managed competition and california's healthcare

At the Intersection of Health, Health Care and Policy Cite this article as: A C Enthoven and S J Singer Managed competition and California's health care economy Health Affairs, 15, no.1 (1996):39-57 doi: 10.1377/hlthaff.15.1.39

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Health Affairs is published monthly by Project HOPE at 7500 Old Georgetown Road, Suite 600, Bethesda, MD 20814-6133. Copyright © 1996 by Project HOPE - The People-to-People Health Foundation. As provided by United States copyright law (Title 17, U.S. Code), no part of Health Affairs may be reproduced, displayed, or transmitted in any form or by any means, electronic or mechanical, including photocopying or by information storage or retrieval systems, without prior written permission from the Publisher. All rights reserved.

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MANAGED COMPETITION AND CALIFORNIA’S HEALTHCARE ECONOMY by Alain C. Enthoven and Sara J. Singer Prologue: More than any other single figure, Alain Enthoven is responsible for establishing and promoting the ideas that are the intellectual underpinnings of America’s rapidly transforming health care system. But the system has evolved in ways that Enthoven and his colleagues did not initially envision. They proposed a world in which organized health care delivery systems, paid on a per capita basis, would compete on price and quality. The delivery systems would be mutually exclusive, each would be marketed by its own health plan, and providers could attract more subscribers by cutting cost and price. Profits would flow buck into the delivery systems that generated them, financing the expansion of the most efficient systems. What has evolved in California, and nationally, is quite different. Publicly owned, for-profit health maintenance organizations , what Enthoven and Sara Singer label “carrier HMOs,” have increasingly come to dominate managed care, particularly in California. These HMOs contract with multispecialty group practices and individual practice associations (IPAs) using various risk&ring arrangements. Many providers have made the transition to managed care reluctantly and only because carrier HMOs created the competitive market that required them to do so. In this paper Enthoven and Singer discuss the current status of health insurance competition in California The growing dominance of managed care has led to lower insurance premiums for large and small employment groups, That may not imply reductions in total spending, because of government programs. Enthoven is the Marriner S. Eccles Professor of Public and Private Management at the Stanford Graduate School of Business , Singer, who holds a mater’s degree in business administration from Stanford, is Enthoven’s special assistant. During the health care reform debate, Singer worked for Rep. Mike Andrews (D-TX).

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40 HEALTH AFFAIRS | Spring 1996 Abstract: There is evidence in California of a broad decline in health care costs to employment groups adopting managed care and managed competition-premium reductions up to 10 percent. National comparisons and utilization data generally confirm the beginning of lower costs. Large California medical groups and health systems have responded to pressure by finding ways to reduce costs and improve quality. While examples are encouraging, there is room for improvement. Two levels of competition have emerged and continue to evolve: carrier competition and delivery system competition. Each model has strengths and limitations, but the existing mix is driving down costs.

H

ealth care costs in California are declining, and market forces are driving a widespread effort by providers to innovate in ways that will have a positive impact on cost, quality, and access. Marketdriven health system reform is occurring faster than federal legislators and regulators can measure, much less control. In this paper we address the following: (1) evidence that change is occurring in California and its extent; (2) the current and potential impact of change on health care delivery; and (3) the connection between lower prices and the changes in health care delivery, including changes in the relationships between delivery systems and health maintenance organizations (HMOs). E vi d e n ce An d E xt e n t O f Ch a n g e In Ca l i fo r n i a Decline in premiums. There is evidence of a broad decline in health care costs to employer groups in California. The California Public Employees Retirement System (CalPERS), the Federal Employees Health Benefits Program (FEHBP), the Pacific Business Group on Health (PBGH), Stanford University, the University of California (UC), and The Health Insurance Plan of California (The HIPC) all have experienced declining premiums in the past three years (Exhibit 1). UC experienced the largest oneyear reduction: 10 percent. Although preliminary 1996 results indicate a small premium increase, the weighted average is based on 1995 enrollments, so it does not account for a potential exodus from the high-cost plan, whose 1996 premiums increased 49 percent. Lower premiums may not imply reductions in total spending, because 1 benefit changes and selection may increase overall spending. For the purchasers we examined, however, benefits have been fairly standard. Also, in general, benefits have not been manipulated to reduce premiums. One exception is that Stanford University increased its copayment from $5 per office visit in 1991 to $10 in 1992. This change resulted in savings carried forward by Kaiser, accounting for approximately 0.75 percent of Stanford’s 6.2 percent reduction in 1995. In addition, the decreases in weighted average premiums probably do not reflect favorable risk selection. CalPERS, the FEHBP, Stanford, and UC have large populations that have been relatively stable over time. The population in CalPERS has been Health Affairs, Volume 15, Number 1 Downloaded from content.healthaffairs.org by Health AffairsInc. on June 4, 2013 © 1996 The People-to-People Health Foundation, by guest

MANAGED COMPETITION

41

Exhi b it 1 California Weighted Average Health Care Premiums, 1992-1996

P urchaser

1996 weighted average total premium m ontha

1996 weighted a ve r a g e individual premium p er m onth a

CalPERS CalPERS (HMO only)

$313.70

$168.63

Percent change in weighted average total premiums 1 9 9 5 - 1 9 9 4 - 1 9 9 3 - 19921996 1995 1994 1993 -4 . 0 0 % -1. 10 % 1 . 4 0 % 6 . 1 0 % -5.30 -0.70 -0 . 4 0 6.90

FEHBP (HMO only) PBGH

291.92

161.74c

-4 . 4 7 ’ -4.30

-5.81 -9.20

2.91 -b

6.13 -b

Stanford University d UC

d

256.50 280.81

156.75 151.89

-4.80C c 2.45

-6.16 -9.96

5.21 -6.33

8.54 1.92

The HIPC The HIPC (HMO only)

