News CoverageBests Review
Big, better, best? Even as some insurers gain national size through mergers and acquisitions, competition is still a local battle
by Meg Green
Mar 01, 2004
Health care may be a local business, but that's not stopping carriers from consolidating nationally.
While many in the industry are skeptical that the $ 16.25 billion Anthem Inc./WellPoint Health Networks Inc. merger, announced in October, will spark additional mergers of that magnitude, many say it's a sign that consolidation among health plans is likely to continue. The costly need for improved technology to drive down rising medical costs will continue to fuel a trend toward consolidation, especially among smaller, less profitable plans, they say.
As the big players get bigger, smaller regional insurers are facing greater challenges to compete with the larger national carriers. National carriers say they'll use their size to run leaner and smarter businesses, and will be able to drive down costs by spreading them among their larger membership. Regional carriers have no plans to surrender, however, and say their home court advantage gives them an edge in dealing with local providers, hospitals and patients.
Some consumer groups fear that fewer players in the marketplace will lead to fewer consumer choices and higher costs for all. Providers fear growing health insurers will gain greater negotiating muscle. Consumer groups and the American Medical Association have called on federal regulators to step up scrutiny of proposed mergers and acquisitions among health insurers.
There's no doubt the health insurance market is undergoing a transition, and some say, the likely winners will either demonstrate large economies of scale, outstanding focus, of both.
The Big Get Bigger
The Anthem/WellPoint transaction, the largest managed-care merger ever attempted, will create the largest health insurer in the nation, surpassing rival UnitedHealth Group. Coincidentally, the same day that merger was announced. UnitedHealth Group Inc. announced plans to purchase Mid Atlantic Medical Services Inc. for $ 3.3 billion. Both transactions can be seen asa sign that the merger-and-acquisition climate among health insurers is heating up again, although experts said it's not likely to match the flurry of activity in the late 1990s. From 1995 to 2000, there were more than 350 mergers involving health insurers and managed-care organizations, according to a 2001 study by the AMA.
The number of health maintenance organizations in the country dropped 30% from 1999 to 2003, falling from 643 to 454, according to Interstudy Publications, which tracks the entities holding HMO licenses in their state of primary operation. Interstudy hasn't tracked preferred-provider organizations as long, but found the number of PPOs fell 2.6% from 2000 to 2002, dropping from 713 to 694.
"I don't think it's going to have the same pace it has had in recent years-it may not reach that level again," said Dr. Peter Kongstvedt, vice president Cap Gemini Ernst & Young's Health Consulting. "But consolidation is always going on in the marketplace, especially smaller plans that can't make it on their own. If they start to get into financial trouble, of have financial needs that they can't afford, they will be acquired."
While consolidation may be a constant force, there are fewer targets today than there were even a few years ago, said Doug Sherlock, senior health care analyst at Philadelphia-based Sherlock Co., a consulting firm.
"When you look at the number of provider-sponsored health plans, there are about 80 of them now, about half of the number there were five years ago," Sherlock said. "Consolidation activity will diminish because there will be fewer opportunities."
But there's no doubt that the Anthem/WellPoint merger will have major ramifications on the market place, said Bob Stein, chairman of global financial services for Ernst & Young. "It's certainly a market-changing situation. It results in a handful of major players with a national presence. It changes the dynamics of the Industry quite a bit, but it won't lead to a consolidation among other players," Stein said.
The AMA spoke out against the Anthem/WellPoint deal, calling it "alarming" and said both that merger and the UnitedHealth Group/Mid Atlantic Medical transaction "should raise concerns that the country is headed toward a system dominated by a few publicly traded companies that operate primarily in the interest of shareholders."
As the number of insurers in the marketplace shrinks, those that remain often gain greater size. About half of all people insured through HMOs in the United States are covered by one of the 10 largest health plans, according to a 2002 Kaiser Family Foundation report. With the exception of the U.S. Department of Justice challenging the Aetna/Prudential merger in 1999, the consolidation among health insurers has "gone virtually unchecked by federal regulators," the AMA said.
