(FORTUNE Magazine) – WHAT ARE NOW EQUAL to half of all pretax profits and rising fast? Answer: company health benefits. No wonder managers are desperate. And no wonder many of them are marveling at a plan adopted by one big outfit to cut the costs after its own bill spurted 39% in 1987. Allied-Signal, the aerospace and automotive parts maker in Morristown, New Jersey, made an innovative deal with Cigna, the Philadelphia insurer. Cigna took over the health care of all Allied's non-union employees and guaranteed to hold cost increases to single digits. Result: Cigna, which ran a nail- biting risk, is making good money on the deal. More important, total health costs for employees in Allied's new plan rose last year by a mere 4%. What Cigna did was simply add a new twist to the old health maintenance organization. Ordinary HMOs, designed to hold down costs, charge fixed annual fees for each member. Patients can see their HMO's doctors -- and only them -- at no cost or for minimal extra fees. But in Cigna's system, known as the open HMO, or point-of-service system, patients are also free to go outside the HMO whenever they need care. In that case, the plan still pays, but only 80 cents on the dollar and only after the year's expenses exceed a fairly stiff deductible. This feature attracts those who might otherwise reject being locked into a limited network of doctors and hospitals. Yet once in the plan, employees rarely use the option to stray outside. When participants stick with the HMO, they start by seeing one of its ''primary-care physicians,'' the present-day counterparts of the traditional family doctor. Their mission: to treat as much as possible and to act as gatekeepers, barring excessive tests, visits to specialists, and hospitalizations at up to $2,000 a day. This, of course, can substantially reduce costs. The open HMO has excited so many companies that last November their benefits managers all but broke down the doors to an unpublicized two-day meeting in New York City organized by Allied-Signal to share its experience. On hand was Dr. Paul M. Ellwood Jr., a longtime reformer of the system who heads a Minneapolis medical-research organization called InterStudy. Says Ellwood: & ''Two-thirds of these companies will be doing the same kind of thing in three years.'' Employers offering plans like Allied-Signal's, or well along in preparations, include May Department Stores, Marriott, Intel, and Sears. A few years ago Southwestern Bell's health costs per employee were rising as much as 20% annually. Then the company offered everyone, except those in rural areas and small towns, a point-of-service plan run by Prudential. Last year the increase was considerably less than 10%. For employees using Procter & Gamble's similar plan set up by Metropolitan Life, the annual increase has plunged from 15% to a bit more than 6%. Says Lawrence B. Leisure, head of group benefits at the Towers Perrin consulting firm: ''The train is coming down the track in the direction of point of service.'' If so, the HMO movement may get a new burst of speed. Membership tripled to 32.5 million in the 7 1/2 years through mid-1989. But according to InterStudy, traditional HMOs grew only 1.7% in last year's first half, while membership in the open variety leaped 14%, to 700,000. Independent HMO companies -- those not owned by insurers -- are just now designing or testing open-ended versions. But Prudential and Cigna are on a tear. In ten years, predicts G. Robert O'Brien, head of Cigna's employee benefits business, more than half of all U.S. workers in company health plans will be in HMOs, up from about one-fifth today. Most of the growth, he says, will be in open-ended plans. Cigna has been aggressively investing in new HMOs, which take about four years to break even. Its HMOs lost $139 million after taxes in 1988, O'Brien says, but only $35 million last year. He promises a profit in 1990. Cigna has just agreed to pay $777 million for Equicor, a joint venture of Equitable Life and Hospital Corp. of America. By adding Equicor's 450,000 HMO members to its own 1.5 million subscribers, Cigna will widen its lead over Prudential as No. 1 among commercial insurers. Also betting heavily are Aetna and Lincoln National. With so many companies selling the new plans -- and good numbers coming from Allied-Signal and others -- it seems premature to call for national health insurance. A year ago many corporate chiefs, particularly heads of smokestack companies with more than their share of retirees drawing medical benefits, began clamoring for a government takeover. But this amounts to abandoning hope that competition will ever rein in health costs, and invites the price controls -- and possibly rationing -- that a government program would bring. Medicare, the federal program for the elderly whose costs have rocketed in the past decade, has already imposed price controls. ''If anything is going to save us from national health insurance,'' says Craig Campbell, chief of benefits planning at Southwestern Bell, ''it will be a form of managed care.'' The term refers to the array of systems for financing the health costs of employees without giving them carte blanche to spend what