February 2000 Bulletin

HMOs misjudge costs, lose $1.25 billion in 1998

Times are a changing for HMOs across the country. HMOs’ total net losses came to $1.25 billion in 1998–45 percent larger than the industry’s 1997 loss–resulting in a -11.5 percent return on equity, according to data in Best’s Aggregates & Averages-HMO. That’s a far cry from the HMO heydays of 1994 and 1995, when net income amounted to $2.98 billion and $1.98 billion, respectively.

"They misjudged their ability to control costs in a competitively priced market," says Joseph Marinucci, senior financial analyst at A.M. Best Co. and an author of the study. "To remain competitive, HMOs undercut their pricing under the assumption they would make it up through contracting or claims management. When that didn’t come to fruition, it heavily impacted the bottom line."

Some areas of the country have fared worse than others. The worst performing markets were in the East and the West South Central regions, which incurred losses of $516 million and $426 million, respectively.

In the East, Harvard Pilgrim Health Care was recently placed under Massachusetts state receivership after the discovery of an accounting error boosted its 1999 losses to stunning $177 million. Elsewhere in New England, Fallon Community Health Plan and Tufts Health Plan have been racking up losses as well.

The Texas market is driving the steep losses in the West South Central region, according to Marinucci.

"Texas invited too many participants into the market. Ideally, you’d think competition is a good thing, but Texas didn’t have the infrastructure to support these types of businesses. The HMOs were all trying to undercut one another and they all suffered as a result," he says.

Texas lost more than $345 million in 1998 and $102 million in the first half of 1999, according to the Texas Managed Care Review Report.

The only area in which HMOs achieved profitability, according to the A.M. Best study, was the Pacific region, with total revenue of $38.4 million–up 14.9 percent from 1997. Marinucci points out that this is a very integrated environment, especially California, and that the successful bottom-line performance is due to risk-transfer.

"A lot of these HMOs entered into contracts with provider groups whereby risk was shifted onto the providers," he says. "They shared in the losses, and in certain cases, they incurred the full loss."

Capitation, though, is on the wane nationally and on the West Coast, Marinucci says.

"A lot of these physicians groups and hospital systems have been burned by it," he says, "and they’re moving away from risk-bearing. But capitation saved a lot of the West Coast plans; it really sheltered them from losses."

Marinucci predicts an upward trend toward HMO profitability this year, "to the point of breaking even."

"We’ve seen a trend in 1999 in which HMOs are realizing that they aren’t going to be able to control things, and the rates are going back up. There’s been a lot of pressure on HMOs to ease up a bit in controlling costs and access. Now the HMOs are saying, ‘If you want more access and less intervention, you’re generally going to have to pay more for it.’ And they’re passing on those costs through rate increases."

For employers, the worst may still be on the way. Nationally, employers saw HMO costs rise 5.4 percent in 1999 after years of nearly flat or declining costs, according to a New York pay and benefit consultant, William M. Mercer. HMOs nationally intend to raise premiums nearly 12 percent this year, according to the Towers Perrin Health Care Cost Survey.

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