Wall Street Comes to Washington

Originally published by the Center for Studying Health System Change (HSC), a nonpartisan policy research organization funded principally by the Robert Wood Johnson Foundation.

Wall Street Comes to Washington: Where Is Health Care Headed?

Even as health care spending growth moderated slightly in 2002 and 2003, employers and workers braced for yet another year of double-digit health insurance premium hikes heading into 2004. At the Center for Studying Health System Change's eighth annual Wall Street roundtable in August 2003, financial analysts and health policy researchers examined cost trends, the hospital competitive landscape, specialty hospital growth, construction booms, and the uncertain future of Medicare managed care. The broad consensus: few effective cost-control tools remained after the retreat from tightly managed care, and premiums would keep climbing while employers pushed more expenses onto workers.

Health Care Cost Trends: Slower Growth but Still Elevated

After surging for several years running, underlying health care spending per privately insured person decelerated for the first time in five years during 2002, dropping to 9.6 percent growth from 10 percent in 2001, according to HSC data. Yet premiums kept accelerating through 2003, averaging 15 percent increases, and would have reached 18 percent had employers not raised deductibles, copayments, and coinsurance levels to absorb part of the blow.

Joy Grossman, HSC associate director, pointed out that with the pullback from tightly managed care, "there are really few viable tools for controlling health care costs." In a weak labor market, employers had grown "much more aggressive about shifting" expenses to their employees. Looking ahead, increased cost sharing might dampen spending somewhat, but expanded capacity in high-margin services like cardiac, cancer, and orthopedic care could push costs higher. Without a meaningful brake on spending, Grossman warned, "premiums are likely to continue to rise rapidly, consumers are likely to become responsible for an even larger share of their medical expenses and more people are likely to lose coverage altogether."

Financial analysts at the roundtable expected cost and premium growth to continue moderating, though Norman M. Fidel of Alliance Capital Management cautioned that insurers would likely keep pricing premiums above actual cost trends to avoid being caught off guard if spending spiked again. Meanwhile, enrollment had shifted markedly from health maintenance organizations to more loosely structured preferred provider organizations, as consumers demanded broader choice and fewer restrictions. Many HMOs had relaxed their own gatekeeping and specialist referral requirements in response to public criticism. As HSC President Paul B. Ginsburg observed, the transition from tight to loose managed care was "pretty much over," and that completion itself was helping moderate the cost trajectory.

Roberta Goodman of Merrill Lynch stressed that managed care companies needed to forecast cost trends more accurately so they could deliver "stability and predictability in the costs they present to their customers, rather than underpricing one year and trying to catch up with dramatic cost increases in the following years." Many insurers had invested in information technology to process claims faster and gain real-time visibility into spending patterns, helping them set premiums more precisely.

Searching for a Cost-Control Strategy

Controlling health care spending in the years ahead posed a formidable challenge. Goodman cited new medical technologies, the aging population, and Americans' deep appetite for health care services as persistent cost drivers. She also noted a "pervasive failure in this country to follow evidence-based medicine, which has tended to increase costs."

Rather than adopt sweeping changes like tiered provider networks or consumer-directed health plans, most employers were making incremental benefit adjustments. Some plans experimented with tiered networks to channel patients toward less expensive, higher-performing hospitals and physicians, but Goodman predicted this approach would gain traction only in larger markets with meaningful price variation among providers.

Consumer-directed health plans generated substantial buzz but drew skepticism from employers. Goodman warned of two fundamental weaknesses. First, these plans risked segmenting the risk pool by attracting younger, healthier enrollees, leaving the sicker and more expensive patients concentrated in traditional plans. Second, consumer-directed designs could not realistically address the small slice of the population that generates the bulk of health care costs. A more productive strategy for high-cost patients, she argued, would be to identify them early, improve coordination of their treatment, and close gaps in their care. "At the end of the day, it doesn't matter what kind of plan you're in; it matters what data you have, what kind of clinical programs you have and whether or not the interactions with the consumers and providers are constructive and motivate changes in behavior on both sides."

Hospitals Strengthen Their Position While Physicians Lag Behind

The hospital industry was enjoying what Gary Taylor of Banc of America Securities called "probably the best" stretch in two decades. Occupancy rates had rebounded, giving hospitals greater leverage in negotiations with health plans. After a generation of contraction that had taken the industry from 5,000 acute care hospitals with 1 million beds down to 4,800 hospitals with 800,000 beds, 2001 marked the first year licensed bed capacity had grown since 1983. Total industry margins rose in 2002 for the first time since 1996, and for-profit hospitals in particular had hiked rates aggressively.

