Overcoming the health plan investment gap: New models for building and managing capabilities

Executive summary

Turmoil in the U.S. healthcare market is squeezing the margins of many health insurers, leaving some — particularly small and midsized plans — with barely enough investment funds to maintain their current operating levels. These insurers simply don’t have the capital to invest in the differentiating capabilities they need to remain competitive. That’s no way to succeed in an environment where the competitive landscape is changing fast, the need for newer technologies is increasing, and customers are growing ever more demanding.

Insurers can free up investment capital by increasing the efficiency of their internal operations, and by finding ways to spend less on building or maintaining “table stakes” capabilities that do not provide a competitive advantage. This report offers three models for doing so: pooled development of new assets with other insurers; commercialization of their own market-leading assets; and strategic sourcing of non-differentiating assets.

The best model for each capability will depend largely on its strategic value, the likely costs of building it, and the financial benefits to be gained. Insurers must carefully analyze their capability portfolio in light of their current and future strategies, and the cost involved in filling the capabilities gaps. If done right, insurers can maintain a healthy operating environment while generating the funds needed to ensure their future success.

The changing healthcare landscape

Various factors have come together to significantly disrupt the health insurance industry in the United States. Spending on administrative activities, combined with profitability caps under the Affordable Care
Act, is hurting profitability. Employers and consumers alike are “buying down” to leaner plans, while new fees and taxes continue to be imposed on the industry. The growing Medicare- and Medicaid-eligible population is making insurers ever more dependent on federal and state funding, and subject to new regulations, even as Medicare and other entitlement benefits are restructured to lower reimbursements further. Finally, insurers are facing increased competition in the form of new, nontraditional entrants into their markets.

As a result, overall industry margins are being significantly squeezed, falling from more than 7 percent in 2005 to less than 3 percent in 2013. That margin pressure is making it very difficult for insurers — and particularly for small and midsized plans such as the “Blues” — to sustainably invest in the capabilities they need in order to respond to changing circumstances and achieve the best cost position for realizing the value of those investments.

If insurers are to succeed in meeting all the competitive demands placed on them, they must develop strategies to free up capital.

It has been difficult enough to invest in the “table stakes” capabilities that all insurers must have to keep up with constantly changing regulations and mandates. Now they must also find ways to make the discretionary investments in new technology tools and assets that can not only lower ongoing operating costs but also enable them to respond to the increasingly consumer-oriented health insurance market. Such investments will allow them to pursue initiatives such as consumer-facing digital and mobile marketplaces, big data, clinical and marketing analytics, service integration across product lines and sales channels, and low-cost, automated back-office systems.

If insurers are to succeed in meeting all the competitive demands placed on them now and in the future, they must develop strategies to free up the capital needed to maintain their current offerings and to develop new differentiating capabilities. That in turn will increasingly require that they conduct a critical evaluation of their current and potential operating models, as they look to develop creative new ways to design and deliver those offerings and capabilities — through collaborations with other insurers, strategic sourcing deals, or asset commercialization. The choices they make now will likely determine their ability to remain competitive as the healthcare landscape continues to evolve.

The investment gap

As insurance companies’ margins continue to decline, the gap between their investment needs and the capital they are generating to make those investments has become critical. Health plans are already investing significant amounts of money to maintain and improve their operations — between 2009 and 2012, capital expenditures rose more than 40 percent at large firms, and almost 100 percent among smaller firms. Most of that money, however, has gone to support the status quo, and not to build the new capabilities needed to thrive in the rapidly changing healthcare environment. While overall investment at the average Blue plan has grown 40 percent in the four years from 2009 through 2013, investment in differentiating activities has fallen from half of the total to less than a third (see Exhibit 1).

Exhibit 1: Health plans large and small have seen double-digit growth in investments, but more and more funds are going to support table-stakes activities

Health plans large and small have seen double-digit growth in investments, but more and more funds are going to support table-stakes activities

This pattern has led to a vicious circle undermining insurers’ efforts to build competitive advantage. As insurers continue to underinvest in differentiated offerings, they lose members. The ongoing loss of membership results in lower revenues, exacerbating the erosion in margins. That in turn further limits their ability to invest in the differentiating capabilities that can give them a distinct competitive advantage — or worse, their ability to maintain market parity (see Exhibit 2).

