The health care system is on the cusp of rapid change, which is being driven largely by health care affordability issues. The prohibitive cost of health insurance is causing access issues, and continued large premium increases are likely unsustainable. The premiums are expensive because the medical costs are expensive. And along with higher premiums, out-of-pocket costs for consumers have climbed to historic highs. Unless health systems improve efficiencies – in tandem with adopting new payment models – both health systems and health plans are apt to see their margins shrink to unsustainable levels.
A 2016 report from the Congressional Budget Office (CBO) concludes that more than 40 percent of hospitals could have negative margins by 2025. Our actuarial practice has drawn similar conclusions by modeling the potential future financial risk for our health system clients.
Over the past several years, the Affordable Care Act (ACA) – combined with mergers and acquisitions of hospitals and provider groups – helped many health systems achieve wider margins. Between 2011 and 2015, US hospitals, on average, had positive operating margins ranging from 4.1 percent to 4.8 percent, according to an upcoming report from Deloitte’s Center for Health Solutions.
But those margins are expected to erode due to rising labor costs, and regulatory changes. One of the strongest headwinds is the changing payer mix (see chart below from our upcoming research). It is expected that by 2024, Medicare – which now pays about 90 cents on the dollar compared to commercial payers – will become the largest payer in the mix, according to a 2016 forecast from the American Hospital Association. At the same time, pressure from government programs and private plans is pushing many health systems to take on more financial risk in the form of value-based care arrangements.
Can health systems offset double-digit negative margins?
Since the enactment of the ACA, 31 states have expanded their Medicaid programs. Along with millions of new Medicaid beneficiaries, Medicare enrollment is swelling as baby boomers retire and leave employer-sponsored coverage. The typical hospital has a double-digit negative margin on its combined Medicare and Medicaid business. This is offset by margins from the commercial insurance side, which are commonly above 20 percent. This mix is tilting more toward the lower-paying government-run programs. In addition, health plans are pressuring health systems to keep costs affordable in response to criticism from their members and their employer clients. Consequently, it is increasingly difficult for health systems to boost their fees to keep pace with rising costs. Given the sizable gap between private and public payers, even a small change in the mix can have a large impact on margins.
By 2025, we expect that 80 percent of overall payments to providers will be value based. Health systems, large and small, are going to compete on their ability to take on risk and provide high-quality, cost-effective care. But for this model to succeed, health plans and health systems will likely have to work closely together in areas such as physician engagement, disease and case management, compliance, and identification and removal of inefficiencies. This won’t be easy given the historic adversarial relationship that exists between many health plans and providers.
Value-based tsunami may alter relationships
There have been waves of value-based care over the years, but the real tidal wave appears to have started about five years ago. One important difference this time is that there appears to be more collaboration between health plans and health systems. As some health systems gain market share by partnering with health plans or by launching their own provider-sponsored health plans, others will likely be on the losing side. It’s a delicate dance, and health systems need to be careful that developing a closer relationship with one health plan doesn’t harm other relationships. Successful value-based programs often require investments, organizational commitment, and an ability to win in a competitive environment. Health systems that are unable to make this transition could lose market share to more sophisticated competitors.
As I see it, there are four levers that need to be pulled to remove excess costs and succeed in a value-based care model:
- (Lever 1) Provider networks:To hold down costs for products sold through the public insurance exchanges, many health plans developed narrow provider networks. This strategy appears to have succeeded. Health insurance plans built around narrow networks are priced an average of 16 percent lower than plans that rely on broader networks, according to research published in the September issue of Health Affairs. Typically, a savings of 10 percent is the threshold where people are willing to change doctors. Our 2016 Survey of US Health Care Consumers found that about one-third of millennials are willing to accept a smaller provider network in exchange for cost savings. Being a part of a narrow network could help a health system attract market share. Some health systems and health plans have taken this partnership model a step further and have invested in a joint entity that takes on full risk of a patient population. Both the narrow-network model and the joint-entity model depend on the ability to measure physician performance.
- (Lever 2) Risk-sharing payment models: Financial models are useful ways to remind the provider about something that is being encouraged (or discouraged). The challenge is that in many instances the financial model represents a very small proportion of the providers business. In these instances it’s important to keep the model simple. Downside risk appears to gain more attention than upside, so risk taking capabilities become important. Of course the best risk mitigation device is to bend the cost curve, so information and activities that enable cost curve bending are key.
- (Lever 3) Care management: This needs to be a data driven, collaborative effort between the health plan and the provider. It means only giving the necessary care at the appropriate site, as well a focus on keeping people healthy. This requires capabilities, which are still being developed, to determine how to help patients avoid a health event, and what triggers patients to comply with care management. It also can require infrastructural change to coordinate care.
- (Lever 4) Member engagement: This could be the most difficult lever to pull. The member can sometimes have more of an impact on the cost of care than the physician or the health plan. This is particularly true for those with chronic conditions. But these patients need help to make the most appropriate decisions. Transparency tools that help consumers compare costs for services, for example, can help reduce cost sharing. Tiered networks can help them reduce costs further by selecting providers or drugs that are in a low-cost tier. Financial rewards tied to wellness activities can encourage patients to take better care of themselves, or more effectively manage a chronic condition. Such strategies can help health plans keep their members out of the hospital, which ultimately leads to lower premiums. To date, however, no one has figured out the best approach to engage members.
People generally resist change. However, I think the health care sector is causing and experiencing enough pressure to change despite our ingrained resistance. As margins shrink, more health systems will likely seek value-based care arrangements where they can change the payment formula. They will likely invest in approaches that allow them to eliminate inefficiencies, which can help them reach a lower price point per member in the market relative to their peers. If they supplement this value proposition with a health plan’s capabilities in analytics, risk, and administration, they can attract market share and keep their populations healthier. When this happens, the health system gets paid more (from a margin perspective) because care costs are lower. In other words, the health system gets paid for creating value by keeping people healthy. Everybody wins.