As health and life sciences companies bet on the future, a specialty focus might have the greatest payoff

My Take

As health and life sciences companies bet on the future, a specialty focus might have the greatest payoff

By Sarah Thomas, managing director, Deloitte Center for Health Solutions, Deloitte Services LP

The Preakness Stakes might not have the same prestige as the Kentucky Derby, but it’s a huge deal in Baltimore and in nearby Washington, D.C. where I live. In horse racing, it’s the jockeys, the owners, and, of course, the horses who receive the glory and the prize money. But it’s often the breeders who see the biggest return on capital (ROC)—a measure of profitability that is relatively standard among for-profit and nonprofit entities across all industries. Last year, Justify won the Derby, the Preakness, and the Belmont Stakes. While his racing life was short-lived (just four months), his second career promises to be much longer and far more lucrative. His breeding rights were purchased for a record $75 million with the expectation that he will sire more champions.¹ A stud might breed more than 200 times a year, and the average foal from a Triple Crown winner could fetch an average of $150,000.²

I see some parallels between the ROC in horse racing and the ROC in health and life sciences where the greatest returns aren’t necessarily obvious. We all know where most of the spending occurs in our industry, but there is often less understanding about the ROC.

Like the people sitting in the grandstands at the horse track, C-suite and other executives at life sciences and health care companies should determine where to place their bets to improve and sustain financial performance over time. A solid understanding of ROC also can be invaluable for health care and life sciences organizations as they look inside and outside the industry for potential partners and new opportunities.

While company leaders often focus on margins, profits, and revenue, ROC offers a fresh lens through which they can see how the efficient allocation of capital can drive profitability. An ROC lens, for example, can highlight some of the challenges a diversified life sciences manufacturer might face.

Where are returns the highest in health and life sciences?

Drug intermediaries and retailers tend to have the highest ROC across the health care sectors, according to our recent report, which takes a look at return on capital performance in life sciences and health care. Organizations in this sector, including wholesalers, pharmacy benefit managers (PBMs), and pharmacies, are transactional and tend to operate on low margins. They are typically not as profitable as other health care businesses. But if we look at these companies through an ROC lens—rather than a profitability lens—it becomes clear that drug intermediaries and wholesalers are among the best-performers in life sciences. In 2017, drug wholesalers had an average ROC of 15 percent, PBMs were at 12 percent, and pharmacies were at 18 percent. By contrast, pharmaceutical and medical technology companies had an average ROC of between 10 and 12 percent.

Over the years, ROC levels have declined across each of the seven sectors we studied, with life sciences companies experiencing the largest drops. Between 2011 and 2017, the ROC for pharma companies declined from 17 percent to 11 percent. Similarly, the ROC in the medtech sector fell from 14 percent to 10 percent. While drug intermediaries and retailers had the highest returns among all sectors during this period, their returns have fallen, too. This is particularly true for drug wholesalers—despite significant industry consolidation.

Here’s a sector-by-sector look at some of the ROC trends we saw in our research:

• Pharmaceutical companies: Research and development (R&D) productivity is one of the major factors behind deteriorating ROC trends among pharma companies. R&D returns (these are the returns companies might expect to achieve from their late-stage pipelines) fell significantly from 10 percent in 2010 to just 2 percent in 2018, according to our annual analyses. This decline is the result of fewer assets in the late-stage pipeline and lower potential sales per asset. During the same period, the average cost to develop an asset doubled. Marketplace pricing and access pressure also likely contributed to the trend—particularly in primary care portfolios where rebate costs have risen dramatically. In addition, large-scale acquisitions appear to have dragged down the ROC for some acquirers.
  
  Specialization could translate to a higher ROC. Pharma companies that are focused on oncology, musculoskeletal diseases, disorders of the central nervous system (CNS), and anti-virals had among the highest returns. Several companies are strengthening their pipelines in these specialties. For instance, our research found that oncology assets represented 39 percent of late-stage pipelines in 2018 among big pharma companies, compared to just 18 percent in 2010. Structural and operating model implications can underpin the lower performance in diversified portfolios and provoke strategic questions like “what if we moved operations for primary care off-shore?” We know that the cost of capital needed to support brands for chronic diseases is higher than for specialty products. Further, big portfolios tend to be weighed down by the legacy infrastructure built to support primary care.

