Technical Qs

Question 1

How is the healthcare industry segmented?

Answer 1

Life Sciences (e.g. Johnson&Johnson, Pfizer, Merck etc.)
- Biotech
- Large Pharma
- Specialty Pharma
- Generics

Healthcare Services (Ex: UnitedHealth Group; Humana; McKesson)
- Other Services: HCIT, Pharmacies, Contract Research Organizations
- Payers: Health Insurers, or Center for Medicare & Medicaid Services
- Providers: Hospitals, Urgent Care, Rehab Facilities, Home Health etc.

Med-Tech (ex: Baxter, Boston Scientific)
- Medical Devices
- Medical Equipment

Question 2

What are the main differences between biotech and other types of pharma companies?

Answer 2

Broadly put, biotech companies use living organisms to create their drugs, whereas the other life sciences categories develop their drugs using chemical compounds. Biotech companies are typically very high growth and based around one product/therapeutic area. Other sub-sectors in the life sciences industry, such as large pharma, are far more diversified with more product lines across several therapeutic areas (e.g., Pfizer, Merck).

Question 3

What do inpatient and outpatient refer to when discussing providers?

Answer 3

Inpatient and outpatient are two common ways to segment the services that healthcare providers offer.

1. Inpatient Care: Treatment where the patient stays overnight at a hospital or a comparable facility.
2. Outpatient Care: Refers to facilities where patients receive treatment but don’t stay overnight.

Question 4

Tell me the difference between acute and post-acute care.

Answer 4

Acute Care: Acute care refers to receiving treatment at a hospital and is associated with shorter-term, often severe injuries and medical emergencies – e.g., urgent care, intensive care units (ICUs), and emergency room services.

Post-Acute Care: Medical treatment received at non-hospital healthcare facilities is classified as post-acute care and can range from short-term rehabilitation to longer-term restorative care. These are all services beneficiaries receive after treatment at an acute care hospital – e.g., physical therapists, skilled nursing, rehabilitation facilities, and psychiatric care.

An illustrative sample care continuum would flow from the Primary Care Physician (PCP) -> Hospital (Acute) -> Rehab Facility, Skilled Nursing Facility (Post-Acute) -> Physical Therapy (Post-Acute).

Question 5

What are the two channels for pharmaceutical drug distribution?

Answer 5

Retail Pharmacy Channel
- In the retail channel, the product flows from the branded pharma or generics company to a distributor that’s typically aligned with a particular retail pharmacy and then onto the retail pharmacy before finally reaching the customer.
- On the funds side, customers’ co-pay just passes through the retail pharmacy onto the PBM. The amount the customer essentially pays and their premium goes from the payer to the PBM based on the negotiated drug prices for the drugs on the formulary (i.e., list of covered drugs).
- For funds flowing out of the PBM, the PBM will pay the retail pharmacies based on those negotiated prices, and the retail pharmacies will pay the pharma and generic companies based again on the negotiated prices. There is much negotiation involved throughout the chain and opportunities for PBMs or retail pharmacies to earn a spread by negotiating different prices with different parties.
- The result being industry consolidations with payers and PBMs merging and retail pharmacies and payers merging to reduce opportunities for “excess” profit from the spread and lead to better margins.

Mail Order Channel
- In the mail-order channel, the products go directly from the generic or branded pharma company to a typically PBM operated mail order facility and then onto the customer. The funds, the customer’s co-pay, go directly to the PBM, and then the payers pay the PBM based on those negotiated drug prices.
- Then it’s the PBMs who will pay the pharma and generic companies for the cost of that product based on the negotiated drug prices.

Question 6

What is the biggest cost driver for pharma companies?

