The Evolution of Healthcare Payments: Past, Present, and Future Opportunities

Co-authored with Shawn Ellis, Managing Partner & Healthcare Partner at Distributed Ventures, with contributions from Shivani Singh

Despite digital innovation in healthcare, healthcare spending has risen to exorbitant levels, with United States healthcare spending tripling to approximately $4.3 Trillion over the last two decades. The significant rise can be attributed to various factors, primarily rooted in the rising expenses within the healthcare sector, including: increasing labor costs, escalating costs for services negotiated between insurers and care providers, corresponding increases in medical insurance premiums paid by employers and consumers, and a lack of price transparency for healthcare services, to name a few. In response, with regards to the flow of payments, there has been an increased focus on prioritizing medical bill negotiations, ensuring precision in medical coding, and an emphasis on tax-advantaged accounts and financing options that individuals can access when facing out-of-pocket healthcare expenses. Despite increased focus and innovation, the Kaiser Family Foundation cites 41% of United States citizens carry medical debt, of which more than half those citizens are considering filing bankruptcy to address the burden of medical debt. At Distributed Ventures, we believe there is significant work to be done to reduce rising healthcare costs and deliver much needed relief to those paying for healthcare expenditures.

Through this piece, our goal is to provide a brief overview of the history of healthcare payments and offer insights into where we think the future of healthcare payments is headed. Additionally, we aim to highlight emerging startups in the sector that are addressing challenges surrounding healthcare payments, an area of focus that Distributed Ventures is acutely interested in.

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A Brief History of Healthcare Payments

Healthcare payments have evolved significantly over time, primarily driven by technological advancements, changing healthcare regulations, and shifting consumer demands. At inception, healthcare payments followed a traditional fee-for-service model, where individuals paid physicians based on the services they provided, without the involvement of health insurance. However, during the Great Depression, many Americans couldn’t afford healthcare, resulting in closures of numerous hospitals across the country. In response, healthcare providers introduced health insurance to ensure they received payment for their services, leading to the development of insurance and managed care models as we know them today — patients visit healthcare providers, providers submit medical bills (called claims) to health insurance payers, and insurance payers pay the bills.

Following the rise of health insurance and until the 1990’s, healthcare providers, insurance payers, and hospital systems relied on paper-based processes to manage their operations, making bill pay error-prone and time-consuming. However, in the late 1990s, a digital revolution began to unfold: healthcare providers adopted the cloud and started using electronic health records (EHRs) — a digital system that stores a patient’s comprehensive medical information, including medical history, diagnoses, treatments, and test results, in a secure and accessible format. In the early 2000’s, a surge in health spending, propelled by rising drug and hospital costs, paved the way for consumer-directed high deductible health plans, which were coupled with tax advantaged health savings accounts (HSA’s). The passage of the Affordable Care Act (ACA), which was intended to expand access to healthcare while controlling costs, further played a role in the proliferation of high deductible health plans (HDHP’s) due to ACA’s requirement for medical insurance access, which in turn prompted both employers and consumers to opt for HDHP’s given their more affordable premiums. Simultaneously, the more widespread adoption of the internet, cloud, and SaaS, lent itself to further portability of health records and a focus on adopting software to manage administrative tasks. In recent years, despite historically slow adoption rates to new technology, the progress in machine learning models and artificial intelligence has garnered significant attention across healthcare executives given their potential to improve various facets of healthcare, including payments processes and advancing flexible payment offerings. Tasks such as medical billing and coding, which involves translating doctors’ medical diagnoses and procedures through clinical notes into billing codes for healthcare providers to bill insurance companies accurately, have become a point of focus and solutions are being built that leverage large language models and medical billing technology to ensure accuracy. With the recent passage of healthcare price transparency regulations innovators are positioned to allow legislation to drive consumer adoption toward cost and quality accountability and the subsequent transformation in healthcare financing.Below is a market map highlighting the key innovative health technology companies in healthcare payments today.

