Follow the Shrinking Managed Care Savings

MANAGED CARE January 1999. ©1999 Stezzi Communications

The industry takes credit for saving money. But now, with premiums and costs likely to rise, HMOs are going to have to prove their worth once again.

Peter Wehrwein

Until recently, even the most ardent critics had to admit that with the advent of managed care in the early '90s, the relentless and seemingly uncontrollable rise in the nation's health bill finally slacked off. Say what you will about gag orders, market-driven health care and drive-through deliveries, the bottom line was, well, the bottom line.

Managed care had succeeded where so many others had failed, ratcheting down annual health care spending increases into the single-digit realm for the first time in recent memory. In 1991, the country's total health expenditures reached $767 billion, an increase of 9.6 percent from the previous year. And while spending has continued to increase in absolute terms — reaching $1.1 trillion in 1997 — the rate of increase has fallen throughout this, the managed care decade. (See "Keeping the Lid On")

If, in sharp contrast to the relatively cheap processing of claims that occurred in fee-for-service medicine, managed care was soaking up millions in profits, utilization review, marketing and the like, it was worth it if the result was saving billions in health care expenditures.

Warren Greenberg, a health economist at George Washington University, likens managed care to a restaurant. "You have to pay the waiter to set the napkin and silverware and bring the food rather than get it yourself. To bargain with doctors, to do preadmission review — that costs money. Nothing is free. Even copayments --they become a hassle."

But now the lid appears to be coming off health care spending. The federal government predicts that expenditures will double by 2007 and employers are bracing themselves for premium increases from 8 to 20 percent next year. In addition, as every health care executive knows, the pressure from pharmaceutical costs is very likely just the tip of the medical expenditure iceberg. With managed care apparently losing its cost-containment grip, a Sturm und Drang chorus of economists, consultants, analysts and, of course, physicians is beginning to ask, where is all that managed care money going and what exactly is it getting us, if not some control of health care costs? These are not, to say the least, friendly questions. How they get answered may very well determine the future of the managed care industry.

Chronic dissatisfaction?

Princeton University health economist Uwe Reinhardt says Americans have, for a long time, paid too much for administration of health care, which he believes explains the country's chronic dissatisfaction with the way the system is run. In Reinhardt's view, managed care has only made matters worse. "Now managed care may have added to the spending on nonmedical items and the question is: To what end? Chances are that it was just on marketing and mindless administration rather than on productive health care accounting."

Sandy Hunt, a San Francisco-based Price, Waterhouse, Coopers partner, levels the oft-heard criticism that "managed care companies don't really manage care, they manage costs." Despite all the lip service paid to disease management, Hunt says it has been her experience that many companies don't have even the most basic information necessary for doing a good job of it, such as how many of their members have been hospitalized and for what reason. Furthermore, she says, while managed care companies can develop the protocols and information systems, "True disease management has to be done by the physician."

Sheldon Dorenfest, a Chicago-based consultant on information technology in the health care industry, says HMO spending on information technology is growing at an impressive rate, but "The managed care companies are not getting the payback they expected and they are trying to do things too fast." He is doubtful that the integrated delivery model that is so highly touted will ever work efficiently on a nationwide scale. So far, Dorenfest sees managed care as "convoluting and tangling an already convoluted, tangled and duplicative system."

So these are the damned-if-they-do, damned-if-they-don't days for managed care executives. Notwithstanding the time when U.S. Healthcare was a Wall Street darling because its medical loss ratio was in the 70s (leaving plenty of premium left over for profit), there is considerable pressure these days not to take much out of the premium dollar — partly because, outside of the true believers in the industry, faith in bona fide management of care has plummeted. Thus Susan Whyte Simon, a spokeswoman for PacifiCare Health Systems in Santa Ana, Calif., boasts that her company's administrative expenses hover at the 11 percent mark and the company's medical loss ratio is 85 percent, give or take a point. This puts PacifiCare on the same level as some philanthropic organizations.

