IN THE MATTER OF EMPIRE HEALTH CHOICE INC.
AMENDED PLAN OF CONVERSION

NEW YORK STATE INSURANCE DEPARTMENT
AUGUST 6, 2002

STATEMENT OF LARRY KIRSCH ON BEHALF OF
CONSUMERS UNION AND NEW YORKERS FOR
ACCESSIBLE HEALTH COVERAGE
Managing Partner, IMR Health Economics, LLC. Brookline, MA (617) 731 2600. Larry@IMRHealth.com

The following is a highly condensed statement offered on behalf of Consumers Union and New Yorkers for Accessible Health Coverage regarding the impact of the proposed Empire conversion on non-elderly "direct pay" individuals, small groups and Medicare Supplement subscribers. It focuses on the anticipated effects on these enrollees and on the health insurance marketplace resulting from the lower minimum loss-ratio standards contained in Article 42 versus the standards currently in-force under Article 43.

As of March 31, 2002 Empire had in-force 21 thousand individual (direct pay) indemnity contracts ( (Hospital Only, Hospital and Basic Medical and Blue Choice); 22 thousand small group indemnity contracts and 130 thousand individual Medicare Supplement contracts. On a combined basis these three enrollee categories represented 7% of the company's total enrollment (or approximately 215 thousand people); also an estimated 10% of annual earned premiums (or, slightly in excess of $400 million).(2)

I. Standard of Review for the Proposed Conversion Transaction

A. The 1999 Insurance Department Decision and Order set forth the standard of review applied at that time to the restructuring of a non-profit (Article 43) corporation to a for-profit Article 42 accident and health insurance company and/or an Article 44 for-profit HMO.

In essence it stipulated that the conversion:

(1) must be fair and reasonable;

(2) must not substantially lessen competition in any line of insurance or tend to create a monopoly; and

(3) must not be inconsistent with law.

The 1999 Decision indicated, specifically, that state law required Empire to demonstrate that withdrawal of individual and group policies by an Article 43 insurer would not disrupt the market. N.Y. Ins. Law §4304 and §4305.

B. Earlier this year, the Legislature enacted Chapter 1 of the Laws of 2002. Among other things, that Act clarified and broadened the Insurance Department review criteria by requiring a determination that:

(1) all enrollees not be adversely affected by the conversion;

(2) the interests of policyholders in the delivery of health care benefits and services not be negatively impacted; and

(3) the "winding down" of the Article 43 corporation be fair, equitable and convenient.(3)

II. Injury to Individual and Small Group Subscribers

The Amended Plan of Conversion indicates that individual contracts issued by an Article 42 (for profit) accident and health insurer shall be subject to a minimum loss ratio requirement of 55% instead of the 80% minimum standard currently applicable to Article 43 corporations. The comparable minimum loss ratio for Article 42 small groups is 60% (compared with 75% under Article 43).

In its Amended Plan of Conversion, Empire makes no proposal to voluntarily limit its target loss-ratio for non-elderly direct pay coverages to any percentage in excess of the minimum permissible under law for Article 42 carriers (i.e. 55%). Nor, does Empire propose to phase in any reduction in target loss ratios over a period of time. Indeed, the only constraint on loss ratios alluded by to by Empire (in its Conversion Q&A) is the force of "competition" for direct pay business. The same situation applies to small group enrollees holding indemnity coverages.

In the case of individual Medicare Supplement policies, Empire proposes to retain the 80% minimum loss ratio under Article 43 for a period of five years. Immediately thereafter, however, minimum loss ratios for this line of business would decline to 65% as permitted under Article 42.

In principle and practice, a reduction in the loss ratio (defined as the percentage of incurred claims to premiums) is tantamount to an increase in premiums unless the insurer finds a way to reduce claims costs or expenses. We see no evidence to suggest that Empire has discovered such a mechanism and thus we believe that a reduction in target loss ratios will drive premium costs up for policyholders.

If New Empire takes full advantage of the lower minimum loss ratios permitted under Article 42, premiums for (1) direct pay individual subscribers could go up by at least 45%; (2) those for small group indemnity contract holders could increase 25%, and (3) Medicare Supplements could increase 24% (at the expiration of the temporary freeze period).

Table 1

Premium Impact of Reducing Target Loss Ratios to Article 42 Minimum Levels

In practice, since loss ratios for Old Empire's Article 43 indemnity business have historically run slightly higher than the statutory minima, a full reduction to Article 42 minimum levels could result in rate increases even greater than the 24%-45% range. (See Table 2)

Table 2

Composite Loss-Ratios 1998-2001 Article 43 Indemnity Business(4)

III. Analysis of the Conversion Transaction

The Insurance Department should--under the 2002 legislation-- apply three of the review criteria already discussed to analyze this element of the transaction:

• Will the conversion adversely affect individual, small group and Medicare Supplement subscribers?
• Is the conversion fair and equitable to these categories of subscribers?
• Will the conversion violate §4304 and §4305 NY Ins. Law by disrupting the individual and small group insurance markets?

A. The Conversion is Likely to Have an Adverse Effect on Individual, Small Group and Medicare Supplement Subscribers.

Although we have been unable to obtain detailed data on Old Empire's gains and losses (e.g. operating margins) for the indemnity products discussed in this presentation, the data we have reviewed on historical loss ratios and underwriting results for the company as a whole, suggests that Empire--like many other Blue Cross-Blue Shield Plans--has probably been operating these lines at somewhat of a loss.

