AN EVALUATION OF
IOWA'S HEALTH INSURANCE REFORM LAWS

Wake Forest University School of Medicine
Mark A. Hall, J.D., Principal Investigator
Elliot Wicks, Ph.D., Consultant
January 1999

 I. EXECUTIVE SUMMARY

II. BACKGROUND AND METHODS

This study evaluates how well Iowa's health insurance market reforms have met their objectives and whether they have avoided possible harms and failures. The primary focus is the state small-group market reform law, but this report also examines state law reforms of the individual health insurance market, and it takes a preliminary look at the small-group portions of the federal Health Insurance Portability and Accountability Act (HIPAA). This is part of an intensive case study of seven states that have enacted varying reforms (Colorado, Florida, Iowa, New York, North Carolina, Ohio and Vermont), funded by the Robert Wood Johnson Foundation. This multiple-case study consists primarily of two rounds of structured, in-depth, open-ended interviews, as well as an analysis of documentary and secondary data. The principal reforms under study are the series of enactments from 1991 through 1997 that provide the following for the small-group and individual markets: (1) guaranteed issue of some or all plans, (2) renewability and portability, (3) rating band restrictions, (4) restrictions on underwriting practices such as risk selection and preexisting condition exclusions, (5) voluntary reinsurance, and (6) public purchasing cooperatives. This report is intended to inform lawmakers, regulators, insurers, agents, purchasers, and the public policy community whether and how state and federal reforms have achieved their multiple purposes or caused any negative consequences, and how these reforms might be improved. The following is a summary of the major findings.

 On balance, Iowa's insurance market reforms have had a positive, but muted, effect in advancing their goals. These are the most successful features:

• The law has not caused major market disruptions and has been effectively administered.
• The market remains competitive in price, product diversity, and number of insurers.
• Enrollment has not declined in the small-group market.
• Price increases have been moderate, and there is less churning.
• The portability-to-individual-insurance provision has been popular.

• Very few standardized guaranteed-issue plans have sold in the small-group market, and there are indications of field underwriting.
• The small-group market remains highly concentrated in a few large competitors.
• Wide rate variation is still allowed, and carriers can still compete to a considerable extent on the basis of risk selection.
• The health insurance purchasing cooperative could not sustain its operations.
• Use of the reinsurance pool has been much lower than expected.

A. Methods

The primary sources of information for this study are various components of the insurance industry. In Iowa, we conducted two rounds of interviews, in the fall of 1997 and of 1998. Included in this interview pool are five independent agents, eight people with three insurers representing over 85% of the small-group market, five people with the Division of Insurance (DOI), and two reinsurance or purchasing cooperative administrators. These were semi-structured in-depth interviews lasting approximately 1-2 hours each. They were based on an interview guide, but the discussions were free-ranging and the coverage of topics varied somewhat among them. Most interviews were in person and one-on-one, but a number were over the phone and in groups of 2-5 subjects.

Also, we collected extensive documentary data and information from insurers, insurance regulators, and agents, and from newspapers and other academic and public policy studies. Finally, we conducted a market testing study to determine the ability of an actual small employer and unhealthy individual to obtain insurance. An employer with three employees contacted 18 agents throughout the state in May 1998 to inquire about the availability of health insurance for the group of three, as well as for a group of two plus individual coverage for one unhealthy employee. These multiple sources of information and data were analyzed using both qualitative and quantitative techniques.

This report is organized in two main sections. The first section reviews the history, purpose, and content of these reforms. The second section presents our findings, to evaluate whether these reforms achieved their purposes and avoided potential harms or failures.

Before we begin, a word or two is required about terminology. Health insurance, like any other industry, has a specialized vocabulary with terms of art that sometimes differ from common understandings, and that often are used inconsistently even within the industry, due in part to regulatory differences among the states. For our present purposes, we value simplicity over precision, so we will use a lay vocabulary that glosses over many of the distinctions that are important within the industry. Thus, we use "insurer" to include, generically, both indemnity carriers and health maintenance organizations (HMOs). We use "managed care" to refer primarily to HMO plans, including point-of-service (POS), in contrast with "indemnity," by which we mean both traditional unconstrained fee-for-service as well as more managed forms of indemnity such as preferred provider organizations (PPOs). When we speak of agents, we generally intend to refer to independent agents, which are sometimes called brokers. We use the terms premium, price, and rate interchangeably to refer to how much insurance costs. And, by health insurance, we mean comprehensive major medical, in contrast with more limited or specialized coverages. Other, more technical, terms will be defined later in the context in which they are important.

A final piece of background information is to note how Iowa compares with other states. Iowa is a small rural state that is much more racially homogeneous than national averages. A greater portion of its economy is concentrated in small firms and self-employed individuals than elsewhere. Health statistics and health care spending are better than national averages, and Iowa entered the reform era with fewer people uninsured (12% versus 18% nationally in 1992).

