Talking Transitions

When Generations Collide

2011-09-13T13:27:00.000-07:00

Fact: Equity prices have wallowed for ten years and counting.
Fact: Financial market turmoil has wiped out retirement accounts.
Fact: Young people are experiencing an unemployment rate twice the national average.
Fact: Consumer deleveraging is likely to persist indefinitely, at least until employment rates and income levels rise.

Where once a young person could find employment, embark on a career and expect to retire comfortably, that social expectation no longer exists. Instead, young people and people near or at retirement find themselves competing for jobs in an economy that simply isn't meeting their demand.

The Perspectives article "Age and the Workplace" considers the evidence for this emerging generational conflict. The supporting numbers extend beyond months and quarters to encompass years and decades. Even if the economy were to turn, the trends in place won't alter anytime soon.

For companies and government to remain competitive, corporate strategy and public policy must address this powerful new social dynamic.

Read "Age and the Workplace" here.

Deleveraging and Consumerism in Health Care

2011-09-02T10:38:00.000-07:00

Consumer deleveraging has instigated a changed mindset.

Although many economists would argue that the debt removal process has much further to go, consumer downsizing thus far has substantially altered behavior. Note, for example, depressed sales in big ticket items.

If consumers, by living more within their means, develop a greater respect for risk, then their approach to health care will likely change as well.

Prior to 2008, in the riskless world of super-sized SUVs and flat-screen TVs, carefree lifestyles repudiated value-based decision making. Today's risk-averse world could easily nurture opposite inclinations that endure.

For health care, the process of payers offsetting responsibility to consumers constitutes (potentially) a similar effect. At least one can hope that government will begin to discern its own approach to value, rather than dictate one to others.

Consumers, by already starting down the road of personal responsibility, should in fact consume health care more efficiently (and responsibly) than they otherwise would have in years past.

In health care's next phase, expect a more balanced approach to risk and return in combination with a general trend towards consumerism to establish a value equation that eliminates years of built-in inefficiency.

Read "Alternative Themes in Health Care" here.

Bad Consequences

2011-08-30T15:02:00.000-07:00

"Bad consequences often follow even the best-intended government action," notes a commentary in Perspectives. Although Hurricane (and later, and more damaging, Tropical Storm) Irene may cost billions, the financial burden could have been worse—much worse.

In yet another example of government intending to protect the less fortunate but doing the exact opposite, the state of Florida in 1993 established two insurance funds to offset planned rate hikes by private insurers. Nearly 20 years later, both funds, despite having become the insurer and reinsurer of first resort, lack anything close to adequate capitalization.

Had Irene barreled into Florida, its impact could have forced a federal government bailout amounting to billions of dollars.

The fact that Florida remains at continuous hurricane risk only adds to the future cost.

What's more, Florida's subsidized insurance overwhelmingly favors the wealthy, those folks most likely to own waterfront properties. In classic big bank fashion, it evokes "heads I win, tails you lose".

The alternative, an environment advocating personal responsibility, would put risk and return into proper balance, and eliminate unnecessary cost.

Read "Case Study: Florida Catastrophic Insurance Funds" here.

Individuals Taking Charge

2011-08-23T07:12:00.000-07:00

"Government needs to foster an environment of resiliency, innovation, and risk taking, and enable a population willing to commit time, labor and money," notes a Perspectives article. "It cannot shield success from failure."

Beyond malicious bankers and politicians, we all need to look hard in the mirror to realize the full extent of blame for the 2008 financial crisis. For decades now, the United States has been losing its sense of risk and return.

Today, most people believe simply that the economic system will heal itself and things will get better. In times past, folks distrusted system solutions as infringements on personal freedom, and endeavored to take direct control of their own livelihoods.

Entitlement programs such as Social Security and Medicare have accelerated this moral shift from responsibility to dependency, and, at the same time, skewered financial judgment. Had consumers possessed better acumen it's unlikely they would have closed their eyes to downside risk to the extent they did throughout the housing boom.

The United States now confronts the difficult task of rediscovering and affirming individual responsibility. Failure to do so damages the nation's future competitiveness, especially against China, India and other emerging countries and their brands of capitalism and democracy.

We can begin by putting consumers more in control of health care, breaking apart massive concentrations of capital (institutions, for example, that are too-big-to-fail), and reforming the tax code to emphasize long-term investment and business building.

The fact that we can no longer afford top-down measures provides some hope that the shift away from dependency will begin sooner than later.

Read "A Deeper Problem in the Credit Crisis" here.

Biosimilars on the Brink

2011-08-22T13:34:00.000-07:00

Biosimilars—follow-on products of innovator biopharmaceuticals—will transform the drug marketplace, according to Steve Grossman writing in Perspectives. This despite substantial skepticism.

Starting as early as 2014, FDA approval of biosimilars could begin to accelerate. Once price competition kicks in, industry economics will transform.

Although the FDA may not issue guidance for several months, recent publications and industry interactions suggest that key officials are already laying the groundwork for these products. Drugmakers, meanwhile, are considering new business models, and, in some cases, committing substantial investment dollars and defining a new product line.

Read "Biosimilars and Market Transformation" here.

The Brick Wall

2011-08-10T14:58:00.000-07:00

We often ask Lyceum participants to speculate on the moment when health care hits the brick wall—that point in time when the reimbursement system goes from unsustainable to insolvent.

Consensus typically points to Medicare and argues five, maybe ten years. Real reform (the kind that truly transforms the industry), folks continue, won't happen until the current system hurtles headfirst into the wall. All other policy action is too watered-down, too constituent-wary.

Fast forward to last weekend (August 5th). Calling a spade a spade in political ineptitude, Standard & Poor's finally published its historic downgrade of US long-term debt. Symbolic, perhaps, but not without considerable consequence.

Yet again, as giant global banks reel, we confront the systemic challenge of too-big-to-fail, painfully realizing that lawmakers and regulators had done nothing to contain its malignancy.

But the fear this time that policymakers have nothing left—no more QEs, exorbitant stimulus packages, or magic bullets—in fact gives 2011 a certain hope that did not exist in 2008.

This time, we might just have to bite the bullet and reconsider how the whole damned system works, from tax law to entitlements.

As no time before, this new reality stands up—like a brick wall—against the great unfunded onslaught of government health care.

What degree and what duration of pain, then, are policymakers willing to exert on the electorate before taking action? Trillions more in stock market losses? Days, weeks, or even months of deliberations?

The sooner the better, we say. Any longer, and the shattered brick wall might just bury us.

ACOs Beyond Payers and Providers

2011-08-04T13:56:00.000-07:00

Accountable Care Organizations (ACOs) don't just represent new business opportunities for payers and providers. Diverse stakeholders from pharmaceutical companies to employers could realize significant business gains in forming targeted partnerships, according a recent Lyceum newsletter article.

"[T]he opportunity is significant for new entrants willing to provide the capital, organization, governance, and leadership to create new relationships with physicians that could dramatically change the health care landscape."

The fact is, most physician practices can't organize themselves into ACOs alone, due to limited resources. They want to realize an ACO's business and clinical control, but fear that partnerships with health plans and hospitals would compromise that control.

As defined in the Medicare Shared Savings Program, ACOs could feature a range of stakeholders as the principle organizer—not just deep-pocketed payers and providers. Such structures could channel substantial benefits to all parties.

Read "Help Wanted: ACO Leadership" here.

Understanding Risk Adjustment

2011-07-30T18:12:00.000-07:00

On Wall Street, capital markets facilitate securities' pricing and allow for efficient capital allocation. Buyers and sellers bid and offer prices based on multiple data points, and, in many cases, gut feeling. Risk—the uncertainty of systemic and non-systemic factors—plays a key role.

Market participants apply different models (some sophisticated, some not) to ascertain the value of a security. Their collective input generates a market bid-ask spread, not always accurate but in most cases more accurate than any one entity could otherwise determine over an extended time period. (Of the 8,500 plus mutual funds almost none beats the market consistently.)

Seems like logical process, right? Well, we should be at least familiar with it since we engage in price discovery in just about every aspect of our lives. That is every aspect except for health care.

In health care, the actual delivery of care (going to the doctor for a checkup, for example), a transparent price discovery process does not exist. Health plans contract with provider groups to pay fees for services that physicians perform. The price setter is in many cases the U.S. government, specifically Medicare the single largest payer which covers health care's highest utilizers, folks aged 65 and older. (Picture Goldman Sachs times one hundred, and everyone else following its lead.)

Unlike the capital markets, a transparent marketplace does not exist. Commercial health plans don't compete across state lines, and within states, plans can exercise near-monopoly power.

Moreover, because of the first-dollar nature of health insurance, what plans charge beneficiaries in premiums includes considerable actuarial assumptions about the health of their population, and how this changes over time.

Health reform (whether the Patient Protection and Affordable Care Act, "PPACA", or competing proposals) targets fundamental change in the payment system.

PPACA requires plans to offer equal access and prohibits differentiated pricing based on health status. It also establishes the formation of accountable care organizations ("ACOs"), care coordination vehicles that require providers to assume degrees of risk.

As a result, risk selection—a result of not having full information in the marketplace—is shifting from plans to providers as a business strategy.

But before providers can consider selecting risk they need to model and quantify it first. Not an easy task when patient populations vary substantially, depending on demographics and location.

The process of measuring risk factors for the purpose of risk-adjusted reimbursement is called simply risk adjustment. (Something that Wall Street does quite efficiently in a marketplace setting.)

As with any type of modeling, risk adjustment is an imperfect science, especially as it pertains to a price discovery process that involves thousands of beneficiaries but only one payer and one provider.

In a recent white paper written for the Massachusetts Medical Society, Milliman, the actuarial consultancy, tackles the intricacies of risk adjustment and submits key principles that both the payer and provider need to heed when looking to form ACOs. [Read the Milliman paper here.]

Many people, the Milliman paper explains, view the ACO concept as a viable alternative to the existing fee-for-service payment system. Not waiting for the U.S. government, commercial entities have already conceived and deployed ACO-type models, which included both a risk-adjusted global payment and a performance-based payment.

The government model continues the fee-for-service system but introduces additional payments based on a set of benchmarks for health care costs, outcomes, and quality. HHS is expected to recognize risk adjustment tools that will determine how much it reimburses groups for exceeding these benchmarks.

Milliman lists the following five key risk adjustment design principles:

The groupings of medical conditions in a risk adjustment model should be clinically meaningful and reasonably specific, in order to minimize opportunities for gaming or discretionary coding.
Diagnoses within the same condition category should be reasonably homogeneous with respect to health care cost and utilization, in order to optimize predictive accuracy and robustness of the model.
Condition categories should have adequate sample sizes, to permit accuracy and stability of model predictions.
The risk adjustment model design should encourage specific coding and discourage vague coding. Vague codes and nonspecific diagnoses should be excluded from the risk adjustment model
The risk adjustment model should not reward coding proliferation. Providers should not be penalized for recording additional diagnoses. In other words, coding more diagnoses should not reduce the risk scores.

"When used to set payment rates," the Milliman report continues, "a risk adjustment methodology needs to strike a balance between predictive accuracy and incentives issues." The problem is physicians are human just like the rest of us, and will arbitrage gaps in mandates and models to realize additional compensation. A risk adjustment model needs to take this into account and avoid awarding overuse and overtreatment.

The ACO environment requires additional principles to address the organization's core competency and patient assignments. Under an ACO structure, the care delivery entity (a hospital or physician group practice) bears responsibility for assigned patient outcomes regardless of who ultimately provides the care—for example, a patients seeking care outside his assigned ACO.

What's more, there isn't a single risk adjustment model. Selecting and engaging a risk adjuster involves a detailed understanding the model itself and how it compares with different vendors.

And there's the matter of coding, the record-keeping system physicians use to indicate diagnosis and treatment. How physicians enter codes affects risk scores, and the coding system itself (encompassing tens of thousands of codes) is changing to an even more extensive system—a sort-of Y2K for health care—with the introduction of ICD-10-CM.

Imagine now that you're a physician and that your practice or affiliation is considering an ACO structure featuring a highly sophisticated risk adjustment process.

For many, the obvious answer is 'why bother?' At least in the fee-for-service model you had a clearer understanding of what your reimbursement rates were. Your compensation now comes down to a pool of money that the ACO's officers will allocate based on a black-box model.

Some who see no benefits in either system are existing the insurance model altogether, or simply vacating the profession.

Over recent years, Wall Street hasn't exactly demonstrated perfection, but at least the marketplace model is transparent. The answer to risk adjustment's complexity as it's implemented might just be market competition and consumer choice.

A Dangerous Political Climate and the Path to Growth

2011-07-28T14:48:00.000-07:00

Try not to gag on this one. At the end of 2008, J.P. Morgan encompassed $1.7 trillion in assets. Today the bank is 25 percent bigger at more than $2.1 trillion.

Despite extensive postmortem analysis on the financial crisis and the universal conclusion that capital concentration is dangerous, too big to fail rages on. In fact, the agency mandated a year ago to monitor this very risk factor isn't even fully functioning and remains leaderless.

At the same time (and more cavalier than three years ago), politicians are hurling ideological barbs at each other, while failing to acknowledge the economy for what is—an engine of prosperity.

Two recent articles in the Lyceum newsletter Perspectives address the worsening political climate in Washington and argue the benefits of simply letting private industry do what it can do.

As long as political extremism overheats the United States and Europe, the challenges of restoring economic recovery and long-term growth will remain unmet. The horrific shooting tragedy in Norway should shake each and everyone of us awake.

It exposes a tense political environment that extends beyond the tiny Scandinavian country. It underscores the need to resolve festering financial problems.

Read "The Path to Growth" and "A Dangerous Political Climate" in Perspectives here.

Care Delivery Doesn't Require a Radical Makeover

2011-06-27T12:06:00.000-07:00

Think of the Patient Protection and Affordable Care Act (PPACA) as legislation in two parts. The first part puts in place insurance reform. Its highly contentious features, including medical loss ratio provisions and the establishment of insurance exchanges, extend government control over the insurance industry.

The second—and much smaller—part initiates reform of the care delivery system. The centerpiece provision, originally just a few pages in length and now several hundred in follow-up rules, formalizes the creation of accountable care organizations (ACOs).

Few would argue that the care delivery system as it currently functions creates the necessary value to sustain the long-term health of the U.S. population. More aptly, value, in terms of costs, quality and outcome, does not even exist as a metric that stakeholders uniformly agree upon.

ACOs, PPACA's authors believe, establish critical functions that occur only in part or not at all: continuum of care, seamless integration, and risk sharing across providers. Consider its propagation the manifest destiny of the Kaiser model.

Dawn Holcombe, writing in Perspectives, disputes the ACO vision. She supports the counterargument that ACOs would accomplish little more than forced consolidation of hospitals and physician practices. Applying her extensive experience in community oncology, she advocates a simpler reform process that emphasizes collaboration and basic information flow between payers and physician practices.

Hospitals, because of their vast inefficiencies and top-line incentives, would make terrible partners. In the case of oncology, they account for 80% of the costs.

The key, Dawn contends, is to promote the entrepreneurial efficiencies of community practices, not destroy them.

Read "Care Delivery Doesn't Require a Radical Makeover" here.

Book Review: 'Reckless Endangerment'

2011-06-23T06:31:00.000-07:00

Every now and then—but hopefully not too often—you read a book that just makes you spitting mad. Not because you disagree with the author's point-of-view, but because he's completely sold you on his can-you-believe-this premise.

In three-hundred pages, Gretchen Morgenson, a Pulitzer Prize-winning business reporter and columnist at The New York Times, and Joshua Rosner, a financial service analyst and expert on the housing market, present a powerful indictment of high-profile individuals who wittingly undermine the U.S. and global financial systems in their pursuit of vast riches.

Their book, "Reckless Endangerment", explains the origins of the financial crisis, the political and economic gains of blind commitment to homeownership, and the betrayal of American taxpayers—most notably, those at the bottom-end of the economic ladder.

Not one of the individuals they detail has gone to jail. Nor will they ever likely pay penance. In fact, some still preside over our political and financial systems.

All remain wealthy (extremely wealthy in some cases), if suffering somewhat-damaged reputations. Bank of America, at the time the new owner of Countrywide Financial, covered, for example, most of the SEC's $67 million fine against Countrywide's CEO Angelo Mozilo, accused of insider trading. Mr. Mozilo's net worth totaled more than $500 million.

The authors deliver substantial evidence, much of it gleaned from years of investigative interviews and note-taking, against people such as Jim Johnson, Robert Rubin, Barney Frank, Chris Dodd, Timothy Geithner, and Mr. Mozilo. Their laundry list includes both Democrats and Republicans, and leaders of the biggest financial institutions in the world.

In particular, they assail Fannie Mae and Goldman Sachs, and the relationship the two institutions form. Both established and exerted considerable market power that prioritized no one but their management teams and employees. Their pretense of serving customers and doing social good was pure hypocrisy—even criminal, as the authors suggest.

Jim Johnson, who transformed Fannie Mae into a personal ATM, left the GSE (Government Sponsored Enterprise) in 1998 a decade before the crisis. Nevertheless, he did more than anyone to position the organization for scandal and abuse. Shortly after resigning from Fannie Mae, he became a board member of Goldman Sachs and head of the firm's compensation committee, a role he performed through 2010.

Likewise, and at the same time, Stephen Friedman, who had run Goldman Sachs from 1994 to 1996, chaired Fannie Mae's compensation committee. His tenure as a board member included Fannie Mae's purchase of a Goldman deal designed to inflate executive compensation, which, as later played out, perpetrated accounting fraud.

"Of all the partners in the homeownership push, no industry contributed more to the corruption of the lending process than Wall Street," write Ms. Morgenson and Mr. Rosner. "If mortgage originators like NovaStar or Countrywide were the equivalent of drug pushers hanging around a schoolyard and the ratings agencies were the narcotics cops looking the other way, brokerage firms providing capital to the anything-goes lenders were the overseers of the cartel."

While the authors highlight Peter Orszag and other noted economists who endorsed the GSEs despite overwhelming evidence contradicting their economic security, they also showcase less well-known individuals who dared to expose the organizations' systemic risk. These include Marvin Phaup and June O'Neill of the Congressional Budget Office, and Armando Falcon, who directed the Office of Federal Housing Enterprise Oversight ("OFHEO"), the regulatory body overseeing the GSEs.

Beginning with President Clinton's political pursuit of homeownership in the early 1990s and culminating in the repeal of Glass Steagall, the country adopted a big institution mindset, where public-private partnerships could provide homes to any person with any credit rating and Wall Street could package high-risk debt and redistribute it as zero-risk debt—of course, with the blessing of the ratings agenices.

At the same time, global events realigned capital flows, a consequence of the Cold War ending and a massive peace dividend taking effect. Times were good, but, by decade's end, clear warning signs had surfaced: the Russian debt crisis, the collapse of Long-Term Capital Management, and the first demise of the subprime market.

After the dotcom meltdown and the mild recession that followed, Alan Greenspan and the Federal Reserve pursued historically low rates. The Wall Street machine kicked in at this point, extracting every penny possible from the U.S. housing market and reaping huge fees at each stage of the securitization process.

When consumer savings rates should have risen, they fell. But everything was safe, according to Mr. Greenspan. The bigger the financial institution, the more it could self-regulate. Risk models, he and others pointed out, were more sophisticated than ever before, and derivative instruments could offset sharp market contractions without having to increase capital ratios.

In 2007, the game ended. Still, we feel its repercussions. Many, including the authors, argue that the financial system and the political process haven't changed. Wall Street's record profits against the backdrop of a struggling economy in the two years following the crisis certainly support this.

What has changed is consumer appetite. High unemployment and a fear of indebtedness have curtailed aspirations of second homes, super-sized SUVs and floor-to-ceiling TVs. Until the consumer regains his confidence, the next bubble might be some time off. But if lawmakers and regulators haven't actually altered the system—restricting too-big-to-fail and breaking apart and privatizing Fannie Mae, for example—then the next crisis could closely resemble the one we've just experienced.

Blame, Ms. Morgenson and Mr. Rosner argue, can and should be made. Beyond anyone else, Wall Street, the mortgage lenders, Fannie Mae and to a lesser extent Freddie Mac, and a handful of politicians understood the game and its complexities.

To win that game, they often crossed ethical and, in some cases, legal boundaries.

Improve Post-Market Safety, Improve a Drug's Entire Life Cycle

2011-06-22T07:11:00.000-07:00

The drug industry and its watchers often define success as the approval of a new product or indication. The FDA's responsibilities don't end there, however.

Writing in Perspectives, Steve Grossman notes that the agency's mission includes "determining whether already-approved drugs perform safely and effectively when used by large numbers of patients in routine medical practice."

The problem is, post-market surveillance utilizes data that's neither easily obtainable, objective, nor complete. To bolster this effort, the FDA has been developing a monitoring system called Sentinel, which incorporates not just claims data but medical records and patient registry information.

Mr. Grossman argues that a more comprehensive system such as Sentinel would greatly improve the entire life cycle of a biopharmaceutical product, and benefit all stakeholders at the same time.

After-market assurance, for example, would likely increase the FDA's drug approval rate, in particular of those on-the-fence products that clinical trials don't complete satisfy.

Read Mr. Grossman's article "Standing 'Sentinel': The FDA and Post-Market Safety" here.

Where Have All the Investors Gone?

2011-06-21T11:39:00.000-07:00

Let's face it. Slow economic growth is here to stay.

