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November 4, 2010

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The Robert E. Nolan Company is an operations and technology consulting firm specializing in the health care industry. For 35 years, we have helped clients redesign processes and apply technology to improve service, quality, productivity, and costs.

Our staff members are all senior industry experts with 15+ years in the industry. Visit www.renolan.com to for health care articles, white papers, and client success stories.

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The Basis of Competition is Changing—Are You Ready?

Merit Smith
Vice President & Director, Health Care

Understanding the impact of reform is a bit like watching mountains emerge from the rain and fog: you don't see the mountain all at once. Perhaps you sense the form of the mountain from a larger patch of gray, then catch a glimpse of it through the fog, then gradually see the shape and, later, details emerge.

We have the reform law, a few regulations, and some public pronouncements. But we don't have key regulations or details for the critical changes that will shape the future of health carriers and the industry.

By "critical changes," I mean the provisions and regulations that change the economic model of health insurance—the detailed definition of the medical loss ratio and the mechanics of rebating premium.

Even without this critical information, we can see the shape of the mountain through the fog. We can tell that the basis of competition is changing. Let's think about the future competitive environment in terms of what we know today.

Here are some things we can anticipate about the future:

Product features and benefit design will be less important. Why? The government will move us toward standardized benefits.

Medical costs will be less important as a component of market price. Why? The HHS will largely dictate the range of medical prices, and mandated minimal medical loss ratio targets combined with rebates will go a long way in reducing carrier incentives to innovate and tightly manage this element of cost.

With standardized benefits and medical prices, what's likely to be the basis for competition? Service experience and administrative costs. Of these two, which will be more important? Administrative expense. Why? New buyers don't have an objective basis for evaluating service, and they don't trust carriers' promises about service. But they can evaluate cost, and they are increasingly price-sensitive.

Will you be ready to compete when your product is distributed via an exchange with a limited number—perhaps five—of health plans? Where will you compete on administrative cost? Aiming to be close to the average of the peer group is old-style thinking that will ensure that you become a non-competitor. Can you compete in an environment where the marketplace sets your price point for your administrative services?

What do you need to do to be ready?

Understand today's administrative cost structure in detail, with more focus than you ever have.
Understand the sensitivity of your cost structure to differences in revenue, units, and fixed and variable costs. Perhaps you have done this but not with the detail, focus, and urgency you will need.
Be prepared to simulate differences in your cost structure based on differences in the ultimate definition of "medical loss ratio."
Begin to manage costs today. Of course, you have been doing this as part of your response to the recession and slow-motion recovery. But taking even more steps today to reshape costs will be easier than doing it in the future.
Renegotiate any long-term contract (for space, systems, law firms) you have.
Be prepared to simulate a number of market scenarios and expense structures.
Understand that expenses are the shadows of management decisions. You and your managers determine your expense structure. How you do that will determine your future under reform.

Nolan has developed a set of tools to help you with this analysis and simulation. If you would like to learn more about how we can help you reset your cost structure for a new environment, call me at 719-339-9803.