Healthcare - Managed Care 2013.12

8/11/2019 Healthcare - Managed Care 2013.12

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Please see General Disclaimers on the last page of this report.

Current Environment ............................................................................................ 1

Industry Profile .................................................................................................... 22

Industry Trends ................................................................................................... 24

How the Industry Operates ............................................................................... 41

Key Industry Ratios and Statistics ................................................................... 47

How to Analyze a Managed Care Company .................................................. 49

Glossary ................................................................................................................ 55

Industry References ........................................................................................... 57

Comparative Company Analysis ...................................................................... 59

This issue updates the one dated May 2013.

The next update of this Survey is scheduled for May 2014.

Industry SurveysHealthcare: Managed Care

Phillip M. Seligman, Managed Health Care Equity Analyst

NOVEMBER 2013

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Topics Covered by Industry Surveys

Aerospace & Defense

Airlines

Alcoholic Beverages & Tobacco

Apparel & Footwear:Retailers & Brands

Autos & Auto Parts

Banking

Biotechnology

Broadcasting, Cable & Satellite

Chemicals

Communications Equipment

Computers: Commercial Services

Computers: Consumer Services &the Internet

Computers: Hardware

Computers: Software

Electric Utilities

Environmental & Waste Management

Financial Services: Diversified

Foods & Nonalcoholic Beverages

Healthcare: Facilities

Healthcare: Life SciencesTools & Services

Healthcare: Managed Care

Healthcare: Pharmaceuticals

Healthcare: Products & Supplies

Heavy Equipment & Trucks

Homebuilding

Household Durables

Household Nondurables

Industrial Machinery

Insurance: Life & Health

Insurance: Property-Casualty

Investment Services

Lodging & Gaming

Metals: Industrial

Movies & Entertainment

Natural Gas Distribution

Oil & Gas: Equipment & Services

Oil & Gas: Production & Marketing

Paper & Forest Products

Publishing & Advertising

Real Estate Investment Trusts

Restaurants

Retailing: General

Retailing: Specialty

Semiconductor Equipment

Semiconductors

Supermarkets & Drugstores

Telecommunications: Wireless

Telecommunications: Wireline

Thrifts & Mortgage Finance

Transportation: Commercial

Global Industry Surveys

Airlines: Asia

Autos & Auto Parts: Europe

Banking: Europe

Food Retail: Europe

Foods & Beverages: Europe

Media: Europe

Oil & Gas: Europe

Pharmaceuticals: Europe

Telecommunications: Asia

Telecommunications: Europe

S&P Capital IQ Industry Surveys

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INDUSTRY SURVEYS HEALTHCARE: MANAGED CARE / NOVEMBER 2013 1

CURRENT ENVIRONMENT

Evolution in managed care

The federal government, through passage of the Patient Protection and Affordable Care Act (ACA) in 2010,is attempting to strengthen the overall US healthcare system by setting regulations that will govern theindustry. The first set of provisions took effect on September 23, 2010, with more implemented in 2011 andsubsequent years. As these new rules have begun to take effect, managed care organizations (MCOs) arebeing forced to evolve and adapt to the changing conditions. S&P Capital IQ (S&P) believes that all sectorsof the healthcare industry are being affected, but the managed care group will see the greatest impact.

The cloud of uncertainty surrounding the legality of the healthcare reform law was removed by the June2012 decision of the US Supreme Court to uphold the individual mandate provision of the law, while alsogiving states the choice to opt out of the Medicaid expansion plan. (The decision is discussed in more detailbelow.)

Until late 2007, a confluence of trends helped the managed care industry thrive: a strong economy, pricing

discipline, moderating medical cost trends, enrollment gains (including an influx of Medicare and Medicaidbeneficiaries into private managed care programs), geographic expansion, and ongoing consolidation.Disciplined control of administrative functionsincluding above-average cost cuts and information systemupgradeswas another positive driver.

Then, a recession began in December 2007. Although it officially ended in June 2009, unemployment ratesrose until October 2009 before trending down, albeit slowly. This rise in unemployment created obstacles to

growth for MCOs, as commercialmembership rolls dropped meaningfully.However, the number and percentage ofthose insured increased in 2012, to263.2 million and 84.6%, respectively,from 260.2 million and 84.3% in 2011.According to the US Census Bureau,2011 was the first year in 10 years thatthe percentage of those insured did notdecline, and 2012 showed furtherprogress.

The Henry J. Kaiser Family Foundation(KFF), a nonprofit healthcare researchand analysis firm, attributed this reversalof trend mainly to the provisions of theACA, and to the decline in income levelsin 2011, making more Americans

eligible for coverage. We think that this reversal was due primarily to the ACA requiring insurers to allowparents to keep adult children on their plans until age 26. Such gains have more than offset the continued

loss of employer-sponsored coverage (at least so far), particularly among adults aged 45 to 64. Moreover,we believe the gains were more profitable for the insurers as the newly insured younger members tend to behealthier, as a group, than the existing or lost enrollment.

According to the Census Bureau, the percentage and number of people covered by Medicaid in 2012 werenot statistically different from 2011, at 16.4% and 50.9 million, while the percentage and number of peoplecovered by Medicare increased in 2012 to 15.7% and 48.9 million, from 15.2% and 46.9 million in 2011.We believe the trend in Medicaid is as expected, given the declining unemployment rates and that realmedian family and nonfamily household incomes in 2012 were not statistically different from 2011 levels.

Chart H06: THEUNEMPLOYMENTSITUATION

(1,250)

(1,000)

(750)

(500)

(250)

0

250

5004

5

6

7

8

9

10

11

2008 2009 2010 2011 2012 2013

Net change in nonfarm employees (thousands, right scale)

Unemployment rate (%, left scale)

THE UNEMPLOYMENT SITUATION

Source: US Bureau of Labor Statistics.

(Inverted scale, thousands)(%)


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2 HEALTHCARE: MANAGED CARE/ NOVEMBER 2013 INDUSTRY SURVEYS

The rise in the number and percentage of Medicare beneficiaries is also unsurprising, as seniors account foran increasing percentage of the US population.

Impact of the ACA on employers in 2014

The reforms set to take effect in 2014 under the ACA would impose a penalty on large employers (thosewith 500 or more employees) that do not offer affordable health insurance to their employees. Further, the

reforms would provide premium tax credits to lower-income persons in order to enable them to buyinsurance in state exchanges if affordable employer coverage is unavailable to them.

According to the National Institute for Health Care Reform (NIHCR), a nonprofit health policy researchorganization, the ACA provides large firms with a strong economic incentive (averaging $2,503 peremployee) to provide insurance to employees. However, small firms (with fewer than 50 employees) willhave less economic incentive (averaging $990 per employee), in large part because these employers will beexempt from the penalty. The NIHCR defines the economic incentive or disincentive as the amountcalculated by adding the dollar value of the employer-sponsored insurance tax subsidy and the value ofavoiding the penalty for not offering insurance, and then subtracting the value of the premium tax creditsthat eligible workers could use in an exchange if their employer does not offer coverage.

Hence, we would not be surprised if some small businesses opt for the healthcare penalty if the total cost ofthe penalties is below that of the cost of their premiums, as noted in an April 2013 Wall Street Journal

article. We are also not surprised by the findings of the US Chamber of Commerces Q2 2013 SmallBusiness Outlook Survey, published in July 2013. In the survey, 79% of respondents said that the ACAwill make coverage for their employees more expensive, while 71% felt that the law will make it harder forthem to hire; in addition, 27% indicated that they will cut hours to reduce their number of full-timeemployees and 23% will replace full-time employees with part-timers.

The Wall Street Journalreported on May 27, 2013, that small businesses seeking to avoid the ACAsprovisions at least for a while are considering offers by some insurers to allow them to renew theircontracts in December 2013, rather than in January, when they would normally renew. The article went onto note that some state regulators and benefits lawyers question the tactic, highlighting that Illinois andRhode Island are disallowing early health plan renewals for small businesses. Separately, a Wall Street

Journalarticle published on May 28 noted that some insurers have begun to offer small companies theopportunity to self-insure. Under self-insurance, employers pay benefits firms or health insurers a fee to

administer the plans, but the employers are fully responsible for paying for their employees medical costs.Under the ACA, companies that self-insure do not have to offer the richer benefits that will be required oftraditional health insurance, in which the insurer is paid a premium and absorbs the medical cost risks. Self-insurance has long been a popular practice among large employers. They absorb the risks, but it gives themmore control over their benefit offerings, is less costly than traditional insurance, and the costs are broadlyspread over a large employee base. The risk to a small firm is that it will have to more fully absorb thesizable medical bills of an employee who has a serious accident or disease.