Among the biggest issues weighing down growth is concern over sovereign debt, and the more general fact that de-leveraging has (much) further to go. While upticks in some developing markets may lift exports and help avoid another recession, the U.S. consumer has neither the wallet nor the optimism to resume recent years' spending levels.

Add to this austere picture, disappointing corporate earnings, incipient inflation, uncertainty over market regulation, and Middle East unrest, and the prospect of stock market gains appears to dim considerably.

Don't be so pessimistic, notes a recent Perspectives article. Even during the years following the 1929 collapse, returns outpaced inflation.

Most important, market participants need to believe in the long-term.

Read "Where Have All the Investors Gone?" here

The Provider Business Model

2011-06-03T06:14:00.000-07:00

On May 31st, Lyceum Associates convened a roundtable session in New York on provider business models. Represented organizations included major commercial health plans, an alternative primary care delivery model, a mid-sized employer, a global consultancy, and a national hospital association.

In addition to several specific points, we realized the following, more general takeaways:

More than ever, health care's participants apply the term 'value' to performance, even if they don't always agree to an exact definition. The result: price, cost and quality now function as interlocking components, and few dispute that the heath care system operates as an economic good.
On integration, many advocate it, but they should not view consolidation as the same effect.
On care coordination, monopoly pricing risks curtailing wide adoption.
On cost rationalization, the rule that 'one person's waste is another person's profit' will constantly contravene.

The provider—especially the independent physician—confronts the greatest economic uncertainty among the health value chain's components, both in terms of pricing power and market positioning.

Over the coming weeks, Lyceum events will consider this uncertainty as a central topic, with emphasis on July 14th at our roundtable summit.

Learn more about Lyceum events here. We look forward to including you!

Gold Standard in Clinical Oncology Care Guidelines

2011-05-27T07:08:00.000-07:00

Most stakeholders agree that clinical guidelines support effective and efficient treatment. Most also agree that the National Comprehensive Cancer Network (NCCN) publishes the most extensive guidelines.

Until now, no one has created a powerful-enough technological platform to allow physicians to utilize the full extent of NCCN's guidelines.

The April 1st launch of Proventys CDS Oncology—a product of NCCN and Proventys, a health care technology company—dramatically alters the landscape. The new web-based system features extensive algorithms that enhance the decision-making process, and, once and for all, advance the industry beyond its bickering over guideline platforms.

Lyceum Roundtable Summit

2011-05-20T10:00:00.000-07:00

SAVE THE DATE!

On July 14th in Washington DC, Lyceum will host a roundtable summit analyzing opportunities and challenges facing the care delivery system, related corporate strategy, and new business models such as ACOs and other care coordination platforms.

The event features three roundtable tracks of eight to 14 participants. Each track breaks down into two separate three-hour sessions. (See below)

View details here. Indicate your interest in participating here. Official enrollment will commence shortly.

"The Provider Business Model"

Track One: "Leadership"

New delivery models featuring care coordination and integration threaten to destabilize the marketplace. Whether large systems or small practices, health care providers now more than ever require capable, business-minded leaders.

What defines a capable leader?
How important are value, accountability and customer satisfaction as business goals?
Over the next two to five years, which providers will gain economic share, and which will lose?
How should leaders expect the relationship between physicians and hospitals to evolve?

Track Two: "Data/ Performance Measurement"

Many industry people expect data and performance measurement tools—such as e-prescribing and electronic health records—to enable economic gains for physicians and health care providers.

Are these expectations too optimistic?
Should provider groups strive for data control? If so, what type of data?
To what extent are payers, by diversifying into IT businesses, recasting the health value chain?

Track Three: "Risk Management"

Efforts to diminish or discard the fee-for-service payment system are accelerating. Replacement models may incorporate varying degrees of provider risk taking. At the same time, health reform threatens to eliminate competition in insurance underwriting.

How much risk and what type of risk will providers likely assume?
How does the demand for risk management expertise alter market positioning among and between payers and providers?

Imprison Criminals, Not the Street

2011-05-17T07:41:00.000-07:00

Unless an appeals court overturns his conviction, Raj Rajaratnam faces considerable time behind bars. His actions could not have been more blatant.

More important than one man's crime is the alarm spreading across Wall Street. For the first time, a federal judge admitted wiretapping as evidence in an insider trading case. Will prosecutors take advantage of a big win and vigorously pursue other fund managers?

Also, there's the question of Wall Street's basic model and how it deals in information. Will the Galleon Case produce extreme legal burdens that overwhelm a system requiring, in the interest of price discovery, speed and efficiency?

"Imprison Criminals, Not the Street" tackles these issues and more in the current issue of Perspectives.

Health Plans Transforming Themselves

2011-05-12T10:54:00.000-07:00

As the chart below shows, the five largest health plans have thrived since President Obama signed the Patient Protection and Affordable Care Act into law, outperforming the S&P 500 by between ten and sixty percent. Beginning a few years ago, commercial plans began diversifying away from their core underwriting and ASO franchises. In recent months and to market cheer, they've accelerated these efforts, in order to combat eroding margins and the full impact of health reform.

The Wall Street Journal discusses this strategy in detail here.

Some questions to consider:

Are health plans more than making up for lost margins and creating more powerful businesses?
Do their diversification efforts materially disrupt the balance-of-power with providers? If so, is consolidation the only response providers have?
Could a different player—a smaller-sized insurer, for example—execute an alternative strategy and roll up out-of-favor underwriting and ASO operations?
What happens if the U.S. Supreme Court strikes down the individual mandate, or the health reform law fails to reach full impact?
What's the likelihood of underwriting competition going the other direction and intensifying?

Click on chart to expand

Source: Google Finance

Winning the Impossible Game

2011-05-09T12:13:00.000-07:00

Sometimes, in trying to impress a reader, a writer can create the wrong impression. Howard Marks, the veteran Chairman of Oaktree Capital Management and author of a widely-read client memo, tightly defines an investment philosophy that he's developed over four decades in his book, "The Most Important Thing".

While he strives to show the reader that long-term investment success requires psychological discipline (second-level thinking, as he terms it), in doing so, he re-affirms something the thoughtful investor knows already: it's nearly impossible to sustain outperformance in money management.

Investment managers, we learn, must overcome many common emotions that undermine consistent success: greed, fear, the willingness to suspend disbelief, the tendency to conform to the herd, envy, ego, and capitulation. They function in markets that are neither efficient nor inefficient, and must constantly mitigate risk exposures where they often have no clue what those exposures are.

He argues that, because cycles are unpredictable and the future is unknowable, the best an investor can do is determine where he is at present, in terms of market conditions. But even that realization is often impossible to achieve, especially if, as is usually the case, one or more negative emotions overwhelms an investor's psyche. (By implication, the clear-sighted folks might as well be needles in haystacks.)

What's more, Mr. Marks advocates Nassim Taleb's concept of alternative histories—where events that already transpired are, in fact, just small subsets of events that could have happened. In supporting this view, he dismisses, for example, an investor's great performance if that investor has assumed unnecessary risk, and luckily skirted harmful events.

Taken together, it's a miracle anyone can outperform the market for any length of time at all.

Why, after reading his book, would anyone trust his or her hard-won earnings with any individual or investment group?

To be sure, examples exist of folks who, over decades (the total time a person might buy and sell investment funds), have beaten the market, but you can probably count the number on one—maybe two—hands. Plenty more individuals have excelled over shorter time periods, but their performance showcases a small sample size (a few years) or may feature substantial losses, or both.

In either case (the long- or short-term period of outperformance), the shareholder entering and exiting a fund makes a critical timing decision that can dramatically affect his wealth's appreciation—or depreciation. Take Mr. Marks himself. He won't retain his position at Oaktree indefinitely, and his eventual departure presents considerable uncertainty to whomever purchases his funds today. (The same holds true for folks investing in Berkshire Hathaway and Warren Buffett.)

Past performance, Mr. Marks reminds us, does not guarantee future success. The shareholder, it would seem, could just as well visit the nearest casino, and claim the same chance for wealth improvement.

If investing in a money manager constitutes mostly luck—or a skill for timing (something Mr. Marks dismisses outright)—then why not create a money management operation instead? That career choice has produced vast riches for many, many different people—often far greater wealth than any of their shareholders.

Mr. Marks does not provide a model for building a money management operation. Instead, he delivers something more valuable—a complete investment framework, the operation's core competency and competitive advantage.

While investment groups can experience massive gains over short time periods, enough for its founders to enjoy a long retirement, most should plan for a long haul. Fat fees (management and, for some funds, performance) may not last forever, nor the ease of amassing assets under management—now especially challenging in the aftermath of the 2008 financial crisis.

The Graham-and-Dodd school of value investing, of which Mr. Marks is a disciple, perfectly fits a long-term approach. It produces a manager who applies patience, extreme diligence and a mental commitment to decades of work. The school—its espousal of frugality—doesn't demand that its students invest in costly trading infrastructure, super computers and complex algorithms, or ramp up risk exposure and deploy leverage and concentrated positions. Rather, it endorses in-depth, pound-the-pavement analysis, downside protection and margin of safety.

Farewell the retire-before-forty era. Pity the fool who expects to catch the next massive momentum wave, and trade his way to riches. Fads appear and disappear, back and forth Mr. Marks' pendulum swings, but steady goes the skeptical, value investor.

The long-term manager traverses the slow road of careful, defensive investing. Sexy, no. Successful business-building, yes.

Mr. Marks does not lack confidence. The book's title might well read "Everything I Have to Say is Important"; he manages, with eye-opening assertiveness, to identify each of his key statements as "the most important thing".

Of course, when it comes to money, we tend to use superlatives. And what could be more important than generating wealth-creating returns? We hope lots of things.

The first nineteen chapters explain different lessons he's learned—pearls of wisdom. Throughout the book, he interweaves excerpts from his client memo which he has published since the early 1990s. The twentieth, and final, chapter presents short outtakes from different issues of his memo, and summarizes his philosophy.

Early on, Mr. Marks distinguishes value investing from other investment styles, and cites the infamous Nifty Fifty of the late 60s and early 70s as a stark example of the perils of growth investing and misplaced risk taking. While certainly some of the companies bellied up, not only did many survive, they thrived: Eli Lilly, Coca-Cola, Philip Morris, Hewlett-Packard, Texas Instruments, and Motorola among the names he mentions. Had someone purchased and held on to equal positions in each company, that person today, forty years later, would have done quite well.

Even if Mr. Marks disparages the Nifty Fifty phenomenon, his repeated argument that patience pays is essential wisdom. An investor's career inevitably spans multiple market cycles—often extreme conditions. Confidence in long-term results contradicts our age of escalating portfolio turnover rates. For Mr. Marks and other contrary-minded investors, it's an obvious opportunity.

Finding and investing in a hot-handed fund manager may well be impossible for most people. Many more could opt to play the game themselves. Now, a manual—replete with enough catchy aphorisms to post as quotes-of-the-day for years to come—exists from which to make a business of it.

The Backlash Against Becoming Rich

2011-04-28T09:48:00.000-07:00

The latest Perspectives article, "Demonizing the Rich", highlights a key irony: "While we applaud our children's and friends' success, when those success stories translate into wealth, we chafe and claim unjustness."

Two high-octane forces explain income disparity in the U.S. One, entrepreneurship, emerges from our freedom to conceive and execute new ideas. The other, large company executive compensation, roots itself in the evolution of the corporate system (particularly in publicly-traded companies), and executives simply being executives at the right place at the right time and wanting to preserve a comfortable way of life.

For folks participating in the first force, fortune gained is fitting, because they risk failure. For those participating in the second force, fortune gained is largely fortuitous.

The article underscores a genuine problem in how corporate boards too often pay their executives undeserved sums. At the same time, it warns that, in not recognizing the other force at play, populist action and the results this action seeks could harm the pursuit of completely justified gains in income.

Rather than unwittingly suppress the entrepreneurial opportunity many individuals enjoy, we should find ways to create the same opportunity for larger numbers of people.

Read "Demonizing the Rich" here.

The Twilight Zone of Health Care Investing

2011-04-26T06:15:00.000-07:00

Writing in Perspectives, John Schaetzl, a long-time investment professional, notes a Twilight Zone opportunity where, by converging, non-profit philanthropic investors and traditional, commercial investors could greatly advance their individual agendas.

"Returns in socially-minded investments are expanding just as for-profit investments are shrinking—and at risk of further contraction," he observes.

The opportunity for coming together exists primarily in developing markets where returns are typically low and investment horizons long, and among early stage investments. "By contributing knowledge and credibility, foundations and other NGOs can smooth the road for for-profit investors, whose experience and expertise doesn't extend to developing markets and their maladies, if they become co-investors and share risk and reward."

The key for both sides cooperating is overcoming suspicion and misunderstanding of the other side's motives. Once in communication, however, the two types of investors can measure and adjust valuation for known differences.

Mr. Schaetzl's Twilight Zone concept takes into account a shifting investment landscape of decreasing returns in developed markets, elongating investment periods, and the massive volume opportunity manifest in the majority of the world's population.

But don't expect investors to realign themselves radically anytime soon. Habits and experience are strongly ingrained.

Those who do recognize the potential fortune of cooperation will likely gain substantially.

Factors Determining ACO Success

2011-04-15T07:28:00.000-07:00

"Financial success or failure of an ACO [accountable care organization] will depend on meeting rules-based budgets set by the Centers for Medicare and Medicaid Services for each ACO’s population," note five senior executives from Milliman, the actuarial consultancy. "To be successful, the ACO will need to: (1) demonstrate quality, and (2) reduce spending below targets."

The executives, whose article appears in the Lyceum newsletter Perspectives, argue that, much more than quality improvement, risk analysis is most likely to generate necessary monetary savings—especially when, three years after an ACO program commences, CMS requires the organization to assume downside risk.

"Few organizations have sufficient assets for [their boards] to gamble on the ACO program’s financial downside without carefully assessing the risk. How should they evaluate this risk? Data is important, but data does not organize itself into risk analysis."

The biggest source of financial failure won't be insufficient data, the authors contend, but failure to calculate risk.

Read 'Factors Determining ACO Success' for more insight, including a view on which providers are best-positioned to gain from an ACO formation.

The Games of Behavioral Economics

2011-04-11T07:30:00.000-07:00

In their book Scorecasting, Tobias Moskowitz, a professor of finance at the University of Chicago, and Jon Wertheim, a senior writer for Sports Illustrated, put many traditional sports beliefs through an econometric wringer.

Although the authors realize a natural audience in the legions of fans, their work should appeal to business leaders as well. Loss aversion, conformity, omission bias, random chance, and 'the endowment effect' don't just impact sports. Human nature can be universally peculiar, and companies and industry participants that recognize and act on this fact gain strategic advantages.

Take, for example, health care and the design of accountable care organizations. The Department of Health and Human Services' 400-plus pages of rules establish tightly conforming structures. And why not? Care variation, we're told, contributes directly to an ineffective and cost-ridden system.

But, in narrowing variation, do highly-conforming structures limit much-needed innovation? Is HHS, in fact, ignoring some of behavioral economics' most powerful lessons?

Whether exploring the unlikely fortunes of an Arkansas high school football coach or the perennial misfortunes of the beloved Chicago Cubs, Moskowitz and Wertheim not only debug many long-held myths; they also challenge conventional thinking.

And since sports always make great analogies, many readers will naturally look to apply the book's revelations to other aspects of daily life, including work environments.

Read our review of Scorecasting here.

Philanthropy, Sustainable Investing and a Private Journey

2011-03-31T07:21:00.000-07:00

Careers don't often unfold in straight lines, entering a company or industry as a trainee and finishing as CEO. For most folks, careers shift—often crossing industries and job titles. Just the same, these different tracks create success, though maybe not in the sense of the traditional corporate ladder.

John Schaetzl is a shifter. Over the course of his career, he's been an educator, consultant, and, most recently, investor. A few years ago, John transitioned to non-profit investing, vacating his position as a highly-regarded analyst and portfolio manager at GE Asset Management.

He explores this transition and the opportunity of 'sustainable investing' in Perspectives.

"I was an investor," writes John, "from what many folks in the philanthropic community and elsewhere might label the 'dark side', the straightforward, for-profit professional investment community.

"I wasn't a bad person or an irresponsible investor. It is just that, like the large number of institutional investment managers, sustainability concerns were not part of my mandate—my legal and fiduciary responsibility—to my investors."

Demographics, globalization and the dynamics of wealth creation have contributed to a well-organized and substantial philanthropic community. John advises some of the largest organizations in the world on how best to allocate capital.

Much of the protocol, and many of the lessons learned, in for-profit investing apply to philanthropy—but not everything, John cautions.

The non-profit and for-profit communities could in several cases function alongside each other, where appropriate jointly target the same investments.

For his effort at a point in time where philanthropy is ascendant, John contributes a rich and, most important, varied background.

Read John's article "Sustainable Investing Made Simple" here.

Drug Product Pricing 101

2011-03-28T07:33:00.000-07:00

What happens when a drug that once cost ten to 20 dollars per dose, now cost $1500? Outrage, of course.

KV Pharmaceuticals, the manufacturer of Makena a drug used to prevent premature labor for high-risk pregnancies, now confronts tough Congressional scrutiny, most notably from Sen. Sherrod Brown (D-OH) who fears the making of another Medicaid cost lever.

Steve Grossman writes in Perspectives that the Makena case provides yet another example of a drug company not bothering "to undertake a sophisticated [pricing] analysis ahead of time". He goes on to explain three approaches a consultancy—or, in the case of a large company, an internal team—might utilize to establish an effective price: value-added pricing, cost plus pricing and comparable value pricing.

For anyone looking to understand more about some of the techniques used in setting drug prices, read Steve's article.

"No one can completely avoid controversy," he notes, "but shareholders, patients, and payers are always going to respond more favorably to companies which use sound reasoning to back up their pricing."

Steven Grossman is president of HPS Group, LLC, a solution-oriented health policy and public affairs company.

The End of Work

2011-03-25T13:22:00.000-07:00

So it's Friday afternoon and everyone's thinking about the weekend. Well, not everyone. And, in fact, fewer and fewer folks as time goes by.

The unemployment rate may be receding but so is the number of folks in a job or actively seeking one. At 64.2 percent, the labor force participation rate is the lowest it's been in a generation.

According to the CBO, the participation rate may continue to decline, due to aging, women opting out, and young people choosing school instead. (Read: "More Americans Dropping Out of the Labor Force")

Hmm—aren't retirement savings still depleted? And if young people are prolonging—or creating—academic careers, how do they reconcile their mounting debt burden, especially if the economy adjusts to a lower employment rate?

Tyler Cowen submits a few questions and thoughts of his own:

1. What is the political economy of a world where so few people work?

2. What kind of low-rent areas will evolve to accommodate some of these people?

3. Will we in fact move to some form of a guaranteed annual income?

Note that the answer to #2 will affect the feasibility of #3. And our current notion of “protecting all the old people” against major health care catastrophes may someday be seen as an anachronism. The more progress medicine makes, the harder this will be to achieve and afford. Feasible future equilibria all seem to involve death panels, which actually may make #3 seem more attractive, relatively speaking, than spending so much money on Medicare. Rationally or not, once the moral principle is admitted of not giving everyone absolute protection against every extreme health care event, this may encourage a shift toward cash transfers.

At least we can expect easier traffic Fridays after five.

How to Define and Implement Accountability in Health Care

2011-03-23T13:16:00.000-07:00

Writing in the Lyceum newsletter Perspectives, Bruce Cutter cautions: "Before implementing accountability we need to define it first. This begins by understanding and addressing value: the provider's—and health care organization's—most important deliverable. Value constitutes that critical 'something' necessary to the process of becoming accountable."

His latest article, "Accountability in Health Care: Definition and Implementation", tackles perhaps the most discussed and least understood aspect of medical system reform.

If, for example, the health care system and its various actors cannot agree to a workable definition, then one of the Affordable Care Act's primary vehicles, the accountable care organization (or ACO), simply cannot function effectively.

Dr. Cutter introduces and answers three questions:

How should we define accountability?
How do accountability and value intersect?
Who should be accountable to whom?

"Ultimately," he notes, "health care organizations, and in particular their leaders, must become accountable for the care of a population of patients. This focus on populations, along with the role of the health care delivery organization (and its leadership), is a profound change from our current health care delivery model and culture."

Read his article here.

After many years of both patient care and leadership, Dr. Cutter is now a health care consultant. Key leadership accomplishments over the past ten years have included design and implementation of a community-based, integrated oncology delivery system, together with development, in close collaboration with a health plan, of a comprehensive quality initiative combined with a pay-for-quality contractual arrangement.

Book Review: 'The Social Animal'

2011-03-18T06:27:00.000-07:00

Want a job at Goldman Sachs? Well, make sure you plan ahead. Way ahead, like in high school. Because if you're applying as an undergrad and don't go to Harvard, Yale, Princeton or Stanford, Goldman won't even consider you.

Okay, maybe you're a little behind the curve, and you attended Berkeley, Michigan, Dartmouth or some other second tier elite school. There's always business school, right? That depends. Unless you go to Harvard, Wharton or Stanford, you won't have a chance. MIT, the University of Chicago, and Columbia simply don't cut it anymore.

As harsh as this seems, academic research now proves this über-selection to be increasingly prevalent. "The portrait that emerges is of a culture that’s insanely obsessed with pedigree," notes one commentator.

If you're Goldman Sachs, Morgan Stanley or McKinsey, why not simply outsource your corporate recruiting to a college admissions officer? After all, most of your corporate leaders attended these schools anyway, and it saves time and money to narrow your source pool.

Entry to big banks, big consultancies and big, well, anything is nothing more than an intellectual achievement game. By not attending a super-elite university, the candidate has already failed.