Stage 1.0. Digitization of Health Records and Payments

Technological advancements in the 1970s created significant improvements in payments and digitized healthcare transactions. Initially, electronic payments gained popularity through the rise of Electronic Data Interchange (EDI) systems, enabling the electronic transfer of payment and claims information between healthcare providers and insurance payers. Later, in 1996, the Health Insurance Portability and Accountability Act (HIPAA) was enacted as a United States federal law, safeguarding health information and setting standards for secure exchange of healthcare data. HIPAA’s mandate for secure electronic transmission led to the rise of healthcare clearinghouses, which acted as intermediaries between healthcare providers and health insurers to enforce HIPAA’s privacy and security policies. All this led to reduced redundant paperwork, improved efficiencies, and accelerated healthcare payment processing.

Building upon these innovations, the Dot-Com era saw the rise of cloud-based practice management systems — platforms that manage scheduling, billing, and other administrative tasks for healthcare providers. As a result, previously time-consuming processes related to billing and administration became faster and less error-prone. Examples of notable technology companies that thrived during this period include:

• Athenahealth, founded in 1997, launched a cloud-based practice management system that helped providers streamline billing, scheduling, and patient management
• EPIC Systems Corporation, founded in 1979, experienced significant growth during the dot-com bubble through practice management software
• Cerner Corporation expanded its product suite to include practice management
• Kareo, founded in 2004, provided practice management to small and medium practices

Despite the transition to the cloud, clinicians had continued to rely on manual note-taking, often with illegible handwriting, to track a patient’s medical history. This led to manual and error-prone medical coding, resulting in incorrect bills and unnecessary back-and-forth between parties. Even though Electronic Health Records (EHRs) solved for a lack of transparency regarding medical history and health records, their adoption among providers remained low prior to 2009, with only 10% of providers utilizing them. While the passage of HIPAA triggered EHR adoption as they offered a secure and centralized way to store patient health data, widespread adoption of EHRs did not commence until the HITECH Act was enacted in 2009. This law provided financial incentives to healthcare providers who began using EHRs, leading to a significant boost in their adoption across the country. In order to capitalize on the trend, technology companies that previously offered practice management systems incorporated EHRs into their product suite, offering a comprehensive solution to healthcare providers:

• Athenahealth added EHR to its practice management services to become a trusted vendor of both
• Kareo expanded its flagship practice management software for small-medium practices, to include EHRs and billing services in an integrated suite
• Medusind, which started as a provider of medical transcription services to healthcare providers in 2002, later expanded to include revenue cycle management (RCM), medical billing and coding, accounts receivable management, and more
• McKesson offered medical billing and coding services alongside EHR
• Change Healthcare (formerly known as Emdeon) offered a range of revenue cycle management services, including medical billing and coding solutions and integrated with EHR to streamline billing and coding

Simultaneously, Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) were introduced in the early 2000’s via the Medicare Prescription Drug, Improvement, and Modernization Act (2003).

• Health Savings Accounts are investment options exclusively available to individuals in High Deductible Health Plans which allow them to contribute funds to cover the health plans deductible and/or qualified medical expenses without incurring a tax liability. Health Savings Accounts provide a triple tax benefit: 1. Contributions are tax-deductible or pre-tax, 2. Interests earned and investments grow tax-free, and 3. Withdrawals for medical expenses are tax-exempt. Additionally, 1. Any remaining balance in the HSA is carried over to the following year without facing any penalties and 2. HSA funds remain under the individual’s ownership, regardless if the person changes plans or retires. Advocates contended that HSA’s not only promote patient choice in healthcare and reduce tax liabilities, but they also drive down healthcare spending by promoting consumer awareness of healthcare costs. As healthcare costs continue to rise, individuals and families are increasingly turning to HSAs to manage their healthcare expenses and employers are more inclined to incorporate HSA’s into their benefits offerings. Consequently, the 2022 Year-End Devenir HSA Research Report showed that there were $104 billion in HSA assets held across 35.5 million accounts (6% YoY increase in assets and 9% YoY increase in accounts), up from $9 billion in HSA assets in 2010 (nearly 1,000% increase).

