If You Think It’s Bad Now, Plans Could See Worse

Cover Story

MANAGED CARE May 2009. ©MediMedia USA

Dwindling market share, rising costs, and a drastic drop in investment income buffet the health insurance industry

Frank Diamond

Managing Editor

It’s not recession-proof. The managed care industry never really was recession-proof. The health care industry as a whole has always been considered recession-proof, says John Fitzgibbon, the national segment leader for health care payers at the consulting company KPMG, but our present economic duress challenges even that belief.

“The idea is that whether the economy is good or bad, people still need to take care of themselves,” says Fitzgibbon. “A lot of health care expenditures have always been considered nondiscretionary. When you get sick, you’ve got to get well. Health care in general is finding that this is not true now. If you look in the press, you see articles about things like drugstores noticing that prescriptions are down. Hospitalizations are falling as well.”

Welcome to the Recession of 2009. It follows on the heels of the Recession of 2008. If you want to be picky about it, you can even reference the Recession of 2007, since the current downturn (OK, it’s all the same recession), the longest since the Great Depression, actually began in December 2007.

Caught off guard

Officials in many industries — transportation, computers, and construction, to name a few — not too long ago felt that the good times were going to roll forever. Health insurance plans were not immune to this irrational exuberance. “The lack of liquidity in the financial markets came as a surprise to almost everyone, and health care companies were no exception,” says Healthcare Industry Report 2009 by KPMG. “The next couple of years will be challenging as health care companies face slower growth or reduced revenue caused by a weak economy.”

How weak an economy? As of the end of March, 5.1 million jobs had been lost in this recession, with two thirds of those cuts occurring since November, according to the Labor Department. The unemployment rate at the beginning of April stood at 8.5 percent, the highest level since 1983, and it is expected to climb even higher, to 10 percent. The consulting company Wolters Kluwer says that the

“A lot of businesses are going to be a lot more demanding with regard to premium increases,” says Princeton University economist Uwe Reinhardt, PhD. Meanwhile, hospitals and doctors will press for high fees.

GDP will contract by 2.6 percent this year, much worse than the 1.9 percent year-to-year contraction in 1982 that had been the largest such decline in the post World War II era.

“It’s not that the health plans are losing employer groups for customers; it’s just that those employer groups are getting smaller,” says Fitzgibbon. “As the economy gets worse and more layoffs happen, that will definitely affect membership, which is a real big issue.”

Dwindling rolls

In its quarterly filings last month, the nation’s largest insurer, WellPoint, reported losing nearly 500,000 members. UnitedHealth Group, the second largest plan in enrollment, lost 325,000 members in the first quarter.

Insurers didn’t just lose members; they also underestimated costs in 2008, and premiums weren’t able to make up the difference. Then, those health plans that invested heavily in Medicare Advantage were caught flatfooted when CMS announced in April that payments would fall by as much as 4.5 percent next year.

Even layoffs at health plans, once unheard of, are happening, although they are slight, considering the number of people employed in the industry. Still, you take notice when:

Cigna wants to cut 1,100 jobs
Aetna lays off 1,000 at the end of last year and isn’t ruling out more cuts in 2009
UnitedHealthcare speaks about eliminating 4,000 jobs, many through layoffs

In this “Gee, we’ve never seen that before” climate, the layoffs may get more pronounced, Fitzgibbon warns. “Health plan employment levels may have been based on the assumption of continued growth. Now they are sizing their employee levels to the business they have.”

Jaan Sidorov, MD, a former medical director at Geisinger Health Plan and now a consultant who sits on MANAGED CARE’s editorial advisory board, offers this thumbnail sketch. “Plans are caught in the middle of a decline in their fully insured membership thanks to rising unemployment among their fully insured business, made worse by the flight of their other business to self-insured products, compounded by a drop in earnings income on their investments.” There is also what Sidorov calls the “actuarial spiral” that comes from having only people with health care needs keep their insurance.

Uwe Reinhardt, PhD, the James Madison Professor of Political Economy at Princeton University, points out that “A health insurance company thrives on the dollars that flow through it, not the number of people it insures. So on the intake side, there will be pressure on revenues, the top line. And then for the expense line, hospitals and doctors will be antsy and pressing for fairly high fees.”

