In October, Bloomfield, Conn.-based health insurer Cigna Corp. announced that it would pay $3.8 billion to acquire HealthSpring Inc., a Nashville, Tenn.-based publicly traded health plan focusing exclusively on Medicare recipients. The deal, which closed Jan. 31, marks a swift ascent for Herbert Fritch, who 12 years ago paid $1 million to acquire half of what was then a hemorrhaging health insurance plan.

Today HealthSpring looks pretty healthy. The company has 340,000 Medicare Advantage members -- senior citizens choosing HealthSpring rather than the federal government to administer Medicare benefits -- in 12 states and Washington, as well as a national standalone Medicare prescription drug business with more than 800,000 customers. The company generated Ebitda for 2010 of $366 million with net income at $197 million.

Fritch's story casts a light onto a large, increasingly important, if dauntingly arcane, area of health economics: the continuing struggle to rein in medical inflation, particularly in the government's Medicare program for older Americans. Fritch has carved out his career in a related area: with private Medicare insurance that's driven by the cost-restraining capabilities of the so-called physician-focused, managed-care model, which, simply put, means using physician practices to keep patients out of hospitals, thus reducing costs.

In practice, HealthSpring creates financial incentives for managing patients' chronic conditions, providing preventive care and applying evidence-based medicine. Savings are then reinvested into primary-physician practices to provide additional resources, like extra office nurses or better IT systems.

HealthSpring says its model has reduced hospital admissions by 12% and slashed emergency room visits by 26%, and through preventive care has increased vaccinations for influenza by 100%, diabetic foot exams by 312% and mammograms by 72%. It also maintains that it is more efficient than the traditional Medicare program, providing the same service for 20% less than the federal government.

Still, it hasn't been easy as the landscape in healthcare continues to shift. Fritch's career is testimony to how the federal government can make or break companies. And even now, the risks and uncertainties remain formidable.

In 2000 when Fritch bought Health-Net, a Nashville-based hospital-owned health plan, later renamed HealthSpring, from a local hospital, he had a difficult time finding investors, since Wall Street had soured on both aspects of his business model, independent physician groups and Medicare Advantage. Nashville-based PhyCor Inc., a publicly traded physician management organization, which had already acquired an earlier Fritch enterprise, was imploding, as was its chief rival, Birmingham, Ala.-based MedPartners Inc. Medicare Advantage fell from favor after the federal government slashed reimbursement rates to private health plans.

Then everything changed. George W. Bush was elected president, and Republicans took over Congress. This facilitated passage of the Medicare Prescription Drug, Improvement, and Modernization Act in 2003, which encouraged senior citizens to enroll in Medicare Advantage by paying additional money for additional benefits, such as vision, dental and prescription drugs.

Current GOP presidential hopeful Newt Gingrich captured the sentiment of the time when he declared that the agency overseeing Medicare would "wither on the vine" as senior citizens opted for better-funded private plans.

Fritch's timing was impeccable. An article published in the journal Health Affairs says Congress' objectives for Medicare Advantage have shifted between improving quality, reducing government spending, providing additional benefits, increasing choices and providing competition for traditional Medicare, depending on the party in power. But for Fritch the objective has always been the same: to create more benefits by managing care. It's a very different approach from the federal government, which pays providers a fee for a service rendered and does minimal care management.

Today the industry appears to be at another crossroads. About 24% of Medicare beneficiaries, some 11.4 million, are enrolled in the program. But the Congressional Budget Office forecasts another major exodus from Medicare Advantage, predicting that history will repeat itself as health plans respond to the Patient Protection and Affordable Care Act of 2010, which slashed reimbursement rates in an attempt to even the playing field between private plans and Medicare. Wall Street analysts, on the other hand, still see Medicare Advantage as a growth business, a bright spot for private insurers likely to be squeezed by healthcare reform. Cigna's acquisition of HealthSpring was the largest transaction in a series of deals in which Medicare Advantage plans were bought by large insurance companies.

For Cigna, which had no meaningful Medicare Advantage business, buying HealthSpring was a means to get into that market, but the deal is more than a bet on that. Cigna is going to try to integrate HealthSpring throughout its organization by offering HealthSpring-like services to employers as an alternative to its current products and by using the model to design products for customers buying health insurance on exchanges introduced by the Patient Protection and Affordable Care Act.

Having a delivery model that emphasizes coordinated care between different providers is viewed by the healthcare community as an essential way to reduce spending. The stakes are high. The federal government needs to shave trillions off the national debt, paring down so-called entitlement programs such Medicare, Medicaid and Social Security. Meanwhile, private insurers are struggling with double-digit medical inflation.

Fritch still thinks he has the way to restrain costs: "We believe that if you're going to produce better outcomes at lower cost, which everyone agrees is the goal, it is really hard to do that without more structure in the delivery system and more accountability and incentive alignment with physicians."

