A low-cost strategy for health plans: Winning in a revenue-constrained environment

As the pressures created by healthcare reform, consumer demands, and rising competition squeeze margins, health plans should consider a low-cost strategy (LCS). To adopt such a strategy, plans have two major decisions: choosing an operating model, and determining the capabilities sets that will enable them to leverage the LCS value chain and differentiate themselves in the marketplace. Those plans that choose wisely can expect sustainable margins averaging 5.5 percent and operating model cost structures that are 20 to 30 percent lower than legacy models.

Show transcript

A low-cost strategy for health plans Winning in a revenueconstrained environment


Chicago Mike Connolly Senior Partner +1-312-578-4580 mike.connolly @strategyand.pwc.com Pier Noventa Partner +1-312-578-4877 pier.noventa @strategyand.pwc.com

New York Gil Irwin Senior Partner +1-212-551-6548 gil.irwin @strategyand.pwc.com Sundar Subramanian Partner +1-212-551-6651 sundar.subramanian @strategyand.pwc.com

San Francisco Thom Bales Partner +1-415-653-3476 thom.bales @strategyand.pwc.com



About the authors

Thom Bales is a partner with Strategy& based in San Francisco. He specializes in operations, technology, and transformation strategy in the healthcare industry. Gil Irwin is a senior partner with Strategy& based in New York. He specializes in technology, operating model, and transformation strategy in the healthcare industry. Pier Noventa is a principal with Strategy& based in Chicago. He specializes in lean operations and technology strategy in the healthcare industry. Casey Le Jeune was formerly a senior associate with Strategy&.

This report was originally published by Booz & Company in 2012.



Executive summary

As the pressures created by healthcare reform, consumer demands, and rising competition squeeze margins, health plans should consider a low-cost strategy (LCS). To adopt such a strategy, plans have two major decisions: choosing an operating model, and determining the capabilities sets that will enable them to leverage the LCS value chain and differentiate themselves in the marketplace. Those plans that choose wisely can expect sustainable margins averaging 5.5 percent and operating model cost structures that are 20 to 30 percent lower than legacy models.



The case for a low-cost strategy

Healthcare reform, changing buyer demographics and behaviors, and new competitors have created an inflection point in the U.S. health insurance industry. To manage these disruptions and position themselves for the future, health plans are rethinking their fundamental strategies, including their way to play, the select set of capabilities that supports it, and their product and service portfolios. As medical benefit ratio minimums, mandated benefits, and rate reviews by the states all come into effect, there is little debate that healthcare reform will usher in margin declines in all of the major customer segments served by health plans. Over the long term, more pressure will be brought to bear by the guaranteed issuance of coverage, retail exchanges, and mandated individual and employer coverage. The rising role of consumers in the marketplace will further increase the pressure on margins. Stimulated by reform and the need for greater consumer involvement in care decisions, the retail market for individual and small group coverage is growing faster than other customer segments. Early consumer research indicates that some members of this broad segment, estimated to include 26 million to 31 million lives, will have higher service expectations and heightened price sensitivity compared to large groups. Shifting and new competition represents another significant force that is likely to constrain payors’ margins still further. Integrated payor– provider organizations can better manage their cost structures, quality of care, and new products and delivery models than non-integrated systems. If they can successfully address their own cost pressures, large provider and accountable care organizations could disintermediate payors. And the opening of reform-mandated exchanges, a playing field that is not yet clearly established, could attract nontraditional competitors. In response to the reform, consumer, and competition trifecta and its effect on margins, many health plans will need to migrate to new ways to play that can offer greater strategic focus, with all of the
Strategy& 5

