a cademy of · under universal coverage, the health plan pricing environment would change greatly....

M O N O G R A P H S E R I E S O N H E A L T H C A R E R E F O R M

Actuarial Issues Related to Pricing Health Plans Under

Health Care Reform

July 1994

Monograph Number Ten

AMERICAN■ ■ ■

ACADEMY of■ ■ ■

ACTUARIES

The American Academy of Actuaries is a national organization formed in 1965 to bring together into a single entity actuaries of all specialties within the United States.

In addition to setting qualification standards and standards of actuarial practice, a major purpose of the Academy is to act as the profession’s public information organization.

Academy committees regularly prepare testimony for Congress, provide information to congressional staff and senior federal policy makers, comment on proposed federal regulations,

and work closely with state officials on issues related to insurance.

The Academy’s nine-member Health Plan Pricing Work Group prepared this paper. The Academy’s Health Practice Council has charged this work group with identifying and describing

the issues, problems, and information needed to adequately price health plan products under President Clinton’s proposed Health Security Act.

The members of the Health Plan Pricing Work Group are:

Paul R. Fleischacker, FSA, MAAA, ChairJudith A. Discenza, FSA, MAAA

Martin S. Huey, FSA, MAAAJames A. Hughes, MAAA

David G. Josephson, FSA, MAAAPhilip J. Lehpamer, FSA, MAAA

Frank Rubino, FSA, MAAAMark D. Wernicke, FSA, MAAAPaula S. Wickland, FSA, MAAA

TABLE OF CONTENTS

EXECUTIVE SUMMARY ..........................................................................................................1

INTRODUCTION ...........................................................................................................................4

THE CURRENT ENVIRONMENT ....................................................................................5

SETTING HEALTH PLAN PREMIUMSIN A REFORMED SYSTEM .....................................................................................................6

Assessing Risk in the Covered Population .......................................................................................6Community Rating .........................................................................................................................7Guaranteed Issue ............................................................................................................................8Guaranteed Access ..........................................................................................................................8

NEWLY COVERED BENEFITS ............................................................................................9Scope of Benefits ............................................................................................................................9Lack of Historical Data for Newly Covered Benefits .......................................................................9Impact of Limitations and Exclusions ...........................................................................................10

ESTIMATING PROVIDER PAYMENTS .......................................................................11Retrospective Adjustments ............................................................................................................11Expanded Access to Underserved Areas ........................................................................................11Freedom of Choice—Providers and Health Plans..........................................................................12Centers of Excellence....................................................................................................................12

OTHER ISSUES SURROUNDINGPREMIUM RATE DEVELOPMENT ................................................................................13

Risk Adjustment Mechanism.........................................................................................................13Non-Termination..........................................................................................................................13Geographical Cost Differences ......................................................................................................13Pricing Constraints .......................................................................................................................14Corporate Alliances.......................................................................................................................14Workers’ Compensation and Automobile Insurance ......................................................................14Administration and Marketing Costs.............................................................................................15Reinsurance ..................................................................................................................................15

A M E R I C A N A C A D E M Y O F A C T U A R I E S■ ■ ■

CONCLUSIONS .............................................................................................................................16

APPENDIX .......................................................................................................................................17Importance of Utilization and Unit Cost Information

in Health Plan Pricing ..........................................................................................................17


EXECUTIVE SUMMARYUnder President Clinton’s Health Security Act1, managers of health plans2 will confront diverse issues, problems,and data needs that they will have to respond to if they wish to continue adequately pricing their products. Thesefactors will affect their existing benefit and rating structures. Without significant changes, historical experience, rat-ing assumptions, and pricing methods for existing products may not be appropriate for projecting the future. As aresult, pricing uncertainty and financial risk for health plans will be greater under health care reform than in the past,particularly during the first few years of implementation.

The Current Environment

Traditionally, health plan pricing has involved collecting individuals (and/or groups) together into “classes.”Premiums have then been determined for each class, targeted to reflect the particular risk presented in a given class.This approach has been used for most types of insurance, as well as by health maintenance organizations (HMOs).

In this environment, it is important to match products and prices with the needs, expectations, and values of poten-tial consumers. In the health insurance/HMO arena, there are many ways to segment the market in order to accom-plish this. Most health plans divide the general population into three categories of business: individuals, smallgroups, and large groups. Consumer values and expectations, along with health plans’ products, underwriting, andpricing, usually differ among these three segments. The segments themselves introduce an element of homogene-ity into the determination and pricing of benefits for the classes within them. The reward for using such a complexsystem is an added level of precision in establishing premium rates that meet company and consumer goals.

Setting Health Plan Premiums in a Reformed System

Under universal coverage, the health plan pricing environment would change greatly. Health plan managers wouldneed to determine the relative impact that different consumer needs and perceptions would have on product pric-ing in a universal access environment. For at least the first several years after enactment of health care reform, healthplan managers would not be able to rely on historical results within a segment to estimate the impact of futureclaims.

A fundamental factor in determining the cost of a health care plan is the profile of the population selecting the ben-efits. Under the Act, individual insureds, rather than their employer, would select a health plan. As a result, healthplans would have virtually no control over which individuals select their plans, and the demographics and healthcharacteristics of existing health plans may change in unknown ways. Health plans would assume significant pricingrisk until their risk pool stabilizes, since their prior experience may no longer be credible.