Source: 2022 Year-End Devenir HSA Research Report

• Flexible Spending Accounts is an arrangement through an employer where employees can allocate a portion of pre-tax earnings towards covering healthcare and dependent care costs. Unlike HSA’s, you do not need to have a high-deductible health plan to participate in this arrangement. However, some of the downfalls of an FSA include that there is a lower contribution limit than HSA’s ($2,850 vs. $3,650 in 2022), funds cannot rollover on a year-by-year basis (e.g., you use it or lose it), and the FSA is owned by the employer therefore it is not portable.

Stage 2.0. Billing Automation, Improvements through AI and ML, and the Adoption of Electronic Payments

Although the adoption of EHRs addressed several operational hurdles, and HSA/FSA’s made some progress in empowering individuals to manage healthcare expenses, the continued increase of healthcare costs indicate a pressing need for additional innovation. One critical area that is rising in focus is healthcare administration, which accounted for a staggering $1 trillion out of the $4 trillion spent on healthcare in the United States in 2021. Out of this $1 trillion, a substantial $300 billion was solely dedicated to payment-related workflows.

In the early 2010s, as AI and ML technologies made significant progress in the technology industry, numerous AI startups emerged in the healthcare payments sector. These companies utilized automated billing and payment processes to increase efficiencies and decrease costs. However, despite these advancements, automating healthcare payments remains nascent today given:

1. The complex regulatory environment.
2. High switching costs for healthcare providers to move away from legacy systems for their payment processing.
3. Interoperability concerns across a wide range of incumbent technologies, including Electronic Health Records (EHR) and Practice Management Systems (PMS), making it harder for new players to have accelerated adoption.

Notable examples of Healthcare startups leveraging AI and ML include:

• Claris Health, founded in 2013, built an AI data analytics tool called Pareo to score claims for irregularities, fraud, and overpayment risks.
• Notable, founded in 2017, uses NLP to digitize physician patient interactions to update visit notes, EHRs, and billing details.
• CodaMetrix, founded in 2018, uses AI and continuous learning to automate coding for areas such as radiology and pathology.
• Anomaly, founded in 2021, uses AI trained on large quantities of claims data to preemptively detect irregularities in claims and identify problematic billing patterns.
• Adonis, founded in 2022, delivers AI-driven insights to providers to improve payment collection and automate reimbursements.
• Aideo Technologies, an AI-powered coding services provider partnered with Surgical Notes in 2023 to bring improved medical coding workflows and productivity solutions to the ASC (ambulatory surgery center) market.
• DeliverHealth acquired Prisidio Health in 2022 to integrate its 800+ providers with PrisidioHealth’s billing coding platform, accelerating reimbursement cycles for providers.

Source: Additional Healthcare startups leveraging generative AI specifically can be found in the recent Sequoia Capital “Bringing Generative AI to Healthcare” article

Simultaneously, advancements in technology, such as smartphones and wireless connectivity, facilitated the adoption of digital payment solutions in healthcare. Through this shift, individuals now have the option to make payments via online platforms, mobile applications, or utilize digital wallets. However, the most significant catalyst for the widespread adoption of digital healthcare payments was the COVID-19 pandemic. While COVID-19 exposed the historical limitations of the United States healthcare system, with complex dynamics between players hindering innovation and driving up healthcare costs, nevertheless, it also presented an opportunity for rapid adoption of long-existing digital technologies. Our team wrote about the importance of COVID catalyzing innovation previously in our No Pain, No Gain: COVID-19’s Shot in the Arm for the Healthcare System piece. Below are some of the key statistics and insights that we detailed:

• Telehealth adoption and acceptance expanded more in the first six months of the pandemic than in the prior ten years
• Investment in virtual care and digital health experienced a significant surge, driving further innovation. There was an astonishing $3.1 billion in new investments for digital health made in Q1 2020, ~2x that of Q1 2019, and the average deal size hit a record of $25 million.
• There was a notable rise in healthcare acquisition and IPO’s. As an example, Teladoc’s $18.5B acquisition of Livongo was at a 364% increase to Livongo’s previous valuation of approximately $4B in a pre-pandemic world, and was completed in order to create a “global leader in consumer centered virtual care”.

