Risk Shifting in Health Care and its Implications: Part 2

Troyen Brennan and Thomas Lee

First posted 8/25/11 on the Health Affairs Blog

Copyright ©2011 Health Affairs by Project HOPE – The People-to-People Health Foundation, Inc. 


The employer outlook can best be illustrated by taking a step back, and analyzing the dynamic between employer coverage and the other major sources of health insurance: the government and individuals.  A fourth source of insurance, the exchanges, will be added in 2014.

The biggest of these four sources are the government payers, Medicare and Medicaid.  Medicare, growing quickly after 2020, is the real demographic sink hole for the federal government finances.  Yet this is not to say that comparatively the government is a generous payer.  Most health care providers barely break even or incur deficits on Medicare, cross-subsidizing Medicare recipients with patients from other segments with better reimbursement.  Similar dynamics characterize Medicaid, which will cover 25 percent of all Americans in 2014.

The legislated growth of Medicaid, and the demographic growth of Medicare, juxtaposed with budget deficits that appear to stretch to the planning horizon of 2020, means that the government must pay less for health care, either in the form of  lower fees or in terms of quality programs that will penalize poor performers.  As mentioned above, providers have long faced lower payment from Medicare and Medicaid than from private payers, and have managed to cross subsidize the poor government payment with the payment by employers and individuals.  Now they will want to accelerate this process, as government payment really drops.

Self-insured versus fully insured employers. The critical source of cross subsidies has been those with employer-provided health insurance.  The employer market breaks down, simply put, into two groups: large self-insured employers, and smaller, fully insured employers.  The former are typically the province of corporations who take advantage of the relatively thin regulatory regime of ERISA to remain independent of state oversight.  Employers rely on large insurers to perform third party administrator (TPA) services—most employees think they are “insured” by the health plans, but their real insurer is their employer.

This is not highly profitable business for insurers, but it is steady and reliable.  The self-insured employer segment was to remain unaffected by health care reform, as it can be viewed as a set of interactions between private corporations that is working well.  However, under the PPACA, self-insured plans with very rich benefits (so-called Cadillac plans) would lose the tax exemption for health insurance benefits that employers currently enjoy.

The small businesses that constitute the fully insured segment are most affected by health care inflation.  Even with recent slowing of the rate of rise of health care costs, small employers have increasingly found that they cannot afford continued comprehensive coverage.  They are in much the same boat as the individuals who do not have coverage through work, or who are self-employed, and purchase insurance policies directly from insurers.

Because small businesses under duress have tended to lay off their youngest (and healthiest) workers first, and because premiums can shift dramatically when the age of several employees goes from one decade to the next (e.g, 49 to 50 years old), the year-to-year increases in these markets can be startlingly high—indeed increase of greater than 40 percent in small groups markets in California gave health care reform a shot in the arm in early 2010.

Exchanges. The new segment after 2014, for most of the country, is the exchange segment.  The PPACA basically creates a “pay or play” environment in which everyone must purchase or be provided health insurance (with the exception of non-citizens).  Small groups (eventually less than 200 employees) and individuals will fall into the exchange segment, where a government-funded organization will help set up standard policies, working with private insurers.

The PPACA models the exchange on the Massachusetts state reforms, and backs it with an individual mandate to purchase insurance, to reduce the extent to which the risk pool is polluted by “free riders” who buy insurance only once there are signs of illness.  Working poor will receive subsidies so that they can afford the purchase of insurance, one of the big costs of the PPACA.

The employer decisionmaking environment. The employer will make decisions in the context of this complicated dynamic between provider cross-subsidy impulses and health care reform.  In the face of rising premiums that result from the pressures of cross-subsidizing Medicare and Medicaid, employers may decide that health insurance is too expensive, and no longer provide it.   Employers face penalties set by the PPACA at $2000 per employee at this point if they do not provide insurance.  But some may find that it is better to pay the penalty and let their workers buy insurance in the exchange segment— pay rather than play.

The Congressional Budget Office, as well as a number of private think tanks, have estimated the potential for this shift, and suggest that less than 10 percent of the self-insured employers should drop coverage, although over the last six months, some have allowed that the percentage could be higher. The health care industry was recently roiled by a report from McKinsey that the shift may be more like 40 percent, a finding not supported by the Urban Institute’s subsequent analysis.

What these reports do not take into account, however, is the dynamic of cross-subsidy.  If employers begin to drop coverage, the self-insured segment could deteriorate rapidly.  Those remaining in this segment will have to bear the brunt of the providers’ effort to cross-subsidize decreasing government payment.  The fewer employers in this segment, the less viable it becomes, and government cuts accelerate this cycle.

Meanwhile, in the exchanges, the state governments will be using insurance regulation to keep premiums low.  As Tennessee Governor Phi Bredesen has recently noted:

Our thought experiment shows how the economics of dropping existing coverage is about to become very attractive to many employers, both public and private. By 2014, there will be a mini-industry of consultants knocking on employers’ doors to explain the new opportunity. And in the years after 2014, the economics just keep getting better.

Thus, there could be a synergy to dumping that increases its rapidity—and gets the employers out of bearing the health insurance risk.

