Strategies for physicians in health care's market revolution.

THE FUTURE OF MEDICINE IS NO LONGER A MYSTERY. Physicians can "read the tea leaves" and calculate their future market position according to the level of managed care enrollment in their local marketplace. The pattern of managed care enrollment and provider integration is quite predictable. (1)

America's practicing physicians don't need a weatherman to know which way the wind is blowing ... from the West, bringing HMOs, capitation, and "medical groups from hell" who take global capitation and dictate payment terms to all providers in the "food chain" of managed care. (2) Managed care is coming to every region and state. As of January 1, 1996, some 630 HMOs served 22.3 percent of the U.S. population, totaling 59 million, who have signed up with HMOs and their popular point-of-service (POS) alternatives. The annual growth rate was 16.7 percent. Despite rapid growth, the managed care takeover is far from complete, especially in the South and Mountain states. More than five states still have less than 5 percent HMO market penetration (please see Table 1).

Managed care is driving the future of medicine

Across the nation, there are still huge variations in medical treatment patterns, health benefit costs, HMO premiums, and provider profitability. Managed care's takeover is well underway, but far from complete. On a national basis, America has reached "Stage 3" in the five stages of managed care's transformation of health care financing and delivery. Southern California and Minnesota's Twin Cities are Stage 4-5 markets, but so are Baltimore, Boston, and Rochester, New York. Market competition and consolidation are impacting a growing number of states and localities.

Doctors are fleeing high-enrollment markets like the West Coast (37.8 percent), and heading to states like Alaska, Montana, and Mississippi, where managed care is virtually nonexistent. But that won't last. The pace of HMO conversion is accelerating, as sophisticated national HMO firms invade new territory in regions like the South Central market, where HMO membership is only 10.5 percent. Low-enrollment markets are coming up the learning curve more quickly, as the conversion from managed care is now measured in months, not years.

Some physicians hope that public criticism of HMOs means that consumers are cooling on HMOs. There has been a spate of adverse media articles on HMOs. Managed care is coming under increasing criticism for arbitrary denials of treatment, limiting consumer access to specialists, and questionable incentives to physicians to hold down costs. Members of HMOs and their primary care doctors have griped for years about the arduous process of obtaining referrals to visit cardiologists, surgeons, and other medical specialists. (3) A number of states and the Congress enacted managed care reform legislation in 1996, such as the 48-hour minimum hospital stay for normal newborns.

But doctors would be naive to think that HMOs will not succeed, because managed care plans are the lowest-price market alternative. In 1996, health care inflation was only 2.9 percent, below the 3.3 percent increase in the Consumer Price Index. Managed care is a big factor in restraining health spending. Employers have accepted HMOs widely. No wonder. HMOs helped employers to hold growth in employee health benefit costs to 2 percent last year, according to the annual survey by Foster Higgins. (4) HMOs recognize their public relations problem, and are fighting back. Managed care plans are offering consumers new options, such as point-of-service and open access plans, which reduce the role of the gatekeeper and allow patients to seek their own specialists.

With the experience that managed care has gained in each of the five stages, key questions should be asked by physicians, as the shift to managed care gains momentum:

* How far will price-based competition among HMOs drive down rates?

* Is there a premium level too inadequate to provide comprehensive care?

* Will HMOs continue to exploit the surplus of facilities and physicians?

* If providers start their own HMOs, will they face retaliation from competing plans?

* Does the profit motive of Wall Street-traded HMOs impinge on patient service?

* Does managed care pit patients against capitated providers?

* Will purchasers select HMOs based on quality, patient ratings, or clinical outcomes?

Five stages of managed care

Physicians in all markets can learn from more advanced markets what managed care will do next in their local area, and which strategies are being successfully employed by physicians to improve their market position.

STAGE 1--"Can't Spell HMO" (0-5 percent HMO)

Locations: Examples: Bangor (ME), Boise (ID), Jackson (MS), Las Cruces (NM), Rocky Mount (NC), Springfield (MO).*

Managed care will inevitably enter all markets. Rising insurance costs and health expenditures cannot last forever. The managed care movement is 50 years old. Prepaid medical care, established in the West and upper Midwest in the 1920s, became Health Maintenance Organizations in the 1970s, championed by Dr. Paul Ellwood of Minnesota-based InterStudy and Alan Enthovin, PhD, the Stanford economics professor who was very familiar with the Kaiser health plan. President Richard Nixon urged the creation of 1,000 HMOs as health inflation fighters. Twenty years later, some 630 HMOs have signed up almost 60 million enrollees, and battle for price and marketshare in every state. (5)

