SOURCE: Strategy& (Formerly Booz & Company)

Strategy& (Formerly Booz & Company)

September 08, 2014 09:15 ET

As Conventional Health Plan Operating Model Becomes Unsustainable, Insurance Companies Face Life or Death

For Payors Big and Small, Survival Depends on Smart Triage of Investments and Costs and Near-Perfect Execution of It, Says Strategy& Research

NEW YORK, NY--(Marketwired - Sep 8, 2014) - The mandates of reform, increased consumerism in healthcare, slowed inflation of medical costs, self-insurers and reduced coverage approaches have converged to constrain insurance plans' top line growth.

They've responded by investing in new markets, differentiated services in existing markets and regulatory compliance initiatives. The result: not higher profit, but decreased return on invested capital, according to research by Strategy&, a member of the PwC network of firms. (Ten big plans undertook $11 billion of such capital expenditures over a three-year period, and return on invested capital actually shrank by 8% in the same timeframe.)

The antidote is for companies to understand what makes them stand apart from their competitors, and based on those strengths pursue a strategic and rigorous program of combining cost-cutting and investing, according to Fit for Growth* in healthcare research at Strategy&, formerly Booz & Company.

"The onus is on payors to make the right bets in this extremely uncertain environment: finding new ways to work with providers, playing in expanding retail markets, deploying new technology, pursuing new operating models that require organization-wide restructuring. But they can't do 'everything' -- not even the biggest players can," said Frank Ribeiro, partner at Strategy&. "Plan leaders need to be very clear about how they're going to compete and how they're going to create value for consumers. This clarity allows them to prioritize spending on those areas that fuel their success, and cut back on those parts of the business where 'good enough' is good enough, even if that area is accustomed to excellence and pushing for what it believes is its fair share of resources." 

Such a Fit for Growth approach can lead to significant cost savings. Strategy& research suggests that a fair approximation of the operating costs of an average-performing plan with two million members is $29 per member per month (PMPM). How far below $29 PMPM health plans can reduce their operating costs depends on how they choose to provide value to their customers. Some simple scenarios show the range of possibilities for health plans to transform and lower PMPM levels.

Some may follow the "lean operator" model, streamlining the way they serve the individual, small group and Medicare/Medicaid markets; in doing so, they may experience a 38% reduction to $18 PMPM. Others may choose to become "direct marketers," driving down costs by eliminating complex offerings from the product portfolio and marketing simpler products through direct channels. These plans could lower costs by up to 60%, to $11 PMPM.

The most radical rethinking of the conventional operating model may be required by the future "risk and network aggregators." These plans will reduce the number of providers in the network to just a few large, integrated organizations that cover the full continuum of care, and may experience cost reductions of over 80%, to $5 PMPM.

"Whether or not you consider $5 PMPM to be fully achievable, the goal of such a target is to show that health plans should be clear about their strategies, and about investing in the few differentiating capabilities that enable that strategy, and go lean everywhere else," added Ribeiro. "When plans closely align their investments and costs with their operating model and strategy, dramatic cost reductions become possible."

"Different customers have different preferences for what they want their health insurer to offer. Thus, all these specialized models can be successful. What isn't successful, however, is trying to be everything to everybody and continuing to compete in an undifferentiated way. If health plans do, they won't be able to fully satisfy any customer segment and their costs will skyrocket," said Strategy& senior partner Gil Irwin. "What these new specialized models have in common is that they involve clean-slate thinking by payors about how they create value, how they need to operate, and how they allocate costs to fulfill that value proposition. Change of these magnitudes is hard to achieve, and may involve a significant -- even fundamental -- rethinking of what the health plan's business offering is."

He added that, as general rules, plans must... 

  • Be clear about how they provide value in a way that others can't.

  • Ruthlessly recast investments towards the capabilities that fuel this value-add position.

  • Cut costs to the minimum in areas that do not add to this value (and direct the savings to the capabilities that do).

  • Recognize that the standard cost-cutting approaches they've used in the past will not produce the transformational levels of cost reduction needed now.

  • Overall, align the operating model to their strategy to make sure money flows from bad costs to good ones.

"Clearly all of this is easier said than done. But it's the imperative in the current environment," said Irwin.

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* Fit for Growth is a registered service mark of PwC Strategy& Inc. in the United States.

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