Drivers of Premium Increases and Review of Health Insurance Rates
Released: 2012-01-20T00:00:00

Introduction

Health insurance premiums represent a contractually agreed upon amount to be paid for a defined set of health benefits during a defined period of time (usually a year). Premiums are typically paid in monthly installments by policyholders (individual coverage) and enrollees (group coverage). Premiums may vary for different individuals with the same health benefits package from the same insurance company. Each variation is referred to as a premium rate. Rating methodologies generally vary between health insurance market segments and may have additional state-specific variation due to differences in state rate regulations. Typically, the following methods are used by market segment:

Individual health insurance market. Rates may vary by age and sex and may also be underwritten, meaning that the insurance carrier assesses the health status of the insurance applicant and uses it to set the rate according to the health risk of that individual. Small group market. What is called a "manual rate" is first calculated estimating the costs by the age and sex of the employees, geographic location, number of employees, and the type of health insurance product. Most states also permit the manual rate to be adjusted by a health status factor. Large group market . Premium rates are determined either from an individual group's medical claims history (referred to as "experience") or from a blended average of manual rates calculated from the members of the group and from the group's experience.

Health insurance premium rates are actuarial estimates of the cost of covering a risk pool of individuals under a particular health benefits package for a particular period of time. Generally, the more generous the benefits package (i.e., large, open networks of providers and low cost- sharing requirements including deductibles) the higher the premiums will be. Just as premiums must be adequate to pay for expected health care use, they also must be sufficient to compensate insurance carriers for taking on the financial risk associated with providing coverage.

The final premium rate calculation often is adjusted to reflect several other factors, such as making up for a previous financial loss and providing excess capital to manage various risks generally regulated under state solvency standards. State regulators have adopted solvency standards to protect consumers by requiring insurance companies to keep certain reserves of capital to protect against asset risks, underwriting or insurance risk, and business risks. Without this required safety net of reserved cash, a health insurance company could go bankrupt if it experiences unforeseen losses, thus resulting in its consumers being placed at full financial risk for their medical claims.

Data from the Bureau of Labor Statistics' (BLS's) Producer Price Index (PPI) for health insurance companies indicates that the year-over-year percentage increase by month in private health insurance premiums has averaged around 4.4% between 2004 and 2010, but has accelerated some since 2009, ranging from 4.8%-5.5% ( Figure 1 ).

The year-to-year increases in the PPI may not appear significant, but there are four relevant contextual factors to take into consideration.

First, premium increases can be much higher in the individual and small group markets, where the smaller risk pools can result in distortions in the average health care costs covered by premiums, due to outlier policyholders or members. In other words, if there are only a few healthy persons to help pay for a sick person, the premiums (all else being equal) will be higher than if that sick person was in a larger risk pool with many healthy persons. Second, in the employer group market, the worker share of premiums has been increasing even more because employer subsidies have been trending down incrementally. The employer and workers shares vary according to coverage tier: self-only, employee-plus-one, and family. However, in the past few years employers have shifted incrementally more of that cost to workers. For example, the average worker share of the total premium for group coverage (for self-only coverage) was 15.3% in 2008 and grew to 17.0% by 2011 ( Table 1 ). Third, as premiums have gone up, the value of the coverage has gone down in terms of higher cost sharing requirements, including deductibles (see the Appendix ). Fourth, real income (i.e., income adjusted for inflation), both per capita and family, has decreased in the past several years. Real income for adults (age 16 and older) declined 4.6%, from an average of $40,389 in 2007 to $38,543 in 2010. Similarly, average family income declined 6.6%, from $73,426 to 68,599 for the same period. As a result, incomes are not keeping up with premium increases, and a greater proportion of incomes are being consumed by health insurance premiums.

The growth of health insurance premiums (and out-of-pocket costs) for individuals and families has been the focus of considerable congressional attention. Using available public data, this report explores the potential drivers of the growth trend in health insurance premiums.

Drivers of Premium Increases

In general, the premiums charged by health insurance companies represent the estimated amount that would be required to cover initially three major components: (1) the expected cost of the health benefits covered, (2) the administrative costs of operating the coverage, and (3) a profit margin consistent with the strategic business goals of the company. The fourth and final component to the premium calculation involves adjustments upward or downward to reflect several miscellaneous factors, such as responding to prior gains or losses, strategically responding to competitors (i.e., pricing lower to gain market share), hedging against uncertainty risks created by a changing regulatory environment, and other factors often collectively described as the underwriting cycle.

