In the course of announcing this summer that he would take a pay cut of as much as $2 million, Foundation Health Corp. Chairman Daniel D. Crowley put into words what many people think about the economics of modern medicine.
“In this environment,” he told a Sacramento audience of physicians and other health care professionals, “it’s doggone piggy to put your face that far in the trough when other people are hurting.”
As managed care sweeps through California and across the country, companies such as Crowley’s are extracting unprecedented economies from doctors and hospitals, sometimes cutting fees as much as 75%. HMO members’ premiums, meanwhile, are falling 5% to 7%.
So where is the money going?
Increasingly, to the HMOs themselves. Last year, the six largest HMOs active in California earned profits of more than $1.13 billion and accumulated combined cash reserves of $5.6 billion.
Such wealth gives these companies increasing clout in Sacramento and Washington. And it finances mergers and acquisitions that may result in less competition and choice for the medical consumer--and, possibly, higher premiums.
Perhaps most controversial, the money also turns up as multimillion-dollar salaries for HMO executives.
Crowley’s salary and bonus last year as head of California’s seventh-largest health maintenance organization was $3.255 million, making him the highest-paid HMO executive in the state. This year, he stands to make $1.5 million or less--not counting stock options that by some estimates could add $10 million or more to his earnings.
Corporate compensation experts say that with the exception of Crowley, it is hard to make a case that HMO executives are overpaid. The salary, bonus and stock options paid to Pacificare Chief Executive Alan Hoops in 1994 came to $2.27 million. That was only about 90% of the CEO’s earnings at an average company of Pacificare’s size and performance, said Graef Crystal, a prominent corporate pay consultant.
(Crowley’s 1994 pay was about three times what the CEO of a company comparable to Rancho Cordova-based Foundation would make, Crystal said.)
The main problem, Crystal said, is a philosophical one. “There is a problem when these people are slicing care, slicing services and then making a million dollars,” he said.
On average, about 80% of each premium dollar paid to California HMOs is spent on medical care, a figure known as the “medical loss ratio.” Among the state’s biggest plans, the ratio varies from more than 90% for Kaiser down to 77.3% for Foundation. Most of the rest is retained for “administrative expenses” or distributed to shareholders as dividends.
Only recently have HMO finances provoked the first stirring of public concern, mostly through the insistence of large employers on premium reductions by flush HMOs. This year, the California Public Employees’ Retirement System and the Pacific Business Group, a consortium of large Bay Area employers, demanded and received premium cuts of 5.2% to 7% from HMOs with which they do business.
“I look at the profit reports in there, some of the executive salaries, and from the purchaser’s point of view, they could share more of that with us, to put it bluntly,” said Tom J. Elkin, until recently chief of the health care division of CalPERS, which as the provider of coverage to more than 1 million state and local government workers is the largest single purchaser of health insurance in the country.
Not only customers have their eyes on HMOs’ bottom lines. Until a slight market correction this summer let a little steam out of the HMO sector, Wall Street regarded the entire for-profit health services industry as a cash machine.
The result of sharply higher market values was windfall profits for HMO executives who bought into their companies early.
Former chief executive Roger Greaves of Health Systems International, the parent of Health Net, joined 32 fellow executives in buying 20% of the company for $1.2 million when it converted from a nonprofit HMO to a profit-making entity in 1992.
By April, when a takeover of Health Net--by then the state’s second-largest HMO--was announced by WellPoint Health Networks, the value of the executives’ stake had jumped to $209 million--a gain of 13,833%. Once the takeover is complete, Greaves’ personal stake will have grown from about $300,000 to $31.8 million.
“That the people who built this multimillion-dollar institution are compensated--that’s America,” Greaves said at the time.
But critics of HMOs, including many physicians, argue that the key to their profitability lies not in American ingenuity but in the advent of a system known as “capitation.”
Most HMOs operate by paying doctors or independent medical groups a fixed monthly fee per patient. This “capitation” is designed to pay for all of that patient’s covered treatment, no matter how intensive it may turn out to be.
While that limits the downside risk for the HMO, the arrangement can impose enormous financial risk on any physician practice or medical group too small to spread it among a large number of patients.
“A health plan gives $29 to $35 a month per patient,” said Dr. Linda Bosserman, a Rancho Cucamonga cancer specialist. For that money, a doctor’s group may be required to pay for a patient’s pharmacy needs, home care, hospital days and such costly procedures as chemotherapy.
HMOs say physicians can be relied on to practice ethically, even under such constraints. But many doctors say the incentive is for groups to minimize services--or even avoid risky patients altogether--by failing to sign up the best doctors.
