Doctor-Operated HMO Struggles to Find Antidote for Ailing Profits

Times Staff Writer

A health maintenance organization that is run by the doctors for the doctors--that's how some Wall Street analysts and medical industry observers describe San Diego-based Western Health Plans.

That perception is fueled by what analysts described as a unique stock ownership structure in which about 75% of the company's publicly traded shares are owned by the 1,100 doctors who provide medical care for Western's 110,000 members.

"It's essentially a family corporation, with aunts, uncles, cousins who are all doctors," according to one medical industry analyst who last year stopped following the company because of its failure to turn a profit. "And as doctors, they all have different objectives than cold-hearted stockholders."

In San Diego, Western operates the Greater San Diego Health Plan.

Doctors' Role Questioned

Wall Street analysts who follow the company wonder if the dominant role enjoyed by Western's doctors is so heavy that Western's board of directors is effectively kept from running the company.

For example, Western recently decided to place caps on how much physicians can receive for each patient visit. But Western has lagged behind other companies that previously placed caps on payments, according to analysts.

Analysts also questioned Western's plan to establish a "clinic" that would use computers and a central staff to operate, for a fee, the business side of its doctors' medical practices. The company has described the operation as a potential moneymaker, a view shared by some analysts. But at least one observer described the program "as more of a service for the doctors than a (business that will create a) revenue stream."

Western "has to decide if it wants to be a public company or a consortium of physicians that is in business for themselves," according to Anthony Marlon, founder and chairman of Las Vegas-based Sierra Health Services, which has competed against Western in Nevada. "Maybe they should do the outside investors a favor and take the company private, where they can run it as they see fit."

Hurt by Competition

As doctors, Western's majority shareholders "want to be paid more (for services rendered), but the company doesn't want to raise its premiums," according to Thomas Cope, an industry analyst with Dillon Read in New York.

Western has been hurt by increased competition during recent quarters.

It reported a $5.8-million loss during the fiscal year ended June 30, after a $740,000 loss during the previous fiscal year. The most recent annual loss included a $1.7-million charge during the fourth quarter to cover costs associated with Western's decision to abandon its fledgling HMO in Nevada.

However, Western President Robert Erra predicted that the company will be able to control its costs and return to profitability during the fourth quarter ending June 30, 1988.

Mirrored Price Wars

Nationally, health insurers have been hurt by competition that mirrors the price wars that depressed margins after the airline industry was deregulated, Marlon said.

"There are too many players trying to sell the same product at almost the same price," Marlon said. "We're beating each other over the head."

Even the nation's largest health insurance companies "are struggling along at below cost" in an attempt to build market share, according to Western founder and Chairman Allan Goodman. "(But) the big companies can't tolerate (continued) losses . . . so there will be a shakeout in the HMO industry."

Western's ability to survive that coming shakeout will be determined by how well it controls costs.

'Conflict of Interest'

"There is an essential conflict of interest between what the physicians want--which is more money--and what (Western) wants--which is less money for the doctors," according to Charles Ewell, a La Jolla-based consultant who works largely with health-care providers. "One side of the house is always pulling on the other."

Goodman, who regularly spends 12-hour days at his practice before attending to his chairman's role, acknowledged that Wall Street has expressed concern about that heavy ownership role.

"There is a conflict between the provider who needs remuneration and the company that needs to make a profit," Goodman acknowledged during a recent interview.

Some doctors "say it's bad for (Western) to make a profit," said Goodman, who maintains that Western must be a "strong and profitable company" in order to compete with larger, better-capitalized companies such as Kaiser Permanente.

Competition Has Advantage

The competitive advantage enjoyed by HMOs such as Kaiser was a central issue in 1978 when Goodman helped to create Western as a privately held, not-for-profit HMO in 1978. Western subsequently went public in December 1984.

During the mid-1970s, Goodman assumed that doctors in independent private practices would find it hard to compete with larger, cost-efficient HMOs that were gaining in popularity with corporations that wanted to control exploding health-care costs.

Western, a so-called "individual practice" HMO, had built-in appeal to independent doctors who were "gradually losing control over the marketplace," according to Ewell. "That erosion was very bothersome to them."

"Our challenge was to take a group of independent doctors and meld them into a system that could compete with (better-capitalized) HMOs," according to Goodman, who emphasized that Western "does not regard medicine strictly as a business. We still think it's important for doctors to exert an influence over various types of care provided in the medical marketplace."

Appealed to Doctors

That strong ownership role appealed to doctors who wanted to remain independent--but who saw the importance of being associated with an HMO, Goodman said.

Western's emphasis on a strong involvement for its doctors still is evident in the HMO's current advertising campaign. Western's radio commercials argue that it offers "the only health plan where all decisions affecting the quality of your care are made by physicians, not business managers."

In addition to a strong voice in Western's medical decision-making, that ownership role also brought the promise of benefits that eventually would be generated by stock ownership, Goodman said.

However, an inherent clash arose because doctors, who collect fees for services rendered, always want to be paid more money, but in the highly competitive HMO industry companies can't raise premiums to pay for increased fees, according to one medical industry analyst.

Reduction Needed

"Western has to reduce its expenses, and the biggest expense it has is doctor fees," Ewell said. "But the thing is like a dog chasing its tail."

The doctors who bought Western stock have seen its value plummet. Western's stock, which hit a high of $5.50 during the past year, recently has been trading for about $2. It closed Monday at 1 3/4.

Western has responded to increased competition with cost-containment measures that Erra believes will return the company to profitability. Analysts believe Western will benefit from a recent premium increase and the decision to put a cap on per-patient payments.

Analysts also credited Erra, who previously was an executive at UC San Diego Medical School and the Scripps Institution, with enticing Dr. Joseph Marcarelli to postpone a planned retirement and serve as Western's medical director. Marcarelli is credited with creating and running several successful HMOs in the West.

Owns Real Estate

Goodman, a successful businessman who owns real estate in San Diego and operates a health club, lays partial blame for Western's financial woes on the Wall Street analysts who constantly badger business managers to "tailor their operations (for) immediate rather than long-term results."

That short-term emphasis was to blame for Western's ill-fated foray into Nevada, according to Goodman.

"We were told that Wall Street is not impressed (by HMOs) that are only in one state," Goodman said. "We made a mistake in Nevada, one of the few mistakes we've made."

In the wake of the decision to abandon Nevada, Western decided to focus on growth in the Southern California market outside its stronghold in San Diego.

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