Answer 6

1. Research & Development (R&D): For pharma companies, clinical trials related to R&D are by far the highest cost. These trials typically take five to seven years going through the various stages of clinical trials (i.e., FDA approval for a product, regulatory hurdles, application acceptances).
2. Production Costs: R&D is followed by the costs of producing pharmaceutical products, which refer to active pharmaceutical ingredients (API) manufacturing.
3. Sales & Marketing (S&M): The third cost is sales & marketing, usually directed at physicians and patients – however, this trails the previous two by a large margin.

Question 7

What roles do pharmacy benefit managers (PBMs) play in the industry?

Answer 7

Pharmacy benefit managers (PBMs) directly negotiate drug prices with retail pharmacies and influence the prices of the products – as their job essentially is to manage the pharmaceutical spend for insurers and to keep drug costs as low as possible. PBMs get paid on the spread between what payers pay them for drugs and what they payout to the retail pharmacies and pharma companies, which further incentivizes them to lower the drug prices. Once a doctor has prescribed a particular drug, the script is handed to a retail pharmacy, and the PBMs dictate which drug to dispense (i.e., a brand or generic). PBMs reduce costs by negotiating drug prices with drug manufacturers and retail pharmacies and driving generic utilization and mail order penetration.

Question 8

Explain the purpose of rebates in the context of pharmaceutical pricing.

Answer 8

Rebates are essentially discounts offered to PBMs by pharma companies to incentivize them to include them in their list of covered drugs (called a formulary). Therefore, PBMs maintain on behalf of the payers a schedule of which drugs are covered for their customers and at what prices. Particularly when there’s high competition for a drug product, a pharma company might give bigger rebates to the PBMs to ensure they remain on the list of the covered drugs – at the expense of reduced product revenue.

Question 9

What type of services do contract research organizations (CROs) provide?

Answer 9

CROs operate clinical trials on behalf of pharma and biotech companies in an outsourced, contractor-type relationship. CROs are hired to manage and lead the medical company’s clinical trials and to perform other specialized tasks to help bring a particular drug/medical device to the market and obtain regulatory approval quicker. Client organizations contract with CROs to use their expertise, which is required to carry out these high-stake trials safely and in a cost-efficient manner – since CROs are an alternative to having to hire permanent, dedicated staff members with the required skill set.

Question 10

What is the difference between a branded and generic pharma company?

Answer 10

A generics company (e.g., Teva Pharmaceuticals) develops and sells generic drugs, which are allowed for sale once the patents on the original branded drugs have expired. Given the commoditized nature of these no-brand name drugs, the generics business model and competition amongst one another is based on winning fixed volume contracts for mass production. Research & development costs are lower for generics companies since there are fewer clinical trials involved. However, sales & marketing costs targeted at retail pharmacies are higher since competition is based on securing those contracts with retail pharmacies. In contrast, branded pharma companies (e.g., Novartis) have patent exclusivity which enables them to compete on product innovation and reputation of quality, rather than pricing-based competition.

Question 11

What are the two pathways for a generics drug being approved?

Answer 11

There are two pathways for approving a generics drug:

1. Paragraph lll: First, there’s the Paragraph lll filing, often called the standard channel. This is when the generics companies wait out until a patent expires and then markets it at the same time as other generics.
2. Paragraph IV: The other channel is called a Paragraph IV filing – when a generics company challenges a patent before it expires. If this is approved by the FDA, the generic company can gain 180 days of exclusivity before other generics can come in. This is a pathway that most generics companies use if they think they have grounds to challenge a patent.

Question 12

Let’s say you’re valuing a pharmaceutical company selling drugs approved for therapeutic usage. What would the basic drivers of revenue be?

Answer 12

For the typical pharmaceutical company, the most basic drivers of revenue growth would be the current number of patients using their drugs, the average price of the drug, and the average dosage of the medication recommended by the medical professional.

Question 13

What assumption would you look at to value a clinical-stage biotechnology company?

