Getting Along or Going Along? Health Plan-Provider Contract Showdowns Subside

Although contract negotiations between health plans and providers stayed contentious over the 2002-03 period, outright impasses dropped significantly, based on findings from the Center for Studying Health System Change's (HSC) site visits to 12 nationally representative communities. The power dynamic settled during this time, with providers -- hospitals in particular -- cementing their stronger bargaining positions and winning concessions from plans through substantial payment rate hikes and improved contract terms. Many health plans came to accept their disadvantaged standing relative to providers, and the resulting calm suggested that plans found it more practical to meet provider demands for higher reimbursement than to push back and risk a full-blown contract confrontation. While no sudden reversal seemed imminent, several developing forces had the potential to tip the scales back in favor of plans.

Providers Retain Upper Hand Over Health Plans

A convergence of factors in the late 1990s handed certain providers -- hospitals above all -- considerable bargaining power over health plans. By 2000, many providers were demanding steep payment rate increases and better contract terms, including reimbursement pegged to a percentage of charges, to make up ground they had previously ceded to plans. Providers began experimenting with more combative negotiating tactics, such as terminating contracts or threatening to do so in pursuit of new agreements. In numerous instances, negotiations deteriorated into acrimonious public disputes. The success of providers who adopted these aggressive postures emboldened others to follow, and contract standoffs became a regular occurrence across the nation during 2000 and 2001.

By 2002-03, providers had only strengthened their negotiating position. Several trends that had initially shifted the balance of power continued shaping local health care markets:

• Even with double-digit premium increases and higher consumer cost sharing, patient demand for broad provider networks persisted, continuing to weaken plans' ability to use network exclusion as a credible bargaining tool.
• Physicians and hospital systems alike pursued consolidation, leveraging the resulting unity to boost their negotiating strength.
• Providers with strong clinical reputations maintained 'must-have' status in health plan networks, giving them outsized influence at the negotiating table.
• In some markets, hospital capacity constraints reduced hospitals' motivation to offer discounts in exchange for higher patient volume.

Still, the contracting landscape had moved past the bitterness of the decade's opening years. Across the 12 communities, contract confrontations were far less common, and network instability caused less anxiety in 2002-03, as plans opted to satisfy provider demands rather than face the fallout of drawn-out, hostile disputes.

The decline in showdowns partly reflected a growing awareness among health plans that providers now held the clear upper hand. While negotiations stayed difficult, most plans approached potential impasses more carefully, recognizing the long odds of prevailing. At the same time, employers showed little resistance to premium hikes -- many simply shifted more costs onto workers -- which further sapped plans' willingness to challenge providers. Only on rare occasions when plans received firm backing from purchasers did they stand up to provider demands, occasionally with success, in the type of brinksmanship that had been widespread in 2000 and 2001.

Plans Meet Provider Demands

HSC examined plan-provider contract confrontations in three markets -- Orange County, California; Seattle; and Boston -- after its 2000-01 site visits. Just as those disputes were representative of fights breaking out nationally, the way they resolved showed both the harsh consequences all parties suffered (especially plans) and how plans reworked their contracting approach through 2002-03 as providers gained even more leverage.

The Orange County market stabilized following the 2001 clash between PacifiCare of California and St. Joseph Health System. After the two local powers split, St. Joseph reportedly held onto roughly three-quarters of its PacifiCare patients as those enrollees moved to rival plans. Most market observers concluded PacifiCare took the bigger hit from the dispute, even though one of the area's largest and most well-regarded physician groups cut ties with St. Joseph afterward because of falling HMO enrollment and capitation revenue.

Perhaps learning from that episode, other plans in Orange County largely avoided direct confrontations with providers. They accepted double-digit payment rate increases while testing new strategies -- tiered-provider networks and financial incentives for medical groups -- that might improve their bargaining position down the road. In a notable development, PacifiCare announced a new contract with St. Joseph two years after their split.

In Seattle, following the bitter contract disputes and major network upheaval of 1999 and 2000, the market's two biggest plans -- Regence Blue Shield and Premera Blue Cross -- set about rebuilding relationships with providers. In the next negotiating round, both offered higher payment rates, more flexible payment structures, and a more cooperative approach to contract discussions. Premera, for instance, established physician advisory boards to gather input on contracting policies and reimbursement rates. Both Blues moved away from adversarial negotiations in favor of network stability, adopting tools like tiered networks. Other Seattle plans viewed the Blues' accommodating stance as fueling higher medical cost trends.

