NEWS ANALYSIS : Health Merger Would Redefine the California Market

WellPoint Health Networks and Health Systems International have agreed to a $1.8-billion merger that would create the nation’s largest publicly held health maintenance organization and alter the California health care marketplace, sources said Tuesday.

The agreement by the two Woodland Hills-based companies, to be formally announced today, would create a giant with the resources, membership and negotiating clout to offer employers a broad range of services. The combined company could also lower its costs and offer employers potentially greater savings, some analysts say, although consumer groups contend that just the opposite would happen as the company gained greater market power.

The merged entity would also seriously contest Kaiser Permanente’s position as the dominant player in the state’s hotly competitive health care market--possibly forcing Kaiser to cut its costs and accelerate changes in its operations. And it could pressure smaller rivals to merge themselves in order to keep up.

A combined WellPoint and Health Systems--the corporate parent of the Health Net health maintenance organization--”would redefine the California market from top to bottom,” said Peter Boland, a health care consultant in Berkeley. “It now clearly sets the state for a direct challenge to Kaiser’s market dominance.”

The merger accord--under negotiation for several weeks--was reached Tuesday afternoon following an agreement on the last major sticking point: who would run the combined company. Malik M. Hassan, Health Systems’ co-chairman, would become chairman. Leonard Schaeffer, chief executive of both WellPoint and its 80% owner, Blue Cross of California, would be president and chief executive.

Under the plan, which requires the approval of regulatory agencies and both companies’ shareholders, Health Systems’ stockholders would receive 1.09 shares of WellPoint common stock for each Health Systems share. In addition, WellPoint stockholders would get about $1.2 billion cash in connection with a related WellPoint financial reorganization.

WellPoint stock gained 62.5 cents a share to close at $34.375 on Tuesday; Health Systems jumped $1.375 to finish at $33.75.

The merger comes after offers to acquire WellPoint, from Blue Shield of California and Kohlberg, Kravis Roberts & Co., were rejected by WellPoint and Blue Cross. Blue Cross and Blue Shield are unrelated.

By creating a $5-billion, for-profit health plan with 4.2 million members--mostly in California--the WellPoint-Health Systems combination raises a host of other issues for health care providers and consumers.

Some consumer advocates and physician groups express concerns that such mergers largely benefit big for-profit managed-care companies and their investors at the expense of patients and health care providers.

Industry observers say nonprofit Kaiser, with 4.6 million members in California and 6.6 million nationwide, would be severely tested by the WellPoint-Health Systems merger. In California, Kaiser has already struggled with declining membership during a period of intense competition. That is a dramatic turnaround from six years ago, when Kaiser’s enrollment was growing so fast it turned away applicants for lack of room.

“If I were Kaiser, I would be extremely nervous,” said Alan Katz, a principal at Woodland Hills-based Centerstone Insurance and Financial Services, a big insurance broker.

Industry watchers noted that a WellPoint-Health Systems combination would offer a breadth of products that could prove compelling for small and large employers, who are the biggest purchasers of health care. Virtually all of Health Systems’ 1.6 million members are in HMOs. WellPoint also operates an HMO, CaliforniaCare, but the bulk of its 2.6 million members are in less-restrictive managed-care plans known as preferred provider organizations, or PPOs. WellPoint and Health Systems also offer so-called point-of-service plans, which give members more freedom to choose doctors, and workers’ compensation programs.

In contrast, Kaiser traditionally has offered one product--an HMO--providing fewer options for members and employers. Kaiser has built its success around an efficient, tightly controlled organization that requires members to use Kaiser doctors, hospitals and clinics. Only recently did it began offering an option that allows members statewide to use outside doctors.

Cary Badger, health plan manager for Kaiser’s Northern California region, concedes that WellPoint and Health Systems would be tough competitors.

But he sees Kaiser’s reliance on HMOs as a strength rather than a weakness.

“Yes, they are a competitive force that offers a breadth of products,” he said. “But I think most people in managed care would would argue that the end game is getting people into HMOs.”

The merger could also pose new problems for a group of medium-size or smaller California HMOs such as FHP International, Foundation Health and Pacificare, whose membership would lag well behind that of Kaiser and WellPoint-Health Systems. FHP and Foundation have already been scouting for merger partners and now may be forced to step up those efforts.

“It does create a Coke-and-Pepsi environment, but there’s a lot of money to be made in being Dr Pepper and Seven-Up,” Katz said. “The California marketplace is so huge and people have such diverse needs that there are no two companies that can satisfy them all.”

But Tom Elkin, health care chief for the California Public Employees Retirement System, one of the nation’s biggest purchasers of medical care, said it may be difficult for smaller health plans to survive. He predicts that by the year 2000, there will be only three to five large health plans operating in California, roughly half the current number.

“If the number of plans gets too small, that could be a problem in terms of less competition and performance,” Elkin said. “But it’s really too soon to tell.”

Others worry that the WellPoint-Health Systems could hurt consumers and health care providers.

“Mergers and buyouts don’t come free,” said Steven Thompson, vice president of government affairs for the California Medical Assn., a physicians group that has been critical of the HMO industry. “We have found that all this corporate merger activity comes out of the hides of physicians and patients.”

Jeanne Finberg, a staff attorney with the Consumers Union office in San Francisco, shares those concerns about HMO mergers. “There seems to be a serious decrease in competition in the market that is likely to restrict consumer choice and access,” she said.