The Commercial Health Insurance Industry In An Era Of Eroding ...

I n s u r a n c e
I n d u s t r y
The Commercial Health
Insurance Industry In An Era Of
Eroding Employer Coverage
New types of public-private arrangements are emerging to boost the
prospects for private U.S. insurers.
by James C. Robinson
ABSTRACT: This paper analyzes the commercial health insurance industry in an era of
weakening employer commitment to providing coverage and strengthening interest by pub-
lic programs to offer coverage through private plans. It documents the willingness of the in-
dustry to accept erosion of employment-based enrollment rather than to sacrifice earnings,
the movement of Medicaid beneficiaries into managed care, and the distribution of market
shares in the employment-based, Medicaid, and Medicare markets. The profitability of the
commercial health insurance industry, exceptionally strong over the past five years, will
henceforth be linked to the budgetary cycles and political fluctuations of state and federal
governments. [Health Affairs 25, no. 6 (2006): 1475–1486; 10.1377/hlthaff.25.6.1475]
Healthinsuranceintheunitedstatesischaracterizednolonger
by a basic split between public and private sponsorship but, rather, by the
large scale and broad scope of the firms that serve all categories of individ-
uals, groups, and public beneficiaries. Diversification into public programs per-
mits private industry to continue growing despite the erosion of employment-
based coverage and, of equal importance, limits its exposure to pressure from any
one purchaser. The “single-payer” structure of state Medicaid programs no longer
constitutes an insurmountable barrier to investor-owned firms, as they can enter
and exit particular states based on changes in payment rates and medical costs.
The structure of the new Medicare prescription drug benefit (Part D), which of-
fers coverage only to beneficiaries who enroll in private plans, moves the commer-
cial health insurance industry from Medicare’s margins to its mainstream.
This paper analyzes the commercial health insurance industry in an era of
weakening employer commitment to providing coverage and strengthening inter-
est by public programs to offer coverage through private plans. It documents the
industry’s willingness to accept erosion of employment-based enrollment rather
than to sacrifice earnings; the movement of Medicaid beneficiaries into managed
Jamie Robinson (james.robinson@berkeley.edu) is the Kaiser Permanente Distinguished Professor of Health
Economics, School of Public Health, at the University of California, Berkeley.
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DOI 10.1377/hlthaff.25.6.1475 ©2006 Project HOPE–The People-to-People Health Foundation, Inc.

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care; and the distribution of market shares in the employment-based, Medicaid,
and Medicare markets. The same cost increases that are driving employers out of
the private health insurance market are driving public programs into that market,
accelerating the growth and consolidation of the industry. The profitability of the
commercial health insurance industry, exceptionally strong over the past five
years, will henceforth be linked to the budgetary cycles and political fluctuations
of state and federal governments.
Changing Patterns Of Insurance Sponsorship: 1994–2004
Employment-based coverage (excluding the elderly with retiree coverage)
peaked in 2000 at 164.4 million—62 percent of the nonelderly population—and
fell by almost five million in the subsequent four years (Exhibit 1).1 Individual pur-
chasing of health benefits declined during the 1990s but has risen by one million
since 2001, absorbing some of those leaving employment-based coverage.
Despite the recent erosion of employment-based coverage, the commercial
health insurance industry has enjoyed an unprecedented period of financial per-
formance. The major investor-owned firms and the nonprofit Blue Cross and Blue
Shield plans have continuously raised premiums ahead of claims costs, reducing
medical cost ratios and expanding operating margins and overall earnings.2 These
price increases have generated sizable shifts in enrollment among the major com-
panies: Aetna and CIGNA have accepted major customer losses to regain profit-
ability, while UnitedHealth Group, WellPoint, and most of the nonprofit Blues
have enjoyed growth in both enrollment and premium revenues.
