A Vignette - Portrait of a Modern HMO.

It's 1995; Clinton healthcare reform has just gone down in flames, and it's a new era for HMOs - HMOs like FTP.  FTP, established in 1992, has already gained a foothold in eight cities along the eastern seaboard.  Following the original business plan, FTP was taken public last year.

But FTP is in trouble. Earnings, and consequently stock prices, have been stagnant.  Enrollments have not grown to expectations; the physicians on FTP's panel (most of whom are new to managed care) have been resistant to changing their inefficient patterns of practice; and it's been difficult to get hospitals in the FTP system (some of which have been rivals for decades) to cooperate with one another. The shareholders are restless, and in response the board has just fired the old CEO (a physician and one of the FTP's founders) to bring in a hard-nosed businessman who will know how to put things right.

That man is Gregory Gekko (distant cousin to Gordon). He doesn't know much about healthcare, but he's not in the least intimidated. The last CEO knew plenty about healthcare, and look where it got him.  Besides, Gekko didn't know anything about greeting cards either before he developed a tiny greeting card company called Greetings-Schmeetings into a multibillon dollar corporation that's giving Hallmark a run for its money.  What Gekko does know is business.

Gekko immediately begins with the two fundamental steps that must always be taken when building a business: First, define your customers.  Second, define the scope of your business (i.e., decide what it is you do to make your customers happy).  Only then, knowing both your customer base and your scope of business, can you decide how best to maximize your profits.

Who are FTP's customers?

To Gekko, making money is everything - but not because conservative Republicans have recently swept Congress, or because it's the new paradigm for healthcare. Making money is everything to Gekko because that's what the stockholders of FTP have put him on this earth to do. Above all, Gekko is acutely aware that when all is said and done, and it is time for him to receive his final judgment, those who will do the judging can only be the shareholders of FTP. He knows from his past business experience that he will have some latitude and flexibility regarding the tactics he uses to make that money, but ultimately, his overriding strategy must be pleasing to those shareholders. Keeping clearly in mind who his own personal customers are, Gekko carefully considers who might be the customers of his company - of FTP.

Gekko knows this is where the last CEO made his big mistake. He'd talked about his primary customers being the patients enrolled in FTP and their doctors. It wasn't until his final shareholders' meeting that he'd finally gotten it. Of course, it was too late for him by then.

Obviously the primary customers of any business are the people who decide to purchase whatever product the business is selling. In this case, those would be the individuals who decide whether or not to use FTP as their health plan. Gekko knows that patients don't really purchase health insurance, nor do their doctors significantly influence those purchasing decisions. Patients and doctors are important on the spending side of the equation, since they determine how much of FTP's money will be frittered away on delivering healthcare.  So they will have to be dealt with.  But they don't buy insurance premiums.

The people who actually make the purchasing decisions are the human resource executives and benefits officers in companies that provide health insurance for their employees.  To FTP, these purchasing agents are all-important; they will determine Gekko's success or failure.  All stops must be pulled out, at whatever the expense, to make these individuals feel very favorably toward FTP.  Gekko is confident in this regard, since he knows many techniques, subtle and otherwise, that can be usefully employed to that end.

What is FTP's scope of business?

This is also pretty straightforward for Gekko.  FTP's main business is to take in lots of money in the form of health insurance premiums, and then try to keep as much of that money as possible. The rest of the insurance premium money, the money FTP doesn't get to keep, must be held on to (and invested), for as long as possible. The best part of course is that, unlike a bank, during the time FTP is holding massive quantities of other people's cash, it doesn't have to pay any interest.

In return for this opportunity, FTP must arrange for the provision of healthcare to the individuals for whom the insurance is paid. But providing healthcare is not how FTP will make its money - it's merely one of the costs of doing business.  It's the price FTP must pay for access to all those insurance premiums. So, how FTP should actually go about providing the necessary healthcare to its enrollees is a completely open question for Gekko. There are a lot of ways to do it, and he's not married to any one of them.  The only firm bounds he sets for his executives are that whatever methods FTP uses to dispense healthcare must be legally defensible, must minimize or mitigate any opportunity for negative publicity, and must be sufficiently acceptable to its customers - i.e., to those benefits officers.

Since his ultimate goal is to make money for the shareholders, Gekko also understands that he needs to be alert to any low-risk investment opportunities - aside from high-grade government and corporate securities, of course - for turning all that cash flow into profit.  

The bottom line is that to be successful, Gekko must maximize the inward flow of cash (health insurance premiums,) and minimize the outward flow of cash (healthcare payments).  Much of his effort will have to be targeted toward these two goals.

Maximizing the inward flow of cash

To maximize the amount of money flowing into FTP in the form of insurance premiums, Gekko must do several things.  He needs to grow and expand FTP into as many localities as possible as rapidly as possible, in order to increase the number of businesses to which FTP can reasonably sell its insurance products.  He needs to create a strong and aggressive cadre of sales representatives who can market, enlighten, persuade, cajole, schmooze, entice, bribe, seduce, blackmail or threaten the benefits officers of those companies to offer FTP as a health insurance option to their employees (and as the sole option, whenever possible.)  And he needs to charge as much for his insurance products as the market will bear.

Keeping premiums high.

Optimizing the cost of his health insurance premiums is pretty simple. Gekko must lower his premiums just enough to induce employers to switch to FTP, but not a penny lower. Since high-priced indemnity insurance plans are still active in all the cities in which FTP operates, all he has to do is to beat their prices by a little bit.  So Gekko sets his rates to a fixed proportion - 90%, in fact - of the indemnity rates, and he's in business. The beauty of this methodology is that, since FTP's rates are fixed to the highest rates in the market, whenever the indemnities are forced to increase their rates, FTP automatically gets a raise, too.

