By Kathryn N. Davis
Len Poulin got a rude surprise this year when he went shopping for health insurance for the eight employees at LBP Enterprises, his Waynesboro computer services company.

Insurance premiums — which had risen modestly in recent years — suddenly soared by 50 percent. Workers’ out-of-pocket costs to cover dependents already were taking a bite out of their paychecks. Poulin, knowing an increase like that could chase hard-to-find workers out the door, tried to get a better deal from a competing health maintenance organization. That company, though, wanted a premium increase just as large.

"It’s a struggle for us," he says. As a small company, LBP doesn’t have the leverage to get lower rates. Larger companies aren’t faring much better. Two Virginia restaurant chains that together employ 240 people are paying 12.5 percent higher premiums this year after several years of single-digit increases, says Jeff Nicklas, human resources director for Shoneys of Richmond Inc. and Tidewater Restaurants Inc. To recruit and retain workers, the restaurants are absorbing some of the increase rather than pass it along to employees, he says.

HMOs were supposed to be the answer to runaway increases in health care costs of the 1980s, and they’ve been delivering on that promise. The industry has used two strategies: It got tough with physicians over reimbursement fees and it employed utilization review to reduce what it considered unnecessary spending. By 1993, premium increases were averaging less than 10 percent, and by 1995 increases were flat, according to the American Association of Health Plans.

Today, double-digit increases are back. Small companies are facing premium hikes between 15 percent and 20 percent, according to the benefits consulting firm William M. Mercer Inc. Larger firms are paying 9 percent to 12 percent more.

HMOs need to find new ways to cut costs, says Louis Rossiter, a professor of health economics at Virginia Commonwealth University’s medical school. "Maybe [HMOs] have wrung out all the price concessions that they can," he says.

The financial pressures are straining HMOs’ relationships with both physicians and consumers. Some Virginia doctors say they’re being pushed to the point of jeopardizing care and have severed ties with managed-care companies. Consumers have rebelled against what they see as rationing, red tape and roadblocks to care.

*   *   *

HMOs underestimated the rate of growth in medical costs and need to compensate with higher premiums, says First Union Securities analyst Joel Ray. Managed-care representatives point to drug companies and politicians as the cause.

Mike Dudley is president of Optima Health Plan, owned by Sentara Healthcare. He says pharmaceutical costs have been increasing 20 percent to 25 percent a year. In 1999, Optima spent about 15 percent of its premium dollars on pharmaceuticals — more than it spent on inpatient care.

HMOs blame direct-to-consumer advertising by pharmaceutical companies. Ads hawk drugs such as Xanax, a prescription drug for the treatment of clinical anxiety and panic disorders, and Flonase, a nasal spray for allergy symptoms. "Consumers watching nightly television shows are treated to very aggressive advertising about prescription drugs," Dudley says. "Physicians now have patients coming in and telling them what kind of drug they want." That puts physicians in an awkward position of having to say "no" to a customer if they think the drug isn’t the best or most cost-effective treatment.

Greg Bowman, president and general manager of Cigna Healthcare of Virginia, says pharmaceutical companies have to recoup the millions they spend on marketing by charging more. In addition, the Federal Drug Administration in recent years has shortened its timeline for approving new drugs, Bowman says, which means there are more new drugs entering the market.

Insurers say the increasing number of government-mandated benefits also hurts them financially. The stories behind the legislation are compelling, but the requirements increase the cost of care. At Optima, at least 50 percent of premium increases are attributable to legislation, Dudley says. The Virginia Association of Health Plans says mandated benefits represent 20 cents of every premium dollar in the commonwealth.

Virginia is among the top 10 states in the country with the highest number of mandated benefits, the association says. Those benefits require insurers to cover longer hospital stays for childbirth and mastectomies, reimburse clinical trials for cancer patients, and lift caps on coverage for biologically based mental illness and drug and alcohol addition. In 1997, Virginia had just 10 mandated health benefits, says Mark Pratt, executive director of the Virginia association. Then in 1998 and 1999, it added 11 more, and another 11 are under consideration this year.

Pratt says mandated benefits can make even bare-bones health plans unaffordable for small businesses. Perhaps businesses were not aggressive in opposing such mandates because they were proposed when health care premium increases were small. "They need to get more involved," Pratt says.

*   *   *

Insurance companies make easy targets for criticism as businesses, care providers, consumers and legislators try to find common ground in the debate over health care. Yet data from 1998 shows that most HMOs in Virginia were either losing money or only marginally profitable. Out of 30 HMOs in the state, 12 had negative margins. Another nine had margins below 5 percent.

Adam Bergman, health care analyst at Scott & Stringfellow, says their weak performance is a reflection of the cyclical nature of the insurance industry. At the beginning of the five- to seven-year cycles, insurers try to increase their market share through price competition. As a result, they underprice their product and start losing money. This leads to an increase in premiums in the latter part of the cycle as they work to get back in the black.

It also leads to consolidation to bring about lower costs and higher efficiencies. HMOs are expected to continue to gain size and economies of scale through mergers and acquisitions. Consolidation slowed in 1999 because of Y2K concerns, but expect more announcements in 2000, First Union analyst Ray says. The greater an HMO’s market share, the more negotiating clout it has with providers. In addition, large plans can spread their fixed costs over many, many members.