248.30

116.89,

-2.81 -3.39

-3 . 6 5 -b

Medicare

281.42

e

281.42

e

-b

-b

-b -b

-b 3.26

Source: California Public Employees Retirement System (CalPERS), Health Plan Administration; U.S. Office of Personnel Management; Pacific Business Group on Health (PBGH); J.C. Robinson, “Health Care Purchasing and Market Changes in California,” Health Affairs (Winter 1995): 117-130; Stanford University, Office of Human Resources; University of California (UC), Employee Benefits Plan Administration; Major Risk Medical Insurance Board; and Health Care Financing Review: Medicare and Medicaid Statistical Supplement (1995). Notes: FEHBP is Federal Employees Health Benefits Program. The HIPC is The Health Insurance Plan of California. HMO is health maintenance organization. a Benefit packages are not comparable. b Information not available. c Weighted by 1995 enrollment. d Excludes catastrophic plans. e 1993.

aging-as of January 1995 the average age was 44.9 years based on “prime life,” up from 43.9 in 1990-which implies, if anything, higher costs. The HIPC’s population has been growing at approximately 5,000 members per month since its inception. The HIPC’s rates are age-specific, although within categories the extent of risk selection, if any, is unknown. Small-group market. All health plans offering coverage to small groups must comply with California legislation, which includes guaranteed issue and renewal and currently allows plans to rate premiums within 20 percent 2 higher or lower than average, on the basis of health status. The HIPC, begun 1 July 1993, is a state-run pooled purchasing arrangement for small employers with three to fifty employees. Health plans that contract with The HIPC must agree not to offer outside The HIPC a similar or richer benefit package at a lower price for persons in the same age, family size, or geographic region category. During its first two years of operation The HIPC negotiated contracts with health plans for an average of 10 to 15 percent less than average smallegroup rates. Because they are released early, The HJPC’s rates set a benchmark for the Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

42 HEALTH AFFAIRS | Spring 1996 rest of the small-group market. Blue Cross and Foundation Health, the only two major health plans that cover small groups exclusively outside The HIPC, follow the premium trends in The HIPC to compete. The rate decline for The HIPC in the past two years, therefore, has been fortunate for small employers purchasing insurance outside The HIPC. National purchasers. National health care purchasers, including the FEHBP and Medicare, have fared better in California than they have nationally (Exhibit 2). Purchaser of health coverage for nine million federal employees, annuitants, and dependents nationally, the FEHBP saw a greater decrease in 1996 weighted average premiums for community-rated plans in California, compared with the national average of FEHBP commu3 nity-rated plans. Weighted average California premiums for individuals, at $161.74 per month, are already lower than the national FEHBP average. Medicare payments have increased at a lower rate in California than the 4 U.S. average. The number of Medicare beneficiaries in prepaid plans also has been greater and has been increasing faster in California than the U.S. average. At least through 1995 Medicare’s per capita rates were based on Medicare’s fee-for-service reimbursement formula. An HMO that applied for a Medicare risk contract received 95 percent of the adjusted average per capita cost (AAPCC) for the area to provide comprehensive services to each enrolled beneficiary. The full impact of competition in California therefore would not be reflected in Medicare managed care spending. Nevertheless, in 1994 and 1995 the AAPCC in major California counties 5 increased at slower rates than the national average (Exhibit 3). Also, since 1991 the ratio of the AAPCC to U.S. per capita costs has declined Exhibit 2 Health Care Marketplace Comparison, California And U.S. Average, 1993 And 1996 Weighted average ind ivid ual p rem iumPercent of p opulation per month in HMOs Lo ca t i o n California U.S. average

FEHB P (HMO o n l y)a M e d i ca r e b $161.74 $290.58 d 168.74 301.33

Increase from previous year California -3.94% d U.S. averaee -0.70

3.26% 4.96

F E HB P C 55.67% 29.10 4.86 2.46

M e d i ca r e b 25.84% 6.97 18.11 10.89

Sources: U.S. Office of Personnel Management; and Health Care Financing Review: Medicare and Medicaid Statistical Supplement (1994 and 1995). Notes: FEHBP is Federal Employees Health Benefits Program. HMO is health maintenance organization. a 1996. b 1993. c 1995. d Excludes California. If California were included, the weighted average individual premium for the FEHBP would have been $166.05 per month, a decrease of 1.93 percent from 1995. Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION 43 Exhibit 3 Adjusted Average Per Capita Cost (AAPCC) In California Counties, Compared With U.S. Per Ca . p i ta Cost (USPCC). 1991-1995 P ercen t chan ge

Ratio of AAPCC to USPCC

Co u n t y U.S.

1995 5.92%

1995 1.00

1994 1.00

1993 1.00

1992 1.00

1991 1.00

Sacramento Los Angeles Orange

4.02 5.02 4.83

3.81 3.25 1.10

1.08 1.41 1.32

1.10 1.41 1.32

1.12 1.44 1.38

1.12 1.46 1.38

1.13 1.47 1.40

Riverside San Bernardino Ventura

4.17 4.89 5.05

1.72 4.01 -3.17

1.17 1.18 1.12

1.18 1.18 1.12

1.22 1.19 1.22

1.22 1.19 1.16

1.23 1.18 1.21

San Diego San Francisco San Mateo

5.48 4.68 4.75

2.17 0.46 -2.42

1.16 1.18 1.00

1.16 1.18 1.00

1.19 1.24 1.08

1.20 1.27 1.13

1.23 1.29 1.18

1994 5.43%

Source: Coopers and Lybrand analysis of data from the Health Care Financing Administration, taken from S. Palsbo, “Trends in the USPCCs and AAPCCs” (Coopers and Lybrand, September 1994).