Sidorov says that more Medicaid recipients and uninsured “means even greater pressure on hospitals and providers to cross-subsidize their business on the backs of the commercial insurers.” As the Wall Street Journal put it recently, “Hospitals and pharmaceutical companies have been pushing through hefty price increases aimed at bolstering earnings, even as government and private insurers are struggling to rein in health care costs.” (Of course, those serving Medicaid might do well. See “Medicaid Plan Poised to Weather Bad Economic Times,” below.)

Medicaid plan poised to weather bad economic times

John Molina, the chief financial officer of Molina Healthcare, says that his 1.3 million-member plan, spread over 10 states, is well-positioned to survive the recession. “We contract with the Medicaid agency and sometimes if there is a separate entity that covers the S-CHIP, we cover some Medicare,” says Molina. “Unlike an Aetna, or a Cigna, or a UnitedHealthcare that has many, many, many payers, we basically have two or three payers in each state.”

Molina Healthcare will surely add beneficiaries. “As unemployment rises, more people will qualify for and apply for Medicaid benefits,” says Molina. “So we are anticipating, and have seen through at least the first few months of this year, increased enrollment.”

That doesn’t necessarily mean more profit, he adds. “People who got laid off may not be using their previous employer’s insurance coverage,” says Molina. “Perhaps they didn’t want to miss work as the layoffs were happening, or couldn’t afford the copayment, or whatever reason. So when they get on Medicaid, which has minimal or no copayments, they haven’t been to the doctor for a while. Our studies have shown that, traditionally, patients use more medical services during the first six months of enrollment. Then after we get them . . . into a routine, the costs tend to go down.”

There are also challenges unique to managing a publicly funded health care plan. “You’ve got states that are being overwhelmed with having to pay a greater percent of the budget out on unemployment insurance, and now with more people on Medicaid, state budgets are really getting hit,” says Molina. “States are being challenged to give the managed care plans rate increases. I’m not saying that it’s not going to happen, but I think it’s going to be more difficult for them to give significant rate increases.”

Still, Molina Healthcare will rely on its experience to deal with what historians refer to as the “known unknowns.”

“The way that Molina Healthcare has been able to mitigate some of these cost pressures is that we have very high control on our administrative costs,” says Molina. “That provides us with a bit of a buffer in the lean times. We have been in business since 1980, so this is not the first recession we’ve been through.”

But is it the first depression the company’s ever been through? Perhaps it is what historians call an “unknown unknown,” an entirely different, and mysterious, animal.

Increased enrollment is what Molina Healthcare has seen through the first few months of this year, says John Molina, the company’s CFO.

In addition, poor stock market performance and lower interest rates battered publicly traded health plans’ investment portfolios. “If you look at what happened in the stock market last year, it was a disaster for health plans,” says Fitzgibbon. “The big public plans were all down more than the market as whole, and the market as a whole was down a lot.”

Nosedive

Fitzgibbon doesn’t recall health plans’ investment incomes ever falling as precipitously as they did last year. “There is a fair amount of uncertainty,” says Fitzgibbon, adding that “everybody’s investment income was down dramatically.” (See “How to Explain the Insurer’s Role in the Market Meltdown,” below.)

How to explain the insurer’s role in the market meltdown

Jaan Sidorov, MD

The best leaders in an organization are often the best educators. Medical and pharmacy directors at health plans understand why insurers’ investment portfolios crashed last year, but a surprising number of managers and administrators that you work with don’t. This may be a good way to describe the market meltdown situation to the managers, directors, various work unit leaders, and others who report to you.

Now, the presentation below may be too much honesty in one serving. Depending on whom you are talking to and the working environment of your particular plan, you may want to consider slowly ladling this out. You may even want to delay disseminating these hard facts of insurance company investing until the current recession recedes and blue skies open. Then, let them know. That way, when the next downturn occurs, they can’t say you didn’t inform them.

Risk, ratios, and rate of return: A guide for the perplexed

While insurance plans pool risk, what they also do is pool the money that has been paid for the transfer of that risk from the individual customers to us here at Health Plan X. Think of risk as a “negative commodity.” Our customers have it and they want to get rid of it. They transfer the risk to Health Plan X, and pay us to take the risk. We take that cash (in the form of the premiums) and keep it to pay for the risks that go bad. At the end of the year, if the amount of money is greater than the amount of bad risk, we here at Health Plan X have a surplus. If this surplus becomes excessively large, some can be given to our investors or owners.

