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Managed Care And Market Power: Physician Organizations In Four Markets

Meredith B. Rosenthal, Bruce E. Landon and Haiden A. Huskamp

Abstract

 
Physicians and other providers have responded to the spread of managed care by adapting structures and strategies to accommodate or resist the pressures exerted on them to reduce costs. In this paper we examine how physician organizations have evolved in four markets and whether their features represent attempts to improve efficiency or resist change. The strategies adopted by physicians in terms of alignment with other providers and development of independent medical management capabilities appear to be sensitive to opportunities to reap cost savings and the competitiveness of physician, hospital, and health plan markets.

Physician organizations have responded to the incentives of managed care by adopting new organizational features and functions, many of which are designed to contain costs while retaining physicians’ autonomy and professionalism.² In addition, we have seen the emergence of large multispecialty groups that accept full risk under capitated contracts.³ About half of managed care enrollees are now in health plans in which physicians or physician organizations are paid by some form of capitation (generally less than full risk), and in these cases health plans frequently delegate utilization management to the physician organization. Such delegation is particularly important for the management of hospital services.⁴

Despite their importance for understanding the impact of managed care, physician organizations have not been studied in the context of managed care market characteristics.⁵ One might expect to see markets converging on similar models of physician organization. In reality, the prevalence and types of physician organizations vary widely across markets. To generate some hypotheses about the source of this variation, we undertook a series of case studies of physician organizations in four regional markets that have a long history of managed care activity and sizable proportions of their populations enrolled in managed care organizations (MCOs). We sought to address several questions: How do physician organizations in different markets vary? Why have physician organizations evolved differently in these markets? What role has competition played in shaping both the number and types of physician organizations we observed?

We identify two primary types of benefits to physician organizations from consolidation: (1) technological and transactional efficiencies, and (2) market power. Technological efficiencies relate to the process of managing care or providing services, while transactional efficiencies derive primarily from improved coordination and alignment of incentives among physicians and other providers. Market power is manifested in this context as negotiating leverage with either payers or other providers who compete for limited health care dollars, such as specialists or hospitals. This leverage affects a physician organization’s ability to influence the level of fees and capitation rates and to bargain for favorable contractual terms generally, as well as to alter the quality or intensity of services.

In the analysis that follows, we look for indirect evidence of efficiency and market power motivations behind physician organizations by examining their structure, the partners with which they align, and the market conditions in which they operate. Where physicians were primarily increasing the scale of their operations, we looked to see whether the organizations engaged in activities that benefit from a larger scale—particularly acceptance of risk contracts and utilization management. If these functions were not apparent, we assumed that market power was a more likely explanation for such consolidation. Similarly, where physicians integrated with other parts of the delivery system, we looked for evidence of management integration or engagement in risk contracting that would reward the transactional efficiencies that might accrue to an integrated organization. In the absence of such evidence or where direct reports of market power were found, we concluded that vertical consolidation was more likely to be the result of the desire to gain bargaining power.

Case-Study Methods

Top Case-Study Methods Overview Of The Markets Case-Study Findings Conclusions NOTES

 
Site selection. We conducted site visits in four health care markets in 1999: Boston, Massachusetts; Portland, Oregon; Minneapolis/St. Paul, Minnesota; and Los Angeles/Orange County, California. All four have long histories of managed care involvement and have experienced high levels of managed care penetration over the past decade, but physician organizations have evolved differently in each. The four markets vary widely in terms of the types of organizations to which physicians belong. In addition, Boston and Los Angeles/Orange County are considered historically high-cost markets; the other two are considered low-cost markets.

Interview protocol. We visited each market and interviewed senior-level representatives (chief executive officer, medical director, and so forth) of single and multispecialty medical groups, IPAs, managed care plans with a large share of the market, and major hospitals and IDSs. We also spoke with practicing physicians in most medical groups. Subjects were selected based on an informal process that involved soliciting the names of the major players at each level of the market from one or more key informants. In total, we conducted twenty-eight in-person interviews.

We developed a sixty-to-ninety-minute semistructured interview protocol for each type of organization (physician organization, hospital, and MCO) that included questions on contractual arrangements between MCOs, physicians, and hospitals; compensation and delegation of responsibility to physicians; provider staffing patterns and network strategy; perceptions of the purchaser environment; and perceptions of the regulatory environment and unique market influences.

Secondary data. We supplemented interview data with information on market characteristics from the Area Resource File Edge database. We also reviewed other published materials, including articles from the academic and trade press.

