Featured Health Business Daily Story, Jan. 10, 2011

Will Record Surpluses Among Not-for-Profit Blues Plans Trigger Price Wars in 2011? (with Table: Not-for-Profit Blues Plans Hold $27 Billion in Excess Capital)

Reprinted from HEALTH PLAN WEEK, the industry's leading source of objective business, financial and regulatory news of the health insurance industry.

By ,
December 20, 2010Volume 20Issue 45

Record surpluses amassed by not-for-profit Blue Cross and Blue Shield plans during the first nine months of 2010 could be used to price products more aggressively next year. And that could put pressure on competitors to hold down their rates or risk losing market share, according to one equities analyst. But other industry observers tell HPW that Blues plans are more likely to hold onto their surpluses due to increased regulatory scrutiny over rate hikes and the unknown financial impact of the health reform law.

At of the end of the third quarter, the risk-based capital (RBC) ratio among 33 not-for profit Blues plans exceeded 810% — up from 739% a year ago and 701% in 2008. The RBC ratio through the first nine months of 2010 translates to more than $27 billion in capital above the required ratio, according to Carl McDonald, an equities analyst at Citigroup Global Markets. In a Dec. 15 research note, McDonald suggested that the surplus amassed by some Blues plans could lead to “more aggressive industry pricing and pressure on publicly traded commercial risk margins.”

McDonald defines RBC as the ratio of a health plan’s net worth divided by the amount of money regulators require the plan to hold. While the National Association of Insurance Commissioners (NAIC) requires insurers to hold a minimum 200% of RBC, the Blue Cross and Blue Shield Association requires its licensees to maintain 375% of RBC.

The $4.2 billion in net income collectively generated by those Blues plans during the first nine months of 2010 is $1 billion more than they generated in 2008 and 2009 combined. Low medical utilization, combined with strong earnings on stock market investments, helped most not-for-profit Blues plans boost their cash stockpiles. Blues plans tend to have more common stock investments than do publicly traded firms. RBC ratios, however, could dip in the fourth quarter as members begin to meet their annual deductibles and the health plan begins paying full claims.

Blues plans that use surpluses to offer artificially low insurance rates would create “a lose-lose” situation for publicly traded plans, says Matthew Coffina, a health care analyst at Morningstar, Inc. “Either they match the competitive pricing and their margins suffer, or they maintain their discipline and risk losing market share,” he tells HPW. He adds that if Blues plans implement this sort of pricing, it likely would be only a short-term strategy.

Thomas Carroll, an equities analyst at Stifel, Nicolaus & Company, Inc., doesn’t expect RBC ratios to have much of an impact. While some not-for-profit Blues plans sometimes “become bigger competitors” when reserve levels are high, it isn’t likely to have much of an impact on for-profit managed care companies on a national basis all at once, he tells HPW. “I tend to think that all managed care companies are hoarding cash, and have been for the last six quarters or so, hoping to better position themselves” for the health reform law. Carroll predicts that 2011, 2012 and 2013 will “repositioning years” for health plans.

Using surpluses to boost enrollment would be just a temporary strategy and an unwise use of capital, adds Stephen Zaharuk, senior vice president at Moody’s Investors Service. However, he says, it’s possible that some Blues plans will tap their reserves to lower rates to retain a large employer client or to ensure retention of a block of business. “But I don’t think we’re going to see widespread pricing competition in an effort to gain membership,” he tells HPW. Spending down reserves also could have a negative impact on credit ratings, adds credit analyst Joseph Marinucci, a director in Standard & Poor’s Insurance Ratings Group. Coverage costs are influenced by underlying medical trend, which varies by region. As a result, some Blues plans might leverage their capital strength to grow or preserve share in a given market segment. But spending down surpluses could impact their rating strength, he warns. “A rating strength for many Blues plans is their balance sheet, which requires capitalization — according to our models — well in excess of minimum RBC requirements,” he says.

How Big Is Too Big?

Uncertainty about the impact of the reform law — combined with increased state and federal scrutiny over rate hikes and shrinking market share on the group side — are the main reasons Blues plans are likely to retain their existing surplus levels.

