As an avid reader of the JofA, I have come to trust it to provide me with accurate and useful information. Having worked in the health care insurance industry for the past six years, I was dismayed at the misinformation presented in a recent article titled "Ask Your Health Plan to Say 'Ahhh'" ( JofA, Mar.99, page 37). Although the article made some very valuable points, a CPA unfamiliar with the insurance industry would find it impossible to distinguish between fact and fiction.
Following are my views and corrections:
- FHP was merged into PacifiCare in February 1997, but FHP was not a subsidiary nor was it in any way affiliated with Foundation Health Corp. or Health Systems International. The merger of these two companies had nothing to do with the merger of FHP and PacifiCare or the problems of FHP.
- The author does not expand on the information available from state departments of insurance, which regulate health maintenance organizations (HMOs). In most states HMOs are required to file an annual statement prepared in accordance with the accounting practices and procedures developed by the National Association of Insurance Commissioners (NAIC). The detail in the annual statement provides a CPA with all the information necessary to determine the financial solvency of an HMO.
- In exhibit 3, the author lists signs that warn of impending financial problems. Among these is "incurred but not reported" (IBNR), which represents the cost of services to members for which the HMO has not received a claim, not "invoiced but not received" as used in the article. "Received but not paid" (RBNP) is the term used to identify claims the health plan has received, but not processed for payment, or claims in process of adjustment. Together, these two amounts represent the claims payable liability of the plan. Using IBNR to judge the prompt payment of claims is not appropriate, unless the HMO is not reporting claims they have in process of payment. RBNP, however, may provide information regarding a claims backlog or timely payment problem. These amounts are disclosed in the annual statement.
- Medical-loss ratio (MLR) is the total medical and hospital service charges (net of reinsurance) divided by premiums, not premiums less administrative costs. MLR is an indicator of the appropriate pricing of the plan. The article says "the higher the MLR the better." I disagree. The higher the MLR the more financially unstable or underpriced the plan. MLR has nothing to do with efficiency. The appropriate measure of efficiency is the administrative expense ratio or total administrative expenses divided by premiums. The lower the ratio, the more efficient the plan at administering health care services. The standard for managed care organizations should be 10% to 15%. For traditional insurance companies that primarily offer PPO/indemnity, coverage should be 15% to 25%.
- The most appropriate measure of financial stability for an HMO (although not discussed in the article) is the "risk-based capital" (RBC) level. In 1998, the NAIC adopted RBC. RBC has been used for years with traditional insurance companies and measures four areas of risk in an HMO—asset, underwriting, credit and business. The baseline RBC for a company is the "authorized control level" (ACL), and a company is generally required to have more than 200% of ACL. This is called the "company action level" (CAL). If a company is at or below CAL, it must provide its regulator with a plan of how it will improve or strengthen its capital position or total net worth of the company.
- The author quotes Ann Robinow on her concerns about a fluctuating stock market: "Many health plans have been making money not on operations but on investments." This shows a lack of understanding of the insurance industry, which historically makes most of its earnings on investments not operations. Given that the average profit margin in health insurance is 3% to 5%, of which investment earnings may comprise one-half, it is misleading to say that a plan making money on investments is a concern. Also, the insinuation that HMOs are investing in riskier stocks is ludicrous. And the idea that HMOs might raise premiums due to a stock market correction is totally false. Most states have regulations that dictate the amount of admitted assets an HMO can have in stocks or foreign investments. The RBC asset risk analysis looks at the quality of investments that the HMO holds. U.S. government securities are deemed the safest investment and carry no risk. All other bonds are rated by NAIC's securities valuation office as class 1 to 6, with 1 being the highest quality, lowest risk. Stocks are deemed highly volatile and are given a large risk discount. If an HMO invests in stocks or low quality/high risk bonds, it is required to have a higher level of capital than an HMO that holds only U.S. government securities.
I would have expected the author to have performed better research in preparing the article. I believe the errors contained therein do a great disservice to CPAs and I recommend that the JofA seriously consider printing a correction to ensure the integrity of the CPA as a valuable and knowledgeable consultant.
Andre M. Lortz, CPA Pueblo, Colorado
Editor's reply: Mr. Lortz is correct in pointing out that FHP is not now and never was affiliated with Foundation Health Corp. That assertion resulted from an editing error, and we apologize for it.
There are many approaches to evaluating the financial risks of health insurance plans, and the JofA welcomes the suggestions Mr. Lortz offers to supplement those discussed in the article, such as making greater use of the extensive data available from state insurance boards and using the RBC and ACL ratios he describes.
In the article, we took an approach to evaluating the risks of health insurance plans we hope many members in business and industry will find enlightening and others choosing health care plans will find practical. Mr. Lortz seems to read the article as being unfairly critical of the health care industry. Many of the issues discussed are not clear-cut accounting standards but matters of opinion about which management accountants are entitled to differing views. Ms. Robinow is entitled to her opinion, as is Mr. Lortz.
CPAs of the future will need to look at management issues from many different perspectives, including that of the customer, as the article does. Accordingly, the JofA stands by the article as a practical and provocative aid for CPAs, especially those in business and industry. In the future we hope to run more pieces that inspire CPAs to take creative approaches to problem solving.
Emily S. Plishner, CFA Senior Editor