Markets at Risk— Current and Future Challenges in a Managed Care Marketplace. C. Providers.


For many hospital providers, at the dawn of the new millennium, the antipathy once reserved for managed care organizations has been shifted to a new villain—the BBA of 1997. The cumulative effects of Medicare reductions are creating considerable strain on hospitals, in particular. As shown in Figure 4, Medicare payments have in fact been at or above costs for hospitals in recent years because of concerted efforts by hospitals to reign in their operating costs, a trend document by detailed MedPAC analyses56. But their ability to continue to reduce costs in the face of dramatic upward trends in pharmaceutical and labor inputs seems to have been depleted. Hospital financial distress is further exacerbated by their inability to make up for BBA reductions through the tried and true mechanism of cost shifting to private purchasers, because these purchasers are using managed care plans to suppress the cost-shifting, as also noted in Figure 4.

The financial results for hospitals (Figure 12) reveal their own reversal of fortune that began to appear in 1998 and worsened in 1999. Not all of this is due only to hospital payment reductions. Failed vertical integration strategies, changes in post-acute payment methodologies, and declining investment income have all contributed to the recent financial downturn57. And this has been a recent downturn, as 1996 and 1997 financial performance for hospitals was the best it has been since the introduction of the prospective payment system in 1983/84.

Figure 12. Aggregate Total Hospital Margin 1981-1999 (In Percent)

Figure 12. Aggregate Total Hospital Margin 1981-1999 (In Percent)Source: American Hospital Assotiation Annual Survey of Hospitals, 2000

In addition to a substantial amount of retrenchment to reduce operating costs, another consequence of deteriorating margins has been a pushback in managed care contracting. Many hospitals have taken the position that they will not longer enter into “bad contracts,” which typically means contracts that pay less than full costs58. Consolidation among hospitals has increased their ability to exercise such concerted action, and continuing BBA-related pressures suggest that even more aggressive negotiating stances will be forthcoming. It appears that some of the withdrawal of HMOs from the Medicare market has been due to the inability of plans to keep existing networks in tact59. The Medicare circumstance is particularly notable because hospitals may be able to engineer a return to full DRG payments, if they refuse to participate in Medicare+Choice HMO networks that are paying them something less than full DRG rates. On the commercial side, the need for plans to raise payments to providers has led to sharp premium increases.

The physician market place has witnessed similar efforts of consolidation to improve negotiating clout. While evidence of physician group membership suggests a steady drift toward more and larger groups, this does not adequately capture the formation of negotiating federations of both multi-specialty and, perhaps more prominently, single specialty in local markets. The failure of practice management companies to be the catalyst for aggregation, left indigenous physician leadership and alliances with hospitals via PHOs and related entities to foster more consolidation in negotiating stances60. In some cases these involve creating federations of multiple PHOs or “super-PHOs” to negotiate with plans. In other cases, single specialty confederations have been organized to improve countervailing leverage. In some markets, single specialty group practices in areas like cardiology and orthopedics have grown rapidly to gain enormous influence in their markets. Influence manifested in both contract negotiation with plans and joint venturing with hospitals to develop new facilities and programs to expand their services.

These cartel-like organizations have benefited from a general willingness to overlook some of the anti-trust implications, except in the most egregious of cases—a fact that stands in stark contrast to the angst that health plan consolidations seems to trigger among providers and public regulators. Only anecdotal evidence exists to suggest that a physician pushback is occurring through these variously configured provider sponsored entities—but plans contend their impact is going to become more prominent as providers discover just how much negotiating leverage they have accumulated.

While recent research demonstrates that the extent of plan to intermediate entity contracting is quite high, it appears that this varies markedly around the country61. It also appears that some, if not many of these physician and physician-hospital groups may not have a goal of accepting risk, but rather trying to negotiate terms and rates to health that may explicitly preclude the use of risk based payments. This bodes ill for those health plans that depend on global and/or professional capitation arrangements as the basis for their cost and care management. The recent announcement of Pacificare to freeze growth in its Medicare product in many markets because provider resistance to risk transfer makes their products unsustainable seems to support this concern62.

  1. M. Freudenheim, “HMO Costs Spur Employers to Shift Plans,” New York Times, September 6, 2000, p. 1.
  2. R. Blendon, M. Brodie, J. Benson, D. Altman, L. Levitt, T. Hoff, and L. Hugick, “Understanding the Managed Care Backlash,” Health Affairs, 17(4):80-94, 1998.
  3. J. Hibbard, L. Harris-Kojetin; P. Mullin, J. Lubalin, S. Garfinkel, “Increasing the Impact of Health Plan Report Cards by Addressing Consumers,” Health Affairs 19(5):138-145, 2000.
  4. Kaiser Family Foundation/Harvard University School of Public Health, Survey of Physicians and Nurses—Chart Pack, Menlo Park, CA: KFF, July 1999.
  5. Medicare Payment Advisory Commission. Selected Medicare Issues: Report to Congress, June 2000, Washington, DC: MedPAC, 2000.
  6. T. Lake, M. Gold, R. Hurley, M. Sinclair, and S. Waltman. Health Plans’ Selection and Payment of Health Care Providers, 1999: Final Report. Washington, DC: Medicare Payment Advisory Commission, 2000.
  7. Medicare Payment Advisory Commission. Medicare Payment Policy: Report to Congress, March 2000. Washington, DC: MedPAC, 2000.