How Much Is Too Much? C A L I FOR N I A An Analysis of Health Plan Profits and Administrative Costs in California H EALTH C ARE F OU NDATION Introduction costs (including marketing, enrollment, customer Health insurance premiums in California are service, and billing). The residual that is left increasing much faster than most other areas of over is called profit in for-profit health insurance the state’s economy. Between 2002 and 2007, carriers, and can be paid to stockholders, used premiums rose 86 percent compared to an overall to finance capital investments, or transferred Issue Brief inflation rate for the state of less than 20 percent.1 to reserves. Nonprofit health insurance carriers At the same time, policymakers and the public are have no stockholders; the residual is known as eager to identify ways to address rising health care net income and may fund capital investments costs, often pointing to health plan administrative and reserves. A proposal requiring carriers to costs as a potential target.2 spend at least 85 percent of premium income on medical care would in effect limit profits and In response to concerns about health insurance administrative costs to 15 percent of premium carriers’ efficiency and accountability, policymakers income. (Throughout this report, the term profit is have considered regulation to ensure that the used to refer to both for-profit carriers’ profits and percentage of premium income that carriers spend nonprofit carriers’ net income.) on medical care, known as the medical loss ratio (MLR), stays at or above a minimum level. For To better understand the potential impact of example, Senate Bill 1440, which passed both policy proposals intended to restrain health houses of the California legislature in 2008, insurance administrative costs and profits, the would have required insurance carriers to spend at California HealthCare Foundation commissioned least 85 percent of premium income on medical researchers from RAND Health to analyze three care. Although Governor Schwarzenegger’s 2007 questions: health care reform proposals included a similar .To what extent has recent (2002 – 2006) growth 1 requirement, he vetoed SB 1440, citing a desire for in premiums in California and nationwide been “comprehensive” rather than “piecemeal” reform.3 driven by growth in administrative costs and The impact of medical loss ratio regulation could profits? be substantial; in 2006, almost half (12 out of 26) of full-service health plans regulated by the .Are California health plans’ administrative costs 2 California Department of Managed Care had an and profits “reasonable”? MLR of less than 85 percent.4 3.What has been the effect of MLR regulations in other states? Health insurance carriers receive income from premiums paid by employers and individuals, and This issue brief summarizes the findings from other sources, such as investment income.5 and discusses implications for the design, The carriers use this income to pay both direct implementation, and monitoring of MLR medical expenses (claims paid to doctors, hospitals, regulation. N ovember and other health care providers) and administrative 2008 Can Administrative Costs and Profits stable, and the 2006 MLR for California carriers (88 Explain Premium Growth? percent) was the same as for the nation.9 To examine whether administrative costs and profits are driving growth in premiums, the researchers analyzed Compared with for-profit plans, private nonprofit annual reports from 2002 to 2006 filed at the California plans had much higher revenues per enrollee ($4,508 Department of Managed Health Care (DMHC). The versus $2,767 in 2006) and also experienced much DMHC regulates all health maintenance organizations larger annual growth in revenue (13.9 percent versus (HMOs) that operate in the state as well as some 5.7 percent). These large differences are likely linked preferred provider organizations (PPOs).6 The analysis to greater market presence of comprehensive HMO therefore primarily focused on HMOs, which provide products among nonprofit plans. In contrast, for-profit coverage to the majority of insured Californians.7 In plans tend to rely more on products with high and 2006, enrollment for the 26 health plans represented increasing consumer cost-sharing, thus lower — and less was almost 19 million people, about 60 percent of all rapidly rising — revenues. Private nonprofit plans spent insured Californians. Among the health plans were eight 90 percent or more of their revenues on medical costs, for-profit firms, nine nonprofit private insurers, and while the MLR of for-profit plans remained constant nine public insurers (also called local health initiatives). at 82 percent from 2002 to 2006. Public plans, whose Estimates of national health expenditures from the Center enrollment includes a