Blues plans’ ability to apply their dominance is now being checked by financial, regulatory and legislative forces. A number of trends are emerging that signal a potential threat to the Blues’ unquestioned market power:

• Spiraling medical malpractice costs and the departure or service reduction of some specialists are making it difficult for insurers to squeeze physician reimbursement any further—and may even be forcing fee increases.

• Inflation of medical costs, coupled with high hospital reimbursements relative to other markets, have fueled several years of double-digit premium increases and intensified consumer and purchaser dissatisfaction.

• High-profile scrutiny of the Blues’ surplus levels have led to bills in the Pa. legislature seeking to reduce them and hearings held by the state Insurance Department in early September.

• The Federal Trade Commission’s Antitrust Division said it plans to give greater attention than it has in the past to health insurance markets, and has recently investigated complaints about health insurance practices in Philadelphia and Pittsburgh.

• In central Pa., the recent termination of a joint operating agreement between Pennsylvania Blue Shield and Capital Blue Cross has brought competition that may increase the relative power of providers and payors.

The reality of these pressures is confirmed in an Oct. 22 report by A.M. Best which focused on Pennsylvania and stated: "The practice of defensive medicine and increase in utilization, demands for higher reimbursement rates from hospitals and physicians, and health-care insurers’ diminishing ability to pass increase expenses to subscribers through premium hikes will negatively impact their earnings and balance-sheet strength."

High Medical Costs

Escalating medical costs are confronting the Blues, and all health insurers, with tough corporate decisions on how to cover their own expenses while keeping their provider panels intact by covering physicians’ spiraling overhead costs. Two trends aggravating that challenge are Pa.’s medical malpractice crisis and the relatively high hospital costs in major Pa. markets.

Although some observers question the degree to which Pa.’s high malpractice costs are impacting physician supply, the Blues themselves acknowledge that the problem is real and that action is necessary to mitigate it.

While Independence Blue Cross (IBC) maintains that the greater Philadelphia region’s per-capita supply of primary care and specialty physicians is 20 to 30 percent higher, on average, than elsewhere in the U.S., there appear to be shortages of obstetrics providers in a few local areas, as well as neurosurgeons, particularly for trauma cases, according to I. Steven Udvarhelyi, M.D., senior vice president and chief medical officer of Keystone Health Plan East. Says John Zamzow, IBC’s contracting and provider network senior vice president, "There are still a lot of orthopedic physicians and practices, but for general surgery or for orthopedic surgery, there may be the beginnings of an access problem in IBC’s service area. We’re concerned about that. It isn’t a major problem yet, but it could get worse."

The state’s malpractice crisis is also pressuring IBC financially by exacerbating the region’s already-high medical utilization, says Udvarhelyi, as physicians practice more defensive medicine to protect themselves from malpractice claims. Citing A.M. Best data for HMOs across the country, Zamzow says that physician visits per thousand patients are 27 percent higher in Pa. than the national average, while commercially-insured hospital days per thousand patients are 20 percent higher.

In 1998 IBC had announced a unilateral reduction of physician payment that left most physician payment levels at less than 80 percent of Medicare fee-for-service payment levels, according to an analysis by the Pennsylvania Medical Society (PMS). The malpractice situation was part of why IBC implemented a 13 percent physician fee schedule increase across all specialties between August 2001 and April 2002—amounting to some $200 million per year, raised capitation payments to primary care physicians, increased performance incentive programs and ended its episode of care program at the end of 2001, says Zamzow.

"We’re seriously considering additional fee increases in 2003," Zamzow adds. IBC has also been an active tort reform advocate in Harrisburg, says Udvarhelyi, who notes that the systemic problem will not go away with interim financial fixes.

HMO per member per month payments to physicians in the Philadelphia Metropolitan Statistical Area rank 16th among the 25 largest MSAs in the country, close to the national median, according to the most recent InterStudy data-which includes a data recording correction over previous calculations that ranked the region’s reimbursement at 25.

