Oscar is going public. I’m sure you’ll be inundated with coverage on the matter this week, so I’ll keep mine short.
In this issue:
Why Oscar’s finances matter so much
Why Oscar’s losses aren’t the full story
Why Oscar’s finances matter so much
You’re probably aware of Oscar, the health insurer that launched in 2012 to compete in the individual insurance market. Their model focuses on the customer experience, with an app and an on-demand team of care coordinators. The goal is to create a differentiated experience that drives high engagement among their members, and in turn to leverage that engagement to save on medical costs, creating a deep competitive advantage.
Until now, we haven’t known if Oscar makes money with that model; the S-1 confirms that they’re losing plenty of it. More on the numbers soon, but for now let’s emphasize how much is stake in these financial results.
Consumer experience is part of a broader trend toward a more consumer-focused healthcare system. Lots of new healthcare companies are launched under the premise of fixing a particularly consumer-unfriendly process in healthcare (lots to choose from!). It’s an open question as to whether that’s a winning strategy or not.
Care coordination is a related trend that promises to create happier customers and lower costs in one stroke (discussed in depth last week). Since Oscar bundles coordination with insurance, its earnings are a strong indicator of whether care coordination can drive savings, net of its costs.
Individual insurance markets need to be healthy if they’re ever to compete with the employer-based status quo. Employer insurance saddles employers with the costs of providing health insurance, and discourages employees from pursuing new ventures on their own. (It persists for tax reasons.) Oscar provides a new approach, and much-needed competition, in many individual markets.
If Oscar succeeds, they validate each of these trends for the industry. If they fail, the industry needs to understand why, and change course. So, I’m rooting for them.
Reasons to be optimistic
Like I said, Oscar is losing piles of money: $406 million in 2020. I’ve personally observed a lot of eye rolling on Twitter about the losses; we all remember WeWork.
But the smart money is still in the game: just last December, Oscar raised $140 million from some name-brand venture funds, and a few months before, raised $225 million from a similar group. Of course these experts could be wrong!
I, a non-expert, just want to start a conversation about what they might be seeing. Some ideas:
Growth: Oscar reported 400k members at the end of 2020, up almost 75% from the year prior, and 529k members as of last week. Growth doesn’t solve everything: if you’re losing money on each member, you won’t make it up in volume. But that kind of growth can justify larger expenses on the line items that don’t grow directly with membership. Unfortunately, even after stripping out such expenses, Oscar is still losing money on each member (see the S-1 pg. 79 for discussion about their “InsuranceCo Combined Ratio”).
Oscar has probably focused so far on the markets where it expects to be most profitable, based on e.g. demographics and competitive landscape. What remains, then, are markets where it should expect to be even less profitable. If you don’t think there are big differences in the attractiveness of insurance markets around the country, you can be more bullish on the future, given Oscar’s improving product and go-to-market experience over time.
Cost control: Oscar needs to get control of its medical costs; the medical loss ratio (i.e. the percentage of premiums paid out in claims) has slowly fallen over time, but in 2020, wouldn’t have really fallen without help from covid-19. That leaves some hope that Oscar’s systems and apps for engaging patients are still in development, and still have more cost savings to realize. The “InsuranceCo Combined Ratio,” which might be a better metric than MLR, seems like its improving more consistently.
Reinsurance: Oscar’s biggest costs are for reinsurance, which is insurance purchased by an insurer 🤯. The reason is actually fascinating: one barrier to scaling an insurance company is the huge pool of capital required to be kept in reserve. Regulators want to ensure that claims can be paid! And Oscar has raised a huge amount of money ($1.6 billion) to fund those reserves.
If Oscar wants to grow faster than its reserves allow, it can rent some capital from someone who has a truly huge amount of it, namely a reinsurer. It’s a similar principle to when startups use AWS instead of a on-prem servers; AWS might cost a bit more per unit, but it’s a variable cost, and scales with the business, while the on-prem server is a fixed cost that must be paid in advance, before the business is proven. Oscar buys reinsurance so it can put some of it’s hard-raised capital toward other projects, like building an app.
As Oscar grows, some of these reinsurance fees should drop. It’s not a huge leverage point, because the drop in fees is nearly offset by higher claims. But it’s something.
Net Promoter Score: High NPS scores contribute to financial performance in two main ways: organic growth driven by word-of-mouth, and lower churn from happier members. Oscar’s NPS is +30; excellent compared to most health insurance companies (roughly zero). Compared to Accolade, which has a similar member engagement/coordinator model, not so much (+70).
Since Oscar is an insurer bundled with a care coordinator, it makes sense to see NPS near the average of those two businesses. Of course, the whole point of Oscar IS to bundle the concierge with the insurer, to improve the customer experience, so they’ve succeeded in that. The problem is that this is baked into their current financial performance; they’ll need to improve NPS going forward to see the financial benefits. Hopefully the above-mentioned product development opportunities help with that.
Sales and Marketing: Oscar spends money to acquire customers in a given year, but then realizes revenue from those customers over multiple years (since lots of customers renew their plan each year). This is even more true for Oscar, which doesn’t publish churn or retention figures, but does have higher engagement that should result in better retention. And since Oscar is growing, many future revenues have already been paid for from an acquisition cost standpoint, which means the long-term margins should be better than stated on their S-1.
Additional opportunities: Oscar is entering the Medicare Advantage space (but only with a couple thousand members so far). Perhaps more interesting is their ability to sell their differentiated tech platform or patient engagement model to other MA players, as they have begun to experiment with. More discussion on this point at the end of last week’s post; this is something to watch but not close to being a proven revenue stream.
Conclusion
Oscar is leading the way on a bunch of interesting avenues to better healthcare, but they can’t keep doing it for long unless they’re profitable. It seems both promising and highly uncertain that they’ll hit a positive operating margin any time soon.
Their best leverage point seems to be a continued focus on their products and platforms that enable a differentiated customer experience, which is simple but by no means easy. They’ve had nearly a decade to focus on it already, how much better can it get from here? At the very least, the big venture funds seem to think they’ve got a chance.
Since Accolade is the public example, I’ll focus on them. (Disclosure, I work for Comcast, which invests in Accolade. More in footnote [1])
In this issue:
The Problem that Accolade Solves
The 2nd.MD Acquisition
Platforms for Point Solutions
Care Coordination Outlook
The Problem that Accolade Solves
Employers pay too much for health insurance and everyone knows it. There are probably lots of reasons for that, but lets start with a familiar culprit: the fee-for-service payment model [2].