In addition, universal coverage and community rating requires that the broadest of bases (total population) will paythe broadest of premiums (the community rate). Contrary to what intuition might suggest, the risk of error increas-es when the most general estimate is used over the broadest of bases because of the lack of homogeneous risks.Community rating, guaranteed issue, and guaranteed access increase health plan pricing uncertainty and risk. Thiswould be particularly true for those health plans that have not been required to operate in that type of environment,since prior experience may well be irrelevant for predicting future utilization and costs.


1

1Hereafter referred to as the Act.2Health plans, as used in this monograph, refer to vendors who will market their products to regional and/or corporate alliances.They include insurance companies, Blue Cross and Blue Shield plans, health maintenance organizations (HMOs), and preferredprovider organizations (PPOs).

Newly Covered Benefits

Under the Act, health plans would be required to provide a guaranteed standard benefits package. The differencebetween the scope and limitations of the proposed benefits, compared with what is included in current products,would add to the uncertainty involved in pricing these health plans. There would be greater uncertainty with pro-jected claims costs during the initial years of reform because the new benefits package detailed under the Actincludes some benefits that are not typically covered under current indemnity or prepaid HMO plans, so little, ifany, historical data would be available.

In the absence of credible experience data, health plans would have to rely on data from existing indemnity bene-fits or government programs, adjusted by estimates of the value of benefit differences for pricing the new benefits.However, the adjusted data may not accurately reflect expected utilization or costs under coverages not previouslyavailable. Also, utilization and/or costs would likely increase once coverage for additional services commences.

Finally, limitations and exclusions that are more or less restrictive than similar provisions currently included undertypical health plans may also present pricing problems. More restrictive limitations may deter individuals from usingservices, while the absence of any limitation might encourage unnecessary or increased utilization relative to existing plans.

Estimating Provider Payments

Another source of pricing uncertainty is estimating provider payments, which are a health plan’s primary expense.Uncertainties here may give rise to significant risk.

Under the Act, health plans would enter into agreements with providers. Health plan managers would be requiredto know how health care providers will be paid and how changes in the method of payment will affect total pay-ments. They would also be required to be able to estimate the effect of any differences in providers’ payment meth-ods and reimbursement amounts.

Health plan managers would also need to evaluate the impact on rates of any global budgeting constraints and the impo-sition of fee schedules. It would be important for them to know if a fee schedule is mandatory or optional and to whichplans it applies. In addition, health plan managers would need to know whether health plans will be allowed to negoti-ate and use lower fees than the schedule. One provision of the Act requires the use of region-wide fee-for-service sched-ules. Currently, there are big differences in provider fee schedules in most regions, so a new uniform schedule wouldredistribute revenue among providers—with unknown ramifications for existing networks and health plans.

On these issues, as well as many others discussed in this monograph, timing and/or data availability problems mayhave an impact on pricing. For example, budgeting constraints and the imposition of fee schedules may not beknown before pricing is completed or, if known, there may not be relevant experience data to estimate their impact.

Health plans would need information on any retrospective adjustments that can, or must, be made. These wouldinclude arrangements like retroactive recoveries from providers in the event a global budget is exceeded or a healthplan’s premium exceeds a threshold level. In addition, health plans would need to know the type of recovery, suchas a flat percentage recovery from all providers and the timing of any recoveries. Some of these cross-plan subsidieswill not be known or may be unknowable at the time prices are determined, resulting in potentially significant riskand uncertainty.

Other Issues Surrounding Premium Rate Development

Risk Adjustment Mechanism. Two provisions of the Act, community rating and guaranteed issue, make somekind of risk adjustment mechanism a necessity. Without effective risk adjustment, health plans will be motivated toavoid high-risk individuals and groups. An appropriate risk adjustment mechanism may also reduce some of theimpact of pricing uncertainty, e.g., the demographic composition of a health plan’s population.

P R I C I N G H E A L T H P L A N S U N D E R H E A L T H C A R E R E F O R M■ ■ ■

2

Once a risk adjustment system is in place, a health plan’s manager will be required to determine how to price prod-ucts based on system guidelines and rules. These may include both prospective and retrospective payments to, orreceipts from, a risk pool and corresponding adjustments in premium rates. Given all the unknowns, the timing andcoordination of risk adjustment data and payments among all the various players will be a major challenge, and addsto the uncertainty in the pricing process.

Risk adjustment mechanisms, by themselves, cannot be expected to resolve every difference between health plans. Thelevel of sophistication contemplated for these factors, at least initially, will make that impossible. Even with risk adjust-ments, some health plans will keep trying to attract enrollees who will use fewer services than the average participant.

If financial incentives toward favorable risk selection continue, health plans that attract worse than average riskswould face pricing or financial difficulties. The ultimate impact on premium levels could very well be the same kindsof pricing spirals observed in a non-mandated market.

Non-Termination. Under the Act, health plans are legally obligated to provide medical care even when premium’s havenot been paid. Consequently, premium rates would most likely have to be increased to reflect uncollectible premiums.

Geographical Cost Differences. Cost differences among various areas of the country (and even among regionswithin states) are commonplace and are routinely managed under the current system. In the local environment con-templated in regional health alliances, coupled with community rates, this challenge may be more difficult to man-age if the alliance covers a broad geographical area with widely varying provider costs.

