The opportunity to redefine market dynamics and build competitive advantages is great within the US health reinsurance industry. Glenn F. Cunningham explains how those who create new products, new processes, new distribution and service delivery and new strategies will achieve success in health markets.Reinsurers play a significant role in supporting the three primary health insurance arenas that exist in the United States. These arenas include indemnity coverages offered by insurance companies, health coverages offered by health maintenance organisations (HMOs), and health benefits offered through employer sponsored self-insured plans.
Many of the US health insurers and reinsurers participating in these markets have suffered poor claim experience and adverse profitability. Many participants view this as merely a reflection of larger health care issues facing the country. Others see these results as a natural consequence of a mature industry. A sense of defeatism contributes to this view. Insurance managers need to reject such notions if they are to improve business performances.All three primary US health markets have presented profitability challenges to insurers and reinsurers, causing a number of reinsurers to exit these markets in the hope of finding greener pastures elsewhere. The remaining reinsurers have an opportunity to participate more effectively - or, in all likelihood, they will be looking for those same pastures themselves shortly. In this article, suggestions are proposed that may help reinsurers participate more effectively in the US health reinsurance market.
Stoploss insurance is most common US reinsurance product
In the US health market, specific and aggregate stoploss insurance are the most common forms of reinsurance coverages. Specific stoploss insurance allows primary insurers to limit their claim exposure for any covered individual over a specified time period. Aggregate stoploss is used by primary insurers to limit their aggregate risk exposure over a group of specific risks.
Reinsurers play an important role in each of these three primary health markets. The availability of reinsurance allows primary insurers - including employers self-funding their health plans - to significantly reduce their risk exposure in a variety of ways. Reinsurance options can and do affect the availability and cost of such coverages. Specifically, the availability of reinsurance coverage plays a major role in allowing large numbers of US employers to design self-funded health benefit plans. Through reinsurance, employers can limit their exposures to catastrophic costs from small numbers of very large dollar claims. Self-funding employers would be unlikely to cover high cost medical conditions, like organ transplants, without the ability to reinsure. By providing stoploss coverage to a number of health benefit programmes, reinsurers create large pools to spread the risk of these catastrophic claim losses.
Reinsurance also plays a significant role in protecting the financial solvency of insurance providers. Insurers can and do use reinsurance to reduce their minimum capital requirements. The availability of reinsurance can also be an important resource in the growth of smaller and start-up health provider groups, particularly health maintenance organisations.
In the health indemnity market, insurers purchase reinsurance for a variety of reasons. They tend to be small regional insurance carriers writing individual or small group health products. Reinsurance terms include a heavy use of specific stoploss. Other reinsurance options include aggregate stoploss for a book of business such as association group business or quota share arrangements. In servicing this indemnity market, reinsurers may also provide the primary insurer with expertise or support in pricing, claims management or case management on larger claims. While the majority of the US population is served by HMO type coverages, the indemnity market is still active and competitive. Industry analysis of reinsurance profit in this segment reveals marginal profitability.Reinsurance has a dual market within the HMO arena. In addition to HMOs, reinsurance is sold to medical provider groups by HMOs. HMO reinsurance is primarily available to smaller, less capitalised HMOs, usually on a specific stoploss basis for hospital claims. This stoploss coverage may be subject to a coinsurance requirement with the HMO responsible for 10%-20% of the per enrollee costs above the stoploss threshold. Reinsurance pricing varies by multiple factors: demographics of members, other coverages, geographic location, benefits, hospital contracts, network coverage for tertiary care, and the target market of the HMO.
The HMO market has been volatile for more than five years. During this period, new reinsurance capacity entered the market and drove pricing competition to an irrational level. This market competition and reinsurance pricing irrationality was driven by reinsurers who were selling reinsurance at a loss - either because of little pricing knowledge or a belief in the intrinsic value of market share. The resulting losses may contribute to stabilisation in the market with less than a half dozen reinsurers remaining. Profit opportunities in this market are further complicated by the growing sophistication of HMOs as purchasers of reinsurance. Larger HMOs understand their claims risk and can effectively play the present reinsurance market, choosing reinsurance options when they know it to be less costly than self-insuring.
HMOs have also been effective at paying a per-policyholder fee (commonly known as “capitating”) to their hospitals and physician groups, shifting risk on to these providers, who, in turn, purchase provider excess coverages directly from reinsurers. Coverage is usually specific coverage protection against high losses. Provider groups tend to be thinly capitalised and thus have incentive to purchase significant levels of protection. This market has been very competitive in the past seven to eight years. Again, the emergence of new reinsurance entrants offering irrational discounts over existing rates resulted in prices dropping to inadequate levels. This pricing irrationality has multiple causes, including aggressive pricing to build market share, reinsurers' misunderstanding of appropriate pricing, and a large number of competitors in a fairly new market.