Fee-for-service rewards providers, because it lets them use an information advantage to earn more. Doctors have expertise that patients don’t, so can recommend, and bill for, extra care. Patients don’t try to stop this, because they’d rather have more care than less, just to be safe. Second—moral hazard!—someone else is paying.
That ‘someone else’ is often an employer, which sponsors the patient’s health plan. For such employers, there are few good options to control costs. Common approaches, like narrowing provider networks or requiring a prior auth for every bit of care, have drawbacks. (And employers are still paying too much).
What employers really need is for employees to help control medical costs: shopping around, comparing prices, declining extra procedures. Employees, who have pre-paid for care via insurance, have no desire or obligation to do any of this. It seems like an impasse…and this is the problem that Accolade addresses.
Accolade is a care coordinator (or ‘navigator,’ I use the terms interchangeably). Members that need help accessing care can call an 800 number to speak with an Accolade Health Assistant, who can answer questions and make recommendations. Health Assistants are not clinically trained, but team up with doctors and nurses on staff. Critically, they’re also enabled by a data/tech/CRM platform that helps ensure they make the right decisions.
For employers, Accolade solves the two money-wasting problems we outlined above:
Reducing information asymmetry. Accolade’s doctors and nurses can advise plan members on clinical issues without concern for whether the member chooses more or less care.
Reducing moral hazard. Accolade can make the case to members when care is expensive and not needed. It can also direct members to less costly options (like outpatient centers instead of hospitals) by default.
This only works if members call Accolade in the first place—none of the cost-saving magic can happen without engagement. Customer experience therefore matters a lot; Accolade needs repeat interactions and good word of mouth to fully realize their value proposition. Employers likewise want engagement, and will go to great lengths to raise awareness for Accolade.
By engaging members, Accolade can understand exactly what care is needed. Data on provider cost and quality—organized and processed in the proprietary CRM—can then help optimize the cost/benefit of care decisions. Accolade is essentially coaching employees to make informed decisions that are good for themselves, in a way that is also good for their employer.
That strikes me as slightly precarious for Accolade. The employer wants cheap care, the member wants top quality care, and Accolade needs to deliver both. They must favor the employer’s needs (to demonstrate savings and ultimately sell more contracts), while appearing to cater to the member’s needs (in order to maintain engagement and trust, which in turn is needed for cost savings). Does that equilibrium result in the members’ best interests? Probably, but it’s a little messy due to principal-agent-type issues.
Which is not to say that Accolade shouldn’t be focused on employers’ costs: Employers hire them in order to save money overall, so Accolade’s value is roughly capped at the total amount of cost reduction they can produce, weighted by their clients’ belief in their ability to keep realizing those savings in the future.
It also means that Accolade’s best customers are those that (1) are under financial pressure to reduce their overall spend, but (2) also are willing to spend more right now on Accolade’s services. So, these employers are taking a risk by investing in Accolade, and I’d expect contracts to shift some of that risk back to Accolade by including a big incentive component.
On the other hand, the incentive component is a friction in the sales process because measuring the benefit is hard. There’s no perfect counterfactual against which to measure savings, so a model must be used. Models contain assumptions, and assumptions can be picked apart in contract disputes.
We began this section by lightly bashing FFS (who doesn’t love bashing FFS!?). I’ll end by noting that any savings Accolade creates for employers are losses for providers, mostly by limiting the inefficiencies in the FFS arrangement that providers are used to enjoying. On the margins, this should make providers more open to value-based care; a small accelerant of that trend. More on VBC later!
The 2nd.MD Acquisition
And but so Accolade paid a high multiple for 2nd.MD (13x revenue), which according to this fascinating page is closer to a pure software play (14x) than anything healthcare-related (0.5x - 6x). Why?
2nd.MD helps patients get second opinions on diagnoses and treatment plans. It connects patients with a curated network of clinical experts, and also connects the patients’ medical data to those same experts, who can then make an informed recommendation.
The quality of the physician network is important for confidence, because otherwise, patients could simply make another cheap telemedicine appointment with an undifferentiated doctor.
The data integrations ensure that the highly-qualified specialists get accurate inputs, and don’t spend expensive time tracking down the data themselves.
2nd.MD’s Big Numbers slide, if accurate, is genuinely impressive; when you’re saving $5k per interaction with almost perfect NPS, you’re probably on to something.
The slide also shows why Accolade is so interested:
If Accolade’s main goals, described above, are to create big savings and to drive high engagement, 2nd.MD convincingly checks those exact boxes.
High NPS is especially important because it translates directly into engagement: net promotors don’t just love the product, they also by definition tell their friends to go use it.
Accolade is competing directly with Grand Rounds, which already does the second opinion thing, so it’s become table stakes.
From 2nd.MD’s point of view, they are like Accolade in that they also need engagement to create the savings that justify their fees. However, to the extent that Accolade has solved for engagement, it is the de facto gatekeeper for companies like 2nd.MD—Accolade Health Assistants control referrals and recommendations. Accolade’s ownership of 2nd.MD therefore increases 2nd.MD’s value because Accolade is now incentivized to send patients to that service.
Platforms for Point Solutions
Interestingly, 2nd.MD is just one example of many health solutions that are competing to serve employees. Most such ‘point solutions’ address a given healthcare need—diabetes management, telemedicine appointments, etc. All of them need member engagement (notice a pattern?) to work, and a solution with no engagement is not getting a contract renewal.
Accolade has found a way to monetize its position as a key driver of patient volume to these point solutions, c.f. their Trusted Supplier Program, pitched thusly:
TSP customers give their employees more personalized health and benefits support, while significantly easing the burden facing their HR teams who want more streamlined benefits management. Accolade's TSP features a ten-step validation process to ensure each solution offered to employers is vetted and industry leading.
The TSP is a bundle of point solutions, vetted by Accolade, that Accolade’s customers can purchase. Three benefits:
Simplicity for buyers. Point solutions are complicated to buy and there are so many to asses that the decisions can overwhelm employers; Accolade’s bundle reduces the number of decisions that need to be made.