Answer 13

A biotech company typically consists of a portfolio of different experimental drug candidates. Because each experimental drug candidate is unique and specific, we must value them separately. We must determine the annual free cash flow of each experimental drug candidate, then use discounting principles to determine the net present value of each unique product. Biotech companies are very cash-dependent, so the company’s current cash balance is also crucial when determining the full equity value of a biotech company.

Model Assumptions:
1. Number of Products in Pipeline/Development Stage: In the first assumption, the number of products under development and the current development phase for each must be identified. Then, it must be determined whether the company has a discovery platform of pre-clinical models and research.

2. Peak Opportunity: Determining the potential peak revenue opportunity within a therapeutic area is often the most important assumption. Sales will grow modestly after the company has achieved peak revenue until patent expiry or loss of exclusivity. Loss of exclusivity means that a brand name drug will lose its exclusive rights to sell in a certain geography.
3. Indication: The indication refers to the use of that drug for treating a particular disease/condition. More specifically, an indication is a specific, identifiable condition that the FDA has cleared a therapeutic drug to treat and can be thought of as a subcategory to a broader therapeutic area.
4. Estimated Time for Completion: The estimated time for completion refers to how long it’ll take for the biotechnology company to complete all necessary clinical trials.
5. Launch Date: Once you have determined the estimated time for completion, you can estimate a launch date for the drug. Once the product has officially launched, you can apply an uptake curve that grows each year until the estimated peak revenue is achieved.

Question 14

What does the “probability of success” rate refer to in receiving FDA approval?

Answer 14

Depending on the targeted therapeutic area, certain drug candidates have a higher probability of success than others. But overall, research has shown that it’s very difficult to achieve “approval” status from the FDA.

When modeling a revenue forecast build for clinical-stage biotechnology companies, the probability of success rate (called the “POS”) must be multiplied to each product line, excluding research & development. The risk-adjusted revenue would then be calculated as the unadjusted revenue multiplied by the cumulative POS rate.

Question 15

Provide an overview of the path to becoming an approved therapy by the FDA.

Answer 15

FDA Approval Phases
Pre-Clinical Discovery: Non-human testing to determine what a safe dosage for humans would be or if it even is safe to proceed with human testing (i.e., animal testing)

Phase 0: An exploratory study usually involving fewer than 15 test subjects and dosage on the lower end due to safety concerns

Phase 1: Human tests to determine if the treatment is safe while testing for the highest dose in humans without serious side effects (typically involves 20 to 80 test subjects)

Phase 2: Continued human tests to determine if the treatment works and testing specific dosing to observe response and efficacy (can involve a few dozen to 300+ test subjects)

Phase 3: Further human tests to determine if the treatment is better and testing the therapy against currently available therapies and treatments (ranges from several hundred to 3,000 test subjects)

New Drug Application (NDA): Formal application submission asking for approval by the FDA – once an NDA is received, the FDA has ~60 days to decide whether to proceed with the process of review.

Phase 4: Involves a thorough drug review by the FDA on all submitted data (e.g., studies conducted, labeling plan, and manufacturing facilities inspections) before making a formal decision on the application

Question 16

How would you build a revenue model for a recently launched generic drug company?

Answer 16

Revenue Model Process
1. To begin, the two main revenue drivers would be recent product launches and the current pipeline.

