This is part III of my series on employer-sponsored health plans. Part I covers the basics of employer-sponsored health insurance, and Part II covers opportunities to reduce overall health care costs. I recommend checking out these articles first.

When I wrote the previous article, one question did not leave me rest: Why is it not done? If it is all there and there are all these opportunities to reduce cost and close efficiency gaps, why are they not being implemented? Basic economic theory tells us that if one company finds a better way of producing a particular output, it will start to dominate the industry through better pricing or quality of service. This will create follower companies that imitate the new method and drives down prices for all. According to this dynamic, health plans should have more broadly adopted cost containment measures such as surgery bundles, more accessible primary care, and innovative provider contracting methods.

However, this is not the case in the healthcare industry in the US. Broader adoption of cost containment methods still has plenty of opportunity to grow and costs keep rising. Why is this the case?

Latest data on health care cost increases by the Kaiser Family Foundation.

Today I want to share my thoughts on this $1 trillion question. I cover the most prominent reasons, but there are probably plenty of smaller ones, too. Here is what I will cover:

Delegation problems
Information asymmetry
Matching frictions
Risk aversion & denial

Let's get to it!

Incentives: Principal Agent problems

The first set of barriers to broader adoption lies in misaligned incentives. Many stakeholders benefit from the current "wasteful" way care is financed; for these stakeholders, this is not waste but profit.

In economic theory, these misaligned incentives are called principal-agent problems. A principal delegates a specific task to an agent and hopes the agent completes the task with the principal interest in mind. However, the agent also has their own interest; instead of maximizing the principal's interest, they will maximize their own benefit. There are plenty of principal-agent problems regarding employer-sponsored health plans, and here are a few.

1. Employer - Employee: Delegating coverage level

It starts with the employee delegating the health plan purchasing decision to the employer. The employee usually should know what is best for their health care, but the employer will choose which coverage level they will offer - they will decide on the cost-sharing amount, access restrictions, and carrier network. This delegation of the decision becomes especially tricky as the employer is optimizing for retention and cost rather than for a plan that maximizes each individual's needs. Especially for larger populations, there will always be some level of compromise the employer needs to make. In addition, an employer might also over-purchase insurance. Employers might be afraid that their benefits are not competitive and thus might buy higher coverage than the employee would buy on their own. However, an individual employee may want to choose a higher salary over a better benefits plan.

This delegation of health insurance buying also goes the other way around. After the employer has picked a set of plans to offer their employees, the employee usually has to choose which plan to enroll. Let's assume the employer covers most of the plan premium, and there are several plans to choose from with different premiums. Why not choose the most expensive plan, if it basically comes for free? I assume many people just enroll in the most expensive plan, even though they do not need as much coverage.

2. Broker: Delegating benefit decisions

As discussed in Part I, it is inefficient for most employers to run their own health plan. They often do not have the resources to oversee their health plan administration and design, so they heavily rely on outsourced vendors to help them with that. In fact, most small and medium-sized businesses outsource the selection and administration of benefits to a broker/ advisor firm to help them select the right plan.

Unfortunately, there are a lot of adverse incentives at play here:

Don't get fired: A primary goal for an advisor is to keep their clients happy and to continue the relationship with them. Because of that, they are better off recommending an established carrier that works vs. pushing for more modern and cost-effective health plan options. (I will cover later why the established carriers don't really have the incentive to reduce costs). Also, they are not directly incentivized to minimize cost, as most advisors are paid a PEPM fee. Thus, they only have to keep expenses low enough to keep their clients happy.
Kickbacks: Brokers do not only get compensated through a fee from their clients. They often get significant bonuses from the carriers and point-solution vendors (PBM, Stop-loss carriers, etc.) they recommend to their clients. These financial arrangements can become very complex. For example, a firm working with a particular carrier might get a bonus if they sign a certain number of lives with that carrier in a year. In another arrangement with a PBM, an advisor/ broker might get a bonus for every prescription the PBM processes.

