On December 31, 1991, then-Gov. William Weld signed into law Chapter 495 of the Acts of 1991, An Act to Improve Health Care Access and Financing. This law–which was supported by most of the major players in health care, public and private–abolished the hospital rate setting system that had been in place in Massachusetts, in one form or another, since 1975. Its passage was part of a growing movement here and across the country to embrace market forces as the way to control health care spending. This push was based on the largely untested theory that competition among hospitals (and other providers) for contracts from health insurers, and among health insurers for members, would be a more effective means of holding down health care costs than government regulation.

The unanimity behind this radical change of course could not be chalked up to the manifest failure of regulation. In fact, most studies found that states like Massachusetts that had aggressive forms of hospital rate setting had lower rates of increase in hospital costs than states with unregulated systems. Yet there was widespread and growing dissatisfaction with hospital rate setting in Massachusetts, which was complex, arcane, and largely incomprehensible to all but a few insiders–not to mention slowly losing its grip on a changing health insurance system.

Health maintenance organizations, which gained members steadily throughout the 1980s, were exempt from the rate setting system, and were able to negotiate lower rates of payment with hospitals than Blue Cross Blue Shield or commercial insurers. As a result, HMOs could offer lower premium rates to employers. Blue Cross was still the largest health insurer in the state, but its increasingly precarious financial condition at the time gave credence to the company’s longstanding call to level the competitive playing field.

Other payers were hurting, as well. Medicaid, one of the state’s certified “budget busters,” was eager to negotiate its own rates of payment with hospitals and move more Medicaid beneficiaries into managed care programs. Employers were experiencing double-digit rates of increase in their health insurance premiums, making them eager for a new approach to cost containment. Even in the hospital industry, cracks had appeared in support for continued regulation, as more and more individual institutions came to believe they could be winners in a hospital market with significant excess capacity.

Support for hospital rate deregulation was not unanimous, however. Consumer groups, organized labor, some academics, a few business groups, and a handful of legislators feared that health care competition would lead to higher health care costs, more people without health insurance, and grave financial threats to essential providers, particularly community hospitals. But these reservations could not stand up to the giddy prospect of pitting rival institutions and health insurers against one another. As Edward Burke, then the Senate chair of the Legislature’s Health Care Committee, put it: “I favor putting the scorpions in the same bottle and letting them fight it out.”

The 10th anniversary of Chapter 495 is an appropriate time to reflect on how this Darwinian approach to health care financing has turned out. Has the state’s match with the market worked? Has the unleashing of competitive forces constrained costs and created a more rational health care system? Or has this infatuation been a disastrous fling?

It turns out that, like most relationships, this one has had its ups and downs. But 10 years of competition have not changed many of the least attractive features of the state’s health care system. Massachusetts still has the highest health care costs in the country and among the highest health insurance premiums. At the same time, the state’s romance with the market has hardly been a harmless dalliance. Many parts of the state’s health care system, in particular many community hospitals, are financially unstable and showing signs of strain. And now, the Commonwealth is faced with the re-emergence of many of the same forces–rising health care costs, recession, and growing state budget deficits‹that prompted the state to begin its affair with the market in the first place.

The more things change…

First, to give competition its due. The invisible hand of the market has been able to reduce excess hospital capacity in Massachusetts in a way that was largely impossible during the prior 20 years of state health planning and regulation. Managed care plans and tighter Medicare payment policies have cut the use of inpatient hospital services by more than a third, and the number of hospitals and hospital beds in the Commonwealth has plummeted. Since 1991, one in four acute care hospitals has closed or converted to an alternative use, such as long-term care. The number of inpatient hospital beds has fallen by more than a third. Once well above the national average, Massachusetts now has lower rates of inpatient hospital use and less hospital capacity than the national average.

