Conditions in the health insurance market.

A host of key trends are affecting the fortunes of all health insurers, including both indemnity and managed care insurers:

l A tight labour market has spurred a movement toward less restrictive medical plans with greater freedom of choice for patients.

  • uing inflation in prescription drug prices is taking its toll. During a time of higher than expected prescription utilisation and increasing demands from consumers, insurers face the challenge of developing the proper mix of changes to plan designs and premium adjustments.

  • ed with rapid growth in the number of senior Americans, the government must quickly find solutions to the shrinking number of Medicare suppliers. Carriers complain that Medicare reimbursement levels trail rising medical utilisation trends. As a result, insurers are reducing service areas or withdrawing from the market.

  • gers and acquisitions, combined with some company failures, will likely continue to recast the health insurance landscape.

  • lementation of new guidelines for electronic transactions as part of the Health Insurance Portability and Accountability Act (HIPAA) will complicate the lives of insurers in the coming year.

    Regulatory issues
    Managed care insurers oppose a key provision in the patients' bill of rights that would give patients an expanded right to sue their health maintenance organisations (HMOs) for allegedly denying medical care. Although the bill's original sponsors were Reps. John Dingell of Michigan, a Democrat, and Charles Norwood of Georgia, a Republican, support largely has been divided along party lines. Managed care insurers and investors worry that if the provision were to pass, litigation costs and judgments would increase, forcing companies to pay devastating damages. Health insurers would be forced to raise premiums, ultimately affecting the people the bill is trying to protect. Some Democrats strongly support the expanded right of patients to sue. President George W. Bush, on the other hand, generally favours limits on the right to sue. The Republican Party's nominal control of both the US Senate and House of Representatives – although with the slimmest of margins – means the chances of a legislative solution more favourable for HMOs may be better, at least in the near term.

    Managed care insurers also are concerned with the implementation of new provisions governing electronic transactions and code sets to be used in those transactions. The legislation is unique; for the first time, the federal government is setting standards for both the private and public sectors. Unlike federal health initiatives that applied only to Medicare and Medicaid providers, HIPAA governs all healthcare providers, payers and clearing houses that transmit or maintain individually identifiable patient information in electronic form. Since virtually all companies use electronic media to store or transmit claims, nearly all must be compliant with the administrative simplification provisions of HIPAA. The rule took effect in October, with a timetable for compliance of no later than 24 months to 36 months for small health plans with $5m or less in annual receipts – or by 16 Oct. 2002.

    These new electronic standards are expected to streamline the processing of healthcare claims. About 400 formats for electronic health claims are in use in the US. The lack of standardisation makes developing and maintaining software difficult and expensive. The lack of standardisation hampers the ability of healthcare providers and health plans to become more efficient and cut expenses. Savings to the entire US healthcare system from these revisions have been estimated at more than $30bn over the next ten years. However, complying with these standards is expected to cost more than $25bin over the next two to three years, rendering the costs of preparing for Y2K computer problems appear an inexpensive undertaking. The extent of a plan's investment will vary based on its lines of business, number of information systems and geographic areas in which it operates.

    AM Best estimates that the impact of implementing these standards will be less for larger companies, which enjoy economies of scale and have the resources to better manage and finance this expense. Smaller organisations may be forced to outsource compliance or align with larger plans to remain in business.

    Preferred providers
    In recent years, the healthcare product mix shifted from the traditional indemnity medical plan to the more tightly managed HMO product and now to the more flexible Preferred Provider Organisation (PPO) plan. PPOs extended their market share to more than 40% in 2000 and remain the leading choice of healthcare benefit members. As consumers and providers increasingly opposed restrictions within managed care, the growth rate of HMO membership declined and consumer dissatisfaction with the healthcare system in the US reached new heights. This dissatisfaction, coupled with a reduced price differential between the two products, has resulted in an increased preference for the direct access to the provider offered through PPO products. Plan members may pay more, but the ability to go outside the network without a referral is a key feature driving enrolment in less restrictive plans.

