Of the many complicated reforms in the Patient Protection and Affordable Care Act (PPACA), four in particular present near-term strategic issues. Two of them require immediate attention in 2011:

• Meeting the new medical loss ratio (MLR) requirements
• Changes in premium rate regulation

Two others do not come into full effect until 2014, but insurers need to be planning for them now:

• Guaranteed issue and related rating limitations
• State health insurance exchanges

How these topics affect insurers varies according to type of health insurance carrier (large, multistate insurers; regional carriers; provider-sponsored or integrated health plans) and nature of regulatory environment in individual states (heavily regulated, less regulated).

Further complicating the picture is the evolving U.S. political and legal environment, in which some parts of the PPACA are being challenged. We will address this issue below, but it is important to remember that, for now at least, the legislation as passed is the law of the land and healthcare plans must proceed with implementation steps.

Meeting MLR requirements

The obvious question about the new MLR requirements—80% for individual and small group plans and 85% for large groups—is: Can health plans meet them?

The short answer is: It depends. Meeting the new requirement will probably be most difficult for insurers in the individual market and least difficult (although generally not easy) for certain types of companies in the large group market. Insurers that can significantly lower administrative and marketing costs, as well as those that are able to shift some risk to healthcare providers, will have an edge on those that cannot.

Tough choices. To meet the requirements, insurers will first consider all possible administrative cost-cutting measures. How far can an insurer lower its overhead? Can the cost of operational functions be reduced? Can the insurer manage claims more efficiently? What are the prospects for better medical management? Efforts might include improving procedures and staff performance, using electronic health record (EHR) systems to increase efficiency, and streamlining billing and collection processes.

Some organizations will take a close look at their sales commission schedules. Some insurers will find it difficult to cut costs there but it remains uncertain if most individual carriers will have any choice but to lower these costs. No insurer will want to be first to lower commissions if it means that brokers will steer customers to competitors' products.

And even as insurers struggle to reduce administrative costs, there will be new costs associated with PPACA regulatory compliance. Expenses for rate filings, monitoring, and other compliance-related functions will rise.

In the long run there may also be pressure to maintain solvency. In addition, as individuals look to downgrade benefits to keep their premiums from increasing, carriers may find it difficult to keep administrative expenses at the same percentage of premium.

Opportunities. In the long term, the MLR requirement is likely to produce some winners and some losers. Companies that may have a hard time competing include traditional individual insurance carriers that operate in multiple states but don't have a big enrollment in any one area. Already, some companies—those that cannot get competitive provider discounts, depend on underwriting for premium rates, and have high expense ratios—are contemplating whether to stay in the business. Their departure could provide an opportunity for new entrants into the market, perhaps provider-sponsored health plans whose overhead is covered by other lines of business and who are able to shift some risk and cost to provider sponsors.

Shifting the risk. Provider sponsor insurance companies may be able to capitate or share insurance risk with their providers, thereby shifting profits and/or risk margin directly to their provider owners through the capitation, which would increase the insurance company's medical loss ratio.

Rate regulation under the PPACA

Another challenging provision in the PPACA legislation requires the federal Department of Health and Human Services (HHS) to work with state insurance commissioners to conduct an annual review of "unreasonable increases in premiums." The law does not clearly define what constitutes an "unreasonable" increase and what the states and/or HHS will do with this information, though recent proposed regulations have begun to clarify the intent. It may be that this provision is primarily meant to ensure transparency in the rate-setting process; whether it will lead to tighter rate regulation in all states is not yet clear. HHS has emphasized that this is not a "one-size-fits-all" regulation and that authority still resides with the states, where current practice varies substantially. Some state insurance departments conduct thorough actuarial reviews of rate-increase requests, whereas some exercise only minimal regulatory action.

Some states have already begun to take a tougher stance against insurers' requests for rate increases; others that have not done so to date may be compelled to increase scrutiny under the new regulations. HHS itself has no statutory authority to regulate premium rates. In states where the insurance department has little or no authority to regulate rates, HHS grant funds can be used to lobby the legislature to expand the insurance department's statutory authority. Additional uses of the grant money include improving or enhancing the existing rate regulation and approval process.