Insurers don’t store their money in mattresses. We could keep it in a bank, but it’s not insured like individual accounts, and, what is more, the bank will take that money and invest it for a profit. So, we invest it ourselves.

Why not? By putting the money to work, Health Plan X can either charge less for the risk or get a greater surplus at the end of the year. It’s usually a combination of both. That’s why savvy investors like Warren Buffet love insurance companies. This is the use of other people’s money.

Another small point: the “float.” Even if there is a risk event that must be paid, any delay in payment generates a little bit more investment interest income. The float can add up.

It used to be that insurers invested their money in dubious things (recall the union retirement accounts and Las Vegas casinos). Today, the investments are tightly regulated by the various states’ departments of insurance. Ultimately, each insurer is domiciled in one state and it is up to that state to make sure the investments are in quality investment vehicles. That definition of quality is why the various rating agencies are so important.

Alas, as we have learned, even quality can crash every once in a while and rating agencies are imperfect. Accordingly, having other people’s money decline in value while the risk is unchanged could lead to a deficit.

One other point: State regulators or rating agencies assess the financial health of an insurer by using the ratio of the amount of risk assumed versus the amount of surplus. While usual measures of profitability, such as PE ratios, medical loss ratios, and profit margins are important, the amount of risk (expressed on top, as a numerator) versus the amount of surplus (which gets built up year after year and is expressed as the denominator on the bottom) held by the company is a critically important metric of an insurers’ financial health.

So (for discussion purposes; the actual ratios used are considerably different), if the risk on top has liabilities of say $10 million and the amount of surplus is $10 million, the ratio is 1. But suppose the ratio is higher? That means the amount of risk exceeds the cushion in the surplus, and if there is a bad year (a lot of fires, hurricanes in Florida, a bad flu season, a report that a new stent cures all heart disease), Health Plan X will have to dig into its surplus. That decreases the overall value of our company.

Worst-case scenario: The surplus evaporates and Health Plan X goes belly up. If, however, we have low risk on top and high surplus on the bottom, the risk could be .8 or .7. That’s good.

If the investment mix on the risk capital is unfavorable compared to the surplus capital, that can play havoc on the ratios, which means that Health Plan X comes under increased pressure/scrutiny from the state regulators and rating agencies.

Last but not least, the for-profit insurance companies are also investments themselves. Savvy investors (like Buffet) undoubtedly look for those ratios to assess the health of those companies. What is more, the insurers themselves are subject to their own assessments of investment safety by the same kind of rating agencies that look at stocks (an example is A.M. Best).

So, if Health Plan X’s ratios get hit, our stock price is going to decline, which adds to the bad news and reinforces the negative feedback in the markets in general. So it’s not just the state regulators that get grumpy; so do the investors.

Jaan Sidorov, MD, is a former medical director at Geisinger Health Plan and now a consultant and member of Managed Care’s editorial board.

How will insurers make up the difference? Not through growing enrollment. The Kaiser Family Foundation estimates that about 9 million people are expected to lose employer-sponsored coverage. The underemployment rate, which includes those who are working part time but want full-time jobs (and their accompanying health benefits), stood at 15.6 percent in March, according to the Economic Policy Institute. “Now an estimated 24.4 million people — 1 in every 6 workers in this country — are either unemployed or underemployed. The number of involuntary part-time workers increased by 423,000 in March and by 4.4 million since the start of the recession,” the EPI reports.

Ken Jacobs, chairman of the University of California-Berkeley Center for Labor Research and Education, says, “Normally, health benefits are something that companies and individuals hold on to. Depending on how long-lasting this recession is and how deep, we could see some deeper changes.”

Even without the recession, the trends don’t appear encouraging, says Jacobs. “We are seeing a long-term decline in job-based coverage,” says Jacobs. “We go peak to peak from 2000 to 2007 and nationally, job-based coverage went down 5 percentage points” but the offer rate stayed pretty much the same.

Smaller companies, especially those with fewer than 10 employees, are particularly hard-pressed, says Fitzgibbon. “As for groups of over 200, just about 100 percent of those are insured, but it drops off pretty dramatically as the employee level declines.”

Ominous trends

Small businesses fueled the engine of economic recovery from recent recessions and may do so this time around, yet there is no guarantee that those added jobs will mean added covered lives.