How did we get to this point? Our big institutions were never this big, and, once, a long time ago, social frameworks determined success, not college admissions officers. David Brooks' new book, The Social Animal, helps us to formulate some answers.

According to Mr. Brooks, who is a New York Times columnist, we live in a bifurcated world. On the one hand, we promote high-achieving cognitive skills, and, on the other hand, we ignore intuition and valuable "soft skills". In his fascinating book, Mr. Brooks describes this great social fissure from the perspective of two characters, Harold and Erica.

As a child, Harold enjoys two loving, married parents. He plays with imaginary friends, his stories end happily, and he cries when his parents go out to dinner on Saturdays. In high school, he comes across an English teacher who imparts a new way of learning. Her method turns Harold from a professional student zeroing in on the right college into a knowledge acquirer, a person who understands the details because he understands the context.

Erica, in contrast, grows up in a broken home, mostly in poverty. She is the child of Mexican and Chinese immigrants. At age ten, she almost gets arrested. Erica is an ambitious person, which we observe when she gains admission to the Academy, a new school built to break its students of poverty's vicious circle by surrounding them with an entirely new culture and a web of new relationships.

Circumstances eventually bring Harold and Erica together. They wed, and we follow their lives and careers, from adulthood to old age and death.

An illustrative writer, Mr. Brooks delivers a powerful narrative. His book assimilates studies in neuroscience, psychology, sociology, and behavioral economics to paint a composite picture of the world in which we live. He often interweaves these studies to explain his characters' comments and actions.

Mr. Brooks' multidisciplinary study works because he creates empathic characters, which he needs to achieve because his subject matter is complex. His characters anchor the book, keeping Mr. Brooks' wide-ranging commentary and multiple scientific citations from drifting and dissipating.

Most important, they succeed in drawing the reader into the story. They resemble people we know. In many ways, they are ourselves.

Towards the end of the book, when Erica's career takes her to Washington, Harold joins a think tank and espouses the Hamiltonian tradition.

Harold found himself in a nation with two dominant political movements. There was a liberal movement that believed in using government to enhance quality. There was a conservative movement that believed in limited government to enhance freedom. But historically, there once had been another movement that believed in limited but energetic government to enhance social mobility.

Alexander Hamilton, a destitute orphan by age 12, became the "most successful treasury secretary in American history". He created a political tradition that inspired Henry Clay, Abraham Lincoln and Teddy Roosevelt and survived until the twentieth century, when it promptly died.

Subsequent government policy, Harold observes, has tried to "fortify material development but weakened social and emotional development that underpins it".

For Harold (and Mr. Brooks), Hamilton embodies a social construct where local communities matter and social fabrics form to allow people to improve their lives as individuals. It emphasizes intuition over IQ, recognizing that what we unconsciously know is more substantial and more powerful than what we consciously know.

Appearing thematically throughout the book, this construct makes for better decision making and more effective organizations, whether business or social structures. Reason and emotion aren't separate or opposite, as Mr. Brooks notes. In fact, they intertwine. The unconscious mind (emotion) assigns a value to a choice; the conscious mind (reason) makes decisions based on those values.

The ten largest financial institutions in 1990 controlled ten percent of U.S. assets. Today, they control 70 percent. At the same time that fewer organizations—whether in finance, health or the retail trades—dominate larger portions of the economy, the leadership pool is narrowing. Social mobility, Mr. Brooks would argue, has become more difficult, and entrepreneurship more incestuous, a consequence of the right schools rather than the right skills.

For an individual to matriculate at the nation's most elite schools, he must demonstrate high scores in various aptitude and achievement tests, none of which measure his total social performance simply because reductive reasoning, which the tests measure, cannot explain dynamic complexity, which characterizes the world in which he will live.

The pity of today's big banks and big institutions, then, is their narrow definition of human capital and inability to achieve a value-aware culture, with the 2008 financial crisis the starkest manifestation of this weakness.

Mr. Brooks expertly addresses a societal problem that continues to worsen. He writes of his book, "This is the happiest story you'll ever read. It's about two people who lead wonderfully fulfilling lives."

His characters are not flawless. We see them as ourselves. And yet, they observe and navigate the world differently. They are happy because they understand how the human mind works, and, together and separately, make the most of this understanding.

What Happens to Employer-Based Insurance?

2011-03-09T18:24:00.000-08:00

The latest Health Affairs Policy Brief addresses the question of what happens to employer-based insurance by considering opposing viewpoints. While there's no clear answer, the likelihood of an employer not maintaining coverage does appear to decrease with the size of the organization.

Beginning in 2014, the Affordable Care Act requires employers with more than 50 full-time employees to offer qualified health insurance coverage, or pay penalties. A qualified plan must be comprehensive (pay at least 60 percent of health care expenses) and affordable (cost less than 9.5 percent of employees' household incomes).

According to the CBO, 6-7 million people would acquire employer coverage for the first time because the requirement would increase workers' demand for coverage through their jobs. Another 1-2 million, who currently have employment-based coverage, would instead move to the exchanges because the coverage would be more affordable. About 8-9 million others covered under an employer plan under current law would lose employer coverage because firms would choose to no longer offer coverage. Employers, the CBO adds, will pay about $52 billion in additional assessments between 2014 and 2019.

In contrast, Market Strategies International shows in a recent survey that the number of workers offered employer-sponsored health benefits would decline by 10 percent by January 2014. 13 percent of workers would lose access to employer-sponsored health benefits and 3 percent would gain benefits.

According to another survey by Fidelity Investments, 65 percent of large employers said they're not seriously considering eliminating health care benefits. But when asked what they would do if others dropped coverage, 36 percent said they too would consider eliminating coverage.

When compared with the cost of covering an employer and beneficiaries, the penalties an employer must pay for not meeting quality standards—or offering coverage—are light. And since these penalties are static and medical inflation is not, they become even lighter over time.

These facts we know:

1. Congress cannot impose stiffer enforcement rules due to Republican opposition.
2. Congress cannot loosen enforcement rules due to Democratic and White House opposition.
3. Large employers will likely maintain coverage, while small employers won't.
4. State insurance exchanges would pick up most of the non-covered individuals, even though few exchanges will likely be prepared for high volumes by 2014.

Keep in mind a wild card not often discussed: the strength of the overall economy, and what shape it will be in leading up to the 2014 deadline.

Should the economy strengthen relative to medical cost inflation, then employers would likely maintain health benefits as an additional form of compensation to lure employees.

Should it worsen or not improve, then an exit strategy seems highly plausible.

The Thorny Issue of 'Essential' Benefits

2011-02-28T08:13:00.000-08:00

The health reform law (PPACA) outlines 'essential benefits' that plans must offer after January 1, 2014. These benefits break down into ten broad categories, from hospitalization, to prescription drugs, to rehabilitative and habilitative services. Under the law, the Secretary of Health and Human Services will decide how detailed to make the essential benefits package and what exactly to put in it.

Keep in mind:

Insurance policies must cover these benefits in order to be certified and offered in Exchanges, and all Medicaid State plans must cover these services.
Individual and small group plans offered outside the exchanges must include the essential health benefits package.
All new group health plans must adjust cost-sharing and deductibles to the limits specified for the essential health benefits package.
The benefits directive does not apply to large group plans.

Focus questions:

How long will the process of defining essential benefits play out?
To what extent will the directive, regardless of details specified or not, impact the political process? Will any meaningful resolution occur prior to the 2012 election?
To what extent does the law permit states to administer their own benefits irrespective of federal guidelines? Will they take advantage of this?

Relevant articles:

Defining 'Essential' Care, Wall Street Journal
Defining Essential Benefits: Congress' Once and Future Role, Health Affairs
'Essential Benefits' A Complex Question in New Health-Care Law, Washington Post
Is Choice of Physician and Hospital an Essential Benefit, Journal of the American Medical Association

"Why Isn't Wall Street in Jail?"

2011-02-23T06:21:00.000-08:00

Matt Taibbi of Rolling Stone Magazine asks: “Why isn’t Wall Street in Jail?”

His answer: "a closed and corrupt system, a timeless circle of friends that virtually guarantees a collegial approach to the policing of high finance."

For the select few on Wall Street who destroyed billions—if not trillions—of dollars in wealth, their own fortunes (and, for many, their reputations) remain largely intact.

But political winds are variable. A populist shift could blow hard against an entrenched system that intertwines big banks and big government.

Wall Street has sinned, notes the latest Perspectives article; investors and the capital markets have not. Fixing the Wall Street problem must not come at the expense of a system that retirees will need to replenish savings, nor compound damages to the capital allocation and price discovery process.

Fix it. But, this time, fix it right.

Turning Back 'The Great Stagnation'

2011-02-17T12:18:00.000-08:00

Tyler Cowen's The Great Stagnation just might challenge Amy Chua and her shock parenting manual, Battle Hymn of the Tiger Mother, for most-discussed book of 2011. Just as Ms. Chua has us reconsidering—or reaffirming—how we raise our children, Mr. Cowen's observations on the dramatic slowdown in U.S. economic growth, life expectancy, and technological change likewise force us to re-evaluate some deeply-ingrained views.

Folks are already weighing in with vigor. New York Times columnist David Brooks recently introduced a social context to Mr. Cowen's thesis in his article "The Experience Economy", a thought-provoking piece if there ever was one.

Mr. Brooks proposes that Mr. Cowen's thesis—our country, having exhausted its economic low-hanging fruit, is now stuck on a technological plateau—"can also be used to tell a related story". Rather than focus on the technological change causing the slowdown, Mr. Brooks suggests it could be a shift in values.

He presents the economic choices of two hypothetical people, a man and his grandson. The first is born in 1900 and dies in 1974, the year from which growth rates continuously erode according to Mr. Cowen. The second is born in 1978, and is currently living the Facebook life to its max. The first, an entrepreneur, built a brake system company. His life begins with horse-drawn buggies and ends with the Moon landings. He "understood that if he wanted to create a secure life for his family he had to create wealth".

The grandson, on the other hand, works for a company that organizes conferences. (Okay, a little close to the bone for this writer.) He lives a "much more intellectually diverse life" than person number one. Moreover, he consumes products that are mostly produced for free, and don't create many jobs.

Most important, this person is more interested in living standards than wealth creation. He possesses a postmaterialist mindset in an affluent information-driven world.

There's a lot to chew on here, and particularly the economic connection of the individual to society.

Does the pursuit of wealth create a more secure life experience, not just for the individual and his immediate family but for larger groups of people?

Can someone pursue better living standards and avoid wealth creation at the same time?

Is the promise of information technology over-hyped?

For which type of firm does the Internet contribute a bigger slice of GDP growth: a long-standing bricks-and-mortar business or a cloud-based start-up?

Do conventional economic gauges (for example, GDP, CPI and employment) truly capture the full extent of economic activity, by either overstating or understating it?

The key difference between the two individuals is that the first person is an entrepreneur and the second is not. We're led to assume the second person feels entitled to a better lifestyle, while not actually having earned it. The first, having devoted his entire life to earning a better standing, has also helped others improve their own standings.

Although the grandson may believe that his way of life is improving as well, when compared with his grandfather and his predecessors, his gains are smaller to start with and progressively shrinking.

Big societal gains begin in small increments. The Internet may not be forming jobs on the scale of the auto industry in its heyday, but at least it provides an expanded opportunity for individuals to become entrepreneurs, however small.

Over the past 30-plus years, as the rate of progress has slowed, our economy, Mr. Cowen points out, has increasingly coalesced around three large systems: government, eduction, and health care. Within these systems, we can further argue that a handful of dominant players have emerged at the expense of smaller ones: for example, consolidation trends in health care are overrunning regional insurers and private practices; major well-funded universities are absorbing educational dollars that might otherwise go to primary and secondary schools; and even the federal government is usurping greater legislative and economic share from states and communities.

If the Internet and information technology can produce an entrepreneurial class that does not automatically sell out to bigger players (and which, for that matter, doesn't actually operate with an 'exit strategy'), then we might recapture the prior generation's growth.

Think of this in terms of the equity funding sources available today: the public and private capital markets. The public markets measure success in terms of quarterly earnings. Private equity, at five years or so, utilizes a considerably longer timeframe, but hardly the full term of a person's working career, the length of time to which early entrepreneurs aspired.

Perhaps the greatest lesson of a persistently languid economy is that real wealth in most cases does not come easily—nor does it come quickly.

Even now, after nearly two years of nine percent unemployment, it would seem that too few folks fear they won't have the independence that comes with having created their own wealth. In contrast to the generations of the first half of the twentieth century, that fearlessness stands out as a crucial difference.

As for Lyceum and its contribution to economic growth, I'll defer to our members and their judgment. Let's just say, few firms offer the idea factory that we do for difference makers to convene in a trusted environment, and explore changing business models.

Commerce, after all, is more than just a transaction. Commerce requires careful strategic planning and a thorough awareness of how a complex world is evolving.

Ms. Chua, who bases her controversial book on self-reliance, would probably agree: True entrepreneurial drive is an undying commitment to a more independent life.

More like an essay, Mr. Cowen's work is about 15,000 words in length, and is available in electronic form only.

Health Care Consulting Survey

2011-02-11T10:46:00.000-08:00

Myriad legislative and economic challenges confront the $2.5 trillion health care industry, and for its components, hardly enough time and resources. Consultancies, large and small, will play a critical role in meeting these challenges.

Please take a moment to complete our brief survey assessing the health care consulting marketplace.

The survey, developed by Lyceum Associates and Ready Consultant (a web-based consultant management platform), supports our goal of providing buyers and sellers of health care consulting services unique access to efficient information and effective project engagement and management.

Many thanks!

How ACOs Become Accountable

2011-02-04T13:13:00.000-08:00

One of the most discussed provisions in the Patient Protection and Affordable Care Act is the establishment of Accountable Care Organizations (ACOs). Often labeled a unicorn, something everyone can visualize but nothing anyone's actually seen, the ACO is conceived as a vehicle for more efficient care.

Where the current care delivery model emphasizes utilization and minimizes patient-physician interaction, the ACO—or integrated care delivery—model embraces care coordination, quality outcomes and risk-sharing. It features many different providers seamlessly integrated, and collectively compensated for producing a continuum of care.

For hardened veterans of the health care industry, the ACO is simply a reincarnation of the HMO; true enough, except for one critical difference. The HMO model features primary care physicians in a gatekeeper role. A patient, or member in the HMO, cannot utilize the health care system without prior approval from his personal gatekeeper.

No surprise HMOs collapsed. Consumers opted instead for plans offering choice and unrestricted use of the health care system.

By not establishing gatekeepers in the HMO sense, ACOs allow members considerable flexibility.

But here's the rub, ACOs, despite member flexibility, still hold providers accountable for member performance. Any members running rampantly over the system would directly penalize providers in the ACO.

Therefore, for providers to believe that they have a fighting chance at enhanced compensation (and for the ACO to succeed), the question of which patients join—or are assigned to—the ACO becomes vitally important.

Our latest newsletter article tackles this critical dynamic called patient attribution, and considers different methodologies ACOs might employ.

Not all ACOs will be alike. In large part, the patient populations they serve will determine how they differ.

Read "ACOs and the Importance of Patient Attribution" here.

Business Risk and the Physician Reimbursement Model

2011-01-26T08:47:00.000-08:00

Picture this. You're a lawyer or financial adviser. You operate independently and take enormous pride in the service you perform. At the same time, you understand that your service is a business, and that no matter how much pride or skill you possess, your business won't float if you don't cover costs.

Now imagine that an obscure regulatory body determines exactly what your clients pay you. Oh, and the people who pay you aren't the ones who actually consume your services.

Talk about out-of-control business risk. On the one hand, straightforward market supply and demand dictate the price levels of your expenses. On the other hand, an anonymous group of people big enough to fill the corner coffee shop presets the price levels of your revenues.

In the normal world, if your costs rise you adjust prices accordingly. If you're a skilled business person and understand your market and customers, you'll set prices that match your specific demand.

In this alternative world, because you have no control over prices, you're reduced to vendor pleading. Any negotiating position—call it pricing power—you might otherwise have had simply does not exist.

That world, of course, is health care.

In health care, the 240,000-member American Medical Association convenes a 29-person committee that 'recommends' physician reimbursement rates to the Centers for Medicare and Medicaid Services ("CMS"). Since CMS accepts and implements the committee's recommendations 90 percent of the time, the committee has become the de facto market price-setter.

Once a year, the Relative Value Scale Update Committee (or "RUC") makes its recommendations. Every five years, it submits broad reviews. RUC has "no official government standing", according to the Wall Street Journal. "Members are mostly selected by medical-specialty trade groups. Anyone who attends its meetings must sign a confidentiality agreement."

"In sessions that can stretch 12 hours or longer each day," the Journal notes, "the committee walks through dozens of services. The discussions can be mind-numbing—a subcommittee once debated whether to factor tissues into the payment for a psychoanalysis session."

But as obscure as RUC is, the formula that CMS uses to determine its fee schedule and implement the committee's recommendations might as well exist a hundred miles underground. Writing in the New York Times, noted health economist Uwe Reinhardt explains the Resourced-Based Relative Value Scale ("RBRVS") as follows:

In a nutshell, for a particular service (e.g., a routine office revisit or an appendectomy or a heart transplant) that we shall call Z, Medicare pays a fee calculated with this formula:
Fee_Z = (Work RVU_Z x Work GPCI + PE RVU_Z x PE GPCI + PLI RVU_Z x PLI GPCI) x CV

Fee_Z is the dollar amount of the fee paid for the service, Work RVU_Z denotes the relative value units for the physicians’ work going into the production of service Z, PE_Z denotes the relative value units of the physician’s practice expenses allocated to service Z and PLI_Z denotes the relative value units for the professional liability insurance premium allocated to service Z.

Each of these three relative cost factors is adjusted for its own geographic price index, GPCI in the equation. Thus, there is one GPCI for the physician’s work, one for practice expenses and a one for malpractice premiums.

The sum of these three RVU components, adjusted by their GPCIs, is multiplied by CV, the conversion factor. This is the dollar amount that Medicare pays for one overall RVU.

Uh?

Maybe to a Princeton economist—or a PhD in mathematics or, for that matter, a Wall Street quant—it makes perfect sense. For most physicians, RBRVS is just the way the world works.

In fact, because the average doc contributes no input anyway, the formula could be any number of tangled algorithms. The consequences would be no different.

And let's not forget that CMS is the dominant payer. Commercial health plans, rather than undertaking an entirely different approach, simply base their rates on what it—the government—pays. (So much for moving to a single payer system.)

Perhaps one of the least noted risks to health care is a sudden and sustained change in vendor pricing levels.

The United States hasn't experienced double digit inflation for 30 years—10 years prior to Congress legislating the RBRVS standard. Nevertheless, price volatility ebbs and flows.

As the chart below shows, current volatility is the highest since the 1960s. (We calculate volatility as the annualized ratio of standard deviation in the Personal Consumption Expenditures index to its mean—the coefficient of variation.)

More than the absolute price level, what's important to business owners is the extent of variation. High variation increases business risk especially for folks with little or no pricing power, and vice versa.

Several experts warn that overly aggressive fiscal and monetary policy could resurrect 1970s-style inflation. Consumers need only visit the local gas station to experience one commodity already rapidly rising in price.

Volatility, of course, would persist (likely elevate) as the economy jumps to this higher level.

What if rents, utility bills and other business costs remain unstable? How does RUC, which only makes its recommendations once a year, compensate for this?

In the collapsing municipal bond market, we see not just the dire finances of state and local governments, but extreme regional economic conditions—unimaginably complex for a 29-person body to manage.

Simply put, committee-based pricing encourages consolidation. It handicaps practitioners who want independence. And it contorts basic economics, favoring obscurity over transparency and inflexibility over resilience.

On Wall Street, bankers—the conventional ones advising corporate bosses on deals and financing, and who generate revenues based on negotiated fees—are ascendant again, replacing enigmatic quants and their bullet-proof trading models. In health care, the foundation stones remain an obscure decision-making process and an indeterminate formula.

To be sure, the same certainty that existed on Wall Street where a limited group of really smart people could protect a business model continues to apply to the care delivery system.

For a lawyer, financial adviser or just about anyone else outside of the health industry, the ability to price a service is an essential business tool.

For a physician that inability is fast-becoming a sacrifice in independence.

A New Yardstick for PDUFA Reauthorization

2011-01-20T07:15:00.000-08:00

For better of worse, PDUFA reauthorization will likely be the only FDA-specific legislation that the 112th Congress considers, notes Steven Grossman in Perspectives. You can bet, therefore, that the 2012 bill will become a lightning rod for device and drug industry issues.

User fees constitute 20% of the FDA's budget, plugging a near $500 million gap that federal appropriations (the agency's other revenue source) leave open. In the prescription drug program, the split is 50:50.

The nation's economic backdrop and emphasis on deleveraging will also weigh on the legislative debate. And depending on how health reform plays out and the extent to which it bites into device- and drug-maker profits, industry could strongly resist efforts to shift more responsibility for the agency's budget onto its shoulders, i.e. paying even higher fees.

The tax payer, meanwhile, will certainly take note of the more-than $2 billion in annual appropriations that the bill will lift from his pocket.

The FDA's scope is endless. At least six to 10 times each day we interact with products it regulates—equal to roughly 25% of consumer expenditures in the United States. Its oversight encompasses 80% of the food supply and nearly every radiation-emitting device.

As with any regulatory body, it fights a constant battle of keeping pace with innovation. It features staffers much less well-paid than their industry counterparts, and substantially inferior technology and organizational structure than fast-evolving private enterprises.