Pricing Constraints. Health plans would also need to consider government constraints on pricing. Overall, underthe Act, the NHB is given very broad powers to set premium and expense caps. Health plan managers would berequired to stay informed about the NHB’s regulations and to modify their premium rates accordingly. However,whether the premium cap will be high enough to allow health plans to charge the premiums required to cover theiranticipated medical and administration expenses is an open question.

The NHB will also determine regional target premiums and promulgate inflation factors for each regional alliance.The information required for determining regional adjustment factors does not currently exist. Thus, regional tar-gets will involve tremendous uncertainty; they may reflect overestimates for some regions and underestimates forothers, with some health plans bearing the financial consequences. In addition, timing differences between theestablishment of regional inflation factors and health plan bids will also add pricing uncertainty as health plansattempt to set prospective premiums.

Conclusions

There is always some degree of uncertainty in developing any health plan premium. The wholesale restructuring ofthe U.S. health care financing system that would ensue after enactment of the Health Security Act would add enor-mously to the pricing uncertainty for a health plan trying to establish an adequate premium.

This discussion has identified four major issues and conclusions.

■ The demographics and health characteristics of existing health plans may change in unknown ways, since indi-viduals would directly select their plan, and new populations (e.g., the uninsured) would enter the system. Thefinancial consequences to many health plans would be unpredictable, and their prior experience may no longer becredible.

■ Newly covered services (e.g., investigational treatments) would be difficult to price accurately at first becausethere are no historical data for basing reasonable estimates.

■ After-the-fact cross-plan subsidies and the unknown impact of government subsidization would make initial pric-ing very risky.

■ Pricing constraints imposed on health plans through global budgets and premium and expense caps may con-strain premiums to levels that may prevent some plans from collecting enough money to stay in business.


3

INTRODUCTIONUnder President Clinton’s Health Security Act, managers of health plans will confront diverse issues, problems, anddata needs that they will have to respond to if they wish to continue adequately pricing their products. These fac-tors will affect their existing benefit and rating structures. Without significant changes, historical experience, ratingassumptions, and pricing methods for existing products may not be appropriate for projecting the future. As aresult, pricing uncertainty and financial risk for health plans will be greater under health care reform than in the past,particularly during the first few years of implementation.


4

THE CURRENT ENVIRONMENTTraditionally, the pricing of health plans has followed the approach used for pricing other types of insurance.Individuals (and/or groups) have been collected together into “classes,” and premiums have been determined foreach class. Like other types of insurance, premiums have been targeted to reflect the particular risk presented in agiven class. A class can be defined according to factors like age, gender, health history, geographic location, etc.The goal of this procedure has been to match the premium charged for benefits with the best estimate of the valueof benefits expected to be delivered to all the people within each class.

This traditional insurance approach has been used for most types of insurance, as well as by health maintenance orga-nizations (HMOs), in a free market environment. In such an environment, it is important to match products andprices with the needs, expectations, and values of potential consumers. Consumers can choose to purchase a com-peting carrier’s product—or make no purchase at all—if premium levels do not match the values they attach to theproduct.

The actuary’s challenge has been to meet price competition and consumer demands by assessing risk and matchingprices with those risks. Actuaries have also proposed various methods for determining classes for grouping insureds,which help companies achieve the goals of growth, profitability, and equity.

In the health insurance/HMO arena, there are many ways to segment the market. However, most health plansdivide the general population into three categories of business: individuals, small groups, and large groups.Consumer values and expectations, along with health plans’ products, underwriting, and pricing, usually differamong these three segments; many health plans focus their marketing efforts on only one or two of them. The seg-ments themselves introduce an element of homogeneity into the determination and pricing of benefits for the class-es within them. Similarly, each segment presents different types of challenges. The reward for using such a com-plex system is an added level of precision in establishing premium rates that meet company and consumer goals.


5

SETTING HEALTH PLAN PREMIUMS IN A REFORMED SYSTEM

Under universal coverage, the old “rules” would disappear. There would no longer be a set of common problemsto be solved. In fact, the challenge would be to determine the relative impact that different consumer needs andperceptions would have on product pricing in a universal access environment. To take one admittedly extremeexample, historical experience in large employer/union-negotiated programs, which typically have a rich package ofbenefits, has been much different from the experience in the individual purchaser market, which reflects a more cost-conscious, carefully limited product design. For at least the first several years after enactment of health care reform,actuaries will not be able to rely on historical results within a segment to estimate the impact of future claims. Forexample, actuaries will be required to consider how an individual purchaser will respond to the significantlyincreased benefit levels provided under the Act, particularly if some treatments were not previously covered.

Assessing Risk in the Covered Population

A fundamental factor in determining the cost of a health care plan is the profile of the population selecting the ben-efits. With universal coverage and community rating, the broadest of bases (total population) will pay the broadestof premiums (the community rate). Contrary to what intuition might suggest, the risk of error increases when themost general estimate is used over the broadest of bases because of the lack of homogeneous risks.

The “new” insureds will come from two sources in the current population: people who have been insured, includ-ing those covered by Medicaid and possibly Medicare, and the uninsured. Under the Act, individual insureds, ratherthan their employer, would be able to select their health plans. The net result may be substantial switching backand forth among health plans and (at least initially) significantly greater pricing uncertainty and risk.

The Currently Insured. To measure the impact current insureds would have on the cost of coverage in a univer-sal coverage environment, it is helpful to divide them into subgroups and attribute rating characteristics (demo-graphics, health status, and other characteristics affecting utilization) to each. In addition, there are some factorsthat influence which kind of coverage or plan a person will choose. To the extent that the rating characteristics of thoseselecting one health plan differ from those who select another, the expected costs of the plans will vary by more than thevalue of their coverage alone.

