Why the Potential CVS Acquisition of Aetna is Brilliant, The Law of Unintended Consequences

Many people have been surprised by the announcement that CVS is interested in purchasing Aetna.  Why would a PBM want to own a health plan?  There has been speculation that the move by Amazon to get into the pharmacy space may be a reason.  But there is another more rationale reason and its based upon a flaw in the Affordable Care Act.

The flaw is known as the Medical Loss Ratio requirement and it reads like this from the CMS website

The Affordable Care Act requires insurance companies to spend at least 80% or 85% of premium dollars on medical care, with the rate review provisions imposing tighter limits on health insurance rate increases. If an issuer fails to meet the applicable MLR standard in any given year, as of 2012, the issuer is required to provide a rebate to its customers.

This requirement was put in place as a way to ensure that health plans did not make money by underutilizing medical care.  But it had the unintended consequence of insuring that costs never went down and here’s why.

Let’s assume that a hypothetical health plan offers a product at a $5,000 premium.  Based on this premium, they must spend 80% or $4,000 on Medical Care and the remaining $1,000 goes to cover administrative expenses and profit. At the same time, it’s fairly common knowledge that 30% and possibly more of healthcare costs are associated with waste, fraud and abuse.  So, let’s use some AHIP data and come up with a scenario.

Perhaps a health plan wants to go after some of this waste, fraud and abuse and targets inpatient hospital costs. Per AHIP this represents 15.8% of a health plan’s spend or $790 in our hypothetical scenario. So now the health plan puts in programs and negotiated pricing that reduces inpatient costs by 10% or $79. Now let’s assume that all other medical costs remain the same. The health plan is now below the 80% MLR requirement and must rebate $79 back to the customers; they can’t keep even a piece of it as a reward for their efforts. Next year under the same scenario, if nothing else changed, they would need to come in with a lower premium (meaning they’ll have a smaller 20% for their admin and profits) or rebate the money again. This is why health plans do not take a meat cleaver to the pork.

BUT… Now let’s introduce a new owner of the health plan, a PBM, which per the same AHIP report represents 22.1% or $1,105 of our hypothetical health plan premium.  The PBM will tell the health plan to sharpen up and use the meat cleaver. Why? Because instead of rebating the savings to the customer, the PBM can increase its cost and or utilization up to $79 to keep the health plan in good graces with the government MLR requirement. In this hypothetical, $79 is equivalent to 7.2% growth for the PBM and is a way, as the owner, to pull more profits out of the health plan which are not allowed to be taken by the health plan under the ACA’s MLR requirement.  Now in the pharmacy case, some of this could be due to better adherence, or higher price or more utilization, some potentially good, some not so good.  In any case, if the PBM is really smart they will take a meat cleaver to every area except pharmacy costs and shoot for the whole hog.

And that potential growth strategy is another unintended consequence of the MLR requirement.

Fred Goldstein is the founder of Accountable Health Inc.

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6 replies »

  1. With a second thought, this should be cancelled by the anti-trust folks!

  2. Parkinson’s Law states that for complex institutions, work expands to use the resources that are available. Since 1960 through 2016, health spending expressed as a percentage of our GDP has increased at 2.33% compounded annually, in addition to economic growth. The only portion of that time interval that health spending followed economic growth was 1995 through 1999 (see Altarum.com health spending reports). The trajectory of health spending over economic growth has worsened since 2015 with full implementation of ACA 2010. There is essentially no strategy within our current healthcare reform that will change this scenario. The elephant in the closet is you and me and all of our colleagues.
    The final number is astounding. The national GDP, 0.54 Trillion in 1960 and 18.57 Trillion in 2016, represents 6.51% annual growth compounded annually. So the actual growth of health spending represents 8.84% annual growth minus inflation. The accumulated inflation was 3.84% compounded annually. The actual growth of health spending was 5.0% compound annually. For anyone who has read the book written by C. Northcote Parkinson regarding the growth of the British Admiralty administrative personnel between WWI and WWI, with no change in the number or technology of ships in their fleet, was 5.00% compounded annually.

  3. The ultimate conflict of interest exists for the payers (private insurance, Medicare, Medicaid, Workers Compensation, Veterans Administration, Native American Healthcare, Community Health Centers, County Welfare, etc.) of healthcare who also define the reimbursable benefits. Its also the explanation for why Primary Healthcare in poorly capitalized. Primary Healthcare is not amenable to actuarial principles. Medicare deals with it by using a strategy to ignore that it exists, with an unintended benefit for the demise of MIPS.

  4. A very important point and perhaps the most critical reason the ACA should be completely upended. In order for insurance companies to produce year over year profits, they must guarantee that medical costs rise. You can see this at the end of the fiscal year where insurance agents go door to door provoking wellness exams and unnecessary care amongst its members. The last thing they want is to dole out a rebate…they will not be able to justify rising premiums the following year. This is why insurers have inappropriately began practicing medicine without a license. If medical costs aren’t rising fast enough, now they can intervene. It is the only way to grow the pie now. I see very little about this. I am not sure the general public is aware of it. Medical costs will never, ever, ever go down until this is corrected.

  5. The scourge of Parkinson’s Law continues in the form of vertical integration. With virtually unlimited access to capital for large institutions,as provided by Medicare and Medicaid since 1965, the rising cost of healthcare continues unabated.

  6. First, I think healthcare fraud is concentrated primarily in the areas of unnecessary physical therapy, especially PT delivered in nursing homes, home healthcare and durable medical equipment. So-called waste is most likely to comprise patient driven requests for non-invasive tests like imaging to ensure that nothing is missed and physician practice patterns that are developed to reflect the reality of our litigious society which means lots of defensive medicine to ensure that they provide what is considered the standard of care in case they are sued.

    As for PBM’s, United Health also owns one called Optum Rx. Anthem sold its PBM to Express Scripts in 2009 and now intends to establish a new PBM called IngenioRx that will bring that business back in house when their current contract expires in 2020. Anthem alleges that ESRX overcharged it by billions of dollars during the contract period. Anthem’s business currently accounts for 31% of Express Scripts’ revenue. Ouch.

    As a business, PBM’s have four ways to make money which are (1) administrative fees, (2) volume based rebates from drug companies, (3) the spread between the amount they reimburse pharmacies for drugs and how much they bill the self-funded employer or insurance company client, and (4) filling prescriptions for generic drugs through their mail order pharmacy. They want to make a certain amount of money from any given account and they don’t really care which of the four buckets the profits come from.

    One attraction of owning a PBM for an insurer is that it’s a largely unregulated business in terms of potential profitability. The insurer can have one subsidiary buy generic drugs directly from manufacturers and resell them to another subsidiary within the firm that operates the drug plan for a significant profit. It’s the price paid by the subsidiary that operates the drug plan that determines whether it met the regulatory threshold for the percentage of premiums spent on medical claims.

    Finally, insurance executives told me in the past that their medical claims break down broadly into three buckets as follows: 40% for hospital costs, inpatient and outpatient combined, 40% for physician fees and clinical services like labs, non-hospital owned imaging and PT, and 20% for prescription drugs. Generics are now close to 90% of all prescriptions but only 28% of the dollars spent on drugs. Specialty drugs are 1% of prescriptions and over 30% of the dollars. The rest are non-specialty brand name drugs.