Greater participation by consumers in saving and paying for their health care is shaking up the US health insurance industry, spawning not only once-in-a-generation opportunities but also increased competition from financial-services firms and benefits managers.

We estimate that annual pretax operating profits for health care-financial services products will grow to more than $10 billion by 2015; whether payers or financial institutions will grab the lion's share is anyone's guess. Changes in government regulations, technology, customer behavior in the face of increasing medical costs, and competition have blurred the boundaries between the health care and financial-services industries, creating a significant opportunity.

A major force behind this convergence is the recent US regulatory change that created tax-advantaged health savings accounts, which encourage consumers to take more responsibility for their own health care. The advent of HSAs has spurred the payers' cross-industry competitors into action. A range of financial-services companies—401(k) and individual-retirement-account (IRA) providers, banks, retail financial advisers, and life insurers—already provide savings, investment, credit, and payments products as well as financial advice. Now, greater consumer participation in paying for health care presents these companies with an opportunity, and many have introduced savings accounts and investment products to attract HSA assets.

But health insurers are not standing idly by: one major payer has even chartered a bank. Payers need to respond to the new environment decisively by developing capabilities (either in house or through partners), including ways to distribute products directly to consumers rather than conducting the majority of their business through employers, as they do now.

In the short term, payers may add these capabilities through partnerships with financial-services firms.¹ The joint ventures that have been formed appear to be tactical rather than strategic, motivated by a desire to get in the game as soon as possible. In the years to come, we think organic product development and mergers and acquisitions will increase, as consumers demand a seamless, integrated experience—something that companies with simple partnerships will find hard to deliver.

The potential impact

The opportunities that convergence presents fall into five major areas, three of which center on the consumer (Exhibit 1).

1. Savings-oriented health care products

HSAs, created by the Medicare Modernization and Improvement Act of 2003, are tax-advantaged products that encourage consumers to take more responsibility in saving and paying for their health care. The accounts allow consumers to own and control first-dollar expenses and to carry their savings from employer to employer. Although HSAs shift more decision making to the customer, the early response has been positive.

An analysis of similar tax-advantaged, defined-contribution accounts, such as 401(k) plans, suggests that there could be 25 million HSAs by 2013, generating $55 billion to $75 billion in revenues and $5 billion to $7 billion in annual pretax operating profits. A majority of the profits could accrue to payers that provide high-deductible health plans in tandem with these accounts, with the rest split among account benefits administrators, asset managers, and companies that issue debit cards for the accounts (Exhibit 2).

Currently, as many as 80 percent of consumers don't reach their health plans' deductibles in a given year, so insurers with distinctive risk-management and underwriting capabilities can win market share by identifying these lower-risk customers. HSAs also provide an opportunity for financial-services players, especially those with direct-payroll-deduction and benefits administration capabilities. In the short term, asset-management firms will likely express minimal interest in this opportunity, given how little money is currently in these accounts. Since banks already have payments-processing capabilities and experience with products such as savings accounts, they are positioned to be the first movers.

Hybrid retirement and health care products present interesting possibilities. As baby boomers approach retirement, the focus will move from accumulating wealth to generating income and protecting assets. Within this large and growing area, preretirees need solutions to manage the economic risks related to health care.² Assets accumulated in HSAs will fall well short, leaving retirement health care as a fertile ground for innovation.

2. Consumer health care payments and financing

Some $1 billion or more in pretax operating profits could be generated by handling more efficiently the $375 billion consumers pay in annual out-of-pocket expenses and by helping providers recover a greater portion of the $60 billion in consumer bad debt related to health care. The traditional capabilities of financial-services companies should position them to succeed in this market. Payers could profit by bundling their core health care products and service capabilities (provider networks and claims processing, for instance) with health care payments. We see at least two major opportunities.

Debit cards. By 2009, there could be more than 14 million debit cards specifically for HSAs and flexible-spending accounts—representing $18 billion in health care spending—for a profit opportunity of about $250 million.³ The total addressable market for these types of debit cards could be 88 million, suggesting considerable growth potential. Insurers and financial-services companies that offer HSAs would benefit from marketing debit cards: although these cards don't intrinsically generate profits, their convenience typically increases enrollment in flexible-spending programs by 25 percent and contributions to the accounts by 25 to 30 percent. Consumers can avoid paper claims and delays in reimbursement, and payers and banks could see processing costs drop by as much as 30 percent. Debit cards allow customers to make payments at the point of sale, so providers would benefit from lower accounts receivables, billing, and collection costs.