Any massive budget surge would likely produce only a fleeting advantage, if one at all.

It should be no surprise, then, when the debate over user fee reauthorization begins later this year that many will scrutinize the agency in a different way. Rather than size, the yardstick will likely be return on investment. (If the new Congress accomplishes anything, it will be the introduction of more business-centric language to debates on the Hill.)

Industry will question the limited extent to which increasing user fees have yielded new product approvals, and whether the Patient Protection and Affordable Care Act and other legislative burdens allow for even higher fees. Taxpayers will question the responsiveness and adaptability of an even larger agency.

At this early point in time, the odds favor a future bill resembling previous reauthorizations—an inflation-adjusted continuation of the same model.

In the coming months, those odds could change substantially.

The Upside-Down World of CEO Pay

2011-01-12T15:45:00.000-08:00

Perspectives latest article targets the upside-down world of CEO compensation at the nation's biggest publicly traded companies. Upside-down because risk and return, in contrast to the way it should happen, correlate inversely.

"Short-term perspectives", it begins, "increasingly dominate how we think and perform."

Too often, boards of directors dismiss the long-term interests of their companies and their shareholders, as a result.

Even in this tenuous post-financial-crisis world, legislators and regulators still won't acknowledge a dangerous, persistent market distortion. What happened before will likely happen again to the detriment of shareholders:

Did Robert Nardelli's contract terms serve Home Depot's shareholders well when the board offered him $82 million ($20 million due in cash within the first 30 days) if it dismissed him?

Did Carly Fiorina's $21.4 million pre-nup serve her shareholders well?

What about Stanley O'Neal and Merrill Lynch? He steered his shareholders into subprime mortgages in the mid 2000s, and was fired “for cause” in October 2007. Still, he pocketed $94 million.

Did legislators and regulators hold directors responsible in any of these cases? Of course they didn’t.

The solution isn't a government mandate or compensation czar, but rather a shift in incentives that allows "old-fashioned entrepreneurship to root itself beyond privately-held enterprises".

And the best way to alter incentives is to alter the tax code.

Read "Turning Fat Cat CEOs into Long Term Lions" here.

We Shall Meet In A Place Where There Is No Darkness

2010-12-31T08:30:00.000-08:00

Big Brother. Facebook. One and the same? Or completely different?

Facebook, as Time Magazine recently put it, is now the third largest country on earth, and, like Orwell's Oceania, transcontinental, omnipresent and amorphous. Some might argue that the more family and friends use it, the more involuntary it becomes.

Still, it's a commercial entity. To survive, it needs to generate profits that provide a sufficient return to its owners.

Read our latest Perspectives article on privacy and Internet regulation here.

Government as the gatekeeper
Broadband Internet did not become ubiquitous until after 2000. The mobile, social networking Internet we use today has only existed for about the time it takes a person to complete high school. (Okay, an eternity for a young person, but a blink of the eye for the rest of us.)

And yet, because the urge to regulate is endemic, many believe it cannot exist without oversight.

Whether Facebook's walled-garden or Google's open platform, different business models are competing for the consumer's wallet. Not unlike the bricks and mortar world, these and other models will succeed and fail based on how well they incorporate customer knowledge.

Most consumers, as we know, are more than happy to share extremely private information in both the real and virtual worlds, which begs the question what exactly is private information?

One regulatory strategy is to view the Internet as a communication—not an information—service. Recently, the FCC, in the name of neutrality, issued an order that makes it the traffic cop of Internet access providers: a move that the new Congress, if not the courts, will surely test soon enough.

Our article points out that the Internet is still a massive information service. Think of all those YouTube videos and digital photos we so willingly share.

At least with Facebook we have some sense of what we're dealing with. Its users have revolted on privacy issues before, and the company has responded.

Government as the Internet gatekeeper is an altogether different proposition. Accountability—the Fannie Mae and Freddie Mac fiascoes demonstrated—does not occur in the same way it does in the private sector. Transparency might as well be a brick wall.

Big Brother would indeed be watching.

What Our Readers Are Reading

2010-12-20T07:29:00.000-08:00

Throughout 2010, Lyceum has featured more than 200 articles and postings in the newsletter Perspectives, the Talking Transitions blog, and ChatterSmart, our short format news forum. We list below the ten most viewed commentaries in each publication.

In aggregate, our three lists boast more than 6,000 views. They span three broad categories—health care, financial systems and entrepreneurship—and encompass multiple topics, including:

Health Policy and Reform, ICD-10, Drug Discovery and Development, Clinical Pathways, Standardized Care, Integrated Care Delivery, Information Technology, Employer-Based Health Care, and Pharmacy Benefit Management in Health Care;
Too-Big-To-Fail, Investment Time Horizons and Alternative Investing in Financial Systems;
Venture Capital, Customer Experience and Business Model Analysis in Entrepreneurship.

Transparency, accountability and innovation appear frequently as common themes—perhaps not surprising given Lyceum's emphasis on dynamic transition. Lyceum participants and their businesses not only respond to market shifts, they will often instigate them.

As always, we encourage our readers to join our discussions and debates, and submit detailed thoughts to Perspectives and quick observations to ChatterSmart. We believe that group problem-solving offers the best route to valuable information gain and needs to involve a variety of stakeholders, large and small.

Most viewed Perspectives (Newsletter) articles

10. "Fixing Health Care's Value Deficit: The Problem of Unexplained Geographic Variation"
9. "Short-Term Trading is a Growing Threat to Capital Markets" *
8. "Simple Strategies to Defeat Incumbent Inertia in Health Care"
7. "Fixing Health Care's Value Deficit: The Solution in Clinical Pathways"
6. "Reform Legislation Aside, ICD-10 Could be Health Care's Biggest Challenge"
5. "The Long Fight is Over for Follow On Biologics" *
4. "Anticipating New Strategies to Gain FDA Approval of Biologics" *
3. "ICD-10 Impact on Provider Reimbursement"
2. "We Can No Longer Afford To Retire"
1. "What Payers and Physicians Need to Look for in Clinical Pathways"
* Membership or subscription required to view

Most viewed Talking Transitions (Blog) posts

10. "In Health Care, It's David Versus Goliath"
9. "Reform Legislation Aside, ICD-10 Could Be Health Care's Biggest Challenge"
8. "Paper: Cost Shifting No Longer an Option"
7. "Book Review: More Money than God"
6. "'Not My Problem!'"
5. "Clinical Pathways Lessen Geographic Variation, Reduce Costs"
4. "Biggest Wave of IPOs since 2007—Or Not"
3. "Promising Business Model Targets Traditional PBMs"
2. "Not Just Access. Understanding."
1. "Finding a New Way in Accountable Care Organizations"

Most viewed ChatterSmart (News Forum) posts

10. "Something New in Drug Discovery"
9. "Dartmouth Atlas Under Fire"
8. "What Happens if Employer-Based Health Insurance Goes Away"
7. "Report Finds Employers at Risk of Not Making Health Plans Affordable"
6. "Government Opts for the Cloud"
5. "Washington Politics Ruin Reform"
4. "States: No Choice But to Reform Health Care"
3. "Venture-Backed Health Care Companies Selling for Less Than Total Raised"
2. "Same Problems for HIEs as for RHIOs"
1. "ICD-10: The Biggest Health Care Event Not Discussed"

Promising Business Model Targets Traditional PBMs

2010-12-14T03:52:00.000-08:00

Four years ago, Walmart launched its four dollar generic drug program. Target, Costco, K-Mart, and others implemented similar plans soon after.

Many experts expected a direct challenge to mail-order pharmacies, and head-to-head price competition. Some believed the pricing initiative doomed the traditional pharmacy benefit management ("PBM") business model.

Not only have the major PBMs survived, they've thrived—and once again deflected a substantial market challenge. Shares in Medco Health Solutions and Express Scripts have more than doubled. Both now trade at or near all-time highs. (The CVS Caremark price is flat, but the company has navigated an unfulfilling merger that has so far diluted the value of the legacy Caremark operation.)

Traditional PBMs, however, should not rest too comfortably, according to a recent white paper by Milliman, the actuarial consultancy. The paper, entitled "The Value of Alternative Pharmacy Networks and Pass-Through Pricing", explores the emergence of transparent retail pharmacy networks that build on Walmart's and other large retailers' aggressive cost-cutting capabilities.

Milliman calls these new business models Alternative Pharmacy Networks, or "APNs". The paper presents analysis that estimates cost savings of between four and 13 percent beyond a traditional PBM service for an average employer with 10,000 lives.

The Milliman white paper thoroughly considers the traditional PBM business model, how APNs function, and what the implications are in terms of contract pricing, transparency and the distribution chain. Read it here.

Restat, a privately-held pharmacy benefit management company, commissioned the paper. Restat deploys an APN model called Align.

Even though pharmacy costs are small as a percentage of total employer health care costs (medical benefit costs can be at least four times as great), the savings are real, especially against a tough economic environment. For large corporations employing tens of thousands, scale advantages could produce even bigger percentage savings.

Because the APN creates a transparent marketplace, it bestows employers, or plan sponsors, an intangible benefit of eliminating the traditional PBM's information advantage. The APN takes away what the PBM knows about drug pricing and how it leverages this.

Most important, the APN is an emerging model. Only a few large employers such as Caterpillar utilize it. One catalyst—beyond sponsors seeking additional savings—could be small PBMs reinventing themselves. The three big PBMs—Medco, Caremark and Express Scripts—are powerful players. Their aggressive strategies and market consolidation leave little room for others to compete.

APNs, Miliman states, feature two characteristics: one, substantially lower drug prices and dispensing fees than traditional pharmacies; two, 'pass-through' attributes including rebates that flow from manufacturer to employer and a PBM that collects no spread or drug cost differentials. (Instead of rebates and spreads, the PBM makes money on a flat administrative fee.)

Whereas, in the traditional model, PBMs negotiate price with plan sponsors, the APN model allows in-network pharmacies to compete for consumers on price and service. Control, in effect, shifts to the employer (the payer), and, depending on how the employer arranges the APN, the consumer.

So why haven't APNs gained greater momentum? There are several reasons. Perhaps the most important is the resilience of mail order, the traditional PBM's core franchise. Mail order is a distinct class of trade, the Milliman paper notes, which means PBMs can purchase drugs from manufacturers at prices lower than wholesalers or retail pharmacies. It also allows for price arbitrage strategies not available to retailers.

The traditional model also wins on market inertia. While the APN does offer real savings, traditional PBMs can argue that they too create savings, and have been doing so for years. Sponsors focus more on trend than details anyway, and new contracting means hassle. Moreover, sponsors care much more about the medical side of the ledger, since it's the principle contributor to price inflation.

No doubt, if the number of employers weighing the APN option accelerates, then the PBM universe could rebalance. The odds of the traditional model collapsing appear slim, however.

For small PBMs and new entrants, the APN model does finally establish a vehicle that can compete against the big three PBMs.

More than existing share, revenue that the APN does claim will likely constitute new share in a growing marketplace of aging baby boomers and new-to-market oral specialty pharmaceuticals.

The big three PBMs have consistently shaped and dominated the pharmacy distribution chain. As time passes, their biggest risk may not be the APN, but their own success in building behemoth businesses that ultimately limit maneuverability.

'Value' and the End of Health Care as a Right

2010-12-09T10:33:00.000-08:00

A surprising new word is making its way into the health care lexicon: value. Its emergence ends the health-care-is-a-fundamental-right argument, and advances the debate over what needs to change.

Value, an economic term, defines health care as an economic good. It emphasizes the rules of supply and demand, and basic strategies targeting efficiency, outcomes and cost.

Michael Porter, the Harvard Business School professor, states in the New England Journal of Medicine:

Value—neither an abstract ideal nor a code word for cost reduction—should define the framework for performance improvement in health care. Rigorous, disciplined measurement and improvement of value is the best way to drive system progress. Yet value in health care remains largely unmeasured and misunderstood.

He goes on to argue that value should be defined around the customer, and that the creation of value should determine the rewards for all other actors in the system. For several years now, right-leaning strategists and economists have addressed value as the essential mechanism for true reform. Folks on the left have argued that because health care is a fundamental right, traditional economics don't apply in the same way they do in other industries. And because they don't apply (private industry will always fail, for example), only a single payer system can deliver that right.

Thanks to the health reform bill and its complexity, the budget deficit and economic malaise, the health care debate has continued. The arguments, though, have shifted.

Like any other service, quality and price vary in health care. Unlike other services, however, no one's quite sure exactly how these factors vary, or, for that matter, what each is. Instead of government's role in providing a right, the left side of the aisle now seems more focused on elevating government's role in defining quality and price, and therefore value.

An altogether different conversation is taking place.

Ultimately, agreeing that health care is an economic good is a huge step forward—and in just one year. From 'value', opposing views can finally address core issues such as the care delivery system in a more constructive fashion. For once, the debate features a common language.

Take Professor Porter and his NEJM article. He calls for an integrated delivery system that combines efforts by providers over the full cycle of care. It's what the health reform bill defines in terms of an accountable care organization, though Porter doesn't use this expression. His HBS colleague, Regina Herzlinger, meanwhile, has long argued for focus factories, a concept that Porter pointedly dismisses.

Like Porter, Herzlinger's factories also center on value and customer experience, and, to an extent, integrated care. While Porter calls for broad-scale change, Herzlinger aims at incremental change.

Her force of change is entrepreneurial drive, where lawmakers empower the private sector to discover best practices for itself. Porter, on the other hand, finely details what the end goal should be. He does not explain the process to make this happen, at least not in this article.

Progress can't happen without debate. And meaningful debate can't occur until there's a common language.

The emergence of 'value' marks a crucial step forward.

Another Holiday Season, Another Prediction

2010-12-06T08:39:00.000-08:00

It's that time of year again, and everyone seems to be in the business of forecasting, especially on Wall Street. According to a recent article in Perspectives, we're just witness to human nature at its most basic: "We all face forward. Ergo, we make predictions."

No different than a Mennonite studying anomalies in an animal's entrails, a modern-day Wall Street analyst slices and dices spreadsheets to predict future events. In some cases he's even deferred his predictive judgment to an algorithm or computer model. (A scary thought, indeed.)

Are we any better off? Yes. No.

It doesn't really matter, because it's who we are.

The best we can do in making and receiving these outlooks is to know our own context. Think of predictions not as absolutes in and of themselves, but as composites of a bigger picture.

Socrates was right. "Know thyself."

Read "Trust Me, I Predict the Future" in Perspectives here.

Focus on Focus Questions

2010-12-03T07:27:00.000-08:00

Lyceum's GatherSmart® website features a news blog called ChatterSmart. We've designed it as an open forum for folks to highlight news stories relevant to Lyceum discussions.

Postings are formatted to include a short description of the issue at-hand: normally a sentence or two. They also include a focus question to encourage the reader to consider a broader context.

Often, we take these questions and explore them in roundtables and events. Listed below are ChatterSmart's ten most recent postings and their associated focus questions.

"Emboldened Opponents Ready to Open New Fronts Against Health Reform" December 3, 2010

Focus Question: To what extent will state and local governments block the health reform bill from taking effect?

"Employee Health Premiums Soar" December 2, 2010

Focus Question: What's the breaking point in employee health premiums? Are consumers now demanding taking control away from government and employers?

"Why Rolling Back the Health Reform Bill Will Be Difficult" November 30, 2010

Focus Question: If the federal government cannot revise even the least favored provisions, how much will it slow its implementation? How much control will state and local governments possess?

"Drug Marketing & Social Media" November 26, 2010

Focus Question: As much as social media marketing could put docs and consumers at informational risk, how does its feedback loop alter the risk profile of drugmakers?

"Summary of Medial Loss Regulations" November 22, 2010

Focus Question: How does the MLR provision affect investment capital in commercial health plans? How does this impact innovation?

"How to Define Quality in End of Life Cancer Care" November 17, 2010

Focus Question: How effective would integrated care delivery systems—or accountable care organizations—be at addressing palliative care?

"Who's Better at Leading ACOs: Physicians or Hospitals?" November 12, 2010

Focus Question: Why couldn't a shareholding structure apply where shareholders control the ACO?

"What's the Role of Patients in ACOs" November 12, 2010

Focus Question: To what extent could ACOs emerge from concierge medicine, where patients and payers are one and the same?

"CFOs Stressing More Than Ever About Health Care" November 2, 2010

Focus Question: As insurance exchanges emerge as alternative markets to purchase coverage, how quickly will employers shift to a defined contribution model?

"McKesson Purchases US Oncology" November 1, 2010

Focus Questions: How does this transaction impact oncology business practices including standardization of care and clinical pathways? What's the impact on strategic positioning in specialty pharmacy—specifically the large PBMs (Caremark, Medco, ESI)? What effect does this have on drug development and demand for lower cost treatments? Should we expect further consolidation among providers?

The Big Bank Coin Flip

2010-12-02T07:34:00.000-08:00

The 2008 crisis paralyzed the global capital markets. It produced shock waves that we will navigate for sometime.

And yet, despite colossal mismanagement, the nation's biggest banks not only survived, but in fact have expanded their share of market activity.

The Federal Reserve's December 1 release of 21,000 credit transactions conducted to stabilize markets reveals just how badly the big guys' business models failed.

We quote the Thought of the Day blog:

Documents from the Federal Reserve indicate that Goldman Sachs (despite claims from CEO Lloyd Blankfein that they were doing “God’s work” and that the firm could have survived without help from the Fed) tapped the Fed’s Primary Dealer Credit Facility (PDCF) 84 times and Morgan Stanley 212 times between March 2008 and March 2009. Citigroup used the facility almost daily, tapering off in April 2009. Bank of America, between September 18, 2008 and May 12, 2009 used the facility more than 1000 times. Other lending facilities made available include the Term Asset-Backed Securities Loan Facility (TALF); Commercial Paper Funding Facility (CPFF) – used by industrial companies in need of over-night financing, with GE borrowing $15 billion a dozen times; Term Securities Lending Facility (TSLF) – providing loans up to 28 days, and the Term Auction Facility (TAF) which allowed banks to bid for loans without the stigma associated with the Fed’s discount window.

As the Thought of the Day concludes, government action avoided a total meltdown.

But where's the fix? If highly concentrated capital and distortions in risk and return (in particular, management accountability) contributed to the original problem, then why do the same business models persist?

Entrepreneurs know that individual success and failure are two sides of the same coin. The same odds, however, don't seem to apply to banks too-big-to-fail.

Maybe that's because when senior management flips the coin, it only half realizes the consequences.

How the Oncology Business Model is Changing and What Drugmakers Need to Do About It

2010-11-23T13:29:00.000-08:00

Since its inception in 2005, Lyceum roundtables and events have addressed industry transition and business innovation among different components of the health value chain. Perhaps no aspect is shifting more significantly than delivery of care, and the business of oncology in particular.

In keeping with our roundtable format, we invited three thought-leaders to explore some of these dynamics. We created the question list below to capture not just the way in which the oncology business model is evolving, but also how the drug manufacturing industry needs to respond:

List and describe the three biggest issues impacting the oncology business model.
How are biopharmaceutical makers responding to these shifts? List and describe three essential strategies.
What is the outlook for access to and quality of care over the next five years?

Longstanding participants in Lyceum, our commentators contribute unrivaled expertise and experience. They are Bruce Cutter, Dawn Holcombe and John Engel.

Bruce Cutter, MD, MMM. After many years of both patient care and leadership, Bruce is now a health care consultant. Key leadership accomplishments over the past ten years have included design and implementation of a community-based, integrated oncology delivery system, together with development, in close collaboration with a health plan, of a comprehensive quality initiative combined with a pay-for-quality contractual arrangement. Bruce is based in Spokane, WA.

Dawn Holcombe. Dawn, a private consultant, was recently Senior Vice President for Payer Relations and Quality Programs for both Supportive Oncology Services and its large network of affiliated oncology practices and the Cancer Clinics of Excellence, as well as Executive Director for the Oncology Network of Connecticut, LLC. Dawn's twenty-nine years in health care have included executive, strategic, financial, and marketing positions in academic and private health systems and physician practices. Dawn is based in South Windsor, CT.

John Engel, Esq. A founding partner of Engel & Novitt, LLP, John specializes in food and drug, public health, and administrative law, and health information technology and science policy and legislation. He provides strategic counseling on a wide range of legal and regulatory, intellectual property, and marketing initiatives affecting pharmaceutical, biotechnology, and medical device companies, as well as organizations representing health care professionals and their patients. John is based in Washington, DC.

Read article here.

State Legislatures Will Decide Health Reform

2010-11-08T05:04:00.000-08:00

Pick your metaphor: hurricane, tidal wave, avalanche, earthquake. However you label the midterm election, it has radically altered the political landscape—though with no greater effect than at the state and local level.

Consider this report from the National Conference of State Legislatures:

Republicans picked up 680 seats in state legislatures—the most in the modern era. The previous record was in the post-Watergate election of 1974, when Democrats picked up 628 seats...

The Alabama House and Senate, Indiana House, Iowa House, Maine House and Senate, Michigan House, Minnesota House and Senate, Montana House, New Hampshire House and Senate, North Carolina House and Senate, Ohio House, the Pennsylvania House, and the Wisconsin Assembly and Senate all have flipped from Democrat to Republican...
This is the first time in Alabama that Republicans have controlled the legislature since reconstruction. The North Carolina Senate has not been Republican since 1870. And Republicans have reportedly taken over 100 seats in the New Hampshire House. For the first time in history, the Minnesota Senate will be controlled by the GOP.

