Philadelphia Reflections

Health Maintenance Organizations, Reconsidered

Paul Elwood

Paul Ellwood once enjoyed the title of Father of the HMO, while the captains of industry who came so close to pushing HMOs down the nation's unwilling throat remain invisible, quite willing to let Bill and Hillary twist in the wind for the near-miss. In the fifteen years since the Plan was dropped by Congress, 10,000 major employers coerced their employees into HMOs; endured much greater employee resistance than anticipated; and watched in dismay as administrative costs ate up the savings. The National Business Coalition for Health has been transformed from its intended role into an information system for encouraging, testing and swapping experience about minor enhancements and tweakings. Much ado about, well, less than was hoped for. But in spite of all that, let me state right here that it would only take one fundamental change to make the HMO model into a popular and desirable system.

HMO

There's an underlying truism about all effective cost-saving measures in a service industry: regardless of whether you eliminate waste or cut into essentials, you have got to fire a whole lot of people. If you fire the loafers, the quality of your product is improved; if you fire the productive workers, the product is injured. The third choice is to streamline your production methods; you may maintain high quality in spite of firing some good people. But no matter how you go about it, if you are successful, it will be the result of putting good managers in charge. The American Academy of Actuaries once calculated waste in the American healthcare system to be 30%, but in spite of opportunities of that magnitude, the present design of HMOs cannot seem to do more than barely break even. And that is in spite of wide-spread dissatisfaction with denials of care, inconvenient service, and increased paperwork. There's a tragedy here. The alternative model has already been tested, shown to reduce costs, and produced the general satisfaction of both patients and physicians.

Kaiser physicians

That model was the original one, called the Foundation for Medical Care, devised in Stockton and Sacramento California in the 1950s. The Foundations were expressly created to compete with Kaiser-Permanente, both for patient satisfaction and cost-effectiveness, so judging their success is simply a matter of getting out the records and submitting them to impartial evaluation. The Foundation movement was brought to a dead stop by the legislation which enabled the present employer-based version of HMO, as well as an unfortunate Supreme Court Decision (Maricopa) whose evidence was never put on trial, but based on a motion for summary judgment. The central underlying difference between an HMO and a Foundation is that an HMO is run by an insurance company, while the Foundations were formed and controlled by the physicians who worked for them. While it might be argued that circumstances have changed in the last thirty years, it still seems reasonable to suppose that physician-run HMOs remain superior to the present insurance company-run variety. The reason for this confidence is the benchmark of Kaiser-Permanente, whose only difference is that Kaiser physicians are paid salaries, and a few of the affiliates own hospitals. Kaiser systems are at present having a serious struggle in competition with an insurance company owned HMOs. Some years, some branches of Kaiser are profitable, sometimes they lose money. The triumphant flag that Foundations waved in their heyday was, "We beat Kaiser."

So where is the problem? Actually, there are two. The Foundations were usually although not invariably set up as non-profit corporations because of squeamishness of the doctors about the appearance of self-dealing. That eliminated both insurance profit and incentive to interfere with payments, although it naturally displeased commercial insurance companies. Since I can name at least two HMO operators who rewarded their CEOs with more than a billion dollars each, you can understand the displeasure with the non-profit competition. The other resistance came from hospitals. The Foundation system of utilization review put a weapon in the hands of the attending physicians in their eternal tension with hospital administrators, giving the administrators little choice but to do what the physicians wanted. Essentially, what the physicians wanted was for hospital quality to be maintained while any cost cuts affected hospital revenue before they affected physician revenue. The predictably unfortunate consequences for the hospital were held in check by opening staff privileges to physicians who were not participants in the Foundation. Their vigilance and competitive power were on the side of the administrator, for the benefit of their own patients in the common hospital. Kaiser, by contrast, usually found that owning closed-staff hospitals was itself a major headache.

A hidden advantage to shifting control of healthcare to physicians is that the system acquires the management talents of the staff physicians, essentially without charge. The plain fact is that most physicians hate administrative work, and it comes closer to the facts to say that physicians abandoned management chores than to say they were deprived of them. And just in case it needs restating, it is easier to teach management to a physician than to teach medicine to administrators. While there may be some initial fumbling, physicians are the logical group to be in charge of the management of a medical system, and indeed most lay people suppose they are already in charge. Unlike the situation just after World War II, physicians would now have much more enthusiasm for administration. Not only are their own incomes suffering, but they see their product beginning to disintegrate. And it has not escaped their attention that most large-hospital administrators are paid more than a million dollars a year. No doubt physician income would be enhanced by shifting from HMO to Foundation, but less than you might suppose. Physicians are a censorious lot.

Technical footnote: Two technical obstacles must be overcome before Foundations for Medical Care -- HMOs run by physicians -- can be restored to viability. For sixty years, insurance has been regulated by state governments as a result of the McCarran Ferguson Law. Large corporations doing interstate business have found it quite unworkable to comply with fifty different regulators and were given relief by a Federal law called ERISA. ERISA is so large and complex as a consequence of a large number of trade-off compromises, that for many years it was deemed impossible to amend it in any way. That gridlock was broken in 2006. The Supreme Court decision in State of Arizona v. Maricopa has always seemed dubious as a result of a 4-3 decision which lacked a majority at the time it was handed down, and in any event, never had a hearing on the evidence. The decision was based on a technicality related to a motion for summary judgment. With the passage of time and changing the membership of the Supreme Court, it is easily possible to imagine a reversal of this decision.

On a political level, the climate of opinion has also changed. Insurance companies, and quite possibly hospitals, might well resist. However, it is the business community which supplied the main political force for the present version of insurance company-controlled HMO. Since that model has proven to be a disappointment from the employer perspective, but the cost problem has become much worse, it may now be possible to persuade business to allow a competitive model to emerge.

Originally published: Saturday, July 28, 2007; most-recently modified: Sunday, July 21, 2019