throughout these counties, with the exception of San Bernardino County, 6 where the ratio has remained steady. These indications of price declines, despite the use of Medicare’s inflationary reimbursement formula, may 7 reflect spillover from competition in the private sector. Medi-Cal (California Medicaid) rates are determined through a political process, so rate fluctuations cannot be attributed to changes in costs alone. Also, experiences of private employers and public programs tell us nothing about the costs of the growing uninsured population. Total health spending in California may not be declining, because the cost of government programs and of the uninsured are still increasing. We merely observe a broadly based, extensive departure from the trends of the past thirty-five years. Progress of price-elastic demand. For health plans to see lowering their 8 prices as being in their best interest, they must face price-elastic demand. Managed competition recommends a variety of interventions to make 9 demand price-elastic. We know of no employer that has applied all of these interventions, but the trend is in that direction. Given potential customers with a broad choice of plans, the ability to compare them, and a financial incentive to seek value, health plans competing for business have good reason to provide high-quality care at the lowest possible rates. The PBGH, formerly the Bay Area Business Group on Health, is an employer coalition that includes such influential employers as Bank of America, Safeway, and Pacific Telesis, seventeen of which participated in the 1996 health plan negotiations, representing $400 million in premiums. Most PBGH employers require workers to pay the difference in premiums or are eliminating the subsidy of more expensive plans. The PBGH has Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

44 HEALTH AFFAIRS | Spring 1996 analyzed the health risks of the population enrolled in each plan but has determined so far that no adjustments have been warranted. In addition, the health plans have agreed to meet performance standards on quality of care, customer service, and data provision. The HMOs each put a total of 2 percent of premiums at risk for all performance standards, weighted according to each plan’s relative weaknesses. During an annual open enrollment period, Stanford offers employees a choice among four HMOs, one with a point-of-service option. Since 1992 Stanford has required employees to pay the full difference in premium for a more expensive plan. With the success of this policy in slowing and reversing premium growth, Stanford shared the savings with employees in the form of increased employer contributions. In 1993 UC similarly replaced an inflationary contribution formula that paid a premium up to the average of the four largest plans with a contribution set at 100 percent of the lowestprice plan serving all campuses. An analysis of the responses of UC employees suggests that 26 percent of health plan enrollees will switch to a cheaper 10 plan when the monthly premium for their own plan rises by $10. The HIPC offers a choice of twenty-four health plans to approximately 5,100 small businesses throughout the state. Before The HIPC was developed, employees of small firms seldom had a choice of plans. The contribution policies of participating employers are unknown; however, employers are required to contribute at least 50 percent of the lowest-price premium. To make The HIPC attractive to firms with younger, typically healthy workers, The HIPC offers rates by age category and family size. In addition, The HIPC plans to adjust payments to health plans based on the average risk profile of enrollees, beginning with the 1996-1997 contract year, thereby ensuring that plans that attract higher-risk populations will be 11 compensated for their additional costs. The state of California is the state’s largest employer, with almost 640,000 covered lives, or 67 percent of CalPERS enrollees. CalPERS purchases health care benefits for people working in more than 1,000 participating agencies. The state used to pay 100 percent of individual premiums up to the average of the four largest plans (plus 90 percent for dependents), a formula that denied health plans with below-average premiums a marketplace reward for reducing premiums and thus contributed to inflation. In spring 1992 the state froze its maximum contribution to employee benefits at 1991-1992 levels in response to the state’s fiscal crisis. This put employees at risk for future premium increases above the maximum. However, because of premium reductions, most of the health plans’ premiums (nineteen out of twenty-four for individuals, including all of the HMOs) were completely paid by the state in 1995. CalPERS relied on threats of enrollment freezes or contract cancellations to negotiate prices. Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION 45 The future is uncertain as we write. In summer 1995 the state proposed to its employee unions a defined composite benefit contribution and the right to apply the difference to other benefits such as dental services and medical spending accounts. To purchase a more expensive plan, an employee would pay the difference between the defined contribution and the premium. This formula would reward employees for economical choices, make demand more elastic, and give health plans an incentive to further reduce premiums. If prices continue to decline, state employees would benefit, giving them a direct interest in lower health care costs not present in the previous formula. As of March 1996, the unions had not settled. The broad picture. Most employers fall into one of three categories: (1) Some use most or all of the interventions to manage competition among competing providers and embrace managed care. These employers drive down prices and experience high and rising HMO market shares (Exhibit 4). (2) Some offer a combination of fee-for-service plans and HMOs but pay all or most of the premiums. They create price-inelastic demand, in which HMOs have an incentive to shadow-price the more expensive, typically fee-for-service, plans. Since the outlays of these employers are tied to increases in fee-for-service rates, their costs will rise. (3) Finally, some offer only fee-for-service coverage and pay all or most of the cost. These employ Exhibit 4 Proportion Of California Enrollees In Health Maintenance Organizations (HMOs) And Point-Of-Service Plans, 1995 P u r ch a se r California

Num ber of enrollees 12,057,900

a

Percent in HMO/ Joint-of-Service plan 38.36% 80.60 55.67 b 69.00

CalPERS FEHBP PBGH

954,000 495,000 a 330,000

Stanford UC

22,000 250,000

100.00 90.27

97,000 c 3,512,500

94.67 25.84

The HIPC Medicare

Sources: Hoechst Marion Roussel, HMO-PPO Digest (Kansas City: Hoechst Marion Roussel, 1995); California Public Employees Retirement System (CalPERS), Health Plan Administration; U.S. Office of Personnel Management; Pacific Business Group on Health (PBGH); J.C. Robinson, “Health Care Purchasing and Market Changes in California,” Health Affairs (Winter 1995): 117-130; Stanford University, Office of Human Resources; University of California (UC), Employee Benefits Plan Administration; Major Risk Medical Insurance Board (MRMIB); and Health Care Financing Review: Medicare and Medicaid Statistial Supplement (1995). Notes: FEHBP is Federal Employees Health Benefits Program; The HIPC is The Health Insurance Plan of California. a 1994. b Proportion of employees in HMOs ranges from 50 percent to 97 percent for PBGH employers. Negotiating alliance contracts with only HMOs. c 1993. Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

