Managing Health Insurance Risk THIS DOCUMENT IS PRIVILEGED & CONFIDENTIAL AND CONSTITUTES ADVICE OF COUNSEL Patrick Ryan, F.S.A., M.A.A.A. Sr. Actuary Wellmark Blue Cross Blue Shield of Iowa

Managing Health Insurance Risk: Basics It’s critical to maintain random mix of risks: 1% of individuals generate 20% of costs 5% of individuals generate 50% of costs 20% of individuals generate 80% of costs Attraction of disproportionate share of high risk will raise average costs – higher premiums for everyone

Managing Health Insurance Risk: Basics Different risks have different incentives to purchase coverage Higher risks: Sicker individuals, or individuals vulnerable to illness (i.e., older) Are less sensitive to price Tend to select policies with broad benefits, lower cost sharing Lower risks: Younger, healthier individuals Are highly price sensitive Are less interested in broader benefits Are less concerned about a higher level of medical management (i.e., an HMO)

Managing Health Insurance Risk: Avoiding Adverse Selection Disproportionate share of high risks lead to the most problematic and most predictable insurance problem: Adverse Selection As more high risks enroll, the average per member cost increases so premiums increase The premium increases (triggered by the enrollment of relatively higher risks) triggers dropping of coverage – or a decision not to purchase – by younger, highly price sensitive enrollees Loss of or failure to enroll younger, healthier risks results in a further increase in the average per member cost and further premium increases This continuing set of dynamics – referred to as an Adverse Selection Spiral – leads to increasingly higher average per member costs –– and higher premiums for everyone

Managing Health Insurance Risk: Avoiding Adverse Selection Insurers are constantly sensitive to the need to avoid triggering an adverse selection spiral Insurers try to avoid triggering the adverse selection process by: Trying to attract young healthy enrollees (to moderate overall costs) by adjusting premiums for younger healthy enrollees to reflect their predictably lower health care expenses (i.e., lower premiums) Strategies that keep prices affordable by adjusting premiums for risk Underwriting (e.g., turn down highest risk) and relying on broader-based funding (high risk pools) than just individual market enrollees to subsidize highest risk

Managing Health Insurance Risk: Making Coverage as Affordable as Possible Greatest challenge health insurers face: attracting balanced pool of risks to keep healthcare as affordable as possible Key Challenge: How to convince healthy individuals to buy insurance coverage? Many healthy individuals: “Insurance is expensive and unnecessary” Older and sicker individuals very motivated to buy

Managing Health Insurance Risk: Using Age Rating Age Rating in Individual Market: Insurers offer lower premiums to younger individuals Community Rating (CR): All ages charged same premium Age Monthly Age Rated Premium Monthly Community Rate CR if Youngest 20% Leave CR if Youngest 40% Leave 19-24 $149 $267 $301 $354 25-34 $169 35-44 $218 45-54 $268 55+ $350 C/R Increases Premiums by 79% for 19-24 Year Olds

Managing Health Insurance Risk: State Experience w/Community Rating Guaranteed issue and community rating can have unintended consequences: Fewer Insured: Maine/New Jersey 50% of individual enrollees dropped coverage High Premiums: Premium for a 25 year-old is: $1,269/month in New Jersey $924/month in Maine Reduced Choice: Lowest deductibles in NJ and Maine: $1,000; The majority of insurers have left these states Underwritten Iowa premium: $169/month Guarantee issue encourages individuals to delay purchase until they become sick

Managing Health Insurance Risk: Pooling Pooling protects individuals and small groups purchasing coverage from the extraordinarily high costs of highest risk enrollees States have recognized this and have required all insurers to pool their small group market States require health plans to pool all small firms and cannot vary premiums by more than a specified amount (e.g., 25% in most states) from average due to health status A large claim for a small firm is spread over the entire pool – not just the small employer Premiums cannot increase based on claims experience more than specified amount (e.g., 15%) Result: In the small group market, low-risk firms pay higher premiums to subsidize high-risk firms

Managing Health Insurance Risk: Pooling Some states have tried to build on the value of pooling by establishing state purchasing pools Experience with state purchasing pools shows: No additional pooling occurs; pooling is still at the insurer level not at the state purchasing pool level Average per enrollee – premiums – costs in any purchasing pool is determined by health status of enrollee

Managing Health Insurance Risk: Effect of Pooling Arrangements State purchasing pools do not address cost drivers for premiums Provider Payment Rates Utilization Enrollees’ Health Status Benefit Package Administrative Costs Risk/Cost of Care (83-90%) Health plans negotiate on behalf of all members Risk Selection Issues: 5% enrollees = 50% costs 20% enrollees = 80% costs Small employer risk volatility Marketing Agents/Brokers Billing Claims Processing Disease Management Customer Service Network Management Risk/Profit Taxes Compliance Costs

Managing Health Insurance Risk: Pooling Small Employers Health Plans Required to Pool All Small Employers Health plans required to pool all small firms; cannot vary premiums by more than 25% from average due to health status A large claim for a small firm is spread over the entire pool – not just the small employer Premiums cannot increase by more than 15% due to claims experience Community Rating Would Increase Premiums by 30% for healthy groups Health Status NAIC Rules Community Rating Community Rate if 20% Drop Tier 1 $346 $454 $476 Tier 2 $399 Tier 3 $447 Tier 4 $526

In Conclusion Greatest challenge health insurers face: attracting balanced pool of risks to keep healthcare as affordable as possible Key Challenge: How to convince healthy individuals to buy insurance coverage?