These changes in performance reflect a changed self-understanding of the
health insurance industry as a mature sector where earnings growth rather than
enrollment growth is the primary metric of success. Wall Street fostered and has
celebrated this change in focus. Exhibit 2 presents the stock price index for pub-
EXHIBIT 1
Trends In Employment-Based And Individual Insurance Coverage, Millions Of People,
1994–2004
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
U.S. population
Total
262.1
264.3
266.8
269.1
271.7
276.8
279.5
282.1
285.9
288.3
291.2
Nonelderly
230.8
232.7
234.9
237.0
239.4
240.7
244.8
247.5
250.8
253.6
255.9
Employment-based
Total
159.5
161.1
163.0
164.9
168.2
175.1
177.8
176.6
175.3
174.0
174.2
Nonelderly
148.4
150.0
152.0
153.9
157.1
160.3
164.4
162.3
161.0
159.7
159.5
Individually purchased
Total
31.3
30.2
28.3
27.2
25.9
27.4
26.5
26.1
26.6
26.5
27.0
Nonelderly
17.3
16.8
16.9
16.6
16.3
16.6
16.1
16.4
16.8
17.0
17.4
SOURCES: C. DeNavas-Walt, B.D. Proctor, and C.H. Lee, Income, Poverty, and Health Insurance Coverage in the United States:
2004, Current Population Reports no. P60-229 (Washington: U.S. Government Printing Office, 2005); and Employee Benefit
Research Institute analyses of data from the Current Population Survey, March 1994–2005 Supplements.
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EXHIBIT 2
Monthly Percentage Change In Health Insurance Stock Price Index, 1996–2006
Percent change
500
400
300
Health Insurance Index
200
Standard & Poor’s 500 Index
100
0
–100
1/97
1/98
1/99
1/00
1/01
1/02
1/03
1/04
1/05
1/06
SOURCE: Lehman Brothers Global Equity Analysis.
licly traded health insurance firms over the past two decades, highlighting the dis-
mal performance of the sector (relative to the broad Standard and Poor’s [S&P]
500 index) during the managed care era in the late 1990s and the subsequent run-
up in prices from 2000 through 2005. These changes in stock prices were particu-
larly dramatic for firms such as Aetna that proved their willingness to raise prices
in the face of enrollment declines and, after passage of the Medicare Prescription
Drug, Improvement, and Modernization Act (MMA) of 2003, for firms such as
United and Humana that have substantial prospects in the Medicare sector.3
Many firms suffered a reversal of equity pricing trends in the first half of 2006.
n Threats to the industry. The commercial insurance industry’s continued fi-
nancial success is threatened by three related trends in the employment-based sec-
tor. First and most obviously, the industry remains reliant on employment-based
business for the majority of its overall earnings, and individual firms may fight to re-
tain that business to the point of moderating premium increases relative to underly-
ing cost trends. This price competition, already evident in surveys of 2006 pricing
yields, would reestablish the “underwriting cycle” that has characterized the pri-
vate health insurance industry, both for-profit and nonprofit, for several decades.4
The cyclical pattern of pricing and earnings results in part from difficulties insurers
experience in predicting medical cost trends, and hence in setting premium prices;
however, it also reflects their proclivity to shave prices during periods when earn-
ings per enrollee are exceptionally high and growth is exceptionally profitable.
The second, and related, challenge to the industry comes from the nonprofit
structure of the Blues plans, which have accrued financial reserves far in excess of
mandated minimums and now face regulatory pressure to offer premium relief.5
The slowdown in premium increases by these plans inexorably drives their inves-
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tor-owned competitors toward pricing moderation, in turn reducing profit mar-
gin per enrollee and overall earnings.
The third, and more slowly evolving, challenge stems from the gradual shift in
product mix from insured to self-insured funding and from comprehensive to
high-deductible benefit designs. Self-insured business and thin benefit designs re-
duce insurers’ exposure to medical cost growth (shifting risk from insurers back
to insureds) and reduce potential profitability per enrollee. Insurers’ earnings per
enrollee for self-insured (administrative services only, or ASO) business are one-
third the level for insured members, while earnings per enrollee in high-deductible
plans are 30 percent lower than in comprehensive plans.6
n Industry response: consolidation. The erosion in employment-based cover-
age and the enrollment losses that normally would have resulted from aggressive
premium increases have been offset, for the major health insurance firms, by exten-
sive consolidation of the industry.7 During the heyday of managed care, from 1980
through 2000, the industry experienced extensive creation of new health plans,
sponsored by medical groups, hospital systems, employers, labor unions, consumer
cooperatives, and other entities. The traditional Blue Cross and indemnity insurers
lost substantial market share to the new entrants. Over time, however, the best-
managed firms, some of which were upstart health maintenance organizations
(HMOs) and others of which were renovated Blue Cross and commercial indemnity
carriers, demonstrated their ability to grow market share and to absorb weaker
competitors. Most of the regional HMOs that had converted to for-profit status have
been acquired, as have many of the nonprofit health plans sponsored by hospitals
and other provider organizations. The industry now comprises four national plans
(United, WellPoint, Aetna, and CIGNA); state-specific Blue Cross and Blue Shield
plans; a few regional for-profit plans (such as Humana, HealthNet, and Coventry);
and, in some markets, regional nonprofit plans (such as Kaiser Permanente, Tufts
Health Plan, and HealthPartners).