organizational and operational coherence, alignment, and efficiency that implies.1 A low-cost strategy (LCS) is one of the most promising of these plays. An LCS is an obvious choice for plans seeking to target the growing retail market for coverage, including health exchanges. It is also aligned with the Medicare segment and some parts of the Medicaid segment. Strategy& models calculate that by 2016, as the market begins to stabilize following the opening of exchanges, plans that have successfully adopted and executed an LCS can expect sustainable margins averaging 5.5 percent, notwithstanding premium reductions of 8 percent. In total, an LCS can push costs down 20 to 30 percent from today’s legacy models. These margins would derive from several sources (see Exhibit 1, next page): • Market share gains, which will come at the expense of weaker players that cannot compete as aggressively on price • Significant reductions in back-office operations costs, with aggressive plans pursuing high auto-adjudication product designs and robust outsourcing, joint ventures, and offshoring • Reductions in medical costs, through more efficient management of high-performance, tiered provider sub-networks; payor–provider administrative integration; and contract structures that enhance provider accountability and transfer care coordination activities • Reductions in commissions and simplified sales with exchangefocused products Of course, like any well-focused way to play, an LCS will require plan leaders to successfully navigate complex issues and make difficult decisions. Among the challenges they will face are determining and implementing the best operating model for delivering low-cost products and serving low-cost customer segments, and identifying and developing the select set of differentiating capabilities needed to execute an LCS.



Exhibit 1 Potential LCS cost savings
Current model
–Average medical loss ratio

Low-cost carve-out
–Tiered networks, (20%) new payment structures

Medical cost


66.1% 2.7%


–Significant dependence on broker


(35%) –Reduced commission


Sales & marketing Advertising & promotion
Front office

–Marketing strategy and segmentation –Sales management –Recruiting, training –Broad advertising –Multi-segment promotion –Customized for medium/large groups –Standard for individuals –Actuarial analysis –Pricing –Profitability tracking


–Focus on exchange sales



–Targeted analytic marketing


Product development


–Simple, narrow products




–No near-term change

0.1% 0.2%

Rating & underwriting

–Rating –Underwriting


–Automated workflow (50%) and processes


Middle office

Network management

–Network strategy and management –Contracting –Provider relations –Utilization management –Disease management –Wellness


–Smaller network to manage, but greater oversight


Medical management Enrollment, membership & billing
Back office


–Core functions to influence behavior, limit risk

1.1% 0.4% 0.1%

–Enrollment –ID cards –Statements –Renewal support –Policy and standards –Contact centers –Online info –Data entry –Validation –Approval and denial –Payment –Finance –Legal –HR –Facilities management –Governance –IT management



–Outsourcing and electronic transactions lower costs

Provider & member services Claims



–Online information and self-help tools





–Simplified products increase straightthrough processing



Corporate functions

Corporate services (including governance) IT


–No change, shared overhead




–Maintains relative cost structure near term, reduction long term



Total 100%

> (20%) >

Total < 80%

Source: Strategy& analysis



NewCo or lean down?

As health plans consider the best operating model for serving low-cost customer segments, they have two primary options: They can establish a new business unit (NewCo) designed specifically to serve these segments and support low-cost operations, or they can “lean down” their existing operations — in essence, adapting them for the new environment. Both options have advantages and disadvantages. NewCo A NewCo may be a new business unit in an established health plan, or it may be a new company, such as those that may emerge out of the so-far-underutilized incentives offered in the Affordable Care Act for the development of health insurance co-ops. The advantages of a NewCo include the avoidance of legacy costs: New and more efficient platforms and operations can be expressly designed for a cost-constrained environment. Presumably, some operations can be outsourced to third-party administrators at a lower cost, especially if the NewCo’s offerings are based on the limited customization of plans and benefits, standardized processing, and end-to-end automation. The bare-bones design and sharp focus on low-cost-to-serve customer segments in NewCos should also yield lower maintenance costs and enhanced operating metrics over the long term. On the other hand, a greenfield NewCo requires high capitalization costs up front and the ability to overcome new market entry challenges related to distribution, provider network management, and actuarial capabilities. Further, there are complex issues and difficult decisions that must be addressed: • In strategic terms, NewCos must identify the competitive field, decide which functions will be kept in-house and which will be outsourced, and determine go-to-market and brand positioning.



