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Printable Version

DR. GINSBURG: I’d like to open the conference now. Please take your seats.

I want to welcome you all to the Fifth Annual "Wall Street Comes to Washington" Roundtable that the Center for Studying Health System Change puts on. This is also the fifth anniversary of HSC. The Center was created by the Robert Wood Johnson Foundation to provide national public and private decisionmakers with information about the changing health system and the effects of those changes on consumers. The Center does not take policy positions, but seeks to inform the thinking of policymakers and organizations that range from trade associations to government agencies to the Congress.

Many people make a special point of coming to this annual meeting to get a perspective that they often don’t hear in Washington, namely, how analysts associated with the financial markets perceive the changes underway in the health care system. And we run this conference not because we’re big meeting mavens, but because our site visit work seeks to gather related information to what these people gather in their daily work. And it’s a way of bringing together two different perspectives on the same events that are happening in health care.

The insights that these panelists provide are very useful to us in our interpretation of the results from our surveys and also in our interpretation of what we collect on our site visits to 12 representative communities.

Let me tell you briefly where we are in our work. As you know, the community tracking study is the core of the Center’s research focus, and as far as surveys, we’re starting to put out trend information now as the second round of surveys from 1998 and 1999 get out of the field and we’re cleaning up the data to look at that. And this summer we’ll be going into the field for our third round of surveys.

With respect to our site visit activities, earlier this month we began our third round of site visits with a visit to Indianapolis, and we have a visit to Cleveland going on this week that I have interrupted to come and moderate this conference. And I may very well be able to bring perspective of what we’re seeing in Cleveland from that.

Let me introduce the speakers we have on our panel. We have five people from the financial industry and a researcher from our own staff to provide perspective on what we’re getting on our site visits. In alphabetical order, I’d like to introduce on my left Dennis Farrell, who is the Managing Director, Public Finance, Moody’s Investors Service, and he’s here because of his experience in rating hospital debt. And I order to rate hospital debt, you need to learn a lot about what’s going on at the hospital, the competition they face, the reimbursements they’re getting, et cetera.

One over to my right is Normal Fidel, who is the Senior Vice President of Alliance Capital Management. Alliance Capital Management is a major money management firm that has an array of mutual funds, and Norman is involved in the research and stock selection for those mutual funds.

The next person is me.

On my immediate right is Roberta Walter Goodman, who is the Managing Director of Merrill Lynch. Roberta has actually been with us since the very beginning of these series, and we’re delighted that she and actually Norman Fidel and Geoff Harris have been willing to continue to come and participate in these meetings. She covers the health industry for Merrill Lynch, and she is, in the Wall Street jargon, a "sell side" analyst, whereas Norm Fidel is a "buy side" analyst.

Joy Grossman, who’s the Associate Director of the Center for Studying Health System Change, is very steeped in our site visit activities and really all of our research, and she’s going to be participating on the panel today not as a co-moderator, as she has in the past, but as someone to bring in the perspectives of what we’re learning at the sites to interact with the other panelists. And Joy has been involved in developing these conferences with me ever since the beginning.

Geoff Harris, all the way to my right, is the Global Head of Corporate Finance of the Health Care Division at Warburg Dillon & Read. So Geoff is another "sell side" analyst, advising the clients of his firm as to what stocks they should buy or not buy.

And, finally, Samuel Murphy, all the way on the left, is the Vice President and Senior Equity Analyst of American Express Financial Advisors. I need to tell you what he does because American Express is into so many businesses, but American Express in Minneapolis runs a huge array of mutual funds. So Sam Murphy is another "buy side" analyst, advising the American Express mutual funds as to what companies they should be buying and selling. Also, Sam Murphy is particularly expert in information technology, and since we wanted to cover that in fair depth today, that’s one of the reasons that we invited him to be on this panel.

I think you see the agenda, which shows that in the first segment of the meeting we’ll be covering managed care and providers of health care. After that segment, we’ll have a question and answer session from the audience. Then we’ll have a break, and then we’ll resume, covering information technology and pharmaceuticals. And then we’ll have another question and answer session, and if I can, I will then give you a summary of what I think are the most important things said at the meeting. Doing the summary is much harder than moderating the meeting, I can tell you.

So I think that’s probably it, and I can go to our first question. One thing I should say is that these questions have been shared with the analysts, not only shared but a much longer list was shared with them, and I asked them to rank the questions as to which ones were good questions and particularly which ones they had interesting things to say about or not, so that this way we avoid asking a question which is a silly question and they might say silly things or not say anything.

Managed Care and Providers

So, anyway, I’m going to begin with managed care and start with a question about the United Healthcare announcement back in the fall, where it was explaining that it was going to be doing a lot less in the way of utilization management.

For additional context, in a number of interviews I did earlier this week in Cleveland to providers, I was told that they’re not doing anything differently, that was just a PR thing. I want to ask the panel their interpretation of the United Healthcare announcement and some of the announcements that followed from others, such as Aetna, as to are health plans doing things differently.

Norm?

MR. FIDEL: Well, I think if you ask most providers, they wouldn’t acknowledge that United is doing anything different because the animosity between providers and managed care is certainly still high. But looking at this whole issue, this whole idea of care coordination where you’re trying to take away the idea of a gatekeeper plays right into the hands of United Healthcare because they have really an open-access model. They have not had a gatekeeper model. So in the United Healthcare system, you do not have to go to a gatekeeper to see a specialist.

So what they’re trying to do in this new program is really taking away some of the utilization control that had been going on and replacing it with other types of monitoring services, whether a patient is sent home from the hospital, they will provide perhaps more attention to that patient with home care than other plans, or while the patient is in the hospital, they may be very active in monitoring what’s happening to that patient in the hospital.

So it’s not as if they’re disappearing from the scene. They’re certainly involved, but they want to try and reduce the number of hassles. And because United Healthcare had already had this care coordination infrastructure place and because the demands of society are for more freedom and less hassle in this booming economy that we’ve had, costs have been less of a concern than they’ve been at other times. It sort of was the right time for United to capitalize on this, not only as a marketing maneuver but also because they were perhaps more in the direction of where societal trends were pushing to begin with.

And they’ve now had a pilot program in four Medicare markets to see how utilization and cost trends have been in that market with this new program versus others, and they claim that actually the cost trends are less in these markets where this new program is tried than in the control groups, where they still have the old system in place. So it’s still early to tell, but that’s some early feedback.

DR. GINSBURG: Geoff?

MR. HARRIS: Just following on on Norm’s comments, I think also the population of which UM or care coordination is aimed has changed; in other words, the focus is on the sick, chronically ill, and on big-ticket items, and, again, seconding what Norm said, to try to remove the hassles and any kind of interference for relatively healthy people who are going to get relatively routine care. So it’s also a shift in emphasis in terms of where you’re applying these techniques relative to the end population.

DR. GINSBURG: Roberta?

MS. GOODMAN: One thing that I think is important in looking at what United is doing is that philosophically I think the company was heading in this direction for a long time.

Back in the early 1990s, the original theory was that if you provide information to providers about their practices and how those practices compare to best practices or to what you know from the clinical research that is published in peer-reviewed organizations’ journals and so on, that you can actually have a positive impact without having to be so much in the face of the provider.

They initiated the care coordination program after two rounds of physician profiling, which was meant to look at some of the chronic conditions that Geoff was referencing, and found that they could, in fact, influence behavior more effectively that way than by micromanaging on the UM side.

That being said, there still are some areas in which they do have the UM. They have not completely removed that. And I think that may be one source of the provider comments.

DR. GINSBURG: Joy?

DR. GROSSMAN: I just wanted to say that when we were on our last round of site visits in ’98, we were already hearing many reports from a variety of plans, both national and local, that they were beginning to think about how to loosen up their authorization process in response both to consumer demand and provider demand. And in some markets, like Orange County, where the providers take a lot of capitation, they’re kind of constrained by the extent to which they can loosen up their internal referral processes, but even there they were attempting to try to speed up the referrals and to try to focus, do some retrospective review, focus on the bigger-ticket items.

So I think there’s been a push across the board that started obviously before the United announcement, and at least in some of our markets, the United products have been called PPOs in drag. So while the providers may still find them onerous, they’re not nearly as strict as some of the other companies.

In some of our markets, there’s been little more than sort of a paperwork process, and even those are minimal. And those plans are still having trouble trying to get their providers to refer in-network. So we really see a range of things out there, and you often hear the stories about the HMOs that are strictest. But there’s really quite a lot of variation out in the market.

The other thing I wanted to say was that with respect to this issue of profiling, I think many will say that providers are very--physicians in particular are very responsive to seeing what their peers do, and that if they’re out of line, that’s an effective mechanism to get them to change their behavior.

It’s also the case that people do say that they respond very directly to financial incentives, and trying to combine the profiling, the financial incentives, I think is a place where plans have had varying success, and obviously providers are often reluctant to engage in contracts where that happens. And we saw some examples, for example, Little Rock, which is a relatively unmanaged market, that back in ’96 they were trying to implement quality incentive payments to providers, and they went ahead, and most of the plans were doing it, and there was a big backlash from the providers, and they dropped it.

But our most recent data actually from our physician survey from ’98-99 suggests that at this point only 16 percent of physicians have their individual compensation affected by profiling results, and this didn’t change over the prior two-year period, from ’96-97 in our first round.

DR. GINSBURG: Okay. Let me ask a question. I think you made a good case that United really is doing something. As far as United’s competitors, the other national companies or Blue Cross/Blue Shield plans or local companies, do you expect them to be going full steam to try to follow suit, or are they going to let this pass them by?

MR. HARRIS: Just a brief comment on that. I think they’re trying to go in the same direction, but they’re starting from much further back. In other words, relative to what Roberta said, United was already headed in this direction, and it was really their operating model even before it became popular. So I’d say the others, yes, are trying to move in that direction, but it’s slow going.

MS. GOODMAN: I also think that some of the companies are still in their heart of hearts thinking that if the economic conditions change, that they can go back to doing things the way they always have. So I don’t think that there has been a philosophical adjustment for a lot of them that this is actually the way that things should go in the future.

MR. FARRELL: Paul, if may, I think it’s virtually impossible to measure this, and I only say that because it’s such a varying moving target. And we have a later discussion on information systems, but I think one conclusion we may walk out with at that point is nobody has the ability to really measure the success empirically. And even if there are changes at the various programs, whether they be PR, as it’s been suggested, or real change, the direction that--or the divide that’s created or continuing to create between providers, physicians, and payers is widening.

Some of the empirical evidence that we have witnessed particularly is coming through on 2000 or 1999 financial statements, and the single issue that has been recurring almost from provider to provider is the significant increase in unanticipated write-offs associated with insurance providers, particularly with managed care, because of delays and because of denials.

It’s virtually, again, impossible since it’s such a complex world, but the one thing that’s very clear is it’s not improving payment to and/or services as we go, because it’s simply--it’s just not happening.

So while I think many have attributed this to be a successful whether it be rhetoric, PR, or actually follow-through, the reality is it’s virtually impossible to measure it because there are so many variables. That’s not to say you shouldn’t focus on it, but, in fact, it’s very, very difficult to measure.

DR. GINSBURG: One thing I’ve been concerned about the effect of this is the issue of sentinel effects and spillovers. I guess the question--to what degree do you have confidence in United’s research that it really is lowering revenue and raising costs with this new approach?

MS. GOODMAN: Well, they’re looking at the aggregate costs. They’re looking at the costs of the UM programs which can be avoided, offset by any increase in utilization that might occur because there’s less monitoring going on.

What they had found was that in the denial process they were not catching a lot, and I think that’s consistent, actually, with research that you’ve done that shows that there are not really substantial differences in utilization at this point between the, quote-unquote, fee-for-service sector and the HMOs, because the fee-for-service utilization rates have come down as practice patterns have changed.

So I think what they’re indicating from their pilot programs in terms of the cost/benefit is probably correct. I think the question would be if every managed care company in the country adopted a care coordination program, removed the UM, would there be a tendency on the part of providers to lift the utilization rates and to admit more and more sort of at-the-margin-type patients. And I think that’s something we can’t know and probably will never know because I think that the industry will continue to evolve.

MR. HARRIS: I think it’s just important to keep in mind that United, I believe, was spending over $100 million a year on its UM operation. So it was against that number that they were trying to measure the savings they were achieving by spending that money, and they determined that that was not a good use of funds. That’s just looking at it from the financial perspective.

MS. GOODMAN: I think philosophically, you know, I think that was where Bill Maguire had been going, the idea that if you give doctors the right information that they will make the right decision in a majority of times. And I think that’s one of the primary thrusts of the foundation that they’ve established at the company to try and disseminate that information and try and make good on that vision.

DR. GINSBURG: Okay. Let me go on to the next topic. Since we met last, there have been a lot of class action suits against health plans and lawsuits by attorney generals, some of which have been--one in Texas has been settled recently. And I have two questions. One, do these suits have much chance of succeeding? And, second, are health plans behaving differently as a result of these threats?

MR. FIDEL: Well, I think right now the strategy of plaintiffs’ bar is to throw everything they can up against the wall and see if anything sticks. And part of it is intimidation. I think particularly the--I forgot what Scruggs group, they refer to themselves, but essentially the tobacco lawyers, you know, they’re hoping that some plan will get afraid enough that they’ll settle for some monetary payment. But it’s going to be a very long haul, and you know, they’re putting up suits virtually covering every area--violations of ERISA, which the Supreme Court just addressed in part as far as physician incentives, which kind of stopped that movement for now, but they’re also going for whole issues of medical malpractice, if that occurs, can you also sue the health plan, is there false advertising, are there other incentives involved with physicians that could be a problem.

So they’re trying everything, and they’re hoping that they’ll be able to get one of these cases in some court someplace where there’s a friendly judge and he’ll certify the case and that will turn up the heat. And they can keep doing this for five or ten years and maybe eventually that will happen. So I don’t think they’re going to quite very soon, but I don’t think there’s--you know, there’s probably some areas where it’s logical to think that a class action will be certified, but we could talk for half an hour about what the problems are in looking at these issues as a real class and whether one really does exist.

And in the Supreme Court judgment of a week or two ago, they essentially addressed the issue of what is quality of care and how can you judge whether or not a denial of a service is ground for being sued. And they kind of said that under ERISA that’s not grounds for it, that that’s sort of one of the functions of a managed care plan.

So, yes, I guess there is a possibility one of these things will see the light of day, but right now it doesn’t look too good for plaintiffs’ bar.

MS. GOODMAN: I think they also were looking at the balance sheets that these companies publish and seeing large amounts of cash and investments and thinking that that was pretty fertile territory.

The problem with that is that most of that cash is not available. Most of it is required for statutory purposes and for paying claims. So if they did end up winning or forcing a settlement in one of these cases, the impact would be directly and immediately on the sponsors of the programs in terms of increased premium. And I think that was something that probably was overlooked in the initial foray into these suits, and now that they’re in, I think it would be hard to back away from it.

