A.M. Best maintains negative outlook for health insurers due to impact of health care reform

A.M. Best Co. is maintaining a negative outlook for health insurance companies. The driving factors are the struggles to grow revenue and the near-term impact from the implementation of health care reform. In 2009, the seasonally adjusted unemployment rate rose from 7.6% in January to a high of 10.2% in October and ended the year at 10.0%. The rising unemployment rate resulted in the loss of members due to layoffs/attrition (known as in-group disenrollment). During the first six months of 2010, the unemployment rate has remained in the high 9% range, and while this is still high compared to recent years, the in-group disenrollment has started to lessen. However, employers have not begun to increase their number of employees. The lack of enrollment gains, combined with pricing pressures in the commercial sector, could offset premium rate increases and impact revenue growth. Furthermore, the number of individuals eligible for Medicaid continues to rise due to the recession. Many states are challenged to balance the budget, and finding additional funds to pay for the additional Medicaid members is difficult. This may lead to more challenging rate negotiations with the states at renewal and/or changes in eligibility or benefits provided, where allowed.

With the phased-in implementation of health care reform beginning in 2010 and full implementation in 2014, A.M. Best does expect to see some changes. One of the most significant changes in the near term is the minimum medical loss ratio requirement for individual, small and large group segments beginning in 2011. Although the definition of what is included in the medical loss ratio is not yet available, A.M. Best does expect to see margin compression as companies comply. Additionally, A.M. Best anticipates health insurers will try to lower administrative expenses to help offset the increase in the medical loss ratio.

The scrutiny on rate increases by many state regulators could impact profitability if requested rate increases are not approved or are delayed. The more stringent rate review process applies mostly to individual and small group products. A.M. Best expects regulatory scrutiny of rates in the individual and small group market to continue. Furthermore, the Patient Protection and Affordable Care Act (PPACA) requires a process be established for reviewing premium increases and requires insurance companies to justify such increases. Today, many but not all states have a rate review process in place, particularly for the individual market.

Companies that specialize in the individual and small group major medical markets as well as smaller stand-alone companies could have more negative rating actions than larger more diversified companies from the effect of the PPACA. For companies that specialize in the individual market, A.M. Best is concerned about the impact of the minimum medical loss ratio requirement of 80%. The individual product line tends to have lower medical loss ratios (low 70% range) and higher administrative expenses, particularly for first-year policies due to the high broker commissions paid and costs associated with set up and administering an individual policy, as well as lower claim expenses that are typically experienced in the first year. Furthermore, beginning in 2014, individual products will be sold via the health insurance exchanges. How many of these individual carriers will operate when the exchanges begin is yet to be seen. Lastly, given the regulatory environment in many states, combined with public scrutiny on individual rate increases, it may be difficult for carriers to obtain the necessary rate increase, which could impact profitability and ultimately the balance sheet strength.

A.M. Best's concerns regarding the small group market are similar to those presented above for the individual market. Beginning in 2011, there will be a minimum loss ratio requirement of 80%, which could impact the profitability of some insurers, although the impact is not expected to be as great as for the individual segment. The implementation of a rate review process may put rate increases under more scrutiny, particularly for those states that do not have a rate review process in place today (where the current process is file and use). Furthermore, beginning in 2014, individuals and small businesses with up to 100 employees will be allowed to purchase health insurance coverage through the exchanges. Here again, how companies that specialize in the small group market will operate in the exchanges remains to be determined. There could also be expense challenges if small group employers drop existing coverage (either stop offering coverage or seek insurance via the health insurance exchanges).

A.M. Best expects many smaller individual and small group carriers may consider exiting the market due to the impact from enactment of PPACA, specifically the minimum loss ratio and guarantee issue requirements as well as the implementation of the exchanges beginning in 2014. Those that stay in the market may have to change their business plan/strategies in order to continue to operate profitably in the new environment. This could include revisiting their product portfolios and considering potential partnerships/alliances.

The potential for more negative rating actions on smaller companies is due to A.M. Best's concern that some of these companies may not be able to obtain the savings on administrative expenses that they would like to achieve given their lack of scale as well as the implementation of the minimum medical loss ratio requirement. Furthermore, there are costs of implementing system and procedure changes for both the PPACA requirements as well as the implementation of ICD-10, which could require major information systems programming in order to be in compliance. A.M. Best expects some companies, particularly smaller ones, to outsource or share resources with other insurers to aid in administrative expense cost savings/control.