part 1 introduction to managed health care · part 1 introduction to managed health care “you...

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Part 1

INTRODUCTION TO MANAGEDHEALTH CARE

“You know more than you think you do.”

—Benjamin Spock, MD(1903–1998)Baby and Child Care [1945]

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Study Objectives

• Understand the evolution of managed care, including the forces that havedriven this evolution.

• Understand current trends in managed care, including how market dynamicscontinue to change over time.

• Understand the public policy and market performance issues facing managed care.

Discussion Topics

1. Discuss why HMOs were formed in the first place.2. Discuss what some of the managed care steps are that employers can take to

constrain health care costs and promote wellness besides contracting withHMOs.

3. Discuss how important to employers it generally is that managed care plansdemonstrate that they offer quality care.

4. Discuss the salient forces leading to the rise and fall of various types of managedcare plans. Speculate on how current and future forces might lead to furtherchanges.

5. Discuss how the relationship between the government and the managed careindustry has changed over the years.

THE ORIGINS OF MANAGEDHEALTH CARE

Peter D. Fox and Peter R. Kongstvedt

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MANAGED CARE: THE EARLY YEARS (PRE-1970)

This chapter addresses the development ofhealth maintenance organizations (HMOs)and other managed care organizations(MCOs) rather than focusing on the opera-tional issues found in the other chapters ofthis book. The historical roots are presented,and some of the major dynamics involved inthe evolution of the managed health care in-dustry are discussed.

The Western Clinic in Tacoma, Washingtonis sometimes cited as the first example of anHMO, or prepaid group practice, as it wasknown until the early 1970s. Starting in1910, the Western Clinic offered, exclusivelythrough its own providers, a broad range ofmedical services in return for a premiumpayment of $0.50 per member per month.1

The program was available to lumber millowners and their employees and served toassure the clinic a flow of patients and rev-enues. A similar program was developed by aDr. Bridge, who started a clinic in Tacomathat later expanded to 20 sites in Oregon andWashington.

In 1929, Michael Shadid, MD, established arural farmers’ cooperative health plan in ElkCity, Oklahoma, by forming a lay organizationof leading farmers in the community. Partici-pating farmers purchased shares for $50 eachto raise capital for a new hospital in return forreceiving medical care at a discount.2 For histrouble, Dr. Shadid lost his membership in thecounty medical society and was threatenedwith having his license to practice suspended.Some 20 years later, however, he was vindi-cated through the out-of-court settlement inhis favor of an antitrust suit against thecounty and state medical societies. In 1934,the Farmers Union assumed control of boththe hospital and the health plan.

Health insurance itself is of relatively recentorigin.3 In 1929, Baylor Hospital in Texasagreed to provide some 1,500 teachers pre-paid care at its hospital, an arrangement thatrepresented the origins of Blue Cross. Theprogram was subsequently expanded to in-

4 CHAPTER 1: THE ORIGINS OF MANAGED HEALTH CARE

clude the participation of other employersand hospitals, initially as single hospital plans.Starting in 1939, state medical societies inCalifornia and elsewhere created, generallystatewide, Blue Shield plans, which reim-bursed for physician services. At the time,commercial health insurance was not a factor.

The formation of the various Blue Cross andBlue Shield plans in the midst of the GreatDepression, as well as that of many HMOs, re-flected not consumers’ demanding coverageor nonphysician entrepreneurs seeking to es-tablish a business but rather providers’ want-ing to protect and enhance patient revenues.Many of these developments were threateningto organized medicine. In 1932, the AmericanMedical Association (AMA) adopted a strongstance against prepaid group practices, fa-voring, instead, indemnity type insurance.The AMA’s position was in response to boththe small number of prepaid group practicesin existence at the time and the findings in1932 of the Committee on the Cost of Med-ical Care—a highly visible private group ofleaders from medicine, dentistry, publichealth, consumers, and so forth—that recom-mended the expansion of group practice as an efficient delivery system. The AMA’sstance at the national level set the tone forcontinued state and local medical society op-position to prepaid group practice.

The period immediately around World WarII saw the formation of several HMOs, someof which remain prominent today. TheseHMOs represent a diversity of origins withthe initial impetus coming, variously, fromemployers, providers seeking patient rev-enues, consumers seeking access to im-proved and affordable health care, and evena housing lending agency seeking to reducethe number of foreclosures. They encoun-tered varying degrees of opposition from lo-cal medical societies. The following areexamples of early HMOs:

• The Kaiser Foundation Health Plan wasstarted in 1937 by Dr. Sidney Garfield atthe behest of the Kaiser constructioncompany, which sought to finance med-

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Managed Care: The Early Years (Pre-1970) 5

cians in independent fee-for-service practice,was a competitive reaction to group practice–based HMOs. The basic structure was createdin 1954 when the San Joaquin County Med-ical Society in California formed the SanJoaquin Medical Foundation in response tocompetition from Kaiser. The foundation es-tablished a relative value fee schedule forpaying physicians, heard grievances againstphysicians, and monitored quality of care. Itbecame licensed by the state to accept capi-tation payment, making it the first IPA modelHMO.

The Adolescent Years: 1970–1985

Through the 1960s and into the early 1970s,HMOs played only a modest role in the fi-nancing and delivery of health care, althoughthey were a significant presence in a fewcommunities such as the Seattle area andparts of California. In 1970, the total numberof HMOs was in the 30s, the exact numberdepending on the definition used. From thenuntil the early to mid-1990s, HMOs ex-panded at an ever-increasing rate. However,beginning in the early to mid-1990s, HMOsconsolidated through mergers and acquisi-tions, resulting in a decline in the number ofsuch plans beginning in the late 1990s, asdiscussed later in this chapter.

