Medicare Reform May Be a Tonic for HMOs

Howard Phanstiel, the chief executive of PacifiCare Health Systems Inc., used to look at Medicare the way a patient might size up a surgeon notorious for slips of the knife: with a decided fear that one was bound to be left less than whole.

That view, though, changed last week.

As Congress passed its historic overhaul of the Medicare program, Phanstiel did an about-face. Instead of walking away from the Medicare population, as he was inclined to do, he is now embracing it.

The new law is “causing us to reevaluate our long-term strategy,” Phanstiel says. “We see opportunities.”


Under the sweeping measure, which President Bush is set to sign on Tuesday, the government will raise the amount it pays managed-care companies such as PacifiCare, which handle the health-care needs of Medicare beneficiaries.

At the same time, Uncle Sam hopes to steer more and more Medicare beneficiaries into private managed-care plans and away from the government-run system.

One ostensible goal of this move is to reduce health-care costs. But many experts think that’s laughable.

As Princeton University’s Uwe Reinhardt sees things, the growing role of private insurance companies probably will drive up the cost of medical care for the elderly -- not cut it. “There is no convincing empirical evidence,” notes the economics professor, “that overall health spending per Medicare beneficiary would be reduced by privatization.”


This is not necessarily a flaw in the law’s design. Indeed, Reinhardt and others suspect that cost control is not the true aim of this legislation.

Rather, the real goal is to move toward a day when seniors will shoulder a greater portion of the cost of their health care. Reinhardt uses the analogy of fully guaranteed, or “defined benefit,” pensions that have given way to more conditional “defined contribution” plans such as 401(k)s.

Medicare beneficiaries currently pay, on average, about 20% of their health costs out of their own pockets. Heaping more of the burden on them is inevitable given the growing ranks of retirees. As hordes of baby boomers stop working beginning later this decade, they will swell the number of Medicare beneficiaries from 40 million today to more than 70 million.

That, in turn, will squeeze everybody else. At present, 3.8 active workers support each U.S. retiree through payments of Medicare taxes. But by 2020, there will be only 2.2 active workers for every retiree.


To limit the future exposure of younger taxpayers, Reinhardt says, the government is bound to transfer “more of the cost of elderly health care onto the elderly.”

However, because such a shift would surely spark a political backlash, changes will be made over time -- executed by private companies such as PacifiCare.

“Managed-care companies will act as buffers,” explains Dr. Schumarry Chao, a Los Angeles based consultant on health costs, “shielding Congress and the government from direct criticism.”

They also stand to profit in the process. That’s why investors boosted PacifiCare’s stock price on the New York Stock Exchange more than 12% in the week that Congress passed Medicare reform.


To be sure, directing retirees to managed care is not condemning them to substandard treatment.

Companies such as Phanstiel’s pride themselves on offering “custom care” to keep people healthy and disease at bay. “If you have a heart condition,” says Phanstiel, “we ask you to weigh yourself and check your blood pressure regularly. If we see that you are gaining weight from water retention, we send a specialist to your house to administer a diuretic” -- and possibly prevent a heart attack (and costlier procedures) down the road.

By offering such services, Phanstiel believes that PacifiCare can claim a sizable share of the marketplace -- and enjoy steady 15% annual earnings growth in the new era of Medicare reform. That would be an improvement from its up-and-down financial performance of recent years.

Medicare’s new prescription drug benefit also could be a boon for PacifiCare. Many seniors are expected to buy their drugs through so-called pharmacy benefit managers such as Medco Health Solutions Inc. and Caremark Rx Inc.


But PacifiCare, which has offered a prescription benefit since 1993, is no slouch in this regard. It has its own PBM, negotiating volume discounts from big pharmaceutical companies and purchasing medicines for 40% less than an individual can buy them at a drugstore.

“We know how to manage senior drug risk,” Phanstiel says.

Here’s betting that Phanstiel also knows how to manage his company’s financial risk -- and that his renewed interest in grabbing a piece of Medicare is a clear sign that the law just passed, regardless of whether it turns out to be good for the elderly, is certain to be good for business.

James Flanigan can be reached at