HMO Model Shaken but Remains Intact

Community Report No. 09 | Orange County, Calif. | Summer 2001 | By Aaron Katz, Robert E. Hurley, Leslie A. Jackson, Timothy K. Lake, Ashley C. Short, Paul B. Ginsburg, and Joy M. Grossman

In January 2001, HSC researchers visited Orange County, California, interviewing more than 80 health care leaders as part of the Community Tracking Study. Orange County's health care market was unique in the degree to which health maintenance organizations dominated and large physician organizations assumed financial risk and care management responsibilities typically handled by health plans themselves. Despite sustained market turbulence, HMOs continued their dominance, though the model faced significant challenges.

Provider Network Disruptions

Two major disruptions shook provider networks since 1998. The first was the November 2000 bankruptcy of KPC Medical Management, the area's largest physician practice management company (PPMC), which abruptly closed 38 clinics and temporarily disrupted access to care for up to 300,000 people. KPC's failure to transfer patient records and test results in a timely manner raised serious quality-of-care concerns. The second disruption came when St. Joseph Health System terminated its contract with PacifiCare, one of Orange County's leading health plans, potentially affecting about 100,000 members who received care through St. Joseph facilities.

Capitated Managed Care Survives Under Pressure

HMO penetration in Orange County hovered around 50 percent, and health plans continued to delegate substantial financial risk to provider organizations. However, the system was under strain. Physician organizations struggled with capitation rates they believed had not kept pace with rising costs, and many sought to shed risk for services they found difficult to manage. Meanwhile, hospitals increasingly refused capitated payment arrangements, with Tenet Healthcare, the University of California-Irvine Medical Center and St. Joseph all moving away from hospital capitation.

California's Balanced Budget Act reductions in Medicare revenue, rising labor costs and statewide seismic retrofit requirements added further financial pressure on hospitals. Nursing shortages were severe, with vacancy rates reaching 20 percent of hospital nursing positions in some facilities. These forces collectively pushed the market toward a potential inflection point, with rapidly rising HMO premiums threatening to drive employer interest toward less restrictive insurance options like PPOs.

Regulatory Response and Market Outlook

The KPC bankruptcy prompted significant regulatory attention. California's newly created Department of Managed Health Care intervened to protect patient access during the transition, while new rules requiring physician organizations to report financial data were designed to prevent future collapses. The state's experience with multiple PPMC failures -- MedPartners and FPA Inc. had failed in 1998 before KPC -- signaled the end of the PPMC model in Orange County and raised broader questions about the sustainability of heavily capitated, delegated managed care arrangements.

Tobacco Revenue Strengthens Safety Net

On a positive note, tobacco settlement funds had provided a significant boost to Orange County's safety net. These resources supported expanded access to care for low-income and uninsured residents through community health centers and other safety net providers. CalOPTIMA, the county's Medicaid managed care program, continued to evolve and expand, though the program's long-term funding remained subject to state budget uncertainties.

Sources and Further Reading

This report was originally published as Community Report No. 09 by the Center for Studying Health System Change as part of the Community Tracking Study, funded by the Robert Wood Johnson Foundation.