The major boost to the HMO movementduring the early period of growth was the en-actment in 1973 of the federal HMO Act.That act, as described later, both authorizedstart-up funding and, more important, en-sured access to the employer-based insur-ance market. It evolved from discussions thatPaul Ellwood, MD had in 1970 with the politi-cal leadership of the U.S. Department ofHealth, Education, and Welfare (which laterbecame the Department of Health and Hu-man Services).4 Ellwood had been personallyclose to Philip Lee, MD, Assistant Secretaryfor Health during the presidency of LyndonJohnson, and participated in designing theHealth Planning Act of 1966.

Ellwood, sometimes referred to as the fa-ther of the modern HMO movement, was

ical care, initially for workers and fami-lies who were building an aqueduct inthe southern California desert to trans-port water from the Colorado River toLos Angeles and, subsequently, for work-ers who were constructing the GrandCoulee Dam in Washington State. A sim-ilar program was established in 1942 atKaiser ship-building plants in the SanFrancisco Bay area.

• In 1937, the Group Health Association(GHA) was started in Washington, DC atthe behest of the Home Owner’s LoanCorporation to reduce the number ofmortgage defaults that resulted fromlarge medical expenses. It was created asa nonprofit consumer cooperative, withthe board elected periodically by the en-rollees. The District of Columbia MedicalSociety opposed the formation of GHA. Itsought to restrict hospital admitting priv-ileges for GHA physicians and threatenedexpulsion from the medical society. Abitter antitrust battle ensued that culmi-nated in the U.S. Supreme Court’s rulingin favor of GHA. In 1994, faced with in-solvency despite an enrollment of some128,000, GHA was acquired by HumanaHealth Plans, a for-profit, publicly tradedcorporation. Since that time, it has beendivested by Humana and the member-ship incorporated into Kaiser FoundationHealth Plan of the Mid-Atlantic.

• In 1944, at the behest of New York City,which was seeking coverage for its em-ployees, the Health Insurance Plan (HIP)of Greater New York was formed.

• In 1947, consumers in Seattle organized400 families who contributed $100 eachto form the Group Health Cooperative ofPuget Sound. Predictably, oppositionwas encountered from the Kings CountyMedical Society.

Only in later years did nonprovider entrepre-neurs form for-profit HMOs in significantnumbers.

The early independent practice association(IPA) type of HMO, which contract with physi-

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asked in the early Nixon years to devise waysof constraining the rise in the Medicare bud-get. Out of those discussions evolved both aproposal to capitate HMOs for Medicare ben-eficiaries (which was not enacted until 1982)and the laying of the groundwork for whatbecame the HMO Act of 1973. The desire tofoster HMOs reflected the perspective thatthe fee-for-service system, by paying physi-cians based on their volume of services, in-corporated the wrong incentives. Also, theterm health maintenance organization wascoined as a substitute for prepaid group prac-tice, principally because it had greater publicappeal.

The main features of the HMO Act werethe following:

• Grants and loans were available for theplanning and start-up phases of newHMOs as well as for service area expan-sions for existing HMOs.

• State laws that restricted the develop-ment of HMOs were overridden forHMOs that were federally qualified, asdescribed later.

• Most important of all were the “dualchoice” provisions, which required em-ployers with 25 or more employees thatoffered indemnity coverage also to offertwo federally qualified HMOs, one ofeach type: (1) the closed panel or groupor staff model and (2) the open panel orIPA/network model, if the plans made aformal request* (the different modeltypes are discussed in Chapter 2). SomeHMOs were reluctant to exercise themandate, fearing that doing so wouldantagonize employers, who would inturn discourage employees from en-rolling. However, the dual choice man-dates were used by other HMOs to get inthe door of employer groups to at leastbecome established.


The statute established a process underwhich HMOs could elect to be federally quali-fied. Plans had to satisfy a series of require-ments, such as meeting minimum benefitpackage standards set forth in the act,demonstrating that their provider networkswere adequate, having a quality assurancesystem, meeting standards of financial stabil-ity, and having an enrollee grievance process.Some states emulated these requirementsand adopted them for all HMOs that were li-censed in the state regardless of federal qual-ification status.

Obtaining federal qualification had alwaysbeen at the discretion of the individual HMO,unlike state licensure, which is mandatory.Plans that requested federal qualification did so for four principal reasons. First, it rep-resented a “Good Housekeeping Seal ofApproval” that was helpful in marketing. Sec-ond, the dual choice requirements ensuredaccess to the employer market. Third, theoverride of state laws—important in somestates but not others—applied only to feder-ally qualified HMOs. Fourth, federal qualifi-cation was required for the receipt of federalgrants and loans that were available duringthe early years of the act. Federal qualifi-cation is no longer in existence, but it wasimportant when managed care was in its in-fancy and HMOs were struggling for inclu-sion in employment-based health benefitprograms, which account for most privateinsurance in the United States.

The HMO Act also contained provisionsthat were seen by some as retarding thegrowth of HMOs. This stemmed from a com-promise in Congress between members hav-ing differing objectives. One camp wasprincipally interested in fostering competitionin the health care marketplace by promotingplans that incorporated incentives forproviders to constrain costs. The secondcamp, although perhaps sharing the first ob-jective, principally saw the HMO Act as a pre-cursor to health reform and sought a vehicleto expand access to coverage for individualswho were without insurance or who had lim-

*For workers under collective bargaining agree-ments, the union had to agree to the offering.

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Managed Care: The Early Years (Pre-1970) 7

ernment in issuing regulations implementingthe act. Employers knew that they would haveto contract with federally qualified plans. Eventhose who were supportive of the mandate,however, delayed until the government bothdetermined which plans would be qualifiedand established the processes for the imple-mentation of the dual choice provisions. TheCarter administration, which assumed officein 1977, was supportive of HMOs. In particu-lar, Hale Champion as undersecretary of theU.S. Department of Health and Human Ser-vices, made issuance of the regulations a pri-ority, and rapid growth ensued.

