Value-Based Care: Health Care Business Model Transformation

In the second episode of Cowen’s Thematic Outlook Podcast Series, focusing on emerging growth and disruptive innovation, Healthcare Facilities, Managed Care, & Emerging Payor/Providers Analyst Gary Taylor, and Head of Thematic Content Bill Bird discuss Value-Based Care (VBC).

Much of the healthcare spending in the U.S. is uncoordinated, wasteful, and influenced by financial incentives. Value-based care aims to change this. Over the coming decade, trillions of dollars of healthcare spending will be redefined by new business models such as VBC. Press play to listen to the podcast.

Transcript

Gary Taylor:

I do believe there’s consolidation in this industry. My long-term thesis is that care management capabilities ultimately have to become a core competency of the large managed care plans.

Bill Bird:

Hello everyone, and welcome to DaVita Thematic podcast. I’m Bill Bird, head of thematic content at Cowen. And I’m really excited to be here with Gary Taylor, Cowen’s senior analyst for healthcare facilities, managed care and emerging payer providers. Each month, our thematic podcast discusses areas of emerging growth and disruptive, innovation topics that are pivotal interest to investors and corporate executives. The raw materials for the themes we’ll unpack are Cowen’s proprietary data sets and Cowen’s ahead of the curve series, where so much of our thematic work is expressed throughout the year.

Bill Bird:

Today’s topic is value-based care, which is one of the highest growth sub sectors in healthcare. VBC brings into play business model transformation, potentially competing for trillions of dollars of healthcare spending, and where Cowen believes the market has hit an inflection point. Before we dive in, I’d like to provide some background on our guest, Gary Taylor. Earlier this year, Gary published a widely read ahead of the curve report called value-based care, the world turned upside down. The report makes the case for an acceleration in VBC, and its thesis is supported by a proprietary roundtable with 16 key opinion leaders. Payment model innovation and more specifically VBC, was one of three healthcare services mega trends highlighted by Gary last fall when he joined Cowen. Gary is a veteran healthcare analyst with 28 years of experience across research, banking and consulting. He brings a unique perspective. Gary has the most comprehensive coverage list of all recent emerging, innovative, disruptive companies in the healthcare facilities and managed care sectors. And he also covers legacy providers. Gary, welcome, and thanks for joining us today.

Gary Taylor:

Thanks very much, happy to be here.

Bill Bird:

Gary, for the benefit of some of the journalists who are listening, how do you define value-based care?

Gary Taylor:

Yeah, value-based care is really about redesigning the payment of healthcare and the delivery of healthcare oriented around the quality of care being provided and the cost of care being provided. And that may sound very natural to the uninitiated but it’s really quite different from how healthcare is delivered and paid for in the US today, which is primarily around what we call a fee for service payment model, where every stakeholder in the system, physicians, hospitals, ambulatory providers, labs et cetera, et cetera, they all currently maximize their economic models and revenues by providing the highest volume of service at the highest price point in the highest acuity. Value-based care is really around redesigning financial incentives so those stakeholders are oriented to provide higher quality and lower cost.

Bill Bird:

Gary, the US is the only industrialized nation that attaches your healthcare to your employment, and a lot of good and bad things stem from that. US healthcare delivery and financing have suffered from structural flaws for a long time now. The big question on new payment models is, why now? What are you seeing that gives you confidence that the market is beginning to tilt in VBC’s favor and away from fee for service?

Gary Taylor:

I think there’s four key reasons that we’re looking at now. One, is the government, federal government is the single largest payer of healthcare, covering 80 million people in Medicaid, 70 million people in Medicare, roughly 15 million people in subsidized cover in individual market Obamacare plans. The government has established goals that support increased penetration of value-based care. Since the ACA, the Affordable Care Act back in 2010, or Obamacare was passed, the government has created an innovation center that has promulgated demonstration projects, payment models, but now has explicit goals which I think we’ll talk about a little later to put all of Medicare beneficiaries and value-based care arrangements by the year 2030 in the majority of Medicaid. Clearly, the first reason is the government is leading and they’re leading in an accelerated fashion over the last decade.