Aetna U.S. Healthcare acquired several large plans that served Virginia residents, including NylCare and Prudential. As a result, Glaudemans says they cover about 550,000 people in Virginia and rank among the top three largest HMOs in the state. He believes the biggest advantages of Aetna U.S. Healthcare’s size are that it can afford to make the large capital investments required to develop e-health programs and that it has the mass of members needed to track the effectiveness of different treatments.

*   *   *

HMOs say they have strategies to cut costs. To better manage drug expenses, HMOs are creating tiered benefits so a patient’s out-of-pocket expense depends on the type of drug he chooses. A drug that costs $7 in a generic form may be as high as $45 for a brand name.

Tom Snead, president and CEO of Trigon Healthcare Inc., says his organization has implemented a three-tiered co-payment program for drug benefits. If a patient chooses a generic version of a prescribed drug, the co-pay is minimal. If he chooses a brand-name drug on the HMO’s formulary, his co-pay increases. A brand-name drug that is not on the formulary has the highest co-pay. Patients decide whether they are willing to pay more for brand-name drugs.

What about the cost savings of utilization review, once a cornerstone of managed care? A crack in that wall appeared last November when UnitedHealthcare announced it would stop requiring doctors to obtain prior approval for most procedures. The Minneapolis-based company said it made the change because it was spending millions every year to review the requests and was already approving 99 percent of them.

Jon Glaudemans, general manager of Aetna U.S. Healthcare’s Virginia market, says many plans are taking similar steps in order to turn their efforts toward new strategies: chronic disease management and "e-health" — providing services over the Internet that help patients manage their own care.

Today’s prevention efforts are different from what HMOs did in the early to mid-1990s, when prevention meant mammograms and cholesterol monitoring. Information systems have helped HMOs focus on a continuum of care for the diseases that cost the most money.

Consistent long-term treatment of chronic diseases such as asthma or diabetes can keep a person healthy, and some small studies suggest that it can save money, too. A three-year study by a Trigon affiliate of more than 750 people in a diabetes management program showed a 16-percent drop in inpatient care costs. Hospital stays dropped by more than a day. Mid-Atlantic Medical Services Inc. reported that when the number of asthma patients receiving good care rose just 4 percent, the rate of hospital admissions dropped 38 percent. In recent years, new companies specializing in disease management have formed to take over chronic-illness care for HMOs and share the savings.

Rossiter says some HMOs are turning to a "demand management" approach, which builds on consumers’ increasing interest in taking charge of their own health care. It includes giving more information through mailings or on the Internet on how to stay healthy or treat chronic illnesses. Or offering 24-hour telephone contact with a nurse who can help decide what care is needed, often avoiding unnecessary doctor visits.

This is part of a movement to "push the care back to the home, ... because a lot of it can be dealt with there," Rossiter says. "The best companies are going to jump on better patient self-care" as a cost-cutting strategy, he says. Some of the new drugs on the market could help that effort by reducing the need for more expensive treatments, he says.

*   *   *

At the same time that HMOs look for new cost-cutting measures, they’re holding the line on reimbursements. Some Hampton Roads physician groups are rebelling against the level of reimbursement they get from HMOs. A 33-doctor practice based in Newport News recently ended its relationship with Optima, saying it can’t provide quality care at the rates Optima is willing to pay.

Doctors there say they have already trimmed expenses and squeezed more patients into their schedules. The practice — Tidewater Physicians Multispecialty Group — saw its own group health insurance premiums rise 17 percent this year, says practice administrator David Warren. At the same time, he complains, many HMOs are offering no increases in the fees they give doctors for treating patients. About 7,000 of Optima’s 300,000 members were affected by the withdrawal.

Optima isn’t the only plan taking heat from doctors in Hampton Roads. Mid-Atlantic Women’s Care, a 60-member obstetrics and gynecology practice, dropped out of the Trigon Healthkeepers HMO because of a dispute over reimbursements. The level of reimbursements from HMOs has been dropping since 1992, says Landy Damsey, a consultant for Mid-Atlantic. For a while doctors could recoup the lost revenue by taking on more patients, but they can’t absorb any more without affecting the quality of care, he says.

Trigon spokesman Jane Olsen says the HMO tries to strike "a delicate balance" between the premiums charged to customers and the rates paid to doctors. "I don’t think it’s fair to pay one OB-GYN group significantly more than another for the same services," she says. The doctors won’t be gone for long, Olsen says. "A similar thing happened in Richmond, but after a year the physicians came back."

*   *   *

While HMOs have come under fire and are changing the way they operate, don’t expect them to fade away. "HMOs are undeniably the cheapest option that any employer has," Scott & Stringfellow analyst Bergman says. There has been some shift toward less restrictive managed care options, such as preferred provider organizations, because the economy is strong and some people are willing to pay a little more. But Bergman predicts that a change in the economy could reverse that migration.

Snead agrees. "There’s a very important role for an HMO product. Everybody can’t afford a Cadillac. Everyone can’t afford a broad-access product."