California’s Physicians Face Financial Meltdown

Many doctors already suffering financial woes; hospitals may not be far behind

CEO SUMMARY: It’s a what-if scenario that may come true. Healthcare providers in the Golden State are going broke at an astounding rate. Physicians seem to be the hardest hit, but signs indicate that hospitals are also heading toward serious financial difficulties. In a nutshell, a decade of draconian cutbacks to provider reimbursement have left many of California’s doctors literally at the point of bankruptcy.

CALIFORNIA’S EXPERIMENT in managed care continues to devastate physicians and other healthcare providers.

Clinical laboratories were the first to be upended by the managed care freight train in California during the mid-1990s. Now it appears that physicians are next on the hit list, with hospitals not far behind.

This is probably the most important under-reported story in American healthcare today. Physician group practices in the nation’s most populous and wealthiest state now stand at the brink of widespread financial collapse. Yet this fact is ignored by the media and unknown to most people.

THE DARK REPORT predicts a financial meltdown of physician group practices in California will occur sometime during the next 12 to 24 months.

This will cut across all sizes of group practices and all types of physician specialties. It won’t affect salaried physicians, such as those employed by Kaiser Permanente or the Los Angeles County healthcare system. But it will affect those physicians in private practice settings, including some pathologists.

Here is the bad news. A recent study by PriceWaterhouseCoopers, the national accounting firm, projects that one in ten physician groups in California holding capitated agreements from HMOs will close their doors during 1999!

Reports are, that by August of this year, at least 15 physician groups had ceased to do business. Several practices are losing as much as $500,000 per month!

The bad news doesn’t stop there. Since 1996, at least 115 of the state’s physician groups and IPA’s (independent physician associations) have also filed bankruptcy or ceased operations. PriceWaterhouse-Coopers reports that two out of three physician groups are losing money and that eight out of ten physician groups cannot meet four basic financial benchmarks.

Failure Of Managed Care

These facts certainly confirm that managed care, as it unfolded in California, failed to meet the needs of physicians as partners and providers to that state’s healthcare system.

THE DARK REPORT believes this information also confirms another important fact. The managed care game in California is soon to hit financial bottom. When it does, state politicians will step in to resolve the mess that payers and providers created, but were unable to solve. Unfortunately, solutions enacted by politicians are seldom viable, particularly in the long run.

For lab executives and pathologists concerned about the future impact of managed care in their own market- place, the California experience should be closely watched. There are increasing signs that the entire private healthcare system in the state is on the verge of a financial meltdown. Thus, any arbitrary political cures will surely be copied as other states encounter similar problems.

In many respects, the economic woes of physician practices in California are identical to the problems experienced by clinical laboratories in that state since 1994. Reimbursement is inadequate to fund services, capitated contracts push risk onto providers, and competitive pressures to access patients encourage providers to tolerate inadequate reimbursement.

There will be one difference in the way clinical labs and physicians get a resolution to these problems. Clinical laboratories chose not to respond with a collective effort. And, clinical laboratories lacked clout with employers, politicians, and payers.

Physicians have an existing framework for unified action. Through state and national medical associations, they already have vehicles for responding in a united fashion. Physicians also have clout. Their direct access to patients gives doctors influence with both citizens and politicians.

The seriousness of events in California should neither be underestimated nor overlooked. THE DARK REPORT recommends that laboratory executives and pathologists watch and learn from the experience of California.

“It’s important to understand one thing about events in California,” stated Michael Casey, Managed Care Analyst of Medical Data International in Santa Ana, California. “Its healthcare experience is unique compared to other states.

“This is because California and Minnesota are the ‘trial and error’ sites for managed care,” he explained. “No other state has seen the kind of managed care experiments that happen in California and Minnesota.”

Progressive Experiments

“Not only are these experiments very progressive, but many managed care initiatives have taken deep root, particularly in California,” noted Casey. “In contrast, there are a whole lot of states where capitation has barely made an appearance.”

Casey recognizes the financial difficulties facing physician practices. “The problem in California has been two-fold,” he said. “One, managed care plans shifted risk onto physicians and other providers. Two, reimbursement levels are below the cost to provide care. This means providers have had to put out money to maintain healthcare services to their patients.

“The solution to these problems is a better balance of risk-sharing between managed care plans and doctors, combined with adequate levels of reimbursement for clinical services,” noted Casey.

California Medical Association Responding To Financial Threat

IT APPEARS THAT arbitrary reimbursement cramdowns may soon become a thing of the past in California.

“The California Medical Association (CMA) is pursuing solutions at two levels—the micro and the macro,” said Hobart Swan, Associate Director of Communications for CMA.

“At the micro level, we are pushing state legislation,” he explained. “One bill would require reimbursement paid by health insurers to be actuarially sound and sufficient to cover the cost of acceptable care. The other would address the problem of forcing physicians to accept pharmacy risk without actuarially sound reimbursement.”

Negotiate As United Group

“At the macro level, CMA wants to give doctors the ability to negotiate as a united group,” Swan noted. “We feel it’s important to unify the House of Medicine. It will take concerted action and a common focus to accomplish the necessary reforms to our state’s managed care system.”

In reviewing activities by CMA, it is clear that one major thrust of the attack on California’s managed care system will focus on the fact that the state’s HMOs knowingly underfund physician reimbursement, while averaging 15% in profits and overhead.

“It is important to recognize that current capitation rates do not reflect the cost of care,” noted Swan. “For example, a Towers Perrin study for 1998 showed the cost of treating pediatric patients (0-21 years old) averages $47 per child per month in California. A 1998 CMA study revealed that pediatricians were only getting an average of $24.24 per child per month. Further, certain pediatricians surveyed reported that they got as little as $10 per child per month!