they like, as under the still-widespread ''indemnity'' system (see table). But what if the impressive savings from point of service turn out to be just another pause before the trip on the double-digit escalator resumes? AMONG DOCTORS, doubters are easy to find. ''It's foolish to expect to control health care costs through competition,'' declares Dr. Arnold S. Relman, editor of the New England Journal of Medicine. The problem, he says, is that the suppliers of health services -- doctors -- are uniquely able to influence demand. The best way to get a grip on costs, Relman argues, is to develop improved ''outcomes'' data that tell which operations and tests work best and which are wasteful or risky. With that kind of information, the medical system will be able to heal more efficiently and safely than now. Yet there's no denying that the more closely health costs are managed by insurers or health networks, the lower the premiums and the slower the inflation. Precisely why comes clear from comparing managed care's three basic forms. -- UTILIZATION REVIEW. Only a decade ago nearly all group health insurance provided simple ''indemnity'' reimbursement: Insurers unquestioningly paid any bill that was not fraudulent. More and more they watch what doctors do in the hope of inducing them to save where they can. In the early Eighties company health plans began requiring prior approval of hospital admissions, except for emergencies. But medical care is like a balloon: Squeeze it here and it bulges there. As hospital stays declined, outpatient treatment surged. So like cops with radar to catch speeders, insurers and others cranked ever fancier software into their computerized claims-processing systems to catch overtreating and overbilling. The scrutiny at Metropolitan Life's national claims analysis center in Westport, Connecticut, has a touch of the Orwellian. Computers crunch hospital data to spotlight inefficient institutions. Outpatient bills are screened for services beyond what the diagnosis calls for, and for ''unbundling'' -- boosting the tab by charging separately for services that normally are billed together. Just one example: The computers kicked out a claim for a follow-up visit by a patient with hypertensive heart disease. The bill ought to have been about $60, but unnecessary tests and unbundling ran it to $615. The bill was bounced back to both doctor and patient. Even a small percentage reduction in huge company health costs can send megabucks to the bottom line. Dr. Arnold Milstein of the Mercer Meidinger Hansen benefits consulting firm is in charge of evaluating some 200 utilization review programs, which he calls ''persuasion machines'' for influencing physician behavior. The best programs chop 5% to 8% from a company's health costs, he says. Alas, these are one-time savings. Thereafter, a company is back on its old inflationary curve, though at a lower base. -- PREFERRED PROVIDER ORGANIZATIONS. Need a coronary bypass? A network called Capp Care can get it for you wholesale -- $26,600, vs. a more typical $50,500. Based in Fountain Valley, California, Capp Care is one of dozens of preferred- provider organizations (PPOs) that sprang up in the mid-Eighties when employers and federal medical programs found groups of hospitals and doctors willing to cut prices in return for an assured volume of patients. Think of PPOs as the medical equivalent of discount clubs whose members cart off bargain washing machines, except that the employer pays the dues and pockets most of the savings. The number of people eligible to use Capp Care's services leaped last year from 1.1 million to 1.5 million. More and more Blue Cross associations, insurers, and medical groups are lining up these discounters. From practically nothing several years ago, total PPO membership has grown to about one-sixth of those covered by company health plans. PPOs are growing at the expense of indemnity plans. Employers view them as a cost-saving compromise for workers who resist joining an HMO. In fact, there's no medical enterprise to join. Some PPOs are nothing more than brokered arrangements, which tiny staffs can supervise because insurers or medical groups handle all the paperwork. Employees are not obliged to use the PPO. But to encourage them to do so, companies pay 90% or even 100% of the bill instead of the usual 80% and will even waive deductibles. But there's rarely a gatekeeper-doctor. And neither doctors nor hospitals are ''at risk'' as in HMOs, which stand to lose if the annual cost of treatment exceeds their subscription income. In short, PPOs offer indemnity health care in carload lots. However, the package often includes utilization review as well as the screening of doctors and hospitals for quality. A year ago BP America (with the help of the Coopers & Lybrand accounting firm) launched a PPO comprising only hospitals, not doctors, for non-unionized workers. Hospital costs for these employees stayed flat. Down the road, BP looks for annual escalations of 5% to 10%. Southern California Edison has figures almost as good. So does BellSouth, which put together a hospital-only PPO with the help of Blue Cross; next year the company plans to bring in doctors.