The complexity of the health plan landscape makes it very hard for employers to oversee what the broker recommends and understand the genuine reasons for the recommendations. To protect employers more from this information asymmetry, the Consolidated Appropriations Act passed in 2021 included a provision that requires brokers to disclose their third-party fees. However, it is up to the employers to ask their brokers/ advisors to disclose their fees.

One last note: similar to financial advisors, brokers fulfill a critical role and there are plenty of great individuals delivering great service. However, employers should do their homework when selecting the right advisor.

3. Vendor: Delegating admin tasks

For self-funded and level-funded plans, brokers will leverage various third-party vendors to deliver the health plan. These vendors include a TPA, a PBM, and point-solution vendors such as case managers and digital health tools. A key thing to consider here is how these different vendors are paid and how they make their margin. Here are three common payment methods:

Per-member-per-month (PEPM): Under this arrangement, the vendor will get a monthly fee for every enrolled member. A challenge with this model is that the vendor is not paid based on outcomes. The primary way for the vendor to increase their margin is by streamlining their processes and reducing their operating costs. Sometimes a conflict can arise, though. Consider this: A TPA or ASO carrier can improve their profit by reducing their operational staff - instead of reviewing every claim, they often rely heavily on auto-adjudication systems. While this is nothing bad, there is no real incentive for the TPA to improve the accuracy of these systems. They would rather automatically pay out a claim than spend manual effort reviewing it and getting it right.
Volume-based: Another way to get paid is by getting a percentage of the claims volume. You can probably see already where the problem lies. If a vendor receives a percentage of money paid out, there is minimal incentive to reduce the overall cost. This type of reimbursement also affects "shared savings", i.e., if a vendor gets paid a cut of the savings they achieve. While these incentives can work, the vendor must not control the benchmark. PBMs and hospitals have long gamed this system by artificially inflating list prices instead of realizing savings.
Utilization-based: This method is pretty straightforward and can be very fair. For example, an obesity management program will only get compensated if it can effectively engage and enroll employees in its program. This gives incentives to build better care. However, it can also give vendors incentives for over-utilization and to bill unnecessary procedures and treatments.

As you can see, every payment method has its advantages and disadvantages. There is no silver bullet in paying vendors. Still, it is essential to know the adverse incentives that exist and account for these, for example, through reporting and performance bonus payments.

Another thing to consider when delegating tasks to a vendor is hidden fees impacting incentives. Especially on the prescription drug side, organizations are masters of hiding how they make money. The major PBMs, ExpressScrips, OptumRx, and CVS Caremark are not charging any PEPM fee - but of course, that does not mean they are free. You can bet they are making a healthy margin on the backend in ways that are not obvious to the employer customer. A particular case of hiding fees is the strategy of vertical integration. The three PBMs I just mentioned are each owned by one of the major health insurance carriers. These carriers have done a great job in the last few years in buying all types of companies in the health plan value chain, from clearing houses to health care providers. This is a great way for them to expand their margin, as a cost center (such as paid-out claims) suddenly becomes a revenue stream for the group. Optimizing these cost centers is not a priority.

4. Carrier networks: Delegating rate negotiations

One type of vendor is a source of unique delegation problems: the provider contracting network. These networks negotiate the rates with the providers the employer eventually has to pay. Carriers like Cigna and Blue Cross Blue Shield are allowing independent TPAs to rent their network and give them access to their negotiated terms.

To understand this delegation problem better, we must look at the dynamic between payers and providers. While many health systems are non-profit organizations, they still have to keep an eye on their profits: given their significant overhead and often inefficient operations, they need to optimize for profitability, or they risk going out of business. Better rates with commercial payers is a crucial way of achieving this, and to improve their negotiation leverage, they have employed several strategies:

M&A: Most health systems have been incredibly active over the last decades in buying up smaller practices, specialties, and primary care and adding them to their organization. Because of that, many markets are now ruled by a few large hospital systems, giving them much power in payer contracting negotiations. Many payers are forced to work with the dominant health system for a specific market to maintain network adequacy.
Branding: The traditional way of increasing price elasticity is to get people to believe that you are the best. Creating a brand lets Apple sell its devices for twice as much as the competition, even though one can argue whether they are twice as good from a pure performance point of view. Health systems are achieving this branding through PR campaigns (have you also gotten LinkedIn and YouTube ads from your local non-profit health systems lately?), and they are investing in marketing so that employees expect the system to be in-network.

