Indemnity insurance: down but not out

Indemnity insurance: down but not out – indemnity health insurance

Harris Meyer

Indemnity health insurance is dead, right? Not exactly. About 30 percent of Americans with employer-sponsored coverage still opt for traditional plans. If you count those who are in PPOs, point-of-service (POS) plans, Medicare and Medicaid, then the majority of Americans still have coverage that allows them a broad choice of providers who get paid for whatever services they deliver. The fact is, indemnity insurance retains a stubborn appeal and a well-defined niche.

Even as managed care solidifies its domination, millions of Americans insist that they have a right to free choice of provider. And as managed care’s warts become more noticeable, some analysts believe consumers could even demand a return to fee-for-service coverage. “Choice and freedom are part of our culture,” says Ralph Smith, president of the Houston Health Care Purchasing Organization, a coalition of 40 large companies and 2,500 smaller ones. The conventional wisdom is that everyone will soon be in an HMO but, says Smith, “if you look closely you’ll see the country is starting to turn in the other direction.”

Smith’s stance is extreme, but not completely beyond reason. Last year’s Foster Higgins survey of benefits found that about two-thirds of companies with over 1,000 workers continue to offer indemnity plans. (Seventy percent of those plans are self-funded.) Still, indemnity enrollment is way down, from 49 percent in 1992 to 27 percent in 1995 at companies with 500 or more workers. Only 16 percent of the Foster Higgins respondents think they need to offer an indemnity plan to attract and retain employees. Indemnity is the sole option at just 15 percent of large companies, half the percentage reported two years ago.

But there are other forces at work preserving indemnity. The nation’s 180 or so indemnity carriers from the 63 Blues plans to national giants like Aetna and Mutual of Omaha to regional carriers like Medical Benefits Mutual–remain a potent political force, especially in state legislatures. And they aren’t rolling over to play dead. Instead, they are consolidating for greater efficiency, buying or teaming up with managed care firms, borrowing cost-saving techniques from managed care, streamlining administrative processes and redesigning benefits to stay competitive. They also retain a stable and lucrative niche administering employers’ self-funded benefit programs. They stand to benefit greatly if tax-favored medical savings accounts (MSAs) become a reality in the next few years.

The way indemnity insurers try to preserve their niche will affect employer-sponsored benefit plans for years to come. What follows is an analysis of indemnity plans’ place in today’s health care landscape and how indemnity insurers are adapting.


The big, old-line insurers have played both sides of the street for years. Prudential, CIGNA, Aetna, Travelers and MetLife (before the latter two merged their health products in 1995) moved to managed care throughout the late 1980s and early 1990s, even as they continued to sell indemnity coverage. CIGNA, Aetna and Prudential continue to use their strength as indemnity carriers and full-service insurers to attract and hold clients with a mix of the old and the new.

Many Blue Cross and Blue Shield plans took the same tack. Blues insurers now own or operate some 200 HMOs, PPOs and POS plans in almost every state. Of the 64 million Blues enrollees nationwide, nearly 30 million are in managed care. That still leaves over 34 million with indemnity coverage. In some geographic areas, indemnity occupies the larger share of the Blues business.

In the last year, a handful of leading health insurers have adopted a more aggressive survival tactic. Blue Cross and Blue Shield of Ohio, for example, agreed last month to a $230 million merger with hospital giant Columbia/HCA–the first liaison of its kind for Columbia and for any Blues plan. If approved by state regulators, the deal would give Columbia control of most of the Ohio Blues’ operations and its 1.5 million covered lives, which are divided 60/40 in favor of managed care. Columbia will strengthen the Ohio Blues financially, with a $300 million infusion of cash reserves. But with hospitals making more money from indemnity insurance, it’s not clear whether Columbia will seek to expedite the movement of the plan’s indemnity policyholders into managed care.

Meanwhile, Aetna’s $8.9 billion purchase of HMO giant U.S. Healthcare, also announced last month, is one of the largest deals ever to combine an old-line insurer with a cutting-edge managed care firm. Aetna gains managed care expertise, clout and market position that it’s been struggling to build for several years. But the insurer brings a national presence, a full array of health products and strong employer focus to the deal.

Aetna’s health business encompasses 11.4 million people nationwide: 4 million in indemnity coverage, 6 million in PPOs and 1.4 million in HMOs. Aetna serves an additional 10 million people through self-insured plans, utilization review contracts, disability and life insurance and behavioral, vision and dental carveouts. U.S. Healthcare brings 2.8 million fully insured enrollees.

