Where to compete in a post-reform world

The power of “where-to-compete” decisions, particularly in an industry in as much flux as US health insurance, is enormous. Our analyses suggest that the bottom-line performance differential between a payor who selects a market-average portfolio across businesses and geographies and an identical payor who instead selects a top-quartile portfolio is likely to be almost twofold. Across industries, McKinsey research (summarized in The Granularity of Growth by Patrick Viguerie et al) shows that the majority of the performance differential among corporations results from their alignment with “rising tide” markets rather than from share gain within less attractive markets.

Furthermore, we have found that there are three “macro” approaches that can enable companies to thrive during major industry disruptions: refocus their portfolio on more attractive businesses, build one or two large new businesses, or radically transform their business model. The first two rely squarely on where-to-compete decisions. The last approach is not for the faint of heart.

Thus, today’s payors must carefully choose which markets they want to concentrate their resources on to win. The choices made will be critical not only within the payors’ core health-plan business but also in adjacent areas within the healthcare value chain.

Choices Within Health-Plan Business

Predictive models we have developed suggest that, over the next several years, there is likely to be tremendous variability in growth potential across markets in the US health insurance landscape. Exhibit 2 illustrates our estimates for the extent of this variability across states and business lines. For example, growth in the individual market could be as low as 32 percent in some states and as high as 141 percent in others.

Current margins are similarly variable. Our research shows that, in 2012, small-group margins averaged 6 percent across the country but ranged from an average of –5 percent to +13 percent in different states.

Admittedly, our models cannot predict the future with certainty, and thus actual growth (in specific states or across the country as a whole) may be higher or lower than our estimates suggest. Nevertheless, we believe that growth and margin variability will be a characteristic feature of the US health insurance landscape for at least several years to come. Indeed, we have found that the extent of such variability rises when we look at the rating areas or micro-markets within each state an individual payor operates in.

A second important dimension to consider is the return on capital each business delivers, most commonly assessed as the return on equity (ROE). Healthcare reform is having a meaningful effect on the capital intensity of each business. For example, both the risk profile and capital consumption of the individual health insurance business rise significantly in a guaranteed-issue, modified-community-rating, risk-adjusted market. Exhibit 3 shows the likely change in the ROE growth characteristics of various payor business lines over the next 10 years. It is important to note, however, that the actual trajectories are unlikely to be as linear as shown. A number of factors, including competitive conduct and further changes in regulations, will alter the trajectories over time. Payors will need to continually assess and adjust their decisions as new information becomes available on market evolution.