#19 - The Healthcare Price Death Spiral

Why health insurers actually want to see healthcare prices increase

Welcome to a fun-sized, holiday weekend edition of Create The Customer, a weekly newsletter discussing the business of healthcare. I’m Isaac Krasny, a healthcare BD guy and strategist. If you find this interesting, consider subscribing. If you already subscribe, consider sharing with your friends, colleagues, and household pets. Tell me what I got wrong on twitter or via email.

Marshall Allen published Why Your Health Insurer Doesn’t Care About Your Big Bills this week in ProPublica. The article follows a man trying to sort out the bills following a partial hip replacement. Specifically, while he’s on the hook for 10% of the total cost of the procedure (thanks to co-insurance), he argues that the total cost includes services he never received, and takes issue with the fact that while he must pay a proportionate share of the total, he has no agency in negotiating the total cost. 

The article, which is certainly worth your 10 minutes to read it, highlights the key issues that have put healthcare prices into a relentless upward spiral. 

Insurers, because they operate as businesses, need to show growth. The publicly traded ones, which are the vast majority, tie their successes largely to the key metric: earnings per share. To grow earnings (profits), insurers can increase revenue and/or reduce costs. Strict regulations limit insurers to an 80% Medical Loss Ratio, meaning they must spend at least 80% of premium revenue paying for their member’s care. This was intended to limit runaway profitability, but the actual effect is more odious. 

As I discussed in Unintended Consequences and the Future of Health Insurance, the net effect of the medical loss ratio requirement is a regular increase in healthcare service prices. The MLR requirement effectively limits earnings growth via cost reduction, meaning the only reliable path to earnings growth is via increasing premium revenue. Like I said in that article, “as you increase the size of the entire pie, the size of each piece gets bigger.” This includes the profit piece.

Insurance companies, then, have no incentive to go back to providers and strike deals that actually lower the cost of care across the board. They want to limit growth enough so they don’t have to ratchet up premiums at a rate unpalatable to their customers (employer groups, individuals via exchanges, etc.) In total, medical cost growth is good for insurer’s bottom line. 

If a health insurer were to actually use their market leverage to reduce prices for healthcare services, the management team in charge likely wouldn’t last very long. Assuming they managed to strike a deal at lower rates with enough providers to make a network (which is a big assumption), this would cascade into lower premiums, which would mean a reduction in earnings. It would also mean layoffs at the insurance company, as there’s less overall capital on which to make a margin. The CEO could feel very good about helping to move healthcare in the right direction while he updated his LinkedIn page to say “interested in new opportunities.” 

There is the possibility that an insurer that continually lowered premiums could gobble up market share as patients and employers flocked to the service, but this company would also face a Herculean challenge in cobbling together a provider network while being known as a company that’s driving down prices (and thus hospital and provider revenue). 

So how do we escape this spiral? While value-based care is movement in the right direction, I’d argue that vertical integration of health insurers will actually do more to nudge insurers onto a more sustainable trajectory. The key here is vertically integrated enterprises where the insurance activity is largely a customer acquisition tool, and where the lion’s share of overall revenue comes from non-insurance activity like delivering healthcare services, or by capturing consumer spending dollars that’d be going to other entities. This is, with little doubt, what Walmart has in mind with their possible Humana acquisition, and what the combined CVS-Aetna will be considering. 

Allen’s story is important for the healthcare conversation as it illustrates a human example of what happens when an industry puts the end consumer in the backseat. The patient in the story is responsible for paying a share of the costs, but wasn’t able to find out the cost beforehand, and has no agency to negotiate it after the fact. His share - which ended up being roughly $7,000 - is entirely dictated by forces beyond his control. In an industry that is ostensibly dictated by the free market, this is an abomination. 

The name of this newsletter - Create The Customer - comes from Peter Drucker, the management guru of management gurus. He states, simply put, the purpose of a business is to create a customer. Healthcare is ostensibly a business, but there is no customer. There is no singular entity concerned with the overall value of healthcare - the whole picture of cost and quality. And the collected force of patient demand - those who care entirely about value - is filtered through payment and providers so as to render it entirely toothless. If healthcare is to be saved, stopped from consuming our entire economy while delivering mediocre results, there needs to be a customer.