"Herb has three passions -- animals, hockey and healthcare," declares Shawn Morris, an executive vice president at HealthSpring, who has worked closely with Fritch for over a decade. "He is not doing this for the money; he really wants to fix a broken system."

Not that Fritch, 61 and a grandfather, is exactly hurting. He walked away with almost $30 million after the Cigna sale -- a $3 million bonus to stay on and $26.7 million in equity. Fritch is the second-largest shareholder in the National Hockey League's Nashville Predators, investing about $7 million as part of an investor group that bought the then-money-losing team in December 2007. He also owns 400 acres of Tennessee farmland, where he has his own private animal park, plus exotic fish, eels and seahorses in a 2,500-gallon aquarium.

Fritch has been in healthcare for nearly four decades. He was born and raised in Duluth, Minn., and graduated with a math degree from Carleton College in Minnesota in 1973. He then joined up-and-coming actuarial firm Milliman & Robertson, today known as Milliman Inc. Richard Nixon had just signed the Health Maintenance Organization Act of 1973, a bill sponsored by late Massachusetts Sen. Edward Kennedy that provided grants and loans to start and expand HMOs, which were seen at the time as a way of curbing medical inflation.

Physician groups, insurers and hospitals hired Milliman to analyze the feasibility of their HMO proposals. Most of these projects were underfunded, which is why they were pawned off on an actuary just out of school. But Fritch developed an expertise and a following. "After a while, I just got to be a little bit of a frustrated consultant and said if anyone could take best practices that I am seeing in a lot of different places, this thing could really succeed."

In 1982 Fritch co-founded, with a former client, New York-based Sanus Corp. Health Systems. After five years, they sold Sanus to New York Life Insurance Co.; the unit was later sold to Aetna Inc. Four years later Fritch went to work in Southern California for Inland Health Plan, also run by a former client.

California was a unique healthcare market and foreshadowed future trends in the industry. Kaiser Permanente had pioneered an HMO model that employed physicals and preventive care and had become a dominant player in some large California markets.

"When I started in the 1970s working with a lot of California physician organizations, they were doing peer review and utilization programs with Blue Cross," says Fritch. "They were doing all these things for efficiency that I didn't see anywhere else in the country. Initially, I couldn't figure it out. The reason is that if they didn't do it with Blue Cross, they would lose all their patients to Kaiser. That competitive environment didn't exist in most other markets."

That didn't mean physicians looking to do capitation -- charging a set amount of money per person rather than billing for each service -- were necessarily efficient. Several physician groups asked Inland if they could receive a capitated payment. A year and a half later, several of these groups went bankrupt. "They really hadn't done anything differently," says Fritch, adding that the groups lacked actuarial expertise to calculate reserve levels and develop performance data.

Fritch realized an opportunity lay in working with doctors. He put these ideas in practice in Hemet, in the heart of Southern California. There a hospital-run health system had found itself stuck with a global capitated payment it couldn't manage. Fritch brokered a deal between the plan, which was administering to 9,000 Medicare beneficiaries, and local providers. Key aspects of the HealthSpring model began to emerge. Doctors helped create a network, and he paid bonuses based on performance. Under Fritch, the plan produced a $3 million surplus.

In 1987, Inland Health Plan was bought by Las Colinas, Texas-based Partners National Healthplans. From 1988 to 1991, Fritch served as a regional vice president for Partners, where he was responsible for oversight of seven southern HMOs.

In 1991 he launched his own company, North American Medical Management Co., in Dallas, replicating his physician-driven model. He boot-strapped the company, taking no salary for two years. When PhyCor bought NAMM in 1995, the company managed 250 independent physician associations in 30 markets. Fritch moved to PhyCor's headquarters in Nashville and served as vice president for managed care.

PhyCor was something of a Wall Street darling. Founded in 1988, its stock hit almost $40 a share by 1996. The idea was to buy clinics from physicians with cash and stock, then manage their practices. Disaster ensued. The company overvalued its assets, then defaulted on its debt covenants. The stock crashed. Meanwhile, some of the physicians resented interference from the company and sued to get out of their 40-year contracts. The company declared bankruptcy in 2002, though NAMM's old assets were not included in the case.

In the wake of PhyCor's demise, physician-association viability was widely questioned. Still Fritch decided to resurrect what he had begun at NAMM. He believed the idea of physician networks was inherently solid and that PhyCor's problem stemmed from a bad operating model. The company had relied on fee for service, just like the physicians contracting with Inland, instead of actively managing care. So he set out to find an inexpensive health plan no one else wanted.

He discovered HealthNet, a Nashville-based health plan owned by Baptist Hospital that was losing money. Fritch served on its board of directors. When the plan violated its debt covenants, the board told management to either sell the business or shut it down.

