The Rise and Fall of HMOs shows how a worthy idea went wrong

The Rise and Fall of HMOs: An American Health Care Revolution
By Jan Gregoire Coombs
Madison,Wisc., University of Wisconsin Press, 430 pages.

This well-written and thoroughly researched book by an unusually knowledgeable author traces two distinct, occasionally intersecting, histories. The first is that of the highly regarded Marshfield Clinic, a multi-specialty group medical practice in central Wisconsin with an admirable history of social responsibility and a mission to deliver high-quality health care. The second involves federal and state health care policies intended to help the rural poor and aged, to promote widespread and affordable financial protection from the costs of health care, and to establish and promote health maintenance organizations as one vehicle to achieve these goals.

To say that public policy did as much good as harm to the health care delivery system in its pursuit of worthy goals would be, in the views of the author and this reviewer alike, to give public policy too much credit. And to say that HMOs like the one formed by the Marshfield Clinic—a type that has become more rare even as HMOs, at least in name, have spread across the landscape—ever got a fair chance to work their magic on a health care system in desperate need of it is to misunderstand the history of this much-maligned innovation in medical delivery and finance.

In 1971, the Marshfield Clinic teamed up with Blue Cross of Wisconsin and St. Joseph’s (Catholic) Hospital to form the Greater Marshfield Community Health Plan, the first health maintenance organization in Wisconsin and the first rural HMO in America. After 15 months, it had enrolled more than 13,600 members and lost more than $482,000, both substantial numbers in those days. The idealism of the doctors got them into trouble: GMCHP enrolled too many direct-pay subscribers (i.e., not in employment groups) in poor health, and it was not able to sign up the city’s largest manufacturer “because its national office purchased all employee benefits,” writes Coombs. “Other losses arose because local agents of competing insurance carriers encouraged sick clients to enroll in GMCHP but warned healthy customers to avoid the clinic’s plan.” The reluctance of employers and agents to participate in an efficient and equitable delivery system reverberates to this day.

GMCHP suffered all the growing pains of the early HMOs: a lack of personnel experienced in prepaid health plan operations, an enrollment policy that was too open, and a lack of employer purchasing policies that would let them compete on their merits. Other pains were caused by the workings of the political process.

“The long-awaited HMO Act of 1973 failed to resolve the nation’s health care crisis and nearly derailed the HMO movement…,” writes Coombs. “Subsequent federal and state legislation intended to facilitate prepaid health care often had the opposite effect. Federal funding gave prepaid health care a legitimacy long denied by the medical profession, but the federal requirements for HMOs deterred many potential sponsors.”

The story of GMCHP, one of the HMOs that struggled to remain true to its mission despite the market and political forces stacked against it, reveals a history of health care reform gone wrong.


What we now refer to as a health maintenance organization has gone through a multitude of forms over the years. The idea, which originated with Dr. Paul Ellwood, a pediatric neurologist from Minnesota turned health policy visionary and reformer, was of a self-regulating health care system that aligned provider incentives with consumer interests. This was done through an “integrated delivery system,” built on the core of a large multi-specialty medical group practice—often with links to hospitals, labs, and pharmacies, and often with a significant amount of revenue based on per capita prepayment. Replacing fee-for-service payments with a per capita prepayment, or a fixed number of dollars per person per month, gave the doctors an incentive to keep people healthy, to solve their medical problems in less costly ways, and to be economical in use of resources generally. In some cases, the health insurance plan had a mutually exclusive contract with its affiliated delivery system, as in the case of Kaiser Per-manente or the former Harvard Community Health Plan. In other cases, the insurance part of the partnership was an independent company, as in the cases of the GMCHP and the Lahey BCBS HMO.

But then the HMO began to evolve, in form, structure, and incentive. Medical societies found they needed a vehicle for their members in solo (or small specialty group) practice to be able to compete with integrated-delivery HMOs, so they created “independent practice associations,” or IPAs. Bay State Health Care was one example.

Then came “network model” HMOs designed to link independent multi-specialty group practices, in which the groups shared cost risks. HealthNet and Pacificare in California were prominent examples; Multi-Group Health Plan in Massachusetts was another.

Then came “capitated primary care networks,” or community-based primary care physicians who accepted risk for the costs of primary care and shared in the risk of referral care. The most prominent was US Healthcare.

