Rise of self-insurance in smaller groups: opportunity and threat

Summary 

• Self-insurance is growing among smaller groups (including those sized 50-250)
• From a competitive point of view, it will be hard for insurers holding attractive groups in risk products to respond given the enormous profit cannibalization of converting from risk to an ASO offering
• But they will need to find some solution: risk products today are expensive for many groups given continuing low levels of utilization; “peanut-butter” share nationals at the forefront of these products (Cigna and now Aetna) won’t have cannibalization worries to stop them from pushing the model
• The channel may provide some temporary breathing room as commission-compensated brokers are unlikely to push ASO models and benefits consultants that usually deal in ASO won’t have much reach into the <250 life segment — but a temporary respite only, as the channel business models are evolving too in response to the MLR floor
• In the long-run, there may not be much defense here but what defense there is will be (1) improving the risk value proposition to reduce the gap and (2) offering both models to keep the customer as they flip from one to the other.

For some time, anecdotes of smaller groups taking the plunge into self-insurance have been trickling out of the news wires. And, although broad statistical evidence has been hard to come by (see a WSJ article from last March for a quick review of national employer surveys), there is good reason for this trend to be sustained. Why?

• The value proposition of self-insured vs. risk (better data, more control, avoidance of premium taxes and fees) is strong and the tools to mitigate the risk impact (stop-loss arrangements) well developed.
• Risk seems to have been “over-priced.” Health plans appear to have priced for 2011 assuming continued economy-driven risk pool decay, potential utilization snap back after several periods of low utilization and an assumption that everyone would price to pay MLR rebates rather than targeting rebates to be minimized. The broad-based Q1 positive earnings demonstrated the weakness of the first two of these assumptions and confirmed the third. Employers who shifted to ASO for 2011 appear to have made smart moves; those who didn’t by and large made health plan investors happy.
• The cost of risk is going to increase under reform In 2014, the health insurer tax by health care reform (starting at $8B in 2014, rising to $11B in 2015 and continuing to grow thereafter) will be allocated based on premiums and ASO fees; a methodology which will clearly advantage ASO.

Nationals are pursuing the opportunity. Cigna has been identified as the leader here and their Q1 results offer some confirming clues. First, a quick review of their reporting: Cigna splits its segment reporting into National Accounts (>5K), Middle Market (250-5K), Select (50-250) and Other (Individual, <50, Medicare etc.). They also report lives by funding model. While they do not provide the cross-tabs of funding model by segment and only show net, not gross changes, comparing changes in lives across each of the segments provides a basis for some estimates. The table below shows movements across these segments netted of the other category:

In Q1, Cigna saw National Accounts (>5K) decline by 77K while its Middle Market (250-5K) and Select (50-250) grew by 174K combined (6% growth in a single quarter for the Select segment). Normally, growth in the Middle Market and Select segments would be spread across both risk and ASO offerings (it was in 2010 with the same pattern of growth across the three segments). In Q1, however, risk lives declined by 46K; all the growth was in ASO lives. This would suggest that the very large share of the new lives in both Middle Market and Select were in ASO (CEO Cordani said over 50% of the new business in Select is ASO which given the typical turnover in a book, could well be all of the net growth. See Q1 earnings call transcript here). For the Middle Market, this is impressive. For the much smaller Select segment, it is a potentially revolutionary.

Cigna is not the only major to see the opportunity. Aetna has spent $600M on its recent purchase of Prodigy with the same target market in mind. Bertolini said in the recent analyst call: “Prodigy will be an asset that we can use in the marketplace to offer a very affordable product which brings insurance to smaller employers, the 200 to 2K employer marketplace” He later talked about using Prodigy as a vehicle for retain 100 to 2K employers flipping between risk and ASO solutions.

These products play into the hands of attackers: ASO offers lower dollar margins per life certainly, but also lower capital costs and high percentage margins. Most important, it provides a differentiated offer for Cigna and Aetna to attack in markets where they have low local share. Large share regional insurers with mid-sized groups in risk products will be challenged to respond: the profit cannibalization will be too daunting. For the nationals, however, with small local share, the cannibalization risk is much smaller, and the potential life acquisition opportunities corresponding greater.

But these products will also face channel frictions: Brokers whose livelihood depends on selling risk products face the same cannibalization barrier as incumbent health insurers. And small group lives do not usually get the attention of benefits consultants. This implies a gap in the channel for engaging small group on an ASO. Cigna fills this gap through a model of “consultative selling” that sounds like direct selling vs. through channels. Perhaps in the medium term, with MLR floor putting pressure on broker commissions, the broker/benefit consultant divide may grow fuzzy and become both interested and capable of selling an ASO model into the risk book. In the long-run, as long as the ASO + stop-loss value proposition is attractive vs. comparable risk products, it is hard to imagine the channel will not adapt to sell the offer. 

Implications

• The trend towards ASO in smaller groups likely to accelerate, reinforced by high pricing on risk, threat of reform taxes making risk more expensive and competitive strategy where thin-share nationals use ASO to slice into regionals.
• Services vendors ( e.g. PBMs, disease management and health and wellness organizations) who sell direct to employers using ASO models need to figure out how to tap into this emerging market.
• High share regionals holding the majority of smaller group risk book will need to find ways to address the cannibalization risk or reduce the value proposition gap between risk and small group ASO + stop-loss.
• The impact on employers opting out of providing insurance in longer run is unclear: ASO conversions may reduce the quality of risk pool and stimulate vicious pricing spirals. On the other hand, the ASO model does offer employers a lower cost option to stay in the game of providing coverage.