Vertical Integration and Market Consolidation by Oliver Wyman Group

VERTICAL INTEGRATION AND MARKET CONSOLIDATION: CONVERGENCE OF THE PAYER AND PROVIDER MARKETS JUNE 4TH, 2015

Terry Stone, Health & Life Sciences Global Managing Partner terry.stone@oliverwyman.com Todd VanTol, Partner & Head of Health Services todd.vantol@oliverwyman.com

The world is changing…how will health insurers best adapt?

By 2018, 1

in 3 Americans will be buying

a different insurance product than they do today, through a channel that didn’t

exist three

years ago, receiving 30% of their care outside of a traditional health system

The Affordable Care Act creates significant economic pressure for both health plans and providers alike

Health Plans

HOSPITAL

Impact of Reform: Illustrative Health Plan Operating Income

Providers

Hospital profitability has dropped significantly Illustrative Hospital Operating Income (by year 2020)2

-32% 2.0%

19%

1.2%

-1.5%

14% 19%

21% 23%

33%

17% 22%

14%

16%

Pre ACA

Post ACA

Medicare Large Grp ASO Large Grp FI Small Grp Individual

-10.0% -8.3%

Initial Margin

Newly Insured

Rate New Eroding Funding Compression Margin Source Mix

1. Kaiser Family Foundation. “Analysis of 2015 Premium Changes in the Affordable Care Act’s Health Insurance Marketplaces” Chart depicts second-lowest silver and lowest-cost bronze plan 2. Oliver Wyman Analysis, Deloitte analysis, Initial margin derived from 2008 Milliman Report titled “Hospital & Physician Cost Shift” © Oliver Wyman | NYC-MKT24601-002

The payer market continues to consolidate with approximately two thirds of the market now served by ten plans US Health Insurance Company Concentration, 2011 By % of commercial health plan members % of Commercial Health Plan Members

100

Recent plan-plan M&A 155 Plans 26 K

88 plans

29 plans 80

2012 $3.8 BN

2012 $4.9 BN

2013 $5.7 BN

20151 $1.25 BN

180K

680K

20 plans

50 40 30 20 10

11M

010

plans Number of Health Plans

Average Membership

1. Acquisition not yet complete Source: InterStudy Data of Commercial Health Plans; Excludes Medicare and Medicaid Enrollment, Reuters, Health Leaders-Interstudy, WSJ, Oliver Wyman Analysis ÂŠ Oliver Wyman | NYC-MKT24601-002

Debt is cheap and well-positioned health plans are evaluating the landscape for consolidation opportunities

I like the pricing environment a lot and we have a lot of capacity to work with to do a cash transaction of meaningful size –and it would be transformative. – Wayne DeVeydt, Anthem CFO

Acquisitions and consolidations are going to become more common as smaller insurers decide they do not have the leverage, staff and resources to meet the requirements of federal healthcare reform.

Consolidation remains likely, with Aetna CEO Mark Bertolini asserting that government business is the focus for inorganic growth, while compatible cultures for post-merger synergies were viewed as the driver in all transactions... [acquisition of Humana or Cigna could be] imminent. – Ana Gupte, Leerink analyst

– Joel Peyton, market analyst with HealthLeaders-InterStudy Source: Reuters, Health Leaders-Interstudy, WSJ, Oliver Wyman Analysis © Oliver Wyman | NYC-MKT24601-002

Beyond M&A, health plans are arranging strategic partnerships to achieve the benefits of consolidation and greater economies of scale As health plans seek to improve their admin cost position…

… some regional payers are partnering to gain greater efficiency without M&A

SG&A PMPM ($)

C B Company A Average efficiency

A Efficient Frontier

Membership months (MM)

Highmark lends its core processing and back office functions to IBC What this means for IBC and our customers [is] it will allow us to further streamline our business operations with the goal to help drive down costs [and] expand and enhance capabilities" .

