The healthcare industry has been buffeted by a growing number of challenges over the past few years. This turbulence struck provider organizations in 2022, while payers were initially sheltered from the storm (Exhibit 1). But conditions became more difficult for payers in 2023, which has continued into this year, and there’s limited respite on the horizon. Unlike the widespread challenges the provider and payer sectors have faced, the picture for pharmacy services has been more nuanced. Some organizations have been propelled by tailwinds from pharmaceutical innovation and new delivery models, while others have battled headwinds from increased regulatory scrutiny. The healthcare services and technology (HST) sector, in contrast, has benefited from continued demand for data, analytics, and software. Along with pressures on earnings, the healthcare sector has also faced challenges in the capital markets, with deal activity in 2024 lower than 2023, according to McKinsey analysis.
Despite the obstacles ahead, healthcare leaders are well positioned to focus on reshaping care delivery by adopting a patient-centered approach and harnessing the latest digital technologies, including AI-powered capabilities. The key to the healthcare industry’s economic recovery is to pursue the $1 trillion improvement opportunity in care delivery transformation, administrative simplification, clinical productivity, and technology enablement. Experience shows that to fully realize this opportunity, leaders must invest and act purposefully even as they focus on necessary near-term performance enhancements.
Providers must boost performance and seek growth opportunities
Provider organizations were among the first groups of healthcare stakeholders to face hurdles as the COVID-19 pandemic began. More recently, supply cost inflation and workforce shortages have weighed on performance. McKinsey analysis estimates that aggregate annual EBITDA growth from 2019 to 2024 will be roughly 2 percent—well below the 6 percent growth in national health expenditures (NHEs). In response, many providers have acted to boost their operating performance, which resulted in steady improvement. Some providers were also helped by CARES Act funding and Medicaid expansion. In fact, provider performance has already recovered to pre-COVID-19 levels in some states, and we anticipate that aggregate performance could recover by the end of this year. Through 2028, we estimate mid-single-digit EBITDA growth for providers, in line with overall NHE increases.
Despite evidence that cost increases are abating, a focus on performance improvement remains critical, because we expect the pressure on provider balance sheets to continue. Median unrestricted days’ cash on hand for large not-for-profit health systems declined to 193 days in 2023, versus 218 in 2019. Many provider organizations have relied on investment income to offset operating losses, based on McKinsey research, but this approach may not be sustainable if returns fall. Organizations not targeting productivity improvements in core operating functions each year are likely falling behind.
Given continued pressure, leading provider organizations must pursue next-generation transformation, enabled by emerging technologies like generative AI (gen AI) to support performance improvement across a range of applications, including clinical operations, workforce, revenue cycle management, and patient access. By one estimate, AI adoption within the next five years using today’s technologies could result in net savings of 5 to 10 percent of healthcare spending, or $200 billion to $360 billion annually in 2019 dollars, across hospitals, physician groups, and private payers. To determine which use cases are best positioned to take advantage of gen AI, providers must discern their existing technology capabilities and data governance requirements. Accordingly, providers will need to decide where to invest to build capabilities themselves versus where it may be best to wait for off-the-shelf offerings from vendors.
Digital tools should build on established and successful solutions to enhance operations, improve patient and physician experiences, and ensure investments pay off. For example, traditional methods to improve patient scheduling apply uniform guidelines, such as setting fixed visit times based on appointment type and assigning a standardized number of patients to each physician. However, new technologies could help deploy more flexible solutions tailored to a provider’s specific needs. AI could, for instance, predict patient volume and accordingly create schedules to match. New technologies can also ease the administrative burden. It is estimated that AI technologies available today could generate $24 billion to $48 billion for hospitals and $10 billion to $30 billion for physician groups in annual run rate net savings from administrative costs within the next five years. Gen AI can build on foundational capabilities like the way providers check in on patients to develop post-discharge summaries—with clinician oversight—that could reduce provider documentation burden and streamline the discharge process.
