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What happened to First Health?

Over the last year or so, there has been quite a bit of speculation, especially in the workers comp arena, about First Health’s future. Consulting clients in particular were unsure of the future direction of the company, as it seemed to have lost its way, embarking on diverse acquisitions, gaining a (well-deserved) reputation for arrogance and heavy-handedness in client relations, and in the process losing credibility both among customers and in the equity markets. Now that First Health is part of Coventry Health Care, a little historical perspective may help shed some light on what went wrong.
The first question is – did anything go wrong? Past management would likely argue that all was according to plan. To refute that (potential) argument, one need look only at the stock price, which declined significantly over the last couple years. I doubt that was “part of the plan”.
One can categorize most of FH’s problems as due to the Innovator’s Dilemma, Clayton Christensen’s terrifically insightful explanation of what happens to companies that fight like hell to hold onto and improve products and services whose time has past. FH was very successful in building and growing a WC network business, one that came to dominate the WC industry and by so doing generated a disproportionate share of the company’s profits. As the market matured, FH did what most companies in maturing markets d – they grew by acquisition. CCN, HealthNet employer services, and Priority Services were all acquired to consolidate share, freeze out competitors, and solidify customer relations. What FH failed to do, and what caused them pain and is likely to continue to afflict Coventry, is innovate.

While FH was building an ever larger and ever broader network of hundreds of thousands of WC providers, the industry was moving to a “specialty care” model. This model recognizes that health care is not a monolithic, generic commodity, but rather a conglomeration of very different components. FH’s fatal error was in applying one cost saving approach, a deep discount model, to all providers.
Two examples demonstrate the fallacy of this model. First, physical therapy. Per-unit prices are NOT the problem with PT, utilization is. When a WC claimant has PT, on average they receive 30 services over the life of their claim, at an average price of about $30 each. Clearly, there are much more savings to be generated by reducing the volume of services than by getting a few percent off each one. Sadly for Fh stockholders, (of which I was one), they just did not get this until far too late. FH did try to develop a PT program in the summer of 2004, but by then it was far too late.
Second, imaging. OneCall Medical, MedLink, MedFocus, et al are all serving the WC market for diagnostic imaging, and by all accounts doing a credible job. FH sought to benefit from their capabilities by including them in FH’s network. All well and good, except FH’s bill repricing system could not accommodate their pricing models. The result – Fh did not capture near the savings they could have with a better bill review process and system. When payers started to figure this out, they went direct to these vendors, cutting out FH, sometimes covertly.
FH made one other major mistake. They often infuriated their customers with their arrogant, take-it-or-leave it approach to negotiations. When they were the only game in town, this worked well; but it set the stage for customers to gleefully kick them out the door (again sometimes covertly) as soon as possible. FH’s negotiations surrounding CNA and the MailHandler’s program, their run at Private HealthCare Systems (where they offered to buy PHCS, went thru the due diligence process, then cut their price, walked away, and, according to some insiders, used the knowledge gained to their advantage in other business deals), their last-minute offer to buy CCN all lost them friends and gained enemies.
Finally, FH went away because they were not able to effectively manage WC medical expense. Medical trend rates continue to advance at double digit rates, and all the while FH is generating huge fees based on their percentage of savings model, a model that has all but disappeared in the group health industry. And for very good reason – the incentives are all wrong.
Where to next? Well, Coventry is run by smart, effective, experienced people who by all accounts have no problem discarding ineffective business models and building new ones. However, there is precious little WC expertise resident in top management at Coventry. While there undoubtedly is a wealth of experience remaining at FH (after the departure of the top execs last month), it remains to be seen who will lead the WC effort and which directions they will head.

Joe Paduda is the principal of Health Strategy Associates



A national consulting firm specializing in managed care for workers’ compensation, group health and auto, and health care cost containment. We serve insurers, employers and health care providers.



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