Carrier contracting networks now find themselves in a difficult position. On the one hand, they need to offer a competitive network regarding the breadth of coverage, as their customers expect certain anchor providers to be in-network. On the other hand, they need to have a competitive network regarding negotiated rates. However, the carrier networks have decided to choose breadth over competitiveness in price. They can afford to loose a few health plan customers, but they cannot afford to loose an important health network.

Some of the restrictions that contract networks put on how health plans can use their networks indicate that provider relationships matter more to carrier networks than the economic value. For example, they may not allow TPAs to "tier" their network, i.e., actively try to steer members to cheaper providers in their networks. Often a network can only be used as a "whole", i.e., one cannot pick a certain provider from the network, but everyone has to be in-network. They also may restrict the number of claim audits a TPA can make to reduce the burden on providers.

5. Payer-Provider: Delegating care delivery choices

Payers don't deliver care. Doctors do. This is the most classic task delegation that happens in health care. However, the fee-for-service reimbursement structure does not give a whole lot of incentives to the provider to become more cost-efficient. They benefit from more utilization, not from less. And while I don't want to throw doctors under the bus - after all, we all rely on them - they often are unaware of the financial impact their choices can have on their patients. For example, ordering the image "down the hall" in the hospital-owned imaging center may be a convenient option for the patient. Still, it can cost a multiple of an image done by an independent facility. Many health systems instruct their doctors only to refer patients within their health network to avoid "revenue leakage".

CMS has pushed alternative provider reimbursement models in the government programs to align incentives between providers and payers. By reimbursing for outcomes, providers are incentivized to be more economical with their resources, optimize for long-term outcomes instead of short-term procedures and improve their operational processes. But there is still a long way to go, and these arrangements have yet to take hold in the commercial space.

Incentives are vital factors to consider when trying to reduce healthcare costs - but there are other challenges to delivering more cost-effective health benefits.

Lack of data access - a form of information asymmetry.

People do many things when they know nobody is watching. This is a key reason delegation problems exist - "I don't know what you're doing over there". A meaningful way to keep agents accountable is through data transparency and asking: where did my money go? This includes getting information about any third-party commissions but also - even more critical - a thorough review of claims data. Claims information can reveal a lot about how resourceful a payer or administrator has spent their claims, whether a health plan is performing at the benchmark or whether it has missed opportunities to realize savings.

However, it is pretty challenging for plan sponsors and their advisors to obtain access to the claims data of their population. Usually, fully-insured health plans don't provide access to claims reports and thus don't allow the employer to review their spending behavior critically.

Companies have found ways around this by using web scraping technology to obtain claims information from their payer, but this has its own challenges. Scraper technology can be brittle, you need customer consent, and it might violate the terms and conditions of the payer web portals.

"Whack a mole" - matching frictions for narrow point solutions

Let us say a plan sponsor gets access to their claims data; there is still a challenge with what to do with it. The cost of the same health condition can vary significantly from person to person and is often very well justified. Identifying the right actions to take to realize cost savings without compromising the quality of care can be quite challenging.

Thanks to the investment of CMS into value-based care arrangements, many vendors have popped up that target different saving opportunities: from importing drugs from Canada to pinging primary care doctors when their patients get hospitalized. However, many of these solutions are often very narrow in scope and only apply to a small number of people. While this can be millions in the US on aggregate, for a single employer, this could mean that only 3-4 employees would qualify for this solution.

There is a significant matching problem here. Every population is different and requires different point solutions. The current friction in evaluating and implementing new vendors makes health plan administrators often focus only on the top 3-4 conditions. The smaller the employer gets, the more difficult the ROI case gets, as the fixed implementation costs can vastly exceed the solution's benefits.

