Proposed Merger Could Create Giant Hmo Deal Illustrates Competitive Pressures On Managed Care Organizations, Especially In California

Two California health maintenance organizations are attempting to create the nation’s largest publicly traded HMO.

WellPoint Health Networks Inc. and Health Systems International Inc. confirmed weeks of speculation Monday, saying they are in negotiations for a stock swap merger valued at about $1.7 billion.

The combined companies would have more than 4 million members and $5 billion in annual revenues. Non-profit Kaiser Permanente, based in Oakland, Calif., would remain the largest HMO with 6.6 million members.

WellPoint and Health Systems cautioned that there are still issues outstanding and no assurance that a final agreement will be reached.

Confirmation of the buyout talks came after a published report Monday in The Wall Street Journal that Blue Shield of California has offered $4.5 billion to buy WellPoint.

WellPoint released a written statement saying that Blue Cross of California - its 80 percent owner - has “received proposals from other parties concerning possible transactions regarding WellPoint.”

Blue Cross and Blue Shield operate separately in California.

The statement said Blue Cross and WellPoint had determined that their buyout of Health Systems offers “distinct advantages in terms of longterm stockholder value, strategic fit, operational synergies and probability of closing.”

The dealmaking illustrates the merger frenzy overtaking the HMO industry, especially in California, the country’s most mature and competitive market for managed care - comprehensive medical care programs available for a fixed, annual fee.

In California, many employers seeking to cut the high costs of health care for their workers have banded together in purchasing coalitions. These coalitions, representing hundreds of thousands, can demand big discounts from HMOs. This has driven the HMOs to merge in order to consolidate costs and offer larger and more diverse medical services and specialities.

Health Systems, the second-largest for-profit HMO in California, is itself the product of a merger last year between Health Net and QualMed, based in Colorado.

WellPoint is the largest for-profit HMO in California.

A combined company would be able to cut administrative and marketing costs and demand bigger price discounts from hospitals and doctors, analysts said.

“The more you push down on provider prices, the more money goes into your bottom line,” said Juan Noble, with the New York securities firm Jackson Partners & Associates.

Michael Taylor, a Boston-based health care specialist with the management consultant Towers Perrin, cautioned that a merger could mean some difficult transitions for patients - at least in the short run.

HMOs hold costs down by restricting patients to a limited number of doctors and hospitals, and consolidation means some of those providers will be eliminated, forcing patients to switch, he said. Also as HMO employees are cut or shifted, patients may have trouble getting their claims handled.

There’s no firm evidence that quality has suffered significantly in the HMO mergers done thus far, but any improvements are usually delayed, he said.

“Anything of this size is going to take more than two years before all the boxes in the table or organization are filled and the company is working efficiently,” he said.

The proposed deals sent the companies’ stock prices up Monday. WellPoint gained $2.75 to $33.75; Health Systems rose $1.37 to $32.37.