Who Profits Most From Americas Baffling Healthcare System?

On October 4, more than 75,000 employees of Kaiser Permanente , a major healthcare chain, went on strike for three days. The strike was the largest in the history of the US health care industry and drew attention to staff shortages in the nation's hospitals and clinics. That same week, ten drugmakers said they would negotiate drug prices with Medicare, the government's health care system for seniors, under a law that effectively forced them to. This is the first time companies will negotiate prices with the government.

These developments are symptomatic of the deep malaise of America's dysfunctional health care system. The country spends about $4.3 trillion a year to keep its citizens well. This is equivalent to 17% of GDP , double the average of other rich economies. However, American adults live shorter lives and American children die more often than in similarly prosperous places. Pharmaceutical companies and hospitals are creating public outrage over high prices. Little attention is paid to the small number of intermediaries who derive much of their income from the complexity of the system.

Over the past decade, these companies have quietly increased their presence in America's vast healthcare industry. They do not manufacture drugs and did not treat patients until recently. It is the intermediaries—insurers, pharmacies, drug distributors, and pharmacy benefit managers ( PBMs )—that stand between patients and their treatments. In 2022, the combined revenue of the nine largest intermediaries (let's call them Big Health) will account for about 45% of the US health care bill, up from 25% in 2013. Big health care companies account for eight of the top 25 companies included in the P&P index's top 500 U.S. stocks by revenue, compared to four for big tech companies and one for big pharma companies.

La Grande Salute was born as a constellation of oligopolies. Four private health insurance companies represent 50% of all enrollees. The largest group, UnitedHealth Group, had $324 billion in revenue last year, behind only Walmart, Amazon, Apple and ExxonMobil, and $25 billion in pretax profit. Its 151 million subscribers represent nearly half of all Americans. Over the past five years, its market capitalization has doubled to $486 billion, making it the 12th most valuable company in the United States. Four pharmaceutical giants generate 60% of US pharmaceutical revenue. One of the strongest, CVS Health, accounts for a quarter of all pharmacy sales. Just three PPEs processed 80% of all prescription claims. And up to 92% of all drugs go through three wholesalers.

With little room to grow their core businesses and antitrust offenders blocking attempts to acquire direct competitors, oligopolists have expanded into other parts of the healthcare supply chain in recent years. Besides increasing revenue, such vertical integration also increases profitability. The Affordable Care Act of 2010 limits health insurers' profits to between 15 and 20 percent of collected premiums, depending on the size of the health plan. But it does not place any restrictions on the income of doctors or other intermediaries.

The law creates an incentive for insurers to acquire clinics, pharmacies and the like and refer customers to them instead of competing providers. The strategy puts the profits of profit-limited insurance businesses into unlimited arms, theoretically allowing insurers to keep a larger share of the premiums paid by patients.

Between 2013 and August 2023, the nine healthcare giants spent nearly $325 billion on more than 130 mergers and acquisitions, according to research firm Irving Levine Associates. Some of these agreements have pushed the companies to penetrate further into each other's territories. In 2017, CVS made a $78 billion offer for Aetna, a major health insurer and rival to UnitedHealth. The following year, Cigna, another major insurance company, acquired Express Scripts, a major PBM , for $67 billion. In 2022, UnitedHealth paid $13 billion for Change Healthcare, a data analytics company that processes insurance claims for most industries, including UnitedHealth's competitors.

UnitedHealth and CVS also buy health care providers. Optum Health, a subsidiary of UnitedHealth, has spent more than $23 billion on such interventions over the past six years and now treats more than 20 million patients through a network of 2,200 clinics. It has more doctors (70,000 employees or members) than the country's largest hospital chain. CVS operates about 1,100 neighborhood clinics and this year alone paid $18 billion for two companies operating in the lucrative senior care market.

Industry leaders say bringing all aspects of patient care — primary care clinics, pharmacy services, PPE and insurance — under one roof is a win-win. In the old fee-for-service model, the big debate in health care, doctors and hospitals were paid for each service they provided, incentivized to do the best they could, and charge as much as possible. However, when the doctor and the insurance company are part of the same business, incentives should be combined and overall costs should be lower.

