How Much Is Too Much:

Have Nonprofit Blue Cross Blue Shield Plans Amassed Excessive Amounts of Surplus?

EXECUTIVE SUMMARY

In the last decade, nonprofit Blue Cross and Blue Shield (BCBS) plans have set aside billions of dollars in surplus, even as they raised rates for many customers. Surplus is the excess of a company's assets over liabilities – essentially a health plan's retained profits—which plans hold to protect the company and its policyholders and providers from financial losses. Nonprofit BCBS plans, including community-owned charitable plans and subscriber-owned mutual plans, held more than $32 billion in surplus at the end of 2008.

Those surplus funds are built primarily with consumers' premium dollars, and insurers typically include a targeted contribution to surplus in rate increases. Surplus can be used to moderate premium increases, yet we found that some financially strong BCBS plans with large surpluses have continued to seek double-digit rate increases.

In our sampling of ten diverse nonprofit BCBS plans, we found that 7 out of 10 of the plans held more than three times the amount of surplus that regulators consider to be the minimum amount needed for solvency protection. For example, as of the end of 2009, BCBS of Arizona has surplus more than seven times the regulatory minimum. Health Care Service Corporation, a mutual insurer doing business as BCBS of Texas, Illinois, New Mexico and Oklahoma, has five times the regulatory minimum. Meanwhile, over the past three years both insurers continued to raise their rates.

In this report, Consumers Union provides background information, analysis and policy recommendations on many of the key issues concerning health insurer surplus.

CU's recommendations include:

• States should rigorously reexamine the purpose of surplus and establish minimum and maximum ranges of surplus based on current solvency risks and other appropriate factors, including affordability for consumers.
• Other non-solvency purposes for surplus, such as business "growth and development" should be transparently presented and weighed against the necessity to keep premiums affordable.
• States should analyze surplus as part of their review process for rate increases. When a company has more surplus than is necessary for solvency protection, regulators should consider disapproving additional contributions to surplus, which are included in premiums increases. In some cases, it may be appropriate to reject rate increases when previously accumulated surpluses are sufficient to absorb potential underwriting losses.

If surplus is found to be excessive, insurers should hold the excess in a rate stabilization reserve designed to offset rate increases, refund excess amounts to policyholders, or for nonprofit plans, spend the money for charitable purposes such as community health programs or affordable coverage initiatives.

• States should analyze surplus as part of their review process for rate increases. When a company has more surplus than is necessary for solvency protection, regulators should consider disapproving additional contributions to surplus, which are included in premiums increases. In some cases, it may be appropriate to reject rate increases when previously accumulated surpluses are sufficient to absorb potential underwriting losses.
• If surplus is found to be excessive, insurers should hold the excess in a rate stabilization reserve designed to offset rate increases, refund excess amounts to policyholders, or for nonprofit plans, spend the money for charitable purposes such as community health programs or affordable-coverage initiatives.

Introduction

American consumers and businesses have experienced rising costs of their health care for decades – often up to twice the rate of inflation for all other products. Before, during, and after the long legislative battle to pass major reforms of the health insurance system, polls consistently showed that consumers and businesses are more concerned about rising costs than any other of the numerous issues related to health care.

The newly enacted Patient Protection and Affordable Care Act (PPACA) does not contain direct cost controls on the price of health care goods and services. Instead, to slow cost growth, the Act relies on a variety of discrete changes intended to improve competition and transparency and to make our health care delivery system more cost-effective. With respect to rising premiums, the Act continues to leave review of rate increases to the states, which have traditionally had this responsibility. The new law does require the federal Department of Health and Human Services, in conjunction with the states, to establish a process for annual review of "unreasonable" rate increases and provides grants to states to improve their rate review. But the authority to approve or deny insurers' rate increases remains with the states, if they choose to exercise it.

Currently, a majority of states have given their regulators the responsibility to review and approve or deny some rates before increases go into effect; other states allow insurers to increase rates without pre-approval but give regulators authority to retroactively review increases. A handful of states merely require insurers to file rates "for information only."