So I would agree with Norm. I think this is going to continue for quite some time.

MR. HARRIS: The only thing I would add is that the collective wisdom of the stock market and the investment community is that the risks have substantially diminished because the stocks as a group have this year responded to strong earnings growth, whereas last year, when you could argue that the earnings were beginning to recover, the stocks did not perform particularly well, in large part because of fears about the prospects for these suits.

So the collective wisdom of the market is that the risks have substantially diminished.

DR. GINSBURG: Are the plans doing anything differently as far as to protect themselves from these suits or from future suits as far as how they do their business?

MR. FIDEL: I would say one area they are is they’re making sure there’s more disclosure to forestall the possibility they could be sued for not disclosing things. And other than that, as far as actual practice mechanisms, I don’t think there’s been much of an impact.

DR. GINSBURG: Good. The next topic is health plans’ mergers across markets. I want to focus on--not mergers of two plans within a market, but plans that are in different markets. And we’ve seen a lot of them in recent years, both in the national and for-profit plans and also in the Blue Cross/Blue Shield world. I was wondering if you have a sense of have these mergers been achieving their objectives.

MR. FIDEL: I’d say it’s very mixed. You know, you can point to some, what appear to be successes, but you can also point to a lot of cases where it doesn’t look like it went very smoothly. And there’s a lot of obstacles here, and I think one of the ones that’s cropped up and has caused the most problem is the MIS systems and trying to integrate them. And many times in the initial phases of the integration, things don’t happen too well because they’re not on one system and there’s a lag in data, and they don’t know where they are at any point in time.

But, you know, I think it is mixed. I think in some cases it makes great sense, and in other cases it didn’t, and the results have paralleled that.

DR. GINSBURG: Yes, Geoff?

MR. HARRIS: I have a similar view, but I’d just add some historical context to it. If you go back to when the industry, the last time the industry was healthy--in other words, we had a premium cycle that was exceeding cost trends--take the period from ’90 to the end of 1994 or early ’94, there were a lot of mergers and acquisitions, and they appeared to be very successful. And I think it’s because the overall health and robustness of the fundamentals in the business were able to cover up any mistakes that might have occurred in the back office or MIS system.

So the Wall Street view at that time was that mergers were terrific. And when United announced a merger or somebody else announced a merger, the stocks typically traded up.

From early ’95 or the middle of ’95 really through very recently, we’ve had a very bad underwriting cycle, with premiums lagging costs, and there were a number of mergers and acquisitions done during that period of time. Those companies that did those mergers and acquisitions did not perform well, and I think a lot of investors jumped to the conclusion that it was because of the mergers and acquisitions. So now the common view is that mergers and acquisitions are bad, they’re difficult to integrate.

My view on that is that had none of those mergers or acquisitions occurred, in other words, had all those companies remained independent, they all would have done poorly anyway because of a poor industry environment and poor industry fundamentals.

We are now returning to a positive underwriting cycle with better industry fundamentals. My guess is that any mergers and acquisitions that occur from here forth, at least for the next few years, will have a greater chance of success because the wind is at their back.

DR. GINSBURG: Is one implication of what you’re saying, in a sense, that the successes or failures of mergers for the most part are small in relation to fundamental of the business?

MR. HARRIS: Yes. And, in fact--yes, because eventually the companies--I mean, they can have some problems with MIS systems. They lose track of--they lose visibility of where their claims may be. If you’re in a healthy underwriting environment, it may not matter that much. You can buy some time. If you’re really skating on thin ice to begin with and you lose track of your cost trends, then you get clobbered. And that happened to numerous companies over the last several years.

But some people have come to the conclusion that the day a company announces that they’re going to buy another company you should sell the stock, I don’t think that’s right. I think you have to look at where you are in the underwriting cycle.

DR. GINSBURG: So certainly there are risks. How big is the upside? Let’s say that you have two companies which don’t overlap very much in their markets, they merge, let’s say they don’t encounter MIS problems. How big is the upside? What’s the potential gain from the merger as far as cutting costs through scale economies or the like?

MR. FIDEL: If you don’t have market share in a region, you don’t have that much. So buying another plan that’s in a different location doesn’t give you that much of a benefit. It makes you bigger, but in practical terms, it’s much more beneficial to have mass in a market which increases your bargaining power, which enables you to cover your costs more easier.

DR. GROSSMAN: In terms of our local market perspective, we’ve seen, I think, a mix of these things, which is that some of the larger national plans that acquired smaller plans in some of our markets have really sort of spent a lot of time maybe thinking about leaving the market or maybe staying in, and then eventually they seem to disappear and they really cut back, you know, and have some more regional sales force, and that’s it, to deal with the large purchasers.

We’ve also seen a lot of our local health plans wanting--you know, in the mid-1990s when the cycle was good, wanting to expand regionally and thinking that was the way to go. And as the underwriting cycle got worse, we’ve seen a retrenchment in the number of markets, and the best example is in New England of Hartford, Pilgrim, & Tufts (ph), where they really ran into problems going into other states and didn’t find economies, at least given the way they did their operations and given the underwriting cycle.

We have seen some examples where plans have expanded, even within a state, for example, a number of Blues plans merging, and there have been some benefits in terms of, you know, easier access to product design and things that maybe the larger plan they merged with had. So we’ve seen a mixed bag, and I don’t think this is going to be a steady state. I think it’s going to fluctuate.

MR. FARRELL: I think the key is what Norman raised, it’s the leverage that you are able to exert over whomever you’re partnering with--well, it’s not partnering--you’re negotiating with, whether it be physicians or providers.

You know, it’s interesting, you look back over history, and clearly one thing we should not allow dictate future behavior in this industry is history, but a great example is what happened to Maxicare. Just having a national coverage doesn’t provide you with a winning formula. So it’s that balance of that leverage on a local and the broader coverage associated, but I think it’s fair to say to rely solely on savings as a measurement of success in the future is not necessarily the sole determinant.

DR. GINSBURG: Roberta?

MS. GOODMAN: I’d make one additional point, which is that health care at the end of the day is very much a local market business. Local markets differ in terms of the organization of the delivery system, the economy, the employer base, and then just basic consumer preferences. And I think companies that have done these out-of-area deals have frequently underestimated the importance of those issues and have underestimated the importance of the differences in the models between the markets that they knew and the markets that they went into via acquisition and, therefore, have not really recognized the issues that they would need to contend with in those new markets.

You know, I think that the result of that has been a very mixed set of fundamentals for these deals that go beyond the overall travails that the industry has had.

I would take issue with one thing, though. I think that the fundamentals of this group are more mixed at the current time than would be suggested by the premium increases, because the cost trends have been highly problematic, and what we have not seen in any meaningful way is an improvement in the gross margin of the business. What we have seen is companies pulling out administrative costs, some of that being a function of scale, and also some significant benefits from capital restructuring, share repurchases, and reducing debt.

MR. FARRELL: To pick up on a question you raised earlier and what Roberta just stated, there’s not a whole lot of upside opportunity. There is a lot of downside risk if an organization enters into a market and doesn’t select it properly. A huge downside risk.

DR. GINSBURG: In fact, one comment I’d want to make to close this topic is that in a sense the media has gotten it right that, you know, the last major merger, I guess between Aetna and Prudential, the media was focusing on the communities where there was overlap, where their share would grow, and that was the right focus because that probably was the most important aspects of this merger for--certainly for the public and certainly probably even for the companies involved.

Let me go on. Our next question is premium increases, cost increases. I guess we’ll start--Roberta started talking about the fact that last year I think we were hearing a lot about the underwriting cycle having turned. Has this turn been delayed?

MR. HARRIS: No. I think the fundamentals of at least the majority of the public companies have improved substantially this year versus last year. I think looking at book earnings, in other words, reported earnings and reported loss ratios, is a little bit misleading. I think you have to peel the onion one step further and look at operating cash flows, which have been going up more rapidly than the earnings that are reported. Those cash flows I think reflect the true underlying strength of the business, and those have been very strong for the top companies like Cigna, United, Wellpoint. Even some of the smaller players like Oxford have had dramatic swings to the positive in terms of their earnings, but also buttressed by very strong cash flows.

So I think we’re in an environment--and I think typically the growth in the earnings will trail the growth in the cash flows after the companies have built up some of the reserves that they drew down during the last underwriting cycle. So I think that to the extent we made predictions last time that the industry was improving, I think by and large those have been on track.

MR. FIDEL: If I could try and put it into numbers, last year--and we’re looking at the commercial business here because the Medicare business is a whole other world with administered prices. So let’s just look at the commercial business, and last year premium rates on average went up between 7 and 7.5 percent, and this year they’re going to be up around 9.25 percent. So that’s about 175 basis points more in price trend, and I think in the years 2001 and 2002 will kind of peak out at about the 10 percent level as far as average rate increases.

Now, if you look at the cost side, as Roberta said, there’s been a dramatic increase in the medical cost trend. And as far as my thinking, in 1999, the cost trend was between 5.5 and 6 percent, so we were getting the beginning of possibly in the commercial business rate increases starting to exceed cost increases.

But this year the cost trends are going to be in the area of 7.5 to 8 percent, so they’re up almost--about 200 basis points in just a year. But we’re still exceeding the cost increases on average.

And I think cost increases on average in 2001 and 2002 will get into the 8.5 percent range. I don’t think they’re going to increase as much in the next few years as they have in the recent few years, because I think prescription drugs, which have been the main ingredients of higher costs, you know, I think are kind of peaking out in terms of cost trend, still at a very high level, but I think on average we’re about a 15 percent cost trend in pharmaceuticals. And I think if you looked at the pharmaceutical industry, we’re going to get somewhat of a moderation in growth and sales for the pharmaceutical industry just because of the combination of fewer blockbusters coming on in the next few years with a lot of patent expirations.

So there’s still upward cost trends going on in outpatient. There’s certainly upward cost trends going on in the hospital business. Hospitals are starting to get relatively good relief from managed care payers, now I think approaching the 4 to 5 percent per year level right now, which is a lot better than a year or two ago. And physicians are even starting to get a little bit of an increase, but physicians don’t seem to have too much bargaining power in the process. A well-entrenched hospital in a specific region has very good bargaining power against managed care, but not too many physicians, because where physicians are organized in large groups, the managed care organizations are very large, and so kind of the bargaining power is equaled out, or it still may be in the favor of the health plans.

DR. GINSBURG: Geoff?

MR. HARRIS: I just wanted to make a follow-on comment because I didn’t answer the question on 2001 and 2002 premium increases. I agree with Norm, you know, 10 percent range, maybe 10 percent plus for 2001 and 2002. The sure sign that those premium increases will begin to come down are when you start to see, at least in my opinion, two things: multi-year rate guarantees, that’s what we began seeing in the end of 1994; and, secondly, when you start seeing new plan starts, in other words, existing health plans that start going into new markets, venturing out into new markets again and starting plans from scratch, much as they did toward the end of 1994. That will represent a return of capacity additions to the industry and will portend much lower premium increases.

But right now we’re actually still going in the opposite direction. There are plan withdrawals from markets, and we’re certainly not seeing any particular activity in terms of new plan starts.

DR. GINSBURG: So that would imply we are not at the peak yet.

MR. HARRIS: No. I think we have at least 2 years to go.

DR. GINSBURG: Yes.

MS. GOODMAN: I would agree with that. I just think that over the long term that the industry has been in a bit of a Catch 22. The costs have been going up, and the managed care companies have had to raise premiums to match or exceed that. As Norm said, there has been more success in the commercial business.

Medicare has been an offset for a lot of the companies that participate in it, but even the companies--and not all the companies. I think the exceptions that Geoff mentioned are the correct ones, but for a lot of the companies, even though ostensibly the premium increases have been outstripping the cost increases, they have shown erosion in their loss ratios. I think that is probably a function of some erosion of the mix of business that they are writing.

But the longer-term issue is that you have to go back and think why did this industry begin to grow in the first place, as it did in the early 1990’s. That was that plan sponsors, corporate America, were not able to absorb the rate increases that they had been getting from the indemnity sector. They were not willing to accept 10-percent-type rate increases, and so they turned to what was a lower-cost alternative and a lower-cost alternative that also offered a lower-trend factor in the premium increase.

What they are facing now from the managed care industry is exactly what they saw in the early 1990’s, late 1980’s, from the indemnity sector. So, in a sense, while I could make a lot of arguments that the patient bill of rights debate and the general relentless attack that the press has had on this industry has contributed at least 100 to 200 basis points of the trend, nonetheless I think the plan sponsors are still looking at an industry that is not solving the problem that it was set up to address in the first place. I think that is a longer-term issue that the industry is at this point not coping with.

DR. GINSBURG: Dennis, do you have any sense of what hospitals are seeing as far as their aim is for managed care plans?

MR. FARRELL: They have begun to see some improvement, but it is lagging significantly from the picture that has been described by Geoff and Norm, particularly the amounts that we are talking about. They are talking double-digits rate increases. I think Norm had said maybe 4 to 5 percent is being passed on at best. I am really just thinking, in the back of my mind, providers whom also have been insurers have concluded that they are lousy insurers because they entered the market exactly in a time frame that this panel concluded was the worst time to enter, and they are now exiting the market which this panel is now concluding is the best time to enter.

One thing we know for certain, either their timing is really lousy and/or their execution is very poor.

What we do see, and I am sure you keep referring to your project in Cleveland, is a great example of where you are seeing providers banding so that they can push back and have some leverage when they are going up against--and it is going up against. It does not appear to be a business relationship anymore. It is significant adversity. So there is a lot of banding together to negotiate and/or demand higher pay increases.

MR. HARRIS: I think we talked about provider-sponsored plans and the prospects for it. Wasn’t it 2 years ago on this panel?

MS. GOODMAN: I think I said it was a great way for providers to dissipate a lot of capital quickly.

MR. HARRIS: Yes. They were pretty negative as a group.

[Laughter.]

DR. GINSBURG: That is very fortunate for providers at least, the plans of that era. Really, very few did it.

MR. FARRELL: It all depends on your perspective or what they were owning up to. I think many were and many continue to because they still think they can do it better than somebody who is in the industry, but the reality is it is a direct conflict of what their core business is.

Again, back to your initial question, there is some improvement. Our firm’s outlook, quite candidly, is actually viewing it as a potential positive, but probably a year or two down the road, again, because of the lagging effect that we were referring to earlier.

DR. GINSBURG: Yes. In a sense, there may be a difference. It is one thing to talk about the contracts that are being inked right now, but then there is a whole backlog of contracts that were inked before which still have time to run.

MR. MURPHY: Can I step in on this?

DR. GINSBURG: Sure.

MR. MURPHY: I think, too, you are finding a big difference between not-for-profit and for-profit hospital chains, whether the larger for-profit hospital chains that do have some market concentration are finding now price increases in the 4-to-5-percent range. A little bit was balanced early on why they were not getting paid. The bad debts were going up, and it seems like that is catching up as well. So I think you really are seeing some of that increased premium dollar flow down to the better managed hospital companies.