The subgroups are based on individuals’ previous source of coverage:

■ Individual coverage;■ Employer-sponsored coverage, both small and large groups;■ Medicaid; and■ Medicare.

Except for those covered under Medicaid and Medicare, individuals in these subgroups are generally employed andare assumed to be in better health than the general population.

No doubt, there are some unhealthy people in the insured population, including those who get coverage when theyare healthy and then get sick. There are, in addition, former employees who, if they can’t get standard coverage,take advantage of extensions of coverage through the group conversion and Consolidated Omnibus BudgetReconciliation Act (COBRA) provisions. Unhealthy dependents are also included among the insured population.

Right now, the people who are covered by Medicaid qualify for it because of low income and/or resources. To theextent that low income is associated with, or due to, poor physical or mental conditions, these people may gener-ate higher claim costs. Offsetting the higher costs from poor physical condition, however, may be lower costs fromthis group’s lower average age and lower propensity to seek treatment.


6

It should also be assumed that, under any managed care plan or health care reform plan, insureds will be urged touse preventive care and to seek early intervention before a condition worsens. They will be encouraged to obtainneeded care rationally, seeking treatment in physician offices instead of hospital emergency rooms, for example.

Most Medicare enrollees are over age 65 and have higher than average claim costs just because they are older and generallyless healthy. Many disabled and/or dialysis-dependent individuals at any age are covered by Medicare, and they, too, typi-cally have higher claim costs.

The insured population represents a broad cross-section of health risks. Because Medicare or group insurance cov-ers virtually everyone age 65 and older, the insured population is older, on average, than the general population.Since morbidity increases with age, the average cost of a plan with a disproportionate number of older individualscan be higher, and therefore unattractive, to younger individuals.

The Currently Uninsured. For the uninsured, major subgroups are not so easy to identify. Some of the reasonswhy people are not insured overlap. Furthermore, except for the older and disabled populations, many people inthis population lack coverage because they are between jobs; so their rating characteristics are actually a lot like seg-ments of the insured population. For convenience, the following subgroups can be considered:

■ Healthy individuals;■ Uninsurable individuals (defined below) at all ages; and■ Individuals (whether healthy or not) who cannot afford insurance.

Many healthy individuals, typically younger people, are uninsured because they have decided they do not need cov-erage or they are not able (or willing) to pay for it. Including this group in any health insurance plan may serve toreduce the average cost of the plan.

“Uninsurables” are people whose health status precludes them from obtaining coverage through individual or smallgroup health plans that are underwritten. In general, they have higher than average claim costs; they may be undertreatment for acute and/or chronic conditions. As a result, any bias on their part in selecting a health care plan canhave an enormous impact on the cost of the plan. Such bias might develop if a health plan gains a reputation fortreating certain expensive conditions effectively or if the benefits under a given plan seem more advantageous tounhealthy risks.

Of the individuals who cannot afford insurance, young people with low earnings ability will likely have low averageclaim costs and therefore decrease the average cost of a plan. Older people, people whose lifestyles don’t promotegood health, or people who have poor health histories will likely increase the average cost of a plan.

Since health plans would have virtually no control over which individuals select their plans, the plans will be assum-ing significant pricing risk until their risk pool stabilizes and experience develops over a period of time.

Community Rating

Community rating under the Act would require that each health plan have a single set of rates for each plan designin a given regional alliance (geographical) area. Rates would vary by family type (single, couple, one-parent family,or two-parent family). All individuals who apply for coverage from the health plan and pay contributions will havecoverage and be charged the same rate, regardless of health status, age, or gender.

Health plans that currently insure an older and/or sicker population relative to those that cover younger and/orhealthier individuals (assuming no changes in covered populations) would have higher average coverage costs and,therefore, higher community rates (unless legal constraints are placed on them). Since individuals, not employers,would be choosing their own health plans, a given plan could attract a relatively different population than its cur-rent group of enrollees. Furthermore, within a regional alliance, if the area to be covered by the alliance is too large,health plans located in high-cost areas would be at a disadvantage relative to those in lower-cost areas. (See theAcademy’s Monograph, Actuarial Perspectives on Regional Health Alliances.)


7

As a result, prior health plan experience may not reflect either the demographic composition or health status of the“new” covered population. This would introduce a high degree of uncertainty into pricing. In addition, the healthstatus of the 39 million uninsured, and which plans they will choose, is an unknown at this point. Also, workersover age 55 would be eligible for subsidized early retirement health benefits. The federal funding for these peoplewould probably be worked into the community rates offered through the health alliances. Thus, it would be veryimportant for all health plans to reevaluate their current rating methodology and assumptions.

A goal of each health plan would be to set rates to ensure that its total premium covers the medical care costs of allenrollees, plus expenses and profit. Under the Act, within a given rate tier (single, couple, one-parent family, andtwo-parent family), competing health plans’ premiums will be averaged; the employer would pay 80% of the aver-age, and the employee would pay the balance. Thus, health plans with premiums that fall below the average wouldhave lower employee contributions, while health plans above the average would require higher employee contribu-tions. Individuals would select health plans based, in part, on how much they will have to contribute. Health planmanagers will have to make decisions on the relationship of the rate tiers to each other, in light of where their rateswill fall relative to the average.

