Recently, there’s been talk of limiting the amount of financial reserves that Massachusetts health insurers are allowed to carry. While this may sound like a good idea, it’s not; reserves provide a safety net that ensures hospitals and physicians get paid and consumers are protected in the event of a disaster, widespread illness, or catastrophic event. While we hope that these things never happen, if they do, health plans need to be prepared to respond. In Massachusetts, our highly-rated health plans have reserve levels that are both responsible and proven. The legislators should protect these resources so they can continue to serve as a financial safety net for all of us.

While obesity remains a major public health issue, researchers at our Harvard Pilgrim Institute brought us some good news this week from a regional study that shows declining obesity rates in very young children. Finally, the hard work from innovative public and private programs is beginning to pay off. All involved throughout our community are to be congratulated, including folks at our Harvard Pilgrim Institute and Foundation where obesity prevention has been our top priority. Much good work has been done yet more still needs to be done. This is one of the many reasons we are proud to sponsor Mayor Menino’s “Boston Moves for Health” initiative. It’s the kind of community engagement program we need to keep us on track.

Last week, the special Commission on Provider Price Reform put a spotlight on the problem of high prices charged by hospitals and physician groups that wield excessive market power.  They recommended a series of strategies to fix this major cost driver.  Economics tells us that in a well-functioning market, prices will vary depending on the value of the product or service we purchase.  For example, some people are fine purchasing a $5,000 used car and others want a new $35,000 electric car.  In either case, we know the value of our choice.  That’s not always the case in health care.  Some health care providers charge much higher prices that others and it’s often not based on higher quality but on market power from brand name or geographic location.  If we expect to make a dent in rising costs, we simply have to deal with this problem.  The Commission on Provider Price Reform is only the latest to tell us so, and it is our hope elected leaders will implement their recommendations.

At Harvard Pilgrim, we’re working with physicians to develop new care delivery models.  This collaborative effort aims to improve patient care, streamline decision making and take waste out of the health care system.  One program focuses on Orthopedic care.  When working closely with physicians and hospitals, we see real opportunity to improve quality and reduce costs.  We put the Orthopedic surgeon at the center of the care team, who coordinates all services based on what is best for the patient.  Our strategy looks at the complete suite of services before, during and after an Orthopedic surgery.  And, based on results, we’ll expand this Orthopedic program into other surgical specialties across New England.  The innovations will save employers money, help keep patients healthier, and improve the physician-patient experience, keeping us all focused on making health care work better.

Click here to listen to Eric’s announcement

*HMO/POS. NCQA’s Private Health Insurance Plan Rankings, 2011-12 – Private. U.S. News/NCQA America’s Best Health Insurance Plans 2005-2009 (annual). America’s Best Health Insurance Plans is a trademark of U.S. News & World Report. NCQA The State of Health Care Quality 2004.

Click here to listen to Eric’s radio segment on Municipal ChoiceNet

Important Information
The Municipal ChoiceNet Plan includes a tiered provider network. In this plan, members pay different levels of cost sharing depending on the tier of the provider delivering a covered service or medical supply. A provider’s benefit tier may change annually on January 1. Please consult the Harvard Pilgrim ChoiceNet provider directory or visit the provider search tool at www.harvardpilgrim.org/choicenet to determine a provider’s tier in the ChoiceNet network. You also may call Harvard Pilgrim to request a paper copy of the provider directory.

Today Harvard Pilgrim Health Care released its 2010 Annual Report – Making health care work better…that’s what we do. I start the report by offering up the three words that come to mind when I think about health care — complex, expensive and personal. We all have different points of view and roles to play in making our system work better for everyone. What are your thoughts and ideas on how health plans, employers, public officials and other health care stakeholders can better collaborate to both lower health care costs and improve quality of care?

These are some of the topics we covered:

• Governor Patrick’s Payment Reform Bill
• Shift from Fee-For-Service to Global Payments
• How premium prices are calculated
• Why transparency is important
• Need to focus on Preventive Care/Patient Responsibility

We also answered viewer’s questions directly from Facebook, and addressed some of the concerns many people have about the health care system.

I encourage you all to watch the clips of the Health Care Uncovered Live Summit using the links below. Do you think health care reform in Massachusetts is moving in the right direction? Have you seen evidence of a more wellness-based approach by your own health care providers?

I welcome your feedback.

Eric

Video Links:

Healthcare Uncovered Clip 1
http://www.thebostonchannel.com/video/27538726/detail.html

Healthcare Uncovered Clip 2
http://www.thebostonchannel.com/video/27538932/detail.html

Healthcare Uncovered Clip 3
http://www.thebostonchannel.com/video/27538873/detail.html

• Premium decrease of 37%
• Premium increase of 16%
• Premium increase of 52%

…even when the medical cost trend is increasing at 10% in all three examples.

To keep the math simple, each example is based on an employer with two employees, but the same concepts are applicable to employers that have up to 50 employee lives.I also assume the customer will keep their benefits exactly the same.