– Karen Godlewski, IBC

Source: Oliver Wyman Analysis, 10 K, 10Q filings (2010, 2011) © Oliver Wyman | NYC-MKT24601-002

Providers also continue to consolidate – but these efforts are increasingly attracting FTC attention Hospital M&A activity has increased significantly

Recent provider-provider M&A

Number of deals

120 100 80

+ +

2013 $3.6 BN

2013 merger

2013 $1.8 BN

60 40

Federal Trade Commission pushback

We now also hear growing concern that provider consolidation in nonoverlapping product or geographic markets may also lead to higher prices, [even for a city hospital acquiring hospitals in outlying areas] – Edith Ramirez, FTC Chairwoman

0 05 06 07 08 09 10 11 12 Nonprofit buyers For profit buyers % of independent physicians1

49%

39%

1. The AMA survey comes to a different conclusion, however they do not dispute that physician practices are increasingly affiliating with health systems Sources: Medical Group Management Association Analysis, American Medical Association; Accenture Analysis; McKesson – Physician Employment – Keys to Success for Hospital Financial Leaders, ASPE.hhs.gov, Health System Measurement Project; American Hospital Association 2010 Annual Survey Data; Irving Levin Associates, Inc. © Oliver Wyman | NYC-MKT24601-002

Is like-like consolidation a good thing? Is it sufficient to create real value?

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The shift to value based care and population-health will require fundamental change in healthcare business models

New risk/profit models Specialized population ecosystems FFS/ Early FFV (1st Gen. PHM)

Expanded care model lens Information businesses and web 2.0

Next Gen Population Health At-Scale

Bridge to wellness/consumer engagement New health services marketplace New basis of competition

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By 2018, projections predict 34% of all MCO revenues will flow through value-based mechanisms; Medicare Advantage may shift even faster

% of Total Managed Care Revenue

Projected growth in Value-Based Reimbursement (VBR - Risk Sharing, Capitation) and Value-Based P4P1 40%

34%

35%

30%

27% 23%

25% 20%

17%

15% 10% 5%

16%

20%

15%

18% Value P4P

13% 11%

10%

12%

2013

2014

2015

2016

14%

16% VBR

2017

2018

Medicare Advantage shift to value • Congressional Budget Office (CBO) estimates that, even without a change in law, MA plans will be able to outperform FFS in 2020 – with average bids that are 6% lower than average FFS spending2 • HHS set a goal of tying 85% of all traditional Medicare payments to quality or value by 2016, and 90% by 20183

1. Barclays. U.S. Healthcare Distribution & Technology HCIT: What We Talk About When We Talk About Population Health. March 4, 2014 2. “An emerging consensus: Medicare Advantage is working and can deliver meaningful reform” American Enterprise Institute 3. HHS – “Better, Smarter, Healthier: In historic announcement, HHS sets clear goals and timeline for shifting Medicare reimbursements from volume to value.” Note: A MCO is a Managed Care Organization, typically a health insurance company © Oliver Wyman | NYC-MKT24601-002

Providers and provider-integrated players, with their depth in the clinical realm, show impressive population health and quality results Provider-driven population health management impacts

Provider-integrated MA plans dominate STARS

12% Reduction in total health care costs 48% Fewer ER visits In Atlantic City

41% Fewer hospital admissions 40% Increase in prescription fills 56% Fewer hospitalizations for CHF patients 18% Cheaper than FFS Medicare 80% Members who have told a friend

1. 2015 STARS rating fact sheet. Depicts MA and MA-PD plans Source: Caremore and Oliver Wyman analysis, 2010; www.slideshare.net/JoinAvado/iora-health ÂŠ Oliver Wyman | NYC-MKT24601-002

In 2015, 12 out of 13 5-STAR MA contracts are payer-provider integrated1 10

Real value in health care is not zero sum… …it is achieving better health outcomes at a lower total cost

We see a multitude of consolidation strategies in the market – Ranging from horizontal, like-like integration to bolder, strategic vertical plays Like-like horizontal consolidation Easier & Near-Term Approach

Strategic vertical Strategic vertical alliances – integration/consolidation JVs, ACOs, CINs Challenging & Long-Term

Traditional cost take-out and improve FFS margin

Financial gains

4–6%

Impact and • Scale-driven efficiency gains effectiveness • Reduced competition and innovation

Clinical transformation to value through expansion of scope of care delivery 10–25% • Significant benefit from transformation of care delivery • Population health-centric mission leads to improved quality of care and outcomes

Like-like consolidation delivers admin and efficiency benefits in the near-term, but does not enable consumer value transformation as vertical integration can Source: Oliver Wyman analysis © Oliver Wyman | NYC-MKT24601-002

Exciting examples of innovation are surfacing through vertical alliances and integration â&#x20AC;&#x201C; Payers and providers are finding new models for partnership Like-like horizontal consolidation Easier & Near-Term

