting tomorrow to be like yesterday will lead a managed-care company down the road to oblivion.

RELATED ARTICLE: On Vertical Integration

Let's dismiss most of the notions about vertically integrated health care. The market doesn't care about PHOs or MSOs. The market cares about cost. They'd like some quality; they'd like to document it. But they don't care about the structure. The action is much more in horizontal integration, and even more so in virtual integration.

We've got to throw away the organization chart as we know it and replace it with a different set of rules, responsibilities, and accountabilities. You can reshape the organization through organizational development techniques; you can work with the human resources component; and you've got IS and IT. What we really have to think through are the impacts of information systems on patient care.

How do you merge patient-care delivery functions with health-plan administration functions? I believe a system integrator will emerge. It may or may not be an HMO. Probably not a medical group. Probably not a hospital. But probably it will be a delivery system and a technology vendor with the information and the technology platform to pull together functions, services, and operations.

Peter Boland

RELATED ARTICLE: On Customer Satisfaction

Eighty-six percent of the public likes their doctor. They don't like the healthcare system. They don't like their doctors' failure to give them information. They like their pharmacist because the pharmacist is actually giving out information and helping them understand it.

From a consumer's perspective, the most important thing in terms of customer service goes beyond information. Give people information about their conditions. And not just to keep taking medication. Give information about exercising with arthritis, about what kind of vitamins may help a prostate problem. Get quality information out. Compare yourself to the managed-care company down the street. Instead of saying, "We care," on your billboards, say, "We have the lowest C-section rate in the state." Let them know you use the hospitals with the best outcomes - and the lowest infection rates. Give that information to the public, and they will flock to you, and we'll have a better health-care system. It may not be the cheapest system, but it'll be a quality system. And the bottom line is that quality health care is the cheapest health care.

Charles Inlander

RELATED ARTICLE: On Growth

Need for speed. Merger mania, Fifty of the top 100 markets are already 50 percent enrolled. You still have some small pieces, but if you're going to control "lives" and have the clout to orchestrate a network, you've got to do something with a 50 percent market share that's already in place. Why are you fighting for lives? Because yon can't push the price button. The big corporations won't allow it. What do you need to do? Maximize share. Dictate terms of pricing and contracts. People should he paying attention to the United HealthCares of the world, because they've assembled probably a market capitalization of $10 billion - mostly from acquisitions.

Wall Street will look past a quarter, but it wants a cogent argument for why you're going to grow - that matches the economics of the overall marketplace. When you look at the business, you see the margins are hard to come by, and unless you've got a strategy for those margins, it's hard to see a sustainable growth rate of 50 percent or 60 percent, short of using the stock currency to acquire it. But the opportunity for buying less advantaged companies, putting your management in, and squeezing cost out is huge.

Edwin Gordon 

RELATED ARTICLE: On Managing Physicians

The prime reason physicians are aggregating into intermediate physician organizations is to negotiate with insurers. By negotiating in a larger unit, physicians can have more market power. Physician-management companies could get involved in the clinical side by being intermediaries between health plans and physicians.

How should health plans feel if they have a choice between dealing with physician organizations and dealing directly with physicians? In some ways, it's a question of division of labor, of whether these physician organizations will be better at managing physicians than the health plan. Sometimes, there's also an issue of physicians preferring to be managed by their peers rather than by "some MBA." In truth, however, many of these organizations are not run by peer physicians. Sometimes they are sponsored by medical societies or formed by physicians, but more and more they're being formed by entrepreneurs.

What it really gets down to is an issue of who's going to do this tough job of getting physicians to change the way they practice.

Paul Ginsburg

Daniel B. Moskowitz covers business and health care from Washington, DC. Peter Boland is president of Boland Healthcare in Berkeley, CA. Charles Inlander is president of the Peoples' Medical Society in Allentown, PA. Edwin Gordon is senior director of Furman Selz in New York. Paul Ginsburg is executive director of the Center for Studying Health System Change in Washington, DC. Each of the sidebars was excerpted from talks given at the Healthcare Leadership Forum held in November 1995.