WellPoint and United each hold 14 percent shares of the national market, with
much higher concentrations in specific geographic markets and customer seg-
ments (for example, multistate employers), while the nonprofit Blue plans control
one-third of the overall market (with local market shares above 65 percent in some
states) (Exhibit 3). The other major investor-owned plans retain 17 percent of the
overall market but may experience further consolidation. The principal nonre-
gional non-Blue plans, such as Kaiser Permanente, cover 9 percent, while third-
party administrators (TPAs) for self-insured firms retain 12 percent.8
Shrinking employment-based enrollment, a dwindling supply of acquisition
targets, and the specter of renewed price competition are driving the commercial
industry toward diversification. Medicaid and Medicare represent the only seg-
ments of the health insurance world that are growing. Each is fraught with busi-
ness and political risks for the industry, which retains uncomfortable memories of
earlier incursions into the public sector, but there is no alternative.
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EXHIBIT 3
Market Shares For Employment-Based And Individually Purchased Health Insurance,
2005
Other (TPA)
United
12%
14%
Other nonprofit plans
9%
WellPoint
14%
Humana
2%
Blue Cross and Blue Shield plans
(excluding WellPoint)
Other major
32%
for-profit plans
17%
SOURCE: M. Borsch, D. Miller, and A. Herman, U.S. Managed Care Industry Outlook (New York: Goldman Sachs Global
Investment Research, 13 January 2006), Appendix B: “An In-Depth Look at Commercial Enrollment.”
NOTES: Includes self-insured (administrative services only, or ASO) as well as insured employment-based coverage. TPA is third-
party administrator (for self-insured employers). Excludes people age sixty-five and older. Total enrollment: 178.6 million.
Medicaid Managed Care
Medicaid represents a growth opportunity for private health insurers, as a re-
sult of the rise in overall program enrollment and the continuing efforts by many
states to outsource management and financial risk. But the basic structure of
Medicaid creates strong challenges, with a single purchaser in each state that
holds private plans to payment rates below those available for employment-based
insurance programs. The history of private plans’ involvement in Medicaid has
been contentious, leaving bruised feelings on both sides, as states have alternated
between increasing payments to attract new entry and cutting payments in re-
sponse to budgetary deficits.9 Many commercial plans entered the Medicaid mar-
ket in the early 1990s but exited by the end of the decade, leaving the sector in the
hands of public fee-for-service (FFS) programs and local provider-sponsored
HMOs. By the beginning of the current decade, however, the continued escalation
of costs and poor financial performance of many local plans had renewed mutual
interest between state Medicaid agencies and the commercial insurance sector.10
Managed care continues to grow both in absolute size and in percentage terms
as overall Medicaid eligibility expands (Exhibit 4).11 Of the forty-five million
Americans enrolled in Medicaid in 2004, twenty-seven million (60.7 percent)
were in some form of managed care, up from eight million (23.2 percent) a decade
ago. Managed care in Medicaid is not purely the domain of comprehensive health
plans but includes “primary care case management,” where the role of insurers is
severely limited. Moreover, much of the enrollment in comprehensive plans re-
mains with small provider-sponsored HMOs, many of which are struggling in the
context of low payments, rising medical costs, and difficulties in financing invest-
ments in information technology (IT). Approximately nineteen million Medicaid
beneficiaries are enrolled in HMOs that transfer to private plans the financial re-
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EXHIBIT 4
Managed Care Enrollment In Medicaid, 1991–2004
Millions of enrollees
Total Medicaid enrollment
Percent of total managed care enrollment
40
Medicaid managed care enrollment
80
30
60
20
40
10
20
0
0
1991
1993
1995
1997
1999
2001
2003
SOURCE: Centers for Medicare and Medicaid Services, “Medicaid Managed Care Enrollment Reports, 1991–2004,” http://www
.cms.hhs.gov/MedicaidDataSourcesGenInfo/04_MdManCrEnrllRep.asp (accessed 11 August 2006).