Credit cards. Consumers use credit cards for just 18 percent of total spending in the health care industry. If this level were increased to the 38 percent average for the rest of the US economy, it would create $500 million to $700 million of net operating profits. Payers are well positioned to capture this opportunity: they could introduce branded credit cards that combine pricing discounts for provider networks, improved information, and point-of-sale credit for large health care purchases. To take advantage of this opportunity, payers should consider partners in card issuance (that is, joining with existing issuers rather than chartering a bank), payment networks, and transaction processing.

3. Supplemental risk products

As the burden of health care and retirement shifts to the consumer, the market for supplemental products (such as insurance for long-term care, critical illness, accidents, and disabilities) will continue to grow. These products are likely to generate net operating profits of $3 billion to $5 billion over the next decade. Life and specialty insurers that focus on individual customers and have strong marketing and sales capabilities can capitalize on these trends. As employers transfer a proportion of the health care risks and costs to the consumer, the premiums that payers earn from traditional products will decline. If payers don't expand their supplemental-insurance products and consumer-oriented distribution capabilities, they stand to lose out to life and specialty insurers.

4. Benefits administration

Opportunities stemming from convergence exist beyond consumer-centered areas as well.Employers continue to outsource the administration of benefits, creating a market with annual revenues of $50 billion and growth of 15 percent. Companies that currently provide outsourcing sevices for benefits administration have emerged from different starting points—for example, pure plays (Exult), business-process-outsourcing and offshoring companies (Accenture), benefits consultants (Hewitt Associates), and corporate-services firms (Fidelity Investments). The different models are converging, however. Niche specialists are excelling in human-resources processes such as payroll, while full-outsourcing providers are offering integrated benefits, consulting, and administrative products.

Many companies are pursuing the latter, investing in technology to become large-scale players. The endgame will probably see benefits administrators forming long-term relationships—and integrating information systems—with employers, giving best-of-breed suppliers, such as provider networks and claims and transaction processors, a chance to participate. Some large financial-services players are building substantial businesses in human-resources outsourcing and, given the breadth of their capabilities, are likely to succeed as benefits administrators. This development threatens payers, which could see the competition chip away at their bundled offerings of insurance, medical management, transactions processing, access to provider networks, and discounts.

Payers could respond by expanding their relationships with employers, either choosing to provide benefits-administration-outsourcing services themselves or, more likely, in partnership with companies such as data processors.

5. Payment assurance and transaction processing

Relations between payers and providers have long been characterized by high administrative costs and delays in payments. This situation will grow increasingly acrimonious as a provider's primary source of bad debt shifts from the uninsured to "balance-after" insurance—the sum of co-payments, deductibles, and coinsurance that remains after the payer's portion of the obligation is met. The movement toward consumer-directed health care will further increase the amount of bad debt. Payers that can simplify the pricing of their provider contracts, determine a consumer's payment at the point of sale, and understand the provider's key economic levers for collections and billing will capture the economic surplus.

In addition, the implementation of existing automation technology could streamline eligibility, claims, and payments processes and save as much as $3 billion to $4 billion in operating costs. Payers could play a leading role because of their central position in and understanding of the payments process. One benefit for them would be a closer relationship with satisfied providers. The improvements in technology will be costly, however, requiring many physicians to move from a paper-based to an electronic system.

How companies can win

Despite the uncertainty surrounding this nascent market, payers and financial-services companies must address two basic issues before convergence gets too far along: the role these companies should play in the value chain and the type and size of their investment. If players make too small a commitment in this phase, they risk becoming irrelevant later (Exhibit 3). Overinvestment can be another result, typically, from being too far ahead of demand. As companies place their bets, they will have to make important decisions (see sidebar, "The organizational challenge").

Choosing a role in the value chain

As we have noted, the health care-financial-services value chain has many participants—insurers, banks, asset managers, credit providers, health care transaction and payments processors, medical-services providers, information and advice providers, and distributors such as brokers, financial advisers, and insurance agents. To thrive in the new business environment, they will have to choose one of three roles: full-service provider, assembler, or niche-product supplier.

