Rating Practices. When Blue Cross and Blue Shield Plans began providing insurance coverage in the 1930s, every subscriber in a given area was charged the same price for coverage -- a practice known as community rating. In this way, the cost of coverage for groups with the poorest health risks was kept at the most affordable level possible. However, it is important to note that under this approach, lower-risk enrollees heavily subsidized the costs of higher-risk enrollees and paid much more than the cost of services they received.

As competition increased in the health insurance market, some carriers began to experience rate coverage for larger employers that is, they began to set premiums for large groups based on those groups' own costs. This meant that for the first time, lower-risk groups could purchase coverage from another carrier at premiums that more closely reflected the costs of their own employees.

This phenomenon occurred first in the large group insurance market, and it represented the first step toward segmentation of the health insurance market and the loss of subsidies for the less stable parts of the insurance market. The practice also developed in response to employers' increasing unwillingness to subsidize the coverage of other groups and individuals.

The passage of the Employee Retirement Income Security Act (ERISA) in 1974 gave large employers another opportunity to lower their health benefit costs by providing incentives to drop insurance in favor of self-funding their health benefits. In this way, employers could avoid the costs of state regulation, including mandated benefit and provider laws, premium taxes and subsidies of state high-risk pools. These incentives further segmented the health insurance market and eliminated almost all remaining cross-subsidies. Currently, fully 40 percent of the group health insurance market is self-funded.

The introduction of experience rating into the health insurance market presented a problem for insurers still using community rating practices. In order to avoid triggering the loss of their very best risks to lower-priced coverage and the subsidy these lower risks provide for other subscribers insurers that used community rating

-

had to find ways to hold onto their low-risk subscribers.

These insurers responded by introducing experience rating practices, and by adjusting their community rates to account for various demographic factors, such as age and sex. By adjusting rates in this way, insurers can give subscribers premiums that more closely reflect their expected use of services while still helping to subsidize higher-risk enrollees. For example, on average, 55-year old males cost four times as much to cover as males under age 30. Insurers might balance the need to keep premiums attractive for younger subscribers with the need to keep coverage affordable for older subscribers by setting premiums for the younger subscribers at half the price available to the older subscribers.

Insurers with a disproportionate number of high-risk enrollees frequently need to make these kinds of adjustments to be able to offer competitive premiums in the marketplace. And by maintaining a good mix of risks in the insurance pool, insurers are able to keep premiums affordable for higher-risk enrollees. The more vulnerable a market is to adverse selection, the more likely an insurer is to have high-risk enrollees and to need rating adjustments.

Experience rating in the small group market is different than in the large group market. Generally, insurers use a practice known as "tier rating" to reflect a small group's own experience in its premium. Insurers review the health status of small group enrollees to determine the group's projected utilization. Based on those projections, small groups are assigned to a rating tier.

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Premiums for groups in each tier are expressed as a percentage of the average premium for small groups with similar demographic

characteristics. For example, an insurer might set up just three rating tiers -- an average tier, a high-risk tier and a low-risk tier. If the premium for an average risk group were $100, premiums for a similar high-risk group could be 10 percent higher ($110), and for similar a low-risk group. 10 percent lower ($90).

However, tiered rating generally is not used when a policy first is issued. Instead, experience is factored into a group's rate when its coverage is up for renewal.

Some small group carriers also use a practice known as "durational rating" to set small group premiums. Carriers that use this practice can reduce premiums in the first year of coverage by as much as 45 percent because they carefully screen-out high-risk groups and individuals and use waiting periods for pre-existing conditions. However, these low first-year premiums are followed by very steep increases in the second and third years of coverage, as the effects of risk-screening wear off.

These rating practices result in a wide range of premiums that can be charged to small groups. While these wide spreads make coverage very affordable for low-risk groups, they also result in premiums for some groups that are unaffordable.

Blue Cross and Blue Shield Plan Practices. In the small group market, many Blue Cross and Blue Shield Plans still community rate their coverage. The remainder use some form of tier rating. Those Plans that no longer community rate their small group and individual coverage do not use individuals' or groups' own experience as the sole determiner of their premiums. Rather, health status or experience is used to adjust premiums in the same way that adjustments are made for demographic characteristics.

Generally, those Plans that still community rate their small group and individual coverage are able to do so because of their larger overall market share, their provider discount arrangements and their provider contracting arrangements. Their large market shares help these Plans stabilize the risk of adverse selection. And their providernegotiated discounts and contracts help offset the costs of covering high-risk enrollees by lowering overall benefit costs.

To address the rating problems that have developed in the small group market, the Blue Cross and Blue Shield System supports the rating reforms recommended by the National Association of Insurance Commissioners (NAIC) in its model act on rate regulation. We are concerned that rules that are tighter than this could cause serious problems in the small group market in many states.

Because the premiums of many small employers currently reflect some of their risk or actual claims costs, requiring every small employers to pay the same premium as under the community rating proposals supported by many Members -- would result in significant rate increases for many small employers. As a result, many of these employers could drop coverage rather than pay the higher costs.

In a voluntary environment, where there is no employer mandate, the impact of a community rating requirement would be exacerbated, as fewer and fewer low-risk small employers remained to help subsidize the premiums of high-risk small employers.

Because of Congressional interest in community rating, Blue Cross and Blue Shield Association staff worked with actual data from six Blue Cross and Blue Shield Plans to determine the magnitude of rate increases small employers would experience under these proposals.

