Health Insurance Company Buys Doctor Practice... A Fable

This video provides an insightful exploration into the financial intricacies and potential pitfalls of vertical integration within the healthcare industry, specifically focusing on health insurance carriers acquiring physician practices. Dr. Eric Bricker presents a "fable" about a large multi-specialty physician practice that sells to a vertically integrated insurance carrier. The narrative serves to illustrate how such acquisitions, while seemingly beneficial, can lead to increased healthcare costs and manipulative financial practices, particularly concerning earnout agreements.

The fable begins with a successful multi-specialty practice utilizing an external vendor, "Vendor A," for a specific patient service, costing $300 per patient per day. This arrangement was mutually beneficial for the practice, the vendor, and the patients. However, upon acquisition by the insurance carrier, a significant change occurs: the carrier replaces Vendor A with its own subsidiary, "Vendor I," which performs the same service but charges $800 per patient per day. The speaker highlights the counterintuitive nature of replacing a cheaper vendor with a more expensive one, revealing the carrier's strategy to increase its overall revenue by inflating healthcare costs billed to other insurance carriers and employers.

The narrative further complicates with the introduction of an "earnout" clause in the acquisition agreement. This clause stipulated that the physician practice would receive future payments from the insurance carrier based on its post-acquisition profitability. By replacing the $300 Vendor A with the $800 Vendor I, the insurance carrier intentionally diminished the acquired practice's profit margins. This strategic move directly reduced the future earnings of the physician practice, thereby decreasing the earnout payments the insurance carrier was obligated to make. The speaker concludes by emphasizing that the insurance company "won double" – increasing its revenue through higher service charges and simultaneously reducing its acquisition payout.

Key Takeaways:

• Vertical Integration's Hidden Costs: The video challenges the common perception that vertical integration in healthcare necessarily leads to cost reduction. Instead, it demonstrates how an insurance carrier owning both the payer and provider/vendor can strategically increase overall healthcare costs to boost its own revenue.
• Revenue Generation Through Cost Inflation: Vertically integrated insurance carriers can profit by replacing cost-effective external vendors with their own, more expensive subsidiaries. This practice shifts costs to other payers (e.g., other insurance companies, employers), increasing the acquiring carrier's top-line revenue.
• Earnout Manipulation in M&A: The "fable" serves as a stark warning about the potential for earnout clauses in mergers and acquisitions to be manipulated. Acquirers, especially those with vertically integrated models, can intentionally reduce the profitability of acquired entities to minimize future earnout payments.
• Importance of Due Diligence in Acquisitions: For any entity considering selling to a larger, vertically integrated organization, thorough due diligence must extend beyond initial valuations to scrutinize potential conflicts of interest, vendor relationships, and the acquiring entity's incentives post-acquisition.
• Impact on Acquired Entities' Profitability: The strategic replacement of vendors can significantly worsen the financial performance and profit margins of an acquired practice, directly impacting its ability to meet earnout targets and potentially undermining its long-term financial health.
• Beware of Financial Incentives: Healthcare stakeholders, including physician practices, employers, and other payers, need to be acutely aware of the complex financial incentives at play in vertically integrated healthcare systems, as these can lead to outcomes that are not in the best interest of patients or overall cost efficiency.
• Strategic Cost-Cutting for Acquirers: The example illustrates a "genius" (from the acquirer's perspective) method of reducing acquisition costs by diminishing the acquired entity's performance, thereby saving money on future earnout payments.
• Transparency in Vendor Selection: The scenario underscores the lack of transparency in vendor selection and pricing within vertically integrated systems, where internal vendors may be prioritized for financial gain rather than cost-effectiveness or quality.
• Broader Implications for Healthcare Finance: The video highlights a critical aspect of healthcare finance where market power and ownership structures can be leveraged to increase profits at the expense of higher overall healthcare spending.

Key Concepts:

• Vertical Integration: The ownership of multiple stages of a supply chain by a single company. In healthcare, this refers to an entity (like an insurance carrier) owning providers (like physician practices) or other service vendors.
• Earnout: A contractual provision in an acquisition agreement where a portion of the purchase price is contingent on the acquired company achieving certain financial milestones or performance targets after the acquisition.
• Multi-specialty practice: A medical practice that employs physicians from various medical specialties, often operating across multiple locations.
• Insurance Carrier: An organization that provides health insurance coverage, typically by collecting premiums and paying for healthcare services.