Health Care + VC: The Unspoken but Generally Recognized “18-month ROI Rule”
I interviewed 40 VCs, health tech entrepreneurs, health care executives, and industry experts and spent hours researching the intersections between health care, public health, and venture capital. What emerged was a multi-part report that I’m calling Preventing Prevention: Barriers to Venture Capital Investments in Upstream and Community-based Care.
This is part five in this series. Here are parts one, two, three, and four.
Funding for this work came from the Robert Wood Johnson Foundation.
Introduction, Background, Etc.
This series of blog posts (see above for the other links) began actually with a simple anecdote from a health care venture capitalist. According to her, there’s a fairly clear cut line that companies looking to sell into health care should recognize when thinking about their business models.
Here’s the “18-month ROI rule”: Insurance companies don’t incorporate new products or services that can’t show return on investment (ROI) within 18 months of implementation.
This is an unspoken “rule”, she claims, held by VCs. And what she notices is that this “rule” pushes investors towards companies that offer more acute services since prevention-oriented services often take more than 18 months to yield demonstrable (health and financial) returns.
(For example: The work of helping an individual lower their weight from an obese level to a more healthy level takes time; and seeing the financial returns of that work, from the business perspective of insurance and health care, takes even longer.)
This “rule” is not written down anywhere, and she’s never seen any math behind why it exists. She just knows that her investment firm as well as others she’s spoken to use it when evaluating companies that want to sell into the health system.
The anecdotes here hold sufficient weight to warrant a deeper exploration into this “18-month ROI rule” via the following questions:
- How wide-spread is this belief among Venture Capitalists?
- Where did this “rule” come from?
- Is it true? That is: Does it point some point of larger market failure or a line at which tradition investors aren’t likely to cross?
This blog attempts to answer these questions. This is not an overly formal study here. Rather the following comes from my understanding of things based upon my individual research as well as from conversations with other investors, with entrepreneurs, industry experts (economist-types), and with folks within health insurance plans.
How Wide-Spread Is This “18-Month ROI rule”?
I’ll first note that this 18 month rule (removing the quotes) was generally validated by every venture capitalist and entrepreneur that I spoke to.
It’s not a hard and fast rule per se, especially as investments occur on a case by case basis. But each had their own version of this rule. For a few people, 12 months was the marker. One person even stated that “many require evidence of return within 6 months.” But 18 months was the line most held by the people I spoke to. (Note: Again, this wasn’t a formal research project. Someone should take that on!)
But from my perspective, I’ll answer this question fairly directly:
It’s quite clear that this 18-month rule is widely held in the minds of health care investors, startups, and those on the seller side of the equation.
Where did this rule come from?
This rule comes basically down to how the health care system operates, and well doesn’t.
Economics. Or: The Way Our Health Care System Works (And Doesn’t). Explaining the market and business reasons behind why an 18-month rule might exist would require a deeper dive into how the U.S. health care system works.
As it so happens, I wrote this:
As the title of that blog post suggests, there are (at least) three major elements of our health system that drive a shorter-term approach to health: Fee-for-service financing, member churn on insurance plans, and the data — including around clinical efficacy — surrounding many upstream interventions.
These point to a single, problematic outcome: Insurance plans, including employer-sponsored insurance plans, just don’t have much incentive to incorporate prevention or health promotion-oriented features into their plan offerings as they aren’t likely to see the financial returns of that work.
This is particularly true for the insurance plans and employers with higher churn rates still working in the world of fee for service.
The Narrow Profit Margins of Health Insurance Companies and Care Providers. Beyond the general market forces, the business of health care contains an incredibly irony that’s at play here.
While there is a LOT of money in health care, most insurance companies and most provider networks and insurance companies don’t have much money to “play” with. Almost all money is out the door in the form of salaries and required spending on the “must have” items just to keep the lights on.
This is especially true for public and many non-profit hospitals who work with poorer and/or sicker populations. (Insurance plans and provider networks that target wealthier and healthier individuals have more money. This points to the financially-savvy but perverse business practice of patient skimming, or “cream skimming”.)
Further, the pipelines through which money flows have long delays. For example, one investor pointed out that ACOs participating in the Medicare Shared Savings Program, those ACOs often heralded as the best model promoting upstream and community-based care, “are waiting 18 months for the (CMS) shared savings payments, leaving them no capital to invest.” (The mention of 18 months here is just coincidental, not corollary.)