Exhibit 2: Underinvestment in new capabilities can create a vicious circle of value erosion

Underinvestment in new capabilities can create a vicious circle of value erosion

Breaking this vicious circle involves, first, improving internal operations to free up funds for investment in new capabilities. Every insurance company, no matter what its investment needs, can benefit from becoming more efficient, eliminating capabilities that do not add value, and consolidating critical capabilities to increase scale while reducing both the required investment portfolio and operational expense needed to maintain and upgrade those capabilities.

Every insurance company can benefit from becoming more efficient, eliminating capabilities that do not add value, and consolidating critical capabilities.

In one case, for example, a large national health insurer decided to consolidate its multiple claims platforms. The effort involved standardizing its operations and processing rules, and migrating to just one claims platform while eliminating the others. The one-time migration costs were significant, but so were the ongoing reductions in investment and operating costs. Indeed, our experience indicates that insurers taking such an approach can reduce operating costs by as much as 30 percent over time.

Ensuring internal operational effectiveness should not be a one-time event. Companies must constantly keep track of their assets and platforms, determining their value through well-defined return-on-investment targets, and recalibrating their entire portfolio accordingly.

Alternative approaches

Despite their best efforts to rationalize costs on an ongoing basis, however, most insurers will find that they still won’t have the funds to maintain their table-stakes activities while simultaneously investing in the new discretionary capabilities needed to succeed in the changing healthcare environment. Nor have they gone far enough in evaluating ways to save money by gaining scale in current activities and day-to-day operations. Insurers should consider three potential approaches to unlocking the additional investment capacity they need to deliver new capabilities: developing new capabilities in collaboration with other like-minded insurance companies; strategic sourcing of technology and operational capabilities; and commercializing market-leading capabilities already in their portfolios through deals with other companies.

Insurers should consider three potential approaches to unlocking the additional investment capacity they need to deliver new capabilities.

Done right, these models can not only reduce the operating expense involved in maintaining the status quo but also, more important, have a significant impact on insurers’ ability to generate the capital required to invest in the capabilities they will need in order to meet the new levels of competition already facing the industry.

Pooled development

As insurers look to improve their technology portfolios, one solution will likely involve collaborating with one or more like-minded health plans to develop and own a specific asset, while sharing the investment portfolio and operating expenses, especially if the asset involves a significant investment. This strategy requires that the partners share a common vision for the assets they plan to create, and that they are willing to standardize their efforts on that vision. Moreover, they must have the ability to govern carefully how the assets are created and managed and how costs are allocated among them. Strong execution is key, as is the ability to monitor financial progress on an ongoing basis, using consistent, agreed-on metrics.

In 1987, for instance, BCBS of Michigan, in partnership with CareFirst, Horizon, and WellPoint (now Anthem), founded NASCO to support membership and claims processing systems for their national accounts, giving each partner plan a seat at the table for making decisions related to NASCO’s strategy. In addition to sharing ongoing core platform investment costs, the deal lowered insurers’ administrative costs by 5 to 30 percent, depending on their level of process reengineering and automation. Since its inception, NASCO has gained scale through the addition of several more Blue plan members, proving the viability of pooled development models. Other examples of pooled development include Blue Health Intelligence, which provides analytics for insurers; Life & Specialty Ventures, for administering ancillary products and services; Availity, which offers healthcare connectivity; and CAQH, which offers services for managing providers.

Sharing assets can reduce partners’ overall burden of investing in a new capability and enable them to share maintenance costs.

Sharing assets can reduce partners’ overall burden of investing in a new capability and enable them to share maintenance costs, though there will be a one-time cost for the partners to migrate to the new system. Even more important, the lowered costs allow insurers to free up capital to spend on other new capabilities.

Strategic sourcing

Health plans looking to acquire new IT assets and processes can also turn to outside vendors that can provide, manage, and update the new systems more economically than the insurers can themselves. This strategy is best suited for insurers looking to maintain or build non-differentiating assets that need to be scaled up quickly and for which reliable vendors are available. Outsourcing a particular process can also be a good strategy if its strategic value is uncertain, since the insurer is no longer fully committed to the expense of creating and maintaining it. But this approach brings with it all the issues typically surrounding outsourcing, and success requires expertise in vendor negotiations and management, and the willingness to address and manage the impact of outsourcing on the insurer’s business units and functions.