Politically, several aspects of this historyare interesting. First, although differencesarose on specifics, the congressional supportfor legislation promoting HMO developmentcame from both political parties. Also, therewas not widespread state opposition to theoverride of restrictive state laws. In addition,most employers did not actively oppose thedual choice requirements, although manydisliked the federal government in effecttelling them to contract with HMOs. Perhapsmost interesting of all was the generally posi-tive interaction between the public sectorand the private sector, with government fos-tering HMO development both through itsregulatory processes and also as a purchaserunder its employee benefits programs.

Other managed care developments alsooccurred during the 1970s and early 1980s.Of note was the evolution of preferred pro-vider organizations (PPOs). PPOs are gener-ally regarded as originating in Denver, wherein the early 1970s Samuel Jenkins, a vicepresident of the benefits consulting firm ofthe Martin E. Segal Company, negotiated dis-counts with hospitals on behalf of the com-pany’s Taft–Hartley trust fund clients.5

Hospitals did so in return for the health planshaving lower cost sharing for its users,thereby generating patient volume at the ex-pense of its competitors.

Service plans (defined in Chapter 2), ofwhich the Blue Cross and Blue Shield planspredominate, placed limits on maximum

ited benefits. Imposing requirements onHMOs but not on indemnity carriers, how-ever, reduced the ability of HMOs to compete.

Of particular note were requirements withregard to the comprehensiveness of the ben-efit package* as well as open enrollment andcommunity rating. The open enrollment pro-vision required that plans accept individualsand groups without regard to their health sta-tus. The requirement for community ratingof premiums (see Chapter 25 for a discussionof community rating) limited the ability ofplans to relate premium levels to the healthstatus of the individual enrollee or employergroup. Both provisions represented laudablepublic policy goals; the problem was thatthey had the potential for making federallyqualified HMOs noncompetitive because thesame requirements did not apply to the tradi-tional insurance plans against which theycompeted. This situation was largely cor-rected in the late 1970s with the enactmentof amendments to the HMO Act that reducedsome of the more onerous requirements. Thefederal dual choice provisions were “sunset-ted,” that is, expired, in 1995 and are nolonger in effect. Further, many states requireforms of community rating for the smallgroup market from all carriers now, not justHMOs; a few states, however, continue tohave differing rating requirements for HMOsthan they do for indemnity plans.

Another reason that HMO development wasretarded was the slowness of the federal gov-

*The ripple effects of the early HMO benefits re-quirements affect the health insurance and man-aged health care market even today. Prior to thecomprehensive benefits that HMOs provided, in-demnity health insurance and service plans (suchas Blue Cross and Blue Shield plans) typically didnot cover preventive care such as well child visits,routine health exams, or immunizations, andrarely provided coverage for outpatient drugs.HMOs were not required to offer drugs either butcommonly did so to entice individuals to join.Soon the drug benefit became commonplace in alltypes of health plans.

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charges of physicians; those limits reflected acomposite of actual charges using a method-ology known as “usual and customary” feecalculation, that is, based on statistical pro-files of what physicians actually charged forindividual services. They also had limits onpayments to hospitals, in some cases payingthem based on their actual costs. As PPOsgrew in the market, the service plans beganto adopt new methods of calculating pay-ment maximums. By the late 1980s, how-ever, even the service plans had createdPPOs in response to market pressures, withthe primary difference being a greater levelof discount paid to providers. (Reimburse-ment is discussed in detail in Chapters 6 and7.) Finally, as noted in Chapter 2 and else-where in this book, there are no clear distinc-tions between managed health care plantypes anymore, though various attributes arediscussed further throughout this text.

Utilization review expanded outside theHMO setting between 1970 and 1985, al-though it has earlier origins:

• In 1959, Blue Cross of Western Pennsyl-vania, the Allegheny County MedicalSociety Foundation, and the HospitalCouncil of Western Pennsylvania per-formed retrospective analyses of hospi-tal claims to identify utilization that wassignificantly above the average.6

• Around 1970, California’s Medicaid pro-gram initiated hospital precertificationand concurrent review in conjunctionwith medical care foundations in thatstate, typically county-based associa-tions of physicians who elected to partic-ipate, starting with the SacramentoFoundation for Medical Care.

• The 1972 Social Security Amendmentsauthorized the federal ProfessionalStandards Review Organization (PSRO)to review the appropriateness of careprovided to Medicare and Medicaid ben-eficiaries. Although the effectiveness ofthe PSRO program has been debated,the PSRO program established an orga-


nizational infrastructure and data capac-ity upon which both the public and pri-vate sectors could rely. In time the PSROwas replaced by the Peer Review Orga-nization (PRO), itself in turn replaced bythe Quality Improvement Organization(QIO), which continues to provide over-sight of clinical services on behalf of thefederal and many state governments.Although the methods used by these or-ganizations evolved along with theiracronyms, their focus remained essen-tially the same.

• In the 1970s, a handful of large corpo-rations initiated precertification andconcurrent review for inpatient care,much to the dismay of the providercommunity.

Developments in indemnity insurance,mostly during the 1980s, included encourag-ing persons with conventional insurance toobtain second opinions before undergoingelective surgery and the widespread adop-tion of large case management—that is, thecoordination of services for persons with ex-pensive conditions, such as selected accidentpatients, cancer cases, and very low birth-weight infants. Utilization review, the encour-agement of second opinions, and institutinglarge case management all entailed at timesquestioning physicians’ medical judgments,something that had been rare outside of theHMO setting. These activities, further dis-cussed in Part III of this book, were crude bytoday’s standards of medical managementbut represented a radically new role of insur-ance companies in managing the cost ofhealth care at the time.

