In 2013, the U.S. spent a whopping 17.4% of GDP on healthcare, more than any other high-income country. The magnitude of U.S. health expenditure is a highly-public, highly-politicized issue, yet few can elucidate why U.S. health spend diverges dramatically from other high-income nations. It is worth trying to understand the cause of this difference and whether any opportunities are created for firms that assist in reducing U.S. health expenditure.
When considering the financial incentives of the U.S. healthcare industry, it becomes evident that this is a system that rewards volume-driven healthcare rather than value-based care, hardly a situation that’s likely to help moderate medical cost growth. According to CMS, national health expenditure in the U.S. is projected to rise at an average rate of 5.8% per year for 2014-24 – an unsustainable level, given the eventual fiscal strain of trying to fund the Medicare and Medicaid programs. It is clear that a dramatic shift in the economic model of the healthcare industry must occur to curtail this ballooning expenditure.
The industry is in the early stages of transitioning to value-based healthcare, where healthcare providers are rewarded for improving patient outcomes rather than increasing the quantity of care provided. The current fee-for-service payment system means that the longer the inpatient stay or the more services provided, the higher the fees generated for the hospitals.
This perverse incentive system, coupled with historically poor accountability for health outcomes, has encouraged utilization of hospital and physician services (even in instances where these services might not be warranted) and has helped increase the cost of U.S. healthcare to egregious levels. If in doubt about the role incentives have to play, ask a barber whether you need a haircut and you’re likely to get a fairly consistent answer!
Conversely, insurers have an incentive to help reduce health care costs (so that their benefits expense declines) and they are seeking to shift risk to the providers through capitation agreements. In these capitation arrangements, providers are paid a lump sum per patient, regardless of how many services the patient receives. The onus thus shifts to the provider to ensure that health care costs do not spiral out of control. A key question is why would a hospital choose a capitation arrangement over getting paid on a traditional fee-for-service basis?
In answering that question, it is worth considering what would occur if the U.S. government became responsible for paying all healthcare costs, an obviously extreme example. Hospitals would simply have to accept whatever the government chooses to pay, given the enormous bargaining power that would accrue to the government as the sole payor. In light of this, it is the bargaining power of the insurers that will determine the extent to which they can enact change with the providers; consolidation of the health insurers, particularly with the announcement of Aetna acquiring Humana and Anthem acquiring Cigna, will most likely expedite this transition to value-based arrangements.
Crucially, the deal could:
- Generate the necessary scale to create negotiating leverage that hastens the transition of providers to capitation contracts; and
- Allow Aetna to combine its provider assets with Humana, helping accumulate data to generate insights that could ultimately be used to improve patient outcomes and prevent expensive hospital visits.
Fears of the consolidation of insurers leading to higher premiums are most likely overblown, given that insurers for large group plans and Medicare must at a minimum pay out 85% of their premiums to beneficiaries; higher premiums without a commensurate increase in medical benefits paid would just lead to the insurers handing back the premiums that fall outside this ratio to members. Furthermore, the fact that the government must approve premium increases for Medicare and Medicaid militates against the argument that consolidation of insurers will lead to premiums skyrocketing. Overall, the U.S. healthcare industry is ripe for change and insurers that have positioned themselves for the shift to value-based care have a large opportunity in front of them.
George Hadjia is a Research Analyst with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.
The Healthcare Dilemma
In 2013, the U.S. spent a whopping 17.4% of GDP on healthcare, more than any other high-income country. The magnitude of U.S. health expenditure is a highly-public, highly-politicized issue, yet few can elucidate why U.S. health spend diverges dramatically from other high-income nations. It is worth trying to understand the cause of this difference and whether any opportunities are created for firms that assist in reducing U.S. health expenditure.
When considering the financial incentives of the U.S. healthcare industry, it becomes evident that this is a system that rewards volume-driven healthcare rather than value-based care, hardly a situation that’s likely to help moderate medical cost growth. According to CMS, national health expenditure in the U.S. is projected to rise at an average rate of 5.8% per year for 2014-24 – an unsustainable level, given the eventual fiscal strain of trying to fund the Medicare and Medicaid programs. It is clear that a dramatic shift in the economic model of the healthcare industry must occur to curtail this ballooning expenditure.
The industry is in the early stages of transitioning to value-based healthcare, where healthcare providers are rewarded for improving patient outcomes rather than increasing the quantity of care provided. The current fee-for-service payment system means that the longer the inpatient stay or the more services provided, the higher the fees generated for the hospitals.
This perverse incentive system, coupled with historically poor accountability for health outcomes, has encouraged utilization of hospital and physician services (even in instances where these services might not be warranted) and has helped increase the cost of U.S. healthcare to egregious levels. If in doubt about the role incentives have to play, ask a barber whether you need a haircut and you’re likely to get a fairly consistent answer!
Conversely, insurers have an incentive to help reduce health care costs (so that their benefits expense declines) and they are seeking to shift risk to the providers through capitation agreements. In these capitation arrangements, providers are paid a lump sum per patient, regardless of how many services the patient receives. The onus thus shifts to the provider to ensure that health care costs do not spiral out of control. A key question is why would a hospital choose a capitation arrangement over getting paid on a traditional fee-for-service basis?
In answering that question, it is worth considering what would occur if the U.S. government became responsible for paying all healthcare costs, an obviously extreme example. Hospitals would simply have to accept whatever the government chooses to pay, given the enormous bargaining power that would accrue to the government as the sole payor. In light of this, it is the bargaining power of the insurers that will determine the extent to which they can enact change with the providers; consolidation of the health insurers, particularly with the announcement of Aetna acquiring Humana and Anthem acquiring Cigna, will most likely expedite this transition to value-based arrangements.
Crucially, the deal could:
Fears of the consolidation of insurers leading to higher premiums are most likely overblown, given that insurers for large group plans and Medicare must at a minimum pay out 85% of their premiums to beneficiaries; higher premiums without a commensurate increase in medical benefits paid would just lead to the insurers handing back the premiums that fall outside this ratio to members. Furthermore, the fact that the government must approve premium increases for Medicare and Medicaid militates against the argument that consolidation of insurers will lead to premiums skyrocketing. Overall, the U.S. healthcare industry is ripe for change and insurers that have positioned themselves for the shift to value-based care have a large opportunity in front of them.
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