Question: Describe the significant economic, social and medical developments that have been driving Blue Shield members' increasing utilization in the recent past.  For each of these developments, explain why it should reasonably be expected to continue in the future and at what level.

Blue Shield does not have information on the specific economic and social circumstances of our members, and therefore, we have no way of connecting our specific medical utilization trends to the economic and social circumstances of our membership.  We forecast our trends based on our actual claims experience and expected/contracted unit cost increases.  However, there has been extensive research and writing about how such factors are influencing health care trends and some of our own data supports this research.  Few of these factors show signs of abating, and thus, no reason exists for us to expect that the utilization trend reflected in our claims experience will decline in the near future.

Medical Technology

By far, the biggest contributor to utilization increases is advancing medical technology.  According to a synthesis of research on health care cost drivers published in 2008 by the Robert Wood Johnson Foundation, "medical technology is the driving force behind the growth in U.S. health care spending."¹   Developments in medical technology include the introduction of new drugs, medical devices, surgical procedures, and diagnostic tests, as well as changes to existing ones.  The report notes that studies estimate that medical technology accounts for between 38 percent and 65 percent of annual increases in U.S. spending growth. Advancing technology drives higher spending because it results in utilization of previously unavailable services and substitution of lower-cost services for higher-cost ones.

The effect of new medical technologies on utilization trend is especially acute in the United States because few screens are applied to new drugs and treatments based on their effectiveness.  In our current environment, medical devices and pharmaceuticals get approved if they pass clinical trials demonstrating they are more effective than placebos.  There is no requirement that they be proven more effective than existing therapies.  In short, there is no systemic process to compare the effectiveness or value of a new treatment vs. existing treatment options.²

As a result, expensive new technologies with uncertain benefits to patients are often put into widespread use. Some examples:

• High-tech diagnostic imaging services. The use of MRIs, CT scans, and PET scans in emergency rooms increased fivefold among adults under 65 years of age between 1996 and 2007, according to a report last year by the Centers for Disease Control (CDC).³ The use of such imaging more than tripled in doctors' offices and outpatient clinics among this population during this period.  While these scans offer much clearer pictures of the body than earlier imaging technology, the overall benefit to patients from their use is not well established.  The CDC report observes that recent studies on advanced imaging technology "have raised concerns that some imaging may be unnecessary."⁴ In reaction to the report, Dr. Rita Redberg, who is editor of the Archives of Internal Medicine, told the Associated Press that "studies have not yet clearly demonstrated that the scans are lowering death rates."⁵
• Surgery to treat stenosis in the lower back. In a study published last year in the Journal of the American Medical Association, researchers documented a 15-fold increase from 2002 to 2007 in complex fusion surgeries to treat the condition.  More than half of the patients receiving the surgery had simple stenosis, which experts say is more appropriately treated with decompression, a much simpler, less costly, and less risky procedure.⁶

  From 2008 to 2009, Blue Shield experienced a 32% increase in the number of covered spinal fusion surgeries among its commercial membership, as well as a 9% increase in all spinal surgeries.

• Angioplasty and coronary stenting.  Angioplasty, a surgical procedure to improve blood flow and reduce blockage in patients with coronary artery disease, was first introduced about 30 years ago.  Since then two major modifications on the procedure have been developed.  Stents, which are used to expand the artery and prevent the reoccurrence of plaque development, were first introduced in the 1980s.  Drug-eluting stents, which release medication to reduce the risk of clotting, were approved for use in 2003.  Immediately after their introduction, the use of drug-eluting stents soared.  The CDC reports that in 2002 bare stents were used in 82% of angioplasties performed (with no stent used in the remainder).  In 2004, the year after their approval, drug-eluting stents were used in 69% of angioplasties, and by 2006, that number had climbed to 77%.⁷

  Although initial studies indicated drug-eluting stents were more effective than bare stents at preventing plaque redevelopment, which undoubtedly helped fuel the widespread adoption, more recent studies have raised safety concerns.  As the CDC report observes: "More recent studies, after the diffusion of drug-eluting stents, suggest that patients receiving drug-eluting stents may be at risk for developing thrombosis, often up to a year after their anagioplasty.  As more data are obtained, evidence suggests that drug-eluting stents may be best targeted at certain population subgroups with coronary artery disease, such as older patients and those with diabetes."⁸

Of course, a great many advances in medical technology produce treatments do provide clear benefits to patients-and these, too, drive increased utilization.  Hip and knee replacements are a prime example. With advances in how these procedures are performed, such as minimally invasive surgical methods and the use of computer assisted surgery, they have become more and more popular.  From 1996 to 2006, rates for total hip replacements increased by one-third, partial hip replacements by 60% and total knee replacements by 70% among adults 45 years of age and older, according to the CDC.  An analysis cited by the agency estimates that by 2030 the demand for total hip replacements will grow by about 175% and the demand for total knee replacements will grow sixfold.⁹ Our own claims experience shows an increase from 2008 to 2009 among our commercial membership of 14.5% for knee replacement surgeries and 8.4% for hip replacement surgeries.