greater share of children with for Medicare and Medicaid Services (CMS) were used relatively low service use, tended to have lower revenues to examine national trends in premiums, administrative per enrollee than either for-profits or nonprofits, and costs, and profits.8 spent 91 percent of revenues on health care. In California, revenues per enrollee increased about 10.6 Overall, the analysis suggests that medical cost increases percent annually (from $2,379 to $3,565) between 2002 account for most of the premium growth in California and 2006, compared to 4.1 percent for the nation (from and nationwide during 2002 – 2006. Across all types of $3,329 to $3,919). See Table 1. MLRs for the health plans, medical costs explain nearly 86 percent of revenue plans in California and nationwide remained relatively increases in California and 89 percent of increases Table 1. Revenues, Administrative Expenses, and Medical Expenses for California Health Plans, 2002–2006 R e v e n u e per E n r o l l ee M e d ica l L o s s R ati o R e v e n u e I n crea s e Due to A d m i n i s t r at i v e Due to 2002 2006 2002 2006 Costs and Profits M e d i ca l C o s t s California Health Plans All $2,379 $3,565 89% 88% 14% 86% For-profit $2,219 $2,767 82% 82% 18% 82% Nonprofit $2,679 $4,508 94% 90% 16% 84% Public $1,403 $1,467 91% 91% 0% 100% U.S. Private Insurers All $3,329 $3,919 87% 88% 11% 89% Sources: Insurance filings with the DMHC and estimates of national health expenditures from the CMS. Estimates are averages across the carriers in the sample and are weighted by the number of enrollees. In 2006, there were 1.44 million enrollees in public plans, 9.66 million enrollees in nonprofit plans, and 7.64 million enrollees in for-profit plans. Notes: All dollar values shown are in 2006 dollars. The consumer price index was used to adjust for inflation. 2  |  California HealthCare Foundation nationwide. For both for-profit and nonprofit insurers DMHC, CDI, and Financial Data Availability in California, increases in medical costs explain roughly Oversight of health insurance carriers in California the same fraction of revenue growth (82 percent and 84 is divided between two state departments. The Department of Managed Health Care (DMHC) regulates percent, respectively), while increases in medical costs health care service plans whose products have explain nearly all of the increase in revenues per enrollee historically emphasized service delivery through health for public insurers. maintenance organizations (HMOs). The California Department of Insurance (CDI) has jurisdiction over Profits and administrative costs in California grew health insurers whose products have historically emphasized the financial protection aspects of substantially during this period (see Table 2).10 Profits insurance, rather than the service delivery modality.11 per enrollee increased from $65 in 2002 to $178 in 2006 The research team was interested in analyzing financial (29 percent annual growth), and administrative costs filings for insurance carriers regulated by both DMHC increased from $190 to $249 (7 percent annual growth). and CDI, particularly since experience may differ Such increases were especially large for nonprofit insurers, systematically between the two regulatory venues. whose profits per enrollee increased from $8 to $189 The detailed plan-level data for the years 2002 to 2006 were readily available in an electronic format from (120 percent annual growth), and whose administrative the DMHC Web site. However, data on CDI-regulated costs per enrollee increased from $133 to $231 (15 insurers for the years 2002 to 2006 were not available percent annual growth). However, because administrative in an electronic format or as summary reports either costs and profits per enrollee were small relative to from CDI or from the National Association of Insurance Commissioners (NAIC). Consequently, the current medical costs, these increases did not contribute analysis was limited to insurance carriers regulated substantially to growth in revenues. under the Department of Managed Health Care, whose enrollment of approximately 19 million Californians Are Administrative Costs and Profits represents 60 percent of the state’s insured population. “Reasonable”? There is no unimpeachable standard by which to judge the appropriateness of health plan administrative costs and profits. To begin to gauge “reasonableness,” health plan profits and administrative costs were compared to several benchmarks. K Profits as a percentage of revenues were compared for California health plans and the S&P 500 Table 2. Breakdown of Per Enrollee Expenses for California Health Plans, 2002 – 2006 P r o f it s A d mi n i s trati v e C o s t s M e d ica l E x pe n s e s Annual Annual Annual 2002 2006 Growth 2002 2006 Growth 2002 2006 Growth All $65 $178 29.0% $190 $249 7.0% $2,124 $3,138 10.0% For-profit $128 $191 11.0% $266 $302 3.2% $1,825 $2,274 5.7% Nonprofit $8 $189 120.0% $133 $231 15.0% $2,538 $4,088 13.0% Public $42 $30 – 8.8% $86 $97 3.1% $1,276 $1,341 1.2% Sources: Insurance filings with the DMHC and estimates of national health expenditures from the CMS. Estimates are averages across the carriers in the sample and are weighted by the number of enrollees. Notes: All dollar values shown are in 2006 dollars. The consumer price index was used to adjust for inflation. How Much Is Too Much? An Analysis of Health Plan Profits and Administrative Costs in California  |  3 Figure 1. rofitability of California Health Plans and P understate the program’s overall administrative S&P 500 Firms burden. Medicare spends $471 per enrollee on administrative costs, which is above the average All CA Plans For-profit CA Plans S&P 500 amount spent across all California health plans ($427) and slightly below the amount spent by 7.5% for-profit plans ($493).12 However, Medicare spends 6.9% roughly 5 percent of revenues on administration, 5.8% which is much lower than the average spent by all 5.0% California health plans (12 percent) and by for-profit plans (18 percent). The apparent contradiction comes from the fact that the Medicare population is older 2.7% 2.4% than that covered by California health plans, and therefore Medicare enrollees incur higher medical expenses. Therefore, Medicare’s administrative costs as 2002 2006 a percentage of revenues are much lower. Sources: Insurance filings with the DMHC, estimates of national health expenditures from the CMS, and financial statements of S&P firms. The DMHC data were used to examine whether growth in administrative costs has been driven by salaries and marketing — two large spending categories (see Figure 1). Profits for California health plans as sometimes identified as potentially wasteful. Although a whole are lower than those of the S&P 500 firms marketing and compensation account for over half of (5 percent of revenues versus 7.5 percent). However, administrative costs, the share of administrative costs the profit margin of for-profit plans in 2002 (5.8 devoted to compensation remained fairly constant at percent) was higher than for S&P 500 firms as a 29 to 31 percent from 2002 to 2006, while the share of whole (2.4 percent), although in 2006, the profit costs devoted to marketing fell slightly, from 34 percent margins for these two groups were similar (6.9 in 2002 to 27 percent in 2006. Spending in these two percent for for-profit insurers and 7.5 percent for the categories has not contributed disproportionately to S&P 500). These simple comparisons do not take growth in total administrative costs. Yet, while growth level of risk into consideration. Conventional wisdom in marketing and compensation have not outpaced is that firms engaging in more risky enterprises overall administrative cost increases, neither have they require greater potential reward. If California health lagged behind; both have increased, along with medical plans face less risk than the S&P 500 as a whole, they spending, at rates that exceed general inflation. may be satisfied with a lower profit margin; but if the health plans face more risk, then they may demand a Table 3. dministrative Costs and Profits Per Enrollee A for Medicare and California Health Plans, 2006 higher profit margin. dollar amount p e r c e n t ag e K Administrative costs of California health plans Medicare $471 5% were compared to those of Medicare (see Table 3). All California health plans $427 12% Medicare is often cited as an efficient insurer, For-profit California health plans $493 18% although reported Medicare program administrative Source: Insurance filings with the DMHC and estimates of national health expenditures from the CMS. Estimates are averages across the carriers in the sample and are weighted by the number costs exclude the costs of fiscal intermediaries that of enrollees. Notes: All dollar values shown are in 2006 dollars. The consumer price index was used to adjust collect premiums and process claims and may for inflation. 