As mentioned in part 1, payors are facing near-term utilization headwinds and blips on their medical loss ratio guidance, leading to selloffs in the managed care market.
Consequently all managed care names are down year to date.
But folks I've talked to on the inside believe that there's a potential larger cause for concern in risk-bearing healthcare names. So I wanted to present some thoughts on how healthcare MCOs might falter given a longer term trend of higher utilization:
Increased potential for mispricing: Given that organizations as large as Humana and United did not see the release of demand, we should expect insurers to price themselves more conservatively headed into 2024.
Increased scrutiny of outpatient utilization: If demand is continually harder to predict on the outpatient book of business, we'll likely continue to see payor scrutiny of outpatient services and thus, an uptick in prior authorization. ASCs don't report insightful utilization data, a point that MedPAC has bemoaned. This arena will be the next battleground as the goalposts shift. E.g., "Okay, now we've pushed more procedures out of the hospital inpatient setting and into outpatient. Now we need to check to make sure we're appropriately paying for those procedures."
Overutilization in healthcare is rampant. Like I mentioned in part 1, we're already seeing that dynamic play out with UnitedHealth's most recent attempt to rev up prior authorizations for GI procedures. GI and endo groups now have to collect and submit documentation in support of future endoscopy procedures. While UHG walked back the policy, providers need to prepare themselves for that reality.
If demand continues to normalize, we may see deeper payor penetration into areas including multispecialty groups, ASCs, and post-acute care to drive down medical spend. I.e., a move beyond just primary care assets.
The end of the Goldilocks Era for VBC?
While the pandemic was a horrible for…quite literally everyone else, it was a boon for both managed care players and value-based care firms. The segment of healthcare enjoyed operational outperformance in the era of historically low utilization, with the ability to drive cost savings through easy fee for service benchmark comparables.
Not too hot…not too cold…but just the right environment for organizations taking on risk to succeed.
Here's my next question for these players, though: what happens if the larger managed care titans start to face headwinds?
Let's say policymakers tighten up risk adjustment around the belt. Then outpatient demand stays hot, and the managed care names struggle with pricing and MLR for a year. Maybe operating margin slips from 5-6% down to 3-4% or lower.
I would speculate that payor struggles would hold downstream ripple effects on the subcapped provider names - perhaps getting push back on risk pricing.
Names that are farther down the risk spectrum - full capitation - would conceivably have substantial price exposure in the event that these dominos fall in line.
Stated differently, if there are structural cost changes occurring in healthcare, then the providers who are primarily in charge of managing that risk and utilization are more exposed. And while nothing is conclusive at this point regarding volume and utilization, things are trending that direction. At least in the short term. The end of the VBC Goldilocks era is nigh.
If margins erode from ~5% to ~3%, this financial dynamic could have bad downstream consequences for the value-based care platforms. This is a bear case for these players. More and more, it seems as if the sweet spot (at least currently) for operating a similar value-based care is exposure to both fee-for-service and risk-based revenue streams.
A recent William Blair note reiterated thoughts on a couple of MA-focused players:
- "AGL is 100% MA risk-based, so any uptick in MBR would impact margins here too. That said, management has consistently indicated that the company was more active in ensuring that care for its population was managed during the pandemic, thus creating less pent-up care relative to the broader market. Still, a broad uptick could modestly impact margins."
- PIII is also 100% MA risk based, and would thus see a similar impact. It is surprising, thus, that PIII shares are up 3% while the managed care providers and AGL are all off 10%-15% today."
I'd like to reiterate that I'm still optimistic about the companies in this space and think they fulfill a core, needed function in healthcare to enable better care delivery, but the above conditions present a real, and considerable headwind. What I'm outlining above could mark the beginning of a bear case in these names.
What levers can a VBC player pull if the topline PMPM gets pressured in the face of heightened utilization? Some speculation from me:
- More aggressive patient steering and narrow networks to preferred providers?
- Decreased shared savings splits with provider partners?
- A bigger focus on ACO REACH to work around managed care contracting?
- A broader move away from Medicare Advantage as MA penetration fizzles out?
There are plenty of variables to consider, and the bearish folks I talk to in the space mention that it's possible for things to spiral into a competitive 'race to the bottom.' For now, expect these utilization challenges to be short-term with moderate impact.
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