Health plans that have insured employees for whom the employer previously paid more than 80% of the premiumcost, for relatively rich plan designs, would need to consider the potential impact on their covered population andcosts if the employer decides to reduce contributions. Individuals may opt for a lower-contribution plan so theydo not have to pay more for coverage than before; this will alter the health plan’s demographic composition. Whenpricing any plan design, the employee cost of paying for deductibles, coinsurance, and copays should be consideredas well. The complexities involved in setting and collecting premiums in the instance of two-worker families shouldalso be evaluated.

Guaranteed Issue

The Act calls for guaranteed issue coverage. Implementation of this would have an effect on price determination,particularly in the early years of the program. This factor is particularly important for health plans that currently arenot required to provide coverage to all who apply and that deny coverage to individuals if there is no reasonable ratesufficient to cover their expected claim costs. For such health plans, it probably would not be appropriate to usehistorical experience in pricing, since it cannot reveal much about expected future experience, which would unfoldunder a whole new set of rules.

Guaranteed Access

Traditional indemnity plans are designed to provide access to any provider. A patient’s unrestricted choice ofproviders can widen the price gap between benefit plans with and without this feature, that is, between traditionalindemnity and managed care plans. This may result in selection against certain health plans, because individualsselect plans that best meet their needs. Health plans must account for this gap, as well as for adverse selection, intheir pricing.

Adverse selection by providers can also occur. Some believe that traditional indemnity plans will provide far bettermonetary rewards than managed care plans so they elect to stay out of network (managed care) plans. The shiftfrom a group choice system to an individual choice system may encourage this type of adverse selection amongproviders, and thus put more pricing pressure and uncertainty on the indemnity plans.

In conclusion, the issues relating to potentially different insured populations, community rating, guaranteed issue,and guaranteed access would increase both the uncertainty and risk in health plan pricing, since prior experiencemay well be irrelevant for predicting future utilization and costs.


8

NEWLY COVERED BENEFITSUnder the Act, health plans would be required to provide a guaranteed standard benefits package. The differencebetween the scope and limitations of the proposed benefits, compared with what is included in current products,would add to the uncertainty involved in pricing these health plans. There would be greater uncertainty with pro-jected claims costs during the initial years of reform because of the new benefit package. (See the Academy’sMonograph Number Five, Actuarial Issues Involved in Evaluating a Guaranteed Standard Benefit Package underHealth Care Reform.)

Scope of Benefits

The Act stipulates that three plans, with different cost sharing levels, must be offered: (1) a high cost sharing indem-nity fee-for-service plan; (2) a low cost sharing HMO plan; and (3) a combination cost sharing point-of-service(POS) plan that combines in-network HMO coverage and out-of-network fee for service coverage. All three planswould cover the same services, as outlined in §1101 of the Act.

The guaranteed standard benefits package stipulates the extent and scope of benefits that must be provided by allhealth plans. Beyond that, certain benefits may be added at the plan’s discretion. For example, coverage of inves-tigational treatments, health education classes, mental health/substance abuse intensive non-residential treatment,and case management are not required. But in reality, competitive pressures on price, as well as the need to com-ply with global budget limitations, may preclude many health plans from offering discretionary benefits.

Lack of Historical Data for Newly Covered Benefits

The proposed guaranteed standard benefits package includes some benefits that are not typically covered under cur-rent indemnity or prepaid HMO plans, so few, or no, historical data are available. These include:

Service (Reference Act §) Indemnity Products HMO

Health professional consultantsfor well individuals (§1112) No Yes*

Clinical preventive services (§1114) No Yes

Family planning services (§1116) No No

Vision care to age 18 (§1125) No** No**

Dental care to age 18 (§1126) No** No**

Health education classes (§1127) No Yes

Investigational treatments (§1128) No No

*Limited coverage may be provided.**Services may be covered as an optional benefit.

In the absence of credible experience data, health plans would have to rely on data from existing indemnity bene-fits or government programs, adjusted by estimates of the value of benefit differences for pricing the new benefits.However, the adjusted data may not accurately reflect expected utilization or costs under coverages not previously


9

available. (See Appendix, page 17.) Utilization and/or costs would likely increase once coverage for additional services commences.

Health plans would need to make assumptions about changes in utilization and costs in developing projections forprices. Section 6002(b)(2)(C) of the Act recognizes the need for such adjustment in connection with the NationalHealth Board’s (NHB) development of the national per capita baseline premium target. Nevertheless, there wouldbe greater uncertainty with regard to both premium targets established by the NHB and premium rates developedby health plans. (See the Academy’s Monograph Number Six, Actuarial Issues Related to Budget Development andEnforcement Under Health Care Reform.)

In any health plan, increases in the level or scope of benefits without increased employee cost sharing generally resultin increases in the utilization of services and, sometimes, the average charge for such services. For example, it ishoped that providing more benefits for preventive services will yield long-term favorable changes in people’s under-lying health status, thereby lowering the incidence of acute and chronic medical conditions. However, the short-term consequence of these new benefits may, instead, lead to increased (induced) demand for services, which woulddirectly affect the cost of the benefit.

Impact of Limitations and Exclusions

Limitations and exclusions that are more or less restrictive than similar provisions currently included under typicalhealth plans may also present pricing problems. More restrictive limitations may deter individuals from using ser-vices, while the absence of any limitation might encourage unnecessary or increased utilization relative to existingplans.