B. The Content and Purpose of Insurance Market Reforms

Iowa's insurance market reforms were enacted in stages from 1991 through 1997. Initial reforms were targeted to the small-group market, defined at first as employers with 2-25 workers but expanded in 1992 to groups of 50. Small-group portability provisions were adopted in 1991, rating restrictions in 1992, guaranteed issue of basic and standard plans in July 1994, and guaranteed issue of all small-group products in 1997. Individual market reforms began in April 1996, with rating restrictions and portability provisions, which were augmented slightly in 1997 to comply with HIPAA.

The core of these reforms is to make sure that any willing small-group purchaser has access to insurance and can retain that insurance through subsequent renewal periods. "Guaranteed issue" requires all insurers who participate in the small-group market to accept any applicant. An important distinction exists between states like Iowa that, prior to HIPAA, required guaranteed issue only for designated policies and states that require this for all policies. Prior to HIPAA, Iowa's small-group guaranteed-issue law applied only to two "state-mandated" plans, a bare-bones version called "basic" and a more common version called "standard." In 1997, however, Iowa conformed its law to HIPAA by requiring guaranteed issue of all small-group products.

Enabling any group to obtain insurance is coupled with a "whole group" concept, which requires the employer to offer coverage to all individuals within a group. This prevents employers from angling for lower-cost policies by excluding sicker individuals in the group and minimizes the selection problems that result if healthier individuals are allowed to drop out of the risk pool and purchase individual insurance. The latter technique is sometimes called "list billing," meaning that the insurer bills for the cost of individual coverage for a list of certain employees. To the extent this attempts to avoid reform laws by having employers pay for less-regulated individual insurance, this practice is usually prohibited. But in a unique move, Iowa law encourages list billing through what is known as the "conduit" provision in the law. This provision requires employers who do not offer group coverage to at least give their employees the opportunity to purchase individual coverage through list-billing arrangements that allow the convenience of payroll deduction.

Insurance reform laws promote continuity of coverage in three ways. First, insurers are prohibited from refusing to renew insurance except for fraud, nonpayment or similar malfeasance. Second, insurers are prohibited from ridering out specific health conditions altogether, and they are allowed to place only an initial 12-month preexisting exclusion on any condition manifested within six months before the date of coverage.

Third, these reforms promote "portability" or continuity of coverage by requiring that subscribers, once enrolled, be able to transfer coverage to a new insurer -- either by changing jobs or changing insurers within the same workplace -- without undergoing a new exclusion period, so long as the gap in coverage does not exceed two months. Iowa was one of the first states to extend the portability concept to the individual market, in a fashion that mirrors but predates HIPAA. Beginning April 1996, Iowa required that all insurers offer a basic and standard plan to anyone with prior group coverage within two months of application. This is not the same as a more encompassing guaranteed-issue requirement since it does not cover everyone applying for individual coverage. However, a similar effect is achieved in combination with Iowa's individual high-risk pool, called the Iowa Comprehensive Health Association. This industry-funded pool offers coverage for anyone declined or rated up for conventional individual insurance. After a year in this pool, a person may invoke the portability provisions just described to transfer to conventional individual coverage.

The next major component of the reforms is to construct a variety of rating restrictions that compress the degree of price variation among subscribers. Iowa follows the National Association of Insurance Commissioners' (NAIC) model by limiting year-to-year premium increases for any given small group to 15% above the insurer's "trend." Trend is defined as the increase in the insurers' rates for new business. The concept is to allow marketwide cost increases that are driven by technology advances, inflation in the medical sector and the like, but to limit those increases that reflect group-specific health risk.

The second component of the rating reforms prevents any insurer from varying its prices among subscribers at any point in time more than a defined range. For small-group products, rates can vary only +/- 25% from the midpoint for policies with similar benefits and "case characteristics." No rate variation for health status is allowed, however, for state-mandated basic and standard policies. Iowa adds another layer of complexity by allowing separate blocks or classes of business for different small-group policy forms. Following the original NAIC model, Iowa applies the small-group rating limits separately to each block or class of business, but to prevent circumvention of the rating limits by block gerrymandering (e.g., defining a block of business to consist of mostly sicker subscribers), the rating law also requires block midpoint rates to be within 20% of each other. Finally, rating differences are allowed to reflect the actuarial value of differences among benefits in different policies. As a consequence, considerable rating flexibility remains. Because each allowable factor can be added to each of the others, health risk adjustments can be as great as two-fold, and additional demographic adjustments can produce rates that vary several fold more at the extreme, although these distant outliers will be rare among groups.

Rating restrictions for the individual market are structured somewhat differently. No restrictions apply within a block, only among blocks. Thus, for a given policy form, there is no limit at the time the policy is issued on the extent to which rates can vary among individuals based on demographic or health risk factors, except for basic and standard individual policies which can have no health risk adjustment within the block. The rating limits apply only to block midpoint rates. For medically-underwritten coverage, block midpoints can vary only 30% for demographics, 30% for health status, and 20% for other factors. Rates for basic and standard plans can vary only half of these amounts. Also, annual rate increases for any block cannot be any more than 15% greater than for any other block.

