Wall Street Comes to Washington:

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

Analysts' Perspectives on Health System Change

Issue Brief No. 17, December 1998

Wall Street security analysts took a hard look at the latest health care industry trends at the third annual roundtable convened by HSC. The discussion centered on costs and premiums, evolving financial relationships among industry players, consolidation dynamics, and pharmaceutical and technology developments. The analysts' bottom line: several market strategies -- vertical integration, provider risk-sharing, equity arrangements, and formularies to control drug costs -- had not panned out as expected. Health plans and provider organizations had yet to discover a reliable formula for controlling costs while meeting demands for broader choice.

Costs and Premiums

Nationally, medical costs were growing 3 to 5 percent per year -- somewhat higher than a few years earlier but well below the early 1990s. The analysts blamed undisciplined pricing for plans' profitability struggles. Fat margins in 1993-94 attracted competition, driving premium increases to 0-2 percent for three years. By 1996, only 35 percent of publicly traded HMOs were profitable. Premiums rose 3.3 percent in 1998, up from 2.1 percent, but far less than industry predictions of 5-7 percent. The number of competing HMOs had mushroomed from 550 to over 800 since 1993.

Drug Costs Climb Steeply

Drug costs as a share of managed care expenses climbed to roughly 15 percent, with 1997 seeing increases as high as 20 percent. Drug benefits under managed care were more generous than fee-for-service. Direct-to-consumer advertising spending hit $1.5 billion, triple the amount two years earlier. Drug production was expanding 15 percent in 1998, with 90 percent of growth in volume, not price. The FDA approved 42 new drugs in 1997 and 54 in 1996. Formulary controls reached only 5-10 percent of Americans. Whether higher drug spending was reducing costs elsewhere remained unclear.

Technology Impact and Financial Rethinking

Harris predicted technology breakthroughs would drive 4-5 percent annual cost increases regardless of care management. The industry was rethinking capitation and risk-sharing. Some payers had bailed out financially troubled providers. The percentage of managed care patients in capitated arrangements had actually declined. Capitation might not work for growing open-access and point-of-service plans. Network design posed thorny trade-offs between access, breadth, and cost control, though broad networks did not automatically mean higher costs.

Consolidation Continues, Vertical Integration Falters

Consolidation would continue but at varying paces. Many local markets were becoming natural oligopolies with three to five dominant plans. Hospital consolidation pace had slowed after Columbia/HCA's problems. Vertical integration had clearly lost momentum, especially hospital purchases of physician practices. About 41 percent of physicians remained in solo or two-person practices. Early consolidation models like PPMCs had largely failed, but newer models avoiding asset sell-offs showed promise. The analysts expressed mixed feelings about the industry's direction -- no magic bullet for managing care and controlling costs had emerged.

Sources and Further Reading

AHRQ — Federal health care quality research.

CMS — Quality Initiatives — Federal quality programs.

Health Affairs — Peer-reviewed health policy research.

Robert Wood Johnson Foundation — Health policy research.

Commonwealth Fund — Research on health care quality.