The Disruptors, Part 1: DTC Insurance
Bright Health, Devoted Health, and Oscar have raised a lot of venture money
The Disruptors will be a series of posts that examines emerging business models with the potential to change the healthcare landscape.
If you enjoy this post, please consider sharing or subscribing, and follow us on Twitter
Earlier this month, startup health insurer Bright Health raised a $635MM Series D, with many of the same investors returning from earlier rounds. Bright Health isn’t alone in raising large amounts of money to start a health plan:
Oscar Health, an insurer founded in 2012, raised $375MM from Alphabet in August 2018.
Startup insurer Devoted Health raised a $300MM Series B in October 2018.
Health insurance markets are full of complex regulations and massive incumbents; is there really much room for a new model? Can that new model scale to justify the venture money, and produce meaningful changes in the healthcare system?
To answer those questions, let’s look at their business model: it turns out that all three companies take a pretty similar approach, consisting of 5 main components.
Component 1: Direct To Consumer Focus
All three companies are focused on the direct-to-consumer (DTC) market, via individual and family plans or Medicare Advantage (MA) plans. Only Oscar appears to have any offerings for employers, which are limited. For now, the venture-backed insurers are consumer-facing insurers, which is important to note because consumer is a much smaller market than selling plans through employers.
Consumer markets are attractive when the customer experience is the thing that matters. As we’ll see, customer experience is a major focus these companies.
For a startup focused on customer experience, the employer market will be hard to crack at first—companies are doing the purchasing, and are focused on getting the best terms for themselves, rather than the best experience for their customers. (It’s the same concept that drives this legendary analysis of the iPhone).
Within DTC, Medicare Advantage is a natural fit for a startup since it’s a large market that’s growing quickly, driven by both demographics and new regulations. And MA is a value-based scheme that gives fixed payments to insurers in return for managing their populations, which is key to this business model. Which brings us to the a discussion of Component 2.
Component 2: Aligned Incentives with Value-Based Care
This one is critical.
Bright, Devoted, and Oscar have all structured their plans to financially align themselves with providers: when providers provide cost-effective care, both parties gain. (I’ve recently posted about value-based care)
The large incumbent players (e.g. United, Humana) are largely built for a fee for service environment, and they’re best positioned to succeed in fee for service. (Value-based experiments by the large incumbent companies are of course common: here’s one example that failed, and here’s a newer attempt underway).
Here’s how the incumbents' positioning works: fee for service creates a fundamental conflict between the payer and the provider (see illustration), and so these providers have become very large in order to improve their market power, which is the best way to control costs in a fee for service world.
Providers in a fee for service scheme can maximize their revenue by increasing patient volume, and billing the maximum amount possible, including care that may not be medically necessary. As a result, insurance companies need a way to control costs, and they do it with scale. Since providers can’t afford to lose the patients controlled by a large insurer, they make concessions on cost and access.
But it’s an uneasy equilibrium. Insurers, even large ones, have only blunt tools to reduce costs. Prior authorization is an example, and it essentially reduces expensive treatments by throwing up a wall of red tape in the way. It works, but creates a bad experience for the patient (who has to wait and deal with uncertainty), and disgruntles providers (who are forced to spend their time filling out forms instead of treating their patients).
In the value-based world, incentives are different, and much-improved:
Two fascinating points here:
In the value-based scenario, scale is not nearly as important as in fee for service. While it still helps in some ways (e.g. for investing in tech platforms), it’s no longer the primary basis of competition. So in shifting to a value-based arrangement, much of the incumbents’ advantage is reduced.
Under value-based care, payers win financially when their members are engaged and receiving the right care, because that’s how they both drive membership AND limit costs. Patients are the winners.
Those are promising signs. On the other hand, the fundamental economics of the value-based arrangement still aren’t clear. If fee-for-service turns out to more profitable for both payer and provider, then value-based care won’t survive outside of Medicare Advantage. And there have been failures in the past, as cited above.
Component 3: Tech and Data Capabilities
Vijay Pande of a16z, who led the funding round for Devoted, wrote at the time that integrated payer-providers have not yet been able to scale, and that, “My belief is that what is limiting this scaling is inherently a tech problem.” The basis for this claim isn’t clear to me and I’ll be exploring it, but it speaks to the importance that these companies place on technology.
For the most part, the technology platforms for these companies don’t yet seem to exist or aren’t public, so we’re left to speculate a bit. Some possibilities:
Processing claims much more quickly for providers so they are paid more quickly
Developing an engine to help identify patients that need more treatment, or are receiving wasteful/duplicative treatments.
Helping providers manage the health of their populations by identifying opportunities to offer care more proactively to at-risk members
Improving operational efficiencies by integrating tech systems with those of the provider, or simply offering a platform for the provider to run their data services off of. For example, allowing patients to view a bill in real time without waiting for any claims to be filed and processed.