Analysts agree that the Aetna/U.S. Healthcare deal will facilitate the giant insurer’s move to managed care. Less talked about is the fact that the deal will create a company, Aetna Inc., that can offer employers a strong mix of health insurance products–from traditional and managed indemnity to HMOs and PPO networks. Employers hope, too, that a combined Aetna/U.S. Healthcare will gain more clout with providers in many markets, bringing down costs and passing along the savings. A merger of this size could have the opposite effect in some markets, however, decreasing price competition in locations where both U.S. Healthcare and Aetna have large market shares.

The new company’s long-term vision has yet to emerge. But Allen Maltz, Aetna’s chief actuary, interviewed before the deal was announced, forecast indemnity’s decline to about 15 percent of the market by the year 2000.


Lacking Aetna’s size and deep pockets, Mutual of Omaha, with 6.3 million covered lives–90 percent of them in indemnity plans– has taken a savvy if less spectacular approach to survival. It has transformed itself into a “managed indemnity” company. Mutual has introduced case management, lower cost-sharing for patients who use some discounted specialty networks and centers of excellence and more coverage for preventive care. The company also plans to require precertification for outpatient surgical procedures. Ron Mimick, the company’s product manager, hastens to note that indemnity plans will lose their appeal if they become HMO clones. “Our intent is to maintain the freedom of choice of providers, at least for day-to-day things like office visits,” he says.

Another indemnity insurer, Pacific Mutual, based in Fountain Valley, Calif., is also making big changes. The company, which has 800,000 covered lives nationwide, is teaming up with providers and PPOs to offer plans with varying degrees of choice. And it’s sharing risk directly with doctors and hospitals. Pacific Mutual’s Jim Burke says the strategy is to appeal to employers’ desire to preserve choice of provider and allow them to keep closer tabs on where the money goes than they could with capitated HMOs. Pacific Mutual has also teamed up with HMO Kaiser Permanente to offer POS and indemnity options. That’s enabled Kaiser, which had no previous experience outside its staff-model HMO structure, to provide out-of-network options to the growing number of companies that are demanding some freedom of choice for their workers.


The future is far less certain for the smaller indemnity carriers. On one hand, they benefit from the disappearance of competitors like Travelers and MetLife. On the other, they face enormous price pressure and a shrinking pool of customers. After 10 to 20 percent rate increases each year from the mid-1980s to 1994, indemnity plan costs rose just 4.4 percent last year. The insurance rating service, A.M. Best Co., estimates that commercial health insurers’ 1995 earnings fell a whopping 30 percent from the previous year.

What’s more, most analysts agree that the era of shadow pricing–in which HMO premiums are pegged just under indemnity rates to attract customers–is over. Most HMOs no longer see themselves as competing against indemnity plans but against each other. The disparity between HMO and indemnity prices has grown larger as a result.

The smaller carriers also claim to have been hurt badly by small group market reform laws, now on the books in 47 states. A study released last month by the Council for Affordable Health Insurance, an Alexandria, Va.-based trade and lobbying group for small indemnity carriers, concludes that state-imposed guaranteed issue and community rating reforms have triggered price increases in the small group market 20 to 30 percent above what they would have been without the reforms. The council based its conclusions on only seven states, however, and regulators questioned the numbers.

Indemnity carriers, with Mutual of Omaha and Golden Rule Life Insurance in the lead, have lobbied state legislators hard on this issue. The companies say they can’t keep premiums affordable and operate profitably if they aren’t allowed to do some underwriting and screen out individuals and groups that try to buy insurance just when they know they need costly care. And they’ve begun to win some important battles. The Kentucky legislature, for instance, last month repealed part of its 1994 insurance reform bill, which instituted modified community ratings, in the wake of data showing small business paid more after the measure took effect.


What really strikes fear in the hearts of indemnity carriers is the possibility of a death spiral. They worry that as rates are forced up by regulations and the need for larger reserves, the price gap between managed care and indemnity plans will grow, healthier subscribers will flee en masse and the sicker plan members will stay.

In fact, indemnity plans already have a less healthy pool of enrollees. But two factors are at work that could reduce the likelihood of the scenario the carriers fear. After years of attracting larger numbers of healthy enrollees, HMOs and other managed care plans are finally getting a greater share of sicker and higher-risk people. In addition, some form of risk adjustment or subsidized reinsurance pool could become the norm in the not-too-distant future. That would mean indemnity plans with less healthy subscriber pools receive premium dollars shifted from plans with healthier pools.

