On the Rebound.

The stop-loss market rang in the new year with big rate hikes. With a return to profitability on the horizon, the strategy seems to be working.

The medical stop-loss market is reeling from rate hikes of 40% this year, and some observers predict more rate hikes are necessary to return the market to normal. While employers are left staggering from sticker shock, insurers are beginning the turn a corner on profit and some reinsurers are considering entering the market.

Many insurers are waiting to see if January's rate hikes were enough to right the ship, with some people raising the possibility that rates would have to increase another 60% to 70% for the industry to get whole again.

Pat Campola, president of Lincoln Re Risk Management Services Inc., predicts another round of rate hikes in the range of 20% to 30% in 2001. "There will be a conservatism next year to make sure you got your numbers right," he said. Lincoln Re Risk Management, a subsidiary of Lincoln National Corp., places most of the risk it writes with sister company Lincoln Health & Casualty Insurance Co.

Medical stop-loss coverage protects self-funded health insurance plans against catastrophic claims. Stop-loss writers estimate that the market generates $4 billion in premium and say that HCC Benefits is the largest writer, followed by Safeco and Lincoln Re.

The stop-loss industry, which includes primary carriers and reinsurers at higher layers, has gone through significant changes recently because of rising medical costs, tighter underwriting, higher premium rates and a more prominent role for reinsurance. "The market is really different today than it was six months ago," said Craig Kelbel, chief executive officer of HCC Benefits, a subsidiary of HCC Insurance Holdings Inc., Houston.

Reinsurers Fuel Change

Reinsurers were forced to make those changes after bathing in red ink for the last several years. Informal industry surveys report that the health reinsurance market lost more than $690 million in 1997 and more than $1 billion in 1998. "Reinsurance is driving the positive market correction, although turmoil is one by-product in 2000," said David Kelley, director of marketing for Cairnstone Inc., a Miami-based managing general underwriter. Reinsurers reacting to the poor results began reducing capacity and strictly monitoring accounts, a role reinsurers rarely had taken before.

Cigna Corp. began pulling back from the medical stop-loss market in 1998. "We were still looking for potential market, but it never hardened sufficiently to make it worth our while," said Cigna spokesman Joseph Mondy. Cigna subsequently discontinued its health reinsurance division this year.

As reinsurers pulled out of the market, primary carriers followed like dominoes, not wanting to assume more risk in medical stoploss contracts. At the same time, reinsurers insisted on tighter control over their relationships with managing general underwriters. For example, some reinsurers began scheduling monthly visits with managing general underwriters to discuss their underwriting philosophies, said David Wilson, managing director of Apex Management Group, a healthcare actuarial firm in Princeton, N.J.

But as the market improves, reinsurers that were standing on the sidelines are stepping in slowly. "They didn't have to take the ride down, but they might want to take the ride up," Campola said. Reinsurers such as St. Paul Re and Tempest Re are looking selectively for opportunities and are eyeing business from managing general underwriters with quality underwriting staffs, said Steve Taylor, a vice president of D.W. Van Dyke, a reinsurance intermediary company in Westport, Conn.

Driven By Catastrophe

Stop-loss medical insurance offers protection to the self-funded employer if claims costs for one year rise above the aggregate. The aggregate is a projection of claims that is used in pricing coverage. The medical stop-loss insurance business is driven by catastrophic conditions, which affect only 1% of claimants but account for up to 30% of costs. Catastrophic claims include cancer, multiple births and transplants.

Rare just 10 years ago, transplants are more prevalent today, and insurers are just beginning to witness the cost impact of diseases such as hepatitis C, which can destroy the liver, Wilson said. Medical costs for hepatitis C are $15 billion annually, and the cost to treat the disease will peak at an estimated $26 billion per year around 2021, according to a recent Milliman & Robertson study. "One epidemiologist says by 2008 there will be a 500% increase in demand for liver transplants, a 300% increase in cirrhosis of the liver and liver cancer," Wilson said.

The rising cost and use of prescription drugs also affect medical stop-loss insurance rates. The main reason for their increased use, HCC's Kelbel said, is the increase of television and print ads for expensive prescription drugs.

"The public sees these ads and asks their physicians for advertised prescription drugs, which increases the use and cost to insurers of certain high-cost drugs," Kelbel said. HCC reports that if current trends persist, prescription drugs will exceed inpatient costs in the next three to five years.

Sticker Shock

Because previous rate increases were minimal through the early to mid-'90s, employers suffered from sticker shock when faced with the 40% rate hikes in January. "The [employers] who knew they were beating the system are looking to take on more risk now," Wilson said. "They realize this is the way it's got to be. Some are angry, but they have to realize they haven't paid their fair share in a number of years." Wilson also predicts an explosion of growth in self-funded health plans as health maintenance organizations increase premiums.

Currently, about 50 million U.S. workers and their dependents receive benefits through self-insured group health plans sponsored by their employers, according to a 2000 report by the Employee Benefit Research Institute. Employers are reacting to the medical stop-loss insurance rate increases by shopping around to make sure their rates are the industry standard. They also are asking their third-party administrators or brokers to redesign their plans so they can assume more risk and raise their deductibles, said Kelley of Cairnstone.