Trouble is, inflation can return with a vengeance. In 1984, Florida's Dade County School Board offered its teachers a PPO plan run by Metropolitan Life. Until 1988, says assistant superintendent Susan Weiner, everything seemed ''wonderful.'' But despite utilization review, she says, costs began to zoom: ''We saw the doctors in the county making up in repeat visits what they were losing in discounts.'' In place of the PPO, the school board now offers a point-of-service plan built around Met Life's HMOs. -- HMOs. On the spectrum of managed care, this is where employers start to get a firm grip on costs. Most primary-care doctors in HMOs are on salary or receive a flat amount based on the number of patients who have chosen them. They may get a bonus if the plan has a good year financially. So they have nothing to gain by running up your bill. For HMO members there's no big bill anyway -- at most a modest ''co-payment'' of $10 per office visit, to deter those who would hog the doctor's time. The new point-of-service feature adds some luster to traditional HMOs. In 1987 and 1988 they were tarnished by the same trends that drove up health costs in general. The government clamped down on Medicare and Medicaid spending, and hospitals and doctors made up for lost income by raising fees for people in private health plans. The AIDS epidemic and new feats such as liver transplants costing as much as $250,000 swelled expenses. Many HMOs wound up in the red, and Maxicare, one of the biggest, filed for bankruptcy in March 1989. To stanch losses, some of the plans boosted premiums as much as 20%. Quite a few employers are disillusioned. A Towers Perrin survey shows that only 51% of them believe that HMOs provide better value for the money than other health plans. Many benefits executives have a strong hunch that HMOs siphon off the young and healthy who require little care, thus forcing premiums higher in indemnity plans that attract sick people who already have close ties with doctors outside the network. Most HMOs don't deserve the bad reputation. William Boyles, editor of the Health Market Survey newsletter in Washington, D.C., rates about two-thirds of the country's 600 HMOs as satisfactory or quite good. He says about one-third -- generally with small memberships -- are ''schlock operations'' that have indeed tried to skim off the good risks. But the leveling of total HMO enrollment masks a profound shakeout. The weaker outfits have been folding or merging into stronger ones. The most efficient HMOs are usually the ''group'' or ''staff'' type, in which salaried physicians work solely for the organization at its own medical centers. Some are so successful they have been in no hurry to offer the new opt-out feature that Allied-Signal finds so attractive. Examples: Kaiser Permanente, the California-based king of HMOs, whose membership jumped last year by a record 600,000, to a total 6.2 million, and the flourishing Harvard Community Health Plan, with 400,000 members and an 8%-a-year growth rate. Harvard is considering a point-of-service option but has no plans to become a national HMO. Says President Thomas O. Pyle: ''The economies of scale derive from increasing your market share within a region.'' HMOs save money in myriad ways, and it all starts with the gatekeeper- doctor. Bothered by chest pains? Heart disease is only one of a dozen possible reasons. Short of serious symptoms, the plan's family physician must rule out the other possibilities before sending you to a cardiologist. If you went directly to one, as allowed in an indemnity plan, he too might rule out heart trouble -- but he might also go ahead with expensive tests. Sensitive to talk that they skimp on care, HMOs survey their members to catch any dissatisfaction. This has been honed to a high art at U.S. Healthcare in Blue Bell, Pennsylvania, a type of HMO called an independent practice association (IPA) because its doctors also see other patients. ''U.S. Healthcare tells us what the patients think of us,'' says Dr. David J. Badolato, a family physician in the network. Doctors who don't maintain a variety of standards are dropped. HMOs' biggest economies are in hospitalization, where they continue to chip away. For people under 65 in Cigna's staff HMO in Phoenix, the hospitalization rate is just about the lowest anywhere: 270 days a year per 1,000 members, barely half the average at indemnity plans. Most mothers get a night's sleep after childbirth and finish resting up with baby at home. Following surgery, many patients are discharged to a less expensive recovery center or are supplied at home with intravenous antibiotics, oxygen, and a nurse. Patients in HMOs are less likely to go under the knife. ''For every ten tonsillectomies done on the outside, we do one,'' says Dr. Paul Lairson of Kaiser Permanente. Kaiser also performs fewer hysterectomies, he says. In the Los Angeles area, where 30% of women with private insurance have their babies by Caesarean section, Kaiser has reduced the ratio to 16%. Other savings turn up, big and small. Don't expect a chest X-ray unless there's a good reason; it won't catch lung cancer early, Kaiser says. Members of U.S. Healthcare are only half as likely to wind up in a psychiatric hospital; the HMO favors outpatient care for mental illness and substance abuse. It also deters excessive medical tests by paying outside laboratories