Health Care Reform's Impact on Health Insurers Part I

So how will the recently passed Patient Protection Act effect the health insurance industry. As I mentioned in a previous post, Wall Street reacted positively to the passage of the bill as stock prices of major publicly traded carriers rose right after its passage. Many look at the requirement to purchase coverage as a boon to the industry, creating over 30 million new customers. However while it is s true that, beginning in 2014, virtually all Americans will be required to buy insurance, or pay a fine, many will be refugees from a health care system that treated them poorly. Think of the boat as a life raft. These could be very expensive customers.

Moreover, between now and 2014, insurers will face some serious financial hits. These new regulations will make our health care system fairer and more affordable. But the rules also suggest that going forward, for-profit health insurance may not be a viable business--unless these companies learn how to keep patients healthy, while insisting on value for health care dollars. Insurers that over-pay drug-makers or hospitals will find that they can no longer turn a profit by simply passing the added expense along in the form of higher premiums.

Consider what will happen in the next three years:

1) This year, Washington sliced funding for private insurers who offer Medicare (a.k.a. Medicare Advantage) by 5%. Next year, payments will be frozen. In 2012, the serious cutting begins. Over ten years, Medicare will slash over-payments to Medicare Advantage insurers by $132 billion.

When the Medicare Advantage bill was passed in 2003, Congress agreed to pay Advantage insurers 12 percent more, per beneficiary, than it would cost Medicare to cover those patients itself . Most agree that this is corporate welfare that our health care system cannot afford.

But recent years, insurers have become increasingly dependent on the windfall payments from Medicare Advantage. As unemployment rises, insurers have been losing customers in the employer-based insurance market, and Advantage has come to represent a larger share of their profits. Humana, for example, has been receiving 60% of its operating income from Medicare Advantage.

Meanwhile, insurers selling plans in the private sector have been scrambling to rachet up premiums fast enough to keep up with the spiraling cost of healthcare. For ten years private insurers’ payouts to doctors, hospitals and patients have been climbing by roughly 8% a year. Rising prices plus volume have driven reimbursements skyward. Each year Americans are taking more medications and undergoing more surgeries and tests. And every year, virtually every product and service in our healthcare system costs more.

This is why, according to Morningstar Investment Research, the health insurance industry showed an average profit margin of just 3.4% in 2009. This means that, in terms of profitability, it ranked 87^th out of 215 US industries.

Given the skimpy profits that the industry has seen in recent years, generous subsidies from Medicare Advantage have remained a “bright spot” for companies such as industry leader UnitedHealth Group.

But under the reform legislation these fat Advantage subsidies will disappear, as they must, and Advantage insurers such as UnitedHealth Group will face tighter regulations. By 2014, insurance companies will be expected to pay out 85% of Advantage premiums for medical care, keeping no more than 15% of premiums to cover overhead and profits. Today, UnitedHealth Group keeps 19%. This is not unusual. The majority of Medicare Advantage plans pocket more than 15% of premiums according to a recent report released by the House Committeon Energy and Commerce.

Good-bye “bright spot.”

Only those insurers that can show that they are providing excellent value for Medicare dollars will continue to receive Medicare payments, and their subsidies will be much lower. Most likely, many insurers will simply give up on the once-lucrative Advantage business.

2) Next year, the new rules regarding pay-outs will apply to private sector plans. Insurers selling in the individual and small group market will be required to spend 80 percent of premium dollars on medical services, while plans in the large group market will be expected to spend 85 percent. Insurers that do not meet these pay-out thresholds will have to provide rebates to policyholders.

3) The new pay-out rules will make premium hikes far less profitable for insurers. Even if an company raises its premiums by 10%--for example, lifting a $14,000 annual premium for a family plan to $15,400--the insurer must pay out 85% of the $1,400 increase, or an additional $1,190 to hospitals doctors and patients , keeping only $210 of the $1,400 to cover overhead and profits.

4) Another new cost for insurers: beginning in 6 months, all new group health plans as well as new plans in the individual market will have to provide coverage for preventive services at no charge. Co-pays and deductibles will not apply to recommended services.

(5) Beginning this year, if you become seriously ill, insures won’t be able to drop your coverage on the grounds that you forgot some detail of your medical history when you applied for insurance. They will be able to rescind your policy only if they can prove fraud, or that you intentionally set out to deceive them. This won’t be easy.

(6) In 2011, insurers will no longer be allowed to cap how much they pay out to an individual over the course of his or her life. If a customer suffers from a serious illness that requires multiple hospitalizations and high-tech treatments over many years, the insurer faces an open-ended bill. Starting in 2014, insurers will no longer be able to limit how much they pay out annually.

Make no mistake: patients need this protection. Parents should not have to worry that the insurance covering a child suffering from cancer is going to “run out” if her care costs too much in any one year—or if she survives too long. But while the new rule is welcome, it will make the insurance business riskier: Actuaries will have a hard time guesstimating just how high those bills could mount, especially over 10 or 15 years. This is another reason why reform is far from a sweetheart deal for insurers.

(7) In 2011 it will become more difficult to raise premiums. Given falling Advantage reimbursements, coupled with rising expenses, one might assume that insurers would simply lift premiums to make up the difference. But it won’t be quite that easy. Reform legislation helps states insist that insurance companies submit justification for requested premium increases. Any company with excessive or unjustified premium increases may not be able to participate in the new health insurance exchanges.

Already, some state regulators are getting tougher. In March, the Providence Journal reported that Rhode Island’s state health insurance commissioner slashed proposed premiums increases, keeping rate increases in the single digits, while calling Blue Cross's proposed 14.6-percent hike "just not affordable." And in April the Massachusetts insurance commissioner rejected nearly 9 out of 10 rate increases—ranging from 7% to 34%--that the state’s health insurers had requested for individual and small group plans as I have mentioned in previous posts.

So while there will be many new customers out there for health insurers, the prospect of them being profitable ones is limited.

Future posts will look at other aspects of the bill.