UnitedHealth is bracing for a struggle next year with the financial effects of shifting Medicare Advantage payment rates.
The health insurance giant released 2024 guidance on Tuesday that included a number of less favorable metrics than analysts expected.
During the company’s investor day in New York City on Wednesday, UnitedHealth executives blamed the outlook on an MA rate change issued by regulators earlier this year that insurers slam as a payment cut.
Pressured metrics include slower MA membership growth, lower margins at UnitedHealthcare and a higher medical loss ratio. UnitedHealth forecast a 2024 MLR of 84%, a full percentage point higher than analysts’ consensus expectation.
Despite the MA headwind, UnitedHealthcare’s financial targets overall still came in in-line or ahead of analyst expectations.
MA rates ‘ripple’ through UnitedHealth’s 2024
UnitedHealth is a behemoth in the U.S. healthcare industry, with one of the largest pharmacy benefits managers, an expanding healthcare IT arm and a growing presence in care delivery, including a network of tens of thousands of physicians.
UnitedHealth is also the dominant health insurer in many markets, including in MA. The Minnesota-based company is the largest provider of the privately-run Medicare plans.
Management has said they expect their share of the market to grow as more seniors age into the government insurance program and select MA over traditional Medicare.
However, UnitedHealth is now saying that MA growth could be depressed next year thanks to a rate notice from the CMS that’s deeply unpopular with insurers.
Earlier this year, the CMS finalized MA rates for 2024 that regulators said should result in a 3.3% increase in revenue for health insurers in the program. The changes also include a new approach to risk adjustment meant to curb upcoding, a practice where insurers inflate their members’ sicknesses to get higher payments from the government.
However, insurers have said the changes, which are being phased in over the next three years, will result in a net decrease to MA revenue overall.
“That rate notice has a material impact in terms of revenues associated with our Medicare Advantage portfolio, and as you can see that ripples through the metrics of the organization,” CEO Andrew Witty said during UnitedHealth’s investor day.
UnitedHealthcare, UnitedHealth’s health insurance division, now expects slower Medicare revenue and membership growth next year than analysts expected.
UnitedHealth expects to add between 325,000 and 375,000 Medicare Advantage members next year, representing almost 4% growth at the midpoint — “well below our model,” commented JP Morgan analyst Lisa Gill in a note.
That’s compared to 11% membership growth year to date in 2023, according to CMS data cited in a TD Cowen note. Previously, UnitedHealth leadership said they expected to grow above the overall MA industry growth rate in 2024, so “this appears to be a disappointment,” TD Cowen analyst Gary Taylor wrote.
However, “we are not materially surprised to see the slower growth rate in 2024 given the changes with the risk adjustment,” Gill said.
Some payers have said the rate changes could force them to cut benefits in MA. Yet, UnitedHealth has spent the last six months reconfiguring its plans in response to the rate notice, looking for ways to contain costs without curtailing benefits, Witty said.
UnitedHealthcare should bring in about $303 billion in revenue next year, mostly driven by Medicaid upside, the company said. TD Cowen’s Taylor noted he was unsure why UnitedHealth forecast the Medicaid improvement, given Medicaid payers are shedding members as states recheck eligibility for the safety-net insurance coming out of the COVID-19 pandemic.
UnitedHealth thinks its Medicaid enrollment will drop by up to 200,000 members next year due to redeterminations, the company said.
Eye on Optum Health
UnitedHealth leadership devoted half of their investor day to talking about the insurer’s plans to expand value-based care arrangements — a “core objective” for the next several years, Witty said.
A key actor in striving for that objective is Optum Health, UnitedHealth’s care delivery network that’s under the umbrella of its health services business Optum.
Optum released stronger 2024 guidance than analysts expected. Much of that growth is due to better-than-expected margins for Optum Health, analysts said.
Currently, Optum Health has about 4 million lives in fully accountable payment arrangements — a number that’s nearly doubled from 2021, said UnitedHealthcare CEO Brian Thompson during the investor day.
Optum Health expects to add another 750,000 lives by the end of next year.
”You should expect us to grow that number substantially each year,” Thompson said. “Our long-term ambition is to transition as many people as possible into value-based care.”
Overall, UnitedHealth expects 2024 adjusted profit of $27.50 to $28 a share, largely in line with what analysts expected.
Expected revenue is $400 billion to $403 billion, higher than Wall Street consensus.
A new perspective on how technology, transformation efforts, and other changes have affected payers, health systems, healthcare services and technology, and pharmacy services.
The acute strain from labor shortages, inflation, and endemic COVID-19 on the healthcare industry’s financial health in 2022 is easing. Much of the improvement is the result of transformation efforts undertaken over the last year or two by healthcare delivery players, with healthcare payers acting more recently. Even so, health-system margins are lagging behind their financial performance relative to prepandemic levels. Skilled nursing and long-term-care profit pools continue to weaken. Eligibility redeterminations in a strong employment economy have hurt payers’ financial performance in the Medicaid segment. But Medicare Advantage and individual segment economics have held up well for payers.
As we look to 2027, the growth of the managed care duals population (individuals who qualify for both Medicaid and Medicare) presents one of the most substantial opportunities for payers. On the healthcare delivery side, financial performance will continue to rebound as transformation efforts, M&A, and revenue diversification bear fruit. Powered by adoption of technology, healthcare services and technology (HST) businesses, particularly those that offer measurable near-term improvements for their customers, will continue to grow, as will pharmacy services players, especially those with a focus on specialty pharmacy.
Below, we provide a perspective on how these changes have affected payers, health systems, healthcare services and technology, and pharmacy services, and what to expect in 2024 and beyond.
