Will the destruction be creative?
Providers vs. Insurers, One Medical and Payment Models, Telemedicine Transcendent
I haven’t published much in this space during the COVID crisis. As the pandemic began, I felt that the important issues (forecasting death rates, distancing policies, various treatment options, PPE shortages) were outside the scope of this blog (including, probably, this post). Covering them further would have merely added noise.
Now, though, many of the above questions are being settled, and there are clearer questions about the state and structure of the industry. We proceed anew.
This post will highlight a few broad themes in the healthcare industry from the past few weeks, and analyze which direction they’re pushing the industry. It’s necessary to make some assumptions about COVID, and I generally assume that the pandemic lasts at 1-2 years, but of course it may end sooner.
(I’ve been watching the Good Judgement Project’s dashboard as a good indicator for this; they currently predict a 65% chance that a vaccine arrives within the next 2 years.)
The sooner a vaccine (or cure) appears, the simpler it is for things to simply revert to business as usual, circa 2019. The longer the pandemic lasts, the greater its long-run impact will be, because more of the existing structures will break down, ready to be replaced by new forms. We’re already seeing some breakdowns.
Providers are struggling
No surprise to those of you following the healthcare news. Sarah Kliff (NYT) writes about hospitals:
The Covid-19 outbreak has shown the vulnerabilities of [the hospital] business model, with procedures canceled, tests postponed and millions of newly unemployed Americans expected to lose the health coverage they received at work.
Perhaps obvious in retrospect, but before this crisis, one might have expected a pandemic to increase demand for healthcare. However, hospitals are currently losing business as patients put off procedures due to COVID fear. Worse, those delayed procedures are the most profitable ones (e.g. elective surgeries).
Meanwhile, hospitals must shoulder the expenses associated with COVID: preparing facilities and workers, rolling out new processes, and scrambling to source ventilators and PPE. Per the Kliff article, they might be losing money on an average COVID patient.
Primary care providers are in even worse shape than hospitals, again because patients delay seeking treatment during COVID. If small and medium sized primary care practices end up insolvent, expect a higher proportion of physicians to be working for larger organizations in the near future.
Insurance Companies vs Providers
All the money that providers are losing is sitting in the insurance companies’ pockets. Members are delaying care due to COVID fear, so insurance companies aren’t on the hook to pay for treatment. As a result, they’re sitting on strong balance sheets, even as they pay out large rebates.
(Brief aside: those rebates aren’t altruistic—the linked article fails to mention this, but rebates would likely be required by the ACA’s minimum medical loss ratio, regardless. A similar set of payments was made last year, even in the absence of a pandemic. Paying rebates now, though, builds up goodwill among current members and may help retain more of them next year).
Given the imbalance in fortunes between insurance companies and providers, this article in Health Affairs asks why insurance companies don’t step in and financially support their network’s providers.
As demand for medical care and therefore costs to insurers have plummeted, private insurers have begun to provide some relief to enrollees. But they should do more for providers, beginning with primary care.
The argument is that if providers start going out of business or consolidating, it leaves insurers with fewer suppliers of care to their members, which increases supplier power. The authors propose that each insurer scales up payments to primary care providers, and they astutely recommend policies that minimize the risk of free ridership, which could happen if some insurers decline to participate.
Still, I’m not sure I buy the original premise, for two reasons:
Any increase in supplier power is a second-order effect, while the first order effect is losing cash. It’s not obvious that larger reimbursements would effectively backstop all of these providers, and even it if did, consolidation among providers might happen anyway (in fact, it’s been a trend even pre-COVID).
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, and referrals are more reliable from the primary care practices that they own. Insurance companies now have a chance to take control over those referrals.
I’ve written before that insurance companies and providers are locked into an adversarial relationship. COVID doesn’t change that, but it does temporarily give insurers the upper hand.
One Medical and Capitation
One group of providers notably is not struggling during the pandemic: practices operating under capitated payments, as opposed to fee for service. (I have previously explained the difference.) With capitation, providers are exposed to the same risks and benefits as insurers—they’re better off when expenses are low—so they’re not suffering from low demand.
As an example, take One Medical (also see previous Caseload coverage). They operate partially under a capitated model: while they bill for individual services, they also receive a fixed ‘per member per month’ payment from partner health plans, as well as an annual subscription payment from individual patients. Together, these revenue streams insulate them somewhat from COVID, although they still mention ‘short-term revenue headwinds’ from their FFS lines during their most recent earnings call.
