Discerning luck from skill can be hard. Baseball has 162 games per season. Boring for some but more than enough games for randomness to average out. How telling is one game? How telling is one case study? It could be random or just cherry picked. It’s the consistent rate attributable to skill that we’re after, whether in money management, baseball managers, healthcare, or other domains. It’s the alpha.
Investopedia describes alpha as “a term used in investing to describe a strategy’s ability to beat the market, or it’s ‘edge.’ ” It’s the return in excess of the market’s benchmark, the S&P 500 for example. It gets deeper (the for example, the Sharpe ratio, and other risk adjusted varieties) but let’s start there. If you consistently beat the market in investing, even by 1 or 2% per year, you can get a Patek Philippe watch and a 7-figure salary.
A great paper called Buffett’s Alpha by three AQR researchers digs deep into Warren Buffett’s record as an investor and capital allocator. Has Buffett been lucky? Is he just a folksy coin flipper? Not even close. The paper concludes: “Our findings suggest that Buffett’s success is neither luck nor magic….but, rather, reward for leveraging cheap, safe, quality stocks….a successful implementation of value and quality exposures that have historically produced high returns.”
In healthcare, or more specifically, employer-provider healthcare, the market, or benchmark, is both what market trend is and what the total costs are. Healthcare Alpha is the happy place of below-market trend and costs. Its consistency is the result of careful contracting, an eye, head, and heart for avoiding waste, aligned interests, healthier and happier employees.
There are obvious adjustments to healthcare alpha. A firm with older employees will spend more. There are variations in regions, industry, size, plan design, demographics, and more. These adjustments, along with data from over one thousand companies, allows for some meaningful comparisons and scorecards. It’s sophisticated enough to be called a proprietary algorithm but not so cool (in version 1.0) to be machine learning worthy.
Below is an example of 10 fictitious firms and the expected premiums (given the real factors mentioned in the the proprietary algorithm) compared to the actual ones. Any gap is either under (costs are higher than expected is bad, all else equal) or outperformance–lower spend, or alpha. Tracking this across a random group, or a book-of-business, helps to decide if we’re working with an average coin, if it’s weighted, whether there is an edge. A consistent outperformance would suggest that. That would be something to brag about, a powerful marketing piece if you have it, and something to consider for compensation contracts. Brokers and consultants take note. Shared savings from alpha generation could increase your income dramatically, and benefit employers and employees. Strangely, most arrangements in healthcare reward you the more you sell, the more you underperform.
If you work in healthcare in the US, what’s your healthcare alpha? Send me a note, and we’ll discuss it.
Disclosures: the author’s personal healthcare coverage is a $5,000 deductible cost-sharing plan (non-ACA); Olavi Group has no consulting or investing relationships to report for any of the firms mentioned.
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