In summary, these differences in benefits, limitations, and exclusions would result in greater uncertainty in healthplan pricing, since prior experience may not be representative of what happens with future utilization and costs.


10

ESTIMATING PROVIDER PAYMENTSProvider payments are a health plan’s primary—and biggest—expense; uncertainties here may give rise to significantrisk.

To price a health plan properly, it is necessary to know how health care providers will be paid and what the effectof changes in the method of payment will have on total payments. Currently, most indemnity plans pay institutionalproviders on a charge or a per diem discounted-charge basis, and physicians on a fee-for-service basis. HMOs, onthe other hand, may pay institutional providers on a per diem or discounted-charge basis, but may also pay them ona diagnostic-related group (DRG) or similar basis. Physicians within HMO practices may be paid on a salary, cap-itation, or discounted fee-for-service basis. Further, a portion of the payments to HMO providers may be withheldthrough risk sharing and/or incentive payment arrangements and paid out only if preset cost and/or utilizationgoals are achieved.

Under the Act, health plans would enter into agreements with providers. The health plans may form restricted net-works of physicians and institutional providers, who may agree to any of the reimbursement methods describedabove. To the extent there are differences in the methods and the amount of reimbursement, or in which providerswill receive payments, health plan managers must be able to estimate the effect of these differences.

Further, in properly pricing the combination cost sharing or POS plan, managers would have to make an accurateestimate of the amount of out-of-network utilization that will take place and its impact on the cost of the plan. Theamount would vary by plan and geographic area. Some examples of reasons for going out of network include guar-anteed access to academic health centers, students at a school outside of the network area, and people who simplychoose to use a provider who is not part of the network (self-referral).

Health plans will also need to evaluate the impact on rates of any global budgeting constraints and the impositionof fee schedules. It is important to know if a fee schedule is mandatory or optional and to which plans it applies.It must also be determined whether health plans will be allowed to negotiate fees lower than the schedule or uselower fees or charges if their provider charges are already less than the schedule. One provision of the Act requiresthe use of region-wide fee-for-service schedules. Currently, there are big differences in provider fee schedules inmost regions, so a new uniform schedule would redistribute revenue among providers—with unknown ramifica-tions for existing networks and health plans.

On these issues, as well as many others discussed in this monograph, timing and/or data availability problems mayhave an impact on pricing. For example, budgeting constraints and the imposition of fee schedules may not beknown before pricing is completed or, if known, there may not be relevant experience data to estimate their impact.

Retrospective Adjustments

Health plans will also need information on any retrospective adjustments that can, or must, be made, includingarrangements like retroactive recoveries from providers in the event a global budget is exceeded or a health plan’spremium exceeds a threshold level. In addition, health plans would need to know the type of recovery, such as aflat percentage recovery from all providers, and the timing of any recoveries. Some of these cross-plan subsidies willnot be known or may be unknowable at the time prices are determined, resulting in potentially significant risk anduncertainty.

Expanded Access to Underserved Areas

Two interim challenges arise when access is expanded into previously underserved areas. First, current medical prac-tice patterns are unknown and will likely change with expanded access. The financial impact of this would be diffi-cult to estimate, adding to pricing uncertainty. Prices can only be stabilized after local patterns are established.Second, high initial utilization could result when previously unavailable services are covered by a plan.


11

Freedom of Choice—Providers and Health Plans

In a mandated but free market, the right to switch health plans without penalty creates pricing uncertainties for allhealth plans. In the pre-reform market, patients (especially those in traditional programs) can change providers atwill to find what they believe is the best treatment for their conditions. Even after reform, pricing uncertainties maypersist within traditional plans.

With annual open enrollment, the same situation could evolve at the level of the health plan. A patient could decideto stay with or find a new provider who’s well suited to his or her needs, even if access to that provider meant chang-ing health plans. Without an extremely refined risk adjustment system, this weakness in control may create pricediscrepancies.

Centers of Excellence

To the extent that a certain facility has a superior reputation for particular courses of treatment, its cost, relative tothose of other providers, may be significantly different. There may be an impact on prices charged to the local pop-ulation, depending on payment protocols. In addition, to the extent that certain health plans attract local patientswith conditions treated at these centers, their prices will be affected accordingly. Also, some managed care plansthat contract with centers of excellence located outside of the plan’s service/geographical area would also be affect-ed.


12

OTHER ISSUES SURROUNDING PREMIUM RATE DEVELOPMENT

Risk Adjustment Mechanism

Two provisions of the Act, community rating and guaranteed issue, make some kind of risk adjustment mechanisma necessity. Without effective risk adjustment, health plans will be motivated to avoid high-risk individuals andgroups. An appropriate risk adjustment mechanism may also reduce some of the impact of pricing uncertainty, e.g.,the demographic composition of a health plan’s population. (See the Academy’s Monograph Number One, HealthRisk Assessment and Health Risk Adjustment: Crucial Elements in Effective Health Care Reform.)

Once a risk adjustment system is in place, a health plan’s manager will have to figure out how to price its productsbased on the system’s guidelines and rules. These may include both prospective and retrospective payments to, orreceipts from, a risk pool and corresponding adjustments in premium rates. For health plans that have to pay intothe pool, the risk adjustment mechanism would likely require higher premiums. On the other hand, some healthplans would receive risk adjustment refunds. Barring any regulatory requirements, these health plans would haveto decide whether to lower premiums to reflect the refund or to add the refund to their surplus. Given all theunknowns, the timing and coordination of risk adjustment data and payments among all the various players will bea major challenge, and adds to the uncertainty in the pricing process.