Gary Taylor:

The second reason is the next largest payers of healthcare are the commercial insurance companies. And clearly, we’re seeing those companies promulgate changes in payment models, along the lines of value-based care, and also engaging in vertical integration to participate more directly in value-based care. Third, absolutely there’s accelerated formation of independent risk bearing physician groups of value-based care companies. We’ve seen a lot of those come public in the last 18 months or so, and there are many more private companies being formed. And so the emergence of these companies is driving towards that addressable market opportunity.

Gary Taylor:

And then finally, I would say macro, and I think you could always talk about macro being a factor, but each year that goes by, the macro becomes more important. When I mean macro, I’m talking about aging in the UDS population, the silver tsunami if you will, the fact that the Medicare program is 40 trillion dollars underfunded on a present value basis, the fact that every 100 basis point increase in the 10 year treasury rate represents about 25% of the total Medicare annual budget. These macro numbers, these demographics and the financial condition of our entitlement programs, really necessitate, created imperative eventually to change the productivity and the cost of providing those services.

Bill Bird:

Gary, one of the drivers you referenced was government goals. Maybe we could go a little bit deeper on that. CMS has established a goal to have every Medicare and the majority of Medicaid enrollees under VBC arrangement by 2030. How do you think about that goal and what do you think will be required to reach it?

Gary Taylor:

Yeah, when we think about getting there in the Medicare program, so getting basically all of Medicare beneficiaries in there, about 60% of Medicare beneficiaries are in traditional government run Medicare and only about 40% of those beneficiaries today are in value-based care programs. There’s a lot of movement that has to happen there. The other 40% are in Medicare advantage plans and probably 80% of those beneficiaries are in value-based care arrangement. Combine the government, federal government, Medicare is probably roughly 50% in value-based care arrangements today or at least in two-sided risk arrangements today. There’s still a lot of movement just on the Medicare side. Clearly, the government’s going to have to continue to support the ACO program, the Accountable Care Organizations. They’re going to have to support the new direct contracting program that just began last year, and they’re going to have to support … And by all this, I mean through funding and through regulation but also support the Medicare advantage program.

Gary Taylor:

And that’s more controversial with more progressive Democrats but the reality is MA, Medicare Advantage, is a key driver of value-based care in government programs and really needs to have sustained financial support. On the Medicaid side, it’s much more difficult. The goal is only to get to 50% or the majority or 51% by 2030, but the penetration rate is far less now because the states with government support run their own Medicaid programs, which means there’s 50 different iterations of what a Medicaid program could look like. And there are lots of small demonstration projects happening in Medicaid. But really, to move that market as quickly as 2030, besides financial incentives, I think there’s really going to have to be some federal mandates that require states to move in that direction. Unlike Medicare, which has a lot of momentum already and you can see how they might get there, Medicaid I think, really is going to require some legislated mandate to accelerate the pace of adoption.

Bill Bird:

Gary, how do you think about some of the other sources of friction to adoption? What are some of the key obstacles and adoption challenges that will have to be overcome for the market to really scale?

Gary Taylor:

Yeah, it’s mostly the entrenched stakeholders. Maybe think about that in three or four different ways. First, if we just say broadly entrenched stakeholders, we think about hospitals who potentially have a lot to lose from value-based care, if value-based care successfully executes on the goal of reducing emergency room admissions and reducing unnecessary hospital admissions and successfully shifting site of care to lower cost, lower acuity sites of care. The hospital industry, which is fairly powerful industry lobby, perhaps the second most powerful healthcare lobby in the US, isn’t necessarily fully supportive of value-based care. In some cases, they present headwinds. But this is also true in the physician community.

Gary Taylor:

When we think about physicians who resist change in general because they’re doing just fine, who remember the 1990s fail years of physician practice management companies and value-based care, there’s still some reticence with the concept even inside of the physician community. And for those that aren’t reticent, there’s a scarcity of physicians that have been trained in practicing longitudinal patient care that’s required for value-based care. There’s also a scarcity of physician groups that have actuarial risk taking capabilities. Some of this is skin in the game, some of this is financial incentives that might be at risk, and some of this is just core capabilities that need be built to pursue the opportunity.

Bill Bird:

Gary, let’s talk about the size of the opportunity. Given the size of our healthcare system, it sounds like the addressable opportunity is enormous. How do you size that addressable opportunity and what kind of growth rates are you seeing?