The next major component of the insurance market reforms consists of two administered reinsurance and risk adjustment mechanisms that protect insurers from receiving a disproportionate share of very high risks. In the small-group market, there is a voluntary reinsurance pool that allows insurers to reinsure any risks that are expected to generate costs exceeding the prices they may charge. The principal funding for the reinsurance entity is from the reinsurance premium paid by the ceding insurer. Iowa follows the NAIC model, which allows insurers to cede to the pool either high-risk groups or individuals within these groups, on payment of a reinsurance premium that for groups is 150% and for individuals is 500% of the market average for the statutory standard benefit plan with the particular case characteristics in question. Since insurers will reinsure only those groups and individuals they predict will have higher expenses than these prices, the reinsurance entity is expected to suffer losses, which are spread back to the insurance market through assessments against participating insurers in proportion to their small-group market shares.

In the individual market, Iowa has a mandatory risk adjustment system for the guaranteed- issue basic and standard plans. This works differently than small-group reinsurance. Individual insurers with loss ratios less than 90% for these plans are assessed in order to subsidize those whose loss ratios are higher than 90%. Also, if individual insurers in the aggregate have a loss ratio above 90% for standard and basic plans, then group insurers are assessed in proportion to their market share, to bring the aggregate loss ratio down to this level. For this purpose, self-insured public and private employers also participate in the risk adjustment system. Doing so allows them to place their high-risk employees or family members directly in these basic and standard plans rather than their having to go first to the state high-risk pool.

The final component of the insurance market reforms in Iowa is a provision authorizing the formation of private purchasing cooperatives to be supervised by the DOI. This differs from the government-run or sponsored purchasing cooperatives that exist in several other states for the small-group market. In Iowa, rather than create a government purchasing cooperative, the reform law allows private cooperatives to operate under regulatory rules.

C. The Dangers of Reform

These reforms have attracted some critics who warn about possible adverse consequences, and a number of quieter voices that warn against setting hopes too high about their success. The strongest fear is that these reforms could be counterproductive, since they have the potential to increase prices and decrease coverage. These reforms may raise prices because they make insurance most attractive to the highest-risk subscribers by holding prices to less than the policy's actuarial value to them. The excess is built into the premiums paid by all purchasers, which will inevitably drive an undetermined number of lower-risk purchasers out of the market, thus raising the market average even more. This phenomenon is known as "adverse selection" against the market as a whole. This potential exists because the decision to purchase insurance remains voluntary, and existing purchasers are thought to be highly price sensitive.

These reforms also create the potential for administrative and regulatory complexity, circumvention, and strategic manipulation. High-risk individuals might pose as small groups to obtain more favorable rates. Low-risk employers might facilitate purchase of individual insurance by their workers or might try to artificially aggregate into groups that appear larger than the 50-worker threshold in order to avoid these laws. Insurers might attempt to avoid higher risks through various legitimate or illegitimate strategies, or they might pull entirely out of these regulated market segments. Also, these rules might cause distortions or unlevel parts of the competitive playing field that tend to favor some types of insurers over others.

This outline of the purposes of these reforms and their potential harms and failings points to four central criteria that can be used to evaluate the success of these reforms: the extent to which they promote (1) insurance availability, measured through increased enrollment; (2) affordability, measured through average prices; (3) market competition, measured in a variety of ways; and (4) regulatory administrability, also assessed in a variety of ways. This report organizes its analysis of the empirical evidence by focusing on these four criteria.

Various components of the reforms have importance across each of these categories. For instance, guaranteed issue, which points primarily to availability, also might increase prices or lead to various circumvention techniques that affect administrability. Or, rating restrictions, which affect primarily affordability, might result in less insurance being purchased. Many components of these reforms affect market competition, and some components, such as purchasing cooperatives, affect each of the criteria in equal measures. Therefore, this categorization scheme does not result in a neat pairing of each component and each effect. This is true to the complexity of this regulatory scheme, however, since each component interacts with all the others and with market and social conditions that are independent of these laws. Also, keep in mind as various statistical and descriptive data are presented that it is impossible to know for certain the actual and full impact of these reforms. A host of other economic and social conditions were changing simultaneously and so we will never know what the conditions would have been absent reform, even if we can tell what they are before and after reform. Nevertheless, by following the interwoven threads of information in this complex tapestry, it is possible to draw some solid conclusions about whether these reforms have worked as intended, and, if so, why, and, if not, why not.
 
 

A. Availability

1. Enrollment Gains

There is no clear evidence that Iowa's insurance market reforms have increased enrollment or decreased the overall level of uninsured, either statewide or in the individual or small employer markets. Statewide, the percent uninsured measured by the March Current Population Survey has fluctuated from year to year but has worsened somewhat since 1994, in contrast with the national figures which remain essentially unchanged (Table 1). Year-to-year fluctuations may be statistical artifacts of the small sample sizes in a state with a population the size of Iowa's. In the small-group market, private coverage appears to have declined somewhat following the 1994 reforms, as shown in Table 2 and Figure 1, but these trends are not statistically significant (at the p<.05 level) except for groups under 25, for which the 1997 level is significantly lower only with respect to 1991, three years prior to the full reforms¹.

