Behind BSCA's 2% Solution

Blue Shield isn't exactly a media darling, but even California news outlets seemed content to spread the upbeat news that a major insurer was capping its income and—get this—was taking this bold step voluntarily. Throw in the refund to policyholders and Blue Shield garners some high fives.

Usually when an insurer makes this type of gesture there's a regulator standing behind the curtain pushing the health plan spokesperson into the media spotlight.

That was pretty much the case in September 2010 when Blue Cross Blue Shield of North Carolina announced that it would make $156 million in refunds to its individual policyholders. In that case state regulators discovered that the Blues plan was collecting reserves to pay for future claims that could extend beyond 2014.

In Colorado, Anthem Blue Cross and Blue Shield agreed in September 2010 to provide a premium credit totaling $20 million to about 90,000 individuals. The refund was linked to a Colorado Department of Insurance review of consumer complaints following rate increases by the insurer.

But in the case of Blue Shield of California, no one had to push company CEO Bob Bodaken out into the public eye. He embraced it. There was a press conference where two-heavy hitters, Bodaken and Paul Markovich, Blue Shield's COO, fielded a wide range of questions. And then there was Bodaken's speech at the Commonwealth Club in San Francisco.

The message was consistent: Blue Shield is taking this step to help make healthcare affordable.

But as optimistic as I want to be, almost a week later a couple of things still bother me about this announcement – what's magical about 2%? And what does any of this have to do with lowering healthcare costs?

In an e-mail statement, Jonny Wong, a Blue Shield spokesperson, said the 2% reflects what the company needs to "make sure we remain strong and viable well into the future, we determined that 2% was the appropriate amount based on several factors. We need to preserve our ability to pay claims, garner an A rating from rating agencies, finance capital improvements like IT and other infrastructure investments, and maintain a prudent reserve for the unexpected, such as earthquakes, pandemics, or public policy changes."

I decided to pose the 2% question to a healthcare analyst who understands the nuts and bolts of health plan finances a lot better than I do. Uwe E. Reinhardt, a Princeton professor and an authority on healthcare economics, fit the bill. He suggested in an e-mail exchange that the 2% is probably close to what Blue Shield estimates will be its average margin over the long run anyway.

A 2% to 3% margin is actually common among nonprofits. Blue Shield's margin in 2010 was 3.1% and so its board decided to make its first round of refunds based on that margin.

Reinhardt said the 2% isn't much as a percent of the premiums paid, but it's a lot as a percent of Blue Shield's value added. He explained that "usually, an insurer pays 80% to 85% of the premium for health benefits. Those are just pass-through costs. There is no reason why an insurer should earn any profits on those costs at all."

But the remaining 15% to 20% of the premium represents the insurer's own production – its value added – for things like marketing, claims processing, managing care, negotiating prices, etc. According to Reinhardt, even with a margin of 2% Blue Shield can still get a 10% to 15% return on the value added. "That's a very handsome return."

Okay, so maybe Blue Shield isn't taking a huge gamble with this step, but I still don't understand how holding profits to a 2% margin and refunding $80 to $340 once a year to some health plan members helps hold down costs.

It doesn't, Reinhardt says . "It does virtually nothing to control costs, which are driven by what hospitals do and what they charge for it, and ditto for MDs and drug companies. It's a good PR move."

Blue Shield could use some good PR right now. There's certainly no love lost between the California Department of Insurance and Blue Shield; the two have been fighting about rate increases for years. Dave Jones, head of the DOI, even termed Blue Shield's announcements as "essentially an admission by the insurer that it is…making excessive profits."

Jones is behind AB-52, which is winding its way through the California legislation. The bill will give extend the DOI's authority concerning insurance rates from just reviewing to approving or denying.

Blue Shield and a host of other health insurers in the state oppose that move. Some see the 2% announcement as an effort to convince lawmakers that the industry can self-regulate.

So if this is just for PR purposes, Reinhardt concedes it's a good gimmick and suggests that other health plans take the same step. "If they are smart, they will. It's a good PR gimmick, certainly for the non-profits."