She says: "Our medical loss ratio is, for instance, is in the same league with what the United Way gives to its member groups or what the Red Cross actually delivers to charity." When Oxford Health Plans announced staggering $507.6 million in losses last summer, the red ink came with a company promise to both abandon unprofitable markets (Medicaid in New Jersey and Connecticut) and slash administrative expenses from the current rate of 17 percent of revenue to 14.5 percent next year. "We cannot ask physicians for fee reductions or our customers for premium increases unless we first lower our own internal administrative costs," the company's newsletter sermonized in August.

In a bind

Well, clearly no one is ever going to say that cutting administrative expenses is a bad thing. Particularly if it means (as it does in the case of Oxford) eliminating costly, nonproductive overhead; Oxford has asserted it will save $35 million annually by eliminating 1 million square feet in office space. Of course, that the Norwalk, Conn.-based company had 1 million square feet in expendable office space in the first place is just the kind of thing that makes managed care such an easy target for its critics.

In any event, this pressure to crank down administrative costs is going to put managed care executives in a bind.

After all, much of what gets labeled administrative costs is the money that plans are using for utilization review, information technology, contract negotiation — in short, all the management that purportedly results in holding the line on the nation's voracious appetite for medical care. Given that the soaring demand for pharmaceuticals is not likely to abate and medical utilization is likely to increase as the baby boomers age and medical technology improves, this could arguably be a prime time for more, not less, investment in information systems and the management of care, and consequently higher, not lower, administrative costs.

Managed care executives are also dealing with pressures on their administrative costs outside of this tradeoff between rising medical costs and pressure to spend less managing them. People can debate the merit of government regulation of managed care, but there is little doubt that requiring health plans to, for example, set up speedy outside appeal processes or opening HMOs up to malpractice suits does cost money.

Harry Sutton, an actuary at Allianz Life Insurance in Minneapolis who worked with the father of managed care, Paul Ellwood, in the 1970s, is unhappy with how far managed care has strayed from Ellwood's original vision. Sutton says managed care has "done very little of substance" in terms of actually managing medical care, yet he also sees government regulation as making matters worse in many cases. "Administrative overhead is probably increased by at least 50 percent over what it would have been because of government intervention and setting up all these regulations," says Sutton.

He complains that the government regulators don't trust anyone and have caused confusion. "HCFA passed regulations three years ago setting how much risk physicians can assume and no one has implemented them." Many also see the higher and higher standards for accreditation as adding administrative costs.

Nonmedical expenses

Managed care executives should not, however, delude themselves; their way of doing business has increased the amount of money spent on nonmedical expenses. Larry Levitt, a health care analyst for the Henry J. Kaiser Family Foundation, points out that when fee-for-service medicine prevailed, the indemnity insurance companies were essentially in the business of processing claims. And while there was grousing then about the paperwork, it was relatively cheap to take a claim, stamp it "approved," and cut a check for the usual and customary charge.

Several states regulated hospital rates, most notoriously New York, and there were hoops to jump through for hospital construction. Yet, overall, the system was relatively lean when it came to administration. According to a Kaiser Family Foundation analysis, the private health insurance administrative cost per person covered in 1987, pre-managed care, was $78. By 1996, the most recent year for which data are available, that figure had increased by about 350 percent, to $275 per person covered. During roughly that same span (from 1985 to 1996), total health expenditures increased by roughly 250 percent, so clearly, administrative costs have grown disproportionately with the advent of managed care.

In an article in March of last year in the New England Journal of Medicine, Stephanie Woolhandler and David Himmelstein brandished statistics that showed health insurance and HMO overhead had increased by $20.8 billion from 1990 to 1994, or from 12.4 to 14.8 percent of premiums. "Contrary to the rhetoric of the market, market forces are apparently 'upsizing' administration," the pair of Cambridge, Mass., physicians wrote.

Granted, Woolhandler and Himmelstein are hardly the most neutral of observers; they have been long-time critics of the administrative costs in American medicine and, more recently, leaders of a group of Bay State physicians opposed to for-profit health care.