The picture in the small-group market is somewhat more encouraging based on numbers reported by the Iowa Division of Insurance, collected through annual reporting from insurers. These reports show that the total number of small groups covered increased 15.5% from 1994 to 1997 (Table 3). Although this data source reports only the number of employer groups, not the number of employees, we saw no indication that the average number of enrollees per group has declined in recent years. However, national studies indicate that the proportion of employees per group who elect coverage has dropped in recent years, especially as the result of increased employee cost-sharing for dependent coverage. Therefore, total enrollment among small groups may not have increased, as suggested by the CPS figures above. On the other hand, the DOI data source reflects policies sold only by indemnity carriers, not by HMOs, and so the increase in the number of small groups covered may be greater than shown in Table 3. Still, the increase in absolute enrollment is not as revealing as the proportion of small groups enrolling. Economic changes may have resulted in a growth in the number of small employers, so the best measure of the level of insurance remains the CPS data, which shows no increase (Table 1). Also, we have found in other states that enrollment counts reported by insurers frequently contain errors.

A further possible indicator of whether small-group reforms have increased availability of insurance is the portion of new coverage that is sold to previously-uninsured groups. DOI data indicate that a remarkable 28-58% of new small-group purchasers lacked prior coverage (Table 3). However, we do not have confidence that this statistic is accurate and meaningful. Previously uninsured is defined by the DOI as lacking small group insurance during the three months prior to enrollment. This can include groups that were chronically uninsured, new businesses, groups whose previous insurance lapsed for three months, and previously-insured individuals or large groups switching to small-group coverage. Given the loose nature of this definition and questions about the accuracy of insurers' data (observe the disparities among insurers in Table 3), there is serious doubt about how much weight can be placed on this statistic.

Data sources are more limited with respect to the individual market. The Current Population Survey shows the portion of the population with individual coverage dropped almost two percentage points in 1997, the first full year of individual reforms. However, this drop may be a statistical artifact of the small sample sizes in a state of Iowa's size. By another measure, individual enrollment related to Iowa's reforms increased in 1997. Premium volume for basic and standard individual plans increased from $1.8 million in 1996, the first partial year of reform, to $9.9 million in 1997, the first full year under the reforms. However, either figure is only a tiny fraction (less than 2%) of total premium volume for individual coverage, so this provides only a limited view of the very early impact of the individual reforms.

On balance, we lack any clear indication that the level of coverage among small-firm workers or individuals has increased following insurance market reforms. Moreover, we have no way to tell whether any trends in enrollment detected from these sources are due to the law or instead result from underlying economic conditions or demographic trends. In order to gain more insight, we turn to the views of informed observers or participants in the market, and to statistics about the number of guaranteed-issue plans sold.

2. Agents Views

Several agents commented favorably about the impact of small-group reforms on insurance availability. One said:

One good indication of whether small-group reforms have increased insurance availability is to observe the number of statutory or "state-mandated" basic and standard benefit plans issued each year. Until 1997, these were the only plans stipulated as guaranteed issue, and so they sold primarily to groups that could not qualify for coverage under traditional, medically-underwritten policies. It is a good approximation that groups purchasing this coverage do so only as the result of the reform law. As reflected in Table 3, fewer than 500 employers have purchased this coverage statewide in the four years since the reform law. On an annualized basis, this is only about 1% of the total number of small groups covered and probably an even lower percentage of total enrollment since guaranteed-issue groups are usually much smaller on average than medically-underwritten groups (owing to the averaging effect that one or two sick individuals have on the insurability of groups of different size).

Almost all the agents we spoke to confirmed that sales of these state-mandated plans are low, and they gave a variety of explanations why. The most common explanation is the perceived inferiority of the benefit plans. The basic plan is a bare-bones type coverage with a low cap on maximum benefits. Although the standard plan is more comprehensive, it has a high deductible that resembles catastrophic coverage:

The final complaint we heard about the statutory plans is that selling them took more, rather than less, work, even though they are guaranteed issue, because prior to the 1997 law, applicants were forced to go through the medical-underwriting process to be eligible even when it was obvious they would be denied conventional coverage.

4. Field Underwriting and Agents Commissions

Insurance market reforms that seek to improve insurance availability can be hampered by various techniques of "field underwriting." This term refers to a practice of encouraging agents to screen out applicants they know or suspect are higher risk. In other lines of insurance, this practice efficiently avoids unnecessary work for the insurer and agent, and helps to steer subscribers to the plans and carriers that are most likely to offer affordable coverage. This practice also helps to detect when applicants are not being truthful about their risk factors. In part, this practice and these reasons explain why agents refer to themselves as underwriters in their professional certifications and trade association names, even though they do not perform the full underwriting function that insurers do in the home office. Property and casualty insurers, for instance, give their lead agents field manuals or software programs that contain the general underwriting parameters so agents will know whether it is worth their effort to submit applications. Insurers or general agents also give field agents informal, "pre-screening" opinions over the phone for the same purpose. As a result, for products that are not guaranteed issue, many applications from uninsurable clients never come in to the home office for a formal decision.