Gary Taylor:

Ultimately, we’re spending almost $4 trillion on healthcare in the US. That is the end game. If you had all commercial patients or enrollment, all Medicare, all Medicaid in value-based care arrangements that were truly two-sided risk arrangements, the ultimate TM is four trillion dollars. We think the market size is less than a hundred billion in true two-sided value-based care actuarial risk arrangements. The Medicare market is farthest along, we think perhaps 20% of the Medicare market is penetrated in this way. From less than a hundred billion today, just the Medicare market alone is a trillion dollar opportunity total US is that 4 trillion number. The companies that we see that are engaged in pursuing the opportunity, are generally guiding, for producing targeting topline revenue growth rates in the 20 to 50% range. It’s a really sizeable opportunity. The growth is really only constrained by the company’s ability to scale and execute against that growth opportunity. The market is really large at this point.

Bill Bird:

Gary, let’s talk a little bit about some of the players in the sandbox, who are the major players in the space? What types of players do you believe are at greatest risk of disruption? And as you think about how the space may develop, how do you see the market developing, including MNA?

Gary Taylor:

Wide range of players participating. When you talk about something as large as a 4 trillion total US healthcare market opportunity, you can imagine there’s a lot of different players that are engaged in pursuing this opportunity. Some of the most obvious are the large managed care companies. United Healthcare is a leader with what they’re doing with Optum Care, over 60,000 affiliated physicians pursuing value-based care arrangements across all lines of business at Optum Care. Humana, which is a Medicare advantage pure play, operates Conviva and CenterWell. These are primary care clinics where the physicians practice and are reimbursed in a value-based care model. Anthem has a similar but smaller clinic model called CareMore. Almost all of the large payers … And we see the nonprofits as well. I’d be remiss not to mention some of the blues that are beginning to make investments in value-based care physician networks.

Gary Taylor:

But you also see what we’d classically call drugstore companies. Walgreens made a majority investment in VillageMD last December. CVS has recently announced that they want to acquire and operate initially 2 to 300 centers by 2024. And then you also have offshoots where the large major dialysis companies in the US, both sides of the US dialysis duopoly, Devita and Fresenius Medical Care, are building integrated models to take financial risk, actuarial risk on value-based care for their special high acuity ESRD populations. And then of course, you have the standalone independent risk bearing provider groups that are pursuing this opportunity exclusively. There are clinic models like Oak Street and Canno and CareMax, and many, many more privates. And then there are affiliate models that affiliate with existing physician practices to enable those practices to move to value-based care. Companies like Agilon and Privia and Apollo, private companies, Aledade, VillageMD and many other privates as well.

Gary Taylor:

Long term, you asked about MNA and what we think. I do believe there’s consolidation in this industry long term, for sure. My long term thesis is that care management capabilities ultimately have to become a core competency of the large managed care plans. And we think those plans ultimately can be an acquirer of many of these independent risk bearing provider group assets. And of course, we’re seeing some of that already. That’s exactly what Optum Care is doing already, that’s exactly what CVS has told the market that it expects to do. But when we think about large US health insurance companies have created value over the last 20 years through enormous consolidation, using that to pressure providers on rates, pursuing a spread pricing model where underlying healthcare utilization trends are 5%, premiums go up six. If trend is seven, premiums go up eight. That value proposition, we don’t think is sufficient over the next decade plus.

Gary Taylor:

We think all the stakeholders, whether they be federal government, state government, employers offering employer sponsored coverage, are demanding a more powerful value proposition from the payers. And you’re going to have to be able to reduce costs and deliver higher quality, which makes value-based care and companies that are skilled at value-based care, ultimately very attractive assets to the insurance companies that will need these as core capabilities.

Bill Bird:

Gary, as you look at the next one to two years, what if any, are some of the things you think may be underappreciated by investors and may have a chance of occurring in 2022 or 2023?

Gary Taylor:

I think a few things there, maybe two or three things. The first is just the sustainable growth rates we think are underappreciated by investors today. We look at the pure play value-based care companies trading at parity, EV to sales multiples with legacy providers, but these new value-based care companies are growing the top line, growing revenue, 20 to 50%, as I said. The legacy providers are growing revenue mid to high single digit, so it doesn’t make a lot of sense to us that they would trade at parity enterprise value to sales valuations. And given that 20, 30, 40% revenue growth, sales multiples that might look rich today, very, very quickly look a lot more attractive, cheaper, lower if you fast forward a couple years with that level of revenue growth compounding. I do feel like the sustainable revenue growth rates are underappreciated.