HEALTHCARE REFORM ARRIVES

Healthcare reform, as defined by the Patient Protection and Affordable Care Act, which was signed into lawby President Obama on March 23, 2010, requires most US citizens and legal residents to have minimumessential health insurance coverage. Accompanying that bill was the Health Care and Education Reconciliation

Act of 2010, which was signed into law on March 30, 2010. (To simplify, both Acts will be referred to asthe ACA in this Survey.)

In February 2013, the nonpartisan Congressional Budget Office (CBO), a research arm of Congress, and thestaff of the Joint Committee on Taxation (JCT) estimated that the ACA (including only those provisionsrelated to healthcare in the Reconciliation Act) would have a gross cost of around $1.6 trillion (about $60billion lower than the projection in August 2012) and would increase the deficit to around $1.2 trillion (aboutthe same amount as projected in August 2012) over the 11-year period from 2013 to 2023. The CBO and JCTbelieve that more people will obtain health insurance through the newly established health insurance


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exchanges and that the reductions in spending from lower Medicaid enrollment are expected to outweighthe increased costs from greater participation in the exchanges. It also expects more people to be uninsured.

US Supreme Court finds healthcare reform law constitutional

On June 28, 2012, the US Supreme Court upheld the constitutionality of the ACA in a 54 vote. The courtupheld the individual mandate provision, which will require Americans who can afford health insurance to

purchase it as of 2014, saying Congress could impose the mandate under its power to lay and collect taxes(as provided in the US Constitution). However, the court rejected the part of the law that made it mandatoryfor the states to expand their Medicaid programs to include citizens under age 65 with family incomes below138% of the federal poverty level under the threat of losing their Medicaid funding. The court ruled that thispart was unconstitutional because it was coercive. The states now have the option to join the expanded planand receive enhanced federal funding.

What does healthcare reform do?

The ACA requires most individuals and their families to have health insurance, and imposes financialpenalties on those who choose not to purchase it. The law also requires employers to provide coverage fortheir employees, with tax breaks to help them provide it and penalties if they do not. It expands Medicaideligibility and provides funding to states to set up special health plans to cover those ineligible for Medicaid,but too poor to pay for their own coverage. It also sets up exchanges where individuals and employers mayobtain health insurance at competitive prices. It prevents insurers from limiting, dropping, or refusing toprovide coverage, and allows dependent children to remain on their parents plans until they are 26.

The reform legislation includes the following features: an insurance program from 2010 to 2014 for adultswho have been without insurance for at least six months and who have a pre-existing condition; a provisionfor children under 19 having a pre-existing condition; an early-retiree reinsurance program; and discountson prescription drugs to Medicare Part D beneficiaries when the beneficiaries reach the coverage gap. Therules and regulations regarding coverage will be phased in over a multiyear period.

The legislation originally aimed to cover 94% of all non-elderly residents (excluding undocumentedimmigrants) by reducing the number of uninsured by an estimated 32 million by 2019, or 34 million by2021. We note that an estimated 23 million people would still have remained uncovered in 2019. However,according to the CBO, the Supreme Court decision would lead to an increase in the number of uninsured:29 million in 2019 and 30 million in 2023.

To further its goal of higher enrollment, the ACA includes provisions for Medicaid coverage, reducedpremium costs, and lower cost-sharing for families that cannot afford health insurance coverage (those withincomes ranging from 100% to 400% of the federal poverty level). According to the June 2012 ruling bythe US Supreme Court, states have the option of providing Medicaid coverage to most people with incomelevels below 138% of the poverty level. According to a study by the KFF published in November 2012, if allstates agreed to the expansion, Medicaid coverage would increase by 41%, and an additional 21.3 millionpeople would get coverage by 2022. Beginning January 1, 2014, the ACA would include lower premiumcosts through tax credits to people with income levels up to 400% of the poverty level and insurance planswith reduced cost-sharing to people with income levels up to 250% of the poverty level.

As of this writing, each state has its own laws to regulate how insurance companies set premium rates forthose seeking coverage, including such factors such as their health condition and demographic status.

However, starting on January 1, 2014, federal law will govern the premium rates applied to individuals andsmall businesses. As per the ACAs minimum premium rating rule, premium rates can vary based on onlythe following four factors: individual versus family enrollment, geographic area, age, and tobacco use. Alsoeffective from January 1, 2014, under the revised ACA guaranteed issue laws, all individual and small-groupapplicants will be guaranteed the issuance of policies, irrespective of their health status or any other factors.

Many will buy their insurance via public state-based) and private exchanges

Starting October 1, 2013, individuals without employer-covered health insurance and some small businesseshave been able to shop for health insurance for the 2014 calendar year (starting January 1) through onlinemarketplaces known as health insurance exchanges. The health insurance exchange concept was set into law


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by the ACA. Some states (14 states and the District of Columbia) operate their own exchanges; in otherstates, the federal government has set up and runs the public exchanges directly (26 states), or worked inpartnership with some states (10 states) to establish and run the exchanges.

In addition to the public exchanges, private exchanges offering health plans conforming to the ACAregulations have been created by human resource consultancies to offer choices for the employees of manymid-sized and large companies. The employer mandatethe requirement that employers with 100 or moreworkers obtain health insurance for their employeeswas delayed to 2015. Also delayed was theimplementation of the Small Business Health Options Program, or SHOP exchange, which would giveemployees of small businesses (less than 50 employees, but up to 100 in 2016) a choice of health plans inthe states where the federal government is involved in operating the exchanges. However, a few statesrunning their own exchanges, including California and Connecticut, have offered the employee choicemodel for small businesses for the 2014 plan year, though it is not required by the federal government.

When one applies for insurance from the exchange, the application will require such information ashousehold size, income, location, and citizenship status. Those earning between 100% of the federal povertylevel, or FPL ($11,490 in 2013 for an individual and $23,550 for a family of four in the 48 contiguousstates and the District of Columbia) to 400% ($45,960 and $94,200, respectively) will be eligible for asubsidy in the form of a tax credit called the Advance Premium Tax Credit. This tax credit is applied to themonthly premiums, enabling the applicant to get the lower insurance price immediately. Hence, for

applicants with incomes within the ranges, the net price they will have to pay is below the full price listed inthe exchange. Those with incomes above the ranges pay the full listed price out of pocket. ParticipatingMCOs receive the full premium price, whether or not part of it is subsidized.

On the public exchanges, the health plans are grouped by levels of coverage, including how much the planwill pay for ones healthcare and what services are covered. All of the health plans have to offer the sameessential benefits, but each can provide additional benefits to attract buyers. Each level is named after ametal (Bronze, Silver, Gold, and Platinum), and they vary by the percentage of costs one has to pay, onaverage, for the healthcare received. Bronze plans offer the lowest coverage, and platinum the most, and theplans vary by the percentage of costs one pays on average toward the healthcare one receives. At the bronzelevel, one pays 40% of the costs out-of-pocket whenever one sees a doctor or purchases a medicine, while atthe platinum level, one pays only 10%. However, bronze has the lowest premium, and platinum the highest.On the exchanges, the health plans are organized by metal level, then by brand ( i.e., by insurer), and then by

type of health plan, such as HMO, PPO, POS, or high-deductible plans with a savings account.

Interestingly, an analysis of the 1,923 plans being sold on 34 federally run exchanges (published in October2013 by KFFs daily online newsletter, Kaiser Health News) found that the exchange plans vary withincounties and across the country, even if they are the same type of plan. This is unsurprising, since the cost ofliving differs in different parts of the US. In any event, 806 of these plans are HMOs and 714 are PPOs.

S&P believes there will be plenty of healthier enrollees in the public exchanges to keep the ratio of healthyand sick applicants in the risk pool relatively steady. Some businesses that employ a large percentage ofpart-timers and provide insurance for those employees are likely to opt to drop that insurance coverage and,instead, provide a small subsidy to help them purchase insurance through the public exchanges. One outfitfollowing this path is Trader Joes, a closely held grocery-store chain, which will provide these workers witha $500 stipend. In addition, various news sources report that to save on employee costs, a number of

employers (including some public school systems) have been reducing their part-time workers hours tounder 30 per week (regardless of whether they previously provided health insurance to such workers). Theseworkers are being encouraged to obtain subsidized health insurance via the public exchanges. (The ACArequires firms to provide employer coverage to employees working 30 hours per week or more.)

