Medigap Insurance: Compliance With Federal Standards Has Increased
Published: 1998-03-06T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Pursuant to a legislative requirement, GAO reviewed insurers' compliance with Medigap loss ratios and standards, focusing on: (1) the overall Medigap market; (2) which Medigap policies had loss ratios below the standards in 1994 and 1995; and (3) which policies resulted in refunds or credits, or, if not, why.
section_title: What GAO Found
paragraphs: GAO noted that: (1) from 1988 through 1995, the Medigap insurance market grew from $7 billion to over $12 billion with most of the growth occurring before 1993; (2) during this 8-year period, loss ratios averaged 81 percent in 1995; (3) in 1994 and 1995, over 90 percent of the policies in force for 3 years or more, representing most of the premium dollars, met loss ratio standards; (4) premiums for policies with loss ratios below standards totalled $448 million in 1994 and $203 million in 1995; (5) loss ratios varied substantially among states, among different benefit packages, and among insurers; (6) although thousands of individual policy forms had loss ratios below standards, no refunds were required in 1994 and only two were required in 1995; (7) the refund provision did not apply because most of these policies' loss experience was based on too few policyholders to be considered credible under the National Association of Insurance Commissioners' (NAIC) refund calculation methodology; (8) a number of policies had a cumulative loss ratio--the factor used to measure compliance--above that required under NAIC's refund calculation method; and (9) a primary reason for requiring refunds was to give insurers an incentive for meeting loss ratio standards, and the high proportion of premium dollars for policies doing so indicates the incentive is working.

section_title: Letter
paragraphs: Millions of Medicare beneficiaries depend on private insurance to cover Medicare’s deductibles and coinsurance and spent over $12 billion to purchase such insurance in 1995. In 1980, the Congress established federal requirements for the sale and marketing of insurance policies designed to supplement Medicare, commonly called Medigap policies. The Congress acted in response to identified marketing abuses and low benefit payouts and has since amended the Medigap requirements several times to further protect consumers and enhance the economic value of policies.
One area the law covers is required minimum loss ratios—the percentage of premiums returned to policyholders as benefits—and refunds or credits when loss ratios fall below standards that currently stand at 65 percent for policies sold to individuals and 75 percent for policies sold to groups. The Congress stipulated that states would continue to regulate Medigap policies as long as they have standards that are equal to or more stringent than federal standards. States that adopt the National Association of Insurance Commissioners’ (NAIC) model act and regulation meet this requirement. We are required to report to the Secretary of Health and Human Services and each state at least every 3 years on insurers’ compliance with loss ratios and standards. This is our second report under this mandate.
Our objectives were to obtain information on the overall Medigap market, determine which Medigap policies had loss ratios below the standards in 1994 and 1995, and identify which policies resulted in refunds or credits or, if not, why. We obtained NAIC computer files for 1994 and 1995 that summarized loss ratio data for all Medigap policies to determine those with loss ratios below the standards. We tested the accuracy of NAIC’s 1995 database by comparing its data with information on a randomly selected sample of reports of Medigap business prepared by insurers and filed with NAIC. Our verification showed that NAIC accurately created the 1995 database. Neither we nor NAIC verified the accuracy of the Medigap business reports. Because the verification of databases for 1988 to 1993 yielded no material discrepancies, we decided to only test the 1995 database. We then contacted all the states, the District of Columbia, and Puerto Rico to obtain information on policies that had refunds or credits. We also obtained copies of the refund calculation forms submitted to states by insurers for a sample of policies with loss ratios below the standards to determine why insurers provided no refunds or credits. We did our work from September 1996 to January 1998 in accordance with generally accepted government auditing standards. (See app. I for additional details on our methodology.)
subsections: section_title: Background
paragraphs: Federal Medigap standards were first established by section 507 of the Social Security Disability Amendments of 1980 (P.L. 96-265), which added section 1882 to the Social Security Act (42 U.S.C. 1395 ss). Section 1882 set forth federal requirements that insurers must meet for marketing policies as supplements to Medicare and established criminal penalties for marketing abuses. As originally enacted, one of the requirements was that policies had to be expected to return specified portions of premiums as benefits—60 percent for policies sold to individuals and 75 percent for those sold to groups. Insurers were considered to have met the loss ratio requirement if their actuarial estimates showed that their policies were expected to do so. Actual loss ratios did not have to be compared with the loss ratio standards. At that time, insurers generally reported loss ratio data to the states in aggregate—that is, a combined total for all policies sold in the state. If states had wanted to verify compliance, this reporting method would not have allowed them to do so for particular policies. In 1986, we reported that section 1882 had helped protect against substandard and overpriced policies. We also pointed out the problem of insurers reporting aggregate loss ratio data and that actual loss ratios were not compared with the standards to verify compliance.