Source: Rock Health’s “2023 Q1 digital health funding: Investing like it’s 2019”

The pandemic further exacerbated rising hospital administrative costs as well. Data from Kaufman Hall, a consulting firm specializing in hospital financial metrics, revealed that by the end of 2021, total hospital expenses had risen by 11% compared to pre-pandemic levels in 2019. Despite accounting for pandemic-induced shifts in volume, there was a noticeable increase in hospital expenses per patient across all categories, including labor costs. Numerous hospitals were already operating at razor-thin margins, therefore even a slight increase in expenses profoundly impacted their profitability. Unfortunately, these challenges continue to persist following the pandemic due to inflation and increasing hospital expenses. According to the JAMA Health Forum, prior to 2020, the weighted median operating margins for United States short term acute care or critical access hospitals stood at 2.8%. In 2020 and 2021, the operating margins improved to an all-time high of 6.5% yet, if we exclude COVID-19 relief from the margin, the weighted median during the period was -1.0%. Today, nearly 50% of all hospitals in the United States still have negative operating margins and the September 2022 report by Kaufman Hall for the American Hospital Association indicated that the most optimistic projection for hospital operating margins still falls 37% below pre-pandemic levels (~1.7%).

Given this ongoing challenge, there is an enormous opportunity for automation to play a key role in optimizing hospital administrative tasks to reduce costs and stabilize margins.

Stage 3.0. Price Transparency, Medical Billing Errors, and the Rise of Healthcare Payments Optimization

The evolution of healthcare payments has historically prioritized business-to-business architecture and solutions, improving healthcare provider and insurer payment workflows. However, more recently, the landscape has shifted to prioritize the needs of patients given the rise of consumer directed healthcare, and with good reason.

With rising inflation and an aging population requiring more healthcare services, healthcare costs have been on the rise. Today, the United States has one of the highest costs of healthcare globally, with healthcare spending reaching $4.3 trillion in 2021, approximately $12,900 per person. The trend of rising healthcare costs was further exacerbated by the COVID-19 pandemic, yet healthcare expenditures have been increasing for decades, growing from 5% of GDP in 1960 to 18% in 2021. Due to rising insurance premiums, copayments, and out-of-pocket expenses, consumers have turned to high deductible healthcare plans (HDHPs) as a way to minimize medical costs, with more than 55% of Americans in 2021 enrolled in HDHPs, an all time high (up from 30% in 2013). As noted previously, a High Deductible Health Plan (HDHP) includes lower monthly premiums yet incurs a higher out-of-pocket deductible before insurance companies begin covering medical expenses.

However, a rising number of individuals are forgoing healthcare altogether as a result of increased healthcare costs. According to a KFF analysis, 41% of adults in the United States currently have medical or dental debt, and owe in aggregate at least $195 billion in medical debt. Furthermore, approximately 25% of adults indicate that medical expenses have hindered their access to necessary care or obtaining prescribed medications. Among those with insurance, 44% express concern about meeting their deductible before their health coverage takes effect, highlighting the fact that individuals with health insurance are not exempt from the burden of healthcare expenses. These factors have motivated efforts to enhance patient experience by increasing accessibility to healthcare through flexible payment options, and also by improving price transparency to encourage competition across healthcare services.