As noted earlier, in addition to the public exchanges, multi-insurer private (or corporate) exchanges havebeen created by human resource consultancies Aon Hewitt, Towers Watson, and Mercer, a division ofMarsh & McLennan Companies Inc. The insurance offered via the private exchanges must comply with theACA and state regulations. One major difference between the two types is that the government does notsubsidize the purchase of policies in private exchanges. Instead, employers will give eligible employees a


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fixed amount for individual or family coverage, regardless of the plan, and the employee chooses among thedifferently priced plans offered by the various insurers participating in the private exchange. The employeecontributes from his or her salary, on a pre-tax basis, the difference between the price of insurancepremiums and the subsidy from the employer. This model has been referred to as defined contributionhealth care, given its similarity to a 401(k) retirement plan, wherein employers monetize their commitmentin the form of a defined contribution rather than a defined benefit, as defined in a report by the Society for

Human Resource Management, a trade group. We believe the use of private exchanges will have a neutralimpact on MCOs profitability.

According to CBO estimates as of May 2013, seven million people would buy health insurance through thepublic exchanges for the 2014 health plan year, while employment-based coverage would total 157 million.The CBO estimated, as of May 2013, that public exchange enrollment by individuals and their familieswould reach 24 million by 2023, while employment-based coverage would increase by 12 million, to 169million.

but the selection in the public exchanges might be somewhat limited at first

For the 2014 health plan year, some large publicly traded MCOs, including Aetna Inc., Cigna Inc., andUnitedHealth Group Inc., severely limited their participation in the public exchanges. S&P believes theywanted to test the waters first to see the profitability of exchange participation. Indeed, UnitedHealth pulledout of Californias individual market in early July 2013, while Aetna has exited seven of the 14 publichealth insurance exchanges in which it originally intended to participate. However, Coventry Health Care,which was acquired by Aetna in 2012, also filed plans under its own name for some exchanges. Aetnadecided to drop out of some states where Coventry filed plans and dropped Coventry plans in some stateswhere it decided to file plans under its own name. All told, Aetna and Coventry combined have plansavailable statewide in 10 states and with limited geographies in seven others. Cigna Corp. is selling plans inonly five states, half of the states in which it had been selling individual plans. In any event, these MCOshave a relatively small presence in the individual market. Humana Inc. and WellPoint Inc., which have largeindividual businesses, appear to be more committed to the public exchanges. All large MCOs will beactively participating in the private exchanges, however.

The large, publicly traded MCOs were not alone in pulling out of exchanges in which they initially plannedto participate. Interestingly, FirstCarolinaCare Insurance Co., a subsidiary of the private, not-for-profithealthcare services network FirstHealth of the Carolinas, exited the public exchange of its home state,

North Carolina. However, Coventry Health Care of the Carolinas, a part of Aetna, remained in theexchange. FirstHealthcares exit appears to us to parallel Aetnas exit from the public exchange of its homestate, Connecticut.

Some smaller, publicly traded MCOs with a significant percentage of Medicaid enrollment (such as MolinaHealthcare Inc., Health Net Inc., and Centene Corp.) are participating in the public exchanges for the 2014plan year, while WellCare Health Plans Inc. is not. However, Health Net has been a long-term player in theindividual, non-Medicaid market. At its September 19, 2013, investor meeting, Molina indicated that it isnot participating in the exchanges to get new Medicaid beneficiaries (which are assigned by the states), butmainly to retain members they are poised to lose due to a change in status (e.g., new employment that givesthe member an income too high to qualify for Medicaid). Those members may wish to remain with theirinsurers to keep their providers (doctors and hospitals), and we do not see pent-up demand from them.However, given these MCOs Medicaid market experience, we believe they are reasonably well equipped to

handle the initial pent-up demand from the previously uninsured who sign up with them through the publicexchanges.

The transition begins

A number of companies have already begun to transition employees and/or retirees (both those under 65years of age and those Medicare-eligible) to private exchanges. The public exchanges are not available forMedicare beneficiaries. Those without access to private exchanges could continue to go to Medicare.govduring its open enrollment period, which began October 15. Early users of Aon Hewitts exchange for the2013 plan year include employees of Sears Holding Corp. and Darden Restaurants. International Business


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Machines Corp., Time Warner Inc., Caterpillar Inc., and E.I. du Pont de Nemours and Co. are among thoselarge companies reported to be moving their retirees to private exchanges run by Aon Hewitt and the otherconsultancies for the 2014 plan year. Walgreen Co. has announced that it will give employees acontribution toward coverage in a private exchange. Employers are also raising deductibles, giving workershealth savings accounts that look like 401(k) retirement plans, setting up private in-house exchanges thatmimic the online insurance exchanges, and encouraging workers to compare prices and shop around for

treatments, according to a September 17, 2013 article in Kaiser Health News.

Note, though, that the ACA does not require companies with fewer than 50 workers to offer coverage fortheir workers. It created online exchanges for the small employers to purchase insurance similar to policiesoffered through the online exchanges for individuals. However, employees of small businesses will be unableto choose from multiple plans in most states until 2015.

but there will still be millions who remain uninsured

Adults living with dependent children and single adults with disabilities whose income falls below 100% ofthe FPL, or all adults with incomes below 138% in states that accepted the ACAs Medicaid eligibilityexpansion, can qualify for his or her states Medicaid program. This can be determined when one appliesfor insurance via a public exchange. S&P believes only a very small percentage of those applying throughthe exchanges will fall into the below-100% category. In any event, once a person is deemed eligible forMedicaid, that person does not choose his or her health plan. The state assigns the Medicaid coverage eitherthrough direct coverage or to an insurer operating in the new Medicaid beneficiarys home county. Thatsaid, S&P believes MCOs will continue to see enrollment expansion from states still transitioning theirMedicaid populations to private insurers.

However, in many states, impoverished adults under 65 years of age, without disabilities and withoutdependent children, are currently ineligible for Medicaid. Under the ACA, their coverage would besubsidized if their incomes are at least 100% of the FPL. However, the Commonwealth Fund, a privatefoundation supporting research on healthcare issues, estimates that some two in five uninsured adults whoare living in the 26 states that have decided not to expand their Medicaid programs (or are undecided) willnot have access to Medicaid or to subsidized health insurance plans on the public exchanges. The CBOprojected in May 2013 that the number of uninsured non-elderly people (including unauthorizedimmigrants, as well as people who are eligible for but not enrolled in Medicaid) will decline from 55 millionin 2013 to 30 million by 2017, and will remain in the 30 million31 million range through 2023.

RESISTANCE TO THE ACA BECOMES SHARPER

The implementation of the healthcare reforms contained in the ACA became more certain with the SupremeCourt decision on the ACAs constitutionality in June 2012 and President Obamas re-election in November2012. Nevertheless, resistance to the ACA has continued. At the federal level, in March 2013, the US Senaterejected Republican Paul D. Ryans attempt to repeal the ACA.

The fight later became more extreme. From September 20 to October 1, 2013, the Republican-controlled USHouse of Representatives sent a bill to raise the federal debt ceiling four times to the Democratic-led Senate.However, it also included provisions to strip financing for the ACA in the first attempt, to delay the healthcarelaw by one year and repeal the tax on medical devices in the second attempt, to delay the individual mandatein the third attempt, and to cancel subsidies for lawmakers in the fourth attempt. In each of the first three

times, the Senate stripped the healthcare provisions and sent the bill back to the House.

The government shutdown began at 12 a.m. October 1, and later that morning, the Senate rejected theHouse measure. Senate Majority Leader Harry Reid (D., Nevada) and President Obama refused to negotiateon the ACA and sought a clean spending bill. Neither side was giving in and many federal governmentdepartments and services shut down. On October 17, after the Democratic-led Senate passed an agreementbetween Senate Majority Leader Harry Reid and Minority Leader Mitch McConnell (R., Kentucky) to endthe tense political standoff by an 8118 vote, the House voted 285144 to pass the deal, and PresidentObama quickly signed it.


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Interestingly, a conservative group of House Republicans, known as the Republican Study Committee,unveiled a healthcare reform alternative on September 18, 2013, called American Health Care ReformAct. This calls for the full repeal of the ACA and, instead, would provide $20,000 in tax deductions tofamilies and a $7,500 deduction to individuals, so they can purchase insurance from vendors in any state. Italso creates a 10-year, $25 billion fund to lower costs for those with pre-existing conditions such as cancer,and allows consumers to carry their insurance from job to job. On October 15, this proposed bill was

referred to the Subcommittee on Regulatory Reform, Commercial and Antitrust Law. As this Surveywentto press in mid-November 2013, the bill had not yet been reviewed on the floor of the House ofRepresentatives.