Kelley expects to see more employers turn to self-funding, but not for a year or so. Rather, they are waiting to see how the shakeout in the health insurance industry plays out before making a decision to switch. They are keeping a close eye on the managed-care industry, which is raising premiums, battling lawsuits and trying to improve its public image. At the same time, they are watching the changes in the medical stop-loss market.

"The reason you won't see a lot of people changing this year is because the health-care world is in turmoil this year, and when that happens a lot of employers are more interested in the status quo while developing a long-term strategy," Kelley said. "In 2001 and 2002, you'll see an uptick in self-funded plans."

The merging of disparate events in the early 1990s set the stage for the current state of the medical stop-loss market. With President Clinton promoting his national health-care agenda, the health-care industry held costs steady at record low levels after a few years of inflationary increases. Even with lower medical costs, uncertainty about the changing health-care market--including the advent of managed care--led stop-loss insurers to price their product very conservatively, Wilson said. "It caused them to overprice at a time when there was a lot of voluntary holdbacks in the health-care industry, so the stop-loss industry enjoyed a lucrative period," Wilson said.

This profitable market attracted more carriers. "We estimated the number of competitors in the late '80s were 50 to 60, whereas the number in the mid-'90s were 160 to 170," Campola said. However, many of the new competitors were underwriters that worked on behalf of the big carriers. But lacking full actuarial staffs and proper pricing models, they didn't have the sophistication of a large carrier. "The way they competed was they took your rate and cut it by 10%," Campola said.

A Heady Time

As a result, medical stop-loss coverage became perceived as a commodity because of the oversupply of potential reinsurance and stop-loss carriers, Kelley said. "There was no difference to some buyers, just buy the lowest rate," he said.

Nevertheless, it was a heady and lucrative time in the business. "Underwriters thought they were infallible," Kelly said. "It was difficult to make a mistake or to have a losing block of business. Everything was going the right way."

The high began to wear off in 1996 as the inexperienced competition, more

expensive medical procedures and poor underwriting returned the industry to reality. In 1998, people in the industry knew there could be a pricing problem, Campola said. The line of business wasn't producing projected profit margins, yet it took almost another year until the industry accepted the sobering fact that rates had to be raised.

"Who is going to be the first to raise rates? It's one of those things that the first one will end up watching a lot of their market share go somewhere else because the competition hasn't followed suit," Campola said.

"If we had perfect hindsight, rates should have started going back up as far back as 1997, but because of competition and lack of recognition of [the] trend, there was a delay of a pickup in prices," said Ed Martin, vice president, health care, Lincoln Re.

To gain the confidence of reinsurers and to ensure a profit, medical stop-loss insurers addressed their past underwriting problems. Most carriers and managing general underwriters confess that the industry ignored fundamental underwriting standards and chased revenue instead. "What happened is underwriters did not follow the manual rates as the proper rate to charge for a particular risk, and they let the market dictate what the rate should be. If you discount 10% each year and the trend is a 10% increase after a few years, you will be in the negative zone," Campola said.

Eventually, two underwriting principles were re-established to set rates.

Underwriters now are following the rates published in the actuarial manuals more closely. In the past, manual rates were used as a starting point, Campola said. Now, underwriters have to justify if they stray from those rates.

Underwriters also gave up the habit of basing their aggregate rates for medical stop-loss coverage on the premiums charged by HMOs. "Employers put pressure on stop-loss carriers to come close to the HMO number, and that had a negative effect o our aggregate experience," Campola said. Currently, Lincoln Re Risk Management is basing its aggregate number on an employer's past claims experience and medical costs trends.

Managing Claims

HCC Lees claims management as key to supporting its strategies. "You have to control catastrophic costs early on. Don't let them get out of control or let the patient drive the costs. You have to use your influence," Kelbel said.

HCC created a division, called Synergy, specifically to control claims. As soon as HCC is notified of a catastrophic claim, such as a transplant or multiple birth, Synergy's team of nurses a and medical director makes sure the patient's treatment makes sense. HCC is trying to avoid expensive complications that drive up costs, so it tries to match patients with high-quality treatment centers. "If you're going to have transplants or neonates, you should have them in facilities that handle those conditions on a daily basis," Kelbel said. "We try to get people to the right place so they can receive quality care and have a full recovery. It may cost more to go to a quality facility, but it's the ongoing cost you can control," Kelbel said.

Managing general underwriters and insurers see a continuation of rate increases and strict underwriting in the future. "We haven't fully recovered from rate deficiencies," Kelbel said. "I think they will go into next year, then there will be more modest increases and a more rational basis to compete with because the competition who needed to exit will have left."

Cairnstone, which insures groups with an average size of 350 people, sees managing general underwriters returning to competing on brand identity and value-added services, not on price.

"I believe that 2001 will mark a change where the stop-loss world is not viewed as a commodity," Kelley said. "Buyers will look at underwriting and medical-management capabilities, financial strength, responsiveness and service."