Gekko understands, of course, that the reason everybody's pushing HMOs in the first place is that they're supposed to reduce the cost of healthcare.  And most people assume that what HMOs charge for their premiums are tied somehow to that lower cost of delivering care.  Gekko just shakes his head.  Why would people assume that?  Why would anyone expect Gekko, a businessperson, to pass his savings on to the consumer (unless doing so results in a clear-cut competitive advantage)?  Businesses are supposed to make as much profit as they can. That's how it works. To do anything else would be unfair to FTP's shareholders, and fatal to Gekko's career.

With all the promises from Gekkonians in the mid-1990s about how their HMOs would save money for the healthcare system, this last point deserves some emphasis.  Despite the aggressive cost-cutting measures taken by HMOs (which now enroll over 80% of insured Americans), the health insurance premiums paid by employers haven't fallen.  In fact, except for a few years during the mid-1990s when the inflation rate for insurance premiums dropped to below 5%, premiums are still increasing by double digit amounts in most years. But with the drastic cuts in services being made by HMOs and the resultant lowered costs, shouldn't we have seen at least a rather sizeable one-time savings in healthcare spending?  Where did it go?

Gekko has already answered our question.  The dollars that HMOs squeeze out of the system are not returned to the payer in the form of reduced premiums; nor are they plowed back into the healthcare system in the form of improved or widened services; rather, they are invested for maximum returns, which are then pocketed by the HMOs in the form of administrative costs, bonuses for top executives, and profit for the shareholders.  

Typical HMOs end up spending around 85% of their collected premiums on actual healthcare, a proportion shareholders and analysts refer to as the "medical loss ratio."  That "medical loss" had better not climb. In 2002, when Aetna was found to be spending as much as 90.5% of its money delivering healthcare, the Wall Street analysts and shareholders went ballistic, and inside of Aetna heads rolled. Keeping premium dollars out of the actual medical arena is critically important for HMOs.   

Growing FTP: acquiring community assets.

Growth is required in order to maximize the inflow of cash. Gekko decides that the fastest way to grow FTP is to acquire major healthcare facilities (hospitals and nursing homes) in all its key cities of operation, and he begins doing so.  Along the way, Gekko stumbles upon a gold mine.  It is a gold mine not directly related to FTP's scope of business, but it's close enough, and the shareholders love it.  

The first time Gekko acquires a community hospital for FTP, he notices that within a week of the transaction the price of FTP's stock rises by 5%.  What he has just done, he realizes, is to cash in on a publicly-owned asset. So Gekko tries it again, and this time the stock rises by 7%.  Gekko's head spins.  This scheme threatens to become such a windfall that Gekko momentarily worries that it might overwhelm the presumed actual business of FTP. The payoff promises to be so astounding, however, that he decides not to worry about it.

Gekko is right.  It's a great scam, and completely legal to boot.  

Non-profit hospitals existed in the first place because their communities decided they were needed for the public good.   Accordingly, these hospitals were established under the nonprofit laws, which required them to function primarily under a charitable philosophy.  Over the decades and in return for their service to the community, these hospitals operated under the public largesse, in the form of their blanket tax-free status, their ability to raise tax-free bonds, and their ability to raise tax-free charitable contributions. Their boards of trustees, made up of prominent members of the community, were charged with guarding the accumulated public value represented by those institutions.

The widespread transfer of not-for-profit public assets (such as a community hospital) to for-profit corporations (such as an HMO) was perhaps the major unnoticed healthcare story of the 1990s. It was fueled by the Gekkonian notion that for-profits are inherently more efficient in providing healthcare than mere charities. Such transfers only occurred at the urging of the community hospital's board of trustees, and had to be overseen, depending on local regulations, by either the state insurance commissioner or the state Attorney General.  That state official, if he or she approved the conversion, was expected to assign a formal dollar value to the hospital.  The HMO then had to reimburse the community for that amount, usually by establishing a charitable foundation.

It is a procedure that might be acceptable in theory.  In practice, however, all too often the hospital's board of trustees permitted, or even encouraged, a low valuation for their hospital.  Also, state insurance commissioners seemed congenitally unable to establish an accurate value for non-profit hospitals. In doing those valuations, for instance, they considered only tangible property values.  They ignored (and neither the hospital's board nor the HMO insisted on pointing out to them) the value of many of the assets owned by the hospital such as trademarks, reputation, name recognition, provider contracts and subscriber lists.  The commissioners didn't insist on going through a competitive bidding process or conducting a formal market valuation. In fact, only the hospital's value as a charity, and not as a business, was considered.  And for some reason insurance commissioners often also seemed quite happy to do the negotiations behind closed doors, and with no public disclosure.  

Within a year Gekko has established a routine for acquiring community hospitals, and it works like this.  First, the hospital's board of directors see fit (when necessary, induced by stock options or offers of directorships within FTP) to severely under-represent the value of their institution to the insurance commissioner.  The insurance commissioner then approves the transfer to FTP at a low valuation rate. Then, after the hospital becomes a hard asset of FTP, its true value is established by the open market as reflected in the price of FTP's stock.  Almost invariably, that value is orders of magnitude greater than the value set by the insurance commissioner.  So, without doing a thing to improve the quality of care or to reduce the cost of care, FTP's market value soars - and all at the expense of the public.  

It's a win-win.  During Gekko's first 2 years at the helm of FTP, not only does the company's stock go through the roof, but also Gekko acquires key medical facilities in all his cities of operation (which he's now expanded to 15). He finds he is able to begin significantly influencing the healthcare markets in most of those cities, and consequently controlling the behavior of even the most recalcitrant of physicians and benefits officers (who suddenly find they have to deal with FTP whether they want to or not).  The health insurance premiums, always optimally priced, are pouring in to FTP at a 25% annual rate of growth.