Integration Strategies Unravel, Competition Intensifies:

In October 1998, researchers traveled to Seattle, Washington, to study the community's health system, its ongoing changes and the effects on consumers. More than 40 health care market leaders were interviewed as part of the Community Tracking Study, a collaboration between the Center for Studying Health System Change (HSC) and The Lewin Group. Seattle was among 12 communities that HSC tracked biennially through site visits and surveys. The first visit, in October 1996, established baseline data for monitoring subsequent developments. The Seattle market was defined as the metropolitan statistical area covering King, Snohomish and Island counties.

A Once-Stable Market Heads for Upheaval

In 1996, Seattle's historically isolated and remarkably stable health care market had appeared poised for transformation. The state had passed and then repealed comprehensive health reform. Boeing, the region's largest employer, began steering workers into managed care. Health plans started contracting selectively with physicians, national plans showed new interest in the market, local insurers consolidated and adopted a regional outlook, and local health systems pursued vertical integration to compete for managed care business.

By 1998, health maintenance organization (HMO) enrollment had grown more slowly than anyone anticipated, and several notable shifts had occurred:

• Multiple providers abandoned efforts to run their own health plans and overhauled their physician integration strategies.
• The traditionally local character of the health plan market was eroding as plans increasingly pursued national and regional agendas.
• Hospital competition had intensified, with a new emphasis on building out specialty product lines.
• Turmoil in the individual insurance market and public programs had reduced the number of plans available to vulnerable populations.

Managed Care Growth Falls Short of Expectations

HMO enrollment and capitated payment arrangements had expanded more slowly than projected, catching both providers and health plans off guard. Although HMO market penetration climbed from 19 percent in January 1996 to 29 percent by July 1997, it still trailed the average for large metropolitan areas and remained low by West Coast standards. Providers estimated that capitation accounted for only 25 to 30 percent of their revenue -- far less than they had forecast. The popularity of point-of-service (POS) products may have played a role, since capitation is harder to implement under those looser arrangements.

Several factors explained the relatively modest HMO penetration. Seattle's market had long consisted of local not-for-profit insurers and providers that coexisted comfortably for more than 50 years. Purchasers and consumers were generally satisfied with local prices, access and quality. Only the homegrown Group Health Cooperative of Puget Sound had substantial HMO enrollment, and it remained a relatively small slice of the overall market. Because local costs and utilization were already low, HMOs had limited ability to offer purchasers dramatic savings, and Seattle consumers generally resisted the constraints of closed-panel plans.

Anticipated policy drivers also failed to produce the expected enrollment surge. The state's 1993 comprehensive health reform bill had been expected to push most of the population into HMOs, but major provisions were repealed between 1994 and 1996. Boeing's 1996 decision to incentivize managed care enrollment successfully moved HMO participation from 10 to 50 percent of its workforce, but other employers did not follow suit, limiting the broader market impact.

Providers Exit the Health Plan Business

In response to changing market conditions, several providers gave up on operating their own health plans. Providence Health System and Virginia Mason Medical Center both sold their large plans -- Providence's to Regence Blue Shield, and Virginia Mason's to Aetna U.S. Healthcare, which used the acquisition to re-enter the Seattle market. A plan established by the state medical society in 1995, Unified Physicians of Washington, shut down after absorbing heavy losses. And Care Net, a plan sponsored by the University of Washington and Premera Blue Cross, was folded into other Premera products.

Sluggish HMO enrollment prevented these provider-sponsored plans from reaching the scale needed for viability, but they also faced more fundamental problems. Most had been created to support the provider's core clinical business by acting as referral feeders and extending geographic reach. Instead, the administrative burden of running an insurance operation diverted management attention and resources from hospital and clinical operations. No single provider system had sufficient geographic coverage to serve the broader Puget Sound region on its own, and securing favorable contracts with hospitals and physicians in outlying areas proved difficult.

Physician Integration Strategies Under Revision

The lackluster managed care environment -- combined with physician oversupply and depressed reimbursement -- prompted Seattle providers to rethink the ownership-based physician integration strategies they had pursued for years. Virginia Mason, a multispecialty group with clinics throughout northwestern Washington and a hospital in Seattle, shifted from acquiring practices outright to building contractual relationships instead. The most dramatic case was Medalia Healthcare, the region's largest primary care group. Launched in 1994 by Providence and Franciscan Health System, Medalia had amassed 45 clinics and more than 300 physicians. But its business model depended on large-scale capitated enrollment that never materialized -- it had projected four times the capitated lives it actually managed by 1998.

In late 1998, Medalia announced a major restructuring, splitting into three geographically focused units, reducing its clinic count and forging tighter relationships with specialists and affiliated hospitals. In Seattle, it signed contracts with the market's two largest multispecialty groups, PolyClinic and Minor and James, securing preferential rates, risk sharing for capitated lives and a stronger referral base. Whether this retooled approach would succeed remained to be seen, but it typified the broader adaptation underway as Seattle providers adjusted to unexpectedly slow capitation growth.

