The University Record, December 7, 1998

Health System copes with managed care cost squeeze

Editor’s Note: This is the first in a series of three articles describing how the U-M Health System has been affected by fundamental changes taking place in the U.S. health care insdustry over the past decade. This first article focuses on the shift to managed care and the impact it had on the then-named U-M Medical Center in the mid-1990s. The second article, to be published in next week’s Record, will explain why academic medical centers are particularly vulnerable to today’s health care cost squeeze. The final installment will focus on how the Health System is changing and growing, so it can continue to provide the highest quality patient care in spite of continuing reductions in clinical revenue. This series appeared in the summer 1998 issue of Michigan Today.


By Sally Pobojewski
Health System Public Relations

Lloyd Jacobs woke up on May 30, 1996, knowing it was going to be a really bad day. For months, Jacobs and members of his cost-effectiveness committee had been analyzing budget reports and meeting with executive officers searching for a way to avoid what had to be done. But there was no alternative. As chair of the committee, it was Jacobs’ job to walk into a press conference and announce the layoff of 200 employees and the elimination of l,055 jobs at the University of Michigan Medical Center—all part of a three-year plan to cut expenses by $200 million.

News of the first widespread layoffs at the Medical Center in more than 20 years sent shock waves through Ann Arbor and the University community. Demonstrators picketed the Regents meeting. Reporters interviewed stunned employees who had just received termination notices. Economists speculated about the impact on the local economy.

Michigan residents were used to hearing about auto industry layoffs and corporate downsizing. But pink slips at the Medical Center? With a $913 million budget, over 8,000 employees and $151 million in research funding, how could one of the world’s most prestigious academic medical centers be in financial trouble?

Like many hospitals around the country, the Medical Center was a victim of forces beyond its control. It was trapped between sky-rocketing costs of medical care and fundamental changes taking place in the U.S. health care industry.

From 1980 to 1995, the total amount spent on health care in the United States soared from $247 billion to $988 billion. In an attempt to control medical costs and reduce a growing budget deficit, Congress started cutting back on Medicare and Medicaid payments to hospitals in the mid-1980s. About the same time, corporations—looking for a way to reduce the escalating costs of health insurance—began moving employees from traditional fee-for-service health plans to managed care. The simultaneous loss of millions of dollars in income from two major funding sources had a devastating impact on the nation’s teaching hospitals.

The beautiful, new Medical Center looked great on the outside. But the people who balanced the budget knew it was only a matter of time. With a $16-million operating loss and a falling admissions rate, the hospital’s prognosis was grim.

The coming of managed care/HMOs

“Things were a lot simpler back in the 1980s,” sighs Tom Marks, who coordinates financial services for U-M Hospitals. “Back then, individualized payment plans and special contractual arrangements were the exception. There were few billing rules and a lot less negotiating with managed care firms or Medicare. Basically, we billed the full amount; they paid the full amount.”

Coping with the financial impact of managed care is one of the more challenging aspects of Marks’ job these days. The concept of managed care originated 40 years ago, but wasn’t widely adopted until the late 1980s in California. The most common form, the health maintenance organization or HMO, manages health care costs through a process called capitation. Under capitation, HMOs give local physicians and hospitals a fixed amount of money to provide medical care for HMO members. All the expenses for treating HMO patients come from one common pot. If there is anything left in the pot after health care expenses, then physicians and hospitals make money; if not, they break even or take a loss. Managed care companies can be either for-profit or not-for-profit.

For-profit managed care is less common in Michigan than in California, Minnesota, Massachusetts or New York where it was introduced much earlier. Michigan’s health care market has always been influenced by the automobile industry and Ford, General Motors and Chrysler employees wanted traditional fee-for-service medical plans from firms like Blue Cross/Blue Shield of Michigan. This gave Michigan hospitals and health systems time to create their own non-profit managed care plans, including Henry Ford Health System’s Health Alliance Plan, Mercy Health Services’ Care Choices and the U-M’s M-CARE. Like other industries nationwide, the auto industry is now encouraging its employees to join HMOs in an effort to cut health care costs.

“Five years ago, the amount of revenue the Medical Center received from managed care was less than 10 percent,” Marks says. “This fiscal year, about 28 percent of our gross revenue will come from managed care. We expect that percentage will continue to increase.”

Managed care creates its own system of winners and losers. Because the primary goal is to cut costs, HMOs favor hospitals that provide medical care at a lower price. To survive under managed care, hospitals need large networks of primary care physicians who refer patients to that hospital. Increased patient volume helps cover the hospital’s fixed operating costs.

Unfortunately, the U-M Medical Center—as it existed in the early 1990s—was a big loser under the terms imposed by managed care. It had fewer than 50 primary care physicians on the faculty, and it was the most expensive hospital in the state.


You can always drop us a line: urecord@umich.edu.