Mergers: Is Bigger Better?

John Carroll
Contributing Editor
Health plan consolidation has its upside, but some who contract with insurers see only the downside

Health plan consolidation has its upside, but some who contract with insurers see only the downside

John Carroll

Contributing Editor

Allan Baumgarten can easily remember how his first examination of the Denver health insurance market back in the late 1990s required a broad review of six to eight commercial insurers competing for the market.

“Now, for the most part,” says the independent analyst, “you’re down to three. You have UnitedHealth Group, a Kaiser plan that deals exclusively with one system, and Anthem/WellPoint. There’s been quite a bit of consolidation.”

That’s not unusual, says Baumgarten, who writes managed care reviews for 10 state health insurance markets scattered from coast to coast. In Cincinnati, Humana, Anthem, and United divide up the bulk of the commercial market. In Baumgarten’s native state of Minnesota, three big players — led by Blue Cross & Blue Shield of Minnesota — staked out the bulk of the market years ago. Other cities are undergoing the same kind of market Darwinism as national plans gain greater penetration following years of frenetic consolidation.

Looking to leverage bigger membership numbers against lower provider costs, some of the managed care groups are running squarely into hospital alliances that have been rapidly consolidating their own business since the 1990s.

“With the emergence of two mega carriers — United/Pacificare and Wellpoint/Anthem — both are trying to exert additional clout in hospital negotiations in Denver,” says Baumgarten.

By most accounts, the showdown has just begun. But like virtually everything else in the controversial world of health care, the future course of the consolidation trend in managed care is a topic that elicits sharply diverging opinions.

Physicians at the American Medical Association have attacked the latest mergers with increasingly sophisticated market analysis demonstrating how swiftly the health insurance market has consolidated. The doctors claim that dominant carriers have already been able to grab a big enough concentration of members to begin dictating lower payments, higher premiums, and restrictive conditions of care for members in just about every market of any significant size in the country. New mergers ahead, they say, will heighten their monopoly powers.

Among the big managed care groups and many of the industry’s top financial advisers, though, mergers are presented in a far different light. Consolidation is seen as a beneficent tool that is swiftly reshaping the commercial health insurance market to fit the same mold as the banking industry. Big national groups will continue to compete against aggressive local and regional operators, offering better services to members and better earnings for investors through economies of scale.

Those polarized visions of the future are laying the stage for a renewed battle in Washington over conflicting demands by physicians, hospitals and MCOs as the industry braces for more M&A activity, even as proposed Medicare cuts threaten them all.

To a number of analysts, the future of managed care looks a lot like Denver.

“You certainly have seen some pretty significant market shares to large players, along with some competition from the Blues,” says Court Houseworth, a managing partner and M&A specialist at Cain Brothers. “We’re seeing more and more analogies to the financial services market: a number of large players dominating the national landscape and regional players continuing to participate. You have a number of Blues with significant market share, cost-effective networks that compete on a regional basis, and the convergence of consumer-directed health plans.”

No more easy deals

A handful of MCOs may well wind up dominating most markets, he adds. But you won’t find a single company able to exert complete control. Mergers of major insurers, he adds, are largely over.

“The easy transactions have occurred,” says Houseworth. Health Net is still rumored as a possible target and Coventry Health Care has been buying up workers’ compensation groups. “United is still on the prowl for specialty managed care and technology type assets. WellPoint is looking at a number of transactions. Growth through acquisition will continue, but not at the same scale.”

Same number of deals, many fewer dollars
Mergers & acquisitions Minimum value
2005 30 $19.1 billion
2006 28 $1.2 billion
Source: Sandy Steever, editor, Irving Levin Associates

Usually when an industry undergoes this level of concentration, says Healthleaders-InterStudy’s Rick Byrne, new groups backed with venture cash start entering the market.

But that trend, he says, hasn’t taken off yet in the managed care world. Physicians and several prominent national insurance analysts say that it’s not likely to happen at all.

In recent years, health insurers have largely escaped being corralled by antitrust laws by focusing on a strategy of buying carriers in markets where they don’t already have a big presence, says Paul Ginsburg, president of the Center for Studying Health System Change. “A more consolidated insurance market is bad for providers,” he adds. “It gives insurers more power to negotiate a lower payment rate.” But antitrust regulators see that as a benefit for consumers. The end result doesn’t always reduce the number of plans competing, but it does give the bigger players a built-in advantage that is likely to prevent anyone else from trying to muscle his way in.