While Highmark has not yet seen any access problems by geography or specialty, it recognizes that hospitals and doctors face the escalating cost of medical malpractice insurance and the risk of lawsuits, and need revenue increases, says George Grode, Highmark’s executive vice president of government, business and corporate affairs.

Accordingly, Highmark has filed for a $68 million increase in payments to physicians for Jan. 2003. The increases, which vary depending upon the Highmark product and the location of the physician, include:

• Check-ups and preventive service increases between 27 and 60 percent.

• Fee increases for office visits ranging from four to 33 percent.

• Ob-gyns, some of whom have dropped ob because of malpractice premiums, will get a five percent increase for deliveries, which will be a 15 percent increase from 2001.

• An estimated $5.8 million increase in 2003 capitation fees to certain primary care physicians in western Pa., including carved out fee-for-service reimbursement for certain services that are currently included in the capitation payment, such as immunizations and minor surgical procedures.

Capital Blue Cross President and CEO James M. Mead also makes a connection between the malpractice crisis and physician fees: "We are concerned about keeping good physicians in the state. As malpractice premium rates continue to increase, physicians are clearly going to demand higher fees in order to compensate them for their costs." Over time, Mead says, all insurers in the region—including Capital, which is contracting with physicians on its own for the first time—will clearly have to raise physician reimbursement to be able to continue to serve their clientele, partly because Capital’s service area is more rural than other markets in the state and fewer specialists translate into greater bargaining power for physicians. Mead says he is aware of a few limited examples of physicians who have either left the area or are reducing services, and says he is monitoring the situation.

Blue Cross of Northeastern Pa. did not respond to interview requests for this article.

The current level of Pa.’s malpractice crisis is not yet sufficient to force insurers to make serious concessions to physicians, believes Mark Pauly, Ph.D., professor and chair of Healthcare Systems at the Wharton School and senior fellow at the Leonard Davis Institute of Health Economics. "As long as health plans still have leverage to push providers around, I don’t see things changing. I think there is still a bit of a way to go in Pa., varying somewhat by specialty, before that counter-revolution can really get under way full-swing," he notes.

The Blues are also faced with another fiscal challenge: many of Pa.’s hospitals are demanding—and receiving—among the highest private health insurance reimbursements in the country.

In 2001, Philadelphia County hospitals had total operating margins of $213 million, up from $155 million a year earlier, while hospitals in the suburban Philadelphia region saw $46 million in operating margins, an increase from $26 million in 2000, according to data from the Pa. Health Care Cost Containment Council. Pittsburgh hospitals saw $163 million in operating profits in 2001 and hospitals in the Allentown-Reading area made $59 million from operations.

According to 2000 InterStudy data, Philadelphia enjoyed the second-highest, and Pittsburgh the third-highest, HMO per member per month payments for inpatient services relative to the 25 largest MSAs in the nation. Non-HMO payment most likely parallels that ranking, believes Stephen Foreman, Ph.D., J.D., M.P.A., director of PMS’ Health Services Research Institute. Part of those statistics stems from higher utilization than in other parts of the country, and part is driven by highly consolidated hospital systems with the clout to challenge insurer dominance and demand higher payments, says Foreman.

In Allegheny County, hospitals tend to be well-paid compared to hospitals in other MSAs because the county has the second largest elderly population in the country, a high rate of illnesses related to coal-mining and steel-making, and a limited number of hospital systems, says Grode.

IBC’s reimbursement rates to hospitals don’t particularly impact what the insurer pays physicians, says Zamzow. But if physicians who admit patients to hospitals and who provide inpatient care could "find a way to practice medicine in a way that got utilization closer to the national average, there would be substantial easing of financial pressures on the whole system," adds Udvarhelyi, noting that IBC’s payments to physicians and hospitals are a function of the overall number of services provided, which is the largest driver of IBC’s costs.