Although this practice may be legitimate and efficient for most lines of insurance, field underwriting for health insurance undermines the purpose of guaranteed-issue laws by making it more difficult for higher-risk applicants to find affordable coverage. This also creates an uneven playing field by encouraging agents to send higher-risk clients to one insurer rather than another. Many interview subjects acknowledged that field underwriting in various forms occurs for health insurance, although some subjects, such as this agent, said that it did not: "I think the carriers have been very honorable, and I think they're doing a good job." Other agents, however, explained in some detail how insurers encourage field underwriting:

The potential for field underwriting to undermine guaranteed issue is limited, however, by the independent status of most insurance agents and the fact they work on commission. Accordingly, their primary loyalty is to their clients, not the insurers, and they have every incentive to sell to both high- and low-risk groups. Indeed, to the extent commission revenue is higher for higher risks, perhaps the incentive is greater for these groups. One agent confirmed this very point:

5. Portability, Preexisting Conditions, and Individual Market Reforms

An aspect of Iowa's reform law that was viewed positively by almost all subjects is the cluster of provisions relating to portability and limits on preexisting condition exclusions. On limiting preexisting condition exclusions, one agent commented:

Iowa's insurance reforms have a unique provision known as the "conduit law," which rather than requiring employers to purchase insurance, requires only that they offer workers the option of buying individual insurance through payroll deduction. This is also known as "list billing," since insurers, rather than selling employers a group policy, send them a list each month of the amounts to deduct from workers' pay checks for insurance the workers purchase individually. Most other states prohibit list billing because they view this as circumvention of their small-group reform laws. Agents frequently dislike this prohibition. Iowa legislators saw the conduit law as a good way to expand coverage without imposing an employer mandate.

Most subjects commented that this law, while a good, innovative idea, has not had any noticeable effect in the market. Employers' only obligation is to give notice that this option exists, but employees seldom read or follow up on this information. It usually requires an agent to press the idea. However, one agent who specializes in selling insurance through list billing said that he could do this prior to the law just as well, so the conduit law has had no impact on his business. Another agent said the conduit law "is a sham as far as legislation is concerned. . . . I don't think it has impacted the desire to acquire insurance through the work site." A labor union representative has been quoted as saying this law is a "do-nothing type of thing," and one employer has called it "totally a waste of time." One informed subject said the conduit law had not been mentioned in over two years. One agent, however, thought the conduit law was working well and was prompting at least one insurer to promote more list billing arrangements:

1. Average Prices and Adverse Selection

In contrast with other states we have studied, we found no data sources in Iowa that allow us to track trends in small-group or individual insurance premiums or rates following the reform law. Therefore, we must rely entirely on the impressions of our interview subjects. Almost no one said that the reform law had driven up prices, as we heard in several other states we have studied. On the other hand, prices do not appear to have dropped or leveled off, as we observed in some other states. Instead, in the small-group market, we heard from most subjects that price increases in the first few years following reform were moderate, in the 6-8% range, but in 1998 prices have increased 8-15%. In both cases, these increases were approximately the same for large groups, indicating that the small-group reform law did not impose a large price burden. The somewhat lower price trends in other states may be due to the fierce competition for market share that resulted in those states from the rapid growth of managed care in their small-group markets, which has not occurred in Iowa. As noted below, this is not due to any defect in Iowa's reform laws but instead to the traditional preference in Iowa for indemnity coverage, and its more highly concentrated market both prior to and after reform.

The reform law might lead to increased prices it if caused adverse selection against the market in significant numbers, that is, if lower risks dropped out of the market and higher risks came in. One subject (quoted above) suggested that this might be the case in Iowa, to the extent that agents seek out high-risk business that was previously declined, but most subjects believed that significant adverse selection has not occurred in Iowa, even following the 1997 move to guaranteed issue for all products. Hence, any increases in price appear to be unrelated to the reform law.