Health Benefits Expenses

Health benefits expenses equal the aggregate products of unit prices for health services times utilization of health services (e.g., hospital visits) or health items, such as prescription drugs. Health benefits expenses represent the largest component of premiums. According to the aggregate health insurance industry statements of revenue and expenses submitted to the National Association of Insurance Commissioners (NAIC) in 2010, health benefits represented about 85% of premiums.

Health benefits expenses on a per member per month (PMPM) basis have trended upwards between 2003 and 2010 in aggregate for the health insurance industry, as illustrated in Figure 2 . The annual percentage increase in total health benefits expenses, typically referred to as medical trend, has generally been over 7% per year during most of that time period, but the rate of growth was 5.0% between 2008 and 2009, and only 1.1% between 2009 and 2010. The medical trend of a particular plan or policy can vary substantively based on such factors as the relative health status of the enrollees and policyholders, differences in coverage policy, differences in the use of managed care techniques, geographic differences, use of restrictive versus open provider networks, and various organizational factors, such as being for-profit or non-profit.

Unit Prices

The unit price of health services and prescription drugs is determined through a contract negotiation process between health insurance companies, health providers, medical device companies, and drug manufacturers or distributors. There is evidence of considerable geographic variation in provider, but not prescription drug pricing. For example, the Center for Studying Health System Change (HSC) found significant differences in payment rates to hospitals and physicians among the eight markets it studied during site visits to nationally representative metropolitan areas during 2010. Average payments for inpatient hospital care, as a percentage of Medicare, ranged from 147% in Miami to 210% in San Francisco. For physician payments as a percentage of Medicare, it ranged from 82% in Miami to 176% in rural Wisconsin. HSC attributed the variation in prices paid by insurers to differences in provider bargaining power. Another study in six California markets between October and December 2008 found that physician group practice integration with hospital systems, hospital mergers, the desire for broad provider choice, growing physician shortages, and a regulatory environment that favors providers all contributed to a price negotiation advantage for some providers.

The power of providers in negotiating higher unit prices has been recognized by some state insurance commissioners that perform premium rate reviews. For example, in the reformed Massachusetts market, the Division of Insurance approved (on appeal) a premium rate increase for Fallon Community Health Plan after finding that, among other things, "individuals and employer groups demand that Fallon provide options that include access to every doctor and hospital, including local providers, as well as access to larger tertiary systems." The Massachusetts Division of Insurance Appeals Board concluded that "[m]arketplace realities mean that Fallon sometimes has no choice but to contract with higher cost providers." Similarly, an investigation by the state Attorney General concluded that large providers with brand-name recognition have considerable leverage over health insurance companies when negotiating prices, and that price increases have accounted for the majority of the medical trend in Massachusetts.

Health care services and items in the United States generally lack unit price transparency because they are considered proprietary contractual negotiations between payers and providers. Moreover, standard measures of producer price inflation, such as the PPI, are inappropriate to examine the unit price inflation among privately insured persons because they include prices paid by consumers that are uninsured or are in government programs (e.g., Medicare and Medicaid). However, one survey by Segal Consulting projected that the annual price inflation for hospitals will increase 7.2% for 2012 (2012 estimates from insurers are based on provider-contracted rates set before the coverage year begins). In addition, Segal projected that the annual price inflation for physicians and prescription drugs in 2012 would be 4.6% and 5.5%, respectively.

Health Service Utilization

Conventional wisdom states that the aging of the American population is the primary driver of increased demand for health services and prescriptions drugs experienced by health insurers. On its face, this seems logical given that the elderly have the highest utilization of health care. However, the overall age distribution of the population actually shifts very slowly over time. Indeed, the median age of the U.S. population is projected to increase just 1.8 years, from 36.9 in 2010 to 38.7 in 2030. In terms of risk based on age, the Medicare program assists the private health insurance market by assuming the liability of coverage for most persons age 65 and older. Ultimately, what matters for the insurer is not merely the general population trends, but the specific age distribution of the risk pool being insured. Moreover, studies have found that while aging does have an impact on rising health care utilization, other factors such as advances in costly medical technology and medical practice patterns drive demand more.

