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Are HMOs Too Big to Go Bust? Just Ask Your Favorite Failed S&L

February 11, 1996|MICHAEL SCHRAGE | MICHAEL SCHRAGE is a consultant and a research associate at the Massachusetts Institute of Technology. He is the author of "No More Teams! Mastering the Dynamics of Creative Collaboration."

Stop me if you've heard this one before:

A sleepy multibillion-dollar industry is thrust into the maelstrom of deregulation and restructuring. Traditions swiftly succumb to radical transformation. The lure of quick profits attracts hordes of entrepreneurs--some brilliant and honorable, others sleazily opportunistic. What's more, this industry is "special"--everyone agrees that the government would never let it go bust. So Wall Street adores this fast-growing, innovative sector.

Inevitably, a few of the more aggressive operators make bad bets. They can't generate the promised returns. Industry leaders get overextended. The regulators are confused. They try to force a few mergers, but bankruptcy starts to look awful appealing. Some of the biggest firms swiftly embrace it. The Justice Department aggressively investigates for fraud. Millions of angry customers--their life savings at risk--collectively scream for a government bailout. Bold legislation is proposed. A new agency is formed to oversee industry consolidation and asset fire sales. Out come the Lotus 1-2-3 spreadsheets. The estimated cost to America's taxpayers? Hundreds of billions. This will ultimately become the biggest taxpayer bailout of a failing industry in American history.

Yet another recap of yesteryear's savings and loan crisis? Not quite. But taxpayers beware: The S&L saga--which is expected to cost taxpayers somewhere between $145 billion and more than $400 billion--offers uncanny insight into what will become tomorrow's health-care headlines if history is nasty enough to repeat itself.

The rapid growth of today's health maintenance organizations is eerily reminiscent of the early go-go good fortunes of the high-flying savings and loans. With comparable mismanagement, HMOs may well become the S&Ls of the next millennium. Bankruptcy law may have a bigger impact on access to quality health care than all the medical schools combined.

"That's not totally out of the question," says journalist George Anders, who is finishing a book on HMOs, "but it's hardly the most likely scenario." Nevertheless, Anders and others acknowledge that the economics of today's HMOs cannot support existing trends without some sort of radical restructuring.

"What happens when all those healthy 66-year-olds turn into 76-year-olds in need of serious medical care?" Anders asks. "Do the HMOs kick people out of coverage, cut back on the quality of care, double or triple their rates, or go down in flames financially trying to give everybody the quality care they expected when they signed up in the first place?"

That challenge is all the more acute given the recent surge in HMO coverage. Just as financial deregulation ignited the explosion in S&L deposits, deregulation and cost-cutting initiatives have made HMOs the dominant medium for health-care coverage. Twenty-five years ago, barely 3 million Americans were enrolled in HMOs. A decade ago, about 20 million Americans were covered. Today, more than 52 million Americans are HMO plan enrollees, and the number is expected to exceed 65 million by the middle of next year. That doesn't yet include the tens of millions of elderly participants as Medicare and Medicaid are brought into the HMO fold.

Of course, HMO networks won't go bust lending money to aspiring Texas shopping mall moguls and Arizona real estate developers. The issue here isn't bad loans and rising interest rates, it's balancing promised business performance with promised quality and quantity of health care. That's going to become ever harder to do.

Today, HMOs enjoy record profits. Industry profits rose roughly 40% from 1992 to 1994--and another 20% in 1995. Unfortunately for investors, it's becoming more and more difficult for HMOs to squeeze cost savings out of traditional medical practices. Indeed, as the population ages--and new diagnostics and therapies materialize--cost pressures on HMOs intensify. A breakthrough in geriatric medicine--say, an expensive new drug to reduce damage from strokes in people over 65--could create enormous financial strains on some HMOs as people requiring more care live longer. Where do the investors go as fat profit margins contract?

Obviously, HMOs could simply jack up their rates (just as the S&Ls could have lowered the rates they promised depositors). But that brings the country right back to the challenge of rising health costs. At some point, there will be calls for tax credits, tax deductions and/or direct tax subsidies to help pay for coverage for those who can't afford HMO care. Either way, HMOs would de facto receive huge multibillion-dollar government subsidies for their customers.

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