Population Health

Increasing rates of chronic disease among Americans are another major factor keeping utilization rates high.  The Robert Wood Johnson Foundation's synthesis of research on health care costs concludes that obesity alone is responsible for 12% of annual health care spending increases in the U.S.¹⁰ The following are figures from the CDC on the prevalence of obesity and diabetes, both of which lead to sharply higher rates of utilization.

• Diabetes prevalence among adults 20 years of age and older was 11% in 2005-2008, up from 8% in 1988-1994.¹¹
• In 2007-2008, almost one in five children older than 5 was obese.¹²
• In 2007-2008, about one-third of adults were obese and about two-thirds were overweight or obese.¹³

Since obesity is a major factor in determining individuals' future rates of healthcare utilization, we expect that recent increases in obesity rates among the population will continue to drive increased utilization even if obesity rates level off.

End of Life Care

Despite repeated studies demonstrating that Americans incur huge and often unnecessary costs in the last 6 months of life (often linked to the number of specialists that practice medicine in a given geography), any attempt to talk about rational changes in end-of-life care is met with enormous cultural and political resistance.  For example, consider the intense opposition and charges about "death panels" that broke out over a provision of the health reform bill that would have provided reimbursement to healthcare providers for advising Medicare patients on advanced care directives.  Despite the fact that more than 80% of patients with long, progressive illnesses say they want to live out their last days in a home or hospice environment, most end up dying in hospitals surrounded by doctors trying to extend their lives often using highly invasive (and expensive) measures. 

Between 1994 and 2004, the rates at which intensive care units were used among Medicare beneficiaries increased by 16%, according to the CDC.¹⁴ The Dartmouth Atlas Group reports that 39% of Medicare decedents received care in ICUs or coronary care units in the last six months of life.  The percentage of Medicare decedents admitted to an ICU/CCU in the last six months of life varied widely, from 23% in Vermont and North Dakota to 49% in New Jersey and Florida. The figure for California was 45%.¹⁵

In an effort to provide seriously ill patients with care that better fits their preferences and manages costs more wisely, Blue Shield offers a patient centered management program.  Focusing on patients with clinically advanced illness and multiple co-morbid disease states, the program provides patients with intensive case management support that includes help not only with care coordination, but also assistance with issues such as terminal care planning.  As documented in the attached journal article analyzing the program, it has succeeded in reducing hospital admissions by 38%, hospital days by 36% and ED visits by 30%, while dramatically increasing home care by 22% and hospice use by 62%. (See attachment 1.)

Q: On account of its substantial share of the California health-care market, Blue Shield has considerable leverage over the hospitals with which it contracts.  Provide an exhibit showing by region and expense category the changes in contractual price from 2010 to 2011.  Also explain what actions Blue Shield has taken in the interest of policyholders to ensure the lowest negotiated prices.  

and

Q: On account of its substantial share of the California health-care market, Blue Shield has considerable leverage over the outpatient facilities with which it contracts.  Provide an exhibit showing by region and expense category the changes in contractual price from 2010 to 2011. Also explain what actions Blue Shield has taken in the interest of policyholders to ensure the lowest negotiated prices.

Given the extreme price sensitivity of health insurance purchasers and the more-than-50% of Blue Shield's total medical spending that goes to pay for inpatient and outpatient hospital care, negotiating the lowest prices possible is a huge priority for us. When we compete for a large employer or public sector customer, it's not unusual for the business to be won or lost over a difference of just one or two percent in the premium, which means that even small increases in our hospital rates can have major impacts on our competitiveness.  As a result, we fight to shave every percentage we can off the increases hospitals seek from us. 