That the market would be more effective than government in shrinking a bloated hospital system should come as no surprise. Policy-makers, particularly legislators, have an understandably difficult time choosing between “worthy” and “unworthy” hospitals. The market can be much more apolitical in its decisions about winners and losers in the Massachusetts health system, though politics still plays a role. Witness the struggle over which community hospitals were to be given permission to perform cardiac surgery, the agonizing over the fate of financially troubled Harvard Pilgrim Health Care, and the state-enabled acquisition of Whidden Memorial Hospital by Cambridge Health Alliance.

Competition may have wrung excess capacity out of the hospital industry, but it’s still not clear that what’s left is all that lean. Proponents of deregulation believed that market-based competition would shift care to lower-cost community hospitals, but instead the elite (and expensive) teaching hospitals, which have always played a bigger role in Massachusetts than elsewhere, have solidified their dominance. Over the decade of deregulation, the proportion of hospital care provided in more costly teaching hospitals has increased, from 41 percent of discharges and 41 percent of hospital days in 1990 to 46 percent of discharges and 47 percent of days in 2000. Similarly, the health care marketplace has done nothing to shift care from hospital outpatient departments to less costly community settings. Massachusetts continues to use outpatient hospital care at a rate that is 30 percent higher than in the US as a whole, no different than 1990.

On an institutional level, the clearest product of competition has been consolidation. Hospitals have merged, partnered, and affiliated at a dizzying pace, both with one another and with other types of providers to form full-service health care conglomerates. The bellwether event on this front was the merger of Brigham and Women’s Hospital and Massachusetts General Hospital, announced in December 1993, to form the Partners HealthCare System. This was a pre-emptive strike against other Boston hospitals, merging two of the strongest institutions in the state in terms of resources and reputation. Partners has subsequently added four community hospitals and a strategic partnership with Dana Farber, not to mention a network of nearly 2,000 primary care physicians and 3,500 specialists. The power of the Partners brand was made clear last year in its ability to extract significant payment increases, first from Tufts Health Plan and then from Harvard Pilgrim Health Care. (Blue Cross Blue Shield had quietly capitulated to the Partners payment demands six months earlier.)

Partners may be the best known, but it is far from the only medical behemoth in the state. Indeed, other mega-health systems dominate their local markets more completely. UMass/Memorial dominates central Massachusetts with nearly half of the hospital discharges in that area; Southcoast rules the southeast with nearly 80 percent of discharges; and Cape Cod Healthcare has taken over the Cape with close to 60 percent of hospital stays. (Partners, in comparison, accounts for about one-third of the hospital discharges in the metro Boston area.) Even the most zealous proponent of market forces would be hard pressed to argue that market forces can control hospital costs where there is little or no competition among hospitals.

The same type of consolidation has happened among health insurers. After nearly 20 years of falling membership and deteriorating financial performance, Blue Cross Blue Shield has re-emerged as the dominant health plan in Massachusetts, growing to 2.4 million members–nearly 600,000 members more than the combined enrollments of the next three biggest health plans in the state, Harvard Pilgrim, Tufts, and Fallon. As of June 2001, BCBS had a net worth of $450 million, compared with the combined total of $280 million of its three major competitors.

In reaching this unassailable position, Blue Cross Blue Shield has benefited from the financial woes of its competitors, brought on by costly and unsuccessful geographic expansions and a nearly fatal case of merger indigestion at Harvard Pilgrim. Blue Cross began to pick up a significant number of new members in 1999, when Harvard Pilgrim, Tufts, and most other health plans experienced significant financial trouble. But Blue Cross was also the beneficiary of another brand of deregulation, in the form of the abolition of any meaningful rate regulation for its Medex and nongroup (i.e., individual) lines of business. As a result of this change, Medex and nongroup have gone from being massive money losers to ranking among its more profitable products.

