Exchanges three years in: Market variations and factors affecting performance

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The third open enrollment period (OEP) for the public exchanges concluded in January. Many carriers—both early-OEP entrants and “wait-and-see” latecomers—believed this new market would achieve stability and sustainable margins in its third year. However, recent events—including carrier turnover (both entrances and exits), plan terminations, and pricing volatility—suggest the market is still in flux.

One reason for the flux is the variability of individual market1 financial performance many carriers have disclosed publicly. For some carriers, significant losses are causing marked changes in enterprise-level capital, cost structures, and strategy. Early indications of 2015 performance suggest aggregate negative margins may have more than doubled; to date, however, only 86% of carriers have released preliminary data publicly. We anticipate that our estimates will evolve as more information is released, such as final 3R results and rebates, as well as 2015 claim run-out2 and adjustments. Whether carriers’ performance in the individual market will improve in 2016 remains unclear.

Some carriers had positive margins in the 2014 and 2015 individual markets, however. Overall, 30% of the carriers (which together covered close to 40% of individual market enrollees) earned a profit in 2014. In 13 states more than half of the carriers in the market were profitable, and in 45 states there was at least one profitable carrier in the market. Preliminary reports suggest some carriers were profitable in the 2015 individual market as well.

Careful analysis of all carriers’ performance reveals several factors associated with better results. These factors suggest that success in the individual market could require many carriers to develop fundamentally different business models.

Four key observations emerged from our analyses:

  • The overall individual market suffered an aggregate loss of $2.7 billion in 2014 (–5% post-tax margins), but performance varied widely among states and carriers.
  • Carriers earning a positive margin in 2014 appear to share several common factors, including narrowed networks and managed plan design.
  • Early 2015 results suggest continued performance variability. Losses may have grown, but some carriers appear to have earned a profit.
  • There is little risk of a market-wide “death spiral” given stabilizing subsidies.

Individual market suffered a loss, but performance varied widely

After risk adjustment, risk corridor, and reinsurance (3R) payments are factored in, the health insurance industry’s aggregate pre-tax margin in the 2014 individual market was –5.2%. The aggregate post-tax margin was –4.8%, amounting to a loss of $2.7 billion nationwide.3 Deconstructing these results to consider a range of factors (e.g., geography, carrier type, plan design, and network) reveals wide variations in performance. Isolating these factors helps identify—and sometimes dismiss—potential contributors to performance.

Geographic analysis exposes considerable differences in 2014 carrier performance across states (Exhibit 1 in attached PDF). In six states, more than 75% of carriers had positive individual market margins. California and Washington posted the strongest results (95% of carriers with positive margins). By contrast, in 18 states, fewer than 5% of the carriers had positive margins. Yet, only six states had no carriers reporting positive margins in 2014.

A handful of regulatory and competitive factors appear to have contributed to the geographic differences, including the allowance of transitional policies (i.e., transitional plans, which had an unfavorable impact), enrollment trends (more is better), and silver-plan price dispersion (less is better). However, the statistical significance for each of these associations is relatively weak.4 Furthermore, the variation in carrier-level performance within each state suggests that carrier-specific factors likely also influenced results.

These carrier-specific factors shaping carrier profitability include carrier type, benefit design, and network breadth. The variations in 2014 individual market margins across carrier type were wide (Exhibit 2). CO-OPs (Consumer Operated and Oriented Plans) were the most unprofitable. Provider-led health plans were the only carrier type to earn a positive post-3R aggregate post-tax margin in 2014, but this result largely reflected the performance of Kaiser Permanente, the most profitable carrier in the 2014 individual market. Almost equally wide was the difference in performance within carrier types (Exhibit 3). For example, there was more than a 40-percentage-point margin spread between the highest- and lowest-performing Blue carriers and a 65-percentage-point spread for provider-led plans.;

Some factors are associated more closely with carrier financial performance

At the individual carrier level, results varied as well. While most carriers had negative margins after accounting for the 3Rs, approximately 30% of carriers achieved a positive margin in 2014.5 At the plan level, patterns emerge around performance differences. In the aggregate, plans based on health maintenance organizations (HMOs) had lower losses than plans based on preferred provider organizations (PPOs), consistent with their ability to enable more tightly managed benefits and care (Exhibit 4). In both 2015 and 2016, the premium increases for HMO plans were roughly half those of PPO plans, which suggests the initial results carriers experienced in the individual market were more favorable for the HMO plans.6

Similarly, plans with narrowed (narrow or ultra-narrow) hospital networks had better aggregate margins and lower claims in 2014 than broad-network plans did, likely resulting in part from unit-cost advantages (Exhibit 5). Plans with narrowed networks also had lower median premium increases than broad plans did in both 2015 and 2016. In addition, the pricing spread between the two plan types has continued to expand—the difference in median premiums between narrowed- and broad-network silver plans from the same carrier increased from 16% in 2014 to 22% in 2016.7 The combination of the improving relative pricing of narrowed networks and their superior financial performance suggests that they may be emerging as one sustainable element of exchange plan design.