4  |  California HealthCare Foundation What Can California Learn from Other Issues to Consider States? The analysis identified issues to consider when Information on MLR regulations from 45 states was determining whether and how to regulate insurers’ collected from each state’s Department of Insurance administrative costs and profits. (DOI) and categorized into one of five groups, depending on the type of market affected: none; individual market What spending levels are appropriate? There are no only; small-group market only; individual and small- definitive answers about the “right” level of spending on group only; or entire market (individual, small-group, medical care versus other costs. Not all administrative and large-group).13 See Table 4. Only six states mandated costs are wasteful and not all medical spending provides minimum MLRs for all segments of the health insurance real value. Most observers agree that there is room for market, stipulating minimum MLRs ranging from 50 improvement in the efficiency with which American percent to 75 percent.14 The latest of these states enacted health care is financed and provided, but perspectives its MLR regulations in 1999. The analysis showed: differ regarding the causes and remedies. If administrative spending is the source of the majority of inefficiencies, K California’s recent proposal to restrict insurance then regulating MLRs will be a useful way to improve carriers to a minimum MLR of 85 percent is unique efficiency. However, if medical spending accounts for the both because it is more stringent than existing bulk of inefficiencies — through inappropriate service regulations in any other state and because no state has use, pricing that does not reflect cost, or both — then recently chosen to regulate the MLR for the entire MLR regulation could be ineffective or even counter- health insurance market. productive. Therefore, it is crucial to analyze the K Existing MLR regulations have had little effect in magnitude and source of inefficiencies in the health care states that have enacted those regulations. There is system and to determine to what extent MLRs are a little relationship between the presence of extensive meaningful measure of efficiency.16 MLR regulation and insurers’ average loss ratio.15 In particular, the mean loss ratio for insurers reporting How should a requirement be applied? A minimum in the 18 states without MLR regulations (83.3 MLR could apply separately to each product issued by an percent) was similar to the mean loss ratio for insurers insurance carrier, or to a carrier’s entire book of business reporting in the six states that regulate the entire (Senate Bill 1440 would have required the insurer as a market (81.4 percent), although none of these states whole to spend at least 85 percent of premium income on required the MLR to be higher than 75 percent. medical expenses). If accompanied by public reporting, clear definitions, and benchmarks to assist in interpreting Table 4. MLR Regulation for Health Insurance Markets MLRs, a requirement that a minimum MLR apply Affected Number Years separately to each product could benefit consumers. Ma r k e t S e g m e n t o f S tat e s MLR Ra n g e E n ac t e d None 18 N/A N/A However, there are two disadvantages to this approach. Individual only 13 50 – 72% 1962 – 2001 First, since medical costs are more variable at the product level, particularly for products with low enrollment, Small-group only 2 60 – 80% 1992 – 2001 insurance carriers would be subject to more variability in Individual and 6 65 – 82% 1991 – 1993 small-group only ensuring that each plan meets the minimum threshold. Entire market 6 50 – 75% 1974 – 1999 Second, since many administrative costs for an insurance Total 45 N/A N/A carrier are not specific to an individual product, allocating Source: Interviews with state insurance regulators. How Much Is Too Much? An Analysis of Health Plan Profits and Administrative Costs in California  |  5 these costs among the products would be difficult and and its definitions are worded and on each carrier’s could make the measure harder to enforce. organizational and financial structures — how integrated the health plan and health care delivery systems are, for How would carriers respond? Firms would have at example. In interviews, DMHC staff suggested that they least three options in meeting a minimum threshold. are not concerned about companies gaming the system First, they could reduce premiums by accepting lower under current regulations. However firms may have profits. This would initially benefit consumers, although increased incentives to game if more stringent regulations it could hurt them in the long term if firms decide to are imposed. leave the state and the remaining coverage options are less competitive. Second, insurance carriers could reduce Conclusions their administrative costs — ideally by cutting spending The absence of readily available financial performance on wasteful administrative activities — presumably the data for Department of Insurance-regulated carriers intent of the proposed regulations. However, carriers makes it impossible to analyze historical trends or could opt instead to reduce spending on administrative estimate the potential impact of MLR regulation for a costs that benefit enrollees and improve efficiency, such small but important part of California’s health insurance as customer service representatives, innovation in design market. Among DMHC-regulated health plans, profits