At Psilos we have been predicting the oncoming wave of consumerism in the health insurance market for sometime, and for that matter we have invested behind our beliefs. But over the last couple of years it occurred to us that it may not be exactly clear what this reality means for insurance companies. This is the subject of this year’s Outlook, titled: A Race to Embrace the Consumer Business Model: Insurance companies must change or face obsolescence.
In our 2011 Outlook we wrote the following: “Psilos believes that the PPACA [a/k/a Obamacare] will accelerate sweeping changes to consumer-oriented business models and distribution channels, as well as increase the competition among insurance companies… These changes are already beginning to occur, but they will accelerate rapidly post- 2014 [emphasis added], when the number of Americans shopping for their own health insurance will increase exponentially at the expense of the current model, in which most people either have their health insurance provided to them by their employers or simply remain uninsured.”
Post-2014 is now upon us, and it would seem that we are in the midst of much of what we predicted three years ago.
To us the most interesting question for investors in the HCIT and services space is exactly how will insurers adapt to the new reality. And so this is the focus of our 2014 Outlook.
The fact is that insurers are not set up as a business to service individual consumers, especially the version of the individual consumer that is born from our current information age, where almost any transaction and piece of relevant information is available to us at will, through the internet and on our mobile devices: except of course our health insurance and our healthcare information. Why? Because the infrastructure of the industry is not set up to service individual consumers, in large part because those consumers have not historically been a primary customer; however, they are now.
Our report takes a broad Michael Porter-esque view of the insurance company value-chain, which today is set up to service their employer customers, and argues it must be completely re-thought and re-engineered to service individual consumers. Within these changes lie ripe opportunities for investors, and those insurance companies that successfully establish a value-chain built for the consumer business have the opportunity for material gains in market share and profitability.
You can read through the entirely of our report here.
If you find it interesting, which I think (hope) you will, I would love some feedback.
Many members of my family, and probably some of my close friends, think I am something akin to a stock broker (not that there is anything wrong with that). In truth, I am on the private investment side of things, often selling investments to public companies, but not actively investing in publicly traded healthcare stocks.
Recently David Whelan, a reporter for Forbes magazine, took an interest in Psilos’ healthcare investment strategy and he asked me to apply that strategy to public company stock selection.
Here is a link to David’s Forbes article that discusses five stock picks, companies that, as David points out, compare nicely to some of Psilos’ private investments. Invest at your own risk!
It’s been a while since I’ve written, and my excuse is typical, I’ve found any number of work projects overwhelming my time to sit, and write, and blog. One such project was the composition of Psilos Group’s 2011 Outlook on Healthcare Economics & Innovation, which I put this together with one of my business partners (and awesome blogger) Lisa Suennen (you can check out Lisa’s blog, Venture Valkyrie, here, where she proves to be a much more consistent correspondent than yours truly).
For those of you that come to these pages for the pop-culture commentary (more to come on that too, I promise), you may note that I manage to get a few words in on healthcare and investing, and after all, this is what I spend the majority of my time on. With that, the Psilos Group report outlines what we see as some of the most significant impacts on healthcare investing of the implementation of the new health reform law.
Chief among these are:
The reality that we should expect a doubling, and potentially a tripling of the individual health insurance policy market, which will result in a dramatic shift in the relationship between insurers, employers and consumers. In many cases, employers will simply stop buying group health insurance, leaving the consumer to directly purchase coverage (partially or fully funded by the employer) on their own through a newly established public or private health insurance exchange.
Health insurance plans will have to become superior consumer marketing and service organizations to thrive and survive, acting more like Starbucks or Apple if they are going to expand consumers’ trust in their brands and grow while their sales process evolves from a primarily business-to-business market towards a much larger business-to-consumer market.
Health plans will have to proactively manage clinical and financial risk through active care coordination for those with chronic illnesses. This dovetails with the need for such organizations to make a quantum leap forward in their commitment to utilize modern information technology to change their business dynamics.
