I have talked often about horizontal and vertical integration in healthcare in these blog pages and on my podcast. One major blog I wrote on vertical integration is here from December 21, 2023: https://www.healthcarelabyrinth.com/do-health-plans-relationships-with-owned-entities-open-up-more-scrutiny/ .
Let me recap a little as background before I get to an extremely interesting infographic Jared Strock did recently. Jared is an actuary and health insurer/Medicare Advantage market and finance expert. He posts daily and is well worth following. I posted his graphic, his LinkedIn, and a recent post he did on LinkedIn below.
Key background on vertical integration from my earlier blog
- Horizontal integration in the payer world is when one plan buys another. Vertical integration occurs when a plan buys entities in the healthcare channel that supply services to the health plan. Three notable examples are: (1) Pharmacy Benefit Managers (PBMs); (2) Pharmacies, including specialty pharmacies; and (3) Physicians and other providers.
- Insurers have historically delegated services to various entities. This occurs with PBMs and certain other service vendors (behavioral health, dental, hearing as well as entities that specialize in managing high-cost services). This can occur whether health plans “own” these entities or not. The entities may be given a set per-member-per-month (PMPM) fee or percentage of revenue, with the entity managing the services delegated and keeping the difference as profit.
- In addition, many plans enter into partial or global risk fund arrangements with providers. Sometimes these providers are explicitly delegated or simply agree to accept risk on services consumed by assigned members. They, too, can be “owned” by the health plan or not. These providers or provider groups (often primary care physicians) receive a percentage of premium for each member. These agreements usually include both medical costs and quality performance metrics. If they hit them, they keep some or all of the delegated service revenue. Sometimes, they are penalized if there are financial losses or misses.
- A reform in the Affordable Care Act (ACA) mandated that insurers spend between 80% and 85% (depending on the line of business and product) of premium on medical expense. This is known as the minimum medical loss ratio (MLR) rule. Except for self-insured ERISA employer groups and welfare funds (which control the funds themselves and insurers are not at risk but simply administer benefits), the minimum MLR hits almost all other insurance products. If an insurer does not hit the minimum MLR, the insurer must rebate the difference between the MLR benchmark and the amount spent to either a member, employer group, or state or federal program sponsor, as applicable.
- The Biden administration and many others are worried about the massive consolidation that is ongoing in the healthcare provider and payer world. New regulations will mean much greater oversight over proposed mergers and acquisitions. This has been a major push of the Biden administration, Democrats in Congress, and to a lesser degree Republicans as well. Some studies clearly point to an increase in costs (and sometimes a drop in quality) with consolidation generally.
- A late November 2023 bipartisan letter from Sens. Elizabeth Warren, D-MA, and Mike Braun, R-IN, to the Health and Human Services (HHS) Office of Inspector General (OIG) has many wondering if lawmakers and policymakers will open up a new regulatory front that will bring heightened scrutiny of health insurers’ finances and internal contractual relationships or related-party contracts.
- Warren and Braun want the HHS OIG to open an investigation on MLR gaming. They were reacting to a recent Brookings Institution analysis and Wall Street Journal (WSJ) report showing the extent of contracting by major insurers with their own subsidiaries and the impact that could have on costs in the healthcare marketplace, especially for consumers. The letter alleges that certain insurers are using these arrangements to evade the minimum MLR rule. In effect, they say insurers are having the subsidiary hike certain prices that the insurers then contract for so as to register a higher medical expense. The money is not paid back in an MLR rebate and the money accrues in additional margin to the overall parent entity. (Go to the earlier blog for more details on the WSJ analysis.)
- The Brookings Institution study (see my earlier blog for details as well) found that United Healthcare, CVS/Aetna, and Kaiser Permanente directed at least 10% of their medical spending to related businesses. In 2019, 17% of United Healthcare’s spending was sent to related businesses, while about 13% of CVS/Aetna payments in 2019 were made to related businesses.
- Most major health insurance entities are going down this vertical integration route, spurred on by the enormous success of United’s Optum services unit. CVS Health already owns significant service assets. Kaiser is an integrated delivery system. Cigna is busy building its Evernorth unit. Elevance Health is investing in Carelon. Humana has picked up significant provider and pharmacy assets.
In comes Strock’s analysis
Strock used his financial skills to comb public company financial disclosures to show just how big related-party transactions have become. Here is a summary of what Strock said in his LinkedIn post (link right below the graphic):
- Public companies usually report revenues for their major subsidiary entities. Thus, revenue may appear in one company (say MA revenue to the health plan subsidiary) and some of the same revenue later in a sister company due to a related-party transaction (e.g., a provider group, PBM, pharmacy, or specialty pharmacy). There can be similar duplicate expenses as well.
- The ultimate parent public company needs to remove from consolidated financial statements this revenue and any expenses related to these related-party transactions.
- These reductions are known as “eliminations.”
- As you can see in Strock’s graphic below, he found almost $63 billion in revenue eliminations in Q1 2024 for the seven big public company insurers.
Graphic source and notes: Q1 2024 financial information for seven major publicly traded insurers. Graphic from recent LinkedIn post By Jared Strock, actuary and Medicare market and finance expert. Follow him at https://www.linkedin.com/in/jared-strock-74233965/ — his daily insights are fantastic for MA interested parties/followers. His LinkedIn complete LinkedIn post is here: https://www.linkedin.com/posts/jared-strock-74233965_unh-elv-hum-cvs-ci-all-report-revenue-activity-7205910481654435840-UC9r?utm_source=share&utm_medium=member_desktop . Graphic Acronyms: UNH = United Healthcare, ELV = Elevance Health, CNC = Centene, HUM = Humana, CVS = CVS Health (Aetna), CI = Cigna, MOH = Molina
The crux of the matter
Strock’s findings on eliminations against gross revenues in Q1 2024 roughly equate to what Brookings found in its analysis, except that United’s percentage of related-party transactions has increased dramatically over the past four to five years. Almost $63 billion per quarter in eliminations means likely $250 billion annually and growing in related-party transactions. I do not think a 5% overall margin for these big seven public insurers is too much (it has come down since the minimum MLR mandate). But a quarter of a trillion dollars in related-party transactions are leading to better derived margins to the vertically integrated companies.
All sorts of consolidation, whether horizontal or vertical integration, is leading to increased costs and prices in the healthcare market. But vertical integration seems especially concerning to regulators and Capitol Hill as we do not know if related-party contracts represent market rates (are the contracts and transactions truly arm’s length?), whether we are paying more (as employer groups, in premiums, and in cost-sharing), and whether the arrangements get around the minimum MLR. Health plans have to be ready for scrutiny and re-examine some of their related-party activities.
#healthplans #consolidation #mergers #manda #integration #medicareadvantage
— Marc S. Ryan
