HEALTH INSURANCE EXCHANGES AND THE INNOVATOR'S DILEMMA--IS THE FUTURE COSTOVATION?

This blog first appeared as Steve Wunker’s piece for Forbes
 
By: Steve Wunker

It’s a heady time in the U.S. health insurance industry.  Over 30 million Americans are expected to acquire coverage as the Affordable Care Act takes effect, yet the boon of new customers is offset by a gnawing fear that profit margins will vanish. 
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Due to the ACA and economic pressures, health insurers that have thrived since the Second World War now face tough choices, and their responses will shape the future of healthcare overall.

The quandary faced by health insurers is an instance of the Innovator’s Dilemma, a concept that originated with my mentor, Harvard Business School Professor Clayton Christensen.  Christensen describes how the principles of good management lead companies to offer feature upon feature designed for their most important customers.  This makes perfect business sense at the time, and yet it eventually opens up a huge gap between companies’ costly and complex offerings designed for these customers and lower-cost, “good enough” offerings that satisfy the majority of customers.  The industry incumbents focus so hard on their key customers that they end up chasing them into a dead end, leaving room for “disruptive innovations” that provide most people with adequate performance, greater accessibility, and lower costs.  Oftentimes, these disruptive innovations are enabled by new technologies and business models.

The ACA has opened the door to disruption in the health insurance industry.  The insurance exchanges brought about by the law and the Internet enable people to shop for coverage as they would for consumer electronics on Amazon.  Leaving aside the technical issues around the launch of Healthcare.gov, which will be in the rearview mirror before long, the shopping is straightforward, if – and this is a titanic if – you are concerned primarily about the comparison categories that the exchanges provide.  The principal category that draws peoples’ attention is cost.  Low-cost plans stand out, even if they are from second tier or almost unknown entities.  While early registrations on Healthcare.gov and state-run sites have tended to favor mid or high-cost plans from well-known insurers, this is very likely due to the fact that these registrants are more concerned about their health than the average consumer.  That will change.

Faced with disruption, incumbents in most industries ignore the threat until it is too late, doubling down on their existing customer relationships.  But the ACA makes that difficult.  Because the law restricts insurers’ ability to charge vastly higher premiums to cover sicker patients, and it prevents barring enrollment due to pre-existing conditions, insurers need to attract healthier patients into their risk pool to balance out the costly, sicker patients they must carry as well.  Hence the ACA creates a business contradiction – it makes attracting young and healthy patients imperative while also turning that marketplace into one that has very slim profit margins.

The ACA also hits another traditional source of insurers’ profits, albeit indirectly.  Through fostering the trend toward paying hospitals and physicians a single “global payment” for a patient or their illness, rather than a fee for every service that the healthcare providers perform, the ACA undermines the part of an insurer’s business called Administrative Services Only.  With ASO, an insurer charges large employers to process claims and handle patients, but the employer assumes the risk of how big those claims will be.  The law encourages claims handling to be simplified, which is good, but then that is another business line which may see its profits evaporate.

The response to disruptions such as these can be costovation, or innovation focused completely on cost reduction.  In the high-cost US healthcare system, costovation is certainly needed.  Unfortunately, it is very hard for a relatively high-cost, well-established insurance industry incumbent to cost cut its way to greatness.  The wheat and the chaff tend to be chopped at the same time.

Understandably, incumbent insurers want to defend against this potential chain of events.  To do so, they must excel at three distinct endeavors:

1.  Lead healthy customers on the exchanges to choose plans not solely on price, but also taking into account an incredibly unique feature of the insurer.  If you cannot think of such a feature, then you see the challenge these companies face.  However we can imagine that factors such as convenience and simplicity might trump price if the price differential is not extreme.

2.  Reduce the expenses associated with their high-cost patients, such as through preventing hospitalization via a combination of remote monitoring technologies and virtual visits by physicians.

3.  Build the loyalty of employers to the company, through a combination of initiatives targeting both the employer and its employees.  If this mission can be accomplished, the employer will not revert to the public or privately-run multi-insurer exchanges, and it may not pressure the insurer too much on its ASO offerings.

Seen through the lens of the Innovator’s Dilemma, these imperatives mean that insurers must broaden the factors on which disruptive plans are chosen, while defending the existing business by addressing the cost issues around their most important / expensive patients and preventing key employers from defecting to disruptive alternatives such as exchanges.

This will be hard.  It is tough to innovate on three fronts, for three distinct customer types.  But it can be done.  Look at Samsung – it relentlessly removes cost in its semiconductor business, adds features in its mobile devices, and pioneers new markets and business models in its medical technology unit.  Samsung pulls this off through being persistently and dispassionately rigorous in analyzing business options, staying unafraid of taking risks, and remaining focused on its markets rather than on the solutions it happens to be selling.

Health insurers excel at dispassionate rigor.  The question will be whether they can succeed at the latter two challenges, which are not historical competencies.  The answer to that question will determine whether we see an explosion of broad-based innovation in that industry – and therefore in the rest of healthcare – or whether the future will lie instead with costovation.
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