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	HSC's 11th Annual Wall Street Comes to Washington Conference

11th Annual Wall Street Comes to Washington Conference

Conference Transcript
June 21, 2006

P R O C E E D I N G S

Paul Ginsburg: I’d like to begin the meeting now, and want to welcome you to HSC’s Annual Wall Street Comes to Washington Conference. The purpose of this conference is to give to the Washington health policy community better insights into market developments that are relevant to health policy. We will be discussing market developments and their implications for people’s health care. This is a core activity of HSC.

Today we have an opportunity to tape a different course of information, equity and bond analysts on this topic, than we’re used to hearing on some of these topics. Equity analysts advise investors about which publicly traded companies will do well and which ones will not, and bond analysts advise on the likelihood of debt repayments.

Good analysts, the kind that you see on this panel, develop a thorough understanding of the markets that the companies that they follow operate in. And they also follow public policy which often has important implications for these companies. Some analysts work for brokerage companies and advise the clients of those firms. Others work for institutional investors such as mutual funds, pension funds, or hedge funds. And we have an analyst from one of the companies whose business is to rate hospital debt who will be participating on the panel on provider issues.

This is the way that we don’t lose perspective on not-for-profit hospitals which are not covered by extensively at all on Wall Street. This is an opportunity for the equity and bond analysts to take a break from their day jobs of assessing the outlook for profitability or solvency of the companies and bring their understanding of market forces to bear on questions that those involved in health policy have on their minds. We also include on each panel Washington-based health policy analysts, and they have made valuable contributions to these sessions by tying the market developments more closely to the health policy issues.

The format we’re going to use is the same as we did last year. This is going to be a roundtable discussion of a series of questions that I’m going to ask, and I have shared these questions with the panelists in advance. We are going to have two sessions, each with a separate panel. The first one will cover health care costs and premium trends, and various issues connected with health insurance including the new Medicare prescription drug coverage. The second panel will cover hospital, physician, and pharmaceutical issues.

There will be opportunities for audience questions after each. There are question cards in your packets. Please fill them out and give them to an HSC staff member. Or you can go to the microphones and ask questions. We will take them from both sources. Please note, though, that the analysts are not permitted by regulations that affect them to answer questions here about the outlook for specific companies. The only time you will hear a company mentioned is if one of them is pointing to it as an example of a phenomenon that they are talking about in the insurance or hospital industries.

I want to thank the Robert Wood Johnson Foundation who funds this conference and is the principal funder of HSC. And thank the folks at kaisernetwork.org who are going to be webcasting this conference, and the webcast will be after noon tomorrow at kaisernetwork.org. HSC will post a transcript of the conference on its website by early next week.

And before you leave the conference, I would appreciate it if you could take a moment to fill out the yellow evaluation form and leave it on the registration table. Be assured that, analysts that we are, we do analyze those evaluation statements and use them to improve on the conference each year.

We have two really terrific panels this year, and they comprise several analysts who have participated in these meetings in the past, and that includes analysts who have participated in these meetings in the past. That includes Christine Arnold of Morgan Stanley, Chris McFadden of Goldman Sachs, Geoffrey Harris who is now with a hedge fund, and Bob Berenson and Bob Laszewski, the last two who comment as policy analysts rather than as equity of bond analysts. And we also have several analysts who are new to this conference, Matthew Borsch of Goldman Sachs, John Wells from Fitch Ratings, and Doug Simpson from Merrill Lynch. We are going to begin our first questions on the new Medicare Prescription Drug Benefit.

First I would like to ask the panelists about your assessment of the results of the 2006 enrollment in these Part B plans; any comments they have on what about beneficiary take-up, and has there been adverse selection? Which benefit designs are most appealing? And also to explain why the average premium came in so much lower than had been projected before this started.

Who would like to begin? Christine?

Christine Arnold: I will start with the take-up. The take-up was much better than we had anticipated. We had expected about 19.9 million Medicare beneficiaries would take up the benefit and be members of PDPs, benefiting PBMs and managed care companies.

What I am not including there is the VA, I am not including federal employees, and I am not including employers who take the subsidy. Because guess what? They had drug coverage before this thing happened, so there is really no change in the world for those people. Excluding those people, 19.9 million people was our projection, and we are at 24 million right now on a comparable basis. The total is about 38 million, so only about 4 million seniors and other Medicare beneficiaries are not represented, not having credible drug coverage.

All the data we have seen suggests that they have made a deliberate decision, that they are either healthy seniors or that they somehow did not take this step and actually sign up. The penetration has been better than expected. Because the penetration has been with the lower benefit designs and the premium has come in so much lower, at $24 per member on average, and this time last year we were looking for an average premium of $37. So $24 on average is the premium, $37 is what we were looking for.

Guess what? Seniors signed up for cheaper plans, and those plans are pretty bare-bones. The selection I think was pretty positive. We got the healthy seniors in. Only 4 million did not show up. We got a lot of seniors in like my dad who does not use any drugs, a very healthy guy, and those people are benefiting from the fact that they will have credible coverage going forward, and the key question is what is going to happen to premiums in the future over time. But that is our view of the world.

Matthew Borsch: Maybe I could just comment on taking up what Christine had mentioned, a projection of 19.9 million which I think that included the MAPD.

Christine Arnold: Yes.

Matthew Borsch: We actually initially had a fairly high projection of 28 to 20 million, excluding the MAPD figure. So it actually came in pretty close to our original projection.

That said, we went through a period late last year and early this year where we were really questioning whether our projection made sense. Bottom line, the take-up has been surprisingly strong. In terms of the benefit design and adverse selection just to make one comment here, for the program overall just given the broad participation, it does not look like adverse selection was necessarily an issue per se.

However, what remains to be seen is where there may be adverse selection between the participating plans. I am particularly interested to see how that is going to shake out between the low-priced plans like Humana’s, and Humana management has indicated that they believe they are drawing in some of the seniors who do not anticipate using a lot of prescription drugs, but want to be in the plan and not get hit with the late enrollment penalty, versus the more expensive plans that are more likely to attract seniors that expect to fully utilize the benefit. But the jury is out on that question.

Douglas Simpson: Not to belabor the issue, but I would echo the comments of Matt and Christine about the take-up. It has been very robust. Seniors definitely seem to be interested certainly in some of the lower-cost PDP plans and MA-lined PD plans. I put my parents on MAPD plans and was a little bit surprised at what they were able to get for their dollar, and they seemed very pleased after the 4-1/2 hours on the Internet it took to sign them up.

(Laughter.)

Douglas Simpson: And I appreciated the fact that halfway through it there was a little block that said if you are not comfortable with computers, click this box. I am not sure how you would actually find that.

(Laughter.)

Douglas Simpson: I think we are early in the process. It is 6 months out since the launch. Thus far I think on the issue of adverse selection, this is where I’m going here, it is a little bit early to tell, but so far the utilization trends I think if anything look a little bit light.

Most of the seniors are going to start hitting the donut hole towards the end of this summer, so that will be interesting. I am sure there will be press articles around that as someone who was previously getting Lipitor for $6 walks into the pharmacy and you are in the donut hole, and it is now $80. So that will be something kind of interesting to watch.

With the timeline having expired, again, going to the issue of adverse selection, it will be curious to see how that plays out politically. One could argue that it makes sense to extend that to the end of the year and just increase participation and tape those 4 million remaining seniors that Christine referenced in her comments, so we will continue to watch that as another item.

Paul Ginsburg: Bob, I know you have a different attitude about adverse selection.

Robert Laszewski: Yes, I think it is way too early to know anything, and I have seen a lot of hard data coming from the plans. I think the first thing that is important to understand is be careful at looking at some of the things you are hearing, some of the things that analysts are being told in the conference calls and so forth.

When the plans say they are coming in at projected levels, they are really using a lot of plugged numbers yet. The data is very difficult to assess at this point. One of the things you do not hear about is there are a lot of plans out there with the dual-eligibles. I know of one plan where CMS is saying they have 200,000 more dual-eligibles than the plan knows about, and this is repeating itself from plan to plan. We have had millions of people signing up toward the end and the problem with doing an assessment of benefit ratios when you have number of people coming in is you book the premium for those people for a month, but maybe they have 2 months’ worth of medicine in their cabinet and it may be a while before they actually go use the plan.

The other thing with these numbers when you look at 24 million signing up, this 5.8 million people that the administration puts an asterisk on and says they are covered troubles me, because we do not know whether they are covered or not or how well they are covered. And most importantly, I think a lot of those 5.8 million people signed up for Part D because they were told that if they did not sign up they would be paying penalties and they did not get the letter saying you have credible coverage. So I think a number of those people have probably signed up and are being double-counted. The take-up rate really varies with that 5.8 million. It is anywhere from 60 percent to 75 percent of the people who did not have coverage on December 31, depending on how that 5.8 million shakes out.

In the benefits business which is where I spent most of my career, you figure you need 70 to 80 percent of the people to get a good cross-section. So we are either at 70 percent or we are close to that, and in terms of adverse selection, we are probably close to the number. But the flip side of that is, the premiums have come in far lower than we expected that they would.

One of the news events that I think a lot of people missed on Part D was when the administration was running around congratulating themselves on the fact that the insurance companies bid 10 percent less than they thought they would bid for the dual-eligibles.

The old underwriter in me said they came in on an existing piece of business 10 percent lower than what it was supposed to cost. How did they do that? And what justifies coming in 10 percent lower? You also have a plan that looks very much like the federal employee plan of which many of you are aware, and you know what you do when it comes time to sign up for the federal employee plan. You know what your particular health care utilization needs are and you find the optimal plan, the best benefit for the lowest price.

I think that there are a whole series of factors going on here, not the least of which is that the data is impossible to evaluate. We will not really know how this came out until probably early next year. The health plans have people signing up and getting on the rolls right through the month of June. July is going to be the first month where you theoretically know who you are covering, and then did the people who signed up in April, May, and June have a bunch of medicine in their cabinets and have not used the plan yet?

The first time you are going to know what the claims side really looks like may be September or October, and it is going to be late in the year before you can really balance premium and claims. Then you are going to have the donut hole for some and not for others. Everybody talks about the donut hole which the plans are really counting on for claims to stop, except the people who signed up in May are not going to hit the donut hole because they signed up in May.

So you get the picture. I looked at real live data from a real live plan that the analysts do not get to see, and through the first quarter they were showing an 113 percent benefit ratio. You do not have to be an actuary to know that that is not good. They are counting on the donut hole and the risk adjusters kicking in, and the rick adjusters are the big factor in this whole thing.

The bottom line is nobody has any idea, which really makes it difficult now to price next year. So do not ask me what the prices are going to look like next year. As one executive who actually does the numbers told me the other day, I said I am not going to quote you on any of this stuff. How are you going to price next year? He says, crap shoot. I don’t know. So it is going to be interesting.

Christine Arnold: I agree with a lot of the points that Bob made about not having transparency, but I would point out three things.

First, 75 to 80 percent of costs that come in 2-1/2 percent higher than you anticipated are borne by the federal government, so we have this thing called the risk corridor. By our estimates, costs have to be 19 percent higher than you anticipated. If you bid an 85 percent loss ratio and a 5 percent margin, 19 percent higher than you anticipated in order to get to break even from a 5 percent margin.

So we have the reinsurance, we have the risk corridors which what I have just referenced, and we have the fact that for dual-eligibles you are being paid for the risk profile of those members, and I do think those factors do mitigate the fact that we are going to have a lot of plan-to-plan reconciliations in the third and fourth quarters, and state-to-plan, because here is another issue.

The states did not turn off their drug cards. When this whole thing was a disaster in January for a month or so with just a flood of seniors in, the states did not turn off their

state Medicaid cards. So you could wander in as a dual-eligible, you just handed them the same card as you handed them for the last 5 years, right?

Here’s my Medicaid card, and that would work. The states for a bunch of these, so we are going to have that reconciliation where the states want that money back because the plans have been paid premiums. So there are going to be a bunch of adjustments, number one.

The risk corridors and the reinsurance really do put training wheels on the program from an earnings perspective. And also keep in mind, point three, that in the seasonality for this business, it was intended to be unprofitable in the first quarter. Every company in my coverage universe except Wellcare reported a loss in the first quarter for PDP, and that is the way the benefit was structured. It is a second-half earnings story from a stock perspective. And I do agree that there is a lot that we do not know, but the point is that the government put on all these training wheels that I think mitigate the impact on earnings. I don’t know what my colleagues feel here.

Douglas Simpson: I would add, echoing again some of the comments on the reinsurance and then the risk corridors, it’s hard to really screw this thing up from a financial perspective because there is so much cushion, and it is hard to make a ton of money, too.

So it is interesting for me, for all the discussion and air time that Part B gets, it does not really move the needle for most of the companies. It just doesn’t. One of the companies we cover had an analyst day in November, and roughly 2 cents out of a $3.50 number is represented by Part B. They must have gotten 25 questions during the analyst day about Part B, and yet nobody asked them what their paperclip spending was, and it is probably about the same magnitude.

It gets a lot of air time and it makes a lot of interesting press stories, but at the end of the day it does not really factor into a lot of these companies’ bottom line in a big way.

Paul Ginsburg: I think that is a good point, and it may be a good occasion to turn the discussion. I do not think that this audience about how the companies come out except when it shows up, either for government obligations or what beneficiaries are going to have to--and that is what I would like to focus on.

What does it look like next year or the year after for the federal government and the beneficiaries?

Robert Laszewski: That is exactly the point. This is I think the third year I have done this, and I keep beating on the analysts to think about next year, and not just where managed care is in the next quarter.

What happens when the risk corridors are delved into, what happens when the federal government makes up for all of the underpricing, is that a good long-term strategy from a business perspective? Because government has a contract to do that today, and we are sort of on auto pilot for the second year as well. But if in fact these risk corridors bail everybody out, then what happens to the Part D policies, a Congress that is facing enormous budgets, a Congress that is already somewhat thinking twice about passing this thing in the first place and Democrats railing against the giveaways to the managed care industry?

