Early Experiments With Managed Care
Beyond technological innovations and service improvements, the Palo Alto Medical Clinic was also one of the earliest medical groups to work with managed care insurance plans. Known initially as "prepaid health care," managed care got its start in the 1920s in Southern California, when the Los Angeles Department of Water and Power contracted with the Ross-Loos Clinic to provide all medical care for its workers and their families at a cost of $2.69 per member per month.
Shortly thereafter, industrial baron Henry J. Kaiser set up similar programs to provide medical services for workers at the Grand Coulee Dam and in his shipyards and steel mills. (Opened to the public after World War II, these plans would go on to become the nationwide Kaiser Permanente insurance system.) A few other plans were set up here and there, but for the most part, "prepaid health care remained a minor phenomenon until the 1970s," according to the Tufts Managed Care Institute.
Prepaid health care requires a completely different way of thinking for doctors used to traditional insurance plans. Rather than receiving payment in full for each service after it is delivered, the doctor is given a certain amount of money per patient before delivery, and has to use that money to cover any care the patient receives until the next payment. This process is called "capitation." Financial incentives are flipped: Instead of increasing patients' use of medical services, physicians are encouraged to reduce health care utilization without compromising quality.
At its best, managed care can improve patient care by emphasizing preventive medicine, chronic disease management and other tools that keep the patient healthy. At its worst, managed care can cause over-restriction of medical services and lead physician groups into bankruptcy.
The Palo Alto Medical Clinic's first experiment with prepaid care came early. In 1946, Dr. Russel Lee and Stanford President Donald Tresidder agreed that the Clinic would take care of all university students for an advance fee of $5 per semester, paid out of tuition. It was the first prepaid plan on the Peninsula, and it did not sit well with the medical establishment, touching off the Santa Clara County Medical Society's efforts to kick Clinic doctors out of the organization. But it worked fine for the students and the two institutions, which kept up the arrangement in some form until Stanford took back control of student health services in the 1990s.
In fact, the student plan worked well enough that in the 1950s, the Clinic decided to create a similar plan for Stanford faculty and staff. The Family Medical Plan covered medical care for $5 per adult per month and $3 per child. It had no deductibles (an out-of-pocket amount the patient must meet before coverage kicks in) and no co-payments (a nominal fee paid by the patient at the time each service is received) – and thus lacked any reason for patients not to use medical services. The plan also failed to structure financial incentives for doctors so that they discouraged unnecessary visits. As a result, utilization rates soared. The national average for doctor visits per person in most traditional fee-for-service insurance plans was five per year. The Stanford plan averaged 14 visits per year. The Clinic, of course, lost money.
"It was the most ill-conceived financial plan there ever was," said Dr. William Clark. "Patients only had to enroll for one academic quarter at a time, and when they were perfectly well, they wouldn't pay. Then, when they were sick or were going to have a baby, they'd join up again .... It was absolutely a fiasco financially, but Russ wasn't going to let it go because, by gum, prepaid care was what there had to be."
Eventually, the Clinic solved the over-utilization problem by adding "coinsurance" of 25 percent, meaning that if an office visit cost $10, the patient had to pay $2.50 of it. Usage dropped to more normal rates. The lesson rubbed off on Dr. Philip Lee, who soon thereafter became President Johnson's assistant secretary of health. As he helped to create the Medicare program, Dr. Lee made sure that a coinsurance factor of 20 percent was included, in an effort to keep utilization rates under control.
The Managed Care Era Begins
Over the 1960s and 1970s, the Clinic gradually expanded its prepaid business. It entered into a direct contract with Pacific Telephone to care for 10,000 Peninsula employees and created a prepaid plan for the elderly before Medicare existed. So it was ready when the Nixon Administration in 1971 announced its plan to fund the development of prepaid "health maintenance organizations" (HMOs) as a way to contain medical costs and expand access to care. In 1979, the group entered into a partnership with Blue Cross and several other area clinics to create TakeCare, a federally qualified HMO that offered prepaid health care to patients whose employers or unions signed them up.
As managed care took off, California led the nation in the number of people enrolled in some form of prepaid plan. Because it was a large multispecialty group, the Clinic was well situated to handle the shift as more of its business became capitated. It had many primary care physicians who could focus on preventive health and act as "gatekeepers" to more expensive specialty care. It had a wide variety of specialists in one place, ensuring that patients received whatever care they needed quickly and efficiently, without extra red tape or costs. It had a large back-office operation that could handle ever-more-complicated contracting, billing and record-keeping requirements without distracting the doctors from medical care. It also had years of experience with the concept of prepayment.
Despite this preparation, the growing presence of managed care and other developments in health care financing began to put pressure on the Clinic's fiscal stability by the late 1970s. This factor played a role as the group's leaders considered a major strategic change for the organization – the creation of a new corporation known as the Palo Alto Medical Foundation.
Back to top