Undoubtedly, employers and individuals continue to face affordability problems, but agents commented that employers who want to purchase insurance have found ways to reduce benefits or share the costs:

One reason that adverse selection has not been a problem is that Iowa's rating restrictions are looser than the community rating rules in some other states. Many subjects commented that the rating bands and allowable rating categories still permit a great deal of rate variation among groups and individuals based on health risk and demographic factors. Although the small-group bands appear to allow only a +/- 25% variation for individual health risk, this, in combination with allowable variation among blocks of business, still permits a 2:1 difference based on health status. One agent partially explained how this is so:

3. Benefit Adjustments and Pricing of Basic and Standard Plans

In addition to asking about the reform law's effects on average prices and the range in prices, we inquired about particular rating practices that relate to how the rating reforms are interpreted and implemented. Our main focus was on how well monitored or standardized are the actuarial judgments that lie behind various rating factors. The rating rules require insurers to provide actuarial justification and certification for their use of a variety of different rating factors and differentials. If this is not done consistently or evenhandedly among insurers, a wider or different degree of price variation might exist than even these fairly loose rules are intended to permit. For instance, the rules are designed to minimize premium variation among blocks of business due to risk selection effects, that is, due to healthier or sicker subscribers belonging to one risk pool rather than another. But, other rating factors, such as age, gender, location, and benefits, are allowed without constraint, as long as they are actuarially justified. The difficulty that arises is that an unconstrained rating factor might be used as a proxy or substitute for one that is meant to be limited. Thus, if both older and sicker patients choose one type of insurance over another, the age rating factor might be exaggerated to capture some of the health risk difference as well.

These examples are stated as theoretical possibilities, but several actuaries acknowledged the potential does exist to manipulate rating factors to some degree. The Division of Insurance requires actuarial certification, but only in the most general of terms. It does not routinely engage in detailed audits or require or inspect actual backup data to support actuarial conclusions. Nevertheless, no one complained that actuarial judgment and leeway were being abused.

In particular, we saw no indication that differences in benefit packages were being used to rate the state-mandated plans higher than is actuarially justified. This does happen in some other states we have studied, where the actuarial value of benefit differences are exaggerated in order to capture some of the health-risk characteristics of the different risk pools that purchased guaranteed-issue versus medically-underwritten coverage prior to HIPAA. In other states, there were extreme anomalies such as leaner "basic and standard" benefit packages costing more than medically-underwritten comprehensive coverage, or two guaranteed-issue plans that differ only by the size of the deductible having rate differences that exceed the deductible differential, due to the fact that higher risks prefer richer benefits. In Iowa, the reform law specifically addresses this concern, first by not allowing any rate variation based on health status for basic and standard plans, and second by requiring that "premiums for identical groups differ only by amounts attributable to plan design and not reflect differences due to the nature of the groups assumed to select particular health benefit plans."

These provisions appear to be somewhat but not entirely effective. Several agents, such as the following, commented that the standardized plans are favorably or reasonably priced, but they still cost more than traditional plans, even though their benefits are not as generous:

C. Market Competition

1. Market Structure and Price Competition

To assess the reform law's impact on market competition, we first examine the structure of the market. Our focus is mostly on the small-group market, since that is the only market segment for which we were provided data.

The health insurance market in Iowa has been and continues to be highly concentrated. Blue Cross continues to dominate with about 60% of small groups, and we are told it has a similar presence in the individual and large-group markets. Principal Mutual, the next largest, has maintained a small-group market share of about 25%. Only two or three other insurers have as much as 2-3% of the small-group market or sell to more than 50 new small groups a year.

This highly concentrated market has remained essentially unchanged in the three years following small-group reforms. We were told by some subjects that, following the reform law, a number of insurers pulled out of Iowa, but most of these apparently had microscopic market shares or were not actively seeking new business prior to the reforms. Some pulled out as part of a national plan of consolidation and strategic focus rather than in reaction to Iowa's version of the reform law. So, the effective number of competitors remains essentially the same as before the reform law.

We did not attempt to measure the degree of competition among agents, but we heard from some that the complexities of both the state and the federal reform laws have made it more difficult for agents to sell health insurance unless they specialize in this product.

We also inquired how price competitive the small-group market has been following reform. Although several interview subjects said the market is price competitive, we did not hear that there is the same degree of cut-throat price competition that we observed in other states, where price competition appears to have intensified following reform. Instead, we heard several comments that it remains difficult to compare prices among insurers. One subject noted that the basic and standard plans, which have the potential to allow "apples-to-apples" price comparison, do not have this result because the requirement of filling out a full application and undergoing medical underwriting before obtaining a quote makes it cumbersome to obtain multiple quotes. For medically-underwritten plans, the ability to engage in meaningful price shopping is undercut by the extent to which insurers can quote highly discounted rates at the low end of the rating band that do not reflect the actual price at which they are willing to sell. One agent explained:

One anticipated consequence of small-group market reforms was to alter the nature of competition by diminishing insurers' ability to compete based on their accuracy in evaluating health risk. From several indications, the reform law has not had this impact to any great extent. The degree of rate variation that is allowed among blocks of business and for various rating factors means that insurers can still compete through risk selection and rating prowess to a considerable extent. Also, several subjects, such as the following agent, noted that insurers attempt to engage in favorable risk selection by altering their benefit packages to avoid attracting the sickest subscribers:

One indication that competitive forces have not changed fundamentally in the small-group market is that, in sharp contrast to other states, there has been little movement toward HMOs. In other states, a rapid rise in HMO enrollment by small employers has coincided with small-group market reform laws, and there is some justification for concluding these laws have facilitated or precipitated this movement. This has not happened in Iowa. Both the individual and the small-group markets remain overwhelmingly indemnity-based. In 1996 and 1997, HMOs accounted for less than 5% of market enrollment, an amount one agent described as a "thimbleful." On the other hand, there has been some significant movement to other types of managed care, namely PPOs, which now account for the great bulk of small-group enrollment. Also, in our market testing study, 16 of 18 agents (89%) offered HMO or PPO coverage as an option to traditional indemnity, and five agents (27%) recommended this coverage. None appeared more favorable to indemnity. Thus, although HMOs still have a low market share, they are an available market option to most purchasers.