So if you do get into those risk corridors big time and there is a significant bailout and the health plans have to provide 20 to 30 percent rate increases in the third year to catch up for all of this, you have a policy mess on your hands, and you do not have a good long-term business strategy either.

Now you have 20 million customers and it is sort of like the 1997 BBA all over again, except this time there are 20 million customers rather than 5 million customers in Medicare Advantage. So I think there is a real issue in terms of the long-term policy and the sustainability of this program.

The Medicare trustees have already said that the trend rate on Part D is about 11 percent. If all things go okay, this thing has an 11 percent trend rate in it. If it does not go okay, then start multiplying that. That is the longer-term policy issue, and it is the longer-term business issue that I think the analysts have to be asking: Company X, you just put 5 million lives on the books here. What is your strategy for the third year?

Christine Arnold: I do think 2008 gets better for the government from a budget perspective, and a little bit tougher for the health plans, and here is why. That 75 to 80 percent that the government takes over 2-1/2 percent in overage and costs, that declines to 50 percent.

Two things happen in 2008 that right size a little bit the situation that we are talking about with the government, and make things a little bit harder for the health plans. It is going to interject, I think, some rationality into the bidding process. We will see those bids probably rise in 2008.

The first thing we just talked about is the fact that those training wheels, the risk corridors if costs are higher than you expected, start coming off in 2008; 75 to 80 percent goes down to 50 percent. So if you really misbid, government is not going to be there to catch your MLR and your profitability, point number one.

Point number two is that the bids are going to be weighted by the membership, so the companies with experience in this program, not the ones trying to come in with new experiences, are the ones who are going to be very heavily weighted. That was supposed to happen in 2007, and we were all fearful because of the underbidding that is perceived to have happened coming into this year with some plans. Those plans cleaned up on the membership, so when they bid next year, they would have a much higher weighting.

Guess what? They are going to be equal weighted in 2007. A sign of relief, right?5 Things are pretty good. In 2008 they are going to weight it again by the membership within each plan. That means that it is going to be harder, it is going to cost you more because you do not have the training wheels to underbid, and those companies with experience are going to have to use that experience or change the benefits starting in 2008.

I anticipate we will see tightening of formularies. That is the lever that we did not see this year. Ninety-one percent of the top 100 drugs are covered by these health plans, and in the lowest plan, 73 percent of drugs are covered. I think the plans that shot for the membership and cover 99 percent of drugs, they are going to start pulling that lever on the formulary which they have not done yet in 2008 because of these two things that we just factored in.

Robert Laszewski: Christine, just watch out for CMS, though, because CMS has already changed the rules on formularies and it is clear that CMS is more worried about the political outcome in terms of the way seniors are treated than they are health plan profitability.

Christine Arnold: Yes, they are requiring that the home health drugs be covered.

Robert Laszewski: Yes, and they can just keep on doing it. Yes, I think that if you tighten up the formularies you have a better chance to managing costs, but CMS has a track record already of siding on the side of the seniors very clearly in that respect.

Christine Arnold: That would be problematic.

Paul Ginsburg: I think the two of you really put this issue on very nicely about what are the incentives going to be for the plans, and what is the incentive going to be for the government. Do you have anything to throw in on that?

MR. BOSCH: Let me offer a long-term comment, which is this issue of potential budgetary problems in the current drug benefit is also, of course, the issue on the medical side and the nonpharmacy side of Medicare. 7

Ultimately the question becomes what are you going to do both in terms of the prescription drugs and the comprehensive coverage, because right now what we have is an in-between. Medicare, of course, is a compromise between the doctors and hospitals and the government from 1965, and that unmanaged benefit and unmanaged program I think most people agree is not sustainable in light of spending trends.

I think you have two alternatives. Either you turn it over to health plans and insurers and give them some profit margin to manage it through the private sector. Or you look at the other extreme which is going to something that is more like a national health policy that would cover not only Medicare, but the commercial population as well. I don’t know that there is a good alternative that is in the middle, and I think the question is broader than just the drug benefit.

Paul Ginsburg: But I wonder if we are headed toward the middle where we will have competition in the private sector, but we will have a lot more aggressive rule setting by the government as to what your formulary can look like.

Matthew Borsch: Right. The potential there is that we go back down the road of the BBA of 1997 where the rule making is in conflict with reasonable business plans from the private sector and you end up with a busted program where the private plans are exiting. I do not see that happening in the next 2 or 3 years, but there is certainly that potential.

Douglas Simpson: I think on the issue of the formulary, the market is going to set constraints around this. It is certainly a level that can be pulled, but to the extent you are signing up people, especially if you are doing an MAPD plan, you need to be very careful.

As to my parents, one parent is diabetic and the other has hypertension and they use a lot of meds. Certainly, if you pick a formulary and one of their meds is excluded, that is not in the interests of the insurer that is underwriting their medical coverage as well, and you can get exclusions, but that is certainly something that is going to come into play.

There is an opportunity there, but I think they are somewhat limited in that ability. I think the bigger thing to watch, it will be interesting to see to the extent that you see very rapid enrollment, we have seen it on PDP this year, Medicare Advantage, people moving from traditional fee for service into private fee for service as kind of a toe in the water and then ultimately Medicare Advantage.

To the extent you beef up that population number substantially, it gives that a critical mass and it will be interesting as approach 2008 to see where politicians are with a large senior population who have embraced these coverages. It is a lot easier to bash these coverages and go after them on the funding side when you have a very small number of people in them. So I think that is the other dynamic that will play out in the political landscape.

Paul Ginsburg: I think you have given me a good transition to start talking about Medicare Advantage. One question I want to pose is, we heard a lot of discussion about the virtues of the integration of the drug coverage with the coverage of hospital and physician services. How real do you think the potential of integration is? Is it just a concept? Or do you think that the plans providing MAPD benefits are really doing something with that integration?

Douglas Simpson: I think ultimately--

Christine Arnold: They are not integrating.

(Laughter.)

Douglas Simpson: I think at this point it has been very much a bifurcated market, but over time I think that is the ultimate end game as to where they would like the beneficiaries to go.

As I said, my parents went on an MAPD plan, I just felt it was simpler for them, and ultimately I think economically they are going to wind up spending up $12,000 a year instead of $17,000. It was a hassle to sign up, to be sure, but ultimately I think they will come out better economically, and then certainly hopefully clinically.

Medicare Advantage, I think the natural progression is to get people involved at the earlier stages of their Medicare life. It is going to be easier to get people aged 65 into the program than it is to convert somebody who is 75 and been in the fee-for-service model for a decade already. Similar to the way we saw 401(k) enrollment in the early 1980s, it was not the 45-year-olds who enrolled in 401(k)s, it was the 23- to 24-year-olds coming out of college, they walked into HR when they joined XYZ Corporation, signed up for their health benefits and signed up for a 401(k).

I think you will see higher takeup rates from the younger population, and over time you will see an evolution in the MA product as those people age into the Medicare population.

Paul Ginsburg: Matt?

Matthew Borsch: I hope I am not jumping on the questions here, but with regard to Medicare Advantage, the really interesting trend has been where the growth has come this year, and it has been not in the traditional local MA-HMO plans where the majority of the enrollment still is, but, rather, in this relatively new private fee-for-service model which according to my understanding the majority of the new MA membership in 2006 has gone into.

The question though, most of it is in rural counties where, if you will, there is a lot low-hanging fruit, seniors who have never had the option of enrolling in an MA plan. In essence the companies are giving them something that is an offer too good to refuse because it has all the flexibility of traditional Medicare plus the coverage of essentially a Medigap policy, but at a substantially cheaper price.

From a straight economic standpoint, it is just a far superior deal to what you can get with Medigap and traditional Medicare combined. Of course, the reason that that is possible is partly because of the artifact right now of these rural counties where you have an arbitrage between the amount that it costs Medicare to provide services to members in the traditional fee-for-service program, versus the national average minimum Medicare payment.

It is not clear ultimately what real value the managed care plans are providing under the private fee-for-service program. It is not clear whether that kind of arbitrage on reimbursement is going to be sustainable. We asked the question to Humana’s CEO last week, and they have been one of the biggest growers in private fee for service, "What is the sustainability of this product?" And what he said was we look at this as managed care lite, and so essentially it is a transition product to something that probably looks more like a PPO.

Of course, that then gets into the question of how do you introduce selective contracting and things like that into these rural countries where traditionally that has not worked.

Paul Ginsburg: I’m glad that you answered other questions. I think this is an area that people in this community are not that familiar with, these private fee-for-service plans. Everything you said made sense until you reported what Humana said about a transition into PPOs.

Why would they be bothering? In a sense, they have found a golden goose here. I don’t know if any of the panelists have a perspective, is there any value in private fee for service from a broad policy perspective, or is this just a transfer from the Treasury to the Medicare beneficiaries living in these areas with something raked off by these plans?

(Laughter.)

Robert Laszewski: I have been really surprised at the interest on the part of health plans into moving into Medicare fee for service. It is the new frontier. One of my clients is one of the most noble not-for-profit plans out there, and they are headed in that direction very strongly. People see the opportunity to make a lot of money.

I can give you two comments on Medicare Advantage. The first is I am surprised that the growth in Medicare Advantage is as slow as it is. I think we are up by something like isn’t it a million lives in Medicare Advantage? I think a lot of that is so much focused on Part B kept people from taking a hard look at it.

I told my relatives who were on Medicare during the Part D exercise that they ought to sign up for Medicare Advantage because it is such a fantastic deal for seniors, and I told them flat out, because the Congress is pouring so much money into this thing. You are getting all these free benefits. You are crazy not to take advantage of it. But they didn’t, and it is very much your experience, the leap was just too much.

The strategy that a lot of people are using, a lot of the players in the market are using, is Medicare fee for service because they see it as a really good transitional strategy, and it is a really profitable opportunity.

The second comment that I would make about Medicare Advantage is I think its days are a little bit numbered because MedPAC, as many of you know, came out with some statistics the other day that said in 2005, Medicare Advantage was paid 107 percent of what the standard Medicare plan was paid on a per-member basis, and it is already up to 111 percent. So we are getting a lot of data now, and this is not news to anybody. We knew the Congress put a lot of money into the program to entice people into it. But Medicare Advantage is getting paid a lot more on a per-member basis, and you have a Congress that is going to be looking for opportunities to cut.

If you get a Democratic House of Representatives, it is going to be really interesting in terms of Medicare Advantage and Part D. I do not have to tell you people that the Democrats have both of those programs in their sites. So the data is there that says we are dumping a lot of money into this program, where’s the beef? Where in fact are the results that say that we are saving money, and if we are not saving money, why should we be doing it? And politically, you want to cut Medicare Advantage, if you are a Republican, you have to find some ways to trim that Medicare budget.

We have all the pressure on the physicians’ side, as you all know. Where is the money come from for the physicians and their fee schedules. So I think a couple years out we have some real problems with Medicare Advantage reimbursement.

Christine Arnold: I think the problem starts next year, actually. There is an overpayment this year. The Medicare Advantage are getting about a 9 percent rate increase in 2006, so this is a great Medicare Advantage year. But part of that is owing to a $2 billion calculation error that they are going to have reverse next year, so it looks like the 2007 Medicare rates are only going up by 2 to 3 percent to correct for the overpayment this year. So I am expecting only single-digit Medicare Advantage enrollment growth next year because they are going to have to cut benefits in order to maintain margins. I am also expect some deterioration in the margin. It is a 1-year hiatus, but that is kind of where we are at near-term.

A couple of observations on Medicare Advantage. Medicare Advantage is the one place I am about adverse selection, because 74 percent of Medicare Advantage have an enhanced benefit relative to PDP, and only 27 percent of enrollment as of early May in stand-alone PDP is enhanced. So if 27 percent of enrollment in stand-alone PDP has the extra drug coverage, and 74 percent of Medicare Advantage has extra drug coverage, then there is potential for adverse selection in Medicare Advantage that I do not worry about in the PDP, given who chose what.

The offset is that over half of the Medicare Advantage plans have zero percent, so 53 percent of the Medicare Advantage plans have no premium. That would appeal to someone who is young and healthy who does not really what the benefits are. That may be the offset, so there is an affordability. But this does not really make sense. We have enhanced the benefits, and yet we are charging no premium. So I guess Bob has a point here that it is probably too good to last.

Matthew Borsch: Could I just jump in with two quick points on what Bob had said?

The first is the 11 percent differential that you referred to, of course, I think a lot of people understand this, but it is important to be looking at this on a comparable benefit package basis I think, because could make the argument from an economist’s perspective of longer-term that if under Medicare Advantage you are providing a substantially larger set of benefits and offsetting what would otherwise be seniors’ out-of-pocket spending requirements, you are offsetting the need for a certain level of Social Security income. So if I think you are going to talk about the efficiency of Medicare Advantage, you really need to look at it on a comparable benefits basis.

The second thing I would say in reference to the Democrats and what they will want to do with Medicare Advantage, this is a little unclear right now because they have historically been the biggest friends to that program. On the other hand, arguably where Medicare Advantage and Part D generally is making the most inroads and helping the most people is in the base of the low-income and moderate seniors. They are the ones who are benefiting from the government’s generosity.

Paul Ginsburg: Let me turn to private insurance for people who are not Medicare beneficiaries. I would like to begin by asking the panel, from the perspective of this audience that we are in front of, what would you say was the most important development in private insurance over the past year, if any?

Douglas Simpson: I guess the first thing I would say is you have to note the consolidation that has taken place in the market, and I think that that has been huge. You have had United take up PacifiCare, certainly WellPoint/WellChoice, we have United John Deere, Aetna has done a bunch of small deals.

So I think the broad theme is consolidation, and we expect that to continue over the next several years. We think about that a little bit more broadly than I think people generally do when they talk about consolidation. To us there are many ways that can happen. It can be large companies buying other large public companies, but beyond that, there is a lot of activity that can take place in the nonpublicly traded market.

There are alliances, joint ventures, partnerships, reinsurance structures. It is going to be very interesting over the next 3 to 5 years we think to watch this dynamic continue. In the commercial world, there are very clear benefits to scale. As the consumer bears more and more of the health care dollar, they are going to demand and place greater emphasis on relative quality of systems and service, in addition to clinical outcomes.