“The Blue Cross Blue Shield plan gets the lowest payment rates from providers because they’re big,” says Ginsburg. “If you’re coming in and you’re not so big, there’s the cost and time in building a network. And the new arrivals are going to get poor rates from providers. This is the barrier to entry into local insurance markets that has led the industry to be more profitable over time.”

“Let’s say a health plan has 80 percent market share,” says Stephen Foreman, PhD, a health care economist at Robert Morris University who has helped the AMA assemble market data on managed care. “How do you compete with that plan? You have to convince employers you’re in for the long term, but a monopoly can undercut you on prices. Given that, why would they go there?”

The bottom line is that underwriting cycles, when insurers cut prices following a period of profitability in order to gain market share, dwindle or disappear altogether with less competition, adds Ginsburg. The national insurers also improve their position with multistate employers, who gravitate to big carriers for coverage.

But an acquisition typically doesn’t lead to quick help on premiums, even for big employers, says Mike Taylor, an HMO veteran and principal in Towers Perrin’s health practice. That’s at least in part because of the slow process of integrating an acquisition into a big national company.

“Health care is a very complicated business,” says Taylor. “It’s very difficult to unplug something. For example, when health plans merge, it takes them a long time to shut down the claims system they’re not going to use and switch to the new one.”

As the big acquisitions get done, he adds, “smaller plans move up the food chain.” That trend was underscored just last March, when UnitedHealth Group bought out Sierra Health Services, the biggest health insurer in Nevada with more than 300,000 members in employer-sponsored plans. But even if the deals are smaller, the local impact can be huge. Analysts quickly homed in on the added clout the deal would bring United with the state’s doctors and hospitals.

Any kind of competition can affect premiums — for at least part of the market. After Aetna acquired U.S. Healthcare 10 years ago, says Neil Model, a longtime Philadelphia broker, the insurer helped change the ground rules for brokers like him who handle health insurance for local companies. In Philadelphia, where Aetna and the dominant carrier, Independence Blue Cross, compete for the bulk of the commercial health insurance market, the effect is clear.

“Independence Blue Cross has become a kinder and gentler carrier of late with its new senior management and increased competition from Aetna,” says Model. And Independence Blue Cross became even friendlier after UnitedHealth entered the market with its acquisition of Fidelity Insurance Group three years ago.

But even if the insurers took a less aggressive approach to negotiating rates, adds Model, some companies have been hit hard by painfully high premium increases.

Several years ago, says Model, Aetna started to determine small group rates — for companies with fewer than 100 workers — based on the health of individual employees. For companies with young, healthy workers, he adds, that could mean an attractively competitive quote. But any company with older, sicker workers, he says, was sure to be offered a hefty premium that most just couldn’t afford. Soon after, Independence started determining small group rates based in part on a company’s demographics — factoring in the age and sex of the workers in determining a quote. Before, small companies were given community-based rates that blended everyone in the same pool.

“Half got rate reductions and half got rate increases,” says Model. “The older group got slammed, sometimes 50 percent or more, from Blue Cross. It was ugly.”

There’s no question that having several carriers provide bids does help at the bargaining table, adds Model, but small companies are being hit with 12 percent to 15 percent annual premium hikes, with little relief in sight. And now that Independence is in talks to merge with Highmark, the dominant Blue Cross plan in western Pennsylvania, Model says a successful combination of the two Blues would create a statewide insurance behemoth that could be described in one word: “Omnipotent.”

Physicians have long inveighed against the growing influence of more powerful MCOs.

“United and WellPoint are clearly bent on market domination, with WellPoint being the nation’s largest insurer and United the second largest,” asserted AMA trustee Michael D. Maves, as the doctors group threw its weight, unsuccessfully, against the merger of United and Pacificare. “The market power resulting from such mergers redirects money away from patient care and into corporate profits.” For now, there are no hard numbers about how the big national plans perform on cost and quality measurements relative to smaller regional plans. But that’s about to change.

