Exchange Fix Stabilizes and Restores “Affordable” to Affordable Care Act

Download PDF Report: Reinsure ACA

This analysis drew its data and conclusions from an Excel based simulator. Details of this simulator are described in:  APPENDIXEXCHANGE SIMULATOR and APPENDIX – METHODOLOGY. The downloadable simulator, permits users to change a variety of assumptions and to view the results in graph and table form. This Excel file contains no macros or VBA that may pay pose a security risk to users.

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SUMMARY

Before the Affordable Care Act (ACA), people with chronic and costly illnesses, if not buried in debt, were sorely stressed from medical liabilities they incurred. ACA shifted excess costs to insurers when it prohibited any health exclusions and annual and lifetime limits. Government reinsurance could further shift these excess costs away from insurers. This last effect would draw Billions of dollars from the Exchanges and allow premiums and costs more in line with pre ACA days.

Lower costs happen despite retaining all the essential health benefits added by ACA. Of note is that while the government reinsurance costs would rise significantly, subsidies for lower-income users drop by billions. When one includes the lower premiums and deductibles for users, combined savings can significantly exceed any increase in government costs. . Users benefit while government pays out more. The difference is in fact identical to a direct tax cut for the middle class.

BACKGROUND

Few issues generate as much controversy as the Affordable Care Act (ACA). As U.S. health care constitutes nearly 20% of GDP, $3 plus Trillion and over $10,000 for every person, the issues are both economic and political. One cannot easily solve the political issues. However, one can add perspective.

First, the bulk of ACA changes have broad acceptance and help make improvements to many different aspects of health care. Most controversy centers on Exchanges and Medicaid Expansion. Alternatives to Medicaid Expansion have not been very helpful, other than to free up Billions of dollars for other uses. More valid ideas exist for amending Exchanges. This analysis focuses on just one ACA amendment.

ACA removed a financial burden from people by prohibiting medical exclusions and caps on insurer coverage. However, those costs did not just disappear. Now insurers are left “holding the bag” for these costs. Government has helped with subsidies. Nevertheless, the long-term answer would be to shift further all the highest user costs from insurers to the government. Note the difference between “highest user costs” and “highest cost users”, as in high-risk pools. Reinsurance keeps everyone in the main pool and offers the most efficient method to achieve affordability. Not only does reinsurance relieve insurers of a costly burden, it also draws billions of “duplicate” dollars from the entire health care system.

Obviously, any major change will affect stakeholders in different ways. The following section highlights a few.

Health Insurer Stakeholders

This would present a mixed bag for insurers. Reinsurance will drastically lower their costs that are coming from a very small minority. Medical loss ratio (MLR) minimums will force down premiums. Exchange Insurers employ a cost-plus scheme that directly affects profit opportunity. Falling costs lower insurers’ profit opportunity; higher costs raise them.

Favorable for insurers is retaining a customer base on which to market additional services. Solve ACA Exchanges’ cost issue and insurers can expect greater user enrollment as well.

Federal and State Government Stakeholders

Reinsurance proposed here assumes Federal government funding. Medicaid costs do involve state government, but their role regarding Exchanges is little changed.

Small Employer Stakeholders

Reinsurance should be a major boon to small employers. Both before ACA and with ACA, small employer health insurance has always been higher than for large employers, not just from economies of scale, but also from many large employers being self-insured. Self-insurance eliminates the “middle man”, namely, the insurers’ markup that adds major costs for smaller employers. Small employers are more likely than large to grow, which could prove to be a jobs boost.

Individual Stakeholders

Lower cost is an obvious benefit for individuals. Another major benefit for individuals is that reinsurance would bring back insurers leading to far more competition on Exchanges. Network “shrinking” should decline along with some of the frustration with the current Exchange market.

Those not eligible for subsidy, though not by any means rich, will gain from lower premiums, deductibles and co-pays.

Young and Healthy Stakeholders

Most people would accept paying a fair share for insurance. However, the extreme skewing of health costs and ACA restraints tilt this unfairly. This has led many to go without insurance, or to pay the penalty as less onerous options. A major reduction in costs would make coverage palatable. There are always a few to argue that about the need for some female benefits. Perhaps they slept through biology class. ACA assures that males and females are treated equally.

Elderly Stakeholders

With reinsurance drawing billions from Exchange health costs, elderly are likely to benefit as much proportionately as younger, healthier people. Older workers are more likely than younger to be laid off in a downturn, and reform would provide an affordable option until Medicare is available.