Section 221 of the Medicare Catastrophic Coverage Act of 1988 (P.L. 100-360) amended section 1882 to require that insurers report their actual loss ratios to the states. The Omnibus Budget Reconciliation Act (OBRA) of 1990 (P.L. 101-508) required essentially that Medigap policies be standardized and that a maximum of 10 different benefit packages would be allowed. The act also increased the loss ratio standard for individual policies to 65 percent for policies sold or issued after November 5, 1991. Effective beginning in 1997, the 65-percent standard was applied to policies issued before November 6, 1991, by the Social Security Amendments of 1994 (P.L. 103-432).
The 1990 amendments also required that insurers pay refunds or provide credits to policyholders when Medigap policies fail to meet loss ratio standards. As implemented in the NAIC model law and regulations, a cumulative 65-percent loss ratio for individual policies (75-percent for group policies) must be met over the life of a policy, which NAIC assumed to be 15 years. NAIC’s methodology compares a policy’s actual loss ratio for a given year with a benchmark (or target) ratio for that year, calculated using cumulative premium and claim experience. If a policy’s actual loss ratio does not meet the benchmark ratio, the insurer must complete further calculations to determine whether a refund or credit is necessary to bring the loss ratio up to standard. Loss ratios on a calendar-year basis for an individual policy are expected to be 40 percent the first year, 55 percent the second year, and 65 percent the third year. Annual loss ratios would continue to increase until they reach 77 percent by the 12th year and remain at that level for the remainder of the 15-year period. This approach anticipates that the higher loss ratios in the third and later years would offset the lower loss ratios in the first 2 years. The methodology is designed to ensure a cumulative 65-percent loss ratio for individual policies by the end of a 15-year period. This same approach is used for ensuring a 75-percent loss ratio by the end of a 15-year period for group policies.
NAIC’s methodology for determining whether a refund or credit is required also includes a tolerance adjustment based on the number of policyholders and the length of time they have held their policies. A policy loss ratio based on less than 500 life-years of exposure since inception is considered not credible, and no refund or credit is required. After 10,000 life-years have accumulated, a policy is considered fully credible. According to an NAIC actuarial advisory group and several insurance regulators, this tolerance adjustment helps ensure that refunds or credits will not occur so often in the early years of policy experience that large premium increases will result in later years.
An important factor in evaluating loss ratios is a policy’s credibility—that is, whether enough people have been covered under the policy to make the loss ratio meaningful. We used two measures of credibility. First, to make the data in this report comparable with the data in our earlier reports, we used a threshold of $150,000 in premiums in a given year in a state.Information in this report on loss ratios that includes years before 1994 use this measure. Second, we used a modification of NAIC’s refund methodology, which, as discussed above, measures credibility by the number of policyholders and the number of years they have held their policies. We used this method to assess whether policies met the applicable loss ratio standards in 1994 and 1995.
Another factor considered when interpreting loss ratios is the length of time a policy has been in force. The refund methodology for 1994 and 1995 indicates that Medigap loss ratios are expected to meet the federal standard after 3 years, which is the criterion we used.
section_title: Overall Medigap Market
paragraphs: In the 1988-95 period, the Medigap insurance market grew from about $7 billion to over $12 billion (see fig. 1), but most of that growth had occurred by 1992. From 1988 through 1992, earned premiums increased by more than 50 percent; from 1992 through 1995, growth leveled off with premiums averaging around $12 billion.
In 1995, 352 insurance companies sold Medigap policies and collected premiums totaling $12.5 billion with 33 companies each reporting premiums of over $100 million and accounting for almost 75 percent of the total (see app. II). The Prudential Insurance Company of America, which underwrote the policies sold through the American Association of Retired Persons (AARP), was the largest supplier of Medigap insurance with 23 percent of the market.
