Industry Outlook -- SERVICES
Turmoil. Mayhem. Cataclysm. And with all that, some really lousy profits. Health care's mightiest players thudded to earth in 1997, starkly bringing into question not only a decade of wholesale restructuring but also the future of an industry that's worth $750 billion.
In March, the U.S. government revealed a broad investigation into allegedly fraudulent Medicare billing and other practices at Columbia/HCA Healthcare Corp. that eventually led to indictments of three executives and the ouster of Chairman Richard L. Scott from the nation's largest for-profit hospital chain. Then came a string of earnings disappointments from nearly all the big managed-care insurers, a trend that culminated with the stunning admission by HMO wunderkind Oxford Health Plans Inc. that it basically had lost track of revenues and costs for an entire year.
For all the public thrashing, though, the underlying economics of health care remain unchanged. The graying baby boom is inevitably lifting demand for medical services. Yet the bill-payers--mainly employers and the government--still have the clout to press for efficiency in a system with too much capacity and few productivity improvements.
All that spells continuing concentration in an industry dominated by increasingly large and capital-intensive players. Independent hospitals and physicians will become ever scarcer, with most of them joining systems that give them more power in negotiating prices (chart). Insurers will seek scale for similar reasons, yielding networks that ultimately stretch from coast to coast. "Consolidation still makes a lot of sense," says analyst Kenneth S. Abramowitz at Sanford C. Bernstein & Co. "It's not a lot of fun, as we're seeing, but when it's over, we'll have much stronger companies."
LYING LOW. Among hospitals, Columbia probably will lie low until the federal inquiry is resolved. Indeed, it will shed one-third of its 340 properties in 1998. After that, says Chairman Thomas F. Frist Jr., it will acquire very selectively: "If there's no value added, there's no reason to have a $20 billion company." Analysts expect that 1998 profits for the giant will be about even with last year's, still 20% below those of 1996.
With once voracious Columbia on the sidelines, "the sheer numbers [of acquisitions] will not be what they had been," says Alan B. Miller, CEO of much smaller rival Universal Health Services Inc. Still, as long as the average hospital is filling just 60% of its beds, merger pressure will continue. Tenet Healthcare Corp., the nation's No.2 chain, could become more aggressive, and big not-for-profit systems such as Daughters of Charity are as hungry as ever.
The drive to reduce capacity also will spark consolidation in so-called post-acute settings such as nursing homes and assisted-living centers, as well as among providers of home health care and other lower-cost alternatives to hospital beds. Well-capitalized entrants such as Olsten Corp. and CareMatrix Corp. are pushing into these traditionally fragmented segments, eyeing growth rates far higher than the overall medical inflation rate. HealthSouth Corp., a chain of 1,700 rehabilitation and outpatient surgery centers, should see 25% profit growth next year, analysts estimate.
The argument for scale, though, is even more urgent for insurers. In many markets, their managed-care products have become commodities--offering similar benefits and sharing the same networks of hospitals and doctors--and increasingly must compete on price to win business. Insurers, employers report, are winning premium increases of 4% to 6% for 1998--higher than in the previous two years but little more than expected medical inflation.
On top of the price competition, enrollment in commercial managed-care plans is slowing, since most workers at big companies already have switched from traditional indemnity plans. Winning new customers means selling to smaller companies or stealing members from rivals--both high-cost paths. Managed care "is a business that operates on thin margins, and small mistakes can be very painful," says Aetna Inc. CEO Richard L. Huber.
That was the message, clearly, from 1997's calamitous third quarter. At both Aetna and Oxford, computer problems masked medical costs markedly higher than expected. Aetna took a $130 million charge to reflect the higher claims; Oxford took a $78 million hit, cut its profit forecast for 1998 by 25%, and watched its stock tumble to $14 a share from $76. PacifiCare Health Systems, CIGNA, Foundation Health Systems, and nonprofit Kaiser Permanente, likewise, confronted unexpectedly high claims in at least some markets.
The upshot: Managed-care insurers' earnings could rise 10% to 15% next year, but not because of huge medical savings. "Really, there are few economies in the delivery of care," says Leonard D. Schaeffer, CEO of WellPoint Health Networks Inc. Rather, costs could jump as Medicare cuts payments to hospitals, which in turn may raise prices for commercial consumers. "As the government squeezes the balloon on one end, it's going to come out on the other," says David B. Friend, a managing director at benefits consultant Watson Wyatt Worldwide.
On the other hand, Schaeffer notes, "there are tremendous economies in administration, finance, and customer service. Our endeavor is to be in that business." But creating advantage there means investing in costly data systems that, besides billing premiums and paying claims, can track patients' medical histories and analyze physicians' treatment strategies. In two years, Aetna has quadrupled the number of employees developing quality measures for doctors and hospitals. New York Life Insurance Co.'s NYLCare Health Plans unit expects to spend $100 million on systems over two years.
JUST CAUSE. Such investments can pay off only when amortized across many customers. So Wellpoint, which bought the health operations of John Hancock Mutual Life Insurance Co. and Massachusetts Mutual Life Insurance Co. in 1997, wants to expand from its California base to 5 or 10 major markets. Aetna likewise "will continue to seek acquisition opportunities," says Huber. Oxford, which still enjoys preeminence in the wealthy New York metropolitan market, could be a target.
The rise of national HMOs surely will invite scrutiny from a nation uneasy with managed care's failings, real or imagined. Already, hundreds of bills aimed at regulating HMOs are circulating in statehouses and Congress--and some could add a lot to health costs. In essence, "society wants inflation," Abramowitz observes.
Ultimately, society has just cause. The current system is proving to be mediocre at managing medicine. It hasn't demonstrated better quality. And it does little for the uninsured, who now number 41.4 million, according to the Employee Benefit Research Institute.
Certainly, insurers still call the shots. But hospitals and doctors, backed by popular support and steeled by consolidation, are taking back ground. Powerful models for health-care delivery are forming in local markets, where medical providers are merging disparate services. In the past four years, for example, University Hospitals of Cleveland has affiliated with or acquired 300 primary care physicians, built a skilled nursing facility and home health-care service, and established a 110,000-member managed-care plan.
Such systems that succeed--and the challenges are formidable--could win price concessions and compete for patients with the largest of insurers. That is where the industry's sturm und drang is headed: bigger, more powerful players battling for local markets. Much blood will be spilled before the winners emerge.By Keith H. Hammonds in New York, with Susan Jackson in Connecticut and Nicole Harris in AtlantaReturn to top