The larger companies have, generally speaking, a better ability to make those investments in customer service and in systems technology. Ten years ago that did not have the same relevance that it has today because people were paying less for health care, but if the monthly premium and co-pays and co-insurance continue to rise as we expect they will, they are going to demand more and be pickier consumers.

There is demand elasticity in health care, and the more out of pocket that you are spending, the more critical of that service that you become. So we think that that dynamic will continue, and I think it will be interesting to watch, and in the Blues universe how some of the smaller Blues wind up dealing with the challenges of consumerism, and I am talking much more broadly than just CDHP. That is one very small piece. I am talking about the general caution of going on to consumers. But I think certainly some of the regions in the Medicare programs did not line up greatly for the state-based Blues plans, and couple that with the encroachment from the larger nationals, it will be interesting to watch and see how that evolves.

Paul Ginsburg: If I can follow-up on the concentration, that presumably this is going to have implications for the people who pay for health insurance and the providers that are paid by health insurance. What is your sense of what we should be looking for?

Douglas Simpson: You bring up a very interesting point. On the provider side, one of the things we hear pretty consistently is that in some of the smaller markets where you once had a dominant Blue with a number of small hospitals, that dynamic has changed.

Now what you may have is a small Blue, UNH and Aetna, and instead of 10 hospitals, you may deal with 3 hospital systems. So the negotiating standpoints have changed, and it is interesting to think about what that means certainly for unit prices. We have heard in some markets that many have commented that hospital consolidation is one of the greater sources of pressure on cost trends for the industry. It will also be interesting to follow this out over the next several years.

I think what is going to wind up happening is the larger companies will continue to gain share at the expense of the smaller companies. This does not happen overnight, but it is a general shift. Each year that leverage works against one-half of the industry and for the other half of the industry. We do not really see that dynamic changing.

Matthew Borsch: I will make a very quick point on the question of further consolidation. Certainly, it seems likely that it will continue to happen particularly amongst the smaller nonpublic plans being bought out by some of the public companies. But I think there is a question as to whether and to what extend the Department of Justice may step in on the next announced public company merger, or perhaps the one after that. We may be a deal or two away from the threshold where antitrust regulators say enough is enough, and it may not be based on just a very narrow market-by-market analysis of concentration, it may be based more on taking a broader view of concentration in the industry. I am speculating, but I think that will be something to watch over the next 12 months.

Christine Arnold: I agree that integration is what is happening. I do not like it. I just get bored. They are all saying the same thing. There has been a total commoditization of the business. The networks have all broadened. Every doctor is in the network because, God forbid the employee benefits manager gets a call from somebody that their doctor is not in network, and then they wonder why the costs are potentially poised to move upward.

I think the benefit of integration in terms of scale is more than outweighed by the detriment of the lack of innovation. When does anything really interesting ever come out of a huge company trying to integrate 30 others? It was the HMOs that came up with something, they were young and scrappy and they were kind of interesting and cool, and those are the companies where things happen that are interesting and that shake things up. That is where innovation comes from. It does not come from -- we have 30 systems here and by next year we are going to have 20. That is not that interesting, and they are all saying the same thing, consumerism. They use different words like health and wealth, or the rise of the consumer, but it is all the same stuff. I think that it is dull. It is.

Matthew Borsch: I think you are right.

Christine Arnold: With employers and consultants, the consultants are like how do I add value walking into a large employer like Morgan Stanley’s benefits department when it is Aetna, Signa, the Blues, United? And it has been Aetna, Signa, the Blues, United for the last 7 years. I do not think there is that much of a benefit of scale to the consumer or to the employer, and I think it is time for innovation. I think the market is ripe for some kind of disruption, I just do not know when it how it will happen. I fear that Bob is right and it is the government.

(Laughter.)

Christine Arnold: And then neither the managed care companies or the hospitals will work as stocks, but that creates other issues.

Robert Laszewski: I think Christine is on to a good point, and I absolutely agree with her. I come from the industry, I spent 30 years in the industry, and it has never been so boring or profitable. I guess there is something to that.

I am troubled by all these mergers, especially when you get to WellPoint/Anthem. Those were two giants. There was no economy. There is no scale. What is going on is people who run the big managed care industry are playing to Wall Street, and they have to grow, and they have to grow their profits.

What is so troubling to me is you can grow your profits in a couple of ways. One is you can have all the mergers and get bigger. The other is you can do a better job of managing care, which is what I thought we were supposed to be in. Then you can take a premium for doing such a good job of managing care and controlling costs. I think the industry has given up on managing care and controlling costs, the people who run it, and so if they want to increase their profits by 30 percent next year, they go buy a company that is 30 percent their size, they add it to their portfolio, and now their profitability went up.

Everybody is just as profitable. Everybody has the same economy of scale out there. If you take a company with 1 million lives and you add a company with 300,000 lives, you have just grown your company 30 percent, and that is what Wall Street wants you to do. The analysts love you for it, and you get a billion dollars in stock options for doing that. Why should you do anything else? This really troubles me, though, because I have said this to you before, I think my industry is on a long walk off a short pier.

Where the heck are we in 5 years, or 6, 7, or 8 years. Everybody has the same trend rate. Everybody’s costs are going up by exactly the same amount. It is really troubling for me when I look at the longer-term outlook for what we are doing. I think we have a lot of people making themselves rich, and selling our industry down the river.

Paul Ginsburg: We had one really good thought about big-picture consolidation. Are there any others that you want to bring up now as far as a major development over the past year? And realize unlike public policy where you can point to this legislation that passed, this is different.

Robert Laszewski: What I wrote down here to your question, Paul, was continued profitability and little downward pressure on prices I think is the development. Why are we making so much money when we are not delivering any value? I sort of resent this because I ran an insurance company back in the 1980s when you lost money in the indemnity business. These guys are making massive amounts of money in the indemnity business and I am jealous.

(Laughter.)

Douglas Simpson: Paul, one thing I would add is this was an interesting thing, and it is this issue of transparency. We hear so much about consumerism, and you can incentivize people with co-pays and co-insurance benefit design changes, but unless you give the information, what do they do with it, or how do they act? What I thought was interesting is this transparency initiative that Aetna launched in Cincinnati last year where they make information available for common procedures in physicians’ offices to individuals, and they can log onto the website and price out different basic procedures.

I thought that was a very interesting real-world application that maybe allows people to become smarter users of health care. It is still amazing to me when I walk around my floor at work and I chat with people and I ask them what they spend on their cable bill, they can tell me to the dollar. And they know if they get HBO it adds $3, if they lose ESPN it saves them $2. They have no idea what they spend on health care, and there is something wrong with that.

Try and call up a hospital and find out what it costs to have a procedure. You cannot. There is just such a huge information lag. So I thought that pilot out of Aetna was interesting. I think we are still a long way away from where people can really be effective consumers of health care. You can still buy a pants much more efficiently than you can purchase health care in this country, and I think that that will persist. But I that was an interesting development.

Matthew Borsch: Could I make a comment both to Bob’s and also to Christine’s point on innovation? One of the things that has happened with the managed care industry, in a certain sense the providers are, not by choice, but helped create a situation where it is very hard for innovative companies to enter the managed care industry because the time and expense involved with building a competitive network de novo, really nobody does it anymore.

Think about doing it in the New York metro area where you would be trying to replicate something that is as well priced and as broad as what Oxford and Empire Blue Cross have. For all practical purposes, nobody is going to do that. They would probably look instead look to one of the second-tier plans. And I thought it was interesting, I think it was last year, that Aetna paid $400 million for a company in Michigan which was essentially just a collection of provider discounts.

If you think about that, that company, HMS, monetized $400 million in discounts that came from the provider community, and how did the provider community allow that to happen? The negotiation dynamics are such that it is very hard for new players to get a toehold in the industry. Having said that, I would take one issue with Bob’s characterization of the earnings picture, to point out that the managed care stocks are down 15 to 20 percent so far this year.

Some of this has been broader health care rotation and the options issue at UNH, but I also think that the market has gotten nervous about what appears to be an uptick in price competition in the industry. So do not rule out competition completely, do not rule out the underwriting cycle, as maybe playing a role, although, arguably, perhaps a consolidation means that margins might come in a little bit but will still remain at relatively high levels compared to industry history. What the market cares about, though, what stocks respond to, is growth in earnings. If you are earning records of $3 billion and it is going to be $3 billion for the next 5 years, that does not work from a stock perspective. Investors want to see it growing 15 to 20 percent every year, and that is some of the pressure that I think you are seeing in the market today.

Robert Laszewski: And so they go buy a company.

Paul Ginsburg: I think this would be a good time to transition to the next topic. What is the outlook for premiums net of buydowns, in a sense if there were no change in buydown, what would premiums be? And do you expect to see turns in the underwriting cycle? Christine?

Christine Arnold: I was cautious on this sector last year, it had performed like it had never performed from a stock perspective, but I thought there were signs of trouble last year.

For the first time last year, we did not have any benefit design changes. Why? Because premium yields fell off a cliff. If the health insurer is going to take 150 basis points off the premium for nothing, why buy down the benefits? So from my perspective, for the first time in 2005, I have a massive divergence between what the companies say they are getting in pricing, and what I am calculating.

Now, of course, I cannot use anything that they report and calculate it myself, I have to rely on what they tell me because this methodology that I have used for the last 7 year is not working. The reality is that pricing fell last year, and it fell 140 basis points from the fourth quarter of 2004 to the first quarter of 2005, 140 basis points.

That is huge. And then it fell another 50 basis points through 2005. So we had 200 basis points, 2 full percentage points, off premium yields in 2005. Unfortunately, while costs decelerated, they did not decelerate that much. So what happened was that the companies, in my view, overreported 2005.

How do we know that? There is this thing called prior period positive development, and it is like talk about boring, but it is a reserve thing. Basically, what happened was these companies had a lot of prior period positive development in 2005, which means 2004 was a whole lot better than they thought it was. They reserved high for 2004 medical claims and they came in lower, and they said, we didn’t need that, voom, into earnings, sort of a nontechnical way of reserve development.

So in it came the earnings in 2005, and the prior period positive development came down in 2006, which means that when they went voom in 2004, they did not replace it in the current period, so there is no voom in 2006. So we have an earnings headwind in 2006 because they overreported 2005 because the cycle turned in 2005.

The good news is from my perspective is that we have had a return of benefit design changes in 2006, and we have only seen 100 basis points of premium yield deceleration, and it is actually justified in my mind because we are seeing the benefit design changes resurge. So what I am looking for is continued benefit design changes. If we do not see continued benefit design changes, this sector is in trouble. The good news is we have them for this year.

Matthew Borsch: I would just make one quick comment which is in general I think our forecast for where the premium yield is going to go is probably to be down about 100 basis points, again, excluding benefit changes, resulting from a combination of some continued core deceleration in medical inflation, and also we believe the impact from competition, those two factors together. With respect to where premium yields are right now, an interesting thing to note is that if you look at some of the major publicly managed care companies and you calculate the premium yields from the reported numbers and the reported enrollment, what you get to are lower premium increases than what the companies are talking about.

Christine Arnold: That did not happen in 2004.

Matthew Borsch: That did not happen in 2004.

Christine Arnold: Or 2003, or 2002, or 2001.

Matthew Borsch: And the difference is really between calculated trend yield in the 4 to 5 percent range, versus the companies talking to Wall Street about rate increases of 7 to 8 percent. I think a lot of this difference gets to changes to movement, not only changes in plan design, but movement to high deductible products, different types of products that involve higher cost sharing and lower benefit.

Christine Arnold: I disagree because there are only 3 million people in the whole world in HSAs, and only a million are employee insured. I think it was price competition. It is not benefit changes, and it is not changes in product, in my view.

Robert Laszewski: I come to somewhat the same conclusion, but I look at a different kind of data having been on the operations side. My perspective is we have had high profitability over the last 4 or 5 years because of what I call the trend windfall.

That is, you started out at about a 12 to 13 percent trend rate a few years ago, and in fact, health care inflation has been falling off and it is headed toward about 8 percent, and every year the insurance company is able to charge what the benefits buyer thought was last year’s trend. In other words, if the benefits buyer is used to 12 percent and the trend is really about 10 or 11, you can still charge 12, and so there has been this windfall of profit.

Back 3 or 4 years ago there was about a 250 basis point difference between what the insurance companies were charging and what the actual trend was, and that has narrowed now, and it has narrowed to the point where it is probably about zero at the moment. This means that the profit margins are narrowing, and that is starting to show up in some results. But while the profit margins are narrowing, they are narrowing to about what you would expect from excessive, so I think you have sort of a mini price cycle going on right now.

From a policy perspective what I think that means is nothing. You are at unsustainable trends, and for you guys who do policy, whether the insurance company is able to charge 10 percent or 8 percent hardly matters, and that is what it really comes down to. So we are down to probably the lowest trend we are going to see for a few years, which is around 8 percent in reality. The benefits market thinks it ought to be about 8 percent, so there is no windfall margin for the insurance companies. But when you look at what costs are doing, when you look at the physician sector and the hospital sector, it seems to be ticking up at about 8 percent and is where real costs are.

It looks like pharmaceuticals were the reason that we have the lower trend. They came from about 14 to 15, and they are down to about 8, 9, or 10 percent. So we have an 8 to 9 percent baseline trend right now. You may see the insurance companies try to come back and get a little more because Wall Street is a little upset with them. So we are in that 8 to 9 percent trend area for the foreseeable future, when wage and inflation are about 2 to 4 percent.

So we have an unsustainable situation, and it is not as bad as it was a couple of years ago. We have maybe a little bit of a mini underwriting cycle from a profitability standpoint. But the bottom line is we are in that 8 to 9 percent range.

Paul Ginsburg: Doug, what is your perspective on pricing?

Douglas Simpson: We have talked a lot about the pricing side, and we are talking about the relationship between pricing and cost. To switch gears a little bit, one of the things that I think is interesting to think about is what could surprise these companies? What could cause them to wake up and way we really missed this?