The average Medigap loss ratio for all policies was about the same in 1995 (86 percent) as it was in 1988 (84 percent), but average loss ratios exhibited considerable variation, increasing in some years and decreasing in others. For example, average loss ratios increased in 1990 and 1991 followed by 2 years of declining ratios and then 2 years of increases. For the 8-year period, the average loss ratio was 81 percent with a low of 76 percent in 1993 and a high of 86 percent in 1995. The average loss ratios for group policies have varied substantially, ranging from 80 percent in 1989 to 95 percent in 1995, while those for individual policies during the period have been more stable (see fig. 2).
In 1995, states differed considerably in average loss ratios. Insurers doing business in Michigan had the highest average loss ratio (107 percent) followed by the District of Columbia (102 percent), Massachusetts (99 percent), Pennsylvania (97 percent), and Maine (96 percent). The five states with the lowest average loss ratios were Nebraska (73 percent), Minnesota (75 percent), Oregon (76 percent), Delaware (76 percent), and Montana (76 percent ). Appendix III lists average loss ratios by state. Moreover, loss ratios varied among insurers within a state. In Michigan, for example, average loss ratios for insurers with premiums over $150,000 ranged from 59.3 to 132.7, and, in Montana, from 29.0 to 108.8.
In 1995, the average loss ratios for the 10 standardized Medigap plans— from the basic Plan A to the top of the line Plan J—ranged from 73.8 percent for Plan G, to 102.3 percent for Plan A. The most popular of the plans, Plan F, is more costly and returns less to policyholders in benefits than the nearly identical Plan C. Plan F differs from Plan C only in its coverage of excess physicians’ charges—the amounts doctors may bill patients above Medicare’s allowed amount, which the law limits to no more than 15 percent. In 1995, Plan F had a nationwide average loss ratio of 75.5 percent; Plan C had an average loss ratio of 89.3 percent. Medicare data show that for over 95 percent of claims, physicians agree to accept Medicare’s allowed amount so insurers seldom have to pay for excess charges. Moreover, Plan F had an average loss ratio in 1995 lower than all other plans except Plan G. Appendix IV lists the average loss ratio experience for all 10 Medigap plans in 1995 by state.
section_title: Policies Not Meeting Loss Ratio Standards
paragraphs: In 1994 and 1995, most Medigap policies that were at least 3 years old with premiums totaling $150,000 or more in the applicable state met the federal loss ratio standards. Premiums on credible policies that had been issued 3 or more years ago that failed to meet the minimum federal loss ratio standards increased from $320 million in 1991 to $1.2 billion in 1993.However, premiums for policies that failed to meet the standards decreased to $937 million in 1994 and to $522 million in 1995 (see fig. 3).
Using information not previously available in the NAIC loss ratio data tape, we incorporated features of the refund methodology to evaluate the 1994 and 1995 loss ratio data for policies that were at least 3 years old. To estimate the number of policies and associated premiums with loss ratios below standards, we measured credibility using the number of covered lives by policy reported to NAIC. Under the refund methodology, experience of less than 500 life-years is not considered credible, but 10,000 life-years is considered fully credible. A tolerance adjustment is added to the actual loss ratio on a sliding scale for life-years falling between those two numbers. In 1994, using covered lives as the measure of credibility, the actual or adjusted loss ratios of 256 of 2,670 policies did not meet the minimum loss ratio standards, and these companies earned $448 million in premiums on these policies. In 1995, the number of policies not meeting the standards was 141 or 4 percent of the total, and the premiums were $203 million. Appendixes V and VI identify the policies with loss ratios below the applicable standard, along with their premiums, benefit payments, and loss ratios. Appendix V lists individual policies, and appendix VI lists group policies.
section_title: Why Refunds and Credits Were Not Required
paragraphs: In both 1994 and 1995, more than 10,000 different Medigap policies, virtually all of which were standardized policies, were subject to the OBRA 1990 refund provision and were required to send refund calculation forms to state insurance commissioners. In those 2 years, a total of almost 14,000 policies had loss ratios below 65 percent for individual policies and below 75 percent for group policies. However, we identified only two policies that made refunds in 1995. One was a standardized policy sold in Iowa that refunded a total of about $19,000 to 148 policyholders. The other was a prestandardized plan sold in Virginia that refunded a total of about $2,000 to 76 policyholders. In follow-up contacts with 15 selected states, we identified only one policy sold in Illinois that refunded a total of about $123,000 to 3,075 policyholders for 1996.