46 HEALTH AFFAIRS | Spring 1996 ers will feel the full force of provider surplus and excess utilization. There is much variation in price in the health insurance market. The ratio of maximum-to-minimum premiums across all PBGH contracting firms in the year prior to collective negotiations for a given health plan ranged up to 1.36, even after adjustments for benefit and health risk 12 differences. Price trends in the parts of the market with elastic and with inelastic demand can diverge substantially. We therefore predict that the trend toward managed care and managed competition will accelerate. It appears that a critical turning point has been reached in the California market. Some large groups have made substantial progress toward managed competition and depend heavily on managed care. Less is known about small groups, although The HIPC is bringing broader choice of managed care plans and more elastic demand to employees within some small groups and may be causing overall prices to decline in the small-group market. Impact Of Change On Health Care Delivery Interventions by purchasers and price reductions by health plans have put great pressure on providers nationwide to reduce costs. Recent data 13 show the beginning of a lower cost structure in California (Exhibit 5). American Hospital Association (AHA) and Medicare statistics reveal a trend toward faster declines in resource use in California than nationally. The number of hospital beds and inpatient days in short-stay hospitals per thousand residents is lower and has declined faster in California than the national average between 1990 and 1993. American Medical Association (AMA) statistics show modest advances in California compared with national trends. The number of physicians per 100,000 population in California is approximately equivalent to, but has risen much more slowly than, the national average. California employs approximately the same propor14 tion of primary care physicians as the national average. This is surprising, given the level of managed care penetration in California, but may reflect a data lag. The number of physician graduates per thousand per year in California between 1990 and 1994 is significantly smaller than the U.S. average and has declined more since the previous decade. Data from the Unified Medical Group Association (UMGA) indicate that medical groups, especially the most efficient, in California are providing care using 15 fewer resources compared with national statistics. Average adjusted total hospital days per thousand population are low and declining more rapidly. Large California medical groups and health care delivery systems have responded to market pressure from purchasers and HMOs by finding ways to reduce costs while improving quality. We regret the lack of routinely reported, standardized data to document this response and the need to rely Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION 47 Exhibit 5 Health System Utilization Statistics, California And U.S. Average, By Data Source, 1 9 9 3 -1 9 9 4

California American Hospital Association (1993) Short-stay hospital days per thousand Hospital beds per thousand Medicare (1993) Short-stay hospital days per thousand enrollees

561.24 2.51

1,656

P ercen t change per ye a r since 1990 -4 . 0 5 % -2 . 5 2

-4.76

U . S. average 838.91 3.57

2,503

P e r ce n t change per ye a r since 1990 -2.68% -1.54

-3.50

American Medical Association (1994) Physicians per 100,000 a Percent primary care Physician graduates per thousand

268 38.11% 331C

0.47 d -9.67

263 38.42% c 607

UMGA versus US. (1994) Adjusted total hospital days per thousand Commercial Average Most efficient Least efficient

151 109 284

-9.89 0.94 -12.61

277.4 -b -b

1,020 652 1,601

-6.15 -9.29 -8.14

3.78 2.06 5.45

-2.77 6.69 -4.78

3.60 -b

2.20 -b -b

8.33 3.52 14.02

-2.56 -7.27 -1.89

7.90 -b -b

5.00 -b -b

Seniors Average Most efficient Least efficient Visits per member per year Commercial Average Most efficient Least efficient Seniors Average Most efficient Least efficient

e

1,682.l _b

2.85 -b d -8.81

-4.92 -b -b 0.82 -b -b

Sources: American Hospital Association, 1994 AHA Hospital Statistics (1994); Health Care Financing Administration, Health Care Financing Review: Medicare and Medicaid Statistical Supplement (1992, 1994 and 1995); American Medical Association, Physician Characteristics and Distribution in the U.S., 1992-93 and 1993-94 (1993 and 1994); Unified Medical Group Association (UMGA), unpublished reports; and Hoechst Marion Roussel, HMOPPO Digest (Kansas City: Hoechst Marion Roussel, 1995). a Primary care includes family practice, general practice, internal medicine, obstetrics/ gynecology, and pediatrics. b Information not available. c 1990-1994 average. d Percent change between 1990-1994 and 1980-1989 averages. e National dam taken from Hoechst Marion Roussel, HMO-PPO Digest (1995). Hospital days include acute hospital days only.

on examples from a nonrandom sample, which might be unpersuasive. However, the scale and quality of this kind of cost-reducing, qualityimproving activity is very different from that of a few years ago and is driven Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