MR. FARRELL: There is an interesting alternative case study going on right now in Pittsburgh where you actually have Highmark, the major insurer, propping up an up-start health care system. I would hardly call it an up-start. It is the surviving or the resurgence of AHERF where they have not invested. It is not an equity investment, but they have loaned $125 million to in essence be start-up capital to compete with another major health system, the University of Pittsburgh Medical Center.

So it is interesting, again, going back to Roberta’s comment. It is very, very locally driven, and it is not always in the best interest for the insurers to drive the providers down to their knees, if not to an absolute crawl.

DR. GINSBURG: Yes. I guess that is long-term thinking.

MR. FARRELL: Yes.

DR. GROSSMAN: That is definitely something that we have seen across the range of our markets that hospitals tend to have more market power than physicians, that most physicians face a fee schedule, and they take it or leave it.

But we have certainly seen a lot more examples reported in the press of sort of difficult contract negotiations and providers walking away from the table, but what we generally hear is usually they end up coming back to the table or signing a contract sometime later down the line because most providers are not in a position to drop plans, although, of course, there are a bunch of celebrated examples of better success.

I think we definitely have heard from plans that plans are concerned about the financial viability of providers. So there is sort of this line to walk as they do better that they need to pass on some of those revenues. The question is how much and when. It may not really be the provider bargaining clout as much as the plans recognizing that.

MR. HARRIS: I was going to say I think some of the California provider systems have actually done pretty well in their negotiations, and I think it is Catholic West right now that started off their negotiation by filing a $50-million lawsuit.

MR. FARRELL: CHW.

MR. HARRIS: Yes. It was in order to, I guess, intimidate them and try to get rate increases.

MR. FIDEL: I think right now we are seeing the biggest disparity in hospital rate increases for managed care that we have ever seen.

I know of cases where well-entrenched hospitals with large market concentration are actually getting double-digit rate increases for managed care this year. Whereas, stand-alone hospitals with no bargaining power, they are lucky if maybe they are getting an increase. So that is a big variation, but in general, it is a lot better for the hospitals in terms of rate increases than it has been for managed care.

When you combine that with the improved situation under Medicare that is happening, now Congress is falling all over themselves thinking about giving give-backs to hospitals from BBA. Even President Clinton is now proposing more money for providers. This is just several months after he had proposed further cuts in his budget for this year. Things happen in election years, and usually it is for the benefit of providers.

DR. GINSBURG: Roberta?

MS. GOODMAN: As long as we are talking about what is happening on the provider side, one thing that I think is important to recognize is that part of what they are doing is recouping or addressing the impact of some very bad contracting decisions that they made in the mid-1990’s.

I think if you go back and you see what the public companies were saying and you look at what hospitals are talking about in modern health care and whatnot, they were all talking about doing these managed care contracts to get incremental market share. They were all thinking that they were able to price this business on the basis of it being incremental and additive, therefore, on a variable cost basis.

The problem is that that business is core business because there has not been that much market share shift as a result of all these contracting activities. So they were cutting some pretty bad deals.

Some of the places that you have seen the most significant rate increases are where some of the worst deals were cut originally and where hospitals were pricing business below the cost of delivering services and really were not going to be sustainable if they did not get some redress in those pricing issues.

DR. GINSBURG: Let me summarize where we have been. So the pharmaceutical trends are very high. They may be about to peak. We are seeing probably more of an increase in hospital rates than physician rates because some hospitals do have better bargaining power and they are starting to realize it.

There is a comment Roberta made that I wonder if anyone would react to. She was saying that various regulatory initiatives, patient bill of rights, pressure on health plans to loosen up in their management, has been a factor. I think you said 1- or 200 basis points.

Are there any comments on that?

MR. FIDEL: That is definitely true. Plus, it is societal demand and a booming economy. Right now, people want more freedom, and corporations are willing to go along with that because it has been an unusual period of prosperity in the economy. So we will see what the future trends are, but right now it is all pointing towards upward cost trends for most parts of health care.

Again, I think drugs is something different, and maybe we will get a little bit of relief there.

DR. GINSBURG: This is a good way to transition to the next part of the question. Employers seem to have been very acquiescent to these premium increases. Will they continue to be, or will there be a point where employers are not so acquiescent and behave differently?

MR. HARRIS: I think they will be as long as the economy is very strong and we have tight labor markets, but I think health plan beware when the economy weakens significantly and there are layoffs or the labor markets loosen and also when corporate profits are under pressure. I think then they will go and become much tougher in terms of negotiating premium increases, tougher on benefit designs, cutting benefits. We also then may see the real impetus toward defined contribution, which I know is the next topic.

I think right now, as long as the economy is so tight, people are just desperate to get workers, I do not think you will see a lot of change.

MS. GOODMAN: Although we have seen in the small group markets the beginnings of some substantial product changes that are designed to reduce the actuarial value of the benefits to make them more affordable for the employer. That is probably important in that the small group rate increases started somewhat in advance of the large group.

MR. HARRIS: And have been larger.

MS. GOODMAN: And have been larger. Exactly.

I think we have also seen some evidence in some of the companies, and this is not across the board and it is not universal, but that there has been some erosion of the risk pools that they are underwriting as some of these rate increases have gone through.

MR. FARRELL: I think your comments are largely true particularly for corporate America, but in small business and middle business size, you are seeing it just dropped, just cannot afford it, if they want to remain competitive. That is what is continuing to contribute to the significant increase in the working uninsured, which is sort of the dirty secret that nobody really brings to the surface.

In many ways the insurers are not necessarily looking to embrace that crowd because it is arguably not very profitable, and hospitals are very nervous about them and give out maps to their public county-owned hospitals.

DR. GINSBURG: I am glad you brought up the small business things because I think we have seen in recent years much higher premium increases for small employers than for large employers.

Certainly, part of that is a reflection of the underwriting cycle. To the extent the large employers are self-insured, they are insulated somewhat from the underwriting cycle, but is there a cyclical phenomenon beyond that?

Presumably, small employers do not always get higher premium increases than large employers because that would mean that the difference just keeps growing over time, but is there a distinct cycle in the small and large segments of the insurance buyers?

MR. FIDEL: I think it comes down to bargaining power, and I think on average you will see higher premium trends to smaller. There may be certain times when that is out of whack, but I think the majority of time, that is what you will find.

MS. GOODMAN: But they respond by cutting back the value of the benefits. So you probably have a growing disparity between the extent of coverage at large and small firms.

MR. FIDEL: Right.

MR. FARRELL: I think your statement is true on a historical basis, but, again, going forward, given the stakes at hand here and the potential for significant loss, it really goes back to the bargaining component.

MR. MURPHY: Can I step back in? Also, in terms of how employers are reacting, I think over the last year, clearly because of the tight economy, people have been pretty accepting of premium increases, but I think you are seeing more and more cases where they are asking the employees to carry a higher portion of that premium. You are seeing three-tier copays where they are asking to take a higher and higher payment on the pharmaceuticals, and if you step back and think about it for a second, it is an interesting dynamic in that if we are right in terms of the premium increases that we have been talking about, we are talking about 35- or 40-percent premium increases over 4 years, in a period of time when most companies have very limited ability to raise the prices.

Nobody really is talking about the inflationary effect of health care now on the economy, and I think you are starting to see this is still a big component of a lot of companies’ costs.

I think if you are a high-tech company and you have got very expensive employees and very few of them, it is not a big deal. If you are a manufacturer, it is really starting to hurt. If you can raise prices 2 percent a year and your health care costs are going up 10 percent a year, I just do not think they are going to take it for as long.

I am not as sanguine when you go out to 2002 that we are going to get the premium increases that we are talking about, and I think we are heading into a very interesting point in time where they are being squeezed by the stock market on one side and demanding increase in earnings and lack of inflation on the other side and not allowing to raise their prices. Here, you have one of your biggest components of costs going up, double-digit increases. I think it is all going to come to a head over the next 1 or 2 years.

DR. GINSBURG: I am glad you pointed us out there. Say in 2002, let’s assume labor markets are not so tight. We have had a few years of these premium increases. What type of direction do you think employers might go? Do you think it would be mostly as far as asking employees to assume more cost, or would they return to the tighter-managed products that they are actively getting away from today?

DR. GROSSMAN: CalPERS actually, recently, just tried to push their entire premium cost onto the enrollees and actually the people who use services; in other words, through increases copays for doctor’s office visits and pharmaceuticals. They were not very successful in that, at least right now.

MR. FIDEL: But I think in the case of CalPERS, they were kind of behind. You would think that CalPERS is sort of a leading edge, but in this respect, they really had not been pushing the costs onto the employees. All of a sudden, it caught up to them, and they tried to do it in a big way in one year and it did not happen. So I think that was kind of an extraordinary case when you look at it that way.

MS. GOODMAN: I think some of it will depend on how individual industries’ and companies’ particular circumstances unfold. I think if you are looking at industries in which labor is still at a premium that they will continue to provide the benefit, and they will try to find some way of doing that. There is a caveat to this, which is it does depend on the political environment to some extent.

But I think they will try and do things like philosophically akin to the three-tier formulary which is to change the benefit, make it more restrictive in certain ways, but also portray it as something that actually does expand choice because, with the three-tier formulary, now you have some coverage for the non-preferred brands. Whereas, before that would have been all formulary and it would have been pretty much 100 percent borne by the employee. So I think they will try and do it that way.

I think that moving back to very restrictive models will be very difficult to do because I think that the mood of the public towards those has been extremely negative and will remain so.

The political caveat is if you had Congress pass a patient bill of rights that had a very onerous external review and/or a liability component, then I think employers would just say, "Okay, we are out of this, and we are going to try to figure out a way of removing that burden from us." I think that would be the wild-card event.

DR. GINSBURG: This might be a good time to move to defined contribution, which we hear a lot about these days.

One thing that is confusing is that people are often talking about two different things. To some people, defined contribution is what Alan Ensovin [ph] was talking about in the late 1970’s where employers continue their role as a purchaser. They offer a choice of plans, and the employer pays the same amount towards the plan no matter which one the employee chooses. I tend to call that "fixed contribution." I think that is what Alan might have called it.

The other thing is the employer basically gives employees a voucher. It sends them to some type of purchasing pool where they choose plans, and one has to wonder if they actually see this either without significant liability problems that Roberta mentioned from the patient’s bill of rights. Either one, we will be seeing a lot of it soon.

MR. FIDEL: I think the thrust behind defined contribution has three motivations on the part of the corporation.

The first is this unknown about liability, and the patient bill of rights, giving the right to sue the health plan. The proponents do not mention it also gives the right to sue the employer, and that is a big item. Employers know about that. Although they are not very vociferous about it in public, behind the scenes, and the lobbying that goes on this country, it is pretty intense, and corporations do not want to be able to be sued. So that would certainly be one motivation behind defined contribution.

But I think there are two others. One other is predictability. If we can go to a system where corporation knows what their health care costs are and then if you pick a plan that is more expensive, you share that cost with the employee, that is appealing to them, especially after, as was mentioned, 2 or 3 years of double-digit increases. This would be one way of them to think of it on the out.

The other area is especially if there are numerous plans offered to the employee in a defined contribution. The corporations would not be hearing as many complaints from their employees about a plan because, in this case, now the employee is picking the plan. It is more of their responsibility. It is maybe not limited to the one or two plans historically that a corporation allows them to participate in.

So I think those are the three primary motivations. It is partly a factor of putting more of the cost onto the employee, but I think that is not the whole picture. It is these other factors, also.

DR. GINSBURG: So these are the motivations. What are some of the obstacles to doing this?

MR. FARRELL: I think a significant obstacle may be the specific industry you are in and to what extent organized labor plays a role.

If you look at the significant strikes that have taken place in the last several years, health care is often a central component. There is much debate as to the rise and fall of organized labor, but there is certainly some anecdotal evidence that organized labor is having a resurgence.

The problem, as we have been talking in this panel, about health care as an economic, the reality is it is a big social and it is down to the core of many people’s decision process.

So it is one thing that you can really galvanize a group about and get some consensus. So that is a potential obstacle that could particularly impair a particular segment of the working force.

MR. MURPHY: I think there is also some legal and structural issues in terms of tax deductibility and whether or not a corporation gives you a chunk of money and then you go out and buy health care on your own, whether that is a tax-deductible item. Today, the corporation can deduct those expenses from their taxes, which is a huge benefit.

I think there are some issues in the legal system about whether this whole medical savings account idea is going to carry over into the next year, the structure of those.

I think there are issues about risk pools. I think that is one of the items. There are 10,000 different flavors that they are talking about for defined contributions. To a further extent, if I am going to give you $5,000 a year, you go do what you want with it, and if you do not spend it on health care, you keep it, which again is just at the end of the day taking more money out of the risk pools. Premiums are going to go up for the sicker people, and the younger people will do better off.

I think there are a lot of different big issues, but at the same time, I think there is a huge drive behind trying to do this. Conceptually, it is pretty attractive from a lot of different perspectives. At the end of the day, it may be the one thing that allows health care spending to come under control if individuals really start to be responsible for their own spending and they see the effects of how they spend their dollars. If they spend it wisely, they get to keep it, and if they do not, they have to spend more the next year. Corporations are begin able to get rid of this burden that is on their back. I think it has got a lot of proponents behind it.

DR. GINSBURG: Joy?

DR. GROSSMAN: One of the interesting things is to date employers have not taken advantage of this. According to our employer survey results from ’96, ’97, only 7 percent of employees have the choice of plans and the employer pays a fixed-dollar contribution. Then there is another 12 percent that have a choice where the employer pays a fixed percentage. So there is only about 20 percent of the people who actually face an economic choice in which plan they select that is significant.

MR. HARRIS: Some of that may be a function of--I do not think there are a lot of products in the marketplace today. I do know there are some private companies that are gearing their whole strategy around a bet that we are going to go to defined contributions. So they are hard at work on coming up with products that might be attractive. Whether it has been a supply issue or demand issue, I am not sure.

DR. GINSBURG: I actually want to get into if you have a sense of what type of products are these companies planning to bring to the market to facilitate this.

MR. HARRIS: The ones that I know would be fixed contributions.

DR. GINSBURG: You mean products to facilitate fixed contributions--

MR. HARRIS: Correct.

DR. GINSBURG: --which in a sense would tackle some of the administrative cost issues--

MR. HARRIS: Right.

DR. GINSBURG: --of running a fixed contribution plan.

MR. HARRIS: And there are also some others now that I think about it that are also looking at more of a voucher system where you would have a broad range of choice between health plans or health care services, and it would sort of be up to you to figure out where you want to spend.

The job of the company, besides offering these products to the employer, would be to try to give the employee tools, internet-based or other tools, to make intelligent purchasing decisions. So it sort of runs in both directions.

DR. GINSBURG: I think the presence of these products could be important. Particularly with the fixed contribution, you have to ask the question how come it has been so long, why a change all of a sudden, and an innovation that makes it more feasible to offer a lot of choice, I guess coupled with employers not wanting to be responsible for the behavior of the plan they offer as opposed to the whole array.