In a number of smaller states and metropolitan areas, managed care is just arriving. HMOs are not always welcome in the medical community. In many Stage 1 markets, physicians enjoy steady profits with little intrusion from health insurers and government payers. Provider integration is rudimentary. Hospital systems are decentralized and hospitals free-standing. Doctors practice mostly solo or in small, single-speciality groups. HMOs enter the market by underpricing traditional insurers, and offering more comprehensive benefits to lure young families into the new plans. HMOs seek discounts from hospitals and physicians. Many physicians are unwilling to participate in managed care in Stage 1, but others decide they cannot miss this market opportunity, even at a cost of lower payments.

STAGE 2--Managed Care Gets Aggressive (5-15 percent HMO)

Locations: Charlotte (NC), Green Bay (WI), Knoxville (TN), Oklahoma City (OK), Peoria (IL), Syracuse (NY).

The pace of change accelerates in Stage 2, as price competition becomes intensive. HMOs may price their plans 10-15 percent below traditional insurers. Blue Cross plans and indemnity carriers fight back by creating PPOs (Preferred Provider Organizations), which compete on price by obtaining deeper provider discounts. HMOs tighten utilization controls to further reduce costs. In the medical community, the best and busiest physicians often ignore HMOs, even as managed care becomes a significant player. These doctors may find themselves excluded from HMO panels by Stage 3, leading to a call for "any willing provider" legislation, opening HMOs to additional physicians--but on the HMO's terms.

Despite physician concern, and sometimes hostility to managed care, Stage 2 markets respond positively to lower-priced health plans. Employers reduce their health plan contribution to the level of the lowest-cost HMO, and 80 percent of enrollees choose the cheapest plan. Providers recognize their vulnerability to HMO payment cuts, and begin to organize multi-hospital systems and Independent Physician Associations.

The pace of network development and provider consolidation picks up in Stage 2. This market stage is an opportunity for physicians to organize and gain market clout in managed care negotiations. Hospitals, for-profit physician practice management (PPM) companies, and sometimes insurance companies begin to acquire primary care physicians. They assume that HMOs will utilize the gatekeeper model to manage utilization and costs. Primary care physicians who organize will have an opportunity to assume risk under capitation contracts by the close of Stage 2. Specialists should be organizing now, but many will wait until market pressures force them to change.

STAGE 3--Managed Care Domination (15-25 percent)

Locations: Atlanta (GA), Chicago (IL), Cincinnati (OH), Dallas (TX), Detroit (MI), Indianapolis (IN), Las Vegas (NV), Orlando (FL).

Physicians must act to secure their market position for managed care in Stage 3. On a national basis, the U.S. is nearing the end of Stage 3, with almost 23 percent of the nation's population in an HMO. By the end of Stage 3, more than 50 percent of "commercial" (under-65 employer-sponsored) enrollees have been converted to HMOs. The HMO takeover gains speed, as government-sponsored patients are offered HMOs. Seniors enthusiastically sign up with HMOs to gain free pharmaceutical, dental, and vision services. The rate of Medicare HMO growth in 1995 was 27 percent, according to the Health Care Financing Administration. (6) States are rapidly converting Medicaid beneficiaries to managed care, capitating costs, and controlling Medicaid expenditures, which doubled between 1990 and 1995. Medicaid enrollment grew 23.1 percent in the year ending July 1, 1995.5 More than one-third of all Medicaid beneficiaries are under capitation, and 25 percent are directly enrolled in HMOs.

Deeper provider discounts and utilization controls stir providers into revolt in Stage 3. Hospitals and doctors organize local PHOs (Physician-Hospital Organizations). Today, there are more than 3,000 PHOs affiliated with America's 4,500 community hospitals. (7) Physicians begin to move IPAs out from under hospital control, establishing physician ownership. For-profit physician practice management companies such as Phycor, FPA, and MedPartners aggressively purchase physicians. So do 60 percent of U.S. hospitals, focusing on primary care physicians. Many hospitals lose money on their acquired physicians, with annual subsidies ranging from $20,000-100,000 per physician. (8)

HMOs consolidate to further increase their marketshare and leverage. New Jersey, once a stronghold of traditional indemnity insurance and fee-for-service medicine, is now a Stage 3 market which must adjust to the takeover of its Blue Cross plan by Anthem, an out-of-state corporation that owns four other Blues plans. There are 26 HMOs in New Jersey, and the new company hopes to grow even bigger by luring some into additional mergers, according to William J. Marino, Chief Executive of New Jersey Blue Cross and Blue Shield. (9)

