The Tolkien-like Maze of Healthcare Payments (Part 1)

Hey everyone! Happy March!!!!! It was a very delightful 71 degrees here in Ohio yesterday. AND IT WAS AMAZING. I’m a firm believer in the “March comes in like a lamb and goes out like a lion” saying so I’m expecting to see a nice late March snowstorm on my next trip home. I mean, it’s already back down to 50 degrees so I feel like coming already.

This week we’re touching on a topic very near and dear to my heart that is filled with regulatory pitfalls in every direction. It’s also gonna be a multi-part doozy so settle in with a drink of whatever your lil’ heart desires and let’s learn how our healthcare is actually paid for in the United States.

One of the biggest areas of investment for me (not only as an angel investor but now at Vol. 1 Ventures) is healthcare. I spent my early years in the most economically depressed area of West Virginia, which just so happened to also be in the middle of a pretty big cancer bubble. Growing up, many of my peers passed away from Leukemia and I heard more stories than you would believe about people dying of the most innocuous health issues. I have seen firsthand the economic and racial disparities in healthcare that most people can’t even imagine us having in the United States and honestly, it’s a cold slap in the face.

Fast forward to today when I do a ton of healthcare consulting for startups, Fortune 500 companies, and massive conglomerates. I love seeing cool technology and using my undergraduate degree in genetics (it’s because dairy farmers use a ton of genetics); it’s nice to actually see firsthand how things have changed since the early 2000’s. I am beyond excited by the possibilities in front of us. Now I get to see all the possibilities for care. With all the amazing innovations in healthcare, nobody should ever have to suffer inequity in care again. Unfortunately, there is a big problem with this aspiration. Who will pay for it? How does one get paid for these amazing innovations? Without getting paid these innovations will never get into the hands of doctors or physicians. Lack of payment causes a chilling effect on healthcare innovation. It also means patients continue to die for ridiculous reasons. End mini-rant lol.

Now we’re going to do a deep dive into how you actually get paid in healthcare. As many of you know I founded a prenatal diagnostics startup in the midst of COVID. The biggest struggle we faced when fundraising was investors asking “How will you get paid for this?” This question annoyed the shit outta me for a few reasons. 1) Because investors would then attempt to tell me how this should happen in a VERY INCORRECT WAY. I now know this is because a lot of healthcare investors listen to what other founders say they need to do for payment and honestly…they’re not correct either. 2) Because this was the area of our company I was most educated and secure in and I didn’t understand why people just didn’t know how reimbursement worked. Well, this is a classic case of me assuming everyone knew what I knew. After many years at Johns Hopkins University and the American College of Obstetricians & Gynecologists (ACOG) I had been deep inside the reimbursement system where most don’t dare to go. If you are an investor in healthcare or biotech in any form you should know this framework and the regulatory structure that is behind it.

It seems like it should be so easy. You have a great idea that could save so many lives. Maybe you even came up with the idea due to a medical condition you have or someone you loved faced and now you are ready to see it in the hands of doctors. How the heck does that happen? It seems like you make something and then doctors or patients pay…voila! Hahaha yeah no. First off, rule number one in healthcare is: IN THE UNITED STATES PEOPLE DON’T PAY FOR THEIR OWN HEALTHCARE. It is preposterously hard to get someone to pay for their medical care. Self-payment only happens for the richest of the rich. Those folks already have amazing healthcare so the chances this even applies to them is limited as well. (And yes, there are some uninsured folks still in this country but due to poverty the chances of them falling into the self-pay category is close to nil.)

First, I did the very gen-z “thing” and asked ChatGPT how reimbursement works. Here’s what we got:

Y’all. Nope. It’s not that simple at all. However, based on the questions I have heard from other investors, founders, and even physicians that is definitely as about much as most healthcare “experts” know.

The first step in this winding journey we will take together is FDA clearance. Almost every healthcare product will require some kind of clearance by the FDA. There are very few exceptions to this. Even software used in care probably needs to be looked at by the FDA. For a very long time, the FDA has stayed out of diagnostic tests as they could be governed by things like CLIA. [Sidebar: To become a CLIA (Clinical Laboratory Improvement Amendments) lab, a laboratory must meet certain federal requirements for personnel qualifications, quality control, proficiency testing, patient test management, and quality assurance. The lab must apply for certification through the Centers for Medicare and Medicaid Services (CMS) and undergo an inspection to ensure compliance with CLIA regulations. Once certified, the lab must continue to meet CLIA requirements to maintain its certification.] We now expect that this year the FDA will even change that regulatory structure and now require even these tests and labs to have clearance. So another exception will bite the dust before our eyes. But, back to the basics…what does FDA clearance mean.

In the United States, medical products and services are regulated by the Food and Drug Administration (FDA). The process for obtaining FDA clearance or approval can be incredibly lengthy and complex. No medical product gets to market within a year of creation. None. Sorry, everyone. If you’re investing in this space the regulatory requirements for the FDA are rigorous and time-consuming. They will add years, not months, on the go-to-market of any product in this space.

The type of clearance or approval required depends on the type of product and its intended use. (Thankfully, the FDA does have a great deal of published materials on different clearances available. If you’re feeling a lil’ ambitious get on fda.gov and take a look.)

For medical devices, the FDA has a classification system that determines the level of regulation required. Class I devices are considered low-risk and are subject to general controls, such as good manufacturing practices. Class II and III devices are subject to more stringent controls, such as premarket notification or premarket approval, respectively.

For drugs and biologics, the FDA requires very lengthy clinical trials to demonstrate safety and efficacy before approval. This approval process can take several years and involves multiple phases of clinical trials. Clinical trials are conducted in three phases. Phase 1 is the first step in testing a new drug or treatment in humans. The goal of phase 1 is to determine the safety of the treatment and to identify any potential side effects. Phase 2 involves testing the effectiveness of the treatment for a particular condition or disease. Phase 3 involves testing the treatment in a larger population to determine its safety and efficacy in a broader context. Once a drug or biologic is approved after the successful completion of these phases, it can be marketed and sold in the United States.

It is important to note that FDA clearance or approval is not the same as reimbursement. Even if a product is cleared or approved by the FDA, it may still not be covered by insurance or reimbursed by payors. Reimbursement is still determined by a separate process…but if you haven’t talked to the FDA there is a strong chance you’re DOA anyway so always start with the FDA.

Over the next few weeks, we’ll be publishing parts 2 and 3 of our series on healthcare payments—the next part is on the very misunderstood and obtuse part of practice guidelines & medical societies in this journey. Have thoughts on part 1? Feel free to email me or reply to this email!