Roberta?

MS. GOODMAN: I think generally what we have seen with health care is the changes tend to be evolutionary, not revolutionary, aside from those which are done by Congress which have had much more rapid and far-reaching consequences.

I tend to think that in the absence of a material change in the liability environment that we will see more of an evolution in this regard and more of a structure like a 401(k) kind of program. There are lot of different options, as Norm was saying. People would have greater visibility on what the tradeoffs would be between those options, which raises an interesting point in terms of some of the current class actions.

Most of the information that people rely on when they select plans are provided by their employer and not by the health plan itself, and I think that is one of the issues that you have to get through.

I think some of the problems with the voucher system have to do with both the behavior of people towards the system where you have the 25-year-old guy who thinks he is going to live forever, taking his $5,000 and going to Aruba or is he going to buy health insurance that he may or may not need. If you end up with those kinds of issues, then you have got a real problem in terms of the affordability of coverage. You have a major issue also in terms of underwriting.

What happens to the 55-year-old woman who has hypertension and diabetes? Who is going to underwrite a product for her? That is really the third set of issues, which is if underwriting an actuarial process was easy, we would not have companies in this industry having shown the kind of profit compression that they showed between 1995 and this year. This is a very tough set of issues.

MR. HARRIS: I am not saying there are easy answers, but I do think there are companies that are working on this now. There are reinsurers that are looking at the very problem that you are suggesting to try to come up with products. Whether they succeed or not, I think we will find out over the next year or so.

MS. GOODMAN: I think there is another issue, too. When you think about how people relate to the health care system, the basic view that most Americans have is they want what they want, when they want it, from whom they want it, regardless of how little the potential benefit might actually be if you look at the clinical literature. Moreover, they do not want to pay one dime towards it themselves.

MR. FARRELL: So what is wrong with that?

[Laughter.]

MS. GOODMAN: Someone else has to foot the bill.

MR. FARRELL: So we have not gotten into pharmaceuticals, but that is a good argument why pharmaceutical companies will always do very well because you can just take a little blue pill and you will be okay.

DR. GINSBURG: Good. I am going to skip the next question so we save some time and get into hospital and physician bargaining power with health plans.

In our discussion of costs, we already talked about hospitals and physicians. The first thing is your forecast. Looking down a few years, what do you see as the trend as far as hospital bargaining power with health plans and physician bargaining power?

MR. FARRELL: I think it goes back to a comment made before. It is really a local market-driven phenomena, whether it be a national investor-owned system or a local regional system. The key word there is "system." The individual providers in an urban market that has various alternatives is at a disadvantage.

We know one thing for certain. To achieve sufficient mass, whether it be owning physician practices, which have not been done very well by anybody, or owning sufficient points of entry, but purchasing other hospitals, it is an extraordinarily expensive path to go down.

At best, we are seeing situations where providers are at least in a position where they can tread water with their heads just above water. Nobody is in a position where they get absolute control. By the way, we are only talking about commercial. You cannot negotiate with the Federal Government. They will pay what they want, and so will local State governments. So, in reality, while I think conceptually it makes a lot of sense, there are a lot of issues that pull and create significant tension.

There are a couple of early interesting case studies where organizations have accumulated sufficient mass, and there is something coming from left field which was completely unanticipated. That was community pushback.

There is a couple of situations going on right now, one in Florida and one in Maryland. Hospitals change their names a lot, but the current name is Ascension Health which is the Daughters of Charity, where they partnered up in Florida and Maryland with non-Catholic systems. It is interesting because they could not get along with the other Catholics for so many years.

It was the community that forced them sufficient pushback, not allowing them to close or reduce the commitment at the various point of entries for the very reasons that Roberta indicated that health care is core.

This long-winded answer that I am giving is yes, there is significant pushback. Yes, there is some, at least, recognition of sitting at the table, but it is not to the degree that anybody had hoped to.

Instead of sitting down at the table and getting a piece of paper that had a reduction of 30 percent as the starting point coming at you from an insurer, it is at least now a single digit and without the brackets, but there is no significant issue at hand.

The piece that was raised before about Catholic Health Care West or CHW suing in California should be a very interesting case to watch. That seems to be the favorite avenue now, sue the insurance companies, and if that is successful, that should really help create a different atmosphere when providers sit down at a table with an insurance company.

MR. MURPHY: I think you have got to go back again. Dennis probably follows a lot of not-for-profit hospital groups as well, but I think over the next couple years, the for-profit hospital groups are in a very good place. It took them a long time, but I think they have adapted to managed care. They have shed a lot of marginal hospitals, marginal assets. They have closed capacity. They have concentrated their power in certain markets, and I think they have become much more sophisticated in the way that they look at the contracts that they get from managed care. So it may not be just on the surface, "We are going to give you a 5-percent price increase," but it may include a lot of things like, "You, the payer, will not share for new technologies that come on the market that we were not expecting that all of a sudden are going to cost us $2,000 to put stents in when we did not think we were going to see those before."

They have come through a significant period of pain. They really did not know what managed care organizations were and how to react to them 5 years ago, and I think they have come a long way in refining the business practices and have become quite sophisticated.

So, for the next 2 or 3 years, I feel quite comfortable.

MR. FARRELL: Your points, I think, are well taken. I am of the belief that may be overstated as far as the advantage that the for-profits have because it depends on the local markets.

MR. MURPHY: Right. I just do not know the not-for-profits. That is who I am.

MR. FARRELL: I am comparing the two. I spend a lot of time with not-for-profits, but let’s face it. You cannot look at not-for-profits and ignore for-profits because it is virtually impossible to differentiate between the two in certain markets.

The inroads that for-profits have made in certain markets essentially made them indistinguishable from a not-for-profit.

Take a tenant, let’s say, in Philadelphia or other markets where they have actually negotiated covenants in order to own those facilities that they have to provide in essence the same baggage or commitment to social practices, bad debt, charity, that the for-profits to. In fact, in some cases, these covenants are so burdensome that they are more cumbersome, like you cannot close facilities for a certain number of years.

Again, those contracts were entered into when the paradigm was a little bit different, but the reality here, your point that you raise in that for-profits have different motivating factors that dictate and they have the ability to make decisions much more swiftly than the not-for-profits, should not be overlooked, but at some point, you run out of cutting down. Cutting costs and reducing expenditures only has one path, and growth eventually has to come back to the surface, particularly with the for-profit or investor-owned environment. That is where the challenge will continue to be.

DR. GINSBURG: Let’s turn to physicians. The Campbell bill is making some progress in Congress which would allow physicians to join together to bargain with health plans. If this bill were enacted, would this make a significant difference? One scenario is yes, it is legalizing physicians forming local cartels, and the others would say it is hard to form a cartel and I do not know if physicians would be good at it. What is your sense as to whether this would have a big impact in the marketplace?

MR. FIDEL: I think it would, but I do not think it is ever going to happen, and let me give you the reasons.

You have got the administration, the Republicans, the GAO, and the Department of Justice all against it. Really, the proponents for it are some people in Congress who are running for election. So I do not see this getting off the ground. It may be around for a while and they will try again, but you are going to need some big changes.

Maybe in California, it would not make that much of a difference because the large physician organizations there have equally large--on the other side of the bargaining table, the plans are very large and concentrated there, too, but in other areas of the country where plans may not be as large, if you can organize physicians, even though they are supposedly not economic matters, we know that is the motivation for these groups forming. It is not really for the clinical benefit of patients as they say. It is for their own economic welfare.

In some cases, geographically, you could have a real shift in the balance of power if you could organize physicians into large groups against less concentrated plans, but I do not think it will happen.

DR. GINSBURG: Roberta?

MS. GOODMAN: One thing which is kind of interesting and has been overlooked in this whole debate is that physicians now can group together in IPAs. What the Campbell bill is about is physicians getting together without sharing any kind of economic incentives with each other, to be able to go and say we are not going to contract with you unless you pay us X.

Also, I think in addition to the direct fee components, there also would be an interest in trying to eliminate a lot of the managed care techniques that right now serve to create accountability and/or reductions in utilization. So I think it would be pretty profound if it happened, but I agree with Norm. I do not think it is going to happen.

In addition to the groups that Norm mentioned being against this kind of legislation, you also have pretty much every consumer group out there for the obvious reason that one of the things that physicians could negotiate to eliminate from contracts is the prohibition against balanced billing.

I think that it would be very significant and very negative, but it is also very unlikely to happen.

DR. GINSBURG: What about unionization of employed physicians? Will this be a significant force, and will it focus more on economic issues or on clinical issues?

MR. FIDEL: I do not know.

MR. HARRIS: It will focus more on economic issues.

MR. FARRELL: That was one of the questions that nobody responded and they were not supposed to ask.

[Laughter.]

MR. HARRIS: What percentage of physicians are employed versus--I do not think it is that--

DR. GINSBURG: The number of employed keeps growing.

DR. GROSSMAN: Yes. Actually, I can tell you that our most recent survey results indicated that 43 percent of physicians are now employed, and that is up from 38 percent, 2 years ago.

MR. FARRELL: What is the timing on that, though? What is the "43 date" of that?

DR. GROSSMAN: Oh, ’98.

MR. FARRELL: I would submit that that is an area that is under a lot of change right now.

It is great. We are talking about physicians, but the attorneys made a killing on this, setting up these structures to have these physicians be acquired and now they are helping them get out of these contracts because nobody is winning. This is arguably another area that the IRS will be looking at, paying enormous prices for practices to lose money and then selling them back at bargain prices.

You should probably see a significant swing in the opposite direction. Nobody has won out on those. The physicians are equally dissatisfied, as are the providers and insurance companies.

MR. HARRIS: What percentage of those are employees of physician groups? Because that is a little different number.

DR. GROSSMAN: Right. That is a mixed bag. That is physicians who are employed by HMOs or by hospital-owned practices or physician-owned practices. So it is a mix.

MR. HARRIS: To the extent they unionize it, that would affect the practice more than it would trickle up necessarily to the health plan. That is a little different.

MR. FIDEL: Also, for those hospitals, years ago it was the practice of hospitals to acquire physician practices, and that still goes on, but if you want to see a trend happening, it is hospitals getting away from that as fast as they can. Essentially, they did it in order to capture the patient referrals by the physician, but they are losing so much money that it is not worth it for them. Virtually, every large hospital conglomerate or multi-unit facility that I know of is either getting out of the business, about to, or has already gotten out of that business.

MR. HARRIS: I think the average loss per year per physician was between 90- to $100,000 for the hospitals.

MR. FARRELL: I think they are lying, too.

MR. FIDEL: That is all allocation of expenses.

MR. HARRIS: So do you think it is higher or lower?

MR. FARRELL: Higher, big numbers.

DR. GINSBURG: I can actually confirm that we hear about large losses per physicians, but I see a lot of energy going into fixing it rather than spinning off the practices.

DR. GROSSMAN: Yes. I was just going to say I do not know how many. I know there is a lot of talk about the contracts unraveling, but because they took so long to get in place and it takes a long time for them to unravel, I am not sure how many physicians are actually no longer employed and have ownership in a practice.

I think in Orange County, there was an example. KPC, I think they were called. They bought out what had been Neb Partners practices. They are losing a ton of money, and now everybody is worried about that, but it has not come undone yet.

MR. FARRELL: Again, my only point is the timing. This is when physician practice groups were the internet industry. You could not buy enough of the stock because it was going. Fortunately, the internet has not completely copied this particular sector, but that helped influence the insurance companies and helped influence the providers in this fast food frenzy to eat every physician you possibly could at ridiculous contracts. So I am actually seeing the opposite. They are divesting as fast as they can and taking enormous losses in the process.

DR. GINSBURG: Good. What proportion of hospital capacity--this is for you, Dennis, in particular--is under financial stress now? That is a meaningful way of saying it.

MR. FARRELL: I think there are really two camps, two answers. For the investor-owned, they are doing terrifically. On the not-for-profit, they are doing extremely poor.

If you want to get a percentage, I do not think in the mid-’90s is an overstatement. It probably is. Again, what defines fiscal stress? If you define fiscal stress that 3 years ago they had so much money falling over themselves, it was arguably immortal given the profits that they were making as "not-for-profits." Much of their investments or much of their revenues have been buffeted by investment as well.

On a pure operating basis, many of them are absolutely just hemorrhaging. A lot of that hemorrhaging is divesture of the physician practices, divestures of the managed care plans that they opened up because they were going to do it better than the companies that did it for a living, divesture of every other integrated practice, such as the McDonald’s they opened and so forth and so on.

But on a pure operational perspective, they are also doing pretty poor. What we have observed is the investor-owned have really made the quick decisive decisions, have done extraordinarily well; on a pure operations basis, doing very well. We are now seeing evidence that on the not-for-profit side that that practice is being copied. In fact, they will do better as well. "Better" is, again, a term that is ill-defined. We do not believe they will ever return to the levels that they once were, number one, and, number two, again, for the same reasons that were raised before about the mergers of the managed care, they have also gone through significant mergers. We can probably go into it later when we get into the technology aspects, but they are extraordinarily challenged in that area as well.

DR. GINSBURG: Let me go on to capitation of providers by health plans. A few years ago, people expected this to develop quite a bit, and it has not. It may have even declined. I was wondering if anyone has an opinion as to whether the growth of the use of capitation to pay physicians will resume or is it just dead for a long time.

Roberta?

MS. GOODMAN: I think it may be resumed selectively in some places, but I think the capitation has not yielded the benefits that providers who entered into those contracts anticipated that it would.

I think, further, if you look at where the market has been going in terms of preferred products, capitation is not really that consistent with the point of service or an open-access model, very difficult to manage those kinds of products in a capitated model effectively in taking account of where it is people will actually on their volition seek care.

So I do not think it has worked particularly well for the providers. I do not think it works particularly well for the growing plan structures, and I also do not think that it has really delivered to the health plans themselves the kind of predictability that they had been looking for given the difficulties that some of these groups have encountered in managing the capitation.

One exception to that probably will always be California because of the organizational structure that is out there, but I would not see this being the wave of the future. Quite frankly, I do not think I ever did.

MR. HARRIS: I also think in light of our earlier discussion, capitation, I think, further opens up the plans to legal risks. I think that has been one of the areas that lawyers have focussed as a creation of contrary incentives that represent a potential violation of fiduciary duties. There may be some response over time to that as well.

MR. FARRELL: It is legal and economic risk from the perspective--again, I know it is unheard of, a hospital ever going into bankruptcy, or at least 5 years ago it was. Again, a great example is the AHERF situation where Health America had this huge contract with them, and even though they had paid for that coverage to be provided, once that organization went belly-up, in essence they are still customers of that insurance company. Therefore, the insurance company is, whether legally or morally, obligated to take care of those patients. If they wanted to stay in business, they had to.