Jerry Flanagan, consumer advocate for the Foundation for Taxpayer & Consumer Rights, said there isn't a governmental oversight agency that looks at whether the cost of care equates to the value of care. "If there are fewer health insurers, then free market competitive forces don't work and we see prices continue to rise," Flanagan said. "We think we will see that continue until there's regulatory oversight. When competition goes away, the federal government should step in to make sure the consumer is protected."
What is unusual about the Anthem/WellPoint transaction is it boosts publicly traded Blue Cross/Blue Shield plans--which have traditionally been smaller, regional and nonprofit--into the largest health plan by membership.
Under the terms of the Anthem/WellPoint merger, WellPoint will become a subsidiary of Anthem, and the company will operate as the Blue Cross and Blue Shield licensee in 13 states. While the merged companies could gain economies of scale (California-based WellPoint will be able to move some of its administrative efforts to less-expensive Indianapolis), the two companies operate as Blues plans in different states, and the merger won't bolster their standing in any local market, said Joy Grossman, associate director, Center for Studying Health Care System Change.
"But for a plan like Anthem and WellPoint, they are always looking for ways to reduce costs and help administrative efficiencies. They are very focused on information technology investments on the administrative side, and critical-care management, which requires acquiring a lot of data and information systems to analyze and help reduce costs," Grossman said.
With an aging baby boomer population increasing the demand for medical care, coupled with continuous inflation of medical costs, insurers are looking to find best practices and apply them across their entire membership. To do that, they must first find what the best practices are, and that means drilling down through claims data.
Technology is a key factor driving the consolidation of Anthem/WellPoint, said Ken Ferber, a spokesman for WellPoint. "The whole issue from our point of view is informatics. It's taking the information that we have, understanding it, and applying it," Ferber said.
WellPoint said it defines informatics as using health-care data to understand and improve health-care delivery. In other words, informatics can mean searching data bases of information to generate knowledge of trends, then acting on those trends.
"It's efficacy and efficiency. Efficacy is how a drug or procedure works in a clinical environment. Efficiency is how it works in the real world," Ferber said. For instance, when it comes to disease management, a certain drug may have been proven to be extremely effective in medical trials, but in real life, patients do not use it as prescribed because of its nasty side effects, so the drug doesn't bring the expected results. In this case, another drug of treatment might have better real-life results.
"Smaller companies cannot engage in this to the extent that larger companies can," Ferber said.
John T. Sarich, industry marketing manager of insurance for FileNet Corp., a Costa Mesa, Calif.-based technology company, said as insurance companies might have once been viewed as financial institutions with back-room operations, today they are "technology companies that happen to sell insurance."
"The bow of the ship is becoming technology," Sarich said. "It's what enables them to do what they need to do."
There's certainly room for improvement. According to a study by researchers at the Harvard Medical School published in the Journal of Health Services, national health insurance could save $ 286 billion annually on paperwork--enough to cover all of the uninsured and provide full prescription drug coverage for everyone in the United States--if it tan as efficiently as Canada runs its nationalized health-care system. The authors found bureaucracy accounts for at least 31% of total U.S. spending on health care, compared to 16.7% in Canada.
Also, if the consolidations bring administrative savings and economies of scale, they're not being passed on to consumers, who are still seeing double-digit premium increases, said Flanagan of the Foundation for Taxpayer & Consumer Rights. "In 2002, premiums increased 250% greater than the rate of inflation. It's certainly true that health-care costs are increasing, but premium rates are increasing at a greater rate. The result for consumers is that everyone pays more for less care," Flanagan said.
Michael Smith, chief financial officer of Anthem, divides the health insurance business into three separate businesses: health finance business--the conventional and long-understood practice of transferring risk; transaction business--the processing of claims, benefits and premiums; and health information business.
It's transactional business that can achieve economies of scale through consolidation as costs per-member-per-month are driven down through backroom efficiencies. But by harnessing technology and studying the claims data, companies can use their health information business not only to run more efficiently, but as a marketing tool.