Also during the 1980s, worksite wellnessprograms became more prevalent as employ-ers, in varying degrees and varying ways, in-stituted such programs as the following:

• Screening (for hypertension and diabetes)• Health risk appraisal• Promotion of exercise (whether through

having gyms, conveniently located show-ers, or running paths; providing subsi-

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Managed Care Grows Up: 1985 to 1995 9

the hospital for outpatient services (for labo-ratory tests) that might be obtained at lowercost elsewhere, hence hurting the ability ofthe PHO to be price competitive. Finally,some IDSs suffered from organizational frag-mentation, reimbursement systems to indi-vidual doctors who were misaligned with thegoals of the PHO, inadequate informationsystems, management that was inexperi-enced, and a lack of capital. In the end, mostPHOs in particular were unable to sustain thefinancial risk for medical expenses.

A second innovation was the growth ofcarve-outs, which are organizations that havespecialized provider networks and are paid ona capitation or other basis for a specific ser-vice, such as mental health (see Chapter 13),specialty disease management (see Chapter10), chiropractic, and dental. The carve-outcompanies market their services principally toHMOs and large self-insured employers. In re-cent years, some of the large health plans thatcontracted for such specialty services havereintegrated them into the main company (so-called carve-in or insourcing arrangements).One reason for the reintegration was the viewthat carved-out services made it difficult to co-ordinate services, for example, between physi-cal and mental health. Similar in concept aregroups of specialists, such as ophthalmologistsor radiologists, who accept capitation risk fortheir services (sometimes referred to as sub-capitation) through contracts with healthplans and employer groups. Capitation is notthe only method of reimbursement to carve-outs or specialty groups; discounted fee-for-service payments may also be used (seeChapter 6).

A third set of innovations are those madepossible by advances in computer technol-ogy. Vastly improved computer programs,marketed by private firms or developed bymanaged care plans for internal use, thatgenerate statistical profiles of the use of ser-vices rendered by physicians have becomeavailable. These profiles serve to assess effi-ciency and quality and may also serve to ad-just payment levels to providers who are paid

dies for health club memberships; orsimply by providing information)

• Stress reduction• Classes (smoking cessation, lifting of

heavy weights, and the benefits of -exercise)

• Nutritional efforts, including servinghealthy food in the cafeteria

• Weight loss programs• Mental health counseling

MANAGED CARE GROWS UP: 1985 TO 1995

The period between 1985 and 1995 saw acombination of innovation, maturation, andrestructuring, each of which is discussed inthe following sections.

Innovation

In many communities, hospitals and physi-cians collaborated to form integrated deliverysystems (IDSs). These had two principalforms. The first entailed mergers or acquisi-tions that resulted in the creation of single le-gal entities, for example, of hospitals andgroup practices. The second was the forma-tion of physician–hospital organizations(PHOs), principally as vehicles for contract-ing with MCOs. Typically, PHOs are sepa-rately incorporated, with the hospital and thephysicians each having the right to designatehalf the members of the board. Most PHOssought to enter into fee-for-service arrange-ments with HMOs and PPOs, although someaccepted shared or full capitation risk. IDSsare discussed further in Chapter 2.

IDSs did not become important elementsof the managed health care environment fora number of reasons, including provider par-ticipation requirements and reimbursementsystems that did not support managed caregoals. For example, most IDSs allowed allphysicians with admitting privileges at thehospital in question to participate rather thanselecting the more efficient ones. Also, thephysicians were commonly required to use

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under capitation or risk-sharing arrange-ments to reflect patient severity. Chapters 16and 17 discuss further the uses of medicalinfomatics.

Another example of the impact of com-puter technology is a virtual revolution in theprocessing of medical and drug claims,which is now much more commonly per-formed electronically rather than by papersubmission and manual entry.* The resulthas been lower administrative costs and su-perior information, with the most prevalentand technologically advanced systems beingthe processing of prescription drug claims,enabling the pharmacist at the time a pre-scription is dispensed to receive informationabout eligibility of the member for coverage,amount of copay or co-insurance required ona drug-by-drug basis (real-time access to ahealth plan’s formulary; see Chapter 12), andpotential adverse effects. Management infor-mation systems can be expected to improvedramatically over the next few years asproviders, almost universally, submit claimselectronically. This impact from informationtechnology is now being furthered by the re-quirements and mandated standards underthe Health Insurance Portability and Account-ability Act of 1996 (HIPAA) for administrativesimplification, accelerating the movement to-ward inexpensive electronic interchange forthe basic health insurance transactions, in-cluding the following:

• Claims• Claims status• Authorizations• Eligibility checking• Payment


Maturation

Maturation can be seen from several van-tage points. The first is the extent of HMOand PPO growth, with HMO enrollment in-creasing from 15.1 million in 1984 to 63million in 1996; HMO enrollment reached78.9 million in 2000, and then declined to66.1 million in 2004.7 This market dynamicis discussed further in following sections.However, insurance carriers are selling hy-brid products that combine elements ofHMOs and PPOs, making statistical compila-tions difficult. For example, there are healthplans that have two networks, a narrownetwork and a broader one, with high costsharing when the broader one is used, andyet even higher when a non-network pro-vider is used. Such a plan functions virtuallylike an HMO with a POS plan and may be li-censed as such, but could also be classifiedand/or licensed as a PPO.

Medicare and Medicaid (see Chapters 26and 27) have also increasingly relied on man-aged care. Whereas Medicaid managed carehas enjoyed relatively steady growth, Medi-care managed care is another story. After ris-ing from 1.3 to 6.3 million between 1990 and1999, Medicare managed care enrollment re-versed itself and declined to 4.6 million in2003.8 This decline has widely been attrib-uted to changes in federal law enacted in1997 governing reimbursement to Medicaremanaged care plans, resulting in financiallosses and withdrawal of such care plansfrom many markets. However, analysis byRobert Berenson concludes that the law’s pro-vision that guaranteed annual increases, at aminimum of 2%, resulted in plans gettingpaid more than they would have received un-der the previous reimbursement formula.9

Other contributing factors besides reimburse-ment changes may have been health plans’lacking the care management systems neces-sary to care for a senior and disabled popula-tion and in some cases the plans havingreduced premiums below, or increased bene-fits above, levels that were sustainable in thelong term to acquire market share early.

