Reform Update: Facing ACA mandates, insurers diversify into technology

Health insurance companies, now required to spend the lion's share of premium revenue on patient care, are looking for higher investment returns elsewhere. As a result, they're increasingly putting money into technology ventures where they expect to realize higher returns.

The medical-loss ratio standard under the Patient Protection and Affordable Care Act requires insurers to spend at least 80% of what they earn from premiums on patient care and related quality improvements. No more than 20% can be used for administrative, marketing and business expenses. The requirement is as high as 85% for large group plans.

Tied to that, insurers are trying to maximize their investment returns while also investing in businesses that are exempt from the 80/20 rule. Technology operations check off both those boxes for them.

“That's been a catalyst for a substantial amount of investment,” said Joshua Kaye, a Miami-based partner at law firm DLA Piper. “We're really seeing it on a national scale. Many insurers view health IT as being on the cutting edge.”

As insurers experiment with new payment models related to population health management, they're particularly interested in cost transparency tools and data and analytics, he said.

The new business lines allow insurers to diversify and strengthen their revenue base, said Jonathan Krieger, managing director at investment bank Berkery Noyes, which focuses on the technology sector.

“There's a lot of activity in the space,” he said. “They need to look for other ways to maintain their margins.”

In 2013, for instance, UnitedHealth Group's Optum division, which works in technology and population health management among other specialties, saw 26% growth in revenue and 61% growth in operating earnings. That helped contribute to UntiedHealth Group's overall strong performance for the year.

In its core insurance business, UnitedHealth saw its 2013 operating margin decline to 6.4%, down from 7.6% the previous year. But Optum's operating margin increased to 6.2% from 4.9% in 2012.

On a second-quarter earnings call, Aetna CEO Mark Bertolini said the company remains active in the M&A market, particularly in the international and technology space. And addressing where Aetna is looking, “it's definitely technology,” he said.

Cigna CEO David Cordani similarly pointed to “ongoing technological investments” as one area of focus in the second half of the year, when asked on the company's most recent earnings call.

In the rapidly growing digital health space, two of the most active acquirers in 2013 were Sandbox Industries, a venture capital firm backed by BlueCross BlueShield Venture Partners, and Lemhi Industries, another VC firm that counts UnitedHealth Group as an investor.

While the overall number of publicly disclosed deals in the insurance sector have remained small, Modern Healthcare's quarterly M&A Watch report found that 55.6% of transactions in the second quarter involved cost containment companies. Another 22.2% of deals focused on services such as administrative and benefit management solutions.

The federal government saw a big payoff last year from a little talked about rule under Obamacare. Starting in 2013, the Patient Protection and Affordable Care Act capped the tax deduction that insurers can claim for paying their executives; the limit is $500,000. The rule last year returned $72 million to public coffers—and that's just related to the salaries of 57 executives. The report from the Institute for Policy Studies found that insurers claimed just 27% of executive pay as tax deductible in 2013, down from 96% the previous year.

A Gallup poll this month found that Arkansas and Kentucky made the greatest strides in reducing their uninsured population, with the number of uninsured individuals declining 10.1 and 8.5 percentage points, respectively, in those states. In Arkansas, where more than one in five people were uninsured last year, the uninsured rate is now 12.4%. The 10 states that saw the deepest cuts to their uninsured populations have two things in common: they expanded Medicaid and set up their own insurance exchanges. The findings confirm an earlier Gallup poll that found that those states that did both saw their average number of uninsured fall 4 percentage points, to 12.1% of residents. In contrast, states doing just one or the other saw their uninsured population decline 2.2 percentage points, to 16.5%.

Follow Beth Kutscher on Twitter: @MHbkutscher