You asked the question. I think most people would say everybody is getting out of it. I think it is really just how desperate are you as a provider and how desperate are you as an insurer. The reality is it is virtually impossible to control.

My view was in the past, the reason why insurers entered into these contracts is because they realized it was an opportunity for somebody else to take on the risk, and it provided an opportunity to take on the profits. I think the jury is in, and it was clearly no profit to be taken by the providers. So the fact that they continue to go into it to me is just absolutely amazing, particularly since such an integral component of being successful in a capitated arrangement has superior information systems and superior ability to control the patient and the physicians. There are no instances that I feel comfortable with that the two of those are in sync.

MR. MURPHY: I think you can jump capitation up to another failed experiment in American health care. Physicians prove themselves to be unable to manage risk. Health plans did not like it because it did not at the end of the day shuffle the risk off like they thought it would be, and I think patients in the American population are very uncomfortable with the concept that physicians have an extremely direct financial interest in the level of care that they provide.

DR. GINSBURG: Joy?

DR. GROSSMAN: I agree with all those things. I would say, just to refer back to what we were talking to earlier about the underwriting cycle, that that probably speeded up the process because the growth and open-access products, some mandated benefits, as well as the pressure particularly on pharmaceutical costs really did in a lot of the people who were under global cap, providers under global cap who wanted to take on pharmacy risk and got into a lot of trouble very quickly. So, in some sense, that probably helped speed up the demise or just prevent future growth in a lot of markets where it had not started.

The other thing, I guess, is there is a lot of variation in this liability issues, and the health plans in California managed to do much better than the ones in Pennsylvania.

We had an example in Newark, New Jersey, where the plans still had to ante up to cover costs.

MR. FARRELL: But they are still entering into it. In New York City, Beth Israel just signed a capitated contract with HIP. HIP’s sister in New Jersey had to go to Governor Whitman to help pay themselves off. They actually had a long. So, again, they are both, I think, organizations that are financially struggling, and they are looking for their place and niche. It is not unique, by the way, to New York. It is in pockets here and there, but it will deny that they are entering into.

Like purchasing physicians, there are still perceptions that they can do it right and better than others have done in the past. I just think it is pitted with a lot of pitfalls.

DR. GINSBURG: This would be a good time, as I am running a little late, to turn to the Q&A. On our first Q&A segment, please come to one of the microphones to ask the panelists about the topics we have covered so far, and hold off on the ones we will get to in the second segment. Please state your name and affiliation.

One thing I wanted to mention, as far as the press, the panelists will be available shortly after. You are welcome to ask questions now, but for questions in private, they will be available after the session for a while to answer your questions. Many of them are not allowed to give recommendations on stocks.

[Laughter.]

DR. GINSBURG: Ann?

FLOOR QUESTION: Ann Gothier with the Academy for Health Services Research and Health Policy.

My question relates to the balance of power between the various entities and a model that actually has not come up in this morning’s discussion. There are two models. My question is to what degree do you see these models around the country, and to what degree do you think they may increase over time.

The first one, you probably do know about, which is where employers in Minneapolis, Minnesota, have done some direct contracting with providers in order to cut out the plans, and that is the Buyers Health Care Action Group model.

The second is something that I have recently heard about, and it is not up and running yet, although it is being developed by the former medical director of United Healthcare, Lee Newcomer. This model will be, in theory, an internet-based system, whereby employers could buy into it and offer a defined contribution. The employees would then have the opportunity to select their providers directly as in this physician for primary care and that physician for specialty care of a various type and various hospitals. There will be a calculator. Their premiums would vary based upon the choices they made.

I am skeptical as to whether or not that will in fact get up and running, but it is very interesting. I wondered what your perspectives around the country had on either of those direct contracting models.

MR. FIDEL: To my knowledge, direct contracting by employers was tried and has not gained momentum and ran into the same types of problems that regular health plans as an intermediary ran into.

At first, they garnered lower prices, but then over time, they had to provide relief to the providers. It seems like that is something that we hardly hear about anymore. I do not know. Maybe in some areas of the country. But that did not have traction in my view.

MR. FARRELL: With respect to the Minnesota or the Twin City markets, it is a lot like OPEC. One sneezes, the other gets a cold. It is so consolidated. It is arguably a very, very fragile system that is there.

If you were to take the Health Care Reform Act of ’93 as the model that would have worked, even back then, Mrs. Clinton suggested that is not what she wanted. The Twin City markets is extraordinarily susceptible to significant failure. You really do not have much room for improvement. It is because it has all been weeded out. There is no more efficiency or improvement in essence there in any of the markets, whether it be provider or payer. That is where you have the employer significant position as well.

MR. MURPHY: I am actually a member of that.

MR. FARRELL: Oh, there we go. I’m sorry.

[Laughter.]

MR. MURPHY: I would say it is just like being in any managed care plan now. I think there are a couple of years where pricing was very good and there was a lot of open access, and now they are becoming much more restrictive. I think we are an example of passing a lot of the cost onto the employee. My health care benefits went up 25 percent this year and the coverage went down.

On the Lee Newcomer idea, I think that is what Geoff was talking about. There is probably, that I can count, 12 or 15 venture capital-backed companies who are trying to figure out how are we going to take advantage of defined contributions if it takes place. I think his business model is probably at the most extreme end of the range, and that is let’s assume Congress says, "Okay, you can do this," and all the companies say, "This is a great idea," it is just like the 401(k) model where they are going to give you a fixed amount of dollars and they will have a system you can access and pick all kinds of different plans, including one where you go directly to physicians.

Right now, it is slim odds that those things will come to be, but there is a lot of very smart people who are putting together companies so that they will be ready if it does happen because it can be a huge sea change.

MR. HARRIS: I think the big part that will be very appealing to employers and consumers, the big challenge is going to be the actuarial challenge. No one knows where these products are ultimately going to price out. I think a lot of people have an evolved model of what they would like it to look like, but now they are into the nuts and bolts of actually trying to get quotes from reinsurers and others to figure out where these products would price out and are they sustainable economically.

DR. GROSSMAN: In terms of that provider piece of it, wasn’t that something that Oxford was trying to do, to be able to let people select sort of the tiers of providers they wanted and they ran into problems trying to price that on the provider side?

MR. HARRIS: I think Oxford was experimenting with some of these concepts even as Oxford Health Plans when Steve Wiggins was running it. Obviously, Oxford Health Plans collapsed with the underwriting cycle. Steve left, and the management that came in really refocussed the business just on the core business.

Steve actually is one of the people who has gone off to start one of these new ventures, going after the 401(k) market.

MR. FIDEL: I think the Oxford effort was, more or less, do you want to join a wide plan or a narrow plan, and you pay less if it is a narrow plan. So I do not think it was as sophisticated as what Geoff and others have referred to.

MS. GOODMAN: Wellpoint is also looking at benefits that are more customized to the individual member. I think the company has been very successful in developing new product and pricing that new product appropriately, but it is also a company with very deep infrastructure, with extraordinary knowledge of their marketplace and with very good systems, which creates an environment that they probably can do some of these things successfully. I think it is very difficult to replicate the data, the know-how, the actuarial capability, the execution, which is really where a lot of these companies have had difficulty in a small environment.

I would make one other point about the Minnesota experience, not that we necessarily need to, but that is if you look at the market there, these are vertically integrated organizations. These are not traditional hospitals that just function as hospitals. They have evolved quite differently than, say, looking at the Daughters of Charity. So I think that that makes them a little bit of a unique place and a unique experience that probably does not replicate really well.

MR. HARRIS: Just following Roberta’s comments. I think Wellpoint is an interesting example of sort of an intermediate step. What Wellpoint has done, as Roberta has mentioned, is to offer a huge number of slightly varied products and allowing consumers a lot of choice, but they are still buying a product.

The concept in some of these internet-based plays is you are actually creating your own product individually to yourself. I think Wellpoint is an intermediate step. They are saying, "We are not ready to go to that step yet, but what we will do is offer a tremendous range of products with varying benefits, and we have the confidence that we can underwrite each of those products accurately."

FLOOR QUESTION: I am Nora Superjones [ph] of the National Health Policy Forum. My question has to do with the Medicare Plus Choice market and with the plans withdrawing over the past 2 years and how Wall Street is currently looking at plan participation in Medicare Plus Choice, whether it is favorable or unfavorable.

MR. HARRIS: The less, the better.

[Laughter.]

MR. HARRIS: That is the Wall Street response.

MR. FIDEL: Last year at this conference, I said that BBA was a deal-buster for Medicare Plus Choice, and I still feel that is the case.

Even if Congress comes back and puts money back into that program, I really think the trust has been broken. It is going to be a long time until managed care embraces a Medicare product. It is going to depend on each year Congress reviewing what the rules are.

MS. GOODMAN: I would agree with all of that.

DR. GINSBURG: I have often been struck in the recent site visits about how everyone is running away from that, including the providers cannot wait to get out of the contracts they signed with Medicare Plus Choice plans.

Yes, sir.

FLOOR QUESTION: Bill Sulgonik [ph] from the Baltimore Sun.

I would like to follow up on the last question. For both Medicare and Medicaid, do you see the governments letting the insurers depart and letting programs collapse? Do you see them raising the premiums to keep the programs together, or is there a third possibility?

DR. GINSBURG: Yes, Roberta.

MS. GOODMAN: I think the issue with Medicare and Medicaid is that you have a system in which the government is setting the price and they are also setting the terms. When government does that, they tend not to set it in such a way that it makes sense for the private market to participate.

Medicare has been a tremendous problem for the hospital industry. The hospital industry, however, has such a huge portion of the volume coming from Medicare that it cannot afford to walk away from it. That has been a source of cost shift to the private sector historically, and I think that continues to be the case.

I think if you look at the history of Medicaid participation for managed care, it has been spotty at best, and I think when we look at Medicare, it was a very profitable line of business up until BBA ’97. Since then, the premiums have failed miserably to keep pace with the underlying medical cost trends that these companies face.

They have withdrawn from markets, each of the last several years, because they are facing those issues. I think at this point, unless there is a fundamental structural change, there is no reason why companies who have responsibility to shareholders should participate in the program.

MR. MURPHY: I think the government will allow a lot of these plans to go away. There are two structural issues. One is the same organization that sets these prices is basically a competitor in terms of a payment structure system, and they see more and more of their business going away towards these for-profit organizations.

I think, secondarily, there is a fairly high level of discomfort at the government level with for-profit organizations in the health care business. I think we see it again and again in the health care business where we have a cycle where they allow companies to make fairly good profits, and you get to a certain point and they ratchet back those pricing mechanisms.

MR. HARRIS: I would just make a near-term comment that the State governments are relatively flush with cash right now just because we have had a good economy. So the Medicaid players that exist, I think, today are actually doing reasonably well, and there are some companies that have specialized in those markets, but I would definitely agree with what was said here that any sort of long-term investment by the private sector and public companies in Medicaid, that was tried a few years ago and the experience was enough to scare people off for a long time.

MR. FARRELL: Paul, if I may, I think I have a little bit of a contrary viewpoint because we have been looking at this is different forces here. The reality is while I do not disagree that States are doing well, I want to suggest that the clamping down on health care expenditures as a component of the Federal budget and the State budget has helped create this economy that we are living in today. It has not gone unnoticed.

You look at every elected official at the State level who has run on the platform of reducing taxes and making government small. What has been historically the biggest component or the most uncontrollable component of government from an expenditure perspective has been health care. They have successfully--let’s face it. The majority of this room voted for it. I think in fact you did not have a choice because both candidates from both parties were running on that platform.

So, in many aspects, as we are talking about insurance cycles, there is a political cycle where you kind of swing one way and then swing another, and until this comes to the forefront, although most people I do not think they voted for less health care, less benefits, and less access, in reality that is what happened.

It was unheard of in the past that midyear, mid-budget year that you cut Medicaid benefits or payments in a given State, but it has been done. It has been done quite successfully for a State government.

I do not like to think that we are the sole measurement of success or not, but look at, let’s say, a State like Michigan. Again, there are multiple issues at hand here. While, yes, the economy has certainly diversified, in reality a significant amount of their fiscal improvement has been capping and reducing their Medicaid and medical expenditures. So they are not independent, at least in my belief.

The only candidate that even brought up health care on the national platform did not win one primary; a good basketball player, but he did not win one primary.

Needless to say, it is coming to the bubbling point, but they are not completely independent. The reality is government has passed that burden on to the providers, on to the insurance companies, and they do not want it back because it has gotten so complicated and so expensive.

DR. GINSBURG: One perspective I want to add, before we go to the next question, about Medicaid, from what I have seen at the sites, it seems those State Medicaid programs are pretty committed to using managed care. I think they also have a sense of how many plans they want in markets.

In a sense, they started out with pretty high payment rates. They squeezed them down. The initial plans dropping out, they were pleased to see that. It seems as though they are pretty flexible. If they lose too many plans, then they raise the rates. I can see this going on. It is not a very pretty thing. I do not think it is going to attract the national players, but I think it will continue and they will have people to do it, although I think there is growing interest in some States in more direct contracting with the providers and putting them at risk.

MR. HARRIS: But that volatility will scare away capital.

DR. GINSBURG: That is right. So you are going to have fairly undercapitalized entities in the business.

Yes.

FLOOR QUESTION: I am Cheryl Fish Patrum [ph] from Families USA.

Following up on the Medicaid questions, to what extent are you seeing national trends versus State trends in the Medicaid market, and how are the plans been nationally doing in this business?

Secondly, in the plans that have had well-publicized, threatened pull-outs, do you have any perspective on how much they are bluffing to get increased rates and how much the plans are really doing poorly?

MS. GOODMAN: In terms of the Medicare program?

FLOOR QUESTION: Medicaid.

MS. GOODMAN: Medicaid. Well, only a handful of the companies actually disclosed Medicaid-specific data in terms of their medical cost experience. By and large, to the extent that they do, the Medicaid loss ratios tend to run substantially higher than those for commercial, and in many cases, they will be equal to or higher than those for Medicare.

I think the participation from the national companies is very market-specific. They will look at whether or not a particular market has a set of structural parameters that allow them to make money. They will participate in those, but I think the general view has been that government has not been a particularly good or predictable partner.

DR. GINSBURG: Good. We have time for one more question.

FLOOR QUESTION: Actually, I had more of a comment than a question. So it might be really brief.

DR. GINSBURG: Okay.

FLOOR QUESTION: This is Sandy Sherman from the American Medical Association.

I want to disagree with this perspective that all of you seem to share that uniformly the private sector plans and private sector providers are better people to deal with than the government.

The AMA certainly has had many problems with Medicare, with Medicaid, with HCFA, with State governments, but at least when Medicare makes a rule, you know what the rules are. They have to publish a proposed rule. You comment on it. You go in and meet with them. You know what your fee schedule is. You know what the payment policies are that are governing the practice. You know what Medicare covers and does not cover.

