Specialty Capitation and the Next Wave of Healthcare Services Innovation
In 2018, I was wandering around the Venetian hotel in Vegas meeting with different hospital and healthcare services folks at the annual Healthcare Financial Management Association (HFMA) conference. Usual topics were top-of-mind including surgeries shifting from inpatient to outpatient, new and forthcoming hospital technologies, and the seemingly endless number of revenue cycle management vendors who just want a minute of your time. It was all pretty boring and I started to fear that this was a waste of time particularly after I had to lobby my boss pretty hard to let me attend.
That all changed when I dropped into a small, almost hidden, conference room where a Chief Medical Officer from a small private operator of primary care centers was giving a presentation on why he believed primary care was going to be the next area of healthcare services innovation. You could hear the eyes rolling from the sleepy hospital executives as he outlined what Oak Street Health was building and how primary care capitation worked. I however was blown away.
The U.S. spends a depressingly low amount of money on primary care despite it being at the frontlines of how many access and navigate the healthcare system. Estimates vary but it's something in the range of 5-8% of total healthcare spending - one of the many casualties of a fee-for-service world I suppose. Predictably, primary care physicians (PCPs) as a result make substantially less than specialty physicians ($265k for PCPs vs. $382k for specialists according to Medscape). Wouldn't it be great if we started to properly invest in primary care in a way where we're actually trying to prevent downstream illnesses/costs as opposed to just waiting for something to break? This was the core of the Oak Street story and it made a lot of sense. What's more, crucially, they had strong existing relationships with health insurance companies who were willing to send them their Medicare patients under "capitation arrangements."
Capitation is a relatively simple concept but I think the following metaphor is helpful. In the same way a project manager who's building a home subcontracts out the electrical or HVAC installation to third parties - so too can health insurance companies subcontract out their primary care services to providers like Oak Street. Health insurance companies like Humana then say to these capitated providers 'hey we'll pay you $X a month per member to manage all of these primary care costs and anything you don't spend you're allowed to keep.' It's a pretty good deal for everyone involved - Humana gets to 'offload' their primary care duties to a high-quality third party provider at a certain cost, Oak Street gets a big pot of upfront money to spend on appropriately caring for patients and can earn an attractive (and unregulated) margin, and patients get a much higher-quality experience vs. traditional/underfunded primary care services.
Fast-forward 5 years - and CVS bought Oak Street for $10.6 billion - an outstanding outcome for some of the best operators in the business. Others too have found success, and failure, in trying to pursue a similar strategy. While the primary care story certainly doesn't end here - it does beg the question of where does this lead next? To me, the obvious answer seems to lie on the other side of the above pie chart - specialty care.
There is a ton of data showing that specialty spending dwarfs primary care but few charts succinctly prove this quite like the below which examines average compensation earned across different specialties. Follow the money.
So where does one go to build the specialty version of an Oak Street-type model? I would first point to an interesting study from UNH's Advisory Board which examined spending buckets across a number of midsize to large employers from July 2018 through June 2021. The study found that five conditions made up half of all healthcare spending through claims paid by these health plans and where, in my opinion, they would logically be most willing to explore the concept of capitation.
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I should stop here to mention that this isn't novel thinking - specialty capitation is already happening in these buckets across different startups and in different capacities but what I am arguing is that this relatively nascent trend is going to accelerate particularly as large managed care organizations like UNH and CVS continue to push deeper into healthcare services broadly and risk-sharing specifically. Further, supported by disease prevalence growth and an increasingly aging population, aggregate spending across these categories has and will continue to explode.
I do have questions though that I haven't been able to answer for myself and would love to connect with folks who have points of view on what I've written here.
First and foremost is around the issue of recruiting. The reason the capitation model can work in primary care is because capitated providers can make compelling salary and bonus offers to PCPs (who as we saw are on the lowest end of compensation across physicians) in order to "acquire" these docs to be a part of their network. I think this is going to become much more difficult - and expensive - to do if, for example, one were to try to build a network of capitated neurology practices when neurosurgeons are already clipping ~$750k a year. Of course you can offer them equity to join as well but for investors like me - that's dilution I have to eat every time we hire an incremental doc - not ideal.
The other and more existential issue I grapple with is cost containment/underwriting in specialty care in general. Going back to my explanation of how capitation works - you need to be damn good at making sure you're able to "price" your contracts with insurance companies in such a way where you're sure you're able to both cover your care costs to the patients you've been charged with managing + earn your margin. This is already difficult to do well in capitated primary care, as evidenced by blowups from the likes of Cano Health, Babylon, etc., and it's likely much more difficult in specialty where the stakes are higher, patients are more complex and care episodes are much more expensive.
It's been a few years since I sat in the back of that conference room in Vegas listening to how Oak Street was going to change the primary care model and build a multibillion dollar business in the process - and ultimately did. Who's going to do the same in specialty care? Because like it or not - someone is going to.
Email me to chat - [email protected]
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