By JEFF GOLDSMITH
Healthcare payment in the US has evolved in decades-long sweeps over the past fifty years, as both public programs and employers attempted to contain the rise in health costs. Managed care in the United States has gone through three distinct phases in that time- from physician- and hospital-led HMOs to PPOs and “shadow” capitation via virtual networks like ACOs to machine-governed payment systems, where intelligent agents (AI) using machine learning are managing the flow of healthcare dollars. This series will explore the evolution of managed care in 3 phases.
Phase I- Health Maintenance Organizations and Delegated Risk Capitation
In response to a long run of double-digit health cost inflation following the passage of Medicare in 1965, the Nixon administration launched a bold health policy initiative- the HMO Act of 1973- to attempt to tame health costs. The Nixon Administration intended this Act to provide an alternative to nationalizing healthcare provision under a single payer system, as supported by Senator Ted Kennedy and other Democrats.
The goal of this legislation was to restructure healthcare financing in the US into risk-bearing entities modeled on the Kaiser Foundation Health plans- a successful group-model “pre-paid” health plan founded in the 1940s and based on the Pacific Coast. These plans would accept and manage fixed payments for a defined population of subscribers, and offer an alternative to what was perceived as an inflationary, open-ended fee for service payment system. In varying forms, this has been the central objective of “progressive” health policy for the succeeding fifty years.
The HMO Act of 1973 provided federal start-up loans and grants for HMOs, much of which went to community-based healthcare organizations and multi-hospital systems. It also compelled employers to offer HMOs as an alternative to Blue Cross and indemnity insurance. While a few HMOs either employed physicians directly on salary (staff models like the Group Health Co-Operatives), or contracted on an exclusive basis with an affiliated physician group (like Kaiser’s Permanente Medical Groups), many more delegated capitated risk to special purpose physician networks- Independent Practice Associations (IPAs)- whose physicians continued in private medical practice.
By 1996, according to the Kaiser/HRET Employee Benefits Survey, HMOs covered 31% of the employer market (roughly 160 million employees and dependents), and the federal government had begun experimenting with opening the Medicare program to HMO coverage. The impact of HMO growth on overall US health spending remains uncertain, because health spending as a percentage of US GDP continued growing aggressively during the next fifteen years, before levelling off during the mid-1990’s around the Clinton Health Reform debate.
Two things brought the HMO movement to a crashing halt in the late 1990’s.
One was a political backlashfrom workers and their families who were simply assigned to HMOs by their employers, rather than choosing them themselves. This unilateral assignment violated a fundamental principle of HMO advocates like Paul Ellwood, who championed consumer choice as an organizing principle of the movement.
Employees and their families so assigned found their access to care narrowed both by limited panels of providers (that may or may not include their family physicians) and by the mechanical application of medical necessity criteria to their care, such as 48 hour hospital stays after a routine obstetrical delivery. Women, who are the pivotal actors in managing their families’ health and were growing increasingly confident of their political influence, went ballistic.
The other political force that helped quash the HMO movement was angry pushback from physician communities, particularly specialists, who bitterly resented the invasion of their professional freedom by prior authorization and medical necessity reviews, as well as pressure to reduce their fees in order to be included in HMO networks. A major concurrent financial blow to HMOs was a sharp downward adjustment in Medicare payment rate for health plans in the Balanced Budget Act of 1998.
By 2014, HMO’s share of the total commercial market had shrunk to only 13%, well less than half of its peak. They were replaced by preferred provider organizations, broad networks of physicians and hospitals in a region operating under negotiated rates and claims review systems. HMO enrollment increasingly tilted toward publicly funded patients under Medicaid and Medicare.
Capitation of primary care physicians under delegated risk shrank by two-thirds from 1996 to 2013 millennium as the HMO share of insured lives contracted. While the HMO industry shrank nationally, Kaiser saw its enrollment grow to almost 13 million, dominant on the Pacific Coast but a negligible presence elsewhere.
United Healthcare ended up acquiring not only a lot of HMOs (Oxford Healthcare, Sierra Healthcare, METRA, PacifiCare, etc.) in the aftermath of the managed care backlash, but also the risk-bearing physician groups that accepted delegated risk from those HMOs (Kelsey Seybold, Healthcare Partners, Atrius, Reliant, etc), which today form the backbone of Optum Health. Most of the capitated payment in Optum Health (almost $24 billion in 2024) comes from health plans other than United itself!
Our second essay will focus on the second phase of managed care development- the dominance of the PPO and the rise of “value based care’ after the 2010 Affordable Care Act.
Jeff Goldsmith is a veteran health care futurist, President of Health Futures Inc and regular THCB Contributor. This comes from his personal substack
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