Monday, July 14, 2008

Underwriting Cycle or Medical Trend Rate Cycle?

Analysts trying to predict the future of the health plan business who are looking for an underwriting cycle will miss the real turns in the market.

Recent health plan earnings issues
have once again raised the question, do we still have an underwriting cycle, and are we entering one?

In my mind, anyone trying to understand the profitability of the health plan business who concentrates on whether or not there is an underwriting cycle underway misses the larger picture.

In the modern health plan era—a time of unprecedented consolidation, financial controls, focused capacity, and prospective provider contracts—I don’t see as much an underwriting cycle as I do a medical trend cycle.

The chart above details the increases in health insurance premiums compared to worker earnings and overall inflation and comes from the Kaiser Family Foundation Survey of Employer-Sponsored Health Benefit Plans from 1988 to 2007.

To me, the most recent 15 years of this 20-year view of health insurance premium increases demonstrates more a health care cost trend cycle than an underwriting cycle.

In the 1970s and 1980s, we clearly had underwriting cycles. (I have the scars to prove it!). But that era was far different from the current one. The health insurance business had a relatively low barrier to enter and lots of marginal players did--often fueled by readily available underwriting capacity from life insurance companies looking to diversify and excess reinsurance capacity--often from offshore. A TPA could quickly enter the business backed by lots of reinsurance capacity and distort local markets in both the small and large case market, for example. That sort of thing is far less common now with the health reinsurance capacity players more often being large and more sophisticated domestic players.

Today we have a consolidated health insurance business dominated by the "adults." While they make mistakes they do not intentionally go on business buying sprees.

I recently attended a Blues sales conference. Often, we hear that there are local non-profit Blues plans out there buying business. I have yet to find one. What I heard at that conference is that this market is just like the markets of recent years--there is always someone who will bid a lower price but that level of competition has always been there. If there is a change today it is that there are so many specialty vendors--disease management, PBM, wellness, trying to pick-off parts of a program.

Saying someone is out there buying business has become too common an excuse for publicly traded plans that would like to deflect attention away from internal problems of their own whether they be customer service or pricing mistakes. I'd like to see some of these "victims" name some names.

One big plan in particular has been claiming their business retention problem can be blamed on the underwriting cycle but that they are so disciplined they refuse to chase lower rates when in fact it is that their service has gone to the dogs and they are creating their own issues business retention issues.

Are there still capacity issues impacting pricing? Yes. But to nowhere near the level we saw them 15 years ago.

The health insurance trend cycle has a lot more to do with whether payers and providers are in equilibrium—whether both sides are getting what they need to make their profit goals—than it does the vagaries of health plan pricing.

Looking back to the 1990s, health care trend fell to near zero not because the health insurance industry figured out how to fundamentally manage health care but because health plans were able to get the upper hand on providers. You might recall physician fee schedules as low as 75% of the Medicare schedule in the late 1990s.

Providers pushed into the corner, reacted. We had the patients’ rights rebellion that might have been better termed the provider rights rebellion. Doctors and hospitals pushed back, employers didn’t back the health plans up, health plans backed down, the lid came off, and medical trend skyrocketed to 13.9% in 2003 as the providers began to catch-up for years of underpayments.

Once things began to build in the providers favor toward equilibrium between payers and providers (beginning in 2003) the medical trend rate began to decelerate. As trend decelerated, profitability was a lot easier for the health plans as they benefited from a trend windfall that covered up a lot of operational “warts.”

Now that we have hit a health care trend bottom, health plan earnings growth has slowed (or even reversed) and the operational warts—the usually small things that get missed when profits are growing at a great clip—begin to show themselves.

It has been a combination of these relatively minor things that Wall Street overreacted to in recent months as health plan stock prices fell on revised earnings guidance. Wall Street’s problem is that it became addicted to the notion that health plans could always report 15% growth and 15% earnings gains.

In terms of real growth, the commercial market has been flat for years.

But the 2003-2007 period was unique. Even though the commercial market was flat, the privatization of Medicare created an enormous growth engine in its place. Now, the low hanging fruit from that new market is gone and Medicare growth looks to be normalizing.

With last week's Senate vote killing private fee-for-service plans by 2011, it is also clear that the tide has shifted in Washington for private Medicare. The next few years will undoubtedly see the payments between private and public Medicare equalized.

During the 2003-2007 period, earnings growth was robust as health care trend decelerated resulting in the extra windfall earnings as plans regularly sold renewal rates closer to the prior year’s trend rate than the prospective trend rate. In addition, the plans benefited from attractive margins on the new Medicare opportunities.

So are we now entering a new underwriting cycle where health plan earnings suffer because of chronic self-imposed health plan underpricing?

No. Throughout my market travels I find no evidence that health plans are deliberately, or even unintentionally, underpricing one another on a consistent basis to gain market share. Such claims from health plan executives lately trying to explain their own earnings problems just don’t pan out.

We are at the end of one phase in the medical cost trend cycle, as the deceleration ends, and entering another phase, as trend is in the early stages of accelerating again. When this happens, health plans face an earnings head wind instead of the nice tail wind they benefited from in the 2003-2007 period.

Analysts trying to predict the future looking for an underwriting cycle that doesn't exist will miss the real turns in the market.

Health care trend just can’t go any lower given the current environment. In the wake of providers getting their catch-up pricing, starting in 2003, and needing progressively less in subsequent years as they completed the catch-up, we had a four-year health care trend “soft landing,” or trend deceleration, that ended in 2007.

Now, the pressure on health care trend has at least a slight upward bias driven this year by a bigger than typical flu season and an uptick in catastrophic claims largely driven in part by more claims for things like serious infections and premature infants.

For medical cost trend to take off in a big way, two are things necessary—higher inflation pressuring providers and/or provider cost shifting driven by government underpayments—haven’t asserted themselves, at least not yet.

People who wonder if there is still any such thing as the underwriting cycle are asking the wrong question.

For at least the last 15 years we haven’t had so much an underwriting cycle, we’ve more had a medical cost trend cycle.

An underwriting cycle is when the health insurance industry cuts its own throat with self-imposed under pricing. In this consolidated and more sophisticated financial environment for the business, little if any of this has gone on—at lease intentionally.

The medical cost underwriting cycle we are now living with has more to do with whether or not payers and providers are in equilibrium—each getting what they need to get to make their own internal profit objectives.

Today, we are as close to that uneasy balance or equilibrium between payers and providers as we ever are. But after four years of trend deceleration and inflation heating up and government looking to make cuts to the entitlement programs, that equilibrium isn’t likely to last long.

We just hit the bottom after coming down the trend curve. The soft landing phase we’ve been going through since 2003 has been the good side—maybe the best period in the history of the health insurance business.

The tail wind is gone and the headwind is growing!

Video of a discussion I had last week with Wall Street analysts discussing the current health plan environment: "Wall Street Comes to Washington"
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