*GF Anderson et al argue that “the UnitedStates lags as much as a dozen years beyond otherindustrialized countries” in the implementation ofcomputer-based health information systems. SeeAnderson GF et al. Health care spending and useof information technology in OECD countries.Health Affairs. May/June 2006;XXV(3):819–829.

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Managed Care Grows Up: 1985 to 1995 11

almost exclusively inpatient hospital utiliza-tion. Practice patterns have changed dramat-ically in the last 25 years, however, andinpatient utilization has declined signifi-cantly. As illustration, hospital care as a per-centage of national personal health careexpenditures declined from 46.9% to 36.6%,whereas physician and other clinical servicesincreased from 21.8% to 25.6%, and prescrip-tion drugs rose from 5.6% to 12.1%.11

Although hospital utilization still receivesconsiderable scrutiny, greater attention is be-ing paid to ambulatory services such as pre-scription drugs, diagnostics, and care byspecialists. Perhaps even more important isthat the high concentration of costs in asmall number of patients with chronic condi-tions has resulted in significantly more atten-tion being paid to disease management, asdiscussed in Chapter 10.

Restructuring

Perhaps the most dramatic development isthe restructuring that began in the late1980s, reflecting the interplay between man-aged care, the health care delivery system,and the overall health care marketplace. Thedefinitional distinctions have blurred asMCOs underwent a process of hybridization,making meaningful statistics difficult to col-lect. Staff and group model HMOs, decliningin number and faced with limited capital anda need to expand geographically, formed IPAcomponents, and in some cases (eg, Health-America of Pennsylvania’s Pittsburgh plan,Harvard Pilgrim [née Harvard Community]Health Plan) even divested the medical groupor staff model component. HMOs expandedtheir offerings to include PPO and point-of-service (POS) products, and some PPOsobtained HMO licenses. HMOs also foundthemselves contracting with employers on aself-funded rather than a capitated basiswhereby the risk for medical costs remainswith the employer, and a variety of hybridarrangements has also emerged. The majorcommercial health insurance companies alsodramatically increased their involvement in

The Medicare Modernization Act, dis-cussed in Chapter 26, contains many provi-sions that are likely to lead to a return ofgrowth for Medicare managed care in bothHMOs and PPOs. Most notable are the provi-sions that result in plans’ being paid at ratesthat are, on average, above Medicare fee-for-service costs.10 How Medicare managedhealth care evolves is not easily predicted,however, in light of the history over the past20 years, particularly given the propensity ofthe federal government to alter reimburse-ment periodically.

Another phenomenon is the maturation ofexternal quality oversight activities. Startingin 1991, the National Committee for QualityAssurance (NCQA; see Chapter 23) began toaccredit HMOs. The NCQA was launched bythe HMOs’ trade association in 1979 but be-came independent in 1991, with the majorityof board seats being held by employer,union, and consumer representatives. Manyemployers are requiring or strongly encour-aging NCQA accreditation of the HMOs withwhich they contract, and accreditation cameto replace federal qualification as the seal ofapproval. NCQA, which initially focused onlyon HMOs, has evolved with the market, forexample, to encompass mental health carve-outs, PPOs, physician credentialing verifica-tion organizations, and others. In addition toNCQA, other bodies that accredit managedcare plans have also developed, as describedin Chapter 23.

Performance measurement systems (re-port cards) continue to evolve, the mostprominent being the Health Plan EmployerData and Information Set (HEDIS), whichwas developed by the NCQA at the behest ofseveral large employers and health plans.The HEDIS data set has evolved and grownon a regular basis; the HEDIS data set that iscurrent at the time of publication may befound in Chapter 23. Other forms of reportcards have appeared since then and continueto develop as the market demands increasinglevels of sophistication.

Another form of maturation is the focus ofcost management efforts, which used to be

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managed care by both acquiring local healthplans and starting up HMOs and PPOs. Inshort, the managed care environment be-came even more complicated.

Another change is role of the primary carephysician (PCP), who assumed responsibilityfor overseeing the allocation of resources.Most MCOs regard gaining the loyalty of PCPsas critical to their success. In a traditionalHMO, the role of the PCP has been to managea patient’s medical care, including access tospecialty care. This proved to be a mixedblessing for PCPs, who sometimes felt caughtbetween pressures to reduce costs on the onehand and, on the other hand, the need to sat-isfy the desires of consumers who may ques-tion whether the physician has their bestinterests at heart in light of the financial in-centives to limit resource consumption. Thegrowing popularity of PPOs as compared toHMOs appears to have led to a shift awayfrom PCP-based plans in recent years, for ex-ample, the requirement for authorization toaccess specialty services, known as the “gate-keeper” requirement. That being said, manyplans (including PPOs) require lower copays ifa member receives care from a PCP than ifthe member receives care from a specialist,thus retaining a primary care focus.

Finally, consolidation is notable amongboth health care plans and providers. Amongphysicians there continues a slow but discern-able movement away from solo practice andtoward group practice. As for hospitals, a sub-stantial amount of consolidation on a regionalor local level occurred, creating large localand regional systems. This consolidation oc-curred largely in the mid- to late-1990s andcontinues today, although at a much slowerrate. National consolidation of hospitals hasnot been a significant factor in recent years,however. Hospital consolidation was com-monly justified in terms of its potential for ra-tionalizing clinical and support systems. Aclearer impact, however, has been the en-hanced ability to negotiate favorable paymentterms, often to the chagrin of the health planswith which they contract12 (see Chapter 7).