The other approaches for employers facing rising premiums are either to reduce the amount that is spent on subsidizing health insurance, essentially shifting risk; or find a risk-bearing entity that can actually eliminate waste and reduce costs.  The former is underway, as the evidence indicates that deductibles and co-insurance are increasingly steadily in the private sector.  A recent survey by the National Business Group on Health reveals that 53 percent of employers plan to increase employeepercentage contributions to premiums, as they believe this will help reduce overall costs.

Often this reduction in support is accompanied by programs that can help the consumer shop appropriately in a health care system long unused to consumer involvement, as noted above.  In addition, reductions in support can be complemented by programs that provide more support should the employee pursue healthy activities — the basis for the so-called Safeway Amendment that can put up to 30 percent of health insurance premiums at risk in wellness programs.

Finding a risk bearing entity that can reduce waste appears to lead employers today to the providers enrolled in accountable care organizations.  If an accountable care organization can reduce costs, and keep some of the profit that comes from eliminating waste, then there is less need for the cross-subsidy from private insurance and the employer group will under less pressure to dump.  But the move to accountable care organizations will likely be mediated by insurer strategy and provider will.


For insurers, the reform process has been unnerving in many ways.  The battle around the medical loss ratio is a case in point.  Medical loss ratio refers to the amount of the insurance dollar that is spent on medical care itself.  Most insurers have long attempted to drive this down to the greatest extent possible.  From a health care activist point of view, this is just a matter of insurers taking premium dollars and trying to keep as much as possible—thereby reducing coverage. Insurers, on the other hand, believe that there is a lot of unnecessary care and that if they reduce it, they control medical costs and can offer less expensive premiums than their competitors, which is how they grow business.

The PPACA view is closer to the former view, and sets forth limits of 80 percent in the individual market, and 85 percent in the large group market.  HHS has issued interim final regulations on what is included in the medical loss ratio, and neither activists nor insurers are happy, which is perhaps the best result.

What the entire episode make clear, however, is that there will be increased regulation of insurers, who will have to figure out how to maintain their cost-cutting programs and still return a profit.  Interestingly, under the HHS regulations, capitation fees all fall under the MLR.  Those capitation fees for providers are expected to cover most medical management and utilization management functions, so this approach might appear more attractive to payers.

Meanwhile, the insurers are watching the segment dynamics closely.  For now they are confident in business remaining committed to providing health insurance for employees. But they realize that the exchange segment could grow rapidly, and most are preparing to do business in this highly regulated environment, where they have much less ability to do medical underwriting.  As well, if Massachusetts is any harbinger of things to come, the private insurers participating in the exchange are going to face strong restrictions on raising premiums.  Thus it becomes less clear how to maintain a fund balance (nonprofit plans) or return value to shareholders (for-profit plans).

New models for insurers. Given this, it is not surprising to see insurers starting to move toward new business plans.  One salient plan is to support providers developing accountable care organizations, or becoming an accountable care organization as an insurer.  CIGNA has decided to pursue the latter.  United has quietly been buying some independent practice associations.  And Aetna appears to be developing support for ACOs, as a wrap-around third party administrator and by providing health information exchange services for organized providers assuming risk.  With medical utilization depressed during this period of reform uncertainty, many insurers are building reserves that they can use to purchase new capabilities for this business line of support for capitated providers.

Blue Cross Blue Shield of Massachusetts’s Alternative Quality Contract program is perhaps the most developed new insurer play.  It consists of three parts: essentially capitated payment for care; a quality bonus program; and support for provider risk bearers.  Initial indications are that is it is improving care.  There are certainly no indications of adverse effects for patients to date, and, in fact, the other two major nonprofit payers in Massachusetts have about the same proportion of physicians (~40 percent) in global budget contracts as Blue Cross Blue Shield.  Indeed, the Commonwealth of Massachusetts seems committed to requiring that insurers use a global risk model rather than fee for service.

Insurers are also evaluating programs that will allow more consumer choice, and reduce costs through smart purchases.  This will be important, especially for the relatively healthy patient, and for discretionary services.  But right now there appears to be a great deal more activity thinking through how the insurer can work with the risk bearing provider.


As reform unfolds, providers are concerned about threats to their ability to provide good care to their patients in their traditional fashion – and that of course translates into concern about reimbursement.  Implicitly, they understand the segment dynamics, and most have concluded that the federal programs will have negative margins going forward.  So they must continue to try to capture the private-pay segments – currently, the large employer self insured market and the fully insured market.

But what happens to those sources of cross-subsidies as the exchanges take shape and insurers face pressure to moderate premiums (similar to Massachusetts), and if the large employers begin to “dump”?  What happens if employers accelerate their shifting of risk to patients, thereby encouraging them to move market share to lower cost providers?  What happens when individual mandates make prices charged by providers a favorite focus for political leaders?  There is no cross-subsidy in this environment, and provider reimbursement simply drops.

A strategy with a limited lifespan? Faced with rising costs of their own, providers are unlikely to accept decreased reimbursement passively.  Most will bargain hard with insurers who represent fully insured and self insured employers, to make up for the moderation of government programs.  In some geographic areas, hospitals have consolidated into systems, often with affiliated medical groups, in part at least to gain negotiating effectiveness.