Those on Corporate/Government Health Care Plans

By removing dollars from health insurance, Exchange costs will be more comparable to corporate and government plans. This may lead some who have an option to switch to join an Exchange and be insurance independent of their employer. It may also be a precursor to transition health insurance from employer based to individual based, or even single payor.

ACA EXCHANGE INTERACTIVE SIMULATOR

The following analysis draws its data from an interactive simulator explained further in the Appendixes. Six cases compare differences from before ACA to two reinsurance cases that bring user costs down to pre ACA days but with far better coverage. For each case, there are two side-by-side graphs below which are the assumptions for those graphs.

ANALYSIS

CASE 1. Pre Affordable Care Act

The following graph shows Exchange member costs under “Pre-ACA”. ACA will change two key (yellow) assumptions that bear noting. One is the “User Annual Limit” that caps what insurers will pay, and second is the Medical Loss Ratio (MLR) that reflects a typical MLR for individuals and small groups prior to ACA. Prior to ACA, insurers paid only to the annual limit, forcing members to absorb any excess costs. Insurers also could raise premiums to increase their margins, as there were no MLR limits on insurers’ profits.

The first bar in the left graph (50% of members) had costs less than their deductible (no blue bar) where insurers paid no claims. The next two groups (40% combined) did co-share with insurers (green bars), but the three groups at right (top 10%) were also forced to absorb their excess health costs (red bars). As regards premiums (line graph), they were low for healthier members but were often 5 times (or more) higher for older, less healthy members. Premiums averaged nearly $440/ month, not exactly affordable to many.

The right graph shows an often-overlooked cost item. The copper (3rd) bar shows government reimbursements ($18B) to hospitals and providers. It covers medical service costs for uninsured people. Analyses have found that the uninsured incur about half the health costs of insured. Government has always been deeply involved in health cost support prior to ACA, just in a less visible way. The low amounts in first two bars are due to only 10% Exchange members being insured.

10.0 M Exchange Population $15K User Annual Limit
$8,000 Avg Health Costs n/a Reinsurance Premium
$2,000 User Deductible 68% Medical Loss Ratio
40% Co-pay / Co-share 90% % Users Uninsured
$10,000 Max Out-of-pocket $2,000 Provider Reimbursemnt

Finally, bottom right shows a significant Insurer “margin” of $97 per month that insurers received. This is the difference between premium received and costs paid out. Self-insured companies get by with far lower margins, while individuals and small business withstand the brunt of insurers’ profits.

CASE 2.1. ACA 2017 Bronze 60%

Like Case 1, the following graph shows Exchange member costs under “ACA mid 2017” conditions and assumptions.

10.0 M Exchange Population n/a User Annual Limit
$8,000 Avg Health Costs n/a Reinsurance Premium
$6,000 User Deductible 80% Medical Loss Ratio
40% Co-pay / Co-share 70% % Users Subsidized
$10,000 Max Out-of-pocket $3,000 Subsidized Payments

The key change, however, was a shift of some $35 B excess cost (red bars) from ALL 10 million now insured members to insurers. This led to large increases in insurers’ costs that insurers passed back to users as premiums and deductibles.

ACA had hoped that with mandatory enrollment, healther members with lower costs would balance those with higher costs. A 3:1 max premium spread also forced up premiums for younger members. With only mild penalties, enrollment ran below expectations, requiring insurers to increase both premiums ($698) and deductibles (to $6,000). Not visible is how many did not enroll due to the effect of these actions.

In the right graph, Gov’t reimbursements for the uninsured are replaced by ACA subsidies for the poorer insured. These costs exceeded reimbursement savings for a small increase. Meanwhile, the sum of all costs rises to over $200 Billion.

CASE 2.2. ACA 2017 Silver 70%

The following graph shows costs for ACA Silver plans. One would expect user costs to decrease when insurers pay more on claims. However, higher insurer payments lead to higher margins, that rise above $100/month.

Those claims payments and added margins actually exceed initial user claims payments. The net effect is that that users come out worse on average. All this assumes an exact 80% MLR effect on margins. Meanwhile, total costs (last bar at right) remain high at over $200 Billion.

10.0 M Exchange Population $15K User Annual Limit
$8,000 Avg Health Costs n/a Reinsurance Premium
$3,500 User Deductible 80% Medical Loss Ratio
30% Co-pay / Co-share 70% % Users Subsidized
$7,000 Max Out-of-pocket $3,000 Subsidized Payments

Case 2.3. ACA 2017 Gold 80%

The following graph shows costs for ACA Gold plans. This is a repeat of Silver plans addressed just above. The more insurers pay, the more margins rise. Together, that raises user costs. Moreover, government subsidies to poorer insured are dependent only on their income. As health care costs rise, this forces government to increase subsidies to keep these insured users whole. If all 10 million users had gold plans, total costs under current ACA conditions would rise above $220 Billion.