What's reasonable? The regulations were released in December 2010. One of the key issues is the definition of "unreasonable." According to the regulations, any rate increases exceeding 10% will require justification.¹

How the meaning of "unreasonable" plays out will be one item to watch. Actuaries commonly consider a rate increase unreasonable if it cannot be actuarially justified on the basis of reasonable assumptions (a criterion that is itself open to differing interpretations). Another approach is to ask if the proposed premium rates permit a plan to remain solvent and/or meet risk-based capital (RBC) requirements. Adequate capitalization would seem to be an important consideration in any rational definition of reasonable vs. unreasonable premium rates.

All the focus on reasonable and unreasonable may be beside the point. The PPACA does not prohibit "unreasonable" rate increases; it only requires that plans provide additional information to justify the rates. It would probably be wise for plans to get past the semantics of the word "unreasonable" and focus on this portion of the bill to mean "certain rate increases will be subject to closer scrutiny." The form that that closer scrutiny will take is still under development. The National Association of Insurance Commissioners (NAIC) is working on a standardized form for justifying rate increases deemed unreasonable. Insurers are watching how several controversial issues play out, including:

• The level of detail required in documents that will be publicly available far surpasses previous regulatory standards in most states. Carriers must disclose their specific experience data for the block of business for which they are requesting the rate increase. The potential competitive ramifications could be substantial.
• Large-group insurance is included in this regulation. Traditionally, regulators have tended to view large group business as a negotiation process between two equally sophisticated parties, with less need for consumer protection than with individual and small group business. For most state insurance departments and most insurers, large group rate regulation will be new territory.

Politicization of the approval process. There is no doubt that the health insurance rate filing process is becoming increasingly politicized in many jurisdictions. Such would appear to be the case in Massachusetts, for example, where there is a bill defining any rate exceeding 150% of CPI as unreasonable, and where, in March 2010, the insurance commissioner denied 235 of 274 requested rate increases. Ultimately, there is the risk that the standards used to approve or disapprove health insurance premium rates may not be actuarially sound, which would prove unsustainable over the long term for the private health insurance industry.

That said, there are some positive elements working in the industry's favor. First, the NAIC has a long track record of reasonable and knowledgeable regulation of the industry. Because HHS does not have rate-approval authority, the NAIC and the individual states have the ultimate say. There is in this process a role for the actuarial profession: actuaries must continue their efforts to make sound, fact-based arguments to regulators.

Guaranteed issue and rating limitations

The PPACA provisions for guaranteed issue coupled with rating limitations will add other major constraints on insurers, especially in the individual and small group markets. Many companies have served these markets successfully, even without big provider discounts, because they are adept at underwriting and managing their portfolio risks. These companies may now find it more difficult to meet the MLR requirements and to price their products at levels that meet "reasonable" regulatory standards. Therefore, companies may need to consider new strategies to remain competitive and some may even leave the market.

The PPACA also requires that the age bands in the individual market narrow to a maximum of three to one, which is lower than currently used in the industry (e.g., five or six to one). This narrower range can only be achieved by lowering rates for older insureds and raising them for younger persons. The latter will provide an even greater disincentive for young and healthy people to purchase health insurance, increasing the effect of adverse selection.

Complicating the guaranteed issue and rating restriction provisions is the individual mandate. On paper, the fact that every person is supposed to purchase insurance or else pay a fine helps protect against the risk of adverse selection. In practice, however, it is likely that some smaller organizations and many low-risk individuals, particularly younger people, will choose to pay the fine rather than the higher cost of healthcare insurance, thereby removing themselves from the risk pool.

If traditional individual and small group insurers exit these markets, other types of insurers may move in. Provider-sponsored health plans, for example, may be positioned to gain members within these market segments, and some large traditional insurance companies might see opportunities here as well. They will face challenges because of guaranteed issue and its effect on premiums, but insurers that operate on a scale large enough to absorb the new risks will be primed to pick up new members.