However, this negotiation strategy may have reached its limits as further gains will only make employers, who have to pay for the higher rates eventually,  less interested in staying in the health benefit game.  Employers who linger are increasingly served by plans that use limits on benefits to drive employees to use lower-cost institutions.  Thus, high-cost institutions are likely to see their demand efface in such a situation.

The movement toward accountable care organizations. As providers realize that the combination of fiscal austerity and the impulses of the PPACA are changing the familiar rules of private insurer negotiating and cross-subsidy of government programs, their interest in accountable health care organizations (ACO’s) grows.  That dynamic is surely manifest in Massachusetts, where the rate of movement in this direction in commercial contracts has been surprisingly fast.  Now, that movement may be accelerated even more by the federal government’s efforts. The PPACA endorsed the ACO concept and required CMS to develop a national program for ACO’s by January, 2012.

The initial regulations for accountable care organization were released in early April, and many provider organizations were underwhelmed, to say the least.  The majority complained that the degree of regulation seemed burdensome and the return on investment small even in the most optimistic scenarios.

In response, the Center for Medicare and Medicaid Services has developed a much more flexible model, called the Pioneer ACO program, demonstrating the government’s recognition that the ACO model is critical to controlling costs under the PPAC A.  What lies immediately ahead for organizations who submit applications in July will be intense negotiating and planning before final go/no-go decisions are made by December 31, 2011.

ACO’s are the fundamental vehicle in the PPACA to move away from fee-for-service medicine and its incentives for over-use of care.  The ACO curbs on cost would be based, on the one hand, on bonuses for hitting quality and cost benchmarks; and on the other as provider global budget risk, i.e., capitation.  The disadvantage of the former is that there are still precious few uncontroversial quality measures for hospitals, and even fewer for individual physicians, and their ability to reduce costs is unproven. The advantage of the latter is that it is already an operational model in some parts of the country; the disadvantage is that it requires a large target patient population (to have an actuarially stable group) and integrated providers with the business acumen and financial reserves to bear financial risk.

The good news for ACO advocates is that in many metropolitan areas, the integrated delivery systems have already assembled the pieces to take capitation — they have size and physician/hospital combinations.  Organizing these components into an ACO that can bear financial risk is still no small task, but it is at least imaginable.  Indeed, for such organizations, an argument for becoming a Medicare ACO is that such a commitment enhances their chances for success in commercial global budget contracts.

The more sophisticated potential ACO’s might also realize that they could grow margin by eliminating unnecessary care under capitation, and perhaps earn a higher percentage of the health care dollar.  Insurers, faced with more stringent regulations on MLR’s, might be willing to turn some of their cost cutting measures over to the providers, which would fall into the medical side of the ledger.  There will be struggles between insurers and providers over responsibilities for management, and the long-term role of insurers inevitably draws scrutiny in such relationships.  But many insurers seem committed to trying to work out new reimbursement mechanisms.

ACO development could also be accelerated by movement from employer-based insurance to the exchange segment.  A state insurance commission-based exchange might conclude that given the limits of cross-subsidy, the need to ensure insurer fiscal stability and the growing costs of coverage, the only solution is to move rapidly out of fee for service and into a pre-paid approach.  That seems to be the Massachusetts assessment.  CMS will likely discern this possibility and has the wherewithal under the PPACA to develop models for risk-adjusted capitated payment, using the newly created Center for Innovation.

The initial reaction to the new ACO regulations was overwhelmingly negative on the provider side of the ledger, as patients were not “tied” to the risk-bearing unit, and the upside from management was limited.  But that likely does not mean the concept will go away.  The real point is, hospitals and doctors are looking seriously at taking responsibility for population health, and they are doing this at least in part because their read is that traditional fee-for-service medicine cannot persist.  The question for providers is moving from “whether” to “how.”  It would appear that insurers and employers are similarly aligned.

The Overall Picture

In conclusion, the current segment structure of American health care is under a good deal of pressure.  The incentives of fee for service have finally broken the federal bank – on that point there is bipartisan agreement — and the limits of employers’ ability to pay will mean that cross-subsidies cannot save the day.  At the same time, the PPACA’s skepticism toward private insurance mechanisms for reducing costs and lack of commitment to maintenance of lightly regulated self-insured segment appear to be combining with fiscal austerity to create the conditions for changes in the locus of risk for the costs of poor health care.

Any such changes in insurance will likely move us toward the accountable care organization concept.  Indeed, with an Obama victory in 2012, we could see care increasingly be provided by ACO’s, with risk adjusted capitated payment overseen by insurance commissioners and exchange personnel.  The movements in this direction are incipient, but there are powerful forces in reform, and in the market, which are impelling us toward a world where providers hold much more risk.

Many loosely organized providers in fragmented marketplaces (i.e., much of the U.S.) have difficulty envisioning their path forward, but they know that their current business models could melt down quickly.  Perhaps not in two years, Bill Gates might say, but almost surely within ten.

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