A Financial Overview of the Managed Care Industry

March 1999

Part 2

Recent HMO Activity

After 6 years of steady growth, HMO profits declined in 1994, 1995, and 1996; in 1997, nearly 60 percent of HMOs lost money (Weiss Ratings). Although HMO net income plunged from 1994 through 1997, HMO enroll-ments were up 72% and total revenues rose 77% over that period (Best's Aggregates & Averages HMO, 1998). At the same time, health services companies have grown increasingly profitable throughout the 1990s.

While underlying health care costs have continued to grow especially for prescription drugs plans competing for market share have until recently sought to hold premium levels down. HMO premium increases moderated through-out the early 1990s, and the rates charged to large employers actually declined by 0.4% in 1996. Since then, premiums charged to large firms have increased 2.0% in 1997 and 2.9% in 1998 (KPMG Peat Marwick). Most analysts now expect premiums to escalate, with one study predict-ing increases of 6-9% in 1999 (Hewitt Associates).



In part due to recent premium increases, some plans including PacifiCare, Wellpoint, and United HealthCare are now reporting positive balance sheets. However, other plans are continuing to report significant losses. For example, Kaiser Permanente, one of the nation's largest and most visible HMOs, lost $288 million in 1998 (or 2.8 percent of operating revenues), on top of a loss of $266 million in 1997 (3.2 percent of operating revenues). Kaiser attributes 1998 losses to increases in the cost of care from pharmacy and hospital services, and the use of non-Kaiser Permanente health facilities.

Responding in large part to financial pressures and to pay-ment reforms in the Balanced Budget Act of 1997, plans have pulled back from some markets, especially in the Medicare program. For 1999, nearly 100 HMOs either reduced their service areas or terminated their contracts with Medicare, affecting more than 400,000 beneficiaries (nearly 7% of Medicare HMO enrollees). The reasons cited by HMOs for the withdrawals were the inadequacy of Medicare s payment rates and the regulatory burden of participating in Medicare, including increased require-ments for consumer protections.

Mergers and acquisitions have been another feature of HMO activity in recent years. The proportion of HMO enrollees in the 10 largest national managed care firms one indicator of market concentration has grown rapidly recently after remaining steady at about 55% for a number of years, rising to 67% in January 1998 (InterStudy). Major mergers in the industry include Aetna's purchase of U.S. Healthcare in 1996 and CIGNA's acquisition of Healthsource in 1997. More recently, Aetna announced that it will buy Prudential for $1 billion. This deal has been criticized by such organizations as the American Medical Association and is under review by fed-eral and state regulatory agencies. Mergers may put a strain on an HMO s financial results, in part because of the difficulties of integrating the businesses acquired. Concerns have also been raised about the resulting domi-nation of a small number of HMOs in certain geographic markets, the impact on providers ability to negotiate pay-ment rates and resulting impact on treat-ment time and options, and patient fears that provider networks will be disrupted. At the same time, mergers can lower costs through economies of scale and increased purchasing leverage by plans.



Issues

Do recent stock price declines signal a shift in prospects for the managed care industry? Many investors were drawn to managed care companies as growth stocks that would achieve success by meeting the rapidly growing demand for lower-cost managed care prod-ucts, as well as the potential to increase efficiency. Now, over three-quarters of those with employment-based health insurance are enrolled in some type of managed care plan, so potential further growth in that segment of the market is limited. Overall, enrollment growth has been especially visi-ble in open-access products, but there are uncertainties regarding the ability of these plans to control costs.

How will rising premiums affect insurance coverage? While premium increases may help to restore the finan- cial health of HMOs, such increases also impact the cost of health care for employers and enrollees. Small businesses (who are least likely to offer coverage) and lower income individuals (who are most likely to be uninsured) are particularly vul-nerable to cost increases. The num-ber of uninsured has continued in recent years to rise by more than one million a year, even in a period of unprecedented economic prosperity and moderate growth in health insurance premiums. Rising premi-ums can only increase the already large number of people uninsured.

Would the passage of consumer protection legislation affect the financial viability of HMOs? Consumer protection legislation has been introduced in Congress and in many states. What would be the impact of provi-sions such as mandating external review programs, prudent layperson payment requirements for emergency care, and health plan liability? Some estimates suggest that the cost of these and other provisions could be large, but independent analyses by the Congressional Budget Office and Coopers & Lybrand (prepared for the Kaiser Family Foundation) point to a more modest cost impact.

What is the future of HMOs in Medicare? Despite plan withdrawals for 1999, HMOs are expected to cover an increasing proportion of beneficiaries. With future pres-sure to lower federal payments to plans, will HMOs con-tinue to find this market attractive and provide expanded benefits such as prescription drugs?

How do market pressures affect quality of care? It is not clear whether profit status matters in the quality of care that is delivered, or whether, in the near future, we will have reliable measures to judge quality across not-for-profit and for-profit organizations. Market incentives have been both credited for eliminating unnecessary care and blamed for forcing providers to skimp on quality and quantity of care.

The Kaiser Family Foundation, based in Menlo Park, California, is a nonprofit, independent national health care philanthropy and is not associated with Kaiser Permanente or Kaiser Industries.

For more information, visit the Foundation s web site at www.kff.org or call the publication request line at (800) 656-4533.

This Fact Sheet is also available in PDF format.