California Firms Enjoy Rollbacks in Medical Costs

When the city of Sacramento went shopping for medical insurance for its 4,000 employees this year, it got a pleasant surprise: rate rollbacks of up to 22%.

Many other employers across the state--from giant manufacturers to neighborhood retailers--are also enjoying rate cuts, or significantly smaller increases. It is a striking turnabout from just three years ago, when California industry was bemoaning medical cost increases of 10% to 15%--far higher than overall inflation.

“It seems that almost all of our clients are seeing little or no increase in their cost of health care,” said Robert B. Cliff, principal at A. Foster Higgins & Co., a Los Angeles employee benefits consultant. “It’s remarkable.”

And a huge relief, especially in Southern California, where many companies are still struggling with the effects of a prolonged recession. Lower employee medical costs might provide companies with more money for other things, such as hiring more workers, developing new products or simply shoring up profits.

Lower rates “have very significantly taken the pressure off,” said Paul Fearer, senior vice president at San Francisco-based Union Bank. “Health insurance is no longer the primary focus it once was. It feels a little more under control.”

At some companies, lower insurance costs could mean $10 or $20 extra in paychecks each month, or additional benefits.

But for hospitals, doctors and other health care providers, the cost advantages enjoyed by others are painful--at least in the short term--as they are forced to reduce their prices to win insurance business.

Both the breadth and size of insurance cost reductions in California are virtually unheard of in other parts of the country, but experts disagree on whether this achievement means that California is on the road to long-term reductions in the costs of health care services.

What is clear is that in key California markets medical prices in the consumer price index are rising at a slower pace than the rate of increase for the nation as a whole. Nationally, medical prices rose 4.6% for the 12 months ended Aug. 30. If that trend holds for the rest of 1994, it would bring the lowest national medical cost increase in two decades.

But in the Los Angeles metropolitan area, medical prices rose just 3.9% for the 12-month period. And in San Francisco prices rose 2.9% for the same period, according to the Health Care Price Index, a newsletter based in Santa Cruz. Overall, the U.S. inflation rate is about 3%.

Experts point to several reasons for the California trend. One is the continued growth of thrifty health maintenance organizations and other “managed care” insurers, which promise cost-efficiency in exchange for limits on physician choice. About 12 million Californians--or roughly half of all privately insured residents--now belong to HMOs. Nearly 8 million others belong to other types of managed care health plans.

Also, these insurers have been waging a fierce price war as they compete in bare-knuckled fashion for a piece of the nation’s biggest health care market, experts say. That price war has spilled over into the hospital industry, where a severe oversupply of beds has left many hospitals hungry for patients--and willing to sharply discount services to get them.

*

Moreover, experts say many California employers have become more sophisticated, and tougher, negotiators when shopping for coverage.

Health care executives say the fact that many Californians are paying lower insurance premiums (or seeing smaller increases) is evidence that managed care and free market competition can reduce medical costs without government interference. Many of these executives opposed the large role that government would have had in President Clinton’s moribund health reform proposals.

“A lot of us were very disappointed when we started to see government trying to get involved in reforming the health system,” said Kurt Davis, head of investor relations for Foundation Health, a Sacramento-based HMO. “If Bill Clinton went to sleep for three or four years, I think he would wake up and find that reform of health care delivery was done.”

HMO executive Roger Greaves says the California marketplace “is doing just what it’s supposed to do. . . . It’s called managed competition and if we can’t (reduce costs), then we shouldn’t be in business.” Greaves is co-chairman and co-chief executive of Woodland Hills-based Health Systems International, which owns the Health Net HMO.

*

But some health care providers complain that insurers are not shouldering their share of the cost-reduction burden. Instead managed care companies are squeezing the profits of hospitals and doctors, they say.

“Leonard Schaeffer (chairman of Blue Cross of California and its managed care subsidiary, WellPoint Health Networks) made more money last year than my whole hospital did!” said Gary Cottongim, chief executive of Redlands Community Hospital.

This fall, two HMOs that the not-for-profit hospital has contracts with “put us on notice that they are looking for rollbacks on rates.” One insurer, he said, has suggested that the hospital cut its daily room rate 10% next year.

Last year, the 203-bed hospital was forced to announce its first layoff in 12 years and has eliminated about 70 jobs--or 10% of its staff--overall. It has also trimmed costs by cutting some community service programs. Nevertheless, Cottongim says most expenses continue to grow, from employees’ wages to utility bills to the cost of everyday supplies like surgical gloves.

“I don’t think these cuts have directly affected the quality of care,” he said. “But you reach a point where you do eliminate more services, you don’t replace equipment and you can’t improve your physical plant because the dollars aren’t there. It hasn’t happened yet, but it will if we continue to absorb the impact of these rollbacks.”

