Federal healthcare reform: a health insurance CEO’s opinion might surprise you

Article Type: Executive viewpoint From: American Journal of Business, Volume 27, Issue 2

About the author

Rick Chiricosta is President and Chief Executive Officer of Medical Mutual of Ohio. Previous to his appointment as CEO, he served as President of the life group for Consumers Life Insurance Company, responsible for development of the infrastructure to facilitate Medical Mutual’s re-entry into the life insurance business in 2008. He also served as Medical Mutual of Ohio’s executive vice president for mergers and acquisitions, responsible for the financial aspects of Medical Mutual’s strategic transactions. He joined Medical Mutual in 1986 as controller of the western division. In 1989, he became chief financial officer for Medical Life Insurance Company, then a wholly-owned subsidiary of Medical Mutual. He held that position until 1998, when he left Medical Life to become vice president and chief financial officer for National Interstate Corporation, a specialty property and casualty insurance company. In 1999 he returned to Medical Mutual as Vice President of Finance. In February 2009, he was named to his current positions. He earned a Bachelor’s degree in Business Administration, Accounting, from the University of Toledo in 1978, became a Certified Public Accountant in 1980 and in 1993 received a Master of Business Administration degree from Bowling Green State University. He is a member of both the American institute of CPAS and the Ohio society of CPAS and has also earned a FLMI (Fellow, Life Management Institute) designation. A graduate of the 2006 Class of Leadership Cleveland, he serves on the boards of the United Way of Greater Cleveland, Kidney Foundation of Ohio, Greater Cleveland Partnership, Cuyahoga Community College Foundation and Team Neo. Rick Chiricosta can be contacted at: rick.chiricosta@medmutual.com

The Patient Protection and Affordable Care Act (“the Act”) is probably one of the most polarizing laws ever to be passed in this country. On one hand, the Act’s proponents say that the “profit-hungry”insurance companies’ greedy practices mandated the Act’s sweeping reforms. On the other hand, the Act’s opponents suggest that it will not only increase (rather than reduce) health-care costs, but it will also result in the federal government’s unconstitutionally meddling in both the economy and our personal lives. My ultimate conclusion may surprise some: both sides’arguments have some merit, and, more importantly, some truth to them. I believe that it is a major over-simplification to characterize the Act overall as favorable or unfavorable, whether you are a consumer, health-care provider,broker, insurer or employer. The Act is complex; indeed, it contains hundreds of specific (and often complex) provisions. This article examines just one of those provisions, the medical loss ratio (MLR) requirement, to show why it is so difficult to judge the Act’s ultimate effectiveness.

The MLR requirement of the Act requires insurers to spend at least 80 percent of every premium dollar collected for individual and small group (less than 100 lives) policies on claims. For groups above 100 lives, the requirement is increased to 85 percent under the theory that, on average, it should cost less to sell and administer larger accounts. For the rest of this article, I will refer to the 80 percent threshold to keep it simple, but the reader should remember the higher threshold for groups above 100 lives. Under the Act, which became effective for calendar year 2011, if an insurer spends less than the required minimum for any segment of their business, it must provide rebates on a pro rata basis to all of its policyholders in the affected segments so the combination of claims costs and rebates will equal the threshold level. Let me examine the MLR provision in greater detail to show how difficult it is to fairly and objectively assess the effectiveness and expected impacts of many of the Act’s key aspects.

When the Act was passed in 2010, the health insurance industry singled out the MLR provision as one of the Act’s most problematic aspects. The industry argued that the MLR provision would kill competition by forcing smaller carriers out of markets, leaving many of them to be dominated by carriers with significant market share. My first reaction as the CEO of the oldest and largest health insurer based in Ohio surprised many people (including some of our own executives). Initially, I felt that as a mutual company, we could turn this provision into a competitive advantage, based on our stated lower profit requirement. To some extent, I still feel this way. But, the more I have learned about the MLR provision’s details, the less I like it.

Let us look at what I like about the MLR regulation. First and foremost, it puts the focus on where it should be. Allowing insurers to spend only 20 percent of every premium dollar on administrative expenses, distribution expenses and profit nullifies some of the more cynical arguments advanced by some regarding why insurance premiums are so high. Personally, I love being able to tell customers and the public that even if we had no administrative costs, made no profits, and paid nothing to brokers, our premiums would still be at least 80 percent of the levels they are now. That is simply because the primary driver of insurance premiums is the cost of medical care provided to insureds, and not(for example) executive pay or excessive earnings, as the media sometimes leads the public to believe. I am constantly amazed at the reaction to this message,which sometimes includes a bit of disbelief. The MLR provision makes it abundantly clear: by definition, our gross margin can be no greater than 20 percent. Frankly, it deflates any arguments that suggest otherwise. For comparison purposes, the gross margin for the S&P 500 index exceeds 40 percent.

In essence, the MLR provision has created a new business model for insurance companies. It’s one in which profits will be maximized by spending less than the 20 percent allowed on administrative and distribution costs rather than by managing to a lower medical loss ratio. While this obviously will put pressure on insurers to be efficient and control costs, it should ultimately prove to be a real benefit for consumers. Insurers will now have a much greater incentive to contain administrative costs, which should lead to technological investments and process improvements that ultimately make it easier for policyholders to interact with their insurers. At the same time, it will benefit insurers who should no longer have to prove their case regarding the medical care costs that primarily drive premium rates.

