The Sentinel Breakthroughs in Health & Technology | Trends in Finance | March 12, 2017
March 12, 2017
March 23, 2017

The Case for a Healthcare Futures Market


As politicians and the public wrestle with redesigning the nation’s healthcare system, all parties are faced with the twin realities of an aging population and rising health costs.

The cost of healthcare in the United States, which has risen inexorably for the last 50 years, is now larger than the Gross Domestic Product of every country in the world except China and Japan.  According to the Congressional Budget Office, in less than a decade from now, Medicare, Medicaid, Social Security and interest on the debt will represent $5.7 trillion out of a $6.3 trillion budget.

At the same time, the pharmaceutical and biotech industries are developing effective but extremely expensive drugs to treat those conditions.  Other factors such as non-adherence to drug regimens, spending on unnecessary treatments and procedures, and the advent of new, very expensive disease curing drugs (for example, hepatitis C) are causing massive financial uncertainty in the insurance industry.

Uncertainty creates opportunity for new financial products. A futures market for healthcare?

In other sectors of the economy, including agriculture, energy and interest rates, there exists a robust futures trading market where industry participants can transfer risk and achieve predictable pricing while at the same time speculators can find opportunity in the trade. Risk transference and mitigation are essential to financial and operating cost management. These critically important financial tools, however, have been non-existent in the healthcare sector.

But this could soon change if Dennis Purcell and his colleagues at Poliwogg succeed. They believe that new financial instruments — such as a healthcare futures market — can help bring stability to this market.  But can diabetes be commoditized and traded like Texas west crude oil or pork bellies?  To call this effort bold and imaginative would be an understatement.

Purcell is no wild-eyed dreamer. After having played a key role in building the legendary investment bank Hambrecht & Quist, (sold to Chase Manhattan bank in 1999 for $1.35 billion) he founded Aisling Capital and built it into a preeminent private equity and venture fund with over $2 billion under management.

More recently he was the co-founder of Poliwogg, a financial services innovator formed after passage of the JOBS Act to create new capital tools for the healthcare sector.  According to Purcell, “As we looked around and thought about what are big problems and what might be innovative solutions, healthcare finance struck me as someplace that was in need of innovation. It’s 10 times bigger than these other markets. Why not a futures market?”

Their theory is that the healthcare sector would use the same tools as the agriculture, finance, industrial and energy sectors to enable the hedging, speculating and risk-transference activities that are essential to both efficient market functioning and encouragement of new investment.

Bending the cost curve in healthcare

The focus in healthcare is given to pricing and operational efficiency.   Much commendable work is being done on how to attack the issue of pricing.  Companies like Real Endpoints are comparing the relative value of drugs in the treatment of a particular disease. As the Affordable Care Act is being repealed will continue to debate the relative value of drugs within the healthcare system.

Operational efficiency is also maturing.  At HIMSS (Healthcare Information and Management Systems Society), 40,000 attendees browsed 2,000 exhibitions that are trying to improve operational efficiency.  Improved electronic medical records, more interconnected operating systems and ways to enhance customer engagement were all on display.  Many were truly impressive.

In order to ‘bend the cost curve’, Purcell believes that financial management must be the underpinning going forward. He thinks that now is the time to develop financial instruments which will provide risk transfer, transparency and more certainty. Because of the advent of electronic medical records and big data, we can now collect detailed information by disease category. A futures market in healthcare is a product whose time has come.

Developing a pure play

“We’re trying to change the risk of healthcare costs to the financial markets,” Purcell says. The agriculture industry, which has a long history of mostly stable pricing, has had a futures market since the 1830s. The energy industry saw difficult price spikes in the 1970s. In 1983, a futures market was created for oil and then for other energy commodities. While there have been a few price spikes since then, oil and gas prices have mostly been steady and affordable for the past 30 years.

Healthcare faces a crisis today similar to that in oil in the 1980s, prices continue to spiral upward, the aging population represents a surge in demand and there are no capital market mechanisms in place to mitigate risk.

What is a futures market?

A futures or forward contract is a legal agreement to buy or sell a particular commodity or financial instrument at a predetermined price at a specific time in the future.  There would be contracts that are based on the cost of treating a disease (i.e diabetes) just like energy (oil, gas) or agriculture (wheat, corn).  The futures market has been important in other industries because companies can buy or sell futures to ensure certainty in the future.  Jet Blue has the opportunity to lock-in its cost of fuel.  Ford Motor Company, on the other hand, is pricing its new automobiles now and knows their cost of goods sold except the healthcare component which is estimated at $2,000 per car. 

A review of large and medium sized companies, who are typically self- insuring themselves, show very comprehensive hedging strategies to deal with interest rate and currency risk.  Yet, their healthcare risk is, by and large, not hedged at all. 

Even individuals who are facing higher deductibles and higher premiums don’t have an effective way to manage the financial costs of their healthcare.  In fact, 62% of all personal bankruptcies are due to medical expenses.  The ability to mitigate this problem through new and better financial tools could provide real benefit to both consumers and producers of healthcare services.

Big data makes creating a “spot price” now possible

In order for a futures market to exist, there must be a spot price (the current cost of the commodity). The units of product are self-evident in other markets (i.e a barrel of oil or a bushel of wheat) but creating a meaningful unit (“spot price”) for healthcare has heretofore been more challenging. Technology has recently provided an answer.  Near universal adoption of Electronic Medical Records enables both the ability to sort vast amounts of data into meaningful subdivisions, and to do it in a timely and reasonably frequent basis.  In healthcare the “unit” as Poliwogg has defined it will be the cost of treating one patient for one disease for one year. This is the spot price from which futures contracts may be priced, as it is both consistent and scale-able an industry participant can now hedge its risk, whether long or short,  in the financial markets and do it at whatever level suits its particular situation.

Indexes are the key

Indexes will underlie the financial management piece of the puzzle. The Poliwogg Therapeutic Indexes will be a series of indexes designed to measure the direct and indirect costs of major chronic diseases in the US.  They are suitable as the basis for a variety of financial instruments such as futures, swaps, options or structured notes.  The source data for the Indexes is paid claims data derived from the largest database of claims currently available.  The Indexes will enable investors the first real opportunity to express an investment opinion on the course of a particular disease and its state of treatment.

Diabetes Type 2 to lead the way

The first Index is the Poliwogg Diabetes Index which includes all the costs (direct and co-morbidities) of treating a Type 2 diabetic for one year.  Simply put, the seller of the diabetes future (most likely a natural participant) will lock in the price of treating diabetes and the buyer of the diabetes future (most likely a financial institution) will see that fixed amount back to the buyer.  The risk and return of diabetes costs (as measured by a well-constructed index) either being higher or lower than the index will be borne by the buyer of the index.  Going forward, as the futures concept matures, Poliwogg will be able to provide sub-indexes with more precise measurement and management.

An ambitious undertaking

The cost of treating diabetes in the US is already higher than the cost of oil that we use.  At over $300 billion annually, every transaction that goes into treating a diabetic is economic in nature.  The list of participants in the market is very long, and includes: insurance companies; self-insured corporations; pension funds; hospital systems; physicians groups; device manufacturers; medical service providers; drug and biotech companies; and financial institutions.  Each one is striving for stability in the market so they can adequately plan for their business going forward.

Clearly the US healthcare system is in need of innovation and change.  A healthcare futures market is a bold innovation capable of significant impact and we will be interested to see how it develops. Stay tuned.    


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