Reprinted with permission. The RMA Journal, June 2012 (pgs 14 – 19). ECONOMIC ENVIRONMENT

Managing the Risk to Payors Posed by Changing Health Care Delivery Models

Health care delivery models are changing rapidly, regardless of how the Supreme Court decides on ObamaCare later this June. Management and boards must remain vigilant and be able to respond quickly—or risk being left behind.

by Don Foster Pending a ruling by the U.S. Supreme Court that could affect, at the very least, the universal-coverage component of the health care reform legislation, America’s health care system is on the verge of upheaval. Changing are the paradigms that have applied historically to the delivery of health care and who pays for it. And these changes are having a profound effect on the private health insurance industry. Attempting to manage the risks created by health care providers’ response to the reform, insurance companies are undergoing a radical transformation. This article takes a look at the early stages of that transformation.

The Traditional Health Insurance Market and Health Care Reform

The model that Americans have grown accustomed to is one in which independent physicians and hospitals partner to provide health care services to consumers who are largely members of employer-based group health insurance plans. These plans have reimbursed the providers through a fee-for-service payment model. Superimposed upon this model are government insurance programs—Medicaid and Medicare—that supplement or replace private insurance. Until the health care reform legislation, they were also based on a fee-for-service reimbursement model.

There is empirical evidence that rather than reducing costs by realizing economies of scale, hospital consolidations historically have actually increased hospital costs.

This traditional model has been implemented through a series of interrelated contracts between those who provide the service and those who pay for it. The employers negotiate group insurance policies for their employees’ coverage and premiums. The insurers negotiate contracts with providers and also process claims. The consumer’s physician-of-choice negotiates admission privileges with a hospital or hospital network. These contracts ultimately dictate the consumer’s choice of physician and non-emergent hospital care. The result has been a volume-based reimbursement system that incented providers to increase the delivery of services, while at the same time separating the consumer from the data related to the cost and price of a particular medical service or product. Who among us, for instance, knows the combined cost to the device manufacturer, the surgeon, and the hospital for an artificial knee implantation? And who cares about the price as long as it is insured? Everyone agrees that health care costs must be contained. The Congressional Budget Office estimates that, at the current rate of increase, one out of every four dollars spent in America in 2025 will be for health care. However, health care and health insurance are not the same thing, and the public debate over the need to control the rising cost of health insurance (that is, the premiums) has focused on the number of people without health insurance and the hidden subsidy paid by those who do buy insurance. But this debate really has nothing to do with the rising cost of the underlying care itself—recognizing, of course, that there is an actuarial correlation between what is paid for the service and the premium for insurance coverage.1 Nevertheless, any reform of the model by which health care is delivered inevitably requires a change in the way Americans go about paying for it. This necessarily implicates insurance coverage. Accordingly, the legislation that constitutes federal health care reform seeks to:

  1. Insure more people (that is, everyone).
  2. Improve the quality of care and overall public health by changing the delivery system to promote prevention and wellness and by requiring providers to account for outcomes.
  3. Reduce costs by moving from the traditional fee-forservice model to one that connects reimbursement to outcomes (“fee for performance”), as well as emphasizing prevention and wellness.

This is a massive change that has enormous implications for the health insurance industry. Health care reform would rein in the tens of millions of uninsured people, many of whom, from a medical underwriting perspective, are younger and healthier than average. This group does not consume health care services at the same rate as the rest of the population. By including them in the insured population, average utilization rates would decline and with them insurance premiums. Or so goes the theory. At the same time, there are elements of health care reform that require coordination of care along a continuum of disciplines, as well as substantial investment in IT systems to collect and report information on treatment outcomes and care management. Physicians as a group are either not able, or are disinclined, to incur that expense. Also, accountable care organizations (ACOs) and the bundled payment model have created great uncertainty among physicians over sources of income and how their services will be priced. The combined effect of the need to increase scale to absorb these additional costs and to create a system that can track and account for outcomes across a continuum of care places pressure on providers to consolidate. This consolidation can come through hospital mergers, as well as the integration of physicians into hospitals and hospital systems as employees, joint venture partners, or some other type of dedicated relationship.

Risk Posed By Provider Consolidation and Integration

The linchpin of health care reform is cost reduction, which creates enormous pressure to increase scale, which conceptually reduces per-unit costs by, among other things, consolidating redundant cost centers and allocating fixed costs across a greater number of units. Increased scale also provides greater access to the capital needed to invest in the improved plant, equipment, and technology that are required by the accountable care and fee-for-performance components of health care reform. There is empirical evidence that rather than reducing costs by realizing economies of scale, hospital consolidations historically have actually increased hospital costs.2 Nevertheless, the demands of cost control in health care reform are such that industry analysts see an urgent need for hospitals to create larger business scale through consolidation. 3 Struggling facilities will close or be merged into larger, more solvent institutions. Some industry analysts predict that, by 2020, one in 20 acute-care facilities could close, leaving but a handful of large health systems in each state.4 At the same time, hospitals are acquiring physicians and physician practice groups at an ever increasing rate.5 They hope to benefit from captive referrals from the physicians they “own” and to control costs by controlling the physicians’ salaries. Physicians benefit from a guaranteed income stream, unified care guidelines provided by the system, and the sophisticated data collection that allows them to account for performance. They are, therefore, willing business partners. This consolidation of providers obviously has enormous implications for the health insurance industry in several ways. First, it increases the bargaining power of providers in negotiating rates of reimbursement for services provided to patients covered by the health insurer. Second, it increases the providers’ access to capital, which in turn promotes further integration and consolidation. And third, by giving the hospital system control over a larger patient group, it incents the system to underwrite its own health plan.

