On TPAs, PBMs, and SMBs
A guide to recent disruption in the small and medium group health insurance market
By Duncan Greenberg and Jan-Felix Schneider
In healthcare, change is slow, but with occasional spurts of transformation. We may be living through one of these transformative moments in the small and medium group insurance space, which for many years was a sleepy cash cow for large payors but is now a hotbed of innovation on multiple fronts.
We’ve seen the greatest fanfare around a new crop of PBMs including Rightway Rx, Smith Rx, and CapitalRx, the last of which reached a staggering $3.5 billion in revenue last year. This is obviously still a fraction of the overall market, estimated at more than $500 billion per year, but many of the startups appear to have found their footing, peeling employers (even some really big ones) away from the mega PBMs with promises of greater transparency and cost savings that can only be achieved through proper incentive alignment.
But drugs are “only” 27% of an employer’s healthcare costs. And the startup PBMs are primarily going after the larger end of the group market. What about solutions that help rein in the remainder for the little guys?
Setting aside the countless cost management point solution vendors that sell into self-funded employers and health plans, opportunities for smaller employers to reduce medical costs largely fall into three categories:
- Plan design & underwriting
- Network & formulary design
- Plan administration & service (un)bundling
Each of these is a proving ground for startups to find a niche in the group market.
Plan design & underwriting
Smaller employers have always been at a disadvantage in buying health insurance. They have less leverage in negotiations, less in-house benefits expertise, and more volatile claims costs.
Prior to the passage of the Affordable Care Act, most would get insurance from a regional or national carrier and pay a premium, with a portion passed on to employees, that was set based on an underwriting process that took into account everything from their employees’ medical history to their size and industry.
While the ACA is best known for eliminating pre-existing conditions as a coverage factor and creating a new and now sizable individual market, it also included language that directly or indirectly impacted group coverage.
First, it effectively did away with medical under-writing in the fully insured segment, requiring a version of “community rating” or pricing based on local averages. Ever since, plans have been constrained in their ability to charge premiums based on the health status of a group’s employee population. This benefits groups with older, sicker employees but hurts groups with below-average claims costs since the healthy groups end up subsidizing the sicker ones. Employers are also saddled with additional costs tied to mandatory benefits and coverage requirements.
This exacerbated issues in the market but small group insurance had been declining for years leading up to the ACA. The most likely explanation for this is a simple one: the smaller the business, the more sensitive it is to healthcare costs and, therefore, the more likely it is to drop coverage in times of budget pressure. Costs have risen relentlessly since 1980. Therefore, coverage has fallen. In a 2023 survey, 94% of small employers reported finding it challenging, at least to some degree, to afford coverage for their employees. Nearly half had taken a loss or eaten into profits to pay for it while 46% had been forced to raise prices.
Prior to 2014, small business owners were almost entirely fully insured since a small risk pool is inherently more volatile, and small businesses can’t absorb sudden cost spikes the way large employers can. But regulatory shifts combined with relentlessly rising premiums and out of pocket costs for employees tilted the equation for many business owners (and brokers, who lose in a shrinking insurance market). They started to hunt for alternatives other than continuing to jack up deductibles.
Payors soon hit upon a way to offer coverage whose cost was still closely linked to a group’s risk profile: level funding. They were able to take advantage of the Employee Retirement Income Security Act of 1974, which largely remained intact post ACA, allowing employers to “self-fund” their health plan and purchase stop-loss insurance, which can be more flexibly underwritten than ACA compliant fully insured plans. Mechanically, the product involves setting aside funds from the employer to pay for a certain volume of claims and buying stop-loss insurance, both at the group and the individual employee level, to protect them from extreme outcomes. The underlying insight with level-funding, which entitles employers to a cut of any favorability from lower-than-expected spend (without the volatility of self-funding), is that it is a better bargain for groups with good risk (read: healthy employees) than fully insured products.