Given the for-profit financial imperatives facing New Empire, it is reasonable to assume that management will be under substantial stockholder pressure to improve the financial results of its individual direct pay and small group business. There being no explicit new mechanism or plan to capture administrative efficiencies or realize lower medical claims costs, it is far more likely that New Empire will respond to these earnings incentives by raising premiums in the indemnity business-- facilitated by the more relaxed Article 42 loss ratio standards.

If, for example, New Empire set a goal of improving individual and small group operating margins to the 4% level--a target observed in various commercial insurance markets-- it is highly likely that subscribers would face substantial premium increases.(5)

Table 3

The Impact of Improving Small Group
Indemnity Operating Margins: An Illustrative Example

What this illustration suggests is that (1) totally apart from any normal rate increase brought about by the higher cost of medical care, (i.e. increase in "trend"), the conversion would very likely lead to an additional hike (on the order of 7% or more) to improve New Empire's profitability, and (2) this profitability-driven increase is made possible by the relaxation of minimum statutory loss-ratio standards.

Empire argues that competition in the individual and small group indemnity markets will constrain the erosion of loss ratios and thereby hold premium rates in check. This argument lacks force. It is well known that the individual and small group markets are fragile and have been teetering for years. Witness the great interest in Healthy New York and other publicly assisted initiatives. While declining non-group enrollments and rising premiums may be explained, in part, by external factors such as changes in the labor force and revised eligibility for small group coverage, there is no evidence to suggest that new insurers are entering this market seeking to gain market share through price concessions. Thus, the constraining role of market competition must be heavily discounted.

B. The Transaction Has a Reasonable Likelihood of Disrupting Fragile Insurance Markets.

In the event that New Empire were to raise individual direct pay and small group premiums in order to improve operating margins (and in response to the relaxation of minimum loss-ratio standards), a reasonable danger exists that these already fragile markets would be further disrupted.

If, as previously illustrated, an additional rate increase on the order of 7%+ were levied on top of any trend adjustment, a predictable outcome is the continuing erosion of the risk pool and the potential that an adverse selection death spiral would be set off. In that event, Old Empire subscribers would be forced either to lapse their existing coverage and obtain benefits elsewhere or drop their insurance entirely. Given the demographic composition of the typical non-group population, for example, many might be economically forced out of the private insurance market and onto the rolls of the uninsured. Or, alternatively, some might be compelled to choose the "spend down" option in order to qualify for Medicaid in which case the state would assume financial liability for medical expenses.

C. The Conversion Will be Unfair and Inequitable to Individual Direct Pay Subscribers.

The proposed plan of conversion exposes individual direct pay, small group and Medicare Supplement subscribers to an unfair and inequitable burden. No other lines of business are at-risk for a sharp drop in minimum loss-ratios and the concomitant pressure of rising premiums. And unlike members of large experience-rated groups for whom replacement coverage would be expected to be priced and sold competitively, individual and small group subscribers enjoy little countervailing market protection.

Given the stressed economic and health status profile of the typical non-group and small group cohort compared to the insured employees of large employer-sponsored groups, the premium impact of the conversion is likely to work a special hardship. People with expensive chronic conditions, for example, may attempt to retain their existing coverage in order to preserve continuity of providers and benefits. Thus, people with lower incomes and compromised health status are particularly at risk.

IV. Conclusion and Recommendation

The proposed Amended Plan of Conversion does not meet three of the review criteria applicable under the new legislation:

• No adverse impact on policyholders
• Fairness and equity
• No market disruption

Consumer organizations and consumers who did not oppose Empire's proposed restructuring in 1999 recognized that there would be upward pressure on premiums as a result of investor demand; yet they took comfort in Empire's pledge--strongly backed by this Department and the Attorney General's Office--that the full value of Empire's assets at conversion would be transferred to a Foundation dedicated to making health care coverage affordable and accessible. For reasons addressed by my colleagues, the Legislature has all but obliterated the Foundation that would have continued Empire's charitable mission and has, instead, made provision for transferring Empire's assets to a state fund dedicated primarily to other purposes.

This impact on policyholders of the transfer of assets is so adverse that Consumers Union and New Yorkers for Accessible Health Coverage believe Empire's amended plan should be disapproved on this basis alone. CU and NYFAHC also believe, however, that the Department should require mitigation of the disqualifying injuries outlined in this testimony since those injuries flow from the change in minimum loss ratios permitted to carriers under Article 42 and associated rate adjustments over and above trend. These injuries could be mitigated by agreement with Empire that direct pay individual, Medicare Supplement and small group loss ratios (for each applicable coverage) not be reduced below current levels and that rate adjustments be maintained at or below trend. In the alternative, the Department should enter an order disapproving the Amended Plan of Conversion.

______

Footnotes:

(2) Enrollment is from Exhibit H of the Amended Plan of Conversion; premium was estimated from the most recent Empire Annual Statement, Exhibit of Premiums, Enrollment and Utilization.
(3) The Department is aware that Consumers Union and NYFAHC believe the legislation creating these decision-making criteria is invalid; for purposes of this portion of our presentation, however, we will assume the validity of the criteria.
(4) Annual Loss Ratio Reports to the N.Y. State Insurance Department. For instance, the small group and Medicare Supplement loss ratios have typically run about five percentage points above minimum levels.
(5) Company-wide, Empire's operating margins are currently on the order of 2.5 percent.

View Files Sorted By Office: Consumers Union OPI, New York - Washington DC Office
West Coast Regional Office - Southwest Regional Office - Consumer Policy Institute

  
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