Inside the Black Box: Special Considerations in Individual & Small Group AcademyHealth - June 8, 2004 Jerry Winkels

1. Inside the Black Box: Special Considerations in Individual & Small Group AcademyHealth - June 8, 2004 Jerry Winkelstein, FSA, MAAA Blue Cross of CA

2. Individual/Small Group/Large Group Comparison Individual Small Group Large Group 1. Issuance May decline Guarantee issue May decline 2. Individual medical underwriting Yes Depends on group size None 3. Level of anti-selection High Medium Low 4. Rating restrictions Varies by state Usually +/- X% None

3. Individual Medical Underwriting → Claim Cost Duration Curve 1.16 1.2 1.02 0.93 0.95 1 0.85 0.77 0.8 0.6 0.6 0.47 0.4 0.2 0 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Year 2 Year 3 Year 4 Year 5+

4. Monthly Premium $120 Monthly Premium $120 Male Age 45 Insured Since 1984 (20 years of coverage) Male Age 45 Insured Since June 7th, 2004 (1st year of coverage, just completed medical underwriting) Claim Cost Duration Curve → 3 Different Rating Approaches 1)Aggregate Rating – All insureds with same attained age pay same rate

5. Monthly Premium $114 Monthly Premium $171 Male Age 45 Insured Since June 7th, 2004 (1st year of coverage, just completed medical underwriting) Male Age 45 Insured Since 1984 (20 years of coverage) Claim Cost Duration Curve → 3 Different Rating Approaches • Durational Rating(with Re-Entry Underwriting) – More recently under-written business pays less

6. Monthly Premium $105 Monthly Premium $315 Male Age 45 Insured Since June 7th, 2004 (1st year of coverage, just completed medical underwriting) Male Age 45 Insured Since 1984 (20 years of coverage) Claim Cost Duration Curve → 3 Different Rating Approaches 3)Experience Rating – More recently under-written business pays less, amplified by prospective evaluation.

7. Aggregate Rating → A Closer Look • Primary rating scheme of Blues • Pros: • Protects insureds against large premium increases if they become “un-healthy” • Encourages “lifetime partnership” – basically saying “we will not discriminate against you rate-wise if you become chronically ill” • Con: Higher initial premium rates

8. Durational Rating → A Closer Look • Primary rating scheme of non-Blues • Pros: • Lower initial premium rates, in a very competitive market • More equitable • Cons: • More administrative work involved with re-underwriting evaluations • Raises sicker insureds’ rates at a time they can least afford it/leads to “closed block” problem/encourages regulatory intervention

9. Healthy – Given only a trend increase Less Healthy – Given a trend increase +5% Least Healthy – Given a trend increase +25% Experience Rating → A Closer Look • Rating scheme used by a small minority • Every renewal year, every insured is placed in 1 of 3 buckets: • Total premium rate limited to 300% of new business rate

10. Experience Rating → A Closer Look • Pro: Lowest initial premium rate • Cons: • More administrative work • Ethical/Morality issues/strongly encourages regulatory intervention

11. The more appropriate way to reduce the “sicker” uninsured is through a State-run pool with assessments; maintaining affordable rates for the majority of insureds who could pass medical underwriting Uninsured Issues – Does Guaranteed Issue/Community Rating Work? • New Jersey implemented Guaranteed Issue several years ago, so that all residents have access to “affordable” Individual Health

12. $299 less or an 80% Savings Uninsured Issues – Does Guaranteed Issue/Community Rating Work? • Due to Assessment Spiral caused by several years of healthier insureds exiting the market, current monthly premium rate for a $5,000 deductible, 50/50 MM coverage for age 42 single male = $376 • In a medically underwritten environment, it would be approximately $77, or 80% LESS!