[Side note: it was surprisingly difficult to determine which payor actually introduced the first level-funded plan. Our best guess is that it was United or someone in the United orbit since they’ve been very active in level-funding since the early days]
Level-funding is not the only option for employers looking for ways to save though. Small employers often work with a Professional Employer Organization (“PEO”) which provides a range of back-office services such as HR administration and payroll, but also offers health benefits negotiated on the employer’s behalf. They vary premiums based on an under-writing process, with the favorability you’d expect for healthier groups. It has been said that the PEOs tend to keep more of the claims favorability for themselves when it occurs, which may be an okay trade-off given the other services employers count on them for. The most prominent PEO startup is Justworks, which spanned 140,000 covered employees as of late 2021 when it filed materials related to a potential IPO. A smaller one is Rippling. According to the National Association of Professional Employer Organizations, PEOs in aggregate serve 15% of firms with 10–99 employees. Gusto serves roughly 400,000 small businesses (in some cases very small ones) and offers many of the same capabilities as a PEO but without being the employer of record or taking over the employer’s back-end operations.
Smaller groups can also join what are called “group captives,” with companies like Pareto Health and Benecon offering a platform for multiple employers to band together to achieve self-funded status on par with a large group. These collectives are sometimes though not always organized around an industry, which is a little bit counter-intuitive since you might think that would create lopsided risk pools. But if the captives are large enough there’s plenty of heterogeneity to smooth out outcomes and they of course get stop loss coverage to soften spending flares. Meanwhile, the captives operate as micro-communities with a collaborative stewardship model and the benefits they select may be tailored to the nature of the work their teams are doing (e.g. construction companies may want to offer better coverage for occupational therapy). Some argue that captives are the most cost-effective way for smaller groups to self-fund.
Over the past ten years, as the individual market grew and stabilized and the fully insured group market continued to shed customers, policymakers cast about for new consumer-driven coverage options. In 2020, ICHRA was introduced, which allows employers to offer tax-free premium subsidies for employees to buy Obamacare plans, an alternative to offering a few plans for employees to pick from. ICHRA platforms team up with businesses to help their workers shop for individual market plans paid for in part or in full by the employer and get paid an admin fee. They also get commissions, although many are now ceding this back to the insurance broker who originally brought them into the relationship. The market is estimated at anywhere from 500,000 to 3 million lives, a fraction of the ~24 million in the ACA and the ~160 million with employer coverage, but it’s growing quickly.
ICHRA and level funding represent two very different (some would say opposite) risk pooling strategies. With ICHRA, employers can effectively shift their employees into a very large and increasingly stable ACA risk pool, which carries lower premiums in some markets (in part because ACA rates are less generous to providers than commercial rates). This makes sense in a variety of situations, but especially for employers with sicker employees who may end up disqualified from level-funding and PEOs, leaving pricey, fully insured coverage as the only other option. With the healthier end of the market latching onto self-funding, what’s left is a higher-cost set of groups poised to shift to the ACA. In the medium to long run, ICHRA therefore becomes a beneficiary of level funding’s ascent.
All told, the menu and mix of insurance products for SMBs have seen a significant make-over in recent years, coinciding most noticeably with the start of the pandemic. There’s ICHRA, which came into existence in 2020 and is small but gaining steam. And there’s level-funded coverage, which had been around for years but apparently hit an inflection point at roughly the same moment, growing from 13% to 40% of the small group market between 2020 and 2024, according to survey data from the Kaiser Family Foundation.
In the world of ICHRA, companies like Remodel, Thatch, Stretch Dollar, and Venteur are making headway, each one targeting a slightly different profile of employer or with a different approach to employee and client engagement (we won’t go into a ton of depth on the landscape here, given copious coverage elsewhere).
Level-funding remains a much more widespread product at this point, where companies like Gravie, Sana, Decent, Angle, and Arlo are seeing success. Arlo specifically offers level-funded, out-of-the-box health plans for smaller employers overlooked by other underwriters (Full disclosure: co-author Jan-Felix is the founder of Arlo). Sana offers virtual care in addition to level funding. Gravie is both a leading level-funding player and a major ICHRA platform, which makes for an interesting all-in-one combination.
Network & formulary design
That’s it for the first regulatory butterfly effect. Now for the second one: the Affordable Care Act also imposed a floor on the medical loss ratio for payors, which basically meant they had to pay beneficiaries a rebate if they became too profitable relative to the premiums they were collecting. While noble in its intentions, the rule created an incentive for large payors to acquire care delivery and pharmacy businesses because they could let costs run up on the payor side (staying just above the floor) only to recapture those costs as revenue in their clinical subsidiaries.
