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Does Health Insurance Administration Increase Health Care Cost Trends?

January 8, 2003

Based on information from health plans serving up to 25% of all insured people, health insurance administrative expenses increased at a considerably slower rate than health insurance premiums since 1998. Overall, health plan administrative expenses increased by 6.2% per year on average, compared with average insurance premium rate increases of 8.4% during the same period, according to the Kaiser Family Foundation. It is especially notable that medical and provider management increased at low single digit rates.

The sharp increase in health insurance premiums contrasts sharply with the slow growth in the overall economy. As a form of compensation, this defies normal economic behavior. In this economic environment, health plan sponsors, policy makers and others are interested in what contributes to this growth.

Administrative expenses are increasingly prominent in discussions on health care costs. As health costs have increased in recent years, some have suggested that reductions in the management of care may contribute to the increase in costs. Katharine Levit, Director of the Office of Health Statistics of the Centers for Medicare & Medicaid Services (CMS), cites "managed care loosening its grip on spending" as a factor in health care cost increases. Others have suggested that a reduction of administrative expenses would contribute to lower overall health care costs to consumers. The 8.7% increase in total U.S. health costs calculated by CMS and published in Health Affairs and expected changes in the Medicare program that may increase the role of private insurance for Medicare members highlight the issue of administrative costs.

Generally, health care costs are expressed in standardized forms such as per capita. To compare the rate of increase in administrative costs with that of health insurance premiums and other metrics of health care costs, we expressed administrative costs in per member per month terms, essentially annual per capita costs divided by twelve. This adjustment eliminates the effects of changes in membership, making the rate of increase in these expenses directly comparable to premium rate increases.

As shown in Figure 1, health administration costs per member per month increased by 6.2% on average since 1998. This compares to an average increase of 8.4% for premium rate increases, according to the Kaiser Family Foundation.

Figure 1. Administrative Cost Increases
Administrative Expenses versus Premium Rate Increases

1999 2000 2001 Average
Premium Rate Increases
Kaiser Family Foundation1 5.7% 8.1% 11.3% 8.4%
Administrative Expense Increases 8.2% 2.6% 7.9% 6.2%

1 Premium rate increases for HMOs. HMO premium rates are less likely to be impacted by buy-downs.

The rates of increase in administrative expenses varied by expense classification. The fastest growing area was account membership and administration, which grew at an 8.2% average annual rate. Areas included in this category are Enrollment / Membership / Billing, Claim and Encounter Capture and Adjudication, Customer Services and Information System Expenditures. Customer services growth was especially strong, growing by 10.4% on average during the period. Claims grew by 9.6%, on average, followed by Information Systems expenditures, at 9.5%. Information systems operations and support grew especially strongly at 17.3%, although this was mainly in 2000 and 1999. In aggregate, these costs totaled $9.02 per member per month.

Marketing and Actuarial expenses grew at 6.4%, on average. These expenses include Product Development / Market Research, Rating and Underwriting, Sales and Marketing, Commissions and Advertising and Promotion. This disguises a remarkable shift within this expense category: While Product Development and internal Sales and Marketing posted declines, external Commissions grew at double digit rates. This category was responsible for costs of $5.36 in 2001.

Corporate services was an area of relatively modest growth, at 4.3%, on average. This expense classification consists of Finance and Accounting, Actuarial, Corporate Services (Including HR, Facilities, Legal, Regulatory), Corporate / Executive as well as Association Dues and Miscellaneous Business Taxes. These expenses comprised $5.07 of the total administrative costs in 2001.

The slowest growing area of expense growth was Medical and Provider Management, which consists of Provider Network Management and Services and Medical Management / Quality Assurance / Wellness / Grievance & Appeals. This expense area grew by only 2.9% on average over that period. This slower growth may be in part attributable to the diminished interest by health insurers in managing care. Representing $1.50 of the total $2.40 of this category, Medical Management remained substantially unchanged since 1998.

Figure 2. Administrative Cost Increases
Summary of Administrative Cost Increases

Percent Change Mix of Costs
1999 2000 2001 Average Value Pct. Tot.
Marketing 9.7% 0.3% 9.3% 6.4% $5.36 24.5%
Account and Membership Administration 14.6% 0.1% 10.1% 8.2% 9.02 41.3%
Medical and Provider Management 8.9% -2.8% 2.5% 2.9% 2.40 11.0%
Corporate Services -8.2% 15.6% 5.4% 4.3% 5.07 23.2%
Total 8.2% 2.6% 7.9% 6.2% $21.85 100.0%

Sherlock Company has been compiling administrative expense information concerning health plans for five years. We believe that this data represents the most complete data set available on health plan administrative expenses.

Our universe is comprised of Blue Cross Blue Shield Plans and publicly traded companies that participated in the Sherlock Expense Evaluation Report (SEER) in the past several years. Blue Cross Blue Shield Plans are similar because of a common heritage, similar business lines and that they operate under licensure rules of the Blue Cross Blue Shield Association. Public companies have also tended to be homogenous since they often have origins as HMOs and they operate under the disclosure and governance requirements of being public. In all years, there were two firms that were both public and Blue.

The firms in our sample together served a high proportion of people served by health insurance programs. In the 2002 editions of our analyses, health plans included in our survey served approximately 17% of Americans with insurance and approximately 25% of Americans with health insurance other than Medicare and Medicaid. While there has been rotation in the firms included in these analyses, 30 firms have at some point participated in these administrative expense benchmarks over the past five years.

Figure 3 shows the pattern of participation among Blue Cross Blue Shield Plans and Publicly Traded companies. Note that, generally speaking, we lose one health plan per year per universe.

Figure 3. Administrative Cost Increases
Continuity of Participation

1999 2000 2001
Blue Cross Blue Shield Plans
Participants 13 17 17
Year – over –Year Participants 9 12 16
Public Companies
Participants 7 7 7
Year – over –Year Participants 5 6 6

Because of turnover due to consolidation and other factors, it was impractical to use the group of plans throughout the entire period of the study. Therefore we calculated the rates of change for each year holding constant the universe of plans between the two measurement periods. While the universe in 1998 differs from that of 2001, each rate of change is calculated to assure consistency. We then averaged these rates of change as a measure of central tendency.

For additional information, please contact:

Douglas B. Sherlock, CFA
Sherlock Company
1364 Welsh Road
North Wales, PA 19454

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