• Medtech companies: While R&D productivity is one reason for falling ROC among medtech companies, another key factor might be pricing pressure from health systems. In the past, sales in this sector relied on the relationship between medtech companies and the physicians who decided which devices, equipment, or supplies to use. Today, hospital and health system procurement experts typically make those decisions. These professionals tend to buy fewer items and drive harder bargains. Medtech products can be difficult to differentiate in terms of patient outcomes, and product development is often focused on incremental changes based on physician preferences rather than on unmet patient needs. As a result, some medtech companies are competing solely on price, which has led to ROC deterioration. In the medtech business, companies that focus on certain diagnostic specialties—such as robotic surgery, cardiology, otolaryngology (ENT services), and in-vitro diagnostics (IVD)—outperformed device makers that had more diversified portfolios. Specialty-focused medtech companies had an ROC of 11 percent in 2017, compared with diversified companies’ 9 percent.
• Hospitals and health systems: These are the most capital-intensive organizations in the health care ecosystem, and their ROC levels are the lowest. Larger health systems tend to have higher ROC than the industry average. In 2017, the average ROC among the five largest health systems by revenue was double (12.3 percent) the average ROC for the rest of the hospitals and health systems we studied. The Affordable Care Act (ACA) expanded health insurance coverage, which helped to reduce losses from bad debt. This, combined with consolidation, contributed to relatively stable returns for hospitals and health systems in recent years. However, in the era of value-based payments and accountable care organizations (ACOs), the importance of being part of a health system network has increased, and some independent hospitals have struggled. The independent hospitals we studied had a 4.5 percent ROC in 2017, compared to 7 percent for hospitals that were part of a health system.
  
  Hospitals that specialize in certain types of care had much higher ROC than acute general hospitals, according to our research. Specialty hospitals tend to deliver care for indications or illnesses that might need intensive care. For instance, surgical hospitals, and hospitals focused on heart, orthopedic, and gynecological services had an average ROC above 20 percent in 2017, compared to 6 percent among general hospitals. However, our findings for hospitals that focus on oncology and cancer care suggest that specialization in and of itself is not always an ROC driver. Health systems might want to incorporate these findings into both their corporate and merger and acquisition strategy going forward.

• Health plans: The health plans we examined said their returns were cut in half—from 13.2 percent in 2011 to 6.8 percent in 2015—in the wake of policy and market turbulence. Various ACA provisions, including the establishment of health insurance exchanges, the individual mandate, and guaranteed issue, initially resulted in losses in the individual line of business, which affected the overall profitability of health plans. However, performance in the individual market, as well as in other business lines, has improved recently. As of 2017, health plan underwriting profitability had recovered to pre-ACA levels, and ROC rebounded to 12 percent.

Where should we place our bets?

We have recently been trying to predict some of the changes that might occur in health and life sciences over the next 20 years. Our vision for the future of health is an opportunity to consider how our existing system might evolve across the industry—and over time. Today, the health care and life sciences sectors are made up of traditional players. But consolidation is happening within each sector, as is convergence (organizations that partner or combine across sectors). The pace of convergence has accelerated over just the last 12 months. Many surprising partnerships are emerging as stakeholders pursue new revenue streams, increase their focus on outcomes, and try to gain more control over parts of this growing market.

When it comes to the future of health, we are nowhere near the home stretch (getting back to my horse-racing analogy). What might be the best long-term bets? Organizations that can successfully mine data to deliver personalized solutions that keep people healthy and functioning at their highest potential could see the greatest returns. These companies will learn to harness interoperable and real-time data and a wide range of technologies that are just beginning to emerge.

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¹ Justify worth record $75 million after Triple Crown, Reuters, June 10, 2018
² Why Triple Crown champs Justify and American Pharoah remain stars, ESPN.com, May 3, 2019

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In the News

Senate releases bipartisan bill targeting health costs, competition, and transparency

On May 23, Senators Lamar Alexander (R-Tenn.) and Patty Murray (D-Wash.), the chair and ranking member of the Senate Health, Education, Labor & Pensions (HELP) Committee, released the Lower Health Care Costs Act, a discussion draft bill that includes many policies aimed at lowering costs and spending. The legislation would address “surprise medical bills” by incorporating elements proposed in recent House and Senate bills (see the May 21, 2019 Health Care Current). Surprise medical bills can occur when a patient is unable to choose an in-network provider, such as during an emergency. The administration and lawmakers on both sides of the aisle have pushed for solutions to solve this issue, which can contribute significantly to medical debt (see the February 12, 2019 Health Care Current).

