The Impact of Manged Care Legislation: An Analysis of Five Legislative Proposals from California – Report

The Impact of Managed Care Legislation: An Analysis of Five Legislative Proposals from California

Health Policy Economics Group
Price Waterhouse LLP

November, 1997

Executive Summary

Managed care has grown tremendously in recent years. From 1988 to 1997, at firms with 200 or more employees, the proportion of employees enrolled in HMOs nationwide increased from 18 percent to 33 percent. The presence of managed care varies by state across the country but is particularly strong in California where the proportion of HMO enrollment is more than 50 percent of the private insurance market in several large metropolitan areas. For example, in Sacramento, 92 percent of those with private insurance are enrolled in HMOs; in San Francisco and San Jose, the proportion is more than 68 percent.

As managed care has grown, in California and throughout the country, complaints against managed care plans have also mounted. Patients have raised concerns that managed care plans deny necessary coverage or provide access to mainly lower quality services. Physicians and other providers have expressed concerns that managed care plans may dictate care, monopolize the marketplace, and exclude independent practitioners. As a result, legislation aimed at addressing some of these concerns has been proposed at the federal and state levels.

This report presents results from a study conducted by Price Waterhouse LLP which was commissioned by The Henry J. Kaiser Family Foundation. The purpose of the study was to assess the impact of managed care reform legislation on HMOs and their enrollees. Specifically, the study analyzes five areas of California legislation: insurer liability, use of drug formularies, mental health parity, direct access to obstetric and gynecologic services, and lengths of stay for mastectomy patients. For each of these areas, the paper examines the specifics of the legislative bills in California, the likely impact of the legislation on HMOs by organizational type, and the corresponding effects for consumers.

Measuring the Impact of Managed Care Legislation

For the most part, many of the concerns about managed care plans have arisen because of the nature of the services provided by these plans. Managed care plans offer a lower-cost alternative to traditional, fee-for-service health insurance. Managed care plans are able to keep costs low through the use of various cost-saving strategies. For example, most HMOs limit access to providers by the use of a gatekeeper, usually a primary care physician, who must give prior approval before enrollees receive services from other providers, such as hospitals and medical specialists. Managed care plans also engage in practices of limiting the types of services provided to enrollees. For example, they may deny coverage for diagnostic tests and other procedures that the plan determines not to be medically necessary. They encourage outpatient treatment rather than inpatient care, and, when inpatient treatment is necessary, they encourage short hospital stays. The purpose of much of the recently proposed legislation is to protect consumers from some of the least desirable features of managed care cost-saving practices.

Managed care legislation, like most consumer protection, has positive and negative aspects. On the positive side, most of the proposals are intended to improve access to health care providers and medical services. As an example of managed care legislation, health plans could be required to give enrollees access to any provider that they choose. This would increase access to a variety of providers and have positive benefits for enrollees. On the other hand, this type of legislation might be costly to HMOs and other managed care organizations. If HMOs incur increased costs as a result of legislation, they would likely reduce covered services or increase enrollee premiums and/or out-of-pocket costs. If HMOs increase their rates, or reduce benefits, then some enrollees may decide to enroll in traditional insurance plans. In the extreme, managed care regulation could make managed care noncompetitive with traditional, fee-for-service insurance.

Difference in Impact by Type of HMO. The impact of consumer protection legislation may vary depending on the type of managed care plan. There are four basic types of HMOs:

  • Staff model-Physicians practice as employees of the organization, frequently in an office comprised of only HMO staff.
  • Group model-The managed care organization pays a physician group a negotiated, per capita rate which the group then distributes among the individual physicians.
  • Network model-HMOs contract with two or more group practices and usually pay a fixed monthly fee per enrollee.
  • Independent practice/physician association (IPA) model-HMOs contract with individual physicians in independent practice or with associations of independent physicians.

Because the physician and the plan are much more integrated in staff and group model HMOs than in IPA and network model HMOs, staff and group model HMOs are most likely to be able to manage care as well as coordinate and control the behavior of plan physicians. IPA and network model HMOs, on the other hand, are more loosely designed and thus are more limited in the methods by which they can control plan physicians.

For the most part, legislation aimed at reforming managed care seems directed toward HMOs. Although there are forms of managed care plans other than HMOs-such as preferred provider organizations (PPOs) and point-of-service plans (POSs)-that may be impacted by health care legislation, this study primarily focuses on the impact of managed care legislation on HMOs.

ERISA. The impact of state managed care legislation could be limited because of preemptions under the Employee Retirement Income Security Act (ERISA) of 1974. ERISA provides a broad federal preemption of state laws that relate to employee benefit plans. State insurance laws, however, do not fall under this preemption. Thus, state laws may affect non-self-insured employer-sponsored plans through regulation of the insurers. Because of ERISA, non-risk-bearing networks contracting only with self-insured plans and the self-insured plans themselves are exempt from complying with state managed care legislation. With respect to liability, however, both non-self-insured and self-insured plans can be shielded by ERISA from state attempts to expand insurer liability. Plaintiffs are permitted to sue only for the value of the benefit denied. They are not permitted to sue for other damages under ERISA. Because of ERISA preemptions, the effects of state-level managed care reforms would be limited since many employer-sponsored plans will not be affected by these reforms. Only the federal government can enact legislation that governs all managed care plans.