Meanwhile, at the state level, the setting up of insurance exchanges had generated opposition, with 26 statesdefaulting to fully federally built and operated exchanges for individuals and families without employment-based insurance. Another example of state resistance, according to an article published September 17, 2013, inthe New York Times, is Florida, which is not participating in the exchange program (thus leaving the federalgovernment fully responsible for setting one up in the state and running it). In addition, however, the state hasrequired that health navigators (i.e., individuals assigned to help people enroll in the exchanges) undergofingerprinting and criminal background checks, and bars them from conducting any business on propertycontrolled by the state or county health agencies. In an article posted on the website of The Hill, aWashington, D.C.based newspaper that specializes in coverage of the US Congress, at least 18 states havetaken steps to restrict the counselors activities or have imposed additional training. And, among these states,several that are Republican-led have imposed criminal background checks and examination requirementsthat exceed whats mandated by federal law. The Republicans have argued that they are trying to protectpeople from fraud and that without this additional scrutiny, the program could admit felons as counselors.Indeed, in October 2013, the websites of several conservative media outlets (Fox News and the NationalReview) provided examples of some people they felt should not have been hired as navigators.

Republican-led states, for the most part, have continued to oppose Medicaid expansion to cover people withincomes up to 138% of the FPL. For example, the Republican governor of Texas, Rick Perry, rejectedMedicaid expansion in his state. Even Republicans who support Medicaid expansion, such as FloridaGovernor Rick Scott, faced opposition from the Republican-controlled Florida House and Senate.

As of September 23, 2013, the governors of 22 states and the District of Columbia supported Medicaidexpansion, 12 opposed, and 16 were weighing options. Many governors opposing expansion said they could

not support expansion without program reforms, legislative approval, or permission to use the Medicaid fundsto purchase private health insurance, according to KFFs statehealthfacts.org website. Interestingly, despite thelaws unpopularity in Southern states, the expansion of Medicaid is supported by about two-thirds of adults inAlabama, Georgia, Louisiana, Mississippi, and South Carolina, according to the Joint Center for Political andEconomic Studies, a think tank. Separately, according to the a May 23, 2013, Politico article, many statesmired in the fight over Medicaid expansion are starting to give up on their first year of full funding, and itsunclear whether they would be able to tap into the funds before 2015. This could mean the loss of hundreds ofmillions, and in some cases, billions, of dollars to cover low-income residents. The challenge many face is theset-up of the infrastructure to accommodate the influx of enrollees.

and some once in favor are having second thoughts

Having once supported the ACA, some unions are now concerned that it will jeopardize benefits for millionsof their members, according to a May 24, 2013, Associated Press article. The problem is that multi-employer

plans, which cover over 20 million unionized workers in retail, construction, transportation, and otherindustries with seasonal or temporary employment, are more costly to run than single-employer plans. Theyhave been facing higher costs as a result of certain ACA mandates: that health plans cover dependents up toage 26, extend coverage to people with pre-existing conditions, and eliminate annual and lifetime coveragelimits. The unions fear that employers will be tempted to drop coverage and have members fend for themselvesin the health insurance exchanges. Interestingly, while workers seeking coverage through the exchanges canqualify for subsidies, the ACA does not allow union members to receive similar subsidies. S&P believes theseunion plans will not disappear quickly, as workers are covered under collective bargaining agreements. The


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New York Timesreported that on September 13, 2013, the US Treasury Department denied federal tax creditsto workers who receive health coverage under employee benefit plans sponsored by more than one employer.

While not exactly resisting the ACA, some large employers may be now considering offering bare-bones plans,according to a May 20, 2013, article in the Wall Street Journal. Some such plans may offer only preventativeservices, and not cover surgery, X-rays, or prenatal care. The ACA requires only plans sold to small employersand individuals to be comprehensive. Apparently, a close reading of the law reveals that companies with 50 ormore workers, which would have to provide coverage or pay a penalty, are not affected by the mandates ofessential benefits. Indeed, employers in low-wage industries have been concerned how they can afford thesebenefits, and some of the policies being offered cost less than the penalty. Interestingly, such plans look to uslike the so-called mini-med plans currently provided by low-wage industries.

THE PUBLIC EXCHANGES OPEN WITH A BANG

The partial government shutdown did not delay the October 1 launch of the public healthcare exchanges,whereby individuals will be able to purchase health insurance for themselves and their families. The Presidentand the US Senate did not budge and the exchange process is moving ahead, despite resistance to thehealthcare reform law, including attempts to delay its implementation by the Republican-controlled House.Indeed, the US Department of Health & Human Services (HHS) has announced the opening of the exchangeswith fanfare.

However, there have been problems, as S&P and others expected, given the glitches in the federally run systemthat were discovered while the system was being tested. One software glitch was the problem in determiningthe level of subsidy one could receive if he or she had income in the 100%400% of the federal poverty level.Many problems have likely been fixed, but various news sources have been reporting heavy on-line exchangetraffic on the first couple of days, suggesting better-then-expected demand, and system problems the first daysthe exchanges were open. S&P believes many of the system problems relate to possible initial system overload.S&P views this, plus the long wait times at call centers, making the individual attempts to purchase insuranceduring that time difficult.

On October 15, the HHS set the deadline of November 30 to fix the system and appointed one of thecompanies behind HealthCare.gov (the name of the federally run exchange website) as the generalcontractor for the repairs. That company is Quality Software Services Inc. (also known as QSSI Inc.),

which was acquired by giant MCO UnitedHealth Group Inc. in September 2012, after the MCO wasselected to help set up HealthCare.gov. (The acquisition was not announced by UnitedHealth, S&P believes,because it was small. Jenner & Block, the law firm representing QSSI in the takeover, announced it onOctober 9.) QSSI had been behind the sites problematic account registration tool and its data hub, whichallows information to be transferred between different groups, but which officials said is functioning well,according to an article posted October 25 on the website of The Hill. In this regard S&P is not surprisedthat some Republican senators became concerned that QSSI might have access to information or wouldbuild the technology in a way that would give UnitedHealths insurance business an advantage, according toan article posted October 25 on the Washington Postwebsite. In addition, computer engineers from techcompanies Google, Oracle, and Red Hat have been enlisted to help with the tech surge to fix the system.S&P has viewed the technical glitches as fixable.

People who wish to be covered as of January 1 have until December 15 to sign up and pay for their first

month of the 2014 health plan year. As this Surveywent to press in mid-November, the HHS had released theenrollment data on the public exchanges covering the period of October 1 to November 2, approximately thefirst month of open enrollment. According to the HHSs November 13 press release, only 106,185 Americanshad selected plans from the state and federal Health Insurance Marketplaces (the HHSs term for the publichealth insurance exchanges) during that period: 79,391 enrolled through exchanges run solely by 14 states and26,794 enrolled in federally run exchanges in the other 36 states and the District of Columbia. According to aWall Street Journalreport on November 13, one HHS memo had projected that some 500,000 people wouldobtain private health insurance coverage. However, HHS notes another 975,407 made it through the processof applying and receiving an eligibility determination, but have not yet selected a plan. (Note that the healthinsurers will not count any of those that enrolled as members until they pay their first months premium.)


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S&P Capital IQ believes the much smaller federal figure relates to the technical issues plaguing the federalmarketplaces (the state marketplaces, in contrast, had very few problems). We also think that those who didnot yet select a plan are still determining which one would be the most suitable. This is likely to be time-consuming process: the associated provider networks may differ, and consumers may be trying to determinewhich set of doctors and hospitals would cover most, if not all, of their needs. While we view the sign-upfigures to date as a bit disappointing, people are looking. HHS reported that there were 26,876,727 visitors to

the state- and federally run exchange websites, and an estimated 3,158,436 calls to state and federal exchangecall centers. We also think the low initial enrollment numbers may reflect the pattern seen in Massachusetts,when that state initiated healthcare reform. According to a New York Timesarticle published November 14,2013, when that state expanded health coverage in 2007, only 127 people (of the 36,167 who ultimatelyenrolled) signed up in the first month, while 7,000 signed up in the last month. The federally run exchangestechnical issues might also explain some of the difference between what was expected and what occurred.

Meanwhile, another problem cropped up. Millions of currently covered Americans were informed by theirinsurers that their plans would be dropped as of January 1, primarily because the plans did not meet all ofthe ACAs essential benefits requirements. This move by the insurers ran counter to President Obamaspromise that those who liked their insurance can keep it, and he expressed regret on an NBC News interviewon November 7. Congress wanted to legislate a change. On November 4, US Senator Mary L. Landrieu (D-Louisiana) introduced the Keeping the Affordable Care Act Promise Act to keep the promise that if apolicyholder liked his or her health insurance, he or she could keep it as long as payments were up-to-date.On November 7, US Senators Joe Manchin (D-West Virginia) and Mark Kirk (R-Illinois) introducedlegislation to delay the implementation of the individual mandate from January 1, 2014, to January 1,2015. On November 8, Representative Fred Upton (R-Michigan) introduced his Keep Your Health PlanAct, which would enable people to keep their old insurance as long as they want; it passed the House onNovember 14. President Obama promised to veto it if it came across his desk.