2. For a generics drug, pricing and annual sales data on the branded drug before the patent expired will be looked to have a benchmark to reference. The branded annual sales can help estimate the total market size for the drug, and this proxy can project how the generic drug will perform (i.e., demand sizing).
3. In most cases, the revenue build will be a top-down model. The total market volume with the average quantity of capsules in each bottle and the estimated price for the bottle will be gathered. Then, the market growth will be projected based on historical growth rates, but this will usually be on the lower end, and most models will assume minimal annual growth YoY in line with population growth.
4. In the next step, the estimated generic market volume as a percentage of the total market will be calculated for each. Initially, the branded drug will retain some market share, but then gradually, this hold on the market will fade as PBMs drive the conversions to generics. Keep in mind, this is the capture rate by all generic companies, rather than just the company being valued. The assumption should be on the higher end (~85%) and then gradually increase each year once the patent has expired.
5. Next, the key variable, the competition, must be accounted for in the forecast. The question that needs to be answered is: “How many generics companies will there be in the market?” This will determine the estimated revenue for the target company and its specific market share. Thus, there should be a line item for the total number of generic companies that will compete with the company being valued. As more competitors enter each year, the revenue should decline from lower quantity and price declines. But once a certain number of competitors have entered the space, it no longer becomes profitable, and the number of new entrants will stagnate close to zero. A reasonable assumption is that when a new competitor enters the market, the price will drop by ~10%.
6. A simplifying assumption is that the market share will be evenly split between all competitors, but this will be driven by the contracts with the retail pharmacies. So generic companies with a history of being well-supplied and reliable can secure favorable contracts and grab more market share.
7. Lastly, now that we have the sale volume (% of total market share) of the company being valued and estimated drug price from sites such as GoodRx or the negotiated price with the pharmacies if publicly available, we can multiply the two to arrive at the revenue for the product.

Question 17

On average, how does the pricing of generics compare to branded drugs?

Answer 17

Typically, the prices on generic drugs will be ~15-20% of the branded price.

Question 18

How would projecting revenue from drugs in the pipeline differ from recently launched generics?

Answer 18

For pipeline products, it may be appropriate to apply a risk-weight to project revenue. The risk-weight will be based on the percentage likelihood that the product will make it through the development and receive FDA bioequivalence approval. This is intended to account for the risk the product may face manufacturing issues or run into quality control difficulties, especially if the particular drug is complex (e.g., extended-release, injected).

Question 19

How would you build a revenue model for a hospital?

Answer 19

Model Assumptions
1. Number of Operating Hospitals & Freestanding Outpatient Surgery Centers: The first key metrics would include the number of operating hospitals and the number of freestanding outpatient surgery centers. Then, a growth rate would need to be attached, which will depend on historical growth and M&A plans announced by management since nearly all growth in terms of location count is driven through acquisitions (rather than organic growth). The reimbursements for services are mostly out of a hospital’s control, so growth through acquisition is the most reliable growth strategy.

2. Utilization Data: Next, the utilization data of each hospital must be calculated. This includes the number of licensed beds (and the weighted average of licensed beds), average admissions (i.e., the inpatient volume), equivalent admissions, the average length of stay, and the average daily census.
3. Average Occupancy Rates: Then, the average occupancy rate will be calculated using the weighted average number of beds and the average daily census.
4. Reimbursement Rates: The reimbursement rates will differ by the payor, and thus the sources of revenue will often be separated by each type (e.g., Medicare, Managed Medicare, Medicaid, Managed Medicaid, Managed Care/Other Insurers).

Existing Hospitals Revenue Projections
1. To start, calculate the average number of beds per hospital. Then, add a row for the implied outpatient volume, which is calculated as the equivalent admissions (a proxy for outpatient and inpatient volume) less the admissions (outpatient volume). Based on this metric, we can derive the average daily volume from admissions, beginning with the inpatient admissions, which will then be multiplied by the average length of the stay. This gets us to the inpatient volume adjusted for length of stay, and then we’ll add the outpatient volume to arrive at the total annual volume.

2. Since we are calculating the approximate average daily volume, we would then divide the total annual volume by 365 for the units to line up.
3. Then, we’ll project the number of hospitals owned for > 1 year and the beds per hospital from historical periods. That gets us to the total number of beds owned by existing hospitals, which will then be multiplied by the occupancy rate and then add a line for the annual improvement. Doing so gets us to the average daily census, which we’ll then multiply by 365 to get to the total annual volume.
4. Using the outpatient volume as a total % of the total annual volume, we can calculate the implied outpatient volume. We’ll now calculate the inpatient volume adjusted for the length of stay by subtracting the outpatient volume from the total annual volume. To arrive at the inpatient admissions, we’ll divide the inpatient volume by the average length of stay to get to the inpatient volume.
5. To get to the equivalent admissions, we can add the inpatient volume to the outpatient volume. Now, we can apply the revenue per equivalent admission assumption metric to it. We’ll assume a growth rate for this metric and then multiply the ending figure by the equivalent admissions to arrive at the total revenue generated by hospitals owned > 1 year.