Without countervailing regulations, health insurance companies have a financial incentive to restrain utilization. Generally, the less they pay in health benefits, the higher their profits will be. Health insurance companies can implement a number of different management techniques or limitations on coverage to restrain health care utilization. Traditional utilization management techniques include utilization review, case management, and physician gatekeeping. Insurers may also attempt to limit the use of high-priced or high-utilizing health care providers through their network contracting process. Since the cost sharing is lower for in-network providers, the plan can financially incentivize its members to use lower-cost providers by contracting only with them. Finally, insurers may choose to not cover a particular procedure, use of a technology, or prescription drug.

Generally, utilization management techniques and restrictive benefits became prevalent in the late 1980s, but their use has been waning since the mid-1990s, in the face of strong consumer resistance to anything other than case management, where coordination between providers and evidence based medicine are used to improve outcomes. For example, in the employer group market, enrollment in health maintenance organizations (HMOs), the most restrictive type of plan, dropped from 31% in 1996 to 17% in 2011, while less restrictive preferred provider organization (PPO)/point of service (POS) plans increased from 42% to 65% during the same time period. In the individual (non-group) market, 2009 data from American's Health Insurance Plans (AHIP) indicate that 82.8% of members with single coverage and 72.9% with family coverage elect a PPO/POS plan, with less than 2% electing HMO or similarly restrictive plans.

As the market has moved away from health insurance products with strong utilization management programs and limited provider networks, utilization of health services and prescription drugs has consistently increased every year, as measured in population-based surveys and gross sales figures. These trends in gross measures of service utilization could be explained by increases in the total population or the number of persons that are insured. In other words, per insured member service utilization may not be increasing. However, studies where researchers have had access to claims data and provider payment rates have found that most of the increase in health benefits expenditures, other than certain outpatient procedures and prescription drugs, are attributable to increases in unit prices, not to increases in the utilization per insured member.

Administrative Costs

In addition to paying for medical claims, premiums are expected to cover the operational costs of the insurance company. Health insurance companies generally are complex organizations requiring specialized human resources and information technology to perform the functions of developing, marketing, and operating a health plan or insurance policy. Table 2 provides a summary review of administrative functions in health insurance plans.

Insurance companies report administrative costs, on a per member per month (PMPM) basis, in regulatory filings. Such data indicate a relatively stable trend, with average costs per company increasing about $3 PMPM from 2007 to 2009 ( Figure 3 ).

However, while average administrative costs have been relatively consistent, there is more substantial variation across the companies observed. Specialty firms (e.g., dental only, behavioral health) generally report below $10 PMPM in administrative costs, and companies with an emphasis on non-group insurance often report more than $100 PMPM in such costs. Administrative expenses have been found to vary by market segment, with non-group insurance costing the highest and large group the lowest. This is attributable to factors such as enrollment size. While group plans can sell to multiple individuals (for example, through an employer's human resources department), non-group insurance must be sold one-by-one to each person, thus increase marketing and sales costs.

A company with multiple products generally prices each product separately. As an example from a different industry, a car company does not have one price for each of its vehicles. It charges separate prices for each car model, even if the different models are sold in the same year. Similarly, premium rates are calculated at the health insurance product level (i.e., the health plan or policy that a person, family, or employer purchases), not at the company or corporate parent levels (i.e., the corporate entity that sells the insurance product). So additional variation might be observed within each company if product level data were publicly available.

These data are also limited by the fact that many health insurance companies have multiple non-insurance businesses. For example, the United Health Group (UHG) includes the information technology and consulting firm Ingenix and the pharmacy benefits manager (PBM) Prescription Solutions in addition to its health insurance benefits business segment. The inherent complexity of a large conglomerate may create unique challenges for accurate cost accounting down to the individual plans and insurance products sold within the organization. These challenges could create barriers to fair and comprehensive regulation of administrative costs across different types of health insurance companies (i.e., small local and regional non-profit insurers versus large national investor-owned, for-profit insurers).

There is no consensus benchmark for what is an appropriate amount of administrative costs. Nevertheless, several industry executives of the publicly traded for-profit firms believe that administrative costs can come down as evidenced in the summary of recent earnings conference calls provided in Table 3 .

