(MONEY Magazine) – On April 1, 40 pediatricians and 35 family practitioners, disgruntled over their fees, pulled out of North Carolina's largest health maintenance organization, the 16,206-member Raleigh Blue Cross Personal Care Plan. One result of this retreat: the Reaves family of Cary, N.C., pictured above, was - reassigned by the HMO to three new doctors. Dick and Sheila Reaves' three children had to start trekking to one pediatrician, their two live-in wards were told to go to another, and the couple were assigned to a new family practitioner. ''We used to have just one pediatrician and one family practitioner,'' says an exasperated Dick Reaves. ''Now we've got three strangers to get used to.'' The Reaveses have decided to quit the HMO when their $156-a-month subscription ends in October and go back to more costly regular health insurance coverage. Unhappily, this kind of service brownout has become so widespread that the once bright promise of HMOs -- comprehensive medical care at a fixed and affordable monthly rate -- has dimmed. At the heart of the matter is the failing financial health of HMOs. Nearly three out of four are running in the red. Last year, at least 16 of the 662 plans in operation merged with sturdier ones or closed outright. Some subscribers are being forced out of their HMOs by punishing rate increases. That fate may befall nearly 800,000 members of Maxicare Inc., the largest investor-owned HMO, with headquarters in Los Angeles and locations in 23 states. To recoup a $256 million loss last year, Maxicare is looking to lop that many members from its rolls by increasing their premiums by as much as 100%. Insurance experts and state regulators expect more shake-outs over the coming months, particularly in oversupplied cities such as Denver, Minneapolis, New Orleans, Raleigh/Durham and St. Louis, where competition has suppressed premiums to below the cost of care. With only 13% of Americans holding HMO memberships, all this would seem at first glance to be a crunch without much consequence. Not so. Employers, goaded by insurers who are worried about exploding health-care costs, have been turning more and more to HMOs and similar restricted-service options and away from traditional free-choice plans that let you pick your own doctor. Between 1984 and 1987, for instance, free-choice plans dropped from 96% to 40% of insurers' group business, according to Health Insurance Association of America, a trade group of health insurers. Faced with insurance rate increases averaging 20% a year, employees have been seeing the light and switching to HMOs. The upshot: over the next year or so, according to analysts, total HMO enrollment of nearly 30 million people -- 96% of them under company plans -- will rise by 10% while the number of plans shrinks by an equal 10%. With all the drawbacks, are HMOs still worth the trouble? The answer: ultimately, yes; at the moment, maybe. (For tips on how to size up an HMO, see the box on page 115.) The concept is undeniably attractive. By paying hospitals and doctors under yearly contracts, rather than by fees per patient, HMOs can provide economical health care. In return, you agree to give up only one thing -- your unlimited choice of doctors. HMOs can save you money -- up to 28%, in fact, compared with traditional health insurance. Monthly premiums at an HMO average $232 for families and $87 for individuals -- about the same as standard insurance. The difference is that HMOs cover virtually all costs after that. Insurance almost always has deductibles and requires you to pay a percentage, generally 20%, of most bills. Sounds fine, but then come the complications. In order to contain costs, HMOs may make you wait longer for an appointment with a doctor, discourage you from entering a hospital, and limit the number of tests and other services you receive. Though the charge is sometimes made that HMOs offer inferior care, recent studies by the Rand Corp., a Santa Monica, Calif. think tank, and Hewitt Associates, an employee-benefits consulting firm in Chicago, show that subscribers receive high-quality care and are content with services. In fact, in a 1986 study, Harvard researchers found that non-HMO physicians tend to overprescribe medical services by as much as 50%. Of course, not everyone is happy with a system of medicine with limits. If you object to anything less than lavish health service, an HMO isn't for you. Yet it is far from an all-or-nothing choice. The original HMOs, and those that still tend to be the most successful, employ only salaried staff doctors who work together under one roof. Later came the independent practice association, which is now the format of the majority of plans. In this type of HMO, doctors in private practice agree to treat some HMO members in their offices along with their regular fee-paying patients. The catch: doctors in private practice have a weak incentive to control costs, since their reimbursement from HMOs is usually a small portion of their income. Until the mid-1980s, failures to contain costs and control doctors were covered by rising revenues from new members. Then, as the market became saturated, the red ink began to flow, with no prospect of stanching anytime soon. At worst this means that subscribers lose insurance coverage when their HMO ( goes