13. Uninsured Issues – Is Pooling the Answer? • Many politicians tout Pooling as the answer to reducing the risk of covering the uninsured under Individual Medical • Pooling reducing the variance of the claim loss expected. Pooling claims above $50,000/year will reduce the overall claim level by 18%, if no Pooling charge • Pooling does little to reduce the overall level of the claim

14. Uninsured Issues – Is Pooling the Answer? • Claim variance is not even a minor concern to the major Individual Medical cariers in a State. • It is the overall claim level that is of concern to Individual Medical carriers, especially if they asked to provide guaranteed issue in return

15. Small Group – Late 70s/Early 80s, The Time of Abuse • There were few State laws protecting the marketplace • Small Group Carriers became increasingly “cannibalistic” • JALIC Experience – Slamming 5% of the Worst Groups was worth 8% to entire block • “Where did the ‘bad’ groups go? • Uninsured MEWAs were “pyramid schemes” who went bankrupt, leaving “insured” Small Groups uninsured!

16. Abuse → Small Group Reform • Regulations vary by state • Rationale • Small employer market is not as sophisticated or powerful as the large group market and therefore needs regulatory intervention • Purpose • Promote availability of health insurance to small employers • Prevent abusive rating practices • Limit use of pre-existing condition exclusions • Improve fairness of small group market

17. Small Group Reform Mandates • Guarantee Issue • Definition of Small Group Employer • States typically specify what rating variables must be part of the +/- X% restriction • States typically allow +/- 25% variance for health status or claims experience, with additional factors allowed for industry (e.g. +/ 15%) or group size • Some States allow complete rating freedom • Other states are community rated—no rate variation allowed • California: Allowed rate variance is +/- 10%, including health status, claims experience, industry and group size

18. Why AHPs Would De-stabilize the Small Group Marketplace • Proposed Association Health Plan regulations would seem to set the stage for a return to the abuses rampant in the late 70s and early 80s, by eliminating State oversight. • AHPs would self-report problems and rely on the US DOL for oversight. The US DOL has testified that it could review each health plan only once “every 300 years”. • Multi-State AHPs could be exempt from State Reform rating rules leading to the following:

19. Average Cost $200 [$800/4] Why AHPs Would De-stabilize the Small Group Marketplace Assume that the Small Group marketplace consists of the following 4 types of groups, in equal numbers, and is in a +/- 20% State:

20. Carriers are able to price appropriately to cover costs with A’s subsidizing D’s Why AHPs Would De-stabilize the Small Group Marketplace Before AHPs enter the market, carrier having equal numbers of A, B, C, D price as follows:

21. AHPs under price Group A versus the market Why AHPs Would De-stabilize the Small Group Marketplace AHPs will enter market and will be able to under price A and overprice D versus the market. Eventually, the AHPs will get all A and no D

22. Why AHPs Would De-stabilize the Small Group Marketplace AHPs will be able to rate all Groups (A, B, C, D) properly! But, look what happens to the rest of the market that has to obey State Small Group rating regulations

23. Average Cost $200 $200 $245 Carrier loses Group A and Group B because they cannot compete with AHPs. For Example, the lowest they can charge Group A is $196 while the AHP can charge $120. Why AHPs Would De-stabilize the Small Group Marketplace After AHPs enter the market, carriers will get no A and B, only C and D

24. Why AHPs Would De-stabilize the Small Group Marketplace The bottom line: • A’s and B’s will get lower rates, at the expense of C’s and D’s • Avoiding State benefit mandates adds small amount to increased AHP competitiveness; Is this desirable?

25. Individual / Small Group – Rate Increase Anti-Selection Assumptions: • 10% rate increase causes 1.5% additional lapses • The additional lapses have morbidity 80% of the average for the plan • Prior claims pmpm = $200.00 • 1,000 Prior Members

26. After 10% Rate Increase $200.61 PMPM Average Claim Cost 985 Members 15 Members ($160 PMPM) Total Claim Cost Total Claim Cost ($200.61)(985) + ($160)(15) = $200,000 $200 PMPM x 1000 Member = $200,000 Individual/Small Group – Rate Increase Anti-Selection

27. Individual/Small Group – Rate Increase Anti-Selection • Prior Monthly Claims pmpm = $200.00 • New Members Claims pmpm = $200.61 • $200.61 is 0.3% higher than $200.00 • Therefore, for each 10% of rate increase, there will be a 0.3% additional claims pmpm increase (on top of normal trend)

28. Thank You