Provider organizations who seek to become Accountable Care Organizations will have to learn to think and act like next generation insurance companies (financially, clinically, technologically) to avoid becoming a repeat of yesteryear’s physician practice management debacle.
If these subjects are of interest to you, the entire Psilos 2011 Outlook on Healthcare Economics & Innovation can be found by clicking HERE. Let me know what you think.
I assume President Obama is going to spend at least some time in his state of the union speech talking about the budget deficit, and maybe even the notion of balancing the budget. It was something that was done before, long ago, in the Clinton administration. Today, polling results indicate that most Americans want Congress to balance the budget without tax increases, i.e., with spending cuts, except most Americans do not want to see significant cuts to Social Security and Medicare. However, it just might be that this proposed combination – a balanced budget with no tax increases and no cuts to Social Security or Medicare may be impossible.
I have been looking at Diabetes data lately and thought I would share with you some of the more interesting statistics, coming from multiple sources, but still underscoring the phenomenon that we are on the front end of a diabetes epidemic in the US.
Like the rolling credits at the end of a film, here we go.
By 2020 an estimated 52% of the adult population of the US will be either Diabetic or Pre-Diabetic.
% Adults
Diabetic
Pre-Diabetic
Total
Today
12%
28%
40%
2020
15%
37%
52%
Health spending on Diabetes and Pre-Diabetes costs about $194 billion today (around 7% of total healthcare expenditures) and is expected to increase to $500 billion by 2020 (at least 10% of total healthcare expenditures).
Most people with Diabetes are diagnosed between 4-7 years after they become diabetic.
90% of pre-Diabetics and 25% of Diabetics are not aware of their condition.
Type-2 Diabetes represents 95% of all diagnosed cases.
The prevalence of Type 2 Diabetes has tripled since the 1980s (causes are believed to be due to the aging population, the longer lifespan of diabetics, and the increase in the prevalence of obesity)
The average annual medical costs for diabetics in commercial insurance plans tends to range from 1.8x-4.7x ($7,800-$20,700) the average annual cost of the remaining members of an insured population (around $4,400).
The average cost for diabetes increases significantly (into the 4.7x category) depending on complications, the most common being hypertension, the others being cardiovascular disease, including peripheral artery disease (PAD), and kidney failure.
Diabetes is the leading cause of blindness in working age people and a major source of Fetal and Maternal mortality during pregnancy.
$1 in $4 Medicare dollars go toward the treatment of Diabetes.
Diabetics use 4-6 times more medical services than non-diabetics.
Diabetics have an average of 23 contacts/year with physicians.
Utilization of physician services by Diabetics is increasing at around 30% per year.
He’s a new character played by Dean Winters in a recent run of pretty-damn-funny Allstate commercials. Check this one out (< 30 seconds).
You see, before you (the driver) caught sight of the hot babe in the awesome pink headband you needed adequate property and casualty insurance to protect you from the distraction that caused you to drive into that light pole. However, in the immediate moment after you drove into that light pole, you did not need insurance, because its cost would have been exactly equal to what you really need, which is a new car. Insurance is valuable to youbefore you run into Mayhem when its price (the insurance premium) is considerably less than the consequences of Mayhem, or in this case, the cost of a new car.
The cost of insurance is much less than the cost of Mayhem because of pooled risk. Lots of other easily distracted drivers bought car insurance too but most of them managed to veer away from the light pole at the last-minute, avoiding damage, thus providing you with a pool of funding to buy a replacement car after the accident. Pooling the risk of low-probability high-cost events makes insurance a very valuable product for all purchasers in their effort to protect themselves against Mayhem.
In the health insurance market Mayhem represents the possibility we might get sick, which we know can be very costly. Very good drivers can drive into light poles. Similarly very healthy people can require health insurance to pay for unexpected costly medical procedures. But either way, the fact that the costs are unexpected makes an event insurable at a price significantly less than the cost of the event.