Longer-term, One Medical is playing offense. First, they benefit strongly from the COVID-related shift toward telemedicine (on which more in a moment). Since they already have a mature platform to deliver care through that channel, increased demand for telemedicine plays to their strengths.
Second, they’re improving the pipeline of employers who will offer their services, likely driven at least in part from their telemedicine position. Despite the pool of commercial members shrinking in a time of unprecedented layoffs, One Medical is increasing its membership guidance for 2020.
I want to emphasize the importance of the importance of their commercial/private pay membership:
Commercially insured customers are essential to hospital margins, because they reimburse at much higher rates than Medicare and Medicaid.
As a result, commercial customers are scarce, and hospital systems compete for them.
When commercial customers become even more scarce (mass private sector layoffs), One Medical’s power and importance, relative to the health systems, increases.
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.
Here’s the market reaction (SP500 and Healthcare Sector ETF performance shown for comparison):
Note that just because One Medical (and other providers with capitated arrangements) have done relatively well, it does NOT follow that capitated payments will always be better for providers; it just happens to have turned out this way for this particular crisis. COVID has punished fee for service in favor of capitation, but the next black swan event could do quite the opposite.
Nevertheless, I believe the current situation will result in a (likely modest) increase in capitation arrangements:
Because the pandemic has helped providers who use capitated arrangements compared to those who do not, mere survivorship dictates an increase in the proportion of providers using capitated payments.
For many health systems / providers right now, uncertainty is a huge risk. Capitation represents a steady, badly needed set of cash inflows, and might be the only choice to stay solvent.
The stresses that providers are currently under will justify decisions that would otherwise be deemed drastic or unwise, which opens new possibilities of all kinds.
Within health systems, the apparatus of billing specialists, administrative staff, etc. that support the fee for service revenue cycle quickly begins to look more like a cost center than a revenue center, now that there’s a shortage of procedures to bill for. Layoffs among this group, while unfortunate, mean health systems become less directly invested in fee for service billing going forward.
Telemedicine Transcendant
I be like damn:
Aside from COVID keeping everyone at home, the telemedicine explosion has been hastened by CMS temporarily loosening regulations. For example:
Telemedicine is now reimbursed the same as an equivalent in-person visit (it had previously been quite a bit less)
Telemedicine can now be performed by any licensed doctor in the country, not just doctors that are licensed in the locality in which they practice.
In the long run, telemedicine isn’t sufficient for every patient encounter. See this thread for a useful discussion about what it can and cannot do:
In the replies, estimates vary widely; my uncertain reading is that maybe 40% of patient encounters can be completed online, but no one really knows.
Nevertheless, the rise of telemedicine has huge implications for the distribution model of healthcare, which until now has been highly localized. If we draw any lessons from our friends in tech and media, we understand that when constraints on distribution are removed, structural changes follow.
To be clear, telemedicine isn’t going to disrupt, say, primary care in the same way that the internet disrupted the newspaper, because there are still costs to delivering an incremental unit of care (mostly in the form of clinicians’ time). But, the equilibrium changes for a few reasons:
Physicians can be recruited from anywhere.
Fixed costs diminish, and can be spread across a much larger number of patients.
A large firm is strongly positioned to negotiate favorable reimbursements from payers.
Telemedicine visits don’t involve any services, so there’s less revenue per encounter (One Medical made this note on their earnings call). That puts further pressure on costs, which in turn drives the imperative to scale.
Economies of scale result in concentrated industry structures, so we should expect just a few winners to emerge. This dynamic suddenly creates a lot of upside for firms like Teladoc or Doctor on Demand. In a winner take all industry, the size of the ‘all’ might be getting a lot larger.
It’s also worth considering that the value of such providers might be maximized by joining with another part of the value chain: either a hospital system or an insurance company. Both benefit from controlling the trajectory patient journey that starts in primary care.
The national insurance companies (Aetna, United, Cigna, etc.) seem like the most natural buyers, as their geographic diversity makes better use of a scalable platform than the mostly regionalized health systems. Those companies all have experience operating as providers; United in particular is one of the country’s largest employers of HCPs via their Optum subsidiary.
In scaling up, telemedicine providers are limited by the supply of physicians they need to hire. But we’ve come full circle: I’ve already noted that physician practices are struggling and the forces of consolidation are building. Telemedicine is yet another such force.
Thanks for reading! For more, visit the About Page, or consider subscribing. You may also like: The Upside-Down Insurance Incentive, Making Drugs Good Enough, EQRx