of health benefits, health care contracting, or utilization and administrative costs increased substantially between reviews. Finally, insurance carriers could increase medical 2002 and 2006, but it was increases in medical costs that spending to reach the threshold. The 12 firms that would drove premium growth during that time. Assessing the be affected by the proposed regulations would need reasonableness of current levels of administrative costs to spend roughly $82 per enrollee, or $836 million in and profits is highly dependent on the benchmark by the aggregate, to reach the threshold. These amounts which health plans are judged. Therefore, it is unclear represent a 3.6 percent total increase in medical spending. whether there is a strong case to be made for regulating To the degree that this increase is devoted to cost-effective MLRs. However, if MLR regulations are implemented, medical care, the MLR regulations will improve efficiency. the state should establish uniform reporting requirements However, if firms choose to reach the threshold by that assure publicly accessible financial data and medical spending on cost-ineffective medical care or by allowing loss ratios for all of the state’s insurance carriers. State unit prices paid to rise, then the regulations could actually regulatory agencies should also take steps to monitor a reduce efficiency. range of potential effects of the regulation, including consumer satisfaction, medical care cost growth, health How will costs impact insurer actions? The costs of plan entry and exit, and the regulatory burden on compliance and the ability of insurance carriers to game insurance carriers and the state. the system should be considered when adopting MLR regulations. If the costs associated with compliance are high, then MLR regulations could actually increase administrative costs. Moreover, insurance carriers are more knowledgeable about their administrative costs and profits than regulators, and could try to find ways to game the regulations by, for example, re-categorizing or redistributing certain types of spending. The possibility of gaming will depend on how precisely the regulation 6  |  California HealthCare Foundation Appendix 1. MLR for California Health Plans, 2006 p l a n Name / t y pe E n r o l l me n t MLR Nonprofit California Physicians’ Service (dba Blue Shield of California) 2,621,060 83.07% Community Health Group 91,836 84.66% Kaiser Foundation Health Plan, Inc. 6,758,447 92.47% On Lok Senior Health Services 1,011 81.45% Scripps Clinic Health Plan Services, Inc. 37,483 94.76% Sharp Health Plan 48,466 90.29% Sistemas Medicos Nacionales, S.A.de C.V. 16,477 68.93% WATTSHealth Foundation, Inc. 1 76.48% Western Health Advantage 85,548 90.37% Profit Aetna Health of California, Inc. 314,692 82.27% Blue Cross of California 4,397,820 79.88% Chinese Community Health Plan 13,231 85.64% Cigna HealthCare of California, Inc. 312,960 93.23% Great-West Healthcare of California, Inc. 53,380 73.55% Health Net of California, Inc. 2,146,892 84.90% PRIMECARE Medical Network, Inc. 220,236 79.89% Universal Care, Inc. 179,410 84.40% Public Alameda Alliance for Health 90,198 85.81% Contra Costa Health Plan 63,474 92.91% County of Los Angeles – Department of Health Services 159,426 80.97% County of Ventura (dba Ventura County Health Care Plan) 11,143 87.36% Local Initiative Health Authority for L.A. County (dba L.A. Care) 795,658 94.88% San Joaquin County Health Commission (dba Health Plan of San Joaquin) 76,035 87.51% Santa Clara County (dba Valley Health Care) 58,340 90.42% Santa Clara County Health Authority 96,570 87.16% Santa Cruz – Monterey Managed Medical Care Commission 88,296 92.44% Source: 2006 insurance filings with the DMHC. How Much Is Too Much? An Analysis of Health Plan Profits and Administrative Costs in California  |  7 Authors Reidy Kelch, Making Sense of Managed Care Regulation in California, California HealthCare Foundation, November Neeraj Sood, Ph.D., Eric Sun, Ph.D., Lindsay Daugherty, 2001, available at www.chcf.org/topics/healthinsurance/ M.A., and Arkadipta Ghosh, Ph.D. index.cfm?itemID=12861. In addition to HMO enroll- ment, DMHC regulates PPO plans offered by Blue Cross RAND is a nonprofit institution that helps improve policy of California and California Physicians’ Service (Blue and decision-making through research and analysis. Shield of California) in which roughly 2.5 million people are enrolled. Endnotes 7.Only health plans characterized as full service were 1.California HealthCare Foundation, California Employer included in the analysis; the researchers excluded dental Health Benefits Survey, December 2007. and vision plans as well as firms that failed to submit one or more reports between 2002 and 2006. 