How can a health plan weather the MLR hit to profitability? Some clues from Coventry


  • Health plan profits will be down dramatically in 2011 due to MLR rules
  • Providing care management services to providers building out ACOs and medical homes can open new revenue streams outside the MLR constraints
  • System profitability (health plan + provider) can be enhanced if the health plan allows providers to keep more of the savings from ACOs while requiring larger fees for its care management services
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Could this be part of the plan behind Coventry’s touted close provider relationships and plans to acquire more health plan subsidiaries from major delivery systems?

Coventry Health has issued guidance that Health Reform’s Medical Loss Ratio (MLR) floors are going to cut Coventry’s profits by 25% in 2011. Press release. Conference call.

Small group, Medicare Advantage and individual lines of business are all contributing to the decline. Individual is hardest hit as the business accustomed to spending ~35% of premiums on admin and profit must now make do with just 20%. Overall, net income is going from 4.4% to 3.2% of revenues. The exhibit below provides a quick tear-down:

Coventry is not alone in seeing the MLR rules hit profits but is being hit harder than some – last month, Wellpoint announced that MLR would take 7% out of its 2011 bottom line – the difference driven by its business mix.
The MLR rules have sent health plans scrambling to reduce admin costs (just take a look at how broker commission rates were slashed). At the same time, the MLR rules also create a perverse incentive regarding medical costs: By limiting a health plan to a 25% “markup” on medical costs (20% over the 80% MLR floor for small group and individual), a “small” medical cost base means less room for profits. What’s more, if new reimbursement mechanisms such as Accountable Care Organizations (ACOs) generate a lot of savings – and the provider agrees to share back a large part of those savings -, health plan profits could look even worse.

How can provider cost effectiveness and health plan profitability can coexist? Some thoughts:

  1. In the analyst call, Coventry talked a lot about building closer relationships with providers, citing alliances with two major systems based on the acquisitions of their health plan subsidiaries.
  2. Working together, plans and providers can strip out system cost (eliminate up-coding/ down-coding, replace “mother-may-I” utilization management with retrospective audits, etc.). But that probably won’t be enough to close the profit gap.
  3. But suppose health plans become vendors to providers? For ACOs to work, providers will need many of the managed care tools health plans have today. By selling these capabilities to the provider, health plans create a new revenue stream and help the provider avoid building infrastructure. In effect, some of the health plan admin costs have been moved to the provider. Again, in and of itself, unlikely to dramatically change the profit picture.
  4. But let’s speculate one step further. Suppose the payer and provider engage in some mutually beneficial contracting. If the health plan allows the provider to keep a greater share of the savings (say 80% instead of 50%) but charges a correspondingly larger fee for the managed care tools (say a success fee of 25% of savings), both sides can end up making more money. Not enough to restore plan profitability by itself, but enough by our simple modeling to add back several percentage points into health plan profits. And, by the way, align both provider and health plan on maximizing the savings value.
  5. Critical prerequisite is a close relationship between the provider and the health plan built on a strong overlap of membership and a willingness to work together on the economics – just what the management at Coventry were touting was a big advantage of their previous acquisitions and a model for how they want to exploit their $850M war chest in the future.

Just speculation so far, of course: HHS has not published the final ACO rules yet and there may be specifics which constrain this kind of approach. Coventry itself says they expect very little growth in its fee business in 2011. It will be very interesting, however, to see how the fee revenue line changes if and when the partnered provider systems put ACO models in place and start saving money.

Below is a simplified version of the modeling

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Let’s say you have a small group insurance product which sold in 2010 for $100 in 2010 and a 75% MLR. $25 would be available for the health plan admin cost and profits. Assuming a $20 admin cost, the payer is earning $5. See column 1 in the table below.

With the 80% MLR floor put in place in 2011, and assuming medical costs remain unchanged, only $19 is left for admin and profit. Even if the health plan is able to trim admin costs by 10%, the health plan goes from $5 profit to $1 profit. Take a look at column 2.

Successful ACO’s do not help things for the health plan. If the provider can reduce medical costs by 10% and shares it all back with the health plan, only $17 is left for admin and profit (column 3). Now the health plan is losing over $1.

Of course, a provider isn’t going to give all the ACO based savings to the plan. It is shared savings after all. Suppose they retain 50%. Well they are happy, profits have got up from ~$5-6 to $8.5. Because the medical costs are higher, the plan is a little better off too – but hardly happy, as it is still not making any money (column 4).

Finally, look at the last column that shows how the solution might work:

Assume that:

  • The health plan provides health management services to the provider
  • It is paid a success fee equal to 25% of the savings generated. Note the incremental costs to the health plan are probably quite low as this infrastructure is already largely in place and therefore the margin will be high.
  • Finally, the health plan agrees to the provider retaining 80% of the savings

The provider is doing quite well—certainly better than if the health plan only agreed to allow 50% of the savings to be retained by the provider. And the health plan has been able to crawl its way back into the black – $3 profit – by replacing premium profits with service fee profits. Look at the last column in the exhibit.

Interestingly, the medical costs and the overall premium for the product under this model is still less than if there was no ACO arrangement at all. (compare medical cost and premium lines in column 2 vs. 4). So to the extent that this kind of generous saving sharing is critical to make the ACO model successful, this can be a good outcome for plan sponsors as well.

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