Measuring outcomes & costs

For the first time, the National Committee for Quality Assurance is gathering data on how much it costs each plan to treat and care for patients, and charting outcomes to determine the level of efficiency that they offer. Those numbers will start rolling out in September. And consolidation of the managed care industry played a big role in the NCQA’s decision to begin collecting them.

“We’ve been measuring outcomes, but what we don’t measure is what it costs to get those outcomes,” says the NCQA’s John Friedman. “Now we want to get at the whole idea of value.”

As far as the AMA is concerned, though, the numbers collected already show that the age of monopolistic health plans has arrived. Big MCOs swelled by recent mergers are calling the shots in a host of regions, says the AMA, as consolidation drives out efficiency and innovation while adding bigger premiums with no added benefits for members.

Citing a study by Irving Levin Associates, the AMA says that there were 400 health insurance mergers between 1995 and 2005. An analysis of 294 insurance markets showed that 95 percent of them exceeded federal standards for a “highly concentrated” market, where a single insurer controlled more than 30 percent of the market. And 56 percent of the market areas, the AMA went on, had a single insurer that controlled more than half of the market.

J. James Rohack, MD, the past chair of the AMA board of trustees, said it was well past time for federal regulators to demand the insurers’ proprietary pricing information to determine for themselves if insurers were charging monopoly prices.

Physician power

A congressman from California, Tom Campbell, wrote a bill back in 2000 that gave doctors collective bargaining rights. Wildly embraced by members of the AMA, the bill passed the House but foundered in the Senate. But even today, Campbell, now dean of the Haas School of Business at the University of California-Berkeley, is adamant that managed care consolidation has left physicians at a growing disadvantage.

There are “tons” of markets where two or three insurers control the bulk of the commercial membership, says Campbell, and that gives the surviving insurers complete control of any terms.

But consolidation has a flip side, he adds. As more power is concentrated in fewer hands, it raises the prospect that the collective bargaining act he once championed will make a comeback. And he has good reason to hope for the issue to re-emerge on Capitol Hill. His co-sponsor on the bargaining initiative was John Conyers, the new chairman of the House judiciary committee operating under a new Democratic majority. Says Campbell: “The wheel has turned.”

AMA’s conclusions

  • In 56 percent of metropolitan statistical areas (MSAs; there are 166 of them), at least one insurer has a combined HMO/PPO market share of 50 percent or more.
  • In 19 percent of MSAs, at least one insurer has a market share of 70 percent or more.
  • In 4 percent of MSAs, at least one insurer has a combined market share of 90 percent or higher.

Source: AMA, 2005

The top 10 heath plans

Dave Colby, the chief financial officer of WellPoint, has often heard the AMA demonize MCOs as driven by greed for ever-growing profits at the expense of patients, physicians, and hospitals. And he’s quick with a dismissive rejoinder.

“That’s a bunch of garbage.”

Colby does agree with doctors on one point: Consolidation of the managed care business is far from over.

In a matter of years, says Colby, “there will probably be 10 health plans that really have the vast majority of the business.”

By WellPoint’s calculations, the top 10 health plans in the country had 27 percent of the market in 1995. By 2005, that figure had swelled to 51 percent of health plan members. And by 2015, he forecasts, the top 10 will probably have about 75 percent of the business.

With 34 million members already under one managed care roof, Colby sees WellPoint high on that list, with a future that would compare with CitiBank’s. Health plans like WellPoint will pursue new acquisitions by going after the kind of carriers that best fit into their organization, says the CFO. For WellPoint, that’s likely to lead to more buyouts of Blues plans.

“We have historically rolled up more companies that look like us and have more of the same type of culture,” says Colby, with a preference for contracted networks of providers over a staff model. “WellPoint is the accumulation of 14 Blue Cross Blue Shield plans over time, and added to that have been some non-Blue plans that have filled out geographic regions.”

Gradually, he says, the national managed care market will look more and more like banking. But further consolidation, he insists, will never throttle competition.

“We compete against hundreds of companies,” says Colby, and that will continue.

As for physicians’ claims that the big MCOs are dictating premiums and pumping up their bottom lines, Colby protests that their position is transparently unsubstantiated by the facts.

“Our medical loss ratio has been at 80 percent or 81 percent for the past 10 years,” says Colby, “and that’s the period of time of tremendous consolidation. If mergers just raised premiums and greater profits, why hasn’t the ratio gone down? We have become more efficient, saving costs on the administrative expense line. We are able to improve quality of care and that is reflected in premiums.”