The fastest growth in healthcare may occur in several segments
We estimate that healthcare profit pools will grow at a 7 percent CAGR, from $583 billion in 2022 to $819 billion in 2027. Profit pools continued under pressure in 2023 due to high inflation rates and labor shortages; however, we expect a recovery beginning in 2024, spurred by margin and cost optimization and reimbursement-rate increases.
Several segments can expect higher growth in profit pools:
Within payer, Medicare Advantage, spurred by the rapid increase in the duals population; the group business, due to recovery of margins post-COVID-19 pandemic; and individual
Within health systems, outpatient care settings such as physician offices and ambulatory surgery centers, driven by site-of-care shifts
Within HST, the software and platforms businesses (for example, patient engagement and clinical decision support)
Within pharmacy services, with specialty pharmacy continuing to experience rapid growth
On the other hand, some segments will continue to see slow growth, including general acute care and post-acute care within health systems, and Medicaid within payers (Exhibit 1).
Several factors will likely influence shifts in profit pools. Two of these are:
Change in payer mix. Enrollment in Medicare Advantage, and particularly the duals population, will continue to grow. Medicare Advantage enrollment has grown historically by 9 percent annually from 2019 to 2022; however, we estimate the growth rate will reduce to 5 percent annually from 2022 to 2027, in line with the latest Centers for Medicare & Medicaid Services (CMS) enrollment data.1 Finally, the duals population enrolled in managed care is estimated to grow at more than a 9 percent CAGR from 2022 through 2027.
We also estimate commercial segment profit pools to rebound as EBITDA margins likely return to historical averages by 2027. Growth is likely to be partially offset by enrollment changes in the segment, prompted by a shift from fully insured to self-insured businesses that could accelerate as employers seek to cut costs if the economy slows. Individual segment profit pools are estimated to expand at a 27 percent CAGR from 2022 to 2027 as enrollment rises, propelled by enhanced subsidies, Medicaid redeterminations, and other potential favorable factors (for example, employer conversions through the Individual Coverage Health Reimbursement Arrangement offered by the Affordable Care Act); EBITDA margins are estimated to improve from 2 percent in 2022 to 5 to 7 percent in 2027. On the other hand, Medicaid enrollment could decline by about ten million lives over the next five years based on our estimates, given recent legislation allowing states to begin eligibility redeterminations (which were paused during the federal public health emergency declared at the start of the COVID-19 pandemic2).
Accelerating value-based care (VBC). Based on our estimates, 90 million lives will be in VBC models by 2027, from 43 million in 2022. This expansion will be fueled by an increase in commercial VBC adoption, greater penetration of Medicare Advantage, and the Medicare Shared Savings Program (MSSP) model in Medicare fee-for-service. Also, substantial growth is expected in the specialty VBC model, where penetration in areas like orthopedics and nephrology could more than double in the next five years.
VBC models are undergoing changes as CMS updates its risk adjustment methodology and as models continue to expand beyond primary care to other specialties (for example, nephrology, oncology, and orthopedics). We expect established models that offer improvements in cost and quality to continue to thrive. The transformation of VBC business models in response to pressures from the current changes could likely deliver outsized improvement in cost and quality outcomes. The penetration of VBC business models is likely to lead to shifts in health delivery profit pools, from acute-care settings to other sites of care such as ambulatory surgical centers, physician offices, and home settings.
Payers: Government segments are expected to be 65 percent larger than commercial segments by 2027
In 2022, overall payer profit pools were $60 billion. Looking ahead, we estimate EBITDA to grow to $78 billion by 2027, a 5 percent CAGR, as the market recovers and approaches historical trends. Drivers are likely to be margin recovery of the commercial segment, inflation-driven incremental premium rate rises, and increased participation in managed care by the duals population. This is likely to be partially offset by margin compression in Medicare Advantage due to regulatory pressures (for example, risk adjustment, decline in the Stars bonus, and technical updates) and membership decline in Medicaid resulting from the expiration of the public health emergency.
We estimate increased labor costs and administrative expenses to reduce payer EBITDA by about 60 basis points in 2023. In addition, health systems are likely to push for reimbursement rate increases (up to about 350 to 400 basis-point incremental rate increases from 2023 to 2027 for the commercial segment and about 200 to 250 basis points for the government segment), according to McKinsey analysis and interviews with external experts.3
Our estimates also suggest that the mix of payer profit pools is likely to shift further toward the government segment (Exhibit 2). Overall, the profit pools for this segment are estimated to be about 65 percent greater than the commercial segment by 2027 ($36 billion compared with $21 billion). This shift would be a result of increasing Medicare Advantage penetration, estimated to reach 52 percent in 2027, and likely continued growth in the duals segment, expanding EBITDA from $7 billion in 2022 to $12 billion in 2027.
Profit pools for the commercial segment declined from $18 billion in 2019 to $15 billion in 2022. We now estimate the commercial segment’s EBITDA margins to regain historical levels by 2027, and profit pools to reach $21 billion, growing at a 7 percent CAGR from 2022 to 2027. Within this segment, a shift from fully insured to self-insured businesses could accelerate in the event of an economic slowdown, which prompts employers to pay greater attention to costs. The fully insured group enrollment could drop from 50 million in 2022 to 46 million in 2027, while the self-insured segment could increase from 108 million to 113 million during the same period.
Health systems: Transformation efforts help accelerate EBITDA recovery
In 2023, health-system profit pools continued to face substantial pressure due to inflation and labor shortages. Estimated growth was less than 5 percent from 2022 to 2023, remaining below prepandemic levels. Health systems have undertaken major transformation and cost containment efforts, particularly within the labor force, helping EBITDA margins recover by up to 100 basis points; some of this recovery was also volume-driven.
