Health Insurers Now Finding Ways to Cut Costs and Shed Risks

Initiatives may reduce lab test reimbursement

CEO SUMMARY: Both employers and health insurers are taking aggressive steps to rein in healthcare costs. Several strategies to control spending and create powerful new incentives for providers are gaining favor. At this year’s Executive War College, Paul Mango of McKinsey & Company, explained these strategies and emphasized that new models for handling health risk are changing the status quo. More employers are self- insuring and putting their employees into high-deductible health plans. One consequence of these trends is more downward pressure on lab test reimbursement.

In today’s healthcare system, almost every health insurer is overwhelmed with information. And it’s a problem that will get worse, asserts Paul Mango, who is a Director with McKinsey & Company in Pittsburgh, Pennsylvania.

“The fact is that many payers are overloaded with information,” observed Mango, who spoke last month in New Orleans at the Executive War College on Laboratory and Pathology Management. “This overload of data means that most payers are unable to use this information in a meaningful way.

“Payers recognize this situation,” he continued. “For example, when asked if their laboratory providers give them both the CPT codes and the full lab test results, most health insurers will answer ‘yes.’

“But ask them if they use the lab test data for other purposes, and the answer is most interesting,” he continued. “They will say, ‘we don’t integrate this lab test data with the rest of our data. It’s too overwhelming.’

“Here is where lab administrators and pathologists can step up and add value to payers in their region,” Mango stated. “It centers around helping health insurers extract insight from all the data and information that they collect. This is equally true for hospitals and health systems.

“Along with payers, hospitals and health systems are just as overwhelmed by the over-abundance of health data—including lab test results,” he said. “And this problem will get worse as the health insurance exchanges authorized by the Accountable Care Act (ACA) create another deluge of information.

“This point is actually quite important: It’s not about raw information,” he said. “The issue is who can deliver the insight and delivering insight will be much more important than having information.

“That’s the point I want to stress for laboratory professionals: It is not about information; it is about insight,” declared Mango. “Pathologists and laboratory scientists are positioned to be able to offer useful insight, since they daily review patient lab results in the context of other clinical data,” he stated. “These core skills can be leveraged at a higher level to support how health insurers utilize the information that they collect.”

Mango identified another significant problem for the health insurance industry that will eventually put pressure on reim- bursement for lab tests. It is the means by which payers underwrite medical risk.

“As a result of health reform, there is a fairly dramatic shift occurring in what we call financial accountability for medical risk,” he said. “The Accountable Care Act further inhibits payers’ ability to manage this risk rather than resolving it.”

The problem is that, under health reform, insurers are being asked to provide insurance to all Americans: 1) without traditional underwriting; 2) with guaranteed issue; 3) with higher minimum medical loss ratios; and, 4) with elevated standard benefits. Taken together, these factors make the risk of doing so too great, asserted Mango.

Medical Risk

“In response to this situation, health insurers are moving away from the risk business at a very fast pace,” stated Mango. “Payers do not want the financial accountability for medical risk because—from their perspective—a very large proportion of the population in this country is now considered uninsurable in the traditional sense.

“Here’s why insurers are getting out of underwriting major-risk health insurance,” he said. “In today’s market, payers can rate the risk of individual patients. It is why, for example, that a 63-year old female smoker with diabetes may pay an insurance premium that is 20 times greater than the premium paid by an 18-year-old, healthy, non-smoker.

“At $1,600 per month, the older person’s premium is 20 times more expensive than the younger person’s premium of approximately $80 a month,” noted Mango. “In today’s medically underwritten individual health insurance market, you easily find a 20-times difference in premiums because of how health insurers underwrite risk.

“But under health reform, this type of medical underwriting is no longer allowed and insurers must provide coverage to all who apply under an ACA rule called ‘guaranteed issue’,” Mango added. “Some states already have guaranteed issue rules, such as New Jersey and New York. In these states, guaranteed issue compresses the premium difference between the young and healthy and the old and sickly.