Inertia - for employees & employers alike

One has to be careful when blaming slow innovation on user inertia. It is an easy way to explain away a problem without looking into the underlying reasons. For example, a lack of great doctor-facing software is often blamed on the unwillingness of doctors to adopt new technology. In my opinion, this is not the reason. There are many structural reasons why Epic is the dominant software rather than more modern tools.

But still, there is quite some inertia that needs to be overcome to drive change.

Patient Engagement

A key challenge for digital health and effectiveness often depends on their ability to enroll people in their program. I always have to get back to Brendan Keeler's chart here.

Good luck trying to engage the average person on their health - Health API Guy

Any solution that depends on the member becoming active by themselves is having a much harder time than a solution that makes it frictionless and inserts itself into existing user journeys. A lot of people only actively engage if there is immediate pain, the rest, you have to meet them where they are. Through better design, better immediate benefits, and other means.

A second challenge is a need for choice. Americans hate restrictions imposed by their health plans: prior authorizations, narrow networks, referrals, etc.! These utilization restrictions can be very effective in reducing healthcare costs, and they can even improve outcomes as they protect patients from over-utilization and unnecessary procedures. However, people dislike the burden associated with them. While this is a valid preference, they probably over-index the importance here because they often don't feel the cost of a non-restrictive health plan. A way to address this is to have people pay the price for a less restrictive health plan.

Buyer Engagement

For most companies, health benefits are a top-three line item in their annual budget. But it is rarely treated with as much scrutiny as other vendors, such as real estate or raw material suppliers. Health benefit design choices are often 100% outsourced, but the employer has to foot the bill.

There needs to be more understanding of how the healthcare supply chain works. There should be more education for CFOs and HR managers alike on how PBMs, provider network contracting, and plan design work. Another essential concept is risk premiums, i.e., understand that anytime you hand over risk to someone else, you will pay a premium. Rightsizing the risk, for example, through a level-funded plan, can be a practical first step to reign in costs.

However, making changes to benefits is a topic loaded with risk aversion. Usually, employers only make significant changes if something has gone very wrong: a critically denied service or a 40% renewal rate. HR leaders are often afraid of the challenges that a change in health plans brings with them, to how this could impact their ability to attract and retain talent.

My thoughts

With all these challenges ahead, I hope you have not given up all hope. There are ways to address those issues:

Align incentives: The economy lives on the division of labor and specialization, but this only works if there are clear performance criteria and transparency. Health plan sponsors should be aware of these adverse incentives and push for measures to address them. This includes asking advisors to reveal compensation and commissions from third parties, putting the right reporting metrics in place, and not only looking at the monthly PEPM price but also considering the total cost of ownership.
Better integration of point solutions: Standards around who the point solutions are for either by ICD-10 codes or other inclusion criteria, as well as clear standards on the effectiveness/ expected outcomes. This will help organizations decide which MSK solution works best for their population and significantly reduce the friction for adopting modern solutions. There is also an opportunity for an aggregator platform that allows health plans to bring in the right solutions given their claims data.
Unbundling the behemoths: The increased consolidation for health care providers and carriers is a major source of rising costs. Hospital-owned primary care doctors refer to health system specialists rather than independent practices; carrier ASOs require their customers to only work with their owned PBMs and stop-loss carriers. While I let the FTC figure out how to break up these organizations sensibly, there is also another way for employers: choose unbundled health plans. With the right partners, they can build a plan that leverages best-in-class solutions for each vendor category.
Open contracting: Another way to improve competition is to reduce the contracting friction between payers and providers. Allowing smaller health plans and employers to build direct contracts with providers and let them pick and choose providers from a health system vs. contracting with the entire organization can significantly improve competition between providers and create pressure to improve operational efficiency and prices.

Many of my above thoughts are anecdotal, derived from conversations with experts in the field, and based on theoretical principles from economics - if you find data points and examples that prove me wrong, please don't hesitate to reach out or comment.

We live in exciting times - all these challenges are not insurmountable, and I am always interested in chatting with people having a passion and thoughts on this space, so please reach out.

Health Tech Stack

Part III: Why health care costs keep rising?