In Boston, Partners HealthCare System continued to dominate because of its prestigious academic medical centers and physician organization. In 2000, Partners fought publicly with each of the three leading local plans and emerged with major payment increases, forcing the plans to raise premiums substantially. Going forward, the plans signaled their intent to avoid such controversies by adopting collaborative contracting strategies, including tiered networks and incentive-based compensation. Tufts Health Plan -- the toughest negotiator among the three plans in the 2000 round -- reached a multi-year deal with Partners that featured quality-based provider incentives, though the detailed terms were kept confidential.

Elsewhere, plans displayed a similar eagerness to sidestep prolonged public feuds. In Indianapolis, Anthem Blue Cross and Blue Shield -- the clear market leader -- faced a 2002 challenge from one of the area's four major health systems, which threatened to walk away from its Anthem contract over payment rates and terms. Instead of engaging in a public standoff, Anthem quietly resolved the tension by negotiating a quality-based incentive arrangement that tied part of the hospital's rate increase to its performance on a quality scorecard. Many observers saw these incentive-driven agreements as a path toward stronger cooperation between plans and hospitals.

Purchaser Support Aids Plans

Despite the broader trend toward fewer open clashes, plan-provider contracting still generated isolated standoffs during 2002-03. In Lansing, Michigan, and Seattle, plans tried to counter provider resistance by rallying purchaser support to pressure providers into stepping back from entrenched positions.

Lansing's two dominant market forces -- Sparrow Health System and Blue Cross and Blue Shield of Michigan (BCBSM), which controlled roughly two-thirds of the local hospital market and 70 percent of private health insurance respectively -- engaged in a fierce public battle in 2002. Described as a 'sumo-wrestling match,' Sparrow threatened to cancel its BCBSM contract at year's end unless it received a substantially larger payment increase than the 3 percent Blue Cross had offered most Michigan hospitals.

Several major employers stepped in, hoping both to restrain premium growth and to preserve access to Sparrow's services. Some declared they would not reopen enrollment periods for workers who might want to leave BCBSM for another plan if Sparrow exited the network. As observers noted, Blue Cross was effectively speaking on behalf of employers seeking to contain health care costs. One public official remarked that 'the battle is really between Sparrow Health System and large, self-funded employers.'

As the deadline approached, Sparrow and BCBSM agreed to extend the existing contract for six months. After further talks, a deal was struck. Although the final terms were not disclosed, most observers believed BCBSM -- bolstered by strong employer backing -- had withstood Sparrow's challenge.

In Seattle, despite several plans' attempts to patch up relationships with powerful providers, a significant contract dispute erupted in late 2001. Swedish Health Services, one of the region's most popular hospital systems, terminated its agreement with Aetna after the national insurer declined requested rate increases. Because Aetna was a key plan for some of Seattle's largest self-insured employers -- Microsoft, Boeing, Starbucks, and Nordstrom among them -- these companies, which bore cost increases more directly, entered the fray. Some employers praised Aetna for fighting price hikes on their behalf; others faulted Aetna for the resulting network disruption. Microsoft, notably, later switched plans in part because of the dispute.

The two sides eventually came to terms, though the specifics remained private. The episode highlighted the potential for employers to shape negotiations actively, especially by leveraging media attention to advance their position.

Will the Pendulum Swing Back?

While providers -- hospitals in particular -- appeared firmly in control of contract negotiations, and many plans had softened their approach to be more accommodating, a number of emerging trends had the potential to shift leverage back toward plans.

Escalating costs threatened to push purchasers to rethink the positions they had traditionally taken in plan-provider disputes. Historically, employers backed providers to safeguard their employees' interests -- choice of provider and access to services -- which undercut plans' bargaining leverage. But because hefty provider payment increases translated directly into premium hikes, and employers had absorbed double-digit premium increases for three straight years, this calculus was starting to change. While purchasers' roles in 2002-03 disputes remained inconsistent, the Lansing and Seattle standoffs demonstrated how employer engagement could influence outcomes and help plans resist payment increases. Still, rising patient cost sharing cushioned the impact of premiums on employers, and few had shown interest in reviving narrow network products, so the near-term direction of purchaser allegiances was unclear.

Growing community scrutiny could also check providers' ability to demand large rate increases. Partners in Boston, which had prevailed against all the market's major plans and drawn the attention of joint Federal Trade Commission and U.S. Department of Justice hearings, worked to counter perceptions that its proposed payment increases were excessive. Hospital pricing practices more broadly faced heightened examination amid controversies involving Tenet and HCA. In Orange County, where Tenet operated 11 hospitals, some observers saw the pricing scandals as evidence that hospitals had grown too aggressive and that public opinion was turning against them.