The Blues, historically allied with traditional providers they paid on a fee-for-service basis, also entered the HMO market, contracting with wide networks of providers. (Most of the Blues converted to for-profit status, but Blue Cross Blue Shield of Massachusetts remained nonprofit.) They were joined by the commercial insurance companies, which also contracted with wide networks of traditional providers. These could be called “carrier-based” HMOs, since the chassis of the HMO was an insurance carrier rather than a medical group or delivery system.

Finally, through mergers, these various models combined with each other to produce mixed-model HMOs. Thus the integrated-delivery Harvard Community Health Plan acquired Multi-Group and merged with IPA-based Pilgrim Health Care. It then spun off its delivery arm as Harvard Vanguard Medical Associates, a large multi-specialty practice group, and ultimately became Harvard Pilgrim Health Care, which is strictly an insurer.

For its part, GMCHP started as a partnership with Blue Cross of Wisconsin and St. Joseph’s Hospital. In 1986, conflicting corporate goals drove Blue Cross and the Marshfield Clinic apart. The clinic established its own Security Health Plan, which operates to this day. In an effort to upgrade the quality of care in the region generally, the clinic enrolled many of the solo practice doctors in the region as affiliates of its plan and worked with them on practice guidelines.

So the term HMO is now non-specific and covers a wide range of health care financing and care arrangements, most of which are quite different from the original idea. What they have in common is a “benefit package,” or coverage contract, that covers comprehensive health services, including disease prevention; low co-payments at the point of service; and a commitment to deliver the services directly or through contracting providers.


None of these varying forms saved HMOs from the backlash that began in the mid-1990s. Patients complained about services denied and referrals refused, but the disgruntlement actually started among physicians. Most doctors working under HMOs, with the exception of the integrated-delivery and network models, still preferred the traditional practice model (choice of provider, choice of treatment, fee-for-service payment), but that model had become too costly for many employer groups. Feeling coerced by market forces, doctors complained to their patients.

Dissatisfaction was strongest among people not in HMOs by choice.

As for patients, many of them were forced into HMOs by their employers, who gave them no choice, little explanation, and none of the financial benefit. Research showed that dissatisfaction was strongest among people in HMOs not by choice. Research also showed that the most satisfied patients and doctors in California were in Kaiser Permanente, presumably in part because they were all there because they wanted to be. The for-profit carrier-based HMOs came in for a disproportionate share of criticism both because their cost-saving efforts were ascribed to profit-seeking, rather than consumer benefit, and because they were mainly perceived as imposing limits on care, rather than organizing and delivering care in better ways.

In response to the backlash, carrier-based HMOs morphed into practically all-inclusive networks of unaffiliated doctors, so that the employees who were not members by choice could still have insured access to the doctor of their choice. This weakened the HMOs’ ability to control quality and expenditures. The carriers also offered “preferred provider organizations,” or PPOs, which gave employees incentives to go to contracting doctors—who in turn had an incentive to accept discounted fee schedules. Not medical care organizations at all, PPOs are discounted fee-for-service systems, close to the traditional model. But they are very flexible vehicles. They can be set up quickly, without actually changing the delivery of medical care. They can be used by employers who prefer to self-insure, or by insurance companies that bear risk. Their only problem is that they can’t do much to moderate the growth in health expenditures. Yet PPOs, whose market share nationally was 28 percent in 1996, grew to 55 percent of the market by 2004, by which time the HMO share was down to 25 percent (from 31 percent in 1996).

While complaining about the rapid increase in health expenditures, employers have remained, in practice, committed to fee-for-service and unorganized medical care delivery. Most offer only PPOs or carrier-based HMOs with wide networks. Those who do offer delivery-system-based HMOs as a choice also offer PPOs and pay a flat 80 percent to 100 percent of the premium of either. With employers effectively willing to pay more for fee-for-service and PPOs, providers of care see no reward for organizing efficient delivery systems. Employers do not understand medical organization. If they did, they would not choose insurance policies that attack efficient forms of delivery.

The Marshfield Clinic and Security Health Plan suffered in terms of payment from government programs as a result of their own success in controlling costs. As Coombs recounts: “Reimbursement from the state and federal [Medicaid and Medicare] contracts were based on a percentage of the average fee-for-service costs for serving beneficiaries. Local charges in central Wisconsin were unusually low because of the influence of the cost-efficient clinic, so GMCHP’s Medicaid reimbursements were a great deal lower than what HMOs in two of Wisconsin’s urban counties received a few years later.”