While front page news stories highlight big shifts on Capitol Hill, gridlock is the likely outcome of the next two years—or, at the very least, vigorous ideological posturing.

Not so in the state capitals where constituents challenge elected officials face-to-face on a daily basis. No longer will these officials delay resolving high unemployment and burgeoning benefit obligations.

Budgets are a mess, and there's little hope for improvement.

According to the policy organization Center of Budget and Policy Priorities: "States will continue to struggle to find the revenue needed to support critical public services for a number of years, threatening hundreds of thousands of jobs."

The organization notes that 39 states have already projected gaps that total $112 billion for fiscal year 2012. It expects that, once all states have prepared estimates, these gaps will likely expand to about $140 billion.

After education, the biggest outlay for states is health care—and Medicaid specifically. As the Kaiser Family Foundation explains, individuals tend to lose employer‐sponsored health coverage during recessions, which increases Medicaid enrollment and spending. Meantime, recessions shrink state revenues, making it more difficult for states to afford their share of the increased spending.

What's more, the federal government, facing a huge deficit itself, won't be able to support expanded Medicaid outlays as it might under stronger economic growth. At 44 percent of all grants to states, Medicaid funding is the single largest source of federal support.

Since the start of the recession unemployment has doubled, while Medicaid enrollment has increased by 6 million people. Already this year, 44 states say they will exceed enrollment and spending growth, according to Kaiser. A dozen states have experienced double-digit annual enrollment increases. In California and New York, Medicaid spending growth has increased by 24 percent and 16 percent, respectively.

And it gets worse. The October payroll report showed labor force participation dropping to 64.5 percent, its lowest percentage in a generation. Millions of potential workers simply have given up on finding a job, and are no longer accounted for in employment statistics.

While, short-term, commercial health plans such as WellPoint and UnitedHealthcare might benefit from lower medical costs on fewer employees in employer-sponsored health care, longer-term they face considerable business risk as this reduced workforce jeopardizes premium income.

For state governments, this means not just an even bigger Medicaid population in the months to come, but fewer revenues to service it. It also means confronting a commercial marketplace turning towards consolidation to sustain topline growth, and the likelihood of higher prices on less competition, as a result.

The health reform bill forces even more spending requirements on states, exacerbating a heavily strained situation. Legislatures and their constituents can't afford it.

Nor can they afford to wait for Washington to fix it.

In July, Ed Haislmaier, a senior fellow at the Heritage Foundation, proposed that state officials target a more competitive private-sector insurance marketplace. He writes:

The best response for state lawmakers is to immediately move in the opposite direction of the new federal legislation by first determining their state’s needs and priorities, and then enacting their own reforms that increase health insurance choice, competition, and coverage while also reducing costs.

Haislmaier believes officials could establish this marketplace by creating a defined contribution option for employer-sponsored health insurance coverage; repealing unnecessary state-mandated health insurance benefit requirements; lowering barriers to market entry through statewide risk adjustment mechanisms; creating a premium aggregation mechanism that enables individuals to buy coverage using contributions from multiple employers; and providing consumers with greater price and quality transparency with respect to insurance coverage and physician and hospital services.

The health insurance exchange, Haislmaier argues, offers one of biggest opportunities for establishing consumer choice and reducing state commitments, if developed outside health reform's regulatory framework and its rigid benefit requirements.

A competitive exchange allowing consumers to choose plans best suited to their needs would help stem excessive spending and limit the accelerating trend toward a concentrated commercial marketplace, at the same time.

In fact, Congress's most effective action could be stalling the implementation of health reform to give states time to design insurance exchanges and set their own houses in order.

Just as a grassroots movement repositioned the political landscape, expect the same effect on state budget deficits. For governors and state lawmakers, as challenging as Medicaid and insurance reform will be, the obstacles are far less severe than taking on the education system.

Health care is priority number one.

Midterm Elections and Health Care Reform

2010-10-18T13:55:00.000-07:00

One thing's for sure: the midterm election will mark the beginning of a new and different political period. Just how new and different we'll know in the days and weeks that follow.

RealClearPolitics, a polling data aggregator, shows Republicans securing a majority in the House and among governors, and possibly even the Senate.

After the economy and jobs, voters cite health care reform and dissatisfaction with government as the most important issues to their vote, according to the Kaiser Family Foundation.

Three factors will shape what happens after November 2nd:

the degree to which Republicans 'win', including not just the total number of seats but also the individual seats themselves, in particular those now held by high-profile Democrats;
the cohesiveness of the Republican AND Democratic agendas, including the administration's response to the new Congress;
the speed of economic recovery and restoration of job growth.

For a great overview of seats won and lost in midterm elections, we recommend visiting USMidtermElections. This site allows you to view and sort midterm results back to the very first one in 1790, for both chambers.

Should, for example, the Republicans win control of both Houses, a majority of governorships, and deliver a consistent and coherent post-victory agenda, while the economy continues to teeter, expect party leaders to attempt dramatic legislative action.

Should the Democrats maintain Senate control and quickly refashion their image, expect softer Republican action, even if economic recovery stagnates.

At this point, odds favor a dramatic momentum shift in favor of Republicans. As of October 18th, RealClearPolitics shows the Republicans securing 212 seats and the Democrats 180 seats, with 43 undecided. The Senate divides between 46 Republicans and 48 Democrats, with six seats too close to call.

The biggest battlefield
Perhaps the biggest political battlefield—and display of these three factors at work—will be health care, and the fight to dismantle the Patient Protection and Affordable Care Act, President Obama's defining legislation.

Republicans have three strategies from which to choose:

a swing-for-the-fences outright repeal;
a house-of-cards killing of key provisions;
a foot-dragging delay of its implementation.

Repeal, while a low probability, is not improbable. If the three factors identified above strongly favor Republicans, then Congress's ability to override a certain presidential veto would depend on how many Democrats choose to vote against the administration. Let's not forget: the Democratic party will feature folks not tethered to the 111th Congress and the 2008 election.

Foot-dragging, on the other hand, would likely happen if our three factors and their dynamics underwhelm. Rather than surprises at the polls, it would be Republicans badly flubbing their message that most likely spawns this reactive strategy—a situation where Republican momentum stalls.

The most likely strategy will be an attempt to kill key provisions, with the goal of forcing the bill to collapse like a house of cards. According to a recent article in the Financial Times, Republicans may seek to defund the scores of agencies that the bill requires the Department of Health and Human Services to set up for implementation. (Depending on the number of seats won, the Republicans could also use reconciliation as a legislative tool to advance this plan of attack, as the Democrats did to force through their agenda.)

Such a house-of-cards strategy, the FT notes, would still require substantial reputational risk just as the next election cycle commences.

To be sure, opposition to health reform won't take place on Capital Hill alone. The constitutional fight over the individual mandate is already making its way to the US Supreme Court. With many of the bill's key provisions—including the individual mandate—taking effect in 2014, the plaintiffs are seeking to accelerate the suit's journey, while the defendants are aiming to slow it down.

Moreover, states and their newly elected governors and local leaders will need to address massive health care obligations right away. Earlier this month, the New York Times reported a first-time disclosure of $200 billion in unfunded liabilities among the cities, counties and authorities of New York.

Many state officials are likely to consider the design and use of insurance exchanges. Until 2014, these officials will enjoy considerable free rein, and could build systems that effectively reduce government commitments by emphasizing market-based solutions. In fact, some conservative thought-leaders argue that state action on the exchanges could do more to curtail the bill than Congress itself. A viewpoint, for example, Scott Gottlieb and Tom Miller recently expressed in the Wall Street Journal.

The stakes are high for both parties, and for the administration and its legacy. Watch for a fierce—and potentially complex—fight to erupt immediately after the 112th Congress takes its seat.

Not just access. Understanding.

2010-09-27T09:17:00.000-07:00

Anyone can access significant players. Lyceum Associates fosters deep, multilayered interaction that creates extraordinary business relationships.

These days, rapport matters more than ever. In a world of instantaneous information, a company's ability to create and execute strategic objectives depends on a thorough appreciation of not just what knowledge it's getting, but also from whom.

Too often, we turn to 'experts' without truly understanding their motives and framework, let alone their expertise. And this can occur within an onslaught of information, in which we don't allow ourselves adequate time to evaluate sources, and rely more than we should on assumptions.

Over its five and a half years, Lyceum has delivered more than 80 roundtables—each one an exclusive event of 10 to 12 participants representing diverse expertise and viewpoints and, collectively, entire industry value chains.

The GatherSmart® website features profiles on each of these participants, allowing for thousands of individual interactions to take place beyond the events themselves. In addition to discussion topics and related commentary, members can search events to identify every participant and his or her professional profile.

They can also chose among different outlets to contribute their own thoughts and opinions: Perspectives (the Lyceum newsletter), ChatterSmart (a short-format newsblog), and a discussion forum.

We have showcased business innovation and industry transition in a variety of industries, and focused in recent years on the intricacies of the United States health care system. By selectively inviting a variety of stakeholders for participation, we utilize group problem-solving as the most effective means of defining and understanding value, whether in terms of business model shifts or workflow redesign.

Members—professionals who continue to participate in our events—gain familiarity and a sense of trust that can otherwise be impossible to attain even in a private, one-on-one meeting or a social interaction. For the better part of a day, a member will analyze and discuss hot-button topics with other key players. Conversations begin as arrays of common interest, and end as discoveries of common ground and likes and dislikes.

Quite simply, there's no better way for one individual to access another individual. It's the advantage of a shared experience rooted in informal exchange and business-centered topics.

A round of golf or a dinner might open new doors for vendors in pursuit of clients, but neither compares to the opportunity of vendors, clients and other subject matter experts jointly analyzing a point of common interest. Vendors won't just discover more about clients: clients will be better able to screen what vendors are offering.

Most important, the opportunity presents itself equally to each person at the table. With participants individually invested in the discussion, the group gains exponentially, compounding the return on that investment.

To extend Lyceum's reach to professionals who might not be able to contribute the same resources, but who contribute valuable expertise and experience, we encourage sponsored events and series. In contrast to a member, a sponsor functions as a partner in Lyceum, and helps to shape roundtable series, including content, locations and participants.

Users include entrepreneurs, corporate executives, industry consultants and experts, institutional investors, and many others. We believe a carefully-arranged assembly of stakeholders will surpass any one person in expertise, and that members will be better able to ascertain their own strengths and weaknesses and to engage others as they strive for personal success.

Not just access. Understanding.

'Not My Problem!'

2010-08-27T10:21:00.000-07:00

What would you do if your employees demanded benefit increases and you had no money to pay for it? Unless you could somehow increase revenues, you'd probably explain an increase simply wasn't possible.

Not so in the fuzzy world of public sector finances.

On June 29th 2001, the New Jersey state legislature approved legislation that revalued the state's pension assets to their June 1999 level. State unions had demanded benefit increases, and officials—not wanting to disappoint key constituents—opted to raise the needed funds in the capital markets, instead of imposing higher taxes.

Problem was, pension assets by mid 2001 were already severely underfunded. In order to entice investors, the state had to show a strong balance sheet, and 1999 was a banner year.

Subsequent bond offering documents not only did not disclose the revaluation until two years later, but also never disclosed the 1999 mark, a date not coincidentally near the peak of the bull market.

By 2007, when the New York Times exposed the state's breathtaking fraud, the State Treasury had issued $26 billion in debt in 79 different offerings.

A recent Lyceum Perspectives article explores the New Jersey debacle—the first ever SEC suit against a state—and the question of how much accountability taxpayers can truly expect of elected officials. Read article here. (And, yes, it took the SEC three years to complete its suit.)

At the most basic level, this extraordinary case reveals the extent to which public officials play by rules completely different than corporate executives—not that the private sector has produced a flawless track record, either.

In the meantime, the federal government continues to create and expand entitlement programs requiring state funding. The question of accountability and investor trust will loom large in the months and years ahead.

Bottom-line: cost of capital will rise as higher interest rates reflect not just sullied finances, but also deep distrust.

Health reform will test this precarious environment almost immediately. Already, according to the Wall Street Journal, many states are demanding that employees make first-ever contributions to their benefits, something private sector employees have always done.

However, employee unions in Michigan—and, yes, New Jersey—are filing lawsuits against such demands, putting even more pressure on elected officials.

The same Journal article cites a report by the Pew Center that calculates state retiree health care and other non-pension benefits as a $587 billion long-term liability for state governments. As of fiscal year 2008, less than six percent of that amount was funded.

New Jersey immediately consented to the SEC's cease-and-desist order, but did not admit wrongdoing. At this point, the SEC has issued no further penalty, and has not cited individuals for prosecution.

If you are an elected official—or, indeed, an employee—of the state, you might say, "Not my problem."

For investors and taxpayers, already confronting a challenging environment, 'not my problem' is the worst possible utterance, a complete voiding of trust.

And if there's no trust, there's no confidence, and no recovery.

Finding a New Way in Accountable Care Organizations

2010-08-10T14:43:00.000-07:00

Docs need better business skills, and fast.

Blame it on the medical education system. Medical schools train students to become world-class clinicians, but most graduates haven't the faintest idea how to manage a business—yet many do just that, establish their own practices.

Blame it also on America's peculiar health care system, which distorts basic economics so familiar to any other industry.

Up until the past few years, business acumen wasn't necessary. Most docs had it easy, a flow of patients as steady as reimbursement. Okay, maybe some aggravation in reimbursement, but whatever the government ratcheted down, the doc could ratchet up through cost shifting, or more generous payments from commercial payers.

That comfortable world is changing rapidly. With or without health reform, the current system can no longer sustain itself. Financial resources are shrinking just as demographics are shifting—a population mix giving way to a larger percentage of health-care-consuming retired people than ever before.

For the first time, many physicians—beyond just primary care docs—are having to spend more time at their desks stressing over the wherewithal of their businesses. Their anxiety: patient flows rising just as pricing power shrinks.

And it's not like no one's seen it coming. Examples abound of docs implementing creative business models, whether simple networks or more elaborate integrated delivery systems.

Still, the majority haven't been that clever. They face certain shock when market dynamics force practices to merge, sell into large organizations, or, worse, shut down. Many docs simply will give up, retire and let someone else worry about the 'new way'.

According to March 2010 survey published in the New England Journal of Medicine, nearly a third of docs said they plan to quit if Congress passed health reform.

Perhaps in the lusher days of more certain economics, we could have viewed health care as a right. No longer. Fundamentally, as we're now learning, it's an economic good. Supply, simply, is finite, and not very good at matching demand.

The more business-focused MDs will discover the new way in integrated care. Health reform addresses this concept in the accountable care organization. An ACO unifies different types of organizations in the delivery of a broad continuum of care, while bearing financial risk for the care provided. Think of it as different tax IDs buying into an economic opportunity.

Risk, a component of every business, will now become a core component of the provider practice—just like its clinical services. And so will information technology, which the ACO's different members will need to share in order to measure performance and assess business risk.

But how exactly does an ACO function? As written in health reform, a government-sponsored ACO is a voluntary formation. It links hospitals and physician practices, different practice specialties, independent practitioners, and more. The Centers for Medicare and Medicaid Services ("CMS") establishes an overall fixed budget, and the ACO must achieve more efficient utilization to remain viable.

If it cannot achieve better utilization, the ensuing budget squeeze could force paycuts on its members.

Utilization refers to how physicians choose to deliver care, taking into account the cost of procedures such as emergency room use, radiology, and specialty visits. It could also feature a more standardized care delivery process, for example, implementation of clinical pathways. The ACO will focus initially on outpatient services, which, according to the actuarial consultancy Milliman, amount to 70 percent of all health care costs.

A July 2010 article in Health Affairs sorts the ACO into five categories by degree of provider risk-taking:

Integrated Delivery System
Multispecialty Group Practice
Physician-Hospital Organization
Independent Practice Association
Virtual Physician Organization

The article's authors argue that an integrated delivery system and multispecialty group practice should consider capitation or bundled payments, because they assume a higher degree of risk than a less structurally integrated system such as a virtual physician organization, which should implement a limited or partial capitation payment program.

In a recent briefing paper [PDF], Milliman highlights the importance of basic risk assessment. It states:

[T]he ACO must preach and practice two challenging and often-overlooked imperatives: establish actuarial cost and utilization targets appropriate the ACO's designated business, and provide medical management to achieve those targets

No doubt, actuarial assumptions will play a key role, and Milliman describes how the ACO might go about making these assumptions. This means building cost models based on population data and the ACO's own utilization capabilities. If the budget targets are generous, the ACO could realize a substantial commercial opportunity.

If the targets are narrow, its leaders might not want to form an ACO in the first place.

Provider services such as medical oncology that depend heavily on Medicare might form ACOs in partnership with CMS. Others such as primary care might form ACOs in partnership with commercial payers—or, to the extent they capture out-of-pocket payments, with patients themselves or their employers. Many might partner with a combination of payers.

MDs can expect substantial displacement in the months and years ahead. Many will lose their independence, either willingly or unwillingly. In addition to the usual clinical challenges, they will also have to overcome business challenges for which they are completely unprepared.

Those docs wanting a voice in the new way will need to come to terms with direct ownership in organizations that integrate and coordinate care across multiple silos.

If better business skills drive better clinical outcomes, we could soon realize major benefits in a health care system based on value.

Clinical Pathways Lessen Geographic Variation, Reduce Costs

2010-08-03T05:20:00.000-07:00

Because physicians often treat patients differently for the same condition, outcomes vary—as do the costs. For government and commercial payers, these variations can result in substantial differences across physician practices and hospitals, and geographic regions.

Even before health reform, many constituents had been targeting variation in care as a leading opportunity for efficiency gains.

In a March and April article series in the Lyceum newsletter Perspectives, Dr. Bruce Cutter describes the solution to geographic variation in clinical pathways. He writes:

Clinical pathways are an agreed-upon, standardized way to treat patients with certain diseases, including cancer and other complex diseases. While they can be thought of as a subset of the better known term clinical guidelines, there are many differences.

The intent of a clinical pathway is to standardize care, and to do so in a way that is evidence-based, patient-centered, and value-focused. Standardizing care in such a fashion decreases unexplained and unwarranted variation and enhances the value equation.

Dr. Cutter, a Spokane-based medical oncologist, goes on to define basic characteristics that constitute an effective pathway, and gives examples of successful demonstration projects. "Critically," he notes, "they shift value creation responsibility to the people who have the most influence over quality and costs, and who have an ethical and fiduciary responsibility to patients: physicians and other members of the health care team."

Read Dr. Cutter's articles here.

In an August 2nd Perspectives article, Dawn Holcombe echoes Dr. Cutter's thoughts with additional insight on a pathway's key characteristics. She segments these characteristics into five areas:

Clinical Source and Maintenance
Pathway Definition
Point of Clinical Decision-Making
Tracking and Monitoring
Documented Ease of Physician Use

Ms. Holcombe, a long-time consultant to oncology providers, argues that not every pathway is a true pathway. Many, in fact, are not much more than tightly defined guidelines. "How those pathways are defined and executed," she observes, "makes an enormous difference."

Once physicians and payers understand what makes up a viable pathway, they can then ask the right questions to make informed decisions. She states:

By asking the right questions, physicians and payers alike will utilize true clinical pathways programs.

They will also avoid programs mistakenly labeled as pathways, which focus more on preferred treatment menus and less on detailed care and reporting—a more tightly controlled way of defining guidelines.

Read Ms. Holcombe's article here.

Clinical pathways are gaining traction in oncology. Dr. Cutter projects that in time we could witness broader adoption in care coordination and integration:

Standardization would allow experts and practitioners to measure a wide range of clinical, quality, outcome, and operational metrics at multiple population levels, and to compare one group to another.

When Docs Take On Economic Risk

2010-07-24T05:37:00.000-07:00

Misaligned incentives distort how health care's participants interact with each other, aggravating patient frustration and worsening trends in care delivery.

Payers reimburse physicians based on volume, not value. Payer risk pools, in turn, favor well beneficiaries over sick beneficiaries. And employers, instead of employees, decide how to consume health care.

At no point do supply and demand actually transact. Rarely are consumers able to make informed decisions.

To the extent that health reform legislation realigns incentives where at least payers and providers operate closer to the same page, efficiency levels could rise.

According to the actuarial consultancy Milliman, the force driving this could be provider risk-sharing. In a recent briefing paper, the consultancy describes this as a process of re-adjusting "health plan payments, provider payments, and individual or group premiums to reflect the health status of plan members".

Think of it as two entities, normally opposed to each other, owning an economic opportunity, in this case a better, more cost effective patient outcome. By owning it, they both share in the upside—and the downside—while utilizing resources more efficiently.

"Instead of fee-for-service," write the paper's authors, "compensation may come in the form of a per-member basis, with bonuses paid depending on the provider's achievement of specified targets and goals. Savings will be shared between providers and payers according to their effectiveness and efficiency. Pay-for-performance components within this overall approach will reward improved patient outcomes as well as straightforward savings." Read paper here (PDF).

By endorsing programs such as accountable care organizations and evidence-based medicine, health reform legislation potentially eases the restraints on factors necessary for risk-sharing to take place. And with advancements in electronic health records providing key technological support, provider risk-sharing stands a reasonable—if not excellent—chance of revival after faring poorly in the 1990s.

(For information about Medicaid risk-sharing projects in the 90s, read here. These projects followed a capitation, or set fee-per-patient, payment model where health plans transferred percentages of government payments to providers based risk assumption.)

As the authors note, failure resulted from:

poor quality measures
insufficient documentation and coding procedures
non-pervasive best practices
weak information technology
unsophisticated risk assessment techniques

Many of these factors, however, have improved considerably.

