Health Plan-Provider Confrontations on the Rise

Health Plan-Provider Confrontations on the Rise

Issue Brief No. 40 -- June 2001 -- Bradley C. Strunk, Kelly Devers, Robert E. Hurley

Over the past two years, a growing number of contract disputes between health plans and hospitals and physicians have flared up in local markets, according to recent Center for Studying Health System Change (HSC) visits to 12 nationally representative communities. Many providers are taking a firm stance in negotiations, threatening to end health plan contracts if their payment demands are not met. These confrontations signal a shift in the power balance in local markets toward hospitals and physicians, and they can potentially disrupt care for large numbers of patients, particularly when the disputes involve a community's largest and most prominent hospitals and physician groups. This Issue Brief presents case studies of confrontations in Boston, Orange County, Calif., and Seattle, illustrating the evolving market dynamics fueling these disputes and the consequences for consumers, including higher costs and reduced access to care.

Evidence of a Shifting Power Balance

The growing frequency of managed care contract disputes over the past two years reflects a transfer of bargaining power from health plans to providers. Five years earlier, health plans were gaining strength as HMO enrollment expanded and restrictive provider networks seemed poised to become the industry standard. Pushed onto the defensive by plans, providers frequently agreed to steep discounts in exchange for promises of higher patient volume. At the same time, providers pursued strategies -- such as consolidation, geographic expansion, and hospital-physician integration -- to bolster their negotiating position.

Confronted by a vigorous backlash, however, managed care plans lost ground in recent years. Purchaser and consumer demand for broad provider choice -- reinforced by debates about any-willing-provider laws in many states -- meant that restrictive networks did not dominate as expected. Instead, health plans had to build and maintain large provider networks to remain competitive, diminishing their leverage over providers. Indeed, after years of building market share and strengthening their brand identities, some providers now enjoy "must-have" status in plans' networks. At the same time, emerging inpatient capacity constraints -- particularly among hospitals with strong reputations -- have boosted hospitals' bargaining power, making them more willing to walk away from plan contracts.

Furthermore, serious financial pressures have driven providers to negotiate more aggressively with health plans. After years of low reimbursement and less patient volume than expected under commercial contracts, providers also faced Medicare payment reductions and other challenges, including higher labor costs from nursing and other staff shortages. These financial strains, combined with greater sophistication in managed care contracting strategies and tactics, brought an end to the era when some providers uncritically accepted contract terms. Emboldened by the managed care backlash, providers are testing the limits of their emerging bargaining power. As a result, contentious negotiations between providers and plans are becoming more common across the country.

Orange County Standoff Impacts 100,000 People

The contract termination between St. Joseph Health System and PacifiCare in October 2000 caught many off guard, given the long and close relationship between the hospital system and the health plan. The fact that the termination would last for five years made the news even more startling. A large percentage of St. Joseph's employees were enrolled in PacifiCare's HMO, and for many employees at PacifiCare's national headquarters less than 15 miles away, St. Joseph and its affiliated physicians were preferred providers. With more than 100,000 people affected -- roughly a third of PacifiCare's local enrollment and a quarter of the people enrolled in St. Joseph's affiliated physician practices -- the community fallout was expected to be substantial.

St. Joseph leveraged a strong clinical reputation and solid financial position to assemble a healthcare delivery system comprising three hospitals with nearly 900 beds and a large number of owned and affiliated physician groups housed under an associated foundation. Consistent with HMO contracting practices in southern California, St. Joseph held risk-based contracts for more than 400,000 HMO members across 14 different health plans.

Like many Orange County providers, St. Joseph faced mounting financial strain under its capitated contracts as medical costs grew faster than expected. Pressure to comply with California's seismic retrofitting standards added to the burden. In June 2000, while existing contracts were still in force, St. Joseph unveiled a new contracting strategy. Through a bid solicitation process, the hospital system proposed drastically reducing contracted plans from 14 to five partner plans. In a bold move, St. Joseph essentially turned the tables on health plans, threatening to exclude them unless they agreed to significant payment increases and five-year contracts incorporating new terms, including per diem payments instead of capitation for inpatient hospital services.

