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Why it’s time for a futures market in health care.

By Greg Simon and Jeff Feldman, co-founders of IMX

FINANCIAL FUTURES were created in the 1970s at a time of very high interest rates and inflation. Those economic ills were cured by the mid-1980s. Oil futures were created in the early 1980s at a time of shortages and rising prices. The oil market stabilized a few years later. Stabilization of prices and supply happened because industry participants could transfer risk and achieve predictable pricing while speculators could find trading opportunities. Today, it is health care costs that are out of control and that have risen to unsustainable levels. Insurance premiums and co-pays are at record highs, and some insurance companies are refusing to pay for some of the most expensive treatments. Capital market tools can do for health care what they did for interest rates and energyprovide stability and reduce pricesall of which is in the interest of patients. But so far, those tools don’t exist for health care.

Creating a Health Care Marketplace

A futures or forward contract is a legal agreement to buy or sell a commodity or financial instrument at a predetermined price at a specific future time. It is a classic two-way market between willing buyers and sellers. Conversely, health care is a one-sided marketplace. Patients receive a service and pay the bill without knowing the price beforehand and without any way to use financial tools (think about home mortgages and car loans) to spread the costs over timewhich is one reason why medical bills are the biggest cause of personal bankruptcies.

 

This one-sided marketplace affects companies as well. A review of large and medium-size self-insured companies reveals comprehensive hedging strategies to deal with interest rate, energy, and currency risk (even the weather!), yet their health care risk is not hedged at all. Insurance companies, in particular, know little about the health issues for the next year’s insured population, so they are subject to price shocks for sicker patients.

 

One of the primary reasons a financial market has not developed for health care is the inability to represent the component costs in an accurate way. In the case of energy, for example, there are financial instruments that represent the cost of various grades of oil, gasoline, natural gas, and coal. Similarly, there are tradable contracts for many agricultural commodities (wheat, corn, soybeans, etc.). To create a financial market for health care, likewise, we must be able to represent the costs of specific drugs, procedures, and so on.

 

Until recently, this has not been possible for lack of data. With the advent of electronic health records (EHRs) we can now receive a current anonymized data feed of paid claims on behalf of patients and know the cost of treating particular conditions in various places and populations. We can define the “unit” as the cost of treating one patient for one disease for one yearor as the cost of a knee replacement or an open-heart surgery. An insurance company could then transfer the risk of any specific cost increases to the financial markets.

 

To put the problem in perspective, the United States spends roughly $350 billion a year on oil. The structured financial products to hedge or speculate on the price of oil, based on that expenditure, totals hundreds of billions of dollars. We spend a similar amount annually just on diabetes care, but there are no financial products to provide predictable and stable prices for vital components of diabetes treatment, such as insulin.

 

The U.S. health care system is at long last edging closer to value-based pricingin which fees are determined by patient outcomes rather than on each service performed. But here, drugmakers will assume new risk, for example, if their drugs don’t work in certain patients. For this approach to scale, pharma companies will need a way to hedge or “lay off” this risk to speculators. Otherwise, they’ll do what they’ve always done: raise prices. It’s now possible using health data to create indexes that represent the cost of treating specific diseases, taking specific medications, and the cost of many medical procedures. Based upon these indexes, we can create financial tools (futures, forwards, options) that can allow for price discovery and risk transference.

Turning Health Care Costs Into Assets

This allows us to turn health care costs into assets, as was done for oil or for carbon credits on the Chicago Climate Exchange. A hospital would be able to sell surgical procedures (knee replacement, for example) in bulk to insurance companies in a competitive marketplace that can provide for true price discoveryand allow for more efficient pricing. Further, if an instrument that represents a procedure, treatment, or drug is available on an exchange, even a prospective patient can purchase it. A health care futures market will lead to stable and lower prices for consumers and more predictability for drug companies, providers, and payers as they learn to do what farmers have done for decadeshedge the future.

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