Managed Care

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Managed Care

Surprisingly, U.S. managed care has been in existence for almost a century. In 1910, the Western Clinic of Tacoma, Washington offered medical services through its network of doctors and nurses for the premium payment of $0.50 per member per month. Nearly one hundred years later, managed care organizations (MCOs) have changed dramatically with increased complexity and significance to the U.S. healthcare market. Aggregate revenues for MCOs in the S&P 500 index grew 30% in 2006 to $212.4 billion while earnings per share estimates are expected to increase by 15% for 2007. The purpose of this paper is to analyze the United States’ managed care industry in understanding the sources of profitability.

Managed Care History

From 1910 - 1970, MCOs were a small part of the healthcare landscape (see Exhibit 1 for industry timeline). As increasing medical costs placed budget constraints on government programs, it was believed that the traditional way of delivering healthcare was financially wasteful since healthcare providers (doctors, hospitals, etc.) had no incentive to keep costs to a minimum. In 1973, U.S. Congress passed the Health Maintenance Organization (HMO) Act, which required all employers with greater than 25 employees to offer two federally certified HMO plans for its workers. Unfortunately for the industry, obtaining federal certification was not an easy process. Strict requirements pertaining to minimum benefit standards, quality assurance, and financial stability made it difficult for HMOs to comply. However, during the Carter and Reagan administrations (early 1980’s), issuance of the regulations became a priority and growth ensued.

Two other elements significantly contributed to industry proliferation: (1) the advancement of computer technology. Software programs enabled patient statistical profiles, tracked physician care, and significantly reduced the administrative costs of processing medical and drug claims. (2) The economic boom of the mid-1990’s. As unemployment dropped below 4%, employers found it necessary to compete for employees, which required a comprehensive offering of group insurance plans contracted through MCOs. These collective elements led to an explosion of managed care enrollment through the 1990’s (see Exhibit 2). Today’s managed care, post year 2000, is evolving. After years of prosperity, the industry is at a crossroads; as an example, the 2006 S&P Managed Care stock index declined (by 6.2%) for the first time in five years. Further complicating matters are soaring healthcare costs, which MCOs were originally designed to reduce.

Five Forces Industry Analysis

Internal rivalry: Industry demand is driven by the rising costs of providing medical care. The profitability of most MCOs depends on efficient operations and the ability to negotiate favorable contracts with healthcare providers. With respect to price competition, average premium prices charged to customers have risen more than 78% since 2001 . These industry-wide increases suggest MCOs engage primarily in non-price competition. An example that supports this suggestion is the recent growth in firms’ provider networks, which can be measured by the number of doctor’s offices, hospitals, and pharmacies that accept the insurance plan in a specific geographic area (Exhibit 5). Through sales and marketing, large MCOs promote expanding networks of healthcare providers as a key attribute to signal their relative strength in the marketplace. For example, UnitedHealth Care lists itself as a company that, “organizes access to quality, affordable healthcare services on behalf of more than 28 million individual consumers, contracting directly with more than 520,000 physicians and care professionals and 4,700 hospitals nationwide” (“UnitedHealthCare Bolsters Access”). A broader network of affiliated healthcare providers serves as a source of competitive advantage in the industry since employers want to...
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