Stage 3 physicians should be organizing for market warfare in Stage 4. They must create regional provider networks to increase their "suppliers clout" with managed care buyers. Hospitals usually take the lead in creating large, well-distributed provider networks that can take partial or global capitation in "single-signature" contracting negotiations with HMOs and insurers. In the Midwest, Aurora Health Care of Milwaukee, Wisconsin, and Advocate Health Care of Oak Brook, Illinois, have formed a strategic alliance to coordinate provider networks to increase their market presence in the eastern Wisconsin/Northeastern Illinois corridor, north of Chicago. (10) The two systems will combine 18 hospitals and more than 600 physicians.

Physicians must move aggressively to position for market warfare which lies ahead. Primary care physicians move into networks. By the close of Stage 3, hospitals and physician practice management companies may have purchased 35 to 50 percent of primary care physicians. Subspeciality physicians migrate into Independent Physician Associations, but IPAs are held back by limited capital and market clout.

STAGE 4--Managed Competition (25-40 percent HMO)

Locations: Albuquerque (NM), Baltimore (MD), Minneapolis-St. Paul (MN), Philadelphia (PA), Phoenix (AZ), San Diego (CA).

Physicians coming up managed care's learning curve should take a lesson from the West Coast--skip Stage 4! As HMOs capture the commercial, Medicare, and Medicaid markets, physicians and hospitals experience significant financial downturns. Providers lose the ability to cost-shift HMO discounts to other payers. There are no other payers other than HMOs. In markets like Minneapolis-St. Paul and San Diego, traditional indemnity health insurance is no longer available. Consumers have all switched to HMOs, PPOs, and POS (point-of-service) plans. A majority of hospitals can barely break even on patient care, and must rely on investment income to keep the doors open.

The combination of capitation, HMO discounts, and managed care utilization controls will drive utilization down to historic lows in Stage 4. In 1995, California hospitals experienced demand equal to 1 hospital bed per 1,000 population. (11) The national average is 2.5-3.0 beds per 1,000. By managed care standards, many regions are grossly overbedded, with 100 to 200 percent excess capacity, according to a national forecast by the Sachs Group in Chicago. (12)

Physician groups may assume risk and control capitation in Stage 4. But the medical groups must be very large, well distributed over the service area, and well managed. In the "West Coast model," large capitated medical groups control 80 to 90 percent of the premium for hundreds of thousands of "covered lives." Few medical groups have emerged outside the West Coast in other markets that have this kind of distribution and market power. Global capitation is a possibility for large physician groups, but the doctors must organize in Stage 3 if they hope to achieve market leadership in capitation. Otherwise, hospitals and health systems that have purchased physician practices will take the lead in capitation.

STAGE 5--Managed Cooperation (More than 40 percent)

Location: Anaheim/Orange County (CA), Madison (WI), Miami (FL), Portland (OR), Rochester (NY), Sacramento (CA), Tucson (AZ).

After brutal market warfare in Stage 4, both payers and providers are ready to shift to cooperation instead of competition. This partnership model for business alliance can only occur when both HMOs and providers are exhausted, and margins have been "pounded below the sidewalk," according to California health care executive Michael Scavato of Marion Medical Center, in San Luis Obispo. (13)

Forms of payer-provider-purchaser strategic cooperation may include:

* Multi-year contracts with locked-in prices/reimbursement

* Exclusive regional network of hospitals/physicians

* Global capitation to integrated health systems/provider networks

* Shared databases and information systems

* "Report cards" on performance

* Joint marketing based on provider reputation

* Quality institutes to develop clinical protocols

* Joint ventures to develop/market new managed care products

* Direct provider contracting by purchasers

There aren't many Stage 5 markets with high HMO market penetration and high cooperation. South Florida/Miami is a Stage 5 market, based on HMO enrollment, but has not advanced to cooperation yet. Providers and payers develop shared data bases and performance-based "report cards." Providers' clinical pathways are aligned with the payers' quality assessment programs. Traditional cost management approaches, like discounting and reducing admissions, have been exhausted.