“Essentially, the top premium comes down and the bottom premium goes up,” he stated. “The socialization of medical risk means the healthier, younger people will pay more premium dollars and the sicker, older people will pay less premium dollars. “That is the beginning of what we would call the socialization of medical risk,” Mango added. “It drives good risk (such as individuals who are young and in good health) out of the market. We have evidence for this trend in every state that has guaranteed issue. As a result, you can predict it will happen.

Socialization of risk

“Here is where the ACA will directly influence and contribute to the socialization of risk,” he noted. “ACA mandates that the maximum health premium spread between the 18-year-old healthy nonsmoker and the 63-year-old diabetic smoker to be 4½- times, but 1.5-times of this is attached to whether one smokes or not. For non-smokers, the maximum spread is 3-times.

“Given that the maximum premium difference in these health plans is 3-times, if you thought guaranteed issue drove good risk out of the market, you’re about to see a lot of other good risk driven out of the health insurance market under ObamaCare,” he emphasized. “This is where the individual mandate of ACA comes into play. The controversial individual mandate in ACA states that the penalty for not having health insurance will be a maximum penalty in 2016 of $695.”

In the example given earlier by Mango, a traditional underwriting of the risk of a healthy young non-smoker results in a health insurance premium of $80 per month, or $960 per year. The older individual, a diabetic and smoker in her 60s, would pay a premium of $1,600 per month, or $19,200 per year.

Shifts to Premium Costs

Together, these two individuals would pay $20,560 per year in health premiums in a market that allows the health insurer to underwrite the full risk. Under Obamacare, dividing this total by the maximum spread of 4.5-times generates a premium for the younger subscriber of $380 per month, or $4,568 per year and for the 63 year old of $1,333 per month, or just under $16,000 per year.”

Obviously, the 63-year-old diabetic smoker would be most happy to have her health premium reduced by 17%. But the healthy young 18-year-old individual has every motivation to drop health coverage that would cost him $4,568 per year and pay the ACA-mandated penalty of $695. Additionally, Mango says even the indi- vidual mandate penalty has a flaw.

“Something very interesting happens if an individual fails to pay that penalty,” said Mango. “There is no penalty for not paying the penalty! The government has only one way to get that money: If the individual overpays his or her taxes, the federal government can take the penalty out of the refund.”

Growth of HDHPs

Having explained why the ACA will encourage further socialization in the underwriting risk of health insurance, Mango next discussed how the health insurance industry is responding to these developments. “To give you an example of how insurers are getting out of the health insurance business, look at the growth in high-deductible health plans (HDHPs),” he stated.

“With these plans, insurers and employers are shifting medical risk to consumers,” said Mango. “This shift is the biggest stealth issue of the last four or five years because it has resulted in a dramatic increase in HDHP enrollment. Despite this nation’s credit crisis and a long-lasting recession, the market for HDHPs has tripled to the point where there are almost 30 million people enrolled in these products. It means that one of five individuals with private health insurance is now enrolled in an HDHP.

“With HDHPs, consumers pay for everything out of pocket, until an annual deductible requirement of $5,000 or more is met,” detailed Mango. “These consumers are very price conscious about buying any service related to healthcare. That is why individuals with HDHPs place great importance on value.

“Health insurers have two other ways they can use to exit the traditional health insurance business,” noted Mango. “First, health companies can serve self-insured employers in contract arrangements known as administrative services only (ASO).

“That’s a viable strategy because ever larger numbers of employers are becoming self-insured,” he commented. “This means that employers assume the financial risk of delivering healthcare to their workers. As a self-insured employer’s ASO, the health plan will evaluate and administer claims on behalf of the insurer’s health benefits plan.

Employers Opt to Self-Insure

“It is useful to understand what motivates these employers to transition to self-insurance,” Mango said. “It is a response to the fact that state legislatures have layered many coverage requirements and regulations on top of health insurance plans. In a state such as New Jersey, these added regulations represent 70% of the cost of the typical health insurance premium!

“However, the health benefits programs offered by self-insured employers are exempt from the state-based requirements,” added Mango. “This means they don’t have to include all the additional coverage requirements that the state typically requires for health insurance plans.