Hospital Acquisitions
1. To forecast the revenue from acquired hospitals, the first assumption will be the new hospitals acquired multiplied by the beds per hospital to arrive at the total beds from acquired hospitals.

2. You’ll then go through the same calculations as we did for the hospitals owned for over one year. In the first couple of years post-acquisition, there should be a lower occupancy rate to be conservative since these are new hospitals that have not built up brand recognition yet.
3. Again, the average daily census will be multiplied by 365 to arrive at the total annual volume.
4. We’ll then make an assumption for the outpatient volume as a percentage of the total annual volume and calculate the outpatient volume. That allows us to calculate the inpatient volume adjusted for length of stay, which is the total annual volume less the outpatient volume. Then, inpatient admissions will be calculated by dividing the inpatient volume adjusted for length of stay by the average length of stay.
5. Ultimately, this allows us to calculate equivalent admissions, which, as a reminder, is the sum of the inpatient admissions and outpatient volume.
6. Lastly, the same metrics will be applied as the existing hospitals. The equivalent admissions will be multiplied by revenue per equivalent admission to calculate the revenue from new hospitals for the year. But since hospitals are not acquired precisely at the beginning of the year, we’ll apply a mid-year adjustment by multiplying this figure by 0.5. Overall, the total revenue will be the sum of the revenue from the existing hospitals and acquired hospitals.

Question 20

How do you calculate the equivalent admissions of a hospital?

Answer 20

The equivalent admission is a proxy for the combined outpatient and inpatient volume.

Combined Outpatient & Inpatient Volume = (Admissions × Total Inpatient & Outpatient Revenue) / Inpatient Revenue

Question 21

What does the average occupancy rate represent, and how is it calculated?

Answer 21

The average occupancy rate is a key measurement of the profitability of a hospital that shows how well a hospital is utilizing its capacity. While the target rate will depend on the hospital and be specific to the location/services provided, an occupancy rate of ~75% is cited as the most profitable percentage whereas, for high-end hospitals in urban densely populated areas, a ~85% occupancy rate is considered “peak profitability.”

Average Occupancy Rate = Average Daily Census / Weighted Avg # of Beds

Question 22

What are the differences between Medicare vs. Managed Medicare and Medicaid vs. Managed Medicaid?

Answer 22

Medicare vs. Managed Medicare
- Medicare: Medicare refers to healthcare coverage managed directly by the federal government.
- Managed Medicare: Also known as Medicare Advantage, this plan is managed by a Managed Care Organization such as Humana or Aetna, which contracts with the federal government to offer healthcare coverage to Medicare-eligible individuals. Medicare Advantage plans have different cost and benefits structures and may include coverage for additional services not covered by Original Medicare, such as prescription drug coverage (known as Medicare Part D).

Medicaid vs. Managed Medicaid
Medicaid: Often called Original Medicaid, this healthcare coverage is offered directly by the government. Medicaid is run at a state level, so the offerings vary by state.

Managed Medicaid: Refers to plans provided by Managed Care Organizations (MCOs). The distinction is that many states have increasingly chosen to contract out their Medicaid program to MCOs because they have realized that the MCOs are more cost-effective and provide better services.

Question 23

What are managed care organizations (MCOs)?

Answer 23

Managed care organizations (MCOs) are medical service providers who offer managed care health plans. MCOs refer to non-government payers in the US. MCOs make their money from the premiums and administrative fees from their customers (e.g., employers, individuals who purchase their health coverage plans).