bankrupt. Federal law provides the subscribers with the slimmest protection: newly defunct HMOs must continue to provide coverage for one month (six months for Medicare recipients). After that, patients must transfer to other insurance. And coverage can be interrupted for months before a switch is completed. Government supervision hasn't been much help either. About half of all HMOs have qualified with the Health Care Financing Administration, which administers Medicare, to take Medicare patients. Such an HMO is expected to follow a list of rules. For instance, it must carry insurance in case of insolvency to cover subscribers' outstanding medical bills and the cost of completing treatment that is already in progress. The HMO must also include clauses in its contracts with doctors and hospitals proscribing them from seeking payments directly from patients if the HMO cannot pay its bills. No one knows how many federally qualified HMOs live up even to these standards, because the number of government auditors is too small to guarantee compliance. Indeed, stories abound of impatient doctors and hospitals dunning patients for money owed by their HMOs. And the biggest HMO failure of all time -- that of the International Medical Centers in Florida early last year -- involved a federally qualified chain. The 170,000 members of the bankrupt HMO went back on Medicare or, with government help, found new HMOs to join. HMOs that don't qualify for Medicare patients are subject only to state supervision. Every state but Alaska, Hawaii, Oregon and Wisconsin has laws that call vaguely for a sound financial plan as a prerequisite for the approval of a new HMO. Unfortunately, many of the regulators' assumptions about what it takes to maintain services -- and therefore solvency -- have been confounded by massive losses and zooming medical costs. Yet only five states (Alabama, Illinois, North Dakota, Utah and Wisconsin) have established guaranty funds to pay the outstanding obligations of a closed-down HMO, assuring that patients will not be dunned for bills. Even this has caused an outcry among HMOs, which would be assessed to contribute to the funds. Their objections: that well-run plans would wind up subsidizing the mistakes of poorly run ones. It is anyone's guess when HMOs will be up and about again. In the meantime, setbacks of varying size are bound to continue, bringing inconvenience and expense to many people. For example, the Honeywell Corp. in Minneapolis & abruptly discontinued its nine-year-old HMO option last fall. The company cited its inability to get accurate data from the HMOs on how premium money was spent. Employees whose health bills were fully covered under the HMO option now have no choice but to pay 20% of medical bills up to a maximum of $1,000 for their own expenses and up to $3,000 for family members. Though no subscriber is immune to trouble when an HMO gets into financial difficulty, individuals and the elderly are particularly vulnerable. Some 18% of the 161 HMOs that accepted Medicare subscribers in 1986 decided that government reimbursement was inadequate and refused to sign up these older members again in 1987. That forced 53,000 of them to find new HMOs or return to their more expensive and less comprehensive regular Medicare coverage. Take the case of Martha Cohen, 63, of Hobe Sound, Fla. and her husband Max, 65, a former carpenter. The Cohens, who are retired, were individual subscribers to United American Health Care, a local HMO. When Martha's cervical cancer was diagnosed in February 1987, the couple were comforted by the fact that at least all her medical bills would be paid for by their $173 monthly premium. It didn't work out that way. American Health Care closed last summer because of insolvency. Most of its 13,500 former members were offered Blue Cross/Blue Shield coverage, but insurers shunned Martha because of her cancer. Eventually, the state found a carrier to cover her -- for $8,000 a year. That's more than 40% of their annual income of $19,200. ''We never owed money,'' says Max. ''Now we're in hock.''

BOX: Check It Out Diagnosing an HMO

While you have no control over which HMO your employer asks you to join, you usually get to say yes or no to the offer. An HMO representative's answers to these questions will help you take the pulse of the plan: -- How long have you been in business? Considering this industry's manifold ills, experience is critical. Two or three years of operation is adequate. If less, the sponsor should have other experience in the field. -- How well do you work with the doctors and hospitals you contract with? Don't take the HMO representative's word for it. Ask for a list of the doctors' phone numbers. Find out how long they've been with the HMO and how happy they are with it and with its hospitals. Patient confidentiality will prevent HMOs from giving you subscribers' names. But if you know of any, ask * them how they like the services they receive. -- How long do subscribers stay in your plan? Ask for the percentage turnover each year. Anything higher than 30% suggests trouble. If you are told that the organization doesn't keep those statistics, be skeptical. Says Erling Hansen, general counsel to the Group Health Association of America, the HMO trade organization: ''You measure what you care about.''