NOTES: Bars denote Medicaid managed care and total Medicaid enrollees, and they relate to the left-hand y axis. The line
denotes Medicaid managed care enrollees as a percentage of all managed care enrollees, and it relates to the right-hand y axis.
sponsibility for managing primary, specialty, and hospital services.
Small HMOs represent acquisition opportunities and have attracted special-
ized, investor-owned insurers whose principal business model is to acquire, reno-
vate, and expand Medicaid plans across multiple states. Centene, Amerigroup,
Molina, and WellCare have been capitalized since 2000 and have grown through
acquisitions of provider-sponsored plans, the Medicaid enrollment of Blue plans,
and bidding for participation when states open new beneficiary categories to
managed care.12 They now account for 18 percent of Medicaid managed care en-
rollment nationwide. The financial success of these investor-owned Medicaid
plans has stimulated interest among the national insurers, whose core business
has been in employment-based benefits. The two largest carriers, United and
WellPoint, have created subsidiaries dedicated to Medicaid, developing special
networks and programs to accommodate the low payment rates, limited physician
participation, diverse languages, and clinical needs of Medicaid and other state-
sponsored programs. Some regional insurers, including Humana and HealthNet,
are very active in Medicaid managed care, while CIGNA, Aetna, and many Blue
plans remain cautious.
Exhibit 5 presents the market shares for Medicaid managed care across the di-
versified and the specialized commercial insurers, the nonprofit Blue plans, and
the local provider-sponsored plans. Attention is restricted to full-service HMOs,
to the exclusion of more limited programs that do not transfer financial risk to in-
surers. The specialized commercial plans have grown from zero in 2000 to 3.5 mil-
lion enrollees in 2005, constituting 18 percent of the Medicaid HMO market. Blue
Cross and Blue Shield plans retain 8 percent of Medicaid HMO enrollment, but
few evince enthusiasm for the sector. The largest single share of enrollment re-
mains with the provider-sponsored HMOs, which hold 53 percent but which are
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EXHIBIT 5
Health Maintenance Organization (HMO) Plans’ Market Shares In Medicaid, 2005
United
WellPoint
7%
8%
Humana
Provider-
2%
sponsored
HealthNet, Coventry,
plans
Aetna, Sierra
52%
6%
Amerigroup, Centene,
Molina, WellCare
18%
Blue Cross and Blue Shield plans
(excluding WellPoint)
7%
SOURCES: United, Humana, and other diversified investor-owned health plan enrollment figures were obtained from company
documents (primarily SEC 10-K forms). Data for WellPoint were obtained directly from the firm (John Monahan, president,
WellPoint State-Sponsored Programs, personal communication, June 2006). Enrollment data for specialized investor-owned
plans were obtained from M. Borsch, A. Herman, and D. Miller, Medicaid Managed Care: Growing Pains and Growth
Opportunities (New York: Goldman Sachs Global Investment Research, 9 June 2006). Nonprofit Blue Cross figures were adopted
from S. Agha-Kahn, S. Navovicz-Peat, and I.F. Barnor, Managed Medicare and Medicaid Factbook 2006 (Washington: Atlantic
Information Services, 2006), after subtracting enrollment in Blue and non-Blue (Unicare) plans owned by WellPoint. Total
Medicaid HMO enrollment figures were estimated based on the Managed Medicare and Medicaid Factbook, after subtracting
out primary care case management enrollment.
NOTE: Total enrollment: 18.8 million.
steadily selling out to investor-owned plans. WellPoint, United, and Humana to-
gether represent 17 percent of the sector, with other diversified investor-owned
carriers (such as HealthNet and Coventry) accounting for 6 percent.