“Today at least one insurer, Cigna, offers a stop-loss program that allows self- insured employers to limit their risk of loss to a certain amount,” he commented. “Such offerings by health insurance companies make self-insurance that much more attractive to employers.

“Thus, the use of ASOs to serve self- insured employers and their HDHPs represents the first way that health insurers are exiting the traditional health insurance business,” noted Mango. “The second way is a more passive strategy. But it has the same effect and is linked to the federal government’s evolving role in assuming healthcare risk.

“Currently, the federal government is on a legislatively-mandated path to take on the financial risk of delivering health- care,” he explained. “This path will make it one of the biggest owners of financial accountability for medical risk,

“This is because of the substantial number of people covered under the Medicare and Medicaid programs,” noted Mango. “Enrollment in these programs is expected to increase significantly in coming years.

“At the same time, another element is poised to shift more risk to the federal government,” continued Mango. “Under ACA, the federal government will subsidize the cost of premiums for people who enroll in the new health insurance exchanges. These federal premium subsidies will be linked to wages for those who are employed and to the federal poverty level for others.

“For individuals in this second group who are at 150% of the federal poverty level, 85% of their insurance premium will be paid by the federal government,” he noted. “For individuals with income at 350% of the federal poverty level, the federal government will pay 25%. Collectively, this puts the federal government on the hook for a substantial amount of health insurance subsidies.

“But that is not the whole story,” stated Mango. “The formula spelled out in the Accountable Care Act will increase the risk the federal government bears. It has to do with the spread between the rate of growth of wages and the rate of growth in health spending.

Negative Spread

“Let’s assume that health premiums go up at 6% to 8% per year, which is similar to the annual rate of increase that has been true over the past two decades,” said Mango. “During this same period, expectations are that wages might go up 2% to 3% per year. The problem for the government is that, under the ACA, it will forever own the negative spread between wage increases and premium increases.

“Therefore, if there is a 6% spread in any given year, we could have a doubling of the federal government’s obligations over 10 to 12 years just to fund the healthcare subsidies that are not attached to wages,” Mango commented. “That will make the federal government the big new owner of medical risk.

“This mandate does not begin until 2014,” added Mango. “In the meantime, to keep their costs under control, health insurers are focusing most of their efforts on a combination of benefit design and payment innovations.

“These two payer strategies go hand- in-hand,” he continued. “Benefit design involves establishing tiered provider networks which establish financial consequences for consumers. Beneficiaries will be free to go to any provider, but going to certain providers will cost them more than going to in-network providers.” (See TDR’s coverage of the New Hampshire Blue Cross Blue Shield “point of service” health plan.)

“Payment innovation is similar except that it affects the provider rather than the consumer,” he added. “Physicians can refer patients wherever they’d like, but the physicians’ reimbursement amount will vary based on where they send patients for services—including lab testing or medical imaging. Physicians can give up that variable part of their compensation if they send patients to the most expensive ancillary service providers.

Implications of this Strategy

“Lab managers and pathologists need to understand the implications of these strategies,” said Mango. “It definitely affects choice in the market by signaling to the consumer and to the doctor that— for the first time—there are real economic consequences for referring consumers to certain providers.

“More to the point, because clinical labs and pathology groups may not recognize this strategy as it unfolds, they are likely to suffer financially,” continued Mango. “These dynamics will be hard to detect because it is difficult to recognize the volume of case referrals that do not come to your lab.

“Certainly labs can see the volume that’s coming in the door,” he said. “But it is not easy to track the volumes of speci- mens going to other providers. The point to emphasize here is that there is a hidden effect triggered by the tiered networks [different incentives to visit in-network providers] now being established by many health insurance companies.

“The jury is out, however, on how the strategy of narrow networks succeeds for payers,” observed Mango. “A number of health plans have established narrow networks, but found they can be very complicated to administer.

“For example, look at the complications for a multi-line payer when it has both narrow and broad networks in the same community,” offered Mango. “That would mean that some hospitals are in the broad networksome hospitals are in the narrow network, and other hospitals are left out entirely.