As insurers demand price concessions, hospitals in competitive, urban markets are encountering a price war of their own as they vie for HMO patients to fill empty beds.

“It’s extremely competitive,” said Glen Kazahaya, chief financial officer of St. Joseph Hospital-Orange. “If you don’t reduce rates, the health plans tell you there is (another hospital) that can.”

Doctors are also feeling the strain.

Dr. Harlan Levine, a Los Angeles primary-care physician, said lower payments from insurers have cut his income and forced him to reduce his office staff. As more staff time is devoted to dealing with insurance company paperwork, he said, “that person can’t answer phones and so there is less attention to patient services.”

Most patients, he said, “are not informed about the insurance company cutbacks and they think the doctor is making the cuts. All this is leading to a schism between the patient and physicians.”

To be sure, huge premium rollbacks like the 22% cut negotiated by the city of Sacramento are highly unusual. Yet employers such as Hewlett-Packard Co., Safeway Stores, Stanford University, the University of California system and Pacific Telesis Group have struck deals to reduce medical premiums next year.

The University of California system will reduce its medical costs by $7 million next year after negotiating rate cuts with its health plans. The 90,000-employee system negotiated medical premium reductions of up to 10% for 1995 after winning an 8% rollback this year, said Carole Swartz, director of employee benefits. The state system requires all health plans to bid on a standard package of benefits, and it pays 100% of the medical insurance costs for employees who select the lowest-priced plan.

“When you have five grocery stores, you make sure they’re all stocked with the same items, but then you tell them I’ll only pay the lowest cost for those items. Suddenly, they all lower their prices,” Swartz said.

The Bay Area Business Group, a private insurance-buying coalition whose members include Bank of America, Pacific Telesis and Safeway, recently negotiated medical premium reductions ranging from 5% to 10% with 16 HMOs. And earlier this year, CalPERS, the state employees pension fund, won a 1.1% decrease in premiums for its members.

Experts disagree on whether many workers are benefiting from the slowdown in medical inflation in the state.

Some point out that some employers have reduced their costs simply by trimming benefits and requiring workers to pay a larger share of the insurance premium.

“Sure, employers are happy” about declining costs, said Robert Mofitt, deputy director of domestic policy studies for the Heritage Foundation, a Washington think tank. “They’re lowering compensation without any increase in wages. . . . What that means (is that) employees are losing compensation arbitrarily.”

But Glenn Melnick, a health policy analyst at the Santa Monica think tank RAND Corp., said workers stand to lose more when medical costs are escalating at a feverish pace.

“Employers, when deciding whether to hire, take into account the total cost of those workers. If health insurance is going up rapidly, wages are depressed. If prices don’t go up over the long run, more of those savings will show up in higher wages,” he said.

Though Melnick and others believe California may be in for several more years of reduced medical premiums, no one knows for certain if the market changes occurring in the state will offer a permanent solution for achieving medical cost deflation.

*

“Tell me in the year 1999 that costs are still down and I’ll believe it,” said health care economist Uwe E. Reinhardt, a professor at Princeton University. “I believe it’s premature to say the California model is working and will be good for the rest of the nation.”

The California premium reductions are “all very tantalizing but the jury is still out . . . ,” said Jack Rodgers, director of health policy economics at Price Waterhouse in Washington.

Rodgers noted that California still has to compete in a national market to recruit doctors and purchase equipment and drugs, “So there’s a question how far one area can get ahead of the rest of the country.”

California still has a sizable share of the nation’s uninsured: more than 6 million residents lack health care coverage. And California is not immune to other forces that will help drive medical costs up, such as an aging population, which will increase demand for medical services.

Victor R. Fuchs, a Stanford University health economist, notes that prices are cyclical in the health insurance business, so the price slowdown in California may, in part, reflect the down side of a cycle. “We may be in a cycle where people are underpricing” to boost market share, he said.

*

Fuchs added: “I’m not convinced that (health plans) know how to translate premium reductions into an actual lowering of health care costs. To do that, you either have to deliver fewer services, use fewer resources, or squeeze suppliers like the physicians, hospitals and drug companies. We really don’t know yet whether true costs have gone down.”

Alain C. Enthoven, a Stanford University business professor and the main theorist for the managed competition strategy for reforming health care, said insurance cycles may explain part of the cost reductions. But he said competition is forcing a restructuring of the state’s health care system that is improving the cost-efficiencies to health plans, hospitals and doctors.

“What’s happening is that enough employers are making the HMOs compete to provide value for the money, and giving them incentives to bring down costs.

“I see a lot of real restructuring and cost reduction in the health care system,” he said. “I see hospitals actively working to re-engineer and simplify their work processes. And I think a lot more can be done.”