10.0 M Exchange Population n/a User Annual Limit
$8,000 Avg Health Costs n/a Reinsurance Premium
$1,000 User Deductible 80% Medical Loss Ratio
20% Co-pay / Co-share 70% % Users Subsidized
$5,000 Max Out-of-pocket $3,000 Subsidized Payments

CASE 3.1. ACA -Base Reinsurance

With greater insurer payments inflating government subsidies and user costs even more, then one logical way to correct this is to lower what insurers pay. Just as ACA shifted user costs to insurers by increasing user protections, one can increase insurer protections by government reinsuring their highest costs. Reinsurance is not an insurer bailout but an efficient way to reduce their involvement in claims payments. MLR constraints will limit margins and any notion of bailout.

Like all Cases, the graph below shows Exchange member costs under “ACA with Government Reinsurance”. This shifts some $34 B of “excess” costs (red bars), but this time from insurers to government. With this shift in costs, the risk to insurers declines to less than what existed prior to ACA. The premium effects are dramatic. The highest Premiums (for older folks) drop almost in half compared to Pre ACA levels, while the lowest decline as well.

One can see the dramatic reduction of Total Exchange Costs by comparing the right graph above with any of the previous ACA cases. The axes on the right graph are fixed at $140 billion for Users, Insurers, and Government, and $280 Billion for all combined. In each of the ACA cases, the combined costs of all three parties were over $200 Billion.

10.0 M Exchange Population $15K Reinsurance Threshold
$8,000 Avg Health Costs 10% Reinsurance Premium
$3,500 User Deductible 80% Medical Loss Ratio
30% Co-pay / Co-share 70% % Users Subsidized
$5,000 Max Out-of-pocket $3,000 Subsidized Payments

Reinsurance greatly lowers user and insurer costs, though increasing costs to government. The total combined costs drop to $130 Billion, some $70 Billion below curent levels.

Every dollar for which an insurer is liable more than doubles the claims cost. This is because insurers add an overhead margin to claims paid. They then recoup via premiums and deductibles from users. If government is liable, there is that much less for insurers to pay. And if they don’t pay, they they also have to cut their margin to remain MLR compliant.

The government is currently paying some $42-45 Billion in subsidies to insurers. As premiums decline with reinsurance, so do subsidies. The net result is a modest $8 Billion increase to about $52 Billion in government costs. Contrast that with at least a $35 Billion reduction in user costs. That has the same effect as a $27 Billion ($35B-$8B) tax cut, and nearly all of that is for the middle class.

What should surprise nobody is that when risk shifts to government, there is no middle man (private insurer) to add overhead for marketing and profit. This is one reason why Medicare and Medicaid cost materially less per person than does private insurance. Government doesn’t charge extra for “risk.” Medicare also fixes prices, relying on doctors in private practice for input, but that is another story.

Less well known is that many of those same private insurers that ACA forced to reduce margins to “only” 15% to 20% perform nearly all the same administrative tasks for Medicare and Medicaid for less than 5%.

CASE 3.2. ACA -High Reinsurance

There is one more appeal to the reinsurance model. Lowering the threshold from $15K to $5K in graph below, transfers the bulk of insurer risk and related cost. Insurers are at risk only for lesser amounts. As claims bypass the middleman and his markup, Exchange premiums decline to near Medicare levels. All the while, insurers can remain in (or return to) Exchanges with an opportunity to sell additional benefits and find ways to lower costs even more. Reinsurance retains the creativity and inventiveness of private enterprise to reign in costs.

10.0 M Exchange Population $5K Reinsurance Threshold
$8,000 Avg Health Costs 5% Reinsurance Premium
$1,000 User Deductible 80% Medical Loss Ratio
30% Co-pay / Co-share 70% % Users Subsidized
$5,000 Max Out-of-pocket $3,000 Subsidized Payments

CONCLUSION

Without changing essential business processes in use today, one can greatly reduce Exchange costs by implementing ACA reinsurance. Shifting most risk from insurers would be like insuers being third party administers for self-insured companies. One major insurer benefit is they retain a built-in customer base where they can market features beyond ACA’s essential benefits. Like other countries with single payor systems, the U.S. can still have a vital albeit smaller private insurance market able to offer health features beyond basic government benefits. They are also free to adapt to special conditions of their markets.

