Sink or swim: the future of small health plans is in question, but many are taking steps to ensure their long-term sustainability in the market.

Small health insurers are tossed on a sea of change. Although some experts predict the plans will survive the storm, others believe regional and community-based organizations may get caught in the undertow of consolidation and globalization by many of the large national plans and will soon disappear from the market.

A recent Conning Research and Consulting Inc. study, "Small Health Insurers: Long-Term Survivors or Lunch-Time Snacks," points to the latter. Authors of the study anticipate that the number of small managed-care organizations, which Conning defines as those with less than $500 million of direct health premiums, will diminish slowly over the next several years with continuing consolidation by many of the larger players.

While others agree the hunger for consolidation by some large health plans won't cease anytime soon, they believe small health plans are positioning for the future with diversification of products, entrance into the consumer-directed health arena and close bonds with their provider networks.

Small Ships

Small health plans dominate their larger counterparts in number by a ratio of two to one. However, the small health insurer sector now controls less than 10% of health insurance premiums in the United States, according to Conning.

While many small plans have experienced modest but consistent growth over the past several years, Conning analyst James Smith said profitability has been more erratic. As a result, they are vulnerable to become targets for the larger and stronger companies looking to complete their offerings. Double-digit premium increases are engulfing the industry, and many large national health plans are turning to consolidation as a solution.

Even for profitable small insurers, long-term independence is not guaranteed, said Smith. "Larger insurers seeking to expand market share often look to acquire successful companies that have established sound local and regional relationships with hospitals and providers."

Another potential challenge to their long-term sustainability is that some small health plans are finding it difficult to compete for price against larger players. "Claims volatility has crippled some small plans," said Smith. "Larger plans can often outbid their smaller competitors because they are more able to withstand claims volatility in a particular region." He believes smaller niche players, however, have a more secured position in the market. "They often fly under the radar screen and experience reasonable but moderate profitability and growth," he said.

The epicenter for many successful small health plans has been the mid-western and southern regions of the United States, said Smith. Their recipe for success has been to grow premium and constrain expenses over the past several years, in addition to building solid relationships with different providers. The majority of the companies are prevalent in the Medicaid market.

In its study, Conning examines the outlook for three segments of the small health plan market. Small managed-care organizations that provide comprehensive hospital and medical, Medicare supplement, Federal Employees Health Benefit Plans, Title XVIII Medicare and/or Title XIX Medicaid, overall have achieved steady business growth over the years, yet many have not been able to produce consistently profitable results as they have grown, according to the study. Conning expects these will gradually decrease in number over the next several years.

California-based small managed-care organizations also may face challenges. While these companies, which comprise about 6% of the state's managed care business, have been able to gain and maintain a significant foothold in the state's Title XIX Medicaid market, their lack of diversification across other product lines could lead to future problems, according to the study. A third sector, small accident and health insurers, have struggled over the years to produce solid profits; however, their success comes from confining theft business to regional or one- to two-state areas or by focusing nearly exclusively on one product offering. Conning also foresees a decline in the number of these organizations in the next several years. Small accident and health plans that have carved out a profitable niche, however, may be bought out by larger entities, particularly if their product offerings and geographical presences complement the larger player's strategic business plans, the study found.

Fighting to Survive

Many small health plans are implementing strategies to stay afloat. "For one, they're solidifying their relationships in the industry, particularly with hospitals and providers," said Conning's Smith. Because health care is often a locally driven model, many industry experts believe regional or community-based health plans hold an advantage over larger players due to their close ties with their network providers.

Local ties also offer pricing advantages and allow for local nimbleness to field specific products, said Merit Smith, vice president and director of management consultant Robert E. Nolan Co.'s health-care practice.

Diversifying product offerings is another strategy some small health plans are using to compete against larger counterparts. "Everyone is concerned about cost, quality and delivery, so if you're a passive arms-length insurer, you can ignore these, but ultimately someone has to address them," said Jack Ebeler, president and chief executive officer for the Alliance of Community Health Plans, an organization that brings together health plans and provider organizations. "Smaller and community-based plans are increasingly turning to consumers as decision makers, and they are now diversifying their financing products very dramatically. The days of one-size-fits-all product solutions are nearly gone."