Overview Of The Markets

Top Case-Study Methods Overview Of The Markets Case-Study Findings Conclusions NOTES

 
While health maintenance organization (HMO) penetration was relatively similar across sites, HMOs differed among the four markets in their use of capitation arrangements (Exhibit 1). Los Angeles/Orange County had the greatest share of primary care reimbursed by capitation; Minneapolis had the lowest. The supply of providers of different types also varied greatly across markets. Boston had the most physicians per thousand residents, followed distantly by the other three markets. Boston also had the most specialists and hospital beds per capita, largely related to a high concentration of teaching hospitals, while Portland and Minneapolis had the least. The Medicare adjusted average per capita cost (AAPCC), an indication of historical patterns of spending and opportunities to reduce costs under managed care, was 40–60 percent higher in Boston and Los Angeles/Orange County than it was in Portland or Minneapolis. Commercial plan premiums, however, were approximately 20–30 percent higher in Boston and Minneapolis than they were in Portland and Los Angeles.

Top Case-Study Methods Overview Of The Markets Case-Study Findings Conclusions NOTES

At the beginning of the 1990s profit opportunities for provider organizations in Los Angeles/Orange County were significant, as capitation rates were reported to be among the highest in the country. Importantly, there was also excess hospital bed capacity and fragmentation of the hospital market. According to observers of this period, hospitals were slow to realize that reductions in hospital spending would be the primary source of profits for physician organizations under the new risk-sharing arrangements with HMOs.⁷ Thus, in most cases, hospitals were paid per diems, and medical groups and IPAs shared the savings from reduced hospital use with health plans. This reduction in hospital utilization rates while per diems were stable or falling was critical to the rapid growth and success of independent medical groups and IPAs in Southern California in the late 1980s and early 1990s. The relative lack of integration between hospitals and physicians in Los Angeles/Orange County (in contrast to Minneapolis and Boston) appears to reflect an absence of strategic (market power) or efficiency advantages to this type of integration.

In Boston, which is also characterized by high-cost practice patterns, the market power of hospitals—particularly teaching hospitals and associated specialists—appears to have led to a different configuration of provider organizations. A substantial share of the local hospital and physician markets is concentrated in two IDSs in Boston. Beyond their size, the IDSs also have bargaining power because consumers perceive them as a necessary element in any network, since they include several of the major teaching hospitals in the area. It comes as no surprise that we found that most physician organizations in Boston were integrated with hospital systems because there was little opportunity for independent capitated medical groups or IPAs to benefit from hospital cost savings as in Los Angeles/Orange County. With the exception of the independent medical group resulting from the spin-off of the clinics of the former Harvard Community Health Plan, only a handful of independent medical groups have been well positioned for risk sharing with MCOs.

While the high AAPCC and commercial spending per capita have slowly pushed both HMOs and providers toward risk-sharing arrangements, less than a quarter of the reimbursement to the IDSs takes the form of capitation. Internally, the major Boston provider organizations, which are the two IDSs, are structured to operate in a capitated environment. In particular, they are made up of smaller risk-sharing and accountability units that are at least theoretically geared toward efficiency and optimal risk sharing. However, little excess capacity has been eliminated, and clinical management has not progressed far. It may be difficult for the IDSs to achieve significant efficiencies because of their size and traditional focus on tertiary care, and this may contribute to their reticence to take on additional full-risk contracts.

Growth of provider organizations in a low-cost market. In contrast to Boston and Southern California, commercial and Medicare plan reimbursement in Portland has been among the lowest in the country (Exhibit 1). As in Boston, the balance of power in Portland rests with the hospitals and specialists. Excess hospital capacity was reduced in Portland through hospital closures and conversions during the early 1990s. Because the hospital market responded quickly to capitation by consolidating and streamlining into two dominant chains, the period of hospital-risk-pool dividends that Southern California physicians enjoyed was not realized in Portland. As a result, while independent (mostly single-specialty) medical groups and IPAs formed in Portland for the purpose of taking risk contracts, they never had the capital to invest in systems to improve business and clinical management. In combination with several years of zero capitation growth, the failure to realize operating efficiencies seems to have precipitated the demise of several physician organizations and has led medical groups and IPAs to be less willing to enter into full-risk contracts.