If you think about the way in which you underwrite health plans, it uses a multivariate model and you input changes in care delivery patterns, changes in unit prices, and you walk through the new procedures, the new technologies, and you incorporate that into the model along with the claims data that you have. The models do a pretty good job of capturing, and it is a short-talk frequency business, and they are pretty good certainly relative to long-tail casualty coverage. At the end of this model there is a residual error factor which is, among other things, kind of everything else. Part of that are changes in the macroeconomic environment, and that is something we spend a lot of time thinking about because, as I mentioned earlier, as people are picking up more of the tab, the sensitivity of the consumer becomes more important in utilization patterns.

If you look at some of the work done by the RAND group over the last 50 years, they calculated demand elasticity on either price or income of about .2 percent. So every time you move personal income up or down by 1 percent, or you change the price of health care by 1 percent, you effect about a .2 percentage point change in health care change.

It is interesting against the backdrop of this dialogue to think about what has been going on. We have seen very weak consumer disposable income on a real basis. We have seen real wage growth negative, and consumer confidence, unemployment, they are all kind of mixed. The consumer is facing higher short-term interest rates which pressure credit debt and mortgage-related debt, and higher gasoline and oil prices. All these things eat into disposable income and leverage the health care premium.

One thing we continue to monitor is the strength of the U.S. consumer, and to the extent you were to see the consumer get much stronger financially, again, as measured by real wage growth or consumer disposable income, you would see an uptick in health care utilization. There would be a lag effect, but it would come. That I think is something worth watching, and I do not think the underwriting models do as good a job as picking that up as they would like. I think they generally rely on it is a 1-year short tail frequency business and we can pick it up just by renewals.

Paul Ginsburg: If I could summarize some of this discussion, when it comes to the underwriting cycle, there were some discussions about some small cycles, but my observation is how much smaller these cycles are than what we used to have. I think pulling back to the discussion about consolidation, the fact that the insurance industry’s entry is much more difficult today than it used to be, probably is a reason that we do not have large swings in the underwriting cycle and probably a reason why on average the industry is more profitable than it historically has been.

I would like to go to the next topic which is developments in network design and provider payment strategies, and I really want to bring up two topics. One is high-performance networks, and the other is pay for performance for hospitals or physicians. Since I read your reports and I read disclaimers, there is a disclaimer that HSC is involved in a study of high-performance networks funded by the California HealthCare Foundation. Otherwise, what is your perspective on how important the developments as far as potential high-performance networks is?

Matthew Borsch: I would quickly say the jury is very much out on this. It has not been established yet. The potential is there, but it requires employers and health plans to have real backbone in making narrow networks within networks work by providing very strong incentives for members to use them. We have not seen any signs that the health benefits community is ready to really push that in a strong way that would lead to widespread effectiveness and adoption.

Paul Ginsburg: Christine?

Christine Arnold: According to the Mercer data, about 22 percent of large employers have these kind of high-performance networks, and if you talk to the benefits leaders, some of the consultants, it is definitely top of mind. That and health advocacy are the big things. The problem is, and I am not sure what health advocacy means, but I am going to give you my definition of what health advocacy means because it has yet to be defined.

I do not think having a high-performance network, and I am sure we have them at Morgan Stanley, like if I got diagnosed with something, would that be the thing I was looking for? Probably not. So I can go to my Mayo website and fill out this health assessment where I say I weigh 120 pounds and then they do not call me to tell me to lose weight.

(Laughter.)

Christine Arnold: You can game them. That is not that funny.

(Laughter.)

Christine Arnold: So I have the Mayo thing, and I am sure you have done that. They ask you if use seat belts and that kind of thing. Then I have the nurse help line that I can call if my kid has a fever or has spots all over and it is on a weekend and I do not know what to do. Then I have my health plan that I can call. Then this is just another thing to add to the last. Great.

Now we have special networks, so if something happens to me, there is a neonatal network, there is a cardiovascular network, I do not even know which ones I have. There has to be some kind of integration. So this is where the one thing that we are talking about, which is health advocacy, could play a role if properly executed.

Shouldn’t there be one number that you can call where somebody who has some medical knowledge, a nurse, a nurse practitioner, a whatever, can integrate all this? I think for this to have any legs at all, we need to stop adding new things, and this is a new thing, and start integrating all the things. And disease management, too, right? There is disease management out there. I have just named five or six things that I know we have at Morgan Stanley which are completely unintegrated, many of which require a separate password if I get onto our intranet, and I cannot even find them.

Shouldn’t I be able to call one phone number and that person pulls up my benefits and says, Christine Arnold, you have just been diagnosed with XYZ. It is really unfortunate. But you know what? We have this high-performance network, and let me education you about what that means, and let me help you. Maybe you should get a second opinion. Maybe getting a second opinion is going to take too long.

Somebody needs to help. Right? So I think the high-performance networks together with some way to integrate all this stuff has tremendous potential in improving people’s health. There are also studies out. Arnie Millstein is all about 40 percent cost savings, right place, right time, high performance definitely has potential, but it is daunting being sick.

Robert Laszewski: I would add on pay-for-performance networks, one of the major Northeastern Blues plans, and this is typical, I will not say which one, say they are going to spend $189 million this year on P for P.

Paul Ginsburg: You are talking about P for P, and not high performance?

Robert Laszewski: I am going to make the same point, P for P, and pay for performance, and they are going to measure how well doctors adopt programs to reduce errors, grade hospitals in patient satisfaction surveys, and they are going to grade hospitals on 5 criteria that the hospitals picks from a list of 14. And how would you like to be graded if you get to pick the 5 out of 14?

The point is, and this gets back to high-performance networks or pay for performance, it comes down to exactly the same thing, and that is we have no mutually agreed-upon criteria between the payers and the providers on what matters. There is no data that really drives you in the right direction.

In high-performance networks you say this is a high-performance doctor or hospital, but you do not really have the data to back that up, it is almost more intuitive. There is just simply no agreement on how you reduce costs. At the same time, you saw I am sure at Dartmouth Medical School, Jack Wennberg has been doing this data for 20 years now that I know of.

Paul Ginsburg: How about 40?

Robert Laszewski: How about 40, but 20 that he has been publishing good stuff. He says, among academic medical centers, in the final 2 years of life care costs vary by a factor of 2, the admit rate by a factor of 5, and the average days varies by a factor of 3. So we have this wide variation, and somebody spending $189 million on patient satisfaction surveys and letting hospitals pick 5 criteria out of 14. This is all fluff.

Why should anybody get serious when you can make the money you are making not rocking the boat? And benefits managers are willing to pay it. For some ungodly reason at $11,000 a year average family cost of health insurance, it is not enough to get people serious. Pay for performance and the high-performance networks are going in the right direction, but there is no traction.

Paul Ginsburg: If I could interrupt you, we are going to go to questions soon, so if you could pass any question cards you have to the aisles and the staff will pick them up, and we will prepare for the Q and A session.

Douglas Simpson: So I do not get the hook here, I will be quick. The one area that is kind of interesting and I heard all the comments that were made previously, but it is kind of interesting on areas like specialty pharmacy, areas that do not lend themselves to underwriting fixes. You cannot solve a $60,000 script with co-insurance. To do it in a meaningful say, you are effectively not insuring it for a large portion of the U.S. population. Slap a 30 percent co-pay on a $60,000 drug and it is $18,000, and you cannot do that.

Some of those types of issues, it is kind of interesting to think, is there a way to structure a network and use steerage to help address those types of issues. But I also keep in the back of my mind that this is an industry where I get a phone call saying that the reason my son was not covered is that he opted out of our health plan, which is pretty amazing because he was 3 months old at the time.

(Laughter.)

Douglas Simpson: So while I was certainly proud as his father, I was a little surprised. I guess he was protesting the premium increases.

Paul Ginsburg: Are there any other thoughts on network? Is there anything you want to say on consumer-driven health care in general while we are waiting? And people can start coming up to the mikes now.

Matthew Borsch: If I could just offer a quick observation on consumer-driven health plans, and it is really a global point. The big question is whether or not the employer-sponsored system of coverage is going to unravel over the next 5 to 10 years, and there are at least two sets of pressures that say that it might.

You have small employers continuing to either not offer benefits, offer partial benefits, or drop coverage. You have more employers pushing enrollment into their self-insured plans or become self-insured, and opting out of the broader underwriting risk pool. And now you have consumer-directed health plans that have the potential to segment and unravel the broader insurance pool that small- and middle-sized employers rely on even further.

I do not have the answer to that, but I think that is going to be a very big challenge over the next 5 years.

Robert Laszewski: Paul, I would say that I think we can get down on the fact that it is getting worse on all fronts and we have not accomplished anything from a public policy perspective. I would just like to say, though, I think there are three important experiments going on in the system right now. One is HSA/HRAs, consumer-driven care, the other is the Part D drug benefit, and the third is the Massachusetts bill.

Those three things I think are very, very important, because we are going to have a serious public debate on health care sometime in the future, and the results will be in on those three things. With consumer driven, obviously, the Republicans and the free-market forces, consumer choice, moving the individual purchase of insurance.

Part D is very important as an experiment because there is the debate about how you bring Medicare costs under control and whether privatizing Medicare is the way to go, and you have privatized a big Medicare benefit and the results will be in 3 years and we will know whether privatizing Medicare makes sense based on what happens to Part D.

The third is Massachusetts because you have a universal mandate. I hope Massachusetts gets implemented. My concern is that it may not because I think the Achilles’ heel is cost containment and being able to come up with an affordable plan, but you have an experiment about all the things that people on the other side of the spectrum believe in. So there are three very important experiments going on that are going to give us some answers when we do in fact get serious about this.

Paul Ginsburg: Let me turn to some audience questions. One actually that was set up by these two comments, Is employer-sponsored health insurance sustainable, or will employers stop offering it to their employees? Does anyone want to take a crack at that? Let’s try to do one answer to each question so we can cover more.

Christine Arnold: Seventeen percent of small employers entering this year increased the premium to the employees, the portion of the premium paid. Keep in mind that only 60 percent of employers that are in the small-group market offer health insurance at all, and on average they require that more than half the premium be paid by the employee.

So we have seen a movement away from employer-sponsored coverage in the small-group market. We are not seeing that in large-group. And actually, the deceleration in premium yields and benefit trends I think pushes that off. We are seeing calculated cost trends in the 5 to 6 percent range, so while not at the level of overall inflation, we are not at a breaking point right now.

The reason larger employers are going to self-insuring from fully-insuring is because they believe that the trend is decelerating, otherwise, if they thought it was going to uptick, they would not take that risk on their income statements. So we are not at a breaking point yet. If trends reaccelerate, which is the big risk to managed care earnings because they will not anticipate it, it will just happen. Or if we see premium yields turning up, which probably will not happen on its own. This is something a year or two out. That will create, I think, more of an impetus for this, but right now things are actually okay.

Paul Ginsburg: I have a question about association health plans. What is your sense if legislation like that should pass as to what implications would that have for the industry?

Matthew Borsch: Just to answer very quickly, I think it would be another step along those lists of things that would segment the underwriting risk pool if not only that legislation passed, but there was a lot of takeup of association health plans amongst small employer groups. You would have that on top of CDHPs, on top of the self-insuring trend amongst the larger employers, to segmented, and ultimately I think undermine the underwriting risk pool.

Paul Ginsburg: Bob has spoken a lot on this issue.

Robert Laszewski: Yes, I am a repentant cherry-picker from the old days.

(Laughter.)

Robert Laszewski: People talk about passing an association health plan bill, and I think as many of you know, there is no law against association health plans. I ran a number of association health plans in the 1980s and the early-1990s, and you could start one tomorrow.

The demise of the association health plan business that I was in was HIPAA and all the state underwriting changes. That is what put the association health plans out of business. There are a few around, but not very many. It would just screw the market up royally. It is about segmentation, it is about back-door segmentation, and all the things that the people who are against it have told you about segmentation is absolutely right.

What was ironic in this debate is the way the Blue Cross plans pulled out of the opposition, and the industry was segmented into two parts. The big plans were willing to see the AHP bill pass because the Senate version gave them the ability to do it. And the smaller or the regional plans that were the one-state Blue Cross plans were scared to death because the big national plans knew they could come into Mississippi and cherry-pick the heck out of the Mississippi Blue plan. All I can tell you is I ran those things years ago, and they are a cherry-picker’s delight.

Paul Ginsburg: We have another question. Why did capitated payment systems for physician and hospital organizations fail?

Christine Arnold: They failed because they separated the process of underwriting with the consequences of underwriting. So if I can set premium yields down 10 percent in order to grow membership but you have to live with the 10 percent payment cut, then I can grow the membership, maintain my margin, and you the doctor or hospital have to live on less.

The problem became most acute in the last down cycle. In 1997 we had a lot of capitation in Medicare and payments did not keep up with cost trends, and in 1997, 1998, and 1999, capitation fell apart particularly in the Medicare segment, but in the commercial segment as rates did not keep up with cost trends.

Paul Ginsburg: Given consolidation in the managed care sector and premium yield declines, how have providers continued to garner such strong pricing increases from managed care payers, and when does that change?

Douglas Simpson: I think one of the dynamics we touched on earlier was certainly in the hospital community provider consolidation. We have heard about that now for years, and that will likely continue. We have seen a change in the negotiating leverage of the providers in many markets with the advent of increased competition among the payers and increased consolidation among the providers. There are certain markets in Pennsylvania where I know point blank there was an individual payer negotiating with multiple hospitals, and that dynamic has just 180 degrees flip-flipped, and it has real implications for unit cost trends.

Robert Laszewski: What created the indemnity market we have today was the patient rates per billion. In the late-1990s when you had the providers and the patients rebel and the benefits managers did not back up the HMO industry and the HMO industry learned it could make more money just passing increases through, we went to the indemnity model.

We moved away from the managed care model and we moved to the indemnity model. So we received a truce between providers and health plans. The benefits managers are willing to pay for it, and we have had enormous profitability. The providers are doing better, the plans are doing better, the benefits managers are willing to pay for it, and something has to change there before we get serious again about managing costs.

