Thursday, June 21, 2007

Commercial Health Care Cost Trend—Finally Hitting Bottom?

Commercia health insurance cost trend peaked in 2003 when costs hit 13.9%. On the same basis, health care cost trend fell to 7.7% in 2006 (Source: Kaiser Family Foundation Survey).

Will medical cost trend keep falling in 2007 or are we near the bottom?

The health insurance business tends to benefit from falling trend rates. Employers and benefit consultants tend to look backward when health care coverage is renewed each year. If an employer saw a 13.9% increase in its medical costs during the prior year, the buyer tends to accept a renewal rate at that level for the upcoming year. If something less than the higher increase in costs occurs in the subsequent year (it actually fell from 13.9% to 11.2% from 2003 to 2004) the health plan not only makes its normal pricing margins but scores a windfall profit as it benefits from the further drop the next year.

I have referred to this phenomenon in the past as the trend windfall.

The managed care industry has reported robust growth and profits these past few years in part because high (if not also falling) trend rates have provided automatic premium growth. The large incremental drops in trend have also benefited health plans with these windfall profit margins. As a result, the health insurance industry has had the fantastic combination of good revenue growth and widening margins during these years.

This is all great—until we inevitably hit the bottom and the windfall profits go away.

It can get even worse if we subsequently get an increase in medical cost trend and we can’t even make basic pricing margins. In an increasing trend scenario, a profit shortfall can occur as buyers tend to demand increases at last year’s lower trend thereby creating a margin shortfall in the subsequent year.

So, it is important to know when medical cost trend hits bottom. It is even more important to know when trend begins to edge up. Both are generally believed to be inevitable in an industry with a long history of “a pricing cycle.”

That’s why the quarterly earnings reports from the publicly traded health plans contain information that is critical to understanding where the market is in its pricing cycle. Having said that, all of the information is still only retrospective.

Looking at past earnings reports, it is clear to us that trend had still been dropping and windfall profits accruing in the third quarter of 2006. Comments in the third quarter earnings reports such as “favorable claim development” and “lower sequential medical ratios on a constant basis” generally reaffirmed that results still reflected some overpricing—and trend windfall.

Some players were even bolder—bragging on all of the excess pricing profits. This comment was typical: “Commercial premium yield…exceeded total cost trend…resulting in an increase in underwriting margin.”

Just about everyone reported lower sequential medical cost ratios in the third quarter. Commercial medical results just couldn’t have been better in the third quarter of 2006.

By the fourth quarter of 2006, results still looked quite strong but there were some indications that maybe the easy money was drying up.

Health plans began to report less favorable claim development from prior periods (an indication of whether pricing was more favorable than actual costs in prior quarters) as well as benefits ratios that looked to be flat or were even increasing slightly.

However, results were mixed and not at all clear at year-end.

When the pricing cycle (and the actual trend levels) hit a plateau, one would expect mixed results at first. Different companies price in different ways and, for any number of operational and internal reasons, tend to see the same things months apart. Mixed results at this point in the pricing cycle could be compared to the results sort of bouncing off the bottom as we finally hit the low point in trend.

So, by the end of 2006 there was some reason to believe the fall in trend was coming to an end and with it the windfall profits. But there was no certainty in the data.

Predicting the health insurance pricing cycle is a lot like economists telling us just when we entered a recession. Current data only leads to suspicions. Economists are only able to tell us when we actually entered the recession—or came out of one—many quarters later when the data is finally clear.

That takes us to the first quarter 2007 results.

The results were still mixed. While there appeared to be consistency among most players, there also continued to be some major outliers.

First quarter 2007 commercial health insurance results:
  • United Health estimated that its full year 2007 commercial medical cost ratio would be 80 basis points higher for 2007 than it was in all of 2006 and talked about a “sustained increase in utilization” of about 30 basis points.
  • United estimated a 7.5% commercial trend for 2007—plus or minus 50 basis points.
  • Wellpoint reported that its benefit ratio declined slightly but notably reported that prior period development was negative indicating pricing might have actually been slightly inadequate.
  • Wellpoint projected a 2007 medical pricing trend of 8%.
  • Aetna reported its commercial medical expense ratio edged up very slightly to 79.6%, from 79.4% in the same quarter a year earlier.
  • But Coventry reported that its medical cost ratio improved 50 basis points over the same period a year ago and reported that its premium increased 5.6% in the first quarter while its claim costs increased 4.8%––indicating improving margins.
  • Humana also reported improving commercial results including a medical cost ratio 70 basis points lower than the same quarter a year ago and Humana projected 2007 commercial trend in the 4.5% to 5.5% range. Interestingly, while having a much lower trend rate than its big competitors, Humana also reported flat enrollment. With those kinds of commercial pricing trend rates, why isn’t Humana growing?
So, it’s still a mixed bag with the very largest players reporting either flat or accelerating costs and two of the smaller but major players saying costs are still coming in at very low medical cost trend levels.

Different blocks of business will see things at different times making these kinds of differences more the norm than the exception.

Have Humana and Coventry learned how to manage health care costs better than United, Wellpoint, and Aetna? That would be a stretch.

More likely these differences have more to do with timing and benefit changes than anything else.

We won’t know just when, or if, trend hits bottom, when or if it began to rise, and the impact all of this had on earnings results until many quarters after it all actually happened.

But, my sense is that we are now bouncing around that bottom.

Perhaps the best news is that there is no evidence that health care costs are increasing from current trend levels in any measurable way.

That could change if the Democrats cut Medicare provider payments later this year. Cuts in doctor and hospital payments—and even lower Medicare HMO payments to providers because of Medicare Advantage payment cuts—could ignite a new round in provider price increases and resulting higher medical cost trend increases.

Second quarter health plan earnings reports will tell us more.
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