Gary Taylor:

Two, I think there will be an increased appreciation for the companies that are doing real care, delivery redesign, are really changing the practice of primary care and how often and how frequently and by what nature they’re interacting with their patients, versus companies that are more oriented towards financial arbitrage, risk coding, et cetera. The sustainable models will have to be very skilled and oriented and focused on redesigning care delivery. And then finally, maybe somewhat underestimated still, despite the recent announcements, is the strategic interest that there’s going to be in the space, the large payers having the strategic imperative to invest in these core competencies that I just described, as well as the tendency of the large health insurance companies really to largely imitate what they see United doing. And United as an industry leader, building the largest and most vertically integrated value-based care entity or business at Optum Care, is something that we think we’re going to continue to see a lot of the health insurance companies copying and pursuing as a strategy.

Bill Bird:

Gary, what are the things you’re watching as you gauge the development of the future of the market?

Gary Taylor:

Yeah, probably three things right now that are key. First, is maybe a little nearer term, and it’s just post COVID execution. A lot of noise the last couple years because of COVID impacting health spending but also impacting the ability of the value-based care companies to really execute on their business models. A key part of their business model is you see that patient in primary care much more frequently. You interact with them through your case managers much more frequently, and this increased dose of primary care is what bends the cost curve downstream and reduces the downstream need for higher acuity services. That business model was interrupted for a couple years to some degree, particularly in the Medicare population, seniors were fearful of the virus for obvious reasons, they were home bound. And your ability for physicians to touch and interact with those patients is more limited, so it’s created a fair amount of volatility around third party, medical expense, medical loss ratio, the metrics that we’re tracking for these value-based care companies.

Gary Taylor:

Just knock on wood, the post COVID execution of the business model’s a key thing from a near term perspective that we’re paying attention to. The second would be the development of the direct contracting program. This is a new program that CMS started April of 2021. It essentially triples the addressable market for two-sided actuarial risk in the Medicare market, because it allows entities to pursue that risk in the traditional fee for service Medicare population, not solely in the Medicare population that’s elected to a role in Medicare advantage. That program began April of 2021. June of ’22 this year, in a couple months, is the first financial reconciliation with CMS of the profits for that model. Whatever the companies participating in that model have accrued thus far as revenue costs, earnings et cetera, June is the first true reconciliation of that with CMS. And we are optimistic about the growth and opportunity for that model but obviously, it’s very early days and that first reconciliation is going to be important to our go forward view.

Gary Taylor:

And then finally, just to reiterate, I feel like I’ve said it a couple times already but just the strategic activity around the space. CVS in particular, the market is waiting to see who they’re going to acquire. They’ve told the market they intend to acquire primary care clinics. They haven’t said if that would be publicly traded companies or private companies. It’s one of the most anticipated events that we’re waiting to see, the strategy that CVS ultimately pursues.

Bill Bird:

Gary, looking ahead, what are some of the marquee events or expert calls that you plan to host related to this theme?

Gary Taylor:

Well, it’s an important theme. We’re going to attempt to remain visible on it. Our futures health conference is coming up June 22nd to 23rd of this year. And it’ll be my first opportunity to participate in that conference. And our intention is to bring more of these value-based care disruptive models to participate in that conference just in a couple months here. We’ve also been engaged in a periodic value-based care call series. Last month, we had a call with Liz Fowler, director of the centers for Medicare and Medicaid innovation. The month before, we had a call with a value-based care consultant. We intend to periodically continue that call series where we’ll host and moderate a discussion, clients can dial into that. [Nondio 0:00:23:39] road shows recently had [Kieno 00:23:41]. Next week, we have Privia. You’ll continue to see us with value-based care companies on the road over the course of the summer.

Gary Taylor:

And then four, and maybe most exciting, we anticipate over the summer and into the fall, some site visits to some of these new companies and clinic models as travel has reopened for folks post COVID. I think there’s an opportunity to get wheels on the ground so to speak, versus the virtual environment that we’ve been living in. We look forward to hosting some events like that.

Bill Bird:

As we wrap up today’s podcast, I want to thank Gary for sharing his thoughts and everyone for taking time out to listen. Be well and see you next month.

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