Looking ahead, we estimate an 11 percent CAGR from 2023 to 2027, or total EBITDA of $366 billion by 2027 (Exhibit 3). This reflects a rebound from below the long-term historical average in 2023, spurred by transformation efforts and potentially higher reimbursement rates. We anticipate that health systems will likely seek reimbursement increases in the high single digits or higher upon contract renewals (or more than 300 basis points above previous levels) in response to cost inflation in recent years.
Measures to tackle rising costs include improving labor productivity and the application of technological innovation across both administration and care delivery workflows (for example, further process standardization and outsourcing, increased use of digital care, and early adoption of AI within administrative workflows such as revenue cycle management). Despite these measures, 2027 industry EBITDA margins are estimated to be 50 to 100 basis points lower than in 2019, unless there is material acceleration in performance transformation efforts.
There are some meaningful exceptions to this overall outlook for health systems. Although post-acute-care profit pools could be severely affected by labor shortages (particularly nurses), other sites of care might grow (for example, non-acute and outpatient sites such as physician offices and ambulatory surgery centers). We expect accelerated adoption of VBC to drive growth.
HST profit pools will grow in technology-based segments
HST is estimated to be the fastest-growing sector in healthcare. In 2021, we estimated HST profit pools to be $51 billion. In 2022, according to our estimates, the HST profit pool shrank to $49 billion, reflecting a contracting market, wage inflation pressure, and the drag of fixed-technology investment that had not yet fulfilled its potential. Looking ahead, we estimate a 12 percent CAGR in 2022–27 due to the long-term underlying growth trend and rebound from the pandemic-related decline (Exhibit 4). With the continuing technology adoption in healthcare, the greatest acceleration is likely to happen in software and platforms as well as data and analytics, with 15 percent and 22 percent CAGRs, respectively.
In 2023, we observed an initial recovery in the HST market, supported by lower HST wage pressure and continued adoption of technology by payers and health systems searching for ways to become more efficient (for example, through automation and outsourcing).
Three factors account for the anticipated recovery and growth in HST.First, we expect continued demand from payers and health systems searching to improve efficiency, address labor challenges, and implement new technologies (for example, generative AI). Second, payers and health systems are likely to accept vendor price increases for solutions delivering measurable improvements. Third, we expect HST companies to make operational changes that will improve HST efficiency through better technology deployment and automation across services.
Pharmacy services will continue to grow
The pharmacy market has undergone major changes in recent years, including the impact of the COVID-19 pandemic, the establishment of partnerships across the value chain, and an evolving regulatory environment. Total pharmacy dispensing revenue continues to increase, growing by 9 percent to $550 billion in 2022,4 with projections of a 5 percent CAGR, reaching $700 billion in 2027.5Specialty pharmacy is one of the fastest growing subsegments within pharmacy services and accounts for 40 percent of prescription revenue6; this subsegment is expected to reach nearly 50 percent of prescription revenue in 2027 (Exhibit 5). We attribute its 8 percent CAGR in revenue growth to increases in utilization and pricing as well as the continued expansion of pipeline therapies (for example, cell and gene therapies and oncology and rare disease therapies) and expect that the revenue growth will be partially offset by reimbursement pressures, specialty generics, and increased adoption of biosimilars. Specialty pharmacy dispensers are also facing an evolving landscape with increased manufacturer contract pharmacy pressures related to the 340B Drug Pricing Program. With restrictions related to size and location of contract pharmacies that covered entities can use, the specialty pharmacy subsegment has seen accelerated investment in hospital-owned pharmacies.
Retail and mail pharmacies continue to face margin pressure and a contraction of profit pools due to reimbursement pressure, labor shortages, inflation, and a plateauing of generic dispensing rates.7Many chains have recently announced8 efforts to rationalize store footprints while continuing to augment additional services, including the provision of healthcare services.
Over the past year, there has also been increased attention to broad-population drugs such as GLP-1s (indicated for diabetes and obesity). The number of patients meeting clinical eligibility criteria for these drugs is among the largest of any new drug class in the past 20 to 30 years. The increased focus on these drugs has amplified conversations about care and coverage decisions, including considerations around demonstrated adherence to therapy, utilization management measures, and prescriber access points (for example, digital and telehealth services). As we look ahead, patient affordability, cost containment, and predictability of spending will likely remain key themes in the sector.The Inflation Reduction Act is poised to change the Medicare prescription Part D benefit, with a focus on reducing beneficiary out-of-pocket spending, negotiating prices for select drugs, and incentivizing better management of high-cost drugs. These changes, coupled with increased attention to broad-population drugs and the potential of high-cost therapies (such as cell and gene therapies), have set the stage for a shift in care and financing models.
The US healthcare industry faced demanding conditions in 2023, including continuing high inflation rates, labor shortages, and endemic COVID-19. However, the industry has adapted. We expect accelerated improvement efforts to help the industry address its challenges in 2024 and beyond, leading to an eventual return to historical-average profit margins.
Over the past 20 years, we’ve seen an evolution in payor contracts from fee-for-service to value-based care (VBC). This evolution is occurring across payor types: Commercial, Medicare, and Medicaid. In recent years, many providers have signed VBC contracts, which often provide better reimbursement rates as a reward for improvements in care delivery and care outcomes.
Specifically, a significant number of providers signed incentive-laden 5-10-year VBC contracts in 2020 moving away from traditional fee-for-service models, which helped improve their financial positioning throughout the pandemic. However, recent economic shifts have changed the landscape in which these contracts exist. Current contracts fail to take into account the rate of inflation and heightened financial distress we are seeing in the industry today. They also do not take into consideration the fact that many COVID-19-era government relief options — such as the CARES Act, Provider Relief Fund, and American Rescue Plan of 2021 — are sunsetting.
