Amazing Halftime Show

As the healthcare sector heads into the second half of 2016, there is much to be excited about notwithstanding the significant political and regulatory turbulence. Actuaries at Centers for Medicare and Medicaid (CMS) recently estimated that the U.S. healthcare system spent $3.2 trillion, or roughly $10,000 per person, in 2015 which was an increase of 5.5% from 2014. The 2015 amount was 17.8% of GDP and is now estimated to increase to 20.1% by 2025. Over 900,000 new jobs will be added in the healthcare sector in 2016 alone.

HC Bill

As these spending and hiring trends emerged, innovative companies solving problems with customer experience, drug pricing and other important areas have already made healthcare technology an attractive sector. Looking forward, venture investment will continue to increase, though other factors will undoubtedly come into play, including the Affordable Care Act and its ultimate impact on healthcare spending. With so many distinct areas in healthcare, which categories are likely to benefit from changes to the way the industry operates? The answer is complex, just like the healthcare industry itself.

The principal reasons for healthcare’s expansion, while almost too numerous to count, include the aging population, greater healthcare insurance coverage as more people purchase on the exchanges, Medicaid expansion, and sharp increases in prescription drug costs. Estimates today are that the consumer is bearing 10.6% of these expenses directly, mostly because of the advent of high deductible plans.

The promise of regulatory reform is meant to reduce overall spending growth, in large measure by driving down the percentage of uninsured Americans and also to encourage innovative new care models and solutions. A core component of reform was the introduction of public exchanges for health insurance. In 2Q16, the financial impact to many insurance companies which introduced new products started to be revealed, often with very disappointing results. For example, UnitedHealth reported over $200 million of losses last quarter alone directly attributable to exchange products. In part, and in response to a dramatically changing regulatory framework, many of the larger insurance carriers looked to merge, only to have the Department of Justice step in to block that wave of consolidation.

In 2014, 11% of the population was uninsured which is now expected to decrease to 8% by 2025; unfortunately, there are still 29 million without insurance coverage today. By 2025, Medicare estimates to have nearly 72 million enrollees, up from 54 million in 2015. As insurance coverage becomes more ubiquitous, expect the national discourse to turn to adequacy of that coverage; that is, will care be both affordable and accessible. The relationships between the patient/consumer and their care providers and insurers will evolve to be more focused on costs and value for services provided, thus ushering in the “golden age” for healthcare technology.

“B2(B+C)”

Against this backdrop, the healthcare technology sector continues to attract significant new investment. Arguably, regulatory reform in combination with a suite of associated technological advances (mobility, extraordinary computing power, analytics, just to name a few) are converging to drive great innovation across the healthcare system. StartUp Health recently published its 2016 Midyear report which estimated that the digital health sector funding was $3.9 billion across 234 companies, while CB Insights estimated that $3.6 billion was invested in 471 companies.

HC Funding

Although much of this activity was focused on early stage companies, just under $2.0 billion of the total was invested in ten companies, highlighting that there are now a number of substantial emerging winners. Simply annualizing the first half investment activity suggests that the healthcare technology sector will see more capital invested than prior years but in slightly fewer companies. Arguably, with nearly 1,800 companies funded between 2014 – 2015, a degree of consolidation and rationalization will be positive for the sector as emerging winners come to the forefront.

It also is clearer, as the healthcare technology market matures, that successful digital solutions are best delivered in the context traditional provider interactions. Early stage companies showing the greatest traction tend to not be stand-alone point solutions but rather augment or enhance or further the quality of the existing clinical engagement. The novelty of new solutions should not ignore its almost secondary role in providing great clinical care. These insights are starting to be manifest in which categories are attracting the greatest levels of investor capital. Perhaps these companies should be called “B2(B+C).”

Nearly $1 billion this year has been invested in 51 companies in the “Patient/Consumer Experience” category, while almost $900 million was invested in “Wellness” 25 companies. Some of the other significant categories include “Personalized Health/Quantified Self” ($525 million), “Big Data/Analytics” ($400 million), “Workflow” ($325 million), and “Clinical Decision Support” ($235 million). Notwithstanding the number of successful break-out companies in the above categories, according to StartUp Health, Seed and Series A rounds represented 55% of the deal volume with an average round size of $3.9 million.

In addition to this private investment activity, public market investors have embraced this sector as well. The Leerink Healthcare Tech and Services index increased on average 17.8% this past quarter and is now trading at 3.8x 2016 revenues and 3.3x projected 2017 revenues. Interestingly, other traditional valuation metrics also are quite robust: the index on average trades at 13.9x 2016 EBITDA and 25.8x 2016 net income (P/E). Projected average 2016 revenue growth for this cohort of 34 companies is 19.9% and 15.0% in 2017 – quite impressive growth rates.