The schedules in the "Provider Increase" Excel document show by region the changes in our contractual prices from 2010 to 2011 for inpatient and outpatient hospital care.   We have provided the increases at the rating region level.  Expense category breakdowns are not readily available for projected trends.  However, we have provided a retrospective breakout of utilization and unit cost trends for 2009/2008 (please note that the trends shown here will differ from those shown in Exhibit IV in the Exhibit Response Excel document of the filing since these trends are net trends and include the impact of benefit mix, line of business mix, duration, and demographics).  You state in your question that Blue Shield has a "substantial share" of the California market and that this gives us "considerable leverage" in contract negotiations with hospitals.  In fact, Blue Shield's total membership is only approximately 15% of the commercially insured population of California.¹⁶ Moreover, our market share is constrained by:

1. Regulatory hurdles that make it difficult for Blue Shield to "walk away", i.e., terminate a hospital and redirect members to an alternative facility and
2. Cost pressures on hospitals that lead many to believe that they would be better off financially dropping out of our network instead of accepting lower reimbursement. 

Blue Shield's ability to "walk away"

When Blue Shield reaches mutually agreeable terms, we sign one contract with a hospital for all of our membership whether it is regulated under the DOI or the DMHC.  The vast majority of our membership is the the DMHC. In order to terminate a hospital and redirect DMHC members to an alternative facility, Blue Shield must receive approval from the Department of Managed Health Care for a block transfer.  Without such an approval, Blue Shield can terminate the contract but must continue to allow members access to the terminated facility and pay full billed charges to that facility, which is typically 2-3 times more than what we would otherwise pay under a contract.   In such a scenario, Blue Shield "walking away" from negotiations causes our customers to pay much more and the hospital to receive significantly more than they would under a signed contract.   Given the negotiating leverage this provides hospitals, many have focused on trying to extend and disrupt the process of Blue Shield gaining an approval from DMHC.  Some have hired outside consultants to explicitly do this on their behalf and we have even experienced unaffiliated hospitals supporting one another in these efforts, e.g., we receive an early termination notice from a hospital that was meant to be an alternative location in our block transfer plan but now cannot serve as an alternative.  Partly as a result of these efforts, it has become much more difficult for Blue Shield to receive timely approvals for block transfers, leaving us too often with the unpleasant imperative of signing a contract with reimbursement that is higher than we would like it to be but is ultimately far less expensive than the alternative of paying full billed charges.

This situation is compounded, when there are no alternative facilities nearby and/or hospitals negotiate in blocks or as a system, often including physicians as well.   Under either of these conditions, developing and gaining approval for a  block transfer can be an enormously difficult and even pointless undertaking.  While some provider systems do in fact operate as systems by integrating and coordinating care, others are looking to negotiate as systems purely for the leverage this creates under these rules. As a result, we are not able to contract with specific hospitals in a large hospital system that provide good value in a specific region while leaving out that system's hospitals in other regions that don't provide better value and for which good alternative hospitals are readily available.  This problem could get worse if providers use the new rules under health reform to form Accountable Care Organizations not to drive improved cost and quality but rather to leverage the system to reimburse them at a higher rate.  This is why the FTC and CMS (as well as Blue Shield and most health plans nationally) have been so concerned about the rules around ACOs and whether and under what conditions "safe harbors" will be granted.  If there is one place state and federal regulators could focus to help the unit cost issue it is to prevent the development of new so-called systems or ACOs whose main purpose is to extract high increases in reimbursement.

Hospital's financial self interest

Ultimately, most organizations make choices and act consistently with their own self interest.  Over the past decade, hospitals have been facing tremendous revenue and cost pressures.  Refer to the Trend Developments.zip for power point slides show that California hospitals lose substantial amounts of money on the uninsured, Medicaid, and Medicare beneficiaries and make up those losses with huge profits on commercially insured members. (See attachment 2.) Overall, their profits are modest at a bit less than 4%, but the disparity in profits earned from different payors is enormous.  The slides also demonstrate that this problem has deteriorated dramatically in the past decade, particularly in Medicare.  Hospitals cannot "negotiate" reimbursement with Medicaid and Medicare and can only receive from the uninsured what they are able to afford.  Therefore, as their reimbursement from these sources drop and their costs as a result of seismic retrofitting and nurse staffing ratios increase, they have one place to go to improve their revenue: health plans.  Consequently, in the past decade it has been far more common for hospitals to demand large increases in reimbursement and be willing to be terminated from Blue Shield's network if they don't get it because they need that level of payment to remain financially viable.  No health plan, Blue Shield included, can terminate the entire hospital network and therefore we have had to focus our energy on the negotiations that are the most egregious.  This "cost shift" or "hidden tax," which has developed largely over the past decade, is enormous.  If hospitals received the exact same reimbursement in aggregate that they do today, and therefore, earned the same aggregate 3.8% profit but received equal payments from the uninsured, Medicaid, Medicare, and commercial insurers, commercial health insurance premiums could drop by $10 billion.  As state and federal governments look to address their fiscal challenges by reducing Medicaid and Medicare reimbursement further (note that Governor Brown's most recent budget calls for a significant reduction in MediCal reimbursement), it will only make this cost-shift to the private sector worse.