• In front-office operations, NewCos must decide which customer segments to serve, which distribution channels to use, and how pricing will adhere to local regulatory requirements. • In middle-office operations, NewCos must have access to and develop a cost-advantaged provider network and contract structure, and shift medical management and quality responsibilities to providers. • In back-office operations, NewCos must determine which technology platform will deliver the best mix of operating costs and service levels, and how and where service will be delivered. • With regards to startup, NewCos must source employees to staff the new unit, as well as other required resources; determine, if applicable, how the legacy business will be supported during the startup; and establish the time frame and appetite for investment. Lean down The lean-down option entails streamlining existing plan operations through the selective and rigorously analytic elimination of non-valueadded costs across all customer segments, including the leveraging of existing low-cost functions and models, such as Medicaid coverage, where they are already in place. The advantages of the lean-down option include enhancing effectiveness and efficiency across the business. This option enables the integration of current services, such as wellness programs, and existing assets, such as informatics, that can enhance low-cost product offerings. Further, a lean-down approach may benefit from economies of scale, particularly in functions such as member and provider services. And, of course, this approach requires comparatively less investment than a NewCo. The disadvantages of a lean-down approach include a lower degree of strategic coherence than with a NewCo. Typically, there is also less potential for cost reduction than with a NewCo, because the leandown company must still service higher-cost segments, and will often have higher legacy costs, greater challenges with organization complexity and inertia, and more difficulty precisely allocating costs. In addition, it may be difficult to offer the lowest-priced products on market because the operation cannot be completely optimized for low-cost segments. In the short term, an aggressive lean-down approach is likely to be the most viable option for most payors, because it is likely to be difficult to
Strategy& 9

An aggressive lean-down approach is likely to be the most viable option for most players.

undertake a NewCo while simultaneously serving existing memberships and balancing complex legacy infrastructures and constraints on new investment against an already overloaded set of post-healthcare reform priorities. Over the long term, however, health plans should be carving out those functions most sensitive to segment customization, at a minimum, and for some plans, a NewCo should prove to be the best option for pursuing a low-cost strategy.



Could the next industry disrupter be a health plan?
The challenges involved in building low-cost businesses are significant. But when these businesses are successfully developed, they can become market leaders, especially in industries that are experiencing disruptive change. • Netflix: In home entertainment, Netflix’s low-cost business model of fixed monthly fees for unlimited streaming and DVD movie rentals — which supplanted consumer pain points, such as late fees, with convenient home delivery, online self-service, and favorable inventory economics — quickly conquered the store-based model of companies such as Blockbuster. • Southwest Airlines: Southwest’s high-efficiency asset model, pointto-point service, and lighthearted service experience enabled it to offer low fares, open new markets, and win customer loyalty. As a result, it became the fastest-growing and most consistently profitable U.S. airline. • Amazon.com: Starting with book sales and expanding across myriad retail categories, Amazon.com’s low-cost distribution channel, self-service, and review and recommendation tools have enabled it to offer deep discounts to customers. Its model has been widely copied by bricks-and-mortar retailers. Although health plans are not exactly analogous to consumer products and services, a low-cost operating model supported by the proper capabilities and well-designed product portfolio could deliver transformative levels of cost reduction and the right to win in this industry.



A select set of capabilities

Whichever operational model for serving low-cost customer segments a plan chooses, in order to more effectively address cost pressures, protect and grow margins, and establish the right to win in a revenueconstrained environment, it will need a select set of capabilities that will enable it to streamline operations and drive efficiency across the entire value chain. The exact capabilities will vary among plans, depending on how and where they choose to differentiate themselves from their competitors. But the capabilities must support and leverage the eight components in the LCS value chain (see Exhibit 2, next page): 1. Product design An LCS requires products with rationalized designs and streamlined benefits that are carefully constructed to serve focused markets offering long-term, profitable growth. The development of such products begins with an evaluation of market health, as well as an analysis of the plan’s network, competitive positioning, and current and historical performance in the market. To attain the lowest possible costs, the core product must be standardized so that it can be offered across the largest number of geographic markets while still complying with their individual regulations. For existing products, performance cost and complexity metrics can be used to eliminate those with low membership and poor profitability. The benefits design of the products should be autoadministered to minimize the need for manual adjudication, valuebased to attract members in good health and lower risk, and aligned with narrow customer segments and provider networks. 2. Sales and distribution LCS sales and distribution are optimized by selling directly to consumers, creating efficient sales processes, and shifting to
12 Strategy&