On November 14, President Obama announced changes to the ACA to give insurers the option to keepoffering consumers plans that would otherwise be cancelled, even if they do not include all of the essentialbenefits. This administrative change is only good for a one-year extension. The term optional suggests tous that the insurers have a choice to offer it to some plans and not others. However, as this Surveywent topress, some state insurance commissioners were for the policy change and some were against. The healthinsurance industry, though not unanimous, was expressing concern that the younger, healthier people willbe interested in keeping old policies, which could overburden the new plans with a greater-than-expected

proportion of high-cost members. We note that the Wall Street Journalreported on November 18 that so-called high risk pools for people rejected by health insurance companies that were supposedly being phasedout as ACA rules kicked in are being given brief second lives in some states due to problems with the federalexchanges. S&P believes this should help temporarily reduce the costliest members as a percentage of thetotal population enrolling through the federal exchanges until the system is fully fixed. In addition, the ACAprovides for a $20 billion fund, paid for by a reinsurance tax imposed on health insurers and employerswho self-insure from 2014 to 2016, that would provide money to insurers that incur high claims forconsumers in the individual insurance market, both inside and outside the public exchanges.

However, open enrollment continues through March 31, 2014, and people have been encouraged to try toaccess the system again if they encounter problems the first time. In any event, the CBO expects seven millionpeople to obtain coverage for the 2014 health plan year through the public exchanges, and has not yet revisedthe figure.

PAYING FOR IT ALL

The federal government plans to provide significant financial help directly to eligible individuals (in the formof premium and cost-sharing tax credits), employers (tax credits), and states (assumption of a greaterpercentage of Medicaid and Childrens Health Insurance Program costs). In addition, the ACA finesindividuals who do not opt for purchasing coverage and employers who offer no coverage to theiremployees. Since these fines will constitute only a small percentage of the total cost of healthcare reform, themoney has to come from elsewhere.


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To compensate for the overall cost, the law has imposed certain rules in the form of cuts and deductionsthat will affect different groups across the industry. For instance, the ACA calls for closing the coverage gapin the Medicare Part D prescription drug benefit (the so-called donut holethe difference between theinitial coverage limit and the catastrophic coverage threshold) by 2020. To help accomplish this, the drugindustry will reduce prices by 50% on brand-name drugs purchased in the donut hole, saving $20 billionover the next 10 years.

The pharmaceuticals industry agreed to increase the Medicaid rebate (which drugmakers pay to stateMedicaid funds for the drugs purchased), plus other concessions and fees on sales to other governmenthealth programs, bringing Big Pharmas fees to about $85 billion over the next 10 years. Medical devicemanufacturers will also contribute to the funding via the laws imposition of a 2.3% excise tax on the sale oftaxable products in the US starting in 2013, which is expected to raise $20 billion over 10 years. (Unlike fees,excise taxes are tax-deductible, thereby lowering the after-tax impact and cushioning the overall effect.)

Meanwhile, in July 2009, the hospital industry agreed to a reimbursement cut of about $155 billion over 10years, in part by reducing the size of Medicares annual market basket updates (the inflation rate adjustment).The ACA also calls for Medicare and Medicaid disproportionate share hospital (DSH) payments to bereduced (effective in fiscal 2014), and that payments made to hospitals will be reduced to account forpreventable hospital readmissions (effective fiscal 2013) and for hospital-acquired conditions (effective fiscal2015), yielding a total $40 billion in savings between 2014 and 2019.

Health insurers face additional fees, minimum medical cost spending limits

The managed care group faces a fee that increases from $8.0 billion in 2014 to $14.3 billion in 2018; insubsequent years, fees will rise by the rate of premium growth. (For not-for-profit insurers, only 50% of netpremiums are counted.) Effective in calendar 2009, the tax-deductibility of health insurer executive andemployee compensation is limited to $500,000 per applicable individual. A 40% excise tax imposed on thevalue of employer-sponsored plans exceeding a certain threshold starts in 2018 and will raise an estimated$32 billion over 10 years.

Under the medical loss ratio (MLR; also known as the medical cost ratio, or MCR) provision of the ACA,effective January 1, 2011, health insurance plans have been required to reserve at least 80% of thepremiums towards healthcare expenditure and quality improvement initiatives, leaving only 20% for SG&Acosts. This provision required the larger group plans to set aside a higher 85% for healthcare and other such

expenses. If a plans MLR falls below the required minimum, MCOs are required to rebate the difference tocustomers. In June 2012, the US Department of Health & Human Services (HHS) announced that insurancecompanies that failed to comply with the MLR provision of the ACA were required to pay $1.1 billion in theform of rebates to around 12.8 million Americans. The rebates received covered premiums collected for the2011 plan year.

and, over time, reduced Medicare Advantage payments

Payments to Medicare Advantage (MA) plans will be restructured going forward. For 2011, MA paymentswere frozen at 2010 levels. Beginning in 2012, the payments had to begin to transition to a percentage ofthe fee-for-service (FFS) cost in each state, estimated by the Centers for Medicare & Medicaid Services(CMS), a division of the US Department of Health & Human Services (HHS). These payments wouldeventually range from 95% of traditional Medicare FFS payment levels in high-spending states to 115% inlow-spending states. The transition will be phased in over three years for most areas, and over four to six

years in other areas, depending on the initial difference between the current MA payments and thebenchmarks.

According to the CMS, MA premiums declined by 10% from 2010 through 2013, while enrollment in MAprograms increased by an estimated 28%. However, on February 15, 2013, the CMS proposed a 2.3%reduction in MA payments for 2014. This outlook changed on April 1, when the CMS issued its final 2014MA payment rate, reflecting a positive 3.3% growth percentage. The new rate assumes Congress will againprevent physician payment rates from dropping.


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The CBO projected the government will save $136 billion over 10 years to 2019. However, starting in2012, bonuses were given to MA plans with quality rankings of at least three stars out of five or those thatare unrated (i.e., plans that are too new or that have too few enrollees).

On November 15, the Wall Street Journalreported that UnitedHealth Group had dropped thousands ofdoctors from its networks in recent weeks, leaving many Medicare patients unsure whether they need toswitch plans to continue seeing their doctors. In its third-quarter 2013 earnings conference call on October17, the company said it expects its 2014 earnings outlook to be impacted by overall Medicare Advantagefunding levels. It also reported spending more healthcare premiums on medical claims in the third quarter,due mainly to government cuts in payments for Medicare Advantage services. According to the notices sentto the doctors, the terminations can be appealed within 30 days. UnitedHealth informed the Wall Street

Journal that the company expects its Medicare Advantage network to be 85%90% of its present size by theend of 2014. Looking ahead, we would not be surprised if other health insurers follow UnitedHealths path.

IMPACT OF HEALTHCARE REFORM ON MANAGED CARE PROFITABILITY

We believe that managed care organizations will face more restrictions as more provisions of the law comeinto effect. (See the accompanying table entitled Healthcare Reform Legislation Implementation Timeline.)Because healthcare reform extends health insurance coverage to the uninsured, the law prohibits certainactions: denying coverage to individuals with pre-existing health conditions; rescission (rescinding enrollees

coverage); applying annual and lifetime limits on required health benefits; and requiring prior authorizationfor emergency and obstetric/ gynecological services. In addition, premiums can vary by no more than 3:1 forage and 1.5:1 for tobacco use, though these premium variations do not apply to self-insured plans (thosewhere employers absorb the insurance risk and pay MCOs fees to administer the plans). Of course, the marginpressure from the new MLR rules and the industry fee also affects profitability.

What qualifies as a medical or benefit cost?

Requirements for minimum MLRs raised concerns among the insurers regarding the cost components thatwill qualify as a medical or benefit cost. MCOs have sought to transfer medical-related administrationcostswhich have been accounted for as selling, general and administrative (SG&A) costs on the incomestatementto medical or benefit costs. On December 1, 2010, the US Department of Health & HumanServices (HHS) published its interim final rule on the MLR requirements for 2011, 2012, and 2013, afterreceiving guidance from the National Association of Insurance Commissioners (NAIC), as required by the

ACA, and one year later issued its final rule.