Health Insurance Company Profits

The average profit margin for the health insurance industry has consistently been low; therefore, profit typically represents the smallest component of health insurance premiums. According to financial data submitted to the NAIC, the average profit margin (net income divided by total revenues) for the health insurance industry was 3.5% in 2010. Because of the membership scale associated with more profitable health insurers, it is unlikely that reductions in net income would have a substantive impact on premiums for individual members. For example, if WellPoint's entire 2010 net income of $2.89 billion were rebated back to its 2010 members, it would result in a monthly credit of $7.22 per member.

There is substantial variation in health insurance company profits due to differences in the size of the companies, their willingness to aggressively manage health costs, and other business goals of the organization. Wellpoint, a large (33.3 million members) investor-owned, national for-profit company, emphasizes reduced costs and value for its investors. In 2010, Wellpoint had $2.89 billion in net income (profits after taxes). By contrast, Blue Cross Blue Shield of Rhode Island (BCBS-RI), a mid-sized (approximately 600,000 members) non-profit company operating in one state with a community mission, took a $14.1 million loss in 2010.

The Underwriting Cycle

The health insurance underwriting cycle refers to the tendency for health insurance premiums and insurer profitability to cycle over certain time intervals. (This is a different, but related, concept to medical underwriting, which is the process by which an insurer estimates the insurance risks and potential medical costs associated with an applicant for insurance based on characteristics of that applicant.) Upturns and downturns in the underwriting cycle are basically the outcome of adjustments to premiums that reflect past experience, expectations of future losses, business strategy, attempts to mitigate possible impacts of regulatory changes, and the changing demands of plan participants and policyholders (e.g., demand for large and open provider networks). For example, a health insurance company may charge premiums above the anticipated amount necessary for the current plan year's costs because the insurer lost money on the product in previous years. This will start an up cycle in profitability until it prices itself out of the competitive market, thus forcing a cut in premiums and ultimately profit margins. Alternatively, the insurer may have a business strategy to obtain as much market share as possible. To do this, the insurer reduces premiums below competitors, even if it reduces profit margins or results in a temporary loss. Once the insurer commands the desired market share, it increases premiums to achieve the desired maximum profit margin that the market will allow.

Adding to the complexity, the insurance company often may attempt to subsidize one policy or plan with profits from another. To illustrate this, Table 4 provides an example of one insurance carrier's actual premium and medical loss experience in one state between 2007 and 2009. The table was abstracted from a premium rate increase request for 2010 for individual market blocks of business with and without maternity coverage from Anthem Blue Cross Life and Health Insurance Company (hereafter referred to as "Anthem") submitted to the California Department of Insurance. For the years 2007 through 2009, the table presents the actual per member per month (PMPM) premiums charged, the PMPM claims experience, the medical loss ratio (the percentage of premiums spent on medical claims), the total member months, and the gain or loss on medical expenses by the maternity and non-maternity blocks of business in the individual (non-group) market. Member months are used to reflect enrollment based metrics because individuals can join or leave a plan or policy on a monthly basis. Thus, having a member for 6 months versus the full year (12 member months) would be meaningful in terms of total premiums collected and likely claims experience.

Anthem's maternity coverage policies had an operational gain in 2007, with relatively few policyholders (in member months). However, these policies operated at a loss in 2008 and 2009 despite a higher number of policyholders. Based on this trend, Anthem projected nearly a $14.2 million loss for 2010 on the maternity block of business. What are some of the options for Anthem or any other insurance company in a situation like this? It could increase premiums in the maternity coverage policies to $320 PMPM to match expected claims costs PMPM for 2010, but that would be nearly a 74% increase from premiums in 2009. Alternatively, Anthem could eliminate the maternity coverage policies, seek out non-premium sources of revenue (e.g., investment income), aggressively implement managed care methods to reduce costs, or make up for the losses in this product with gains from another product line. The latter option is what is suggested by this data. In other words, losses from the maternity coverage are financially cancelled out for the company by gains from the policies sold without maternity coverage.