48 HEALTH AFFAIRS | Spring 1996 at least in part by premium reductions. Clinical improvements. Clinical improvements will be the main source of continued savings in the health system in the future. Clinical effectiveness initiatives at Sutter Community Hospitals of Sacramento (Sutter General Hospital and Sutter Memorial Hospital) produced savings of $1.9 million in 1994 by refining treatment protocols for coronary artery bypass surgery, total hip replacement surgery, congestive heart failure, and back disease, and by sharing these protocols with physicians across the system. Sharp HealthCare’s Grossmont Hospital, near San Diego, reduced the inpatient stay for hip replacement surgery from eight days in 1989 to 3.4 16 days in 1995 and cut costs by $4,500 per case. Treatment for total hip replacement now involves extensive preoperative education. In addition, a nurse visits each patient’s home to assess safety for recovery, develop a relationship with the patient, and discuss the patient’s needs with a caregiver. During the class and home assessment, patients are screened for surgery based on their physical and mental health, desire for surgery, and ability to carry out the program. A clinical protocol has been developed for in-hospital care, in which patients start physical therapy immediately after surgery and continue therapy at home with a visiting therapist. In another project at Sharp, The Birthplace enrolls more than 200 obstetrics patients per month in a nurse-midwife/ obstetrician comanagement model. Approximately sixty low-risk women per month choose to deliver their infants as outpatients. The overall cesarean section rate for the program during 1993 and 1994 was 13 percent, compared with 21 percent 17 locally. The cesarean section rate for the subset of low-risk patients was 6 percent. Kaiser Southern California reduced its elderly population’s average use of hospital days per thousand by 30 percent. A team determined that two of Kaiser’s ten hospitals had considerably lower utilization rates; admission and discharge rates varied by as much as 36 percent. Kaiser identified and implemented nine “best practices,” including creating a continuing care department to develop alternatives to inpatient admission, providing care coordination in the emergency room to avert inpatient stays, and conducting daily physician-led care coordination rounds. Kaiser saved $6.3 million per year between 1991 and 1994, driven by the drop in inpatient stays. In 1992 UniHealth, based in Burbank, assigned clinical case managers to a specific diagnosis rather than to a unit. Case managers help guide patients and their families through the system, including after discharge, and support physicians by improving communication with patients. At one hospital the introduction in 1994 of clinical case management for congestive heart failure reduced the overall cost per case by 39 percent, for a total savings of more than $277,000 over nine months. Satisfaction levels for Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION 49 patients with congestive heart failure with clinical case management were higher than those for patients without case management. In addition, the readmission rate for congestive heart failure fell 33 percent to 7.1 percent. Appropriate clinical capacity. One way to reduce hospital costs is to consolidate, thus eliminating excess capacity. There are formidable barriers to closing hospitals, particularly nonprofit hospitals. Catholic Healthcare West (CHW) offers a rare example of a nonprofit hospital closure. After losing $20 million in its Sacramento region, CHW restructured five independent hospitals into one division with one board, charged with addressing total market needs. After estimating an excess of 1,000 acute beds in Sacramento, the regional board announced plans to close one facility with 210 beds, which is expected to yield savings of $10 million per year. The board also consolidated CHW’s high-risk obstetrical services at one site and its open-heart surgery at two high-volume centers. CHW joined with Sutter Health to provide clinical laboratory services to the region. Economies of scale. Systems can achieve economies of scale by consolidating duplicative services. In 1994 Sharp HealthCare restructured its seven hospitals, consolidating many functions horizontally. One director each is responsible for all laboratory, radiology, cancer, heart, women’s health, transcription, appointment scheduling, and information systems services. By reorganizing and eliminating 100 out of 131 managers, Sharp saved $7-8 million per year. By centralizing functions, Sharp saved another $3 million per year. In essence, Sharp was able to gain some of the benefit of closing a hospital without actually doing so. Eventually, such consolidations could result in excess capacity in the workforce and wage reductions. The sale of the nonprofit Good Samaritan Health System of San Jose to and the formation of a fifty-fifty joint venture of Sharp with the for-profit Columbia/ HCA Healthcare Corporation, announced in late 1995, may predict a trend. The Good Samaritan merger, effective 4 January 1996, has already resulted in announcements of reductions in staff by approximately 18 25 percent. Prevention. Appropriate care provided early saves money for systems in the long run. Friendly Hills, near Los Angeles, employs nurse practitioners trained in geriatric medicine to ensure that its patients in nursing homes follow their treatment regimens closely and that problems are identified and handled promptly. These geriatric nurse practitioners also maintain close relationships with both patients and families. This program has reduced by more than half (to seventy-one in 1994) the transfer of patients from extended care facilities to the acute hospital. In addition, many of these admissions were planned. after assessment by nurse practitioners, rather than on an emergency basis, which tends to be more expensive. Appropriate incentives. Systems can promote appropriate and efficient Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

50 HEALTH AFFAIRS | Spring 1996 care through physician compensation by placing physicians at risk for the cost of care and the cost of poor quality. At HealthCare Partners, based in Los Angeles, approximately 250 mostly primary care physicians receive a salary plus a bonus, which can equal up to 30 percent of their base salary. The bonus is determined by the following factors: (1) patient satisfaction as determined by an independent firm’s survey of fifty patients per physician per year compared with a national average; (2) peer surveys across specialties for appropriateness of service; (3) evaluation by nurses, staff, and providers for teamwork; and (4) traditional peer review. Upcoming bonuses also will incorporate individual physician scores on Health Plan Employer Data and Information Set (HEDIS) quality measures. Advancement and promotion also are tied to meeting and exceeding the goals. Since the implementation of the formula, no physician who failed to meet the minimum requirements upon second evaluation remains with Partners. Use of new technologies. Adoption of new technologies can have a significant impact on cost and quality. An online patient record and a pharmaceutical interaction database enabled Sharp to implement a successful telephone-based triage system. The telephone advice system at Friendly Hills, run by nurses and supported by written protocols and guidelines produced by physicians, satisfactorily deals with more than 60 percent of the approximately 1,000 phone calls per month from patients seeking medical advice. This results in an estimated 10 percent reduction in office visits. Surveys indicate that patients, especially working parents of schoolage children, like the telephone advice program. In 1991 Sharp began investing in a new information system that integrates patient care, financial, and human resources information across all Sharp facilities. Laboratory, pharmacy, radiology, and transcription also share the same system. Sharp receives and preloads enrollment information from health plans into the database, enabling Sharp to identify and pursue those enrollees who should come in for primary and preventive care. The automated patient identification and demographic information also helps transcriptionists to save time, make fewer errors, and eliminate duplicate patient records. The system allows managers to easily compare resource use and performance across hospitals. Similarly, physicians receive information that allows them to compare their practice patterns with those of their colleagues anonymously, to identify areas for improvement. Academic medicine. Very large cost-cutting opportunities exist in academic medical centers. Stanford University Hospital recently announced plans to reduce the costs of existing services by more than $28 million per year and to invest in new technologies and patient services, expected to generate an additional $6 million in revenue in 1996. The overall budget improvement of 8.6 percent comes during the sixth year of Stanford Health Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION

51

Services’ Operations Improvement Program, which has generated a total reduction in the annual hospital budget of more than $83 million while increasing revenue by more than $30 million. Room for improvement. Although these examples are encouraging, there is still a great deal of room for improvement. In California, as elsewhere, there is an excess supply of hospitals, hospital beds, and specialists. Administrators predict layoffs of physicians and hospital closures. The average hospital occupancy rate in California was 52.4 percent of licensed 19 beds in 1994, which suggests that many hospitals are underused. Excess hospitals and bed capacity lead to strategies to fill beds, which in turn lead to excess costs. The most efficient medical groups now provide care using a 20 total of 169 total adjusted hospital days per thousand population. Assuming a desirable occupancy rate of about 85 percent, these rates-perhaps unrealistic in the short run-imply that California needs 0.54 beds per 21 thousand population, or approximately 17,000 beds. California had 78,481 licensed beds in 1993, more than four and a half times the requisite 22 number. In addition, too many hospitals continue to perform costly, complex procedures. Hospitals could reduce spending and improve outcomes by concentrating procedures such as open-heart surgery in efficient regional 23 centers. Instead, despite the American College of Cardiology’s recommendation of a minimum of 200 to 300 open-heart procedures per facility per year, only fifty-seven of 119 California hospitals in 1992 performed at least 200 such procedures, and only twenty-eight California hospitals per24 formed more than 300. Closing departments and hospitals is proving to be difficult politically, especially in the nonprofit sector, as local communities, local boards, and big donors all struggle to keep them open. Although the number of medical school graduates per thousand is declining in California as it is in the rest of the country, there are still too many. Medical residents with specialized training have found few jobs and 25 low pay awaiting them, especially in California. Physician salaries face downward pressure with excess supply. Preliminary data from the AMA show that for the first time in fourteen years, physicians’ median incomes 26 dropped 3.8 percent in 1994 to $150,000. Managers of medical groups in California typically estimate necessary reductions of beds and physicians of 50 percent or more. Too many specialists may perform too few procedures per doctor and lack proficiency, or they may perform too many procedures per capita and provide inappropriate services. Projections of such drastic reductions have caused significant anxiety, especially among specialists. There remain significant variations in utilization statistics of medical groups across California. The UMGA reported that for commercial plans among twenty-seven medical groups in California in 1994, doctor visits Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

52 HEALTH AFFAIRS | Spring 1996 ranged from 2.06 to 5.45 visits per member per year, and total adjusted hospital days for persons under age sixty-five ranged from 109 to 284 per thousand members. For senior plans, doctor visits ranged from 3.52 to 14.02 visits per member per year, and total adjusted hospital days ranged from 652 to 1,601 days per thousand members. Although these groups have not been audited for quality, these data suggest that some medical groups are performing relatively economically, while many others could improve. Comp etition, California Style The originators of the competing HMO strategy envisioned that compet27 ing delivery systems would be paid a fixed price per person per month. The delivery systems would be mutually exclusive; carriers (health plans) would be integrated with providers and would act as their marketing arms. There would be separate prices for each system. Providers could attract more subscribers by cutting cost and price. Consumers could save money by choosing a less costly delivery system. Profits would flow back into the delivery systems that generated them, financing the expansion of the most efficient systems. Employers and purchasing groups would offer a wide choice of plans, including point-of-service options, through which members could gain access to all providers. Instead, but for the notable exception of Kaiser Permanence, what is emerging in California are delivery systems marketed by several carriers, each of which markets many other delivery systems also. We refer to these entities as “carrier HMOs.” Carrier HMOs come in a variety of forms. The most effective competitors contract with multispecialty group practices and selective individual practice associations (IPAs) on a per capita basis. Other carriers create a network by contracting with unrelated physicians. The current financing and delivery system evolved in part as a consequence of providers’ resistance to managed care. Providers made the transition reluctantly, only because the carrier HMOs created the competitive market that required them to do so. Delivery system competition did not emerge for several reasons: (1) Traditionally, physicians pocket the profits in their group practices, leaving no capital to create organized systems and finance expansion; (2) medical groups are democratic, and successful physicians have no incentive to change or expand their practices; and (3) most physicians lack management expertise. In addition, physicians traditionally have been reluctant to monitor and report publicly their quality of care and to dismiss poor performers from their groups. Nonprofit delivery systems have had weak incentives to expand because they have not been motivated by profit. Even in Kaiser Permanente, the drive for expansion came more from management than from physicians. Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION 53 Carrier competition happened because the California market provided a large profit opportunity. Premiums were rapidly increasing. There was a large surplus of hospitals and doctors that was attributable to the previous period of open-ended, cost-unconscious demand. Employers wanted the simplicity of offering one or a few carriers while still offering workers a wide choice of providers, so the carriers moved rapidly to sign up large networks. Purchasers started to demand and reward value for money. Carriers could make large profits by supplying less costly coverage while driving hard bargains with the providers over whom they had leverage because they controlled the flow of contracts. Faster growth generated higher profits and market capitalizations, so the carriers rushed to expand. From the purchaser’s point of view, carrier competition is superior to no competition. Competition among carriers offering essentially the same provider networks also helps to limit risk selection and to make demand price-elastic. However, carrier competition has left some problems; it is interesting to observe how market forces are working to resolve them. First, if several carriers offer essentially the same delivery systems, it is hard for purchasers to make meaningful or useful comparisons of quality of care. Now, major purchasers, such as CalPERS and the PBGH through the California Cooperative HEDIS Reporting Initiative, are planning to reach through the carriers and demand delivery system-specific data on quality. Second, this model insulates delivery systems from market forces, in that a medical group cannot attract more members by cutting cost and price because the carrier controls the price to the purchaser. However, carriers can reward the more cost-effective groups by directing enrollment their way. Carriers are offering networks with access to fewer providers to purchasers that want lower costs. Health Net offers a reduced network to The HIPC, although member relations so far have suffered from confusion about access to doctors who are usually in the Health Net network. Moreover, carriers invest in joint marketing projects with the more efficient medical groups. Carriers can penalize high-cost groups by threatening to freeze or by actually freezing enrollment or terminating contracts. State regulations in California do not permit health plans to offer cash rebates to consumers for choosing a particular medical group. Third, carrier competition insulates consumers from the costs of their choices: An enrollee pays one premium for access to a health plan and then can choose a high- or low-cost medical group within its network. Employer groups that use managed competition reward workers with lower premiums for choosing lower-price plans, and plans can use the above-described methods to influence patients to choose economical groups. In this way, the reward for being a low-cost medical group may come indirectly. Fourth, a carrier’s reward for investment in information systems or perDownloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