Narrow and Broad Networks

“I expect that the intricacies of operating these networks will discourage healthplans from developing many narrow net- works,” he continued. “They are complex and difficult to administer.

“There is another reason why narrow networks are failing, added Mango. “Again, health insurers are learning this lesson the hard way. It centers on the issue of non-par emergency room charges. This refers to the higher charges that come from non-participating providers.

“Health plans have a contract rate for in-network providers,” continued Mango. “The out-of-network rate is often four to five times higher than the contract rate. “Each time a patient goes to an emergency room (ER) of an out-of-network hospital, it is very expensive,” he stated. “Those higher charges from the ER visit typically offset any savings that accrue to the health plan because it traded lower price for volume within the network.”

Financial Changes Ahead

Mango’s analysis of how healthcare reforms will trigger specific consequences provides lab executives with essential insights they can use to better prepare their labs for the significant financial changes that are approaching. Further, Mango has explained why both employers and health insurers now seek ways to avoid paying prices for lab testing from hospital labs that can be as much as 2.5 times higher than the lowest discounted lab test prices of the national laboratory companies.

“Price Bands Imposed by the ACA Will Further Narrow and Socialize Medical Risk”–Paul Mango

06-04-12 image 1

1Illustrative example for health status underwriting in states with no rating regulations and with rate banding regulations.

SOURCE: E-health insurance coverage search; Senate Finance Committee Policy Option Papers; McKinsey analysis

IN HIS PRESENTATION AT THE EXECUTIVE WAR COLLEGE LAST MONTH, Paul Mango, Director, McKinsey & Company, presented this slide to illustrate how medical risk will be socialized. He offered the example of the health insurance premiums that would be paid by a 63-year-old female smoker with diabetes and an 18-year-old healthy, non-smoking male.

With traditional underwriting, the older woman would pay premiums of $19,200 per year and the younger male would pay $960 per year, which is a 20-times difference. Under Obamacare (the third medical risk band showed above at far right), dividing this total by the mandated maximum spread of 4.5-times would mean that the younger subscriber’s premium increases to $4,568 per year and 63-year-old woman’s premium declines to just under $16,000 per year.

As Mango noted, the younger subscriber would see nearly a five-fold increase in his health premiums and would be financially-motivated to drop insurance coverage and simply pay the penalty of $695 per year mandated by the Accountable Care Act (ACA).


As Employers Self-Insure, They Adopt HDHPs and Encourage Employees to Shop for Providers

CONSUMERS ENROLLED in high-deductible health plans (HDHP) are poised to exert significant change to healthcare in the United States. Clinical labs and pathology groups will experience these changes as consumers in HDHPs select their healthcare providers.

“Back in 2006, there were just 6 million consumers enrolled in HDHPs,” stated Paul Mango, Director at McKinsey & Company. “Today, about 30 million people are covered by HDHPs.

“McKinsey has predicted that when HDHP enrollment reaches approximately 15% of the insured population, it will represent a critical mass of value-driven consumers and these individuals will be at the forefront of some dramatic changes in how healthcare is delivered,” he noted. “With annual deductibles of $5,000 or more, these consumers are assuming substantial finan- cial risk for their healthcare.

“HDHP members need transparency and access to specific information about providers,” said Mango. “As they go to buy healthcare services, HDHP consumers want information about quality and price in order to choose the hospitals, physicians, clinical labs, and other providers who offer the most value.

“This surge in HDHP enrollment has not gone unnoticed,” he added. “To serve these 30 million HDHP members, intermediary companies are springing up to offer information to those consumers and help them better manage their financial risk when they make decisions about where they go to seek care.

“As part of broader trends, surveys conducted by McKinsey analysts determined that managed care companies recognize that the reimbursement they pay to a hospital laboratory for a CBC or any routine lab test typically can be 2½ times higher than what is charged by Laboratory Corporation of America and Quest Diagnostics Incorporated,” observed Mango. “In turn, this 2.5 times higher price for hospital lab testing versus other lab testing sources gives payers a real incentive to provide that transparency information to individuals in HDHPs.