Apps and portals through which patients can get information, schedule appointments directly with providers, pay bills, review treatment regimens, etc.
Note that several of those solutions, even down to simple things like scheduling an appointment, require close collaboration between the payer (who built the app) and the provider (who owns the booking system). It’s a clear case of integration enabling a better customer experience.
Component 4: High-Touch Customer Experience
I mentioned above that in a value-based scheme, customer service becomes the basis on which plans compete, especially for DTC products. It’s no surprise, then, that each of the three startups offer concierge services that help patients navigate their care.
Concierge services can include things like proactively reaching out to patients who need a follow up visit, finding them rides to appointments, or answering questions about treatment options. In the case of Devoted, they’ll even employ clinicians directly to visit homes and provide care.
The high-touch experience is intended to engage members, which builds loyalty (reduces churn each year, an important economic driver for startups with high CAC), and keeps them healthier (reduces future hospital costs).
Crucially, it’s enabled by integrating with providers (who will need to work closely with the care coordinators). Concierges are also a vehicle for executing on any recommendations that emerge from the data platforms. So all of these elements are mutually reinforcing, creating a unique internal consistency. And it’s another example of integration improving customer experience.
Unfortunately, it’s hard to see this concierge experience scaling very broadly without the help of some significant innovations in the tech and data platforms. Concierge labor represents a large variable cost that grows linearly with patient volume, and present a drag on margins that should otherwise grow as these businesses scale.
Component 5: Narrow Networks
Our startups all have narrow provider networks, which is notable because customers generally prefer broad networks. There are, however, a bunch of benefits to offset set that:
Cost control: Oscar started out with broader networks, but has been steadily reducing them. Devoted’s networks are narrow, and Bright has gone the furthest, partnering with just a single provider system in each market.
Smaller networks have lower costs because an insurer can pick only the most cost-effective providers, and can negotiate better terms with those providers by offering more patients/market share. On the other hand, widening a network attracts some patients, but there are diminishing returns.
(I’ll also speculate that the patients who care most about a wider network tend to be sicker (they care about the network in order to access a specific specialist that treats their condition), and not desirable to cover. Which if true, is a major problem).
Here’s an illustration of what the cost-benefit looks like:
Improved integration: Integrating with a provider takes significant effort. Care coordinators employed by the payer must learn the provider’s procedures, people, and systems, a process that scales poorly. Integrating with fewer providers makes it possible to do a much better job.
Improved profit sharing: With a single provider partner (as in Bright’s case), it’s possible to align financial terms on the entire population of patients, which makes incentives extremely clear and simple. The provider system can, for example, be certain it will capture the benefits of good primary care that reduces expensive hospitalizations later on. When there are many providers in the network, that isn’t possible, and a weaker version of the value-based care plan is implemented. This is one innovation that I think works in Bright’s favor relative to it’s peers.
By the way, why would a provider want to partner up with a payer? Well, we mentioned above that incumbent payers are geared toward fee-for-service, it stands to reason that the same holds true of providers as well. Switching to a value-based world involves new challenges like taking on financial risk that providers might not be experienced with. Managers will be accustomed to trying to fill their expensive hospital beds, rather than empty them. A partnership with a payer can help manage the transition.
Putting It All Together
Speaking superficially, I happen to love this new business model, because of the elegant way the pieces all fit together. Here’s a quick matrix that shows the connections between each of the components. We’ve already discussed these above, I’m just summarizing out of pure appreciation.
Important note: just because I find the model elegant doesn’t mean it will work!
Outlook
The bullish story here is that a new opportunity has emerged, especially in the Medicare Advantage market, for a new business model that serves patients better. It uses an integrated approach with value-based incentives in order to enable a better customer experience, and to save on costs by preventing hospitalizations.
Because these companies are being built from the ground up, there’s disruptive potential against the larger incumbent insurers, who have optimized themselves around fee for service. These incumbents may not properly prioritize customer experience, since their success to-date has arisen from an adversarial relationship with providers that actually creates a poor customer experience. The venture-funded insurers can therefore win this battle.
The bearish case is that these businesses are very capital intensive to build, as shown by the large and repeated capital raises, and they’ll need to show a large return to justify that capital. That means operating at scale, and also escaping from the DTC markets into the large employer-driven insurance markets, where the incumbents will remain in a better position.
And before that even becomes an issue, the profitability of these companies in their currently small markets needs to be proven. Are the economics better than fee for service, for both the insurer and the provider? How many narrow-network plans will the market truly support? What about once they start growing into each others markets and start competing directly with one another?
If you enjoyed this post, please consider sharing or subscribing, and follow us on Twitter