CO-OPs – “Innovation” Run Amok?

Innovation in healthcare is often associated with break-through scientific discoveries in the lab, which leads to profound new therapeutics and devices. This decade, however, will be characterized by innovative new business models powered by novel software and hardware platforms. Arguably these advances will have greater impact on outcomes and cost of care across large populations. At its core, there are a handful of trends driving this wave of innovation: (i) dramatic shift from acute care models to prevention and wellness; (ii) greater emphasis on point-of-care and decentralized care delivery; (iii) development of personalized, predictive and preventive solutions throughout healthcare; and, (iv) an increased role of data, adaptive learning systems and automation in every corner of the healthcare landscape. Of particular interest are technologies which create and support integrated platforms that manage and coordinate care and are location agnostic.

Central to this entire transformation is the dilemma that provider systems have historically been structured to treat the individual as an individual but are now being pushed to manage populations. In contrast to that, payors must do the reverse; that is, historically health insurance products and services were structured, priced and delivered as if each individual were the same, but now those same products need to be tailored to the individual given the obvious differences among members. Both are searching for successful models of “mass customization.” A fascinating set of conflicting industry dynamics indeed.

Among a protracted and unprecedented philosophical debate about the appropriate role of government in healthcare, perhaps one of the greatest experiments in healthcare business model innovation is playing out right in front of us today – and the results are decidedly mixed. In 2011 The Patient Protection and Affordable Care Act (affectionately known as ACA) provided $6 billion in funding to launch the Consumer Oriented and Operated Plan (CO-OP) program. CO-OPs were intended to be new non-profit, consumer-oriented health insurance providers by state, offering competitive insurance products on the health insurance exchanges established by the ACA. After a series of legislative actions, the total amount of funding available was reduced to $3.4 billion, and by the beginning of 2014 when the program was officially launched, 23 CO-OPs had been established with $2.4 billion in loans.

While a few CO-OPs experienced meaningful membership demand, even in some cases exceeding first year forecasts, the Office of Inspector General published a report this past quarter which found significant shortcomings with nearly every CO-OP. Overall eight CO-OPs have already failed, putting at risk nearly $1 billion in federal loans. In fact, just this past month, a handful of CO-OPs were decertified and are winding down operations (Colorado, Kentucky come to mind – Iowa/Nebraska already liquidated earlier this year). Notwithstanding that the ACA established three funding programs (Reinsurance, Risk Corridor, and Risk Adjustment – the “Three R’s”) to shield these CO-OPs against market risk while they sorted out their pricing models in the first three years, the losses have been staggering. Unfortunately the measurement models, particularly for Risk Adjustment, are both crude and imprecise, often leading to perverse subsidies to established insurers with the best provider network discounts to emerging payors.

The technical challenges of the launch of these CO-OPs were widely reported with websites crashing, long wait times and poorly designed interfaces. The forecasted enrollment across all 23 CO-OPs by the end of 2014 was 658,000 members, far in excess of the 475,000 who actually enrolled (although New York had forecasted 31,000 members and saw 155,000 enroll, highlighting that there were pockets of notable success). Most of these CO-OPs had to compete against entrenched insurers, underscoring the power that an incumbent brand may carry over new innovative products that are introduced to a market.

Perhaps what is more disturbing is when one reviews the financial statements for each of the CO-OPs (which I did), only one CO-OP (Maine) had its first year premium income exceed claims expense, raising questions around pricing and the ability to accurately assess the health of the members enrolled. Only three of the CO-OPs projected to make money in their first year of operations; in reality, none of them did. In aggregate, the 23 CO-OPs collected first year premiums of $1.65 billion as compared to $1.88 billion in claims. Most staggering though is the $380 million of first-year administrative costs incurred by the 23 CO-OPs. In the face of these losses, the federal risk corridor funding programs, whereby health plans with less healthy populations were subsidized by plans with healthier populations, were withheld for many of the CO-OPs, which have led to a severe cash shortfall for some. Overall, the 23 CO-OPs collectively lost $375 million to enroll 475,000 members in 2014 or roughly $800 per enrolled member.

It is not just the CO-OPs that have suffered mightily as a number of private insurers have announced significant losses in their individual plan businesses. Highmark Health of Pittsburgh recently shared that it has lost $318 million through the first half of 2015. In response to this unsettled environment, there is significant evidence that many insurers will move to more narrow networks, to channel consumer access to less expensive providers. Many state insurance commissioners have confronted filings for dramatic rate increases, often times in the significant double digits.

A number of questions remain unanswered. Where do these members go when their CO-OP is decertified? Would these people have enrolled in other insurance plans even if the CO-OPs did not exist? Fundamentally – what went so wrong? It is widely believed that many of the “entrepreneurs” who took the government up on its offer to start an insurance CO-OP likely lacked the depth of understanding for how to underwrite new members and did not fully appreciate the extraordinary associated regulatory burdens, much less how to run an insurance company. It certainly appears that the absence of significant up-front equity start-up capital shifted the entire financial risk to the government as to whether this experiment was successful. What the ultimate cost to U.S. taxpayers is still not known, but it is clear that the jury is decidedly out during the early innings of this grand experiment in business model innovation. Perhaps there will be another wave of entrepreneurs who will create interesting businesses from these failed CO-OPs?

These transitions, which providers and payors are currently undergoing, coupled with regulatory reform, the aging population and tremendous cost pressures, all point to a period of unprecedented upheaval. We continue to see extraordinary talent entering this sector to build the next-generation of product and service companies. The level of activity this past quarter underscores how exciting this sector is right now.

Specifically, the healthcare technology sector witnessed significant activity as 148 companies raised $1.6 billion this past quarter according to Mercom Capital Group, which is a sharp increase from the second quarter 2015 activity of $1.2 billion and 139 companies, respectively. Year-to-date over $3.5 billion was invested in the healthcare technology sector. This level of investor interest might cause one some pause as perhaps too many “me too” companies are being created.

An important barometer as to the overall state of the healthcare technology investment climate is the level of IPO and M&A activity, which was weaker than prior periods. In the third quarter 2015 there were only 2 IPOs and 57 M&A transactions, which may simply reflect the summer doldrums and volatile stock market.   Interestingly there was only $500 million of debt financings as compared to $1.6 billion in the second quarter 2015.

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