# Healthcare Exchanges: Math Doesn’t Work

Employers of all sizes are rushing into healthcare exchanges these days — often after heavy prompting by their consulting firm or broker. Part of the expectation is that employers can cap their future health plan costs while giving active employees more options. Sounds great, doesn’t it?

The problem is the math doesn’t work. In addition, this approach has been tried before and flopped miserably.

The previous iteration of healthcare exchanges was in the early ’90s and was called “cafeteria” plans. The same claims were made: “No longer will your costs be at the mercy of healthcare inflationary trends. You can control how much you want to increase your subsidy each year – that is, if you want to increase it at all.” This failed because the math worked against the strategy then, too.

Let’s take a steely-eyed look at the numbers. If a company puts employees into an exchange because it wants to cap its costs going forward, that creates a reverse leveraging effect on employee payroll deductions.

Here’s an example: Assume premiums (or self-insured budget dollars) are \$10,000 per employee per year and the company contributes 75%. The company pays \$7,500 per employee per year (PEPY), and the employee pays \$2,500. If plan costs increase 10%, and the company’s contribution stays flat, the employee cost will increase by \$1,000 per year (\$10,000 x 10%). That means the employee payroll deductions will go from \$2,500 to \$3,500, or an increase of 40%!

If costs go up another 10% in the next year or two, and the company contribution remains flat, the employee payroll deduction will increase another \$1,100, for a total of \$4,600, or a total increase of nearly 85% over a few years.

What employers quickly realized in the ’90s was that, if they didn’t keep increasing their subsidy level at a market rate, the cost to employees became intolerable. This reality led to the demise of so-called cafeteria plans.

If that is not enough, consider this. Some benefit managers hope exchanges will lead employees to choose less costly plans, ones with even higher deductibles. However, in an era in which 80% of plan dollars are being spent by 6% to 8% of plan members (called outliers), that notion is flawed. Why? The 92% who aren’t spending much may choose plans with higher deductibles and copays, but the outliers won’t. Period. The result is having about the same claim dollars as before but collecting less in employee contributions, an unsustainable proposition for employers.

Further, some outlier spending is deferrable. An outlier-to-be in a high-deductible plan can switch to a low-deductible plan in the following year, have an expensive surgery and then switch back. That, of course, is the definition of adverse selection.

A private exchange may look like a good fit for your situation, but beware. If your consulting firm owns an exchange, really beware.

Alas, considering the rush into exchanges today, it looks like history is doomed to repeat itself.

# So What Is the Actuarial Value Of My Health Benefit Plan?

Introduction
Now that health care reform is gradually rolling out into the market, the concept of the “actuarial value” of a specific set of benefits is increasingly important. The Patient Protection and Affordable Care Act of 2010 defines four metallic categories of benefit plans ranging from Bronze to Platinum. The actuarial value of these categories range from 60% for Bronze increasing by 10% for Silver, Gold and capping out at Platinum at 90%. The benefit plans offered through the public exchanges will be required to offer benefit plans that are valued within ±2% of each of the metallic levels. This limitation is critical to benefit plan sponsors as they evaluate their current benefit plans.

Actuarial Value Defined
The actuarial value of a specific health plan is the ratio of net value of the actual benefits to the value of these same benefits without copays, deductibles, limits, and/or coinsurance or other items paid for by the individual covered under that plan. For example, in the case of a plan with an actuarial value of 70% (i.e., the Silver plan), this suggests that 30% of the cost is the responsibility of the individual and 70% is paid for by the health plan or carrier involved. Similarly a Gold plan (i.e., 80%) would cover 80% of the cost with the individual responsible for 20%.

As long as the plan has an actuarial value within 2% of the metallic target it would qualify for that metallic level. For example, a plan with an actuarial value in the range of 68% to 72% would qualify as a Silver Plan. A plan with a value outside of the 2% range would not quality as a specific metallic plan and could not be offered. As a result, it is critical to be sure you know the actuarial value of your plan and what metallic plan it qualifies for.

