The New Role of Private Investment in Health Care Delivery (2024)

Disruptive innovation as a business philosophy has brought benefits to many parts of the economy. But in health care delivery, evidence increasingly suggests that not all disruption creates value for patients. A central issue for policy is how to encourage truly value-adding innovation for patients and payers without hurting patients or bankrupting society.

The Good and Bad of Innovation in Health Care Delivery

Investment in health care delivery organizations has been extensive in recent years. One of the more promising innovations has been new primary care models.¹ Relative to the traditional model of patient-initiated, office-based primary care, these models focus on more intensive patient outreach and providing care in more efficient settings. Some of these models are ‘high touch’ practices, generally targeted to a population of sicker patients (e.g. delivering more intensive preventive care, addressing social determinants, active redirection from EDs to doctors’ offices). Most of these models (including Aledade, Oak Street, ChenMed, and Iora Health) focus on the Medicare Advantage population, though some enroll Medicaid patients as well (Cityblock). Other practices are ‘high tech’ models (Firefly Health and NavigateNow, a subsidiary of United HealthCare), that focus on virtual and home-base care as the first option, and in person care if needed.

The idea behind these models is that better primary care will pay for itself in reduced acute care, hence the focus on Medicare Advantage. Some models charge a membership fee, believing that people will pay for better care even if there are no overall cost savings for the system. Rigorous evaluations of these models’ effects remain elusive, though limited evidence for some have been encouraging. Based partly on this optimism, the financial valuations for such firms have soared.² Just in the last three years, Amazon acquired One Medical for $3.9 billion, which had acquired Iora Health for $2.1 billion. CVS acquired Oak Street for $10.6 billion. Walgreens became the majority owner in VillageMD for $5.2 billion, which then acquired Summit Health-CityMD for $8.9 billion.

At the same time, there has been a raft of new private investments in the health care industry focused on cost cutting or revenue enhancements (increased prices and utilization), often funded by private equity (PE). In the classic scenario, a PE firm secures financing to buy the target facility or practice, charges a management fee, and saddles the clinical operations with debt (using the clinic’s own assets as collateral for the loan). If the acquired entity can repay the loan – either by cutting costs, raising prices, or billing more profitable care – it stays afloat. If not, it is sold to the next highest bidder, often outside of health care. Newer wrinkles to this approach include buying an earlier stage technology or drug developer, using projected future revenue as the collateral. Typically, the PE firm is in and out in 5–10 years, often less.

In other industries, this disruption has on occasion been beneficial. Firms that were losing money prior to private equity become more efficient after.^3,4 Those that have been unable to compete go under. Resources are freed up for use elsewhere, though communities and workers have often lost a great deal.

Moving duplicative resources out of health care is valuable, but not all resource closure is good. Payment rates in Medicaid are sufficiently poor that many nursing homes could make more money as assisted living facilities or condominiums than through serving very sick elders. That does not mean that we should close nursing facilities, however. Some of the worst failures of private equity have involved bankruptcy of hospitals serving large shares of low-income or uninsured patients.⁵ The services provided were valuable, but not very profitable.

Not surprisingly, quality can suffer when the focus is on extracting dollars rather than on patient care. Recent studies on nursing facilities⁶ and hospitals⁷ show this. Costs are often higher too.^6,8

Distinguishing good from bad innovation is often difficult. So is developing policy responses in real time. Innovators can destroy value more rapidly than it can be built. As a result, federal and state regulators are struggling with how to adapt to this new wave of private financing. In an environment of rapid change, it is important to lay out the rules in advance. Reaction is too late. We discuss a few prospective strategies with respect to new forms of medical innovation.

Tax Policy

Tax policy plays a central role in encouraging innovation. Many health care startups are funded through private capital and benefit from a host of favorable tax rules. The most important of these is that returns from investing are realized as capital gains, not ordinary income, which effectively cuts the tax rate on payouts in half. One proposal is to make firms wait longer before money taken out of private equity investment can be realized as capital gains – for example, 10 years instead of the current 3 years.

One would not want such a policy to harm the type of innovative primary care models noted above. But this can likely be avoided. Building a new primary care practice and bringing it to scale may well take longer than a decade. Thus, discouraging quick profits selectively reduces the returns to “financial engineering” (e.g., dividend recapitalization and related strategies to bolster returns without changing the good or service produced) but not to truly beneficial patient-facing innovation.

An Escrow Account for Failure

Firm failure happens in all industries. But health care is different because failure is so costly to communities and patients. Thus, it is prudent to acknowledge that failure may occur and plan for it.

One way to plan would be to require private equity investors to set aside money in case of failure. For example, for every dollar taken out of the company in management fees or other payments to related companies, a dollar would be put in escrow. If the organization is still in operation after a decade, the escrow account would revert to the private equity owner. If the organization fails, the escrow account would belong to the public (e.g. a state government), which could use the funds to defray the costs of care or create a safety net for the patients. Effectively, the controlling company would have to return to society the amount of money removed from the organization if the organization goes under.

State Monitoring

One policy being pursued by several states is to require more transparency when ownership and other key operational changes occur. Thirteen states have enacted material change legislation that requires heath care providers undergoing material changes in ownership to apply for pre-transaction notification. These proposed changes can then be evaluated by state agencies and possibly contested by the state Attorney General. In Massachusetts, where one of us has been involved in the process (DC), some proposed notices have been withdrawn after scrutiny and others have gone ahead only with price caps put in place.

Conclusion

In health care, the “corporatization” train has left the station, accelerating rapidly on lightly regulated tracks. What remains needed is thoughtful policy that builds some guardrails, applies the brakes where appropriate, and avoids derailment where patients could suffer.

Contributor Information

David M. Cutler, Department of Economics Harvard Kennedy School of Government and T.H. Chan School of Public Health, Harvard University, Cambridge, MA;

Zirui Song, Department of Health Care Policy and Center for Primary Care, Harvard Medical School, Harvard University, Boston, Massachusetts; Department of Medicine, Massachusetts General Hospital, Boston, Massachusetts.

References