Let’s make a deal

Competition has dramatically restructured health care and health insurance in this state, but with a steep price tag. Hospitals and health plans have spent hundreds of millions of dollars on mergers and acquisitions, often incurring huge financial losses as they expanded beyond their traditional business and markets. For example, Beth Israel Deaconess Hospital is losing close to $10 million a year on its physician practices, and has sustained operating losses of over $200 million in the past four years. Partners has lost over $100 million since 1996 on its physician groups. Tufts Health Plan lost well over $100 million on its expansion into–and then hasty retreat from–Rhode Island, Maine, and New Hampshire. Harvard Pilgrim was saved from bankruptcy only by state receivership and a restructuring of its long-term debt.

Hospital downsizing and restructuring have also taken place with little regard to vital services. Every hospital with financial problems has threatened to–and in some cases did–close its inpatient psychiatric service. In the last year, a crisis of overcrowded emergency departments and ambulance diversions has worsened. The emergency room problem, which is seen in many other parts of the country as well, has many causes, including a shortage of nurses, pharmacy and radiology technicians, and other types of health care workers. But ambulance diversions are also occurring because the state has fewer hospital emergency rooms and far fewer empty hospital beds to move emergency patients into, particularly in intensive- and cardiac-care units.

The financial condition of Massachusetts hospitals as a group is also unstable, as evidenced by the loud and plaintive cries of financial distress from the hospital industry over the last three years. Many hospitals are, in fact, doing quite well. According to data from the state’s Division of Health Care Finance and Policy, the list of hospitals that have had positive operating and overall financial results in each of the last three years includes Berkshire, Baystate, Brockton, Cape Cod, Cooley Dickinson, Harrington, Holy Family, Massachusetts General, Salem, South Shore, St. Anne’s, and Sturdy Memorial. But other hospitals are in severe financial distress.

Equally disturbing, there is a growing gap between the financial “haves” and “have-nots” among the hospitals. The disparate financial condition of hospitals, and years of stagnant funding, are creating increasingly acrimonious battles among the hospitals over how to fund the state’s uncompensated care pool, the fund used to pay hospitals and community health centers for care provided to individuals who are uninsured or underinsured. (The pool was established in 1985 to distribute the costs of providing free care more equitably among hospitals and to reduce financial disincentives for hospitals to provide free care.)

To be fair, deregulation is only one factor in this story. In the early years of deregulation many hospitals were flush, largely because profit margins on the federal Medicare program were very high, particularly for teaching hospitals. Hospitals poured this money into mergers, acquisitions, and integration–often with disastrous results. They were also willing to give significant discounts to managed care plans to maintain or even increase their volume of patients, because profits from Medicare patients could subsidize losses on managed care business and on Medicaid, which has long been a below-cost payer. Health plans, in turn, stabilized their premium rates by pitting hospitals against one another and by reducing their use of hospital inpatient care. This allowed them to offer a kinder, gentler form of managed care than was the case in much of the country, with broad and overlapping provider networks, few restrictions on care, and continued fee-for-service payment for most providers.

For these reasons, and for a time, it seemed as if market forces and competition had worked. Health insurance premium rates stabilized in the mid-1990s, for both employers and public payers like Medicaid. But the Ponzi scheme of cost-shifting collapsed with the passage of the federal Balanced Budget Act in 1997, which dramatically reduced the rate of increase of Medicare hospital payments. Hospitals soon found themselves losing money on the rates paid by all three major payers: Medicare, private health plans, and Medicaid.

The effect on hospitals and other providers of Medicaid’s low payment rates was amplified by the tremendous growth since 1997 in the number of Massachusetts residents covered by Medicaid. As of last August, almost one million people were covered by MassHealth, the state’s Medicaid program, making it the second largest health plan in the state in terms of enrollment (about 20 percent of MassHealth members are enrolled in HMOs). Along with a strong economy, steady expansions of eligibility for Medicaid have helped the state reduce the proportion of the population without health insurance, bucking the opposite trend nationally. But it has also made Medicaid a much more important source of payment for hospitals–one they can no longer afford to lose money on.