54 HEALTH AFFAIRS | Spring 1996 sonnel development to improve the performance of its contracting medical groups, or in preventive services for the group’s whole population is attenuated because the benefits of the improvement will be shared with other carriers marketing those groups. However, as carriers achieve large shares of a group’s business, they are likely to find that such investments make sense. In addition, they are finding that, through investments in information systems, they may gain the loyalty of medical groups. Carriers’ ability to pressure providers is enhanced as carriers consolidate through mergers. Provider groups may not be able to refuse a large carrier’s demand for price reductions if the carrier controls a large portion of the group’s business and as provider oversupply increases. This has enabled for-profit carriers to maintain their gross margins, which for California 28 HMOs in 1994 ranged from 3.2 percent to 27.0 percent. This variation reflects large differences in accounting for profit and administration and in services HMOs provide. HMO retentions may be used to support quality measurement and improvement, reduce the cost of services in the future, invest in the health of the enrolled population, or finance expansion. Possibilities for the future. How will market forces resolve these issues? First, market forces are driving out excess capacity on the provider side. Hospitals are consolidating. Doctors in California are leaving medical practice. At least fifty doctors left the Sacramento region because of the 29 squeeze. A new equilibrium will be reached. Second, delivery systems will merge and grow, as the recent MedPartners/ Mullikin/ Pacific Physician Services and Caremark/ Friendly Hills/ CIGNA mergers demonstrate. If a provider group were to treat enough of the population in a given market, it would be difficult for a health plan not to contract with it. For example, if current trends continue, the Sacramento hospital market will soon be divided between Kaiser, Sutter, Mercy/ CHW, and UC Davis Medical Center, with capacity in balance with needs. A carrier would then have as much difficulty dropping Mercy as Mercy would have dropping a carrier. Third, carriers will have to allow delivery systems enough revenue to generate capital for facilities and to hire good doctors. Fourth, if purchasers continue strategies to increase price elasticity of demand, carriers will need to find ways to differentiate themselves. Already, where benefits are standardized and carriers contract with overlapping provider networks, the carriers become virtually perfect substitutes for one another, and demand becomes completely elastic, making competition intense. Both Stanford and UC have benefited from this as purchasers. Strategic alliances with delivery systems that carriers emphasize and in which they invest would be a way for carriers to differentiate themselves. Alternatively, medical groups could create their own health plans to market their services directly to employers, Several medical groups have Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION 55 attempted this without great success. Sharp, Mullikin Medical Centers, Sutter, and UniHealth all operate HMOs or own them to some degree. However, these examples make up a small proportion of the HMO business in California. UniHealth is also the largest shareholder of PacifiCare but maintains an arm’s-length relationship. In addition, the California Medical Association (CMA) has formed its own managed care organization and plans to introduce an HMO in 1997. Provider groups in California are limited in aggressively marketing their own health plans by fear that other plans will stop marketing their provider services in retaliation. In addition, most integrated delivery systems see a distinct marketing role for health plans. The issue they raise is whether that role is worth 20 percent or more of premiums. On the other hand, given the record of providers, it seems reasonable to question whether a provider-run health plan would push medical groups aggressively enough to reduce costs and monitor quality. Moreover, carriers in California have very large capitalization, while provider groups have very little, making it difficult for the latter to comply with solvency requirements for HMOs and to compete effectively. Although eased requirements for provider-run organizations under the new Medicare proposals may change the current dynamic, new entry has been impractical given the resources required and because, even if the health plan were very successful, the medical group could suffer loss of enrollees in the short run because of retaliation from health plans. Although new delivery system-run health plans are unlikely, California already has a mixed model with the large presence of Kaiser Permanente: both delivery system and carrier competition. Each model has its strengths and limitations. Different states will evolve their models in different ways. The important thing for Californians now is that competition among the existing mix is driving down the costs of health care, and this trend appears likely to continue. The authors thank the following persons fur their assistance in preparing this paper: Al Barnett, Maggie Callway, Debbie Danziger, Richard Della Penna, Peter Ellsworth, Ed Geehr, Terry Hartshorn, Steve Heath, Ed Kopetsky , Dick Kramer, Gary Loveredge, Robert Margolis, Gloria Mayer, Patricia Powers, Sharon Reavis, Sandra Shewry, D.J. Stadtler, Karin Tober, Dirk Thornley, and Larry Wilson.