Best of all, Congress could make the threshold adjustable to rebalance, as needed, consumer affordability and private insurer sustainability. That is a fiscally conservative idea with a major benefit both to the middle class and to the health of all Americans.

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APPENDIX – METHODOLOGY

 STEP 1 – DEFINE THE HEALTH COST “CURVE”

To find a solution, one needs to understand the problem. Health care insurance is not like most insurance policies about which many are familiar. With most insurance, there is a fairly symmetrical form to their costs: some low, some high, most near the middle. Acceptance occurs when those with lower costs feel the “premium” is worth the protection.

However, health costs are extremely skewed, with a huge majority of low cost members expected to cover extremely high costs of a tiny minority. Adding a mandate to buy health insurance simply adds to the discontent.

The first step was to develop an exponential math equation that would roughly mirror the actual health cost distribution where the top 1 % consumes 20% of all costs, the top 5 % – 50%, and the top 10% – 60% of all costs. Then build a table with 100 cells of equal population sorted by cost. The graph below does this and highlights how skewed health costs are. With an average cost for the U.S. of about $10,000/year, it was necessary to limit the right axis values in order to view any of the lower costs for 90% of the population.

ACA further limits insurers to a maximum ratio between highest and lowest premiums of 3:1. Insurers responded by increasing deductibles in order to maintain reasonable premiums. The result was deductibles rising to the $4,000 to $6,000 range. Even with high deductibles, premiums are still uncomfortably high. Deductibles are often far above 80% of the members. These lower cost members never collect any of the insurer’s co- payments. Even at $2,000, few members exhausted their deductible (red line) in the next graph.

STEP 2 – HIGH-RISK POOLS VS. REINSURANCE

Nearly all agree of the need to shift costs from insurers to government. This analysis considers two ways. In an effort to bring down costs, some favor funding (state run) high-risk pools that remove high cost members from the main pool.

Applying this to the highest 4% cost members yields the graph above. With High-risk Pools, Health Insurers have total protection only from those in the pool. They still retain the risk that one or more of those in the main pool will incur exceedingly high costs. With over 95% of members still at risk for substantial claims, insurers will cover this risk by raising premiums, deductibles, or both. As pools often have stricter conditions, users face obstacles for even small claims.

Another way to shift risks and costs to government is with reinsurance, a form of which ACA included until Congress blocked its funding as a “bailout of insurers.” A permanent form of reinsurance is needed like shown in the next graph.

Several kinds of reinsurance are available. “Treaty” transfers risk when overall costs exceed a threshold. “Facultative” is the recommended form for health reinsurance. It covers only an individual’s excess costs. Insurers already have systems in place, as the logic is identical to annual limits of yesterday. Only now, costs are forwarded to government, not returned to the user. An important conclusion is that reinsurance protects health Insurers from high costs over the entire pool. They can more readily define risk and do not need to add more risk for potentially large claims from any member.

Another advantage is for those with chronic illnesses. If they incur common injuries or sicknesses having nothing to do with their chronic illness, they still have pool coverage common to all. Unlike high-risk pools, reinsurance offers ALL members equal treatment for any illness or injury.

Finally, one can compare the costs of high-risk pools versus reinsurance. In the graphs above, assigning the top 4% to high-risk pools is equivalent in cost (but with greater risk) to setting a $22,000 average reinsurance threshold.

STEP 3 – COMBINE MEMBERS WITH LIKE COSTS

At this point, there are 100 cells (members) each representing 1% of the population. Now consolidate the100 cells into six groups or “buckets”, where the total cost of each is higher and the population is smaller than the preceding group.

This led to population groups (in ascending cost order) of 50, 30, 10, 5, 3, 2 = 100. The result is having the cost for each group and total. The actual total cost is not important. What is important is knowing the percent of total costs are in each group. Applying these percents to any cost total determines the costs for each group. Total cost is simply a product of Exchange members and their average costs.

STEP 4 – BUILD EXACT PROCESS FOR CLAIMS

With costs by group defined, the next step was to build the precise and detailed logic or rules of how insurers process all health claims. All insurers must abide by the same rules in the table below, but not necessarily using the same values.

