How health plans can enhance investment returns

The structural break in healthcare has created a major challenge for U.S. health plans. Top-line growth has been constrained by a number of factors, such as a softening in the secular inflation in medical costs, rising numbers of coverage buy-downs and self-insurers. Meanwhile, the near-term and long-term outlooks have been disrupted by a host of forces, including rising levels of chronic disease, emerging consumerism and the mandates of reform.

Payers haven’t been sitting on their hands. From 2009 to 2012, our research shows that ten leading publicly held plans, representing 60 million members nationwide, undertook $11 billion in capital expenditures (CAPEX). These investments, which grew as a percentage of revenue for seven of the 10 companies, funded expansion into new markets, such as insurance exchanges, fostered the delivery of differentiated value in existing markets and enabled regulatory compliance at the federal and state levels.

Unfortunately, these plans’ financial results show that these investments did not lead to higher profits. In aggregate, the 10 plans reported that return on invested capital (ROIC) shrank by 8% over the same period. In fact, only two of the 10 insurers reported increased ROIC. 

In 2014 and beyond, it is essential that health plans intensify their focus on ROIC growth for several reasons.

First, from a strictly financial standpoint, the high levels of complexity and discontinuity in today’s business environment mean that CAPEX spending will likely remain high, both as a percentage of revenue and in the absolute sense. This puts immense pressure on ROIC.

Second, future success is critically dependent on making the right bets in a wildly uncertain environment. Plan leaders know that business as usual cannot continue. They are investing in a host of new capabilities to enable them to work with providers, play in expanding retail markets and deploy new technology. They are also investing in new operating models that require organization-wide restructuring. If the returns on these investments are unsatisfactory, a plan’s ability to attract new capital and plow it back into their business will be impaired.

No matter how health plans choose to differentiate themselves, they can improve ROIC through clear strategy, targeted investment and operational commitment. In our consulting practice, we have found that the path to higher returns starts with three key questions:

• Are there clear growth priorities driving investments?

• Are resources and costs deployed toward those priorities and not others?

• Are the organizational elements necessary to achieve those priorities in place?

1. Strategic Clarity: The first step is to ensure that there is clarity around investment in the organizational capabilities required to achieve growth.

For instance, we recently helped a leading health plan formulate a new strategy centered on a shift to value-based contracting, an expansion into the retail segment and a repositioning in Medicare and Medicaid business segments. This required making the most of scarce talent and financial resources. At the outset the leadership team analyzed its capability needs by cluster. It determined that the new strategy would require highly evolved and differentiated capabilities in network development and clinical constructs in order to drive competitive advantage. On the other hand, its product development and customer insight and acquisition capabilities required relatively less differentiation, and its “table stakes” capabilities in back office and infrastructure were more than adequate.

In contrast, there are still many plans that have not made the tough decisions. Instead of choosing a clear strategy and then bringing to bear all of their investing power, they adopt an “all of the above” strategy that requires them to spread investments thinly across a host of often-unrelated initiatives.

2. Resource Alignment: Once a strategy is in place, establishing the proper alignment of resources is the crucial next step. This creates a platform to make better decisions for deploying capital. Such a platform enables leadership teams to confidently redesign the organization’s cost structure in a way that will not only fund growth, but also eliminate low-productivity investments and operating expenses.

Resource alignment is very different from traditional cost cutting because it asks what capabilities are required to achieve the strategy before it seeks savings targets. Viewed through this lens, incremental changes in both capital and operating cost structures can be attained without cutting essential spending. For example, the leaders of the health plan introduced above used the capability segmentation created in the process of achieving strategic clarity to make smarter OpEx decisions. Instead of across-the-board cuts, they ruthlessly optimized service levels and leaned out table-stakes capabilities, while directing additional funding to differentiated capabilities, such as value-based contracting.

3. Supportive Organization:The final step toward improving health plan ROIC is the creation of a supportive organization-one that facilitates growth and enables incremental changes in cost structure by creating a meaningful case for change, aligning leadership in its pursuit and mobilizing people.

The leaders of the plan referenced above realized that its structure had evolved over the years into one in which business unit leaders were zealously protecting their own turf-the size of their domains had become a measure of their importance. Further, decision-making had been stifled by overreliance on committees and executive leadership. Their response: develop a new operating model-streamlining decision rights and moving them closer to the market, improving integration across divisions, and deliberately defining modes of interaction to increase coherence and collaboration. They promoted standardization to minimize complexity and its costs. And finally, to ensure management’s focus and engagement, they aligned incentives to build a more nimble organization.

By taking these three steps, the leaders of the health plan not only successfully identified a 20% reduction in administrative costs, but also set their organization up for success by better aligning it with a well-defined strategy. Similarly, other plans can channel their investments to the capabilities that differentiate them in the marketplace and support their strategies, and reduce or eliminate all other expenses. In short, they can ensure that capital begins to flow to good costs and away from bad costs. The result will be a leaner, stronger, more strategic plan with improved financial performance and enhanced ROIC.

About the Authors

Thom Bales is a partner with Booz & Company based in San Francisco. He specializes in operations, technology, and transformation strategy in the healthcare industry.

Gil Irwin is a senior partner with Booz & Company based in New York. He has led many of the Firm’s strategic transformation engagements for our health plan and health services clients.

Anil Kaul is a partner with Booz & Company based in Chicago. His areas of expertise are organizational design, performance measurement, process design, cost analysis, implementation of business process outsourcing/offshoring, and shared services.

Pier Noventa is a partner with Booz & Company based in Chicago. He specializes in operating model transformation, lean operations, and technology strategy in the healthcare industry.

Frank Ribeiro is a partner with Booz & Company in New York. He focuses on overall corporate transformation and associated capability-building programs to increase an organization’s effectiveness and efficiency.