But the messenger does not negate the basic, take-home message: Managed care ain't no free lunch. That it costs a tidy sum to do utilization review, to buy the computers and information technology necessary to run an HMO, to have a sales and marketing force — that should shock no one. The real key question is not whether managed care adds administrative costs — it does — but what are we getting for our money?

Medical loss ratios

Consider giant United Healthcare. In its quarterly SEC filing in November, the company reported that its selling, general and administrative expenses had increased by $409 million (23 percent) during the first nine months of 1998 compared to 1997. Meanwhile, mainly because of the deal that United struck with the American Association of Retired Persons at the beginning of 1998, its premium revenues soared by $4 billion during that same nine-month period. In the SEC filing, the company explained, quite reasonably, that the rise in operating expenses was necessary to "support the corresponding $4 billion, or 45 percent increase, in revenues...." In short, more business means higher costs of doing business. Yet, at the same time, the handiest measure of the company's ability to manage medical costs and hold the line on health-care spending — the medical loss ratio — slipped from 84.4 percent in the first nine months of 1997 to 86.3 percent in 1998 (a higher medical loss ratio, of course, suggests less control over medical expenses).

In absolute terms, that translates into additional millions for care. United explains the rise in medical loss ratio as a consequence of underperforming Medicare markets where the company lacks the scale to operate efficiently. That may very well be. But from another angle, it may portend the hard times ahead for managed care executives in coping with medical costs.

PacifiCare's November SEC filing tells just a slightly different story. PacifiCare prides itself on its low administrative costs as expressed by percent of operating revenue. Yet according to the company's SEC filing, during the first nine months of 1998, the company's marketing, general and administrative expenses rose by 9.7 percent compared to the same period in 1997, while its total health care services costs rose 6.8 percent. In other words, the company's spending on administrative costs outpaced its spending on health care.

A big part of this problem of assessing the administrative costs vs. medical-savings benefits equation of the managed care era is sorting out just what has been classified as an administrative cost. Allan Baumgarten, a Minneapolis-based industry consultant, notes that publicly traded companies are under pressure from Wall Street to show large profit margins and low medical loss ratios. But for Main Street (and state regulators and lawmakers) it is in the interest of the companies to be just the opposite: lean on the margins and fat on medical expenses.

Minnesota reports yearly on the performance of HMOs in the state, which by law must operate as not-for-profits. Those reports, which have financials back to 1992, paint a picture of a steady rise in expenditures for outpatient care (44 percent from 1992 to 1997) and for inpatient care (46 percent), while administrative expenses rose a measly 7 percent. (See "Shell Game?") That would look good to a state senator suspicious of health plans that profited at the expense of patients and doctors.

But HMOs actually have a fair amount of discretion over what is reported as an administrative expense under the guidelines set by the National Association of Insurance Commissioners, which are what the state uses to prepare its report. Baumgarten says that Medica Health Plans, the largest HMO in Minnesota, several years ago shifted some management fees to United HealthCare and changed its report so those fees wound up being counted as medical, rather than as administrative, expenses. For Medica — which under a contractual arrangement parcels out some management services to United — this shaved several percentage points off its administrative-cost tally, bringing it below what the state average for HMOs was at the time, says Baumgarten.

In California, there is a similar problem with what gets construed as an administrative expense. For five years now, the California Medical Association has published the Knox-Keene Expenditures Summary. (Knox-Keene is the popular name of the law under which health plans in California are licensed.) The summary breaks a health plan's expenditures down into medical care, administration and profit (or surplus). Year in, year out, Kaiser Permanente has had the lowest administrative costs and the largest percentage of premium dollars going to medical care, according to the survey. The association trumpeted in a March 1998 news release for the latest Knox-Keene summary that the not-for-profit "Kaiser Permanente returned more than 96 cents on the dollar to medical care while spending 3 cents for administration."

But Levitt, at the Kaiser Family Foundation (an independent health care philanthropic organization with no ties to the health plan) says that number may be distorted because of Kaiser's basic organization as a group-model HMO with its own hospitals. "It is possible that the administrative costs are buried and just not showing up," he says. Baumgarten concurs: "The Kaiser organization has lots of different pockets where it can allocate different expenses."