Review of Health Insurance Rates

The regulation of private health insurance has traditionally been under the jurisdiction of the states. Most states have used their regulatory authority over the business of insurance to require the filing of health insurance documents containing rate information for one or more market segments or plan types. Under the Patient Protection and Affordable Care Act ( P.L. 111-148 , ACA, as amended), the federal government assumed a role in health insurance rate reviews by providing grant funding to states for such reviews and requiring, among other things, that insurers justify rate increases under certain circumstances.

State Rate Filing and Reviews

As the primary regulators of health insurance, states oversee many aspects of the industry concerning the insurance products offered in the market and the entities that sell insurance. One fundamental area in which states exercise regulatory authority is through the imposition of rate and form filing requirements. "Form" refers to the language in the insurance contract and typically is required when a new plan is offered in the market (or changes are made to that plan). "Rate" refers to the price of a unit of insurance. Rates are filed with the initial form and usually must be filed each time an insurance carrier proposes to change rates for a plan (or if changes in the form filing affect rates).

Not all states actually conduct rate reviews. For those states that do, the purpose is threefold: to ensure that rates are sufficient (to guard against insolvency), but not too high (must be actuarially justified), nor unfairly discriminatory (variation in rates must be based on differences in expected claims). There is substantive variation in state regulation of health insurance rates. Some states collect rates for informational purposes only or as part of their form filing requirements. Over half of states have "prior approval" requirements, where insurance companies must file proposed rate changes and the state has the authority to approve, disapprove or modify the request. However, prior approval authority typically also includes a deeming period; if the state does not take any action and the deeming period elapses, the filing become effective. Under such a scenario, prior approval requirements may effectively work just like "file and use." File and use requires insurers to file rates with the state, which become effective either immediately or on a date specified in the filing. Under either of these scenarios, the state may disapprove a rate filing if it does not meet a certain compliance standard, such as a minimum anticipated medical loss ratio. Several states have file and use requirements. One state has "use and file," which means the filing becomes effective when used, though the insurer is required to file rates with the state. (A list of rate filing requirements by state is provided in Table 5 .)

Limits on publicly accessible rate review data make comprehensive uniform comparisons between states elusive. Only 13 states have public Internet access to rate filings or summary statistics on rates. Moreover, there is considerable variation in how states with rate review regulations make their information public. For example, the Maine Bureau of Insurance posts rate filings only for insurers that are called to present their requested increase at a public hearing, whereas the Oregon Insurance Division publicly provides a list of average rate increase requests and approvals by regulated entities and provides access to individual rate filings and approvals.

In terms of approvals of rate increases, there is considerable variation between states. For example, Oregon approved 68.3% of recent requested rate increases, whereas Massachusetts approved only 14.2%. These differences are likely due to both differences in regulatory standards, geographic variation in health insurance markets, health services utilization patterns, and health provider payment rates. The available public information suggests that states approve, adjust, or reject requests for rate increases primarily based on an analysis of cost trends in relation to rate increases approved in prior years, and that the approved rates can be double-digit percentage increases from the previous year. To illustrate, consider the case of Regence Blue Cross Blue Shield of Oregon, which requested an average annual increase of 26.4% for its individual health plans but was approved for a 17.3% increase effective January 1, 2010. Despite medical costs increasing 12.6% from the prior year and a financial loss of 9.7% ($15,476,565) on these policies over the period of May 1, 2008, through April 30, 2009, Oregon decided that the lower rate increase was appropriate because Regence had received an approved average rate increase of 26.5% on the same policies for the previous year. By contrast, Health Net Health Plan of Oregon's individual health plans requested and received a significant average annual rate increase of 22.8% effective on October 1, 2009. Oregon believed that the increase was justified because Health Net lost money on these policies each year between 2005 and 2008 (in aggregate $1,436,505) and it had received average rate increases less than the average increase in medical costs for four of the past five years.