Exhibit 2 The LCS value chain

8 Corporate functions 7 Service delivery LCS Claims processing 6 Care management 5

1 Product design 2 Sales & distribution

Quote-toinstall Provider networks 4


Source: Strategy&



capita-based commissions. To as great a degree as possible, sales should be acquired through low-cost channels such as exchanges. LCS sales will focus intensely on the retail customer. This requires a deep understanding of consumer behavior and needs; targeted marketing, loyalty, and referral programs that can increase customer retention and lifetime value; and the ability to track and influence member coverage migration. The efficiency of sales processes can be enhanced by aggressively pursuing self-service channels, developing low-cost marketing collateral (such as e-brochures), and rightsizing the sales team, as well as providing it with robust CRM capabilities with consumer analytics. Sales commissions should be shifted to a “per employee, per month” structure in which tiered commissions are decoupled from medical cost inflation, rewarding the most productive salespeople and tying bonus programs to key business drivers. 3. Quote-to-install In an LCS, the quote-to-install process should be highly automated and standardized and should include self-service and enhanced broker quotes, as well as automated underwriting and case install. Brokers should quote groups of fewer than 100 members; retail customers should be able to shop, make minor product customizations, and receive quotes automatically. Quotes should be simplified based on community rating standard offerings. Automated underwriting systems should be adopted to cut processing time and cost, pre-priced benefit level components should be adopted, and renewal processing should be streamlined. Case install should be enhanced with template contracts that enable data structure and benefit mapping to accurately capture customer intent during case install, and auto-loaded benefits and adjudication rules for standard benefit contracts. 4. Provider networks To support the competitive pricing needed in an LCS, members should be steered into tiered provider networks in which in-network providers include a limited number of the most efficient specialists, hospitals, primary-care physicians, ancillary providers, and other par, nondesignated providers. These networks can be further enhanced through accountable care contract models that are supplemented by decision support tools and incentives to encourage members to use designated
14 Strategy&

providers whenever possible. Eventually this is likely to lead to greater payor–provider integration, either virtually, through innovations in technology and contracting, or through direct acquisition and management. 5. Care management LCS care management should be focused on automation and simplified services in the near term. This could include the adoption of preventive health and wellness programs, and automated provider utilization management, first-level rules reviews, and case management, as well as centralized reporting and expanded provider touch points aimed at improving care quality. In the long term, an LCS will require enhanced collaboration and shared responsibility with members and providers. This could be achieved with a shift to patient-centered medical homes. Also, networks with accountable care contracts should supplant payorbased care management, creating a model that is more similar to how integrated payor–provider organizations function today. 6. Claims processing In an LCS, plan benefit designs and medical and claims policy should be engineered to enable straight-through processing. To achieve this, plans will need a highly efficient claims process that reduces benefit setup errors by automating upstream processes and that uses simple, standard product attributes. Claims processing should include electronic channels for intake (and reject nonelectronic input), automated routing for a multiple claims system, and automated access to eligibility and benefit data. The opportunity further exists to consider how the adoption of standard medical products, services, and protocols could be utilized to eliminate claims (with the exception of payment tracking as necessary). 7. Service delivery Service delivery in an LCS will use standardization and upstream quality to enable self-service channels, enhance call center processes, and improve customer retention rates. Members should receive incentives to use online, self-service channels for common inquiries; all product and benefit details should be available online; and electronic IDs, explanations of benefits, and bills should be adopted.
Strategy& 15