Health plan consolidation has also been ro-bust and continues today. Smaller localhealth plans have been acquired or in somecases ceased operations because of a num-ber of forces. Large employers with employ-ees who are spread geographically havegenerally been moving toward national com-panies at the expense of local health plans.For smaller plans, the financial strain of hav-ing to continually upgrade computer systemsand other technology can become excessive.Smaller plans may also find themselves un-able to negotiate the same discounts aslarger competitors, exacerbating the financialstrain. Smaller plans in unique markets suchas in rural areas or where physician loyalty ishigh (as may be found in one of the few suc-cessful provider-sponsored health plans; seeChapter 2) may continue to thrive, but that isthe exception.

Even larger health plans have been targetsfor acquisition, primarily in the for-profit sec-tor. Indeed, as of 2006 all of the Blue CrossBlue Shield plans that had converted to for-profit status have been amalgamated into asingle company: Anthem (sometimes referredto as Anthem/WellPoint, reflecting the namesof the two large predecessors). At the time ofpublication, four commercial for-profit com-panies accounted for the majority of coveredlives: CIGNA, Aetna, United Health Care, andAnthem/WellPoint. Consolidation has not onlyoccurred in the for-profit sector but also inthe non-investor-owned (NIO)* sector, pri-marily in Blue Cross and Blue Shield plans.Market growth in the Blue Cross Blue Shieldsystem has been considerable as a result ofmany factors, including its generally broadprovider networks, the managed care back-lash, and the Blue’s improved ability to offernational accounts when compared to the

*NIO is a term preferred by a number of not-for-profit health plans because Blue Cross andBlue Shield plans in particular are taxed as thoughthey are for-profit health insurance companies,not as though they are charitable organizations.

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Managed Care in Recent Times: 1995–2005 13

though they were really part of health insur-ance in general. Other problems were highlyemotional though not actually a threat tohealth, such as denial of coverage for carethat was genuinely not medically necessary;for example, an unnecessary diagnostic test.Finally, a major source of contention withmany consumers was the requirement thatthey obtain prior authorization from their pri-mary care physician to access specialty care,although arguably this provision both re-duces costs and increases quality by ensur-ing primary care physicians are fully apprisedof the care that their patients receive.

A few problems, however, were real or—atleast potential—threats to health, such as de-nial of coverage for truly necessary medicalcare or difficulties in accessing care resultingin subsequent ill effects on health. Althoughquite uncommon in practice (although notstatistically studied), isolated problems ofthis nature could generate adverse publicity.The emotional overlay accompanying healthcare outstrips almost any other aspect of life.The loss of life or limb in a spouse or childcauses grief in ways that a house fire or los-ing one’s employment does not.

The managed care industry was not sim-ply an innocent victim of bad publicity. Ashealth plans and managed care companiesgrew, their ability to actually manage the de-livery system was severely tested and fre-quently found wanting. Where clinicallyoriented decisions on coverage were oncedone with active involvement of medicalmanagers, the rapidly growing health plansbecame increasingly bureaucratic and distantfrom their members and providers. Rapidgrowth also led to greater inconsistencies indecision making regarding coverage for clini-cal services. The public’s perception that de-cisions regarding coverage of clinical carebeing made by “bean counters” or otherfaceless clerks may not have been fair or ac-curate in the opinion of managed care execu-tives, but neither was it without merit.Decision-making authority was often dele-gated and applied using general policies and

prior decade. In any given state, the Blueplan often has the highest market penetra-tion of any health plan.

MANAGED CARE IN RECENT TIMES:1995–2005

The economic boom of the mid- to late-1990schanged the dynamics in the managed healthcare industry. As a result of unemploymentdropping below 4%, corporate profits becom-ing robust, and the economy growing, em-ployers found it increasingly necessary tocompete for employees. The anti-managedcare rhetoric of political campaigns, com-bined with media “horror stories,” helpedfuel negative public sentiment about man-aged care. Despite generally positive per-ceptions of their own health plans, mostconsumers have negative perceptions aboutmanaged care in general.

The Managed Care Backlash

Anti-managed care sentiment, commonly re-ferred to as the “managed care backlash,”became a defining force in the industry. Polit-ical speeches, movies and television shows,news articles, and even cartoons increasinglybegan to portray managed care in an unflat-tering light.

In some respects, this is not surprising. Be-cause managed care had significantly lowercosts than traditional health plans did, itbecame a dominant form of health care cov-erage when many employers put their em-ployees (and dependents) into managed careas their only type of coverage. When thenumber of individuals in managed care be-came substantial, the number of problemsrose as well, including individuals who didnot want to be in a managed care plan. Someof the problems were mostly irritants, suchas mistakes in paperwork or claims process-ing in health plans with information technol-ogy (IT) systems that were unable to handlethe load. Commonly, the consumer associ-ated such problems with managed care even

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not necessarily with a sense of compassionor flexibility.

When enough instances of serious prob-lems occur, they make good fodder for newsthat uses the well-proven reporting techniqueof “identifiable victim” stories in which ac-tual names and faces are associated withanecdotes of poor care or other very realproblems. Whether problems portrayed inthe news may or may not have been repre-sented fairly from the viewpoint of the healthplan was irrelevant. When added on top ofdisgruntlement caused by minor or upsetting(though not dangerous) irritants caused byhealth plan operations, the public is not liableto be sympathetic to managed care, particu-larly with the backdrop of few insurancecompanies being loved.

Perhaps the most serious charge leveledagainst the managed care industry was theaccusation that health plans deliberately re-fused to pay for necessary care to generateprofits and enrich executives and sharehold-ers. The negative reaction was enhanced bymedia stories of multi million dollar compen-sation packages of senior executives. Puttingaside the fact that financial incentives drivealmost all aspects of health care to varyingdegrees, this was a particularly perniciouscharge that health plans faced, specificallythe increasing number of for-profit plans.

