he year 1998 was tumultuous for many segments of the health care system. This essay covers four key developments that are likely to lead to profound changes:

• After four years of extremely low rates of increase, health care costs grew more rapidly in 1998, and health insurance premium increases for 1999 are likely to grow by an even greater margin.
  
  
• Many physician organizations experienced problems with their attempts to take on financial risk and related care management responsibilities.
  
  
• The backlash against managed care seems to have intensified as stronger measures to provide consumer protection appeared on the legislative agenda and more loosely managed products gained in popularity.
  
  
• In Medicare, policy makers were dealing with both unexpected impacts of the Balanced Budget Act of 1997 (BBA) and discussions of long-term reform to the program.

he year was frustrating to many, especially to those whose vision of the future of health care delivery includes provider organizations or health plans using systems and an evidence-based approach to improving quality. Financial pressures and a backlash against managed care made it that much more difficult for organizations to pursue such a vision.

The perspectives expressed here about the past year are informed by a variety of sources. I drew upon our second round of site visits to the 12 communities we are tracking intensively. We were surprised at the amount of organizational change between 1996-1997 and 1998-1999 visits. Conferences sponsored by HSC and other organizations have deepened our understanding of some issues, especially physician organizations. The press, which is increasingly covering events in different health care markets, is another source I found useful. Formal and informal discussions with policy makers were also quite valuable. Finally, after choosing the four topics, I conducted interviews with individuals who are experts in these areas.

Cost Trends

In fact, private health insurance premiums in 1998 increased 3.3 percent, according to KPMG Peat Marwick data, and substantially higher increases are expected for 1999 premiums. Underlying costs also increased in 1998-about two percentage points more than in 1997, as estimated by Milliman & Robertson. Even more important was the perception that the health insurance underwriting cycle had turned. After three to four years in which premium increases had been smaller than increases in under- lying costs, I believe that there are clear signs that insurers will be raising 1999 premiums more rapidly than underlying costs will increase.

Although the media had carried predictions of large premium surges for 1997 and 1998-which did not occur-forecasts of a surge for 1999 are more likely to be on the mark because of changes in insurer behavior. In the early to mid-1990s, health insurance had been highly profitable as a result of unexpected declines in the rate of growth of costs. Insurers responded to this by aggressively entering new markets and seeking to gain dominant positions. In many site visit interviews conducted by HSC in 1995, insurers lamented how competitors were setting premiums below costs when entering markets.

In contrast, in 1998, insurers were responding to years of underwriting losses by abandoning geographic and product markets where the prospects for near-term profitability were uncertain. Media reports throughout the year told of prominent insurers exiting selected markets. Although the biggest headlines focused on withdrawals from Medicare and Medicaid markets, plans withdrew from commercial markets as well. With capital leaving the health insurance industry, conditions are ripe for price increases in excess of the increase in underlying costs.

As this essay goes to press, the only systematic estimate of 1999 premium increases is for large corporations. According to Towers Perrin, the largest employers experienced a 7 percent increase in 1999, compared with 4 percent in 1998. As of mid-year, underlying cost increases were driven by spending for pharmaceuticals, according to Milliman & Robertson. The 14.1 percent increase in pharmaceutical spending per person for 1998 is dramatically higher than the 1.0 percent decrease in inpatient hospital services and the 8.2 percent and 4.6 percent increases in outpatient hospital and physician services, respectively.

The rapid growth in pharmaceutical spending is likely attributable to the more rapid rate of new drug introductions and increased marketing efforts, especially those aimed at consumers. Health plans and purchasers are now focusing their cost-containment efforts on pharmaceuticals. In many cases, health plans have had mechanisms available to limit pharmacy spending, such as formularies, but employers have not pursued those approaches. Now, there is increasing interest in using consumer incentives to favor generic and brand-name drugs that are in a formulary. Some believe that putting physicians at risk for pharmaceutical spending is the most effective cost-containment strategy, but the rapid and unpredictable increases in spending have led physician organizations to resist taking risk for these services.

"We've seen the best and the worst of times in terms of costs-the worst in the late '80s and early '90s, and the best right after the demise of health reform. My sense is that we'll see neither of these extremes in the future."

