As Cutbacks Hit Limit, Health Costs Rise Anew

Health care costs are on the rise once again as inflation, demographics and change sweeping the managed-care industry combine to undercut the effects of several years of frenetic cost cutting.

The reversal of the health cost pendulum is being blamed on the rising costs of drugs and medical technology, health care mergers that reduce competition, a bid by HMOs to shore up sagging profits, the aging work force and fear that further cost cutting could endanger the quality of care.

The shift was underscored Tuesday when the influential California Public Employee Retirement System, a leader in forcing costs down, announced a 2.7% rise in HMO premiums for its members next year--its first increase since 1993.

And the federal government reported Tuesday that consumer medical costs rose 0.4% last month, their sharpest rise since December 1995.

Over the past several years, the shift of millions of people into health maintenance organizations and other managed care plans has saved employers--and, to a lesser degree, consumers--billions of dollars.

California, dominated by HMOs, has been the scene of some of the most aggressive cutting. In the Los Angeles area, managed care firms have pushed monthly medical premiums as low as $85 per member, believed to be the lowest rate of any major U.S. city.

While premiums were being lowered, the underlying cost of medical care has been rising only slowly. Last year, for the first time ever, the growth in the medical component of the consumer price index--in California and nationally--hovered slightly below the overall U.S. inflation rate of about 3%.

Stanford University health economist Alain Einthoven has estimated that CalPERS alone has saved $1.7 billion in the past five years because of the ability of managed care, when pressured by the million-member pension fund, to slash medical premiums.

But those days are over for the foreseeable future. In California, experts forecast that medical premiums paid by employers and their workers will rise 4% to 6% next year--a relatively modest hike when contrasted with the double-digit spikes in medical inflation that wreaked havoc on the nation’s economy earlier this decade.

The increase is expected to be higher nationally. And costs are expected to rise more rapidly for non-HMO plans, including traditional indemnity plans and managed care plans that allow patients greater freedom to choose doctors.

The increases will be bad news for employers spoiled by several years of lower medical inflation that has helped them keep employee compensation costs under control. And consumers will feel the jolt when employers pass those additional costs through to workers, compensation experts say.

Small businesses, which experienced premium increases of 6% this year nationally, and their workers already are feeling the accelerating costs. Small firms generally lack the bargaining clout of large businesses.

“Health care cost pressures have resumed and will continue to build,” said Henry E. Simmons, president of the National Coalition on Health Care. “Unfortunately, it seems the ‘easy’ savings in health costs have already been squeezed out.”

The reasons behind the sharp drop in medical premiums over the past few years, and their current rise, are complex. For one, managed care companies have accepted narrower profits to gain more members and greater market share.

Industry officials and analysts say that some California HMOs have in recent years priced their commercial medical premiums--that is, their non-Medicare business--at or below cost to gain business.

“Most of the large HMOs in California have not been making a profit on the commercial business,” said Dr. Jacque Sokolov, chief executive of Advanced Health Plan, a Los Angeles consulting firm.

At the same time, managed care firms have demanded that doctors and hospitals accept sharply lower fees. This, in turn, has set off a flurry of mergers among insurers and providers scrambling to gain more market clout.

Those mergers, some analysts say, are another factor behind accelerating medical costs by creating ever-larger health insurers, medical groups and hospital systems with control over big blocs of patients.

“When the number of competitors goes down, the level of price competition also goes down,” said Glenn Melnick, a professor at USC’s School of Public Administration specializing in health care finance.

“Prices have firmed up in the market for hospital and physician services. Some medical groups are so large that the health plans don’t have a viable alternative but to contract with them. There is concern that this consolidation is getting to the point where it might be anti-competitive.”

The most recent examples of HMO mergers are the pairing of PacifiCare Health Systems and FHP International, and the marriage of Health Systems International and Foundation Health, forming Foundation Health Systems.

The merging companies insist that they will save money by their consolidations, and employers will try to translate that into lower premiums.

“Some of this merger activity we are seeing should result in increased efficiencies that we expect to see reflected in the premiums,” said Patricia Powers, executive director of the Pacific Business Group on Health, an influential health insurance purchasing coalition of such major California employers as Bank of America and Chevron Corp.

But the managed care companies argue that they face pressures of their own that justify higher premiums. Industry profits were pummeled last year by higher-than-expected medical costs and industry price wars, and now these companies are under pressure to shore up earnings.

HMOs say drug costs, for example, are rising 10% to 15% a year. Pharmaceuticals comprise about 10% of an HMO’s overall medical costs.

“We’ve been unable to get our arms around rising drug costs,” said Mark Hyde, chief executive of Lifeguard Health Care, an HMO based in the Silicon Valley. “Drug companies are doing great, [yet] they’re not taking much heat.”

Although some experts dispute it, managed care executives also complain that new legislation, such as federal and state laws mandating minimum-length stays in the hospital after childbirth, are another factor in pushing up medical costs.

Meanwhile, there is growing criticism that some HMOs have gone too far in cutting costs. Consumers are complaining, and doctors and others voice increasing concern about their ability to deliver adequate medical care at such cut-rate prices. Even some health plan executives say they are reluctant to demand cuts in doctor pay.

Many experts agree that the changing climate, and the fact that the most obvious cutbacks have already been made, will make it difficult to match the dramatic reductions in physician and hospital costs of the past several years.

“We have squeezed [physician costs] very, very tight,” said Dr. Arthur Southam, chief executive of Health Net, the HMO operated by Foundation Health Systems.