The boon of consumer-driven health plans across the industry is expected to spike even higher over the next two years, and small plans are beginning to jump on the bandwagon. For instance, smaller plans are increasingly eyeing health savings account options for employers and members.

Many believe small niche players also will sustain their place in the market. "There's a niche market out there and there will still be a need for smaller regional players in the future that can fill a niche that some of the larger players cannot," said Bill Epling, regional vice president and chief financial officer for HomeTown Health Network, a locally owned and operated management care organization that centers on small to medium-sized employer groups and the Medicare market.

Plans that don't carve out a niche in the next years will face challenges due to the capital requirements needed to support infrastructure that keeps them competitive, said Jean Reed, senior vice president of managed care for Sioux Falls, S.D.-based Avera Health Plans.

Smaller plans also are increasingly going after specialty-product markets that are being offered by many larger nationals, such as dental, vision and ancillary products.

They now understand they need them to achieve growth, said Nolan's Smith. But companies have yet to determine how they will accomplish that goal, he added.

According to Conning, both small and large plans focus primarily on comprehensive business--a combination of hospital and medical coverages through plans such as health maintenance organizations and preferred provider organizations. This product line accounts for a little more than half of the premium income generated by small managed care organizations, while nearly 70% of the larger plans' premiums are generated by comprehensive business. Smaller plans tend to concentrate more of their resources to the Medicaid market. More than 30% of the small plans' premiums are dedicated to the Medicaid line, compared with only 8% for larger companies. For the most part, larger companies dominate the Medicare market, said Conning's Smith. Less than 14% of small plans' premium base consists of Medicare business.

Nolan's Smith also believes small health plans have an upper hand when it comes to creative plan designs and product innovations. "The small guys may get squeezed out of the multisite market by the nationals and will have to deal with the affordability crisis, but they may respond to it more creatively than the nationals. There's an emergence of services and ways of delivering care that are just off the radar screen, such as with the use of debit or prepaid service cards," said Smith.

Some smaller health plans are looking at the possibility of outsourcing or forming alliances for important capabilities, said David Knott, managing partner for Booz Allen Hamilton's New York office. "So where the smaller plan doesn't have scale economies in their own core business, they can turn to utility players or large outsourcing companies with enormous scale and capability and capitalize on that scale."

Technology also is becoming a focus for some smaller players. While many have lagged behind larger health plans due to financial constraints, they're now starting to make strides with advanced and sophisticated Web-based tools for consumers, distributors and employers.

Onward Bound

"Many of these plans are probably in better shape than they look on financials because they may not be public and may be commingled with a hospital system," said Nolan's Smith.

Growing opportunities in Medicare also may open the door for some small plans. "Plans can thrive in that market by serving local consumers," said Ebeler of the Alliance of Community Health Plans."And I think to the degree that the market focuses on quality measurements, you'll see small organizations improving and there's opportunity for them to thrive in the market that many outsiders are skeptical about--a market with much more consumer empowerment."

But will continued consolidation change the landscape of the small player? "As larger companies continue to eye each other, many may choose to ignore the smaller ones," said Conning's Smith. "But, the larger players positioning efforts over the next few quarters are still likely to dictate the next strategic steps for many of the smaller players," he said.

Key Points

* Small health insurers outnumber their larger counterparts two to one, but control less than 10% of health insurance premiums in the United States.

* Some small health plans are attractive targets for larger health plans looking to consolidate or complete their offerings.

* Small health plans have the advantage of close, local ties with provider networks, which in turn create strong distribution networks and pricing advantages.

Learn More

Avera Health Plans Inc. A.M. Best Company # 64515 Distribution: Independent agents, brokers, direct

HomeTown Health Network A.M. Best Company # 68576 Distribution: Associated broker agencies, internal sales staff

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