Full-service providers will use their in-house capabilities largely to develop proprietary products, such as UnitedHealthcare's HSA offering through the bank the company chartered, Exante. This approach resembles the integrated model that most health care insurers use today, in which an individual payer supplies all the components—the insurance, the provider network, the claims transaction processing, and medical-management services. To succeed with this model, companies must achieve parity with more specialized players in most parts of the value chain—and distinctiveness in some parts. UnitedHealthcare is arguably the only current example, but we believe that many others will pursue this course in the next two to three years.

Assemblers will select and distribute best-of-breed products as some investment advisers do with financial products. Merrill Lynch, for instance, offers a broad suite of products but does not develop many of them. For this approach to be successful, companies must choose and seamlessly integrate the various health and financial products. They must own the consumer relationship and compete directly with full-service providers that, by contrast, will try to do almost everything in house.

An assembler could, for example, offer the consumer an HSA transaction account from a bank; the investment products that make up the HSA from, say, Fidelity or Vanguard; the high-deductible health care plan from an insurer; a long-term-care product from a financial-services company like Genworth Financial; and a critical-illness product from a life insurer. We think many players may try this approach, but none is doing so yet.

Niche-product suppliers would rely on specialized skills such as developing pricing models, underwriting, risk management, product design, and understanding and navigating government regulations. To pursue this approach, companies must believe that a focus on such areas will help them to achieve a significant, inimitable advantage. A current example is the partnership between Assurant Health, which creates specialized health insurance products, and State Farm, which sells them directly to consumers.

Investing in capabilities

Depending on the capabilities needed to compete in each part of the value chain, companies must decide where they should concentrate their investments. We believe three capabilities will be critical.

An advice-based consumer distribution channel. Offering good advice to consumers is critical, given the complexity of many health care and financial products. As customers leave the current employer-oriented system and take more responsibility for their health care choices, the challenge of providing them with quality information will become more acute. The ability of full-service providers and assemblers to offer this kind of advice will be vital, since both models involve dealing directly with consumers.

In much of the financial-services industry, it is the distribution channel rather than the product owner that captures much of the profits. This pattern is also likely to appear in the health care arena, since insurers and financial-services firms have direct contact with the consumer. Therefore, their ability to offer reliable counsel to consumers is important. No current participant has a distinctive capability in distributing these products, although many have skills to build on.

As the consumer becomes the dominant decision maker, payers must build on their relationships with employers and their knowledge of health care to train agents who deliver advice and sell products at the consumer's workplace. Financial-services firms have varying levels of experience in this area but struggle to help customers manage their income and expenses for retirement.

Health care-related skills for developing and underwriting financial products. Financial-services firms have a limited understanding of the underlying economics, operational requirements, and regulations related to health care products. Meanwhile, payers have little knowledge about financial-services products. To meet the consumer's needs, companies will need a full suite of product-development capabilities, though they need not manufacture all the products themselves. These capabilities would be applicable regardless of the business model a company chooses.

Sources of competitive differentiation include individual-health-risk underwriting skills and sharp consumer insights. The majority of health plans are underwritten for groups, leaving many payers with little experience developing products for individuals. On the other hand, financial-services companies such as life insurers have plenty of underwriting skills for individual customers but limited data and experience in health care.

Efficient transaction platforms. Today health care claims-processing platforms are separate from banking and payments systems, but this can't remain the case for long. Consumers will demand affordable and convenient payment and transaction options that integrate, for instance, health savings accounts and hybrid health-retirement plans. The cost of processing health care payments can often be 15 to 20 percent of the transaction value, compared with 1 to 2 percent for retail payments. Integrating claims and payments systems will be complicated, but players that can pull off this trick will build substantial operating-cost advantages. This capability would be most useful to a full-service provider or a niche-product supplier that could provide the transaction platform or back-office outsourcing.

The convergence of health care and financial services is real and will drastically restructure the value chain of the health insurance industry. Participants are testing the waters through cross-industry partnerships, and leading companies are investing to build their capabilities. The next stage of evolution, fueled by acquisitions and rapid organic growth, will bring upheaval in the market and in the industry's structure. Some players will exit, and new competitors will emerge with powerful business models. Eventually, traditional payers and financial-services firms will combine capabilities and assets to deliver integrated products, with powerful benefits for consumers.

For players in both the health care and the financial-services industries, inaction is not an option. An array of profitable opportunities awaits those willing to pursue them. To succeed, executives must decide what role their companies should play in the value chain, what types of investments to make, and how to organize their health care-financial services initiatives.