National and Regional Plans Reshape the Insurance Landscape

Until recently, a handful of local health plans had controlled 70 to 75 percent of the Seattle market. By 1998, five national plans had entered through acquisitions and affiliations, gradually eroding the locals' dominance. Kaiser Permanente Northwest affiliated with Group Health. Aetna U.S. Healthcare acquired Virginia Mason's plan and, through its national purchase, NYLCare's local enrollees. United HealthCare entered via its acquisition of Travelers' small local book of business.

The two local Blues plans were also expanding beyond Seattle. Blue Cross of Washington and Alaska, rebranded as Premera Blue Cross, began marketing throughout the Northwest, while independent Blue Shield plans across Washington and neighboring states consolidated to form Regence Blue Shield. These moves reflected the evolution of Seattle's economy: Boeing's merger with McDonnell Douglas prompted it to standardize benefits nationally, and other local companies acquired by national corporations were pushing for contracts covering broader regional and national employee bases.

Group Health, still the largest HMO in Seattle, continued to lose market share and sustain financial losses. Its 1996 affiliation with Kaiser was supposed to provide access to national accounts and resources for infrastructure improvements, but the anticipated benefits had not materialized, and the organization was reportedly scaling back the relationship.

Individual Insurance and Programs for the Poor Under Pressure

Seattle's health plans, like those elsewhere, had suffered significant financial losses in recent years. Problems were especially acute in the individual insurance market and public programs. Insurance reforms -- including portability, guaranteed issue and limits on pre-existing condition exclusions -- had raised plans' costs, while the state capped premium increases. Premera Blue Cross, the largest individual carrier, secured a contested 19 percent rate increase in 1996 but continued losing money and ultimately announced it would stop accepting new individual applications in December 1998. Group Health and Regence Blue Shield also sought regulatory permission to cap enrollment on certain individual products.

Many individuals were turning to the state's Basic Health Plan (BHP), which offered subsidized coverage for the working poor and unsubsidized coverage at higher income levels. Because BHP benefits were more comprehensive than most individual policies -- including immediate maternity coverage -- the unsubsidized component suffered severe adverse selection. Pregnant women enrolled for obstetrical coverage and then dropped out after delivery. Inpatient utilization among nonsubsidized enrollees ran nearly two and a half times higher than among subsidized enrollees. Premiums for nonsubsidized BHP coverage skyrocketed 62 percent from 1998 to 1999, following a similar jump the prior year.

The state's Medicaid program, Healthy Options, faced its own difficulties, particularly with automatic enrollees who tended to have higher-than-average health costs. Several plans priced their products higher to avoid receiving automatic enrollees, while others withdrew entirely. The state's requirement that plans offer both Medicaid and BHP products if they wished to participate in either one meant that dropping one product forced exit from both, further reducing consumer choices.

Hospitals Compete Aggressively Along Specialty Lines

New pressures bore down on Seattle's providers as shifting alliances redirected referral patterns and health plans squeezed reimbursement. Competition among area hospitals intensified around key specialty lines, particularly cardiac and cancer care. Hospitals that had once been praised for cooperative behavior and community-oriented decision-making were now seen as aggressively pursuing reputation and market share at rivals' expense.

The cardiac care battle escalated in 1996 when Group Health established a joint POS product with Virginia Mason and closed its downtown hospital, shifting tertiary care -- including high-end cardiac work previously sent to the University of Washington -- to Virginia Mason. The University of Washington responded by launching a cardiac-care joint venture with Northwest Hospital. Swedish Medical Center recruited most of Providence Seattle Medical Center's cardiologists and established an aggressive new cardiac health management program.

A parallel fight emerged in cancer care. Fred Hutchinson Cancer Research Center was launching the Cancer Care Alliance with the University of Washington and Children's Hospital, including a jointly sponsored outpatient center that would direct inpatient care exclusively to the University of Washington Medical Center and Children's Hospital. Previously, Fred Hutchinson had referred inpatients to Swedish Medical Center or Children's; now Swedish stood to lose roughly 9 percent of its daily census. National carve-out specialty management companies like Cancer Treatment Centers of America also entered the market, adding another competitive dimension.

Issues to Track

Escalating competition and the arrival of national players had pushed Seattle's local organizations to find ways to protect and strengthen their core businesses. As managed care growth plateaued, providers, plans and state policy makers appeared to be in a period of reassessment and adaptation. Key questions going forward included what strategies would emerge as providers moved away from vertical integration, how intensifying specialty competition would affect relationships among physicians, hospitals and plans, whether the local character of the Seattle market would continue eroding, and what impact ongoing difficulties in individual insurance markets and public programs would have on both plans and beneficiaries.

Sources and Further Reading

• Community Tracking Study Household, Physician and Employer Surveys, 1996-1997, Center for Studying Health System Change.
• U.S. Census Bureau, Population Estimates, 1997.
• Fountain, D.L., Gournis, E., Lesser, C.S. and Alvarez, D., "Integration Strategies Unravel, Competition Intensifies: Seattle, Washington," Community Report No. 06, Winter 1999, Center for Studying Health System Change.