As operating performance stabilizes, providers can also contemplate new strategies in high-growth areas to support their top line. Ambulatory surgery centers (ASCs) and home health (both healthcare and home services) are two such areas, with each projected to see 7 percent annual revenue growth through 2028 (Exhibit 2). Care delivery is expected to structurally change as economic pressure and patient preferences shift toward lower-acuity sites, reimbursement expands to a broader range of settings, and new medical technologies enable more care outside the hospital. In aggregate, 10.3 percentage points of commercial and 10.9 percentage points of Medicare volume that takes place in hospital-based settings could shift to alternative sites without compromising clinical outcomes. These shifts could correspond to a reduction of $114 billion to $148 billion in overall healthcare spending annually.
This move toward ASCs creates opportunities for providers to reevaluate their footprint to ensure their services and facilities align with the needs of their patients. Provider organizations that can balance investments in their core operations with noncore growth areas, as well as optimize costs related to shared services, may be able to enhance patient experiences and improve continuity of care while also shifting to a more sustainable financial footing. That said, many health systems continue to rely on the economics from their hospital outpatient services, and the continued growth of physician groups and private equity buying ambulatory assets could further erode how much of this volume (and corresponding margin) these systems retain. Leaders will need to better understand the competitive landscape, including new entrants and changes in physician compensation.
Payers need to manage costs to remain competitive
For payers, challenges intensified in 2023 and have continued in 2024. So far this year, many payers have been focused on margin recovery and overcoming challenges, based on earnings calls. In fact, some plans have been performing below breakeven profitability although most had been profitable in the year or two before this (Exhibit 3). Headwinds include accelerating utilization after a pandemic-induced reduction, propagation of inflationary pressure from providers to payers, end of pandemic health emergency measures, changes in risk adjustment regulation, and a tightening of government reimbursement. These conditions are expected to persist, per McKinsey analysis, given that the federal budget deficit and debt remain elevated and reimbursement increases are unlikely. Payers will thus need to shift their strategies and capabilities and explore new opportunities for growth and efficiencies in core segments like Medicare Advantage (MA) and Managed Medicaid. They will also have to closely manage their own medical and administrative costs, including core operational improvements enabled by new technologies. Payers could save $150 million to 300 million in administrative costs and $380 million to $970 million in medical costs for every $10 billion in revenues, according to McKinsey research. Payers will also have to offer innovative product designs to employers that provide more attractive rates.
In government lines of business, headwinds are expected to persist. MA plans are facing revenue and cost challenges from new guidelines for risk coding and rising costs. Furthermore, changes to the Star Rating methodology are also affecting MA payers, with only 62 percent of members in 4+ Star plans for rating year (RY) 2025, the lowest since RY 2016. Overall, Star Ratings fell from an average of 4.12 in RY 2024 to 3.92 in RY 2025, per McKinsey modeling. Utilization rates also remain high, especially as the population ages. Overall, these factors could create revenue and cost pressures amounting to $80 per member per month, and McKinsey expects that this could present an opening for more competition in MA, as national insurance companies assess their strategy.
In Managed Medicaid, enrollment declined about 7 percent annually since 2022 after eligibility redetermination started in 2023, per McKinsey analysis. But there are a few growth opportunities, like from states transitioning fee-for-service members to managed care, potential Medicaid expansion in remaining states, and eligible but not enrolled individuals. However, states are tightening rate increases postpandemic to bring them in line with their long-term intended managed-care organization margins, weighing on median profitability, based on McKinsey research.
In the commercial market, payers are expected to increase premiums, but it is unlikely that employers will absorb costs entirely. In McKinsey’s 2024 Employer Health Benefits Survey, 52 percent of employers identified medical inflation and increasing cost of care as among the top three challenges they face in building benefit packages. Notably, small and medium-size businesses, which predominantly opt for fully insured plans, are actively seeking more budget-friendly alternatives. The reality is that fully insured membership has been steadily decreasing and overall market growth has plateaued. Therefore, growth will likely stem from the gradually increasing self-insured sector.