Cooperation. Plan members, and Accolade, are better off when employers purchases high-quality point solutions that are willing to share data and cooperate.
Access. Point solutions lucky enough to join the program gain priority access to more members, since Accolade will refer to the trusted supplier by default
Nevertheless, one line in the S-1, pg 122, gives me pause:
Customers pay Accolade on an incremental PMPM basis, and we generally receive a revenue share from the trusted supplier
Accolade, as the first point of contact for members, controls demand for all of the point solutions, and presumably can have a large impact on patient volumes for those services. They’re using that position to extract value from their suppliers, which is an Aggregator strategy—one that seeks to control the relationship between users and suppliers (clunky graphic below to illustrate).
Accolade intermediates the point solutions and their clients
That’s not a problem in and of itself, since aggregators tend to win by providing an excellent consumer experience. But unlike, say, Google, Accolade’s competition isn’t a click away—members don’t have any alternatives outside of the ones their employers buy for them.
Does Accolade bundle the best suppliers, or does it push the products of the highest bidders? Would benefits teams, who buy these services, always know the difference? It’s another principal-agent problem, and I wonder if competitors will follow, or if they’ll differentiate by foregoing the monetization, and pointing out that Accolade might not be positioned to impartially choose the best option for each employer.
Care Coordination Outlook
The final point about Accolade that I want to explore is its relationship to coordination and navigation services elsewhere in the healthcare system. A few examples:
Oscar (payer in the individual market): includes a concierge feature
Bright Health (payer in the Medicare Advantage market): Features Care Management Coordinators that actively manage members’ health to reduce costs to the plan
Iora: high-touch primary care that runs on capitated (i.e. value-based) contracts and includes many aspects of care coordination
From these examples, I’ll draw a quick heuristic: anyone that ultimately pays for care—plan sponsors, or risk bearing providers—can benefit when their patients make better decisions (or, more cynically, can benefit by nudging their patients). Care coordination provides that nudge.
And important implication is that as providers take on more risk (through value-based care initiatives), the payer becomes less invested in the savings that Accolade can generate; cost management becomes the provider’s problem. Care coordination, therefore, will integrate more naturally with the provider side than the payer side.
A second heuristic: higher cost patients require increased coordination. I think that’s why care coordination is so prevalent in the Medicare market (>88% of seniors have a chronic condition, many have multiple chronic conditions). The fact that Iora seems to be moving more into Medicare Advantage—which has higher concentrations of high-risk patients— strongly suggests that care coordination is in demand there.
Accolade seems to encourage this line of thinking in their S-1, filed under Growth Strategy (pg 119, my ephasis):
We see further opportunity to enter adjacent markets, including government-sponsored health plans, such as Medicare Advantage and Managed Medicaid…Our focus and experience in the navigation and coordination of benefits and healthcare, coupled with our technology investments, position us to take advantage of emerging healthcare trends surrounding care coordination and value-based care initiatives. We believe that we can leverage our existing platform and scalable solutions to successfully expand into these markets.
Accolade is aware of opportunity it’s current employer-sponsored market, but there’s a tension between committing to the still sizable opportunity there, and a timely entrance into the fast-developing Medicare Advantage market, where their existing approach might need to be heavily modified.
Let’s end with some food for thought: if care coordination is to become an essential part of any risk-bearing healthcare venture going forward, it makes sense to structure a care coordination firm not as an Aggregator—which intermediates patients and providers—but rather as a platform, which connects patients to providers. Currently, the Medicare Advantage startups are building their own coordination tools that integrate directly with their insurance function, but if they were all able to buy an Accolade product, it would enable a far larger number of plans to compete (because no one needs to make the technology investments, for example, that go into a coordination platform).
Just this week, Oscar has agreed to license their tech platform—which enables care coordination—to a payer-provider in Florida. I’m bullish.
Footnotes
[1] Disclosure: My employer, Comcast, owns about 5% of Accolade, and is also Accolade’s largest customer, per their S-1. However, I have no access to any nonpublic information about Accolade. As such, I’ve drawn only on public sources of information, like news articles and public filings, for this analysis. I do own some Comcast shares which I suppose makes me technically long Accolade, but I have no direct position in Accolade.
[2] Fee for service (FFS) is when providers get paid for each service they provide. More care results in more payment, so under FFS, there is a built-in incentive for providers to perform a lot of expensive care. Contrast with value-based-care (VBC) which, involves some form of flat payment to the provider (per case, or per patient), and means the provider wins by providing less care. In BOTH cases, providers have an information advantage over the patient.
[3] Accolade gets paid on a per-member, per-month, or PMPM basis. I don’t see the exact number in the S-1 but it seems to be at least $5 and possibly closer to $10 PMPM.
[4] Financials. Accolade lost 50 million bucks in fiscal 2020; even ‘Adjusted EBITDA,’ (banker-speak for ‘let’s ignore profit and just focus on cash’) was negative $30 million. What’s the point of all the money-saving care coordination if you have to torch $30 million every year to do it?
One of the big clues in the S-1 is Accolade’s extremely high retention (between 95% and 100% for all 3 reported years). Don’t take them quite at face value though: Accolade typically brings on new customers for 3 year contracts (S-1, pg 32). For a high-growth company, where most customers are less than 3 years old, it makes sense for average churn to be low, but eventually increase as contracts expire. The true life expectancy of a customer relationship is uncertain, but from Accolade’s perspective, the point is that it’s probably very long.
High retention means that money spent on acquiring customers is an expense in the current year, even as the customers themselves will keep paying for many years. Other expenses, like money spent on developing the technology platform, should scale (since the platform is created once, then sold to every customer). To the extent that Accolade has to build a bunch of custom integrations for each new customers—always a risk in healthcare—that will be less true.
More details in the image below. Sorry about the formatting, this was quick and dirty and “for fun.”
The previous issue of The Caseload was about GoodRx, and I’m overwhelmed by the number of people that have read or responded to it, especially those who have gotten in touch directly. To all of you: a big, sincere thanks.
Near the end of that last issue, I teased that GoodRx and Sesame have something interesting in common: they’re both making life easier, in small ways, for uninsured patients. GoodRx demonstrates that a great business can be built in the uninsured (or cash-pay) healthcare market; there’s also a case (which I’ll make shortly) that the mainstream system of commercial insurance increasingly misses the mark.