2.A recent poll by the Kaiser Family Foundation found that 66 percent of Americans believe that reducing waste 8.Total premiums received by insurers were identified by and fraud in the health care system would do “a lot” using CMS’s estimates of private insurers’ spending on to lower health care costs. See www.kff.org/kaiserpolls/ “health and health services,” which CMS calculates as the upload/7784.pdf. total amount of premium income received. Spending on medical claims was identified using CMS’s estimates of 3.SB 1440 veto message, leginfo.ca.gov/pub/07-08/bill/sen/ private insurers’ spending on “personal health expendi- sb_1401-1450/sb_1440_vt_20080930.html, accessed on tures.” Combined spending on administrative costs and October 7, 2008. profits was identified using CMS’s estimates of private 4.What share of health insurance carriers would be affected insurers’ spending on “administrative costs and net cost by a particular policy proposal depends on the propos- of private health insurance.” These total estimates were al’s specific requirements. For example, SB 1440 as converted to per-enrollee figures by dividing the costs passed August 31, 2008 by the California Senate would by the number of persons with private insurance. The allow insurance carriers to: average their costs across number of insured persons was derived from estimates all products, whether regulated by the Department of from the Medical Expenditure Panel Survey. Managed Health Care or the Department of Insurance; 9.Although the MLR is defined as the percentage of premium exclude taxes from their aggregate premiums; and include income spent on medical care, this research reports the as health care benefits certain costs (programs determined percentage of total income, which includes interest and to improve quality of care, disease management, telephone investment income spent on medical care, administra- medical advice lines, and provider pay-for-performance tion, and profits. These three categories sum up to total payments) that may historically have been categorized as income, not premium income. On average, these other administrative costs. SB 1440 Senate Floor Analysis, sources of income account for less than 2 percent of the www.leginfo.ca.gov/cgi-bin/postquery?bill_number=sb_ income received by a health insurer. 1440&sess=CUR&house=B&author=kuehl, accessed on August 31, 2008. 1 0.Profits are defined as revenues minus medical and admin- istrative costs. Because nonprofits and public health plans 5.The term premiums is used to refer more generally to do not earn profits, the more appropriate term might payments received by the health insurer for health care be net income. However, the term profits is used in this benefits, such as premiums, co-payments, capitation paper for both for-profit and nonprofit plans. payments, and payments from Medicaid and Medicare. 11.Roth and Kelch, Making Sense of Managed Care Regulation 6.For an overview of California’s regulatory environment in California. for health coverage, see Debra L. Roth and Deborah 8  |  California HealthCare Foundation 1 2.CMS calculates Medicare administrative costs by summing administrative expenses spent by Medicare itself (this information obtained from the trustees report) with administrative expenses associated with private organiza- tions, such as Medicare Advantage and private prescription drug plans (this information is estimated by CMS itself ). These estimates do not include any administrative costs associated with fiscal intermediaries involved in the collec- tion of premiums and the processing of claims. 1 3.The five states whose information could not be obtained were Connecticut, Indiana, Maryland, Nevada, and Wyoming. No information on Washington, D.C., MLRs was obtained. 1 4.These six states are Colorado, New Hampshire, New York, North Carolina, North Dakota, and South Dakota. 1 5.Average 2002 to 2006 loss ratios for the 45 states in the analysis were based on insurer year-level data obtained from the NAIC. The NAIC data are based on health insurance firm reports filed with the state’s DOI. The health insurance providers in the NAIC data provided coverage for 31 percent of insured Americans under age 65 in 2005. State-level MLRs were computed as mean loss ratios of insurers reporting in a particular state weighted by total revenue of each insurer. It is important to note that the MLR of an insurer reporting in a particular state reflects the MLR for all transactions of the insurer and not just the transactions in that particular state. Loss ratios for insurers reporting in Alaska could not be computed due to missing information. 1 6.For example, see James C. Robinson, “Use and Abuse of the Medical Loss Ratio to Measure Health Plan Performance,” Health Affairs, Vol. 16, No. 4, 1997, pp. 176–187. How Much Is Too Much? An Analysis of Health Plan Profits and Administrative Costs in California  |  9