Risk adjustment mechanisms, by themselves, cannot be expected to resolve every difference between health plans.The level of sophistication contemplated for these factors, at least initially, will make that impossible. Even with riskadjustments, some health plans will keep trying to attract enrollees who will use fewer services than the average par-ticipant.

If financial incentives toward favorable risk selection continue, health plans that attract worse than average riskswould be faced with pricing or financial difficulties. The ultimate impact on premium levels could very well be thesame kinds of pricing spirals observed in a non-mandated market.

Non-Termination

Under the Act, health plans are legally obligated to provide medical care even when premium’s have not been paid.So premium rates would have to be increased to reflect uncollectible premiums. The effect on different health planswould vary, and price differences may be caused by the timing and level of revenues ultimately received.

Geographical Cost Differences

Cost differences among various areas of the country (and even among regions within states) are commonplace androutinely managed under the current system. In the local environment contemplated in regional alliances, coupledwith community rates, this challenge may be more difficult to manage if the alliance covers a broad geographicalarea with widely varying provider costs. (See the Academy’s Monograph, Actuarial Perspectives on Regional HealthAlliances.)

One potential problem for pricing involves travel outside a participant’s home area. The reason for the travel couldhave a significant effect on the extent of pricing complexity that results. Travel may range from the “two home”situation to the incidental circumstance of vacation or, more importantly, to travel for treatment of specific illness.The impact of each of these must be examined when premium levels are set. Emergencies can occur when peopleare (temporarily) outside their local service areas. The definition of payment protocol for these situations must bevery clear. Health plan pricing must recognize these costs, as well as the rules for determining payment.


13

The causes or results of these types of travel will have different effects by region of the country. For example, vaca-tion areas will have seasonal influxes of population; “college towns” will have lower than average use of services. Inaddition, the adequacy of risk adjustment compensation for such factors must be considered. Health plans that coverdifferent geographic areas will have to adjust their different data sets to reflect such variations by area.

Pricing Constraints

Health plans will also need to consider government constraints on pricing. Overall, under the Act, the NHB willhave very broad powers to set premium and expense caps. Health plan managers would be required to stay informedabout the NHB’s regulations and to modify their premium rates accordingly. However, whether the premium capwill be high enough to allow health plans to charge the premiums required to cover their anticipated medical andadministration expenses is an open question. For example, under the Act, premium caps are to include an allowancefor administration equal to no more than 15% of the projected per capita health care expenditure, or 15% / (100%+ 15%) = 13% of the total target premium. Of that 13%, health plans must, or may be required to, pay the federalgovernment to support academic health centers and graduate medical education, regional alliance administration,state premium taxes, and contributions for a state guaranty fund. Collectively, these payments alone might take asmuch as 8% of premium, leaving only 5% of premium for the health plan’s own administration. Many health plansmay find this amount inadequate. (See the Academy’s Monograph Number Nine, Administrative Costs for RegionalAlliances and Health Plans Under the Health Security Act.)

The NHB will also determine regional target premiums and promulgate inflation factors for each regional alliance.The information required for determining regional adjustment factors does not currently exist (although somenational data exist). Thus, regional targets will involve tremendous uncertainty; they may reflect overestimates forsome regions and underestimates for others, with some health plans bearing the financial consequences. In addi-tion, timing differences between the establishment of regional inflation factors and health plan bids will also add pric-ing uncertainty as health plans attempt to set prospective premiums. (See the Academy’s Monographs Number Seven,A Review of Premium Estimates in the Health Security Act and Number Six, Actuarial Issues Related to BudgetDevelopment and Enforcement Under Health Care Reform.)

Corporate Alliances

An employer with more than 5,000 employees could choose to opt out of the regional alliance system and insteadretain its own health plan(s) by forming a corporate alliance. Health plans offered by corporate alliances wouldbe subject to the same requirements as those offered by regional alliances. Thus, most, if not all, of the issues,problems, and data needs discussed in this paper would apply and need to be evaluated. In addition, employerswould need to evaluate the impact on their costs of the 1% payroll tax and other potential assessments resultingfrom health care reform, including changes to ERISA. (See the Academy’s Monograph, ERISA Changes underHealth Reform.)

Large employers with health programs whose cost exceeds the average of that assumed for the regional healthalliances will likely opt for the regional alliance system. This would add yet another element of adverse selection anduncertainty in health plan pricing for the regional alliance.

Workers’ Compensation and Automobile Insurance

Under the Act, health plans must provide for medical benefits under workers’ compensation insurance and auto-mobile insurance. Reimbursement for these benefits would be obtained from workers’ compensation carriers andautomobile insurance carriers.

Health plans’ administrative systems may have to be modified to handle claims adjudication for these programs andto obtain reimbursement for the claims from the other carriers. Also, managed care plans may need to expand their


14

provider networks to include providers who specialize in the treatment of occupational illnesses and injuries andautomobile injuries. These new costs may not be completely reimbursed by the workers’ compensation and auto-mobile insurance carriers.