Flexible Payment Options

There has been a growth in the number of companies that are providing customers with tax advantaged accounts and additional options to cover their healthcare expenses. Examples of such companies include:

• Thatch, founded in 2021, provides personalized healthcare programs to startup employees leveraging ICHRA’S and HSA’s
• TempoPay, founded in 2022, provides prepaid cards to help employees take care of out of pocket expenses, help employers provide better benefits, and help carriers serve more users
• Lively and Zenda offer HSA accounts to cover for out of pocket expenses
• HealthBridge, founded in 2017, pays an employee’s out of pocket expenses immediately and then creates monthly statements for the employee
• Payzen, founded in 2019, aims to make hospital bills affordable by offering personalized credit at the point of sale using AI to asses consumer risk
• Walnut, founded in 2021, uses AI to analyze a consumer’s spending patterns on their personal debit and credit cards, and offers BNPL options at the point of sale
• Nibble Health, founded in 2021, offers cards and zero-fee / zero-interest credit options to employees to pay healthcare bills
• Webster Financial (NYS: WBS) acquired Bend in 2022 to enhance Webster’s commitment to its HSA clients; Bend offers HSA accounts to its customers
• Priority Payment Systems (NAS: PRTH) acquired PayRight Health Solutions in 2018 to add flexible healthcare payment options to Priority’s providers

While it’s crucial to acknowledge the benefits of flexible payments and tax-advantaged accounts, it’s equally important to recognize that these measures alone do not address the fundamental problem of inflated healthcare prices. This is due to disparities in access to HSA’s, FSA’s and other tax advantaged accounts given eligibility limitations and the limitations imposed by funding caps.

Nonetheless, when combined with proactive initiatives undertaken by healthcare providers and systems to enhance the accuracy and efficiency of coding and billing processes, the integration of tax advantaged payment accounts, flexible payment options, and optimized healthcare payment solutions shows promise in narrowing the affordability gap in healthcare.

Price Transparency

Another frequent pain point for healthcare consumers is a lack of price transparency associated with services rendered. Historically, healthcare pricing has been opaque and provider networks can be challenging to navigate. Many consumers find it difficult to understand the overall cost of comprehensive care. For instance, while a patient might figure out the cost of an X-ray for a broken ankle, determining the full expense of care, including multiple doctor’s visits, medications, and physical therapy, proves challenging. Lack of transparency led to unexpected and unaffordable bills for consumers, contributing to the staggering $100 billion per year in healthcare debt in the United States, and making healthcare the leading cause of bankruptcy in the United States.

The good news is that price transparency has come a long way over the last decade through the enactment of relevant rulings and laws. In 2019 and 2020, respectively, the Department of Health and Human Services finalized two rules in response to Trump’s Executive Order, entitled “Improving Price and Quality Transparency in American Healthcare to Put Patients First,”: 1. CY 2020 Medicare Hospital Outpatient Prospective Payment System and Ambulatory Surgical Center Payment System, which mandated hospitals to disclose standard charges publicly, 2. Transparency in Coverage, which required group health plans and insurance issuers to provide estimates of expenses for covered items or services from specific providers upon request. Additional rules include, the Consolidated Appropriations Act, 2021 enacted on December 2020, prohibits certain ‘gag clauses’ in contracts with healthcare providers, and offering a provider cost and quality data through a consumer engagement tool. This rule also includes release of de-identified claims and encounter information. This rule further assigns fiduciary responsibility to the employer for developing a process for evaluating healthcare plans in the future. These rulings and their final approval set the groundwork for a patient-driven healthcare system by increasing price transparency for all hospitals in the United States and empowering patients to make informed decisions about the cost of hospital items and services they might need. The subsequent Health Care Price Transparency Act of 2021 rulings furthered this initiative. Hospitals are now required to publicly disclose their standard prices and negotiated discount cash prices for common health services in a machine-readable format with payer-specific negotiated rates, and de-identified minimum and maximum negotiated rates, including gross charges. The rule also mandates hospitals to offer patients an out-of-pocket cost estimator tool or payer-specific negotiated rates for at least 300 shoppable services. This measure provides more specifications related to how hospitals must disclose pricing information for the benefit of the end patient and aims to further foster a competitive environment within the healthcare industry.