Regardless, risk-sharing faces a big challenge in overcoming entrenched inertia and the fear of another disappointing failure. Both providers and payers will need to trust the new system before shedding the old one, and any number of successful demonstration projects may not motivate wide enough adoption to bend the cost curve.

Risk sharing, though, is an intriguing concept, and could easily apply to provider practices beyond the scope of government programs: concierge and retail-based care delivery, for example, where consumers align their own dollars with providers' dollars to ensure the best possible care.

Not matter what, it comes down basic economics. At this point, we can expect large government deficits and profit constraints on payers and providers to overwhelm trust and fear issues, and motivate consideration of alternative systems.

Any economic improvement or good standing, especially among providers, would likely diminish risk-sharing's chances for adoption.

In Health Care, It's David Versus Goliath

2010-07-20T13:27:00.000-07:00

"You can't teach an old dog new tricks," so the saying goes. And for incumbent business models in health care, nothing could be more true.

If anything, federal health reform is a catalyst for industry consolidation, where increased regulation will force payers and providers to seek scale advantages as profits decline.

While government subsidies might target alternative payment models such as bundled fees and care delivery platforms such as accountable care organizations ("ACOs"), business leaders will have to utilize external—non-government tethered—strategies for sustained organic growth.

Writing in the Lyceum newsletter Perspectives, health care consultant Erik Swanson notes:

In order to survive, existing participants in the health care system need to change how they make money. Smart new entrants stand to capture substantial profits if they can achieve disruptive change.

The biggest opportunity is in customer experience. Make it better, and your product or service will do just fine, thank you.

Swanson, who cut his teeth running corporate strategy for WellPoint and advising the health care industry as a partner at Accenture, observes:

The introduction of insurance exchanges and a newly accessible individual market, for example, could ignite a consumer-driven revolution in how health care is financed and delivered by emphasizing retail-based models and customer experience.

Another opportunity is in information and advice. Health care data is already plentiful, and will continue to grow exponentially. Until businesses can move beyond just selling formatted data, and turn it into interactive advice, data will only clog space in some vast server farm.

Swanson points to efforts by Walgreens and Averde Health that target improved customer experience. He also gives the example of Blue Shield of California, CALPERS (a large employer), Hill (a physician group) and Catholic Healthcare West (a large hospital system) partnering to create an integrated system, which other participants elsewhere in the country might seek to imitate.

Read his article here.

Despite the challenges of health reform, innovators enjoy a massive advantage unlike any other industry: incumbent inertia. Whether big insurance, big pharma or big hospital, the strategic goal of existing players is to do the same thing, just in a bigger way.

Like David and Goliath, it could only take a smartly aimed slingshot to take down a lethargic leviathan.

Consumers will be there to lavish the rewards.

Financial Market Time Periods Have Compressed, Don't Expect It To Last

2010-07-16T09:59:00.000-07:00

Whatever happened to long term investing?

Turnover on the New York Stock Exchange is now annualizing at 110%, where the total volume of individual shares bought and sold is 10% greater than the total shares listed the exchange. 10 years ago it was 88%; 20 years ago, 46%.

In 1980, turnover amounted to one-third of shares listed.

To put this in terms of a holding period, today's market participants buy and sell the entire Big Board once every 11 months, versus once every three years 30 years ago.

And with algorithmic, or computer-driven, trading propelling most of the volume (about two-thirds of total), it would seem unlikely that portfolio-churning abates anytime soon.

For corporate management, a 100% turnover rate effectively means confronting an entirely new shareholder list every 12 months. For some companies, this list could change even more frequently, every nine, six or—gasp!—three months. And sometimes more often.

No wonder time horizons for strategic planning continue to shrink. Expectations simply aren't what they used to be. According to a recent study by Booz Allen, the global mean tenure of departing CEOs has dropped from 8.1 years to 6.3 years between 2000 and 2009, and the forced turnover rate for CEOs is 36.7%.

Maybe we should view time compression as symptomatic of machines taking over. Investing and code writing, after all, now appear synonymous.

Just the other day, the Wall Street Journal profiled a group of twenty-somethings trading on Artificial Intelligence. While not boasting the seconds- or milliseconds-long holding periods of the high frequency variety, this fund still claims a 300% turnover rate, suggesting a primary (if not exclusive) emphasis on technical factors.

Perhaps, a 100 years from now, machines will even operate corporate C-suites, with A.I. guiding expansive enterprise resource planning ("ERP") systems.

What about the more immediate future? Is the market heading towards such extreme time compression that company and industry fundamentals disintegrate into irrelevancy?

Don't bet on it.

Back in February 2007, we wrote a lengthy article for the Lyceum newsletter Perspectives called "A Return to Long Horizons". It considered the overriding impact of technological advancements, and how they're manifesting in reduced transaction costs.

We argued that rapid-fire traders would crowd short-term strategies and create new opportunities for more patient investors. We pointed to advancements in information technology as causing the market to shift to short-termism, and their commoditization as causing the market to rebalance—eventually—to adopt longer time frames. Read it here.

Later that year, all hell broke loose, and market turmoil waylaid any sense of measured thinking among investor classes. Panic—don't we know—begets panic, and all money runs for cover.

Now, we think our thesis (outlined below) deserves another look—especially as financial regulation courses its way across market participants. (Regulators could do much better than the infinitely complex financial reform legislation to encourage a healthier marketplace and allow different investment strategies to compete. For example, they might simply have considered forcing banks to capitalize bonuses to foster greater ownership of risk-taking.)

From "A Return to Long Horizons":

The information revolution fundamentally altered the practice of money management, with commission reductions and the rise of absolute return investing becoming its consequences, rather than its drivers. Simultaneously connected, portfolio managers could better assess a data point’s validity, especially those who could act on its immediacy. Imagine a world without your Blackberry – now imagine it without any form of electronic communication.

Better performance on better information attracted shareholder dollars. Greater buy-side power, whether under the guise of alpha or absolute return, then augmented market liquidity: sell-side transparency rose and transaction (or trading) costs declined.

While the Internet unexpectedly advanced the quality and quantity of information, its success is now commoditizing information as access points proliferate and costs decline. Together with government regulation (fair disclosure and Sarbanes-Oxley), information’s evolutionary surge has turned to level the playing field – at least for those playing the trading game.

Here's a graph we drafted to illustrate our viewpoint.

In keeping with our theme, we're thinking long term. Short-termism could continue to compress financial markets even more tightly, but at some point the long-term folks will regain the edge.

And that's what matters most: that edge, where one investor class is able to achieve better returns at less risk to capital relative to other classes.

At the very least, the 2007-8 time period made it absolutely clear that absolute return is an absolute fallacy. Investing is a relative game, and we were right about that:

As prospective shareholders begin to rank money managers more by peer performance and risk-return conditions continue shifting against portfolio churning, margin-of-safety will replace absolute return as the buzz-phrase of the next five years.

So long as policy makers and regulators don't completely warp the marketplace, long-term folks will have their day once more.

Okay, we admit that might be an awfully large qualification.

For the market's stake, we're going to take it.

Noted Health Economist Ignores the Bigger Picture

2010-07-10T06:45:00.000-07:00

Writing in the Health Affairs blog, Uwe Reinhardt states:

The bulk of the medical benefits procured by an insurer for residents in a given market area are produced by providers within that market area. In general, both private and public insurers have only limited, if any, control over the volume of the medical benefits that local clinical decision makers ask insurers to purchase for the insured. Furthermore, the larger the number of insurance companies active in a local market, the smaller any insurer’s market share will be — other things being equal — and the less leverage any insurer will have in bargaining with area providers over the prices of health care.

His posting addresses the question of insurance concentration, and the need for larger numbers of independent insurers to compete in local markets. Read here.

He concludes:

Ideally, in my view, the market for health insurance would be oligopolistic, which means that only a few insurers — each with some market clout vis à vis providers — would compete for enrollees in a local market. What the ideal number would be is an interesting question on which economists can have a lively debate.

For such an acclaimed health economist, Prof. Reinhardt misses the bigger picture. His analysis completely ignores the unrealized economic impact of folks who actually consume health care: patients, caregivers, taxpayers—the consumer.

Health care is unlike any other industry in that buyers don't consume, and consumers don't purchase (at least not directly). And with no market-based force counterbalancing supply, value—on a transaction basis—is indeterminate. Value, instead, is something that actuaries, academics and government officials determine.

Of course, he has a point. If health care persists as is—and as health reform intends—markets will become more concentrated.

Expect States to Take Control of Health Reform

2010-07-09T07:10:00.000-07:00

According to the Center on Budget and Policy Priorities, 46 states face budget shortfalls. With the unemployment rate averaging close to 10% nationwide and economic recovery pacing gingerly, additional spending requirements could devastate an already precarious condition.

For many states, health reform could not have come at a worse time. In the Lyceum newsletter Perspectives, Ed Haislmaier writes:

The broad effects of health reform legislation, if implemented as enacted, will be to impose significant new Medicaid costs on state taxpayers, disrupt state health insurance markets and the current coverage of tens of millions of Americans, and usurp state authority. (Read article here.)

In response, states should pursue aggressive strategies that protect their citizens and take control of health reform. Haislmaier, a senior research fellow at the Heritage Foundation in Washington DC, proposes six approaches:

Shift non-elderly Medicaid and CHIP enrollees into premium support.
Refuse to administer the new federal high-risk pools.
Decline federal “premium review” grants.
Implement state health insurance market reforms and exchanges based on state, not federal, designs.
Insist that federal officials explain publicly how they will administer health reform.
Conduct and publicize “benchmark” analyses.

Haislmaier’s article, excerpted from a longer study published on July 1st (read here), could provide an important roadmap for states as they tackle crushing budget deficits. He argues, for example, that states possess an immediate opportunity in designing their own insurance exchanges:

By enacting their own insurance market reforms and creating their own exchanges, or similar administrative mechanisms, based on their own designs now, states can make it politically more difficult for federal officials to implement provisions of the new federal legislation (such as minimum federal benefit standards) that will drive up premiums and reduce coverage choices.

Strategically, states should assume one of two scenarios: a new Congress that repeals health reform or a protected fight against implementing the legislation as enacted.

In either case, states would be wise to apply their own reform while they can. If the latter, harsh economic reality will likely force aggressive action, regardless of political intent.

Although few believe the former, political climates can shift quickly. All eyes will focus on the mid-term election.

Biggest Wave of IPOs Since 2007—Or Not

2010-07-07T06:45:00.000-07:00

Despite market uncertainty, 91 companies filed with the SEC in the second quarter to sell $24 billion of shares, according to Bloomberg. The news agency reports:

Investors in U.S. IPOs lost 7.2 percent so far this year as the Standard & Poor’s 500 Index fell to an almost nine-month low. Leveraged-buyout firms, which spent $2 trillion on takeovers during the credit-market bubble, announced the biggest stock sales and accounted for at least 50 percent of the deals filed with the SEC in April through June.

KKR itself will list on the NYSE on July 15th, and later this year, together with Bain, will sell shares in the hospital operator HCA. The HCA transaction will be the largest IPO since Visa, and total nearly $5 billion in shares. Proceeds will be used to pay down $26 billion in debt, or 80% of its purchase price. At $3.5 billion market cap, Universal Health Systems is currently the largest listed hospital operator.

Since their listing in June 2007, shares in Blackstone Group, the latest major private equity firm to go public, are down 75%—40% worse than the S&P 500. See chart here.

Among the 90 other companies seeking a listing is Zipcar, a car sharing firm that rents cars by the hour. Reminiscent of the dot-com era, it hasn't earned a profit since its founding in 2000.

Complicating any IPO are uncertain conditions. The S&P, for example, is down 9% from the beginning of the year, while the VIX is 40% higher at a level near 30. And with IPOs loss-making thus far this year, investor appetite would not appear sufficient enough to swallow the entire pipeline.

The question then is: If not the entire pipeline, then how much—or little—of it?

Don't expect any easy exits for debt-financed acquisitions, especially if corporate debt costs rise.

Paper: Cost Shifting No Longer An Option

2010-07-02T03:37:00.000-07:00

In a recent briefing paper (PDF), the actuarial consultancy Milliman outlines the urgent reimbursement crisis. Whereas, in the past, providers utilized cost shifting to offset below-cost Medicare and Medicaid reimbursement (charging commercial health plans more to compensate for lost revenue from government plans), they now face two demographic events that will negate that strategy in the next ten years:

the flood of new Medicaid patients starting in 2014 as health reform kicks in
the transition of baby boomers from high-margin commercial business to becoming Medicare eligible

Between 2010 and 2020, Milliman estimates the Medicare population will increase from 12% to 16% of total, and the Medicaid population to increase from 17% to 21% of total. Over this time period, the yield on billed charges (calculated as allowed charges divided by billed charges) will decrease from 44% to 39%. At the same time, health reform will impose additional pricing constraints on commercial health plans, making it more difficult for them to increase reimbursement.

Milliman concludes that providers will have no choice but to become more efficient. (Of course, many may elect to refuse government plans, consolidate or exit the business.)

It recommends various strategies, including:

making facilities management more efficient as demand for beds exceeds capacity
understanding the demographic mix in their particular area
investing in service sectors that afford consistent margins in the long term
rethinking cost structures and potential lowering expectations for future income

Just as demand for health care services crosses an inflection point, supply is likely to contract.

Book Review: "More Money Than God"

2010-07-01T05:51:00.000-07:00

In 1920, Babe Ruth had perhaps the single greatest season of any baseball player. His 54 home runs totaled more than any one team—except, of course, the Yankees. Since the game's inception in 1876, no one had hit more than 29 in a season, a record Ruth set the previous year while playing for the Red Sox. Experts reckon that if Ruth had played under modern rules, his home run tally would have been close to 100.

More than his individual feats, we can measure Ruth's significance in how he changed the game, from shifting its style of play to expanding its monetary value.

Like baseball, transcendent figures have also altered the financial market landscape. In his book "More Money Than God", Sebastian Mallaby chronicles the history of hedge funds, their economic and social impact and the larger-than-life individuals who shaped their development.

Throughout his diligently researched narrative, Mallaby carefully builds the argument that hedge funds are essential components of modern finance, and effective vehicles at making markets efficient. As such, he believes regulators should tread carefully in imposing constraints.

While no one person may have changed the market landscape the way that Ruth transformed the game of baseball, Mallaby highlights some well-know names who've come close: Alfred W. Jones, Michael Steinhardt, George Soros, Julian Robertson, Tom Steyer, and Jim Simons among others.

He views these individuals not just as savvy traders and investors, but as true innovators, like Ruth folks who brought something new to the game which later generations would replicate and execute as common practice.

Time and again, despite highly variable market conditions, hedge funds are successful because they deploy an effective, proprietary model that banks simply don't posses—or no longer posses as publicly traded entities. He writes:

The very structure of hedge funds promotes a paranoid discipline. Banks tend to be established institutions with comfortable bosses; hedge funds tend to be scrappy upstarts with bosses who think nothing of staying up all night to see a deal close. Banks collect savings from households with the help of government deposit insurance; hedge funds have to demonstrate that they can manage risk before they can raise money from clients.

Mallaby, however, might want to explore the relationship between banks and hedge funds more closely. As different as they appear to be, they feed off each other. One cannot exist without the other. Banks, for example, provide prime brokerage services that finance hedge funds and facilitate their strategies. Hedge funds, in return, produce not only generous commissions, but also market-changing innovation that banks assimilate.

Regulation may not come down on hedge funds, but any change in how regulators target banks could yield lasting effects. What would happen, for instance, if banks are no longer able to trade proprietary accounts?

The book is at its best when describing famous trades and how titans navigated extreme market conditions. By featuring many—but no all—of the industry's leading figures, it juxtaposes the different thought-processes and strategies.

Take the dot-com market mania. Both Stanley Druckenmiller and Julian Robertson scoffed at it. Druckenmiller, early on, amassed a large short position, but quickly changed directions, and rode the billowing wave. The ensuing crash trapped Druckenmiller, and caused massive losses. Exhausted, Druckenmiller would leave Quantum shortly after.

Robertson, a value-investor, tried to hold his core strategy. Also suffering big losses, he shuttered his giant fund as the meltdown unfolded. As Mallaby describes, it wasn't just Tiger's out-of-sync strategy that sank it, it was also the fund's massive size and the market's knowledge of its positions:

In 1998, LTCM had gone into its death spiral as its brokers began to call in loans, leading Robertson to write to his investors about the dangers of excessive leverage. In 1999, Tiger was in danger of unraveling too—not because brokers were calling in their loans but because investors were calling in their equity. In both cases, moreover, widespread knowledge of the hedge funds' holdings contributed to their troubles.

Other highlights include descriptions of how Steinhardt traded his way to huge gains in the 1970s and how Paul Tudor Jones adeptly timed the 1987 crash. But, as Mallaby points out, it was Soros' bet against the British Pound that elevated hedge funds to the global stage, and for the first time held legislators and central bankers to account:

The next few days [leading up to Britain's exit from the European exchange-rate mechanism in 1992] marked a watershed in the relationship between governments and markets. A financial tidal wave broke across Europe, demonstrating how huddles of traders in midtown Manhattan could have consequences globally. Druckenmiller and Soros were the central players in this drama, but they were not the only ones.

This accountability is significant because it establishes a powerful check and balance between election cycles.

Whether Robertson's swagger or Simons' secrecy, Mallaby's protagonists showcase profound idiosyncrasies that manifest in their funds' cultures. Using the Amaranth blow-up as a case study, he illustrates how funds can implode if their managers don't fully comprehend risk, and fail to impose a culture based on their own individual success. (Ostensibly a multistrategy fund, Amaranth instead concentrated its capital on a single energy trader.)

Mallaby selected mavens who began with a just a few million dollars—not the hundreds of millions or billions in seed capital that more recent managers enjoy. They are scrappy individuals who risked time, effort and personal wealth to earn fortunes.

With few exceptions, they did not amass these fortunes over a few short years. It took 10, 20 years or more. John Paulson, for example, who made $3.7 billion in 2007 alone launched his fund in 1994 with two million dollars.

As the next generation of hedge fund managers takes root, it would be worthwhile to explore the generational contrast. Are investor and manager expectations appropriately aligned? Does the new generation need to reinvent the incentive structure?

Mallaby contends that hedge funds, unlike banks, are valuable market participants because they are not too-big-fail institutions. They bear no cost to taxpayers. While on an individual fund basis that may be the case, his argument is not altogether convincing. As he points out, hedge funds including proprietary trading desks will often converge on the same trades, forcing extreme price movements. Dominating daily trading volumes, they have also—on a collective basis—now become default providers of market liquidity.

Any chain reaction of funds imploding would cause extreme market disruption and exacerbate price movements that could already be extreme. We could easily see, as a result, the Federal Reserve intervening and lawmakers debating support of companies ravaged by forced sales.

Among the social costs would be higher risk premiums—a de facto transaction tax that all individuals would bear.

The picture of where we go to from here is far from clear, not just because market participants must navigate financial market reform alongside socioeconomic transition, but also because a new generation of hedge fund managers is emerging.

Three generations have passed since Babe Ruth transformed baseball. As much as the game has evolved, the total change is arguably not as great from his retirement as it was from the period prior to his playing—a career that began in 1914 and ended in 1935.

Will the same be said of Robertson, Soros and Simons? Much will depend on how the total market evolves, not just big banks and hedge funds, but mutual funds, pension funds and individual investors.

For the moment, at least, we can reflect on an historically significant market era that began about 50 years ago with Alfred Winslow Jones, and which is just now entering an entirely new phase.

Paper: Employer-Based Health Care Confronts Big Questions

2010-06-10T14:45:00.000-07:00

In a recent briefing paper on health care reform, the actuarial consultancy Milliman offers various strategic considerations for employers as they approach the year 2014, and the choice of continuing coverage:

If a suitable individual market emerges through the American Health Benefit Exchanges (beginning in 2014), employees will have an alternate source of coverage that will essentially compete with employer-sponsored plans. Employers will need to analyze the value of continuing to directly offer healthcare benefits compared to offering cash to employees to purchase coverage on their own or simply discontinuing the benefit

This decision is similar to employer decisions to provide defined benefit plans (e.g., pensions), defined contribution plans such as a 401(k) plan, or some combination of both types of plans. However, active employee healthcare programs differ in many aspects from retiree income benefit programs. The awareness and immediate use of healthcare benefits must be considered in the decision-making process. This decision could represent a fundamental change in the employer-employee relationship.

Read the Milliman Briefing Paper here (PDF).

The paper goes on to list several questions for consideration, including:

Will employees understand the importance of purchasing coverage? What assistance will they need from their employees?
What is the (selection) impact on the remaining covered population of employees who elect to change coverage from their employer plans to exchange plans?
What is the post-tax impact to employees of any change to the health care benefit program?
How would discontinuing traditional defined-benefit health care benefits affect attraction, retention, and productivity?
How would the employer's competitive position be affected by discontinuing traditional benefits (or by continuing to offer continuing benefits)?

Other legislation provisions that may affect employer costs include:

Minimum loss ratio requirements for insured plans
Increased prescription drug costs stemming from 12-year patent protection of biologics
Increase in taxes paid by insurers passed through to employers and individuals
Ban on physician-owned hospitals which could limit unnecessary care prescribed
Increase in Medicaid provider reimbursement (to primary care physicians) may decrease cost-shifting to employer-sponsored plans
Success, or failure, of various efficiency initiatives in wellness, provider reimbursement, cost control, and quality of care

If legislators don't increase penalties for not offering coverage (now at $2,000 per employee), large employers may face a relatively straightforward cost-benefit decision. Politics, however, may complicate that decision, if employees buckle at having to pursue their own health care choices, and the state insurance exchanges fail to become viable structures.