Taking those facts together, I wonder: is there room for a new cash-pay value chain to emerge alongside the existing insurance-based value chain?
In this issue:
The Insurance Bundle and its Shortcomings
Why Insurance Wins Anyway
Success in the Cash-Pay Market Looks Different
How it Happens, and Why it Matters
The Insurance Bundle and its Shortcomings
Let’s start by summarizing the jobs that health plans do, which ones they do well, and where they come up short. There are four main jobs:
Insurance Job #1: Pooling Risk. Most obviously, insurance plans of any kind exist to protect their members from large financial losses, especially related to rare and unpredictable events. Car wrecks, natural disasters, and ER visits all cost more money than most people have on hand at any given time. By collecting a manageable premium each month, insurers smooth out members’ cash flows and guarantee they stay solvent.
For the most part, health plans pool risk effectively, but increasingly fail on the margin. First, premiums increasingly are not manageable, given that the average family spent ~$20k on them in 2018. Second, these high premiums don’t actually remove downside risks for members, as surprise medical bills become more and more common. And finally, cost sharing has increased substantially in recent years, which functionally means that risk is just being passed back to the members. Taken together, these factors make health insurance a worse deal than in the recent past.
Moreover, providers are taking on meaningfully more risk as part of a broader shift forward value-based care. When that happens, the risk pooling function of a payer is correspondingly reduced (because providers bear the financial risk instead). That isn’t necessarily a failure by insurers, but offloading a key part of their value proposition reduces their importance and centrality.
Insurance Job #2: Making Care Decisions. The complexity inherent in medicine creates an information asymmetry problem: patients lack the expertise to determine which care is needed, and which care is superfluous. They need a doctor’s advice to address their illness, but doctors obviously benefit financially from erring on the side of more care (assuming fee-for-service). So, to control costs, patients need help declining unneeded care.
Theoretically, an insurance company can serve that function (e.g. with prior authorizations), and has the right incentive—controlling costs—to keep doctors in check.
The counterargument to that theory is that patients all have different preferences and risk tolerances, and also that doctors’ clinical assessments are highly nuanced, often uncertain, and situation-specific. Individualism and nuance are necessarily lost in the prior authorization process, so it’s reasonable to believe that many health outcomes could be improved by keeping the decision making power (which is inextricable from financial risk) with the patient. As I’ve written in the past, the prior authorization process diminishes the customer experience.
A quick example: Assume patients A and B have the same diagnosis. A wants to try the latest, most expensive, and risky procedures to cure a given illness, while B is skeptical and prefers less treatment. If these patients work for the same employer, they’re probably on the same plan, pay the same amount, and even receive the same care, despite their vastly different preferences.
Removing the insurer from the decision, though, increases moral hazard, which limits the insurer’s ability to cost-effectively pool risk, which in turn is why this job typically comes bundled with risk pooling. But it’s an awkward fit. Moral hazard can be reduced by implementing cost sharing measures (like high deductibles and coinsurance), but as noted above, those just push risk back onto members and reduce the overall value of the product.
Insurance Job #3: Negotiating Prices. Insurance plans strike non-public pricing deals with providers (and pharmacies, via PBMs). Again speaking theoretically, this helps members because the plan can negotiate on behalf of many members at once. While a single patient can’t possibly know the going rate for untold types of procedures, insurance plans can and do. Plus, patients are often too sick at the point of care to negotiate prices on their own.
On the other hand, plans don’t have much incentive to negotiate low rates with providers. That results in occasional situations where it’s actually cheaper to not have insurance; edge cases to be sure, but suggestive that insurers aren’t using their market power to achieve low prices. The evidence that insurers reduce costs for their members seems mixed.
Insurance Job #4: A Substitute for Debt. Outside of healthcare, large expenses that are predictable are usually financed by a combination of savings and debt. Examples include cars, college educations, home appliances, and so on.
Lots of predictable expenses exist in healthcare, too (e.g. chronic care management, some joint surgeries), but they’re paid for with insurance, rather than debt. Insurance is designed to deal with unpredictable events (all those actuaries and claims processors add overhead), so it’s more expensive than debt when it comes to financing predictable care. This is a job that insurance simply isn’t cut out for, but it gets bundled in anyway. And note that this makes the Job #1 (risk pooling) much easier on insurance companies: if many of your claims are actually completely predictable, pooling risk is not just trivial, it’s unnecessary.
Compared to filing an insurance claim, it might seem like a bad outcome for patients to go into debt over a medical expense. However, the main difference between debt and insurance is the timing of the payments: with debt, patients owe a steady stream of payments after the service is provided; with insurance, the payments are owed in advance. (In both cases, there is also an interest payment—with debt it’s made explicit; with insurance, plans collect interest on the float.)
The main takeaway from examining these jobs is that we demand a lot of our insurance plans, and in trying to accomplish everything, the plans come up short.
Why Insurance Wins Anyway
For all of the problems with traditional health insurance, only around 10% of Americans go without. There are two big reasons for that.
First, the regulatory environment strongly favors insurance. On the employer side, tax rules mean that employers can provide health insurance with pre-tax money, and workers expect employer healthcare in lieu of higher, but taxable, wages. That’s because the alternative would be to buy private insurance with post-tax money. Additionally, companies with over 50 employees are required to offer coverage.
Outside of the employer market (and setting aside Medicare and Medicaid for now), there’s the individual ACA market. There’s no tax deduction here, but the ACA itself subsidizes low-income patients’ insurance, meaning that their cheapest route to healthcare access is also through insurance.
(Quick aside, one angle on the ACA is as a subsidy to insurance companies: anyone who couldn’t afford insurance is given a mandate + cash to go buy insurance, which means the final result is…more cash for insurance companies. Said differently, the ACA increases total spending on health insurance in order to make health insurance more affordable to low-income buyers. It uses insurance as a vehicle for economic redistribution, but that doesn’t mean it achieves, or even tries to achieve, lower spending in aggregate. Also N.B., I mostly like the ACA.)
The second reason most people get insurance is that the healthcare system is hard to access and navigate without it. Interestingly, that difficulty is a function of the extent to which the system is built for people with insurance. For example, cash-pay patients depend on transparent pricing to get a fair deal. However, hospital systems and pharmacies rarely publish prices, because people with insurance don’t need to see them. A general feedback loop emerges, which is that as more people have insurance, the system increasingly can neglect those without it, which in turn encourages more people to sign up for insurance.