Few Blues Plans are “is going to look at their surplus as being too big,” says Doniella Pliss, a senior financial analyst at A.M. Best Co. Moreover, not-for-profit Blues plans have limited financial flexibility compared with their publicly traded competitors, which can issue stock to raise capital.

Health care consultant Joseph Paduda, president of Health Strategy Associates, LLC, agrees that Blues plans aren’t likely to use excess capital to lower rates. Instead, he suggests such funds will be spent on IT infrastructure improvements, acquisitions and “health reform prep work.”

McDonald says some Blues plans might continue to build reserve levels in anticipation of millions of uninsured people who are expected to gain health coverage in 2014. Presumably, the Blues plans are going to cover a large percentage of them, McDonald tells HPW. And to support those new members, they will need additional capital, and not-for-profit Blues don’t have many avenues to raise capital.

“As a result, Blues plans probably won’t go crazy on pricing.…They are not going to write business that they know is unprofitable,” he explains. But in markets where a large for-profit health plan has a profit margin of 7%, for example, a competing Blues plan might be willing to reduce premiums and accept a 5% margin. In his note, he wrote that such a strategy would not be irrational and would force the for-profit entity to adjust its pricing if it wants to retain the account.

Surplus Could Aid MLR Compliance

Carroll says that some not-for-profit Blues plans might use excess surplus levels to ensure compliance with the medical loss ratio (MLR) requirement, which goes into effect on Jan. 1.

Pliss agrees that that provision, which requires health insurers to have an 80% MLR for small-group and individual products, will likely have more influence on pricing than RBC ratios. Some Blues plans might tap their reserves to ensure they achieve that threshold, rather than having to rebate members, she says.

Publicly traded health insurers typically have lower MLRs than not-for-profit Blues plans. As a result, those health plans might opt to reduce coverage costs to ensure compliance. “And that would put pressure on the Blues plans to lower their prices to compete.”

Blues plans that do opt to use their reserves are likely to use it to reduce coverage costs in the individual and small-group markets, says McDonald.

In states where Blues plans are able to medically underwrite, they might use reserves to win “good risk” members before their ability to underwrite risk goes away in 2014, Pliss adds. While that strategy could help them win market share over the next few years, Carroll contends that increased market share in the individual market might not give them a leg up on competitors once the insurance exchanges become operational in 2014. “I think the individual market is going to become a completely different animal,” he says.

Contact McDonald at carl.mcdonald@citi.com, Marinucci at joseph_marinucci@standardandpoors.com, Paduda at jpaduda@healthstrategyassoc.com, Zaharuk at stephen.zaharuk@moodys.com, Coffina at matthew.coffina@morningstar.com, Carroll at tacarroll@stifel.com and Pliss at doniella.pliss@ambest.com.

Not-for-Profit Blues Plans Hold $27 Billion in Excess Capital

As of Sept. 30, 2010, 33 not-for-profit Blues plans held more than $27 billion in capital in excess of the minimum threshold reserves required by the Blue Cross and Blue Shield Association, according to an analysis conducted by Citigroup Global Markets (see story, p. 1). Below is a look at excess capital among Blues plans that have the most competition with publicly traded health plans. BCBSA requires licensees to maintain a risk-based capital (RBC) ratio of 375%.

Blues Plans in Competitive Markets

Total Capital Through Sept. 30, 2010

Required Capital

Risk-Based Capital as of Sept. 30, 2010

Cash in Excess of 375% RBC ratio

Blue Cross Blue Shield of Arizona





Blue Cross and Blue Shield of Florida





Blue Cross and Blue Shield of Kansas City





Blue Cross and Blue Shield or Kansas





Blue Cross and Blue Shield of Louisiana





Blue Cross and Blue Shield of North Carolina





Blue Cross of Northeastern Pennsylvania





Blue Cross & Blue Shield of Rhode Island





BlueCross BlueShield of South Carolina





BlueCross BlueShield of Tennessee





Blue Shield of California





Capital BlueCross





CareFirst BlueCross BlueShield (D.C., Md.
and Va.)





Health Care Service Corp. (Ill., N.M., Texas and Okla.)





Highmark Inc.





Horizon Blue Cross Blue Shield





Independence Blue Cross





SOURCE: Citigroup Global Markets, based on data filed with the National Association of Insurance Commissioners. December 2010.

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