Insurance companies that can give employers "greater value" through their use of technology will be successful, Smith said. "Employers value precise information gathered from very broad sources of data," he said.
For instance, if employers knew which local doctor of hospital of treatment provided the best outcome--better care for patients, resulting in less time off from work, at a lower cost--they'd want their employees to get that care. Larger health insurance companies have better access to greater amounts of data, and that data might have more value to employers than similar data derived from smaller health insurers, Smith said.
It's easier to take advantage of new information technology, and the efficiencies it brings, it a company has a greater membership to spread the cost over, said Kongstvedt of Cap Gemini Ernst & Young. "A plan with 1 million members and a plan with 3 million members would have to spend the same amount of money upgrading IT, but the 3-million-member plan would have a lower cost per member," Kongstvedt said.
Chasing National Accounts
A major driver of mergers and acquisitions is competition among health plans for large national accounts. "There's only so many of those accounts that have employees across the country, and the only way to get more business is to take it away from someone else," Grossman said.
The competitors that Anthem/WellPoint face on a national level include Aetna, UnitedHealth and Cigna.
"It's a little counterintuitive. The merger is reducing the number of competitors, but making a stronger national competitor," Grossman said.
Dean Hatfield, principal at Mellon's Human Resources & Investor Solutions, said he's concerned that the "Big Four" will consolidate. "My concern would be the lack of choices; especially if the Aetnas, Cignas and United-Health Cates start merging, you start running out of choices on a national level," Hatfield said. "If they drop to three, it makes it tougher to have the variety. The costs could end up being passed along to employers. You need competition."
In recent years, Aetna Inc. has bucked the trend to grow through acquisitions. While still a national player, it has reduced its membership in recent years from a high of 21 million in 1999 to 13 million members today, said Fred Laberge, a spokesman for the company.
"Aetna made a number of major acquisitions in the 1990s, and that strategy has changed. We had a lot of problems in 2000. We were losing money every quarter," Laberge said. "We brought in new management, and made the decision that we wouldn't keep growing at all costs. It was not as important to be large as to be profitable."
Aetna raised premium rates, even if it meant losing business, Laberge said, and has had seven consecutive profitable quarters. The company is now looking at "tuck-in" acquisitions, smaller acquisitions in strategic areas, such as acquiring the Chickering Group in December, which provides health insurance for college students.
"We do believe we have the scale and the networks of hospitals and doctors practices to be very competitive in the landscape," Laberge said.
Large and Local
The issue isn't how big a certain company is, but how large its local market share is, said John Fitzgibbon, national industry director for managed care at accounting and tax firm KPMG LLR Even with 26 million members, the combined Anthem/WellPoint would have only 10% of the U.S. population as members. "You can't make global statements about health care," Fitzgibbon said. "It's a market-by-market business."
To have influence in a local market, Stein of Ernst & Young said an insurer must have at least a 10% to 15% market share. "Then you begin to have some bargaining power with providers. If you don't have that, you'd be hard-pressed to get the price you need from providers," Stein said.
According to a 2002 study by the AMA, in 48% of highly concentrated HMO and PPO markets with populations more than 1 million, a single payer had a market share greater than 40%. In 24% of those markets, a single payer had a market share in excess of 50%. For example, in the metropolitan area of Chattanooga, Tenn., the Blue Cross Blue Shield Plan of Tennessee had a 77% market share, with Cigna running a distant second at 11%. Among states, Anthem Blue Cross Blue Shield had a market share of 69% in Maine, with Aetna having the next largest market share at 16%.
"The combined effect of these market conditions is to enable an insurer with a large market share to increase premiums while also reducing physician payments," the AMA said in its study.
Dave Wilson, chief actuary of the Ventures Group, a division of NiiS/APEX, a Princeton, N.J.-based consulting firm, noted mergers give big carriers the ability "to drive harder bargains with providers by having critical mass."
But also, he said it's possible for a company to have too much market share. For example, in Pittsburgh, Highmark Blue Cross Blue Shield owns 61% of the HMO/PPO marketplace. "Between Highmark and the government, it's pretty close to a single-payer system. There is no such thing as tough negotiations; it's almost like a budgeting process," Wilson said. "If you negotiate too hard, it's almost like playing chicken on the highway. If you negotiate too hard, you'll bankrupt providers and then where will your members go for service?"