Difference In Lab Test Costs

“By the way, it was not the ‘big bad payers’ who were the first group to call attention to this dramatic difference in the cost of lab testing services,” revealed Mango. “It was the employers who saw that there was a difference of about 2.5 times what they were paying for lab tests versus what they could pay if they were self-insured.”

Mango believes that market fundamentals in favor of continued growth in HDHP enrollment are well established. “Keep in mind that another big trend is for employers to drop the full-risk health plans of insurance companies and move to self-insurance,” he pointed out. “Numbers show this trend is happening at a rapid pace. We expect it to continue because employers are taking on more risk by becoming self-insured. But at the same time, they are handing off that risk to their employees in the form of HDHPs.”


Employers, Payers, and Physicians Joining Together to Create New Care Delivery Models

IN ADDITION TO ‘NARROW NETWORKS’ with a limited number of contract providers, health insurers are pursuing several other strategies to control healthcare costs, noted Paul Mango, Director, McKinsey & Company.

“These strategies fall into two broad categories: payment bundling and integration,” he said. “In payment bundling are: capitation, accountable care organizations (ACOs), episodes of care, patient-centered medical homes (PCMH), and pay-for-performance. Integration involves the development of integrated delivery networks.

CAPITATION: “Full capitation is one of the many experiments that health plans are developing nationwide,” Mango added. “In some markets several of these strategies may be visible. In other markets, not so many. Full capitation will be relatively rare, but examples exist. In New York, it is reported that Montefiore Medical Center and insurer EmblemHealth are in talks to develop a full capitation plan.

ACOs: “Of course, ACOs are a hot concept now,” he noted. “In California, CalPERS, Catholic Healthcare West (now Dignity Health), and Hill Physicians developed an ACO. This is a risk-bearing product, in which doctors, hospitals, and ancillary service providers work together to manage risk more effectively than they would by working separately. There are reports that this group has lowered health costs by 10%, which is a good start.”

EPISODES OF CARE: Geisinger Health in Pennsylvania and Horizon HealthCare in New Jersey are examples of this strategy,” explained Mango. “Under an episode of care arrangement, the health system can control much of the risk. This strategy can extend to a lot of different conditions, ranging from hip and knee replacements to spinal surgeries.”

PATIENT-CENTERED MEDICAL HOMES: “Patient-centered medical homes have been in use for many years and Humana is one of the best in the business,” he said. “It’s extraordinary how they have reduced both admissions and readmissions as well as unnecessary utilization. Even with the decreases in Medicare Advantage reimbursement in the last couple of years, Humana has been very profitable by reducing utilization costs in the range of 15% to 20%.”

PAY-FOR-PERFORMANCE: “Pay-for-performance could be a popular mechanism for reimbursement because health insurers are discussing the possibility of not raising providers’ reimbursement rates,” he noted. “Instead, they will give them an opportunity to increase their total income by 50% if they adhere to certain parameters. Health plans know that the range in prices for certain services, such as lab tests, medical imaging, and ambulatory surgery, can be as wide as 2.5 times the lowest price. That means the doctor has to change where he or she sends patients for these services. It’s relatively easy to do so and it can have a huge effect on the physician’s income.”

INTEGRATED DELIVERY NETWORKS. “In my hometown, Pittsburgh, we’re experiencing a lot of market turbulence over how much formal integration we will have in the delivery network,” he said. “There are three types of integrated networks. The one most relevant to

95% of the country is called “bilateral open.” In this arrangement, a health system would have to open up its network to other providers unless it’s a dominant player with 40% or more of the market. If that network is opened up to other providers, the health system may have to contract with other health insurers. As you can imagine, this is strategically very complex.

“The other end of the spectrum is bilateral exclusive, which is what Kaiser Permanente does,” he added. “Kaiser contracts only with itself as a provider and the providers within Kaiser only contract with one payer. That is strategically very simple but it is economically volatile. In other words, the game is won or lost on January 1 every year depending on what Kaiser wins in enrollment. And if they don’t win a lot in enrollment, they still have the fixed costs of being a fully-integrated provider.”


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