Low HMO penetration should not necessarily be seen as a consequence of the reform law. We were given several explanations for this phenomenon. First, we were told Iowans have a strong preference for indemnity-based insurance. Second, the sparse population in most parts of the state make it difficult to form exclusive or restrictive provider networks. In other states, large employers' movement to HMOs in the late 1980s and early 1990s paved the way for small-group enrollment in HMOs, since the necessary provider networks were already in place. These conditions conducive to managed care do not yet exist in Iowa.

In other states where HMO networks did exist for small employers, there was intense price competition, since HMOs were desperate for enrollment gains necessary to justify their investments in network development. The strong presence of HMOs also tended to alter the nature of competition, since they traditionally have not competed based on their medical underwriting skills. That these trends occurred at the same time as the reform laws in other states may be largely a coincidence rather than the result of the laws' design. But the fact that they did not happen in Iowa means that changes in competition have been much less pronounced than elsewhere.

4. Purchasing Cooperatives

The purchasing cooperative component of the reform law is intended to promote all of the purposes of the small-group reforms. But rather than scatter this discussion throughout each part of this report, we consolidate our evaluation here because most of the purposes relate directly to promoting market competition.

In 1994, the Independent Insurance Agents of Iowa, a trade association, created the Independent Health Alliance of Iowa (IHAI), which was also known by the generic name HIPC (pronounced "hippick") for health insurance purchasing cooperative. Its enrollment grew rapidly to over 600 groups and 4,000 lives within less than a year and to over 1,200 groups in its second year. At its peak, eight insurers participated. But the HIPC never came close to reaching the original expectation of hundreds of thousands of enrollees. It ceased operations in 1995 when John Alden, the largest insurer, pulled out and the company that contracted to do the administrative work was purchased. The new owner declined to renew the contract.

Opinions varied widely on whether the HIPC was a good idea, from "a terrific concept, a terrific idea for the consumer, a great idea for the agent" to "a nightmare for the customer." Rather than resolve this disagreement, we analyze what did and did not work well for the HIPC, and what lessons can be learned about its failure.

On the positive side, we heard that when the HIPC was operating, it achieved the two main objectives of enhanced employee choice and intensified price competition. The HIPC allowed individual employees to select from a large slate of insurers and benefit packages and to change their choices each year at open enrollment. One agent who commented on this positive feature said:

Other positive features included allowing employers more flexibility in how little they had to contribute to the premium (only 20% compared with the normal 50%), and requiring participation by as few as 50% of eligible employees. The HIPC also offered group insurance to self-employed individuals, who otherwise could purchase only individual coverage, and it allowed an easier route to obtain quotes on standard and basic guaranteed-issue plans.

As for the HIPC's negative features, several agents commented at length on the complexity and greater work involved both for them and for employers when individual employee choice is allowed. According to one:

Another drawback was that, even though a good number of insurers participated in the HIPC, neither of the two dominant insurers (Blue Cross and Principal) did. They account for over 85% of the small-group market. We heard various reasons why they may have declined, including sour grapes over being denied authority to operate a single-carrier purchasing cooperative. But for whatever reason, the HIPC opportunity attracted only insurers with very small market shares. Some agents said this made it more difficult to sell the HIPC to their clients, in part because the reputation of these smaller insurers was not as good:

A final set of features resulted in the HIPC's attracting worse risks than the outside market, which made it difficult to remain price competitive and made it less attractive to participating insurers. First, it was easier to obtain price quotes for basic and standard guaranteed-issue policies without having to undergo full medical underwriting. As a result:

Second, the HIPC adopted modified community rating rather than using the full flexibility of the rate bands, and it declined to use gender and industry rating factors that were in widespread use outside the HIPC, so its rates were disproportionately attractive to less-healthy populations. It also offered the same rates to groups of one, even though these are generally seen as being higher risk due to greater adverse selection and higher in per-person administrative costs. This reinforced the impression that the HIPC was primarily for people who could not afford insurance elsewhere, and it made the HIPC less attractive to insurers. It would have been difficult to avoid this result, however, without aggravating other problems, since the more rating factors and underwriting discretion that is allowed, the more complex the administrative operation becomes. One subject said that the individual-choice form of purchasing cooperative is feasible only with age-adjusted community rating, but this rating method is not feasible as long as risk rating is allowed in the rest of the market.