Paul Ginsburg: I have a question about the impact of obesity on the industry.

Christine Arnold: The impact is that we all lie on the Mayo survey.

(Laughter.)

Christine Arnold: There has been a move afoot among some of the larger employers like GE, even Smith Barney and Xerox, to start to award points for changing behavior and lifestyle. If you smoke and you complete a smoking cessation program, get a coach and get tested and you do not have any nicotine in your blood, great. Or if you get your BMI down to a certain point. Or if you go to an NCQU accredited physician as your primary care doc or some other criteria, employers are starting to award points which reduces either the co-pays or deductibles that you have to pay, or the premiums that come out of your paycheck. We have also, of course, seen things like $25 for each completion of a health risk assessment that then goes to the health plan, and they can attempt to enroll you in the disease management program.

Paul Ginsburg: I have a good question, and it is a good final question. Why can’t cost trends go much lower? It was close to negative in 1996.

Douglas Simpson: One thing is I think it could go lower, stop innovating, and I think that is a big part of this. I think when people talk about medical costs inflation, they equate it to CPI, and I think the reality is there is quite a bit of a difference.

One of the not-for-profit health plans we deal with was speaking with an audience and they said, Why is the inflation so high? Can’t we get it down? And he said, yes, we can give you surgery and we’ll take out your gallbladder and you will have a 6 inch scar. You wanted laparoscopic surgery.

You could do those types of things, and nobody wants to. So you buy a car this year and you buy the same car next year, it does up 3 percent, that is inflation. If you buy the same car next year and it has a DVD player, air conditioning and fancy tires and rims, it is going to cost more than the 3 percent increase. I think that is the one thing you do not see mentioned very much in all the discussions about medical cost trends is the extent to which there have been improvements in care, and that is a big driver of this.

It is interesting what Americans are willing to pay for and what they complain about, but there has been substantial innovation and it comes at a cost.

Matthew Borsch: Just a quick point on that. Looking back at the cost trend low in the mid- to late-1990s, you have to factor into that the reflection of the benefit of the large shift to managed care and one-time trend benefits that came with that wholesale shift into managed care. You could see that happen potentially again with a wholesale shift into consumer-directed health plan products.

We really do not know what the growth trajectory is, if in fact we are going to move wholesale to CDHPs, if it is going to be on a 5- year or 15-year time horizon, but that would clearly be something that would have the potential to do it. Whether the consequences in terms of all of the out-of-pocket spending would be acceptable or not remains to be seen.

Paul Ginsburg: I think at that point I would like to thank this panel for a phenomenal job, and we will restart at 10:45.

(Recess.)

SECOND PANEL

Paul Ginsburg: I would like people to begin taking their seats. We are ready for the session on providers, hospitals, physicians, and pharmaceutical companies. I probably ought to begin by asking about the first question. The first set of questions is about underlying health spending trends. I am talking about what has been going on with hospital spending and what is your outlook for the near future, and first ask a general about what is the outlook for hospital spending and what are the drivers of it. Chris, do you want to start?

Christopher McFadden: Thank you, Paul. It is a pleasure to be back again this year. I would say starting with the hospitals is to have a more modest kickoff to the panel.

Certainly, unit volumes in the hospital industry continue to be very modest, driven by a variety of factors. Driven by the ongoing migration to outpatient settings, driven by what continues to be higher levels or certainly high levels of patient sensitivity to costs, and that is having clearly an effect on admission patterns. And I would say a third factor that has come to the surface in the last 6 months or so is the perception at least that perhaps physicians are modify some of their practice behavior in a way that defers hospital admissions within an electable course of treatment strategy both because of the mechanics of trying to practice in an office-based setting and in a hospital-based setting, and perhaps some lost efficiencies that come with those tradeoffs, as well as sensitivity around the malpractice environment where malpractice is again a topic at least in the physician community that has been as sharp concern and perhaps there is some perception that there is more risk associated with an inpatient than outpatient experience.

I think it is hard within the alchemy of those issues to know what is the most important factor, but at least those three factors are having an impact. What is interesting, when you look at the data is actually revenue per admission is increasing, and that is not unintuitive, because if what is happening is a cohort of slightly sicker patients or more developed cases are what is being represented in the admissions pattern, then the revenue pre combined with some of the pricing increases which have consistently been in the mid to high single digits will drive higher revenue per admission even if admission trends in the absolute sense remain relatively modest.

John Wells: I think in the hospitals that I cover which, as Paul mentioned, is primarily the not-for-profit world, we are seeing cost trends and spending trends accelerate at a fairly healthy pace. I think the drivers of that continue to be pension expense and largely bad debt expense, but also as we look at on-call coverage for many hospitals, hospitals having to pay for physicians to provide coverage in the ED is certainly impacting spending trends, as well as capital costs and capital expenditures.

Maybe to a lesser extent we still see supplies, labor, and insurance as being significant cost drivers. Labor is not as concerning as has been in some of the previous years, but we do note that as a percentage of revenue, labor and benefits expense has not fallen below 51 percent of hospital revenue since 2000. Then on the physician side, primarily we are seeing physicians still struggling with liability insurance and certainly getting squeezed more on the revenue side.

Paul Ginsburg: One thing that struck me is for years people have commented about the hospital building boom, about how many cranes are up there, how much construction is going on. But it seems there is a disconnect between this discussion of spending trends and all this capacity that is being built. Are there any comments on that?

Geoffrey Harris: I would add to the previous question, and then I will address this one. Admissions trends have been surprisingly weak at least relative to expectations over the last couple of years. Often admissions trends tend to lag economic growth by a couple of years, but for some reason, and I would like to list a few, the admissions trends have really not picked up even a couple of years now after a rebound in economic growth from the slowdown in the early part of this decade.

I think there are probably five things, a couple of which have been mentioned, but maybe five things that are affecting this. One is changes in benefit designs, shifting more costs over to consumers. Secondly, rising uninsured. Third, and probably very importantly, competition from other delivery sites, namely, outpatient facilities, surgery centers and that sort of thing. Fifth, I think some of the disease management initiatives that were somewhat panned in the previous panel are having some impact in terms of hospital utilization trends and may be shifting to other settings. Then fourth, and again somewhat surprisingly, I think new technologies are typically associated with increased medical utilization, but I can think of at least one instance, for example, drug-eluting stents, where they have actually resulted in a reduction in certain cardiac procedures due to lower restenosis rates, in other words, patients who would otherwise come back for another procedure are not anymore.

So I think there are a series of factors that have influenced admissions trends. I think in that context it is surprising that there has been a hospital building boom, although I think a lot of that has been focused in outpatient capacity as hospitals have tried to address changing market demand.

Christopher McFadden: And I might just build on Geoff’s comments by saying relative to the construction environment, when you look at some of the data, and the Census Department of all entities has put some interesting data about this trend has looked like over the last couple of decades, one is, you have a certain replacement cycle. When you think about the stock of hospitals in this country that were boluses of building over time, there certainly was a bolus of building 35 to 50 years ago, and so you have some upgrade and replacement of that bricks-and-mortar infrastructure.

But I think the other element, and Paul I know will touch on this a second in the context of DRG, refinement proposals that have come out of CMS, if you think over the last several years what has been really important to the average hospital CEO has been the admissions pace, particularly in some high-income categories like cardiac and orthopedic, spinal and some other key categories.

One of the ways that you compete for physicians in those areas, particularly in more densely populated urban markets where they have multiple admission privileges is to make sure that your hospital has the latest and greatest stuff, and that may be the latest and greatest imaging technology, that may be the latest and greatest surgical suites, and that, too, I believe has contributed to some of the capital spending that we have seen.

It will be interesting and it will hard to prove except for a couple of years from now whether this realignment of some of the reimbursement methodologies under the DRG program perhaps shifts that incentive modestly as the income potential, at least within the cardiac area, is not what it was historically.

Robert Berenson: I would just pick up on those comments and refer to the work from the Center for Health System Change, to give you a little plug, has done this past cycle.

I was involved with interviewing a lot of hospital executives, and we are going to have an article published next month, about the increasing service line strategy that hospitals are adopting where floors are no longer med surg floors, they are heart centers, oncology centers. In one place with an educated population they are not advertising genital-urinary problems, come here, they have branded it a pelvic floor dysfunction center, a sleep center.

(Laughter.)

Robert Berenson: So there is sort of an appeal to consumerism, not the part of consumerism that expects people to use their money to theoretically reduce costs, but the part of consumerism that wants the best and the greatest. And I agree completely with the disability of attracting physicians to the newest and the best as well. We are characterizing this as a continuation and an accentuation of sort of a medical arm’s race where the competition is not overpriced, but it is over essentially the state of the art and branding that state of the art in a way that consumers and physicians will respond to. But the flip side of that, and, again it picks up one of the comments made, is that physicians are getting into the same business.

These would be examples of disruptive technologies which permit a lot of things that used to happen inpatient or even outpatient, but within the hospital environment not can safely be done in ambulatory surgery centers, or increasingly, even in physicians’ offices, and physicians in many parts of the country are getting very entrepreneurial.

So you have simultaneously hospitals trying to develop close relationships with those physicians who they need to market a service line, and in some places that means actually employing and giving incentive bonuses for physicians to part of that service line strategy, and other physicians trying to compete with that service line by doing it on an outpatient basis outside of the hospital orbit with their own facilities.

We can talk a little bit more about that, but I think that is an interesting dynamic when we can talk about whether that whether that will promote price competition or not.

Paul Ginsburg: I a few months ago published a paper which was focusing on future demand for hospital services, and the purpose of the paper was to say that aging is not as large a factor as people think. In subsequent interviews with the media, I started saying, and I want to run this by the people on the panel to see if I was right, the biggest uncertainty in hospital capacity planning for the future is how much of the outpatient work you can expect the hospital garner and how much of it is at risk of being lost to physician-owned ventures. Do you have any reactions to that?

Geoffrey Harris: The main comment I would make is that as long as physicians are allowed under Stark legislations to set up and own physician-owned entities, I think that that is a trend that will continue and be a significant challenge to hospitals.

I can think of one example in a particular market in Texas that happens to be represented by a number of for-profit companies where an entrepreneurial physician group set up a specialty hospital as well as some additional facilities and has taken all of or a significant percentage of the profitable patients from the general hospitals in the arena. So they are suffering, and the physician-owned hospital is full. As long as that is allowed legislatively, I think that will be a continuing challenge.

Robert Berenson: Just to pick up the regulatory environment on this, one is certificate of need, and, obviously in a lot of states there is not much certificate of need left.

It was interesting to talk to health plan executive who in the context of specialty hospitals became advocates of states adopting certificate of need because they did not actually see the competition that was being created by specialty hospitals as an alternative to community general hospitals as leading to price competition.

There was some disagreement amongst the plan executives we did interview, but at least a significant number of them said we want certificate of need, and some states have actually gone that route. The second piece of this is Stark, and it is real clear that there are lots of exemptions. The clearest one is that Stark does not apply to a physician practices which purchases or leases the equipment itself, and it is not just referring to another facility where the physician may have some ownership.

So one of the trends that is going on is single specialty physician mergers not primarily anymore for the sole purpose of having more leverage and negotiating rates with managed care plans which has been a strategy that single specialty groups have done, but, frankly, to have scale to be able to refer enough patients so that an oncology group might purchase a PET scan or lease a PET scan, or a neurology-neurosurgery group might do the same thing with an MRI machine. So there is a merger so that there is enough volume to self-refer, and there does not seem to be a specific regulatory barrier to that.

I think most people are looking at correcting some of the pricing distortions at least on the Medicare side that make certain services uniquely profitable and others not so profitable, and that might be one approach.

Christopher McFadden: If I could, just one additional comment because I think that the term entrepreneurial instincts or incentives on the part of physicians are obviously an integral part of seeing ambulatory strategies or outpatient strategies continue to migrate and be successful.

One of the things that is interesting to think about is the complexion of medical students in residency programs, because what one sees in those programs is a fairly meaningful demographic shift, a much, much higher percentage of women are in those programs either as part of dual professional families or dual physician families.

And there has been a lot of discussion that the next generation of physicians may be more inclined to want to be employed and 9:00 to 5:00 or 9:00 to 7:00, as opposed to be trying to run these expanded enterprises of their inpatient business, their practiced-based business and their ambulatory surgery center, minority interest on the west side of town and their minority interest on the east side of town, because that takes a lot of effort and a lot of energy. It does not say that people do not have energy and effort, but it might say they want to apply it in a different way or achieve a different work-life balance.

So I think as we think about the combination of that element, the reimbursement element, and the costs of doing business element, I think you could see a dynamic in which you get a little bit of a polarization. You see some of that outpatient or ambulatory work flow back into hospitals, and as technology continues to enable, perhaps more flow into the pure practice, and that middle tranche, what we think about as things like ASEs and dialysis and imaging centers, may be a slow-growth part of this continuum of care that we see in the marketplace.

Paul Ginsburg: That is an interesting point, and maybe if I could ask Bob what percentage of physicians need to be entrepreneurial as individuals to get into a very entrepreneurial physician sector?

Robert Berenson: I do not have that answer. What percentage of your practice needs to be capitation before you flip to practicing differently, that is that kind of question and I am not sure I know the answer. But I was going to make a comment on this one, at least some physicians are becoming entrepreneurial, and there are always come in a community who have been venture capital of various kinds that is out there, and, again most of the attention is on specialty hospitals, but the bigger thing is on other things, imaging centers, ASE’s, other kinds of activities like that.

The hospital then reaches out sometimes not happily, but often half the loaf is better than no loaf, so the hospital reaches out and said we can do a joint venture with you. We will bring the managerial stuff to the table, we will bring our capital to the table, and so physicians who do not want to be entrepreneurial may be in, who knows if this is good or bad for the world? Is it a focus factory?