Strategic vertical alliances (JVs, ACOs)

Strategic vertical integration/consolidation Challenging & Long-Term

Detailed on subsequent slide ÂŠ Oliver Wyman | NYC-MKT24601-002

Innovation Health is an example of Aetna’s strategy to partner with health systems and provide enablement solutions to support transformation Partners

• Innovation Health is a partnership between Aetna Accountable Care Solutions and Inova • The partnership has developed commercial and MA HMO and PPO products in Northern Virginia, as well as self-insured group products • Successful first year of the partnership (2013) – achieved growth of 140 K members

"Both Inova and Aetna believe that shared accountability translates into a powerful new value proposition for consumers… This joint venture with the region's largest health system signals a new level of Aetna's commitment to payment reform and stronger provider collaboration." – Mark Bertolini, CEO, Aetna

Anthem Blue Cross and seven Southern CA health systems have partnered to create Vivity, a regional integrated health system with HMO product Partners

• The Vivity partnership is a JV between Anthem and seven health systems which will use a capitation model – All partners pool premiums and share financial risk/gain equally – Providers held to quality of care, efficiency targets • Vivity aims to reduce costs through improved data sharing and care management

This integrated approach I would call game-changing in the Los Angeles marketplace.

• Coverage launched January 1, 2015 – Joseph Swedish, CEO, Anthem Sources: “Hospitals and Insurer Join Forces in California,” New York Times, September 17, 2014; “Reform Update: Will Anthem's Vivity gain traction among large employers?” Modern Healthcare, September 18, 2014 © Oliver Wyman | NYC-MKT24601-002

Tandigm Health is a new venture focused on empowering and incenting PCPs to improve quality and reduce unnecessary utilization Partners

• Tandigm launched in April 2014 as a JV between Independence Blue Cross (IBC) and DaVita (HealthCare Partners) • The model is PCP-centric – Tandigm sees PCPs as a customer, prioritizing collaborative design and service, and assuming all risk for membership served • Tandigm was launched to address record high utilization in the Philadelphia market

Great care starts with a trusting relationship between the physician and the patient. This new company will work in tandem with primary care physicians to create a new paradigm of high-quality, affordable health care – Tandigm Health. – Daniel J. Hilferty, President and CEO, IBC

Healthcare organizations are grappling with their course of action: Get bigger to gain scale, or go deeper through vertical integrations?

Like-like consolidation to achieve greater scale

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VS.

Targeted vertical investment and integration to broaden capabilities

Three major business model archetypes for payers to consider Skinny and Simple

Value Experience

Healthcare Partner

Value Vision

Low cost, simple health insurance

Superior experience from high Trusted advisor to help you value, preferred providers navigate & make better choices

Solution Design

• Narrow network, high deductible, operational excellence

• Alternative product focused • Healthcare service model on care and experience • Advice and access • Partnered or owned assets

Price • ~10%, Highly certain Advantage

• 10%, up to 20%+ long term • Varied certainty unless full • 10%, up to 20%+ long term risk

Experience • Moderate to low Potential

• Med-High, but variable

• High, and unique

Strategic Control

• Low • Low-High (varies by exclusivity) • Relatively easy to replicate • Brand value accrues to • Provider consolidation partner, vs. Payer threatens

• High • “Own” consumer influence, network becomes “irrelevant”

To Consider

• Short-term must-do • Partner or own assets? • Major scale to sustain • Avoid commoditizing • Local vs. absolute scale? • Challenge of scaling

• Major change in business • Layer with other strategies • Scale vs. investment?

Keys to success in considering vertical integration strategies

• Don’t fear vertical integration

− All M&A is challenging – 60−70% of deals overestimate synergies1,2

• “Smart” test and learn

− Systematic approach to testing “small bets” vs “spaghetti against the wall”

• People and culture matter

− Know who you are about to marry, don’t try to change them

• Align, align, align

− Clear objectives that are purpose built − Must be win/win for a partnership to work

• Its all about execution

− Leadership makes all the difference − Relentless alignment to objectives, ruthless accountability, and continuously adapting

1. When to Walk Away from a Deal. Harvard Business Review. April 2004 2. Where Mergers go Wrong. McKinsey on Finance. Number 10, Winter 2004 © Oliver Wyman | NYC-MKT24601-002

www.oliverwyman.com blogs.oliverwyman.com/healthcare/

ÂŠ Oliver Wyman | NYC-MKT24601-002