Simply stated, VBC contracts negotiated pre-pandemic are not only obsolete but likely contain pricing provisions that do not consider either unprecedented cost increases or difficulty in meeting performance incentives due to changes in patient behaviors. The result is an urgent need to reassess payor contracts of all types across all payor types.
However, before you renegotiate your contracts, you need to carefully consider your organization’s structure and business model so that you can ensure you’re working toward the best possible outcome.
To begin, take some time to examine the following considerations:
· Market Position: Having greater market share often leads to better-negotiated rates. Your organization should understand its market position before renegotiating its VBC contracts to understand what advantages you may have.
· Total Reimbursement & Total Value: Assess your total reimbursement rates, base reimbursement, and incentive reimbursement opportunity.
· Current Yield: Determine the percentage of total cost and the value of your denials and write-offs.
· Fee-for-service vs. Risk-based Models: Fee-for-service-based models should assess their steerage. Risk-based models should identify actuarily sound allocations, percentage of premium reconciliations, and risk adjustments/risk scores.
· IT Infrastructure: Evaluate your IT infrastructure. For example, is your EHR system set up for data analysis and able to benchmark KPIs? It’s important that your systems are designed to provide this information for negotiations and to ensure you have a complete picture of your patient population.
· Business Structure: Some provider organizations benefit from VBC models more than others. For example, a primary care provider (PCP) is more likely to coordinate along the continuum of care than a specialist. This enables the PCP to potentially have more control over the cost of care and revenue streams than specialists, making them a better candidate for a risk-based contract.
Carefully considering these six factors is a crucial first step to renegotiating your value-based contracts. Once you’ve made these considerations, you’re ready to move forward.
Ready to get started renegotiating your value-based contracts? Read our insight to get five tips for negotiation success.
Value-based healthcare, the holy grail of American medicine, has three parts: excellent clinical quality, convenient access and affordability for all.
And as with the holy grail of medieval legend, the quest for value-based care has been filled with failure.
In the 20th century, U.S. medical groups and hospital systems could—at best—achieve two elements of value-based care, but always at the sacrifice of the third. Until recently, American medicine lacked the clinical knowhow, technology and operational excellence to accomplish all three, simultaneously. We now have the tools. The only thing missing is “system-ness.”
What Is System-ness?
System-ness is the effective and efficient coordination of healthcare’s many parts: outpatient and inpatient, primary and specialty care, financing and care delivery, prevention and treatment.
By bringing these disparate pieces together within a well-functioning system, healthcare providers have the opportunity to maximize clinical outcomes, weed out waste, lower overall costs and provide greater levels of convenience and access.
Who Are The Search Parties?
In the future, system-ness will be the variable that determines whether healthcare transformation is led by (a) incumbent health systems like Kaiser Permanente and Geisinger Health or (b) the retail giants like Amazon, CVS and Walmart. The latter group has become an ever-growing threat in the healthcare arms race, quickly amassing their own (though still modest) systems of care through billion-dollar acquisitions.
Although both the incumbents and new entrants will struggle to implement value-based care on a national scale, the victor stands to earn hundreds of billions of dollars in added revenue and tens of billions in profits.
To better understand the power of system-ness, and the challenges all organizations will face in providing it, here are three examples of value-based-care solutions implemented successfully by Kaiser Permanente.
1. Preventing Problems, Managing Disease
Research demonstrates that preventive medicine and early intervention reduce heart attacks, strokes and cancer. Yet our nation falls far short in these areas when compared to its global peers.
One example is hypertension, the leading cause of strokes and a major contributor to heart attacks. With help from doctors, nearly all patients can keep high blood pressure under control. Yet, nationally, hypertension is controlled only 60% of the time.
We see similarly poor rates of performance when it comes to prevention and screening for cancers of the colon, breast and lung.
Undoing these troubling trends requires system-ness. In Kaiser Permanente, 90% of patients had their blood pressure controlled and were screened for cancer. Getting there required a comprehensive electronic health record, a willingness for every doctor (regardless of specialty) to focus on prevention, leadership that communicated the value of prevention and a salary structure that rewarded group excellence.
2. Continuous Care, Without Interruption
Most doctors’ offices are open Monday to Friday during normal business hours—only one-fourth of the time that a medical problem might occur.
At night and on weekends, patients have no choice but to visit ERs. There, they often wait hours for care, surrounded by people with communicable diseases. Their non-emergent problems generate bills 12-times higher than if they’d waited to be seen in a doctor’s office.
There’s a better way. In large-enough medical groups, hundreds of clinicians can provide round-the-clock care on a rotating, virtual basis—using video to assess patients and make evidence-based recommendations.
This approach, pioneered by physicians in the Mid-Atlantic Permanente Medical group, solved the patient’s problem immediately 70% of the time without a trip to the ER and, for the other 30%, enabled coordination of medical care with the ER staff.
3. Specialized Medicine, Immediate Attention
When a primary care physician needs added expertise (from a dermatologist, urologist or orthopedist), it’s usually the responsibility of the patient to make their own specialty appointments, check with insurance for coverage and provide their medical records.
This takes hours or days to coordinate and can delay care by weeks, resulting in avoidable complications.
But in a well-structured system, there’s no need to wait. Using telehealth tools at Kaiser Permanente, primary care doctors can connect instantly with dozens of different specialists—often while the patient is still in the exam room. Once connected, the specialist evaluates the patient and provides immediate expertise.
This way, care is not only faster and less expensive, but also better coordinated. Data from within Kaiser Permanente show that these virtual consultations resolve the patient’s problem 40% of the time without having to schedule another appointment. For the other 60%, the diagnostic process can begin immediately.