Expect an already uncertain employer-based marketplace to weigh heavily on corporate strategy, especially if health care costs continue to escalate and economic recovery slows or falters.

Health Care M&A

2010-06-08T11:29:00.000-07:00

On June 22nd, Lyceum Associates is pleased to present the first installment of a roundtable series exploring health care M&A and corporate strategy.

Practitioners and experts unanimously expect reform legislation to alter the value chain, though not exactly how or to what effect. At the same time, capital markets are also transforming, and forcing corporate management to negotiate new challenges, including access to and cost of capital.

The combined effects could contribute to radical corporate realignment. Our series will anticipate these shifts, and provide 360-degree snapshots of an industry in transition.

June 22nd focus questions will include:

How are payers and providers adjusting to regulatory compliance? How might differing speeds shift balances of power?
What are strategic opportunities in pharmacy life-cycle management?
How is cost of capital affecting corporate positioning?
Which components of the value chain are most likely to experience business model shifts? Which are least likely?
Are consumers likely to force greater accountability?
Where does information technology have the biggest impact?
How will the health care consulting marketplace evolve?

Learn more and enroll here.

Buffett Contradicts Himself

2010-06-07T10:34:00.000-07:00

Of the different players contributing to the 2008 financial crisis, many would place the credit rating agencies at the top of the list. So why does Warren Buffett defend Moody's and its CEO, Raymond McDaniel?

The simple answer may be to protect his investment. Berkshire Hathaway controls 13% of the company. His June 2nd testimony before the Financial Crisis Inquiry Commission in New York, however, suggests a more problematic mindset, and points to striking contradictions in his otherwise logical thought process.

The latest article in the Lyceum newsletter Perspectives considers Mr. Buffett's disappointing testimony. Read it here.

1. As Mr. Buffett indicates, he does not personally rely on credit ratings, but his ability to pick mispriced stocks does depend on everyone else relying on them. Does his own fortune, then, excuse the agencies for being wrong?

2. Raymond McDaniel was just one more "among many who missed warning signs of the crisis”. It would be unfair to single him out for blame. Okay, if that's the case, then we should blame no one, and completely dismiss the notion of 'risk'.

3. “I’m not arguing that this is a perfect model [the rating agency model, paid for by the issuers]. It’s very difficult to think of an alternative where the user pays." Hmm, what about the analysts Mr. Buffett pays for research? Isn't this an alternative?

4. 90% of Moody's 2007 investment grade ratings became junk twelve months later. Still Mr. Buffett does not view McDaniel and his firm as erring.

At issue here, as with financial reform itself, is the question of risk and return. If lawmakers and regulators continue to shield certain individuals and institutions from risk, then they force all of us pay a social tax in higher risk premiums, to compensate for inappropriate risk-taking.

And the more the shield is extended, the greater the cost we bear in market inefficiency.

Hospital Consolidation Does Nothing to Fix the Problem

2010-06-03T08:49:00.000-07:00

Hospital consolidation maximizes the same bet on a failing business model, according to Stephen Hyde in his latest Lyceum Perspectives article, "'Patient Value' and a Better Business Model for Hospitals".

Since the year 2000, 2000 hospitals have been involved in nearly 1000 M&A transactions. But while health care has come to emphasize scale (not business innovation)—big carriers, big hospitals, big pharma, etc.—health reform is likely to upend the traditional payment model, and starve the system of reimbursement.

Scale, now, just means bigger costs and greater inefficiency. No one is truly thinking through the underlying business model.

Instead of the same old thing, Mr. Hyde challenges hospitals to develop an entirely new model:

Consolidation and integration can be fine ideas (when properly structured and executed), but neither is focused on producing a survivable business model. Getting that will require a laser focus on one thing—the only thing—that can permanently make hospitals financially and competitively invincible: patient value.

Maybe the best solution would be for hospitals and health insurance companies to come together and develop local-based plans that emphasize quality and competitive pricing.

Read Mr. Hyde's article here.

What Happens If Employer-Based Health Insurance Goes Away?

2010-05-26T11:13:00.001-07:00

According to a recent survey of large companies (median size: 5,600 employees) by Towers Watson, 94% of companies expect health reform to increase costs. While most expect to continue offering health insurance, 43% of those offering retiree benefits expect to reduce or eliminate them.

88% plan to pass cost increases on to employees, and 74% anticipate reducing health benefits and programs. 20%, moreover, expect to pass increases on to customers. Read more here.

Writing in the Lyceum newsletter Perspectives, Steve Hyde argues that employer-based health insurance will continue its decline at an accelerating pace, as health reform progresses. He states:

The reform law, with its universally available insurance exchanges and generous middle-class premium subsidies (and free Medicaid for many earning $10-15/hour), effectively removes both barriers to exit. And the $2,000/employee play-or-pay penalty, according to Medicare’s actuary, “would not be a substantial deterrent to dropping or forgoing coverage.”

Read Steve Hyde's article here.

If the pace does in fact accelerate, expect commercial and government health plans to shoulder the extra burden, which will manifest in higher premiums and tax rates. Most impacted could be the state Medicaid programs.

And while Mr. Hyde believes group-based coverage is inherently flawed to begin with, the alternative of a government-sponsored individual market does nothing to rectify the economic misalignment of payers not consuming and consumers not paying—at least not in a direct and transparent fashion.

Access to care is also likely to suffer as hospitals will find it increasingly difficult to offset declining Medicare and Medicaid reimbursement with higher charges to private payers. Hyde argues:

Hospitals must anticipate the risk of losing their ability to shift growing government losses onto private payers. For most, responding will require nothing less than replacing the standard business model that has sustained them for decades. Those that don’t could find themselves in mortal jeopardy.

If costs do rise as employers expect, public and private payers experience worsening budgets, and access to care deteriorates, expect a severe consumer backlash. But this isn't the stuff of years to come.

Depending on how the global economy navigates the current economic recovery, including the challenges Europe now presents, any sustained increase in capital costs will exacerbate these negative trends.

Consumer response would be immediate.

Short Sellers Are Grown Up Goths

2010-05-24T09:53:00.000-07:00

Picture this. Instead of inhabiting the grown-up world of financial markets, we're back at high school. What teenage subclasses would investors represent? Quants, no doubt, are the jocks. They are the brash muscle guys, the BMOCs. The huge sums of money their algorithms whirl around move markets and all participants. The geeks have inherited the earth.

Long-term fundamental investors are the new nerds: bookish, no longer conventional, and happy to stay at home. One day, they could be relevant once again.

Momentum investors are the cheerleaders: always looking to chase what's hot, and avoid what's not. The trend is their friend: they wouldn't be caught dead at study hall.

And what about market contrarians? This clique lurks around the dark corners of financial disclosure, hunting for corporate fraud and hated for its efforts. Cynical and shunned, these short-sellers are the goths.

In his new book, "Selling America Short", Richard Sauer chronicles his experience as an SEC attorney and administrator and an analyst for one of the most gothic of short-sellers. Combining legalese and descriptive flair, he details some of the SEC's highest profile cases over the past several years: ACLN, Lernaut & Hauspie, AremisSoft, Overstock.com, NovaStar, and Fairfax Financial Holdings.

Amazon.com Widgets

He also delivers a hard-punching defense of David Rocker and his colleague Marc Cohodes, who later would lead the short-lived hedge fund Copper River. Sauer advised Rocker as a defense attorney and later worked for Cohodes as an analyst.

The SEC, he writes, has a difficult time finding its regulatory advantage:

Most of what happens in the market in the market is a puzzlement even (or perhaps particularly) to the people who regulate it. From its deep waters, things now and then float to the surface that can be identified as requiring a certain treatment under the law. Other pieces of market flotsam, when seen, are harder to classify. But what lies beneath the surface for the most part remains a mystery.

In fact, he argues that the agency suffers a distinct disadvantage, not just because it's poorly staffed, but that it's underresourced. Rogue targets, especially if located overseas, often use complex legal maneuvering to thwart the agency's challenges, and force it to burn through its limited case budgets.

According to Sauer, the SEC is constantly reconciling its own economic reality:

In deciding to litigate a run-of-the-mill case, a government agency will do a cost-benefit analysis, however informal, balancing the importance of the matter against its potential cost, and the likelihood of losing at trial. But in high-profile cases in which the agency will be criticized for inaction, the analysis shifts to one of weighing how much grief it will get should it bring the case lose compared to the amount to be expected should it forego bringing the case at all. And, of course, the pain from a eventual loss at trial will not occur for a few years, so it is given a sort of psychological discounting to present value.

Perhaps its biggest disadvantage is that it's a government agency, run by politicos with staffers doing the actual investigative work, often at odds with each other. Sauer cites the example of the insider trading case against John Mack, soon to be CEO of Morgan Stanley. Despite some significant evidence, the politicos killed the case before it could be more thoroughly investigated.

High-octane mouthiness
Cohodes, who possessed "disarming candor and high-octane mouthiness", had once shown up at a shareholder meeting dressed as a referee. Whenever he deemed that management was misleading, he blew his whistle and threw a red penalty flag.

Unlike trading firms, Cohodes and other contrarians typically manage concentrated portfolios of companies carefully scrutinized for fraudulent practices, such as falsified revenues, money laundering, and phantom asset valuations.

Pay-offs, though substantial, might not occur for several months, or years in some cases, as Sauer notes:

Short investments often follow a path of long-term pain followed by sudden jubilation when the short-seller at last "gets paid" for his trouble and patience. Timing, as in stand-up comedy, is everything, and hard to get right. Warren Buffet has said it's easier to pick bad companies than to predict when they will come to grief. They can blow up without warning or their faults can escape notice for longer than anyone who believes in efficient markets would think possible.

Copper River, which Cohodes formed after Rocker retired in 2006, fought a long, costly war against Patrick Byrne, CEO of Overstock.com. The several pages Sauer devotes to the various fronts and battles portray Byrne as borderline psychopathic. The reader almost feels embarrassed at having walking into a bitter family feud.

Lehman's collapse, the SEC ban on short-selling and rough-treatment by Goldman Sachs sank Copper River almost instantaneously. The SEC ban, hypocritical for executing the same market manipulation it prosecuted, did nothing to ease volatility, and Goldman's actions, attacking a bleeding hedge fund—and also a prime-brokerage account—in shark-like fashion, strongly suggested front-running and total disregard for Chinese Walls.

So, what of financial reform? For someone like Sauer, he's seen it all, and is decidedly pessimistic:

When the government imposes rules that come down to telling economic actors to "tell the world what you're really up to" some will regard this as more a challenge than a directive. Something to finesse when the stakes are high. And experience teaches that they will succeed in getting around the new rules and the government sloggers who enforce them—until they become altogether too good at it and bring on the next crisis. A cycle of creative destruction that creates less than it destroys.

Goths see dark while the rest of us see light. As in high school, many different actors make up the financial markets. The balance among these cliques can shift, but they are each important to each other.

Short-sellers expose the dark side of company management, which most of us want to believe is doing the right thing. And with regulators usually steps behind, they represent an important self-correcting mechanism.

Lawmakers, not realizing this balance, could overshift market equilibrium. Imagine, for example, a world of just jocks and cheerleaders. Not a pretty thought.

Health Care Costs Continue to Rise

2010-05-13T04:33:00.000-07:00

Just published: the 2010 Milliman Medical Index. This closely monitored index reports total annual medical spending for a typical American family of four covered by an employer-sponsored program. It examines key components of medical costs, and charts changes over time for both employees and employers.

Key findings include:

7.8% total increase in costs, from $16,771 in 2009 to $18,074 in 2010 (remember that CPI declined 0.4% in 2009)
$10,744 employer's share of costs (59% of total)—the first time above $10,000
48% inpatient and outpatient share of total spending, the largest component
$22,098 cost for Miami, the most expensive city, and $16,071 for Phoenix, the least expensive city
59% total increase in costs for employers since 2004, and 65% for employees

Read report here.

As to the near-term impact of health care reform, the report expects costs to shift from employees to employers, and provider/payer negotiations to intensify, as regulators put more pressure on the premium rate-setting process.

Factors that will raise costs for employers include:

expanded dependent coverage for adult children up to age 26
no lifetime and annual limits
restricted cost sharing for preventive care
prohibition of preexisting condition exclusions for children's coverage

Long-term impact is less certain, according to the authors:

Debate continues on the extent to which the changes from healthcare reform have potential to bend the long-term cost curve; however, for the near-term, the underlying drivers of increasing healthcare costs are not expected to immediately change...

For now, the onus of control remains with insurers, who will attempt to put pressure on providers to lower costs to a level that approved premium rate can support. There may be more extensive shifts in market dynamics in 2014, when the government takes on an even larger proportion of payment responsibility due to expansion in Medicaid, the creation of exchanges, and the availability of subsidies for certain lower-income individuals.

As the report suggests, we can expect lots of strategic challenges for employers and insurers over the next few years.

And while costs may ease somewhat for employees, payers will bear an extra burden, which they will look to offset with reimbursement cuts to providers (hospitals, docs) or, in the case of employers, higher price points for their end products.

Adding to these challenges would be a stagnating economy, structurally high unemployment, or rising inflation—or, worse, any combination of the three.

Wall Street Succumbs to Short-term Trading

2010-05-10T12:11:00.000-07:00

We depend on computers for just about everything. Has this become an over-dependence on Wall Street, and a direct threat to how capital markets should function? Yes, according to the latest article in the Lyceum newsletter Perspectives.

The article highlights the May 6 market collapse as another signal of a perilous shift from fundamental investing to short-term trading:

The May 6 market crack glaringly exposed the fundamental flaw of quantitative trading: machines have advanced faster than man’s ability to control them, or for regulators to understand them. The actual cause—a “fat finger”, an algorithmic trade gone astray, an errant high-frequency trading program, or a rogue quant—is less important than the culture that has not only permitted, but encouraged, such activity. In today's capital markets, speed has overtaken deliberation, action has replaced thinking, and irrationality has swamped reason.

At risk is a total loss of confidence in the capital markets' ability to support economic growth.

Quantitative traders have devised a quick means of making exorbitant profits, and converted capital markets into a casino. Their actions risk lost confidence among millions of small investors, which would make us all losers. Businesses will find it difficult and more expensive to raise capital, jobs will be lost, and retirees and shareholders will see their savings dwindle.

Read article here.

Government needs to take action, and point financial market reform to investing—not trading.

Hospitals Face Uncertain Future

2010-05-07T06:47:00.001-07:00

Over the past year, share prices in hospital operators have made impressive gains. Community Health Systems and Health Management Associates, as illustrated below, have outperformed the S&P 500 (bottom, brown line) by a nearly two-to-one margin, and Tenet Healthcare by more than three times.

Investor enthusiasm also extends into the private markets. In the days after President Obama signed health reform into law, Cerberus Capital Management announced a $830 million investment in Boston's second largest hospital network, Caritas Christi. According to reports, Cerberus may also target additional investments in hospital operators.

And just today (May 7th), HCA, the nation's largest hospital operator, has filed for a $4.6 billion IPO to pay off debt incurred by its private equity owners, KKR and Bain Capital.

While prospects might seem good, big questions remain, especially in two of hospitals' primary revenue sources: state governments and commercial health plans. Noted health care entrepreneur and pundit, Stephen Hyde, is cautious:

While [32 million newly insured users] may mean an end to the era of chronic unreimbursed care, it also brings on a new age of chronic under-reimbursed care. Without fundamental changes in how hospitals operate, increased losses will make it difficult for many of them to survive.

He argues that a combination of different factors could severely challenge profitability as costs outpace revenues on rising volume, including:

no credible source of higher Medicaid payments, especially if state budgets remain stressed
increasing demand for non-ER services and strains on capacity, as providers continue dropping Medicaid coverage
an escalating inability of commercial health plans to subsidize shortfalls through cost shifting

As would be true with any 3,000 page law, health reform will, no doubt, showcase an expanding list of unintended consequences in the years to come. Mr. Hyde points to the perils of badly conceived health insurance exchanges, as one example:

[T]he federal rules for the new state insurance exchanges contain some nasty landmines that are actually more likely to force insurers to be seeking subsidies rather than providing them. These rules include overly rich mandated benefits, excessively restrictive patient cost-sharing limits, uneconomic medical-loss-ratio mandates, unrealistic premium controls, continued medical inflation, and the probability of serious adverse selection... (Read more here.)

So, one, the bill mandates state insurance exchanges, a distinctly different target than the care delivery system; two, the rules laid out governing the exchanges severely restrict private carrier pricing and profitability; and three, hospitals, the recipient of the unintended consequence, will no longer be able to rely on private sector payments to offset below-cost Medicaid reimbursement.

At the same time, we're now witness to the consequences of severe government indebtedness, which we may soon experience in the quality of our health care system.

Will Biosimilars Alter Biotech Landscape?

2010-05-03T16:54:00.000-07:00

Though flawed, the pathway for follow-on biologics establishes a new dialogue between the FDA and manufacturers, according to Steve Grossman of FDA Matters. It encourages different strategies for best-possible routes to market for follow-on, or biosimilar, products:

The new law “protects” the reference product from competitors, by denying competitors the benefits of the new approval pathway for 12 years. This isn't market exclusivity, because there are other ways to get a biosimilar approved. Also, this isn't data exclusivity, because the competitive product can have its own data and still not be able to use the new abbreviated pathway for approval. What, in fact, the new law has granted to the reference product is 12 years of “pathway exclusivity”...

For drugs approved more than 12 years ago, companies that wish to market biosimilars will choose between the abbreviated pathway and filing a full Biologic License Application ("BLA"). For drugs approved less than 12 years ago, companies will either wait, or go the full BLA route.

Many companies—even those with the opportunity to take the abbreviated pathway—will decide that the full BLA exceeds the cost of collecting additional data. Some will take the data from their biosimilars already approved in Europe, and discuss with the FDA which pathway is likely to work best.

Other companies will work towards approval of BLAs for so-called “bio-betters”—new products that are similar to an existing product, but which are safer, more effective or easier to use.

What comes next depends in part on the FDA. The new law clearly empowers the FDA to find ways to get more biosimilar products on the market. Since this can only be partially achieved through the abbreviated pathway, we believe the agency will be looking for ways to make the BLA process friendlier for biosimilar and bio-better products.

Any change in the ability of manufacturers to approach the FDA—or any change, for that matter, in the FDA's confidence in approving biosimilars—could unleash powerful market forces, and upset innovators', such as Amgen, Genzyme and Genentech, longstanding balance and legal maneuvering.

Although overly restrictive patent law hamstrings the pathway itself, Grossman's argument suggests that investors can still expect manufacturers to pursue biosimilar products, even if via a traditional BLA process.

As the pathway stands now, for example, applicants must hand over the full application dossier to the reference product manufacturer 20 days after filing, in effect risking, upfront, privileged information on patents and corporate strategy.

Expect basic economics to dominate the drug supply chain over the coming months and years. Payers such as health plans and employers will demand a more competitive marketplace to drive down prices, and manufacturers will supply a larger number of competitive products.

A new dialogue with the FDA—or just regulatory confidence in biosimilars—provides a valuable opportunity for competitors to help payers improve affordability and access.

Is Our Own Debt Crisis Just Around the Corner?

2010-04-28T10:33:00.000-07:00

As debt contagion sweeps across Europe, we might consider our own perilous situation. Unfunded pension plans are overwhelming states, and threatening our own crisis. We posted an important article today called "We Can No Longer Afford to Retire", which highlights the damage inflicted on retirement accounts: read here.

An estimated 78 million baby boomers will begin turning 65 in 2011, creating further pressure on the already over-burdened Social Security system. Two years ago, the federal government estimated that by 2017 Social Security would be paying out in benefits more than it was taking in. Four years ago the estimate had been 2019. It is now expected that more money will be paid out this year than the System will collect.

The scale is much larger than publicly perceived:

In an April 27th survey, Putnam Investments of Boston revealed that 40 percent fewer Americans expect to fully fund their IRAs this year than last year, and that “62 percent (believe) their savings are unlikely to provide them with a sizeable retirement nest egg”. With total retirement assets in the U.S. at about $18 trillion, that works out to around $175,000 per worker—nowhere near what will be required... Two years ago, Roger Lowenstein suggested in his book While America Ages that total cumulative retirement deficits are approaching one trillion dollars. A recent study by the Stanford Institute for Economic Policy Research would indicate that Lowenstein's number is too low. The Stanford study reviewed the unfunded liability for California ’s three largest pension funds—CalPERS, CalSTRS and the University of California ’s Retirement System—and determined that those three funds alone were underfunded by more than $500 billion

Our economic shift from consumption to savings is not just a response to a biting recession, but a generational turning point, where suddenly we cannot afford our own retirement, and the deficit is so great that the fix can be nothing less than a dramatic and lasting change to how we live our lives.

The Age of New Finance Comes Crashing Down

2010-04-20T06:27:00.000-07:00

September 2008 changed everything. Or did it?

By month's end, Lehman had filed for bankruptcy, Merrill Lynch had sold itself, AIG was a ward of the state, and Morgan Stanley and Goldman Sachs were bank holding companies. By year's end, the government would invest directly in over 600 banks.

Credit flows, moreover, had dried up, paralyzing business activity across Main Street. Free market evangelists were crying 'Uncle', and dashing for cover under taxpayer money.