Government generally has done a poor job of creating market conditions in which delivery-system HMOs could succeed. An important exception to this was and is public employee health insurance programs. The federal government and the governments of states like California, Minnesota, Washington, and Wisconsin have offered their employees a wide range of choices, including traditional insurance plans and HMOs, and a more or less fixed-dollar contribution so the employee could keep much or all of the savings from choosing an economical health plan. (Alas, Massachusetts does not qualify for this roll of honor. The state’s Group Insurance Commission pays a high fixed percentage of the premium of the plan of the employee’s choice, thus systematically paying more to higher-priced health plans—usually fee-for-service—and attenuating any incentive to enroll in a lower-priced health plan.)

On the federal level, the 1973 HMO Act tried to help in the private market by requiring employers of 25 or more to offer employees a choice including one group practice HMO and one IPA, if such plans served areas where employees lived and if they “invoked the mandate.” For the most part, however, HMOs were reluctant to invoke the mandate: Forcing the customer to do business with you is not a good way to start a relationship. Employers could, and many did, find ways to evade the intent of this provision of the law, which was repealed in the 1980s.

Employers in general compounded this problem by not even offering choices of carrier. A survey in 1997 found that the employers of 77 percent of employed insured Americans did not offer such a choice. (Three “plan designs” from Aetna—an HMO, a PPO, and a consumer-directed plan, all with the same fee-for-service doctors—do not open the market to delivery system-based HMOs.) Worse yet, some 20 percent of employees were offered an HMO without a choice, thus bringing on the backlash against managed care.

Harvard Community Health grew until it hit a ‘glass ceiling’ in the mid-1980s.

Among integrated-delivery HMOs, Kaiser Permanente expanded beyond its West Coast locations with some successes (Denver, Atlanta, Washington, DC) and some failures (New York, Connecticut, North Carolina, Kansas). Harvard Community Health Plan in Boston and Group Health Cooperative in Seattle grew rapidly up to the mid-1980s, when they hit “glass ceilings,” having enrolled all they could from choice-offering employers. These group practice HMOs were not good candidates to be a single source of health insurance for an employer. Many people want the option to choose their own doctors and certainly do not want to be forced to change. Group practice HMOs can prosper only if they are a part of an offering of responsible health plan choices.

In the mid-1980s, Harvard Community Health Plan and Group Health Cooperative found themselves forced to make themselves acceptable to “single source” employers by merging with or developing large networks of solo practice doctors, rather like what the Marshfield Clinic had done. Unfortunately, solo practice is inherently less efficient than group practice, so these organizations lost their cost advantage over other forms of organization. (According to Coombs, this problem was one to which GMCHP did not succumb: Apparently, market conditions in central Wisconsin made it possible for the Marshfield Clinic to control the practices of the solo doctors in their affiliated Security Health Plan, assuring reasonably economical practices.)

In California, integrated-delivery and group practice-based network HMOs have done very well among employers that offer choices and fixed-dollar contributions, with market shares of 75 percent to 80 percent. Employers like Stanford, University of California, and Wells Fargo can pay a fixed dollar amount at or below the price of the low-priced HMO and save a great deal of money.

This history, in my view, does not indicate that group practice HMOs are unpopular; rather, it illustrates the inability of employers to put together a strategy that gives employees a responsible choice and lets employees keep the savings for themselves.

he difficulties faced by HMOs as they tried to deliver health care in a more efficient and effective way, only to be subverted by pressures from bigger forces—private and public—show why it is time for fundamental modifications of the employment-based health insurance system. These modifications could include such alternatives as regional exchanges that serve many employers and broker multiple choices for every employee; or, better still, in the views of the author and this reviewer, complete replacement of the employment-based system. Employment-based health insurance leaves out too many people, especially in rural areas where many people do not have an employer.

A promising example of non-employment-based health insurance has recently been proposed in Wisconsin by state representatives Curt Gielow, a Republican, and Jon Richards, a Democrat. Under the proposed Wisconsin Health Plan, all employers would pay a payroll tax (in lieu of health insurance premiums); all residents would have a health insurance purchasing account and an annual choice of health care plans and providers. Such a model would open up the opportunity for all residents in central Wisconsin to join and get their care from the Marshfield Clinic, or any other delivery system of their choice—not to mention encourage, rather than undermine, true HMOs.

Meet the Author
Indeed, a similar model of universal coverage and choice of health plan could open the market anywhere to integrated-delivery HMOs for anyone who wanted to join them —and keep the savings for themselves. As health insurance is increasingly priced out of the market, it will become increasingly important to offer people the opportunity to save money by joining an efficient delivery system.

Alain Enthoven is Marriner S. Eccles Professor (Emeritus) of Public and Private Management in the Graduate School of Business at Stanford University.