Key provisions of the HELP Committee’s bill include:

• In-network rates for some services with surprise medical bills: Out-of-network physicians would have to accept in-network rates if care is delivered at a facility within the patient’s provider network.
• Mediation for surprise bills: The bill proposes two types of mediation to settle payment disputes. Price benchmarking—which the House Ways and Means Committee recently proposed in the No Surprises Act—would establish a benchmark payment rate based on the average in-network payment rate in the service area. The other proposal would allow “baseball-style arbitration,” in which each side proposes a price and an independent arbiter chooses the final rate (see the April 9, 2019 Health Care Current). Last month, a bipartisan Senate working group released the Stopping the Outrageous Practice (STOP) of Surprise Bills Act, which also proposed baseball-style arbitration.
• New rules for drug rebates: The legislation would require PBMs to pass all rebates to plan sponsors. This differs from the US Department of Health and Human Services’ (HHS’s) proposed “safe harbor” reform, which would allow drug makers to negotiate discounts with PBMs and health plans and apply the discounts at the point-of-sale to reduce prescription drug prices for Medicare Part D and Medicaid managed care beneficiaries.
• Elimination of spread pricing: The bill would prevent PBMs from charging health plans more than the PBM paid for a drug and keeping the difference. In an April hearing, Senators Charles Grassley (R-Iowa) and Ron Wyden (D-Ore.) told witnesses, all of whom represented PBMs, that they had asked HHS to investigate spread pricing (see the April 16, 2019 Health Care Current).
• Faster generic and biosimilar drug entry: The bill also seeks to reduce drug prices and increase competition by targeting patent protections. The House recently passed a similar package of bills (see the May 21, 2019 Health Care Current).
• Increased transparency: The bill calls for health plans to provide patients with their claims data, information about their in-network physicians, and expected out-of-network costs. Additionally, the bill asks the Government Accountability Office (GAO) to compile a report on possible security gaps for patient information, specifically as patients share their data with third parties, such as mobile apps—which are not covered by HIPAA. According to a recent My Take, in 2018, health care led all industries in the volume of cybersecurity breaches.

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House committees propose capping costs for Part D beneficiaries

On May 23, the House Energy and Commerce Committee and the Ways and Means Committee released draft bipartisan legislation to cap out-of-pocket costs for Medicare Part D beneficiaries. The bill would limit a beneficiary’s out-of-pocket spending to the amount of the Part D catastrophic threshold—$8,140 in 2019. The bill also proposes to reduce the government’s share of catastrophic coverage from 80 percent to 20 percent over four years, which would gradually shift more costs to health plans. According to policy experts, shifting the costs to health plans could give them a financial incentive to choose lower-priced drugs for formularies and to negotiate better deals with drug makers.

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Patient access to online health data remains flat, but use varies, ONC reports

While a majority of health systems have electronic health records (EHRs), only about half of patients (51 percent) say they had online access to their health data in 2018 (down slightly from 52 percent in 2017), according to a report from the Office of the National Coordinator (ONC) for Health Information Technology (HIT). Of those who said they had online access to their data, just 3 in 10 patients said they looked at their information at least once within the past year.

The report’s findings come from the nationally representative Health Information National Trends Survey (HINTS), which looks at the use of medical records and other electronic devices for health-related purposes. Factors associated with lower use of data include health care utilization, gender, socio-economic status, and education, according to ONC. For instance, college-educated people who had access to electronic health data were more likely to access it (68 percent) than patients who did not have a college degree (48 percent). ONC also noted that smartphone and tablet owners are relatively tech-savvy when it comes to tracking health-related information, and nearly half of patients who owned smartphones or tablets used health and wellness apps in 2018.

(Source: The Office of the National Coordinator for Health Information Technology (ONC HIT), Trends in Individuals’ Access, Viewing and Use of Online Medical Records and other Technology for Health Needs: 2017-2018, May 2019)

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ONC releases report on physician interoperability

Interoperability among office-based physicians has remained relatively constant, according to a May 2019 data brief from ONC, which assessed data from the 2015 and 2017 National Electronic Health Record Surveys. While only 10 percent of physicians reported engagement in all four categories of interoperability—electronically sending, receiving, querying, and integrating patient health data into their EHRs—data query rates specifically increased by 50 percent from 2015 to 2017. Physicians’ rates of engaging in the remaining three categories did not change during this time. The study also found that:

• Physicians who participated in value-based payment models and who used certified EHRs had higher engagement rates for all four categories.
• In 2015 and 2017, physicians who engaged in all four interoperability categories were twice as likely to have patient health information from outside sources, compared to the national average.
• Among physicians who engaged in all four categories, a higher percentage reported having electronically available patient health data from outside sources in 2017, compared to 2015.