With narrow margins there’s little room for error. This leaves those within the health insurance system to make more predictable investments. They need their money to pay off.
Is there truth behind the 18-month rule? Does it point to THE line at which markets fail?
Market failure in health care is an impossible conversation to have. The personal nature of health, the humanness of living and dying, the complexity of what causes disease and sickness, even the very definition of what it means to be “sick”, take us quickly from any conversation about economics to one of values and ethics. That’s well beyond the scope of what I want to do right now.
Health care is a highly regulated market. The question is not so much “is there market failure” (duh, there is) but more so “What market incentives are currently created by our current set of regulations?”
But it’s certainly true that along the spectrum of care that can be given — from the clearcut, urgent, and immediate interventions that aim just to keep you alive (e.g. ER visits) to the more ambiguous, upstream, and community-based services that aim to promote wellness and prevent disease (e.g. parks and clean air) — the business of health care and health insurance shifts from profitable to not profitable. At some point, work to help people be healthy goes from sustainable business model to operating at a deficit.
At some point we go from health care delivery to public health.
But… is that line at the point of 18 months? Maybe, sure, for some types of services in some places.
Beyond that, we’d just have to look at each individual company and the particular problem they’re trying to solve in each particular market they’re hoping to work in.
A few entrepreneurs provided more color on this interaction.
They highlighted how the health care system is notoriously difficult to sell to, that there are long sales cycles to work through, and that there’s a general hesitation from all parts of the system to be the first at anything.
They noted that yes 18 months is the typical timeline they’re given to prove their value to a health care provider or insurer they’ve sold to.
However, they also noted that there are ways in which an entrepreneur can pitch themselves to demonstrate their value. Indeed it’s on the entrepreneur to figure this out, being creative if needed to do so. So while they generally see this 18-month rule as a barrier, they work hard to find ways to show their value within a shorter time frame.
Said another way: Entrepreneurs see it as their responsibility to make the sale.
For example, one entrepreneur who works within the Medicaid market has found that they can help Medicaid Managed Care Organizations, which work within counties at the approval of the state, better make their argument to their state for funding. This company works with MCOs on the front end to frame their applications as being innovative and data-driven, and this helps the MCO get their state approval and their funding, funding which then goes to buying the services offered by the company which helps them become innovative and data-drive. So this company is able to show ROI to an insurer before they even make their sale to that insurer! (If that doesn’t show the complexity of and the failure of traditional markets in U.S. health care, I don’t know what does.)
One also pointed out that, particularly in higher-churn markets, the cost of a preventive service just gets added to the price of insurance. “People forget that something like 90% of what we pay for in the US health care system adds costs.” (Actually, maybe this demonstrates the point even better.)
Overall…
This was a messy issue to try and parse out, and I’m only slightly sure I did an sufficient job. But I haven’t seen anything like this written elsewhere. My hope is that this contributes in some way to related conversations out there.
As I’ve stated elsewhere, health care in the U.S. is not one single system, but a complex system of systems. That is: it is not a single market, but many markets with different regulations and payment models weaving very different sets of incentives and market conditions for different people with different needs, even if they go to the same doctor. And this makes any sweeping statement about points of market failure, or for that matter: sweeping statements about health care in general, rather difficult to make.
With that said, the 18-month ROI rule does capture, in a simplified way, some economic and business realities of our health care system.
VCs who really know health care well will tell you that if they this 18-month rule lightly. It’s a guide post, even if over-simplified, held by many health care VCs and entrepreneurs alike.
And there are real reasons behind the rule existing, reasons that point to the complexity of (and market failures within) the U.S. health care system. The hard work of policy making figuring out how to align the flow of dollars with values held. In this case, policy makers should be thinking about how to lengthen this 18 month window. Or at a bare minimum, the question is: What frameworks help nudge the market to reward work done further upstream?
In this blog series on barriers to venture capital dollars going towards upstream and community-based care, we’ve thus far focused on VC expectations, how they generally think and operate, and how the market forces within health care shape how they think and operate.
But there are some non-market factors at play as well that are relevant. I’ll attempt to dive into those issues — and really: what it means to be human — next.