    Further fuelling the trend is a pattern of higher rates of premium increases for HMOs than for PPOs. Poorer operating results and a rise in insolvencies for HMOs forced the increases, narrowing the price differential between the two products. The average differential between HMO and PPO offerings now ranges between 5% and 10%. This has made the flexibility of the PPO product the key factor in the purchase decision, although cost remains one of the most important factors. For the industry as a whole, escalating medical and pharmaceutical costs have led to rate increases of 12% to 18% for 2000, depending on the product and market segment.

    Variations on the PPO plan include the POS (point-of-service) plan and the open access HMO plan. The open access HMO plan removes the ‘gatekeeper' requirement but still restricts the member to a defined network of providers.

    Another factor favouring PPOs is the move toward national quality accreditation standards. The National Committee for Quality Assurance and the American Accreditation HealthCare Commission, also known as URAC, are developing a core set of reporting standards and quality control measures for PPOs. Some of these measures include:

  • ndardised information for health plans within a defined network;

  • accountability for reporting of clinical interventions; and

  • ndardised customer service quality issues.

    Voluntary accreditation has not gained a strong foothold in the PPO market. Low interest among employers and the costs of becoming accredited are two key reasons for lower levels of participation. However, as HIPAA legislation subjects health insurers to a standardised format of information exchange, the popularity of PPO accreditation is expected to increase.

    The HMO industry is expected to continue to strengthen its balance sheet and operating performance through 2001. Key drivers will continue to be market acceptance of double digit premium rate increases and the resulting positive impact on companies' operating performance. However, the rise in consumerism and the demand for coverage that offers greater access with fewer restrictions is limiting this segment's share of the total healthcare market.

    The industry's earlier recognition of $2.1bn in net losses – $1.2 bn in 1998 and $847m in 1997, because of predatory pricing aimed at gaining market share – hurt its overall capitalisation. In response, health plans sought to meet capital requirements by seeking funds from parent organisations or by issuing surplus notes. As a result, the ratio of surplus notes to net worth grew 31.7% between 1997 and 1999. The HMO industry's balance sheet strength improved in 1999 and 2000 because of higher premium rates and effective cost controls, especially at the nation's largest managed care firms. Net worth increased by 11.8%, and underwriting leverage decreased by 4.1% between 1998 and 1999. AM Best anticipates that improvements in operating performance will continue to strengthen the industry's balance sheet strength in 2001.

    A key driver of the recently improved operating performance has been growth in premium revenue per member per month, which outpaced growth in healthcare expenses on the same basis. Major factors in revenue growth were increased utilisation of physician and non-physician services; the proliferation of pharmaceutical direct-to-consumer advertising and demand for lifestyle drugs; and employers' greater willingness to absorb increases in benefit expenses to retain and attract employees in a tight labour market.

    AM Best expects HMOs to continue concentrating on specific components of utilisation management (disease and case management programs, clinical quality initiatives, preventive care, alternative therapies and discount programs, etc.), as a means to achieve differentiation in the marketplace, to improve operating performance and to partner with the provider community. Premium increases are expected to outpace expenses at for-profit and not-for-profit HMOs through 2001. However, rate increases will likely occur under the watchful eye of politicians concerned about the proposed patients' rights legislation, providers concerned about reimbursement pressures, which may be exacerbated by collective bargainings; and consumers.

    Total HMO enrolment remained relatively flat during 1999 and 2000. That followed four years of steady growth, with a compound annual growth rate of 13.9% between 1995 and 1998. As reported in Best's Aggregates and Averages, HMO edition, during 1999, the Group and Staff models recognised enrolment decreases of 14.7% and 13.6%, respectively. These two models of healthcare delivery, referred to as ‘closed panel HMOs,' have generally offered a smaller panel of providers and collectively accounted for a minor share of the industry's total enrolment. On the other hand, the Independent Practice Association, Network and Mixed model HMOs collectively recognised a marginal enrolment increase of 2.1% between 1998 and 1999. These three models of HMOs generally have offered the broadest provider participation and continue to service a majority of HMO enrollees.

    Overall, we expect the HMO segment to continue experiencing flat to declining enrolment in the coming year. Traditional qualitative factors such as the experience and competence of a management team; operating scale and market leverage; and effective brand promotion should continue to provide a sustainable competitive advantage on a local market basis. Furthermore, organisations that effectively use technology to provide reliable information on demand, as well as to enhance overall service to stakeholders, should achieve differentiation in the marketplace.

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