Health plans may be tempted to make up for lost market share by raising premiums, but employers will have none of it, Reinhardt, the economist, says. “The employers will simply say, Look I just can’t do it.”

All the pressure points that this recession bears upon the health economy are difficult to track, says Jeff Goldsmith, PhD, a contributor to the Health Care Blog (http://www.thehealthcareblog.com/ [1]), a well read collection of opinions by credible authors. “The insulation that health insurance has traditionally provided workers against a recession has really burned away and there are a very large number of people who are nominally insured but who at a practical level can’t afford to get care. There is something on the order of 60 million people who are having trouble paying their medical bills and a significant fraction of those folks have health insurance.”

This is the case even though the American Recovery and Reinvestment Act of 2009, the stimulus, will subsidize COBRA for laid-off workers by up to 65 percent of premium costs. “It used to be that when you laid off 20,000 workers, maybe 20 percent of them might have the resources to buy COBRA,” says Reinhardt. “But now with that subsidy you might have 50 percent to 60 percent who can afford it. You are still losing market share, though.”

Sidorov adds: “In the meantime, the Obama administration and the media have painted insurers as evil, and even though they are funding COBRA, I’m not sure it is enough because the persons likely to keep it aren’t necessarily healthy. At any rate, now is no time to go public with any substantial premium increases to make up for the shortfalls.”

Now, some good news

Are any plans well-positioned? “It is not written that the larger plans will automatically dominate local markets,” says Goldsmith. “You go to a place like Wisconsin and you have a lot of health plans started out by physician groups like the Marshfield Clinic that are still a very large factor in that region’s health insurance system. They are probably going to do pretty well.”

The top 60 health plans in the country cover about two thirds of the people, Fitzgibbon estimates. None of those plans, as far as he can tell, are in danger of going out of business.

“The good thing about being in the health plan business is that as long as you can see a year down the road, you can adapt,” says Fitzgibbon. “If membership declines, you can adjust your infrastructure to that. If you get pricing resistance from employers, you can adjust the benefits to whatever the premium level is. Health plans are pretty adaptable.”

It will turn around

“Maybe not in the next year, but in the next few years it will turn around,” Reinhardt says. If health insurance reform works at all, it seems unlikely that there will be a Medicare-like, government-run competitor for non-elderly people. What that might mean is that an awful lot more federal money will flow to individuals in the form of subsidies and that they will be driven into the arms of the private insurance industry.

“In the short view, it is going to be tough,” he adds, “but if there existed in this country investment managers who had a five-year horizon, to my mind they would buy health insurance stock now.”

Looked at from one angle, you could even say that the recession is a needed corrective, says Goldsmith. “If there is good news for health plans, it is that the [entire] health care industry has entered recession. It is the only time I can remember in 30 years where I’ve seen prescriptions down, physician office visits down, and hospital admissions down all at the same time.”

Recession may be the only thing that can finally — finally! — help payers get a handle on runaway costs. There will be winners, insurers that have launched health improvement initiatives. “After years of trying to build metrics and databases that enable them to identify potentially high-risk, high-cost subscribers, they actually are in a lot of cases able to bend the cost trend for these folks,” says Goldsmith. “They are actually managing care by predicting health risk in advance of illness and intervening, not just trying to manage the cost of clinical services after they are needed. This is cutting-edge.

“It is a tiny fraction of enrollees who generate the majority of the cost in a group. The fact that health plans are learning how to manage those costs is a plus.”

Meanwhile, Sidorov says, “Now’s the time to hunker down, stick to underwriting, manage trend as much as possible, block and tackle — because that’s what you do in downturns. The market always softens up and good times lie ahead.”

Challenging times for health plans

We’ve never seen anything like this” is a phrase that economists have used with disheartening frequency since last September, when the first of the Wall Street meltdowns hit. Unprecedented challenges buffet every section of the economy.

In a draft of its soon-to-be-published 2009 Managed Care Industry Report, the consulting company KPMG states, “Most health care companies are finding that their businesses are less recession-resistant than previously thought, and the future is uncertain. Managed care companies are faced with declining enrollment as unemployment increases [in] a tough pricing environment. This will undoubtedly be a challenging year financially for managed care companies.”