Capital Blue Cross is passing on to customers some of the costs associated with rising medical utilization costs and high hospital reimbursement, while tapping its reserves to minimize price increases, says Mead. Capital has had an operating loss on its basic insurance product for the last six years and this year, as competition with Highmark intensifies, Capital will end the year, not only with an underwriting loss, but also with a significant bottom line loss, Mead adds.

Regulatory and Legislative Scrutiny

While they are paying more for medical services, Blues plans are also weathering intensified public scrutiny of their surplus levels, as well as lawsuits and legislative bills seeking to reduce them. On top of that, the federal government has also announced that it has begun to intensify investigations into potentially anticompetitive practices in the health insurance industry.

Several class action lawsuits were filed late last year against IBC and other Pa. Blue Cross plans alleging that they had accumulated excessive surplus levels that should instead be used to reduce premiums. The issue was widely reported in the press and came to a head in hearings held by the state Insurance Department.

"Substantial concern has been expressed by consumers and legislators regarding the levels of reserve and surplus" held by the four Blue Cross plans in Pa., state Insurance Commissioner M. Diane Koken said at the opening of an informational hearing held September 4th "to assist the Department in further examining the issues" and "evaluating and determining future policy and actions" regarding the health plans. Although it has the authority to roll back subscriber premiums, Koken stated that the hearing was not specifically related to any decision of filing before the Department, nor would any decision be made at the conclusion of the hearing. Whether the Department will take any action may depend on the next administration’s appointments and priorities.

Prior to the hearing was the discovery that Pa.’s four Blue Cross companies are required by Insurance Department formulas to maintain minimum surpluses collectively totaling some $1 billion, while the companies have accumulated nearly $2.7 billion more than those minimum requirements—during a time of double-digit premium increases.

The discrepancy put the Blues on the defensive and prompted a series of actions by Pa. legislators. Rep. Phyllis Mundy (D-Luzerne) sponsored HB2708 to require nonprofit health insurers to use surplus funds to reduce premiums for subscribers if they had more than three months’ worth of claims payments on reserve, and introduced HB2301 to require any Blue Cross company that converts from nonprofit to for-profit status to be subject to public hearings and to require it to place its assets in a charitable foundation for community health care needs. Both bills remain in the House Insurance Committee, according to Ron Boston, a Mundy staffer.

Other proposals call for a House investigation of insurance reimbursement rates to physicians and hospitals, a study by the State Government Commission of charitable assets held by Blue Cross companies, and the establishment of a consumer advocate for insurance in the state Attorney General’s Office.

As health plans have been raising premiums to offset the increasing cost of medical care in the state, those premium hikes have been taking a toll on health care purchasers, cutting into the profit margins of some employers and forcing many to curtail benefits or pass more costs onto employees.

Not all companies, however, are expressing their discontent by criticizing the large Pa. Blues’ surpluses. Charles P. Pizzi, president and CEO of the Greater Philadelphia Chamber of Commerce, testified at the Sept. 4 Insurance Dept. hearing that IBC’s surplus "assures employees that their coverage is in place and that they have little to fear about the financial viability of the insurer." Major hospital systems, such as the University of Pennsylvania Health System, made similar comments at the hearing.

Smaller companies, however, are being squeezed hardest, as they can’t avail themselves of cost-reducing disease management programs and lack purchasing leverage, even at the group purchasing level, says Cliff Shannon, president of SMC Business Councils, which represents 5,000 businesses in western and central Pa., and whose endorsed group health insurance programs are with Highmark and Capital.

The ability to bring volume business to health plans no longer carries clout, says Shannon, as the Blues plans have departed from community rating in their underwriting and are recruiting business on the basis of risk: differentiating premiums by age, sex and industry, tweaking benefits to make coverage less attractive to high risk individuals and not offering coverage to bad risks. Shannon says that small businesses are hit the hardest because they tend to have older employees and lack the ability of larger companies to screen employee participation based on health care costs.