Step Description Paid by…
1 Deductible Member
2 Co-pay/Co-share % by Member, balance by Insurer
3 Out-of-pocket Maximum Limit on what member pays. With ACA, Insurer liable for excess
4 Reinsurance Threshold Limit on what insurer pays. (Gov’t) Reinsurer liable for excess
5 Who Pays Excess Costs – 3 Cases 1. Pre-ACA – Members paid
2. ACA mid 2017 – Insurers pay
3. ACA Reinsurance – Gov’t pays
6 Derivation of Premiums using cost + accounting All health costs paid by insurer + a Margin to cover overhead – max set by Medical Loss Ratio limits
7 ACA Subsidies /

Reimbursements

% eligible & Avg Gov’t Subsidy or

Pre ACA Provider reimbursements

APPENDIX – EXCHANGE SIMULATOR

All the graphs above drew their data from an interactive simulator that covers 3 Cases or phases of ACA health care.

  • Phase / Case 1: Pre ACA using earlier business processes
  • Phase / Case 2: ACA in 2017 using current processes
  • Phase / Case 3: Amended ACA adding a new process for government reinsurance

In addition to three basic cases, one can change 14 values that determine payment of costs and derivation of premiums:

  1. Exchange Population (+/- 10 million)
  2. Average Health Care Costs (now about $10,000)
  3. Insured member Deductible $
  4. Insured / Insurer Co-payment %
  5. Insured Maximum Out-of-pocket $
  6. Annual Limits for users (now outlawed by ACA)
  7. Government Reinsurance Threshold $
  8. Reinsurance Co-payment % (in lieu of premium)
  9. Medical Loss Ratio (70%+/- pre-ACA, 80% ACA)
  10. Uninsured pre ACA whose costs Gov’t reimbursed
  11. The reimbursement amount paid to providers
  12. Number of subsidized Exchange members
  13. Cost of Gov’t Payments for subsidized members
  14. Finally, toggle between 5:1 or 3:1 premium ratios

All the graphs in this document, plus the table below are available for download and experimentation in an Excel spreadsheet. This Excel file contains NO macros that can interfere with network security. It does contain over 2,400 “formulas”. This interactive ACA simulator is available at “insr.us/reinsureaca”

APPENDIX 2 – EXCHANGE SIMULATOR RESULTS

The table below shows assumptions and results for six cases. One is before ACA, three are cases representing Bronze, Silver, and Gold ACA, and finally two showing ACA with Reinsurance. Identical logic applies to all cases. Focus on the top three rows and their sum, “Total Cost All Sources” row, in yellow. While Government costs go up, User and insurance go down.

Today those combined total costs are running over $200 Billion. Note in the last two columns with reinsurance, total costs drop significantly to about $130 Billion. The $8-10 Billion increase in government is more than offset by member decreases of $40 Billion, and by insurer decreases of $50 billion. Reinsurance literally “drains” billions of dollars from Exchanges.

APPENDIX 3 – EXCHANGE SIMULATOR DETAIL COMPUTATIONS

The table below shows the detailed calculations for the final case, “ACA with High Reinsurance”. The assumptions are in yellow in column D. The eight blue shaded rows describe the computations immediately below each. Section D, “Reassigned Excess Costs” shows who bears excess costs (user, insurer, or this in case, government) and how much are those costs.

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Attacks Can’t Obscure Health Law’s Valuable Benefits

Download PDF version Report>> Attacks cant obscure benefits-Huff Post

Huffington Post Posted: September 23, 2010 09:04 AM
http://www.huffingtonpost.com/andrew-kurz/attacks-cant-obscure-heal_b_735873.html

Attacks Can’t Obscure Health Law’s Valuable Benefits

After decades of trying, health care reform is finally a reality. The Affordable Care Act (ACA) is sweeping in scope (it has more than 300 sections) and takes four years to implement. Critics say Americans don’t want it, but if that’s true, it’s only because of false claims by those who do not know what its provisions are or who are being spun by people who have an economic or political interest in blocking the law.

Health reform provides coverage to millions of people while correcting many current and serious defects. It isn’t perfect, but it has countless positive elements being ignored by critics. One key example is Section 2718, “Bringing down the cost of health care coverage,” which takes effect today (September 23). It brings sorely needed cost-control mechanisms while retaining health insurers’ ability to innovate. The provisions of section 2718 are eminently reasonable, and if the atmosphere were not so politically charged, they would receive strong bipartisan support.

Insurance accounting used to be straightforward. The hospital sent a bill. The insurer paid most of it, and forwarded the balance to you or your employer. With the advent of for-profit insurers, which now dominate the industry, accounting and classification of costs have become creative enterprises. Continue reading

Insurers’ Efforts to Shift Admin Costs to Medical Costs

Download PDF Report >>> Insurers’ Efforts to Shift Admin Costs

Senator Rockefeller recently came out with a report cautioning about health insurers efforts to shift Selling, General and Administrative (SGA) expenses to medical costs.  A shift would increase medical loss ratios (MLR) allowing insurers to keep more earnings. Two uncertainties affect predictions.  First is how plans are grouped and second is how one computes “medical costs” and “premiums”.  Below are reasonable interpretations of the new law that favor consumers, not insurers.

