Employers in 1998 can count on rate increases from health maintenance organizations.

HMOs say they need to make up for low rates offered in their drive for market share and that medical costs have risen. Some also face pressure to earn more for Wall Street, and many providers are demanding higher payments.

In 1997, employers typically were hit with HMO rate increases of between 1% and 6%, though the increases often were nearer to the lower rather than the higher end of the rate hike scale. The 1997 rate hikes brought an end to a three-year run of generally flat and, in some cases, lower rates for employers.

In 1998, HMO rate hikes will again be in the 2% to 6% range, with HMO executives and others expecting most rate hikes to fall in the 3% to 5% range.

Even though HMO rates are climbing, the increases will be much less than for other types of health care plans.

Insurers and benefit consultants say that for traditional indemnity plans, employers in 1998 can expect rate increases of 8% to 15%, roughly in line with this year's rate increases.

Preferred provider organization rates are expected to rise 8% to 12% in 1998.

Rates for point-of-service plans generally will continue to be one to two percentage points more than rate hikes for traditional HMOs.

Managed care executives say years of flat and falling rates -- as HMOs battled one another for market share -- have taken their toll. They say they need rate hikes to improve margins and restore battered bottom lines.

"The message has been pretty clear: HMOs have been struggling. Margins are just not at acceptable levels. Over the previous two or three years, there was a tremendous drive for membership that weakened some margins," said Dana Benbow, vp-underwriting at Prudential HealthCare Group in Roseland, N.J. Mr. Benbow expects rates to rise at traditional HMOs by between 3% and 5%, with "more in the 4% to 5% range."

David Olson, vp-investor relations for Foundation Health Systems Inc., a Woodland Hills, Calif.-based HMO, said, "We think that there's a general recognition in the marketplace that rates had probably gone down too far." He said "per-member revenues" will rise between 3.5% and 4% next year, the HMO's first increase in three years.

A spokeswoman for Oakland, Calif.-based Kaiser Permanente, the nation's largest not-for-profit HMO with about 8.8 million enrollees, said, "Our rates have been, frankly, probably too low over the last several years, and that actually is contributing to what in '97 is our first projected loss for the program as a whole, so clearly we have to look at not only controlling costs, but also at rate increases."

The Kaiser spokeswoman said rates will be going up by "single digits," though rate increases will vary from "one group to another."

Others note that publicly held HMOs are feeling the heat from Wall Street and shareholders to boost margins and ultimately profits.

"Shareholders are demanding better results. So rates have to go up," said Randall Abbott, regional practice leader in the Little Falls, N.J., office of Watson Wyatt Worldwide.

"There has been a wakeup call from Wall Street," agreed Lew Devendorf, a principal in the Stamford, Conn., office of William M. Mercer Inc. Indeed, stock prices in HMOs such as Oxford Health Plans and PacifiCare Health Systems Inc. plunged after adverse earnings reports.

At the same time, HMOs and other managed care organizations are facing pressures from an increasingly sophisticated provider community for increased payment rates.

"Providers really are starting to push back. Doctors are getting kind of fed up with some of the reimbursement levels. Some specialists are saying to HMOs: 'No. Your rates are unacceptable,'*" said Mary Case, a principal at The Kwasha Lipton Group in Fort Lee, N.J.

"Over and over again" providers are saying they are "struggling to make it," with their current capitation rates, said Daniel Hoemke, corporate vp for national accounts at Cypress, Calif.-based PacifiCare, an HMO with about 3.8 million enrollees. PacifiCare expects rate hikes of between 3% and 5% next year for major national accounts and a sizable portion of the mid-sized market.

Higher prescription drug costs are another big driver of rate increases for all types of health care plans.

"One thing is very clear: The drug portion of health care costs is going up significantly. There have been a lot of drug cost increases as well as an increase in utilization," said Harvey Sobel, a principal and consulting actuary at Buck Consultants Inc. in Secaucus, N.J.

Corporate benefit managers gripe that physicians deserve some of the blame for spiraling prescription drug costs.

"More and more drugs are being overprescribed. Doctors have no idea what the cost of a prescription is," says James Cole, manager of health programs at Bluffton, Ind.-based Franklin Electric Co. Inc., a manufacturer of electrical pumps. Franklin is projecting a double-digit increase in its PPO costs next year.

Frank Keenan, vp and chief actuary with New York-based NYLCare Health Plans, which has about 1.3 million HMO enrollees, said, "There has been an introduction of more costly drugs, and people are aware of and asking for more" prescription drugs.

Demographic changes -- especially among HMOs -- are becoming an increasingly important cost driver, some say.

When HMOs first began to make inroads in the group market, a higher proportion of enrollees were young, healthier employees with low health care costs.

But as HMOs have become more mainstream and enrollment expands to cover more older employees, "Their claims experience has to deteriorate, and that puts cost pressures on HMOs" said Kwasha Lipton's Ms. Case.

HMOs are "dealing with an aging workforce, and that is not going to get any better," said PacifiCare's Mr. Hoemke.

While health care premiums and costs clearly are going up, buyers in many cases still have considerable leverage -- especially if their experience is good -- in trimming back proposed rate increases.

"There is a lot more wiggle room than anyone ever talks about," said Helen Darling, manager of international compensation and benefits at Xerox Corp. in Stamford, Conn.

While most of the HMOs that UNUM Corp. contracts with settled for rate hikes of between 4% and 6%, those are smaller rate increases than the HMOs had initially proposed, said Thomas Hopkins, director of enterprise benefits at the Portland, Maine-based company.

While HMO decreases are now just about a thing of the past, some buyers -- especially the very largest -- have negotiated very small rate increases.