Call centers should provide easy navigation, automated channels for simple information, and first-call resolution. The call experience should be interactive and empathetic with a view toward up-selling and crossselling. Customer service representatives should have the decision rights needed to resolve issues and make spot offers, as well as a complete view into the member’s product and benefit details. Plans that will continue to serve a diverse customer base and premium segments will need to consider tiered service models as they establish LCS units. 8. Corporate functions: Information systems and others Demand management within corporate functions, especially information systems, can also enhance an LCS. Capping discretionary spending with tight guidelines often yields immediate savings, and hidden discretionary spend can be identified by examining variances and trends in run budgets. Opportunities to reduce support costs by 20 percent or more can often be surfaced by analyzing and communicating the true cost of application service levels throughout the organization. All eight functional centers in an LCS plan must consider the competitiveness and scale of their capabilities. They will have to embrace aggressive outsourcing and partnership utility models to realize best-in-class costs and scale benefits.



Meeting the LCS challenge

Even though all eight components of the LCS value chain offer potential avenues for supporting a low-cost strategy, plans should consider prioritizing their efforts around those functions that can provide the three greatest points of differentiation in the market in the near term: sales and distribution and provider networks, which drive acquisition and market share, and service delivery, which drives retention. Then, over time, they can programmatically map and engineer investments in the remaining functions to support a low-cost strategy. Within these broad priorities, an LCS must be customized on the basis of the inherent assets and capabilities of a plan. Regional plans, especially the Blues, might seek to leverage their local market density and build penetration through brokers. They can use innovative network design, tiering, or absolute provider contract concessions to drive value, purpose, and ultimately a lower cost of care and price point in the market. National plans may choose to leverage the level playing field in the exchanges for distribution and thus establish a competitive advantage through scaled resources in brand building, targeted marketing, and customer convenience in the consumer segments of the market. Meanwhile, their inherently lower market densities will probably limit the provider contract effect, requiring national plans to both deliver tiered networks and seek out provider collaboration models that can rapidly be applied across regulatory and geographic borders. The additional administrative and provider enablement burden imposed by these conditions can be addressed with better care management information technology and tools. But no matter how plans choose to address the low-cost market, address it they must. Most plans will have to respond to changing conditions by assessing their current operations and tailoring an LCS that reinforces their corporate strategies. Some plans have already started to develop individual elements of an LCS, and a select few have successfully driven this strategy end-to-end across their companies.



These latter plans have realized that in order to capture the full benefit of an LCS, they must undertake a systematic enterprise-wide transformation that is fully championed by leadership and driven by a relentless analytic scrutiny of cost drivers and value-added operational components. They have also discovered that an LCS is not an excuse for low-quality care or poor service. Rather, its rewards derive from the consistent delivery of a value proposition that meets the fundamental needs and expectations of the consumer. The winning LCS will fulfill an inherent pledge to the consumer to provide access to high-quality care, shared risk, and quality service.




See “Post-Reform Calculus for Health Plans: Choosing a Business Model That Delivers the Right to Win,” by Sundar Subramanian, Gil Irwin, and Curt Bailey (Strategy&, 2011). www.strategyand.pwc.com/media/uploads/ Strategyand-Post-Reform-Health-Plan-Business-Models.pdf



Strategy& is a global team of practical strategists committed to helping you seize essential advantage. We do that by working alongside you to solve your toughest problems and helping you capture your greatest opportunities.

These are complex and high-stakes undertakings — often game-changing transformations. We bring 100 years of strategy consulting experience and the unrivaled industry and functional capabilities of the PwC network to the task. Whether you’re

charting your corporate strategy, transforming a function or business unit, or building critical capabilities, we’ll help you create the value you’re looking for with speed, confidence, and impact.

We are a member of the PwC network of firms in 157 countries with more than 184,000 people committed to delivering quality in assurance, tax, and advisory services. Tell us what matters to you and find out more by visiting us at strategyand.pwc.com.

This report was originally published by Booz & Company in 2012.

© 2012 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. Disclaimer: This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.