To determine why policies with loss ratios below the applicable standard in 1994 or 1995 did not have to make refunds, we selected a random sample of these policies with earned premiums under $1 million and asked the states, the District of Columbia, and Puerto Rico to send us copies of the refund calculation forms for the sample and for all policies with premiums over $1 million. All except Michigan responded. From the information on these forms, we determined the reasons refunds were not required and projected the results to the universe (see table 1).
About 97 percent of the policies below the loss ratio standards had earned premiums of less than $1 million. Refunds were not required for most policies because their experience was not considered credible because they had less than 500 life-years since inception. Most of the policies with earned premiums of $1 million or more did not have to pay refunds because, although their loss ratios in 1994 or 1995 were below standards, their cumulative loss ratio since inception was greater than the benchmark ratio for the year in question. The benchmark ratios were designed with certain assumptions about policy lapse rates and other factors to ensure that the cumulative loss ratio over 15 years was at least equal to the federal loss ratio standards. Because benefit payments are generally low in the first years when policyholders are younger and healthier and increase as they age, benchmark ratios are significantly below the loss ratio standards at first and gradually increase over the years. Because all of the policies subject to the refund provision in 1994 and 1995 were issued within the last 3 or 4 years, they had benchmark ratios below loss ratio standards. In fact, in 1994 and 1995, the highest benchmark ratio for any policy was 58 percent; about 9 out of 10 policies had benchmark ratios under 50 percent.
section_title: Conclusions
paragraphs: Millions of Medicare beneficiaries purchased Medigap policies, spending over $12 billion in 1995. Federal loss ratio standards and refund requirements are the main means of ensuring that Medigap policyholders receive value for their premium dollars. Medigap policies representing most of the premium dollars had loss ratios in 1994 and 1995 that were higher than federal law requires. Most policies with loss ratios below standards in 1994 and 1995 were not considered credible and, thus, were not subject to the refund provision.
The amount of premiums paid for policies with loss ratios below standards has declined substantially from 1993, the last year before the refund provision became effective. The primary reason for requiring refunds and credits is to give insurers incentives to meet loss ratio standards and thereby avoid possibly unfavorable public relations consequences. The relatively low amount of premiums for policies with loss ratios below the standards indicates that the incentive is working.
In commenting on a draft of this report, NAIC officials offered some technical suggestions, which we incorporated where appropriate.
We are sending copies of this report to the governor of each state, NAIC, and interested congressional committees. We will make copies available to others on request.
If you have any questions about this report, please call me at (202) 512-7114. Other major contributors to this report are listed in appendix VII.
section_title: Scope and Methodology
paragraphs: We obtained from the National Association of Insurance Commissioners (NAIC) its computerized database of insurance companies’ Medigap annual experience exhibits for 1994 and 1995, the latest available when we began our work. In 1994, earned premiums totaled $12.7 billion for all policies, and, in 1995, earned premiums totaled $12.5 billion. In the databases we identified policies issued after 1991 and therefore subject to the Omnibus Budget Reconciliation Act of 1990 refund provision. We then identified those policies with loss ratios below the federal loss ratio standards. These policies had earned premiums of about $1.3 billion in 1994 and $.7 billion in 1995. We did not test the accuracy of the 1994 database, but we did test the accuracy of the 1995 database and found it to be accurate. Moreover, our prior work has found these databases to be accurate.