Because the PPACA requires all Americans to have health insurance by 2014, it is imperative that states strive to maintain affordable premiums. This will require states to carefully scrutinize insurers' proposed rate increases to ensure they are absolutely necessary for maintaining the solvency of the system. States must exercise or expand their authority to refuse to allow rates to rise beyond that.

In this context, one issue that is becoming increasingly important as states use or improve their rate review is how much surplus an insurer should hold for solvency protection. Surplus is the difference between a health insurance company's assets and liabilities. In other words, surplus is primarily retained profits that are built with consumers' premium dollars and held by insurers. [1] The primary reason that insurers hold surplus is to protect the company against unexpected financial losses. Surplus may also be referred to as "net worth" or "capital and surplus." [2]

State regulations require all health insurers to hold a minimum amount of surplus to protect the solvency of the company and its ability to pay its members' medical claims in the event of financial losses. But while states require a minimum amount of surplus, most state laws do not set an upper limit on how much surplus an insurer can accumulate and hold. And in most states, regulators do not have an explicit mandate to consider an insurer's surplus level when deciding whether to approve or deny rate increases.

With few constraints on how high surplus can go, many health insurers have amassed millions or even billions of dollars in surplus, far beyond the required minimums. Even as they have become financially strong and able to weather a potential underwriting loss with minimal danger of insolvency, many insurers have continued to seek double-digit rate increases on individual market or small business consumers, and have continued to build even larger surpluses with premium dollars. In the face of the ever increasing cost burden on consumers, the question arises: how much surplus is too much?

This issue is particularly salient with respect to nonprofit Blue Cross Blue Shield plans because many nonprofit plans are chartered as "charitable and benevolent" organizations with a mission to provide affordable health care. Other nonprofit BCBS plans are organized as mutual companies that are owned by their policyholders. As nonprofits, the "profits" of these companies must be used for the benefit of their members or the community-at-large. BCBS plans potentially could use portions of surplus to reduce the need for large rate increases, but evidence suggests that they do not use these large stores of capital to moderate premiums.

In a few examples, Consumers Union found:

• Blue Cross Blue Shield of Arizona raised rates for its individual market customers between 14.5% and 19.4% in 2007, 13.1% and 15% in 2008, and 8.8% and 18.4% in 2009. From 2007 to 2009, the company grew surplus from $648.3 million to $717.1 million, an amount more than seven times the regulatory minimum.
• Regence Blue Cross Blue Shield of Oregon raised rates on some individual policies an average 25.3% in April 2009 and 16% in April 2010. As reported at the end of 2009, Regence has $565.2 million in surplus, about 3.6 times the regulatory minimum.
• Blue Cross Blue Shield of North Carolina raised rates on some individuals and families 18.44% in 2008, 8.5% in 2009, and 12.24% in 2010, while growing surplus to $1.4 billion in 2009, about 4.5 times the regulatory minimum.
• Health Care Service Corporation (HCSC), a mutual insurer doing business as Blue Cross Blue Shield of Texas, Illinois, New Mexico and Oklahoma, raised rates in Texas on some individual and family plans multiple times in a year from 2007 to 2010. Some Blue Cross Blue Shield of Texas rate increases exceeded 20%. In Illinois, the company raised rates 10.2% in 2007, 18% in 2008, and 8.4% in 2009 for some customers, and in New Mexico, some customers faced annual increases of more than 20% since 2007. At the time of these increases, HCSC's surplus grew from $6.1 billion in 2007 to $6.7 billion in 2009, up from $4.3 billion just four years earlier in 2005. The company's surplus is five times the amount that regulators consider to be the minimum necessary for solvency protection.

This report provides background information, analysis, and policy recommendations on many of the key issues concerning health insurer surplus. While this brief focuses on nonprofit BCBS plans, many of the principles and recommendations discussed may apply to for-profits as well.

Topics covered in this brief include:

• Why surplus is an important issue for consumers.
• How states currently regulate health insurer surplus.
• Aside from solvency protection, other purposes that nonprofit insurers identify as creating a need to maintain a large surplus. How does this affect premiums?
• Calculations of target surplus levels: is the methodology out of date? Are there signs of excess surplus in the system?
• Forums for addressing surplus adequacy: the states, the National Association of Insurance Commissioners, and the federal role.
• Recommendations for action.