However, the once hotly contested contract disputes between health plans and providers have cooled down in recent years, according to the Center for Studying Health System Change. The study found the balance of power has shifted to providers, especially hospitals, and health plans are often going along with demands for higher payment rates and better contracting terms, then passing those higher costs along to employers and consumers through higher premiums.
Room for Everyone
Smith of Anthem said that while there's likely to be continued consolidation, "we believe the regionals are also likely to continue to flourish. There will always be a place for single-state or relatively small benefits plans, just as community banks continue to thrive alongside very large, multiservice regional and national banks."
Sherlock said he's optimistic that the market is evolving to simultaneously give consumers more choice, and greater managed care. He said health insurers will provide opportunity for consumers to directly benefit by selecting less expensive, but more restrictive, health networks through defined-contribution benefit plans. And he sees the market evolving into large players who have great economies of scale, and those who are small, but very focused.
Ernst & Young's Stein agreed: "The market seems to be a bipolar situation. There are large players concentrating on bigger markets, and smaller, specialists organizations focusing on smaller geographics."
As consolidation strengthens the position of market leaders, the lessons those leaders learn through running more efficiently may ultimately help the entire industry.
"The only way we will drive to more efficient medical care is through larger players establishing standards among treatment protocols," Stein said. "The only way we will get more efficient delivering care is if the national organizations use their influence on the provider community to disseminate delivery standards that have proven track records. A patchwork of 500 different managed-care companies around the country won't have the ability to do that."
The 11 Largest Insurance Company Managed Care Deals Since 1997
Ranked by deal value of announcement
Rank Buyer State
1 Anthem Inc. Ind.
2 United HealthCare Corp. Minn.
3 Anthem Inc. Ind.
4 UnitedHealth Group Inc. Minn.
5 Cigna Corp. Pa.
6 WellPoint Health Networks Inc. Calif.
7 Aetna Inc. Conn.
8 WellPoint Health Networks Inc. Calif.
9 WellPoint Health Networks Inc. Calif.
10 WellPoint Health Networks Inc. Calif.
11 UnitedHealth Group Inc. Minn.
Rank Target State
1 WellPoint Health Networks Inc. Calif.
2 Humana Inc. Ky.
3 Trigon Healthcare Inc. Va.
4 Mid Atlantic Medical Services Inc. Md.
5 Healthsource Inc. N.H.
6 Carefirst Inc. Md.
7 NYLCare Health Plans Inc. N.Y.
8 RightCHOICE Managed Care Inc. Mo.
9 Cobalt Corp. Wis.
10 Cerulean Companies Inc. Ga.
11 AmeriChoice Corp. Va.
Date of completion/ Deal value
Rank announcement Status termination ($ Millions)
1 10/27/2003 Pending NA $ 16,247.1
2 5/27/1998 Terminated 08/10/1998 5,654.9
3 4/29/2002 Completed 07/31/2002 3,980.8
4 10/27/2003 Pending NA 3,301.1
5 2/27/1997 Completed 07/31/1997 1,404.9
6 11/20/2001 Terminated 03/06/2003 1,370.0
7 3/16/1998 Completed 07/15/1998 1,350.0
8 10/17/2001 Completed 01/31/2002 1,346.9
9 6/03/2003 Completed 09/24/2003 885.8
10 7/09/1998 Completed 03/15/2001 700.0
11 6/18/2002 Completed 09/23/2002 517.0
NA = Not available
Note: Financials based on stock price the day before the deal was announced.
Source: SNL Financial, Charlottesville, Va.
In your Neighborhood
While insurers might be able to save money and run more efficiently by upgrading their back-office functions, health insurance is still a local business, said Dr. Peter Kongstvedt, vice president of Cap Gemini Ernst &Young;'s managed-care consulting practice.