The major plans scrambled to meet the new contract requirements, and ultimately all reached agreement except PacifiCare. The standoff could not have come at a worse time for PacifiCare. As the nation's largest Medicare HMO contractor, PacifiCare was hit hard by the 1997 Balanced Budget Act, which limited most Medicare plans to only a 2 percent annual payment increase. Many of the plan's providers were beginning to reject risk contracts. The plan's stock price plummeted in mid-2000, and key senior executives turned over. Then, the St. Joseph disruption struck directly in the plan's home market.

The dispute played out publicly in the community through newspaper stories and advertisements filled with accusations and conflicting claims about expected payment increases. The confrontation's intensity and timing -- coinciding with the open enrollment period for many local firms -- reportedly dismayed employers and consumers and caused great uncertainty. Informed observers estimated that when the full impact of the contract termination became clear, perhaps half of the 100,000 people involved would end up with other plans or providers, with both St. Joseph and PacifiCare losing volume and substantial revenue, at least in the short term.

Specialists Gain Ground in Seattle

In the late 1990s, many Seattle physician groups faced increasingly difficult financial circumstances. Some suffered from poorly negotiated fee-for-service and risk contracts, while others lost referrals and struggled with reduced Medicare and Medicaid payments. Health plans compounded physicians' financial stress by holding payments relatively flat for several years. Under mounting financial pressure, some large physician organizations successfully resisted plan demands and avoided unfavorable reimbursement changes.

One of the most widely publicized disputes occurred in late 1999 between several single-specialty physician groups and Regence Blue Shield, Washington's largest insurer. Regence had decided to adopt recently enacted Medicare physician fee schedule changes for its commercial products, causing reimbursement for surgical services to decline relative to primary and pre- and postoperative care. Although Regence claimed the overall reduction would be only 3-5 percent across all specialties, some surgeons argued payments for certain services would drop by as much as 30 percent. In October 1999, about 150 Seattle specialists chose not to renew their Regence contracts effective January 1, 2000, to protest the new payment system.

Several factors converged to give the groups significant leverage: they represented a substantial share of Seattle's specialists, including a large neurology practice, a major orthopedic practice, and the biggest general surgery group; physicians realized that leaving a particular health plan would not necessarily be a fatal business decision; and the physician groups launched a proactive education and advocacy campaign that generated considerable support from insurance brokers, employers, and Regence itself.

Responding to unhappy employers and consumers, Regence worked to bring the surgeons back into the plan's network by convening a physician advisory panel. In June 2000, Regence and the surgeons reached a compromise after six months of negotiation and a period when consumers either had to find new physicians or pay higher out-of-pocket costs to see their current ones. Although the plan did not yield to all of the physicians' demands, Regence agreed to delay implementation until 2001 and incorporate adjustments to boost surgical service payments under the new system. Most observers viewed this as a significant win for the specialty groups.

Prestigious Hospital System Prevails Over Major Boston Plan

Partners HealthCare System and Tufts Health Plan announced a parting of ways in October 2000. Although they eventually reached an agreement, more than three months of contentious contract negotiations took a toll. Tufts and Partners -- which includes the renowned Massachusetts General and Brigham and Women's hospitals and more than 4,000 affiliated physicians -- could not agree on payment rates. A contract termination could have caused an estimated 100,000 people to lose access to Partners' hospitals unless they selected another plan that included the hospital system in its network.

Claiming losses of $42 million from treating Tufts' enrollees over the previous two years, Partners argued it could no longer accept payments that failed to cover the system's costs. According to local news reports, Partners initially demanded a 29.7 percent increase over three years, or 9.9 percent annually. Partners' earlier success in securing a double-digit payment increase from Blue Cross and Blue Shield of Massachusetts, the largest Boston health plan, further emboldened the hospital system.

Tufts countered with a much smaller increase. Meeting Partners' demands, Tufts contended, would require immediate premium increases of 20-25 percent, threatening a loss of business the plan could not afford. On top of rising medical costs, the plan was recovering from significant financial and membership losses, largely due to an ill-fated regional expansion strategy in the late 1990s.