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Percent of Small Groups Size 2-25 Receiving Rate Increases Under Pure
Community Rating

0.0%

As illustrated in Table 2, this analysis shows that about half of all small employers covered by these Plans would receive rate increasesunder community rating proposals that would not permit adjustments for demographic variables such as age and gender. While the increaseswould vary, some small employers would see their rates increase by over 100 percent. The analysis showed that half of the subscribers from these six Plans would receive a very significant rate increase to subsidize the higher-risk employees covered by these Plans. It's important to note that rate increases resulting from community rating requirements would be only part of the overall rate increase small employers would face under reform proposals. As shown in Table 3, other factors that would increase rates include health care cost inflation as well as the added costs of selection and the guaranteed availability requirement.

Selection costs reflect the loss of lower-risk policyholders, who either drop their coverage entirely or choose another insurers. The costs of guaranteed availability reflect the added cost of making coverage available to high-risk small employers. As noted earlier, about 4 percent of the covered population incurs 50 percent of the expenses. Under reform proposals, insurers would be opening their doors to the "4 percent." Several state-level studies have estimated the cost of a guaranteed issue requirement at about 10 percent. As a result of these additional factors, small employers that would receive a 50 percent rate increase as a direct result of community rating could in fact receive a total rate increase of nearly 100 percent.

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Table 3

$6.000

$5,000

Plan A - Sample Rate Increase for 21% of Small Groups 2-25 Under Rating

$4,000

$3.000

$2,000

$1.000

$0

In a voluntary market, we believe rate increases of this magnitude could increase the number of uninsured small employers, as small employers decided to drop the more expensive coverage.

In addition, insurers that traditionally have had, or continue to have, more liberal enrollment practices can easily be placed at a major competitive disadvantage under a community rating requirement. As discussed earlier, their enrollment of higher-risk, higher-cost groups would result in an average or single rate that would not be competitive in the marketplace. And perversely, the requirement would reward insurers that have been very selective in the risks they accept. For these reasons, we support the NAIC's rating requirements, which permit limited use of health status and claims experience and do not limit demographic variation in rates. We believe these provisions, while not going as far as some Members would like, would benefit small employers significantly. Premium rates would be much more stable and predictable, and the use of a small employer's own claims experience or health status in setting its rate would be limited. While these reforms would raise rates for some small employers -- because of the coverage of higher-risk small employers and the compression of rates --we believe that the small employer market could tolerate these rate increases without encouraging more small employers to drop their current coverage because of high rate increases.

We therefore support the rating requirements in H.R. 1565, introduced by Representatives Johnson and Chandler, which recognize our concerns by incorporating the NAIC's rating provisions.

CONCLUSION

In conclusion, the Blue Cross and Blue Shield Association shares the Subcommittee's concerns about the cost and availability of insurance coverage for small employers, and we look forward to working with you to address these problems. However, we do not believe that proposals that include a community rating requirement would further the goals of increased affordability and availability. Thank you for the opportunity to present our views today.

0899c

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Chairman STARK [presiding]. Thank you.

Mr. Helms.

STATEMENT OF RICHARD HELMS, SECOND VICE PRESIDENT AND ACTUARY, PRINCIPAL FINANCIAL GROUP, DES MOINES, IA, ON BEHALF OF HEALTH INSURANCE ASSOCIATION OF AMERICA

Mr. HELMS. I am Dick Helms, second vice president and actuary with the Principal Financial Group. The Principal is a member of the Health Insurance Association of America, HIAA, a trade association representing commercial insurers which provide health insurance to more than 95 million Americans.

You'll have to excuse my voice this morning as I've managed to get a cold. It is a pleasure to testify before you on the issue of small employer market reform.

The written comments provided will address in more detail several important aspects of the bills under consideration. In my oral comments I would like to focus on a few key issues and how the proposed bills address them. The first of these is rating.

Because small employers are very price sensitive and because cost is the major obstacle for most of the uninsured, it is critical that we deal carefully with rate regulation in the small employer marketplace. I believe H.R. 2121 and H.R. 3626 go too far in this area and create bigger problems than they attempt to solve.

By restricting rating for demographics, such as age and sex, in addition to claims experience, they will result in substantial rate increases for many small employers. An HIAA study of H.R. 3626 shows 45 percent of small employers would receive increases of at least 5 percent, and 20 percent of small employers would receive increases of at least 20 percent.

The results would be worse under H.R. 2121 if the rating restrictions applied to all plans, which I think is unclear in the law.

In both cases, these increases would be on top of general trend increases, and they would be on top of increases associated with other reforms that have been mentioned here, such as making coverage available to all and providing for continuity of coverage. Finally, these estimates also do not reflect the impact of lower cost. groups dropping coverage as they receive major rate increases.

H.R. 1565 is most consistent with the work of HIAA, Blue Cross/ Blue Shield Association and the NAIC. On the Principal's business, I have estimated the effects of H.R. 1565 would be more moderate and lead to fewer groups dropping or choosing not to purchase coverage.

The second point I would like to address is the need for reinsurance or other risk adjustment mechanisms. I believe such a mechanism is a critical element of small employer market reform.

HIAA, Blue Cross/Blue Shield, and NAIC have designed several possible approaches that I believe can work. Without such a mechanism, we penalize carriers who succeed in writing the employers for whom this legislation is intended. The carrier's choice then becomes one of underpricing, and thus taking losses in an effort to attract more healthy risks, or having to price for the risks that they have and driving their healthier groups elsewhere.