HD32 - The Review of The Blue Cross/Blue Shield Plans' Administrative Expenses, Reserves and Investments in Subsidiaries and Affilliates

  • Published: 1988
  • Author: State Corporation Commission
  • Enabling Authority: House Joint Resolution 284 (Regular Session, 1987)

Executive Summary:
The 1987 General Assembly requested in House Joint Resolution 284 that the State Corporation Commission conduct a review of the Blue Cross/Blue Shield plans operating in Virginia regarding the following criteria for operational efficiency, including, where appropriate, comparisons with commercial health insurers and Blue Cross/Blue Shield plans in other states:

A. the percentage of subscriber premiums devoted to administrative expense;

B. the adequacy, inadequacy or excessiveness of reserves; and

C. whether the amount of the Blue Cross/Blue Shield Plans' investment in subsidiaries and affiliates poses any undue risk for Blue Cross/Blue Shield subscribers.

In addition, the Commission was requested to make a determination based on its review of the above-referenced criteria as to whether Blue Cross/Blue Shield subscribers are exposed to unreasonable expense or undue risk. The Commission was instructed to report its findings to the 1988 General Assembly and, in the event that the Commission recommended further study, the report was to set forth the proposed study objectives and research design as well as the estimated cost of such further study.

After examining the methodology necessary to conduct this study and in recognition of the time requirements and current internal staffing capability, the State Corporation Commission contracted with Technical Associates, Incorporated to conduct an operational review of the performance and diversification of the two Blue Cross/Blue Shield plans for the period 1984 to 1986. These were the years in which diversification activities had been most prominent. Technical Associates was requested to present its findings to the Commission for consideration as part of the Commission's report.

The study was conducted under the direction of the State Corporation Commission's Bureau of Insurance. The two Blue Cross/Blue Shield plans cooperated in providing extensive information necessary to conduct this study. The results of the research of Technical Associates are found in Section II of this report.

The original report was presented by Technical Associates to the Commission in October, 1987. The original report covered data and analysis through the end of 1986. The Commission, upon reading the original report, became concerned that performance trends of underwriting and administrative expenses and reserve levels were deteriorating. In view of these concerns, the Commission requested that Technical Associates· update the report through the end of the third quarter of 1987 (September 30, 1987). This update would provide the Commission and the General Assembly with more current information about the Blue Cross/Blue Shield plans. The results of the updated report are found in Section III of this report.

After analyzing the original and updated reports prepared by Technical Associates, the Commission concurs with the factual findings contained in those reports.

With respect to the specific criteria for review set forth in House Joint Resolution 284, the Commission's findings are as follows:

A. The percentage of subscriber premiums devoted to administrative expense.

1. Blue Cross/Blue Shield plans experience significantly lower expense ratios than commercial accident and health insurers.

2. The expense ratios for Blue Cross/Blue Shield plans in Virginia as well as in other states have worsened during the period of study.

3. Blue Cross/Blue Shield plans in Virginia perform similarly to their counterparts in other states. Blue Cross/Blue Shield of Virginia consistently had a more favorable expense ratio than the average for other states' plans during the entire period of study. Blue Cross/Blue Shield of the National Capital Area, however, consistently had a less favorable expense ratio than the average for other states' plans during the entire period of study.

4. The Blue Cross/Blue Shield Plan of the National Capital Area's claims adjustment and administrative expense components of total expenses are well in excess of similar ratios for the Blue Cross/Blue Shield Plan of Virginia and for Blue Cross/Blue Shield plans of other states.

B. The adequacy, inadequacy or excessiveness of reserves.

1. The average number of surplus reserve days for commercial accident and health insurers and Blue Cross/Blue Shield plans in other states is in the same range.

2. Blue Cross/Blue Shield plans in Virginia have a considerably lower number of surplus reserve days than the average for commercial accident and health insurers and Blue Cross/Blue Shield plans in other states.

3. The Blue Cross/Blue Shield Plan of Virginia's number of surplus reserve days declined considerably during the period of study but is still above the 30 day minimum reserve requirement established by the Commission. The number of surplus reserve days went from 66.3 in 1984 to 45.3 through September, 1987 rising as high as 74.6 in 1985.

4. The Blue Cross/Blue Shield .Plan of the National Capital Area's surplus reserve days declined significantly during the period of study. The number of surplus reserve days went from 71.4 in 1984 to 26.6 through September, 1987 rising as high as 73.4 in 1985. This is 3.4 days below the 30 day minimum reserve requirement established by the Commission. The Commission is concerned that the reserves for this Plan may no longer be adequate.

5. The Commission has concern about the potential adequacy of reserves for both Blue Cross/Blue Shield plans in Virginia based on declining trends in performance during the period of study.

A primary indicator of performance for purposes of this study is the underwriting ratio. This underwriting ratio combines the loss ratio and the expense ratio. The ratio does not take into account investment income. A ratio in excess of 100% indicates that, to the extent not offset by investment income, a plan is losing money and its number of surplus reserve days will decrease.