This is why I’ve been so struck by both Sesame and GoodRx, and why I’ve focused on them for recent essays. Both companies are focused on addressing the needs of patients outside of the dominant insurance system, and by doing so, they’re making it easier to be uninsured.
If you believe in the power of the insurance lock-in feedback loop mentioned above, that positioning begs further examination. On the other hand, if you’re really ambitious and trying to disrupt the system, you need an attack vector from an angle that’s orthogonal to everyone else’s. And the best place to build a business with high upside is generally not in the part of the market where needs are broadly satisfied; change is likeliest where things suck the most.
Let me state it plainly: the underserved cash-pay market is a wedge for broad disruption an insurance-based ecosystem that is failing patients on multiple fronts, but has few apparent vulnerabilities.
Success in the Cash Pay Market Looks Different
The needs of uninsured/cash pay patients are different than those with insurance. Here’s a quick sketch of some of those needs; it’s apparent there are some gaps.
(Readers, what have I missed?)
The development of the cash-pay market, if it happens, won’t be linear: there is a kind of feedback loop where each additional need that gets addressed enables the ecosystem to address the needs of more and more patients, which then de-risks further investment in the ecosystem broadly. Starting a flywheel like that is notoriously difficult; the recent success of GoodRx provides some reason for optimism.
Going to market in the cash-pay segment is also hard: insurance companies have an established sales channel (employers) that doesn’t exist for cash-pay consumers. As I’ve written, GoodRx has succeeded in part by selling through doctors, but centralized sales channels are scarce, and the default ones (Google and Facebook) are expensive.
Further complicating the picture is that not all cash-pay patients are the same, or have the same needs. Some might be financially stable, but decide against insurance because they’re young and healthy. Others might be low-income immigrants who are unable to get Medicaid coverage that they would technically qualify for. The more fragmented the customer needs become, the harder it is to meet them all.
The reward for businesses that tackle these challenges is an eventual seat at the table of the mainstream healthcare market, without having to directly challenge behemoths like United, CVS, and Cigna.
How it Happens, and Why it Matters
It remains to be seen if the cash-pay ecosystem can mature enough to provide an experience that’s “good enough” for most consumers. To gain adoption, it will need to be better than the traditional insurance market on at least a few dimensions. Let’s assume, for the sake of a thought experiment, that it gets there.
This would likely trigger a migration of some marginal customers who are especially poorly served by insurance, relative to the improved cash-pay experience. Those marginal customers are likely to be younger and healthier than the rest, so their defections would drive up premiums, triggering more defections. I don’t think this cycle continues forever—regulations lock in insurance, and insurance plans can cut prices—but it does expand the cash-pay market from where it sits now.
Small employers would have the option to unbundle insurance from employment, possibly by offering higher salaries to workers, who can use the money to get care through the new value chain. Large employers can’t do this though; again, they’re required by the ACA to offer insurance.
That leaves providers, who would gain from less burdensome interfacing with insurance plans (e.g. fewer prior auths). On the other hand, they still need to addressinsurance plans for some customers, and so maintain the overhead to do so (billing consultants and the like), while also putting more resources into the expanded cash-pay channel. While providers are used to selling to insurance companies, they’ll have to re-orient to also sell to cash-pay patients, a tall ask.
For the healthcare system as a whole, maybe the biggest question is whether a cash-pay ecosystem would lower the cost of care. I think there’s reason to be hopeful: end consumers that can compare prices are a powerful mechanism for regulating costs. But supposing it doesn’t? Consumers will return to their insurance plans. From that standpoint, the cash-pay ecosystem represents a call option on a better healthcare system: great if it works, but otherwise no harm done. It’s part of a portfolio of approaches that the healthcare system is taking to reduce costs, alongside ideas like provider risk bearing, or digital tools that increase patient engagement.
Bonus
I got beaten to the punch by Nikhil Krishnan at Out of Pocket this week. He’s got a great post on price transparency that touches on some of the same themes, and he’s always worth a read. (Link)
I’ve wanted to dig into GoodRx for a while. Now that they’ve filed an S-1, I’m well past due to write them up.
In this issue:
How PBMs work, and how they dominate their value chain
Gaps in the pharmaceutical value chain for cash pay / uninsured patients
How GoodRx makes money, and the keys+threats to their high margins
Why should GoodRx pursue telehealth if it lowers their margins?
Pharmacy Benefit Management for Fun and Profit
Before we get to GoodRx, let’s first understand the value chain that they operate in, in particular the role of the PBM. (If you already know this, or just don’t care, feel free to skip to the next section!)
Here’s how I picture the market for insured patients:
PBMs sit right in the middle, which is notable because they do not manufacture, distribute, dispense, prescribe, or bear risk for the costs of drugs. Instead, they make money off of the people who do those things, aggregating demand on one side of the market, and using that demand to set the terms of their relationships with suppliers.
PBMs originated as claims processors for insurance companies. Prescription claims are both tedious and numerous, so it made sense for insurance companies to outsource this function to a third party that could do it more efficiently. (Modularity! Although PBMs have since begun re-integrating with payers).
In practice, this means PBMs are highly concentrated, do a lot of purchasing, and know more about drug prices than anyone else. They use that advantage to generate revenue as intermediaries between insurance companies and pharmacies. (And also other sources of revenue, such as from drug companies, which we’ll ignore for now.)
Specifically, PBMs maintain a ‘network’ of retail pharmacies that are willing to accept the (low) prices on offer, much in the way an insurer maintains a network of doctors. Unless pharmacies join these networks, their customers won’t have drugs covered by insurance and will go elsewhere.
When an insured patient buys a drug from a pharmacy, the pharmacy bills the PBM for it. The PBM pays the pharmacy, then turns around and bills the insurance plans a higher amount, making money on the difference, or spread. In some cases, the PBMs might not use a spread but will charge the pharmacy a network fee per transaction.
Cash Pay Patients are Under-Served
That’s for insured patients. Things look different for cash pay patients, where all of the stakeholders are under-served:
Cash pay patients pay full list price for their drugs in cash, and those list prices are much higher than the PBMs’ negotiated prices. Furthermore, patients don’t have a good way to shop around and compare prices across pharmacies. Pharmacies don’t publish their retail prices on their website, at least not in a consumer-centric way (most patients have insurance, so shopping around is moot). And even if they did, there’s no price comparison site for drugs like those that exist for, say, flights and hotels.