Federal Rate Review Under ACA

The Patient Protection and Affordable Care Act (P.L. 111-148, ACA, as amended) includes provisions to increase transparency of proposed rate increases, but it does not go as far as to include a formal approval process for proposed increases. Specifically, the Health and Human Services (HHS) Secretary must, in conjunction with the states, establish a process for the annual review of "unreasonable" increases in rates for health insurance coverage beginning in the 2010 plan year. The term "unreasonable" is not defined by the law and presents a challenge in preventing unintended consequences such as providing additional market leverage to large, national for-profit companies over small, local non-profit insurers. The complexity of making such a determination generally requires analysis of multiple factors by actuaries and accountants. Such a review generally does not lend itself to the use of simplistic benchmarks such as merely prohibiting double-digit percentage rate increases. As the National Association of Insurance Commissioners (NAIC) notes:

The process should identify "potentially unreasonable" increases, with further review by states and/or the HHS Secretary to determine any mitigating or exacerbating factors and decide whether the increase is actually unreasonable. Any increase that is necessary to avoid a future financial loss on the block of business is usually considered reasonable, unless there are compelling reasons to determine that it is unreasonable. Rates that produce a financial loss can affect consumers by impairing the financial soundness of the insurer, reducing the insurer's incentive to provide good customer service, reducing the insurer's incentive to continue providing coverage and shifting costs to other blocks of business.

Health insurance issuers will be required to submit to the HHS Secretary, and the relevant state, a justification for an unreasonable premium increase prior to implementation of the premium, and the HHS Secretary will publicly disclose the information. The justification requirement does not provide the HHS Secretary with the authority to prohibit the plan from implementing the rate increase. In other words, this is a "sunshine" provision designed to publicly expose premium increases determined to be unreasonable. On December 23, 2010, the HHS Secretary issued a notice of proposed rulemaking for the ACA rate review provisions, with a comment period ending February 22, 2011. The HHS Secretary proposes that when the average increase, alone or in combination with prior increases in the preceding 12-month period, is 10% or more then the rates will be subject to more review to determine if they are unreasonable. The proposed regulation stipulates that HHS would be adopting a state's determination of what an unreasonable rate increase is if the state has an effective rate review program. The proposed regulation specifies that a state's rate review program would be considered effective if the state has the legal authority to obtain the data and documentation necessary to conduct an effective examination. Further, the state must have the ability to review the data and documentation submitted in support of the proposed rate increases, including an examination of the reasonableness of the actuarial assumptions used by the insurer, the validity of historical data underlying the assumptions, and the insurer's accuracy with past projections. If the state does not have an effective rate review program, the Secretary proposes that HHS would conduct the review. HHS would determine that a rate increase is unreasonable if:

The rate increase is excessive. The premium charged would be considered excessive if it is unreasonably high in relation to the benefits provided. HHS would consider if the rate increase results in a projected future loss ratio below the medical loss ratio standard required under Section 2718 of the PHSA. HHS would also consider if any of the assumptions on which the rate increase is based are not supported by evidence or do not support an increase of the magnitude being proposed. The rate increase is unjustified. Health insurance issuers would be required to provide certain data and documentation to HHS supporting the proposed rate increase. If the data and documentation submitted are incomplete or inadequate then the proposed increase would be determined to be unreasonable. The rate increase is unfairly discriminatory. A proposed rate increase would be unfairly discriminatory if it results in premium differences within similar risk categories that are not permissible under applicable state law or, if no state law applies, do not reasonably correspond to differences in expected costs.

To support the premium rate review process, ACA requires the HHS Secretary to carry out a program of grants to the states. These grants have an appropriation of $250 million for states to use during the five-year period beginning with FY2010. On August 12, 2010, HHS announced that 42 states and the District of Columbia were awarded $43 million in grants during the first cycle of funding. On February 24, 2011, HHS announced a second cycle of funding of approximately $200 million, for which states will be given multiple opportunities to apply for funds. "On September 20, 2011, HHS awarded $109 million to 28 States and the District of Columbia."

Final Rule on Rate Review

CMS published the final rule implementing the rate review provisions in ACA in the Federal Register on May 23, 2011. The final rule clarifies which proposed rate increases would be subject to review (i.e., defining "unreasonable" rate increase), establishes a process for rate review to be conducted either by the state or CMS, and specifies notice requirements to inform the public about the process and outcome of the rate reviews. The final rule also includes a comment period, for which it solicits comments on whether individual and small group health coverage sold through associations should be subject to ACA's rate review requirements.

The final regulations implementing the ACA rate review provisions are not intended as a substitution for existing and future state review of rates. Throughout the final rule, CMS refers to the ongoing authority of states to impose filing requirements and conduct their own review of rates.

