Consolidation Continues, Financial Pressures Mount:

In February 1999, researchers visited northern New Jersey to study the community's health system, its evolution and the consequences for consumers. More than 60 health care market leaders were interviewed as part of the Community Tracking Study by the Center for Studying Health System Change (HSC) and The Lewin Group. Northern New Jersey was one of 12 communities HSC tracked biennially through site visits and surveys. The first visit in April 1997 created the baseline for monitoring changes. The study area was defined by the Newark primary metropolitan statistical area (PMSA) and included Sussex, Warren, Morris, Essex and Union counties.

Consolidation Meets Financial Pressure

At the time of HSC's 1997 visit, hospitals in northern New Jersey had recently undergone extensive consolidation in response to the deregulation of hospital rates and expected growth in managed care. The closure of one inner-city hospital had triggered concerns that services would migrate to the suburbs and that access in urban areas would deteriorate. Since then, hospital merger activity had slowed. Dire predictions about inner-city access and safety net viability had not fully materialized, though some downsizing had occurred. Health plan consolidation, however, had accelerated sharply due to both national and local mergers.

Other key developments since 1997 included:

• Two health plans collapsed amid allegations of unsound financial deals, mismanagement and inadequate state oversight, disrupting both providers and consumers.
• Hospitals and many health plans struggled with deteriorating financial performance.
• Efforts to build physician-hospital contracting entities and expand risk arrangements had stalled.

A Diverse Market Shaped by Local and Regional Forces

The northern New Jersey market, as defined by the Newark PMSA, spanned a diverse landscape of inner cities, affluent suburbs and rural communities. The area was notable for its extreme concentrations of both wealth and poverty and significant ethnic and racial disparities. Health status varied widely, with rates of AIDS and substance abuse in Newark among the highest in the nation.

The urban-suburban divide segmented the hospital market, with some systems anchored squarely in the suburbs and others operating almost entirely in inner cities. Health plans, by contrast, typically operated on a statewide or regional basis with broad provider networks to serve the area's large employers and its many commuters traveling to and from New York, Pennsylvania and Delaware. With unemployment at just 4.8 percent, employers offered generous, nonrestrictive health benefits to attract workers. HMO penetration remained low at 24 percent, compared with 34 percent for metropolitan areas nationally, and organized purchaser activity was minimal.

State policy had played an important role in shaping the market. In the early 1990s, New Jersey began deregulating the hospital industry -- abolishing rate setting, relaxing certificate-of-need regulations and restructuring the charity care reimbursement program. More recently, the state turned its attention to managed care regulation. The broad-ranging Health Care Quality Act, signed in August 1997, established consumer protections and a health plan report card documenting patient satisfaction and clinical performance.

Health Plan Failures Shake the Market

The collapse of two health plans sent shockwaves through northern New Jersey. HIP of New Jersey, a prominent group-model HMO, had been in dire financial condition since at least 1997. It sold its physician practices and clinics to PHP Healthcare, a Virginia-based company that was itself heavily indebted and operating at a loss. Although PHP's financial condition continued to worsen, the state contended it had limited regulatory authority over the arrangement because it was structured as a subcontract with an out-of-state entity. When PHP went bankrupt, the state took over HIP's operations and ultimately dissolved it.

The demise of American Preferred Provider Plan (APPP) followed a different path: its owner diverted plan funds to affiliated businesses that defaulted on loans, and when net worth fell below state solvency requirements, regulators assumed control and filed for bankruptcy on the plan's behalf.

After each collapse, the state worked to ensure continuity of care and facilitate enrollment transfers to other plans. APPP's 32,000 Medicaid enrollees were moved to another plan relatively smoothly. HIP's liquidation caused greater disruption, requiring more than 100,000 consumers including roughly 22,000 Medicaid beneficiaries to find new coverage. The state mandated a 30-day open enrollment period, but new premiums were frequently higher than what consumers had been paying, and an estimated 30,000 HIP members had still not selected a new plan by the enrollment deadline.

The failures also hit providers hard, leaving an estimated $80 to $120 million in unpaid HIP claims and more than $37 million in APPP claims. Under eventual settlements, hospitals and physicians received 30 cents on the dollar for pre-takeover HIP claims and 20 to 23 cents for APPP claims. The state moved to raise health plan solvency requirements and increase regulatory oversight, while legislative proposals backed by the governor would create a guaranty fund -- financed by contributions from health plans -- to protect against future plan failures.

Consolidation and Worsening Finances

The most conspicuous consolidation was taking place among health plans. Aetna Inc., already the largest HMO in the area with more than a third of enrollees, had grown its market share substantially through its 1997 merger with U.S. Healthcare and subsequent acquisition of NYLCare in 1998. Federal approval of its acquisition of Prudential stood to increase its market power even further, prompting concern from providers and consumer groups about reduced payments, higher premiums and diminished choice. Horizon Blue Cross Blue Shield of New Jersey, blocked from a proposed merger with Anthem, repositioned itself for expansion into Delaware and New York markets under the Horizon brand.