However, Tufts faced mounting pressure to return to negotiations. Partners' contract termination during Tufts' largest annual open enrollment period put the plan at a disadvantage, creating the possibility of large-scale enrollment shifts if members wanted to maintain access to the Partners system. As the impasse played out in the media, consumers and physicians flooded both organizations with calls expressing concern about losing access to Partners' providers, while local employers pressed the two sides to find a resolution. The state attorney general, though limited in authority to intervene, sent a letter urging both parties to resume negotiations and avoid disrupting consumers.

Shortly after Partners broke off negotiations, Tufts attempted to contract directly with some large physician groups affiliated with the system. But physicians decided it was in their best interest to remain aligned with the hospital system. With few remaining options, Tufts resumed talks with Partners one week after the breakdown, and the two sides settled several days later. While neither side disclosed specifics, Tufts confirmed the deal included significant payment increases.

Lessons Learned

Much of how these confrontations played out is typical of the contentious contract negotiations that HSC has observed in communities nationwide. In each case, prominent providers challenged health plans and demonstrated a readiness to terminate or simply not renew contracts. Recognizing that the threat of withdrawal gave them the upper hand in the current market environment, these providers drew a line in the sand.

At stake in the short run was the threat of considerable consumer disruption. Both providers and plans turned to the news media or made direct appeals to patients to rally them as allies, contributing to a general sense of instability in the healthcare system. In two cases, final breakdowns in negotiations coincided with plans' open enrollment seasons -- a time when the opportunity for enrollees to switch plans leaves those plans most exposed. Some large local employers used their influence with plans to press for settlement and avoid disruption for employees. In contrast, state policy makers and regulators were largely absent from these disputes because contract disagreements among private organizations typically fall outside their authority. However, one notable exception occurred in Boston, where the state attorney general urged both sides to reach an agreement out of concern for potential consumer harm.

In most recent confrontations, plans have largely conceded to providers' demands. Events in Orange County vividly illustrate what can happen when they do not -- significant disruptions to access and continuity of care. However, plans are quick to point out that the consequences of capitulation may be even more serious, especially if higher provider payments are financed by increased premiums and greater consumer cost sharing.

This predicament is likely to persist in the near future. As providers remain under financial strain from low payment rates, rising costs, and slower Medicare revenue growth, more aggressive bargaining with health plans represents one of the few avenues for relief. A key concern among the plans involved in the disputes in Boston, Orange County, and Seattle was that provider pushback could snowball as others, sensing an opportunity, would model their negotiations on the trailblazers. Although not all providers will secure better contracts, HSC's observations suggest that organizations with strong reputations and solid physician-hospital relationships are well positioned to succeed.

New market developments could diminish these advantages, especially if rising premiums and a slowing economy renew interest in restrictive network products. Formal or informal involvement of state and local policy makers could also play an important role in constraining providers' aggressive negotiating tactics going forward. In particular, perceptions that providers have accumulated excessive market power and can command inflated prices could trigger antitrust scrutiny, which might lead providers to moderate aggressive behavior over time.

Ultimately, the extent to which the power balance shifts back toward health plans remains an open question. Much will depend on the strength of the brand-name status and consolidated market power that providers have built over recent years and on the persistence of consumer and purchaser resistance to restrictive managed care. In the near term, both sides appear prepared to test these positions, which for consumers makes the prospect of continued network instability and higher costs likely.

Sources and Further Reading

KFF Employer Health Benefits Survey — Kaiser Family Foundation data on health insurance premiums, employer costs, and the market dynamics that drive plan-provider contract negotiations.

Health Affairs: Managed Care and Provider Networks — Peer-reviewed research on managed care backlash, provider bargaining power, and the effects of plan-provider disputes on consumers and costs.

CMS Medicare Physician Fee Schedule — Medicare reimbursement policies and fee schedule changes that contributed to the financial pressures driving provider contract disputes.

Commonwealth Fund: Health Insurance Market Research — Research on health insurance market dynamics, network adequacy, and the impact of provider consolidation on consumer access and costs.

AMA Managed Care Contract Resources — American Medical Association guidance on managed care contracting, physician negotiations with health plans, and network participation decisions.