It is impossible to know whether the HIPC's failings could have been avoided or could still be corrected and the idea made to work. One informed source said that the two greatest obstacles were the lack of participation by Blue Cross and Principal Mutual, and the more liberal rating rules. Neither of these appear correctable without fairly fundamental changes in the reform law and the HIPC's structure, changes which would be legitimately opposed for other reasons. Nevertheless, two agents expressed regret that the HIPC idea did not succeed and hoped that it could be made viable.

D. Administrability

1. General Compliance and DOI Enforcement

Finally, we address a series of concerns about the administrability of these laws. The Division of Insurance has a knowledgeable and dedicated staff. When complaints are filed, the DOI has a reputation for responding quickly. One insurer commented that the DOI is vested in making these reforms work, and it is "all over" a problem once it is brought to their attention. One agent said:

In other respects, though, the DOI has not been fully effective. Due to limited resources and competing priorities, it has not initiated much enforcement or monitoring activity with respect to these laws. Its enforcement is almost entirely reactive, by responding to complaints, as this agent explained:

2. Border Problems

We also inquired into particular enforcement issues that might be especially troubling. One of those relates to field underwriting, which we discussed above. Other areas include associations and self-insurance. These are concerned with what we refer to as "border-crossing" problems. The potential for these problems arises when one segment of the market is regulated differently than another. This creates possible strategic advantages for low- or high-risk groups or individuals to cross into or out of the market, at either the high-size or low-size ends of the market, thereby unraveling or eroding the market divisions that are necessary to sustain this regulatory structure.

Associations. Good risks might leave the small-group market at the high end if small groups attempted to aggregate artificially into a group larger than 50. This might occur through what are known as associations, the variety of which are too complex to describe thoroughly. In the past, they have gone under the acronyms of MEWAs or METs. They also exist in the form of business and trade groups, such as chambers of commerce, that offer their members the chance to purchase a group policy.

Several subjects commented that association purchasing arrangements are much less prominent than prior to reform. This is due to the fact that the law looks behind the surface of the association and regulates insurance according to the size of the employer group that purchases it. Also, the rating rules no longer allow insurers to maintain large differences in rates for different blocks of small-group business. This limits the extent to which healthy groups can get lower rates by forming associations. These restrictions appear largely successful, although a couple of subjects commented that there have been some continuing problems with associations set up out-of-state not complying with the law.

Self-insurance. Another border-crossing concern is the threat that the reform law would induce medium-sized groups, those in the 25-50 range, to self-insure. This might occur if a group felt it could save money by avoiding the rating bands. It is primarily for this reason that rating rules are not extended to groups any larger than 50. Partial self-insurance can be marketed to smaller groups by selling stop-loss policies with very low attachment points, in the range of $10,000 per employee, which is equivalent to a high deductible catastrophic plan, but is structured to avoid characterizing the plan as ordinary insurance. However, we observed little indication this was happening. One agent noted that there was some of this activity prior to reform, but that it has since died out. Another agent, however, thought that more small employers have been self-insuring in recent years. However, this agent did not attribute this trend to the reform law, but rather to marketing efforts by TPA firms and the desire to avoid the premium tax and mandated benefit laws that apply to regulated insurance.

3. Reinsurance and Risk Adjustment

A final feature of the law that cuts across several of our categories of discussion is reinsurance and risk adjustment. These are intended to provide a relief valve for insurers who are forced by guaranteed issue or rating restrictions to accept risks they believe are not adequately covered by the allowable premiums. The small-group reinsurance pool has played almost no role, however. The two largest insurers, representing over 85% of the small-group market, have opted not to participate because they are large enough to absorb their own losses or purchase commercial reinsurance, and they fear that smaller insurers will use this mechanism more aggressively, thereby forcing them to pay assessments out of proportion to their use of the reinsurance pool. Among smaller insurers, although participation in the pool has remained widespread, at over 40 insurers, these insurers seldom use the pool. At its peak, in 1994, there were only 14 lives ceded to the pool, but this quickly shrunk to the present level of only a single person. Apparently, insurers concluded that they were ceding too many cases in the first year, cases that ultimately did not produce high claims. This is seen in the fact that the pool maintained a very enviable medical loss ratio (the portion of premium paid out in medical claims) of less than 2% through 1996.

The risk adjustment system established for individual-market basic and standard plans works differently than small-group reinsurance, and has had greater impact. Insurers whose loss ratios exceed 90% for these plans receive subsidies from other insurers and large self-insured groups. In 1996, six insurers were eligible for subsidies totaling about $95,000, which is about 5% of total premiums collected. In 1997, losses were much greater, such that five insurers were eligible for $3.5 million in subsidy, or about 36% of total premiums.
 
 

^{1Also, the 1996 level for the self-employed is significantly lower than in 1991 and 1993, but there is no obvious reason why this would result from the small-group reforms, and this may be an artifact of changes in the survey questions in 1994. Also, coverage for the self-employed improved sharply in 1997, although not with statistical significance.}