Presidential candidate Barack Obama campaigned—and won—on a platform of ending eight years of "extreme Republicanism". His stimulus bill would formally repudiate the doctrine of laissez-faire, and shift the country's economic alignment away from Friedman back to Keynes.

In his new book, "The End of Wall Street", Roger Lowenstein delivers an insider's view of the people both aggravating and abating the mortgage crisis that nearly bankrupted all of Wall Street's biggest firms.

It originates, he notes, in government overreach.

Most of the booms of recent decades were financed by private sector companies such as technology promoters, or Wall Street banks, or oil drillers. The U.S. housing boom of the early twenty-first century was different, thanks to its intimate relationship with the U.S. government... And though other industries—defense contractors, say, or public transportation—also depended on government, only in housing did the government so greatly disturb the natural supply and demand.

The subprime explosion could not have expanded as it did without Fannie Mae and Freddie Mac executing congressional mandates for affordable housing.

But while government ignited the flame, Wall Street poured on the gasoline. Financial engineers devised complex securities that, instead of shielding against risk, allowed it become an inferno.

What truly failed was the postindustrial model of capitalism. The market's tools for measuring risk simply did not work. And the most sophisticated minds on Wall Street proved no wiser than country loan officers.

Working from over one hundred interviews, Lowenstein adds personal dimensions to his narrative that help us understand how and why key players acted as they did. Most striking, perhaps, is his portrayal of Treasury Secretary Hank Paulson, whose take-charge style both aided and hindered the abatement process: why, for example, he chose to save Morgan Stanley and Goldman Sachs, but allowed Lehman to fail.

We view Paulson's transformation from free-market advocate to full-on interventionist, almost as if we were with him real-time.

Other actors that Lowenstein brings to life include the embattled Lehmen CEO, Dick Fuld; the soft-spoken Ben Bernanke; the prescient boss of JP Morgan, Jamie Dimon; and the disastrously disconnected Citibank bosses, Chuck Prince and Robert Rubin.

We learn that Stanley O'Neal spent nearly as much time on the golf course alone as he did in Merrill's CEO office, that Vikram Pandit would order a $350 bottle of wine for one glass because nothing else on the menu was sufficient, and that Joseph Cassano, head of AIG's Financial Products division, was able to walk away with his $34 million bonus and a $1 million per month consulting contract, in addition to the $280 million he had already earned.

Throughout, Lowenstein juxtaposes the chaos among Wall Street bosses and government officials with the lucid insight of Robert Rodriquez, CEO of First Pacific Advisors. Rodriquez had it right all along, and the track record to prove it. The core issue of the crisis was not liquidity. It was capital. For the system to survive, it would have to recapitalize, and, if private markets could not do it, then government would need to inject taxpayer dollars.

Has Wall Street changed, as Lowenstein argues? And is Friedmanesque capitalism done with?

Well, no. Still scorched by dramatic investment losses, no one's likely to play the leverage game anytime soon. And even when a new leadership generation emerges less fearful of debt's damaging flames, new rules will prevent the big banks from revisiting 30:1—or event 20:1—leverage ratios. (A new generation on Wall Street can come every few years, about as long as it takes a board to replace a CEO after some bad turn.)

Cheap financing and too-big-to-fail resuscitated Wall Street in 2009. If anything, capital is now more concentrated in fewer players, which means that even at lower leverage the scale would still be dangerously tipped.

All big firms are still publicly traded entities. Restricted stock notwithstanding, employees and shareholders, as before, are competing for different goals. Until each employee can be made to feel he is contributing directly to the firm's bottom-line, each person will seek entitlement, demanding what he believes he is owed. A partnership model would go a long way toward reversing this.

While Paulson and company may have been late to recognize the problem, that's just the way it is: regulators are nearly always one step behind. It would be naive to assume otherwise, unless regulation is so draconian that it chokes capital flow altogether.

For the electorate, the choice between Keynes and Friedman might belong to back-page academics, but the notion that big is bad is a top-line concern. Despite mounting economic recovery, confidence in government doing the right thing is slipping. For many, the big Wall Street firms are as soiled as Congress itself, and the two are now inextricably connected.

Friedman espoused a limited role for government, and a belief that free markets are the best route to more wealth for all. As with today's electorate, he likely would have scorned government overreach, both in abating and facilitating the crisis.

The point isn't that Friedmanesque capitalism failed or is over. Policy, these past ten years, morphed it into something else. Had capital truly become democratized, and not settled among massive institutions, the crisis may never have reached the point it did.

If the electorate continues its swing away from big government, and by association big banks, Friedman's revival could become a distinct, near-term possibility.

Biotechnology Gets a Shot in the Arm

2010-03-22T08:05:00.000-07:00

Yesterday's passage of comprehensive health reform no doubt opens a Pandora's box. And while legal challenges may eventually block its full implementation, an outright repeal is unlikely, which means many—if not most—provisions will remain in effect.

One such provision is the creation of a pathway for follow-on biologics ("FOBs", or generic biologics)—new versions of innovator products. For years, the industry has been at an impasse over data exclusivity and patent law.

A pathway now exists, for better or worse. Increased competition will likely make it better for all parties: generic makers, payers, patients, and even innovators.

This morning, Steven Grossman of the HPS Group—and a veteran policy expert on the biopharmaceutical industry—posted an important article on his blog FDA Matters, which we've also published in our newsletter Perspectives. (Read here.)

He writes:

The market was not waiting for the law to pass. Even though a legislatively-created FOB approval process was uncertain, Pfizer, Merck, Novartis, Teva and other major biopharmaceutical companies had already made decisions to be involved. Billions have already been spent or committed by companies before they knew the final FOB ground rules in the US.

More knowledge about the discovery, creation and manufacturing of biologics will be good for innovators, as much as imitators. Some of those biologically-similar products will themselves be innovative. As a result, many will require full approvals rather than being able to take advantage of an abbreviated FOB pathway.

Innovators will benefit from progress on characterizing biologic molecules, new testing methodologies and manufacturing improvements. To take a single example, the FOB market will force new investments in understanding immunogenicity that will benefit the entire industry, as well as patients.

The question now is, What's next?

Expect more dollars invested in biotechnology and specialty pharmacy, the high-value-added supply chain for these products. (Winners could include Medco, CVS, Express-Scripts, and Magellan Health Services.)

Market movement won't occur overnight. It could take five years or more to gather momentum. It's not just product development cycles and legal challenges that affect this, but also specialty pharmacy imbalances as the supply chain retools and expands.

That momentum will be substantial.

Mandated use of electronic health record and ICD-10 implementation will facilitate this momentum by enabling greater specificity in care delivery and establishing more efficient reimbursement.

Because personalized medicine cannot occur without a more competitive marketplace for biopharmaceutical products—and the FDA has been reluctant to approve follow-on products without a pathway—the creation of a pathway is essential to medicine's evolution, and therefore unlikely to be repealed.

Of course, this doesn't mean lawmakers won't alter its details, the 12-year exclusivity period or patent provisions.

Just the basic construction of a pathway should be enough to accelerate powerful market momentum.

This Time It's Still the Same Problem

2010-03-13T06:37:00.000-08:00

BOOK REVIEW

Michael Lewis has a problem. Liar's Poker, his expose on 1980s Wall Street, was supposed to appall readers, not enthrall them—or even entice younger generations to aspire to its excesses. He expected his book to be a requiem to a bygone era.

Alas, the money got better, and easier. Bonuses inflated, and so did the lifestyles. Salomon Brothers and its raucous bond floor transformed from a partnership of quirky personalities into a publicly traded, financial services behemoth, where fat cats gambled other people's money at no risk to themselves.

Risk and return completely disconnected. In his new book, The Big Short, Lewis writes: "Success is individual achievement, and failure is a social problem."

He describes a new financial world of big investment banks gorging themselves on Mexican immigrants purchasing $700,000 homes, with $14,000 in earnings. These banks' financial wizardry is so cunning, they believe, that they can manipulate the ratings agencies, and swiftly move two-steps ahead of regulatory bureaucracy. Their customers are so trusting of a AAA rating, that even far-away German pension funds will purchase their billions of dollars in financially engineered products, no questions asked.

Ultimately, the banks' illusions would manifest for what they were—delusions—and they would destroy themselves and, nearly, the system itself.

Several pundits have claimed clairvoyance in predicting the subprime meltdown. The Big Short focuses on those who not only actually forsaw it, but who also staked their reputations, wealth and even their health on their convictions.

And while they proved themselves prescient and gained vast riches as a result, Lewis devotes his pages instead to their moral outrage at the system's corruption. He portrays his protagonists as neither sympathetic nor necessarily the sort of people readers might want to aspire to. They are bright, abrasive, obstinate—and completely obsessed at pursuing their bets against the broken financial system.

Of Greg Lippmann, the Deutsche Bank trader who famously shorted the subprime mortgage market while his colleagues continued packaging ever-more esoteric CDOs, he writes:

Thin and tightly wound, he spoke too quickly for anyone to follow exactly what he was saying. He wore his hair slicked back, in the manner of Gordon Gekko, and the sideburns long, in the fashion of an 1820s Romantic composer or a 1970s porn star.

Even his brief glimpse of John Gutfreund reveals a tortured man: "As he began to describe his career [while on a panel about Wall Street at Columbia Business School], he'd broken down and wept." Gutfreund's biggest and most fateful act, we learn, was his decision to turn Salomon into a public corporation.

Timing the financial system's demise is neither easy nor an overnight accomplishment. Steve Eisman (the acerbic, onetime bank analyst at Oppenheimer, and now hedge fund manager), Charlie Ledley, Michael Burry, and their partners and associates dedicated months of careful analysis to proving and disproving their theories. They also faced the additional challenge of placing their bets with illiquid credit default swaps, not the best vehicle for price discovery, but the only pure vehicle available targeting the faulty subprime loans.

They endured immense skepticism that they were correct, much of it their own, and withstood long periods of market irrationality. In the first half of 2007, for example, the long descent for subprime loans began as default rates escalated, but pricing in CDOs, which packaged the worst of these loans, remained firm. Merrill Lynch and Citigroup, in fact, continued to pump out even more of these toxic products. For Burry, who began building his positions in 2005, this period and the whole of 2006 nearly cost him his fund.

Throughout his book, Lewis juxtaposes two investment styles: on the one side, the short-term anything goes approach by Wall Street traders, and, on the other side, the go-slow careful analysis of his plodding protagonists.

Even Burry's two-year bet would not constitute a classic long-term approach among dedicated value investors. For the hedge fund world in which he existed, it might as well have been decades.

Burry could not escape the expectations of investors demanding continuous monthly gains. Lewis illustrates these investors, extremely wealth individuals, and their demands as irrational as the market itself.

Algorithmic trading, Wall Street's current elixir, has compressed holding periods into milliseconds. So long as quantitative trading produces fantastic wealth, don't expect long-term investing to expand beyond its confines.

Despite their success, Lewis' protagonists had had enough. It was time to move on.

However, it's the Eismans of the world whom the financial system can depend on to keep the big Wall Street firms honest. Time and again, these firms have demonstrated their complete inability to restrain themselves, at least as public corporations. Nor can government, perpetually steps behind and conflicted, provide that restraint.

The problem wasn't that Lehman Brothers had been allowed to fail. The problem was that Lehman Brothers had been allowed to succeed.
—The Big Short

Have the big banks really changed? Sure, we won't see them peddle derivative products on subprime loans anytime soon. Nor will we likely see them deploy 30-to-one leverage ratios.

The incentives, though, haven't changed. Even after a financial system seizure, the crisis' worst offenders could still walk away richer by millions. For all the talk of risk, there is no risk, at least not on an individual level. And the system supporting this hasn't changed.

Michael Lewis may have done a better job exposing Wall Street's ugly undersides, and perhaps he will succeed in encouraging future generations of bright-eyed MBAs to reconsider their career choices.

Could this be the bygone era he expected 20 years ago? No way. Not until there's more transparency, more balance, and more Steve Eismans getting their due.

When the Money Grid Went Dark

2010-02-15T08:07:00.000-08:00

BOOK REVIEW

In June 2005, John Mack returned to Morgan Stanley as CEO, replacing his bitter rival, the staid Philip Purcell, a one-time McKinsey consultant and the boss of Dean Witter. Since his departure four years earlier, the firm's shares had collapsed 40 percent.

Shareholders—and many of the firm's directors—wanted a more aggressive leader. Goldman Sachs, Bear Stearns and Lehman Brothers now followed a new market paradigm, and Morgan was not keeping pace.

Mack, a former bond trader, had been serving as chairman of the hedge fund giant Pequot Management. He acted swiftly, committing billions in risk capital to proprietary investing and trading. His objective: double revenues in five years while keeping costs flat.

By 2007, own-account trading was dominating the big Wall Street banks' banner profits. Morgan, like its competitors, was leveraged at more than 30 to 1, borrowing $30 for every dollar it owned.

Life was great. Mack and other Wall Street bosses were earning tens of millions of dollars, while their gargantuan firms controlled the world's capital flows.

And then the lights dimmed. It was August, and the party was ending.

In little more than a year, Bear, Lehman and Merrill Lynch would disappear. Morgan would come within days of collapse, and even mighty Goldman could not guarantee a certain future.

Scott Patterson's fascinating new book, The Quants, describes the extraordinary paradigm that catapulted Wall Street into the stratosphere, and ushered its sudden descent. "Quant" is Wall Street lingo for a mathematical whiz-kid, the nerd with the PhD from MIT or the University of Chicago.

For years, brokerage firms confined quants to backrooms, building models supporting front-line traders and research analysts. By the early 90s, quants were proving that their skills were much more valuable, though mostly at small hedge funds.

The big firms noticed, but did not commit completely to their labyrinthine models until after the dot-com meltdown. They were feasting just fine, thank you.

For all their size, Wall Street's mighty banks tend to focus their gambling on a handful of market activities, whether technology banking or proprietary trading—an ironic contrast to the mantra of diversification preached as they peddle their different products and services.

The tech bubble boosted profits, and bankers controlled Wall Street. Quantitative investing exploded from the ashes of the stock market collapse. Its breathtakingly complex strategies and their uncanny success lured billions of dollars from pension funds and endowments, not just wealthy individuals.

Wall Street's new titans were traders, wholly confident in the ability of black-box strategies to mint massive profits.

Character sketches
Using vivid character sketches, Mr. Patterson offers his reader a fast-paced narrative focused on quantdom's central figures. The godfather is Ed Thorp, a math genius whose books Beat the Dealer and Beat the Market became must-reads for the legions who followed him. Thorp devised a mathematical formula for card-counting, which he later applied to the markets as the pioneer of covertible bond arbitrage. Perhaps most important, he perfected a business model to sustain his strategy.

Other characters include Ken Griffin, the imperious founder of Citadel, with whom Thorp shared his trading strategy and business model; Cliff Asness, the hot-tempered founder of AQR; Jim Simons, the reclusive founder of Renaissance Capital; and Peter Muller and Boaz Weinstein, who orchestrated in-house hedge funds at Morgan Stanley and Deutsche Bank.

Sometimes friends, sometimes rivals, these kingpins share an obsession for poker, and would live well as professional players, if not for the enticement of Wall Street's billion dollar payoffs.

They work behind glass doors, travel in private jets and pursue the Truth.

"The Truth was the universal secret about the way the market worked that could only be discovered through mathematics. Revealed through the study of obscure patterns in the market, the Truth was the key to unlocking billions in profits."—The Quants

Another one of Mr. Patterson's core characters is Eugene Fama, who, he writes, "connected the dots and put the efficient-market hypothesis on the map as the central feature of modern portfolio theory". Professor Fama's hypothesis presents the notion of market equilibrium, where the market's various participants in hunting for inefficiency collectively create efficiency and balance.

As the market bounces around, its returns fall along a bell-shaped curve. For quants, the Truth occurs in detecting small price variances caused by market participants continuously working towards an equilibrium, and knowing that small moves are more likely than large ones.

Their mainframe computers deploy rapid-fire, complex algorithms that hunt for microscopic price discrepancies. Leverage allows them to expand small gains into massive gains. For years, they sourced (borrowed) cheap (low-interest rate) Yen-denominated capital, paying it back with their outsized returns and keeping the profits, the so-called carry trade.

Mr. Patterson explains how each of quants "was becoming part of and helping create a massive electronic network, a digitized, computerized money-trading machine that could shift billions around the globe in the blink of an eye, at the click of mouse". He defines this network as the "Money Grid", a machine with "octopuslike tentacles reaching to the farthest corners of civilization, yet it is also practically invisible".

Complex algorithms, the quants would learn, do not account for irrational human behavior, and once-in-every-10,000-years events can occur once every few years—or, even, every few days. The black swan—a term coined by quant-doubter Nassim Nicholas Tabel to describe unexpected events—does not just exist in Australia, it exists in every country on every continent.

Nor do they account for the dangerous concentrations of capital that form when copycat funds plow into similar positions.

New governance
Patterson avoids direct finger pointing, and does not portray quants as nefarious wrong-doers: rather as victims of miscalculated self-confidence. And while it's tempting to blame "hedgies" for collapsing the financial system, it would be wrong to do so.

The system itself allowed hedge funds to emerge and flourish. The irony of Mr. Mack concentrating and leveraging his firm's capital is that he nearly destroyed Morgan Stanley at the behest of his shareholders—or, rather, the core group which brought him back in 2005 to compete with Lehman Brothers and Bear Stearns.

Mr. Mack and his CEO cohorts bear a considerable portion of the blame, as they lorded over the system that fed aggressive risk-taking. But they weren't alone. Government contributed directly to the financial collapse, with poorly crafted legislation and insufficient regulation, in particular rules creating and fostering the sub-prime mortgage market and poor oversight of mounting system-wide risks.

Patterson's book reminds us that Wall Street governance needs to change. Financial innovation is too smart and happens too quickly for any government regulatory body to keep pace. The only way for the system to find balance is for its participants to regulate their own risk-taking.

Clearly, the publicly-traded investment bank model does not work, at least not as scripted. Take basic accounting rules. Even though a firm possesses considerable "intellectual capital"—and, in fact, could not exist without this capital—accounting rules don't force it capitalize this expense and place it on the balance sheet.

Instead bonuses appear as an expense item on the firm's P&L, inflating returns. If firms capitalized employee bonuses, shareholders would view risk-taking much differently.

Ideally, a firm would seek to align itself more closely with shareholders, or government would encourage this. The simplest means for this to happen would be for the firm to scrap its shareholder structure altogether, and return to its original partnership model. Goldman only listed in 1999, and arguably has performed best for having lasted the longest as a private partnership.

Once risk-capital becomes owners' capital the dynamic changes. The dollar you gamble isn't just someone else's dollar, it's mine. So be careful.

For all their perfection, black box models are not perfect. They had survived various currency and debt crises, the spectacular blow-up of Long-Term Capital Management, and numerous other market spasms. The hubris of the narrow cadre of individuals controlling capital flows—investment bankers, central bankers, and government officials—was their belief that the models were indomitable risk-reduction tools.

No doubt, new models will emerge, likely featuring behavioral finance and more "qualitative" elements. Already, many experts are concerned that quant-driven strategies targeting dark pools and flash trading could destabilize the financial system once again.

Until the system itself gets smarter, don't expect smart models to abate volatility anytime soon.

Reform Legislation Aside, ICD-10 Could Be Health Care's Biggest Challenge

2010-01-20T08:26:00.000-08:00

Regardless of how reform legislation plays out, the health care industry still has stormy seas to navigate in the months ahead. Business intelligence technology and regulatory compliance will feature prominently among these navigational challenges.

Expect health information consultancies to benefit strongly, as payers and providers increasingly seek external advice.

Last week, Milliman, an actuarial consultancy, blasted a warning shot across the industry's bow. In its survey on ICD-10 readiness, it reported that 70 percent of respondents, mostly health plans, indicates little or no prepared action.

The International Classification of Diseases, or "ICD", is a coding system that connects the entire $2.5 trillion industry. Payers and providers use it to communicate on reimbursement and administrative transactions, as well as care delivery procedures, including documentation of a patient's visit, research activities, public health reporting, and quality reporting.

A year ago, the Department of Health and Human Services ("HHS") mandated its adoption by October 1, 2013—late in coming, as the rest of the world has already switched from the earlier ICD-9 version.

The differences between ICD-9 and ICD-10 are stark. Whereas ICD-9—nearly 30 years old—provides about 13,000 diagnosis and 3,000 procedure codes, ICD-10 provides 68,000 and 87,000 codes, respectively. The format and syntax of the two systems vary substantially, as well.

Many industry insiders, in fact, compare its implementation to the time, effort and dollars spent on Y2K.

For providers, and a typical three-physician practice, the Medical Group Management Association estimates an average cost of $84,000 in system upgrades. At the same, HHS is also mandating that these practices meaningfully use certified electronic health records, and comply with new HIPAA regulations.

Many practices, as a result, confront not only severe financial challenges, especially in a pressured reimbursement environment, but also significant workflow disruptions, with potential impact on patient care.

Three-physician practices constitute about one of every two practices, and 80 percent of all outpatient visits. Any grassroots upheaval will impact the system as a whole.

Just as share prices of health IT vendors performed strongly throughout 2009, shares in health information consultancies could gain in 2010. Since January last year, Allscripts-Misys Healthcare Solutions (MDRX) is up over 130 percent. Cerner Corporation (CERN) is nearly 150 percent higher.

Among the large health information consultancies, Accenture (ACN), IBM (IBM) and even Dell (DELL) and Hewlett-Packard (HPQ) could all see increasing demand for their services.