A major cause of concern in Pa., says Shannon, is that "the Blues’ gigantic reserves cushion is an impossible-to-resist temptation to manipulate the marketplace, underpricing to get the most profitable, preferred demographics in order to squash the competition or to engage in aggressive expansion." In his testimony at the reserves hearing, Shannon said that the Blues’ reserves and surpluses should be reduced to "calculations by the Insurance Department, leavened with information from the Blue Cross Blue Shield Association."

Shannon believes that the business community should attempt to get Blues plans to lower reserves through government pressure, and to exert further pressure on legislators to prevent for-profit conversions by Blues plans that would allow them to carry off substantial portions of their surpluses that should remain in the community for public health purposes. Shannon has made contact with legislators who are concerned about the surplus and conversion issues and says he has spoken with his competing business association counterparts about a legislative agenda in Harrisburg for the coming year.

The federal government may also take a firmer hand in monitoring business practices of Pa.’s dominant insurers. An area of primary concern for a newly organized Antitrust Division of the U.S. Justice Department (DOJ) will be "the evaluation of mergers of, and unilateral or coordinated conduct by, health insurers," according to Deborah Platt Majoras, Deputy Assistant Attorney General in the DOJ’s Antitrust Division, in remarks at a Health Care and Competition Law and Policy Workshop held on September 9, 2002 by the Federal Trade Commission.

Given the increased level of consolidation of health insurance markets in the past few years, the DOJ said it will pay close attention "to whether any particular merger would give the merged insurer sufficient market power to increase prices or reduce quality in the sale of managed care plans in specific geographic areas or to acquire monopsony power over providers," Majoras noted. "Likewise, we will continue to focus on collective or unilateral activity by health insurers that may raise competitive concerns, depending on the insurer’s market power and other relevant market conditions," she added.

In the past several months, Majoras said the DOJ has investigated a complaint by providers in the Philadelphia area that a form of "all-products clause" instituted by an insurer with substantial market share (which DOJ did not name) was anticompetitive. Majoras also said that the DOJ continues to receive and evaluate complaints about managed care plans’ use of "most favored nations" (MFN) clauses to determine if they merit more complete investigation or enforcement action. She specifically mentioned Highmark, which had recently proposed to the Pa. Insurance Department the inclusion of such a clause in Highmark’s contracts with hospitals. "During the mid-1990s, the Division had advised the Insurance Department that Highmark’s proposal then to institute an MFN policy raised serious competitive concerns. While we were evaluating Highmark’s latest MFN proposal, Highmark abandoned it," Majoras said at the FTC panel.

"For two to three years, neither the FTC nor the DOJ was doing a whole lot in health care. If you look at what’s happened this year, and what the interests of the agencies seem to be, I think you’re going to see a more aggressive antitrust enforcement stance in the health care sector," says Jeff Miles, Esq., chair of the Washington, D.C.-based American Health Lawyers Association, Antitrust Practice Group.

Competition in Central Pa.

Beyond the strain of high medical costs and intensified regulatory and legislative scrutiny, Blues plans in central Pa. face an additional challenge—one that is perhaps unique in Pa: meaningful competition. The region offers a test case to see whether that competition increases the relative power of providers and purchasers there.

As of this April, Pennsylvania Blue Shield split from Capital Blue Cross, terminating a joint operating agreement for their PPO, point-of-service and indemnity plans under which Capital handled payments to hospitals and Blue Shield—a Highmark company—reimbursed physicians. Each company will now cover both hospital and physician services for those products while competing against each other, and against other insurers, for 1.3 million insureds in a 21-county area including York, Lancaster, Harrisburg, Reading, Allentown and Bethlehem. The Keystone Health Plan Central HMO is still jointly owned by the two companies.

The region’s rural character already affords some physicians more clout than in other regions, given the limited number of specialists in some regions, says Mead of Capital Blue Cross. The Highmark-Capital competition holds the promise of greater bargaining leverage for physicians, he forecasts. According to Mead, Blue Shield and Capital collectively had a 41 percent market share at the end of 2001. As beneficiaries in the region come up for renewal, he says, Capital has been signing on 52 to 55 percent of the business. That translates into Capital shrinking to 20 to 25 percent market share.