Though constrained in their ability to reject provider payment demands outright, plans pursued several initiatives to ease tensions and engage consumers more directly. The expansion of preferred provider organizations (PPOs) reflected employers' interest in broadening choices while transferring more responsibility to consumers and encouraging price sensitivity. PPO options with coinsurance -- where patients pay a percentage of the bill -- gave consumers greater visibility into covered benefits, network composition, and coverage levels. This shifted some decision-making away from plans and reduced their exposure to blame for high costs. Plans' growing interest in consumer-directed health plans followed a similar logic, putting even more authority and price exposure in consumers' hands.

Tiered-provider networks -- where consumers pay different amounts depending on the cost or quality of the provider -- represented another tool plans began deploying on a limited basis to reshape the power balance. These products could give plans more flexibility in determining rates and new leverage in price discussions. In Orange County, some hospitals accepted lower payment rates to secure placement in the preferred tier of Blue Shield of California's tiered hospital network. However, although plans in nearly all 12 markets explored tiered networks, many encountered significant barriers. Providers frequently objected, and dominant providers in some markets blocked the development of tiered products by refusing to participate. Purchaser indifference also slowed adoption. Ultimately, tiered networks and consumer-directed plans needed stronger buy-in from purchasers and consumers alike to meaningfully alter the plan-provider power dynamic.

Plans also tried to improve provider relations by offering more attractive payment arrangements, particularly incentives built around quality measures. Providers generally found these pay-for-performance programs appealing because the programs carried little downside risk and could reward high performers. Quality-based compensation arrangements for physicians and hospitals were under development in Orange County, Boston, Indianapolis, Lansing, and other markets.

Implications

The two-year period produced few contract confrontations across HSC's 12 tracked markets. While negotiations remained tense, providers -- especially hospitals -- overwhelmingly secured the terms they sought. Two key issues stood to shape the future of plan-provider relations and the balance of power.

First, plans and providers may have been developing more sophisticated approaches to contracting. The fact that only two major disputes occurred across 12 markets over two years suggested that dissatisfied parties had moved beyond hostile tactics. Efforts by both sides to negotiate more privately supported this reading, and a shared awareness of the damaging consequences of impasses may have created greater reluctance to escalate disputes.

Second, regulatory intervention could challenge provider dominance. Through consolidation and disciplined bargaining, more providers were achieving 'must-have' network status and capitalizing on it. This concentration of power prompted growing appeals from plans, purchasers, and consumers for regulatory action. The Federal Trade Commission signaled its intention to revisit previously approved hospital mergers in response to complaints about excessive hospital market concentration. The possibility of regulatory scrutiny could push providers to moderate their demands.

As providers secured large payment increases and plans maintained profitability by passing those increases on through higher premiums, purchasers and consumers emerged as the real losers in this contracting environment. Many viewed prevailing cost trends as unsustainable. Ongoing pricing pressures -- particularly if paired with a sluggish economy -- could trigger a more vigorous backlash, potentially reaching into the public policy arena with demands for rate regulation or broader health reform.

Sources and Further Reading

Strunk, Bradley C., Kelly J. Devers, and Robert E. Hurley. "Health Plan-Provider Showdowns on the Rise." Issue Brief No. 40. Center for Studying Health System Change, Washington, D.C. (June 2001).

"Bitter Contract Dispute Reaffirms Blues' Dominant Position in Lansing." Community Report No. 5. Center for Studying Health System Change, Washington, D.C. (Spring 2003).

Gabel, Jon, et al. "Health Benefits in 2003: Premiums Reach Thirteen-Year High as Employers Adopt New Forms of Cost Sharing." Health Affairs, Vol. 22, No. 5 (September/October 2003).

Mays, Glen P., Gary Claxton, and Bradley C. Strunk. "Tiered-Provider Networks: Patients Face Cost-Choice Trade-Offs." Issue Brief No. 71. Center for Studying Health System Change, Washington, D.C. (November 2003).

HSC Community Tracking Study site visits to 12 nationally representative metropolitan communities: Boston; Cleveland; Greenville, S.C.; Indianapolis; Lansing, Mich.; Little Rock, Ark.; Miami; northern New Jersey; Orange County, Calif.; Phoenix; Seattle; and Syracuse, N.Y.