In the private sector, a lot of that is just unknown. You talk about physicians being given a fee schedule as a take-it-or-leave-it kind of a deal. A lot of times, they do not even know what the fee schedule is. They do not know what the rules are that the plan is offering them. They have no opportunity to negotiate.k These are a lot of the changes that physicians are seeking to make with the Campbell bill. It is not just give us higher payments. It is tell us what the payments are, tell us what your policies are, tell us what the plan covers, what it does not cover.

So we are certainly on great fans of big-government programs, but I think this kind of black-and-white portrayal of how it works is not accurate.

MR. HARRIS: Maybe if the Campbell bill were rewritten to be a disclosure bill as opposed to a negotiating bill, it might not be opposed by the health plans.

DR. GINSBURG: I think you have really raised an issue as to whether some people that are fairly conservative--and I think physicians--economically would feel they would fare better as regulated than in the marketplace, but I am sure we will have many iterations of that.

It is time for a break. We will take a 10-minute break, come back, and get into information systems, pharmaceuticals, and a little more on hospitals if we can.

[Recess.]

Information Technology and Pharmaceuticals

DR. GINSBURG: Thank you. Our next topic is information technology, which we’ve certainly all read about a lot as perhaps we’re going into a new phase in health care, and the first question I’d like to ask is: For years, we’ve been hearing that information technology would soon become a vehicle in which large administrative efficiencies would be achieved, clinical care would be improved through greater coordination, and clinical practice would be supported by easily accessible information on practice parameters and the like. Yet the developments have always lagged behind these expectations.

The first question to get us started: Will the Internet be changing this? And maybe I could start with you, Sam.

MR. MURPHY: Sure. I think the short answer is no. I think the Internet is--I think you need to step back for a second and kind of look at the history of what’s happened here. On the surface, health care looks like the absolutely perfect application for Internet and for technology. There are lots of different types of systems out there. They don’t talk together, very fragmented infrastructure, should be a lower-cost way to put information out in physicians’ practices and lots of different sites.

But, you know, the story that we’re talking about is very much the same one we talked about back in 1995 and 1996 when we had another huge burst in information technology excitement, at least from the public stock market perspective, with the same type of goals being named, and at that point in time it’s, hey, we’ve got client server technology that now is going to enable all these companies to do this.

And the reality is, although the Internet is an enabling technology and is a big move forward and is important, the real things that are hanging up the use of technology in health care aren’t addressed just by this technology infrastructure, and that is, A, it is a massively fragmented business; B, it’s an extremely complicated business; C, you have a mix of for-profit and not-for-profit organizations that have different business goals; and, D, at the end of the day, the only way that any of this information technology really has an impact on care is if you can get broad acceptance at the physician--right at the point of patient care, implementing technology.

So then you get into a whole new level of interrupting patient flow and physician work flow, and whether or not you really are adding any value to a physician’s day by asking them to interact with a computer while they’re interacting with the patient rather than just scribbling things on a piece of paper.

So my short answer is I think there’s immense promise in the area of using technology in medicine. There’s been huge barriers. We’ve gone through two cycles. First we did it in 1995 and 1996. Last year we did it in about six months, where all these e-healthcare companies came public and there was a lot of excitement. And the reality is very few of them yet can show any real traction in getting the broad health care community to adopt any of these new technology standards and really put them to use.

So I’m looking for it, and I’m excited about the opportunity, but I just don’t see yet today any technology platforms out there that are really going to support it. And I don’t think the Internet is a big enough change to really get over those intrinsic hurdles in the industry.

DR. GINSBURG: Agreement? Disagreement?

MR. FIDEL: That’s a pretty depressing thought, isn’t it?

[Laughter.]

MR. FIDEL: Well, from my view, the toughest part to link is the physician. The connectivity to the physician has proven to be very difficult. They’re not embracing the technology too well, and they don’t want to pay for it. And so, for example, we’ve seen some initiatives like a Healtheon where, you know, they’re trying to provide a service and the docs are sort of signing up, but they don’t have to pay for it because Microsoft and DuPont are now paying for the subscriptions, which will end in time, and we don’t know who’s going to pay for it two years from now.

We have the health plans who feel companies like Healtheon could, you know, maybe get too big and control the pricing structure of this thing, so now they’re getting together to do it themselves, and maybe that is a solution or part of the solution. But, you know, there’s so many hurdles of standardization and you’ve got HIPA in the background where we don’t know how long that’s going to take until those requirements become standardized.

And so, you know, you can just see another whole example of how things get delayed in trying to do these things because the standardization isn’t there, and as was mentioned, there’s just so many interest groups who are involved. And, you know, my guess is it is going to take longer than everyone expected.

DR. GINSBURG: Geoff?

MR. HARRIS: I think I’m sharing some of the thoughts particularly here that at the end of the day there will be very few pure-play, stand-alone Internet companies in the health care space. I think that the Internet, as we look back, will be a very powerful tool that existing players will use to reduce costs, increase connectivity, and that will happen over time. But I don’t know if you’ll have a--I’m trying to think of--an Amazon that is sort of a pure Internet company that displaces existing players in the market.

The only place you may have them are in some of these defined contribution entities that we talked about, but then that act more as exchanges.

DR. GINSBURG: Yes. Well, I think the real focus is not whether some company is going to be very successful, but whether it’s really going to change the way medical care is delivered.

MR. HARRIS: I think it already--I mean, it has to some degree in terms of just patients showing up at their physicians’ offices much more knowledgeable today than ever before. But how you measure the impact of that, either on quality of care or satisfaction or practice patterns, I think is difficult to assess.

DR. GINSBURG: Roberta?

MS. GOODMAN: And I think in some ways while the--I think you have to look at the Internet as having two components: One, looking at it on the administrative side, if you can streamline some of the administrative transactions and some of the communication processes, you can reduce costs. I think on the medical side, I think that the Internet has been probably a contributor at the margin to the increase in cost trends, partly because patients are showing up more informed, but also, I think, as people are diagnosed or are having problems that they’re seeking diagnoses for, there are just so many information sources out there, and one of those will always tell them that if you do X, there will be or there could be a cure. And I think that that has been an issue, partly because there’s no real control of how good the information is on the Internet that people are accessing with regard to medical conditions and medical treatments. And there’s a lot of charlatans out there, unfortunately.

MR. HARRIS: The community that the Internet may have the biggest impact on, or perhaps detrimental impact on, are insurance brokers. I mean, I do think that the Internet will have significant impact on distribution and will become a greater source, particularly in the small-group market, of insurance sales. So I could see the margin of the insurance brokers being compressed or in some cases their being eliminated from the process.

MR. FARRELL: Yes, the difference here versus other Internet plays is the industry knows the Internet is here to stay and what benefits it has, so you won’t have any big home runs coming out of left field that will take significant advantage of the core players in the industry. Yes, you might end up with a priceline.com for purchasing, but in many ways you already have some of those efficiencies in place, and it’s just making it much more efficient.

Again, we talked about before that health care was and will remain a local phenomenon, and given the ease that development and the ability to transport this knowledge, you should see things on the fringe a la, you know, maybe some rural hospitals having access to some things, giving their consumers more opportunity.

You will likely see some hook-up ventures with a local system or a local provider or a local insurer with more national--give the appearance to have more hook-up, but in reality there will still be some--the driver will be the local market because you want to go with your trusted local broker or your local provider. But the home run that was, you know, so pronounced as--that gave so much credit in other areas is unlikely to occur.

Geoff raised the whole issue of HIPA and in many ways privacy. There’s a lot of opportunity--I’m sorry. There’s a lot of opportunity that one can conceptualize transference of data, but there’s a lot of issues associated with security and private, and so it’s a real issue at hand.

MR. MURPHY: And I want to be clear. I mean, my comments were specific to this question because we’re talking about kind of the Holy Grail of health care technology.

MR. FARRELL: Right.

MR. MURPHY: Large administrative efficiencies, clinical care is going to be improved, greater care coordination, easily accessible data to support clinical decisions. I mean, these are big projects, and I think you’re going to see lots of little niche areas where the Internet can be effective. But the question is: Can you effect broad sweeping change? And I think if you look at it there, you need to break the question into two pieces. One is: Is the Internet in and of itself going to do it? And the answer I think is no. And question two is: What does it take to get the broad health care community to really embrace technology, to get physicians to actively use technology? That is, you know, at the end of the day the linchpin of the whole thing. You need to get to all these different pieces of the health care system to cooperate together to share information across it.

And I think, again, those are the hurdles and it’s not a pure technology hurdle. And in the last round and in this round of public companies coming public, you’ve seen some relatively successful, very narrow players. But as soon as you get to this issue of care coordination, better clinical care, better clinical practice, you open up a massive can of worms, and it’s a huge project. If somebody’s successful at it, it’s going to be the greatest thing since sliced bread. But it’s a massive undertaking.

DR. GINSBURG: Yes, and I guess what really we’re hearing as far as the big things, that’s unlikely to come from a new player entering, but from the existing players incorporating the technology into their work.

Good. Let me go to the consumer side. I think Geoff had mentioned something, but what--in a sense, the notion of consumers being better informed and taking a more active role in their health care. How would these services be paid for? Is this something that you can see a way out of?

MR. HARRIS: Well, I think the hope is that the models shift from being informational to transactional; in other words, the consumers will go to a site to get health information, and then the way the site will make money down the road is by allowing the consumers to engage in some kind of transaction activity using the website. But getting from A to B or, in this case, I guess, B to C, but getting there has proved to be very difficult for a lot of the companies. So there are companies that have active websites, but they can’t make any money. Dr. Koop is a good example, seems to have a lot of activity but they haven’t figured out how to translate that into a viable economic model.

MS. GOODMAN: And there are a lot of sites that are sponsored by non-profit organizations that are free, so it’s hard to see how someone necessarily, unless there is some dramatic better feature to it, is going to want to use something that does end up creating a charge. If you can go to the Mayo website for free and get the state of the art from Mayo, why would you go to, you know, XYZ sponsored by someone that you don’t know and get that information?

MR. HARRIS: Yes, and this gets back to the comment I made earlier that I think it’s the existing players that will use the Web as a tool, but ultimately they’ll be paying for it. It may be a marketing expense. It may be some kind of cost of doing business. I think there will be few sort of stand-alone Internet players that can actually figure out how to generate revenue and earnings.

MR. FIDEL: And in the under-65 market, really, you know, it’s really only--as far as getting the transactions, it’s really only for the uninsured, since health plans are not going to let you do a transaction with someone not in that network. So that’s been a big stumbling block for the companies that have been trying to do drug transactions, getting prescriptions filled on the Internet. Obviously, the PBMs or the health plan itself, you know, they want you in their network. They don’t want you going to some place outside the network unless you want to pay fully for that.

DR. GINSBURG: Good. This issue of who’s connecting the health plan, the physician, perhaps the--yes, not only business transactions but information, do you have a sense of down the road what type of entity? I mean, will it be the health plan, will it be providers, will it be a vendor that actually is the source of that connectivity?

MR. FIDEL: I think the health plan is in the catbird seat here because they’re the ones that are paying the bills. And so, you know, an individual vendor has to--it’s more difficult for them to break into the system, so I think there’s a natural advantage for the health plans, and especially in a consortium-type of arrangement, you would think they have the advantage with them.

But this is a big country with a lot of innovation, and I’m sure there will be a place for a lot of different entities. It’s just I’m trying to point out that the health plan has the natural advantage right now.

MS. GOODMAN: We’re seeing in some of the markets in which there are very dominant local players that those dominant local players are connecting directly with their providers, partly because when you start looking at the complexity of the contracts that the claims relate to and that the transactions with the health plans from the providers relate to, you really start getting very, very fine--it’s not like buying a book with a 20 percent discount. You have to look at all of the rules, and it’s extremely complex and extremely cumbersome. And so one size is hard to fit all. Designing an all-purpose solution that can fit from an HMO that operates under capitation in a gatekeeper model, to a point-of-service, to a PPO, to an open-access plan, et cetera, it’s very difficult to do that.

So I think that it is going to be more direct, and I also think just from a mechanical standpoint, once you’re on the Internet, it’s pretty easy to get from place to place. You just bookmark it and there it is, as long as they have the proper utilities.

MR. MURPHY: I think we’re going to know the answer to this question in the next six to 12 months, and like Norm said, the health plans are in the catbird seat. They’re trying to put together some level of consortium to work together, and this is such a logical business opportunity where they spend a huge amount of money on paper processing of claims, high labor costs both for the physicians and for the health plans, and the real Catch-22 has always been the very fragmented nature of this business. No one health plan has enough business with a physician, so a physician says I’m not going to put seven different systems in, I want to use one. And the health plans all way we don’t want to do something because we only have 10 percent of this physician’s business.

So if these guys can get together and put aside their animosity and competitiveness long enough to come up with a standardized format, I think they’re going to win this battle, and we’ll probably know within the next six to 12 months whether they’re going to be able to do that or whether or not they’re going to continue to have enough infighting amongst themselves that they won’t be able to accomplish it.

MR. HARRIS: There’s a group of California plans that’s endeavoring to do that, and--

MR. MURPHY: Well, it’s more than just California. I mean, now they’ve added--I mean, pretty much everybody is--

MR. HARRIS: It’s a big group.

DR. GROSSMAN: Yes, that helps address a question that I had. We’re pursuing this issue for our next round of site visits, and we are starting to see already there’s a lot of variation. Local plans have the advantage of, you know, working directly with the providers and having larger market share. They have some disadvantages, obviously, in terms of capitalization. And on the other hand, the larger plans, you know, have these sort of big efforts, but when you get down into the local market, it’s not really clear what actually trickles down and gets used in the local site. So it seems there’s kind of this uncertainty about where--you know, who’s actually going to ante up and get it done besides these selected, you know, examples of specific ventures that work well, for example, trying to manage chronic conditions or something specific that a plan does.

MR. MURPHY: And I hate to be the chronic depressor on all these things, but it seems to me that what this speaks to is the fact that we’ve way overstated the potential efficiencies that are going to come out of all this. I mean, people talk about $200 billion a year wasted on paper claims, et cetera. If it was $200 billion, they’d figure out how to have it work and it would be up and running.

[Laughter.]

MR. MURPHY: So I think we probably--it’s a much more complicated issue, and when you make all these--I don’t know where that number came from. It’s the number you hear all the time. If it was real, I think these companies would have figured out how to make it work, because this is not a big technology issue. Just come up with a standard claim form, and it interfaces into your claim system and put it out on the Web, and you could, you know, for $50 a physician have this up and running in no time flat. So I--well, enough said. I hate to keep depressing people.

DR. GROSSMAN: We’ve definitely heard over the years how difficult it is for local health plans in particular, but all plans seem to get doctors connected, even to do claims processing, that it’s still this huge hurdle and most of it is done in paper, and, you know, that rural docs in particular do not have computers.

And so, I mean, one of the promises that this potentially held out was that physicians could, you know, buy a PC, pay on a monthly basis for their software, and outsource somebody taking care of it, that they didn’t have to hire, you know, an IT staff and do all this stuff. So how do you balance that? Is that really just--you know, it would have happened already with the PC? Or do you think there’s some--you know, the docs will come on board if there’s some advances made on the payer side?