Competitive Risk of Hospital-owned Health Plans

A study of integrated health care delivery systems by the Government Accountability Office (November 2010) revealed that of the 15 large systems analyzed, 10 offered a health insurance plan.6 According to those who run the systems, these plans not only provide their members with financial resources in the form of premium revenues and savings from properly managed care, but they also yield data on plan members that can be used to promote better coordination of care and disease management.7 Another benefit that a hospital-owned plan provides is increased bargaining leverage with other plans that insure patients treated by physicians employed by the hospital. It can use its own plan for price competition, or it can force patients insured by the competing insurer to go “out of network” by refusing to enter into a contract at all. That forces the patient either to incur the increased cost of paying rates that have not been negotiated down by his or her insurance company, or to change insurers. Until recently, health plans owned by doctors and hospitals were on the decline, having been purchased by the larger insurers.8 However, with macroeconomic forces compelling the restructuring of the health care delivery system into larger and larger hospital networks that employ the physicians—combined with the clinical and financial benefits reported by the integrated delivery systems that currently offer a health plan—it is natural to expect that the percentage of plans owned by providers will increase.

The Insurance Industry Response

Traditional tools for mitigating the risks associated with such a seismic change in the delivery of care, and the metrics for determining how much the provider is to be paid for that care, will not work. For example, the market risk created by competition from other insurance companies cannot be mitigated by reducing premiums or increasing coverage if the one dominant hospital in a region owns all of the physicians and precludes access to those physicians, and/ or offers a competing insurance product. For the health insurer to survive, it must have access to covered lives. And to gain access to covered lives, the insurer must have access to the doctors who treat those patients. However, those doctors are well on their way to being employed by consolidating hospital systems. So what can the health insurance companies do to survive? The first thing they can do is prevent the hospitals from controlling the doctors by employing the doctors themselves. The larger insurers have already started down this road:

  • In November 2011, United Health Group purchased Monarch HealthCare, an association of 2,300 physicians in California.
  • In August 2011, WellPoint acquired CareMore Health Plan, a Medicare Advantage plan that operates neighborhood care centers, which it plans to expand into other WellPoint markets.
  • Humana Healthcare has announced plans to acquire SeniorBridge Family Companies, which controls 1,500 in-home care providers. Humana had previously acquired Concentra, an operator of urgent-care clinics.
  • In Pittsburgh, Highmark, Inc. is implementing a provider network strategy that includes the purchase of physician practice groups and the development of a network of urgent-care clinics and medical malls.

United, WellPoint, Humana, and Highmark are the first, second, seventh, and ninth largest health insurers in the country, as measured by total medical enrollment.9

Another benefit that a hospital-owned plan provides is increased bargaining leverage with other plans that insure patients treated by physicians employed by the hospital.

Insurer-owned clinics are also on the rise. In addition to WellPoint and Highmark, Bravo Health has opened walk-in urgent care and preventive health clinics in Philadelphia and Baltimore. CIGNA has plans to expand its CareToday chain of clinics. Humana offers concierge-type services to people with chronic diseases in four locations in Florida and one in Cleveland. United has acquired 38 clinics in Texas and Florida that provide care to seniors. The final piece to the puzzle is to buy the hospitals. In the past, the nonprofit community hospital has had difficulty gaining access to capital markets.10 It has relied on the municipal bond market as a source of capital. Under health care reform, the capital markets are likely to gravitate to the more solvent and larger health systems. Industry analysts therefore believe that it will be increasingly difficult for the smaller, nonprofit hospitals to raise capital.11 The insurance companies, with their large cash reserves, can solve that problem. To date, the only large insurer that has gone so far as to acquire an entire hospital system is Highmark, which has committed to acquiring the five-hospital West Penn Allegheny Health System in Pittsburgh. These are not your mother and father’s health insurance companies. They are companies that are offering pay-for-performance insurance products that tie payment to predefined measures of quality, access, patient satisfaction, cost, and efficiency. At the same time, they are becoming actively engaged in the performance part of the equation. While an integrated delivery system offering an insurance plan is not a novel concept, a health insurer getting involved in the delivery of health care is. In the 1990s, there was a short-lived movement among insurers to acquire physician practice groups as a response to managed care, but it did not last long and has not been repeated—until now. Then, the motive was to control utilization and thereby increase profit. Now, it is driven by a need to respond to macroeconomic influences that are forcing the consolidation and integration of health care providers. The risk to the insurer is that when the music stops, all of the chairs will be occupied by a limited number of large, integrated delivery systems in which a network of hospitals employs all of the physicians and specialty clinics, offers its own health plan, and controls both the care and insurance purchase decisions of the patients they serve.