Insurer Liability

Background. Traditionally, insurance plans have not been the target of liability suits since they have not been viewed as being participants in the decision-making process regarding the treatment of patents. With the evolution of managed care, this has changed. By definition, managed care plans manage patient care. The plans not only reimburse a portion of the medical expenses incurred by a patient, they may also greatly influence a patient’s treatment. As a result, recently, there has been a legislative movement to hold managed care plans legally accountable for their role in the decision-making process of patient care. The concept behind the legislation is the idea that if managed care plans face a greater potential for lawsuits, they will be more likely to make decisions that are in the best interest of their patients.

Legislation. Insurer liability legislation has been introduced in the U.S. Congress and in numerous states. In 1997, the California legislature considered five bills related to insurer liability. Three of the bills-SB 324, SB 557, and AB 794-extend liability to managed care organizations by expanding the definition of the practice of medicine to include decisions regarding the medical necessity or appropriateness of any diagnosis, treatment, operation, or prescription. Among other actions, AB 794 also requires that health plans make available to the public, upon request, the criteria used by plans to determine whether to deny or authorize health care services. A fourth bill, AB 536, solely requires plans to make available to the public, upon request, the criteria used in deciding whether to deny or authorize care. The fifth bill, AB 977, provides that a health care service plan would be liable for damages for harm to an enrollee that is caused by the plans failure to exercise ordinary care or caused by decisions made by employees, agents, ostensible agents, or certain representatives of the health care service plan.

Impact. In this study, we assess the impact of expanding liability to managed care organizations through legislation. We find that the impact of expanding malpractice to managed care plans has the potential to greatly reduce their ability to control costs through case management, especially for group model HMOs, but the actual impact may be negligible because of a number of mitigating factors.

First, most employer-sponsored plans may be able to avoid liability by claiming the ERISA preemption. Second, to the extent that group model HMOs are currently being successfully sued in California, then the potential for additional lawsuits may be slight for those HMOs. Therefore, the impact of managed care liability legislation may mainly be limited to a subset of IPA model HMOs, but the effect on these HMOs would be modest. We estimate that at the most, premiums of IPA model HMOs would increase from 0.1 to 0.4 percent.

To the extent that management efficiency is reduced as a result of expanded liability, enrollees would likely gain access to care that they otherwise would not have received. Some of this care may be appropriate and necessary, thus improving the quality of treatment for some enrollees.

Use of Drug Formularies

Background. In the early 1990s, many managed care organizations adopted the use of drug formularies as a method for reducing the costs of prescription drug coverage. A formulary is a list of drugs, rated on clinical and cost criteria, that have been approved and are covered by the plan for treatment of particular illnesses. As a result of concerns about the effects of formularies on managed care enrollees, various forms of legislation have been created.

Legislation. In 1997, more than 40 bills concerning drug formularies have been introduced in more than 25 states. In 1997, the California legislature considered three bills that address issues related to drug formularies: SB 625, AB 974, and AB 1333. SB 625 requires that plans provide an expeditious process by which prescribing providers may obtain authorization for a medically necessary nonformulary prescription drug, make known to the enrollee any reason for disapproval, and make available their formularies upon request. AB 974 requires that a plan provide coverage for a drug if coverage for that drug had been previously approved by the plan for the enrollee and if the drug continues to be prescribed by the physician. AB 1333 prohibits a plan from requiring physicians to prescribe a drug from the formulary if the appropriate drugs from the formulary have been tried and have been unsuccessful in treating the patient.

Impact. By making the consumer better informed, legislation such as SB 625 may enable enrollees in managed care plans to have more negotiating power regarding their treatment, but we do not expect large financial consequences for managed care plans. Based on our assumption that formularies enable plans to save money by providing the most cost-effective medications, as a result of AB 974 and AB 1333, we would expect HMOs (particularly IPA model HMOs) to incur increased costs. Because these bills are limited in scope, the resulting increases in premiums for HMOs would be fairly modest-most likely significantly less than 0.6 percent. In general, both AB 974 and AB 1333 provide certain enrollees easier access to nonformulary drugs while not having a significant impact on the financial stability or the management style of HMOs.