“If you’re a great cancer specialist, everybody wants to see you at $35 a month. But chemotherapy can cost $1,000 to $2,000 a month,” Bosserman said. “For a small medical group, it’s better to have doctors people don’t want to see.”
The squeezing of doctors’ fees is possible in this state because California over the years attracted far more physicians than are needed to treat its population.
“In California, there is tremendous excess capacity at every level” of the health delivery system, said Glenn Melnick, a researcher at the RAND Corp. in Santa Monica. With too many doctors scrambling for too few patients, California soil has proven fertile for HMOs acting as “brokers” to extract concessions.
“The basic dynamic of the system is to drive doctors out of business,” said Joseph White, who is studying HMOs on a grant from the Brookings Institution. The HMOs “are just cutting payments. That’s how they get the savings--not through managing care. But at this moment, insurers can find M.D.s faster than M.D.s can find patients.”
The Competition Factor
Still, many experts question whether the savings now offered to Californians by HMOs are sustainable. A significant portion of the cuts may be the product of the ferocious competition for customers occurring in the California market among 11 major HMOs and a score of smaller ones. As competition scales down, in part through mergers of present-day rivals, analysts say this component of the savings will disappear.
Another factor, they say, is the well-documented phenomenon of “favorable selection.”
HMOs tend to attract younger, healthier members than fee-for-service health plans because sicker patients are more resistant to changing doctors or giving up the choices that traditional coverage allows. But as market-share-hungry California HMOs begin signing up older and sicker populations, some experts say, their costs--and premiums--are likely to rise sharply.
“The savings are a one-shot phenomenon,” said Arnold Relman, a former editor of the New England Journal of Medicine and a vocal critic of for-profit HMOs. “In California, the unprecedented reduction[s] in premium prices are coming because it’s insurance for the relatively young, relatively healthy, employed people and their families.”
Already, the savings that managed-care companies extract from doctors and hospitals are being paid for by higher costs in less-visible parts of the health care system.
One 1993 study done for Medicare found that the government’s costs rose 5.7% for beneficiaries who selected Medicare managed care plans that in theory should have been cheaper. The reason: Healthier patients joined the HMOs, which were consequently overpaid for their care.
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Following the Dollars
The profits of some of California’s biggest HMOs have risen dramatically in recent years--and the organizations’ top executives have been richly rewarded. But the percentage of their premium income that the health plans have been spending on health care--the so-called medical loss ratio--in most cases has been flat or falling. That means more money is going to overhead, pay, dividends and profits.
Health Systems International (parent of Health Net)
Members: 1.24 million
Location: Based in Woodland Hills
Chairman and CEO: Malik Hasan
1994 cash compensation: $1,418,221
Revenues... Profits... Medical loss ratio (In millions) (In thousands) 1992 $1.6 $44 81.1 1993 $1.9 $24 80.1 1994 $2.3 $88 79.7
Pacificare Health Systems
Location: Based in Cypress
CEO: Alan Hoops
1994 cash compensation: $847,803
Revenues... Profits... Medical loss ratio (In millions) (In thousands) 1990 $.98 $17 86.7 1991 $1.2 $25 85.4 1992 $1.7 $43 83.2 1993 $2,2 $62 84.1 1994 $2.9 $90 83.1
Location: Based in Fountain Valley
CEO and President: Wescott W. Price III 1994 cash compensation: $953,000
Revenues... Profits... Medical loss ratio (In millions) (In thousands) 1990 $.98 $28 81.4 1991 $1.3 $40 81.6 1992 $1.5 $33 83.5 1993 $2.0 $44 83.8 1994 $2.5 $59 83.2
Location: Based in Rancho Cordova
CEO and President: Daniel D. Crowley
1994 cash compensation: $3,255,000
Revenues... Profits... Medical loss ratio (In millions) (In thousands) 1990 $.98 $11 81.1 1991 $1.1 $27 78.7 1992 $1.3 $52 77.2 1993 $1.5 $62 75.9 1994 $1.7 $82 77.3
Kaiser Foundation Health Plan
Members: 4.6 million
Location: Based in Oakland
Chairman and CEO: David Lawrence
1993 cash compensation: $1,077,129
Revenues... Medical loss ratio (In millions) 1990 $8.4 93.0 1991 $9.8 93.0 1992 $11.0 90.8 1993 $11.8 90.8 1994 $12.2 91.1
Note: Kaiser is non-profit.
Source: Los Angeles Times