As a result, employers may reduce plan options and shift to defined-contribution plans as they look to contain costs. Payers can consider offering a range of nontraditional plan types that are more tailored to employers’ needs. For example, multiple payers have highlighted individual coverage health reimbursement arrangements (ICHRAs) as core to their strategy going forward. First introduced in 2020, ICHRAs are tax-advantaged arrangements that allow an employer to provide a defined contribution toward an employee’s purchase of individual coverage. We expect that ICHRAs may become increasingly attractive with small-group businesses, since their premiums have remained above individual premiums since 2022. While ICHRA adoption remains in the early stages, the segment is already experiencing double-digit growth. Between 2023 and 2024, adoption is expected to increase 29 percent. If ICHRAs follow the trajectories of other benefit innovations, like 401(k) retirement savings plans and high-deductible health plans, there could be meaningful runway for further growth.
Specialty drugs and complex value chain expected to shape pharmacy sector
While some pharmacy service organizations have encountered obstacles over the last several years, others have benefited from favorable conditions. Retail pharmacies continue to experience margin compression because of inflation, labor shortages, greater competition, and rising real estate costs. Additionally, pharmacy benefit managers have faced calls for greater transparency. And as demand for broad-population drugs like GLP-1s maintains its momentum, their high cost is creating tension in the system, as payer coverage has been slow to take off.
Nevertheless, the biosimilars pipeline is robust, and launches over the last few years have gained more market traction than during the early days of biosimilar approval. Over the past decade, $36 billion spent on biosimilars translated to $56 billion in savings compared with what would have been spent without them.
Additionally, innovative models like direct-to-consumer delivery and integrated medical and pharmacy care delivery are starting to gain traction but remain small in absolute terms. Furthermore, specialty pharmacies are on the rise and are likely to remain a key to growth, with an 8 percent CAGR in specialty drug spending expected between 2023 and 2028, per McKinsey analysis. The anticipated sales growth will come from a range of therapeutic areas, including oncology, immunology, and neurology, will spur this growth. Within specialty drugs, approvals of cell and gene therapies are expanding to more indications and thus broader populations. While the cost of these treatments remains high, there is evidence that spending per patient could decrease as indications expand (Exhibit 4). At the same time, the growing potential base of patients implies that total spending on cell and gene therapies could increase up to an estimated $28 billion by 2030—roughly three times the 2021 level.
Furthermore, the value chain for pharmacy services may evolve in the coming years. At present, it is complex, involving multiple stakeholders with varying incentives and complex value pools. Also, variance in pricing conventions and price concessions can make the true underlying cost of care challenging to understand. Many organizations are also investing in more integrated care delivery models to support pharmacy value. In another example, a recent study found that medically complex Medicare Advantage members in a pharmacy care management program had a cost of care that was $108 lower per member per month after 12 months. As scrutiny around drug pricing, transparency, and flow of funds continues, innovative partnerships, care delivery capabilities, and transparent business models could gain more traction.
Healthcare services and technology sector is growing yet fragmented
Unlike other healthcare sectors, healthcare services and technology has grown steadily to meet the rising demand for new data, analytics, and software (Exhibit 5). Revenue and EBITDA in the sector have experienced a CAGR of about 9 percent since 2019, according to McKinsey analysis. Similar growth rates are expected through 2028 for HST overall, while double-digit growth is expected in data, analytics, and software.
The HST landscape comprises many highly specialized vendors and subsegments. In this way, the top ten HST companies account for approximately a quarter of the sector’s revenue, while the next 100 companies contribute an additional 15 to 18 percent, based on McKinsey research. Several factors contribute to this high level of fragmentation, including limited interoperability between data sources and systems (for example, claims and electronic medical records), regulatory complexity, and a diverse customer base spanning providers, payers, and pharmaceutical and biotechnology companies.
Given these dynamics, many value creation opportunities accompany the growing demand for more advanced technologies, such as gen AI. For example, technology advances may help vendors lower customer acquisition costs. Companies may also need to build deep vertical expertise and capabilities, rather than just a focus on technology and process.
There is also a need for technology integration as vendors seek to create a more seamless user experience. Vendors that can successfully support integration across different data sources, translate data into actionable insights, find new applications for advanced analytics and AI tools while ensuring they address any cybersecurity risks could be well positioned for long-term performance.
The challenges are far from over. The turbulent US fiscal outlook, the growing need for healthcare services, and persistent inflation are likely to continue to buffet the industry. But these challenges also offer an opportunity to reimagine the future of care and create sustainable improvement for healthcare organizations, patients, and communities.