HOW ENROLLEES ARE GROUPED

The first order is to define “group.”  The more groups are combined, the greater the opportunity for balancing out gains and losses, which is the whole idea of insurance.  Continue reading

Non-Partisan CBO Estimates of Healthcare Reform

Download PDF Report >>> CBO Estimate of Healthcare Reform

SUMMARY

Few doubt how unsustainable current medical trends are.  With medical inflation consistently outpacing the CPI, health costs will continue to take a greater share of the economy. Private insurers claim they can solve the problem with reform but without a Public Option.  History suggests this is a dubious claim at best.  Looked at from multiple angles, private insurers are not likely to succeed.  Profits gains have far exceeded key indices, medical loss ratios have gone way down while costs have gone way up, competition is diminished by concentration of major insurers, and tort reform complaints carry little water.

DISCUSSION

The graph below shows CBO projections of under 65 population by insurance group. The top, red bars are the uninsured that continue to grow each year.  While insurance through employment is fairly consistent, greater employee cost sharing is an increasing burden.

Neither the Senate nor House reform proposals provide financial support to unauthorized immigrants.  When analyzing various effects of reform, this group has no effect. For data consistency for both before and after reform, unauthorized immigrants are not included in the populations.  Removal lowers uninsured population between 5 and 8 million over the 10 year period.

 Source: CBO, Oct 7, 2009 letter to Senator Baucus

While the country may be coming to some agreement that reform is needed, differences exist on how to achieve reform. Health Insurers want to have participation mandatory which is a valid point. Except they have offered no other steps on how to reduce costs and are against Public Option that would offer real competition. However, they would be beneficiaries of millions of new customers.

Those customers would come from those currently uninsured, or insured through individual and employer groups. In the graph next column, CBO assumes reform includes an Exchange that would shift nearly 40 million from uninsured, individual and employer groups (left side of graph) to Medicaid and the Exchange (right side).  Note that not all the movement is to the Exchange.  A large number of uninsured poor would switch to Medicaid.  Still, the Exchange is expected to grow quickly to nearly 25 million. This group is the target for private insurers and Public Option.

So why is it necessary to have a Public Option on the Exchange?

 On its face, private insurers could certainly cover 25 million new enrollees without government involvement. But the catch is that the government IS involved because of another feature of reform.

 Source: CBO, Oct 7, 2009 letter to Senator Baucus

That reform feature is “affordability credits”.  Even those with insurance find their total health care costs consume so much of their income that they do not get needed care. Affordability credits help those with lower incomes pay premiums and shared health costs. The effect is shown in the chart below. Medicaid pays for the very poor while credits help less well off people in the Exchange.

 Source: CBO, Oct 7, 2009 letter to Senator Baucus

In short, the Government will be paying some $100 billion each year in credits to Exchange enrollees, much of it going towards insurance premiums.  Will private insurers provide good value for this outlay? Their track record is not encouraging. 

Health care costs fall into two categories: medical cost outlays and administration / overhead costs. In 1993, 95% of premiums went for medical costs at Investor-owned insurers as shown below.  Over the next 14 years, this decreased to just above 80%, a shift of about 14% or one percent per year.  Meanwhile Medicare administration and overhead costs have remained fairly constant through the period.  While some may argue this is not a direct comparison, the fact that Medicare medical loss ratio stayed constant while investor-owned insurers drop significantly cannot be denied.

 Sources: PricewaterhouseCoopers’ Health Research Institute, and U.S. Center for Medicare & Medicaid Services

14% becomes urgent when you consider premium dollars as shown in the chart below. Private insurance runs over $600 billion. 14% of this is nearly $90 billion per year.  Fortunately, one-third of private insurers are non-profit.  But that leaves some $60 billion added overhead including contribution to profits since 1993.

Source: Center for Disease Control – Health, United States 2008 Figure 19

Profits did not grow to $60 billion, but they sure did grow as shown below, exceeding by a huge margin the S&P 500 and CPI for urban wage earners.  All the growth occurred since 2002.

Sources: U.S. Dept. of Labor, Bureau of Labor Statistics, Standard and Poors, and Health Insurers’ 10K’s

Not only did investors do well, but so did executives and all at the expense of people paying for health insurance. 7 insurance CEO’s drew nearly $70 million total compensation in 2008.