Actuarial Cost Model
The primary tool used to derive the actuarial value of a specific set of benefits is the actuarial cost model. This is a tool used by actuaries which presents detailed utilization, unit cost information, Per Member Per Month cost information, value of copays/ deductibles/ coinsurance, etc. The actuarial cost model typically includes assumptions for each of the major service types which could include as many as 50 or 60 categories of service. The standard definition used by our company includes the following categories:

 Hospital Inpatient Medical Stays Surgical Stays Pediatric Stays ICU/CCU Neonatal ICU Behavioral Health – Mental Health Behavior Health – Substance Abuse Detox. Behavioral Health – Rehabilitation Maternity – Mother (Vaginal) Maternity – Mother (C-Section) Maternity – Well Newborn Maternity – Other than delivery Out-Of-Area Skilled Nursing Total – includes mat and snf
 Hospital Outpatient Emergency Room Outpatient Lab & Path Facility Outpatient Surgery – Hospital Based Outpatient Surgery – Free standing Outpatient Surgery – Other Home Health Partial Day – Rapid Treatment Unit Partial Day – < 24 Hour Observation Bed Partial Day – Behavioral Health – Mental Health Partial Day – Behavioral Health – Substance Abuse Other Outpatient (PMPM) Out-Of-Area (pmpm)
 Radiology & Chemotherapy (Non-IP) CT/MRI/Nucl/Angio – Professional CT/MRI/Nucl/Angio – Technical Mammography Radiation Therapy Other Radiology – Professional Other Radiology – Technical Chemotherapy Services – Facility Chemotherapy Services – Other Out-Of-Area (pmpm) Total
 Physician Services – Primary Care Primary Care Surgery IP Visits – Primary Care Office Visits – Primary Care Emergency Room Visits – Primary Care Lab & Path – Primary Care Office Consults – Primary Care Immunization & Injection – Admin Preventive Services Cardiology – Primary Care Pulmonology – Primary Care Allergy – Primary Care Behavior Health – Primary Care Primary Care Management Fee Total
 Physician Services – Specialist Inpatient Surgery Outpatient Facility Surgery Office Surgery Anesthesia Services Inpatient Visits – Specialist Inpatient Visits – Behavioral Health (Psych/Sub Abuse) Inpatient Visits – Newborn Office Visits – Specialist ER Physician Visits Radiology – Inpatient Professional Lab & Path – Specialist Office Lab & Path – Inpatient Professional Lab & Path – Outpatient Professional Consults – Specialist Immunization & Injections – Serum Physical Therapy Speech Therapy Occupational Therapy Obstetrics – Delivery (Vaginal) Obstetrics – Delivery (C-Section) Obstetrics – Other Well Woman Exams Cardiology – Specialist Services Pulmonology – Specialist Services Allergy – Specialist Services Neurology Dialysis Outpatient Behavioral Health – Specialist Services Other Medicine Out-Of-Area (pmpm) Total
 Prescription Drugs Generic Formulary – Brand Name Non-Formulary – Brand Name Mail Order Drugs Total
 Other Services Ambulance Appliances & Prosthetics Chiropractic Services Podiatry Services Vision Services – Exam Visions Services – lenses, frames, etc. Total

Categories are often modified based upon the needs of the actual situation. However, for each of the specific categories of service, the critical assumptions are presented. These assumptions are for a specific population, managed in a specific way, with specific demographics, assumed charge levels, assumed health status, and assumed benefits.

An example of a specific set of utilization and cost assumptions is shown in the following table:

Illustrative Cost Model For Hospital Patient Services

 Hospital Inpatient Annual Admits Per 1000 Length Of Stay Annual Bed-Days Per 1000 Average Cost Per Day N/A Average Cost Per Stay PMPM Claim Cost Medical Stays 21.20 3.90 82.68 \$4,522.82 N/A \$17,639.01 \$31.16 Surgical Stays 14.50 4.45 64.53 \$8,308.59 N/A \$36,973.24 \$44.68 Pediatric Stays 7.50 4.20 31.50 \$5,628.40 N/A \$23,639.29 \$14.77 ICU/CCU 4.50 4.30 19.35 \$9,045.65 N/A \$38,896.28 \$14.59 Neonatal ICU 2.20 5.50 12.10 \$4,116.77 N/A \$22,642.26 \$4.15 Behavioral Health – Mental Health 2.50 6.50 16.25 \$3,483.58 N/A \$22,643.26 \$4.72 Behavioral Health – Substance Abuse Detoxification 1.10 5.40 5.94 \$1,809.13 N/A \$9,769.30 \$0.90 Behavioral Health – Rehabilitation 0.30 10.50 3.15 \$1,340.10 N/A \$14,071.00 \$0.35 Maternity – Mother (Vaginal) 11.60 2.35 27.26 \$5,156.02 N/A \$12,116.64 \$11.71 Maternity – Mother (C-Section) 3.90 3.95 15.41 \$6,030.43 N/A \$23,820.20 \$7.74 Maternity – Well Newborn 15.50 2.20 34.10 \$1,356.85 N/A \$2,985.06 \$3.86 Maternity – Other than delivery 0.91 2.10 1.91 \$6,017.03 N/A \$12,635.76 \$0.96 Out-Of-Area 4.30 3.50 15.07 \$7,236.52 N/A \$25,327.81 \$9.08 Skilled Nursing 1.80 11.45 20.61 \$1,742.12 N/A \$19,947.32 \$2.99 Total – includes mat and snf 91.81 3.81 349.85 \$5,202.06 N/A \$19.821.75 \$151.66

