“Corporatized” Healthcare Encountering Big Losses

HMOs and PPMs find sustained profits to be elusive in world of managed care

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CEO SUMMARY: When the clinical laboratory industry found itself losing hundreds of millions of dollars in recent years, few people imagined that billion-dollar HMO and PPM companies would soon experience similar losses. Current trends in the managed care marketplace indicate that problems for these huge healthcare companies translate into continued downward pricing pressure for laboratory testing.

RECENT EVENTS SUGGEST THAT huge financial losses suffered by the clinical laboratory industry during the 1995-1997 time period will not be unique within the healthcare world.

When United Healthcare Corporation disclosed a $900 million charge and a $527 million loss for second quarter last week, industry experts were caught dumbfounded. After all, this was the managed care company considered to be the darling of the industry.

But United Healthcare’s financial woes are consistent with the experience of a large number of health insurance plans. Oxford, Foundation Health Systems, and Kaiser Permanente are just a few of the huge companies which reported losses during the last 12 months.

Their experience is not isolated. Throughout the United States, many regional health plans also posted losses during 1997 and the first half of 1998. This recent wave of widespread financial instability within the health insurance industry caught analysts off guard. Further, there is no clear consensus as to when finances may improve for health insurance companies.

Physician practice management (PPM) companies are another healthcare segment posting surprising financial losses. Highfliers like MedPartners, Inc. have hit the financial stone wall even as the investor community was flocking to acquire stock in almost any PPM company.

Allegheny’s Bankruptcy

Further, the recent bankruptcy of Allegheny Health Education and Research Foundation’s Philadelphia operation may be an early sign that more than a few hospital systems will soon be forced to publicly declare that their financial position is precarious. Allegheny’s eight Philadelphia hospitals are losing $26 million per month, or $292 million per year! Expect similar announcements of poor finances by other hospitals and health systems over the next 18 months.

None of this should be a surprise to clients of THE DARK REPORT. We have been firm in our conviction that all segments of healthcare will undergo significant financial and organizational restructuring in the next few years.

Pressures to reduce healthcare costs by the buyers (employers and the government) directly conflict with the desires of users (patients), who want high quality healthcare and immediate access. The increased cost of new healthcare technology only compounds the cost control problem.

Radical Change

That is one reason we believe that economic, social, and political forces acting upon healthcare will continue to force radical change upon all aspects of the industry. Our experiences during the last eight years represent the early stages of a dramatic and radical overhaul to the entire healthcare system.

Commercial laboratories were probably the first segment of healthcare to sustain several financial losses. Hospital laboratories are undergoing a similar period of widespread consolidation and reduction to capacity.

Clients and readers of THE DARK REPORT should understand that Oxford and United Healthcare (managed care companies), MedPartners and FPA Medical Management (PPMs), Allegheny and other hospital systems are simply the first victims in the coming wave of financial stress to their particular segment of healthcare.

Severe revenue Cutbacks

Just as the commercial laboratory industry was hit with severe cutbacks to revenue and profits, so also will PPMs, managed care plans, and hospitals undergo a similar process.

This will not be good for clinical laboratories. These are the main users and buyers of laboratory testing. If they cannot make sufficient operating profits to sustain their own operations, they certainly cannot be generous with their reimbursement for laboratory testing.

The future is not promising for the laboratory industry. During the next five years, clinical laboratory finance will be affected as much by the finances of other healthcare providers as with the value-added services and impact of new diagnostic assays offered by clinical laboratories.

For this reason, it is important for laboratory executives to understand that these huge losses will not be isolated to a few companies. Look at the underlying economics.

Within the healthcare insurance industry, large companies are dealing with two fundamental problems. First, they do not have effective information systems. Large HMOs and insurers find themselves unable to collect timely and usable data on medical costs and utilization. They are not able to give providers accurate and timely lists of beneficiaries.

Underprice Their Premiums

The direct consequence of this failing comes at rate renewal time every fall. When HMOs establish premium rates, they underestimate their actual costs, causing them to underprice their premiums. They are then forced to adhere to those unprofitable premium rates for an entire year.

Second, during the last two years, middle America’s unpleasant experiences with how closed panel HMOs limited their choices caused them to buy healthcare insurance differently. They now pay an extra premium to get the option which allows them to go out-of-plan for service.

During 1997, a significant number of HMO enrollees exercised this choice option and used outside doctors. The higher costs incurred as a result of this trend caught HMOs by surprise and contributed to widespread industry losses by year-end.

In the physician practice management company segment of healthcare, easy money days have ended for large corporate operators like FPA, MedPartners, and PhyCor. Their rapid growth and financial success wasbased more on acquisitions of additional practices than it was from improved management of acquired physician practices.

For five years or so, that made them the darlings of Wall Street. But now that these companies are big, multi-billion operations, they face an unsolvable management problem: how do they get each clinic or physician practice to increase revenue, increase productivity and decrease costs year after year?

Motives of PPM Executives

THE DARK REPORT believes that there is no fundamental alignment in the motives of PPM executives and the physicians working for their company. As a result, it will be nearly impossible for MedPartners and other PPMs to generate “same store” growth rates of 10% to 15% per year at individual practice sites.

The hospital segment has a capacity problem. There are too many hospital beds in most metropolitan markets. Politics being what it is, closing hospitals is a rare occurrence. But sooner or later, the people who pay the bills will refuse to subsidize empty hospital beds. Only then will the supply of hospital beds decrease enough to meet demand.

Market Directions

What lessons should be drawn from these developments, and the market directions they seem to point to? First, clinical laboratories should begin to do their own evaluation of the financial condition of managed care plans and PPMs. It serves no useful purpose to get the contract for laboratory testing, if sometime within the contract’s term the contractor cannot pay laboratory testing bills, leaving the lab holding unpaid invoices.

Financial losses at certain PPMs and the bankruptcy of FPA should be a warning to pathologists about the downside of PPMs. The financial woes of many large PPMs come just as pathology-based PPMs are entering the marketplace and seeking to purchase pathology practices.

For example, some physicians in California sold their practice to FPA in January and received stock worth $18 per share as payment. After FPA’s big losses and the subsequent bankruptcy in July, the FPA stock held by these physicians was worth less than $0.20 per share!

Laboratory executives and pathologists should keep track of how well these companies do over the next 24 months. Their success or failure provides a good market indicator of where the healthcare industry is heading. Should additional companies also post extraordinary losses, it will be tough for clinical laboratories to generate revenue growth and operating profits.

Huge Losses Posted By Many Companies

1. United Healthcare Corp. Reports $564 million loss for second quarter, due to a $900 million charge.
2. Oxford Health Plans, Inc. Reports a $508 million loss for second quarter, comes on top of similar losses posted during the last six months.
3. Allegheny Health Institute And Research Organization:
Puts eight Philadelphia hospitals in Chapter 11 bankruptcy with ongoing losses of $26 million per month.
4. FPA Medical Management: Files Chapter 11 bankruptcy and posts a $200 million loss.

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