Still, Investor-owned insurers argue that their profits are a mere 3% of revenue.  Another and better measure is Return on Equity (ROE) which is profitability based on investment.  By this measure, health insurers are earning 17%.  From the chart below some industries do have greater returns, but 17% should be nothing to complain about.  The 10 insurers are even higher than credit card issuers.

Sources: 10K reports for top 10 Investor-owned Insurers and  CCH Almanac of Business and Industrial Financial Ratios, 2009 Edition

Now high returns to executives and investors might have some justification if private insurers were successful in containing and bringing down the major component of health care – medical costs.  Yet, year after year, medical costs outpace the CPI.  One could almost argue that insurers “administer” health care costs rather than provide a value added “management” of those costs.

Competition often has something to do with companies holding down costs.  In competitive markets, insurers need to maximize cost control efforts to maintain market share.  But is there really competition?  The graph below shows the market share of the top two insurers in each state weighted for population covered.

 Sources: AMA, Consumer Union, Sector & Sovereign analysis

Over half the U.S. population lives in states where two insurers control over 60% of the market.  That is not a good omen for competition.  For instance, insurers claim that their market share allows them to negotiate lower rates with providers.  It would not be fair to paint all insurers with the same brush. But a number of insurers have been found not to be driving down rates, but of negotiating with providers to NOT contract lower rates with their competition.  Instead of reducing costs, these illegal acts increase medical costs compared to a truly competitive environment.

Insurers and others also argue that tort reform would bring down medical costs owing to current waste of defensive medicine. There is no argument about the waste. But is it due to defensive practice or simply practice? Data suggests that the latter is more prevalent.

The graph below, derived from Dartmouth College data, groups two sets of hospitals, the 100 highest cost, and 100 lowest cost hospitals for Medicare spending per decedent during the last two years of life.  The bars represent average costs by states that have enacted tort reform setting caps on non medical damages.  For the lowest cost hospitals, tort reform shows virtually no effect on hospital costs. For the highest cost hospitals, it is mixed. But there is no clear evidence that tort reform will substantially lower costs.

Source: Dartmouth_hosp_DAP_Hosp_HRR_ST_01_05.xls

So far, private insurers’ track record suggests that left to the free market, they will not be very successful in lowering costs, either administrative or medical costs, with or without tort reform.  It may be unrealistic to even expect investor-owned insurers to succeed given that their number one priority is to their investors.

Instead of using their actuaries to data mine patterns to help providers reduce costs, their efforts are focused on denying claims and raising premiums to high claims groups.  Instead of returning surpluses to people paying premiums, they are buying back billions of dollars of their own stock to increase value to their shareholders.

Thus far the focus has been the cost of illness. Another aspect is the benefit of staying healthy. Corporations have had success in wellness programs. They not only reduce health care costs, but lower absenteeism. (http://www.uscorporatewellness.com/USCW White Paper 2009.pdf)  Some insurers offer wellness programs, but they often include a health risk assessment on employees and that runs a risk that insurers may use that data in setting rates for the company: if towards lower rates, good. If higher rates, not so good.

Fortunately, large corporations are the biggest block of insured people, and their wellness efforts can have a broad effect.  The graph below shows the U.S. population by source of health care coverage. Big business covers 45% of the population, 28% who self insure and another 17% who shift risk to insurers.

Source: CBO, EBRI, CMS, Goldman Sachs Research estimates

Groups at a disadvantage to big business include individual and small group business and the uninsured that together make up over a quarter (27%) of the population. If private insurers are unable or unwilling to lower administrative and medical costs for them, then the next best alternative is to offer a Public Option.

Without progress in both lowering administrative and medical costs, the affordability credit paid for by the government is going to cost taxpayers more than can be justified.  The question is not whether a non-profit Public Option will succeed. The question is whether private insurers can succeed after years of failing to take the needed steps to contain costs.

The stakes are huge. CBO projects that with a Public Option, the insurance picture changes dramatically as the graph below shows. Medicaid grows a bit for the poorest, but the uninsured and non employer based population can look forward to more affordable insurance.  Meanwhile the majority of the population is unaffected.

 Source: CBO, Oct 7, 2009 letter to Senator Baucus

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Medical Loss Ratio

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Medical Loss Ratio or MLR is a ratio used to measure what percent of Premium revenue for health insurance is paid out in medical claims.  The remainder of premium is used to cover selling, general and administrative (SG&A) expenses as well as operating margin or profit.