One regional plan with 500,000 individual commercial members moved half of its members onto insurance exchanges, and outsourced its back-end enrollment, billing and payment, and customer service functions for exchanges. The move led to investment savings of more than US$25 million that could be devoted to more strategic initiatives, and its per member per month (PMPM) operating costs were as much as $5.50 lower than those of a comparable plan that kept those services in-house.

Outsourcing IT-supported processes reduces up-front investments even more than a shared asset structure does — though again, there will be a one-time migration cost. Many insurers will also find attractive the variable cost structure of these arrangements, in which cost depends on extent of use, especially in an uncertain business environment.

Asset commercialization

Finally, health plans with truly market-leading capabilities should consider offering them to other insurers looking to strengthen their own offerings but unwilling to make the necessary large investment in such capabilities on their own. The revenue generated by such deals not only can defray the cost of creating and maintain the offering, but also can be reinvested in new capabilities to maintain the plan’s competitive advantage.

One regional Blue, for example, had already built strong back- and front-office capabilities, including a flexible benefit system and an industry-leading employer and group analytics system. Its efforts to commercialize these capabilities were successful, increasing membership by 60 percent while generating enough new revenue to subsidize not only the initial cost of the new system but also the ongoing cost of updating the system as regulations and mandates changed. The plan reduced the system’s ongoing operating costs from $2.70 to $1.60 PMPM.

No matter which of these approaches insurers choose, the financial benefits to be reaped depend largely on economies of scale.

Of course, this strategy would likely take many insurers out of their comfort zone. It requires that the insurer have the strategic vision to create attractive new products and to manage and update them as changes in technology and in regulations and mandates require. Moreover, the insurer would have to develop the sales and marketing infrastructure needed to take the product to market, the ability to provide post-sale services as required, and the willingness to manage customer expectations. Examples of companies that have successfully commercialized their assets include Highmark (claims platforms and business process optimization), BCBS of South Carolina (a variety of back-office services), and UnitedHealth’s Optum (fraud and abuse management and other services).

No matter which of these approaches insurers choose, the financial benefits to be reaped depend largely on economies of scale. As Exhibit 3 indicates, alternative operating models will likely require less up-front investment than building similar capabilities in-house, all else being equal. And for any given investment, the cost PMPM will decline as the number of members or partners grows. Of course, the ultimate savings to be gained from any asset will depend on the degree to which its processes and technology are standardized. And the pattern may hold true only so far — as scale increases, there will likely be a point of diminishing returns, due primarily to the increase in complexity as the number of members grows, and even an increase in investment cost PMPM.

Exhibit 3: Under most conditions, increased scale will drive lower cost — but only up to a point

Under most conditions, increased scale will drive lower cost — but only up to a point

Choosing the right approach

In the rapidly changing, and always uncertain, healthcare environment, it is up to insurers to determine what kind of insurance provider they want to be.

In the rapidly changing, and always uncertain, healthcare environment, it is up to insurers to determine what kind of insurance provider they want to be — a low-cost, high-quality plan; a direct-to-consumer insurer; an integrated payor-provider; or another model. The choice will depend in large part on the assets and offerings they have now. So they must first realistically assess their current operational footprint and services portfolio, and how those services are currently obtained. Then they must analyze both their differentiating and their table-stakes capabilities, their maturity, their market strength, and any capabilities gaps. A careful benchmarking of the investment and operating costs for all capabilities against industry standards will indicate the investment needed to maintain current capabilities and acquire new ones. That information, in turn, will enable plans to decide on which approach to choose to acquire capabilities where gaps exist, and to reduce operating costs if the cost of maintaining the capability is high. Finally, plans must settle on a road map for acquiring each capability. (See “Smart sourcing.”)

Smart sourcing

A client of ours, a midsized regional Blue plan, was facing declining membership and eroding profitability due largely to a lack of table-stakes consumer and customer-facing capabilities, and the back-end processes and technology needed to support them. Its technology platforms were inefficient, fragmented, and expensive to maintain, and its technology costs were twice those of its peers. As a result, the company was spending all of its potential investment capital on trying to keep up with changing regulations and mandates. But maintaining the status quo would lead only to further market-share erosion as members fled to more competitive plans.

The effort to remedy the situation began with an assessment of the plan’s current strategy, the maturity level of its table-stakes operational capabilities, and the differentiating capabilities needed to carry out its consumer and medical value strategies — intended to promote a more customer-facing orientation through better market segmentation and to shift from fee-for-service to reimbursement based on the value of the care provided. It became clear that to acquire the necessary differentiating capabilities while achieving competitiveness in tablestakes areas, the company would have to vastly expand its ability to build new capabilities by creating an alternative operating model that would increase the funds available for investment.

