Archimedes was more of a philosopher than an actuary. Still, he helped explain an important yet little understood phenomenon in medical premiums more than two millennia ago when he uttered the statement, “Give me a place to stand and with a lever I shall move the world.”
Archimedes understood the concept of leverage. It’s a term closely associated with physics and helps explain how a subtle force, when applied in the optimal proportion with a fulcrum in the optimal position, can have a disproportionate effect on the movement of an object.
In the medical insurance market, we have a situation in which a concept called leverage actually increases premiums above and beyond increases in unit prices and the number of units consumed. Medical insurance leverage isn’t as powerful a force as leverage is in the physical universe, but it does exhibit a slight and consistent upward pull on premiums unless it’s corrected.
Let’s examine this phenomenon and discuss some strategies that employers can use to minimize the financial impact of this force.
What is leverage in a medical insurance context? It’s the change in the portion of medical expenses paid by insurers and patients when patients face a fixed dollar cost (a copay or deductible) and the insurer is responsible for the balance of an increasing cost.
Here’s a very simple example: An insurer negotiates a reimbursement rate of $100 for a physician visit. The patient is responsible for a $20 copay and the insurer pays the $80 balance. Fast forward four years, when the negotiated rate for that visit is now $130. The patient still pays $20, while the insurer now reimburses $110. The total cost of the service increases by 30% ($130/$100). The insurer’s payment increases by 37.5% ($110/$80).
The difference doesn’t seem like much, until you multiply it by six to eight visits per year for each of 150 covered lives at a company with 70 employees. With leverage, the insurer’s financial responsibility rises at a rate higher than total medical costs because of the cost-shift from patients to insurers. Insurers then adjust their premiums to reflect their financial responsibility (which increases with leverage) rather than total cost of care.
Strategies to minimize the impact of leverage
What’s the antidote to eliminate or minimize the impact of leverage on premiums?
Option 1: Raise patients’ financial responsibility.
The simplest counterweight is to raise patients’ costs to reflect the rise in negotiated rates for services. For example, if average negotiated rates increase by 10% in a given year, raising office visit copays from $25 to $27.50 maintains the balance. The annual rebalancing is impractical. A more viable strategy is to increase the copay by an even-dollar figure like $5 after two years, increasing the copay from $25 in year one to $30 in year three.
Increasing the deductible – say, by 10% from $2,000 to $2,200 in our example above – also protects the employer against the impact off leverage, though leverage is not as much of a problem with a deductible as it is with services subject to a copay. Why? Most individuals don’t satisfy their entire deductibles in a year. If that office visit above were subject to the deductible and it increased from $100 to $130, the patient would pay the entire bill (thus negating leverage entirely, as the insurer doesn’t reimburse any of the cost). Increasing the deductible protects employers from leverage among employees and dependents who exceed the deductible (typically 15% to 50% of the employer population, depending on plan design and dollar value of the deductible).
Employers can achieve the same objective over a period of several years by making periodic adjustments. For example, an employer moves from a $2,000 to a $2,500 deductible in the third year (when a second 10% annual increase in negotiated rates moves the unleveraged deductible to $2,420).
An alternative approach is for an employer to purchase a medical plan with a very high-deductible (say, $5,000 for self-only coverage) and then fund a Health Reimbursement Arrangement (HRA) to reimburse the back end of the deductible (say, the final $3,000, making the net deductible $2,000). The employer can then decrease the value of the HRA each year, leaving employees with a larger share of the deductible – but more even percentage of rising total claims costs – before the HRA begins to reimburse claims.
Option 2: Introduce coinsurance.
Coinsurance refers to the process of splitting costs between patients and insurers on a percentage basis, rather than assigning a fixed-dollar responsibility to patients. We typically see coinsurance reflecting the insurer’s portion of the bill ranging from 50% to 90%.
Until recently, coinsurance was applied primarily to services delivered by non-contracted providers. To discourage patients’ utilizing providers outside the insurer’s network (who don’t fall under the negotiated pricing or plan rules that apply within the network) insurers often impose a separate, higher deductible on out-of-network services and apply coinsurance as well.
Coinsurance is a perfect antidote to leverage because both patients and insurer pay the same percentage of a rising bill. As a result, a growing number of employers are choosing plans that introduce in-network coinsurance. Rather than covering services at 100% after the patient has met the deductible, many plans now impose coinsurance. Thus, while the services subject to deductible create leverage when the patient satisfies the deductible, additional services subject to coinsurance maintain the financial balance between patient and insurer and thus don’t increase leverage.
Coinsurance is also growing in popularity for higher-tier prescription drugs. As the cost of specialty pharmaceuticals rises out of proportion to total medical spending, coinsurance helps insurers reduce the impact of leverage.
Most plans cap a patient’s total cost for a drug, which then increases leverage. For example, a patient responsible for 30% of a $5,000 drug must pay $1,500. If the insurer caps the patient’s responsibility at $500, the insurer covers $4,500. If the cost of the drug increases to $6,000 (+20%) the following year and the cap remains at $500, the insurer’s cost increases by the full $1,000 (+22.2%).
One challenge with coinsurance is setting the right percentage – one that requires patients to pay an adequate share of the total bill without discouraging them from seeking necessary care. A 20% coinsurance on a $120 physician visit ($24) is less than a $30 or $35 copay that is becoming the standard in most plans. Increasing the coinsurance to 30% solves that problem, but it may create a barrier to care for a diabetic patient who needs $5,000 of care (an additional $500 in coinsurance responsibility) to manage her condition.
Option 3: Increase employees’ share of premiums.
A third method of managing the impact of leverage is to increase the share of the total premium for which employees are responsible. This is an imperfect approach, since it isn’t directly tied to medical costs and doesn’t target individuals who actually utilize services and thus drive leverage.
It is, however, a simple and subtle way of minimizing the impact of leverage on employers. As leverage drives the total premium higher than the increase in negotiated rates, employers pass along some of that increased cost to employees, who pay a smaller percentage of the total provider bill when prices rise but a larger percentage of the total premium, thus keeping employer and employee costs in balance in the aggregate.
Putting leverage in perspective
Leverage is not the main driver of premium increases. Prices per unit of care and total units of care consumed are by far the largest contributors to annual increases in premiums. Leverage is a smaller factor, but one that employers can manage when they understand what leverage is and how it contributes to their escalating premiums.
Over time, though, like compounding interest and the flow of the Colorado River through what we now call the Grand Canyon, the subtle annual impact of leverage can multiply to become a factor in premiums.