Fritch had difficulty persuading investors to buy into his plan. No venture fund read beyond his initial statement of his business plan, he says. He tapped friends and family, but even they were unconvinced. "When I woke up in the morning, I wasn't sure I had enough money to do it," he says. His goal was to raise $2.5 million. He ended up buying half the plan for $1 million, investing some of his own money. Several years later he used about $5 million in operating surpluses to buy the rest of the company from the hospital. By then it was operating at a profit.

Fritch's fundraising difficulties had a lot to do with passage of the Balanced Budget Act of 1997, which cut reimbursement rates for health plans administering Medicare and tried to close a big loophole. Before the act, many health plans cherry-picked the healthiest patients. Plans sometimes recruited healthy-looking senior citizens in parks or placed their office on the top floor of walk-ups to discourage the unhealthy, one private equity investor says, adding that the program had "been out of control."

After the Balanced Budget Act was enacted, many private health plans dropped out of the program, and fewer seniors signed up for private plans. Enrollment fell from 7 million in 1999, about 18% of total Medicare beneficiaries, to 5.3 million by the end of 2003, or about 13%, according to a December 2004 article in Health Affairs.

In this environment, Fritch promised investors he would make the company profitable within four months of closing the deal in September 2000. He set about renegotiating rates with hospitals, providing incentives for a different group of doctors and reducing benefits. Since many companies bailed out of Medicare Advantage, there was only one other health plan catering to Medicare beneficiaries in middle Tennessee, and it folded in January 2001. HealthSpring picked up its client base.

In November 2000 Fritch went to PhyCor and bought back what was left of the physician association in Houston, which he considered to be NAMM's flagship operation, for $200,000. The association had basically gone out of business, but many of the doctors had retained relationships with Fritch and asked him to return to reorganize the group. From 2002 through 2006, Fritch expanded HealthSpring into Alabama, Illinois and Mississippi, looking for underpenetrated markets, usually in urban areas.

Everything changed with the passage of the Medicare Modernization Act of 2003. Reimbursement rates rose to a point where they actively favored private plans over the traditional Medicare program. The act introduced a drug component to Medicare, which became another weapon in private plans' arsenals.

Traditional Medicare had become a complex proposition, requiring seniors to sign up for several different programs: Medicare Part A, covering inpatient hospital costs; Part B, covering doctor visits and outpatient care; and Part D, covering prescription medications. (Part C covers seniors in the Medicare Advantage program.)

Private plans could incorporate all three aspects of the plan into one offering, reducing the complexity. Plans could also register to provide prescription drugs to beneficiaries in the traditional Medicare program. The all-encompassing nature of the private plans made them appealing to less affluent seniors, who couldn't afford to pay for supplemental coverage and enjoyed the additional benefits, like dental and vision.

Participation in private plans soared. Medicare enrollment went from 5.3 million beneficiaries in 2003 to just over 10 million in July 2008 -- almost 23% of all beneficiaries were enrolled in Medicare Advantage, according to data published in Health Affairs. Investors piled heavily into the industry.

Fritch noticed the trend after a rival had been sold for a very high multiple and decided to attempt a leveraged recapitalization. In November 2004 GTCR Golder Rauner LLC recapitalized HealthSpring in a deal valued at $438.6 million. The Chicago-based private equity firm invested $139.7 million in equity. The proceeds from the buyout were used to pay back angel investors and provide working capital. It was the first time HealthSpring had taken on debt.

GTCR's investment was short-lived. Within a year and a half, HealthSpring launched an initial public offering, which raised $367 million and priced the company at 19.5 times earnings. The sponsor made a fourfold gain and exited. The company used the proceeds to repay debt. Fritch didn't sell any of his shares. "The stock price dropped significantly after that," he says. "We were fighting to get back to that [IPO] level for most of our history as a public company."

With Medicare Advantage plans suddenly attractive, and competition increasing, growing organically became more difficult. As Fritch says, "[E]veryone and their brother" started entering the industry, leaving few markets untouched. HealthSpring looked around to acquire critical mass. In August 2007, the company paid $355 million to buy Leon Medical Centers Health Plans in Florida's Miami-Dade County, adding about 25,700 member.

Still, the Obama administration's Patient Protection and Affordable Care Act of 2010 seemed to take away many benefits that the Medicare Modernization Act had bestowed. Its goal was to achieve pricing parity between private Medicare plans and the traditional system, focusing on regional disparities and weighting reimbursement accordingly. The government hoped to save $131.9 billion over 10 years by paring down Medicare Advantage, wrote Barclays Capital analyst Joshua Raskin.