and radiologists a flat annual fee. But like other HMOs, this one covers preventive care that indemnity plans don't. Beyond an appropriate age, free tests for colorectal cancer and mammograms are aggressively encouraged. TWO OBSTACLES have barred HMOs from becoming the mainstream of medicine. There's that persistent suspicion that they get more than their share of the young and healthy. Such talk steams Glenn Hackbarth, vice president of the Harvard Community Health Plan. Membership there is slightly younger, he allows, but it includes lots of women in the expensive childbearing years. To counter the creaming argument, HMOs have begun to offer discounts to employers whose work forces are significantly younger or cost the plan less money. The new point-of-service plans are aimed squarely at the other objection, that HMOs force you to stick to a list of participating doctors and hospitals. The marketing approach could not be simpler: Lure 'em in by allowing 'em out. The scenario at Prudential, says senior vice president Samuel Havens, ''is that as time goes on, a larger and larger percentage of patients will use the network. And if the trend goes far enough, there will be no more out-of- network services.'' To keep employees in the network for Allied-Signal's plan, Cigna tried to enlist many doctors who were already seeing Allied employees. It had the most trouble in New Jersey, a stronghold of indemnity health insurance. Recruiting was far easier in Phoenix, where Allied has a large aircraft jet engine plant and group health plans have a big following. Cigna's network has grown rapidly to accommodate Allied employees, who include most union members. Dr. Glen Stockton, an internist and family practitioner, joined it after some of them requested him. He prefers the HMO to the hassles of utilization review, where ''you can get a long-distance call from some faceless person wanting to know why you admitted somebody to a hospital.'' And how is the new plan going down with Allied-Signal employees in the area? A sampler of comments runs the gamut. One woman is ''very pleased'' with her HMO family physician, and a man whose son needed knee surgery says things worked out ''wonderfully well.'' But when another's son had a sports injury, the father had to ''call Cigna every day'' for permission to see a specialist. Getting past the primary-care doctor to the allergist or dermatologist can be difficult, a couple of other workers complain. Despite the problems, the system is working. An impressive 83% of the eligible employees' health care dollars are being spent within the network. At Southwestern Bell the figure is 80% and rising. CAMPBELL of Southwestern Bell gives this advice to companies considering a point-of-service plan: Make sure all the stakeholders -- employees, doctors, and hospitals -- accept the change and make clear that the company is going to ''stay the course.'' Winning over the employees is the challenge today. A few years from now it could be finding enough gatekeepers. Fewer students in medical schools are seeking careers in primary care these days. A new Medicare payment plan for doctors -- which raises fees for family physicians and cuts them for some specialists -- may reverse this trend, but nobody is sure yet. Another worry: malpractice suits. In a Michigan case settled out of court, a woman with cervical cancer tried to collect from an HMO whose gatekeeper- doctor refused to allow a Pap smear. Except for a few companies that take care of some employees at their own medical clinics -- Gillette, Goodyear -- employers contract out all their health care to an insurer or HMO. Until now, that has kept their deep pockets beyond the reach of malpractice suits. But if the company adopts a health plan with a powerful new inducement to go / through a gatekeeper, could it be found liable if something went wrong? Companies like Allied-Signal believe they have skirted the danger by relying on the HMO to screen doctors and by allowing employees free choice outside the plan. The long-term answer, both to malpractice suits and wrestling down costs, is to take the guesswork out of medical care. Ellwood of InterStudy says that new data pinpointing the most effective treatments for 18 major ailments could begin to alter patterns of care within two years. The possibilities excite Kennett Simmons, chief executive of United HealthCare, a big Minneapolis HMO company: ''What we have that we never had before is massive amounts of information in computer systems and the computer power to get it out and use it.'' That is especially welcome news as the results of plans like Allied-Signal's draw more companies and employees to HMOs -- because they, more than any other providers of health care, have the incentives to use new data to bring costs down. Among U.S. companies overall, the killer expense is still definitely at large. But there's reason to hope that some are at last closing in on it.

CHART: NOT AVAILABLE CREDIT: SOURCE FOR TABLE AND CHARTS: CIGNA CORP. MANAGED MEDICAL PLANS SAVE MONEY... ...AND ARE WINNING MARKET SHARE Cigna's spectrum of health plans (table) shows that as managerial control tightens, costs and the anticipated inflation rate shrink impressively. In 1981, aside from a small number in staff, group, and other HMOs, all U.S. workers were in unmanaged ''indemnity'' health plans; today fewer than half are.