This article first appeared in statnews.com. It is co-authored with Bryan Roberts.
Health care in America often feels like it moves at a glacial pace, if that fast. Case in point: fax machines remain indispensable as a way of transferring information. On a larger scale, the U.S. health care system still struggles with readmissions, medication adherence, chronic disease outcomes, and more. True innovation is rare.
But every so often a crack in the ice occurs that leads to rapid change. Sometimes legislative action is the trigger. The Affordable Care Act and the HITECH Act sparked lots of innovation and startup activity. As we look to 2021, though, the odds of a split or Republican-controlled Senate are high and so the likelihood of major innovative legislative change is low.
In the absence of legislative or regulatory decree, we believe that two requirements — aligned economic incentives and the availability of data and information — can trigger bursts of innovation in our super complicated, fragmented, highly regulated, and archaic health care system. Without these two, not much happens.
Viewed through the lenses of incentives and information, it becomes clear why some potential innovations are broadly adopted and others never gain traction. The U.S. is stubbornly resistant to things like preventive care and paying family caregivers. Why? The economics make no sense for payers, so providers have no financial incentive to carry them out.
On the flip side, the U.S. quickly adopted the use of new hepatitis C drugs and telemedicine amid Covid-19. The adoption of expensive hepatitis C drugs occurred because they offered providers cures for their patients with few side effects and they were profitable for the drugs’ manufacturers. The switch to telemedicine made economic sense for payers because it is cheaper than in-person visits and it was a lifeline for providers when patients were reluctant to go for office visits.
Several characteristics of the U.S. health care system drive the need for clear and material incentives for innovation. Most importantly, the industry generates very little profit outside of pharmaceuticals. Gross margins are a fraction of what they are in other business sectors and net margins for these businesses hover distressingly close to zero — and sometimes below. As a result, publicly traded health care businesses tend to trade between 0.5 and two times annual revenue, compared to software businesses that trade at 10 times to 30 times annual revenues.
Such anemic financials mean that health care businesses have little ability to adopt new ideas that lack compelling near-term financial benefit, even though they may have innovative attributes like convenience, improved outcomes, and user satisfaction. While companies in other industries with high-margin, high-customer lifetime value can adopt — or at least explore — innovations with longer-term or nebulous payoffs, health care companies require acute, tangible economic results.
Another critical characteristic of the health care ecosystem is its highly transactional relationship with its users: patients. In business terms, health care companies have high customer churn (the percentage of customers who stop using a product or service during a set period) and low levels of satisfaction and loyalty.
Most health care providers don’t track the metrics that populate the management dashboards of most other businesses, things like customer acquisition cost, annual revenue per customer, customer churn, or gross margin by customer. When they are tracked, often by new entrants rather than incumbents, the numbers are generally poor compared to other industries.
For example, health insurance companies often cover a fully insured member for only 18 to 24 months. This short relationship affects nearly everything about how an insurance company subsequently behaves with respect to its members. Being financially responsible for someone for such a short period of time can never justify investments in longer-term health, whether preventive care or excellent chronic disease management, since the results would only benefit competitors — the member’s next health plan.
Health systems are little better. Rarely do they have any idea how much it costs to acquire a patient or a doctor. Those hospital billboards along highways advertising short emergency department waiting times and new services are expensive and it’s hard to assess their value. Few health systems calculate the long-term value of a patient. Instead, they view each patient-care event as a purely transactional relationship optimized for near-term revenue, which makes sense given the tight financial statements and the revenue model. This leads them to deliver as much care as they can with little investment in following up to ensure that the care was effective or to anticipate future care needs.
Access to information and clinical and claims data that can generate insight at the point of innovation adoption or action is often overlooked, but is of equal importance to financial incentives. Despite widespread digitization of data, it remains difficult, slow, and expensive to gain the information required to give clinicians the financial incentive to make the right decision. Even when primary care providers have incentives to gather, organize, and act on information, downstream specialists and hospital providers have no desire to share clinical data because the goal would be to find ways to reduce utilization — and therefore lower revenue — for these providers.
This is part of the reason why, even though data sharing protocols exist for nearly real time awareness, clinical and billing data lag days to months after care is provided since they are often available to accountable care organizations or capitated primary care providers only after a bill has been received by Medicare or an insurance company.
The canonical current manifestation of both aligned incentives and access to data and information is Medicare Advantage, a program that Medicare beneficiaries can opt into that delivers all of the Medicare benefits through private insurance companies. It is often lower cost and offers additional benefits in exchange for more care management by the Medicare Advantage insurance companies.
This alignment, together with strong economic and demographic tailwinds, is the reason why most insurers, many integrated delivery systems, and primary care groups are doubling down in this business segment. In Medicare Advantage, insurers not only have access to the information they and their partners (employed or delegated-risk physicians) require to make better choices, but they also have financial incentives to take better and lower-cost care of patients based on the potential for large profits or losses based on the difference between the patient risk-adjusted payment from the government plus quality bonus payments and what care actually costs. An added benefit is that Medicare Advantage payers have longer member-retention periods, closer to eight years compared to two years for commercial insurers.
This constellation of characteristics — financial incentive, information availability, and a longer-term customer relationship — can lead to more longitudinal and proactive care for chronically ill patients. In some cases, financially motivated capitated primary care physicians are able to achieve 40% decreases in hospitalizations in Medicare Advantage plans compared to fee-for-service primary care physicians working in traditional Medicare with very different financial incentives.
The different performance of affordable care organizations (ACOs) can also be explained by the alignment or misalignment of incentives and information. ACOs were designed to try to replicate the success of Medicare Advantage care in the larger traditional fee-for-service Medicare program. In essence, primary care physicians, who are traditionally small businesses with little market power, can band together in an ACO to get statistical scale to enter into a risk and quality contract with Medicare. The ACO is given a benchmark cost per patient based on risk and geography. If the cost of caring for that pool of patients comes in below the benchmark, the physicians and Medicare share the savings.
Although the program generated $1.19 billion in net savings in 2019, the success of individual ACOs is unevenly distributed. ACOs led by independent physicians, which have no facilities and capital equipment overhead, saved $201 per beneficiary. In contrast, hospital-led ACOs saved just $80 per beneficiary. This makes sense, as hospitals have less incentive than independent primary care physicians to save money since much of the money they are saving is from decreasing revenue from their hospitals.
We do not see health care innovation as unpredictable. We believe that what gets adopted and the rate of adoption is explained fully by incentives and information. Strong incentives coupled with meaningful insights from information can make glaciers thaw and improve health care rapidly.
Bob Kocher and Bryan Roberts are partners at Venrock, a venture capital firm, where they invest in health care businesses.