Large hospital systems with strong brand recognition in their communities held a distinct advantage in contract talks with health plans. Still, health plans had grown more aggressive in negotiations too, particularly around stop-loss provisions for expensive cases. Goodman noted that when Blue Cross Blue Shield of Tennessee refused terms demanded by HCA hospitals, the insurer picked up 200,000 new members, suggesting that patient loyalty ran more strongly to physicians than to hospital brands.

Physicians, lacking the organizational leverage of hospital systems, had secured far smaller rate increases. Many responded by investing in specialty outpatient facilities where they could capture greater revenue. As Fidel observed, physicians had been "at the low end of the totem pole as far as rate increases, and that's contributed to them taking a lot of procedures into settings where they can make more money in the process."

The Specialty Hospital Boom

Hospitals focused exclusively on cardiac care, orthopedics, and other lucrative procedures were multiplying rapidly. Federal law already restricted physicians from referring Medicare and Medicaid patients to facilities in which they held financial interests, but an exception for whole hospitals allowed physician-owned specialty institutions to operate freely. CMS Administrator Tom Scully said the agency had considered narrowing the exception but concluded it lacked the legal authority to act unilaterally, urging Congress to step in.

Though only about 100 specialty hospitals existed at the time, the market was growing fast. Taylor described cardiovascular services as a $140 billion market expanding nearly 10 percent annually, with orthopedics approaching $100 billion and growing at about 7 percent. Operating margins of 20 to 30 percent made these segments irresistible to private investors and equity firms. Physician ownership was "absolutely critical to the growth of this industry," Taylor added, and if Congress removed the whole hospital exception, "this industry goes away overnight."

Meanwhile, ambulatory surgery centers continued to proliferate, numbering about 4,000 at that point. Services that once required hospital settings were migrating into physician offices at a rapid clip. Cataract procedures, gastrointestinal scoping, and other common interventions increasingly took place outside hospital walls, eroding a revenue stream that urban nonprofit hospitals especially could not afford to lose.

A Hospital Construction Wave

With interest rates at 45-year lows, hospital construction spending jumped 20 percent in 2002 and another 20 percent in 2003. Eighty-six percent of nonprofit hospitals surveyed by Banc of America planned expansions within two years. Suburban locations with affluent demographics and favorable payer mixes were the hottest markets.

Yet hospital balance sheets were not uniformly strong. Bruce Gordon of Moody's Investors Service noted that in only three of the past 15 years had bond rating upgrades outpaced downgrades. In 2003, downgrades ran at 3.5 times the rate of upgrades, and 10 percent of nonprofits carried ratings below investment grade. Moody's expected credit quality to hold steady in 2003 but face "strong pressure in 2004 and beyond."

Many hospitals were doubling the size of their emergency departments and outpatient facilities. Gordon described packed emergency rooms where patients waited in chairs because there were not enough treatment bays. He viewed these expansions as a smarter use of capital than the acquisitions and physician practice purchases of earlier years, three-quarters of which had "stumbled coming out of the blocks." Ginsburg raised the possibility that hospitals were "overshooting" with construction plans, and Taylor agreed that nonprofit hospitals "may overshoot the mark," as they had done historically.

Medicare Advantage and Prescription Drug Reform

CMS Administrator Tom Scully expressed confidence that Medicare reforms then moving through Congress, which bundled prescription drug benefits with an overhaul of the managed care program, would make Medicare Advantage attractive again. Before the Balanced Budget Act of 1997 constrained payments, "Medicare HMOs were unbelievably popular, especially with poor people in inner cities," Scully said. Health plans, he added, "follow the money like everybody else."

Wall Street analysts were less optimistic. Goodman called the prevailing euphoria about Medicare reform and drug benefits representing "an opportunity for everybody throughout health care" unrealistic. Fidel expected a Medicare drug benefit to lift pharmaceutical sales by 4 to 6 percent but warned that drug makers' "ultimate fear" was government price controls if spending ballooned. He doubted any pharmacy benefit manager "would accept risk in a stand-alone drug benefit as part of a Medicare program," as proposed in the Senate bill. Goodman agreed that such a program "could be a party to which hardly anybody comes."

Conference Panelists

The roundtable was moderated by Paul B. Ginsburg of the Center for Studying Health System Change. Panelists included Norman M. Fidel of Alliance Capital Management, Roberta Goodman of Merrill Lynch, Bruce Gordon of Moody's Investors Service, Joy M. Grossman of the Center for Studying Health System Change, Tom Scully of the Centers for Medicare and Medicaid Services, and Gary Taylor of Banc of America Securities.

Sources and Further Reading

Centers for Medicare and Medicaid Services — Federal agency overseeing Medicare and Medicaid programs.

Health Affairs — Peer-reviewed journal covering health policy and spending trends.

Kaiser Family Foundation — Health policy research and employer health benefits surveys.

Robert Wood Johnson Foundation — Health and health care research philanthropy.