Following the NAIC, the HHS defines medical costs (the numerator in the MLR ratio) as health careclaims, plus any expenses to improve health care quality. Expenses in the quality improvement categorycould include activities that result in measurable improvements in patient safety or patient outcomes, preventhospital readmissions, promote wellness, or enhance health information technology (IT) to improve quality,transparency, or outcomes. Under the ACA, the provider credentialing is a part of the quality improvementexpenses; however, insurance broker and agent compensation are viewed as administrative expenses andfunds used to fight medical fraud are viewed as cost-containment expenses. The denominator of the MLRcalculation comprises earned premium revenue, minus federal and state taxes (including regulatory licensesand fees). The taxes, however, do not include taxes on investment income and capital gains.

In any event, some rules do not apply until 2014 and later. This is due to changes to the marketplace in

2014 related to the offering of individual and small group plans through the exchanges, and to adjustmentsrequired by statute to the MLR formula to account for payments or receipts for risk adjustment, riskcorridors (which pertain to the potential for changes in risk), and reinsurance. In the absence of waivers,many insurers paid rebates in 2012 for below-floor medical loss ratios they realized in 2011.

Competition from CO-OPs?

The ACA created the Consumer Operated and Oriented Plan (CO-OP), a new kind of nonprofit health insurerrun by its customers. CO-OPs are designed to offer affordable and consumer-friendly health insurance optionsto individuals and small businesses, who may come together to create a CO-OP and apply for a federal loan.The federal government has committed to offer loans to non-profit organizations to help establish CO-OPs.


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They are still required, however, to meet the same state and federal quality and financial standards as otherhealth insurance plans and, like insurers, offer a variety of health plans. The aim of the CO-OP is to increasecompetition, leading to a reduction of premiums, and improving healthcare quality and customer service.Consumer-governed health insurers have a 40-year history, but they cover only two million Americans and,therefore, experts are skeptical about CO-OPs.

Nevertheless, CO-OPs have generated much interest. The government had set an October 17, 2012, deadlinefor nonprofit groups to apply for the first round of $3.8 billion in funding to start CO-OPs. Eventually, 24CO-OPs that had signed loan agreements with HHS as of December 2012 received funding under the plan.This accounted for just $2 billion, and the remaining part of the funding was eliminated by the legislationpassed by the US Congress on January 1, 2013, as a part of the fiscal cliff deal.

HEALTHCARE REFORM LEGISLATION ORIGINAL IMPLEMENTATION TIMELINE*MANAGED CARE ITEMS

2 1

Bans lifetime limits on health insurance policies and permits only annual coverage limits, as determined by the Secretary of Health and Human Services(HHS); bans rescissions (revocation of a policy due to illness).

Eliminates pre-existing condition clauses for children up to age 19.

Establishes a tax credit for small business with up to 25 employees and annual wages of below $50K to help subsidize employees insurance costs.

Requires insurers to adopt specified internal claims and appeals procedures.

Creates a temporary high-risk health insurance pool program to provide coverage for uninsured individuals with pre-existing conditions.

Provides a one-time rebate of $250 to Medicare Part D participants to begin process of reducing the so-called donut hole gap in coverage. Between 2010

and 2011, gradually reduces coverage gap for both branded and generic drugs.

2 11

Tax on pharmaceutical industry begins: a fee of $2.5B in 2011 increases to $4.1B by 2018, then declines to $2.8B in 2019 and thereafter.

Establishes minimum medical loss ratio (85% of premium revenue for large groups and 80% for small groups) by requiring payment of a rebate to eachenrollee below that amount.

Payments to Medicare Advantage (MA) plans set to different percentages of Medicare fee-for-service (FFS) rates (ranging from 95% to 115%). Cost sharingfor Medicare-covered preventative services eliminated.

Five-year demonstration grants awarded to states to develop, implement, and evaluate alternatives to current tort litigation.

Develop national strategy for quality improvement, with healthcare services delivery, patient outcomes, and population health given priority.

2 12

Insurers required to use uniform explanation of benefits (EOB) forms developed by the US Secretary of Health and Human Services.

Bonus payments to high-quality MA plans begin; rebates for MA plans reduced.

Fee-for-service and managed care payments for Medicaid increased to at least 100% of Medicare Part B FFS rates for primary care services fromphysicians in family medicine, general internal medicine, and internal medicine specialties.

2 13

Establishes of Consumer Operated and Oriented Plan (CO-OP) program to foster creation of nonprofit, member-run health insurance companies to be

offered through exchanges to spur industry competition.

Medical device excise tax (equal to 2.3% of providers device revenues) begins; excludes devices sold to the general public (e.g., eyeglasses, contactlenses, hearing aids, etc.).

2 14

Increased Medicaid and SCHIP eligibility will extend health insurance coverage to some 10 million individuals (rising to approximately 16 million in 2017).

Penalties implemented for hospitals that do not meet ARRA requirements for use of electronic health records under Medicare.

Imposes fee on health insurance providers, starting at $8B for 2014, rising to $14.3B in 2018 and thereafter.

The establishment of health insurance exchanges will extend health insurance coverage to some 8 million individuals (rising to some 23 million in 2017).

Requires states to establish American Health Benefit Exchanges, to facilitate the purchase of insurance. Insurers will compete for the business ofindividuals and predominantly small employers that have not been able to obtain coverage at the same favorable rates as large employers. In addition,states may form regional exchanges. Each plan participating in an exchange must meet standardized affordability, basic benefit, and consumer protectionrequirements, as well as state requirements. Initially, only individuals and small employers (up to 100 employees) will be eligible to participate. Multistateplans may be offered in the exchanges beginning in 2016. States may permit businesses with more than 100 employees to purchase coverage in theexchanges starting in 2017.

Establishes a so-called individual mandate: all US citizens and legal residents will be required to obtain qualifying health coverage. When fully phasedin, it imposes a tax penalty of $695 (or 2.5% of income) for individuals who do not purchase coverage or do not meet the hardship exemption.

Establishes an employer mandate under which employers must provide insurance, pay penalties, or, in certain situations, do both.

Extends prohibition on rescissions to all individuals in group health plans; limits ability of insurance companies to discriminate in terms of premium ratingsbased on family rating, age, or tobacco use, and implements guaranteed issue requirement.

Establishes an independent Payment Advisory Board to submit legislative proposals with recommendations to reduce the rate of growth in Medicarespending if it exceeds a target rate.

MA rebate system based on plan quality phased in; MA plans required to have medical loss ratios no lower than 85%.

Annual fee on health insurance plans begins.

After 2 14

Effective January 1, 2018, the Cadillac tax beginsan excise tax levied on health insurers of employer-sponsored health plans whose aggregate valueexceeds a certain threshold. For 2018, the threshold is $10,200 for individual plans and $27,500 for family plans; the tax is to be indexed to inflation.

*Any changes or temporary adjustments to this original timeline are discussed in the text of this Survey.

Sources: Standard & Poors; Congressional Budget Office; Ropes & Gray; Foley Hoag; US Chamber of Commerce.


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Each state has seen different combinations of people and organizations coming together to form a CO-OP. Forinstance, in Montana, the states former insurance commissioner has joined some prominent physicians andleaders in labor and business to found a CO-OP. In contrast, in New York, the Freelancers Union, a nonprofitorganization for independent workers, has formed a CO-OP and plans to bring in some of its 150,000members, among others.

Some positive aspects to reform for MCOs

Under the healthcare reform law, the CBO in May 2013 estimated that there will be 25 million fewer peopleuninsured by 2016, a number that will remain unchanged through 2023. MCOs have started benefitingfrom some positive effects of the healthcare reform. One example has been the rise in enrollment amongyoung adults between 18 and 25 years of age (who may be covered by their parents policies) amid declinesin other age groups within the under-65 cohort. Looking ahead, S&P believes the increasing enrollmentexpected to start in 2014 through expanded Medicaid eligibility will not only help increase MCOspremium revenue, but also help them leverage SG&A costs. Note, though, that the size of the premium ratehikes that the MCOs may be able to charge will likely be limited by several factors: competition from theexchanges, an actuarial-based formula designed to achieve the requisite MLRs, and state and federalmonitoring of premium increases. In addition, higher enrollment may provide MCOs more clout in pricenegotiations with hospitals and doctors.

