Flight Path

March 6, 2013

Payers struggle against market headwinds

Historically, managed care organizations haven’t been as active in managing care as they have been in paying claims. While they advocate for value, actually being able to produce it in a volume-based healthcare climate is nearly impossible. As other stakeholders begin to embrace value strategies, competitive payer organizations will come into a more ideal role.

The next few years are going to produce unprecedented changes in the environment for payers. Responding to the new market will call for nimble strategies and constant reassessments.

“The fittest will have many opportunities, but right now, this is a story about headwinds,” says Mark Tomaino senior industry advisor at Welch Carlson Anderson & Stowe, a New York private equity firm.

He says those organizations that have the capital-both human and financial-as well as the insight to change the status quo will benefit from the industry tailwinds. There’s revenue to be gained by the 26 million uninsured people who are expected to sign up for coverage, but the cost of business realignment and the upcoming $8 billion health-insurer assessment could easily offset the gain.

Either way, the air currents are almost exclusively directed by the Patient Protection and Affordable Care Act of 2010 (PPACA) and its implications.

 

 

1. Medical Loss Ratio and Rate Review

Experts agree that much of PPACA amounts to insurance regulation. Among the provisions, the state rate review and minimum medical loss ratio (MLR) policies have the most capacity to limit insurers’ profit potential. The limitations have also been a driver of some recent merger and acquisition activity (M&A) as plans seek out economies of scale.

MLRs are calculated by dividing healthcare claims and quality improvement expenses by premium income-less taxes and regulatory fees. Since 2011, by law, health plans must maintain a ratio of at least 85% for large-group plans and 80% for small-group and individual plans. Several states were granted transition programs by the Department of Health and Human Services (HHS) to help them move from lower MLRs to the policy standard over time, since it was unlikely plans in those states would achieve 80% and 85% in 2011.

Any plan not reaching the prescribed MLR threshold must issue rebates to customers. Last year, insurers issued $426 million in rebates in the individual market, $377 million in the small-group market, and $541 million in the large-group market, for a total of $1.3 billion in rebates, according to the Kaiser Family Foundation (KFF). For example, Blue Cross of California, a not-for-profit, issued more than $38 million in small-group rebates for 2011.

While payers will hone their MLR strategies over time, the threat to profits remains. Most have scoured administrative costs and sought outsourcing opportunities with fixed costs to keep MLRs in check.

“In essence, the difference between being profitable and not being profitable, is the MLR regulation,” Tomaino says.

Rate reviews conducted with varying levels of control by states are meant to provide an actuarial check on premium pricing for individual and small-group products. Any premium hike in the neighborhood of 10% or more could be considered “excessive” by a state, based on federal standards, and could be up for review. Some states ask for justification, while others actually deny rates and send plans back to the drawing board.

Losing control of pricing could eat away at plan potential. Since the federal provision went into effect, premiums in the individual and small-group market were lowered by $1 billion because of states’ new empowerment to review rates, according to KFF.

As profitability faces additional threats, plans must work on reducing administrative costs, driving out inefficiencies and gaining where they can.

Necessary investments might include technology upgrades or partnerships to create new capabilities that will drive down non-medical outlays. For example, BlueCross BlueShield of North Carolina and Blue Cross Blue Shield of Kansas City have collaborated on a claims, enrollment and billing system for individual and small-group markets. Not only will the two plans use the system internally, they can sell its capability as a service to other Blues.

 “Too many payers are still running on legacy systems,” Tomaino says. “It’s going to be really important for them to make investments that drive administrative efficiency. With MLRs, you can’t afford 15% administrative costs, which is not far off from what some of these legacy-system costs run.”

He says plans that are acquiring other plans outright in some cases are deriving economies of scale through predictable G&A (general and administrative) expenses that increase less in relation to medical expenses. Gaining more enrollment with low proportionate administrative costs is a wise move. 

However, plans that are acquiring provider entities might be out for something different, Tomaino says. In the past, a larger supply of providers meant more care and more profit for hospitals, but the provider paradigm is shifting to evidence-based, appropriate care. With the 85% MLR, providers stand to benefit from the change in care delivery.

“Payers now want to get in on that profit opportunity, and that’s driving payer/provider consolidation,” he says.

 

 

2. Direct Competition in Exchange Markets

Health insurance exchanges will become shopping malls for consumers purchasing coverage. And just like at the mall, consumers will compare products but will most likely make their final decisions based on price. Experts caution that exchanges could lead to the commoditization of plan products.

The change in market dynamics will call for unique offerings that satisfy consumer wants, as well as a shift toward business-to-consumer relationships-something managed care organizations have little experience with. Marketing in the exchanges will not be a simple matter of transferring an existing product into a different package.