However, a Q1 2023 study found that hospitals have been slow to comply with the requirements: only 24.5% of hospitals are adhering to the ruling, while only seven hospitals have received monetary penalties for noncompliance. For those who are compliant, a recent study by Peterson-KFF uncovered that there are still issues plaguing the disclosed data including:

1. Inconsistency in specifying prices for services
2. Varying levels of data quality, with negotiated rates occasionally showing questionably low or high values
3. Crucial pieces of information are often missing

Simultaneously, the data from compliant hospitals reveals significant discrepancies in charges for basic services and exposes instances where major health insurers negotiated unfavorable rates for their customers. As shown below, based on pricing data, Mississippi Medical Center negotiated higher prices for insured patients than those without coverage.

Source: The New York Times

Despite the issues plaguing healthcare price transparency today, price transparency around health services are showing promising signs of improvement. However, in order to reach the key objectives of reducing healthcare costs and supporting patients in managing their medical costs, software is needed to accurately compare prices across providers. Several companies are making large strides to accelerate price transparency in healthcare and support consumers as they make healthcare decisions, including:

• Turquoise Health, founded in 2020, aggregates publicly posted machine-readable files (MRF) pricing data from hospital and payers, and lets users browse and compare prices of elective services offered by hospitals
• Serif Health enables businesses to utilize recently published machine-readable pricing data from health plans, allowing companies to compare reimbursements, strategize pricing, and enhance contract outcomes
• Surest (Bind) offers a centralized platform for users to see their treatment options, compare medical costs, and add coverage

As healthcare costs continue to rise, innovative solutions that are bringing price transparency to the forefront for ease in comparing services and providers will continue to attract consumers, payers, and employers alike who will benefit from increased competition across health systems and providers.

Medical Billing Errors

Another interesting trend resulting from the Price Transparency Act is the increased visibility into medical billing errors. With hospitals now mandated to disclose pricing data for the various services they offer, consumers can compare their medical bills to this data to ensure accuracy. Several companies have emerged, such as GoodBill, Resolve Medical Bills, and Slingshot Bills, that help consumers review their medical bills for errors, ultimately saving patients thousands of dollars. Data from these companies suggests that nearly 13% of all billed costs are erroneous.

Simultaneously, an increase in medical billing error detection will result in added expenses for providers and health systems, given elongated reimbursement negotiations and denied claims. As of 2023, the United States sees over $4 trillion in health insurance claims filed annually, with 15% (equivalent to $600 billion) initially denied — a figure that is on the rise. We believe there is an opportunity for software to help hospitals streamline their processes, reduce the occurrence of medical billing errors, and reduce expenses linked to denied claims.

However, implementing automation into the provider healthcare payments process is not a simple task. Incumbent players, such as Cerner, Athenahealth, and EPIC, have extensive integration within provider systems, creating hurdles for new entrants to make significant inroads. Nonetheless, the industry is experiencing strong tailwinds due to the prevalence of price transparency and the rising administrative expenses of hospitals, creating incentives for providers to adopt changes. Additional notable companies in this space include: PayGround, which enables employees to view, manage and pay all their medical bills in a single platform, AESOP Technology, which developed prescription error detection technology to help catch expensive errors in medical bills, and Enter Health, a revenue cycle management platform leveraging AI for claims analysis and appeals.

Looking Ahead

Healthcare payments have undergone significant changes, driven by technological advancements, regulations, and consumer demands. Despite this progress, a number of challenges persist, and startups are emerging to tackle these issues. At Distributed Ventures, we are interested in companies that are tackling one or more of the following solutions: Provider Solutions (Reducing healthcare administrative costs, reducing errors in medical bills and claims) and consumer solutions (improving price transparency, finding and negotiating errors in medical bills, and providing flexible payment options to increase accessibility in healthcare)

We’re interested in speaking with others who are passionate about this topic. If you’re a builder or thought leader, we’d love to connect with you! Please feel free to reach out to our Healthcare Team (carolina@distributedvc.com and shawn@distributedvc.com).

We look forward to connecting!