Health care spending comprises almost 20% of our national gross domestic product¹ and everyone is 100% confident that health care is “broken”. The health care system is ripe for disruption, yet multiple entries into the health insurance landscape by venture backed start-ups have resulted in catastrophically high losses and liquidations in multiple states. While there is great opportunity in this $4T industry, the pareto principle (aka the “80/20 rule”) should be kept top of mind when assessing the prospects of new health insurance companies, particularly in assessing which cost centers yield competitive advantages.

What Happened to Oscar, Bright and Friday?

In the Affordable Care Act (“ACA”) individual market alone, Oscar, Bright and Friday (collectively “OBF”), the three most well-known health insurance start-ups, have collectively lost $1.3B from 2014 to 2021.((See Medical Loss Ratio Data and System Resources (CMS)))

Exhibit 1

To understand why, you must understand how a standard health insurance company spends its premium dollars in a post-ACA world. The following table shows the percentage of premium dollars spent in the listed categories with a comparison between all individual market carriers combined versus OBF-specific results for 2014-2021.

Exhibit 2 ²

The first thing to note is that, on average in the ACA markets, 80% of premium dollars are spent on medical expenses. Medical expenses are directly related to a health plan’s ability to negotiate favorable contractual reimbursement rates with physicians and hospitals. A plan with more members has more leverage to negotiate favorable reimbursement rates. Start-ups begin with zero members, so the baseline assumption should be that they will not be able to compete on medical costs immediately out of the gates.

Most start-up insurers focus on tech-based features as a competitive advantage. The problem is that tech only drives a portion of that 17% administrative expense noted in Exhibit 2. So even if they could produce 10% greater efficiencies than the Blues, 10% of 17% of the premium results in only 1.7% improvement on the premium. If the Blues are 5% better on medical reimbursement (which they are at least), they beat that 1.7% with a 4.1% advantage (81.5% x 5%).

So how did OBF grow to 1.3 million members by 2021? The simple strategy of “buying enrollment” or pricing at a loss. OBF could have priced products that were 10% more expensive than established health plans but that would have resulted in minimal growth. Instead, they priced their products at intentional losses, resulting in a -9.0% profit margin. The following is an example of Friday Health Plans’ pricing in the Dallas, Texas marketplace – in 2021 and 2022 Friday Health Plans’ product was approximately 10% – 15% cheaper than Blue Cross, Blue Shield of Texas in this marketplace.³

Exhibit 3

What Strategies Can Help Start-Ups?

• Start-up health insurance companies need to understand their strengths and weaknesses. As an actuarial consultant, I had a few principles when considering a new product launch:
  • Maximize Margins – Never leave money on the table. There may be geographic areas, benefit levels or markets where you have a competitive advantage on cost, and if there is, find ways to maximize those margins to supplement the rest of your business. This seems obvious, but surprisingly a lot of organizations leave money on the table or fail to identify the right areas of opportunity.
  • Land the Plane – Better to land the plane than to sink the boat! Rather than growing enrollment rapidly through risky underpricing, grow at the right rate with appropriately priced premiums. Building a cost-effective network may take some time for a start-up health insurer. It is always better to aim a little high on first year premium rates and work on calibrating them in years 2, 3 and beyond than to put yourself in a hole through underpricing.
  • Focus On Your Greatest Strength – It is hard to gain enrollment, but being focused on the greatest area of differentiation is the best bet to grow. This could mean a certain regional presence, ability to control costs, relationships with medical groups and hospitals, filling a market gap, etc.
  • Don’t Lie to Yourself – The simple fact is that people typically buy insurance based on premium cost, network and plan designs – in that order . . . anything else (like customer service or shiny apps) are likely bonus items that can be tiebreakers but will not drive sales by themselves. Focus on strategies to compete on cost while also building brand and differentiating tech-solutions.

Other Marketplace Opportunities?

• Since 2014, there has existed an alternative marketplace with a variety of product options not subject to the ACA. This includes 1) Health Sharing Ministry products which have grown 10-fold since 2014 to 1.7 million enrollees, and 2) short-term, limited-duration (STLD) products which have 3 million enrollees nationwide.
• There are additional innovative products in this landscape that share a similar cost-structure with STLD plans and which have favorable margins that can allow for start-up products to compete on day one. An example is shown below:

Exhibit 4

• From a start-up perspective, the key benefit of the non-ACA marketplace is that the margin (15%) that is built into the competitive landscape allows for new carriers to price a product that is both competitive and profitable.
• The non-ACA landscape provides a great opportunity for a faith-based health insurer to fill a market gap by offering a product that is cost-effective in relationship to the ACA, values-aligned with pro-life benefits, and competitively priced compared to similar products.
• The large group, fully insured market may also allow for start-ups to target employers with younger and healthier employees, since the large group market is not subject to risk adjustment. In other words, if a plan gets the healthier members, it can charge competitive premiums based on the better risk, rather than paying other carriers through a risk-adjustment mechanism (which is what happens in the individual and small group ACA markets).

Conclusion

The health insurance industry has many areas that are ripe for disruption. However, you cannot ignore simple realities of how health plans compete, one of which is that more established health plans have a greater ability to negotiate favorable contractual rates with providers. Entering markets takes an understanding of how you will compete on premium rates and network offerings and choosing select areas that allow you to focus on your strengths and maximize your margins. One area that has not been taken advantage of is establishing a pro-life, faith-based health insurance carrier. Presidio is positioning itself to be the first carrier to do so by targeting markets where it has the greatest strengths, and focusing on building a path to launching in more traditional markets when ready to compete on cost without pricing at a loss.

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1. Healthcare Spending in the United States Remains High (Peter G. Peterson Foundation) [↩]
2. See id. [↩]
3. 2022 QHP landscape data (healthcare.gov) [↩]