The utilization is shown on a “Per 1,000” basis and the claims cost is shown on a PMPM basis. PMPM stands for per member per month. The total shown above for Hospital Inpatient suggests that the overall inpatient hospital cost per covered life would be \$151.66 per month prior to any offsets for deductibles, copays, coinsurance, provider discounts, medical management, demographic adjustments, etc. Similar assumptions are available for the rest of the categories previously shown. This information was developed for a typical commercially insured under age 65 population.

Developing Actuarial Values
Once the benefit design is determined, the information from the actuarial cost model is adjusted for variation in benefit design with the overall value of the benefits determined. The ratio of the value of the benefits to the overall value of covered services is the actuarial value of the benefit plan.

This is a fairly complex process. The government has developed their version of this process and has published a Federal AV Calculator. The final version of this was released on February 20, 2013. Most consulting firms have developed their own calculator to help their clients understand the process prior to the release of the Federal AV Calculator. Since the final calculator was released, there continues to be some serious concern by health actuaries as to the reasonableness of the federal calculator. We continue to use our own AV Calculator in addition to the Federal AV Calculator to better help our clients understand what variations in benefits lead to various AV values. This is a dynamic process with varying opinions depending upon the various plan designs and resulting AVs.

The following chart shows an illustrative result using our firm's AV calculator. This was prepared for a specific plan design in a specific geographic region. It is illustrative only to show the various components of cost variation.

The above table shows each of the key variables affecting the actuarial value. Each is important to appropriately incorporate into the calculation. The starting Claim Cost in the first column is determined from the actuarial cost model previously discussed and will be adjusted for:

• Geographic region
• Health status
• Smoking/non-smoking
• Medical management
• Utilization and cost inflation trend
• Demographics

The first adjustment reflects the overall nature of the health benefit plan. A richer plan is associated with higher utilization, a lesser benefit plan is associated with lower utilization. The copay/deductible adjustment either raises or lowers the starting claims cost. The next step eliminates any costs that are excluded from the eligible expenses.

This particular example excluded brand drugs.

The next step evaluates the value of various copays (i.e., office visit copays, pharmacy copays, etc.). These are deleted from the value of the benefit costs since they are paid by the individual. Next coinsurance and deductible values are deducted. This example was developed for a \$1,750 deductible 80% coinsurance plan. The last two adjustments are for the value of a family deductible limit and the out-of-pocket limit yielding the final cost. In this situation the final cost was \$218.30. This was compared to the net value of benefits after excluded benefits (i.e., \$309.85) with a ratio of 70.45% or a “silver” plan per our model.

Assuming this was consistent with the “authorized AV calculator” this plan could become a qualified plan under the Patient Protection and Affordable Care Act.

Complications
As you can see there are many different steps in the process to determine the actuarial value of a benefit plan. There are even more assumptions that have to be made to obtain these estimates of value. Armed with this information the plan sponsor can make informed decisions as to what benefit plan is appropriate and what they want to offer, if any.

These calculations are frequently based upon considerable amounts of professional judgment. Not all actuaries think alike so there oftentimes can be professional differences of opinion. It is critical that the plan sponsor obtain professional input they can trust and rely upon.

The American Academy of Actuaries is the primary organization granting credentials that are relied upon in the industry. One approach to obtaining relevant and reliable input is to insist that your advisor is a qualified health actuary with credentials from the Academy. In most situations, this individual would have both an FSA and MAAA credential and be a recognized member of the Society of Actuaries Health Section. Others are qualified to provide this type of input but valid actuarial credentials provide increased assurance that good input is being offered.