The Foundations For System-ness
Few organizations in the U.S. can or do offer these system-based improvements. Doing so requires skilled physician leadership, a shift in the financial model and a willingness to accept risk.
In fact, most organizations across the U.S. that claim to operate “value-based” systems actually rely on doctors who are scattered across the community, disconnected from each other and paid on the basis of volume (fee-for-service) rather than value (capitation).
As a result, patient care is fragmented and uncoordinated, leading to repeated tests and ineffective treatments, thus increasing medical costs and compromising medical outcomes.
Value-based care (superior quality, access and affordability) requires teams of clinicians working together as one—all paid on a capitated basis.
Without capitation, dermatologists will insist on seeing every patient in their office where they can bill insurance five-times more than with a tele-dermatology visit. And gastroenterology specialists will insist that all patients have colonoscopy rather than recommending low-risk patients do a safe, convenient, at-home colon cancer screening (called a fecal immunochemical test or “FIT”) at 5% of the cost.
In these cases, individual doctors don’t consciously make care inconvenient for patients. Rather, it is the only choice they have when working in a fee-for-service payment model. Ultimately, system-ness is best achieved when health systems are integrated, prepaid, tech-enabled and physician-led.
Amazon, CVS, Walmart Know About Systems
These three companies are global leaders in “system-ness,” at least in retail. Combined, they have a market cap of $1.88 trillion, employ 3.4 million Americans and are looking to take a slice of U.S. healthcare’s $4.3 trillion annual expenditures.
Already, they manage complex order-entry and fulfillment systems. They use technology to streamline everything from customer service to supply-chain management. They are led through a clear and effective reporting structure.
In terms of competing for healthcare’s holy grail, these are huge competitive advantages compared to today’s uncoordinated, individualized, leaderless healthcare industry.
As retailers vie to bring their system knowhow to American medicine, they are acquiring the pieces needed to compete with the healthcare incumbents. They’ve spent tens of billions of dollars on medical groups that are committed to value-based care (One Medical, Oak Street Health, etc.). They’ve also spent massive sums on home-health companies (Signify) and on pharmacies (PillPak), along with expanding their in-store, at-home and online care options. Many of these care-delivery subsidiaries are focused on Medicare Advantage, the capitated half of Medicare where financial success is dependent on high quality medical care provided at lower cost.
What’s more, all these retailers have a national presence with brick-and mortar facilities in nearly every community in the country—a leg up on nearly every existing health system.
Who Will Win—And Why?
Trying to pick the victor in the battle to transform American medicine at this point is like selecting the winner of a heavy-weight championship boxing match after three evenly matched rounds. Intangibles like stamina, courage and willingness to absorb pain have yet to be tested.
In The Innovator’s Dilemma, the late Clayton Christensen examined historical battles between incumbent organizations and new entrants. After analyzing dozens of industries, he concluded new entrants routinely become the victors because the incumbents move too slowly and fail to embrace the need for major change.
And from that perspective, if I had to wager, I’d put my money on the retail giants.
But there’s an even more worrisome potential outcome: neither those inside nor outside of healthcare will make the necessary investments or accept the risk of leading systemic change. As a result, the movement toward value-based healthcare will stall and die.
In that context, purchasers of healthcare (businesses, the government and patients) will encounter a difficult reality: over the next eight years, medical costs will nearly double, creating an unaffordable and unsustainable scenario. As a result, our nation will likely experience reduced medical coverage, increased rationing, ever-longer delays for care and a growth in health disparities.
If that day arrives, our country will regret its inaction.
Healthcare’s most recent billion-dollar deal took the industry by surprise, leaving medical experts and hospital leaders grappling to comprehend its implications.
In case you missed it, California-based Kaiser Foundation Health Plan and Hospitals, which make up the insurance and facilities half of Kaiser Permanente, announced the acquisition of Geisinger, a Pennsylvania-based health system once acknowledged by President Obama for delivering “high-quality care.”
Upon regulatory approval, Geisinger will become the first organization to join Risant Health, Kaiser Foundation’s newly created $5 billion subsidiary. According to Kaiser, the aim is to build “a portfolio of likeminded, nonprofit, value-oriented, community-based health systems anchored in their respective communities.”
Having spent 18 years as CEO of The Permanente Medical Group, the half of Kaiser Permanente responsible for the delivery of medical care, I took great interest in the announcement. And I wasn’t alone. My phone rang off the hook for weeks with calls from reporters, policy experts and healthcare executives.
After hundreds of conversations, here are the three most common questions I received about the acquisition—and the implications for doctors, insurers, health-system competitors and patients all over the country.
Question 1: Why did Kaiser acquire Geisinger?
Most callers wanted to know about Kaiser’s motivation, figuring there must’ve been more to the acquisition than the press release indicated. Although I don’t have inside information, I believe they were right. Here’s why:
Kaiser Permanente has a long and ongoing reputation for delivering nation-leading care. The organization has consistently earned the highest quality and patient-satisfaction rankings from the National Committee for Quality Assurance (NCQA), Leapfrog Group, JD Power and Medicare.
And yet, despite a 78-year history, dozens of hospitals and 13 million members across eight states, Kaiser Permanente is still considered a coastal—not national—health system. It maintains a huge market share in California and a strong presence in the Mid-Atlantic states, yet the organization has failed repeatedly to replicate that success in other geographies.
With that context, I see two compelling reasons why the Kaiser Foundation Health Plan and Hospitals wish to become a national brand:
Influence. Elected officials and regulatory bodies often turn to healthcare’s biggest players to set legislative agendas and carve out national policy. At that table, there are a limited number of seats. By shedding its reputation as a “local” health system, Kaiser could earn one.
