Photograph by Christopher Furlong — Getty Images
By Bill Woodson
August 18, 2015

Health plan deals have dominated recent headlines. Just last month, Aetna (AET) announced it would buy Humana (HUM) and Anthem (WLP) announced it would buy Cigna (AKAM). It’s unlikely that mergers and acquisitions in the sector are behind us. Almost in the shadow of payers’ moves, provider systems around the country also are entering into new relationships at a frenetic pace. In this year alone, we’ve seen major deals including Barnabas Health and Robert Wood Johnson Health System combining their 11 hospitals to form New Jersey’s largest health system and Prime Healthcare Services’ takeover of six-hospital Daughters of Charity Health System. Those add to the less headline centric, but even more pervasive private practice acquisitions that are happening every day in the health delivery space.

If you’re just counting the number of deals, you’re missing 75% of the story. The industry is trying to consolidate and disintermediate itself at the same time. The outcome should be good for consumers but requires a strong dose of Dramamine for those trying to make it happen. In health care, bigger and better are not two words that go together… yet.

Some experts see this activity purely as a response to health care reform. Although clearly a factor, such deal-making actually is just the most visible sign of a fundamental, long-overdue restructuring of the industry.

Today’s wave of consolidation is just one of the trends enabling market evolution. Simultaneously we are seeing significant convergence across industry sectors, blurring of the lines between payers and providers as acquisitions increasingly go vertical. In February, a subsidiary of St. Louis-based Ascension Health announced plans to buy U.S. Health and Life Insurance Co. Budding consumerism among Americans feeling heightened pocketbook pain for health services, and cohesion—business models and technologies enhancing value orientation—round out what we monitor as four “Cs” catalyzing local health care ecosystems’ readiness to transform their approach to doing business. Allina Health and Health Catalyst may represent the best example of cohesion, by announcing a partnership early this year to combine technologies, clinical content and front-line personnel in an effort to improve the quality and lower the cost of care for Allina’s patients.

 

There’s no denying the significant consolidation in the provider sector, however. M&A mania has become so widespread that many are predicting the demise of the independent hospital. In our contrarian view, local market dynamics and the diverse mechanisms through which hospitals can gain much needed scale leave room for a broad range of organizations. Just look at Community Health Systems, which announced earlier this month that it plans to shed 38 hospitals, most of them in small markets, and shift its focus to large markets and regional networks.

The factors pressuring hospitals to consolidate or refocus efforts today are multifaceted. Systems are trying to solve for equally potent forces: a more exacting payment environment and increasingly savvy consumers. Not only must they look to do more with less, health systems must differentiate themselves on how they meet the needs of an increasingly demanding consumer marketplace.

Both providers and payers, though, find it hard to make the math work. Payers salivate over coverage expansion even as they gnash teeth to manage their medical loss ratios to create shareholder value. Many providers, meanwhile, face stagnant to declining revenues and a faltering inpatient growth engine. Skewed income distribution has fueled M&A activity, since non-Medicare margins at a growing number of hospitals have dipped below 1% while others’ top 5%. One reason for deteriorating profitability: many common hospital cases have been swiftly moving to more efficient outpatient settings. Within the next 10 years, in fact, we project outpatient volumes will soar 21% while inpatient demand drops 4%, an extraordinary decline given changing U.S. demographics. Faced with these financials, hospitals should position to slash 15% to 20% out of their operating structure. It’s not surprising, then, that many seek instant scale through a merger, even though the track record on cost savings from health system consolidation has been mixed.

In addition to solving the economics, providers and payers are trying to create well-oiled systems of care to maximize efficiency and enable seamless patient journeys through diverse sites and services. Full asset mergers aren’t the sole solution; varied transaction types and strategic partnerships will come into play. Only then will industry stakeholders be positioned to thrive under new payment models that reward high-value care rather than high-volume.

 

Below the birds-eye view of the national health care market, the four Cs already are transforming regional and local care delivery. Of the hundreds of markets we routinely track, analyses suggest a third, comprising 46% of the US population, are primed for value-based care. Those with looser affiliations and less payment experimentation are lagging. But the pace of change, like that of M&A, is accelerating. By 2018, we project that progressive markets will span the West Coast and Northeast, while many in the Rocky Mountain region continue down that path.

The local nature of health care will persist. The future landscape certainly will look different, just not monolithic. Anticipate five or six large national systems, some with a Catholic heritage and others primarily investor-owned. There also will remain strong local and regional systems large enough to bend the cost curve and assume clinical and financial risk for the populations they serve. The number of independent hospitals and health systems inevitably will decrease, but not all independent hospitals will be swallowed up by large chains. Certain community-based hospitals and systems that are indispensable in their local markets have the potential to survive, and even thrive, in the new era.

Nationally, we expect transaction volume among providers and payers to continue to accelerate over the next few years but decline by 2018. Yes, there will be fewer larger payers, but they still will have to respond to complex dynamics at the local level and a provider environment more heterogeneous than current activity suggests. There’s an arm wrestling match just under way over who should profit from health insurance premiums―providers or payers. It’s not a zero-sum contest. The winners will be those who meet consumers’ needs on their terms.

There’s no question that a major industry shakeout is under way, and there will be considerable turmoil as this all plays out. In the end, though, health care’s transformation should result in a system better able to meet demands for access and quality at a lower price point.

Bill Woodson is senior vice president at Sg2, a MedAssets company.

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