"For an OB or neurosurgery group in central Pa. where there’s a limited number of others in that specialty, we may buy 15 to 20 percent of that practice’s services. That is not going to give us the kind of bargaining power against someone who’s the only game in town. In fact, even at 40 percent in this market, we didn’t have the bargaining power because we don’t have other places to send patients," says Mead.

Although part of Capital’s competition with Highmark has been on physician reimbursement to build its panels, the rate of its fee increases is being checked by the need to hold down premiums, which Mead says is the primary focus of the competition, at least initially. "The reality is, we also want to have physicians in our network and every player here is going to be faced with the fact that they’re going to have to increase reimbursement to physicians. Nobody is going to be writing blank checks, but the pressure is there," Mead notes.

"You can’t negotiate with 7,000 doctors but, with respect to some specialties, some practices, we have been a lot more flexible than any of our competition," adds Mead, noting that Capital sought advice from the PMS on its physician contract and has thus far built a new network of 6,800 physicians, comprising 85 to 90 percent of the physicians in the region.

The company now has contracts with all 37 acute care hospitals in its service area. One way it has tried to get better rates from hospitals, says Mead, is to calculate the average dollar amount of claims in the pipeline for a hospital and advance to the hospital an interest-free check based on that figure, effectively eliminating accounts receivable. Mead says that Capital plans to try such an approach with physician practices.

Competition with Capital has been good for the market’s vitality so far, offering more choices and options for customers, and allowing physicians to negotiate with two Blues companies, each with half of their previous market share, says Grode, noting that providers are negotiating more on service, timeliness of payment and electronic interface. Grode says that Highmark is open to negotiating with physicians in central Pa., but notes that it is open to negotiating in western Pa. as well. "We must be careful not to abuse our market share. We need effective partnership with providers," he adds.

Contracts with hospitals and doctors are very similar across companies and premiums in the aggregate are the same across companies, although Highmark is able to provide a better rate to companies that are located throughout the state, while Capital has an advantage in the "high touch," local 2-50 employee market, says Grode.

Competition with Capital has also provided some opportunities to both Blues’ competitors, according to Grode. HealthAmerica has gained market share, as some companies, now that they are offering two different Blue options, have decided to also offer HealthAmerica, he says. Grode projects that the competition will result in a slight dilution in the aggregate market share of Highmark and Capital.

Reports of whether the competition has already brought benefits to physicians are mixed. Physicians have yet to see meaningful opportunities for contracting leverage, observes Harrisburg-based attorney Charles I. Artz, Esq. Any benefits are still theoretical at this point, because both Highmark and Capital are still very large companies, Artz says.

Over the last month or so, Capital Blue Cross has appeared more willing to negotiate with smaller physician practices on reimbursement and contract language, while only large practices enjoyed that ability before the split from Blue Shield, says Middletown-based Dennis Hursh, Esq., who believes that the competition is making the difference. Enough practices were scrutinizing their contracts, rather than automatically returning them, for Capital to be more receptive to discussion, Hursh says.

For example, he notes, some physicians have been able to change the contract clause, "Plan has sole discretion," to "Plan has sole reasonable discretion," concerning matters such as medical necessity determination. He has also heard, anecdotally, that some practices have been able to negotiate higher fees with Capital for some CPT codes.

Hursh has not yet seen evidence of Highmark offering these concessions.

The outcome of central Pa.’s Blues competition is not easily predictable because a market with two dominant players can bring price fluctuations oscillating between periods of agreement and aggressive competition, notes Pauly.

Unlike other regions in the state, competition in central Pa. may signal opportunities for other health insurers to enter the market, according to Foreman. Conversely, with $2.1 billion in reserves, compared to Capital’s $616 million, Highmark could probably drive Capital from the market in a price war and has a corporate challenge in terms of how it chooses to compete, Foreman adds.