Direct Contracting Moves Down-Market as TPAs Replace Carrier-Owned Administration

The pressure on self-insured employers is no longer theoretical. Premium increases have compounded year after year, claims denials and prior-authorization friction have intensified, and the executives running the largest health plans have absorbed enough public scrutiny that the structural concerns about vertical integration are now mainstream. Employers, employees, and the providers actually delivering care are looking at the same equation and arriving at the conclusion that the current cost trajectory cannot continue. That convergence is what's moving direct contracting from a strategy reserved for the very largest employers into a model that mid-sized self-insured plans are starting to evaluate in earnest.

Gary Herschman is Co-Chair of the Health Care Transactions Group at Baker Donelson and a former Trial Attorney at the U.S. Department of Justice. He represents physician groups, health systems, and other providers nationwide on major transactions, mergers and acquisitions, joint ventures, and regulatory matters. His work, which often puts him squarely in the middle of these deals, gives him a direct view of how the cost pressure inside the carrier-controlled model is reshaping what self-insured employers are willing to consider.

"Managed care in itself is a good idea. The problem is how extreme it's become, and a lot of people are fed up with it,and with middlemen skimming real dollars off the top," he says. That friction, he asserts, is a big reason some employers and providers are now open to direct contracts. Employers can pull back a chunk of the dollars now flowing to carriers and pharmacy benefit managers. Providers, meanwhile, can trade some rate pressure for more predictable payments and fewer administrative hoops.

TPAs are the bridge, not the next middleman

The instinctive concern about direct contracting is that employers are not equipped to administer their own health plans. Herschman agrees with that read, but argues it has been wrongly used as a reason the model cannot work. The independent TPA layer is what makes it work. "Most employers don't want to be administering their self-insured plans. There are some really qualified independent TPAs that are important to involve," he says. "If there's a large hospital system in the region where most employees of a self-insured company are located, then contracting directly with that health system and having a TPA administer it can save a lot of money for the company while paying healthcare providers more reasonable fees."The same holds true for large, multi-specialty physician groups, or large single specialty groups, such as orthopedics and cardiology.

The cost math sits at the center of his argument. Carrier profit margins, combined with the additional profits captured by carrier-owned PBMs, owned physician groups, and owned ASCs, represent a meaningful share of every premium dollar. Routing that spend through an independent TPA changes the equation. "If you're cutting out 20 to 30 percent of premium dollars that go to big carriers as profits, then although you have to pay a TPA 5 to 10 percent to administer the direct contracting arrangement, there's still significant savings," Herschman explains.

That spread is what makes the model attractive enough to move past the Fortune 100. The TPAs that handle these arrangements outside the major carrier networks are the operational layer that lets a self-insured employer act on the savings without taking on the administrative burden the carriers built their business around.

The regional model is the cleanest entry point

The simplest version of direct contracting is geographic. Employers whose workforce is concentrated in a single region can contract with a local health system, which includes the full range of employed or contracted physician specialties and outpatient clinics (e.g., physician offices, urgent care, behavioral health, imaging centers, ASCs, etc.) to provide the bulk of care needed. Then, the employer would add wraparound coverage for patients traveling out of town and any tertiary services that the system may not provide, along with stop-loss coverage for outliers. "In most major metropolitan regions and even small cities, about 90 percent or more of the healthcare is covered in the community where people live," Herschman says. The employer profiles he sees as natural candidates are not Fortune 100 names, but the next tier of self-insured companies whose workforces sit in one place, like a school district, a trucking company, or a chain of convenience stores or auto dealers. Each of those scenarios involves employees concentrated enough such that a single regional health system can cover the majority of employee healthcare needs.

The same logic creates an opening for the providers on the other side of the table. Health systems competing for regional market share have an incentive to direct-contract with self-insured employers, and Herschman doesn't see a reason the terms would change materially as smaller employers come on. "If there's a company with 200 employees, another with 400, and a third with 600, why not bring them all on? It grows the number of employees and spreads out risk." This is the mechanism by which he sees direct contracting becoming accessible to mid-sized employers that historically may have lacked the leverage to negotiate around carrier networks. "That being said, we are also seeing direct contracting arrangements involving larger, self-insured companies and unions with a larger, national presence. These arrangements can be entered into with health systems, or large physician platforms, with locations in multiple states, or with different health systems and large physicians groups to cover different regions," he shares.

Carveouts make the model real before it becomes total

For employers not ready to move their full health plan into a direct-contracting model, a more graduated approach could be to start with the highest-cost categories. Herschman points to musculoskeletal care, oncology, OBGYN, and cardiac services as a few of the top spend areas where carveouts are easiest to structure and produce savings. "A self-insured employer can potentially carve out these categories from its broader network and directly contract with a local group for more reasonable fees than they get paid from insurance companies." He's seen this play out in practice with orthopedic and multispecialty groups directly contracting with school systems and trucking companies on MSK care specifically. Larger employers have gone further, flying employees to specific hospital systems outside of the region to receive high-cost services from quality providers willing to charge reasonable fees in exchange for predictable volume.

An employer that pilots a single high-spend category with a single provider can validate the savings and the member experience before disrupting the rest of the plan, which makes the advantages of a move easier to explain to the board, to brokers, and to employees themselves.

What the next two to five years actually require

Herschman is careful to note that the market is not mature enough yet for direct contracting to become universal. The current adoption curve looks more like a snowball at the early end of its descent than an avalanche. The health systems best positioned for the shift are the ones that can offer continuum-of-care coverage across hospitals, physician offices, imaging, surgery centers, behavioral health, and pharmacy. Smaller or narrower providers can still pursue carveout categories, but the systems that can serve as a near-complete network for a regional employer will provide the best option for self-insured employers evaluating a directly contracting model now. Companies looking to explore a direct contracting model should first assess whether a local provider system would consider partnering with them on a such a model, and then find an independent TPA experienced in brokering these arrangements—some of which are now powered with AI platforms—and that can also arrange for stop-loss coverage and a wraparound for out-of-area care. "I think if that's possible, then it's going to be a no-brainer financially," he says.

The shift will not be neat, and it will not be uniform. What is clear from Herschman's vantage point is that the conditions for direct contracting to expand beyond the largest employers are now in place. "It's going to take a decent amount of time. I don't know whether it's three, five, or ten years from now, but once enough employers are convinced that this model is feasible and results in significant savings, direct contracting will be much more prevalent."

While direct contracting arrangements can offer meaningful opportunities to reduce healthcare costs and improve care coordination, employers should recognize that implementation involves more than negotiating favorable provider rates. On the employer side, self-insured group health plans remain subject to ERISA's fiduciary standards, requiring plan fiduciaries to act prudently and solely in the interests of participants and beneficiaries when selecting and monitoring providers, TPAs, and other service providers. Employers must also consider potential prohibited transaction issues, compliance with claims and appeals requirements, mental health parity and other applicable health plan mandates, and, where multiple employers participate in a common arrangement, whether the structure complies with ERISA's multiple employer welfare arrangement (MEWA) rules and related state insurance laws. Accordingly, direct contracting initiatives being considered by both healthcare providers and self-insured employers should be evaluated with experienced ERISA and healthcare regulatory counsel before implementation.