Kaiser Reports Huge Loss, Many HMOs Losing Money

A variety of intractable problems cause more than half of health insurers to bleed red ink

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CEO SUMMARY: Poor financial performance of many managed care plans is bad news for clinical laboratories. Those insurance plans losing money find it tough to increase reimbursement for laboratory tests. Financial struggles of the health insurance industry should be closely watched for its impact upon physicians, hospitals and laboratories.

TURNABOUT IS FAIR PLAY. After reporting years of fat profits, HMOs and the large health insurers are now posting sizeable losses. At least half of the major HMOs reported losing money in 1997.

As these companies reported their year-end earnings, the biggest surprise came from Kaiser Permanente. The managed care giant reported a loss of $270 million for 1997 on revenues of $14.5 billion. In 1996, Kaiser earned profits of $265 million.

The loss was the first ever reported by Kaiser. Collectively, sizeable losses at Kaiser, Oxford Health Plans, PacifiCare Systems, and Aetna/US Healthcare demonstrate the severe troubles now faced by the healthcare insurance industry.

Financial analysts see no quick way for the HMOs to fix these problems. Many analysts predict several more years of financial turmoil before the industry regains profitability. If true, rough times lie ahead for clinical laboratories. Unprofitable HMOs will find it difficult to be generous in their reimbursements for laboratory testing.

Financial woes of the managed care plans come at a bad time for clinical laboratories. In many instances during the last year, contract renewal negotiations between laboratories and managed care plans led to higher reimbursement. Anecdotal evidence of this trend was reaching THE DARK REPORT with increasing frequency.

Common Problems

Kaiser’s problems are common to those of other troubled HMOs. During the course of 1997, Kaiser increased membership 19%, to 8.97 million. But three things caused the oldest “managed care” organization in the United States to lose money. First, the company offered employers low premium rates to attract new accounts. Kaiser had aggressive goals for increasing membership. But these low premiums failed to cover the cost of servicing the new members.

Second, Kaiser’s members traditionally use the company’s “in-house” services. But large numbers of new enrollees, particularly in California, meant Kaiser had to let those members go outside the system for care. Kaiser says that up to $180 million of non-network care resulted from this phenomena.

Third, the rate of increase in medical costs exceeded Kaiser’s expectations. Matched against low premiums, this acerbated the resulting losses.

Similar Experiences

All three problems should be familiar to clinical laboratories. In the early years of managed care, laboratories underwent similar experiences in discounted pricing, leakage of tests, and increased costs.

One comment by a managed care expert will ring true to laboratory executives. Uwe Rheinhardt is a health-economics professor at Princeton University. He defines the financial strategies of managed care plans as “less than brilliant.”

“They [managed care plans] have been going for market share, feeling that they need to be big,” noted Rheinhardt. “They compete to see who can offer the lowest premiums, to the point that the marketing people set the rates and the actuaries are sent out of the room. They they pray to God and their medical directors that they can keep expenses low.”

Applies To Laboratories

Rheinhardt’s observations might apply to a number of laboratories, both national and regional. In the first years after 1990 sales and marketing people were frequently allowed to offer money-losing capitated rates, despite the protests of financial officers who knew the true cost of testing.

Clinical laboratories then entered a period, starting around 1993-94, where the disastrous financial consequences of offering money-losing capitated rates become obvious. Since then, the commercial laboratory segment of the industry has struggled to regain satisfactory profit margins. This market phase is entering its fifth year.

That is why THE DARK REPORT considers it critical that laboratory executives understand the serious consequences to their own finances if it develops that HMOs have entered a similar period of sustained financial losses.

Payment for laboratory services comes primarily from two sources: Medicare/Medicaid (the government) and private insurance plans. Certainly the government is not in a position to generously increase existing reimbursement levels for laboratory testing in coming years. That leaves private insurance plans. But if industry losses continue over the next two to five years, then laboratory testing reimbursement levels will suffer.

Two Compelling Facts

THE DARK REPORT offers two compelling facts that will retard the HMOs’ ability to reverse financial losses in coming years. First, they can only set prices one time per year. If they underprice premiums, they must wait one year before they can come back and make up that mistake.

Second, the HMOs’ information systems still offer incomplete and “late” data on utilization and costs. Thus, each time they sit down to calculate premiums, their analysis of costs during the immediate past period may understate actual costs by a significant amount.

Combine these two business problems, and you can understand why it may take the HMO industry several years to regain an equitable balance between actual costs and premium income.

One other factor will retard this effort. Even when an HMO establishes a rigorously accurate cost analysis, the marketplace will limit the amount of cost increases it can push along to employers. If they need a 16% price increase to regain profitability, will employers accept that? Or will employers resist “exorbitant” price increases and switch to competing plans?

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