MR. MURPHY: Well, I think there’s a lot of validity to that, but it’s been so fragmented that nobody’s had enough--I mean, the other challenge on this is, there’s a lot of physicians’ offices out there, and the challenge for all these companies that have been trying to access this market is: If you’ve got something that’s going to bring in a revenue stream of $10 or $20 a month, it’s very difficult to justify having a salesperson go out to that physician’s office. It’s very difficult to have a technology person go out and install software, et cetera.

So I think it is a challenging market, but you’re right, the Internet, if everybody got together on the payer side, should solve that because you should be able to just sent out a diskette that you could load on the computer, and I think more and more frequently physicians’ offices do have computers, even though there are some who don’t.

So my guess is get there on this issue; again, if the health plans can get together and come to agreement on what a common format ought to be, it should be pretty simple.

DR. GINSBURG: You know, one thought I had is if some of these things succeed and there really is greater connectivity, is it conceivable that this could make small medical practices more viable again in the future? Could this actually serve to reverse the trends away from small practices?

MR. MURPHY: It could, yes.

DR. GINSBURG: That’s speculation.

Maybe it’s a good time to turn to pharmaceutical issues, and--

MR. FARRELL: Just one point back on the technology component and it either supports or goes against some of the theories that we’ve been advocating here. But, again, this industry was arguably the most impacted or paralyzed industry by Y2K, and so much effort and time and focus was to make sure that your monitors were not going to shut off or your half-lives weren’t going to be calculated incorrectly.

Many organizations were just absolutely paralyzed both on the provider and on the payer side that the distractions and focus has really not eased up yet. There’s still a lot of band-aids and rubber bands and sticks of glue that are holding technology components together. So it’s arguably poised for significant improvement and investment in this arena.

Again, I’m not sure whether that supports the fact that this may happen more swiftly than in the past, because, you know, in the last year or two or, arguably, three, it was really in a defensive mode, the whole industry. And now it’s a different focus, and, you know, I guess the real crime is that so much time and effort was focused on arguably not the future but just making sure the status quo was going to be an operable environment.

DR. GINSBURG: I’m glad you raised that. We really can’t forget the fact that there’s been so little progress in the past few years that this industry was so consumed with the Y2K problems that, really, it didn’t have any resources to--

MR. FARRELL: Yes, the only positive out of Y2K is it delayed the implementation of the outpatient PPS for BBA.

[Laughter.]

DR. GINSBURG: Any other thoughts on the information technology before we leave it?

[No response.]

DR. GINSBURG: Okay. I guess we talked a little bit before about the pharmaceutical spending and the outlook for the next few years, and Geoff mentioned at the beginning that he saw pharmaceutical spending growth peaking in a couple of years because of factors such as patent expirations and not a lot of blockbusters in the pipeline. So are there any other thoughts on that?

MR. FIDEL: Well, I think it was me that--

DR. GINSBURG: Norm.

[Laughter.]

MR. FIDEL: I mean, the medical trend I think may actually decelerate a little bit because we have the--you know, the plans really are implementing three tier, and so for the plans, the medical trend may decelerate because of the change in the design of the plan. It doesn’t mean the spending for pharmaceuticals, when you include the out-of-pocket, is going to slow necessarily, but for the plans it may.

Also, we do have a lot of patent expirations coming, and we probably won’t equal the tremendous onslaught of new blockbusters that have hit the market in the last five years in the next few years, although many of those products that were introduced in recent years are really starting to--they still have an impact on year-to-year growth. So if medical--if drug trend is 15 percent now, I think it may actually flatten out or decline a little bit.

Now, the other half of the equation is we have the whole issue of the Medicare drug benefit, and, of course, if that gets implemented, let’s assume that something does pass through Congress in 2001 or 2002, starts to get phased in in 2003 and maybe fully phased in by 2006, by 2007 you know that there’s going to be tremendous increase in demand for drugs. Only a third of people over 65 in the U.S. have good drug coverage right now, usually because they have it from their former employer and they’re now in retirement. But Medigap and even managed care do not provide a good drug benefit today. It’s a lousy drug benefit, when you get down to it, and a third of those people have no drug benefit. So it means a tremendous increase.

Now, of course, the Medicare business is a separate issue when you look at it from the health plan point of view because they’re either in the business or not. But total spending on drugs is sure to be very vibrant in this country because the elderly really haven’t had good coverage in the past, and you only have to look at--in the U.S. drugs represent only about 8 percent of health care spending, whereas in virtually every other country in the world, drugs represent 15 to 25 percent of health care spending, even though supposedly prices are lower overseas than here. And I think the answer to that is that in every other country people 65 and over usually have good or better insurance coverage because there’s national health care or government-provided health care benefits in those countries.

DR. GINSBURG: Any other comments on the trends before we get to employer or Medicare, just the likely trend in drugs?

MR. MURPHY: Well, can I just--when you say that a trend is going to flatten out, do you mean it will stay at 15 percent?

MR. FIDEL: I think it will flatten out to maybe decline a little bit because of the factors that I mentioned, including the prevalence, more prevalence of the three-tier drug benefit, which maybe now is offered in 25 percent of all health care plans, up from 10 percent a year ago, and maybe it will be 50 percent in another year. I mean, it really is being embraced.

DR. GINSBURG: Yes, you mean that the 15 percent will be a lower number, it will still--

MS. GOODMAN: But it will also be a larger percentage of the spend, so the contribution to the trend itself probably doesn’t--

MR. FIDEL: It’s still there, but, you know, we’ve been having an accelerating trend for the last few years. I think we’re about at the point where it may stabilize and start to go down.

DR. GINSBURG: Geoff?

MR. HARRIS: The only comment I would add is that the stocks have begun to anticipate some of this and that the large-cap pharma stocks over the last year and a half have not performed as well relative to the market as they had in the previous years. And this year we’ve seen a fairly sharp upswing in the generic and specialty pharma stock performance, which would validate some of the things--

MR. FIDEL: Yes, well, I don’t agree with that, Geoff.

[Laughter.]

MR. FIDEL: I think, you know, the drug stocks were poor performers until recently, and the thing that’s changed is, you know, we now have a perception of a slowing in economic growth and the market has turned more towards stable growth stocks--

MR. HARRIS: We’re talking about relative to other health care--

MR. FIDEL: Pharmaceutical stocks have been very strong in the last few months when that market perception change happened back in March.

DR. GINSBURG: Okay. Why don’t we get to employers? It’s a big topic at employer conferences as to how they’re going to respond to drug spending. And like the figures you gave, I’ve been struck at how rapidly the three-tiered copayments has taken over. Do you expect this to be the norm--actually, in a few years to be the norm for benefits?

MS. GOODMAN: I would say yes except for situations in which you have collective bargaining arrangements that call for other more generous coverage.

DR. GINSBURG: And I’ve seen some data, actually by Brandeis Group studying drug trends, which show that most of the savings from three-tiered cost-sharing come from greater payments by consumers as opposed to a lot of switching of drugs. And I wonder if this could be something that starts to become perceived more negatively by consumers because of that, and whether that would block its adoption.

MR. FIDEL: Well, consumers have to make up their mind. Do they want more freedom and more choice? And if they do, they’re going to have to expect to pay for some of it. You can’t get a lot more freedom and a lot more choice if you don’t want to pay more, and you just can’t expect the health plans to give all this choice and absorb all the cost.

So the consumer and the employer and whoever the other interested parties are will have to make that choice. Again, in a booming economy, you know which choice they’re going to make, and the future will hold what it will hold.

MS. GOODMAN: I also think that as you look at the reason that the three-tiered formulary has been so successful is that if you’re going from a situation in which you’ve got a generic at whatever and a brand that’s on formulary at something more than that and then no coverage for drugs that are not on formulary, that the three-tier actually does provide the consumer with somewhat better coverage if he or she was using a non-formulary drug or would want to use the drug that would have been non-formulary.

I think that’s somewhat different than looking at a much more restrictive situation with regard to providers because it’s psychologically saying we’re going to allow--you know, we’re going to provide coverage for all these different things, just coverage for certain things will be better than others.

MR. FIDEL: And, Paul, your comment that observing these three-tiered systems, that the big change is in more out-of-pocket expenditure rather than behavior change, as far as going with the less expensive drug, and that really is borne out throughout history, because if you look at the whole issue of therapeutic substitution, which is essentially getting someone to change what drug they’re going to use because it may be less expensive, the classic example is when you have a major class of drugs and a major drug in that class goes off patent. Whether it be Zantac or any other product, you will not find after that patent expiry that the generic product is taking a greater share of the market. In other words, people are still sticking with the brand name product that they want. You would think that at 60 percent or 80 percent less price the market would flock to a cheaper product within that category, but it just doesn’t happen because people want the drug they want.

MR. MURPHY: And I don’t think you’re going to see a big backlash, because if you really think about it, what they’re talking about is it’s going to cost you $20 to get a prescription now instead of $10. So for the vast majority of the people, it’s going to be $20, $40 a year, spread out over a couple of visits to their pharmacy, and I don’t think most people--it’s not like you’re dumping a huge increase in cost right up front that’s obvious.

MR. FIDEL: Well, I think it can be greater. You know, sometimes you get up to a $40 or $50 copay if you go with a non-preferred drug, but your point is well taken.

DR. GINSBURG: Yes. So in a sense, what we’re hearing is that consumers are going to accept this much more readily than accepting closed formularies, which at least at this point they’d have a lot more problems with.

MR. FARRELL: Well, and the pharmaceutical companies are arguably geniuses in this arena because the direct marketing--I mean, anywhere you go, on television you see this wonderful, beautiful scenery for Claritin. You go a subway in New York, you see all--you can’t even pronounce these words, and what they’re trying to do, which is, again, extraordinarily clever and arguably successful, is market directly and actually take a different approach entirely, eliminate the middleman and the decisionmakers and the payers and just go right to the source. And it’s been, again, so far very successful.

DR. GINSBURG: Let me talk about the Medicare drug benefit. It seems as though there are some issues that we’ve seen a lot before in health policy as to whether this should be something just for low-income people or for everyone, should it be government or private sector. But there’s one thing that seems to be somewhat unique, which is coming up with a way of pricing the drugs. If we have a Medicare program, how is the government going to determine what price? Everyone says, no, we don’t want price controls, and there’s a lot of talk about using pharmacy benefits managers to negotiate prices.

Is there any sense that this would work in the Medicare program?

MR. FIDEL: I think it could work, you know, if you don’t burden them with too much regulation, because what may seem right in one market is not right in another market, and you can’t have a federal program dictating local market conditions.

So, you know, the idea that--you know, obviously it doesn’t look like we’ll have price controls, at least in the early years of a Medicare drug benefit, because of what’s happened over the last six or seven years. People don’t want to go back there again. But, you know--I forgot the point actually I was getting at, but--what was I talking about?

[Laughter.]

DR. GINSBURG: If PBMs would work.

MR. FIDEL: Yes, the PBMs can work as, you know, they’re realizing efficiencies in the commercial market now, and it could work in the Medicare market. I’m just afraid that the heavy hand of government regulation will stop--you know, will impede that process.

MR. FARRELL: My concern about the heavy hand of government regulation is what’s the alternative. Every other government program that’s been initiated or opened in this particular industry has been at an exorbitant cost. I mean, you have coming out of the woodwork unanticipated--you know, just the volume is tremendous, and the bottom line is, you know, on its face value, Medicare--you know, if you’re successful treating a Medicare patient, you’re creating a greater burden on the system later on, unlike the private insurance cycle where you have somebody who is now going to contribute and pay the monthly--these people aren’t paying in the system. It’s the taxpayers. So it creates an imbalance further down the road. That’s in essence what your question is, Paul. How is it going to be paid for?

The only solution I can see is it’s being pulled back later on because it’s just not going to--which is, you know, very, very difficult to give something, then take it away, even more difficult to give and take away from a senior than it is from a child. So it’s particularly very, very difficult.

MS. GOODMAN: I also think when you start looking at what the PBMs have been able to do in the private sector, it’s because they do make trade-offs within categories. And I think that one of the risks with a Medicare program would be that whatever was excluded from the category, there would be a lot of political pressure to expand the definition and get those in so you don’t get the benefit to the manufacturer of the increased volume. I think that is a concern.

And I would agree with what Dennis has said and what Norm has said. I think that the cost would almost inevitably outstrip whatever estimates were made of the benefit, and whatever the initial structure would be would be either shifted very heavily to the private sector in the form of increased risk and reduced margins if it was a private sector risk-bearing entity that was out there, or there would be a squeeze on the price through price controls coming in at some point. I just--

MR. FARRELL: Or some other place. I mean, do you introduce means testing? Do you raise the age level? I mean, the bottom line is it’s a balloon that will burst if it’s not delicately balanced.

DR. GINSBURG: I guess the tough things on PBMs is that we see a model--a lot of people like the model that they’ve seen in the private sector, but there are all these reasons to suspect that it won’t work as well in Medicare because of the points that Roberta brought up.

Would it be better off--I mean, is it actually a feasible option to think in terms of most-favored-nation pricing instead of using PBMs for pricing?

MS. GOODMAN: Again, that’s the same problem. You’re asking people to take reduced price but not in exchange for any other consideration, really, because, again, when the private sector negotiates a reduced rate, presumably there is some market share benefit that you get from doing so.

MR. FIDEL: Right. This is trying to administer a market mechanism, and you’re creating impediments to it by not allowing them to get that market--in other words, they’re getting the discounts because they’re able to influence the type of drug or the volume of that drug, and now by most favored, you’re taking that mechanism away from them. So it makes it difficult to see how it could really work efficiently.

DR. GINSBURG: Are you talking about a fairness issue or a workability issue?

MR. FIDEL: A workability issue.

DR. GINSBURG: Okay. And is this because maybe Medicare and Medicaid, which already uses this, would just be too large a part of the market for a most-favored-nation thing to work?

MR. FIDEL: Well, the PBM now, you end up--you know, the price of the drug is determined after the fact, after you see how much of that drug is actually consumed. And through their practice in setting up formularies or incentives, they’re influencing that. But if you have a Medicare benefit where all drugs approved by the FDA have to be made available, which is part of one of the major proposals, which right away you don’t have to read more than two lines and you already see the limitations being put on the PBM in how they can operate.

And so, you know, I just--it’s hard to mix the two. You have to, I think, go one way or the other.

DR. GINSBURG: Sure, okay.

I would like to go back to a question on hospitals I did not get to before in the first round, which is the financial stress that Dennis was describing about hospitals.

I would actually like to start with him. What are the major mechanisms that hospitals are using to respond to the losses they have had on their ventures and their poor operating results?