56 HEALTH AFFAIRS | Spring 1996 NOTES 1. H.A. Huskamp and J.P. Newhouse, “Is Health Spending Slowing Down?” Health Affairs (Winter 1994): 32-38. 2. California Assembly Bill 1672. In July 1996 this rating band will narrow to 10 percent. Legislation (S.B. 599) has been introduced to reduce the rating band to zero. 3. U.S. Office of Personnel Management, unpublished reports, 1991-1995. 4. Health Care Financing Administration, Health Care Financing Review, Medicare and Medicaid Statistical Supplements (1992, 1994, and 1995). 5. S. Palsbo, “Trends in the USPCC and AAPCCs” (San Francisco: Coopers and Lybrand, 16 September 1994); and Health Care Financing Administration, “Standardized Per Capita Rates of Payment,” for years 1991-1995 (Baltimore: HCFA, 1991-1995). 6. Palsbo, “Trends in the USPCC and AAPCCs;” and HCFA, Office of the Actuary, “Enclosure I,” Comparison of the USPCC, 1991-92 through 1994-95 (Baltimore: HCFA, 1992-1995). 7. See W.P. Welch, “HMO Market Share and Its Effect on Local Medicare Costs,” in HMOs and the Elderly, ed. H.S. Luft (Ann Arbor, Mich.: Health Administration Press, 1994); and L.C. Baker, “HMOs and Fee-for-Service Health Care Expenditures: Evidence from Medicare,” National Bureau of Economic Research Working Paper 5360 (Stanford, Calif.: NBER, November 1995). 8. Price-elastic demand occurs if a health plan is able to attract enough additional customers by lowering its price to offset the revenue loss. If consumers have neither the incentives nor the information with which to make choices among health plans on the basis of value for money, a situation known to economists as “price-inelastic demand” results, and health plans have no reason to lower their prices. 9. A.C. Enthoven, “The History and Principles of Managed Competition,” Health Affairs (Supplement 1993): 24-48. 10. T.C. Buchmueller and P.J. Feldstein, “Consumers’ Sensitivity to Health Plan Premiums: Evidence from a Natural Experiment in California,” Health Affairs (Spring 1996): 143-151. 11. S. Shewry et al., “Risk Adjustment: The Missing Piece of Market Competition,” Health Affairs (Spring 1996): 171-181. 12. See J.C. Robinson, “Health Care Purchasing and Market Changes in California,” Health Affairs (Winter 1995): 117-130. 13. American Hospital Association, Hospital Statistics, 1994 (Chicago: AHA, 1994); American Medical Association, Physician Characreristics and Distribution in the U.S., 1992-93 and 1993-94 ed. (Chicago: AMA, 1993 and 1994); HCFA Review: Medicare and Medicaid Statistical Supplements (1992, 1994, and 1995); and Unified Medical Group Association, based on twenty-seven California medical groups with 19.2 million member months on commercial plans and 2.2 million member months on senior plans. 14. Primary care includes family practice, general practice, internal medicine, obstetrics/ gynecology, and pediatrics, but not primary care subspecialties. 15. Also see J.C. Robinson and L.C. Casalino, “The Growth of Medical Groups Paid through Capitation in California,” The New England Journal of Medicine (2 1 December 1995): 1684. 16. V.J. Keston and A.C. Enthoven, “Total Hip Replacement: A History of Innovations to Improve Quality while Reducing Costs” (forthcoming). 17. “Number and Percent of Live Births Delivered by Cesarean Section, California Counties,” Vital Statistics of California, 1994 (Sacramento: California Department of Health Services, forthcoming). 18. Jody Twichell, marketing and communications, Good Samaritan Health System, San Jose, personal communication, 20 February 1996. Downloaded from content.healthaffairs.org by Health Affairs on June 4, 2013 by guest

MANAGED COMPETITION 57 19. California Office of Statewide Health Planning and Development, “Quarterly Aggregate Hospital Financial Data for California, 4th Quarter” (Sacramento: OSHPD, 2 May 1995). 20. Assumes a mix of 89 percent commercial to 11 percent seniors, based on a mix of resident population over and under age sixty-five in California in 1993. U.S. Department of Commerce, Bureau of the Census, Statistical Abstract of the United States, 1994 Edition (Washington: U.S. Government Printing Office, 1994). Total adjusted hospital days include days in acute, skilled nursing, and psychiatric facilities. Days are not adjusted for characteristics such as age (other than senior and not senior) or risk mix. 2 1. Based on 1993 California resident population of 31,211,000. U.S. Department of Commerce, Bureau of the Census, “No. 26, Resident Population,” in Statistical Abstract of the United States, 1994 Edition. 22. American Hospital Association, “Utilization, Personnel, and Finances in States,” in 1994 AHA Hospital Statistics, 48. 23. H.S. Luft, J.P. Bunker, and A.C. Enthoven, “Should Operations Be Regionalized?” The New England Journal of Medicine (20 December 1979): 1364-1369; and E.L. Hannan et al., “The Decline in Coronary Artery Bypass Surgery Mortality in New York State: The Role of Surgeon Volume,” Journal of the American Medical Association 273 (1995): 209-213. 24. California Office of Statewide Health Planning and Development, “Volume of Coronary Artery Bypass Grafts for 1989-1992 from the Patient Discharge Data Set” (Unpublished report, OSHPD, 21 April 1995). 25. G. Anders, “Once a Hot Specialty, Anesthesiology Cools as Insurers Scale Back,” The Wall Street Journal, 17 March 1995, Al; and G.W. Ruhnke, “Residencies and Employ ment under Managed Care: A Medical Student’s View,” Health Affairs (Spring 1996): 113-117. 26. M. Freudenheim, “Doctors’ Incomes Fall as Managed Care Grows,” The New York Times, 17 November 1995, Al. 27. P.M. Ellwood et al., “Health Maintenance Strategy,” proposal first presented to the secretary of health, education, and welfare, March 1970, and subsequently published in Medical Care (May 1971): 250-256. 28. California Medical Association, Knox-Keene Plan Expenditure Summary, FY 1994-95. Excludes plans with enrollment below 20,000. 29. Freudenheim, “Doctors’ Incomes Fall as Managed Care Grows.”