Administration and Marketing Costs

Under any reform proposal, changes in commissions, taxes, types of administrative expense, and/or service provi-sion will inevitably occur. Careful analysis will be required to establish the appropriate expense loading (or targetclaim/loss ratios). Health plans will also need to consider the impact on expenses of meeting additional govern-ment reporting requirements, including extra reporting of health care data required by regulation and cost/treat-ment data and protocols. (See the Academy’s Monograph Number Nine, Administrative Costs for Regional Alliancesand Health Plans Under the Health Security Act.)

Despite the need for careful review of processes and costs in the reform environment, recognizing these items inestablishing premium rates should not pose any particular problem. As mentioned before, a problem occurs if aglobal budget sets an artificially low expense cap.

Reinsurance

Health insurers and HMOs seek the protection of reinsurance in the face of uncertainty and to protect their finan-cial interests from the costs generated by individual, very expensive claims or an unexpectedly high number of claims.

The risk adjustment mechanism, within and across regional alliances, may provide some portion of the protectionfrom pricing uncertainty that will be required under a new system. This mandatory mechanism would only com-pensate for differences in perceived risk not accounted for in community rating. Retroactive protection from theeffects of individual large claims and/or the cumulative effect of an unexpected number of claims may still bedesired.

Reinsurance coverage may include:

■ Aggregate coverage to protect the health plan from overutilization of services, particularly those outside its ser-vice area;

■ Carve-out coverage to handle the costs of certain risks, such as high-risk maternity/premature infants, organtransplants, or mental and nervous/substance abuse; and

■ Stop-loss coverage to pay for all or a percentage of any individual’s costs over a specified threshold, such as$100,000.

While the Act does not prohibit reinsurance, it does not indicate how the cost of reinsurance and/or claim recov-eries would affect a health plan’s premium pricing or the reporting and budgeting of a health plan or an alliance. Inany event, a health plan would need to incorporate the net cost of reinsurance in its pricing.


15


16

CONCLUSIONSThere is always some degree of uncertainty in developing any health plan premium. The wholesale restructuring ofthe U.S. health care financing system that would ensue after enactment of the Health Security Act would add enor-mously to the pricing uncertainty for a health plan trying to establish an adequate premium. This monograph hasdelineated those uncertainties.

This discussion has identified four major issues and conclusions.

■ The demographics and health characteristics of existing health plans may change in unknown ways, since indi-viduals would directly select their plan and new populations (e.g., the uninsured) will enter the system. The finan-cial consequences to many health plans would be unpredictable, and their prior experience may no longer be cred-ible.

■ Newly covered services (e.g., investigational treatments) would be difficult to price accurately at first becausethere are no historical data for basing reasonable estimates.

■ After-the-fact cross-plan subsidies and the unknown impact of government subsidization would make initial pric-ing very risky.

■ Pricing constraints imposed on health plans through global budgets and premium and expense caps may con-strain premiums to levels that may prevent some plans from collecting enough money to stay in business.


17

APPENDIX

Importance of Utilization and Unit Cost Information in Health Plan Pricing

To price a health plan product, utilization and unit cost information relevant to the targeted population must beavailable, either directly or indirectly.

For example, suppose a premium is to be set that will cover the cost of an annual physical examination for a givengroup of individuals. If it is known that physicians charge $200 for such examinations and one-half the populationwill use this service once during the covered period, then for every 1,000 insured individuals, 500 x $200 = $100,000is needed to pay the physicians. If another 15% is needed to cover the administrative expenses and profit objectivesof the insurer health plan, then $115,000 in annual premium will be set for every 1,000 individuals covered.

In this example, the health plan needed to estimate the unit cost ($200 per examination), the utilization (1/2), andits expenses (15%) in order to adequately price this coverage. If the utilization, unit cost, or future expense compo-nents are not directly and individually known, adequate pricing can be established if the total dollars (i.e., $115,000)can be reasonably projected from prior experience.


18


19


20

Details of the methodology may be found in an article by several WG members; see Richard Frank et al., “Paying for MentalHealth and Substance Abuse Care,” Health Affairs (Spring (I) 1994): 337-342. Since the overall extrapolated numbers shownn the article for 1994 were judged low in light of the 11% annual growth seen for insured spending, the estimates for 1990 weresed instead because survey data existed to support the numbers.


21


22

2Technically only the first 30 days would be automatically covered. The second 30 days are available only in the case of a threatto self or to others, pharmacological stabilization, or somatic therapy. Since unlike a private mental hospital, a state hospitalwould provide the second 30 days of hospitalization even without insurance coverage, it was assumed that the benefit wouldresult in a de facto 60-day benefit.


23

3The 1990 state per capita spending is from Mental Health United States, 1992, Table 3.4, p. 184.


24

4Different assumed growths yield different uninsured premiums and hence different induction factors. While 6% as the midpointof the 0-12% growth range was used above, it was for illustrative purposes only and should not be assumed to be a best estimate.


25


26


27


28


29


30


31


32


33

continued

1NOTE: This illustration is not a recommended plan design. It is only an example of a plan that is consistent with

the principles above. Whether this plan would be within the range of costs presented elsewhere in this paper woulddepend upon other specific provisions included in any final legislation.


34

1NOTE: This illustration is not a recommended plan design. It is only an example of a plan that is consistent with

the principles above. Whether this plan would be within the range of costs presented elsewhere in this paper woulddepend upon other specific provisions included in any final legislation.

American Academy of Actuaries1100 Seventeenth Street NW

7th FloorWashington, DC 20036

a cademy of · under universal coverage, the health plan pricing environment would change greatly....

Documents