Someone who is sick and is not insured does not need health insurance; they need to be provided with healthcare. Including someone who is already sick in an insurance pool is the same as including you in an automobile insurance pool after you drove into the light pole. The event is no longer unexpected, and so your individual premium, which is the cost of your new car, will be spread among the members of the insurance pool, the economic equivalent of your passing a hat around and collecting enough money to pay for your car – in this instance you are not being insured, you are being subsidized.
A type II diabetic with health insurance that covers the costs associated with diabetes is being both insured for the incidence of diseases other than diabetes and subsidized for the known costs associated with diabetes.
Continuing with our property and casualty analogy, consider flood insurance. There is a much higher probability of Mayhem occurring at a property located on a riverfront than for a property located on a hilltop miles from the water, and, as such, it costs much more to purchase flood insurance for riverfront property. I wonder, is this fair? Would we all stand up for a homeowner’s right to live by the river and insist that the unit price for all property insurance be the same regardless of where the property is located? If we did the cost to insure waterfront property would reduce and the cost to insure the hilltop property would increase, effectively subsidizing riverfront home ownership. Now, is that fair? If we were to subsidize anything shouldn’t we instead subsidize safe behavior, a la, living away from water and well above sea level?
A seemingly healthy person with an unhealthy lifestyle that receives health insurance at the same price as people with healthier lifestyles, as is typical in most Group Health insurance models, is being subsidized for the higher probability of Mayhem.
Insurance markets, left to their own devices, are awesome at pricing risk and incentivizing safe behavior (we all know your premium is going up after you file your auto insurance claim for driving into that light pole). However they (insurance markets) don’t handle subsidization well at all. If subsidization is going to be required, then it must be structured by forces outside of the insurance market.
The Group Model of health insurance, which is used in the market for corporate-based insurance, is one such structure. If you work for a corporation and you are receiving a health insurance benefit from your company, you most likely pay the same per member cost as everyone else at your company. This is done by pooling both the risks and the subsidies.
Clearly the pooling of subsidies creates fertile ground for Moral Hazard, a phenomenon discussed frequently here, but curiously left out of much of the discussion regarding the problems of health insurance, particularly when the subject is healthcare reform. Healthcare reform claims to be insurance reform, but in fact insurance is insurance – if you have a pre-existing condition you cannot be insured for it because it is already there (your car has hit the light pole). At the public policy level “healthcare insurance reform” as it is defined within PPACA, is the regulation of the portion of health insurance that represents subsidies and their funding.
All other things equal, an increase in the probability of Mayhem (more unhealthy people) and the expansion of subsidies into the insurance pool (the insuring of more sick people) will cause proportionate increases in health insurance premiums. On this basis alone, the provisions of the health reform bill are unquestionably inflationary w/r/t insurance premiums. Count on it.
As a greater portion of insurance premiums represent subsidy, the role of the health insurer has to change from one of underwriting risk, i.e., pricing the probability of Mayhem, to managing risk, i.e., working to reduce the cost of known conditions within the insurance/subsidy pool, the latter requiring a substantially different set of skills than the former. This transformation of the health insurance industry was already under way prior to the passage of PPACA (our healthcare reform law), as corporations began requiring risk management programs from their insurance companies. Without this transformation, healthcare inflation is destined to sustain at its current levels, probably for eternity, or at least until the increases in the prevalence of chronic illnesses and the probability of Mayhem achieve some steady state, which with the baby-boomers now reaching 65 years-old will not occur anytime soon. Regardless of who “pays” for the insurance/subsidies the costs of healthcare are going up, up, up, until the system shifts toward a structure where patients, payers and providers are economically accountable for managing risk.