Health plans broadly faced diminishing profit margins after years of holding down premiums to build market share. Plans were seeking increases of 10 percent or more for 1999 contracts.

In the hospital sector, merger activity had slowed. St. Barnabas Health System, formed in 1995-1996, now included 11 hospitals and was the state's largest system. Atlantic Health System, formed in 1996 with four community hospitals, pursued a merger with the Robert Wood Johnson Health System that would have made it even larger, but the deal collapsed in early 1999 over disputes about control and mission differences. Via Caritas, a three-hospital Catholic system formed in 1997, dissolved entirely when its members concluded they had little to gain from remaining together.

Both surviving merged systems -- St. Barnabas and Atlantic -- struggled with poor financial performance. While both had made progress on administrative consolidation, there had been little consolidation of clinical services or capacity. System-level infrastructure investments proved costly, and absorbing the debt and excess capacity of financially weak hospitals weighed on performance. Statewide, hospital operating margins had deteriorated from 1.4 percent in 1996 to negative 1.3 percent in 1998. Hospitals attributed the decline to shortfalls in state charity care funding, financial repercussions from plan failures, continued payer demands for discounts and the growing impact of the federal Balanced Budget Act of 1997.

Physician-Hospital Contracting Entities Gain Little Traction

A major objective of the recently formed hospital systems was to improve their bargaining position for managed care contracts by coordinating contracting across hospitals and affiliated physicians. Both St. Barnabas and Atlantic pursued such strategies, with mixed results.

Atlantic launched Health Resource Partners (HRP), a large-scale management services organization designed to handle risk contracting for nearly 800 affiliated physicians across four hospitals, investing $12 million in infrastructure. But HRP was unable to negotiate acceptable terms with plans, largely because plans refused to delegate clinical care management responsibility along with financial risk. Atlantic scaled back HRP to serve physicians at a single hospital. St. Barnabas, after retreating from a strategy of purchasing physician practices that yielded fewer benefits than expected, was developing the St. Barnabas Physician Partnership, a super-PHO targeting more than 4,000 physicians. The partnership secured a Medicare demonstration project using global payment at three hospitals, which provided an important initial contract and potential proof of concept.

Outside these system-level initiatives, physician organization remained quite limited. Most doctors continued practicing in solo or small-group settings. While many local PHOs existed, they did not require physician exclusivity and wielded little market power as a result.

Safety Net Survives but Remains Under Strain

In 1997, many observers had predicted that the northern New Jersey safety net was in peril, primarily because of hospital rate deregulation and the adoption of mandatory Medicaid managed care -- both expected to push hospital payment downward and potentially threaten the financial viability of inner-city hospitals. Since then, the overall financial environment for providers had indeed worsened, and some safety net downsizing had occurred. But the worst-case scenarios had not come to pass.

State funding for charity care had dropped dramatically from $700 million in 1992 to $300 million in 1997 with the implementation of rate deregulation. In 1998 and 1999, however, funding was modestly increased to $320 million annually, and the Hospital Relief Fund, targeting institutions with disproportionate shares of high-cost cases like HIV/AIDS and complex neonatal care, received an additional $58 million, bringing it to $183 million total. These increases particularly benefited inner-city hospitals, though their provision of charity care continued to exceed state funding.

Some inner-city hospitals found ways to mitigate financial pressure. Newark Beth Israel, now part of the St. Barnabas system, appeared to benefit from its affiliation with financially stronger hospitals. Others leveraged NJKidCare, the state's children's health insurance program established in April 1998, to capture reimbursement for previously uninsured patients, though slow enrollment limited the gains.

Mandatory Medicaid managed care, phased in rapidly since 1995, now covered 95 percent of eligible Medicaid welfare beneficiaries and was generating an estimated $400 million in annual savings. A low auto-assignment rate relative to other states was considered a marker of success in minimizing negative impacts on enrollees. However, community health centers reported revenue declines under capitation and growth in uncompensated care, leading several to close sites, reduce hours, cut staff and scale back outreach programs.

Issues to Track

Northern New Jersey's health care market continued to experience substantial change. Consolidation was proceeding in both the hospital and plan sectors, though more slowly for hospitals. Financial performance had deteriorated for hospitals and many health plans alike. Hospitals were pressing the state for increased charity care funding and stricter plan payment oversight, while plans were asking employers to accept higher premiums. Physicians remained largely unorganized, with little bargaining power in the market. The safety net had not deteriorated as catastrophically as feared two years earlier, but serious financial pressures persisted.

Key questions ahead included what impact health plan consolidation -- particularly Aetna's growing dominance -- would have on premiums, provider reimbursement and competition, how the state's regulatory role would evolve in the wake of plan failures, whether hospital finances would stabilize and whether systems would begin consolidating clinical services and capacity, whether PHOs and other physician contracting entities could gain traction in securing risk contracts, and whether safety net providers would remain viable as financial pressures continued to mount.

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.
• Lesser, C.S., Gaylin, D.S., Andersen, A.M. and Brown, L.D., "Consolidation Continues, Financial Pressures Mount: Northern New Jersey," Community Report No. 12, Spring 1999, Center for Studying Health System Change.