Early 2015 results suggest continued variability in carrier performance

Our initial perspective, based on emerging financial results reported for 2015,8 is that aggregate losses in the individual market may have more than doubled from 2014, with post-tax margins between –9% to –12% (Exhibit 6). The larger losses are most likely the result of two primary factors: higher year-over-year medical loss ratios (MLRs) (around 4.5% to 5% margin reduction) and lower reinsurance payments (another 3.5% to 4% margin reduction).

The majority (around 60%) of carriers that filed financial results publicly (as of April 28, 2016) reported a higher MLR in 2015 than in 2014. A subset of carriers (close to one-quarter) did report positive margins in 2015, but there is some turnover between the two years in terms of which carriers generated a positive margin. As mentioned above, our preliminary estimates of 2015 carrier financial performance as well as the size of the aggregate 2015 losses are likely to evolve as we gain insight into additional factors.

There is little risk of a market-wide spiral given stabilizing subsidies

The individual market has little risk of entering a classic insurance “death spiral” as long as the federal government continues to offer subsidies to those with incomes below 400% of the federal poverty level. Given the unique regulatory conditions of this market, the key determinants of its stability are not the traditional factors (risk and cost of care for this segment), but rather the ongoing subsidy payments.

The majority of enrollees currently in the individual market—an estimated 69% of those in the market, both on and off the exchanges9—qualify for subsidies, which cap their premium contributions to a percentage of income10 (Exhibit 7). Our modeling work suggests this mechanism acts as a powerful market stabilizer, making coverage affordable for a broad segment of the individual market regardless of premium increases (albeit at a higher rate of government spending). Similarly, the cost-sharing subsidies offered to many enrollees help stabilize the market but increase government spending. In addition, our modeling suggests that the percentage of enrollees eligible for both types of subsidy will likely rise. Thus, under the current design of subsidized and mandated coverage, there will likely continue to be a large, viable individual market.

As the above findings illustrate, the individual market faces continued challenges. Yet, there are real variations in market and carrier performance revealing opportunities for differentiated results. There are also specific actions carriers can take to improve near-term performance on the public exchanges and position their businesses for longer-term sustainability. To succeed, however, many carriers may have to develop a fundamentally different business model—the commercial segment model is not viable for the public exchanges. Carriers will also have to remain nimble to adjust rapidly to the market’s evolution.

The findings in this Intelligence Brief provide a perspective on the evolution of the individual market. The information is based on publicly reported data as of April 28, 2016.

To read the full article, including exhibits and methodology, download the PDF below.

Download the full article (PDF)

  1. Throughout the paper, “individual market” refers to the entire individual market, both on and off exchange.
  2. Claims run-out refers to the period of time after the plan year has ended during which claims can still be submitted for reimbursement, thus altering total booked claims as calculated at the end of the plan year.
  3. Several regulatory changes made after carriers filed 2014 premiums (e.g., extension of transitional plans, change in expected risk corridor payments) may have contributed to the losses.
  4. As measured by R-squared values. Analysis was based on carrier margins weighted by QHP enrollment, limited to carriers with over 1,000 QHP lives.
  5. McKinsey on Healthcare Infographic. 2014 individual market post-3R financial performance. February 2016.
  6. McKinsey on Healthcare Infographic. 2016 exchange market remains in flux: plan type trends. December 2015.
  7. Coe E, Bello J, Lamb J. Hospital networks: Perspectives from year 3 of the exchanges. March 2016.
  8. Estimates are based on publicly available data (published by the National Association of Insurance Commissioners in its Supplemental Health Care Exhibit) for individual market business booked through year-end 2015 for 82% of individual market carriers; see methodology for further detail.
  9. The overall individual market income distribution was based on McKinsey internal modeling estimates, given the limited data available for off-exchange enrollees. Among on-exchange enrollees specifically, a higher portion are subsidy-eligible; ASPE reported that 83% of 2016 enrollees are receiving subsidies in its March 11, 2016 report, Health Insurance Marketplaces 2016 Open Enrollment Period: Final Enrollment Report.
  10. The premium cap is determined independent of premiums and premium increases; as a result, subsidized individuals will not experience premium rate increases tied to those filed by carriers.