Moreover, unlike in Boston, there was little-interest on the part of hospitals in forming IDSs to accept managed care contracts. This difference may be explained by low capitation rates or by the fact that the major hospitals were not concerned with increasing occupancy rates, given their low levels of excess capacity and ability to maintain relatively high per diem rates and profit margins. In short, the Portland hospitals believed that there was nothing to gain from buying up or otherwise affiliating with physician organizations on a large scale. To the extent that independent capitated physician organizations reduced hospital utilization rates, the hospitals simply raised per diems to maintain revenue streams. Moreover, many primary care physicians and management executives in Portland believe that specialists have thwarted primary care physicians’ efforts to profit from capitation by forming cartels that enable specialists to resist risk sharing, utilization management, and downward pressure on fees.

Market power of managed care organizations. In Minneapolis the distinguishing features of the market appear to be related in part to MCOs’ favorable position relative to the other markets. While the majority of physicians are affiliated with one of several large clinic-based medical groups and IDSs, none of these IDSs is a dominant player. This leaves the Minneapolis MCOs with much market power over providers (both hospitals and physicians). An illustrative comparison may be made with the Boston market, which in other ways is similar to Minneapolis (in terms of vertical integration and the low rate of risk sharing). The Boston managed care market is fairly concentrated as well, but MCOs face more consolidated and powerful providers because of the dominance of the two major IDSs (and the teaching hospitals in general).⁸ One of the most striking features of the Minneapolis market, given its long history of high managed care penetration, is how little risk sharing there is between providers and managed care plans. Recall from Exhibit 1 that only 47 percent of primary care services in the Twin Cities delivered by group practices are reimbursed by capitation, the lowest in the sample and below the national average. Despite the attempts by the purchasing coalition (the Buyers Health Care Action Group, or BHCAG) to shift the focus of competition and care management to health systems, MCOs still retain most of the responsibility for clinical management in Minneapolis. Several physician organizations in the market have called for other employers and managed care plans to adopt risk-sharing and competitive (where consumers pay more for higher-cost delivery systems) arrangements with them.

For their part, MCOs report reluctance to share risk with providers, citing providers’ lack of risk management capability. Some purchasers and providers believe, however, that MCOs do not share risk because of their market power. They argue that the plans are able to maintain high premiums and low provider fees because of the lack of price competition. Thus, they have little to gain from risk sharing. In no other market were MCOs reluctant to share risk with providers. In Boston, where providers are nearly as inexperienced with managing risk, the MCOs continue to look for ways to introduce more risk sharing as they in turn are pressured by purchasers to constrain premium growth.

While MCOs’ market power is a compelling explanation for the lack of price competition and risk sharing in Minneapolis, an alternative explanation may lie with employers and other purchasers. MCOs may not be delegating risk and utilization management to providers because they are being asked to compete not on costs, only on service. As several subjects noted, this may be true because of the high prevalence of administrative services only (ASO) contracts used by self-insured plans (Exhibit 1) or because employers are less concerned about cost control than in other markets because of tight labor-market conditions.⁹ Evidence that cost control is a low priority to purchasers relative to consumer satisfaction is the relative lack of primary care gatekeeping, which is used in some markets (such as Boston) as a substitute for risk sharing with specialists.

Conclusions

Top Case-Study Methods Overview Of The Markets Case-Study Findings Conclusions NOTES

 
Our exploration of physician organizations in four markets has revealed much diversity in both the structure and the functions of these entities in spite of a similar history of managed care penetration. We have highlighted several important differences in the managed care environments of these markets related to market power and opportunities to reap the rewards of more efficient organizational forms.

In particular, the potential for growth of independent (that is, not vertically integrated) physician organizations appears to be a function of the market power of hospitals, the market power of MCOs, and the potential financial rewards for improving the efficiency of care delivery. Where downward pressure on premiums existed alongside relatively weak hospitals, physicians took the opportunity to profit from reducing costs by accepting delegated risk and utilization management (Los Angeles/Orange County). Where hospitals were in a position to resist decreases in their revenues and premiums were low to begin with, the lack of resources and rewards for improving clinical management thwarted the growth of large independent physician organizations (Portland). In Boston and Minneapolis, strategic considerations appeared to result in the alignment of physicians and hospitals in vertically integrated organizations as a counterbalance to MCOs’ market power. Similarly, in Portland the formation of specialist organizations appeared to be motivated by a desire to resist attempts by primary care organizations to profit from reducing specialist costs (through reducing either fees or referrals). In Boston the relative market power of these delivery systems combined with high premiums appears to present an opportunity for providers to profit from delegated contracts. While there is some movement in this direction, neither risk sharing nor clinical management by providers is highly evolved in Boston. Overall, only a small share of physician organizations outside of California, including the IDSs we visited, had developed much capacity for utilization or clinical management and shared risk with MCOs.