Pharmacies profit from cash pay patients, but high list prices for cash pay mean that many such patients leave their prescriptions unfilled, rather than paid for. And pharmacies can’t lower these prices without eroding their position in the much larger insured segment.
PBMs represent insurance companies, so don’t have a way to make money off of cash pay patients. If they could find a way to take a cut of the cash pay business, it would be a growth opportunity.
Physicians who are treating uninsured patients want to prescribe drugs that the patients can afford (and adhere to), but they don’t know which drugs are affordable.
Enter GoodRx, the hero of our tale.
GoodRx brings PBM pricing to uninsured patients
GoodRx solves all of those unmet needs at once, simply by presenting the PBM’s prices to the patient in the form of a coupon.
Patients avoid the ultra-high cash pay prices (GoodRx says their prices average 70% less), and can shop around for the very best deal.
The PBM can now collect their transaction fee from the pharmacy, sending part of that fee back to GoodRx.
The pharmacy doesn’t come out great, but will accept the coupon in order to make the sale, plus it’s already agreed to the price anyway among insured patients.
I want to connect GoodRx’s operation back to a concept I previously wrote about, framing One Medical’s business model is a form of arbitrage:
One Medical’s business can be thought of as aggregating private pay customers, and then selling them to health plans at a markup via their partnership program.
GoodRx operates on a similar principle: uninsured patients are valuable for PBMs, but hard to access. GoodRx offers a value-added service to those patients, which means patients use GoodRx as their first stop in shopping for drugs. PBMs then pay GoodRx to access those patients.
Flipping that around, GoodRx first acquires the patient, then monetizes it by ‘selling’ it to the PBM. Buy low, sell high.
The great thing about an arbitrage business is how little it costs: GoodRx spends nothing on direct unit or labor expenses. Their ‘Cost of Sales’ line item comes down to odds and ends like AWS fees, and so the margins that they generate are excellent. In that sense, it’s a more powerful approach than One Medical’s, which must build out a costly footprint of tastefully decorated storefronts to attract patients.
High margins, though, are a bit like blood in the water: they attract a lot of sharks. How durable will GoodRx’s margins turn out to be in the long run? There are two threats that concern me the most.
Margin Threat #1: Scalable Customer Acquisition
If you think of GoodRx as arbitrage of patients as described above, then customer acquisition really should be considered a direct cost for analysis purposes. A retail business buys widgets and sells them at a markup, and records the price they pay for each widget under ‘Cost of Goods Sold.’ GoodRx buys patients and sells them to PBMs at a markup, so operationally, their customer acquisition cost is equivalent to COGS, even though it doesn’t show up that way on the income statement.
The problem with acquiring patients cheaply is that, eventually, costs start to increase. The first customers to find your product are the ones that really need it, they’re the segment where you have the best product-market fit. As you scale, it takes more advertising dollars to acquire a marginal customer, even as you must also invest to build your brand.
Furthermore, the best places to look for new patients tend to be places like Facebook and Google. You can buy low because you have a nice app, but Google can buy lower because their search engine is one of the greatest products of all time. So, Google captures more of the value. This is part of what has happened to Dollar Shave Club and the online travel agencies.
I think GoodRx has found a way around that trap in the form of…doctors. Doctors don’t generate any value for GoodRx directly, but are critical as a marketing channel. A patient that hears about GoodRx from their doctor is not just aware, but getting a valuable endorsement from a trusted source. GoodRx knows this (pg 119 of the S-1):
…approximately 17% of our website visitors are healthcare professionals. Our NPS score among healthcare professionals who use our platform was 86 as of February 2020, and over 2 million prescribers have a patient who has used GoodRx. We are able to integrate our pricing information and GoodRx codes directly into EHR systems, enabling healthcare professionals to provide prices from our platform directly to their patients at the point of prescribing, including via EHR-sent text messages and emails.
See also, under ‘Marketing’ (pg 126):
We have also built GoodRx Pro, an app designed specifically for healthcare professionals to facilitate electronic prescriptions. This app is integrated with our prescription offering to enable physicians to quickly find the form, dosage and quantity of medication that they intend to prescribe and seamlessly send pricing that is available on GoodRx to their patients.
This is just beautiful. Somewhere, a marketing team figured out how important doctors are in driving adoption, even though the doctors produce no value for GoodRx directly. This insight was elevated to a product team, which created an entirely separate app devoted to exploiting it.
Selling through doctors is difficult. Pharma companies mobilize enormous sales forces to do it, a brute force approach that pays off because their reps carry bags full of multi-billion dollar drugs. GoodRx can’t afford that, but they get a good result by building an app that adds real value to the doctors, which translates directly into customers. Even if the doctors don’t have the app, GoodRx is right there in the EHR, which by the way is happy to offer GoodRx’s data because it adds value to their own systems.
Finally, note that the ‘Pro’ app is a fixed cost, not a direct cost—it will enable GoodRx to scale their customer acquisition much more effectively than a sales force, or relying too much on Google ads.
Margin Threat #2: Competition
In financial disclosures, companies love to play up their competition because (a) the point is to warn investors about risk and (b) they don’t want to get regulated. GoodRx says this about competitive threats:
Within the prescriptions market, our competition is fragmented and consists of competitors that are smaller than us in scale. There can be no assurance that competitors will not develop and market similar offerings to ours…
‘Fragmented’ is another way of saying that there are a lot of competitors emerging. Indeed, a Google search for “cheap prescriptions near me” yields a massive ad load from competitors like WellRx, RxSaver, etc. If any of these become large, it gives PBMs a better BATNA, patients another choice, and lowers switching costs for both, certainly reducing GoodRx’s margins. Common ways to stave off competition include economies of scale, network effects, switching costs, branding, etc.; are any of those in play?
There might be a scale effect in the sense that generating more patients allows better terms with PBMs, which enables lower costs, which enables lower prices, which loop around to attract even more demand. Combined with a head start on the experience curve and a head start in brand building, that might produce a semi-durable advantage. Certainly GoodRx has done a fine job of executing thus far.