Not surprisingly, indemnity carriers and their trade groups, such as the Health Insurance Association of America and the Council for Affordable Health Insurance, are intensely interested in risk adjustment. But Richard Coorsh, an HIAA spokesman, cautions that there is no consensus yet on how this would or should work. And it’s far from certain that managed care plans would agree to subsidize indemnity insurers unless a nearly foolproof risk adjustment formula could be found.

Meanwhile, many indemnity carriers have something more concrete going for them. While statistics show that employers in the aggregate are paying 10 percent, 20 percent or even 40 percent more for indemnity coverage than for managed care, in some markets and for some employers the net difference is negligible. A recent study of 37 Fortune 100 companies by benefit consultants Towers Perrin, for example, found that while HMOs undeniably delivered more efficient care–with savings from utilization controls estimated at 19 percent they did not save companies money over indemnity plans. Why? Because the higher costs of the richer coverage (with no co-pays, and reduced deductibles or cost-sharing) offset the efficiency gains.

In markets where HMOs are less effective at controlling costs, it may be cheaper to maintain an indemnity plan, advises Emmett Seaborn, a Towers Perrin principal based in Stamford, Conn., who conducted the study. But he cautions benefits managers to carefully break down costs by location, employee health status and plan design rather than looking at the bottom line alone.

Indemnity carriers have another ace up their sleeve. With the managed care revolution centered in urban and suburban America, indemnity coverage is the only game in thousands of small towns. But how long will that last? Recent market dynamics have given managed care plans the incentive to spread to less populous areas. Larger companies are no longer content with indemnity coverage for employees in far-flung outposts, and small businesses have become a growth opportunity as they get more comfortable with managed care.

Last year’s Foster Higgins report found that 40 percent of employers with 10 to 499 workers now offer a PPO plan, up from 30 percent in 1994; 27 percent offer an HMO, a rise from 22 in 1994. The majority say they switched to save money and expand employee choice, while a sizable minority continue to offer indemnity coverage only because no suitable managed care plan is available. Towers Perrin’s Emmett Seaborn also says many companies have grown tired of trying to convince a small group of sicker, higher-paid and more risk-averse employees to move out of indemnity into managed care plans. “Twenty to 30 percent of people are pretty intransigent and aren’t likely to move no matter how companies design their benefits,” Seaborn says.


There’s one benefit design that is keeping small employers anchored to indemnity: the move to self-fund and win ERISA preemption. Indemnity carriers have been very successful in marketing low-threshold stop-loss coverage to small employers, who then self-insure the first $2,000 to $5,000 of their liability and register as ERISA-qualified plans.

But this tactic is threatened, too. Many states are moving to set $10,000 to $25,000 thresholds for stop-loss coverage, while indemnity insurers fight tooth and nail to keep the threshold below $5,000. If they prevail, as they have already in a few states, indemnity will hold on to an important and even growing niche (See News & Trends, April).

MSAs would make that niche even bigger. If Congress approves tax exclusions for such accounts this year or next, MSAs are widely expected to be packaged primarily with indemnity catastrophic coverage. But there are widely varying estimates of how many employers will be interested and just how MSA plans will be designed. The American Academy of Actuaries estimates that the MSA legislation now being debated in Congress, if passed, could establish an option that would attract from 10 to 15 percent of the population, mostly employees of small businesses. The academy warns, however, that risk selection of the healthy would be a serious problem. Advocates scoff at that notion and say that market share could go higher.

MSAs could give some indemnity carriers other advantages as well. Diversified insurers like Fortis, for example, are well-positioned to develop attractive portfolios of products around MSAs, says Carl Schramm, a Baltimore-based insurance consultant and former head of the HIAA. For instance, they could design plans to allow customers to use MSA funds for long-term care coverage. Schramm predicts that if MSAs get the green light in Washington, smaller and mid-size indemnity carriers will become hot properties for acquisition by Aetna, CIGNA and Prudential and the big managed care operators.

Everyone in the industry is waiting on tenterhooks to see if Congress passes, and the president signs, an insurance reform bill this year. The portability measures at the center of the bills wending their way through Congress would apply to all health plans and products, but indemnity carriers would feel the impact most acutely. And passage of group-to-individual portability measures could force indemnity insurers to raise rates in the individual market, they claim. But while the prospect of federal reforms may cause more acute anxiety among indemnity insurers than among other players in the health care industry, they clearly have every intention of staying in the game.

Harris Meyer is a health care writer in Chicago.

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