Further, according to a study published in September 2011 in Health Affairs, a monthly health-policyjournal published under the aegis of Project HOPE, a nonprofit international health education organization,the number of uninsured and underinsured adults in the 19-to-64 age group increased from 61 million(36% of that age group) in 2003 to 81 million (44%) in 2010. In this context, underinsured refers to thoseadults who report at least one of the following three indicators: family out-of pocket medical care expensesare equal to or more than 10% of income; medical expenses are at least 5% of income; or the per-persondeductible is equal to or more than 5% of income. Rising health costs and recessionary pressures haveaccounted for the increase in the underinsured population. According to the study, the ACAs reforms, ifsuccessful, could result in a 70% drop in the number of uninsured people and a huge decline in the numberof underinsured people. Also, based on the latest census figures (see The Pressing Need for HealthcareReform below), the number of uninsured declined in 2011, which was the first full year the ACA was ineffect. Meantime, millions of Americans are expected to have their existing individual health policiesterminated by the MCOs at the end of 2013 because the plans do not comply with all of the ACArequirements, which state that the new policies have to cover all 10 essential health benefits. S&P expectsthis group to be among the first to utilize the exchanges.

S&P believes the MCOs that are better able to manage under healthcare reform may well benefit byacquiring the less successful ones, thus improving economies of scale and negotiating clout.

THE PRESSING NEED FOR HEALTHCARE REFORM

The problems facing the US healthcare system, while not new, have been intensifying, partly due to an agingpopulation, but recently exacerbated by the overall weak economic environment. US spending on healthcarerose at more than twice the rate of general inflation from 2004 to 2009, according to the Centers forMedicare & Medicaid Services (CMS), a division of the US Department of Health & Human Services(HHS). In 2011, healthcare spending is estimated to have grown 3.9%, to around $2.7 trillion, while overallinflation, as measured by the consumer price index, rose 1.2%.

Based on CMSs latest projections (published in September 2012), healthcare spending was estimated to havegrown by 3.9% in 2012 (over the estimated spending in 2011) to around $2.8 trillion and is projected to growby slightly under 3.9% in 2013. According to the CMS, these projections assume that the scheduledMedicare physician payment rate updates under the Sustainable Growth Rate formula do not occur,including a 24.7% cut scheduled for January 1, 2014. S&P is not surprised, since the US Congress hascontinued to override this physician payment reduction provision. Instead, it employs an alternativescenario, one in which physician fee schedule rates are assumed to grow 0.7% annually from 2014, amethod and rate consistent with the 2013 Medicare Trustees Report.


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The US healthcare budget is expanding and growing more burdensome. In 2012, the federal government isestimated to have paid around 26% of healthcare expenses in the US, a proportion that would graduallygrow to 31% by 2022, according to CMS estimates based on current law as of September 2013.

Despite continued efforts to improve the level of coverage in the US via the expansion of Medicare, theChildrens Program (CHIP), and other private and government programs, the number of those lackingaccess to health insurance coverage has remained stubbornly high as a percentage of population since 2002.While the latest available data from the US Census Bureau indicates that the number of uninsured peopledeclined to 48.0 million in 2012, or 15.4% of the US population (from 48.6 million in 2011, or 15.7%), itremains one of the highest percentages in the industrialized world.

The Census Bureau also noted that the percentage of people covered by private health insurance hasessentially leveled off; it was 63.9% in both 2011 and 2012. However, this figure is below 2009s 64.5%and 2008s 67.2%. Meanwhile the percentage covered by government health insurance programs, includingMedicare and Medicaid, increased to 32.6% in 2012, from 32.2% in 2011, 31.2% in 2010, 30.6% in

2009, and 29.1% in 2008.

S&P believes that the number andpercentage of uninsured increasedthrough 2010, given the loss of jobs

amid the weak economy, while thedecline in 2011 was attributed mainly tothe ACA rule that children may becovered by their parents healthinsurance policies until the age of 26.Although the unemployment rate hasdeclined from its peak of 10.1% inOctober 2009 to 7.3% in August 2013,S&P believes that many of the new jobopenings, particularly in small firms, stilldo not provide insurance coverage.However, by 2015, according to theACA, they will be required to enroll the

new hires in a health plan. (The targetdate was 2014 for large firms, but thiswas delayed by one year.) Indeed, the

KFF noted that 57% of small firms (those with three to 199 workers) offered health benefits in 2013, downfrom 61% in 2012. In contrast, 99% of employers with 200 or more workers offered health benefits in2013, up from 98% in 2012.

State budget deficits appear to be abating

According to the June 2012 report by The Center on Budget and Policy Priorities (CBPP), which conductsresearch on public policy, budget shortfalls in the fiscal year (FY) 2012 collectively totaled $107 billion. ForFY 2013, the report said that 31 states are projecting budget shortfalls totaling $55 billion. (Forty-six stateshave fiscal years ending on June 30. Unlike the federal government, all states but Vermont are legally requiredto balance their budgets.) Without the necessary revenues, states will have difficulty providing services such as

healthcare and education. Nonetheless, according to a September 2013 report by the CBPP (an update from areport first released in June), in the 31 states for which data were available in June 2013, state income taxcollections in the first ten months of FY 13 were, on average, 5.7% higher than in the year-earlier period.

According to the CBPP, state revenue systems still face major challenges. States are still recovering from theimpact of the recession as their revenues likely still remain 3% below pre-recession (200709) levels, afteradjusting for inflation. It also noted that states without income taxes are missing out on the opportunity forincreased revenues, noting that part of the recent boost reflects the fact that income taxes are better growingwith the economy than sales or other taxes. In earlier reports, the CBPP noted that the states obsolete tax

Chart H01: THEUNINSUREDPOPULATION INTHE US

12

13

14

15

16

17

30

35

40

45

50

55

2002 03 04 05 06 07 08 09 10 11 2012

THE UNINSURED POPULATION IN THE US

Number of uninsured (millions, left scale)

Percent of total population (right scale)

Source: US Census Bureau.


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systems are unable to keep track of the e-commerce sales and service sector, and that the federal government iscutting federal spending, which accounts for around 25% of the states revenues. It also warned that manystate policymakers, such as governors and leading legislators, have been planning large tax cuts, which wouldfurther deteriorate state revenues.

In FY 2012, states were compelled to increase their Medicaid spending by an average of 28.7%, primarily tosubstitute temporary Medicaid federal stimulus funds that expired in June 2011. The vast majority of theseshortfalls in FY 2013 have been closed through spending cuts.

To help find cost savings, states have been re-engineering healthcare payment and delivery systems byupgrading their health information technology (IT) systems and developing integrated healthcare models.States have been increasingly relying on MCOs over the years to care for their Medicaid beneficiaries.Indeed, in FY 2010, 13 states expanded their use of managed care. By FY 2013, 35 states reported theywere expanding managed care, including 10 states that indicated plans to implement managed long-termcare, according to the KFF in a report dated October 2012.

According to a study published October 2013 by the Brookings Institution, a private nonprofit organizationdevoted to independent research and innovative policy solutions, by mid-2013, at least nine states hadapproved utilization of Accountable Care Organizations (ACOs) for providing care to their Medicaidbeneficiaries. An ACO is an organization run by the healthcare service provider, in which the participating

providers are collectively responsible for the care of an enrolled population. They also share in any savingsassociated with improvements in the quality and efficiency of care by aligning Medicare with Medicaid.Nonetheless, S&P believes the MCOs would be directly affected by state rate cuts.

Approximately 11 million more individuals will get health insurance through Medicaid under the ACA,according to the CBO. Given this, we believe state budget pressures would worsen dramatically, if not forthe ACA calling for the federal government to cover 100% of the costs related to newly eligible individualsfor the years 201416. While the new number of individual getting insurance under the ACA is expected todecline due to the Supreme Court decision, the number varies for different years. For 2022, four millionfewer people are expected to be insured under Medicaid. However, states would be on the hook forpotential Medicaid budget shortfalls that could occur as the federal support gradually declines to 90% foryears 2020 and later.

Uninsured struggle with healthcare access, costs

According to a KFF report published in October 2012, uninsured patients are experiencing significantdifficulties in accessing and affording health care. About 26% of uninsured adults surveyed say they haveforgone care in the past year because of its cost, compared with 4% of adults with private coverage. Thereport also noted that people without Medicaid or some other insurance were less likely to visit a doctor, andmore likely to have unmet needs for prescription drugs, eye care, or mental healthcare. Further, these peopleare less likely to receive timely preventive care, such as check-ups and screenings.

According to an article published online by Health Affairsin October 2012, the proportion of people under 65years of age, with a high medical cost burden (defined as spending greater than 10% of family income onhealthcare) grew to 19.2% in 2006 from 14.4% in 2001. However, this figure did not change much during the200709 recession and stood at 18.8% in 2009, despite decreasing income and rising unemployment. Thedrop in average annual family income to $61,000 in 2009 (from $65,000 in 2006) was offset by lower out-of-

pocket health spending, which declined to $1,231 in 2009 (from $1,454 in 2006) due to the shift fromprescription drugs to cheaper generics.

