Health System Change in Orange County, California

Round One Site Visit

Case Study
September 1997
Douglas L. Fountain, Joy M. Grossman, Srija Srinivasan

range County, California, is one of the most competitive health care markets in the country. Physician-run organizations, hospitals and regional and national managed care companies all wield significant power and influence, so that competition among these sectors is fierce. In addition, the health care climate here has a strong business orientation because of the history of for-profit entities in the three major health care sectors; state regulation that encourages separation of provider and insurance functions and physician and hospital services; and the conservative tenor of local business and politics. Capitation has emerged as the dominant payment mechanism for primary care services and has influenced the structure of relationships among health plans and providers. Physician organizations, hospitals and health plans are all seeking to increase their size and leverage through acquisitions and mergers.

For many large health care corporations, Orange County is a piece of the Southern California and state markets, rather than a local health care market unto itself. Strategies pursued by plans and providers reflect a mix of decisions at the local, state and national levels. The county line has defined the market for some local physician groups and hospitals, as well as responsibility for administering a number of public programs. However, health insurers typically lump Orange County into their Southern California and/or state strategies, and competition plays out within the context of this larger market. Local private purchasing of health care is not consolidated, but statewide purchasing groups reportedly influence the regionalization of plans and providers that compete across the state.

Physician-run enterprises and HMOs have a long history in Orange County. The community is also home to 34 hospitals, many of which have been in operation for more than 50 years. The evolution of managed care here has contributed to the view that Orange County’s experience forecasts the future for other communities experiencing managed care growth. The dynamics at work in this market include:

• extensive use of capitation to pay primary care physicians;

• organization of physicians into entities that can manage care under capitated arrangements;

• competition among hospitals seeking volume to cover their fixed costs; and

• recent growth of Medicare managed care and implementation of Medi-Cal managed care.

Health plans, physician groups and hospitals are pursuing horizontal consolidation strategies in attempts to bolster their own market leverage. Four of California’s largest HMOs recently consolidated into two plans; three of the four have a strong presence in Orange County. Similarly, two national hospital chains with a presence in Orange County are consolidating through Tenet’s purchase of OrNda, placing 11 of 34 local hospitals under one owner. Physician practices, too, are consolidating, including several mid-size to large entities.

State regulatory barriers prevent hospitals and physicians from achieving certain types of integration. California’s corporate-practice-of-medicine law prohibits employment of physicians by corporations. In addition, the state’s HMO law prevents hospitals and physicians from assuming risk for services outside their licensed service scope, although a recent modification allows such risk assumption with a limited HMO license.

However, hospitals and physician organizations have found mechanisms for sharing in the risks and rewards of capitation, and for bolstering their leverage with health plans. Hospitals have sought closer links to those physicians who act as gatekeepers and referrers to inpatient care by sponsoring IPAs and management service organizations (MSOs) that align physicians’ incentives with their own. Joint risk pools, for example, are one way to accomplish the alignment of physicians and hospitals. In addition, hospitals and physicians are working to form county-wide contracting networks. Health plans have tried to temper the joint bargaining leverage of physician-hospital contracting arrangements by pursuing long-term contracts that lock in desirable provider reimbursement rates. In general, exclusive provider-plan relationships have been abandoned.

It is unclear how the balance of power will shake out between physician groups and hospitals or among the provider, insurer and purchaser sectors, or what impact this competition will have on Orange County’s residents. Despite competitive pressure, respondents report that most health plans, hospitals and physician groups are running profitable businesses. Until now, their competition has produced hospital utilization rates and health care premiums well below national averages. It has also spurred ownership consolidation, but has not forced any major organizations to exit the market or close down. Some respondents cited potentially adverse impact on quality of care, such as apparent delays in referrals to specialty care. Primary care physicians, in particular, may be "at their limit" in terms of what they can do at prevailing market prices, respondents said.

Amidst these market pressures, the makeup of the population is changing, and demands on safety net providers may increase. Although the county historically has been affluent and ethnically homogenous, the number of immigrants, many of whom work in low-wage jobs, is growing. In addition, respondents believe competitive pricing and reduced funds for cross-subsidization may weaken the safety net. Although CalOPTIMA, the county’s managed care plan for Medi-Cal (the state’s Medicaid program), has won praise for improving access and quality of care for Medi-Cal recipients, the indigent population is projected to grow while availability of services for this population is expected to shrink. The health care system for the uninsured may be threatened while the rest of the health care system "dukes it out."