To determine why policies with loss ratios below standards were not required to refund premiums or credits, we randomly selected a sample of policies with earned premiums of less than $1 million and selected all those with premiums of $1 million or more from the NAIC 1994 and 1995 databases. We asked state insurance commissioners and those for the District of Columbia and Puerto Rico to provide us with copies of all refund calculation forms that insurance companies filed with them for the related policies. All except Michigan responded. However, for about one-third of the policies, we received no refund calculation forms because states could not locate or did not receive the forms or the forms had been purged from the files.
subsections: section_title: Sampling Errors
paragraphs: The data in the columns of table 1 (on page 10) covering policies with earned premiums under $1 million represent projections of our sample to the universe of policies in NAIC’s databases for 1994 and 1995. Each estimate has a sampling error associated with it. The size of the sampling error reflects the precision of the estimate: The smaller the sampling error, the more precise the estimate. We computed sampling errors for table 1 at the 95-percent confidence level. This means that the chances are about 95 out of 100 that the actual number being estimated falls within the range defined by our estimate, plus or minus the sampling error. Table I.1 shows the sampling errors for table 1.
section_title: Medigap Insurers With Earned Premiums Over $100 Million in 1995
paragraphs: Prudential Insurance Company of America Bankers Life & Casualty Company Empire Blue Cross & Blue Shield Medical Service Association of Pennsylvania-Pennsylvania Blue Shield Blue Cross & Blue Shield of Florida Blue Cross & Blue Shield of Virginia Blue Cross & Blue Shield of North Carolina, Inc.
Blue Cross & Blue Shield of New Jersey, Inc.
Mutual of Omaha Insurance Company Anthem Insurance Companies, Inc.
Blue Cross & Blue Shield of Michigan Blue Cross & Blue Shield of Alabama Blue Cross & Blue Shield of Tennessee Blue Cross & Blue Shield of Connecticut, Inc.
Standard Life & Accident Insurance Co.
Blue Cross & Blue Shield of Kansas, Inc.
Blue Cross of Western Pennsylvania American Family Life Assurance Company of Columbus, Georgia State Farm Mutual Automobile Insurance Company Blue Cross & Blue Shield of Minnesota, Inc.
Arkansas Blue Cross & Blue Shield Southeastern Group, Inc.
section_title: Medigap Loss Ratio Experience by State, 1995
section_title: Loss Ratio Experience for Medigap Standardized Plans With Earned Premiums in Excess of $500,000, 1995
paragraphs: (continued)
States had alternate Medigap standardized programs in effect before the federal legislation standardizing Medigap was enacted and have waivers from this requirement.
section_title: Medigap Insurers With Loss Ratio Experience Below the Minimum Standard for Individual Policies, 1994 and 1995
paragraphs: Actual or adjusted loss ratio(continued)
Actual or adjusted loss ratio2CMO ET AL M4 ET AL (continued)
Actual or adjusted loss ratio50277 (1-90) (continued)
H(65) 9703(I); 9708,17,09(G) (continued)
M169 ET AL M4 ET AL H(65) (continued)
M115 ET AL M2 ET AL MC-86-1 MO1 SM 20/20 SMSP - 88 - 1 (continued)
Actual or adjusted loss ratio(ED 4/84) 2CMO ET AL M154 ET AL (continued)
section_title: Medigap Insurers With Loss Ratio Experience Below the Minimum Standard for Group Policies, 1994 and 1995
paragraphs: GC500(D)
GSC1667 VAP1008 VAP1030 VAP1030A VAP1030D 337,987 614,725 557,304 56,367 137,803 192,331 343,121 348,048 26,405 57,625 71.9 63.3 70.0 61.8 56.8 (A7-92)
GC500(D) (continued)
CB 44.7 CB 44.8 GB 10-A2.1 GB 10-A2.2 GC500(D) (continued)
GC500(D)
MSP) (continued)
GC500(D) (continued)
Actual or adjusted loss ratio(continued)
GC500(D)
ST-II(B)-1 GC500(D)TX (continued)
section_title: Major Contributors to This Report
paragraphs: Thomas G. Dowdal, Assistant Director, (202) 512-6588 William A. Hamilton, Evaluator-in-Charge Michael Piskai Wayne J. Turowski The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent.
U.S. General Accounting Office P.O. Box 37050 Washington, DC  20013 Room 1100 700 4th St. NW (corner of 4th and G Sts. NW) U.S. General Accounting Office Washington, DC Orders may also be placed by calling (202) 512-6000  or by using fax number (202) 512-6061, or TDD (202) 512-2537.
Each day, GAO issues a list of newly available reports and testimony.  To receive facsimile copies of the daily list or any list from the past 30 days, please call (202) 512-6000 using a touchtone phone.  A recorded menu will provide information on how to obtain these lists.