Physicians and hospitals find new ground for cooperation in Stage 5, under global capitation. All parties recognize the need for physicians to take the lead in clinical cost management, with hospitals cooperating in reducing costs and substituting ambulatory and continuum-of-care alternatives. The new payer-provider focus for controlling costs is long-term "demand management" strategies of health promotion, improved access to care, health screening, early prevention and detection, and managing health risks of chronically-ill enrollees. Capitation provides incentives for community health involvement, from access issues and environmental health threats to education and quality of life.

Providers haven't reached a health care "Nirvana" yet, even in Stage 5 markets. Until health reform provides continuous health coverage for the 40 million uninsured, there will still be major gaps in the system. Providers and payers may not fully cooperate until purchasers--employers, business coalitions, government programs, and consumers--force local health systems to end cost-shifting and refocus on performance indicators of health. Few HMOs or provider networks are taking an "investment" perspective in managing for long-term goals of health status and healthy communities. Hard-hit physicians must take heart. The pace of change is accelerating, as markets advance through the five stages. The process of health care transformation and market reform will drive many metropolitan markets to Stage 4 before the year 2000, and more into Stage 5.

TABLE 1 U.S. HMO ENROLLMENT: FIVE LEADING AND LAGGING STATES

                 HMO/POS     % OF STATE   RATE OF
STATE           ENROLLMENT   POPULATION   GROWTH

High enrollment states
Oregon           1,435,294        44.8%      14.1%
California      12,994,240        40.3       11.4
Massachusetts    2,368,886        39.0        1.5
Maryland         1,576,981        30.9        5.4
Utah               602,548        30.1       23.7

Low enrollment states *
Iowa               137,938         4.9%       6.3%
Idaho               44,466         3.7      165.7
Montana             26,102         2.9       26.3
South Dakota        20,408         2.8       -2.1
North Dakota         7,886         1.2        5.8
Mississippi         31,785         1.2       63.3

* Alaska and Wyoming had no licensed HMOs until 1995,and no data is
 reported yet.

--Richard Hamer, "HMO Industry Report." InterStudy Competitive
Edge.6(2). September 1996, p.28.

Footnote

* Market data source is Richard Hamer, "HMO Regional Market Analysis." Part III. InterStudy Competitive Edge, 6(2):1-151, for enrollment data. Jan. 1, 1996.

References

(1.) Coile, R. The Five Stages of Managed Care: Strategies for Providers, HMOs and Suppliers. Chicago, IL: Health Administration Press, 1997.

(2.) Coile, R. The Five Stages of Managed Care. Cost and Quality. 5(2):35-38. July, 1996.

(3.) Rundle, R. L. "Heeding Patients' Mounting Frustration, HMOs Move to Cut Referral Red Tape." The Wall Street Journal. May 30, 1996. pp. B1, B2.

(4.) Poe, S. and Erb, J. "Health Care Costs Rose A Moderate 2.5 Percent in 1996." Press Release, Foster Higgins, New York, NY, January 21, 1997.

(5.) Hamer, R. "HMO Industry Report." Part II. InterStudy Competitive Edge. 6(1):1-132. April, 1996.

(6.) Hamer, R. "HMO Industry Report." Part II. InterStudy Competitive Edge. 6(2):1-120. Sept. 1996. page 32.

(7.) Hill, J.E. and Wild, J. "Survey Provides Data on Practice Acquisition Activity." Healthcare Financial Management. 54-71. Sept. 1995.

(8.) Zismer, D.K. "Ensuring Adequate Return on Investment for Primary Care Networks." Healthcare Financial Management: 33-37. Mar. 1995.

(9.) Freudenheim, M. "Health Plans in New Jersey Face Rivalries." New York Times. May 30, 1996. pp. C1, C4.

(10.) "News at Deadline: Aurora Health Care and Advocate Healthcare" Modern Healthcare. 26(19):4. May 6, 1996.

(11.) Coile, R. and H. L. Menkin. "California Healthcare Outlook 1996-2005." California Healthcare Association, Sacramento, CA. Jan. 1996. pp. 1-12.

(12.) Sachs, M. "Health Care 1999: A National Bellwether." Sachs Group, Evanston, IL. 1995. pp. 1-17.

(13.) Scavato, M. "Presentation to the Board of Directors." Marion Medical Center, San Luis Obispo, CA. Oct. 15, 1995.

Russell C. Coile, Jr., is the President of the Health Forecasting Group, in Dallas, Texas, and the national strategy advisor for Chi Systems in Ann Arbor, Michigan. His latest book, The Five Stages of Managed Care, was published in January, 1997. His newsletter, "Russ Coile's Health Trends," was 100 percent accurate in predicting the "top 10" trends last year.