Thursday, April 9, 2009

Will Health Insurers Become 'Too Big To Fail?'

If a federally supported public plan is launched without careful planning, the answer is they could become that way.

Here's why:

We’ve all heard how the life insurers are in trouble. While Prudential’s, The Harford’s and Lincoln’s investments were more conservative and heavily regulated than those in the shadow banking system, the life insurers were not immune to the carnage in their residential and commercial real estate-backed holdings. Undercapitalized, their variable annuities products (which guarantee minimum returns) are now stressing their balance sheets. Seeing a bail out on the horizon, many life insurers bought banks, which made them technically eligible for the Troubled Assets Relief Program (TARP).

On the face of it, TARP isn't a bad idea. Life insurers own a whopping 18% of the corporate bonds that undergirds a big part of the credit markets. If they can’t buy bonds, these markets’ short term prognosis will remain grim.

Which made the Disease Management Care Blog ask: why aren’t health insurers also in trouble? Well, they are. Rising unemployment is leading fewer persons buying employer-based insurance, which, in turn, is resulting in decreased earnings. Furthermore, many of the commercial health insurers are being battered by problems involving their parent company.

Yet, despite the AM Best downgrades, they’re holding their own. Health insurers are aggressively fighting back by cutting their workforces and reducing their budgets. The DMCB wonders if they were aided by being less inclined to seek big returns by investing in real estate. It could also be argued their bailout has partially arrived in the form of COBRA subsidies. What’s more, the prospect of the Feds mandating coverage for all with means tested subsidies should help. It looks like the insurers are going to weather this storm intact.

But the DMCB thinks there may be a bigger reason for the health insurers’ relative well being: they’re aggressively regulated by Departments of Insurance at the State level. This has functionally forced health insurers to uncouple their business into regional entities with separate P&L statements, separate ‘Yellow Books’ and separate regulations. This is not only true for many of the 'Blues' and other not-for-profit insurers, but even the giants Aetna and Cigna are made up of regional subsidiaries defined largely State by State with oversight by 50 different Insurance Commissioners. While it’s true that all insurers are regulated at the State level, the DMCB thinks health insurers receive more than their fair share of scrutiny. The result has been a crazy quilt complexity that is further scrambled by the different features of the large group, small group and individual markets. No wonder that relief from State regulation has been sought for years. And no wonder that the economic contagion couldn't spread through the health insurers as easily.

In light of this, what are the implications of healthcare reform? As previously discussed in a prior post, the DMCB believes community rating, guaranteed issue and having to compete against a public plan will increase health insurer mergers and acquisitions. As a result, small insurers will evaporate and the remaining health insurers will get even bigger, arguing they need the economies of scale and access to capital that comes with size. If healthcare reform doesn’t include 'single standard' Federal regulations, the DMCB expects the insurers (the ones that are left standing) to seek them, which will in turn allow them to centralize their operations outside of State oversight.

And once that happens, they’ll be too big to fail.

Which is why the DMCB is still a big fan of Nassim Taleb, the author of the highly readable The Black Swan, who recently penned this interesting editorial in the Financial Times. His ten recommendations for ‘Capitalism 2.0’ deserve consideration while policy makers and regulators struggle to minimize the future risk of rare catastrophic financial upheavals. They are listed below, followed by the implications for health insurance reform from your trusty DMCB:

Nothing should become too big to fail – The last thing we need is one or more AIG-like health insurance entities with a critical mass of beneficiaries and providers vulnerable to unpaid bills.

No socialization of losses and privatization of gains – It’s not unusual for insurers to contribute to State-regulated ‘insurance for insurers’ risk pools. In light of recent events, do we know if they are adequate? Who will be responsible for this once health insurance goes truly national?

It is foolish to trust the very experts that got us into this messHear hear! Says the DMCB; health insurance executives should know that failure to fulfill their fiduciary responsibility means they will be banished from the business for life. Will Timothy Geithners of Washington DC really be interested in protecting us from a future health care insurance 'Black Swan?' Do they even know how?

Do not let bonuses hide hidden risks and tie them to downside risk – While health insurers have an underwriting cycle with good and bad years, it’s not just revenue. It’s those ratios on the balance sheets that denote capital adquacy and clinical quality in their dashboards. Bonuses need to be aligned with what is important.

Keep it simple – If readers of this blog cannot understand the fundamentals of their health insurance plan, something is wrong. Ditto legislators, policy makers, regulators and community-based watch dogs. Ditto when the insurers go national.

Ban complex financial products – The DMCB thinks the health insurers’ balance sheets were relatively untouched by this pollution. If that’s not the case, it needs to be fixed and kept that way.

It is not the role of government to restore confidence – It is the role of health insurers to maintain confidence now and in the future.

Leverage is the problem, not the solution. Health insurers are just as vulnerable to the temptation to assume debt in their operations and acquisitions. Regulators at the State or Federal level will need to maintain their vigilance and be given the adequate staff and resources to do so.

Definancialize economic well being – The integrity of a health insurance policy needs to depend less on interest income and more on old fashioned risk pooling.

Blow it up and start over again with Capitalism 2.0 – And don’t spare the health insurers.


Will you be going to the World Health Care Congress? The DMCB agrees this is one of the premier meetings on health care reform and is very much looking forward to what everyone has to say. If you can't make it, think about that nifty video portal. And, whether you go or not, check in with the DMCB and at the WHCC blog for exclusive updates.

See you there.


James Larson, CMPE said...

The payors are in trouble:

They're stock price has tumbled about 60%

The bonds they "float" to pay claims (they hate tapping their reserves to pay claims, and as you said they're revenue from premiums is down) are more difficult to sell and the cost of those funds is higher.

The result: they are taking more of a "float" on payments to doctors. 43% of the physician practices I recently polled report increased payment delays, erroneous denials, and "off contract" (low) payments.

The state Insurance Commissioners are only partially effective at mitigating these problems - largely because physician practices don't report the abuses often enough. One success story, however is that Anthem (WellPoint) is under the Insurance Commissioner's microscope in Ohio for playing games with payments to doctors.

One way to look at this is the insurance companies are getting a bail-out of sorts from the doctors they are under-paying.

Jaan Sidorov said...

Interesting point Jim.

I don't know if the 60% share price fall, however, necessarily portends a worse prognosis because EVERYONE'S share prices have tanked. I know this because of my 401K.

Over the short term, cash flow issues may tempt some unscrupulous insurers to intentionally delay payment to providers. Because of those alleged behaviors - as well as accusations of recissions,denials of care, hard knuckled take-it-or-leave-it contracting and maintaining high surpluses - the State Insurance Depts have been on health insurers like red on a tomato.

THAT'S why the States have been so active in the health insurance space and why - maybe - health insurers have been prevented from becoming to big to fail.