ACO profitability: Reasons for optimism


  • A new article in the NEJM suggests ACO economics will be unattractive because of the costly upfront investment and low probability of shared savings payments.
  • However, the results of the Medicare Physician Group Demonstration project show good earnings potential for providers (average >$5K per physician).
  • Further: best-practice sharing, emerging narrow networks and scalability of ACO capabilities are likely to significantly enhance ACO economics for providers.
  • It is likely that the most adept providers will be the ones forming ACOs; given delivery system capacity constraints, however, providers opting out of the ACO model will still be important: How health plans will manage the care provided in these settings (all the while adapting to MLR and other healthcare reform imposed financial constraints) is a critical – and open – question.

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A new article at the NEJM suggests caution regarding the economics of ACOs. The key line: “the limited data [available from the CMS physician group demonstration project] suggest that most organizations will lose money in the first 3 years under the ACO model.” The rationale:

  • Group practices were selected for the pilot based on likelihood of success – so any success seen may not tell us much about what will happen at other practices which lack the same scale and experience with managing patients.
  • Expensive “ticket to play” (the article cites an average $1.7M initial investment in start-up and first year’s operating costs; also, since most of the practices had some experience with capitation, there was likely some legacy infrastructure not included in these costs).
  • Many practices did not generate savings (especially in early years) and therefore got no money.

Certainly, some of the article’s caution is warranted: ACO economics won’t work for everyone. And there remains a lot of uncertainty about the impact of as-yet-unreleased regulations and the effect of ACO formation on payer/provider negotiating leverage. However, the idea that ACO economics will be broadly unattractive based on what we learned in the Medicare demonstration is not persuasive.

Let’s start with the actual results of the Medicare demonstration. The key results are summarized below: Note: similar to the Haywood / Kosel article, I have only included the initial capital costs and the first year start up costs that were published here. The last three columns of summary analytics focus on the results of the first three years to be comparable with the Haywood / Kosel views.

A couple observations on the results:

  1. Not everybody wins: Half the participating practices made no or very little money despite significant upfront investments (e.g. Billings invested the most at $13K per provider with no savings at all over the 4 years).
  2. Big investments do not necessarily mean big savings (Dartmouth, St. Johns, and Michigan invested less than the average $2.7K per provider and generated significant payments).
  3. It can take time to get it right (St. Johns made nothing the first two years, then saw payments grow rapidly; Michigan stumbled a bit in PY2, then grew rapidly through PY4).
  4. Success can be fragile (Everett, Integrated Resources and Michigan saw their payments decline in one or more years).
  5. Most important: on average, an ACO appears to pay off well: even if half of practices earn no payments, the rewards on the remainder easily cover the upfront costs for all.

The fact that many of the practices had experience with capitation before the demonstration does not limit the validity of the results, for several reasons:

  1. Having experience with capitation doesn’t mean you are good at it or that the advantage was decisive: While the four practices that received payments in PY2 (Dartmouth, Everett, Marshfield, Michigan) started off with lower than average patient costs, two of these saw their savings payments fall or disappear in PY3, PY4 (Dartmouth; Everett). And, while true that the other six started off with higher than average costs, these made progress towards lowering costs in the first two years, and two went on to earn substantial shared savings payments in PY3, PY4 (Integrated, St. Johns).
  2. Healthcare IT is a key – and probably very expensive – part of the infrastructure which the participating practices had or put in place. But HIT is also what is being subsidized by the HITECH incentives which lowers the cost of the “ticket to play” for practices considering ACOs.
  3. Health plans and other vendors deeply experienced in care management are certainly interested in serving the ACO market, creating a viable outsourcing option for much of the infrastructure and capability required to operate an ACO.

There are also good reasons to regard the Medicare demonstration results as conservative indicator of future ACO economics:

  1. Near-term: Learning: These were pilots and, by definition, an experiment. Lessons about what works will be synthesized and transferred to other practices. The ACO conference and consulting “industry” will ensure that lessons are transferred and adoption of best practices accelerated.
  2. Medium term: More prospective patient assignment: The demonstrations assigned patients to the ACOs retrospectively (that is, looked back at patient behavior and determined which ones received the bulk of their care within the practice). Retrospective assignment makes it harder for the practice to know which patients to manage. Coupling ACOs with the emerging trend towards narrower networks, however, will create more effective prospective patient assignment, enhancing the ability of ACOs to manage know which patients to manage for the most impact.
  3. Long-term: Schumpeter and scalability: Of course, not all ACOs will succeed. But in a world where a reasonable share of providers can make ACOs work, providers seeking unmodified FFS rates will feel increasing pressure. Eventually, they will increasingly start to throw in the towel and combine with working ACOs or retire. And, given the scalability of investments required to put an ACO in place, these “winners” will be able to leverage their investments across a larger pool of patients.

There’s good reason why “smart money” is investing in ACO experience (note: the former CEO of Carillon has joined an investment firm to acquire and develop businesses in the physician management and ACO arena).

Of course, Schumpeterian “creative destruction” towards a high performance, transparent, cost effective delivery system will take time. There is something to the point that ACO models play to the strengths of the best performing providers. If these jump on the ACO bandwagon early, what does that mean for the rest of the delivery system – where, in all likelihood, the providers least equipped to coordinate care, manage patients, and below average quality will be concentrated? Payers can’t do without them: provider capacity is already tight and healthcare reform’s coverage expansion will only exacerbate the problem. Payers will therefore need to make care effective through these providers as well. So don’t expect payers to strip out all the care management capability any time soon…even if ACOs live up to the promise.

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