A HEALTHY MERGER?

By Jill Smolowe

CONSUMERS AND INVESTORS OFTEN get nervous stomachs when they hear talk of synergy, that snaggle-toothed harbinger of bad mergers. So Aetna Life & Casualty Co. chairman Ronald Compton was administering verbal sedatives last week when he talked about the proposed merger between Aetna and U.S. Healthcare Inc. that will create the country's largest medical-benefits corporation. "The two companies are in fact complementary," said Compton. "They are yin and yang."

Feel better now? If the deal is approved by stockholders, as expected, the combined entity, to be known as Aetna Inc., will provide health care for 23 million people, or 1 in every 12 Americans. The $8.9 billion merger, which mirrors a recent batch of smaller consolidations in the managed-care field, is a clear signal that big medicine is here to stay, whether you like its bedside manner or not. "The main effect of the huge merger is that it will be replicated by insurers across the country," says Kenneth Abramowitz, a health-care analyst for Sanford C. Bernstein in New York City.

The pressure to get big--and to use that leverage against other competitors, doctors and hospitals--is spreading like a virus through the entire industry. "These giant health-care mergers are happily galloping toward an oligopoly," says Sara Nichols, Washington director of the nonprofit Physicians for a National Health Care Program. Wall Street analysts foresee a day in the not-too-distant future when the whole country's health-care needs will be largely served by a handful of providers.

What this contraction of services will mean for consumers produces a yin-yang split in perception. Optimists predict that the half-dozen or so remaining big players, with their enlarged networks, will have the clout to force doctors and hospitals to hold down medical costs, which will stabilize premiums for individual and corporate customers. "We're the only mature industrial society on the face of the earth that doesn't like big," says Compton. "Which would you rather have? [A few] real efficient giants competing with one another, or 30 or 40 companies that don't have that scale?"

Skeptics wonder how consumers can benefit from fewer choices, be it in airlines or medicine. They also voice concern that patient care will collide with the profit motive and get the worst of it. Under a system known as capitation, which pays HMO providers a set monthly fee for each enrolled patient, doctors are offered a financial incentive to limit both the number of patients they see and the types of services they provide. Says James Tallon, president of the United Hospital Fund, a philanthropic and health-services research organization in New York City: "In the old system, sick people were what drove the money in. In the new system, sick people are what drive profits out, and that's the challenge."

As a result, say critics, patients will have to dip into their pockets to obtain the services they really need--or go without proper care. "You are going to see lower utilization of high-cost procedures, fewer lab tests, less radiology activity and a very noticeable drop in mental and behavioral health," says Elliot Pollack, an attorney with Pullman & Comley, a Connecticut firm that represents health-care providers such as Bridgeport Hospital. "Managed care has too much market power."

The proposed Aetna Inc. will undoubtedly play a leading role in determining which perception prevails. For staid and paternalistic Aetna, a longstanding leader in traditional indemnity plans (you pick the doctors; they pick up the bills), the consolidation catapults the 143-year-old company smack into the center of the brave new world of managed care, where consumers must choose from a company-approved network of doctors, who agree to fixed charges for most services. Or consumers can join health-maintenance organizations, which directly employ doctors and nurses. "We are going into the managed-care business because that's what people want," says Compton. "A recent study said 71% of all American employees are now covered by one form of managed care or another."

Actually, Aetna is already well entrenched in managed care, serving 7.5 million of its 11.3 million clients through such operations. But U.S. Healthcare has proved far more aggressive and agile in establishing footholds and driving down managed-care costs, through a combination of shrewd salesmanship, sophisticated computer tracking and tough bargaining. Last year, while Aetna earned $474 million on $13 billion in revenues, a net profit of 3.64%, U.S. Healthcare's profitability was far greater. With just 2.8 million clients, it racked up $380 million in earnings on $3.6 billion in revenues, or a 10.55% net profit.

U.S. Healthcare has been rewriting the economics of the industry. "The entrance of U.S. Healthcare into virtually any market led to increased cost controls in that market and to real intense competition," says Jonathan Weiner, a professor at the Johns Hopkins School of Public Health in Baltimore, Maryland. "In many ways, even those not enrolled in U.S. Healthcare benefited in some degree." For the company, which has been an East Coast powerhouse among health-maintenance organizations, the merger offers ready access to all 50 states.

U.S. Healthcare's operating style has paid off big for management. As Weiner notes, "A lot of people, particularly physicians, have criticized the many millions of dollars of profits ceos of U.S. Healthcare and other for-profit managed-health-care companies have made." Leonard Abramson, the founder of U.S. Healthcare, whom Compton hails as a "visionary genius," stands to pocket some $920 million in cash and stock from the merger--not bad for a guy who drove a cab to put himself through pharmacy school. Last week Abramson boasted, "We intend to set the standard against which all health-care companies will be measured."

That sounds more like a threat than a promise to critics who think U.S. Healthcare has earned higher marks as a penny pincher than as an efficient health-care crusader. U.S. Healthcare spends about 75 cents of every dollar in premiums on medical care, compared with the 81 cents averaged by managed-care plans in general and the 85 cents spent by Aetna specifically. That means that 14.5 cents of every U.S. Healthcare dollar goes to administration and 10.5 cents goes to profit--an interesting contrast with the 2 cents of every Medicare dollar that goes to administrative costs. A study of U.S. Healthcare and 11 other commercial HMOs by the office of the New York public advocate concluded, "The higher percentage spent on administration was contrary to the expectation that the industry's dramatic member growth should produce greater economies of scale."

The study, released in January, covered New York State, one of the biggest markets for each company. It found that HMOs place "unreasonable restrictions on access to needed services." One common requirement, for example, is that members contact their HMO before seeking admission to an emergency room. The report cited five instances in which a pregnant woman arrived at a hospital via ambulance after her water broke, only to be denied coverage by U.S. Healthcare for failing to phone in for precertification.

U.S. Healthcare also came under fire a month earlier, when David Himmelstein, a network physician, charged that he had been fired after he appeared on the Phil Donahue show and criticized HMO financial incentives for denying care. "They've got a gag clause," Himmelstein said at the time. "If you say anything bad about them, they can fire you." The company denies that a clause exists for such a purpose, and Himmelstein was subsequently reinstated. But he remains unbowed. "Lip service is paid to quality," he says, "but the real interest is in cost."

Aetna seems unconcerned that its stately reputation could be tarnished by U.S. Healthcare's scruffier profile. "We're bigger, therefore we're somewhat more bureaucratic," says Compton. "They're smaller geographically as well as in personnel size, which makes them a little quicker. I'd like to be a little quicker." U.S. Healthcare officials will see that he is. Compton will be chairman of the merged entity, but two U.S. Healthcare executives will run the managed-care business, and Abramson will sit on the Aetna board. Compton maintains that the arrangement leaves room for both companies to play to their respective strengths.

Compton is right when he says bigness isn't necessarily bad. Aetna's merger with U.S. Healthcare is recognition that the monstrously expensive old system is receding. Big-medicine corporations may be the answer in the long term. Or, as some have suggested, doctors and hospitals may yet form their own organizations to sell services directly to consumers, without middlemen like Aetna and U.S. Healthcare. In the meantime, patients will have to try to live with what they've got.

--Reported by Stacy Perman and Jane Van Tassel/New York

With reporting by STACY PERMAN AND JANE VAN TASSEL/NEW YORK