Both plans have experienced a deterioration in the underwriting ratio which has continued throughout the entire period of study. Through September, 1987 the Blue Cross/Blue Shield Plan of Virginia had a 105.5% underwriting ratio and the comparable ratio for the Blue Cross/Blue Shield Plan of the National Capital Area was 106.6%. This performance, coupled with the continuous decline in the number of surplus reserve days is the focus of the Commission's concern regarding the potential adequacy of reserves for the plans in Virginia.

C. Whether the amount of the Blue Cross/Blue Shield Plans' investment in subsidiaries and affiliates poses any undue risk for Blue Cross/Blue Shield subscribers.

Blue Cross/Blue Shield of Virginia subscribers lost at least $14.3 million in reserve level protection due to investments in affiliates. This figure is based on the fact that the Plan received only $21.7 million for the $36 million it reported it invested in for-profit subsidiaries of Consolidated Healthcare, Inc. Reserves have also been affected to some degree by the substitution of $21.7 million in Consolidated Healthcare, Inc. preferred stock for high grade securities whose dividends are dependent on the flow of funds from Blue Cross/Blue Shield of Virginia.

It is reasonable to conclude that diversification has posed risk for subscribers of the Blue Cross/Blue Shield Plan of Virginia and that such risk actually resulted in losses. At the same time, the risk of diversification was not so significant that it seriously undermined the performance of Blue Cross/Blue Shield of Virginia or jeopardized the interests of subscribers.

For the future, the risk resulting from diversification will continue to prevail for subscribers of Blue Cross/Blue Shield of Virginia. The extent of that risk will depend on a host of factors such as the growth in diversification activities, the performance of affiliates, and the performance of Blue Cross/Blue Shield of Virginia.

With respect to the Blue Cross/Blue Shield Plan of the National Capital Area, this Plan lost $16.2 million due to diversification activities. This figure is based on the combined equity position of the subsidiaries in 1986 (negative $13 million), coupled with the initial investment in subsidiaries of $3.3 million. In addition, the Plan has guaranteed more than $20 million of the lines of credit of its subsidiaries, and was owed more than $9 million by its subsidiaries at mid-year 1987.

The main difference between the two Blue Cross/Blue Shield plans operating in Virginia is the number of surplus reserve days available to absorb losses in the performance of the Plans or their affiliates or subsidiaries. The Blue Cross/Blue Shield Plan of Virginia's number of surplus reserve days stood at 66.3 in 1984, 74.6 in 1985 and lowered to 51.8 in 1986 and 45.3 through September, 1987. The figure for the Blue Cross/Blue Shield Plan of the National Capital Area was 71.4 in 1984, 73.4 in 1985, but down to 40.4 in 1986 and further down to 26.6 through September, 1987. Further, losses in subsidiary operations rose during the period of study. The combination of the deterioration in the number of surplus reserve days, increasing underwriting ratios, increasing expense ratios, and subsidiary operations losses has caused the Commission concern about the risk posed to subscribers of the Blue Cross/Blue Shield Plan of the National Capital Area because of diversification.

Conclusions and Recommendations

Based on its review of the criteria established in House Joint Resolution 284, it is the Commission's opinion that the Blue Cross/Blue Shield Plan of Virginia's subscribers are not, at this time, exposed to unreasonable expense or undue risk. While diversification has posed risk to subscribers of this Plan, the risk of diversification has not been so significant as to seriously undermine the Plan's performance or jeopardize the interests of subscribers.

The Commission is concerned, however, that subscribers of the Blue Cross/Blue Shield Plan of the National Capital Area are exposed to a higher level of expense than the Blue Cross/Blue Shield Plan of Virginia and Blue Cross/Blue Shield plans in other states. Further, the combination of the deterioration in the number of surplus reserve days, increasing underwriting ratios, increasing expense ratios, and subsidiary operations' losses has caused the Commission concern about the risk posed to subscribers of the Blue Cross/Blue Shield Plan of the National Capital Area because of diversification.

The Commission recommends to the General Assembly that it be granted authority to raise the minimum contingency reserve requirement to greater than 30 days for any plan if the Commission determines that stronger financial protection is needed for subscribers. The Code currently states that the minimum contingency reserve requirement shall not exceed 30 days. The Commission's recommendation would provide for a minimum contingency reserve of at least 30 days but no more than 60 days. This recommendation is made in the interest of affording subscribers stronger financial safeguards, to protect subscribers, to promote solvency and to provide a financial safety net should the Plan become insolvent.

The Commission is currently conducting a financial examination of the Blue Cross/Blue Shield Plan of Virginia and will conduct a financial examination of the Blue Cross/Blue Shield Plan of the National Capital Area in 1988. The Commission will closely monitor the financial condition of both plans throughout 1988 to insure solvency and provide adequate protection for subscribers. The monitoring of both plans will include a careful evaluation of the relationship between each plan and its subsidiaries and affiliates.