In the early 1990’s, the average MLR was over 90% and in 1992-1993 the MLR approached 95%.  Though that may have been a high water mark for MLR, it was not unusual for MLRs in the 1980’s and earlier to be above 90%.  Health insurance companies ran the business with leaner overhead than is seen in more current times.

Wall Street frequently uses the Medical Loss Ratio measure to determine profitability for health Insurers.  For Wall Street, a lower MLR is considered good as it indicates that the insurer has control over its medical claims.  Higher MLR’s may
suggest that the insurer either has a bad book of business or is not so well managed, either or both which could adversely affect profitability.

MLR’s dropped fairly rapidly in the 1990’s and continued a more gradual decline to the low 80% levels in recent years.

Health care reformers have focused on increasing MLR’s as a way to control health care costs. Since MLR by definition is a ratio of two numbers, one can increase the MLR by either reducing premium revenue, or by paying more claims from the same revenue.  Since no one arbitrarily pays claims, forcing an increase in the MLR should put downward pressure on premiums. In that case, what expenses need to be cut.

For them to focus on reducing claims does them little good as lowering claims does nothing to increase the MLR.  For insurers to retain some measure of profitability, they have to look at cutting their general and administrative expenses.

Medical Loss Ratio declining over time

The graph below shows MLR trends from 1992 to 2007.  In the early 1990’s, the average MLR was over 90% and in 1992-1993 the MLR approached 95%.  Though that may have been a high water mark for MLR, it was not unusual for MLRs before 1990 to be above 90%.  Then again, as one goes back in time, more health insurers were non-profit than there are now.  These companies ran the business with leaner overhead than is seen in more current times.

A critical question for health care reform is how fast and how far can these trends be reversed so that more of the premium dollar goes to medical claims instead of overhead expenses and profits.

 Source: Price Waterhouse Coopers Medical Loss Ratio Annual

 MLR includes multiple variables to control

The graph below shows three cases, each with three bars.  The base case is typical of today, the second assumes lower claims, and the third assumes higher claims. 

 The first bar in each case represents claims, SG&A expense  and profit margin. The second bar represents premiums and a small investment income (green). By definition, profit plus expenses must equal revenue so those two bars are always equal length.  The third bar of each case is the MLR. 

In the second case, claims are lower. But unless premiums are reduced, the MLR will go down. Further the premium reduction will eat into profits to maintain the MLR. If claims rise as in the third case, and if the market will bear, higher premiums will generate added profits without incurring a reduction in MLR.

Effect on MLR if profits & expenses held constant

The graph below shows the same three case format as the prior graph. The base case is the same as above.  In the second case, however, both claims and premiums are reduced by 5%.  It also assumes no change in profit or expense.  In an environment of falling costs and claims, the MLR will decline by nearly one %.

But the health care prices have been in an ever increasing trend.  If overhead and profits are held constant, a 5% increase in both claims and premiums will raise the MLR by almost 1%.  But as was shown above, the MLR continues to decline. Unless there is competitive downward pressure on premiums, the profits will tend to rise and MLR’s decline.

A key unanswered question is whether there exists enough competition to drive prices down or at least keep them from rising faster than general inflation. 

Raise the minimum MLR as a step to Cost Control

California is one state that is considering raising the MLR to a minimum of 85%, and increase from about 82%.  The graph below shows two ways this can occur. 

The first is to hold premiums constant as claims rise to 85%.  This will result in significantly lower profits unless overhead is sharply reduced, from around 16% to 13%.

The second method is to reduce premiums to more quickly reach 85% MLR with no changes in claims. If insurers want to maintain current levels of profits, this method will require even steeper cuts in overhead expenses than in the prior case.  Insurers can be expected to resist these moves.

Still, one does not have to go back that many years to find total overhead and profit to be less than 10%.

 

Sensitivity in MLR to changes in overhead and profit

The graph below shows 5 bars representing decreasing levels of overhead and profit and their effect on MLR.  Or conversely, how much do overhead and profit need to be reduced to reach higher MLR levels.

For insurers to reach an 85% MLR without increasing premiums, they will need to reduce overhead and profits by some 20%. An 88% minimum MLR would require reductions of 33%.  Health care reform should allow for significant cuts in general and administrative expenses. With insurance exchanges, selling expenses may be reduced. But it is hard to imagine the levels of cuts needed to help bring about cost control without some reduction in profits as well.

If this nation is serious about reform, it is optimistic to think that insurers’ profits will remain relatively unaffected by these changes. But the high tech industry had a nice ride to new highs, before it was brought back to reasonable levels.

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