Kenneth E. Thorpe, Tulane University

Physician Organizations

One of the greatest obstacles for many physician organizations was that the market did not develop as expected. Capitated arrangements did not flourish as anticipated in many communities, in part because health plans, in response to purchaser and consumer demand, increasingly offered more loosely managed products that are less amenable to capitation. Another factor was the reluctance of some health plans to delegate responsibility for care management to provider organizations and providers' unwillingness to accept financial risk without this enhanced role.

Physician organizations appear to have fared the worst in markets with a history of capitation. Costs grew more rapidly than anticipated as providers and plans sought to accommodate demand for more loosely managed products and to respond to state patient protection legislation. Unexpectedly rapid growth of pharmacy costs also contributed to this trend. Under capitated arrangements, physician organizations were financially liable for these cost increases and struggled in vain to outpace mounting losses. This problem was most pronounced in Orange County, Calif., one of HSC's sites, where many physician organizations had signed multi-year contracts tying payment rates to premiums rather than costs.

Physician organizations faced internal problems as well. The issue of physician productivity became rampant as physicians made the transition from being owners to being salaried employees. Notoriously independent-minded, many physicians bristled under the management of their new organizations.

Perhaps most disconcerting was physician organizations' difficulty in developing the infrastructure necessary to manage financial risk and streamline and improve clinical care delivery. These advances were viewed as the great promise of physician organizations, particularly publicly traded PPMCs. However, market observers now contend that PPMC leadership gave too much attention to acquisition of practices at the expense of activities such as information support. As a result, the value provided to practices in the form of management and infrastructure was not sufficient to justify the overhead.

Does all this mean that physician organizations are not long for this world? I do not believe this to be the case. Physician income remains under pressure, as health plans continue to seek discounts, and Medicare fees-commonly used as a benchmark for physician payment-have been on the decline, especially for procedural-based specialists.

This downward pressure on fees means that physicians will continue to look toward organizations to help them gain negotiating leverage. Indeed, many single-specialty groups or IPAs have emerged in response. Increasingly, physicians, hospitals and health plans across markets appear to be coming to the conclusion that what physician practices need-information systems to manage risk-can be purchased from vendors. Medical services organizations (MSOs), which provide management services to physicians but do not own practices, have been around for some time, but were overlooked at a time when vertical integration seemed promising. Now this model is becoming increasingly attractive. Entrepreneurial MSOs are becoming more prominent, especially in California, and in many markets, PHOs are reinventing themselves as MSOs that provide this more targeted function for physicians.

"The most appropriate manager of care is a physician, not an insurance company, and physician organizations need to figure out how to harness this. Doctors can integrate information about a patient's care and know the optimal time to prescribe a drug or have a patient hospitalized."

J.D. Kleinke, Health Strategic Network, Inc.

"What's emerged out of all of this carnage and chaos in physician organizations is a more rational approach to surviving in a capitated environment. The leading physician organizations are redoubling their commitment to managing capitation by purchasing services such as information and accounting systems."

Alan Hoops, Pacificare

Managed Care Backlash

An important factor behind the managed care backlash is that many employees are not offered a choice of an unmanaged product. I wrote about this last year in our annual report, and many have agreed with that assessment. The media also are fueling the backlash, and scholarly literature is now documenting the media's role.

Consistent with this perspective, the 1998-1999 HSC site visits suggest that the backlash is a national phenomenon, fueled in part by the national media, and that there is a remarkably uniform agenda on patient protection in state legislatures despite differences in how satisfied communities are with managed care. In Boston, a community with extensive managed care experience and in which perceptions of quality are relatively high, the state legislative agenda on managed care regulation is quite similar to areas such as northern New Jersey, where consumer perceptions are not nearly as favorable.

In employment-based insurance there is a clear trend toward more loosely managed products, indicating consumer resistance to "true" managed care. Point-of-service and preferred provider organization products, which cover services to providers outside a network, are growing, while HMO products, which are more restrictive, are not.

Products that modify gatekeeper requirements by providing direct access to particular specialists, such as dermatologists, allergists and gynecologists, or to all specialists within a network are being introduced rapidly. Health plans are expanding mechanisms through which patients can appeal plan decisions, often involving outside experts. Although some of these changes are in response to legislation or the expectation of it, many are in response to demands by customers-principally employers and employees.