One result of the backlash was new con-sumer protections at the state and/or federallevel, or at least the threat of such legisla-tion. For example, many states have passedlegislation—the so-called prudent lay personrule—guaranteeing payment for emergencyservices if the precipitating symptoms couldreasonably have been interpreted as anemergency, for example, chest pain that sub-sequently turned out to be indigestion.States have also passed bills instituting state-supervised independent appeals processesin the event of a medical denial. Finally, sev-eral unsuccessful attempts were made at thefederal level to pass a so-called Patient Bill ofRights, which would have mirrored at a na-


tional level provisions that many states hadadopted.

Last, a frequently cited reason for the man-aged care backlash is American’s desire forchoice. People simply did not want to be toldthat they could not go to any provider andstill receive full coverage for their care. Thisattitude caused many HMOs to expand theirnetworks aggressively and fueled the shiftfrom traditional HMOs to less restrictiveforms of coverage. For example, whereas en-rollment in HMOs decreased from 24% in1998 to 15% in 2005, PPO enrollment in-creased from 35% to 61%. Also noteworthy is that traditional insurance has become ofonly minor importance, with the percentageof enrollment in traditional plans. That is,those without contracted networks or otherforms of managed care, which stood at 73%of employer-sponsored plans in 1988, declin-ing to only 3% in 2005.13

Another example of the movement towardless restrictive forms of coverage is that a num-ber of HMOs abandoned the primary carephysician model (the so-called gatekeepermodel discussed in Chapter 2) to one of “openaccess,” allowing members to access anyprovider in the network (though usually withlower copays for primary care than for spe-cialty care).14 During this time, the managedcare industry kept pointing out the good thingsit was doing for members such as coverage forpreventive services and drugs, the absence oflifetime coverage limits, coverage of highly ex-pensive care, and so forth, but to no avail.

The managed care backlash has becomemostly an echo. The volume of HMO jokeshas declined, news stories about coverage re-strictions or withheld care are now uncom-mon, and there is little or no state or federalattention paid to placing restrictions on man-aged care plans. The HMO’s legacy of richerbenefits, combined with the general loosen-ing of medical management and broad ac-cess to providers, collided with other forcesby the end of the millennium, and healthcare costs once again shot up.

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Managed Care in Recent Times: 1995–2005 15

stitutional) as evidenced by continuinglarge variations in practice behavior andinsufficient adherence to evidence-basedmedical practice

• High incomes for some types of pro-viders (regardless of efficiency or quality)

• The cost of complying with governmentmandates

These usual suspects are not the only onespushing health cost inflation, however. Tworelatively new categories are establishingthemselves as major drivers of cost inflation:(1) rapidly developing (and usually expensive)medical technology, in some cases diffusedwidely with minimal evidence of effective-ness, and (2) genomics. Examples of newmedical technology are the implantable car-diac defibrillator, drug-eluting vascular stents,new orthopedic implants, and miniaturizationof devices, to name a few. In the arena of ge-nomics, the appearance of so-called specialtypharmacy, injectable drugs that are proteinsmanufactured through DNA replication, hasled to treatments that may not be used fre-quently but that are hugely expensive whenthey are used, commonly costing in excess of$10,000 per patient per year or more. The dis-covery of various alleles (ie, genes) for cancerthat help guide physicians as to the best ther-apy depending on the genetic profile (eg, forbreast cancer) are all adding to cost inflation.On a more positive note, although stem cellresearch has yet to result in concrete thera-pies, such new approaches to treating diseasecould be discovered and result in both im-proved treatment and lower cost.

Managed Health Care in Mid-Decade

At the same time health benefits costs beganrising, the economy began to soften, and in-creasingly U.S. companies have become con-fronted with competition from abroad fromcompanies that do not face the insurancecosts of their American counterparts. Thesetwo forces led not to a return to traditional

The Return of Health Cost Inflation

The rapid increases in health care costs expe-rienced in the late 1980s and early 1990shad slowed considerably by the mid-1990s,but health cost inflation returned by the turnof the century. Managed care had been a sig-nificant contributor to holding down the rateof rise, but many of the fundamental reasonsfor increased health care costs remain today.It is worth noting that although the percent-age of the gross domestic product (GDP) con-sumed by health costs throughout much ofthe 1990s remained steady at around 13.2%,this was only partially because of lowerhealth cost inflation. The other reason wasthe robust growth of the GDP itself; in otherwords, health cost inflation slowed while theoverall GDP grew at a higher rate than it hadfor many years.

The health economy is too complex toascribe inflationary pressures to any singleattribute, or even a small constellation of at-tributes. Where health cost inflation wasonce caused as much by unnecessary utiliza-tion as by anything else, other forces have al-ways been present. The lessening of some ofthe controls traditionally associated withmanaged health care combined with a richerbenefit package has certainly contributed torising health costs, but numerous other fac-tors have also been in play. Examples ofother such factors are the following:

• Drug therapy advances and prescriptiondrug prices

• Shifting demographics, including the ag-ing of the population

• Expectations for a long and healthy life,regardless of costs

• Greater consumer demands upon thehealth care system

• The litigiousness of our society, leadingphysicians to practice defensive medicine

• High administrative costs related to thecare that is delivered

• Inefficient or poor quality care renderedby some providers (professional and in-

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managed care but rather to an increase incost sharing with consumers through higherpayroll deductions for health benefits cover-age and, more important, in the form ofchanges in the benefits. Levels of copay-ments and co-insurance have been rising andin many cases have become more complex.For example, physician office visit copaysthat were once most commonly $5.00 arenow $20.00 or higher, and pharmacy bene-fits that were once simple copays now havewidely differing levels of copayment tieringas well as significant deductibles. Ironically,cost sharing was the primary method of costcontrol available to indemnity insuranceprior to the advent of managed health care.