Survival. In recent years, companies like Amazon, CVS and Walmart have been scooping up organizations that provide primary care, telehealth, home health and specialty care services. These “retail giants” are spending up to $13 billion per acquisition. And they’re consuming already-successful healthcare companies like One Medical, Oak Street Health, Signify, Pill Pack and many others. Like an army preparing for war, these corporate behemoths are amassing the components needed to battle the traditional healthcare incumbents and ultimately oust them entirely.
The Geisinger deal expands Kaiser’s footprint, adding 600,000 patients, 10 hospitals and 100 specialty and primary care clinics. These assets lend gravitas, even though Geisinger also comes with a 2022 operating loss of $239 million.
The lesson to draw from this first question is clear: size matters. The days of solo physicians and stand-alone hospitals are over. Nostalgia for medicine’s folksy, home-spun past is understandable but futile. To survive, healthcare players must get bigger quickly or team up with someone who can. That insight leads to the next question and lesson.
Question 2: How much value will Kaiser give Geisinger?
Almost everyone I’ve spoken with understands Kaiser’s desire for greater national influence, but they’re less sure how this deal will affect Geisinger Health.
Geisinger’s Pennsylvania-based hospitals and clinics have been locked in territorial battles for years with surrounding health systems. More recently, the pandemic, combined with staffing shortages and national inflation, have challenged Geisinger’s clinical performance and eroded its bottom line.
Assuming Kaiser plans to invest roughly $1 billion in each of the four to five health systems it’s planning to acquire, that surge in cash inflow will provide Geisinger with temporary financial safety. But the bigger question is how will Kaiser improve Geisinger’s value-proposition enough to grow its market share?
In public comments, Kaiser leaders spoke of the acquisition as an opportunity for Risant to “improve the health of millions of people by increasing access to value-based care and coverage, and raising the bar for value-based approaches that prioritize patient quality outcomes.”
Many of the experts I spoke with understand Kaiser’s value intent. But they question how Kaiser can could deliver on that promise since The Permanente Medical Group (TPMG) wasn’t involved in the deal.
If, hypothetically, Kaiser and Permanente leaders were to strike a deal to collaborate in the future, TPMG’s physician leaders could bring tremendous knowledge, experience and expertise to the table. Otherwise, I agree with those who’ve expressed doubt that Kaiser, alone, will be able to significantly improve Geisinger’s clinical performance.
Health plans and insurance companies play an important role in financing medical care. They possess rich data on performance and can offer incentives that boost access to higher-quality care. But insurers don’t work directly with individual doctors to coordinate medical care or advance clinical solutions on behalf of patients. And without strong physician leadership, the pace of positive change slows to a crawl. As a example, research conducted within The Permanente Medical Group found that it takes only three years to turn a proven clinical advance into standard practice—that’s nearly six times faster than the national average.
For decades, the secret sauce for Kaiser Permanente has been the cohesive success of its three parts: Kaiser Health Plan, Kaiser Foundation Hospitals and The Permanente Medical Group.
And KP’s results speak for themselves:
90% control of hypertension for members (compared to 60% for the rest of the country)
30% fewer deaths from heart attack and stroke (compared to the rest of the country)
20% fewer deaths from colon cancer
The big lesson: insurance, by itself, doesn’t drive major improvements in medicine. It must be a combined effort between forward-looking insurers and innovative, high-performing clinicians.
But there’s another takeaway here for doctors everywhere: now is the time to join forces with other clinicians in your community. Together, you can collaborate to improve clinical quality. You can augment access and make care more affordable for patients. Simultaneously, this is the time for the insurers and the retail giants to figure out which medical groups can deliver the best care and make the best partners. Neither side will flourish alone. And this leads to a third question and lesson.
Question 3: Will the deal work?
Almost all of my conversations ended with this query. I say it’s too early to tell. But as I look years down the road, one part of the deal, in particular, gives me doubt.
Today, Geisinger uses a hybrid reimbursement model—blending both “value-based” care payments with traditional “fee-for-service” insurance plans. In addition to offering its own coverage, it contracts with a variety of other insurance companies. Rarely have I seen this scattered approach succeed.
Most healthcare observers understand the inherent flaw in the “fee for service” (FFS) model is also its greatest appeal to providers: the more you do the more you earn. FFS is how nearly all financial transactions take place in America (i.e., provide a service, earn a fee). In medicine, however, this financial model results in frequent over-testing and over-treatment with minimal if any improvement in clinical outcomes, according to researchers.
The “value-based” alternative to FFS involves prepaying for care—a model often referred to as “capitation.” In short, capitation involves a single fee, paid upfront for all the medical care provided to a defined population of patients for one year based on their age and health status. The better an organization at preventing disease and avoiding complications from chronic illness, the greater its success in both clinical quality and affordability.
Within the small world of capitated healthcare payments, there’s an important element that often gets overlooked. It makes a big difference who receives that lump-sum payment.
In the case of Kaiser Permanente, capitated payments are made directly to the medical group and the physicians who are responsible for providing care. In almost every other health system, an insurance company collects capitated payments but then pays the medical providers on a fee-for-service basis. Even though the arrangement is referred to as capitated, the incentives are overwhelmingly tied to the volume of care (not the value of that care).
In a mixed-payment model, doctors and hospitals invariably prioritize the higher paying FFS patients over the capitated ones. When I think about these conflicting incentives, I’m reminded of a prominent medical group in California. It had a main entrance for its fee-for-service patients and a second, smaller one off to the side for capitated patients.
I doubt the time spent with the patient—or the overall care provided—was equal for both groups. When income is based on quantity of care, not quality, clinicians focus more on treating the complications of chronic disease and medical errors rather than preventing them in the first place. Geisinger has walked this tightrope in the past, but as economic pressures mount, I fear doctors will find the two sets of incentives conflicting and difficult to navigate.