A super-enormous spending bill gets press attention, so I’ve been talking with the media these days (1) regarding recent health insurance premium rate increases following the enactment of health reform, which is estimated to cost approximately $250 billion per year once fully realized. While rate increases by Aetna and certain Blue Cross and Blue Shield plans correlate with the recent passage of health reform, it is hard to believe health reform is the cause, at least not entirely. The fact is that health insurers have been raising premiums at hard-to-believe rates for well over a decade. The primary cause then and now is runaway healthcare inflation. It is true that for the most part insurers, like any other business, look to maximize profits, but most markets for health insurance are extremely price competitive. Generally it is the increase in expected medical expenses that drive rate increases, and unfortunately demand for medical care has been increasing at approximately 3x the rate of general inflation. From what I can tell this will continue forever until fundamental structures in the healthcare system change, so expect ongoing rate increases from insurers to persist, despite the political pressure.
A recent study by the Kaiser Family Foundation, while subtle in its presentation, is astounding in its exposition of runaway medical inflation’s impact on health insurance premiums. Take a look at the charts below.
From just this small amount of data it is clear that health insurance premiums have been sky rocketing for almost two decades. US inflation averaged 2.4% per year, while health insurance inflation has averaged 7.8% per year, with the brunt of this premium increase being absorbed by employees at an average rate of 9.5% per year. Wage increases have essentially kept up with inflation, meaning the annual disposable income of the average insured family, in real terms, was reduced by nearly $2,000 over the past decade as a result of medical inflation. W/r/t employers, their bills rose at 7.8%, about 3.25x their ability to raise prices. Result: employees and shareholders are getting squeezed.
Why so much medical inflation?
There are lots of little reasons that emanate from one major trend: we (the US and its medical profession) keep getting better and better at keeping people alive.
There are many definitions of the word “doctor,” the most relevant to understanding medical inflation being (from MWD – free version):
Doctor : (n) a person who restores, repairs, or fine-tunes things
Today there are an astounding number of ways to restore, repair and fine-tune humans. “Take two aspirin and call me in the morning” is all but gone. We now understand thousands of causes of the headache, from too much protein in the diet, to brain tumors, to meningitis, to stress, to something called Syringomyelia ($1 to the first reader that knows what this is, and no fair if you are Neurologist), and so on.
We now know so much that we are increasing exponentially the things that doctors can restore, repair and fine-tune, creating treatments for ailments, many of which were once life-threatening that are now survived regularly, leaving us with an older and sicker population that costs more and more to fine-tune every year. In short, much of our medical inflation is a symptom of our amazing technology and our wealth. Modern medicine, while an awesome exposition of human inventiveness, is slowly and steadily eating away at the more productive sectors of our economy that created the means for such inventiveness in the first place.
Will it end?
If the “it” is invention, the answer is clearly no. We will forever be extending our life expectancy and reducing the health and fitness levels necessary to achieve it. Medical invention will not be stopped.
If the “it” is medical inflation, the answer is not anytime soon.
Much of the healthcare chat on this blog, and that of my business partner Lisa Suennen, involves the many structural changes that must take place within the healthcare economy in order for medical inflation to come under control without the government resorting to over-reaching measures like rationing of care and reimbursement controls. Many changes are underway, and everyday we meet new companies designing new systems and technologies created to both reduce healthcare costs and improve quality. Unfortunately it will be many years, perhaps decades before the healthcare system begins to function primarily around a cost/quality paradigm. I would look for measureable changes in the following areas before expecting any meaningful downward shift in the medical inflation trends:
Patients evolve toward more active, cost and quality conscience consumers of healthcare and health insurance.
Insurers evolve to managers of health risk rather than pure underwriters.
Providers evolve their business models from a strict fee-for-service reimbursement model to a more pay-for-performance model, like most advanced industries (will doctors offer one-year warranties? – why not?).
