Tag Archives: contingency

Hide and Seek With Healthcare Profits

Little did I know that the children’s game of Hide and Seek would provide valuable lessons for a life in business. But success requires trying new strategies, moving in different directions and venturing away from the illusion of comfort that home base appears to provide.

To win at Hide and Seek, you had to be flexible in your thinking to find great hiding spots, had to make a decision while the countdown was ticking and had to move fast if you wanted to win. Managing healthcare profits in a post-ACA world works the same way.

Hide and Seek is a business strategy used in healthcare like no other industry. The key players resist transformational change and use the power of political lobbying, fear, confusion and an almost unbelievable – you can’t make this stuff up – kind of limited transparency.

By lack of transparency, I mean like playing Hide and Seek with no moon in the sky and wearing all black. There’s no way you were going to find my hiding place!

Fully insured health insurance companies and HMOs are exceptional at playing Hide and Seek, with profit margins hidden in the premiums.

Besides the Affordable Care Act and its new extra charges and taxes, you have to look really hard to find out where the contingency margins are hiding in the premium calculations – especially when you consider that there is very limited transparency in the actual healthcare renewal calculations. Ask yourself – did your employees’ good health and low healthcare utilization inure to your corporate bottom line or to the insurance companies?

So, where are the good profit margin hiding places in the fully insured premiums? Let’s take a peek at the ones hiding inside the employer-paid healthcare premiums? For starters, try looking at the pooling charges, medical claims trend factors, demographic load factors, pharmacy claims trend factors or the capitation trend factors.

Of course, there are more profit margin hiding places in the retention factors, IBNR reserve, claim stabilization reserve, pending claim reserve and the earned interest rate assumptions built into reserves.

Don’t limit yourself playing Hide and Seek with your local fully insured health insurance company or HMO, because the game is rigged against you as long as there’s no financial transparency, profits can be hidden, your company’s good claims subsidize bad risks and you have no way of being rewarded for good claims.

The situation reminds me of the poor kid who always lost at “Bubble gum bubble gum in a dish” or “Engine, engine #9 going down Chicago line” to pick who was going to be “it” first. He didn’t know he was playing a rigged numbers game.

The answer was hiding in plain sight… and no one told him.

And, now you know!

Why Low Loss Ratios Can Be the Wrong Goal

Many agency owners take great pride in generating low loss ratios year after year. These agencies are often very, very profitable — they are the perfect cash cows, in business school parlance. But, in my experience, their growth is painfully slow. Often, their agencies are not managed closely, beyond the focus on loss ratios. And the agencies are often small. 

These agency owners are not happy with the many carriers who have deemphasized loss ratios. They cannot fathom why any carrier would not LOVE their good loss ratios. The result has become stressed, or even fractured, agency/company relationships.

These agency owners do not understand that loss ratios that are too low (and each company will define “too low” differently) are not in some companies’ best interests. How can too high a profit margin be bad?

  1. When loss ratios are too good, it may mean rates are too high, resulting in too little growth. Companies, particularly stock companies, need to show growth, especially after the softest market in industry history.
  2. If growth is too slow, companies may be losing market share. Company management often has considerable pressure to attain specific market share.
  3. Loss ratios that are too low may also mean that profit is not being maximized.

Maximizing profit is not the same thing as achieving a high profit margin. The former is in dollars, and the latter is in percentages. This is a crucial difference between running a company and running an agency, and agency owners are well-served to understand it. If a company wants to maximize profit, it might want to increase revenue by lowering rates even though that would mean higher loss ratios. For example, if a company has a 35% loss ratio and $100 million in premiums, its gross profit (excluding expenses) might be $65 million. However, if it decreased its rates and subsequently increased premiums to $125 million at a 45% loss ratio, it would generate $68.8 million in gross profit. That is a $3.8 million improvement.

Many agency owners would like to increase their books 25% and go from a 35% loss ratio to a 45% loss ratio, too, but those that focus on low loss ratios probably will not get their share of that 25% growth, yet their loss ratios will still increase.

Frustration at agencies greatly increases when companies price to a 55% , or higher, loss ratio. The company still makes plenty of profit at a 55% loss ratio (if it does not, then the company has serious expense issues that go far beyond the points of this article). However, agency owners make most of their money in contingent bonuses from carriers for growth, retention, low losses and so on, and profit sharing by carriers declines precipitously at 55%. The agency owners' lifestyle is curtailed. The value of their agencies is impaired. Their business model is in shambles.

If a company is truly pricing to a loss ratio in the mid-50s or even higher, agency owners might consider doing business with different carriers whose philosophies more closely match theirs. Easier said than done, obviously, so maybe a better solution is updating their business model. Growth is more important today to many carriers. Sitting on a cash cow annuity for a decade or more is not as feasible as it once was, and wishing otherwise will not help.

Many companies desire fast growth because:

  1. Some executive bonuses are tied to fast growth.
  2. The company is being set up to sell.
  3. The company has reserving issues and needs the extra premium to dilute the effect of a reserve increase. Growth is only a temporary solution, but companies have used it forever. The fast growth, which makes executives look heroic, is almost always created by low, unsustainable rates that eventually result in higher loss ratios. Nonetheless, growth is initially far more important than profit. (The smartest executives are gone by the time the problems arise, leaving their successors to sort out the mess.)

Agents doing business with companies that emphasize growth may want to evaluate whether there is risk to the agency and its clients. If so, creating a plan to offset these risks can create excellent opportunities.

Agents can fight reality, and fighting will feel good for masochists, but few will be able to avoid doing business with at least a few growth-focused carriers. Don’t keep telling carriers how short-sighted they are. Capitalize instead by understanding their perspective and using your resources to deal with the carriers you choose.

NOTE: None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules and regulations.