ONC noted that increased provider participation in the Merit-Based Incentive Payment System (MIPS) or alternative payment models (APMs) could help increase interoperability among physicians. According to Deloitte’s 2018 Survey of US Physicians, when asked what changes they would make to their current EHRs, the majority of physician respondents—62 percent—said they would improve their EHRs’ interoperability capabilities.

In February, HHS and the US Centers for Medicare and Medicaid Services (CMS) released proposed rules aimed at driving the US health care system toward greater interoperability and promoting the secure access and exchange of electronic health information. In April, HHS announced extension of the public comment period for these rules to June 3, 2019.

(Source: Office of the National Coordinator for Health Information Technology, Interoperability among Office-Based Physicians in 2015 and 2017, May 2019)

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Nearly 1 million children lost CHIP or Medicaid coverage last year

More than 828,000 fewer children had health coverage through Medicaid or the Children’s Health Insurance Program (CHIP) at the end of 2018 compared to the prior year, according to a new report from the Georgetown University Health Policy Institute. Researchers determined that 912,000 children in 38 states lost Medicaid and CHIP coverage last year, while enrollment increased by 84,000 in 12 states. The overall enrollment decline represents about 2.2 percent of all children who have health coverage through the program.

The researchers noted that even a small drop in enrollment is unusual. Between 2000 and 2016, enrollment declined in only one year (2007) by 1.1 percent. Researchers said it is too early to know if children have moved to private health coverage or if they have become uninsured. This question won’t be answered definitively until national census data are released this fall.

(Source: Georgetown University Health Policy Institute Center for Children and Families, Medicaid and CHIP Enrollment Decline Suggests the Child Uninsured Rate May Rise Again, May 28, 2019)

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Breaking Boundaries

Can a small piece of paper and a smartphone help parents diagnose ear infections at home?

Ear infections, a childhood rite-of-passage, can be stressful to parents who make multiple trips to the pediatrician’s office every year. By age three, most American children have had at least one ear infection, with some children experiencing multiple infections. Researchers at the University of Washington have created a simple test that uses a smartphone and a folded piece of paper to accurately detect fluid in the ears—a possible sign of an ear infection.

Common ear infections, along with another condition known as Otitis media with effusion (OME), typically cause fluid build-up in the ear. Most infections or cases of OME clear up without intervention, but too much fluid, or chronic fluid build-up, can cause pain or even serious complications such as hearing loss. Pediatricians can diagnose ear fluid by examining the eardrum. The researchers created an inexpensive but accurate test that parents can use at home. The app they developed plays chirping sounds that are funneled through the ear canal by a paper cone taped to the phone that sits on the outer ear. The waves of sound bounce from the middle ear back to the phone and are analyzed by the app. Signal fluctuations allow the app to determine if fluid in the ear is likely.

The team tested the app on children between the ages of 18 months and 17 years who had been admitted to the hospital and used the results to refine the app’s predictive algorithm. Half of the children had been scheduled to undergo ear-tube surgery, while the other half were scheduled for procedures unrelated to their ears. In this initial study, the app was able to predict whether someone had ear fluid with 85 percent accuracy, and correctly predicted if someone did not have fluid with 80 percent accuracy. Researchers also tested the app on younger children and made sure that parents would be able to use the app outside of a medical setting.

The app could become a diagnostic tool in the virtual medicine cabinet that helps avoid a trip to the doctor. Moreover, physicians in the developing world could use the app as a screening tool.

Analysis: Deloitte’s 2018 survey of health care consumers found that people are increasingly open to new channels of care—particularly at-home diagnostic testing. About half of survey respondents said they are comfortable using an at-home test to diagnose infections (e.g., strep throat and urinary tract infections) before going to the doctor for treatment. We also found that the number of consumers who use wearables to track their health data has more than doubled since 2013—and consumers have become more comfortable with sharing their data.

Deloitte’s recent paper, Forces of change: The future of health discusses how by 2040, high-cost, highly trained health professionals will be able to devote more time to patients who have complex health conditions. Data and technology will empower consumers to address many routine health issues at home.

The paper describes how a child with an ear infection could, instead of visiting a clinic or doctor’s office, use an at-home diagnostic test to get a diagnosis. Open and secure data platforms would allow the parent to verify the diagnosis, order the necessary prescription, and have it delivered to the home via drone. This example illustrates how consumers will likely be able to address health issues at home while allowing physicians to focus on cases that truly require human intervention.

(Source: Shraddha Chakradhar, A smartphone app could help diagnose ear infections more accurately — and at home, STAT News, May 15, 2019)

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