By David J. Gibson, MD &

Jennifer Shaw Gibson

The business model for managed care health insurance companies is failing.  One must admit that the model had a terrific 40-year run.  These companies started in the early 80’s as undercapitalized, counter culture centric, utopian experiments that primarily appealed to young Birkenstock wearing beneficiaries.  Their premiums were inexpensive given the selection advantage they enjoyed over the existing indemnity products that dominated the market at that time.

Over the ensuing decade, the indemnity option all but disappeared from the market as young, health beneficiaries migrated in mass to the managed care product while leaving the older, sicker beneficiaries in the indemnity product.  Mergers of these small companies into massive, Fortune 500 behemoths ensued.

These corporations hired armies of medical managers to staff departments specializing in utilization management, quality assurance, disease management coordination, pharmacy management, etc.  Providers were herded into discount contracting networks with their services being traded as commodities in arbitrage transactions across the entire U.S. market.  Life was good.

During the late 80’s and early 90’s, these companies were the darlings of Wall Street.  Investor’s made money, insurance executives appeared on the cover of national business and news magazines, employers saved money and beneficiaries were freed of financial liability with first-dollar coverage and $5 - $10 co-payments.

My, how times have changed.  Over the ensuing two decades, the staff or group model HMO product has all but disappeared from the market.  The IPA based HMO products are little more than PPOs in drag.  Capitation has been definitively rejected by both the beneficiaries and the providers based upon perceived conflict of interest charges.  Providers have evolved in contracting sophistication wherein they are now able to game both the unit pricing and the utilization of services beyond the ability of the insurance carrier to counteract this trend.

The fundamentals upon which the managed care health insurance companies are built are now under assault at multiple levels by both public and private third-party-payers.  These payers have learned over the past 4-decades that managed care has not delivered on any of its promises.  HMOs and PPOs have not reduced costs, flattened the inflationary curve for premiums, delivered superior outcomes, managed or coordinated care for those with chronic diseases or increased accessibility compared with less costly product options.

Despite the hype from the few remaining meretricious managed care apologists, we have now learned that the only component of the managed care financing system that has any economic value is the discounted service contract at the core of the product.  With the shift from a consumer centric to a provider centric market discussed in our previous paper, these discounted networks no longer appeal to physicians and hospitals.

Today, health insurance companies generate their margins on two managed care “cash cow” products that are now slated for extinction.  The first is Medicare Advantage (MA) which the Democrats have targeted for elimination.  Both the House and Senate bills will cut more than $160 billion over 10 years from the projected growth of Medicare payments for MA products.  These reductions represent a significant portion of the funding that is required to finance ObamaCare.  Specifically, these MA cuts will fund the expanded coverage of the uninsured in Medicaid.

A just released report by the Medicare Payment Advisory Commission found that last year Medicare spent about $14 billion more for seniors enrolled in private plans than would have been the case if those beneficiaries had stayed in the traditional program.

The health insurance company MA business model is not complicated.  They charge the Medicare Program 114% above regular per-member-per-month (PMPM) rates and pay providers at or below Medicare allowable rates for services.  They then increase the scope of benefits slightly beyond Medicare mandated coverage.

The value of these MA contracts to insurance companies is significant.  These MA products now enroll more than 10 million of the 45 million Medicare beneficiaries.  The first Obama budget cut $177 billion in Medicare Advantage funding.  Since the Democratic takeover of the White House and continued control of the Congress, whenever Obama's healthcare reforms, which include scaling back or eliminating the MA product, have been threatened, managed care stocks have performed well.  On January 19th, managed care stocks soared ahead of Republican Scott Brown's victory in the Massachusetts Senate race.

It is certain that the consequences of losing these profitable MA contracts, should the Democrats prevail in Washington, will have profound implications as to the value of managed care stock valuations in the market going forward.

The second involves health insurance companies renting out their contracted discount provider networks to private health plans known as either ERISA[1]  or Taft-Hartley[2] Trusts. The insurance companies developed and maintain these contracted provider panels to service their own managed care products.  Therefore, the rental of the network represents revenue that drops directly to their bottom line.  As discussed above, these network contracts are traded by insurance companies across the country in an arbitrage like market.

The value of these access fees charged to private health plans is closely guarded proprietary information.  However, to get a sense of the magnitude of the value this represents, the typical private health plan pays $25 per employee per month (PEPM) to access the discounts for provider services.  This access fee represents a significant portion of the administrative load within a typical ERISA or Taft-Hartley trust premium  With the accelerating decline (see “The Day the PPO Died”) of discount network contracting, the revenue derived from these rentals will soon disappear.

The loss of these two revenue sources for health insurance companies now operating across all markets in the U.S. calls into question their survivability.  The business model for these companies and their required stock earning performance cannot be sustained without the MA and the network rental revenue.

Far beyond all of the above adverse trends, the evolving realities in the market will not support these managed care products in the future.  Within the context of the current recession, wherein the U.S. economy has shed 8.4 million jobs, the most rapidly increasing segment of the market is the individually insured and those recently unemployed retaining coverage under the Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA).  Managed care products are designed for the shrinking group health market rather than these new evolving markets.

As demonstrated by the current experience of WellPoint in California, the company just announced a 39-percent increase in premium costs for the individual market; these managed care companies cannot deliver a sustainable product to the exploding individual market today.  The products lack the flexibility that the individual market requires for product pricing based upon prepackaged scope of service coverage.

Just as was the experience in the late 80’s when indemnity products were not price competitive; so is the case today when managed care products enter the death spiral as they experience adverse risk selection.

So, where is health insurance headed in the future?  The answer lies in the reality that the market is moving from wholesale distribution through employer sponsored group health structures to retail wherein the individual will make the purchasing decisions for themselves and their dependents.