Why Is Surplus An Important Issue For Consumers?

One out of three Americans with private health coverage is insured by a nonprofit Blue Cross and Blue Shield (BCBS) plan. [3] Those plans held more than $32 billion in surplus funds on their balance sheets at the end of 2008, an average of about $897 million per plan. [4] That represents a sharp increase over levels reported just a few years earlier.

The growing amount of surplus, particularly among nonprofit BCBS plans, has precipitated debate about how much surplus protection is adequate and cost-effective and how much surplus is "excessive." This debate has already begun to bubble up in state legislative and regulatory proceedings. The topic promises to come under even greater scrutiny as the rate review and insurance access provisions of the federal health reform law are implemented and as insurance regulators continue to confront the double-digit rate hikes sought by some plans.

All health insurance companies need surplus to reduce the likelihood of plan insolvency and to ensure that unforeseen contingencies do not render a company unable to meet its obligations to its policyholders and providers. Apart from a clear interest in assuring insurers' financial safety, consumers also have an interest in nonprofits' surplus because the funds are generated wholly or in large part out of subscriber dollars. While maintaining sufficient capital on hand to deal with potential financial difficulties is universally acknowledged as an essential aspect of consumer protection, accumulating more surplus than is necessary may impose an unwarranted financial burden on subscribers.

Subscribers contribute to surplus by paying a "risk and margin" component of their monthly premiums, sometimes referred to as a "contribution to surplus" or "contingency load." The amount of premium targeted as a contribution to surplus usually is between 1% and 6% of premium, although it may be higher or lower in individual cases. Thus, a contribution to surplus is built into subscribers' rates. When, in actual experience, the rates result in premiums exceeding medical claims and administrative expenses, the difference (profit) is added to surplus. Subscribers may also fund surpluses indirectly. When a health plan invests its profits in a portfolio of stocks and bonds or generates capital gains or losses on other business investments, these activities add to or reduce surplus. In sum, almost all surplus of nonprofit plans originates from subscriber dollars. [5]

State insurance regulators who oversee surplus funds typically have as their primary objective financial safety, namely protecting the solvency of insurance companies – making sure that plan subscribers and health care providers are not left with unpaid claims. As a result, their main focus is on setting and monitoring minimum surplus levels. And while all can agree that financial safety is of pre-eminent importance, regulators also need to become more attuned to the affordability of health insurance for consumers. They will have to broaden the scope of their financial review to make sure that accumulated surplus funds provide good value and are no more costly than necessary to provide reasonable financial safeguards.

How Is Surplus Currently Regulated?

The essential reason that nonprofit BCBS plans amass surplus is to protect their subscribers and health care providers against the risk of the plans' default, arising, primarily, through a sustained under-estimate of claims expenses. According to Scott Serota, the President and Chief Executive Officer of the Blue Cross and Blue Shield Association, "Blue Cross and Blue Shield companies maintain strong financial capital for one purpose – to ensure their ability to pay members' medical claims in good times and bad times..." [6] This purpose – hedging against unpredictable and unanticipated claims – is commonly called solvency protection.

Safeguards against the insolvency of insurance plans have long been at the forefront of regulatory policy toward surplus requirements. The insolvency of the West Virginia nonprofit BCBS plan in 1989-1990 galvanized intense efforts by state regulators to develop financial benchmarks, analytic tools, and reporting requirements to assure capital adequacy and provide an early warning of impending financial distress. The goal was to institutionalize a series of graduated regulatory responses that would address potential insolvencies before they boiled over.

