Breaking news: Creating a healthcare futures market

The answer to the question, “Who is getting funded in 2017?” may well be a disease state rather than a category of company.

A new market structure—a healthcare futures market—is being developed as an alternative to, and enhancement of, existing funding mechanisms. It is being created by Dennis Purcell, founder and senior advisor of Aisling Capital LLC, and co-founder of Poliwogg, a financial services firm dedicated to creating the capital market tools for the healthcare sector similar to those that have long been available for the agriculture, finance, industrial and energy sectors. These tools, including a futures market, will enable the hedging, speculating and risk-transference activities that are essential to both efficient market functioning and encouragement of new investment.

Dennis Purcell, Aisling Capital and Poliwogg

If other sectors are any indication, these tools also may provide a way to stabilize and contain healthcare costs. If healthcare payers and providers can reduce operating uncertainty through hedging/risk transfer and thereby lessen their financial risks, they may be able to develop future budgets more accurately, with less need for cushioning to absorb unpredictable spikes in costs. Investors will gain a vertical investment device that enables them to focus tightly on a segment of the industry, such as diabetes care. Drug and device developers will gain a hedge against patent expiration and obsolescence, locking in future sales. Lastly, sources of venture and development capital will be able to offset at least some of the risk of failure in new companies.

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.

It is important to note that futures markets are organized by specific product. There is no agriculture contract but rather individual contracts for wheat, corn, soybeans and other crops. The same is true in energy. Yet healthcare, which comprises 18 percent of the US gross domestic product (GDP), is still organized horizontally. “Today, if investors are interested in healthcare and diseases, they must invest in companies that are developing therapeutics in certain areas. Eli Lilly, for instance, is a major player in diabetes, but its pipeline also includes therapeutics for rheumatoid arthritis, various cancers, Alzheimer’s disease and other conditions” Purcell says. Because healthcare is a horizontal rather than vertical market, “there’s no way to invest in a disease state in a pure manner.”

Futures markets stabilize costs

Creating a futures market for healthcare creates a vertical market that mirrors healthcare consumption from diagnosis to therapeutic, compliance and reimbursement. This helps stakeholders better manage their costs. “Natural participants include payers, providers, drug developers and investors that are looking for consistency,” Purcell says.

For example, he elaborates, payers, including self-insured corporations and governments, could use a diabetes futures market “to cushion against future pricing shocks and thereby employ a more uniform and consistent standard of care.” Providers such as hospitals and dialysis centers could use a diabetes futures market to better forecast and manage their revenues, which would help ensure consistent operating margins, while drug and medical device developers could use it as a bulwark against patent expirations. Both groups could use futures to help manage product obsolescence. “Investors and asset managers could explore the diabetes futures market to gain exposure to a new asset class that has limited correlation with existing financial products,” Purcell adds.

This system was highly effective in bringing stability to oil markets in recent decades. As Purcell elaborates, “The price of oil soared from USD 15 per barrel in 1998 to USD 150 per barrel in 2012 (a 1,000 percent increase), yet the price at the pump only increased from USD 1.06 to USD 3.34 (a 315 percent increase).” The oil industry was able to contain costs by borrowing against future demand, secure in the knowledge that its future products already were sold. Therefore, companies could invest in exploration and production, and new companies had improved access to venture and other capital.

Diabetes futures first to launch 

Poliwogg plans to launch the healthcare futures market by starting with Type 2 diabetes—a more than USD 400 billion annual market in the US alone. To place this in context, the United States spent USD 315 billion in crude oil consumption in 2015. This one disease, diabetes, cost the United States more than crude oil.

“Last year, UnitedHealth Group paid USD 100 billion in healthcare claims. Diabetes represents 10 percent of that,” Purcell says, and costs will continue to rise. “There are 80 million pre-diabetics in the US, so the cost of diabetes will continue to go through the roof,” he predicts.

Those expenses can be balanced by new drugs and delivery mechanisms that improve both outcomes and patient adherence. “Because most of the complications are from non-compliance, longer-acting medications and other strategies that improve compliance will dramatically reduce complications.”

Poliwogg has aggregated the paid claims from 1.5 million diabetics and captured the costs of treating one patient for one year, including such co-morbidities as hypertension and obesity. The analysis is based on five years of data from Blue Health Intelligence (the data analytics arm of the Blue Cross/Blue Shield Association).

“The first application of our indexes is to set a benchmark against which participants in the healthcare industry (so-called natural participants) create contracts through which they can engage in risk mitigation and exposure hedging. This is done every day to great effect in other industries," Purcell says.

“To start and sustain a diabetes futures market,” Purcell says, “we need to get the natural participants on board and to create swaps.” For example, he explains, a large financial institution may issue an insurer a note for USD 100 million with the interest rate tied to the cost of diabetes. The insurer collects the interest on the note. Ordinarily, this would incentivize inflated costs. However, the insurer has an incentive to keep costs low because it typically pays 80 percent of the costs of claims it receives. “It is paying what the market will bear. Consequently, it can’t game the system,” Purcell says. As with existing futures markets, investors can determine whether to invest at the current price, short the market by forming a contract to buy if the rate drops, or agree to a higher price it will pay in the future.

Purcell says Poliwogg will launch the diabetes index first in early 2017, and is developing plans to develop similar indexes and markets for other major diseases and conditions, such as Alzheimer’s disease and asthma. These additional products will be released throughout 2017 and subsequent years.

A healthcare futures market is a logical addition to current healthcare financing options, creating a new environment in which to create value for stakeholders throughout the healthcare financing system. Exactly how this will work and how young biotech companies can benefit has yet to be determined, but its introduction promises to radically affect financing in 2017.

Learn more about the healthcare financing environment for 2017 in the panel discussion, “Venture funding: Who is getting funding and who is not?” with Dennis Purcell at Biotech Showcase™, January 9–11 in San Francisco.