The consolidation of Medicaid managed care plans by multistate carriers will
accelerate to the extent that state agencies view them as financially solvent and
committed to the sector. Stability among insurers is a virtue for Medicaid regula-
tors with unhappy memories of cleaning up after health plan bankruptcies. Public
programs also perceive virtue in having national plans that offer pharmacy benefit
management, disease management, and other specialty services. In the short run,
the proliferation of investor-financed specialized plans and the heightened inter-
est among the diversified national carriers permit state agencies to put their pro-
grams out to bid for those willing to accept low payment rates and detailed perfor-
mance requirements. However, the continuing consolidation of the Medicaid
managed care sector will reduce the number of competitors and may force states
to maintain payment rates at levels that retain private plans in their programs.
Diversified, multistate plans have proved themselves willing to exit particular
markets if they cannot obtain an adequate return on their invested capital. The
Medicaid managed care sector may stabilize into an equilibrium where the “sin-
gle-payer” ability of each state Medicaid program unilaterally to set payment rates
is balanced by the ability of private health plans to exit and focus activity else-
where.
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The Medicare Modernization Act
Medicare offers the greatest opportunity for and poses the greatest challenge to
the commercial health insurance industry. The aging baby-boom generation is ex-
pected to increase enrollment from forty-three million in 2005 to fifty-three mil-
lion in 2015 and then to seventy-eight million in 2030. With spending per benefi-
ciary almost three times higher than for people with employment-based coverage,
Medicare offers revenue gains on a scale that cannot be matched elsewhere in the
economy.13 The history of private plans’ participation in Medicare has been volatile
for many of the same reasons afflicting Medicaid plans, with cycles of overpay-
ment, plan entry, and enrollment expansion followed by underpayment, plan exit,
and enrollment declines.14 MMA created a new upswing in the Medicare managed
care cycle, legislating additional payments to drug-specific and full-service health
plans. Depending on the sustainability of the federal payment levels and the indus-
try’s response to the new environment, MMA could either accelerate the privat-
ization of a quintessentially public program or generate a financial debacle for the
industry that dwarfs the effects of the Balanced Budget Act (BBA) of 1997.15
MMA authorized the creation of freestanding prescription drug plans (PDPs)
for beneficiaries enrolled in FFS Medicare and expanded funding for the full-ser-
vice Medicare Advantage with prescription drug (MA-PD) products.16 It also of-
fered a partial subsidy for employment-based retiree health plans and mandated
the transfer of dual eligibles from Medicaid to private PDPs. MMA’s implementa-
tion has been plagued with administrative difficulties, permitting wildly diver-
gent predictions concerning enrollment patterns. During the first open enroll-
ment period, up through 15 May 2006, thirty-eight million beneficiaries,
representing 90 percent of those eligible, gained coverage in either a PDP, MA-PD
plan, retiree program, or other governmental program (for example, military).17
MMA has attracted numerous entrants into the Medicare prescription drug
plan market, as pharmacy benefit managers (PBMs, such as Medco and Caremark)
and retail pharmacy chains have rushed in.18 Bidding and price competition for en-
rollment has been fierce, resulting in a windfall for Medicare beneficiaries, whose
premiums are lower than anticipated, but generating speculation about below-
cost pricing and an eventual market shakeout. Specialized for-profit plans such as
WellCare, HealthSpring, and Universal American have entered the capital mar-
kets; nonprofit Blue Cross and provider-sponsored plans have expanded their of-
ferings; and full-service insurers have renewed their involvement in what seemed a
moribund business sector. The commercial plans with traditionally large Medi-
care enrollment, including Humana and HealthNet, have offered new products in
new geographic markets, while commercial plans such as United, WellPoint, and
Aetna, which had dropped most of their Medicare enrollment after the BBA, now
offer HMO products in selected areas and preferred provider organization (PPO)
products on regional and national levels.19
Exhibit 6 presents the distribution of enrollment and market shares in the com-
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EXHIBIT 6
Market Shares In Private Medicare Plans, 2006
Small plans
13%
United
Major nonprofit plans
26%
12%
WellPoint
PBMs, pharmacy chains
6%
10%
Humana
Other major for-profit plans
17%
16%
SOURCE: Drug Benefit News 7, no. 9 (2006): 4.