Such an evolution spawns subsets of ideas like wellness, care management, value-based health insurance, healthcare information exchanges, insurance exchanges, provider pricing based on quality scoring, telemedicine, and on and on. I have been and will be discussing them all with the understanding that without meaningful progress medical inflation is here to stay. Expect it (healthcare inflation) to continue at about 8%, so in 5 years our average family will cost about $20,000 or more a year to insure.
The role of the health insurance company is changing rapidly, accelerated by many of the provisions in PPACA, including new regulations regarding Medical Loss Ratio.
What is Medical Loss Ratio?
One of the key tenets to healthcare reform is the requirement that health insurers maintain a minimum Medical Loss Ratio, which historically has been defined as the ratio of medical expenses to total insurance premiums (it should be called the medical expense ratio, but claims expenses in the insurance industry have been called “loses” since, well, forever, and hence the convention sticks). Insurers that fail to achieve a minimum MLR, expected to be somewhere in the range of 80-85% depending on whether the plan is large group (85%) or small group/individual (80%), will be required to provide a refund to policy holders.
Some numbers, please…
Suppose that in a given year a health insurer has 20,000 members that are charged an average premium of $4,800 per year ($400 per member per month or PMPM in industry parlance), equating to Annual Premium Revenue of $96 million per year.
If the regulated MLR is 85% the amount of money this health plan is required spend on medical expenses equals $81.6 million per year (85% of $96 million).
Suppose it turns out that medical claims actually equal $74.8 million or 78% of premium for that year. Prior to healthcare reform the excess $6.8 million would be considered profit for the health insurance company. Under reform the $6.8 million must be refunded ratably to the policy holders for that year, resulting in an average rebate of $340 per member ($6.8 million divided by 20,000).
If the opposite occurs and medical claims are $88.4 million (92% of premium), the insurance company covers the $6.8 million shortfall out of its capital (profits).
This brief, simplified example illustrates an important aspect of MLR regulation, it effectively eliminates any potential for unexpected upside to the health insurer for underwriting the risk. If the insurer does better than expected, i.e., the MLR is low, the excess profits inure back to the policy holders. This has similarities to the model of a mutual company, wherein the policy holders are actually owners of the company, without the downside of unexpected losses accruing to policyholders.
Purpose
The purpose of Minimum MLR is to regulate the “value” provided by health insurance companies. The theory is an insurance company provides greater value to its policyholders when a higher percentage of premiums is used for healthcare costs, versus, say administrative expenses or profits. By demanding a minimum MLR legislators and regulators believe they are protecting consumers from potentially uncompetitive or collusive insurance markets, among other things.
Issues Arise
This regulation presents a myriad of issues, some of which are actuarial, but most of which derive from the definition of Medical Expense. The exact components of Medical Expense are left to HHS to decide, but PPACA (specifically Sec.2718. BRINGING DOWN THE COST OF HEALTH CARE COVERAGE) does provide some guidance, declaring Medical Expense to be equal to (paraphrased): (i) reimbursement for clinical services provided to enrollees plus (ii) costs for activities that improve health care quality. It is very clear what (i) above means, i.e., the money paid for medical claims. It is in (ii) where the debate begins.
Defining “Costs for Activities that Improve Health Care Quality” will be left to the bureaucrats, and from what I can tell they are taking an open minded approach to the types of services that will be included. Over the weekend the Wall Street Journal published an Op-Ed piece by Newt Gingrich and David Merritt titled Who Decides on Health-Care Value? (New rules to micromanage insurance companies could cost patients). I present it to you not as a position that I support but rather as an introduction to the debate on this subject. Please give it a read (along with some of the comments, pro and con) and I will come back to this subject soon to take a look at some of its ramifications for investors in the healthcare sector.
VEBA stands for voluntary employees’ beneficiary association, a trust fund established solely to manage and provide employee benefits, including healthcare coverage. While VEBAs have been around since the 1920’s, they have been used sparingly, until recently, when several large, long-lasting industrial corporations have used them in employment negotiations with their unions as a way of fixing the value of future retiree healthcare benefits.