“I can’t necessarily take my commercial model and inject that with more robustness,” says Becky Ditmer, a principal with Ernst & Young LLP’s healthcare advisory services group. “That’s not going to be enough. The exchanges and the whole drive to consumerism are going to require a change.”

Ditmer cautions that the landscape is evolving as such that payers must reinvent their strategic positions, rather than just trying to move forward with the same products and processes enhanced by some type of administrative efficiency. She says cost, quality and access are converging to form stiff headwinds for insurers.

“The need to do business differently comes from the very commercial-driven focus led by the employers,” she says. “We’re seeing that shift to a very consumer-driven approach. Reform is the catalyst for why this ecosystem we call healthcare needs to change.”

Even as progress reports from Massachusetts, Utah and California indicate the general direction of exchanges, it’s anyone’s guess how each unique market will respond to the new shopping experiences. Some could see thriving competition while others have low participation or unstable premiums. 

Case Western Reserve University’s J.B. Silvers, a John R. Mannix Medical Mutual of Ohio professor of healthcare finance, compares exchanges to the launch of Medicare Part D prescription drug programs in 2006.

“When I looked at Part D, I thought it was not going to work,” Silvers says. “Why would anybody enter a new insurance market for a population for which you have no experience, you have no idea how much they’re going to use, and you’re on the hook for a flat amount because you have to put a bid out there? It turns out everybody did it.”

In Part D, the federal government watered down much of the risk for managed care plans to ensure enough players entered the market. The set-up worked so well that competition flourished, premiums remained lower than first estimated, and the government actually spent less than expected.

 

 

Risk adjustment

In the exchanges, three mechanisms reduce risk for managed care plans.

  • Risk adjustment will shuffle money from the plans with lower risk members to the plans with higher risk members in order to stabilize premiums. 

  • Reinsurance will truncate risk for plans that end up with especially costly populations for the first three years of operation. 

  • And finally, risk corridors will provide protections from the federal government around insurers’ uncertainty in rate-setting. If costs come in 3% above a plan’s initial projections, the plan will receive payments from HHS to offset the loss. However, plans that overcharge will be obligated to remit some of the savings back to HHS.

“You give me a business where they take that much of your risk away, and I’d go for it,” says Silvers. “Why not.”

He believes plan participation will be fairly active in each market, even if some of the large national players start out small and grow over time.

“The way the rules are written, exchanges are very favorable for insurance companies, so I’d be very surprised if they aren’t engaged in most of the areas even though a lot of insurers are saying they’re only going to go to a selected number,” Silvers says.

For example, UnitedHealthcare executives report the insurer will only look at 25 markets. Silvers says he doesn’t believe it. The organization might start out in a small number of markets where it has competitive advantages-such as favorable provider contracts-then grow from there.

“Plans won’t take all [providers], so they’ll try to be selective and aggressive in their contracting and push back and give compensation systems to doctors through ACO mechanisms to drive cost lower,” he says.

Pricing exchange products will resemble a competitive bidding process as consumers make side-by-side comparisons in the online shopping portals. What’s tricky for insurance carriers is predicting reasonable medical liability for what will be an unfamiliar or previously uninsured population that might not choose the best product for their health needs.

California recently revealed consumer costs for subsidized populations in the Covered California exchange marketplace. For silver plans, a family of four with an annual income of $23,550 will pay approximately $39 per month in premiums with the balance picked up by the subsidy. Primary care visits will carry a $4 copay, generic drugs also a $4 copay, and various other services will have modest cost sharing.

Tomaino says the exchanges also represent a threat to commercial plans because more and more of the population will be covered by Medicare, Medicaid and subsidized products. Payers will need to work hard to attract and enroll members.

“And this is going to be putting a tremendous amount of pressure on insurers because enrollments are flat, but enrollments may actually go down over time,” he says.

 

 

3. Lost Opportunities

Another significant threat to managed care organizations in the next 12 to 24 months will be any loss occurring as a consequence of not moving fast enough. Partnering with providers is a key strategy for future survival.

A successful payer will reach across the table and integrate providers into an overall solution, says Ditmer. Too many providers are confused by accountable care and risk sharing, especially in smaller practices, and payers must start the conversations.

“There are snippets out there that it’s a revert to HMOs-that’s way too simple,” she says. “If you’re not talking about it, then they’re making it up or they’re getting their advice from somewhere else.”

Silvers says flexibility and experimentation will bring best practice delivery models to the forefront in the near future. For example, there are more than 200 Medicare ACOs, with which managed care organizations are not involved. ACOs will be a change model, he says. If a Medicare ACO successfully manages chronic conditions, for example, private insurers will need to find a way to capitalize on the opportunity, too.

“They’re going to have to direct traffic through contracts or special deals or joint ventures or whatever,” he says. “In the next five years, we’ll learn an awful lot about how to restructure the system.”