Even with these constraints, Blue Shield has been more aggressive than any health plan in pushing back on hospitals demands.  For example, in 2010, we were more aggressive than any other health plan in California in threatening hospital contract terminations and in actually terminating contracts.  As reported by the Department of Managed Care, Blue Shield took action more frequently last year than any other California health plan to initiate the filing of block transfer plans and in following through to completion of a plan, which indicates termination of a hospital. (See attachment 3.)  While these data relate to care provided to HMO members, we contract with hospitals for HMO and PPO members jointly so the figures provide a good indication of how aggressive we've been in negotiating with hospitals on behalf of our members in products regulated by the Department of Insurance. 

Given all of information provided above, it should be also be clear why it is inappropriate to use information such as the annual increase in national health expenditures as a benchmark for commercial health insurance increases in California.  Since it involves averaging the cost of Medicare, Medicaid, the uninsured, and commercially insured individuals, national health expenditure data mask the dramatic cross-subsidies in the system and ignore the specific dynamics in an individual state, such as laws that require hospitals to meet seismic retrofitting and nurse staffing ratio standards.  For example, if national per capita health care spending were to increase by 5% in 2010, that fact would offer no indication of how much a California health plan's costs might be increasing in 2010, and would therefore be an inappropriate benchmark to use in reviewing rate increases. 

Q:  You have stated that your estimates of price inflation trend are mainly based on Blue Shield's own historical experience.  Describe the significant economic, social and medical developments that have been driving Blue Shield's in-patient price inflation in the recent past.  For each of these developments, explain at what level it should reasonably be expected to continue in the future, and why.

and

Q:  You have stated that your estimates of price inflation trend are mainly based on Blue Shield's own historical experience.  Describe the significant economic, social and medical developments that have been driving Blue Shield's outpatient price inflation in the recent past.  For each of these developments, explain why it should reasonably be expected to continue in future, and at what level.

Blue Shield typically enters into multi-year, legally binding contracts with hospitals for inpatient and outpatient services.  These contracts include specified levels of reimbursement for those services for each year of the contract.  As a result, unit cost increases for 70% of the hospitals in our network had already been established for 2011 at the time of our rate filing. 

With respect to reimbursement rates not yet established, we always strive to negotiate the best possible rates.  However, our ability to successfully push back against the increases hospitals seek is constrained by several significant factors.  Below is a discussion of these factors, including our assessment of the role each is likely to play in the future.

Hospital market power.  Over the last decade, hospitals in California have significantly increased their leverage in negotiations with health insurers.  A study published last year by the Center for Studying Health System indentified "three factors in California that are driving the shift of negotiating power from private insurers to hospitals and physicians:

• consumer demand for broader provider networks following the managed care backlash;
• consolidation of hospitals into larger, powerful systems and tighter alignment with physicians; and
• growing hospital and physician capacity constraints.¹⁷

The consolidation of hospitals into larger systems, and the way in which those systems negotiate with health plans, has been especially detrimental to our ability to restrain hospital price increases.  The study offers a good description of what we face in the marketplace for hospital services as a result of this development:

Sutter Health and Catholic Healthcare West have been especially active in acquiring other California hospitals. Sacramento-based Sutter Health has two dozen northern California medical centers and hospitals, some with multiple locations.  Catholic Healthcare West has thirty-three acute care hospitals throughout the state.

Negotiating as a system across a broad geographic area avoids antitrust scrutiny, which focuses on local market concentration. At the same time, this strategy permits hospital systems with strong bargaining positions in some markets to negotiate high rates elsewhere as well. Some respondents described particular hospital systems, such as Sutter, as adopting an "all or none" negotiating strategy, which means that a single contract defines the terms. The terms include all payment rates of all of the system's hospitals, not just those hospitals that plans deem important to include in networks.

Analysis by Blue Shield of data from the Office of Statewide Health Planning (OSHPD) offers further evidence of the effect of hospital market power on rates. (See attachment 4). The analysis compares the relationship between hospital operating margins and their local market shares. Not surprisingly, we found a strong correlation between the two. Of the 24 California hospitals with the largest shares of total privately insured patient discharges in their county of operation, 15 had operating margins above the average for California hospitals for the 4 quarters ending September 30, 2010. 