This triggered a way of M&A activity in which PBMs, pharmacy chains, providers, and payors all linked up. CVS and Aetna merged. Cigna acquired Express Scripts. United bought Catamaran, folding it into OptumRx, and also went on a provider practice acquisition spree. Over time though, these actions sowed seeds of disgruntlement in the group market as the implications of this strategy (higher costs for employers in some cases) gradually came to light. Against this backdrop, a crop of PBM startups was born.
On the provider network side, there’s a bit less recent activity to point to, but still plenty of creative models, largely geared toward medium groups and above. The BUCAHs boast broad, well-negotiated and closely guarded networks that startups have a hard time replicating, often turning to lower-quality stand-alone national networks like Multiplan that are expensive to rent (or have bad rates). Centivo’s answer to this has been to establish narrow “alt networks” oriented around primary care relationships in a variety of markets, giving it a tighter grasp on unit costs.
Then there are companies like Harbor Health, founded by insurance veteran Tony Miller who previously started Bind, which is building a network of self-operated clinics, starting in Texas. This mini-network will eventually become the basis for an employer-focused insurance offering.
Another flavor of network innovation is Sidecar Health, which has built a benefits marketplace in which employees are reimbursed at a transparent rate based on an analysis of local cash price prices (employees pay any amount over the preset price for a given service). They don’t build networks per se since the cash-pay prices exist with or without them. However, they do gather data to help employees make cost-informed choices. By disintermediating health plans and avoiding formal network builds they unlock efficiencies for members and providers.
Surest, formerly known as Bind, now owned by United Health Group, is apparently growing quickly. Like Sidecar it offers plans with neither deductibles nor coinsurance, varying costs, displayed transparently upfront, based on provider cost and quality. Unlike Sidecar, it’s built on top of United Health’s contracted national network. It’s been available to fully insured and self-funded employers. This year it became available to level-funded employers as well.
Going back to the 2010s, network innovation took the form of a wave of reference-based pricing companies aiming to corral out of network spending by benchmarking reimbursement more systematically. These gained popularity but have come under scrutiny in recent years given provider abrasion, the opaque fees earned by the insurance companies they partner with, and balance billing implications for patients.
Most recently, the hot trend has been dynamic copay plans that incentivize better use of the network. In March, Amino Health announced a new platform, Pilot Health, with APIs that enable health plans and TPAs to offer plans such as these.
Plan administration & service (un)bundling
What’s less often talked about is recent developments in group plan administration. Yuzu Health and Avant Health are two examples of a new crop of startup TPAs that are using technology to power products with leaner operations, more flexible plan design and/or more scalable member engagement.
Historically, this has been a challenging area for founders to make inroads in, with attempts spanning what is now three generations of disruptors:
- Cohort 1: Collective Health (2013)
- Cohort 2: Centivo, Flume (2017, 2018)
- Cohort 3: Yuzu (2022), Covet (2022), TrueClaim (2023), Avant (2024)
Among the reasons why it has proven difficult:
- TPAs themselves are sometimes loss leaders, with the larger platforms making much of their margin on their network, ancillary services, and PBM access. Thus new entrants without full-stack offerings tend to be less price competitive. More importantly, many of the large TPAs are aligned with ASOs (owned by the same carrier with a premium network at their disposal), so plan administration is a smaller part of what the employers are actually purchasing.
- It’s historically been a services heavy business. In fact, one of the main selling points for an employer to work with a stand-alone TPA is white-glove attention and more flexibility in customizing the offering, two factors that inherently impede scalability.
- There are many capabilities needed simply to operate, with a less-than-stellar landscape of vendors to fall back on and lots of integration edge cases to deal with (Flume pivoted away from its TPA business to solve this integration problem for payors and TPAs)
- Health insurance is highly sensitive and brokers, who work with the same clients over many years, may think twice about making a bet on an unproven vendor that could cause hiccups.