Back to the future

The situation today is eerily similar to 1991. Health care costs and health insurance premiums are rising at double-digit rates. Increasing hospital costs are once again a major factor fueling the rise in premiums, along with spending for prescription drugs. The state’s economy is in a recession. Unemployment is up, and the number of people without health insurance is no doubt rising as a result. There is a large and growing state budget deficit, fueled in part by fast-growing and seemingly uncontrollable health-related costs.

When we faced these problems a decade ago, the consensus solution was to abandon much of the state’s planning and regulatory apparatus and rely on competition, market forces, and managed care to fix them. In the 10 years since, these forces have indeed remade the health care industry in Massachusetts according to the logic of the marketplace. But the market has rewarded the strong, rather than the efficient, weakening providers of vital services and creating monopolistic institutions that will be uniquely resistant to control by market means. Whatever benefits the state has reaped from deregulation, competition will not be the answer to problems competition has generated.

No new compelling policy idea in health care has emerged to replace market-based competition and managed care. Massachusetts is like Rip Van Winkle, the fellow who drank a potion, slept for 20 years, then awoke to an unfamiliar world. State government has only begun to shake off the soporific effects of the market elixir and re-engage in any serious way with health policy-making. But there is a need for new models of regulatory oversight to temper and tame the market’s often unhappy results. Among the areas in desperate need of the state’s clear-eyed attention–and action:

• Health care planning: There appears to be little if any coordination or planning among state agencies involved in various aspects of health care. What’s more, we lack an ongoing forum and process for bringing key stakeholders together around critical health care issues. Nearly two years after a 42-member state health care task force was appointed by the governor in response to what state leaders called a “health care crisis,” we have just begun to develop a basic understanding of the new health care landscape in Massachusetts, let alone come up with any serious recommendations for action. Since it’s clear we cannot rely on the market to give us the hospital capacity and services we need, where we need them, the state must re-assert leadership and devise a systematic and proactive state health planning process, led by an accountable and empowered point person.

• Rationalizing the hospital financing system: Our state and nation pay a tremendous price for our fragmented financing system in health care. While the state by itself cannot eliminate that fragmentation, we need to find ways to make the pieces work together more smoothly. One of the virtues of the state’s old hospital rate setting system was that there was ongoing scrutiny of hospital payment rates and hospital financial conditions, and the state was able to intervene in various ways. While no one wants to resurrect the old rate setting approach, we must develop new hospital payment mechanisms that meld regulation and competition. This new model has yet to be designed; doing so will require creativity and willingness to experiment. We can, however, learn a great deal from what’s worked and not worked in other states and countries. Among other things, this new model will have to strengthen and share more equitably the cost of the state’s hospital uncompensated care pool, create a mechanism to more adequately finance unprofitable but essential services, and develop new approaches to hospital payment in areas where a single hospital dominates the market.

• Reducing the number of people without health insurance: State and federal budget problems could reverse the progress Massachusetts has made in shrinking the ranks of the medically uninsured. But now is exactly the wrong time to retreat. Rising premiums for private health insurance and a faltering economy make the programs that expand coverage more important than ever. Making sure everyone is covered is also critical to creating a rational and affordable health care system in the Commonwealth. One part of the solution could be regulatory. The state should re-establish stronger oversight and protection for health insurance consumers with little or no market power: the elderly, small businesses, and those who buy individual (nongroup) coverage. While deregulation in this area has relieved the state of responsibility for rising premiums, consumers have paid a tremendous price for this hands-off attitude. The state must also explore new ways to make affordable coverage available for the growing number of people the private health insurance market does not serve. These include permitting lower-income people to purchase low-cost coverage under public programs, a model that has worked well in several other states.

After a decade of hospital deregulation in Massachusetts, we need to heed the admonishment of economist Arthur Okun: “The market has its place but the market must be kept in its place.” Whether we can shape a more appropriate place for the market in our health care system over the next few years will have critical implications for the health of hospitals and other providers, and all of us, for decades to come.

Nancy Turnbull, a former deputy commissioner of insurance, is director of educational programs and a faculty member at the Harvard School of Public Health.