To show that insurance garnered under the ACA will be affordable, the HHS released a report in September2013, stating that about 10.7 million of the estimated 21.9 million uninsured Americans eligible to buyinsurance through the healthcare exchanges may be able to pay $100 or less per person per month, aftertaking into account their available premium tax credits. In a report published in October, the HHS claimedthat based on data from the federally-facilitated and state partnership exchanges, 1.3 million (46%) of the 2.9million uninsured single, young adults (ages 18-34) eligible for the health insurance exchanges could getcoverage for $50 per month or less after tax credits. Finally, a study published November 2013 by the


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McKinsey Center for U.S. Health System Reform, a unit of management consulting firm McKinsey & Co.,found zero-net-premium products widely available on the exchanges. The study estimated that seven to eightmillion people (85% of which were currently uninsured) might be eligible for such plans, though many maystill face co-payments for services delivered.

MEDICARE MANAGED CARE UNDER INCREASING PRESSURE

Medicare Advantage (MA), which uses private payers to manage the care and cost of Medicare participants,is not new, but the program became more popular because of provisions in the Medicare Prescription Drug,Improvement, and Modernization Act of 2003 (MMA) that significantly raised MMA plans reimbursementrates and expanded their availability and flexibility. The program aimed to attract more Medicare recipientsand private payers to Medicare managed care. While most Medicare recipients (approximately 49.4 million,according to the KFF) are still enrolled in traditional fee-for-service plans, a growing number participate inMedicare private health plans: around 15.0 million (including 14.4 million in MA) as of September 2013,according to the CMSroughly 28% of all beneficiaries, according to our estimates. MA has providedMCOs an opportunity for additional profits and revenue growth.

The MMA is best known for creating the Medicare Part D program, the first government-sponsoredprescription drug benefit for seniors. Part D members who do not participate in MA plans (most of whichinclude Part D benefits) numbered 20.1 million as of December 2012. For MCOs, one of the attractions of

participating in Medicare Part D has been the opportunity to transfer some Part D enrollees to the broaderand higher-margin MA contracts.

Nonetheless, the Medicare Advantageprogram has become increasinglycontroversial, mainly becausegovernment payouts per Medicarebeneficiary are higher in MA than intraditional Medicare fee-for-service.In its March 2011, March 2012, andMarch 2013 reports to Congress,MedPAC estimated the MA paymentper person to be 110%, 107%, and

104%, respectively, of traditionalMedicare fee-for-service payments.

According to an article publishedDecember 2012 in Health Affairs,

utilization rates for a majority of services in Medicare Advantage HMO plans were lower during the periodfrom 2003 through 2009 than in traditional Medicare. For instance, compared with traditional Medicare,emergency department visits were 25%35% lower; inpatient medical days were 20%25% lower; andambulatory surgery or procedures, which were 25% lower in 2003, narrowed to a 7% difference in 2008.Proponents of managed care say that integrated managed care plans deliver services more rationally bytailoring their provider networks to the needs of users, imposing pre-approval requirements, and reviewingutilization rates, because they have financial incentives to reduce the use of services.

According to a report released by the KFF in December 2012, beneficiaries will have around 20 MedicareAdvantage plans to choose from in 2013 (about the same number as in 2012), well below the high of 48 in2009. Further, the report states that most of the enrollees in Medicare Advantage plans in 2012 will be ableto stay in the same plans, with higher premiums in 2013. An article dated March 28, 2012, in the NewEngland Journal of Medicinestates that over the last four decades, Medicare spending per enrollee hasgrown by a rate 2.6% higher than the rate of growth of per capita GDP. If the trend goes on, by 2060, allfederal revenues will be spent on Medicare. However, according to the article, there have been signs ofslowing growth in Medicaid expenditures, with Medicare spending per enrollee falling in line with thegrowth in per capita GDP. Further, in November 2011, the actual Part B premium for 2012 was fixed at$99.90, as against the actuary-projected premium of $106.60. In addition, in February 2013, the CBO

Chart H03: MedicarePrivate PlanEnrollment

5.3 5.56.1

7.6

9.0

10.411.3

11.912.6

13.9

15.0

0

2

4

6

8

10

12

14

16

2003 04 05 06 07 08 09 10 11 12 *2013

MEDICARE PRIVATE HEALTH PLAN ENROLLMENT

(Millions of enrollees)

*As of September.Source: Centers for Medicare & Medicaid Services.


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brought its Medicare spending projection down by $143 billion for the 10-year period from 2014 to 2023(partly offset by reductions of $48 billion in collections of offsetting receipts and $10 billion in Medicaresavings as a result of sequestration) from its August 2012 projection, which implies slower growth inMedicare spending.

Insurers say that their plans provide more benefits and save money for recipients vis--vistraditionalMedicare. Nevertheless, national MA reimbursement rates, which edged up in 2009, grew more slowly in2010, despite the deferral of the drop in the physician payment rate required by a legal formula. (Congressonce again postponed the latest rate cut until December 2013, and we think it will be above the 27.4% cutexpected in 2012 unless it is delayed again or a permanent fix is found. As we noted earlier, the CMSassumed that this cut would be postponed again when it set its final MA reimbursement rate for 2014.)Looking ahead, while MA payment rates will transition over a three-year period to 2014 to a benchmarkthat varies from 95% to 115% of fee-for-service payment levels, depending on the geography, the MCOswould also be eligible for bonus payments, based on quality rankings.

Consequently, MCOs that have banked heavily on Medicare growth, such as Humana Inc., WellCareHealth Plans Inc., and Universal American Inc., have said they might curtail benefits to maintain margins orat least temper the pressure on margins. Indeed, Avalere Health, a healthcare advisory, published in March2012 an analysis of the Medicare private plan payment data released by the CMS, and noted that MedicareAdvantage plan enrollees received on average over $70 in additional benefits and reduced cost-sharing in

2010 at no charge to them.

A phased payment rate cut may notkeep MA packages as attractive asthey were in 201012, but S&Pbelieves that they will still offermore benefits than the traditionalfee-for-service program in order toretain members. As long as they do,MCOs are likely to see MAenrollment expand, aided by thecoming influx of the baby-boomergeneration, many of whom work for

companies that provide managedcare health insurance coverageunder the aegis of the MCOs.Companies may also findopportunities for consolidation and,

hence, improving economies of scale, as smaller, weaker players (including not-for-profit MA plans) findthemselves unable to operate profitably under the ACA rules. We think the probability of an eventualshakeout in the industry is high. Starting in 2014, MA plans will be faced with reduced reimbursement ratesthat are designed to bring MA payments in line with traditional Medicare payments and a mandated MLRfloor of 85%. Separately, the standalone Medicare Part D programs, now mature, will also continue togrow, but remain only modest earnings-per-share (EPS) contributors due to their very slim margins.

DUAL ELIGIBLES

According to MedPAC, in 2011, there were about 10 million dual eligibles: low-income seniors andyounger persons with disabilities who are enrolled in both Medicare and Medicaid programs. They are themost costly group of beneficiaries for both Medicaid and Medicare, accounting for a disproportionateamount of spending. In the Medicare program, dual eligibles account for about 19% of the population, but31% of spending; in the Medicaid program, they account for 15% of enrollees, but 40% of spending. GiantMCO UnitedHealth Group estimated that for 2013, combined Medicare and Medicaid spending on dualeligibles will reach $330 billion, with Medicare covering $180 billion (including costs for prescription

Table B04: MCOmembershipenrollment

MANAGED CARE ORGANIZATION MEMBERSHIP ENROLLM ENT

(Ranked by Medicare Advantage enrollees, as of June 2013)

TOTAL MEDICAL % CHANGE MEDICARE ADVANTAGE

ENROLLMENT FROM DEC. ENROLLMENT (THOUS.)

COMPANY (THOUS.) 2012 DEC. 2012 JUN. 2013

UnitedHealth Group 45,000 10.0 2,565 2,920

Humana 12,371 2.3 2,326 2,446

WellPoint* 35,666 (1.3) 1,545 1,467

Aetna Inc. 21,968 20.4 448 948

CIGNA 14,286 1.7 426 458

WellCare Health Plans 2,842 57.9 213 272

Health Net 5,352 (1.5) 234 236Universal American 134 0.0 134 134

Molina Healthcare 1,847 2.8 36 36

*Senior membership; Medicare Advantage membership not reported separately.

Source: Company reports.

Documents

Healthcare - Managed Care 2013.12