But conditions have become a bit more favorable in a variety of ways:
- As fully insured products are unbundled and insurance models become more dynamic and personalized, there’s an opportunity for stand-alone TPAs to step in and work with local plan designers, level-funded plan sellers and other insurance innovators (the fully insured market is also in play). This opportunity is especially interesting when it comes to claims adjudication which to this day is highly manual and constrained by antiquated technology.
- Employers have grown mistrustful of the large payors, and are more primed than ever to consider alternatives. Like the startup PBMs, which differentiate on incentive alignment, the startup TPAs have no conflicting loyalties — they have no clinical channels or intermediaries to steer volume to.
- There’s a growing willingness among brokers to take a risk on new players and insurance models. Health Rosetta, for example, is a community of upstart brokers who are trying to differentiate by building health plans that are more customized for small employers. They are combining different, independent vendors into a holistic solution. Examples include Level Health, Clearwater, and Turnkey Health. These moves are not just limited to brokers — a growing number of Direct Primary Care clinics is launching plans in partnership with brokerages, for example HIPNation. All are looking for TPAs flexible enough to support their needs.
- There is also interest from traditional stop-loss carriers to get into the small-group, level-funded space. The large-group stop-loss business is highly-competitive and faces margin headwinds (incidentally, stop loss was a hot topic in Cigna’s recent earnings). This is one of the market needs Arlo addresses: they help carriers increase their stop-loss market share without having to sacrifice risk margins. Another major player here is Allstate Benefits (which was recently bought by Nationwide).
- Startups can leverage a growing number of technologies, libraries, and open-source projects to analyze client data, enabling real-time identification of savings opportunities. They can also offer greater transparency around claims data as they are less precious about who can see what, especially if they’re not the ones creating the network.
- LLMs have the potential to make customer service more personalized and scalable, which can enable cost savings in the form of better guidance for employees as they select doctors and drugs.
- Modern tech (including but not limited to LLMs) can also be used to run back-office functions in a more automated fashion, streamlining operations, which could be fed into better pricing but far more importantly is what enables more flexible plan design, even for groups with fewer employees, dislodging legacy vendors.
What happens next?
Between ICHRA, level funding, and captives there are many moving pieces on the insurance product and under-writing side. A few immediate questions:
- It’s easy to imagine ICHRA reaching 5 million lives over the next 10 years. The bigger question: will it will reach, say, 50 million over time?
- Level-funding represents a return to pre-ACA, experience-based under-writing practices. For now it’s more widespread than captives, but will the captives approach, with its spreading of risk over larger pools, ultimately win out?
- Also, in level-funding, is the growth we’ve seen sustainable or is it fueled in part by aggressive under-writing which history suggests could lead to profitability challenges for some companies down the road?
In terms of network and formulary design:
- Most of the network innovation has centered on medium (and large) groups even though small groups are potentially as good a fit or better for tailored networks. Will ICHRA tip the scales here given the ACA’s narrow network prevalence? Or will ACA carriers introduce off-exchange plans that resemble the rich PPO offerings of large employer land?
- What role will narrow networks play in the level-funded space? Currently most level-funded plans are PPOs, but will they incorporate other contracting arrangements such as narrow networks or capitation models?
- Will the startup PBMs move down market eventually or continue to focus on the upper end of the employer spectrum?
Finally, on plan administration:
- The big payors still dominate in small and medium group, offering administrative services that are bundled with plans and networks. Will we start to see these disaggregate as the number of plan design innovators grows and as employers seek greater transparency across their insurance vendor stack?
With any luck, we’ll see the medical cost equivalent of a startup PBM — a super payor, if you will— take shape, offering committed savings, built on transparency and a more flexible integration approach that makes unbundling and re-bundling a possibility for employers of all sizes, not only the jumbos but also the mom and pops. It could steer its SMB clients to a captive, level-funding, or ICHRA depending on their needs; layer on a built-from-scratch network or achieve similar results with dynamic cost shares tied to high value care; and it could integrate with a startup PBM, plus whatever other partners had savings to offer, all powered by a modern TPA. Or maybe the market will surprise us and this concept will take root in a different way: with a PBM expanding outward to capture the rest of the healthcare dollar.
