Feb 15, 2024. In early 2023, I became aware that United Health Group (UNH) was likely to possess a durable competitive advantage, since it had evolved over about 40 years to become a market dominating company, with an impressive total stockholder return. In order to discover the basis for this competitive advantage, I searched in vain for a book written by or about UNH founders or the company history. I did find a book about the US Healthcare insurance system history: Ensuring America’s Health: the Public Creation of the Corporate Health System. Christy Ford Chapin, published 2017. The following historical outline of the US health insurance system takes liberally from this interesting book.

From the inception of the income tax in 1913, fringe benefits including employee health insurance, were made tax deductible. Over time, public demand grew for comprehensive health insurance.  At the time of price controls during the war time economic policies of FDR, employers offered the tax-deductible employee health insurance fringe benefit to augment compensation and attract workers. The employer tax deduction for employee health insurance was more specifically codified in the Internal Revenue Act of 1954.

In insurance markets other than health insurance, the insured outcome is something that all parties to the insurance contract have an incentive to avoid.  A driver tries to avoid car damage, a home owner avoids burning his house down; the insurer certainly shares the sentiment. As premiums exceed claims most of the time, the company can accumulate a “float” of funds to be invested in order to earn additional income and build the financial resources to fund future claims. The size of the financial reserves thus accumulated, is the basis for the insurer’s promised ability to back claims successfully.

In contrast, in the health insurance market, the customer finds it desirable to make claims for service, a sentiment shared by the provider, and there are no clear  definitions as to what services are legitimately necessary for health. This means that health insurance is unprofitable in the sense that claims paid will tend to approach premium revenue, leaving no room for accumulation of float.  This means that it is a peculiar property of the US health insurance market, that the insurance company must be an important arbiter of the reimbursement rate for health care services.   Because in order to be profitable, the insurance company must devote systematic attention to controlling medical costs, where neither customer nor service provider have an incentive to do so.

Because of the poor economics of health insurance, early (following the Great Depression era) insurance policies covered a limited range of essentially catastrophic coverage.  In the 1940s employers began to offer naturally desirable more comprehensive health insurance partly to stymie labor unions’ influence.  As private insurance spread rapidly to become a popular benefit, unions demanded comprehensive coverage for their members as a counter for moderated wage increase. Physicians’ groups encouraged private insurance, while insisting on fee for service, and fended off insurer influence over reimbursement or choice of care. Physicians feared insurer restrictions on price and provider independence, which they considered to be a gateway to government sponsored coverage and associated control of reimbursement and practice. Private insurance companies, while unsettled about low margins, had similar fears regarding the development of government insurance, therefore tended to supply demand for progressively more comprehensive policies.  Their business grew rapidly.  Health care insurance was paid for by a third party, namely the employer, union or government. Regarding government payment, at this point in history, it was the growing Federal Employees Health Benefits Program which paid for and in effect subsidized private insurance for federal employees.  With prices determined by providers and ancillary healthcare service or equipment providers, who could be confident their costs would be covered, consumers were not restrained by prices, and healthcare price inflation exceeded that in the rest of the economy.

In the absence of other restraint on prices, private insurers gradually began to take a role in determining reimbursement. They were aided over time and experience by the evolution of actuarial data needed to do this effectively. As health insurance became more comprehensive, the many claims to be covered, involved innumerable conditions and treatments.  Over time, the complex data sets needed to make sense of claims administration were developed, at times including data sharing among different companies. This developed expertise in controlling reimbursement costs.

Healthcare inflation was a public policy issue which led to the formation of Medicare and Medicaid, the feared government sponsored plans, after at least a decade of discussion and negotiation. By that time the private health insurers had established a business infrastructure to address billing and payments.  In the political conflict between proponents leaning toward a government single payer system and those for private insurance, the use of the private insurance company model to administer the government sponsored systems, subject to government regulation and funding, was appealing as a viable compromise.

The creation of fully government funded health insurance, administered as it was by private insurers, who would thereby profit, meant that the private insurer model was further embedded in the structure of the US health care.  As price inflation did not abate, the insurance companies gradually increased their control over reimbursement, leading to DRGs, formation of HMOs, PPOs, and the current system, of which value based care is the latest attempt to maximize value per cost, while optimizing outcome as a value to the customer.

In summary: private health insurers play an indispensable role as mediator, or market maker, in the US health system.  They insure comprehensive health insurance, which most of the population regards as indispensable.  This is paid for at least as a strongly established expectation, if not legal entitlement, by employers and, ultimately, state and federal government. Because of the natural incentive to consume healthcare, in the peculiar economics of healthcare insurance policies, claims made tend to chase the level of premiums revenue, and gross margins are correspondingly attenuated.  But because of inexorably expanding demand, and reliable payment for insurance, health insurer revenues will tend to continue rising.  A company which has a market dominating position in this ecosystem, has access to total addressable market which will likely grow for the foreseeable future.  Market growth is driven by population growth, especially of the aged; increase in price and frequency of utilization; increase in government funding, among other factors.

The question remains, how can a company establish a market dominating position in this system? It would need to widen the gap between claims expenses and premiums revenue; that is, minimizing the medical loss ratio (MLR), funds paid for medical costs of members, divided by premiums revenue.  By economies of scale, in which an insurer accesses a relatively larger population of customers (potential patients) as members, it could demand relatively lower reimbursement prices from healthcare providers.  Meanwhile, access to a large number of providers attracts contracts from large corporate employers and large numbers of individuals, government entities or other payors. Moreover, it can build access to a diversified network of healthcare facilities that build on mutual synergies, to encourage lower prices as well as attract business from payors.  For instance, association with a large number of rehabilitation medicine providers could lead them to accept a lower reimbursement bid, if the insurer is also associated with a correspondingly large number of referring orthopedists. 

Other than minimizing the MLR relative to premiums revenue, the health insurer could create additional revenue streams by selling other services, derived from its experience in insuring, that raise productivity and lower costs for its customers as well as providers. For example, healthcare billing software, clinical pathway analytics, pharmacy services. 

Finally, the insurer could build or acquire healthcare providers that are incentivized to reduce cost relative to value through management guidelines developed by the previous insurance experience.

In a subsequent article, I will outline how United Healthcare uses these strategies to maintain a consistent competitive advantage relative to other insurers.