On the flip side, switching costs are low for both patients and PBMs. Margins are high enough that even an inefficient upstart could absorb lower margins and still earn an attractive profit. There are relatively few barriers to entry. To maintain a dominant position, GoodRx will need more tricks…like telehealth?
Why telehealth?
Over 90% of GoodRx’s 2019 revenue came from the core prescription product that we’ve discussed above, and a bit more comes from selling ad units on their app. The rest comes from:
Hey Doctor, a telemedicine provider that they acquired last year
GoodRx Telehealth Marketplace, which launched this year
That’s two bets on telemedicine just 11 months apart, which is striking because of the lower margins in telehealth. As Kevin O’Leary hilariously notes:
I find it funny that GoodRx has to call out its telehealth platform HeyDoctor in the risk factors section of the S-1 because the margins are so much worse than the core business. “Our business model is so good that if we’re too successful in the telehealth space it’s going to be bad for us financially”. What a flex.
And yet…it’s a fair warning! You have a core business that is growing quickly and extremely profitable. Do your newest investors really want to fork over their capital when you spend it on a less profitable telehealth business instead?
Aside from the obvious synergies around cross selling, I’ll offer two angles:
The LTV/CAC angle. GoodRx invests a lot in patient acquisition (building good apps, advertising). Once a patient hits their website, though, it’s time to monetize.
One monetization tactic involves collecting a fee on the patient’s prescription—this is GoodRx’s core product—and telehealth will be a second tactic. Many GoodRx users are sick and will need convenient doctor visits. As long as the margins in telehealth are positive, then adding a second monetization tactic will increase the lifetime value (LTV) of each patient. In addition, more users will find the platform organically, so cusomter acquisition costs (CAC) go down. Taken together, this means the LTV / CAC ratio should improve dramatically with each additional tactic.
To be clear, LTV / CAC is not a perfect metric, since it says nothing about customer volume. Consider an alternative use for the funds spent on telehealth: GoodRx could drive more volume AND margin by spending its cash buying more customers for its high margin business. But that’s only a short-term win.
Telehealth might produce lower margins but it juices the unit economics of the business for the future, where each new customer is monetized in multiple ways and is stickier. That in turn justifies higher marketing spend, and allows GoodRx to be profitable at higher volumes.
In my view, GoodRx correctly takes the long view by investing in a low margin opportunity.
The Telehealth-as-a-complement angle. I wrote in June that one possible outcome of the telehealth industry is heavy consolidation, given that there are economies of scale, and geographic distribution constraints that have been removed. This would be a poor outcome for GoodRx, since doctor visits are a powerful complement to their business (visible in their Q2 numbers, which are down as the pandemic halts doctor visits). Products become more valuable when their complements are commoditized.
To understand the risk, picture a powerful, centralized telehealth provider. This hypothetical company would be in a great position to offer its own prescription discount solution, because the doctors it employed would all use it. Alternatively, it could contract with GoodRx, but capture much of the profit through the terms of that contract. GoodRx therefore wants to foster healthy competition among telehealth providers, and owning a piece of the action (HeyDoctor) or running a marketplace, help do exactly that.
Conclusions
GoodRx’s high margins are grabbing all of the headlines. A profitable startup, in 2020! But unit economics at the patient level are a better way to assess GoodRx’s prospects than just margins.
Unfortunately, the unit economics can’t fully be derived from information in the S-1. Regardless, a bet on GoodRx must include a point of view on their ability to continue bringing in customers cheaply, and account for the various ways those customers can be monetized. Further, it must consider the potential impact of competitors that are already chasing those very same margins.
Structurally, GoodRx is making things a little better for uninsured patients - in that way, it complements Sesame. I’m going to explore the implications of a market that caters to uninsured patients in an upcoming essay.
You should read the whole thread, but let me summarize so we’re all on the same page.
Primary care practices are hurting financially as people delay treatment during the pandemic.
Blue Cross NC intends to help the practices in its network by covering their COVID-related losses, making payments like it’s still 2019 (if only!), through a program called Accelerate to Value.
The catch is that the practices who accept these payments must join an ACO*. They’ll also be nudged toward taking capitated** payments in a couple years.
I recently covered the current dynamic between payers and their primary care providers, arguing that while cash-rich payers have an interest in keeping their networks of doctors (i.e. their suppliers) afloat and un-consolidated, they also have an opportunity to extract some value in the process:
Instead of giving the money away freely via reimbursements, why not use the cash to take an equity position? Blue Shield of California has done this already. For health systems, primary care referrals are a key source of profitable patients…Insurance companies now have a chance to take control over those referrals.
BCNC hasn’t bought equity—they’ve bought something much more interesting.
Paying to pay for value
BCNC is offering a generous set of payments, so what do they get for their money?
Cash keeps independent providers financially secure, so they’re less likely to sell to a big hospital system, which would increase supplier concentration and weaken insurers. Aid recipients are in fact required to remain independent throughout the program. (Note that this benefit accrues to BCNC’s competitors as well, especially free riders who pay nothing.)
Blue Cross ensures that the practices in their network remain open in the near term, servicing members who still need care. Providers must pledge to stay open, embrace telemedicine, and coordinate care during the pandemic.
Most important, BCNC accelerates an already aggressive strategy to move its operation toward value-based payments
Let’s expand on that last point, because BCNC has been seriously committed to value. In early 2019, they launched a value-based payment program called Blue Premier, which already includes 8 of the largest health systems in the state. All providers involved must accept two-sided contracts, accepting the risk of losing money for delivering inefficient care.
In the rest of the country, value-based care (VBC) has caught on much more slowly, partly because providers face up-front costs and new risks that they have little incentive to accept. In order to get providers on board quickly in NC, BCNC must sell to them, commit resources, and presumably make financial concessions.
It takes real courage to commit to this strategy because BCNC has a lot to lose. It already controls the majority of its market, VBC is unproven at this scale, and a bet in the wrong direction could be damaging.
Moreover, the outcome of the strategy holds big implications for VBC in the rest of the country. A well-executed, successful program will quickly attract followers in other markets. A flop could deter potential followers, further entrenching fee for service. Stakes are high.