While consistent liquidity remains elusive overall, there were some notable transactions in healthcare, although most of the IPO activity admittedly centered around the biotech sector with 15 IPO’s to date. According to Mercom Capital, 8 healthcare technology companies raised $270 million in the public debt and equity capital markets as compared to 111 M&A transactions year-to-date, the top four of which were valued at over $1.5 billion (very few of them disclosed transaction values). Undoubtedly much of the M&A activity likely involved larger platform companies rolling up smaller point solutions to extend their core offerings.

Selected Areas of Opportunities

While technology innovation promises to improve almost every element of the healthcare marketplace, there are a handful of specific themes that captured significant attention this year including issues of access to care, drug pricing, and fraud and abuse. As consumers continue to experience rapidly increasing insurance premiums and are challenged to readily find affordable care, compelling new start-ups will continue to emerge to develop solutions and services to address these needs. The healthcare consumer will want to see measurable value.

Primary Care: Much of the innovation in primary care falls along two dimensions – patient engagement to drive impact and business model changes. The first half of this year saw the introduction of the Medicare Access and CHIP Reauthorization Act (MACRA) which created payment incentives to move Medicare fee-for-service patients into risk-based reimbursement models. As primary care providers, who are a relatively small portion of overall healthcare costs, start to realize the power of the “shared savings” model, analysts expect a significant reduction in downstream specialist spend (which the primary care provider directly influences through referrals). In order to facilitate this new payment model, expect to see greater adoption of telehealth platforms, engagement solutions and bundled payment models. All of this is pointing to a world of “on-demand” healthcare.

Drug Pricing: While prescription drugs only account for approximately 10% of national healthcare expenditures, according to the Bureau of Labor Statistic’s Producer Price Index year-over-year pharmaceutical pricing increased 9.8% through May 2016. The lack of pricing transparency, exacerbated by complex discount and rebate programs, frustrate both lawmakers and consumers to no end. According to IMS Health, total prescription drug spend in 2015 was $425 billion, making this an attractive market for innovation and disruption. In addition to novel digital adherence solutions and direct-to-consumer ecommerce platforms, expect to see further payment model innovation which ties drug pricing to outcomes. These “value-based” payment models will introduce pricing discounts if certain clinical end-points are not achieved.

Notably, with a greater emphasis on precision medicines, an increasing number of patients are expected to turn to expensive specialty pharmaceuticals, which will likely put additional upward pressure on prescription drug spend. Anticipating this development, CMS recently announced proposed changes to Medicare Part B injectable drug payments in 2017 which will allow manufacturers greater pricing flexibility tied to outcomes.

In response to upward trend in drug pricing, 30 of the country’s largest employers formed the Health Transformation Alliance in an effort to push for greater value for drug spend. Initially focused on renegotiating existing pharmacy benefit management contracts, expect to see more sophisticated data analytics to identify other sources of savings. Notably, 170 million Americans rely on their employers for health benefits (and while the Alliance above only accounts for 6 million of them, the group spends in excess of $20 billion a year on benefits).

Fraud and Abuse: Earlier this summer, CMS announced that over two years (2013 – 2014) nearly $42 billion of fraud was prevented through more effective provider oversight and screening. The agency estimated that for every dollar invested in the technology to manage the program’s integrity, precisely $12.40 of savings were realized. Superior analytics undoubtedly will improve patient care through greater clinical insights but these tools also will have dramatic impact on work flow and the management of the healthcare system overall.

And in the breaking news category, the Justice Department just announced its largest criminal healthcare fraud case which involved $1.0 billion of fraudulent Medicare and Medicaid billings in South Florida. The interagency Medicare Fraud Strike Force, which has gone after 2,900 defendants ($10 billion in billings) since 2007, relies on a network of nine locations and mines multiple databases to identify suspicious billing behavior.

Obviously the case studies of how innovative technologies impact healthcare are nearly infinite. Providers and payors will continue to focus on population health management, value-based care models, supporting solutions such as wearables and remote monitoring and telehealth, to continue to provide more effective care at acceptable costs.

4 Comments

Filed under Uncategorized

4 responses to “Amazing Halftime Show

  1. Dan Gebremedhin

    Great overview of the current landscape!!!!!!

  2. Love the characterization of the unique B2(B+C) business model in health tech . . . brilliant insight!!!

  3. Roberto Feliz, MD

    Healthcare is the “only market” in which the consumer-patient has very little saying in the actual cost or price he or she is willing to pay for their services.
    When it comes to money, everyone benefits: insurances, hospitals, doctors; pharmaceuticals, laboratories, equipment suppliers. But, what about the patients?

    Until patients are incentivized to maintain “good health” and are incentivized to and benefit from the savings achieved from adequate and cost effective care, no real dramatic change will occur in the savings of healthcare dollars.

    We need to think outside the box: change the present healthcare delivery system by changing the present incentivization equation.

    Roberto Feliz, MD

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s