The company evaluated the entire spectrum of operating model choices — in-house development, pooled development, and strategic sourcing — against such criteria as operational fit and feasibility, financial impact, and strategic control. Ultimately, it chose strategic sourcing of key big-ticket IT platforms as the basis for a distributed but much more cost- and capital-efficient capability architecture.

As a result, the company significantly reduced its investment and operating costs for its traditional IT platforms, freeing up investment capital for new differentiating capabilities, including the analytics needed to support better product design, consumer engagement, and integrated care management platforms. The transformation road map it created for developing those capabilities put the company on track to reach the desired capability maturity level within five years, reduce IT costs by 30 percent, and restore membership and margin growth.

In creating the road map, several factors must be considered. Processes involving significant market uncertainties or technology risk may need to be outsourced. Whether the offering is strategic or not will likely influence how it is acquired and maintained. And its maturity compared to those of competitors may open up the possibility of commercialization, no matter how strategic it is. Finally, the potential for outsourcing a particular capability depends on the availability of vendors that can supply it.

Exhibit 4 offers two decision trees, the first for developing a new capability, the second for managing and improving an existing one. An insurer looking to gain a new offering or asset that involves considerable market or technological risk should, if possible, outsource it to a vendor that can better manage that risk. If the risk and the strategic value of the new capability are low, then it should be acquired either through a vendor or, if no vendor is available, through pooled capability development. Highly strategic capabilities should be developed through a pooled process if the cost is high, or in-house if the cost is low and the insurer wants to maintain full ownership.

Exhibit 4: A decision tree can help guide the choice of delivery model for each capability

A decision tree can help guide the choice of delivery model for each capability

As for existing capabilities, if the insurer wants to continue to invest in a process or asset that is mature and strategically valuable but low in investment cost, it should be maintained in-house; if, however, the investment cost is high, it might be a candidate for commercialization. Mature but less strategic technologies could be maintained with partners on an ongoing basis to reduce investment costs. Less mature but highly strategic capabilities should be developed in partnership with other insurers if the cost is high — assuming no competitive issues — and in-house if the cost is low. Immature, less strategic needs should be considered for outsourcing.

As technologies and processes evolve, of course, how they are managed may very well change. In-house capabilities that become market leaders could become candidates for commercialization, for example, as could capabilities that are initially developed through pooling of resources.

Every insurer will likely be further constrained in how it chooses to maintain and develop its assets depending on individual circumstances.

Every insurer will likely be further constrained in how it chooses to maintain and develop its assets depending on individual circumstances. How plans manage unprofitable business segments, for example, will depend on their strategic goals; nonprofit insurers committed to a specific mission should perhaps consider outsourcing the segment’s assets to reduce costs, whereas for-profit plans should consider simply eliminating them. Similarly, the ability to pool development resources will likely be constrained by the plan’s size and scope. Regional plans will be freer to collaborate with noncompeting plans, while national insurers will likely prefer to continue to maintain their assets in-house. And nonprofit plans with close ties to a particular locale or membership, such as a union, may not be able to outsource any element of their operations, and so must turn to internal operating models to reduce costs.


As the need to invest in new technology and new service offerings becomes more acute, it is inevitable that insurers in every part of the industry will turn to one or more of these approaches to remain competitive. The large national plans will likely take advantage of internal consolidation models and strategic partners to keep increasing their scale, while continuing to acquire smaller plans both to increase scale and to build capabilities. Those with unique differentiating capabilities may also try to commercialize those assets to reduce investment costs and generate new revenues.

Regional plans like the Blues, on the other hand, will increasingly collaborate with one another to build pooled capabilities, whereas small for-profit plans will outsource significant portions of their operations and technology to reduce costs and to acquire new differentiating capabilities. Finally, new entrants in the market — whether provider-led health plans, retail, or niche players — will face similar investment and operating scale challenges, and thus will need to focus on their truly differentiating capabilities and aggressively partner on or outsource the less strategic ones. Still others will try to combine all their outsourced capabilities into a unique portfolio of differentiated services.

This vision of the future of the health insurance industry assumes, of course, that plans look to new ways to develop the competitive capabilities they need. Those that do not, we believe, will find themselves traveling a slow path to value erosion and, ultimately, irrelevance.