Health plans and capitated providers contend that these changes are contributing to cost increases and are leading them to push for premium increases. A big question is how employers will respond. Will they pay the extra costs? Will they pull back from the loosely managed products in the face of more rapid increases in premiums? Or will they move further in the direction of defined contribution mechanisms, where employees decide how much choice and flexibility they are willing to pay for?

"Putting real resources into ombudsmen or consumer assistance programs, as well as timely and effective independent grievance mechanisms, could help address the managed care backlash. This could demystify managed care, and might help resolve problems at earlier and less contentious stages."

Ronald F. Pollack, Families USA Foundation

Medicare

BBA provider payment cuts appear to have achieved more budget savings than had been anticipated. Medicare outlays for fiscal year 1998 increased only 1.5 percent from the previous year, substantially less than had been forecast. Early reports from the first two quarters of fiscal year 1999 suggest that outlays actually declined, which is unprecedented. Those health care organizations affected by numerous BBA provisions-for example, academic health centers that provide skilled nursing and home care services-appear to be at particular risk for a sharp decline in their Medicare revenues. Alongside efforts to get Congress to restore some of these cuts, these organizations are likely to embark on major initiatives to cut costs.

A lot of attention was given to the withdrawals of a number of private plans from the Medicare program. Reasons for withdrawal include BBA constraints on payment rates, unexpected increases in costs (especially for pharmaceuticals), increasing regulatory burdens and uncertainty about future payments. The stage of the insurance underwriting cycle probably exacerbated the reaction on the part of the plans. Although growth in enrollment in Medicare risk plans still increased in 1998, it was only a 16 percent increase, less than previous years. Publicity about the withdrawals and the fact that some continuing plans dropped or narrowed prescription drug benefits hurt the image of managed care.

In many markets, private health plans in the Medicare program appear to be grappling with a difficult transitional problem. In those markets in which the Medicare payment rate is high, plans have typically not charged enrollees a premium. This has made the plans quite attractive because beneficiaries in the traditional program either have much more substantial cost sharing and more limited benefits or pay a substantial premium for Medigap coverage.

As Medicare payments are constrained, it becomes more difficult to earn a profit without charging a premium. Plans have dropped benefits and, in some cases, have even left the market, rather than begin to charge a premium. This may be driven by fears of risk selection-that having the only premium in the market and having drug benefits will attract the sicker patients and deter the healthier ones. The inadequacy of current tools to pay plans more for enrolling sicker beneficiaries is leading to a situation in which products that consumers are most eager to buy (namely, plans with drug benefits) are not being offered. Perhaps the risk-adjustment enhancements scheduled for implementation in 2000 will help in this regard.

Finally, the National Bipartisan Commission on Medicare Reform led many to begin to think about key structural changes for Medicare. Ideas receiving the most attention involve changing the relationship between traditional Medicare and private plans. The commission chairs developed a proposal in which traditional Medicare would compete with private plans under a structure called premium support, which resembles the Federal Employees Health Benefit Program. I think the proposed change is likely to be more limited than what both proponents and opponents imagine. As under Medicare+Choice, the future market share of private plans would depend on whether their costs grow more slowly than those in the traditional Medicare program. If cost growth was lower, the proposed premium support mechanism would ensure that some of the savings would go to the Medicare trust funds.

"While the rhetoric of the 1997 Balanced Budget Act is more competition, more managed care, the dominant reality is lower payments to providers, lower payments to health plans."

Peter Kemper, HSC and a commissioner of the Medicare Payment Advisory Commission

Conflicting Pressures Ahead

But at a time when organizations need to be seeking to meet these laudable quality objectives by experimenting with mechanisms to more effectively organize the delivery of care, rising costs and purchaser resistance to premium increases are making efforts to innovate more difficult. At the same time, the public feels that care has been managed too tightly. Consumers' desire for more choice and autonomy is often in conflict with the efforts of the best plans and integrated delivery systems to improve quality and reduce costs. Meanwhile, the number of uninsured is growing. Public and private decision makers will need both skill and luck to navigate these turbulent waters.

Paul B. Ginsburg, HSC president

I am grateful to Charles Buck, Lawrence Casalino, Alan Hoops, J.D. Kleinke, Ronald Pollack, Kenneth Thorpe and Gail Wilensky for valuable discussions. My colleagues at HSC-Joy Grossman, Peter Kemper and, especially, Ann Greiner and Cara Lesser-provided excellent advice and comment. None of these individuals is responsible for the views stated, which are my own.