For a quick review from the last post, the premium is determined by two components: the Base Rate – or the average rate for all small employers and individuals covered by an insurer – and the Rating Factors.

The Rating Factors allowed by state law are: Customer’s Industry, Customer’s Geographic Location, Size of the Customer and Percentage of its employees choosing to purchase insurance, Wellness and Tobacco Use and, most importantly, the age of the employees.

Changes in the average age of an employer’s employees can dramatically affect year over year premium changes. The age factor may increase or decrease significantly if the mix of employee ages changes. So here are three examples that are calculated using state regulated formulas that produce some surprising results:

37% Decrease:   One group with 2 employees. A 60 year old and a 20 year old. If the 60 year old leaves the group, the premium renewal will be a 37% decrease.
16% Increase:   Same group in the first example, but the 20 year old leaves. The group receives a premium renewal increase of 16%.
52% Increase:   One group, 2 employees. A 45 year old and a 20 year old. If the 20 year old leaves the group, the premium renewal will be a 52% increase.

Intuitively, I get the first example. When an older person leaves the group, then insurance rates would go down. But the 2nd and 3rd example don’t make sense at first glance. Why would a two person group retaining the 60 year old produce an increase which is lower than when a group retains a 45 year old?

The detailed calculations are at the end of this blog, but the short answer is that state regulations require groups with younger employees to subsidize groups with older employees. In Massachusetts, the group with the oldest employees can’t be charged more than two times what the group with the youngest employees is charged, even though the true spread in medical costs is much greater.

To match the actuarial reality with the state regulations, Harvard Pilgrim first establishes rate factors for each age category. These factors range from about 0.4 to 2.4. We assign the appropriate age factor to each employee within a group and then calculate the average to determine the age factor that will be used to calculate the group’s rates. Under the regulations, the group’s factor must fall between 0.66 and 1.32. If the actual factor falls above 1.32, we assign it a factor of 1.32, resulting in a subsidy to that group. If the actual factor falls below 0.66, we assign it a 0.66, requiring that group to subsidize the pool. In our example, these rules work to limit the size of the increase for the group with the 60 year old employee (who receives a subsidy), but not for the group with the 45 year old employee (who does not).

The wide swings in premium rates that can occur have become a concern for policymakers. The Massachusetts Legislature recently enacted a new law directing the Division of Insurance to establish a so-called “bumper” or “cap” on how much any employer’s rates can increase because of changes in the average age of its employees. The good news is that this will limit the rate shock that some employers have experienced. It will, however, come at a cost. All small employers will need to pay a little bit more in order to fund the bumper. It may also have an unintended consequence of limiting choice, as an employer must stay with their existing employer to receive the benefit of the bumper. Harvard Pilgrim will continue to work with policymakers to strike the right balance when setting the bumper.

Now, for those who want to see the math on the three examples:
37% Decrease: Employer group is 20 and 60 year old. 20 year old age factor = 0.480 and 60 year old age factor = 2.016. The average age factor of this group is (0.480 + 2.016)/2 =1.248.

In year two, if the 60 year old leaves and the 20 year old remains, the employer group’s age factor would be 0.480. Since this is less than the minimum age factor of 0.66 (set by regulation), the age factor is increased to 0.66.

This produces a year over year decrease of 47% for the age factor of this employer group of (1.248 – 0.66)/1.248.

Combined with the 10% increase in the base rate produces a 37% decrease for this customer.

16% Increase: Employer group is a 20 and 60 year old. 20 year old age factor = 0.480 and 60 year old age factor = 2.016. The average age factor of this group is (0.480 + 2.016)/2 =1.248. If the 20 year old leaves and the 60 year old remains, the employer group’s age factor would be 2.016. Since this is greater than the maximum age factor of 1.32 (set by regulation), the age factor is decreased to 1.32.

This produces a year over year increase of the employer group’s age factor of 6% = (1.32 – 1.248)/1.248.

Combined with the 10% increase in the base rate produces a 16% increase for this customer.

52% Increase: Employer group is 20 and 45 year old. 20 year old age factor = 0.480 and 45 year old age factor = 1.177. The average age factor of this group is (0.480 + 1.117)/2 =0.829.

If the 20 year old leaves and the 45 year old remains, the employer group’s age factor would be 1.177. This factor is within the regulated range of 0.66 to 1.32.

This produces a year over year increase in the group’s age factor of 42% = (1.177 – 0.829)/0.829.

Combined with the 10% increase in the base rate produces a 52% increase for this customer.

I hope you see the point. Even if factors that affect a whole book lead to an average increase of 10%, specific employer groups may see very different results. When the mix of ages of its employees changes significantly, all bets are off. If young people leave the group, annual rates for the customer may increase dramatically.

