Markets

How Insurance Really Works, Courtesy of WellPoint

By David Hamilton

Updated on: April 24, 2008 / 5:02 PM EDT / MoneyWatch

Give WellPoint credit for clarity, if nothing else. Its first-quarter earnings were terrible, but the company's outline of its plans to bounce back -- reasonable or not -- also offered a revealing window into how insurers actually think about the business of providing health coverage.

With virtually the whole insurance industry in a funk, WellPoint's 25 percent net-income decline isn't exactly unique. Compared to rivals like UnitedHealth Group, however, WellPoint didn't beat around the bush when it came to diagnosing its ills. In short, the giant insurer found itself paying too much out in benefit claims and taking in too little in the way of premiums. Coupled with losses in its investment portfolio -- recall that insurers are basically claims-paying machines with giant piles of cash that have to be invested somewhere -- that was enough to force WellPoint to lower its 2008 forecast for the second time since March.

But it's WellPoint's plans for recovery that are particularly illuminating. In the company's conference call yesterday, CEO Angela Braly forthrightly noted that WellPoint will -- guess what? -- raise premiums, primarily on sick people and the elderly who are using too many prescription drugs, while doing its best to pay less for medical care.

Don't take my word for it, though. Here's Braly on how WellPoint plans to "minimize attrition of profitable business due to rate increases," straight from WellPoint's most recent conference call:

At times certain benefit designs, in particular geographic areas have worse than average experience and require higher than average rate increases. As an example, we have certain blocks of high-deductible plans with richer coverage after the deductible is met that require and are receiving higher than average rate increase. For many of these customers we can offer benefit buy-down that included different coinsurance percentage after the deductible is met to produce a more affordable premium.

In other words, people who use their insurance too much need to pay more, either through higher premiums or by shouldering a larger share of their healthcare costs ("coinsurance" refers to the percentage of covered medical costs that the individual still has to pay, even after copayments and deductibles). There's something weirdly admirable about the candor with which WellPoint reduces the business of insuring people against financial ruin resulting from unexpected health problems to a matter of shifting financial burdens to the sick -- or, at the very least, those who want the best possible protection for themselves and their families.

We now expect a full year 2008 benefit expense ratio to be in the range of 83.3% to 83.6%, less than the first quarter of 2008 due to expected premium rate increases, enhanced medical management initiatives, a more normal pattern of prior period reserve adjustments, seasonality adjustments and membership mix changes.

Here, Braly is promising to cut WellPoint's claims payments -- the "benefit expense ratio" refers to the percentage of premiums that the company has to pay out in claims -- from first-quarter levels in a variety of ways. "Medical management" is shorthand for rationing care, denying claims and generally making it more difficult for members to cost the company money. "Membership mix changes" is another interesting phrase, one that suggests WellPoint is eager to insure more healthy people and fewer sick folks. (Recall that WellPoint unit Blue Cross of California is currently in hot water with state regulators for using any excuse possible to cancel the policies of people who start running up big medical bills.)

Braly also had some revealing things to say about WellPoint's advantages vis-a-vis its competitors, particularly in terms of its size (the insurer is the nation's largest in terms of membership):

However, we also continue to have what I believe is the best value proposition in the market. We have more providers in our networks, with better discounts than anyone else. Well healthcares locally delivered, and locally consumed, having scale matters. We have been the number one market share in almost all of our 14 Blue states, and four of these states, our market shares in excess of 40%, and another four of these states our market shares in excess of 30%.
This allows us to negotiate deep discounts from providers in our Blue states and to implement programs intended to optimize the cost of care. We are aggressively executing on our strategy to expand best practices and improve contracting performance across our organization. We have launched a pay for performance initiative in many of our states, like the one in California we announced last month to establish consistently effective program across the enterprise.

This is a dense and complex way of saying that, by virtue of its size, WellPoint is better positioned to hammer down costs in negotiations with doctors and hospital groups. Note that size doesn't appear to offer any other advantages -- here, it's all about shifting WellPoint's costs of providing coverage back onto the medical providers who lack the bargaining power to push back aggressively. WellPoint's scale doesn't make its business any more efficient or lower its costs in any other way, simply because -- as Braly herself notes -- "healthcare is locally delivered and locally consumed." (I've corrected what looks to be a transcription error from SeekingAlpha.)

I'm not sure I've ever seen a health-plan executive explain so clearly exactly how little economic value health insurers create with a business model that essentially amounts to taking money out of one pocket and putting it into another. Nor have I ever heard an insurance CEO spell out the vast gap between the way health plans actually work and how they market themselves. It's all worth bearing in mind the next time you happen across something like WellPoint's statement of its "commitments" as an insurer:

At WellPoint, we are dedicated to improving the lives of the people we serve and the health of our communities. From the boardroom to the mailroom, every associate is expected to honor the company's commitments to our diverse customers, fellow associates, shareholders and the communities we serve - helping us become the most trusted choice among consumers.
Our business strategies mirror our commitment to providing affordable quality care to our members and the public. In line with our vision to become the most valued company in our industry, we must:

Bring affordable quality health care and coverage to medically underserved communities

Educate people to take an active role in their own health

Work with our health care partners to improve quality of care

Help shape public policy that makes health care more affordable and more accessible

WellPoint's Social Responsibility Report outlines how the company is improving the lives of the people we serve and the health of our communities.