"Doctors in hospitals in rural Kentucky are from Mars. Doctors and hospitals from Southern California are Venus. You can't do what works in Kentucky and drop it in California," Kongstvedt said. He said negotiations with hospitals and doctors need to be local. "If you fly in from California and say we're here to negotiate and we're flying out at 3, you're going to leave without anything in your hand. You want to have nurses in the hospital doing a concurrent review of the hospital. You want someone in there to help facilitate. Even companies that have done a lot of mergers and acquisitions almost always leave managed-care delivery and marketing in a local office."
Regional companies may lack the size of big national carriers, but they think their proximity to the local market gives them an edge that a national plan can't match.
"We are not threatened," said Betty Chowning, interim chief executive officer of CHA Health Care, an insurer formed in 1995 by a group of Kentucky hospitals. With 200,000 commercial members, CHA is one of the largest managed-care companies headquartered in Lexington, Ky. "We feel we have a role in the marketplace because we think with our local governance. We have the ability to make market changes and the flexibility to do the things we need to do to be competitive in the market."
Chowning said even without having the size of big national competitors, including fellow Kentucky-resident Humana Inc., CHA has access to strong technology through outsourcing and Betty Ch vendors. "Our reporting structure to employers, our information and our database are just as strong as anyone's in the marketplace," Chowning said.
M-Plan, a hospital-owned plan of 190,000 members in Indiana, also can compete with the larger national players, said Alex Slabosky, president of the plan. In addition to being impacted by the Anthem/WellPoint merger, Indiana recently has seen UnitedHealth buy Golden Rule Financial Corp. for $500 million.
"With consolidation, you are seeing more and more larger organizations that have huge amounts of capital, and have the ability to spread the cost of product development and technology over many more members than smaller regional plans," Slabosky said. "The advantage that we think we have is all health care is local, and we are local. We are owned by local providers, we work very closely with local providers and doctors, and we feel we know the market very well."
The Great Divide
Slabosky compared the health-care industry to the banking industry, where a wave of consolidations among banks resulted in large corporations that had lost contact with the local market.
"The managers and executives work someplace else, and they are not in touch with their clients. When it comes to health care, they are not in touch with the doctors and hospitals," Slabosky said.
M-Plan also outsources technology, he said. "That gives us access to technology that we couldn't develop individually, and gives us expertise to technology that we couldn't employ locally. Also, there are more and more opportunities for organizations to share data. Bigger isn't necessarily better."
Slabosky also said that nonprofit plans, like M-Plan, have an advantage over their for-profit colleagues. That thought was echoed by Vin Capozzi, senior vice president of sales and marketing for nonprofit Harvard Pilgrim, based in Boston.
"I don't have to answer to my shareholders. I don't need to run at the same margins that a for-profit does. Our mission is to improve the health of our members and the health of society. It's a truer mission in terms of balancing everyone's interest," Capozzi said.
When national employers look to buy health insurance, they are of two schools, Capozzi said. On one hand, they may want to do business with just one carrier that does business nationwide. On the other hand, they may want to choose the best player in the market.
"While you might gain in some administrative owning efficiencies by going with a national plan, what you lose is the regional touch," Capozzi said. He noted regional plans tend to perform better than national plans from a clinical quality standpoint "because we are closer to the patients and providers."
The National Committee for Quality Assurance does annual surveys of customer satisfaction and effectiveness of care, and "we're the only plan on both lists," Capozzi said. "We're the warm and fuzzy kind of plan that people hope a plan is like."
Provider-sponsored plans often are more focused than their national counterparts, said Doug Sherlock, senior health-care analyst for Philadelphia-based Sherlock Co., a consulting company. "There's an awful lot to be said for provider-sponsored plans. Typically, they are focused on one or more product areas, and that gives them a high degree of efficiency.
Provider-sponsored health plans operate at considerable lower per-member-per-month costs then larger, for-profit national plans."
States With a Dominant Health Insurer In the HMO/PPO Market
In 13 states a single health insurer has a market share greater than 50% among health maintenance organizations and preferred provider organizations. Most of those insurers are Blue Cross Blue Shield plans.