The most recent significant development isthe rise of the consumer-directed health plan(CDHP), including such variants as HealthSavings Accounts (HSAs) and other types ofhigh-deductible health plans. CDHPs are de-scribed in Chapter 2, and issues associatedwith consumerism are more fully discussedin Chapter 20. A hallmark of a CDHP, though,is the notion that consumer choice and con-sumer accountability have substantially in-creased in importance. Health plans areimproving the ability of members to choosephysicians, hospitals, benefits plans, and soforth easily, using technology such as theInternet. They are also providing memberswith better information regarding the qualityand cost of the care they are seeking alongwith information to help them understandtheir health care options. Aspects of inform-ing consumers through data or informationtransparency, decision support tools, finan-cial budgeting tools, and the like are cur-rently the focus of much effort in all healthplans, not just CDHPs.

The other aspect of CDHPs in their variousforms is a benefits design that depends ongreater cost sharing with consumers, a dy-namic also observed with almost all benefitsdesigns whether considered CDHPs or “tradi-tional” managed care products. Through theexistence of a gap in coverage between thepre-tax savings and when the high-deductiblehealth plan coverage comes into play, the


consumer is responsible for expenses. It isnot yet clear whether CDHPs as they exist atthe time of publication actually require morecost sharing by consumers than do otherplan designs because of the rapid increasesin cost sharing in all benefits designs. In fact,one study reports that CDHPs actually reducecost sharing for many groups, in particularthe small group of members responsible forhalf of all medical spending.15

Managed care has not ceded the field tothe imposition of higher cost sharing com-bined with improved information to assist indecision making. For example, new pay-for-performance programs are being tested andimplemented to align financial incentives forroviders with quality goals, as discussed fullyin Chapter 8. Practice behavior by physicianshas evolved, and as care management be-comes more sophisticated, managed carecompanies have placed more emphasis onchronic and/or highly expensive medical con-ditions, with less focus on routine care, asdiscussed in detail in Part III of this book.

CONCLUSION

The health care sector in the United States ishighly dynamic. The roots of managed healthcare, and health insurance in general, aremany. The continued growth and evolution ofmanaged health care is affected by the healthsector economy, marketplace needs, legaland regulatory requirements, changes inhealth care delivery, consumer demands, pol-itics, and a myriad of other forces, many ofwhich interact with each other. What startedout with simple roots has become complexand robust and will only become more so.

ADDITIONAL RESOURCES

Following is a list of several good sources onmanaged care trends. (Note: All Web ad-dresses are current as of August 2006, butare subject to change.)

1. The Center for Medicare and MedicaidServices (CMS), especially the Office ofthe Actuary; navigate to http://www.cms

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References and Notes 17

3. The Sanofi-Aventis Managed CareDigest Series, updated annually and ac-cessible at http://www.managedcaredi-gest.com (free with registration).

4. HealthLeaders–InterStudy, accessible athttp://home.healthleaders-interstudy.com (requires purchase).

.org, or more specifically to http://www

.cms.hhs.gov/NationalHealthExpendData/(free).

2. The Henry J. Kaiser Family Foundation(http://www.kff.org), particularly the se-ries on the health care marketplacetrends (free).

References and Notes

1. Mayer TR, Mayer GG. HMOs: Origins and de-velopment. N Engl J Med. 1985:312,590–594.

2. MacLeod GK. An overview of managed care.In: Kongstvedt PR, ed. The Managed CareHandbook, 2nd ed. Gaithersburg, Md: Aspen,1993:3–11.

3. Starr P. The Social Transformation of AmericanMedicine. New York, NY: Basic Books, 1982:295–310.

4. Strumpf GB. Historical evolution and politicalprocess. In: Mackie DL, Decker DK, eds.Group and IPA HMOs. Gaithersburg, Md:Aspen, 1981:17–36.

5. Spies JJ, Friedland J, and Fox PD. Alternativehealth care delivery systems: HMOs andPPOs. In: Fox PD, Goldbeck W, and Spies, JJ,eds. Health Care Cost Management: PrivateSector Initiatives. Ann Arbor, Mich: HealthAdministration Press, 1984:43–68.

6. Fielding JE. Corporate Cost Management.Reading, Mass: Addison-Wesley, 1984.

7. Kaiser Family Foundation. Trends and Indi-cators in the Changing Health Care Marketplace.Place TK: Kaiser Family Foundation, 2005,Menlo Park, CA:Exhibit 2.13.

8. Data available from the Office of the Actuary,Centers for Medicare and Medicaid Services,and Kaiser Family Foundation, op cit, Exhibit2.17.

9. Berenson RA. Medicare disadvantages andthe search for the elusive “level playing field.”Health Affairs Web Exclusive. December 15,2004:W4.

10. Biles B, Nicholas LH, and Cooper BS. The costof privatization: Extra payments to Medicareadvantage plans—2005 update. CommonWealth Fund Issue Brief. December 2004.

11. Smith C, Cowan C, Heffler S, et al. Nationalhealth spending in 2004: Recent slowdown ledby prescription drug spending. Health Affairs.January/February 2006;XXV(1):186–196.

12. Devers KJ, Casalino LP, Rudell L, et al.Hospitals’ negotiating leverage with healthplans: How and why has it changed. Part II.Health Services Res. February 2003;XXXVIII(1):419–446.

13. Kaiser Family Fund. Op cit, Exhibit 2.3.14. For additional discussion of some of the

changes that HMOs and other managed careplans have made, see Draper DA, et al. Thechanging face of managed care. Health Af-fairs. January/February 2002;XXI(1):11–23.

15. Remler DK, Glied SA. How much more costsharing will Health Savings Accounts bring?Health Affairs. 2006;25(4):1070–1078.

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