The big lesson: as financial pressures mount, the most effective approaches of the past will likely fail in the future. All healthcare organizations will need to make a decision: keep trying to drive volume and prices up through FFS or shift to capitation. Getting caught in the middle is a prescription for failure.
Examining the healthcare acquisitions made by Amazon and CVS, it’s clear these giants have decided to move aggressively toward a model more like Kaiser Permanente’s—one that brings insurance, pharmacy, physicians and sophisticated IT systems under one roof. These companies, along with Walmart, are aggressively marching down a path toward capitation, focusing on Medicare Advantage (the value-based option for Americans 65+) as an entry point.
So far, Geisinger has hedged its bets by maintaining a hybrid revenue stream. I doubt they can do so successfully in the future. That brings us to a final question.
The biggest question remaining
Over the next decade, hospital systems, insurers and retailers will battle for healthcare supremacy. The most recent Kaiser-Geisinger deal reflects an industry that’s undergoing massive change as health systems face intensifying pressure to remain relevant.
The most important issue to resolve is whether these shifts will ultimately help or harm patients. I’m optimistic for a positive outcome.
Whether or not the retail giants displace the incumbents, they will redefine what it takes to win. For all their faults, companies like Amazon and Walmart care a lot about meeting the needs of customers—a mindset rarely found in today’s healthcare world. As these companies grow ever larger, they’ll place consumer-oriented demands on doctors and hospitals. This will require care providers to deliver higher quality care at more affordable prices.
The retailers will only do deals with the best of the best. And they’ll kick the underachievers to the curb. They’ll use their sophisticated IT systems to better coordinate and innovate medical care. Insurers, hospitals and doctors who fail to keep up will be left behind.
Over time, patients will find themselves with far more choices and control than they have today. And I’m optimistic that will be good for the health of our nation.
Published in the April edition of Health Affairs Forefront, this piece unpacks why payers and other corporations have replaced health systems as the top bidders for primary care practices, driving up practice purchase prices from hundreds of dollars to tens of thousands of dollars per patient. While corporate players like UnitedHealth Group, Amazon, and Walgreens have spent an estimated $50B on primary care, it pales in comparison to the potential “$1T opportunity” in value-based care projected by McKinsey and Company.
The authors argue that this tantalizing opportunity exists because the Centers for Medicare and Medicaid Services (CMS) invited corporations to “re-insure” Medicare through capitated arrangements in Medicare Advantage (MA) and its Direct Contracting program.
While CMS intended to promote risk and value-based incentives to improve care quality and costs, the incentive structures baked into these programs have afforded payers record profits, despite neither improving patient outcomes nor reducing government healthcare spending.
The Gist: While the critiques of MA reimbursement structures in this piece are familiar, they are woven together into a convincing rebuke of the “unintended consequences” of CMS’s value-based care policy.
Through poorly designing incentives, CMS paved a runway for corporate America to capture the lion’s share of the financial returns of value-based care, paying prices for primary care that health systems can’t match.
Meanwhile, despite skyrocketing valuations for primary care practices, primary care services remain underfunded and inadequately reimbursed, pushing primary care groups closer to payers with excess profits to invest.
Running a health system recently has proven to be a very hard job. Mounting losses in the face of higher operating expenses, softer than expected volumes, deferred capex, and strained C-suite succession planning are just a few of the immediate issues with which CEOs and boards must deal.
But frankly, none of those are the biggest strategic issue facing health systems. The biggest strategic issue is the reorganization of the American healthcare landscape into an ambulatory care business that emphasizes competing for covered lives at scale in lower cost and convenient settings of care. This shift in business model has significant ramifications, if you own and operate acute care hospitals.
Village MD and Optum are two of the organizations driving the business model shift. They are owned by large publicly traded companies (Walgreens and UnitedHealth Group, respectively). Both Optum and Village MD have had a string of announced major patient care acquisitions over the past few years, none of which is in the acute care space.
The future of American healthcare will likely be dominated by large well-organized and well-run multi-specialty physician groups with a very strong primary care component. These physician service companies will be payer agnostic and focused on value-based care, though will still be prepared to operate in markets where fee-for-service dominates. They will deliver highly coordinated care in lower cost settings than hospital outpatient departments. And these companies will be armed with tools and analytics that permit them to manage the care for populations of patients, in order to deliver both better health outcomes and lower costs.
At the same time this is happening, we are experiencing steady growth in Medicare Advantage. And along with it, a stream of primary care groups who operate purpose-built clinics to take full risk on Medicare Advantage populations. These companies include ChenMed, Cano Health and Oak Street, among others. These organizations use strong culture, training, and analytics to better manage care, significantly reduce utilization, and produce better health outcomes and lower costs.
Public and private equity capital are pouring into the non-acute care sectors, fueling this growth. As of the start of 2022, nearly three quarters of all physicians in the US were employed by either corporate entities (such as private equity, insurance companies, and pharmacy companies), or employed by health systems. And this employment trend has accelerated since the start of the pandemic. The corporate entities, rather than health systems, are driving this increasing trend. Corporate purchases of physician practices increased by 86% from 2019 to 2021.
What can health systems do? To succeed in the future, you must be the nexus of care for the covered lives in your community. But that does not mean the health system must own all the healthcare assets or employ all of the physicians. The health system can be the platform to convene these assets and services in the community. In some respects, it is similar to an Apple iPhone. They are the platform that convenes the apps. Some of those apps are developed and owned by Apple. But many more apps are developed by people outside of Apple, and the iPhone is simply the platform to provide access.
Creating this platform requires a change in mindset. And it requires capital. There are many opportunities for health systems to partner with outside capital providers, such as private equity, to position for the future – from both a capital and a mindset point of view.