Mental Health Parity

Background and Legislation. The idea of requiring parity in health insurance coverage for mental disorders has been a much debated issue in recent years. In 1996, President Clinton signed into law the Mental Health Parity Act of 1996 which amended ERISA and the Public Health Service Act to provide parity between annual and/or aggregate lifetime dollar limits on mental health benefits with the limits on medical and surgical benefits of group health plans. Various forms of mental health parity legislation have been passed in numerous states. In 1997, the California legislature considered AB 1100 which would mandate health care plans to cover biologically based severe mental illnesses for enrollees of all ages and cover serious emotional disturbances of children under the same policy terms and conditions applied to other medical conditions.

Impact. As a result of AB 1100, those with severe biologically based mental illnesses and children with serious emotional disturbances would likely obtain improved access to mental health services, since their conditions would be subject to the same policy coverage as other physical illnesses. These enrollees would be likely to use more mental health services which, in turn, would lead to increased costs for the health plans.

We estimate the increase in premiums resulting from these increased costs would be approximately 2.1 percent for all plan types in California. Specifically, we estimate that there would be a 1.0 percent premium increase for HMOs, 2.7 percent increase for PPOs/POSs, and 3.6 percent increase for fee-for-service plans.

This bill would also increase the market share for managed care plans since those plans would have lower increases in premiums than traditional fee-for-service plans. Furthermore, since HMOs, particularly group models, are good at managing care, enrollees may not experience as significant an increase in access to mental health services as those in fee-for-service plans. The effects of parity would fall more strongly on fee-for-service plans which use the limits on services to control costs instead of case management techniques which are the mainstay of managed care. For that reason, the mental health parity legislation would tend to increase enrollment in HMOs.

Direct Access to Obstetrical and Gynecological Services

Background and Legislation. As with care from other specialists, many HMOs require that a woman have a referral from her primary care physician to see an obstetrician and gynecologist. However, many have argued that women should have direct access to obstetricians and gynecologists who, in many situations, are viewed as primary care physicians. Legislation providing some form of such access has been passed in many states. In 1994, California enacted legislation enabling women to choose an obstetrician and gynecologist as their primary care physician. In 1997, the Assembly and the Senate in California passed legislation (AB 1354) that would have required health plans to provide women with direct access to obstetrical and gynecological services, but that bill was vetoed by the Governor.

Impact. Given that women in California could already choose obstetricians and gynecologists as their primary care physicians, we estimate that AB 1354 would result in slightly higher premiums and out-of-pocket costs for HMO enrollees, approximately a 0.35 percent increase.

At the same time, enrollees would benefit from easier access to obstetrical and gynecological services and, in some circumstances, would benefit from improved quality of care. We expect similar impacts on both IPA model and group model HMOs. However, this type of legislation could have a longer-term impact on managed care that would be much larger in magnitude, if it sets in motion other legislation that would hinder the ability of managed care plans to limit access to specialists other than obstetricians and gynecologists.

Lengths of Stay for Mastectomy Patients

Background and Legislation. Since the 1996 passage of federal legislation mandating lengths of stay for maternity visits, mandating lengths of stay for mastectomies has become a common area for managed care legislation. In response to increased outpatient surgeries and decreased inpatient lengths of stays for mastectomies, legislation mandating minimum hospital stays has been introduced at both state and federal levels. In 1997, the California legislature considered bills that would mandate that the hospital length of stay for mastectomies be determined by the physician in consultation with the patient and those that mandate a 48-hour minimum stay.

Impact. We estimate that if a 48-hour minimum stay for mastectomies were enacted, the mean length of hospital stay for mastectomies would increase by 11 percent, from 2.0 days to 2.2 days. This estimation is based on the assumption that 25 percent of the short-stay patients-those who would have previously stayed less than 48 hours-elect to stay the full 48 hours if this legislation is enacted. In terms of an increase in health plan premiums, we estimate that the 48-hour minimum stay would result in only a one-hundredth of a percent (0.01%) increase in premiums, for both IPA model and group model HMOs. We would expect a similar increase in California and nationwide.


Based on our analyses, we were able to draw several conclusions which we hope will provide a starting point for further analyses of these proposals as well as other proposals that would regulate this industry.

First, proposals for managed care reforms improve some aspect of medical care or access to services for enrollees in managed care plans. Every proposal that we considered would, to some extent, force HMOs to offer more and/or better services to enrollees.

Second, proposals for managed care reforms tend to increase health plan costs and raise premiums. More services implies higher benefit costs for health plans. The plans, in turn, pass the costs along in the form of higher premiums. We estimate only small premium increases as a result of specific pieces of managed care legislation. However, if a large proportion of current managed care legislation were enacted, then the impact might be very large premium increases accompanied by a large shift in enrollment to fee-for-service plans. The impact of legislation, however, would likely vary according to type of HMO.

Finally, the impact of state managed care legislation could be severely limited by ERISA which enables self-insured plans to avoid compliance with state legislation. Furthermore, under ERISA, both self-insured and non-self-insured plans can avoid the attempts of states to expand insurer liability. In order to ensure that reforms affect all health plans, legislation would have to be passed at the federal level.

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