Many believe that the future of managed care lies in the devolution of clinical management and financial decision making to providers. Physician organizations, independently or in alignment with hospitals, are the natural locus for such a decentralized system. The extent to which this devolution will occur, however, remains unclear. As a result of flat premiums throughout the 1990s and consolidation within the hospital industry, few markets will have the opportunities that existed in Southern California to allow physician organizations to develop medical management systems during times of excess capacity and to receive financial rewards that result from decreased hospital utilization. Not surprisingly, many of the physician organizations in the markets we visited had difficulty adapting to risk contracting because they lacked the proper systems and skills needed to manage risk effectively and did not have the time or resources needed to develop these areas sufficiently. Without the ability to manage risk, physician organizations will have difficulty adapting to this role.

Despite the recent era of economic prosperity, the specter of a return to rapidly increasing health care premiums is beginning to cause concern among purchasers and policy-makers alike.¹⁰ As costs continue to escalate, physician organizations will need to evolve before they can be viewed as a broadly viable force for innovation in managing care.

Editor's Notes

 
Meredith Rosenthal is an assistant professor of health economics and policy at the Harvard School of Public Health. Bruce Landon is an instructor in health care policy and medicine at the Harvard Medical School. Haiden Huskamp is an assistant professor of health economics at the Harvard Medical School.

The authors gratefully acknowledge financial support from the Alfred P. Sloan Foundation, the California HealthCare Foundation, the Agency for Healthcare Research and Quality (Grant no. HS09929), and the Commonwealth Fund. They are indebted to the physicians and executives who spoke with them and without whose time this work would not have been possible. They thank Vivian Wu and Matt Cioffi for excellent research assistance and data analysis. Helpful comments on earlier drafts were provided by Joan Buchanan, Arnold Epstein, Richard Frank, Tom McGuire, Joseph Newhouse, and two anonymous reviewers.

NOTES

Top Case-Study Methods Overview Of The Markets Case-Study Findings Conclusions NOTES

 

1. P. Kletke et al., "Current Trends in Physicians’ Practice Arrangements: From Owners to Employees," Journal of the American Medical Association (6 August 1996): 555–560.
2. E. Kerr et al., "Quality Assurance in Capitated Physician Groups: Where Is the Emphasis?" Journal of the American Medical Association (6 August 1996): 1236–1239; E. Kerr et al., "Primary Care Physicians’ Satisfaction with Quality of Care in California Capitated Medical Groups," Journal of the American Medical Association (23 July 1997): 308–312; B. Landon et al., "A Conceptual Model of the Effects of Health Care Organizations on the Quality of Medical Care," Journal of the American Medical Association (6 May 1998): 1377–1382; D. Blumenthal, "Effects of Market Reforms on Doctors and Their Patients," Health Affairs (Summer 1996): 170–184; and E. Mort et al., "Physician Response to Patient Insurance Status in Ambulatory Care Clinical Decision-Making: Implications for Quality of Care," Medical Care (August 1996): 783–797.
3. J. Robinson and L. Casalino, "The Growth of Medical Groups Paid through Capitation in California," New England Journal of Medicine (21 December 1995): 1684–1687.
4. J. Newhouse et al., "Managed Care: An Industry Snapshot" (Unpublished manuscript, Harvard University, 2000).
5. Kerr et al., "Quality Assurance in Capitated Physician Groups";; Kerr et al., "Primary Care Physicians’ Satisfaction"; and A. Hillman et al., "Contractual Arrangements between HMOs and Primary Care Physicians: Three-Tiered HMOs and Risk Pools," Medical Care (February 1992): 136–148.
6. Kerr et al., "Quality Assurance in Capitated Physician-Groups." We should note that the practice of utilization management itself was far more common among California HMOs than among their counterparts elsewhere, as well. L. Casalino and J.C. Robinson, The Evolution of Medical Groups and Capitation in California (Oakland: California HealthCare Foundation, 1997). Because utilization management techniques were developed and familiar to physicians, their greater use would be expected.
7. Robinson and Casalino, "Growth of Medical Groups."
8. Although one of the large Boston IDSs is experiencing financial difficulties, the largest Boston IDS recently won a large rate increase from one of the health plans, largely on the basis of its control over access to many of the Harvard teaching hospitals and their affiliated physicians.
9. U.S. Department of Labor, Bureau of Labor Statistics, Local Area Unemployment Statistics (Washington: BLS, 2000).
10. C. Hogan, P.B. Ginsburg, and J.R. Gabel, "Tracking Health Care Costs: Inflation Returns," Health Affairs (Nov/Dec 2000): 217–223.

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