Last month, this recession passed the 16-month-long recessions of 1974–1975 and 1981–1982 in terms of length. The fortunes of some health plans in 2008 offer a guide to just how damaging it has been. “Eight of the nine companies in this report suffered declines in net income and other key measures,” says KPMG. “... Premiums rose during the year, driven by increased medical costs. However, medical costs rose faster, resulting in higher medical cost ratios.”

The operating margin ratio (pretax operating profit divided by revenue) generally declined in 2008.

Just how bad will it get? “The price-earnings (PE) ratio reflects the market’s expectation of future earnings growth and risk. It is the ratio of a company’s stock price to its earnings per share. Industry PE ratios declined significantly in 2008.”

Source: KPMG, 2009 Managed Care Industry Report, May 2009

Note: Medical cost ratio is calculated by dividing medical cost expense by health care premiums. Pretax operating margin ratio is pretax operating profit divided by revenue. Price-earnings ratio is the year-end stock price divided by diluted earnings per share for the year. Because Kaiser is a not-for-profit corporation, no PE ratio is recorded.

Employer update

What affects employers affects heath plans. It’s difficult to separate what’s going on in the marketplace and the stock market and all the other financial problems besetting the economy from how health plans perform.

For instance, Jane Jensen, an office practice leader at Watson Wyatt Worldwide, predicts that health plans may be affected by many companies’ restructuring of their HR staffs. “Some of our employer clients — already lean in the HR department — have seen cutbacks in head count that have an influence on their vendor selections.

“In the past, an organization might have had an idea about ‘best in class’ outsourcing to multiple vendors. Now, with staff reductions and fewer dollars for complex administration, we have had clients revisit their approach to vendor management to look much more seriously at vendor consolidation. For large, national employers, that kind of vendor consolidation may end up favoring the larger, national players and hurt the smaller, local health plan.”

Jensen says that 2010 might be an even more difficult year for plans. “Through either direct plan reductions or premium increases that encourage movement to less costly plans, many employees are likely to be participating in less generous medical plans in 2010 than they are today,” she says. “One might anticipate a reduced demand for more elective health care services in 2010 as a result.

“However, to the extent that it is affordable, we also might see an uptick in utilization and cost yet this year as employees try to take advantage of the more generous plan designs of 2009.”

Given the recent events in the economy and financial markets, what changes do you expect to make?

Looking ahead to 2009 and beyond, which of the following best describes the future of HR cost-cutting measures in your company?

Source: Watson Wyatt Worldwide, Effect of the Economic Crisis on HR Programs, Update: February 2009

Note: Based on a survey taken in mid-February of HR executives at 245 companies.

Disquieting trends

These challenges could very well exacerbate long-term trends. In its Healthcare Industry Report, KPMG states that the percentage of people covered by employer-sponsored health plans has been declining for the last five years. “Almost all employers with more than 200 employees offer health coverage, but smaller employers are far less likely to offer coverage.”

In addition, “Even when firms offer health coverage, not all employees are covered,” says the report. “New employees are often not eligible until they have been employed for a specified period of time. In addition, part-time workers often do not qualify for coverage.”

Long-lasting effects

Of course, new employees and part-time workers may be a growing presence in an economic downturn — and beyond. The report No Recovery in Sight: Health Coverage for Working-Age Adults in the United States and California, by the University of California-Berkeley Center for Labor Research and Education states that the effects of this recession could be felt for years to come. “The health coverage landscape in 2012 could turn out to be worse than what is predicted in this brief, because the longer the recession lasts, the greater the likelihood it will result in deeper economic shifts that could shape employer-based health coverage in years to come.”

The report focuses on the growing problem of the uninsured. “The share of American adults between 18 and 64 covered through an employer-sponsored health plan fell from 69 percent in 2000 to 64.2 percent in 2007.” Meanwhile, “... the share of uninsured working-age adults went from 17.6 percent to 19.6 percent, for a total increase of 6 million adults without health coverage.”

Percentage of companies offering coverage

Percentage of employees covered by companies offering coverage

Source: KPMG, Healthcare Industry Report, Fourth Edition, 2009

Source: University of California-Berkeley Center for Labor Research and Education, No Recovery in Sight: Health Coverage for Working-Age Adults in the United States and California

Note: Policy brief uses data from the March Supplement of the household-based Current Populations Survey (CPS)