NOTES: Total enrollment: 19.5 million. PBM is pharmacy benefit manager.
bined PDP and MA-PD Medicare market as of April 2006, highlighting the strong
role played by the diversified full-service insurers such as United, Humana, and
WellPoint but also the continued presence of nonprofit entities in some states and
specialized PDP entities nationally.20 Total enrollment was almost twenty million
(13.8 million PDP, 5.9 million MA-PD), excluding Medicare beneficiaries covered
through retiree programs, those in federal employment and military programs,
and those not electing any coverage for prescription drugs. Because of its acquisi-
tion of PacifiCare and marketing alliance with AARP, UnitedHealth Group is the
dominant player, with almost five million enrollees and a 26 percent market share.
Humana has focused on the MA-PD and PDP opportunity, with 3.2 million en-
rollees and a 17 percent market share; it now derives three-quarters of its earnings
from Medicare and has been losing enrollment in the employment-based sector.21
WellPoint and the other investor-owned insurers, such as HealthNet and Coven-
try, account for 22 percent, nonprofit plans (principally Kaiser Permanente and
several Blue Cross plans) account for 12 percent, and PBMs and pharmacy chains
account for 10 percent.
The consolidation of the Medicare sector is already beginning, evidenced most
graphically in United’s acquisition of PacifiCare. The short-term potential lies
with local provider-sponsored plans, which in 2005 had a combined enrollment of
1.7 million.22 Limits to consolidation will come from nonprofit Blue plans, from
Kaiser Permanente, and from selected regional HMOs. In the short term, growth
in overall enrollment and entry by new plans will continue to generate competi-
tion on the basis of lower premiums and richer benefits. This price competition,
more than direct mergers and acquisitions, may serve as the proximate cause for
consolidation, by driving out PBMs and pharmacy chains that cannot shift enroll-
ment from low-margin PDPs to high-margin MA-PD products.
The greatest future challenge to commercial participation in Medicare is the
same as the greatest past challenge: the fluctuating commitment of the Centers for
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Medicare and Medicaid Services (CMS). The contemporary land rush is driven by
the Bush administration’s dedication to expanding enrollment as part of a larger
effort to reduce federal regulatory purview. However, the fat years of generous
payments easily could be followed by lean years of payment cuts, as federal budget
deficits compete for resources and insurers’ robust profits attract attention. Opti-
mists and pessimists with respect to the MMA business opportunity mainly are
distinguished by the year in which they predict cutbacks, rather than by any dif-
ference in opinion as to whether cutbacks will occur.
Concluding Comments
The contemporary erosion of private employment-based coverage and expan-
sion of public programs could have been expected to reduce the role of the com-
mercial health insurance industry as an intermediary between the purchasers and
providers of care. Instead of retrenching, however, the commercial sector is diver-
sifying into Medicaid and Medicare and consolidating into firms that serve the
full range of public and private purchasers. The interest among private insurers in
serving public programs is reciprocated by the interest among public programs in
outsourcing the management of their coverage benefits, provider networks, and
enrollee expectations to private health plans. State and federal coverage sponsors
increasingly lack the will to navigate the conflicting claims for resources between
beneficiaries, taxpayers, and other stakeholders. They seek someone else to per-
form that inevitably thankless task.
Privatization is well under way in the Medicaid sector, where state budgetary
pressures have generated a rapid conversion to managed care and, within managed
care, to the multistate commercial insurers. While budgetary pressures will con-
tinue to tempt Medicaid programs to cut payment rates, states are reluctant to see
the commercial carriers depart and relinquish enrollment back to sometimes-
unstable provider-sponsored plans. Over time the sector could reach political and
market equilibrium with continuous participation by commercial plans that earn
a sustainable, if not exciting, profit margin and with state agencies that interpret
their role as purchasers of health insurance rather than of health care itself.
The role of commercial health plans in the Medicare sector is far less developed
than in Medicaid, and future trends are necessarily speculative. Medicare does not
face severe budgetary pressures for another half-decade, at which point the baby-
boom generation will become eligible for coverage. The contemporary efforts at
outsourcing program management to the private sector stem from philosophical
rather than financial sources. Advocates of private-sector involvement believe that
the purchasing of health services, and the inherent trade-offs thereby required, are
best performed through market contracting rather than governmental regulation.
The Bush administration has demonstrated its affinity for this vision by gener-
ously funding the Medicare Advantage program and, especially, by restricting cov-
erage for prescription drugs to those beneficiaries who enroll in a private PDP or
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