Value-based care needs primary care
While Blue Premier has successfully won the large health systems in North Carolina, those systems are not enough to enable the full shift to VBC. Around half of the primary care market in NC is held by independently owned practices, and such practices play an especially important role in the ACO model:
PCPs are most often are the first point of contact with the patient, so they’re most able to make early or preventative interventions
PCPs deliver care across many different patient needs, so they’re positioned to coordinate care across siloed specialists
PCPs manage chronic diseases most efficiently, which is important because un-managed chronic diseases lead to poor health and expensive hospitalizations
There’s evidence that smaller, physician-led ACOs reduce cost more than large hospital-led ACOs, at least in the Medicare market
So BCNC needs to engage a lot of PCPs, but it’s especially tough to entice an independent primary care practice into the value-based scheme. They have smaller patient populations, so risk-bearing is a real issue. They lag behind the health systems in EHR implementations that enable coordination and reporting. They’re independent and all need to be sold on the matter individually.
I’m picturing tall stacks of memoranda on BCNC letterhead, brimming with incentives and pilot programs to bring these PCPs into the fold…and all of a sudden COVID hits. Now BCNC has an immediate way to get their independent primary care doctors to try VBC. Expensive, but worth the price because it’s far simpler and faster than any option available 6 months ago (or 6 months hence).
ACOs are complicated; Aledade partnership
It remains to be seen how many practices join BCNC’s program, given how many strings are attached. Even with the generous payments on offer, there are serious hurdles to joining an ACO. For one example, ACOs each have governance structures that define how savings are distributed to each participating provider; a small practice joining an ACO, with no option to back out, might get forced into poor terms.
There needs to be an on-ramp that actually enables these doctors to be successful and happy in the new scheme. Aledade theoretically fills that need.
I think of Aledade as a software-driven service that helps doctors form ACOs, and operate more effectively in them. In their words:
Aledade offers primary care providers access to cutting-edge data analytics, user-friendly guided workflows, unparalleled regulatory expertise, strong payer relationships, and local, hands-on support from attentive experts. Our goal is to make it simple for your primary care practice or community health center to participate in value-based care while improving outcomes for patients and supporting a cost-effective, high-value healthcare system for your community.
While Aledade is focused on ACOs, I suspect much of their value actually comes from applying process improvements and management skills that many small practices lack, regardless of their ACO participation. Applying workflows, checklists, and data insights will improve nearly any organization that was missing those things; all the more so because Aledade has a lot of experience testing them out across many practices. But Aledade’s services happen to be much more valuable to ACO participants than fee-for-service-based practices:
An ACO represents a big enough change from the practice’s fee-for-service operations that the practice becomes more open to making managerial and process changes (or it joins an ACO because it’s open to making changes).
The complexity of an ACO means that poor processes cause much more financial pain to an ACO participant than to a FFS operation.
Fee-for-service fails to punish poorly operated practices, or reward the well-operated ones. ACOs (in theory) create the incentive to operate more effectively, which creates demand for a business like Aledade. In turn, Aledade’s existence enables ACOs to grow more quickly and move forward—there’s a positive feedback cycle.
ACO success depends heavily on good execution, which makes Aledade critical to BCNC’s strategy.
Revisiting Bright Health; value chain comparison
I wrote in January about Bright Health, a startup insurer in the Medicare Advantage market. Bright, like BCNC, pursues a value-based strategy, but their respective value chains look quite different.
Bright partners with a single health system in a given market (a narrow-network strategy), then acquires Medicare Advantage members by offering low premiums and other perks. Those patients represent important volume for the health systems.
How does Bright gain the leverage it needs to ink a deal with a prestigious health system that will attract members, and enough members to attract the health system? It has to offer additional value to both health systems and consumers, which it does by integrating analytics, care coordination, and assistance with workflows—many of the same services that Aledade offers to ACOs!
BCNC doesn’t need to offer such services—they can outsource them to Aledade because they offer other services. First, they bundle medical services for patients. Unlike Bright Health, they cultivate wide networks; patients buy from BCNC to access those wide networks, which gets them a lot of choice across the full spectrum of care.
Second, BCNC bears financial/insurance risk, at least in the FFS value chain. During the transition to VBC, though, financial risk is gradually moved to the providers. That sounds like a win for BCNC, since risk is usually something bad, but it actually weakens them, because they cede control over that part of the value chain to their suppliers (providers).
How do insurance companies add value with VBC?
When a firm gives up control over a step in its value chain, it loses power in the market, even if it does so for the right reasons (like reducing financial risk). The financial benefit becomes a strategic loss. To illustrate, here are two unlikely and speculative scenarios that BCNC could face after pursuing their value-based strategy:
Large providers offer insurance plans. A sufficiently large health system could conceivably meet the full range of medical needs of an insured population. If that provider is also willing to take on financial risk, and to go to the market with an insurance product, it can benefit immensely by removing BCNC as an intermediary. Think cheaper plans, no prior authorizations, seamless patient experience, etc. It’s a big reach to get to this equilibrium, since competing insurance plans would remove this provider from their networks. But I also believe it’s a stable equilibrium, and examples like Kaiser Permanente and Geisinger, though rare, show that it’s possible.
Aledade offers insurance. Aledade could find themselves in a similar position to Bright Health, with the valuable addition of many ACO relationships. They could bundle access to those ACOs’ service to offer patients a compelling insurance product, simply by integrating the next service in the value chain. Not especially likely any time soon—Aledade is still chasing profitability in its core business—but illustrative.
The point is not that either scenario is very likely. Rather that, for all of its commendable vision and leadership, BCNC sacrifices risk bearing that added value to its core insurance business, without replacing the risk bearing with another value add. As a result, their products become more of a commodity, and, other players get an opportunity to offer higher value-added services. As it transforms into a value-based payer, BCNC must also ensure that it keeps its business differentiated and relevant.
Bonus
Since we’re discussing BCNC, check out this excellent and beautifully packaged analysis on spending patterns in North Carolina, published this week. Do yourself a favor and spend some time scrolling through it.
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(*) An ACO—simplifying a lot—is basically a network of primary care practices, that can also include specialists and hospitals. Importantly, ACOs are paid according to a value-based scheme, meaning that they earn more when they keep costs down, and when patient outcomes are good. After perusing many confusing explainer articles of how ACOs work, I can finally recommend this deck, which is dry, but detailed and digestible.
(**) Capitation means the provider is paid a fixed amount in return for providing care to a given population of patients over a given time period. Providers who reduce costs can pocket the savings, while providers that are inefficient can lose money.