Some hospital executives actually say it has been good for what they are doing that they have this potential competition from physician-owned ventures, that they have woken up to the need for greater efficiency and responsiveness, both to doctors and patients. Is it a focus factory or is it just a branding tool to get more patients is the open question. But at least in some communities, you actually have the hospitals and the docs joint-venturing and you do not need quite the same entrepreneurial doc out there. But you do need at least some sort of entrepreneurialism in the physician community, but I do not think it has to be a dominant factor.

Paul Ginsburg: I was just thinking of a physician that I know that is entrepreneurial and runs a ten-physician group, and the other nine physicians do not have to be. They can just have regular hours.

John Wells: I wanted to add that I think for a physician to be entrepreneurial they certainly need access to capital, and the hospitals through joint ventures have been the partners in that access to capital.

It is difficult, I think, for many physicians to go out on their own and open an endoscopy center or whatever the case may be, and I think hospitals recognize that they need to better align themselves with the physicians, and they have been doing through a number of means, joint ventures being one. But a lot of hospitals also get a little bit nasty and can to some extent have influence on a physician’s reimbursement if they somehow have influence over managed care companies in their contracting with physicians or refusing to contract with physicians. Then also some hospitals have revoked admitting privileges for physicians who have been entrepreneurial. Those are not ideal tactics because you tend to alienate physicians, but that is happening in some markets.

Geoffrey Harris: I am reminded on this topic that everything is cyclical. If you go back into the mid-1990s, there was an entire set of public companies that were known as physician practice management companies that were represented by entrepreneurial corridors who banded together and actually accessed the public equity markets in order to build large physician organizations that would theoretically have more negotiating leverage with payers and bring efficiencies to the system.

Most of them had, in fact, very unhappy endings. They turned out not to be well managed, they grew too quickly, they took on a lot of insurance risk that was alluded to in the prior panel, and were unable to manage costs relative to the premiums they were taking, and many of them actually went out of business.

But I still think that the underlying entrepreneurial spirit in many physicians is still there, and now it is coming forth in a different way, through ambulatory surgery centers and the other things that have been talked about in the panel so far.

Paul Ginsburg: I am glad you brought up some of the history because there has been a history of a lot of failures on the part of hospitals particularly in working with physicians. I recall interviewing a manager of a large single specialty group, and the topic of joint ventures between hospitals and physicians came up.

Unprompted he just volunteered, I don’t think these joint ventures are going to work. They are responding to the pressures of the moment, but I don’t think as a long-term viable organization they make sense. Do you have any comments on that?

Christopher McFadden: I think in part it comes from where they come from, what was the original motivation. As we have referred to, certainly some of the hospital-physician relationships end up being defensive reactions to a third party who enters the market or enters the discussion and persuades a physician group that they can earn more, have a better practice environment and ultimately have a more satisfied professional experience by building something off campus and managing it with a third-party capital partner, and then you get the hospital response to that.

Those may be relationship and structures that are organized in a very hasty manner, and, therefore, may have some flaws associated with them, and that may be the basis for why these are not as successful. It comes in a very complicated set of dynamics. There is a contracting element, there is a physician productivity element that is critical to it, there is a patient experience element, and I think if you do not get each of those three things calibrated right and with the ability to be malleable to shifting market conditions, then the ability for that to be sustained and be successful is really going to be likely impaired.

Geoffrey Harris: I think on this topic, just going back to the mid-199os, a lot of the hospitals actually tried to purchase physician practices, and they actually did. Those were outright failures in most cases. They just did not work.

I think now the more sharing JV approaches in some cases are working quite well. In fact, there is an ambulatory surgery company whose strategy is to JV with physician groups and with hospitals and bring the three together, the ambulatory surgery company, the doctors, and hospitals, and they actually have had quite a lot of success in the marketplace, so it is sort of a hybrid strategy. But purchasing practices at least historically was a big failure.

Robert Berenson: If I could comment on two things that have been said. One is the 1990s strategy of purchasing was related to purchasing primary care practices with the view that we were going to be in a world of capitation and having lives, and ensured lives was going to be name of the game. That never played out. Capitation except in California and a couple of other places pretty much has gone by the boards.

So what you had done was convert an entrepreneurial fee-for-service doc, I don’t know about entrepreneurial, but a fee-for-service doc interested in increasing productivity, to often a salaried doc who has been paid off and not particularly interested in not improving increasing fee-for-service productivity.

The current activity is around specialists, not around primary care docs. It has developing alliances with specialists to drive the service line competition, whether it is hearts or cancer or whatever it might be, in a fee-for-service world.

There are some lessons to be learned, but it is sort of a new game. The primary care docs are sort of left out at this point. The second point I was going to make is just how interesting it was in the 12 markets we go to all the time, and the predominant response from the hospital executives was we don’t love the joint ventures, but, again, half a loaf is better than none, and that is the alternative, so we will maintain relationships and we will do the best we can.

There was a minority, but a fairly vocal minority, who said we will not do this. We are in a position in this market where we will not joint venture with the docs. That is our business. They absolutely said they had a policy against it and they were going to aggressively compete. That was I think a minority, but not an insignificant minority. I think local market factors largely determine it.

Christopher McFadden: One of the things that has become a very interesting subtext to the ambulatory service center, Geoff alluded to a number of companies who have built nice public enterprise valuations on their ability to enter this market. Below the scene, though, is a fairly active what the industry calls resyndication market.

In a typical model, you go into a market and maybe you will find that anchor tenant physician group or physician who is going to be a 30 or 40 percent owner or a 25 percent owner, the public company is going to have its 51 percent or a minority position. This leaves some slices of the pie that get spread around some other physicians who are going to be partners in this practice.

What is happening is that they are all trading or resyndicating those ownership slivers among themselves and it is becoming a very active market. It does make you wonder whether they are making these practice affiliation decisions because of practice questions or because of pure financial questions. There is a gain to be had by being early like many circumstances in a new practice and then resyndicating it either back to the company or to another physician who maybe enters the community sometime in the future or the like.

I think it makes the point that others on the panel have made, that whatever we think about these dynamics, there is always that creative tension between the financial incentives as well as the practice and clinical elements of whatever provider or care-delivery model we are talking about.

Paul Ginsburg: As far as the hospital employment of physicians, is that something that comes across the radar screen in your work, John, or in yours, Chris, as far as a significant enough phenomena?

John Wells: In my area certainly more recently we are seeing hospitals employ more physicians and specialist to drive that service line strategy. What is important to note is that they are doing a much better job of employing physicians, whereas when the employment of physicians ramped up 5 to 10 years ago, there were not incentive-based contracts, and now you are seeing much more structured contracts and incentive-based contracts so hospitals do not lose a significant amount of dollars on employing physicians.

They are employing hospitalists and intensivists to manage the patients while they are in the hospitals, and they are doing a better job with throughput as a result in the hospitals. We are certainly seeing a lot of that.

Paul Ginsburg: Would you characterize the relationship with their employed physicians as much more a simulation of private practice than salary?

John Wells: Yes, I think so. I do not think that the hospitals are interested in managing their practices per se, but having them be a financial partner in this situation.

Christopher McFadden: I would 100 percent echo John’s point, particularly on hospitalists. It is surprising just in 6 to 12 months how topical the issue of hospitalists has become. I think it speaks to, as was alluded to earlier, the notion that needs to be some additional financial incentive to get referring physicians to come in and provide some of the inpatient care, and hospitalists are a very logical response to that.

The other area, and it is somewhat déjà vu all over again, is we have released one national public hospital company that competes particularly in suburban markets out talking about primary care practices again. So as much as there is a tattered history for those types of strategies, I think in some level of desperation over trying to get unit growth into hospitals that had been such disappoint unit growth sorts of businesses over the last couple of years in markets where you have multiple admitter circumstances of multiple hospitals in a marketplace, the view is getting a concentration of owned, employed, or purchased primary care practices are again a strategy that can help drive.

The different mix here, though, is instead of going in and making an asset purchase of that practice and then bringing the physicians in as part of that asset purchase, they are actually hiring the physicians themselves and setting them up in a stand-alone clinic that the hospital would own and operate. So it is a slightly model and a slightly different twist on an old story, but it is coming back to that idea that we can somehow create value by having feeder networks of owned physicians. And again I would come back to at least prospectively what incentives some of the new DRG reimbursement methodologies may bring to the party in terms of that shift back to more primary care medical-surgical admissions as being at least marginally more lucrative way to run your mix of inpatient experiences.

Paul Ginsburg: This might be a good time to go to the thing that has come up a couple of times, and has been planned as a question, your sense of the Medicare’s proposed rule on the new DRGs and the restructuring of rates to be based on costs rather than charges and how profound an impact is that going to have if it goes through in the marketplace.

Geoffrey Harris: From the perspective from where we sit on Wall Street, I think the hospital reaction in fact has been surprisingly modest, and I do not know whether that is because they think the initial proposals are going to be so radically reformed and/or phased in that they have not reacted as strongly.

The strongest reaction, ironically, has actually been some of the medical device manufacturers particularly in the cardiovascular area because there is where the proposed cuts are largest, in the cath lab and other areas, and in some cases, the proposed cuts of 20 to 30 percent would result in payments to hospitals that are at or below the current prices of the devices going in for those procedures. I have been surprised, and I would be interested to see what the other panelists are saying at how quiet the hospitals themselves have been related to this very significant proposed change.

John Wells: I would say that most of our hospitals have a fairly good diversification of revenues and are not generally concerned about this DRG recalibration. Those that have a concentration in heart and services and maybe some other higher-acuity services are concerned and do recognize that as being a potential revenue loss. On the flip side if, the cost weighting, change to cost basis, some hospitals actually see a potential benefit in coding opportunities. But I think what we always talk about in our group is that what CMS does always has the law of unintended consequences, so we are certainly keeping an eye on it.

Robert Berenson: I was going to make one comment about the law of unintended consequences. I have been doing some work recently on trying to figure out if there is a role for hospitals in chronic care management particularly related to Medicare patients where I think you all know the data, 5 percent of Medicare beneficiaries generate 47 percent of the cost, and in particular, beneficiaries with five or more chronic conditions are responsible for two-thirds of the costs and a lot of those are related to conditions that involve hospitalization, congestive heart failure is the classic, where the CMA quality measures relate to inpatient quality, but then the patient goes home and the hospital has nothing to do with that patient anymore and some think that the hospital rather than just a third-party disease management vendor might have the sort of infrastructure and relationship and potentially community relationships with physicians to play a role in that chronic care management.

Interestingly, in talking to hospital CFOs, even in the standard cases, there is a negative business case for us investing in something to keep people out of the hospital. That is sort of the standard. That is partly mitigated by them then saying but on the other hand, if we are near capacity, we would just as soon have the heart failure patients not here so we can have those high-paying surgical patients, the stent patients, the CABG patients.

If we correct the distortions in pricing, suddenly maybe we go back to the original negative business case which is we really do want those heart failure patients and COPD patients and will not invest as much, that is a potential unintended consequence that I would be looking at. It is interesting as to the extent to which let’s say in Medicare which is administered pricing should try to pay for the underlying costs. That is what RBRVS for physicians is supposedly trying to do, and that is what we are now going to be doing with DRGs.

Instead of basing the DRG payments in charges, we are going to go back to try to allocate costs properly and based them on an underlying cost. That is not the same as providing incentives for particular behaviors that you want to see, and sometimes there can be a conflict in that, but that is an unintended consequence.

Paul Ginsburg: I think that what we are talking about is CMS trying to move from unintended incentives to neutrality, and there certainly ought to be a worthwhile discussion about how about some intended incentives.

Robert Berenson: That is better said. That is a policy issue. I think right now we are trying to get to neutrality, and the question as Paul phrases I think for the future in Medicare would be to what extent should you actually have positive intended incentives to accomplish things, and how good are you at anticipating what those unintended consequences are going to be.

Christopher McFadden: I would build on that by saying two quick comments. One is that certainly anecdotally there are a lot of people that I have heard wonder out loud whether or not it really is budget neutral because it seems at least anecdotally health systems that have gone through the methodology that was included in draft regulations have gone through their CMI, case-mix index, calibration are coming with something for what is a middle of the distribution CMI, maybe the not the type of neutrality to their anticipated reimbursement as was perhaps originally discussed.

Secondly, I think the severity indexing which is the second leg of this, and the implementation of that is at this point perhaps hard to exactly pin down, but certainly provides a bridge to what is ultimately the best outcome or the best incentive which is quality and which is always a big of a third-rail issue in any health care discussion because you get into the inevitable vortex of how do you measure it and how do you take into account all the variables.

But if we can at least get into a severity discussion and make that something that is more relevant to the reimbursement methodologies, that takes away a few disincentives around how people may be skimming away certain of the mix of patients in a particular DRG category and I think moves us down the path toward something which is a more encouraged environment which is where you begin to take both severity on one axis and quality on the other and use both of those metrics as a way to think about how to financially reward and incent providers in the marketplace.

Paul Ginsburg: A policy perspective on this is that if you take a change that at least is supposed to be budget neutral, and you would think that given the specialty hospital issue that the general hospitals as a group should be net gainers, but perhaps the net gain is not that large so that the uncertainties about maybe it is not budget neutral, or just within a trade association and the fact that there are losers among general hospitals as well as winners maybe produces the result Geoff said was kind of a modest response to it.

Clearly, the device manufacturers have the basis for it is going to hurt them a lot more. I wanted to ask a quick question about hospital leverage with health plans for prices.

I know the leverage has been strong. Do you have any sense of trends in that? Is it getting stronger, weakening, staying about the same? Or are we getting to the point with nonprofit hospitals that even if the leverage is strong, they have already reached the target margins and they are not going to keep raising prices at faster trends than costs.

Geoffrey Harris: My sense as we sit here today is that hospital pricing is, or price increases I should say, are relatively stable to perhaps slightly moderating in the mid-single digit range. Again, something that was talked about in the prior panel, the amount of health plan consolidation I think has counteracted a lot of the provider consolidation. So the net effect is that there is some balance between the two.

But I would expect going forward that particularly with benefit design changes and so forth if I had to bet that the health plans gain the upper hand here particularly with capacity expansions and also the ability to move services outside of the hospitals. I would expect moderating hospital price increases. That is one person’s point of view.