The National Association of Insurance Commissioners (NAIC) took the lead, putting in place a set of model statutes and regulations incorporating a formula for minimum capitalization requirements, a tracking and enforcement system, and early warning triggers. With technical support from actuarial professionals, the NAIC developed a framework for determining minimum requirements for risk-based capital (RBC) for various types of insurers. The NAIC promulgated the Risk-Based Capital for Health Organizations Model Act in 1998 to link minimum surplus requirements to each carrier's unique risk and operational profile. Since then, more than 30 states have adopted statutes, regulations or bulletins that follow or are similar to the NAIC model for minimum surplus. [7]

Under the NAIC model, a company is assigned a minimum RBC level (i.e., a minimum amount of surplus) based on its exposure to various types of risk. If surplus for a company ever falls to this minimum RBC level, regulators are authorized to take control of the company – thus, the level is referred to as the "authorized control level" or RBC-ACL.

State regulators use five action levels to monitor the company's risk-based capital: (1) when capital and surplus is 200% or more of RBC-ACL, no action is taken; (2) when it is between 150% to 200% of RBC-ACL, the company must submit a financial plan to regulators describing what actions it will take to increase surplus and improve financial strength; (3) when it is between 100% and 150% of RBC-ACL, regulators have authority to examine the company and issue corrective orders to address financial problems; (4) at 70% to 100% of RBC-ACL regulators have authority to take control of the company; (5) if total capital and surplus is less than 70% of RBC-ACL, regulators are mandated to take control of the company.

Applying those risk-monitoring levels, 200% of RBC-ACL is commonly known as the minimum level of surplus that a health insurance company must hold because it is the point above which no regulatory action will be taken. The Blue Cross and Blue Shield Association requires BCBS companies to hold at least 375% of RBC-ACL to avoid triggering more active monitoring by the Association. If RBC-ACL falls below 200%, the Association may revoke the company's right to use the Blue Cross Blue Shield trademarks. [8]

The NAIC and the developers of the RBC system have consistently taken the position that the capital benchmark represents a minimum index of safety, not an optimal amount of surplus for health insurers. They have also argued that one carrier's RBC score cannot be compared directly with another's to reflect relative degrees of financial security. The RBC "score" represents, as a percentage, each company's actual surplus compared to RBC-ACL, the minimum required amount of surplus.

In addition to minimum surplus required under the NAIC model, states may have other minimum net worth requirements. Massachusetts, for example, uses the NAIC model and, in legislation enabling the merger of Blue Cross and Blue Shield, required the company to maintain a surplus not less than five percent of all expenses and insured claims incurred in each year. [9]

As stated above, there is a growing concern that current levels of surplus amounting to multiples of the NAIC benchmark (200% RBC-ACL) have gotten out of hand – more so in certain plans than others. For this report, we collected data for the period 2001 to 2009 for a mix of ten nonprofit BCBS plans that are incorporated as traditional public charities. The plans selected are of various sizes (ranging from large, statewide plans such as Blue Cross Blue Shield of Alabama to small sub-state plans such as Blue Cross of Northeastern Pennsylvania) and from a mix of states from Oregon to Massachusetts.

Table 1 presents the surplus in millions of dollars and RBC scores maintained by the ten plans in our sample. Each score can be compared against the NAIC minimum benchmark of 200% RBC-ACL, the point of triggering increased regulatory monitoring. In 2009, at the top of the range, the Arizona plan held surplus more than seven times the NAIC benchmark level; at the bottom, Alabama had about 2.5 times the NAIC's benchmark for RBC.

We can see from Table 1 that some plans are holding large amounts of surplus relative to their required minimum risk-based capital. [11] In 2001, the ten plans held a total of $4.61 billion in surplus, for an average of $32.90 per member per month. By 2009, surplus had risen sharply to $9.14 billion. This represented an average of $71.23 per member per month.

While the NAIC has established a protocol and system for regulating minimum surplus requirements, it has yet to address the corresponding question of appropriate maximum levels. There is currently no widely-accepted standard governing the level at which a health insurer's surplus would become excessive and inefficient. In recent years, however, the idea of enacting a reasonable surplus ceiling as the logical counterpart of a minimum surplus benchmark has begun to gain traction. Growing interest in a surplus ceiling has emerged from an amalgam of factors:

• The first factor is that surplus is accumulated from subscriber dollars, thereby contributing to rising premiums. Some experts had expected higher surpluses to function as a rate stabilizer; regrettably, there has been little evidence to support this proposition.
• The second stems from the growing gap between actual surplus levels and the much lower minimum surplus levels designated by the NAIC's model system. In some instances actual BCBS plan surpluses have exceeded the NAIC "safe" level by 5-6 fold or more, thereby raising questions about excessive surpluses. A related concern is the amount of the cushion between surplus levels and losses actually experienced by insurers.
• A third factor is that as nonprofit BCBS plan surpluses have trended higher, not all of those plans, particularly those chartered as charitable and benevolent organizations, have made commensurate contributions to certain charitable needs, especially affordable healthcare for the uninsured.