MR. FARRELL: To go back to the point that we raised before, taking a leaf out of the book of for-profits or going about it their own way, that is focussing on core businesses again and in fact divesting of the non-core businesses, stop managing with the new strategy of the day and then going back to their core values. It is not a sexy, sophisticated formula. It had gotten just so out of control that what we are witnessing now is hospitals actually going back and calling themselves "hospitals," which I know is a unique phenomenon. So that is probably the singular most positive aspect that we can see in the long term.

There are two other components that we indeed have spoken about today. We have seen a shift in the insurance cycle and the lag that is bringing back monies to the hospitals, but again at a lower level and lagging the insurance industry.

The concerns or observations that we have, unlike previous insurance cycles, I believe that the expectation is that it will not reach the heights that it once was. So the profits may never return to the degree they were before, and that is arguably because it is the balance of power that you mentioned before has resulted in significant consolidation at all levels, whether it be the providers, the insurance, the pharmaceutical companies.

There are many parallels that can be drawn to the provider industry to many other industries a la banking, which I was thinking about when you talk about internet, as you do everything on the internet now, or even in transportation. Everybody complains about how the airlines are overbooked, off schedule, and losing money. It sounds a lot like a hospital to me.

You cannot say this is health care. I would beg to differ. I would want to make sure I am in a plane that has all its parts working and the pilot knows what he or she is doing. They are not that dissimilar.

The third point is going back to one of the comments that we read earlier. I am afraid to give anybody the correct credit over there. I will mess it up. It is the guys over there. It has to do with the political ramifications of the fiscal crisis that has gone on in the provider world.

Again, you look at President Clinton’s proposal to bring money back. The mere fact that a year ago they were looking to cut $9 billion more out of the providers is no longer the approach, but in fact, politically, the lobbying has been very successful to stem the cuts, if not restore some money. Even if you are going into a stable environment, that is a much more positive picture to this industry because of the significant drop that it has gone through.

I want to emphasize that the greatest improvement that we see is focussing within and focussing on executing their strategies, and that strategy principally being going back to core business.

MR. FIDEL: One of the areas that has put hospitals under stress has been rising bad debts, and I think there have been two sources to that.

One has been under Medicare outpatient. Medicare has been paying such a small percentage of charges that a lot of the copays is put on the individual Medicare beneficiary, and it is very difficult to collect money for the hospital from a Medicare beneficiary. Self-pays is referred to as "no pay" in the industry.

MR. FARRELL: Right.

MR. FIDEL: The new perspective payment for outpatient Medicare may address some of those issues in the future, and that may ameliorate the situation.

I think the other reason for rising bad debt trends, which was referred to before as "lack of pay" or "late pay" by managed care to hospitals, in this case, it has been the fault of both hospitals and managed care. I think the principal reason has not been that managed care is deliberately not paying on time. I think the contracts got so complicated that neither the hospital nor the managed care company really knew what was owed for a patient encounter in a hospital.

So a managed care company is not going to pay a claim if it is incorrectly billed, and maybe half the claims were incorrectly billed. So they got kicked back and delayed. Once a claim is a certain age, you have to either start writing it off and writing it off. So I think that has contributed.

I think there is an effort to go back to more simplicity in the contracts between hospitals and managed care, but, again, that is going to take a while and a lot of renegotiation and a lot of negotiating cycles until that really has an impact. But at least I think it is headed towards that direction rather than getting worse.

MR. FARRELL: It is likely to get worse in the immediate near term because in this process of cleaning up the operations and cleaning up the balance sheet, which is sort of the nice way of putting it, in reality it is restating previous earnings that were overstated which is the negative way of looking at it, but in many ways more accurate.

You are going to see 1999 and 2000 performance be very, very ugly, to the extent that the resulting balance sheets are going to be impaired considerably.

The other aspect, the double whammy that hurt hospitals, they all learned about the equity markets and bought all the internet stock and were doing terrific and relied so much on investments. When they realized they are not a money management fund, they are a provider of health care, it is really where they need to be focussing on.

Traditionally, what had happened is the reliance on that as a source of underwriting their operating losses became so tempting that in many ways it masked the real issue of addressing the underlying problems. That is one of the reasons why I think when we are distinguishing the not-for-profit versus the for-profit, for-profit did not have that luxury because cash and investments is a non-performing asset in their world, as opposed to it is a cushion on the not-for-profit side.

DR. GROSSMAN: I wanted to talk about two other things that we did not mention which are the pharmaceutical costs and labor supply shortages.

MR. FARRELL: Sure.

DR. GROSSMAN: Do you have any sense of where hospitals are going to try to control those?

MR. FARRELL: Pharmaceutical cost is singled out by every institution as the problem. I do not know if it is really the problem, but it is their unwillingness to say no. Because, again, it is a very competitive industry, they are racing to the bottom of the ladder to see who gets down there first. It is not independent of everything else. The systems and the controls are not in place to prohibit the use of drugs that are outlandish, and it is unfortunately not until maybe a full cycle later whether it be a quarter or 6 months before they realize they are in the hole with that area.

There likely will be some improvement, but the reality is the pharmaceutical company, like the Federal Government, is an easy whipping child because, in essence, it is an inanimate object. It is no single problem or individual that you can focus on.

Labor is actually, I think, the bigger concern, and I think all of us are faced with this in our own shops as well. Why would anybody want to go and take a job at a hospital, arguably even in a physician’s role, today, is beyond me. Your pay is lousy. You are treated like crap. Benefits stink. You get good health care benefits. I take that back. You work lousy hours, and you do not get equity, although you would not want equity.

[Laughter.]

MR. FARRELL: The current economic environment is particularly challenging.

We used to recruit nurses from the Philippines and other countries. It is labor shortage, and it is not just nursing. It is the best-kept secret, although it is beginning to come out. It just does not make any sense for anybody to go into this industry today.

The indicator that I like to look to is another area that I work with, colleges and universities. If you look at the applicants and you look at the number of students that are enrolled in these sectors, there is only one other sector that performs worse, and that is the number of students trying to get their MBAs.

If you remember way back when, all the people flocked to become teachers after Kennedy spoke, and then we ran a shortage. So that is a big issue of concern.

MR. HARRIS: I was going to say this is largely a cyclical phenomenon. We have had no labor shortage in the early to mid-’80s and then a huge labor shortage in the late ’80s. Then labor was relatively free in the early ’90s and now has gotten tight again. One need only look at the performance of the nursing home industry where labor is an even bigger component than it is in hospitals.

You will see, let’s say, Beverly Enterprise, their stock price in the early to mid-’80s. It got up to 20 bucks. Then, in ’87 and ’88, it got down to $3. Then, in the early to mid-’90s, it got back up to close to $20 and now it is at $3 again. I think part of that is the labor cycle.

MR. FARRELL: Again, the concern that I have is that you hear everybody reducing labor force, but nobody has ever cut a single body that has a clinical responsibility. It is truly amazing, if you ever read those press releases, which to me it feeds the other concerns about infrastructure from a technological component. I am not talking about from a clinical technological, but a financial information system or hooking up to your physicians and/or billing.

So these less-than-glamorous, both on the outside and inside, areas are particularly troublesome, and I think if there is an area that is underinvested in the business office and in the whole technological component of that end of the business, it is this particular sector.

DR. GINSBURG: I guess we are getting kind of late. This would be a good time to get into our questions. I would love to hear questions from either the information technology and pharmaceuticals or something we discussed this morning.

Bob, do you want to start?

FLOOR QUESTION: Bob Helms with AEI.

The pharmaceutical industry recently got some economic advice from that great economist, Bill Clinton, advising them that they should not worry about price controls because they could make it up with this volume that Mr. Fidel talked about that they would get with the Medicare drug benefit.

So my question is even if there is a volume effect, wouldn’t it still have a big effect on their R&D decisions about doing research on new, risky, long-term projects?

MR. FIDEL: I am not sure I understand your question. You assumed something. I did not catch what you assumed.

FLOOR QUESTION: That you have a new benefit and it is a volume effect; the elderly consumer, a lot more drugs. But you could have that with the existing inventory of drugs.

My question is about the future supply of new--the incentives to do R&D on a new product which is perceived to be way out there. You know it is long term, it is high cost, and it is very risky to do that R&D. It seems to me that what is driving that R&D decision now is the expectation of occasionally having a blockbuster which you can make a lot of money on, but if you have the perception that if you are successful, then you have price controls on that new product, then why do the investment in the first place?

MR. FIDEL: I see. Well, I think you only have to look at ’92 and ’93. R&D was growing in the low teens for the drug industry each year.

The Clinton plan came by 1993. R&D growth had slowed to 5 percent. So, already in a year or two, you could see the impact because of the fear of price controls. So I entirely agree with you.

First of all, if you have PBMs controlling the system, they are going to contract 10-to-20-percent discounts, and that will be offset, I think, by the greater volume because of the demand. So I think that is fine for the industry.

For the industry, that would be the same issue they are dealing with in the private market now. Essentially, they are not getting the full price, but they are doing just fine because there is a lot of incremental profitability and demand growth is very strong.

The threat of price controls is a chiller. It would be very negative for R&D spending if that became a greater and greater probability.

MR. HARRIS: It would also reduce capital access.

MR. FIDEL: Right now, we are in an incredible time in history. We are at a time when the number of drug targets is increasing from 500 to about 10,000 because of the genomic information that we are discovering, which President Clinton, I guess, will have his ceremony next week announcing the joint--we will not get into that.

Essentially, by having all of these 100,000 genes now identified in the body, it is thought that probably 10 percent of them will become meaningful targets to develop drugs. Historically, almost all of the drugs that have been designed in history have been designed from 500 drug targets, and we are going to 10,000. So, looking out 5, 10 years, we are going to have a lot more drugs filling drug industry pipelines, and they are going to be probably better drugs because they are going to be designed with a greater understanding of the disease process.

DR. GINSBURG: That is a good point. Certainly, a lot of policies, not just price controls, but patent policies, et cetera, are likely to have an effect on pharmaceutical R&D, positive or negative. We have usually focussed in discussions about more R&D is good and less R&D is bad, but I wonder is there some notion of what the right amount of R&D should be and are we above it or below it. Any comments on that?

MR. FIDEL: I do not know if anyone knows the answer to that question, but I think what I mentioned before is the R&D is going to be much more productive in the future than it has been in the past because we are really concentrating now on the knowledge of genes, how they affect proteins, and how that results in real drug targets. A lot of drug discovery in the past was done through serendipity and just luck, and we are getting much more scientific with better knowledge. I do not know if more is too much. I do not know how to answer that question.

DR. GINSBURG: This could be a session where if everything else stayed the same, this change in technology would generate more R&D because the potential is so much greater than it has been.

Bob, did you have a final comment?

FLOOR QUESTION: Could I attempt to answer your question?

DR. GINSBURG: Yes.

FLOOR QUESTION: I think from an economic standpoint, if you go back to economic literature, theory, and so on, you will not find any definition or much guidance that will tell you what the proper amount of R&D will be, but you can find literature that says under what system will people have the right incentives to keep doing what is the economically efficient appropriate amount.

Summary

So, to me, the question is if you turned this over to a government agency of some sort, are they going to be able to define the proper amount better than a bunch of competing risk-takers. Everything I know about economics tells me I think we would be better off letting the market determine that, although I cannot tell you what it should be.

DR. GINSBURG: Yes. I think in all of these things, we are always simulating a market and trying to adjust to what the various departures from it are, but let’s not get into that.

Let me try to summarize some of the things that I took notes on that came up at the conference. We started out with the United Healthcare announcement, and there was a consensus that, yes, it is real, although United is the company best positioned to do this. It makes sense for insurers to be focussing their management activities on the sick and the chronically ill and not on the rest of the people.

Class-action suits are unlikely to succeed. If they affect health plan behavior, it is likely to be in the area of more disclosure.

On mergers among health plans, the experience has been mixed, and I think there was a consensus that out of area deals, they really have pretty limited potential and do have some risks in the information system area of going awry.

There are predictions that premium increases would continue to be large. They would get next year to the 10-percent area and perhaps stay there for a year, and that might be the peak of the cycle. Some of the regulatory issues and the loosening of managed care is a contributor to it.

Employers will continue to be passive in response to these increases as they have been because of tight labor markets, but that once labor markets are no longer so tight, they will likely cut benefits. They are more likely to increase cost-sharing than to return to more tighter management of care once labor markets are looser.

We were talking about defined contribution, the two types of it, and our panelists mentioned some of the positives and negatives. They did mention a chance that if something significantly happens in the liability area that we could get a very rapid movement to it as employers try to limit their liability, but in that absence, the movement is likely to be slow and that there is some very important venture capital going into both models of defined contribution, both the model where the employer continues to be the purchaser, but offers a lot more choice of plans, as well as the model where the employer really steps out and just basically gives a voucher to employees.

It came up as far as bargaining power between plans and hospitals and physicians that this varies very much by market. Should the Campbell bill pass, that would have a big impact on physicians’ bargaining power, but it is unlikely to pass for a host of reasons, particularly some of the consumer perspectives about its potential to eliminate balanced billing.

Hospital financial conditions are really pretty poor at the moment, and it is likely that hospitals will deal with this by getting back to their core businesses and shedding a lot of the other things they have taken on. They are not going to be money managers. They are not going to own health plans as much or reduce the degree they own physician practices, but going back to trying to provide hospital services more efficiently.

The panel did not expect a return to the earlier growth in capitation. They saw it as pretty much dead, not consistent with the open model that we are moving to today, not the wave of the future. People have problems with the contrary incentives, and plans are uncomfortable with the legal risks that it exposes them to.

We talked about is the internet going to transform health care. The answer was no. The health care industry has a lot of characteristics, its fragmentation, its complexity, the mix of for-profit and non-profit that are going to get in the way. The internet has immense promise, but there are huge barriers.

One thing that came up is the internet will over time become more important in health care, but it is not going to become more important by some dot-com coming in and taking over. More likely, it is going to be introduced incrementally by the existing players in health care rather than a new entity muscling the existing players aside.

One of the big barriers is standards, and in a sense, if standards could be developed, there could be a lot more in the way of transactions between health plans and providers through the internet with insurers probably being the ones that wind up controlling this infrastructure because they are in the best position to do so.

So we will not see any big internet project, but there are lots of niche areas. One thing that was mentioned is the distribution of insurance, particularly the small and medium employers who are in the individual markets, that the internet could pose a very strong competitive threat to brokers because of the hugely lower cost that the internet can do in distribution.

In pharmaceuticals, we talked about the three-tiered copayment which is growing very rapidly and it is going to continue to grow, and this is going to be the prime means of controlling drug costs rather than closed formularies because consumers, for the most part, are willing to pay more to ensure that they are in control and have broader choice.

I think that is it.

I want to thank the panelists very much for doing a great job.

[Applause.]

DR. GINSBURG: You have contributed a huge amount.

I also want to thank the people at HSC that worked hard in preparing this conference, the Public Affairs staff, and Joy Grossman who contributed as well.

I am pleased to adjourn the meeting. I think the panel should be around for a little bit to answer questions in private.

[Whereupon, at 12:08 p.m., the conference concluded.]

 

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