Beyond the U.S. market, payers also have an opportunity to expand their products globally. For example, Cigna’s expatriate plans for large employer firms and supplemental plans bring in more than $3 billion in revenue, and growth rates could surpass domestic business.

But global growth can also come from acquisitions, as UnitedHealthcare has done with its purchase of Brazil-based Amil for $4.9 billion. United already has a presence in Portugal, India and the Middle East through joint ventures.
Asia and the “BRIC” countries of Brazil, Russia, India and China remain ripe markets.  MHE

SIDEBAR: MERGERS  & ACQUISITIONS >> 

 

Mergers & acquisitions

THE SIX LARGEST INSURERS had a fairly profitable year in 2012, thanks to lower utilization and improved commercial pricing. With the Supreme Court ruling on the Patient Protection and Affordable Care Act (PPACA) and the re-election of President Obama, a few political certainties helped improve the outlook for managed care organizations in the third and fourth quarter. 

Most insurers are proactively moving forward with healthcare overhauls, hoping to prosper rather than endure. Not surprisingly, the industry has seen an increase in mergers and acquisitions (M&A) as insurers seek enrollment growth, revenue diversification and access to new markets.

For example, Cigna purchased HealthSpring for $3.8 billion in order to gain Medicare Advantage and Part D membership. The deal surprised analysts because Cigna hadn’t been especially aggressive in government business previously. Cigna paid about $500 per member for 800,000 Part D enrollees, and about $10,000 each for 340,000 Medicare Advantage members. 

“They got scale because they gained a whole bunch of Medicare Advantage members, but they also gained added capability from technology and figuring out through the risk sharing model how to align with physicians,” says Becky Ditmer, principal within Ernst & Young LLP’s Health Care Advisory Services group.

Other noteworthy deals include Centene’s purchase of specialty pharmacy Specialty Therapeutic Care Holdings ($152 million); Health Care Service Corporation’s purchase of Blue Cross & Blue Shield of Montana ($18 million); UnitedHealthcare’s purchase of Amil  in Brazil ($4.9 billion) as well as two Florida plans with significant Medicare Advantage membership; Humana’s purchase of Senior Bridge (which had $72 million in sales in 2011) and Metropolitan Health Networks ($850 million); Aetna’s purchase of Coventry ($5.7 billion); WellPoint’s purchase of Amerigroup ($4.9 billion) and 1-800 CONTACTS ($900 million); and DaVita’s purchase of HealthCare Partners ($4.4 billion).

Deals don’t always deliver

A recent study of 44 health plan M&A transactions between 2006 and 2012 conducted by Deloitte’s Center for Health Solutions indicates, however, that some deals don’t deliver on the financial value anticipated at the outset. In fact, according to the analysis, fewer than half of the deals led to sustained improvement in market value.

“It’s going to be harder generally for health plans to make money, especially in individual and small group segments, which is where they’ve driven a lot of earnings historically,” says Brian Flanigan, principal, Deloitte Consulting. “Given all the challenges from an earnings and investment standpoint, health plans are going to look to buy, to sell or to merge with other plans to gain strength and access to a larger balance sheet to weather the storm that’s on the horizon.”

Flanigan says he expects M&A activity to accelerate over the next several years as more PPACA policy provisions are implemented. He recommends that plans complete due diligence to avoid the destruction of value in M&A deals.

One year post-merger in the deals Deloitte examined, 55% of acquiring plans had increased their value compared to an industry index, but results varied. The median outcome was a 2% loss in value. After three years, only 39% had increased value.

“It’s going to be more difficult for health insurers to make money on a core medical-based insurance product,” Flanigan says. “Plans are generally looking for opportunities to get into new and additional revenue streams whether that be Medicare or Medicaid or in new services, businesses or supplemental service lines that are not too far from the core.”

For example, new integrations might include acquiring provider assets, physician groups or health systems, he says. The lines between health plans and providers are starting to blur with accountable care and risk sharing starting to gain traction.

Ditmer agrees plans will continue M&A activity, but partnership is the more common scenario. For example, sharing patient data to improve outcomes is an attractive proposition. Payers must get much closer to providers as the industry reforms payment systems, she says.

“Where they really can take advantage is by looking to partner and/or acquire that relationship with providers in pursuit of that accountable care construct-not necessarily an ACO but the idea of bringing that collaborative care model to bear and changing out the reimbursement with that,” she says.

Rather than networking with providers for volume, in the future, plans will likely need to offer more. For example, providers can look to plans for their expertise in data analytics, predictive modeling, risk management, case management and care coordination services to drive improved outcomes. And providers will need the assistance if they want to increase revenue in the emerging value-based market.

“Nobody has figured out how to pull it all together,” Ditmer says.  MHE