John Wells: I would agree. Our hospitals have told us of a 5 to 7 percent range of expected increases at least over the short-term. But what is important I think to note at least from our vantage point is that hospitals are certainly better negotiators of managed care contracts than they were 5 to 10 years ago, and they have a significant amount of data, more data than they had, which allows them to be better prepared when they go in to negotiate contracts and know the break-even points and know what changes to contracts will do to their profitability for these contracts.

And a lot of them have left the table if they do not get what they want, and that continues to happen. So I think that the leverage, some people have opinions about how that is shifting, they certainly are better negotiators.

What is also important to note from what we hear from our managed care analysts, and what we believe to be true, is that the consolidations have not resulted necessarily in increased leverage because there was not contiguous growth in any given market necessarily. But what it has resulted in is managed care organizations trying to restructure contracts, so there are fewer discount from charges contracts, or fewer stop- loss provisions in contracts. We are seeing that a little bit, and that does cut into the profitability for hospitals.

Christopher McFadden: The only thing I would add would be it feels like at least at the margin, and this is again a bit of an anecdotal point, is more hospitals are trying to think about multiyear contracting decisions as opposed to single year, and there may be some information content in that about what hospitals executives think the pricing environment is going to look like 18 months from now.

If you think perhaps there is a weakening trend, you are more incented to go out and try to put a multiyear managed care agreement together today in current prices, and, again, you have kind of hedged your position a little bit. Some people have strong points of view at either end of the single-year versus multiyear continuum, but it feels like those who sit in the middle of that point of view are perhaps leaning toward multiyear as a better strategy given the current pricing climate that we see.

Geoffrey Harris: I just thought of one other factor. I think a lot of this also has to do with what happens in the future, really with what employers, and more broadly, consumers and society are willing to accept. I do think that if health plans were allowed to more aggressively direct patients and exclude certain hospitals, and this has been tried in the past and there has been a lot of backlash, clearly health plans I think could exert a lot of leverage on pricing. Having said that, at least to date, employers and certainly society at large, the patients, have resisted exclusion of significant facilities from networks and that has I think in some sense artificially strengthened the hand of the providers versus the payers.

Robert Berenson: I have just two quick comments. One is I refer people to an interesting table in the March MedPAC report which documents over a period since 1986, payment-to-cost ratios, private payments to hospitals. Since 1999, it has been on an upswing probably reflecting hospitals’ desire and ability to do some cost shifting as public payers are paying relatively less. And there was a big jump between 2003 and 2004 with private payers paying a greater percentage above cost than they had been. So at least 2004, hospital leverage was still pretty good.

The second comes out of what was an issue brief we published on the specialty hospital situation. Again, this is very anecdotal, but from the perspective of some health plans, what they saw when there was increased competition for services between specialty hospitals and general hospitals, there was actually price competition for those particular services, but at least from the plans’ perspective, they paid more out to the physician venture in self-referral and ability for physicians to induce demand to their own facilities, and they also paid more to the hospitals in the other services in which the hospitals had monopoly pricing power. So the hospitals competed and lowered their prices on those heart procedures that they were in competition, but they made it up elsewhere. So at least the plans thought that they were paying more as a result of this competition, and that is why some of them anyway wanted some certification of need restrictions.

Paul Ginsburg: I would like to turn the discussion to prescription drugs now, and first begin by asking the panelists about the state of the pipeline of new drugs. I gather it has been very thin in recent years, and will it continue to be?

Geoffrey Harris: Certainly, yes, the pipeline has been thin in recent years particularly out of the larger capitalization traditional prescription companies. There has been a lot of activity coming out of biotech particularly in the oncology arena where there are some very expensive drugs that have been approved. But the net effect is that certainly on the large pharmaceutical companies, the research productivity has been very disappointing at least from their perspective.

Going forward, it is unclear. The companies are certainly spending ever increasing amounts of money to develop new drugs. The pipelines, at least as evidenced by data presented at the recent American Society of Oncology meeting and the American Diabetes Association meetings which just literally finished a few weeks ago, suggest that maybe there is a little bit of pick-up out of the larger pharmaceutical companies in terms of new and interesting product candidates.

But, of course, they are facing enormous patent expirations that are largely offsetting any possible benefit from some of these newer products. Biotech continues to be very productive and it is responsible for enormous increases in market value of some of the biotech companies, Amgen and Genentech, for example.

Christopher McFadden: I would add to that by saying one of the portions of the market that we spend time thinking about are what is known as clinical research organizations. These are companies that provided outsourced development services both to biotech and pharmaceutical companies, and they provide a bit of a unique insight because it may be the case that the companies that Geoff referred to, and I agree with Geoff’s characterization 100 percent, may be hesitant at times to let the investment community or the outside world inside the pantry.

But by looking at the activity levels of some of these organizations, you can get an interesting viewpoint, and business is, as they say, on fire. We have seen for the last several years particularly in the preclinical markets, so this is before we get into human studies but out of the lab, what has been 2 or 3 years of extraordinary growth in demand. Part of that is mixed.

Biotech, which, as Geoff alluded to, has had better success in innovation and tends to outsource at a slightly higher level than pharma does, and there is a little bit of that in the numbers. But even taking that into account, it is hard not to be encouraged and think that there is some next leg of innovation. Let me put some time stamp on this. A product that is in a toxicology test today probably does not have the prospects to be approved by the FDA for 6 to 8 more years, just to put some time horizon on what we are talking about. As we get closer to a final FDA submission, we are in full human trials, or what we call phase II to phase IV studies, and now in the last 6 months or so, we have begun to see a sharp upturn in the number of compounds that are in phase II-IV studies. Those are products or molecules that have the prospects to be 1 to 3 years away from FDA approval.

So I think after a long and somewhat painful trough of very modest productivity, at the same time that I think we have had such a heightened or a higher level of safety oversight brought to products, that perhaps this notion of wanting to dispense with the product earlier in its discovery or development cycle rather than have a negative surprise later has probably pushed out the improvement a bit further.

But I think there is strong evidence to suggest that that pipeline is beginning to build, and as we look out again maybe 2 to 4 years from now, assuming we get a normalized level of product success, that in fact we will begin to see some products to flow into the marketplace.

Paul Ginsburg: What would you say the environment is for pricing on pharmaceuticals and biologicals? When you think of the market policy, what is on companies’ minds as they are pricing?

Christopher McFadden: A tale of two cities. The biotech organizations in addition to great productivity are getting seemingly unsustainable pricing power for their products. Part of that pricing power comes from the fact that a lot of these therapies are incredibly efficacious and exist in singular markets. They treat a disease in a category for which is there is not a substitute therapy or a substitute that brings nearly the same level of efficacy, and, therefore, you really have a circumstance which from a crass economic point of view gives you a lot of pricing power.

Pharmaceuticals at the other end of the continuum could not have less pricing power, or so it seems that way. Innovation has been lower. The capacity and the success of generic companies to bring to market both broadly commercially acceptable and readily available generic substitutes and do so in a timely manner has shifted the mix there a little bit.

And even in the product categories, and Geoff probably has a more important view on this than I do, where there has been some pharmaceutical or small molecule innovation, they tend to be crowded therapies, and, therefore, managed care organizations have become extraordinarily effective at having those competing therapies compete against each other, and that impacts pricing, discounting, and rebating and some of the other mechanisms that are out there.

Christopher McFadden: I think we have a very interesting test case on this subject of pricing coming up literally June 23, and that is the day that Zocor goes generic. This is an increasingly crowded category of cholesterol management, and this is the first time that we really have a very successful, efficacious, major drug in a category where there are a lot of data around the effectiveness of the respective drugs going generic.

What we have seen, at least in one instance I can think of, is a major pharmacy benefit management company at the behest of its employer/customers in essence shut out almost completely one of the major brands in anticipation of switching the majority of their members to generic Zocor. I think what happens over the next 6 months in this category is going to have a profound impact on what happens to pricing in many of the other categories, depending on how it plays out.

Just to second something that Chris said, in the oncology area and in certain areas, there is tremendous pricing disparage because there are few alternatives, and so it is a tale of two cities.

Paul Ginsburg: Let me suggest if you have questions to put on the cards, it would be a good time to finish them up and pass them forward as we continue and prepare for the Q and A session.

In a sense, from both of you it is a real divide between what is happening in pharmaceuticals where the new benefit structures and new attitudes of employers is really very successful, versus biologicals where there is not much they can do. Presuming insurers are doing things with authorizations probably much more than benefit structure, do you have a sense of how much potential there is to react to it, or is it going to be a major cost driver for insurance?

Christopher McFadden: Geoff may have been poised to say the same thing as I will apologize, but I do think in just the last 6 months or so we are beginning to see, Paul, to your point, some early evidence that the toolkit, if you will, that pharmacy benefit managers and managed care organizations have deployed in the pharmaceutical space over the last 5 or 6 years, things like step therapies, prior approvals, things like formularies where there are therapeutic alternatives available, are beginning to encroach or beginning to be felt in what the managed care industry calls the specialty drug arena.

They do not call them biologic by name, they call them the specialty drug arena. So as some of the major PBMs have actually gone out and purchased specialty drug organizations, for example, Medco bought a company called Accredo, Express-Scripts bought a company called Priority, they are bringing some of that capability in-house and may begin to see as we look out 12 to 18 months more of that effect in some of the pricing and utilization trends.

Because I think to your point as well, clearly benefit managers and corporate employees array all the costs and what that rate of growth is, and this is one that really stands out in terms of being something that is growing faster than they would probably comfortably like to see.

Geoffrey Harris: Just following on to that, I think the question is what is the appetite today for therapeutic substitution as opposed to just generic substitution. Upon until very recently, the appetite in the employer/payer community, physician community, has been high for generic substitution, but very low for therapeutic substitution.

Again, with this illustration or case study with Zocor I think may be a first step in which we see genuine therapeutic substitution, and if in fact that plays out, there are situations with biologics where there actually are a lot of alternatives. I can think of the rheumatoid arthritis example, and there are a number of very productive products, and if therapeutic substitution becomes more commonplace, I could see competition, for example, in that area developing. Where I think you will have less competition on the pricing side at least for some time is probably in the oncology area where the success rates of existing drugs, notwithstanding a lot of progress, are still relatively low. So there is always room for a new potential drug and the manufacturer will milk the market for all its worth.

Paul Ginsburg: While I am going through these questions, this would be a good time to pose this question in advance to the panel as to if we held this meeting in 2010, and there is a good chance we will, what issues as far as hospitals, physicians, and pharmaceuticals, are we likely to be focusing on?

John Wells: I think that what is present in the hospitals that I cover, certainly the tax-exempt status of hospitals will continue to be a discussion and it will be interesting to see what happens 5 years down the road with that.

Certainly, universal health care and how health care is structured in our country. And I think what is interesting is when you talk about the cost trends in this company, and I know these are being studied, but a few of the companies that we cover are integrated delivery systems.

They have health plans, they have their own physicians, they have hospitals, and they are closed networks and the members of those health plans go to the physicians and the hospitals. Kaiser is an example, Intermountain HealthCare. Intermountain HealthCare claims that if the whole company were structured as they are, they would save Medicare billions and billions of dollars, and I think there is some truth to that, and I think there will be studies done and evolution towards looking at those types of health systems and their benefits and advantages.

Robert Berenson: I do not know about 2010, but if I could do 2015, I think one of the real challenges, once again in the Medicare context anyway, is going to be dealing with what I think is an inevitable set of disruptive technologies that are going to take things out of inpatient and to some extent outpatient hospital settings to community settings, whether it is in a physician’s office or some other place.

The question is how does Medicare address what is now an essentially siloed payment policy where it has a set of criteria to look at whether hospital margins are adequate, whether they have access to criteria, and how does public policy address the fact that actual care is shifting in the Medicare context from Part A to Part B? At that point, hospitals to some extent become a safety net not just for the uninsured, but for everybody, where there need to be some explicit subsidies to assure that there is a place for very sick people to go when lots of their ability to subsidize those services may be decreasing.

It just seems to me inevitable that just for convenience and the connection to the physician, often the same day ability to do things and the same day in the next office is going to drive things away from the hospital. Maybe I am wrong. Maybe the hospitals’ strategy of joint venturing is going to work in putting the facilities in the community. But I think we are going to have to at some point address this issue of how do you move money from one silo to the next.

Christopher McFadden: I think whenever one has a conversation about health care, you are dealing principally with the concept of OMP, other people’s money, whether that is the government’s money, the state’s money, your employer’s money, you never are talking or rarely talking about your own money. And if we are here in 10 years or 15 years, I think we are going to be talking about a radical transformation or at least evolution in which we are talking far less singularly about OPM, and we are talking a lot more about everyone in this room’s money.

That is I think the economic reality of the health care economy in this country regardless of what payer you happen to be talking about on any particular day. That does not mean we are talking narrowly to consumer-directed health plans or HSAs or what other current incarnation. I agree with Bob’s comments that it just says that as technology becomes more mobile, there is a value-to-price consideration for that innovation that is worth evaluation, and some people are going to view it as important to them and some not.

I think individuals combined with the information and a richness of content that clearly does not exist today but of which I think we are making some important progress today to empower those decisions becomes what is the dominant secular dynamic in the health care market as we know it.

Geoffrey Harris: The only point I would add, and it was mentioned in the prior panel, is that people know exactly what they spend on cable and what they get for spending a little more, and what get less of for spending a little less.

I think as health savings accounts and consumer-directed health plans and so forth continue to grow and individuals are more and more responsible for the health care dollar, that they are going to demand more information, more transparency, from hospitals, but also from all sectors of health care so that they can make with their physician more informed decisions instead of leaving it completely up to somebody else.

Paul Ginsburg: Thank you. I have a bunch of good questions here, and let me just start as a segue from what Geoff just said talking now about 2006, Please comment on the impact of price transparency initiatives on hospitals, hospital pricing, and hospital negotiation with physicians and suppliers. We hear a lot about it in Washington. Out in the hospital world does that get on their radar screen?