A handful of states have moved to limit "excessive" surplus. Pennsylvania pioneered one approach in 2005. In an opinion regarding the surplus of the state's four BCBS plans, the state Insurance Department developed what it viewed as sufficient RBC ratio ranges for each nonprofit BCBS insurer. The Department found that a sufficient surplus range for the two larger BCBS plans was 550% to 750% of RBC-ACL, while a sufficient range for the two small plans was 750% to 950%. Under the Department's order, the plans are not permitted to incorporate a contribution to surplus into premiums when they are operating within these ranges.

Specifically, the Department established four categories related to these ranges: surplus in excess of the plan-specific sufficient range is defined as "inefficient" or "excessive" and, unless justified, the plan must reduce surplus to the sufficient range; one step down, when surplus is within the "sufficient" range, no "risk and contigency factors" (i.e., contributions to surplus) will be permitted in premium rates; a step below the sufficient range, surplus will be deemed "efficient" and the plans will be allowed to incorporate contributions to surplus in rates; and below that, surplus will fall under benchmark levels and the plans will be exposed to regulatory intervention. [12]

Maryland has enacted a statute which authorizes its Insurance Commissioner to determine if a nonprofit company's surplus is "excessive" and to order the company to create a plan for distributing any excess surplus to subscribers. [13] Michigan has capped surplus for BCBS of Michigan at 1000% of RBC-ACL, but advocates have argued that the cap is not an appropriate standard for adequate surplus. [14]

In addition to these efforts to control surplus growth, some states with legal authority to approve or disapprove rate increases for certain types of BCBS business (e.g. coverage for individuals not insured by employer plans) have used their rate review process to zero in on the component of premium that goes directly to build surplus or profit. In Rhode Island, regulators have repeatedly denied Blue Cross and Blue Shield of Rhode Island's request for contributions to surplus of 2.5%. In two examples in 2007 and 2008, the state's Health Insurance Commissioner held that such contributions were not necessary when the non-group subscribers subject to the increase were "particularly vulnerable to the high costs of health care," and when Blue Cross surplus was above minimum requirements at more than 24% of premium revenue for the prior year. [15]

Similarly, as part of a recent rate decision, the Maine Insurance Commissioner denied Anthem Blue Cross and Blue Shield of Maine a profit margin in its proposed rate increase on the grounds that previously accumulated surpluses were sufficient to absorb any potential underwriting losses and that it was appropriate to balance Anthem's profit expectation against the financial hardship the increase would impose on subscribers. The Commissioner's decision was affirmed on appeal. [16]

Outside of those actions, most states do not put limits on how much surplus insurers can accumulate and most do not have an explicit mandate to consider whether surplus levels are sufficient or too high when deciding to approve or disapprove a requested rate increase.

ENDNOTES

[1] Throughout this report, the term "insurers" refers to all companies offering health insurance, including health maintenance organizations and preferred provider organizations. Unless otherwise noted, the term "nonprofit" in this report includes community-owned charitable organizations and subscriber-owned mutual plans.

[2] Insurers often refer to their surplus as "reserves." However, surplus is to be distinguished from reserves which are set aside for known liabilities, such as reserves for incurred but unpaid claims, funds containing pre-paid premiums, or funds set aside for future expected medical claims.

[3] This includes individuals in self-funded plans whose insurance is administered by a nonprofit Blue Cross and Blue Shield plan. Calculated from data in Alliance for Advancing Nonprofit Health Care, Basic Facts and Figures: Nonprofit Health Plans, http://www.nonprofithealthcare.org/resources/BasicFactsAndFigures-NonprofitHealthPlans9.9.08.pdf.