Individual consumers will behave quite differently than group health purchasers.  For openers, the most important variable in decision making for non-utilizing young and in-good-health customers will be product price rather than scope of service.  The option to purchase products across state lines from companies not encumbered by state mandates will accelerate this market reality.  Customers will demand self-selection of add-on insurance products (vision, dental, reproductive services, wigs for cancer patients, mental health, etc.) on an elective basis rather than accepting pre-packaged broad scope of service products.

Consumers, just as they have done so in every other segment of our economy, will ruthlessly evaluate the value that any service brings to the market.  The entire overhead related to managed care has not demonstrated market value over previous decades.

Consumers will demand full transparency as to costs, levels of service and quality of disease management performance.  Consumers will expect objective and verifiable data from independent sources as to how doctor A vs. doctor B maintains blood sugar levels in diabetic patients along with subsequent preventable morbidity. 

If the industry does not create these objective rankings, consumers will turn to outside data based companies to deliver this information.  In addition, consumers will expect or they will impose price stratification based upon this provider performance information.

Consumers will not tolerate third-parties between them and the providers they select to deliver services.  As a result, insurance companies will have little or no role in packaging or delivering services in the consumer market of the future.  These companies will devolve back to their traditional role of major medical underwriters which will resemble the reinsurer role of today.  The consumer will be the primary insurer for most if not all out-patient services.

In essence, this brings us back to where we started during the World War II era in health care financing.  During that period, health insurance underwrote major medical costs and focused on financing hospitalizations.  During this era, health care costs increased at a rate consistent with the rest of the economy.  Developing low deductable, low co-payment products ushered in the current era of hyper inflation.  As a result, we now have health insurance products that only the deepest pockets in America could afford - the government and the employer.  Now even these payers cannot afford the current cost structure.

Likewise, the distribution of product will evolve into internet based vehicles.  Just as we now have with all other lines of insurance, the Progressive on-line purchasing structure eliminates an entire level of commissioned brokers and allows consumers to design their health insurance coverage as to scope of services, deductibles and co-payments that best serve their needs.

Individual financially at-risk consumers will also not tolerate the cost shifting that now empowers the mainstreaming of both Medicare and Medicaid.  As we previously discussed, without cost shifting, the entitlement market will quickly devolve into a second-tier delivery structure.

Consumers will not place a high priority on local care for high cost diagnostic testing and therapeutic interventions in the future.  This seeking of services from more efficient and lower cost regional, national or international options will directly challenge the monopolistic strategies that hospitals have implemented over the past three decades to challenge the third-party-payers within their markets. 

For most hospitals, the loss of elective high-end procedures will be devastating.  In an American Hospital Association (AHA) report dated April ’09, elective high end admissions typically represent 9 or 10-percent of a typical hospital’s admissions but deliver 25-percent of the margin.  With international options for high-end care such as most orthopedic, cardiovascular, reconstructive, dental procedures, etc. priced at 10 to 20-percent of current domestic costs, most prognosticators are anticipating that financially exposed consumers will tend to migrate toward these options when the pricing and outcomes data becomes available in the future.  To view how this data is becoming available go to www.reflectivemedical.com.

So, what have we learned from this 30-year experience in managed care and network discount contracting; and what does this experience portend for the future?

1.      We have learned that the overhead for the “Rube Goldberg” designed managed care infrastructure cannot be demonstrated to have any economic value to the financially at-risk consumer.  As a result, health insurance companies will devolve into reinsuring the consumer in the private market who will be the primary financial risk taker in the future.  As was the case in the original major medical era, this is the natural market position for health insurers in the future.

2.      The idea that third-parties can manage care and thereby improve quality, rationalize utilization, coordinate care for chronic conditions or stabilize cost has been definitively discredited. 

3.      We have learned that the only force in the market that can actually reduce service cost is the financially at-risk consumer of services.  The lower premium cost trends for pre-tax medical savings accounts and the declining cost per unit of services that have not generally been covered in the past by third-party payment (most cosmetic surgery, ophthalmologic laser procedures, reproductive interventions and most of dentistry, etc.) supports the current private sector initiatives to reduce the scope of covered services and define their corridor of financial risk per unit of service.

4.      We have learned that individuals covered by front-end loaded financial risk indemnity products have higher utilization rates for preventative services.

5.      Over the coming years, the private sector market will become transparent for consumers as to cost, quality and outcomes data.  The new transparency based insurance products will define the level of payment they will provide for covered services.  The consumer will then negotiate directly with the providers they chose to determine price in advance of services.  The consumer can select any provider in the market without restriction to a defined panel.  It will be a shock for most providers in health care today to face an information armed consumer in their waiting room demanding to negotiate up-front the price for services to be rendered.

6.      These newer products are migrating toward payment at the point-of-service.  These products will alleviate the growing and progressively uncollectable aging accounts receivables that are crippling provider business units across the country.

7.      The flip side of the above will be the demand for even greater discounts per unit of service from providers in return for immediate payment.

8.      Finally, the market will determine the market value for individual provider services rather than insurance companies.  The era of commodity pricing by CPT code is over.

Welcome to the new world of American health care.  We predict that managed care will be remembered as a temporary market aberration that had its origin in academic utopianism. 

Discount panel contracts may survive into the future in government entitlement programs in that they will serve primarily as a tool for enforcing price controls.  However, in the private market where access, outcomes and service commands a premium, managed care has no chance of sustaining itself in the current Internet delivered, transparent market.

davidjgibson@reflectivemedical.com

David Gibson is the C.E.O. of Reflective Medical, a health care software development company. Jennifer Gibson is an economist specializing in evolving health care markets as well as a futures commodity trader specializing energy.