Question 24

What impact did Medicaid expansion have on hospital reimbursements?

Answer 24

The expansion of Medicaid eligibility to those with lower incomes was of the key focus points of the Affordable Care Act (ACA). Medicaid reimbursement rates have historically been the lowest of all the various payer types. So the Medicaid expansion that happened through the Affordable Care Act (ACA) had a positive impact on hospitals since more patients now had health insurance rather than being uninsured. The caveat being more oversight over hospital practices, outcome-based payments, and penalties for non-compliance.

Question 25

How do you calculate the medical loss ratio (MLR) and why is it tracked?

Answer 25

The MLR ratio is used to measure the percentage of premiums an insurance company spends on claims and expenses that directly improve healthcare quality. Under the Affordable Care Act (ACA), this provision’s intended purpose was to ensure a minimum percentage of the health insurance premiums were used to pay claims and encourage providing value to enrollees while limiting insurance companies’ marketing and administrative expenses.

Medical Loss Ratio (MLR) = Medical Costs / Premium Revenue

For example, a medical loss ratio of 80% indicates that the insurer is using the remaining 20% of each premium dollar to pay overhead expenses.

Question 26

What are some of the main health plans used today?

Answer 26

• Preferred Provider Organization (PPO)
• Health Maintenance Organization (HMO)
• Point-of-Service (POS)
• Indemnity Plans (Fee-for-Service)
• Health Savings Account (HSA)

Question 27

What are preferred provider organizations (PPOs)?

Answer 27

Preferred provider organization (PPOs) refers to contractual arrangements in which healthcare professionals and facilities provide services to their subscribed clients at discounted rates. The PPO is structured as a subscription-based membership in which healthcare professionals have agreed with an insurer (or a 3rd party) to provide medical care services at reduced rates.
PPOs are by far the most common form of managed care in the US. Under PPOs, payers will steer patient volume towards certain providers in exchange for contracted reimbursement rates.

Question 28

What are health maintenance organizations (HMOs)?

Answer 28

As a healthcare plan alternative to PPOs, an HMO is a network that provides health insurance coverage for a monthly or annual fee. The coverage is limited to the network of doctors and other healthcare providers that are under contract to the HMO, and participants are required to first receive medical treatment from a primary care physician (PCP).

HMO contracts have the benefit of lower premiums relative to traditional health insurance plans because the health providers have the advantage of having patients directed towards them; however, the downside is the restrictions related to coverage access.

Question 29

What are point-of-service plans (POS)?

Answer 29

A point-of-service plan (POS) can be viewed as a hybrid managed healthcare care plan between HMO and PPO. Similar to an HMO, plan holders are designated an in-network physician as their primary care provider. However, the patient may go outside of the provider network for healthcare services like under a PPO plan.

The benefits provided will depend on whether the policyholder uses in-network or out-of-network healthcare providers. Relative to HMO and PPO, POS represents a small fraction of the total health insurance market.

Question 30

What do indemnity healthcare plans involve?

Answer 30

Often called “fee-for-service” plans, indemnity plans enable patients to direct their own healthcare decisions and enjoy greater flexibility. The benefits are greater flexibility in being able to visit any doctor or specialist at a hospital. The insurance company that provided the healthcare plan will then pay a set portion of the total incurred charges from the visit.

However, the patient must pay an annual deductible and out-of-pocket payment for services before submitting a reimbursement claim. Once the requirements are met, the insurance provider pays a percentage of the total costs based on the usual, customary and reasonable (UCR) charges of comparable providers.

Question 31

What do usual, customary and reasonable (UCR) fees refer to?

Answer 31

The usual, customary and reasonable (UCR) fees are the fees paid out-of-pocket by insurance policyholders for healthcare services. The UCR is the amount paid for a medical service based on what nearby providers typically charge for the same (or similar) service and often varies depending on the geographic area in which the service was provided.