[4] A.M. Best, 2008 Market Review, August 10, 2009. While aggregate surplus for the BCBS plans dropped slightly from 2007 to 2008, this decline came after several years of growth.

[5] For-profit health insurers build surplus with subscribers dollars and may also raise capital in financial markets.

[6] Letter from Scott Serota, President and CEO of the Blue Cross and Blue Shield Association, to District of Columbia Insurance Commissioner Gennett Purcell, September 8, 2009, http://disb.dc.gov/disr/frames.asp?doc=/disr/lib/disr/pdf/serota_letter_re-carefirst-090809.pdf.

[7] See Risk-Based Capital General Overview, National Association of Insurance Commissioners, July 15, 2009, available at www.naic.org.

[8] The Association may require a particular BCBS company to have a minimum surplus even higher than 375% if other mechanisms for solvency protection are not in place.

[9] See Study of the Reserves and Surpluses of Health Insurers in Massachusetts, Massachusetts Division of Health Care Finance and Policy, May 2010, at pg. 4.

[10] The drop in reported surplus from 2004 to 2005 for Blue Cross Blue Shield of Massachusetts was the result of a change in company structure. Prior to 2005, HMO Blue was a division of BCBS MA and the annual financial statements of BCBS MA included the results for the HMO. In 2005, BCBS MA established HMO Blue as a wholly-owned subsidiary, and has since then filed separate financial statements for the two corporate entities. Thus, the surplus reported prior to 2005 includes HMO Blue, while the surplus since 2005 does not.

[11] Another measure of surplus sometimes used by insurers or regulators compares the amount of surplus in a given year to total revenues for the year. This measure is commonly called SAPOR, or "surplus as a percentage of revenue." A surplus that is 15% to 25% of revenue in a given year is sometimes considered adequate for solvency protection. For example, the Office of the Health Insurance Commissioner of Rhode Island uses surplus as a percentage of revenue at 23% as a benchmark for adequate surplus. See In re: Blue Cross & Blue Shield of Rhode Island – Class DIR, Recommendation of the Hearing Officer, Feb. 21, 2007.

For seven out of ten plans in our sample, the amount of surplus, measured as a percentage of revenue, increased from 2001 to 2009. In 2001, seven of the ten plans held surplus very close to or less than 25% of revenue. By 2009, only three plans held close to or less than 25%; the other seven plans held surplus as a percentage of revenue at 30% or higher.

[12] See In Re: Applications of Capital BlueCross, Highmark Inc., Hospital Service Association of Northeastern Pennsylvania and Independence Blue Cross for Approval of Reserves and Surplus, Determination of the Pennsylvania Insurance Commissioner, Feb. 9, 2005, pg. 36. The Commissioner stated, "if surplus is sufficient, such that any reasonably probable "drain" will not reduce surplus below a safe operating level, then there is arguably no purpose for accumulating additional surplus from ratepayers." (page 35).

[13] See Maryland Insurance Code § 14-117. The District of Columbia, which, like Maryland, has regulatory authority over CareFirst BCBS passed a statute, aimed at CareFirst surplus, requiring the company to "engage in community health reinvestment to the maximum feasible extent consistent with financial soundness and efficiency." D.C. Code § 31-3505.01.

[14] See e.g., Petition for Review, Abraham v. Blue Cross Blue Shield of Michigan, Brief for Petitioner Ghada Abraham, Sept. 8, 2008.

[15] See In re: Blue Cross & Blue Shield of Rhode Island – Class DIR, Recommendation of the Hearing Officer, Feb. 21, 2007 and Feb. 15, 2008.

[16] See "Anthem Sues State of Maine over Rate Hike Request Denial," Maine Public Broadcasting Network (Oct. 5, 2009), available at http://www.mpbn.net/; Anthem Health Plans of Maine, Inc. v. Superintendant of Insurance, No. BCD-WB- AP-08-24, April 21, 2010, available at http://www.maine.gov/pfr/insurance/.