So the purpose of this blog is to open up the so-called “black box” for calculating insurance premiums. To begin, I will only focus with the part of the insurance market that can see some of the biggest swings – namely the “merged market,” which includes small employers (50 or fewer employees) and individuals.

I recently sat with one of our senior actuaries (Greg) and asked if he could give me a straight-forward example of a small employer’s health insurance premium renewal and to explain how the rate was calculated and why a premium would go up or down substantially.

The “Base Rate”
So, let’s start with how the premium rate is calculated for a typical merged market customer. We start with something called the “base rate,” which can be thought of as a dollar amount that the health insurer needs to charge for an “average” customer. (And, by the way, in Massachusetts, about 90% of what the insurer needs to charge goes to paying for medical claims.)

But not all customers are “average,” and the laws in Massachusetts allow health insurers to modify the base rate for each customer to reflect the impact of certain factors. These “rating factors” have demonstrated their reliability in explaining the cost of claims a customer will likely incur in the future.

How we Adjust the Base Rate
What factors do state regulators allow?

• Age: The age factor for an employer group measures the average age of the members covered through that employer.
• Industry of the customer: Employees of certain industries consistently show higher or lower medical costs relative to the average.
• Geographic location: The customer’s location is considered since certain areas of the state have hospitals, physicians and other providers that are much more or less costly than other areas.
• Size of the employer group (the number of employees), as well as the percentage of those employees who choose to purchase insurance.
• Wellness and tobacco use: These are relatively new factors that I expect the market will want to use more and more. For example, I increasingly hear that non-tobacco users should be allowed to pay less for their insurance premium.

What these factors all share is that they contribute to a more accurate prediction of how future medical claims costs will vary by customer. And the policy question is how much should these factors adjust the base rate up or down?

Average Base Rate vs Individual Experience
State legislators and regulators try to find the fair balance somewhere between charging all customers the same “average” base rate, and, on the other end of the spectrum, adjusting that average according to the amount of medical claims each customer will incur in the future.

That is why health insurers are allowed to use some rating factors to modify premium rates…but with limitations. For example, consider the role of the age factor. Actuarial studies document that the oldest employees with insurance will incur 4 to 5 times the medical claims cost of the youngest. Yet Massachusetts law lets the maximum ratio to be 2 times. So the application of the rating factor is allowed, but just partially. Therefore, the smaller this ratio becomes, the greater the cost shift from older to younger persons.

Furthermore, there are some factors that relate to the cost and use of medical services that are not allowed at all by Massachusetts law. For example, the regulations forbid health insurers to charge higher rates to employer groups with members who have suffered with high cost conditions or who are likely to do so in the next year. The spirit of this regulation is that the burden of sharing the cost of very sick members should be borne by the whole population, rather than just one small employer group.

Year over Year Increase to Premium

Okay, so the premium rate for an employer group is determined by the average base rate and the group’s particular rating factors, as allowed by state regulations. What determines how much that rate will change from one year to the next? Well, the answer is surprisingly straightforward: it will depend on the CHANGE in the base rate and the CHANGE in the customer’s rating factors.

But, as they say, the devil is always in the details. (If you can hang in there, please keep reading…) Why does the average “base rate” change from one year to the next? As we said, the base rate is the dollar amount that needs to be charged to the average customer so that the health insurer can cover the cost of claims (about 90% of the rate), administrative expenses (about 9%), and a contribution margin (of about 1%). The base rate will increase because the cost of medical claims is increasing.  (In fact, administrative expenses have been declining.)  For Harvard Pilgrim and many other carriers in recent years the “trend” in the cost of medical claims has been about 10%, mostly due to the increase in reimbursements to health providers, increases in the use of higher cost services, and the expected impact of new state and federal health care mandates.

If that was the only change, then all customers would get about a 10% increase. But the other determinant of an employer’s premium rate is its rating factors. Are these likely to change? Unless the employer moves to another geographic area or changes its entire business, the area factor and the industry factor won’t change. For most accounts, it is the age factor which drives the difference.

Let’s assume the customer:

• Will keep their benefits exactly the same;
• Will maintain an identical employee and dependent population (other than growing one year older);
• Has employees reasonably distributed across many age categories.

In this example, their health insurance premiums would increase by approximately 14%. This is because the base rate increased by 10% and the cost associated with the population’s average age increasing by one year (assuming no retirements) drives roughly a 4% increase in cost.

With normal turnover (older employees retiring, younger employees hired), the impact of aging is about 1 – 2% on average for accounts producing an 11% to 12% increase in the example above.

If you figured out that the mix of employee ages and the change in the mix of employee ages from one year to the next must be a major driver in premium change, you are correct!  Imagine what might happen if, in this economy, an employer laid off the youngest workers…

In Part II of “Opening The Black Box,” I want to provide an example that drives a premium decrease of 37%, and a premium increase of 16% and 52%. In these three examples, it is the change in the employer group’s age factor that explains these results. I will also discuss how a recently enacted law will address this.