No more fat city

In 1990, the average length of stay in a hospital in this country was 7.3 days. Six years later, post-managed care, it was 6.2 days. In 1990, there were 5,420 hospitals in this country and 929,000 hospital beds. By 1996, there were 260 fewer hospitals and 65,000 fewer hospital beds. Meanwhile, the number of outpatient visits to hospitals rose from 303 million in 1990 to 441 million in 1996.

Even if Harry Sutton and others are right, and managed care has evolved so that in deed, if not in name, the industry acts more like a volume purchaser than a manager of care, the point is that from a cost-containment perspective it worked: Managed care weaned American health care from expensive inpatient hospitals and hospital care. Sometimes it went too far with rigid rules and poor judgment about denying care, but it did work.

"The magic was bed days," says Charles Peck, M.D., director of physician and managed care services for Arthur Andersen & Co. in Atlanta. "Now we are really getting into the slog-through-the-mud stuff. The days of fat city are gone." And there are plenty of people who think that today's managed care organizations and systems are ill-suited for the slog-through-it stuff like honest-to-goodness disease management.

Anne Anderson, an analyst at Atlantis Investment in Parsippany, N.J., says managed care organizations are "used to treating the doctors like bad guys" but they have to turn more control of risk and care over to physicians to succeed in the years ahead. She foresees a struggle between physicians and HMOs over the premium dollar, with the physicians pushing for a large share and the HMOs wanting to hang on to their share for dear life. "It is going to be a real tug of war, and I don't think the patient is the one who is going to win."

Dorenfest, the Chicago consultant, is also not terribly optimistic. He doubts that organizing the health care system into integrated delivery networks will ever result in efficient health care. And he warns: Don't be dazzled by computers and pretty software. Look closely around the beautiful new work station in any hospital, he says, and you'll find a parallel paper-based universe of medical records. Most folks in medicine don't trust the electronic record, he says, and find the software incompatible with keeping a complete record. Dorenfest sees the whole system as a very shaky nonsystem. He doesn't hold out much hope for massive, far-flung integrated delivery systems as ever being efficient.

It is a fair question to ask whether the sheer size of the large managed care companies and the many players in the market are just adding layers of complexity — and perhaps unnecessary cost — to American health care. In describing its preparation for the year 2000 computer problem to the SEC, United HealthCare said it had 40,000 computing devices, used 475 different software applications and did business with 300,000 medical providers and 92,000 vendors.

Size begets size

Burton VanderLaan, M.D, president of Accord Health Network, a Chicago-area contract management firm set up by a dozen hospitals to supply physicians with information infrastructure to cope with managed care and capitation, says that in Accord's first year, it administered 13 HMO capitation contracts with 1,315 different benefit plans.

VanderLaan says it cost $650,000 to set up the information infrastructure and takes a work force of about 35 to keep it running. To achieve the kind of economies of scale needed to bring the cost of the operation down to where it equals the acceptable rate of approximately 10 percent of the professional capitation paid to contracting physicians, the network needs about 100,000 covered lives, he says.

VanderLaan argues that Accord not only helps physicians' pocketbooks, but offers the opportunity to improve practice because the network's information systems can churn out data for all the standard preventive services — childhood immunizations, mammography, Pap smears and so on. "The services we provide really help the physicians manage the care of their populations better. The power that the data brings you is substantial," he says.

Princeton's Reinhardt also sees the value of investing in what he calls "a health care accounting system" that will allow for objective assessment of health care cost and quality. "That will eat money," Reinhardt said, "but it is money well spent if it enhances the value we get per overall dollar of health." In Reinhardt's opinion, however, what health plans have done so far with their administrative costs has not been productive but "an unproductive musical chairs game, in which one group shifts costs to the other and one party buys the other, only to spin it off again later."

Peter Wehrwein is a Boston-based health and science journalist.