Unfortunately, we see nothing on the horizon that leads us to believe that hospitals will see any diminution of their market power in California in the near future.  Indeed, hospitals could see an increase in their market power as a result of the Accountable Care Organization provisions of federal health reform, which encourage them to combine operations with medical groups.  While we strongly support improving care coordination and have ourselves partnered with hospitals and medical groups to accomplish that goal, we believe the trend toward Accountable Care Organizations will result in increased bargaining leverage for providers unless steps are taken by policymakers to avoid that consequence.

DMHC Block Transfer Process

As discussed previously, our leverage in negotiations with hospitals is significantly undercut by the process we must undergo to get the necessary approval from the DMHC before we can terminate a hospital.  As long as this regulatory regime remains unchanged, and we see no signs of any move for reform in the Legislature, it will continue to limit our ability to restrain hospital price increases.

Cost shifting

As the slides on hospital costs referenced above indicate, hospitals in Blue Shield's network are losing large amounts of money treating patients covered by government programs and making up those losses with big profits earned off of their privately insured patients.  For the 4 quarters ending on June 30, 2010, hospitals in our network had negative margins of 31% and 20% on their Medi-Cal and Medicare business, respectively, but made a profit of 34% treating privately insured patients.  Unfortunately, this dynamic is likely to grow worse in the years ahead as a result of the following factors:

• Budget pressures at the state and federal level that will likely constrain spending on Medi-Cal and result in reimbursements to hospitals that do not keep pace with increases in their costs.
• Major expansion of Medi-Cal eligibility under federal healthcare reform, which means hospitals will see a big influx of new, but money-losing, patients.
• Reductions in future increases in hospital reimbursement levels under Medicare, as provided under the federal health reform law.  

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¹Robert Wood Johnson Foundation Policy Brief "High and rising health care costs: Demystifying U.S. health care spending"  October, 2008  http://www.rwjf.org/files/research/101508.policysynthesis.costdrivers.brief.pdf

²The Institute of Medicine's Roundtable on Value and Science-Driven Health Care, on whose board of directors Blue Shield CEO Bruce Bodaken serves, is a leader in the movement to incorporate comparative effectiveness analysis into medical practice.

³Centers for Disease Control  Health, United States, 2009  p. 68 http://www.cdc.gov/nchs/data/hus/hus09.pdf

⁴Ibid

⁵Boston Globe "Use of MRI, CAT scans rising in hospital emergency rooms" February 18, 2010  http://www.boston.com/news/nation/articles/2010/02/18/use_of_mri_cat_scans_rising_in_hospital_emergency_rooms/

⁶USA Today "Study: Riskier surgeries for back pain raise costs" April 6, 2010 http://www.usatoday.com/money/industries/health/2010-04-06-back-surgery-costs_N.htm

⁷Centers for Disease Control  Health, United States, 2009  p. 78 http://www.cdc.gov/nchs/data/hus/hus09.pdf  

⁸Ibid

⁹Centers for Disease Control  Health, United States, 2009  p. 76 http://www.cdc.gov/nchs/data/hus/hus09.pdf 

¹⁰Robert Wood Johnson Foundation Policy Brief "High and rising health care costs: Demystifying U.S. health care spending"  http://www.rwjf.org/files/research/101508.policysynthesis.costdrivers.brief.pdf

¹¹Centers for Disease Control  Health, United States, 2010  p. 14 http://www.cdc.gov/nchs/data/hus/hus10.pdf

¹²Centers for Disease Control  Health, United States, 2010  p. 22 

¹³Centers for Disease Control  Health, United States, 2010  p. 23 

¹⁴Centers for Disease Control  Health, United States, 2009 p.84

¹⁵Ibid

¹⁶It is worth noting that under the Horizontal Merger Guidelines issued by the U.S. Department of Justice and the Federal Trade Commission in 1992 (see Section 2.22) as well as the Statements of Antitrust Enforcement Policy in Health Care issued by the U.S. Department of Justice and the Federal Trade Commission in 1996 (see e.g., Statement No. 8) that market shares below 30-35% do not raise competitive concerns absent extraordinary circumstances.

¹⁷Center for Studying Health System Change press release "Growing California Hospital-Physician Market Power Foreshadows Challenges to National Health Reform"  February 25, 2010 http://www.hschange.com/CONTENT/1118/