Employer Health: Third-Party Administrators

A multi-part series on investment opportunities in employer health businesses

Healthcare costs are employers’ biggest non-payroll expense, and they continue to climb. In response, a host of innovative employer health businesses have emerged to help employers better manage those costs and improve employee wellness and satisfaction.

In this article series, Harris Williams senior professionals from our Healthcare & Life Sciences (HCLS) Group and Business Services Group explore the key sub-sectors of the growing employer health industry.

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This article concentrates on third-party administrators (TPAs), which help self-insured companies manage their health insurance plans.

CEOs Are Strongly Focused on Healthcare

With employers insuring nearly 160 million Americans, healthcare remains the most significant non-labor cost for many companies.1 This cost continues to rise as the population ages and chronic conditions become more prevalent.

In fact, U.S. national healthcare costs have grown 50% between 2012 and 2020, compared with a forecasted U.S. GDP growth of approximately 2% (Figure 1).2 For CEOs, this has translated into a steep rise in annual contributions—which now average $5,946 a year for single coverage and around $14,561 for family coverage.3

Figure 1: U.S. Employer Healthcare Costs Rising Dramatically

Sources: Merritt Hawkins, CMS, CDC, BLS, and Partnership to Fight Chronic Disease

“Healthcare expenses are rising faster than inflation or any other category of costs, and CEOs are focused on managing them more effectively,” says Nick Owens, a director in the HCLS Group. For many, adds Owens, such cost reduction involves self-insuring: taking on the financial risk of paying for healthcare versus paying an insurer to assume that risk.

Two decades ago, just 60% of U.S. companies with 200 employees or more self-insured their health benefits, a figure that jumped to just under 80% by 2017. Today, self-funded plans cover nine in 10 workers at enterprises with at least 5,000 employees.4 There are now approximately 8,000 self-insured employers in the U.S. (excluding quasi-governmental entities, such as universities and school systems, and labor unions) with 1,000 employees or more. In five states, at least half of all private employers offer a self-insured plan (led by North Carolina with 53%), while in 21 states, 40% or more are self-insured to some extent.5

Self-insurance’s growing popularity is rooted in the fact that it’s typically less expensive for employers than coverage underwritten by traditional insurance companies. “Self-insuring is also becoming more accessible due to the growth of captives, which allow small employers to band together to gain a similar level of control and cost savings as traditional self-insurance,” Owens notes. “Greater penetration of self-insurance will drive continued demand for TPAs to help manage benefits and tech-enabled solutions to help reduce costs and improve outcomes.”

TPAs Meet a Growing Need

The increasing prevalence of self-insurance has created significant opportunities for third-party administrators (TPAs), companies that help self-insured employers administer benefits and control healthcare costs. This roughly $200 billion segment has grown by 8.3% between 2010 and 2019.6

Figure 2: Large and Growing TPA Market

Source: IBIS industry research

The market’s size and growth, as well as a TPA’s ability to leverage trusted, direct employer relationships to serve as a conduit for additional services, is driving strong investor attention, as evidenced by recent M&A activity. Strategic health insurers such as United and Centene both made significant TPA acquisitions in 2019. Private equity interest in the sector has also been robust. 

Leading TPAs Share Three Key Qualities

What are savvy investors looking for in this segment? Three key factors enable leading TPAs to outpace competitors and achieve outsized growth.

1. Client Mix and Specialization

One factor is a focus on specialty customer segments, which are often more complex, have higher barriers to entry because of the need for deep industry knowledge and expertise, and offer more low-hanging fruit from a cost-saving standpoint for employer clients. For example, Taft-Hartley funds (also referred to as multi-employer plans) are complex entities managed by boards of trustees staffed with similar numbers of union and employer representatives. Taft-Hartley plans are more difficult to administer, in large part because of specialized capabilities required to handle contribution accounting and fund accounting, as well as member service requirements to ensure high satisfaction for union members. This higher degree of difficulty, combined with the complex fund decision-making process, results in sticky relationships and attractive margins within this segment.

“We typically see that specialty segments, including Taft-Hartley, have much more complex administration requirements, which are not well served by the large insurance company administration services only (“ASO”) offerings,” says Cheairs Porter, a managing director in the Harris Williams HCLS Group. “That allows TPAs who can meet those needs to create stickier relationships and protect themselves against competition.” 

TPAs that focus exclusively on large commercial employers tend to face increased competition from ASO offerings from large insurance companies and other large benefit managers. These larger entities’ ability to also offer network solutions and other services may make it more difficult for independent TPAs to compete on price. Firms that focus on small and medium commercial clients have tended to stay out of the crosshairs of larger competitors, which have historically not focused as much on the small and medium segment. 

2. Value-Added Capabilities

The ability to offer complementary tools that drive cost savings for employers also enhances a TPA’s value proposition and creates stickier relationships, as clients view their TPA as a partner in their mission to reduce healthcare spend. “These integrated solutions often have a technology angle and can be internally developed or facilitated through a third-party partnership,” notes Derek Lewis, a managing director in the Business Services Group. “The ability to offer more comprehensive solutions is truly differentiating.”

For example, some successful TPAs have either internally developed or partnered to offer reference-based pricing capabilities that replace the typical PPO billed charges and, instead, pay providers based on the actual cost of services performed plus a reasonable margin. This results in significant savings for self-funded employers. Others employ nurses and use data to identify high-risk members to coordinate care, which helps employers reduce costs while increasing wellness and satisfaction among such employees. 

“Over time, we also expect TPAs to do more to help control pharmacy benefit costs, as this is the number one issue that TPAs say they hear about from their clients,” says Owens.

3. Proprietary Provider Networks

While most TPAs are network agnostic, some have developed their own provider networks. This drives higher profit margins and positions a TPA to more effectively compete with insurance company ASO offerings. “Network ownership also facilitates the development of narrow network health plans, which can drive even greater cost savings for self-insured employers while reducing premiums for employees who choose such plans,” notes Porter. 

Conclusion

CEOs are acutely focused on healthcare costs, which have only been heading in one direction. As costs continue to balloon, employers are looking to take control by self-insuring and partnering with technology and service providers to better manage costs while also boosting employee wellness and satisfaction. 

TPAs directly address this burgeoning need, helping companies enjoy the financial benefits of self-insuring while focusing on their core strengths and functions—not benefit administration. Investors and buyers are taking notice, with a number of significant transactions completed in recent months at rising valuation multiples. Savvy investors are prioritizing TPAs that offer value-added solutions in addition to claims processing, and that are adept at serving more complex, specialized end markets.  

Published February 2020

 
Sources
1. Merritt Hawkins, CMS, CDC, BLS, and Partnership to Fight Chronic Disease
2. ibid
3. KFF 2019 Employer Health Benefits Survey, September 25, 2019, https://www.kff.org/report-section/ehbs-2019-section-6-worker-and-employ...
4. “American employers are in the healthcare business,” Collective Health, February 28, 2018, https://blog.collectivehealth.com/employer-driven-healthcare-270bfb7ee8c7
5. “Employer Trends in Self-Insured Health Plan Coverage,” Employee Benefit Research Institute, September 5, 2019, https://www.ebri.org/docs/default-source/infographics/36_ig-selfinsur-5s...
6. IBIS Industry Research