“Not only do managed care companies offer underfunded contracts,” Swan added, “but these contracts are unfair to physicians. They are forced to accept terms, such as pharmacy risk, or not get access to patients.

“This shows the market influence of the major managed care players in our state,” noted Swan. “The six largest insurance plans cover 92% of the market. It creates a situation where large medical groups feel compelled to sign contracts in order to retain access to enough patients to support their practice.”

Owed Millions Of Dollars

“Fiscally-unsound reimbursement set up widespread financial problems,” stated Swan. “Everything began exploding when FPA’s bankruptcy left California docs with $61 million in unpaid claims. Less than one year later, MedPartners’ failure meant another $60 million.

“The healthcare system in California is a shaky artifice, a Hollywood set that looks impressive from the street, but holds nothing behind it,” offered Swan. “People in California remain unaware that the doctor treating them today may only be one week away from bankruptcy and the closure of his practice.”

Few experts will dispute the fact that physicians in California were too willing to accept risk without possessing the management resources and expertise to manage that risk. But the subject of reimbursement exposes the managed care industry to some valid criticisms.

“Capitation rates fail to accurately reflect the cost of providing care,” said Hobart Swan, Associate Director of Communications for the California Medical Association (CMA). “Numbers published in the PriceWaterhouseCoopers study demonstrate this fact.

Concern over this disastrous financial situation for physicians caused the California Medical Association to issue a public warning last month. CMA also convened a special meeting. At that gathering, Cherise Skeba, a senior manager at PriceWaterhouseCoopers, noted that the healthcare system in California is losing $1 billion per year.


ANECDOTAL STORIES ABOUND in California. They describe the dilemma between the need to provide patient care, and the fact that such care often goes unreimbursed.

Daniel Higgins, M.D., an emergency room physician in Los Angeles, testified in a state senate committee meeting last March about the financial problems of a colleague.

According to Dr. Higgins, the bankruptcy of FPA Medical Management caused an oncology colleague to go bankrupt. While waiting to get reimbursed from FPA, this oncologist continued to purchase chemotherapy drugs out of his own pocket for his cancer patients.

Below National Average

According to Skeba, its average premium of $120 per member is $7 below the national average, and California is considered to have a high cost of living. This sets up an interesting contradiction. Because of these low premium payments, California’s healthcare system averages $83 million per month less than the average state!

Skeba also noted that, during the six year period from 1993 to 1999, the amount that HMOs paid to physicians to care for their enrollees actually dropped from a high of $45 per patient per month to a low of $29. This number is 30% below the national average.

THE DARK REPORT observes that hospitals in California are another class of healthcare providers which have significant financial problems. THE DARK REPORT predicts that, from 1999 forward, an increasing number of hospitals in California will report financial losses.

Reimbursement Rates

If this comes to pass, it demonstrates that managed care, as practiced by HMOs in California, failed to incorporate providers into a winning formula of clinical excellence at reasonable rates of reimbursement.

What will be the consequences of these developments? THE DARK REPORT predicts a bevy of legislative remedies in the Golden State. Politicians always love to solve high-profile issues. But just as the Medicare/Medicaid programs are turning rotten after 33 years of operation, so also will California’s legislative palliatives prove to be worse than the current situation.

THE DARK REPORT believes that future events in California related to the financial woes of physician practices will trigger several responses.

One, physicians in private practice will mount a high profile campaign to educate Californians and their elected officials about the one-sided arrangements common in the managed care system that exists today.

Two, we may soon see the collapse of a managed care system built on providers assuming unlimited risk against capitated reimbursement. As reported in the last issue of THE DARK REPORT, California hospitals are already rejecting capitated arrangements. Certainly doctors are ready to act in a similar fashion.

Stronger Legislation

Three, we expect to see stronger legislation enacted, accompanied by vigorous enforcement. New laws will require managed care companies to pay reimbursement which is sufficient to cover the cost of care. Such reimbursement arrangements would have to be validated by independent actuaries.

Unfortunately, THE DARK REPORT expects that resolution to government funded healthcare programs in California, particularly MediCal and Medicare, will prove extraordinarily difficult. Progress in reforming managed care and developing the next generation of health delivery vehicles will instead come from the private sector.

Our predictions of an impending financial meltdown for physician group practices in California will actually strengthen the financial fortunes of clinical laboratories and pathology practices in other areas of the United States over the next few years.

Managed care plans need providers. They also want as few restrictions on their operations as possible. This is why there will be slow and begrudging progress toward mutually beneficial contracts between laboratories and HMOs.

This won’t happen overnight. But the self-interest of HMO executives is strong. In the next few years it will be in their best interest to offer clinical laboratories, physicians and other healthcare providers an improved con- tract relationship.

Delayed Payments Earn HMOs big $’s Each Year

Every healthcare provider has the same problem: getting timely payment from the payer. The American Psychological Association (APA) decided to calculate the amount of money insurers pick up by delaying or denying claims and forcing them into the appeals process.

PriceWaterhouseCoopers did a study for the APA and results were released in August. If claims were delayed the maxi- mum 377 days permitted under Senate Bill 1344, private health insurers would earn $280 million per year on interest from the “escrowed” funds.

PriceWaterhouseCoopers assumed an average rate of 6.15% per year on investments. It calculated year 2000 private sector healthcare expenditures at $440.1 billion, and assumed that only 1% of this would be delayed for the 377-day maximum.

Just delaying 1% of private healthcare expenditures allows private insurers to pick up $280 million in interest. Now you can better appreciate the economic incentives HMOs have to delay timely payments to providers!


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