When the federal government first proposed the cuts, HealthSpring's stock crashed, tumbling 74% from $19.88 on Feb. 6, 2009, to $5.23 on March 6. Nonetheless, HealthSpring managed to boost its Ebitda margins from 7.8% in the first quarter of 2009 to 10.9% in the first quarter of 2010, wrote Stifel, Nicolaus & Co. analyst Thomas Carroll.

For Fritch, one of the biggest implications of the Obama bill was the need to use scale to create efficiencies and comply with new government oversight. Part of the new act requires a plan to submit quality data to the government and comply with new standards to receive higher government rebates.

On Aug. 26, 2010, HealthSpring acquired Baltimore-based Medicare health plan Bravo Health Inc. for $545 million. The merger made HealthSpring the largest standalone company in the U.S. focusing on Medicare Advantage. When the acquisition was announced, Fritch said in a statement that it demonstrates "our commitment to Medicare Advantage and our confidence in the long-term future of the program."

The Bravo deal set off a wave of acquisitions for Medicare health plans. Humana Inc. paid $790 million for Addison, Texas-based Concentra Inc., a privately held healthcare company, in December 2010. Humana acquired two other Medicare health plans, Arcadian Management Services in August and MD Care Inc. in January. In August, WellPoint Inc. acquired CareMore Medical Group Inc. for about $800 million. In November, UnitedHealth Group Inc. bought XLHealth Corp. for about $1 billion.

Rather than stymie the industry, the general consensus among analysts is that the Medicare segment is likely to grow. Barclays' Raskin forecasts long-term revenue growth of 7% through 2019.

Fritch insists that he was not shopping the company when Cigna approached him in May. In July, the company hired Goldman, Sachs & Co. and Skadden, Arps, Slate, Meagher & Flom LLP as its outside advisers. Five companies showed interest in HealthSpring, according to the proxy. Cigna ended up buying the company for $55 a share in an all-cash deal, a 37% premium on the closing price of $40.16 on Oct. 21, the last trading day before the deal was announced. The overall deal value was 7.6 times enterprise-to-Ebitda value for the 12 months ended June 30.

"We were always skeptical that someone would buy us for the membership and the Ebitda, and then integrate us and destroy the model," says Fritch. He believes, however, that Cigna will allow HealthSpring to maintain "integrity in what we built, allowing us to go faster and flourish."

The acquisition gives Cigna a significant stake in the Medicare business. Previously, the insurer had a sliver of the market, about 44,000 members. "Prior to the transaction, we viewed Cigna as being out of position in the most attractive growth area in managed care," wrote Susquehanna Financial Group LLLP analyst Chris Rigg.

Cigna also has the capacity to fund future acquisitions. Fritch says he's keeping in touch with several smaller regional Medicare plans. Cigna's commercial business could also act as a feeder into HealthSpring's commercial business. Sharing IT and patient data will improve the company's analytical capabilities, says HealthSpring's Morris, noting that the same group of physicians and clinics could be used across different product lines from employer-based products to Medicare plans. HealthSpring operates 13 clinics across the country.

Some of the most interesting part-nerships between the two organizations may be in developing new coordinated models in markets where the government has a heavy hand, such as insurance exchanges born out of healthcare reform or even Medicare accountable-care organizations, or ACOs, where quality measures and integration are paramount.

HealthSpring is also talking to various hospitals about formatting ACOs, says Morris, adding that the talks are occurring where there have been successful physician associations. This is a second take. HealthSpring tried working with hospitals in the '90s, but found that doctors influence behavior patterns more than hospitals, says Fritch.

HealthSpring's physician-group model may also be applicable to caring for subsets of the population, such as Medicare and Medicaid enrollees. HealthSpring has been active in the latter sector recently. On Aug. 5, the Texas Health and Human Services Commission selected HealthSpring to provide managed care for aged, blind and disabled Medicaid patients in the Hidalgo Service Area.

But even as Medicare health plans are absorbed by major insurers, the rules governing them remain in flux. Analysts argue that there still isn't enough data to know for sure if managed-care organizations lower cost and improve quality. They maintain that private plans can still favorably select patients, choosing only the healthiest people, and that the plans' funding has never reflected the true cost of care.

Meanwhile, Republican leaders such as House Budget Committee Chairman Paul Ryan believe private health plans are a key instrument in reducing deficits and reshaping Medicare. Ryan's plan would change Medicare from a defined-benefit plan to a defined-contribution plan, meaning that the government pays a set amount toward the cost of private health insurance for each enrollee.

"That is one of the challenges we deal with. Depending on who is in power you get pretty broad swings," says Fritch. "Arguably, [the Medicare Modernization Act] passed under a Republican administration, may have gone too far to pay too much. I think Obamacare is just the opposite. It's OK for the first couple of years, but arguably cuts too deeply in the future. If Republicans get back in, it may all change, and the Ryan plan would be a huge boost for the amount of members going into private plans." In short, the turbulence in healthcare isn't over yet.