Pricing has begun to trend upward, but it will take some time to approach rationality. Physicians and provider groups have become accustomed to current pricing levels and may have difficulty paying a larger fee for stoploss coverage. As a result, we may see a trend wherein providers are required to retain more of their risk. Reinsurance profitability in this segment has been virtually nonexistent, with loss ratios sometimes approaching 200%.
Reinsurance also plays a significant role in the third US health market. Employers in the United States offer self-funded health benefit plans to their employees. The marketing of these plans to employers usually includes some level of employer stoploss coverage purchased from insurance carriers. Stoploss needs exist primarily among employers with at least 50 but under 5,000 employees. Employer decisions to purchase stoploss are commonly related to their cash flow and the duration of time they have been self-insured. Employers with strong cash flows and those who have been able to develop their own self-funding experience are less likely to feel the need for stoploss protection.
Insurers provide stoploss coverage on both a specific and aggregate basis. Specific coverage limits an employer's liability for the costs of each covered employee. Aggregate coverage simply limits the employer's total risk exposure as a percentage of some expected amount of claims. Smaller employers tend to purchase both types of coverages. Larger employers usually purchase specific coverage only.
Stoploss levels are determined and priced using a number of variables. These include group demographics and coverage types. Generally, for every covered employee, employers retain up to 10% of the group's expected annual total claims. Therefore, specific deductibles average approximately 10% of total expected claims. Levels of aggregate stoploss vary by size of the business. Smaller employers may attach stoploss points at 120%-125% of expected claims. Larger employers with more predictable claims have lower stoploss attachment points.
There are over 100 providers of employer stoploss coverage in the US market. Coverage is usually purchased through third party administrators (TPAs) who can provide employers the full range of services required to self-fund and administer such plans. Third party administrators shop these opportunities to a number of insurers, driving both market opportunities and pricing competition. TPAs administering these employer self-funding benefit plans have a fiduciary responsibility to the employer being covered.
Insurer and reinsurer participation in health markets over the last five to six years has been marked by significant losses or at best marginal profitability. A number of factors have contributed to the poor performance including aggressive competition among insurers and reinsurers, misalignment of risk and reward factors between insurance brokers, third party administrators, managing general underwriters and true risk participants. Risk participants, particularly reinsurers, have allowed themselves to be followers rather than drivers of crucial elements such as underwriting and pricing. In many instances, crucial performance drivers have been controlled by Managing General Underwriters or TPAs whose incentive is to drive revenue with no downside performance risk. Risk players need to attack this issue aggressively.
Opportunities exist to increase profitability
Those choosing to participate in these challenging markets need to reject some commonly held views, primarily the notion that poor profitability performance is a given in these markets and in our industry. Such views misinterpret the laws of economics; no economic law holds that some industries or lines of business have to be less profitable than others. Many in the insurance risk industry comfort themselves with the belief that our industry and its dynamics are unique. They are not. If we took the time to look outside of our industry, we would see plenty of evidence that a business can be highly successful in industries and markets where most are performing poorly.
Business entities can create competitive advantages and value for shareholders despite challenging business environments. Insurance and reinsurance participants in the US health market commonly bemoan the existence of excess capacity, inadequate pricing, and competition from bigger rivals or new entrants. These are real business challenges, but rarely do we criticise ourselves for a basic lack of financial discipline in managing our market, product participation and profit. Some even argue that building market share is the only opportunity for success. This is a curious argument given the poor performance of the overall market and the experience of those executing this strategy over the past five to 10 years. Such an argument provides an easy excuse for market participants and contributes to a sense of helplessness.
Successful businesses in many other industries have proven that building market share is not the route to guaranteed success in challenging markets. Market share should be viewed as the reward for creating value and competitive advantage in your chosen market. Viewing market share in this way refocuses a business on building competitive advantages as the priority. Market share should always be the result of expanding or leveraging hard earned competitive advantages. Success in these markets will not be the result of simply choosing the most profitable segments and riding a wave. The choice of strategy and the ability to build sustainable competitive advantages will be the important factor.
Troubled industries like this one offer even greater potential for rewards than others appearing to be more profitable. Profitable industries tend to have imaginative and dynamic business entities that drive increased revenue and profits. Competing for a share of that success is naturally strong. In contrast, in under performing business sectors, the competition usually lacks a defined strategy, financial discipline, creativity or innovation.
In such an environment, the opportunity to redefine market dynamics and build competitive advantages is greater. Leadership in our markets will be earned by those who create new products, new processes, new distribution and service delivery and new strategies.
Glenn F. Cunningham is managing director, Accident & Health Reinsurance Business, Transamerica Reinsurance.