The three-year hiatus from rising health care costs and premiums is definitely over.

Next year, observers say, employers can expect group health care rates, which already have started an upward trend, to continue to rise in response to higher health care costs, after a period of flat or decreasing rates.

The first signs appeared as far back as January that after three years of small increases in health care costs, the run of health care cost stability was coming to an end.

In 1996, group health care costs for active and retired employees had risen just 2.5%, according to benefit consultant A. Foster Higgins & Co. Inc. of New York, which conducted a survey of 3,290 employers.

But, in the wake of deteriorating financial results, many health maintenance organizations that had frozen or lowered rates over the previous three years were boosting rates 2% to 6% in 1997.

One reason was that managed care may have been nearing its saturation point. "The best way to achieve savings is to get employees to move from traditional indemnity plans to managed care plans. That shift has happened," said John Erb, a principal in William M. Mercer Inc.'s Miami office.

Towers Perrin also concluded from a new survey that group health care costs for active employees would rise an average of 3% in 1997.

Mark Jamilkowski, an HMO analyst with Conning & Co. in Hartford, Conn., said larger, more well-established HMOs had an improved outlook for 1997 "as their pricing is ahead of anticipated medical trends and they seem to have a firmer grasp on the cost drivers both from the medical and administrative sides."

First-quarter HMO earnings continued to suggest that HMOs were beginning to emerge from the trough of the competitive pricing cycle as rate hikes took hold.

"Generally, the first quarter was better than it has been, but the outlook for the second half is a lot better" particularly when compared with 1996, Mary O'Connell, an HMO analyst with Louis Nicaud & Associates in San Francisco, said earlier.

Then the signs at midyear renewal season confirmed what had been anticipated: Health care coverage costs were increasing, and the mid-single-digit increases many saw for this year could possibly lead to premium increases approaching double digits in 1998.

"I expect many HMOs as well as insurers will start reporting that the heat is on," said Joseph T. Lynaugh, president and chief executive officer of NYLCare Health Plans Inc. in New York. "I think health care cost inflation is definitely coming back."

In addition to inflation, another potential cost factor that emerged was legislative mandates, such as laws outlawing "drive-through" mastectomies; perceived public ire over managed care practices spurred such bills.

Some experts think mandates will mean higher premiums. "If you legislate certain procedures, it will increase costs," said Lee Exton, a consultant with Watson Wyatt Worldwide in Los Angeles.

However, at least for now, the impact of these 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 Mary Case, a principal at The Kwasha Lipton Group in Fort Lee, N.J.

Meanwhile, by their first-half earnings reports, HMOs' rate hikes were beginning to work their way to the bottom line, said observers.

Arun N. Kumar, director at New York-based rating agency Standard & Poor's Corp., said the HMO industry could "expect margins to improve modestly through the second half and '98 to be a much better year than '97."

By earlier this month, HMO executives and others said they were expecting another 2% to 6% in rate increases in 1998.

However these observers said employers can expect rates for traditional indemnity plans to increase 8% to 15%, roughly in line with this year's rate increases, with preferred provider organization rates expected to rise 8% to 12% next year.

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 said years of flat or falling rates as HMOs battled one another for market share took their toll, and the rate hikes are needed to improve margins and restore battered bottom lines.

"We think there's a general recognition in the marketplace that rates had probably gone too far," said David Olson, vp-investor relations for Foundation Health Systems Inc. in Woodland Hills, Calif.

A spokeswoman for Oakland, Calif.-based Kaiser Permanente, the nation's largest non-profit HMO, with about 8.8 million enrollees, offered a similar viewpoint. "Our rates have been, frankly, 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," she said.

But employers may still find they have at least some leverage in negotiating their health care premiums. Helen Darling, manager of international compensation and benefits at Xerox Corp. in Stamford, Conn., said, "There is a lot more wiggle room than anyone ever talks about."