Explain?
In past decades most unions negotiated a compelling set of retiree healthcare benefits to cover many of the healthcare expenses excluded from Medicare. Over time the life expectancy of retirees has expanded beyond initial actuarial expectations and healthcare costs have grown at a rate in excess of overall inflation, resulting in enormous and unexpected costs for retiree medical, so much so that in the case of the US automotive industry these costs began to erode global competitiveness.
Over the past few years corporations including the large autos have been able to work with their unions to renegotiate the form of retiree benefits, converting from a “defined benefit” structure, where benefits are fixed and the costs vary depending on utilization and market prices, to a “defined contribution” structure, requiring the benefits to vary based on a fixed funding budget.
In the case of the United Auto Workers Union (UAW) this led the auto companies to establish and fund the UAW Retiree Medical Benefits Trust, which is, to my knowledge, the largest VEBA in the US, with a reported asset value of over $45 billion including large equity stakes in General Motors, Ford and Chrysler. According to press reports this VEBA is now responsible for providing life-long healthcare benefits for 800,000 retired auto workers and their spouses. This deal was cut in the face of a potential collapse of the US auto industry and it remains to be seen as to whether the VEBA has enough assets to fund its potential obligations to the union’s retirees.
Some numbers, please…
“We believe we’re saving our clients over $500 million each year while providing as good or better benefits for retirees. The group model is the evil here; it is a wildly inefficient way to deliver what is available via guaranteed issued coverage in the individual market” – Bryce Williams, CEO, Extend Health
Back in May I posted The Coming Age of (Health Insurance) Exchanges about, in part, Bryce Williams’ company, Extend Health, an operator of the largest private Medicare insurance exchange. The post provides a reasonable amount of detail on how an exchange works and why it should be expected to deliver more value for the healthcare dollar.
Recently, Employee Benefit News published Private Exchanges Have Potential to Breathe New Life Into VEBAs, an article that details the work of Extend Health in saving both corporations and its individual retirees healthcare costs through its exchange model where retirees over the age of 65 purchase individual Medicare Advantage and Medicare Supplemental insurance plans using funding provided by their prior employers. This results in 25%-40% savings to the corporations, an average of 30% savings in out-of-pocket costs to the individual retirees (about $500 per year) and a 96% retiree satisfaction rate.
Implications for the VEBAs?
Given the savings that Extends’s Medicare exchange model has generated for corporations, it only makes sense that it would make a useful tool for a VEBA, with a goal to extend the life of its funding as long a possible by earning a return on unused capital and purchasing healthcare for its constituents as efficiently as possible. Current data suggest that the exchange should create 20%-30% greater buying power for the VEBA’s over a typical Group Model.
You can read the Employee Benefit News article here and access my prior post on healthcare exchanges here.
Many members of my family, and probably some of my close friends, think I am something akin to a stock broker (not that there is anything wrong with that). In truth, I am on the private investment side of things, often selling investments to public companies, but not actively investing in publicly traded healthcare stocks.
A super-enormous spending bill gets press attention, so I’ve been talking with the media these days (1) regarding recent health insurance premium rate increases following the enactment of health reform, which is estimated to cost approximately $250 billion per year once fully realized. While rate increases by Aetna and certain Blue Cross and Blue Shield plans correlate with the recent passage of health reform, it is hard to believe health reform is the cause, at least not entirely. The fact is that health insurers have been raising premiums at hard-to-believe rates for well over a decade. The primary cause then and now is runaway healthcare inflation. It is true that for the most part insurers, like any other business, look to maximize profits, but most markets for health insurance are extremely price competitive. Generally it is the increase in expected medical expenses that drive rate increases, and unfortunately demand for medical care has been increasing at approximately 3x the rate of general inflation. From what I can tell this will continue forever until fundamental structures in the healthcare system change, so expect ongoing rate increases from insurers to persist, despite the political pressure.
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