At least that's the theory. And there is some truth to this. Despite recent labor issues, Kaiser Permanente has historically been held up as a model of efficient, quality healthcare. With 39 hospitals and over 24,000 doctors, its business is highly integrated and covers hospital and clinical treatment of Kaiser insurance plan members. In April of this year, Kaiser announced that it would acquire Geisinger Health, a Pennsylvania-based health system, to expand its comprehensive care model to more states.

However, vertical integration can have negative side effects. For example, many studies have shown that once hospitals have physician practices, prices increase, but quality of care does not. A healthcare organization that controls many aspects of patient care can raise prices for competitors who want access to its network. Some fear that pressure will be put on doctors to provide care to patients at the lowest cost, which will reduce the quality of care.

So far, there is no evidence of problems with the model, said Richard Frank of the Brookings Institution think tank. But in other areas that are in excellent health, signs of oligopolistic behavior are already visible. Consider PPE . These intermediaries are the focus of lawmakers and regulators because of their role in determining drug prices. At least four different bills aimed at regulating PPE are advancing in Congress. For nearly two decades, the Federal Trade Commission ( FTC ), America's top antitrust agency, has opposed efforts to strengthen oversight of PPE , arguing that such measures would harm consumers. However, in July 2022 , the FTC reversed course and began investigating the business practices of the largest PBMS.

At stake is the opaque pricing of PBMs , which charge list prices for drugs and reduce the rebates that PBMs seek from drugmakers. PPEs claim to be the antidote to Big Pharma But critics argue that big PBMs don't offer discounts to health plans, instead pocketing most of the difference and limiting access to less profitable treatments for them. In August, Blue Cross of California, a regional health insurer, dropped PBM CVS in favor of smaller companies to save on drugs for its nearly 5 million members.

In fact, American healthcare brokers are extraordinarily profitable. A study by Neeraj Sood of the University of Southern California and colleagues found that intermediaries in the healthcare supply chain generate annual excess returns, defined as the difference between the return on invested capital and the weighted average cost of capital, which achieved 5.9% during this period. The period from 2013 to 2018, compared to 3.6% for the S & P 500 index as a whole.

A large number of super profits are finally attracting new entrants to the healthcare industry. Insurance companies like Bright Health Group and Oscar Health position themselves as a transparent, consumer-friendly alternative to the old guard. Online pharmacy Mark Cuban Cost Plus Drug Company, founded by the billionaire of the same name, avoids middlemen, buys cheap generic drugs directly from manufacturers and sells them to consumers at a fixed margin of 15%.

Perhaps the greatest harm to health is caused by the Amazon. In 2021, its healthcare ambitions were hampered by the closure of Haven Healthcare, a non-profit joint venture with America's largest bank JPMorgan Chase and its largest investment firm Berkshire Hathaway. Haven aims to reduce healthcare costs for employees of all three companies. But despite Haven, Amazon is expanding its healthcare business. The company paid $3.9 billion for primary care provider One Medical last year. It also operates Amazon Clinics, an online service that offers virtual consultations, and RxPass, which allows members of the Prime subscription service to buy unlimited generic drugs at a low cost. John Love, Amazon's chief pharmacy officer, believes the tech giant's focus on customer experience, combined with its vast logistics network, makes it ideally suited to revolutionize the industry.

So far newcomers have had little impact. Lisa Gill of JPMorgan Chase believes most people underestimate the complexity of the healthcare business. The dominant company has built its own network of doctors, hospitals, insurers and drug manufacturers over decades. Repeating this process requires time and institutional experience. Mr. Cuban admits it's difficult for drugmakers to include brand-name drugs in their pharmacies because they fear upsetting the big PBMs . And without the support of brand-name drugs and major health insurance companies, the scale of his business remains small. Limiting insurers' profits makes life difficult for industry newcomers, who struggle to compete with the bargaining power of consolidated giants. Even Haven, which represents 1.2 million American employees of its three sponsors, did not have enough market power to force health care providers to lower prices. Amazon's pharmaceutical business has yet to break into the top 15 pharmacy chains in the US. Great technology can be powerful. But for now he too is leaning towards good health. ■

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