There is a legitimate question about whether the 20 percent allowed for expenses and profit is adequate to allow the industry to survive. I do not think there is any doubt that the answer to this question is ultimately “yes”,but not before the industry makes some fundamental changes. Product distribution, including broker compensation, is perhaps the area ripest for change. Before the MLR provision’s implementation, broker compensation for some products exceeded amounts included in the determination of premiums for all of the insurers’ other expenses. In terms of relative value, it is simply not reasonable to think that the entity selling the policy would be allocated as much or more of the premium as the entity that handles the underwriting,provider network management, enrollment, billing, customer service, care management, and claims processing (not to mention the acceptance of risk). The 20 percent limitation has forced all insurers to re-evaluate what they can afford to pay their brokers. In our organization, reducing broker compensation translated into a direct reduction in premiums for our customers. Again, from my perspective, this is a favorable development because it makes our products more affordable for consumers. In fact, this may be the only provision in the entire Act that directly leads to this result. So, I find it surprising and somewhat disturbing that the National Association of Insurance Commissioners passed a resolution recommending that broker compensation be excluded from the MLR calculations in order to ensure adequate consumer access to this valuable resource.

Let me state clearly and for the record that I truly believe there is a role for brokers in the future delivery of health insurance; however, this role will probably be different in the future than it was in the past. Product simplification and standardization, along with the planned elimination of underwriting, will affect how consumers use brokers, much like online trading has affected the use of investment brokers. The compensation paid will have to reflect the value added to this process. Insurers and providers will have to find ways to take costs out of the system if they are to survive into the future, and it is reasonable to expect those involved in product distribution to do the same. In my opinion, those who are successful at doing so are likely to grow and thrive at the expense of those who try to maintain the status quo.

Now, let us look at what I believe are three of the primary problems with the MLR provision as it currently stands. First, there is a fundamental disconnect and an inconsistency between the MLR regulation and other regulations regarding the federal government’s oversight of rate filings. From my perspective,the MLR provision’s very existence should inherently eliminate the need for any review of rate filings. Insurers who charge premiums greater than what are needed to produce a medical loss ratio of 80 percent or more will have to rebate the excess premium to their policyholders. So the very fact that insurers may have to defend their rate filings, and possibly be pressured to decrease rates when they do, seems patently unfair to me. I take exception whenever any party,whether it is industry, the government, or consumers, is unwilling to approach an issue in a fair, balanced way. The MLR provision essentially provides automatic assurance that an insurer cannot make excessive profits. Consequently,further rate scrutiny seems completely unnecessary. The current plan, however,exposes insurers to more rate scrutiny than ever before despite this built-in statutory protection. I can only wonder why.

Second, the MLR provision’s market segmentation method of medical loss ratio calculations calls to mind the adage, “the devil is in the details”. Recall that when I first learned of this provision, I thought that although it would be a challenge to operate within a 20 percent allowance, the industry needed to accept this requirement and figure out how to do so on a profitable basis. Later, however, I learned of a troubling aspect of this provision that significantly changed my opinion. As the regulations are currently drafted, each insurer’s medical loss ratios are calculated separately by market segment(individual, small group, and large group), state and legal entity. I believe this is a major flaw that has the potential to create significant problems for insurers. In essence, it eliminates the insurer’s ability to offset losses or results that are below expectations in a segment of their business with better than expected performance in another. Of course, in a perfect world, all products and market segments perform equally well. But in reality, certain geographic areas or market segments will perform better or worse than normal. Can you imagine if Best Buy had to operate under a statute providing that no store could exceed a given profit margin while losses on unprofitable stores were unlimited? Are we headed for an environment where auto dealers’profits will be capped on their service department, but losses on car sales would have to be absorbed no matter how great? As a business model, this approach fundamentally fails. I initially took the position that the 20 percent expense and profit allowance was reasonable. But when I found that “devil in the details” – namely, the inability to net losses and make this calculation in the aggregate, my support for this provision changed dramatically.

Third, and finally, the MLR provision poses a potential (and ironic, given the Act’s aim) problem for consumers. In a strange twist, preventing insurers from spending more than 20 percent of premiums on administrative costs and profits actually disincentivizes them from trying to contain the actual cost of care, which comprises the other 80 percent of the premium. This happens because the more money paid out in claims to providers of all types, then the higher premiums in the market will be. Higher premiums will result in the absolute dollar value of the MLR provision’s 20 percent threshold also being higher. Of course, in most states, insurers still operate within an extremely competitive marketplace. As a result, they will likely be unwilling to intentionally allow medical costs to rise just to produce a greater allowance for expenses and profits. But the concern exists just the same, and it does not bode well for consumers if the industry reacts accordingly.

In summary, the MLR provision essentially amounts to a form of price controls. But let us be clear: those price controls are directed at the insurance industry and not the health-care industry. Although I generally oppose price controls, I personally believe that the industry could use this provision to make the case that many of the attacks on insurers regarding health-care costs have been misguided (to say the least). In reality, everyone involved in the equation (i.e. insurers, providers, employers, brokers and consumers) must accept some responsibility for health insurance premiums being what they are.

I fully realize that as the CEO of a health insurance company, I am supposed to be fundamentally opposed to health care reform and, more particularly, the Patient Protection and Affordable Care Act. However, I hope the balanced analysis I have provided here of just one single provision of the Act proves that it is not that simple. You can bet that anyone who either patently dismisses the Act as terrible or fully embraces it as the ultimate solution to the health care problem probably has not taken the time to study the hundreds of provisions within the Act. In the end, the Act’s numerous provisions will do little to reduce health-care costs. But that does not mean that there are not some good concepts and provisions that are in the overall best interests of all affected parties. If everyone would show some willingness to compromise, perhaps we would finally make some progress toward solving this problem. Until then,provisions like the MLR regulation will become binding law before we fully understand all the implications and consequences that may accompany their implementation.

Rick ChiricostaMedical Mutual of Ohio, Cleveland, Ohio, USA