There’s also no question that bigger numbers give the company more power over provider compensation, he adds, which has helped rein in premium growth.

“Nobody is just purely entitled to a rate increase every year,” he says. But insurers also have a vested interest in making sure that they don’t cut payments to the point where providers start to go bankrupt.

That’s a point that some of the analysts are quick to highlight as well. Negotiations may get tough, but at the end of the day, insurers and providers still need each other to survive.

“Hospitals and health plans are both low-margin businesses,” says Healthleaders-InterStudy’s Midwestern market analyst Rick Byrne. “Neither one can afford to do without the other.”

Bigger volume does deliver bigger overall profits, says Colby. But it also works to the advantage of members.

Pittsburgh’s problem: big plans, big providers

Back in 1999, two years after he became executive director of SMC Business Councils in Pittsburgh, Cliff Shannon was warning about the dangers of health care consolidation a few years after two regional Blues plans had fused into Highmark Blue Cross Blue Shield and the University of Pittsburgh Medical Center (UPMC) continued to expand its network of hospitals. But even as Shannon warned about the potential for painful rate hikes from big players, he waxed enthusiastic in one interview over the potential that employer groups like his had for bargaining for lower rates while driving better quality in care.

The alternative: “We can negotiate the terms of surrender on behalf of our member companies, and that’s not very satisfactory.”

Eight years later, Shannon says that many small businesses in the Pittsburgh area put up the white flag long ago. Highmark still dominates the business, he says, and UPMC is now trying to acquire Mercy Hospital, which would give it slightly more than half of the local hospital market.

Instead of the big local health plan and hospital group duking it out, says Shannon, they came up with a negotiated settlement. With big employers demanding that UPMC hospitals be in the Blues’ network, the health plan ultimately capitulated to the hospital group and agreed to include it in every one of its plans. Highmark dropped a lower cost non-UPMC alternative, adds Shannon, leaving local companies on the hook for sharp annual premium increases that sometimes hit a range of 50 percent to 100 percent.

UPMC offers a health plan of its own, he adds, but has been limiting new members to the healthiest people. For a small employer with graying workers with health problems — not unusual in an old steel town with an aging population — the result is a steadily rising rate of the uninsured. Companies simply bow out of the insurance business altogether.

The health economist Stephen Foreman has used Pittsburgh as an example of an extreme model for consolidation, when one health plan achieves a dominant role. And once on top, he adds, a powerful health plan has plenty of tools to protect its turf. He completed a study for the state medical society several years ago that claimed state Blues plans were purposefully avoiding head-to-head competition, dividing the state market county by county. As for local businesses, says Shannon, their experiences every year make for a cautionary tale on local consolidation around a single dominant insurer and one big hospital group.

“There’s no competition for small businesses that have older workers, or female employees, or anyone with acute chronic illnesses,” says Shannon. “In case of gender, women of childbearing age are good for a 35 percent price hike. If they’re in their late 40s or 50s, it’s good for another big wallop. In other states there are limits,” but Pennsylvania law leaves small businesses on the hook for unlimited premium increases.

Highmark isn’t shy about discussing its dominant position in the market, but insists that the pointed criticism leveled against it is unfair and inaccurate.

“There’s lots of competition here,” counters Highmark spokesman Michael Weinstein, who calculates the Blues’ market share in Pittsburgh at about 55 percent to 60 percent. That share has actually fallen somewhat over the last 10 years, he adds, as Aetna, United, Cigna, Coventry’s Health America, UPMC, and other insurers have offered up competing plans. And there’s also always the threat of other plans coming into the market to consider when rates are set, he adds.

Weinstein declined to comment on whether the UPMC contract requires Highmark to offer UPMC’s network in all of its plans, but he insists that the 10-year deal struck in 2002 gives employers real price stability for a long period. Highmark has kept average premium increases for big groups down to 6 percent to 8 percent over the past few years, he adds, which is in line with national trends that show steady moderation in the rate of premium rate hikes.

Highmark also doesn’t apologize for having a big network of providers in its plan that includes UPMC. “Highmark has always had as one of its strongest components the fact that we offer products with the broadest choice.”

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