The Impetus Toward Closed Systems

Given the uniqueness of provider/payor relationships in different markets across the country, it is difficult to predict how those relationships will evolve on a national scale. There is also the always uncertain reaction of government, whether federal or state. It is certain, however, that the model for the delivery of health care, and how the providers are paid, will continue to evolve in response to health care reform. And as cost becomes the key determinant in the delivery of health care, patients’ choice of physician and hospital will be a great deal more limited than it has been to date. For instance, Blue Cross and Blue Shield of Massachusetts has already launched a plan that limits access to 15 high-cost hospitals. Employers who sign up for the plan will receive a premium discount. Consumers can still choose to go to the higher-cost provider, but they will have to pay for it. The prevailing view is that the consumer will follow his or her pocketbook, not the hospital. A model that could evolve is that of the “closed system”— one that serves only members of the system’s health insurance plan. Certainly, powerful economic forces will propel the model in that direction as hospital systems consolidate, the independent physician disappears, and payors and payees merge. For those providers that did offer a health plan, payments by those plans represented but a small percentage of the hospital system’s total revenue from private health plans. The system was dependent on referrals from physicians whose patient base was covered by a variety of private insurers— usually selected by an employer. The hospitals’ economic survival depended on accepting payment from whichever insurance company covered its patients. That dependence diminishes as the number of hospital systems shrinks and those that remain grow larger. Patients who remain loyal to their primary-care physician will be directed to the hospital system that employs that physician. The hospital system can now afford to require that any patient using its services be a member of its health plan, and vice versa. For the insurance company that is now in the health care delivery business, there are enormous financial advantages to controlling the quality and quantity of care its plan members receive. They can also increase the cost to their competitors by charging them more than they charge themselves for access to the insurer-owned hospital system. And both the provider and the payor save on the administrative costs associated with the cyclical renegotiation of contracts. A limited number of hospitals sell coverage conditional on care being provided by an affiliated physician and, if hospitalization is required, at a system hospital. One is Steward Healthcare Systems, which operates 10 community hospitals in Massachusetts and whose Steward Community Choice insurance product covers care only at a Steward hospital. Another, and the most prominent member in this group, is Kaiser Permanente, the nation’s sixth-largest health plan and largest nonprofit, whose 8.9 million members must select care from one of 36 systemowned hospitals and medical centers in nine states and the District of Columbia.


Uncertainties surrounding health care reform are such that no one can confidently predict what the care delivery and reimbursement models will look like five years from now. We are but one election or one court decision away from having to revamp all of the current thinking about health care reform.

We are but one election or one court decision away from having to revamp all of the current thinking about health care reform.

In the meantime, management and boards must remain vigilant and respond quickly to a rapidly changing marketplace or risk being left behind. And they should keep in mind the law of unintended consequences, which has often applied whenever government attempts to regulate an industry. Don Foster is a principal in the Philadelphia office of the law firm Offit Kurman, P.A. He has represented health care insurers, hospitals, and physician practice groups in litigation and general practice-related business matters. He can be reached at


  1. According to the most recent U.S. Census Bureau statistics, 16.7% of the U.S. population does not own private or government health insurance. This represents about 49 million uninsured nonelderly Americans. Of this group, 29.7% are in the 18-to-34 age group. See Kaiser Commission on Medicaid and the Uninsured, “Changes in Health Insurance Coverage in the Great Recession, 2007-2010,” Issue Paper (December 2011).
  2. W. Vogt, “Hospital Market Consolidation: Trends and Consequences,” National Institute for Health Care Management, Expert Voices (November 2009).
  3. See Governance Institute, “Hospital Consolidation Trends in Today’s Healthcare Environment,” White Paper (Summer 2010); and “Hospital M&A Outlook 2012: 5 Key Trends,” Becker’s Hospital Review (December 21, 2011).
  4. The Camden Group, “2012 Healthcare Industry Outlook: Capital and Cost Pressures Persist, Triggering More Consolidation,” Press Release (January 5, 2012).
  5. R. Kocher, and N. Sahni, “Hospitals’ Race to Employ Physicians: The Logic behind a Money-Losing Proposition, New England Journal of Medicine; 364:1790-1793 (May 2011).
  6. Government Accountability Office, GAO-11-49, “Health Care Delivery” (November 2010).
  7. Ibid.
  8. American Medical News, “Health Plans Owned by Doctors, Hospitals Are Disappearing” (November 9, 2009).
  9. Congressional Research Service, “The Market Structure of the Health Insurance Industry,” No. R40834 (November 17, 2009).
  10. S. Norland, “Hospitals Face Tightening Access to Capital,” Health Care Financial Management (July 2004).
  11. Governance Institute, “Hospital Consolidation Trends in Today’s Healthcare Environment,” White Paper (Summer 2010).