The change in mindset, and the access to flexible capital, is necessary as the future becomes more and more about reorganizing into an ambulatory care business that emphasizes competing for covered lives at scale in lower cost and convenient settings of care.
Cross-subsidy economics are increasingly challenged for America’s hospitals. Aging Baby Boomers are moving from commercial insurance to Medicare, decreasing the share of patients with lucrative private coverage, and insurers are increasingly reticent to provide the rate increases providers need to make up for the worsening mix.
At a recent executive retreat, one health system debated the best strategies to increase their capture of commercial volume. Most of the conversation focused on traditional market-based tactics to increase access and awareness in fast-growing, higher income areas of their service region.
For instance, the system’s chief marketing officer was pushing to increase advertising in the rapidly expanding suburbs, and advocated building ambulatory surgery centers in a wealthy area of town with a boom of new home construction.
The chief strategy officer shared a different perspective, supporting an employer-focused strategy. His logic: “In most businesses,the CEO and the janitor have the same benefit plans. If we only focus on the wealthy parts of town, we’re missing a big portion of the workers with good insurance.” He advocated for a new round of direct-to-employer contracting outreach, hoping to steer workers to high-value primary and specialty care solutions.
In reality, any system looking to move commercial share will need to do both—but even the best playbook for building commercial volume is unlikely to close the growing cross-subsidy gap. To maintain profitability in the long term, health systems must reduce costs for managing Medicare patients by delivering lower-cost care in lower-cost settings, with lower-cost staff.
While healthcare is delivered locally, the business of healthcare is regional, and the regions are only getting bigger. Hospital and health system mergers alike have continued to shift from local to regional, and the recently announced merger between Advocate Aurora Health and Atrium Health clearly highlights that the regions are only getting bigger.
Advocate Aurora, with a presence in Illinois and Wisconsin, and Atrium Health, with a presence in North Carolina, South Carolina, Georgia, and Alabama, will combine to create a $27 billion health system that will span six states and make it one of the leading healthcare delivery systems in the country. The combined organization, which will transition to a new brand, Advocate Health, will operate 67 hospitals and over 1,000 sites of care, employ nearly 150,000 teammates, and serve 5.5 million patients. Together, Advocate Health will become the 6th largest system in the country behind Kaiser Permanente, HCA Healthcare, CommonSpirit Health, Ascension, and Providence.
We have seen a number of large health systems come together recently, including Intermountain Healthcare + SCL Health to create a $15 billion revenue system, Spectrum Health + Beaumont ($14 billion), NorthShore University Health System + Edward-Elmhurst Healthcare ($5 billion), LifePoint Health + Kindred Healthcare ($14 billion), and Jefferson Health + Einstein Healthcare Network ($8 billion).
The exact reasoning for each merger differs slightly, but one of the common threads across all is scale. But not scale in the traditional M&A sense. Rather, scale in covered lives; scale in physician infrastructure and alignment; scale in clinical and operational capabilities; scale in technology, innovation, and partnerships with non-traditional players; scale for capital access; and scale for insurance risk to compete in a value-based world. It is no longer the strong acquiring the weak. Rather, strong players are coming together to gain scale to face the headwinds in a unified manner.
For Advocate Aurora and Atrium, coming together is about leveraging their combined clinical excellence, advancing data analytics capabilities and digital consumer infrastructure, improving affordability, driving health equity, creating a next-generation workforce, research, and environmental sustainability. Together, they have pledged $2 billion to disrupt the root causes of health inequities across underserved communities and create more than 20,000 new jobs.
Both Advocate Aurora and Atrium are no strangers to mergers. Advocate and Aurora came together in 2018, and prior to that Advocate was intending to merge with NorthShore before being blocked due to anti-trust. Atrium has grown over the years, merging with systems such as Navicent Health in Georgia in 2018, Wake Forest Baptist Health in North Carolina 2020, and Floyd Health System in Georgia in 2021. In the newly proposed merger, Advocate Aurora and Atrium are coming together via a joint operating arrangement where each entity will be responsible for their own liabilities and maintain ownership of their respective assets but operate together under the new parent entity and board. This may allow the combined entity more flexibility in local decision-making. The current CEOs, Jim Skogsbergh and Eugene Woods will serve as co-CEOs for the first 18 months, at which point Skogsbergh will retire, and Woods will take over as the sole CEO.
Mergers can come in various shapes and structures, but the driving forces behind consolidation are not unique. With the need to compete in value-based care, adequately manage risk, gain scale across covered lives, physicians, and points of access, successfully deliver affordable high-quality care, and the need to deal with the vertical and horizontal consolidation of the large-scale payers, the markets that health systems operate in must be large enough to be effective and relevant. We fully expect to see more of these larger scale health system mergers in the near term.
The physical delivery of healthcare is local, but, again, the business of healthcare is not; it is regional, and the regions are only getting bigger.
The healthcare industry has made some strides in the “journey to value” across the last decade, but in reality, most health systems and physician groups are still very much entrenched in fee-for-service incentives.
While many health plans report that significant portions of their contract dollars are tied to cost and quality performance, what plans refer to as “value” isn’t necessarily “risk-based.”
The left-hand side of the graphic below shows that, although a majority of payer contracts now include some link to quality or cost, over two-thirds of those lack any real downside risk for providers.
Data on the right show a similar parallel in physician compensation. Whilethe majority of physician groups have some quality incentives in their compensation models, less than a tenth of individual physician compensation is actually tied to quality performance.
Though myriad stakeholders, from the federal government to individual health systems and physician groups, have collectively invested billions of dollars in migrating to value-based payment over the last decade, we are still far from seeing true, performance-based incentives translate into transformation up and down the healthcare value chain.
HENRY KOTULA 