Exchanges: The nexus of healthcare reform

The state exchanges mandated by the PPACA are not required to be in effect until 2014, but states are planning for them now and insurers need to consider how to position themselves with respect to the exchanges. States have a wide-ranging authority to set the conditions of the exchanges, and there are many questions to be answered in each case, for example:

• What level of product and essential benefits will be required by an exchange?
• Will there be separate exchanges for individuals and small groups, or will they be combined in one pool?
• What kinds of market forces may be created by exchanges that influence carriers operating outside the exchange?
• Which states' exchanges will have a cost-control mechanism, and which will not?²
• Will there be interstate exchanges?
• The political atmosphere within some states is strongly opposed to the healthcare reforms. Will those states try to avoid developing an exchange, or establish an exchange so weak that it cannot function effectively?

For existing insurers, the incentives and drawbacks of participating in the exchanges will not become clear until the answers to the above questions become clear on a state-by-state basis. In general, though, the primary advantage of participating in an exchange is access to a potentially large market segment, especially if there are as many as 20 to 30 million new individual entrants, nationwide, from the ranks of today’s uninsured. Unless prevented by regulation, Medicaid insurers and health plans may see the exchanges as an opportunity to expand their business by appealing to those people receiving federal premium subsidies. Many of these people will likely move in and out of Medicaid eligibility and prefer not to change insurers frequently.³

Adverse selection is one of the risks facing exchanges, which could occur if the exchange population includes a higher proportion of less healthy people. A carrier operating both within and outside of an exchange will have to pool its experience; if its customers outside the exchange are lower-cost and those inside are higher-cost, premium rates will have to be averaged because the new law requires the same premium inside of and outside of the exchange. If a carrier chooses to operate only outside the exchange, and if it were able to attract lower-than-average risks than in an exchange, the carrier could offer lower-cost rates and have a competitive advantage over those carriers that operate in both markets.

Conclusions

For 2011, the immediate tasks around healthcare reform are to develop a strategy for meeting MLR requirements and dealing with any likely state objections to rate increases. But it will also be a time to think through critical questions for the medium term:

• Given the changing circumstances of the healthcare market in the era of reform, can your healthcare plan survive in the long run? If the answer to this is "No," then 2011 may be the year to plan your exit from the market.
• If the answer to the first question is "Yes," then what do you have to be especially good at doing in the future?
• How can you start positioning your book of business not only for surviving under the new model, but for recognizing and seizing upon new opportunities?

Changes to the legislation? Finally, the changing political climate in the wake of the 2010 midterm elections and the ruling in Virginia that found the individual mandate unconstitutional—not to mention other pending litigation—introduces a new element of uncertainty. It appears that the PPACA may undergo some modifications—not only as a result of court rulings but also potentially as a result of changes to PPACA funding at the Congressional level—but it is not clear what the changes will be. Moreover, currently pending legal cases brought by a number of states may result in the invalidation of the individual mandate—or even a court-ordered enjoinment of the entire reform program while the cases make their way through the appellate courts, which could take as long as two years.⁴ In addition, many of the provisions discussed in this paper—specifically, premium rate regulation and health insurance exchanges—are intended to be implemented at the state level; the political environment in some states is such that moving forward with that implementation may be unlikely.

In these circumstances, companies and plans need to be nimble and on top of any changes that develop. Some of the law's provisions could change quickly, and a company that's slow to react may find itself caught going the wrong way.

1 U.S. Dept. of Health and Human Services (Dec. 23, 2010). Rate increase disclosure and review. Federal Register. Retrieved Jan. 17, 2011, from http://www.regulations.gov/#!documentDetail;D=HHS-OS-2010-0029-0001.

2 As of this writing several states have already taken steps to institute exchanges, with differing solutions to this question. For example, the Massachusetts Health Insurance Exchange has a cost-control function, but the Utah Health Exchange does not.

3 This segment would include those who, because of fluctuating income levels, might bounce back and forth between Medicaid eligibility and non-Medicaid subsidy eligibility.

4 Sack, K. & Pear, R. (Nov. 26, 2010). Administration is bracing for setbacks to health law. New York Times.