Christopher McFadden: My sense is modestly at best. Unfortunately, if you stack-ranked the issues that a hospital administrator woke up this morning thinking about, bad debt and the uninsured was probably on that equation, contract negotiations and managed care was on that equation, earthquake remediation in California was on that list.

I think transparency for purposes of time horizon is not yet at the top of that list, but I think having said that, is rising quickly. And clearly, both commercial payers like Humana, Aetna, what the Blue Cross/Blue Shield Association just announced, what CMS has just moved toward, is pushing that up the agenda.

I had a chance a chance to speak to a group of hospital CFOs, and the simple analogy that I used was you would envision that when the corporate managers at Dell sit around and figure out how to price the next PC, they probably have a very detailed list of what the monitor, the keyboard, the motherboard and all the other components cost, and they summarize that up. Then they put some sort of margin on it, and that is their marketing price.

I am not sure that in hospitals today we price products and services the same way. I think we sort of say what did we get for it last year, what rate of growth off of that base do we think it is going to be, and how relative we think chargemaster is and what is the competitive climate.

We sometimes do not have the type of internal cost accounting, for very legitimate reasons, that will allow us to get to that level of input cost, and I think ultimately to compete in a more transparent world, hospitals are going to have to move that way. And the suppliers that feed into those calculations are going to have to be able to speak that language and be able to contribute to that analysis.

Paul Ginsburg: I will go to the next question which is about the issue of capacity and access to care to the less-profitable line of business such as mental health. I think this question is really pointing out that if we have unusually profitable services, we also have services like mental health that are very unprofitable, and are we going to start seeing capacity problems or access problems in the let’s call them inadvertently unprofitable services?

Geoffrey Harris: This may be more of a Wall Street reaction, but ironically, a sector at least in the for-profit setting and the public market setting that is booming right now is, in fact, mental health. The companies that are providing inpatient and outpatient psychiatric services are enjoying very robust admission trends right now, and actually fairly favorable reimbursement trends. I would go back in history a little bit.

This industry did extraordinarily well through the 1980s and early-1990s and then the payers came in and dramatically restricted length of stay and put a lot of pressure on reimbursement because there had been a lot of capacity expansion. Roughly half of the freestanding capacity in this sector was shut down during the 1990s and that has resulted in perhaps even a shortage of capacity today, and, thus, improving profitability and pricing ability of the freestanding psychiatric players today. Ironically, this is a segment at least for the public companies that is booming right now.

Paul Ginsburg: Actually, maybe what we should be looking at as an unprofitable sector is primary are, and maybe that is where we will be seeing this. The next question is, Do you see the increasing use of health information technology in patient information in clinical measures having a significant effect on hospital and physician practices? Let me rephrase that. At what point do you see information technology having a significant effect on hospital and physician practices?

John Wells: I think as it relates to hospital and physician practices regarding information technology, if it is directed by the providers is a way to tie the physicians into the health system, so that is a benefit for the hospital and the health system.

As it relates to the hospitals, I think the investment in IT is going to be beneficial is you believe three things, that it is correlated with quality improvements, and that increased consumerism will have an impact on volumes, and the third thing is that if you believe that quality can result in efficiencies. We do believe all those things, and we are seeing our providers and physician practices benefit from information technology and that is expected to continue and to be more pronounced for those who can invest in information technology.

Robert Berenson: May I just make comment on that one? It seems to me that information technology is necessary but not sufficient to drive quality and efficiency? I keep thinking about all the claims for interoperability and that a physician is going to be able to document that all the tests and the MRI was done last week at the emergency room and there is no need to repeat it, on a fee-for-service system that rewards doing more, it is not clear that there is still not an incentive to repeat it.

I think you have to deal both with information technology as well as the underlying financial incentives in the system to really see the kind of behavior change that we need.

Christopher McFadden: I would add that it is interesting that some of the pay-for-performance programs that both the commercial insurers and some of the pilot programs that Medicare has put into the marketplace have some very specific milestone- and event-driven dynamics that physicians have to be attentive to to be reimbursed.

It may be something as simple as saying to a woman who is in the second or third month of the pregnancy have you started taking vitamins. That may seem like a very simply thing, but there may actually be a remuneration for posing that question, and that may be a $15 event to the physician to use perhaps a flawed example.

If you are a physician and you have seen 10 to 15 patients that day, the odds that you are going to be reminded to make that query on your own is probably pretty low and you will have let that window of opportunity pass you by. If you have some information technology that actually prompts you to make sure to participate in that pay-for-performance program with this patient at this time that you should do that test, or pose that question, or engage this discussion has a financial impact and a clinical impact, that is something that all of a sudden draws people’s interest.

We are actually seeing an interesting level of bottom-up interest in physicians actually upgrading and employing newer IT capabilities to respond to this. That does not ignore or subordinate all the other justifications for why they could be doing it, but it seems to be something that is actually drawing people to make some investment decisions.

Geoffrey Harris: I think some of it depends on who is delivering the message. I think if it were the health plan delivering the message, then it is cookbook medicine, and there is a lot of resistance in the physician community.

I think if it is third parties, if is academic research, information systems that are gathering information perhaps at the provider level, then all of a sudden it’s evidence-based medicine and that is okay and that is something that is desirable. I think the fact that that term has come into existence and is being embraced bodes well for clinical information actually beginning to have some real impact on practice.

Paul Ginsburg: Actually, the next question was about pay for performance and what impact is that having on hospital/physician relationships and where is this headed.

Robert Berenson: I earlier talked about the forces that have in some ways physicians competing with hospitals, and this is one where there is actually some potential for some synergistic behavior. Clearly, a lot of the quality measures that CMS has for hospitals in the premier demo or just in the CMS reporting, the hospitals have to engage the physicians mostly in ordering things that they had forgotten about.

It creates new systems, and at least some people in hospitals say it creates a new culture where they are providing information to physicians in some kind of a rigorous way about their performance and physicians they think respond to the data. So I think it could potentially have some impact to improved relations.

Just to say something about pay for performance, I think it is not coincidental that most of the measures that have been adopted and are being put into use are measures of underuse. They are mostly related to primary and secondary prevention, and they are not related to overuse where you have a fundamental conflict between giving somebody 2 percent more to not do something where they have 100 percent in doing it. It is a lot easier to deal with this underuse. It is important, it is primary and secondary prevention of diabetes and other important conditions, but it is a whole new challenge to use pay for performance to try to reduce spending.

Paul Ginsburg: One last question. Do any of these hospital and physician competitive strategies have implications for patients? For example, the cost of care or access to services in their community? That is what I thought we were talking about, but I don’t think we made it clear. Would anyone like to point out what are the implications of this competition for patients?

Robert Berenson: The simple answer is there will be more choices. If you want your pelvic dysfunction taken care of, you will have a few competing to do it. To me the problem is, as one of the other people in the previous panel said, it is mostly self-declared quality. It is self-declared, we are at the cutting edge, and it is our radio ad that we are the best, but we do not have real agreement on what the measures are and who is overseeing the measures so that the consumer actually has a verifiable place to go to find that those claims, those self-proclaimed assertions about quality are actually right.

Paul Ginsburg: I would like to close the meeting now, and first remind people please fill out your yellow evaluation forms. I would like to thank again the Robert Wood Johnson Foundation for its support of this conference, and kaisernetwork.org for broadcasting it. I want to thank our panelists who really did a superb job all day, and the HSC staff that you have seen at the desk and around the room.

(Applause.)

(Whereupon, at 12:02 p.m. the

CONFERENCE was adjourned.)

Participant Biographies

CHRISTINE ARNOLD - Managing Director, Morgan Stanley

Christine Arnold is a managing director at Morgan Stanley and covers the managed care industry. She joined the firm in 1999 as the senior managed care research analyst. Arnold was ranked No. 1 in the 2004 and 2003 Greenwich Survey. In 2000 and 2001, she ranked No. 2 and No. 3 in the Institutional Investor All-America Research Team Survey. Arnold has spent 14 years in investment research and has specialized exclusively in managed care for the past 10 years. Before joining Morgan Stanley, she worked in research at Goldman Sachs; Furman Selz; and Montgomery Securities; and in corporate finance at Burns Fry, a Canadian investment bank. Arnold earned her bachelor’s degree with a concentration in finance from Georgetown University.

Rober Berenson, M.D. - Senior Fellow, The Urban Institute

Robert Berenson, M.D., is a senior fellow at the Urban Institute and an expert on health care policy, particularly Medicare, with experience practicing medicine, serving in senior positions in two presidential administrations, and helping organize and manage a successful preferred provider organization. From 1998-2000, he was in charge of Medicare payment policy and managed care contracting at the Health Care Financing Administration (now the Centers for Medicare and Medicaid Services.) In the Carter administration, he served as an assistant director of the Domestic Policy Staff. He was also national program director of IMPACS-Improving Malpractice Prevention and Compensation Systems-a grant program funded by The Robert Wood Johnson Foundation, from 1994-1998. A board-certified internist who practiced for 12 years in a Washington, D.C., group practice, Berenson is a fellow of the American College of Physicians and a graduate of the Mount Sinai School of Medicine.

Matthew Borsch, M.B.A., M.P.H. - Vice President, Goldman Sachs & Co..

Matthew Borsch, C.F.A., is an investment research analyst covering the health insurance and managed care sector at Goldman Sachs. He was voted Next Generation Analyst by Institutional Investor magazines in both the 2003 and 2004 All-America Equity Research poll. Before joining Goldman Sachs in 2001, Borsch was an executive with Physicians Health Services, a health insurance company, and Telesis Medical Management, a physician management company. Prior to that, he spent 7 years as a management consultant with Accenture. Borsch is also an adjunct professor at Columbia University, where he has taught graduate-level courses on the managed care industry since 1997. He received his M.B.A. and M.P.H. from Columbia University and his undergraduate degree in economics and mathematical sciences from The Johns Hopkins University.

Paul B. Ginsburg, Ph.D. - President, Center for Studying Health System Change

Paul Ginsburg, a nationally known economist and health policy expert, is president of HSC, a nonpartisan policy research organization in Washington, D.C., funded principally by The Robert Wood Johnson Foundation. Previously, Ginsburg was the founding executive director of the Physician Payment Review Commission (PPRC), created by Congress to provide nonpartisan advice about Medicare and Medicaid payment issues. Under his leadership, the PPRC developed the Medicare physician payment reform proposal that was enacted by Congress in 1989. A highly respected researcher, Ginsburg previously has worked for the RAND Corp. and the Congressional Budget Office. He earned his doctorate in economics from Harvard University.

Geoffrey Harris, M.A. - Hedge Fund Manager

Geoffrey Harris is a principal and health care portfolio manager at a $2.5 billion hedge fund. Harris has 20 years of buy-side and sell-side analytical experience, as well as research management in health care. Previously, he was a managing director and global head of health care research at UBS, a managing director of health care research at Smith Barney and vice president of health care research at Tucker Anthony. Harris earned a master’s degree in management at M.I.T. and his undergraduate degree in economics from Oberlin College.

Robert Laszewski. - President, Health Policy and Strategy Associates, Inc.

Robert Laszewski is president of Health Policy and Strategy Associates, Inc. (HPSA), a policy and marketplace consulting firm. Before forming HPSA in 1992, Laszewski was executive vice president and chief operating officer, Group Markets, for the Liberty Mutual Insurance Group. For 10 years he also served as national adviser on health policy issues for Ernst & Young. He is North American chair of the Global Medical Forum and also chairs the forum’s work in China in partnership with the Chinese Health Ministry. He was a founding board member of the bipartisan Alliance for Health Reform, as well as a member of the Board of Overseers of the C. Everett Koop Foundation at Dartmouth and the Dartmouth Medical School. He has offered his perspective on health care reform in testimony before several committees of both the House and Senate of the U.S. Congress. Laszewski has participated extensively in the nation’s health care debate, especially on health insurance reform and the impact it will have on existing health insurance programs, the insurance industry, and the evolving role between payers and providers.

Christopher McFadden - Managing Director, Goldman Sachs & Co.

Christopher McFadden, C.F.A., is a senior equity analyst at Goldman Sachs responsible for U.S. health care services research coverage. He serves as a member of the Global Investment Research (GIR) Sounding Board. McFadden joined Goldman Sachs in 1999 as a vice president in equity research. He became a managing director in 2004 and is currently deputy business leader for the U.S. Healthcare Group. Before joining the firm, McFadden worked as a senior research analyst at Wheat First Securities (today Wachovia Securities). Prior to that, he held marketing and management positions at Xerox Corp. He serves as a board member for the Greenwich Village Center of the Children’s Aid Society. McFadden earned his undergraduate degree in political science from the University of Richmond and studied graduate economics at Virginia Commonwealth University.

Douglas Simpson, M.B.A. - Senior Director, Merrill Lynch

Doug Simpson has been a sell-side analyst for more than a decade, with experience covering managed care, healthcare services and property/casualty insurance. Simpson is the senior managed care analyst for Merrill Lynch, with which he has been associated since 1999. He previously worked as an equity analyst at Bear Stearns and J.P. Morgan. He received his bachelor’s degree from Bucknell University with a major in management and his M.B.A. from The Wharton School at the University of Pennsylvania. He was named an "up and comer" in the 2004 Institutional Investor All-America Research Team Survey and was ranked among the top 5 managed care analysts by Greenwich Associates in 2006.

John E. Wells - Senior Director, Fitch Ratings

John Wells joined the health care and higher education group at Fitch Ratings in 2000 after working with Fitch’s public finance surveillance group. Wells is responsible for analyzing and rating health care and higher education transactions. He also participates in the development of protocols for rating actions. While in surveillance, Wells was responsible for maintaining the accuracy of ratings, credit analysis, and the development of surveillance products. Prior to joining Fitch, he was a supervising analyst at the New York City mayor’s office of management and budget, where he was involved with managing the oversight of four city agency budgets. Wells earned his M.P.A. in public finance and advanced management techniques from Columbia University School of International and Public Affairs. He is a member of the Healthcare Financial Management Association, the Municipal Analysts Group of New York and the Municipal Forum of New York.