For example, earlier this year, the Pacific Business Group on Health, a San Francisco-based buyers' coalition generally composed of very large employers, negotiated a 1% average rate increase with the HMOs from which its members buy coverage.

"While Wall Street is talking up 4% to 6% rate hikes, our rate changes will be considerably less than that," said Xerox's Ms. Darling.

"We're talking about low single digits, not the kind of increases stock analysts have been talking up," Ms. Darling added.

Even as mergers have increased the clout of HMOs, many still can't afford to present buyers with take-it-or-leave-it rate increases.

"Competitive pressures still are high. HMOs have to be mindful of what their competitors are doing in the marketplace," said Joseph Martingale, a principal with Towers Perrin in New York.

How much rates will increase will depend on many factors, not the least of which is the size of employers.

For example, while HMO and POS rates for employers with at least 50 employees will increase by an average of 4%, smaller groups can expect rate increases averaging 6%, said Kerry O'Brien, assistant director of marketing communications for HIP Health Plan of New York.

Employer size and experience are key variables in the negotiating process, HMO executives say.

"The amount of clout that an employer would have in negotiating rate increases really will vary depending upon their size," plan design and experience, said William Hudock, vp-underwriting and pricing for Owings Mills, Md.-based Blue Cross & Blue Shield of Maryland, which expects to raise HMO rates 3% to 5% in 1998.

Mr. Keenan of NYLCare said, "You have to make your best case and say this is what your experience demands."

Employers that have banded together to buy coverage, such as the Pacific Business Group on Health, generally have had the most immunity to big rate increases.

Employer coalitions "seem to fare better, and that is because combined, they have a very large population and the risk pool is large," said Paula Wallace, HMO program manager for Hewlett-Packard Co. in Palo Alto, Calif.

"Coalitions will exert pressure where individual employers may not have a lot of clout," said Mercer's Mr. Devendorf.

Others say both employers and health plans are tough negotiators.

"I think that employers still have significant clout, but I think health plans are beginning to be much firmer in assessing their cost and making sure they are pricing properly relative to their underlying costs," said Ron Williams, president of Blue Cross of California Businesses, a subsidiary of Woodland Hills, Calif.-based WellPoint Health Networks Inc.

How much of an effect the wave of HMO mergers is having on rates is a matter of controversy.

In California, for example, where four HMOs now control about 85% of the market compared with about a dozen companies a few years ago, "Consolidation means HMOs will push buyers for bigger rate increases than what they received a few years ago," Mr. Devendorf said.

In fact, he notes, large, multistate managed care organizations already have begun to flex their muscles, knowing employers with large proportions of employees in their plans may be more willing to accept rate increases because of the disruption they would have to face in trying to move large populations of employees to other HMOs.

Others say they have yet to see any impact on rates from HMO consolidation.

"There are still many, many HMOs competing, so from the buyer perspective, we have not yet seen any adverse consequences of mergers and acquisitions," said Mr. Martingale of Towers Perrin.

While some HMO executives say mergers and consolidations eventually could lower costs through reduced overhead, they acknowledge it will take time for such savings to be realized.

In fact, mergers actually can swell costs initially.

Systems conversions and integration of membership "frequently requires that you maintain redundant systems and product lines for longer periods of time than you might like, and there are some costs associated with it," said Mr. Hoemke of PacifiCare, which is integrating its acquisition of FHP International Corp.

Indeed, in the short term, HMO mergers can result in a "significant disruption relative to claims processing and administration," said Mr. Abbott of Watson Wyatt.

Still, down the road, Mr. Abbott says the benefit of larger HMOs to the buyer is that the managed care organizations may have more leverage in negotiating with providers for better rates.

"Advantage No. 1 of mergers is more purchasing power," said Laurie Scarborough, director of investor relations at Humana Inc. in Louisville, Ky.

But another form of power that managed care executives and employers do worry about a little has been congressional meddling in the health care market.

Last year, for example, Congress -- responding to a wave of public protest -- passed legislation to go into effect Jan. 1 that will require health care plans to offer 48 hours of inpatient coverage to mothers and newborns after a normal vaginal delivery and 96 hours of coverage after a Caesarean section.

In addition, legislators passed a measure, also to go into effect Jan. 1, designed to eliminate discriminatory annual and lifetime dollar limits on mental health care benefits.

For now, the impact of those legislative mandates should be minimal.

"I have never seen any HMOs say they are going to increase rates" because of a mental health care benefit mandate, said Ms. Case of Kwasha Lipton.

"I could say at least from a PacifiCare perspective and most real quality health plans, I don't think it is going to have a huge impact," Mr. Hoemke said.

But there are nagging worries that if congressional intervention continues, it will have an effect on costs.

"If those things continue, they're really micromanagement," said Suzanne Mercure, manager of health programs for Southern California Edison Co. in Rosemead, Calif.

If there had been legislation mandating a four-day hospital stay in the days before gall bladder surgery could be done on an outpatient basis, "where would be today?" asked Ms. Mercure.

But if the cost impact of recently passed mandates has been negligible, there is real fear of what could lie down the road.

In particular, benefit experts are alarmed about a piece of legislation -- the Patient Access to Responsible Care Act of 1997, now backed by nearly a majority of the House of Representatives -- that would open up employers and health care plans for punitive damage awards for actions of physicians. The measure also would make it harder to establish PPOs and would force health care plans to provide for services they never previously covered (BI, Nov. 17).

If the PARCA bill is passed, health care costs "could increase by double-digits. Employers would face a liability that they can't manage in the real world," Mr. Abbott said.

Still, health care experts say HMOs and others have to do a better job of providing quality care, one of the reasons for congressional interest.

"The biggest challenge is getting quality. What good is a bargain X-ray if a radiologist can't read it?" Mr. Abbott asked.