Definition of "Unreasonable" Rate Increase

Beginning on or after September 1, 2011, a proposed rate increase will be tentatively considered unreasonable, and therefore subject to review under ACA, if the increase either is 10% or more (over a 12-month period beginning on September 1), or meets or exceeds the state-specific threshold (applicable to a 12-month period beginning on September 1). The 10% threshold is for transitional purposes only, until the state-specific thresholds are established. In developing a state-specific threshold, the HHS Secretary will consult with a state and may review relevant information provided by other stakeholders. The rate review process (described below) will determine whether or not the proposed rate increase is unreasonable, and relevant information about each review conducted will be published online.

Preliminary Justification

For each proposed rate increase subject to review, a health insurance issuer must submit a Preliminary Justification, which is composed of the following:

Part I—a summary of the proposed rate increase, including claims experience, utilization and cost trend projections, changes in benefits, claims and non-claims costs, current and projected premiums, and a three-year history of rate increases for the insurance product. Part II—a justification for the rate increase, including description of data and assumptions used, explanation of primary factors driving rate increase, and description of overall experience of the insurance product, including expenses and loss ratios. Part III—a rate filing document. (Instructions regarding the compliance with Part III will be provided through CMS guidance.)

Parts I and II must be submitted to CMS and the applicable state (in a state that already has a mechanism in place to accept rate submissions from issuers). Part III must be submitted to CMS. In addition to the data and documentation components described above, CMS may request additional information if the insurer's submission is insufficient for making a determination. Parts I and II will be posted on the CMS website, with a disclaimer that describes the purpose of the Preliminary Justification. CMS also will provide information through its website regarding the process by which the public may submit comments on the rate reviews that CMS conducts.

Rate Reviews Conducted by State or CMS

Reviews of the proposed rate increases will be conducted either by a state or CMS.

A state will conduct the review if it has an "Effective Rate Review Program" (described below), and it discloses to CMS its analysis for making the determination whether or not a rate increase is actually unreasonable. CMS will accept the state's determination and post the state's decision online. If the rate is determined to be unreasonable and the issuer is allowed under law to implement the proposed increase, CMS will provide the state's determination and explanation to the relevant issuer.

CMS will conduct the review if the state does not have an Effective Rate Review Program. Under this scenario, CMS will apply three tests to determine whether a proposed rate increase is unreasonable or not:

Is it excessive? Will the proposed increase lead to premiums that are unreasonably high in relation to the benefits provided? Is it unjustified? Are the data and documentation provided by an issuer incomplete, insufficient, or otherwise lacking in relevant information that reasonableness of the proposed rate increase may not be determined? Is it unfairly discriminatory? Will the proposed rate increase lead to premium differences among insureds that share similar risk profiles that either are not allowed under state law, or do not comport with differences in expected costs?

After completion of each rate review, CMS will post its final determination on its website and provide explanation to the relevant issuer.

As discussed above, a state will conduct the rate review if it has an Effective Rate Review Program. CMS will evaluate (and may re-evaluate) whether a state has such a program in place, according to the following criteria:

The state collects data and documentation from issuers that are sufficient enough to examine (1) the validity of assumptions used to develop the proposed rate increase, and (2) past projections and actual experience. The state conducts effective, timely reviews of such data and documentation. The state's review process includes the examinations described above, which takes into account factors specified in the rule that may impact rates (factors such as medical trend, benefit and cost-sharing changes, and others). The state's review of rates is based on statutory or regulatory standards.

A state with an Effective Rate Review Program will be required to publish on its website Parts I and II of the Preliminary Justification for proposed rate increases. Moreover, the state must establish a mechanism to receive comments from the public regarding those proposed increases.

CMS reviewed all available state regulatory documentation and met with state insurance regulators to determine if a state had an Effective Rate Review Program. As of July 1, 2011, 40 States, the District of Columbia, and the U.S. Virgin Islands have effective review for all insurance markets and issuers (see Table 6 ).

Final Justification

Upon receipt of a determination that a proposed rate increase is unreasonable, the health insurance issuer may:

Decline to implement the proposed increase or choose to implement a smaller increase. The issuer must notify CMS of either action. However, if the smaller rate increase still meets or exceeds the applicable threshold, the issuer must submit a new Preliminary Justification for that smaller proposed increase.

or

Implement the rate increase that was determined to be unreasonable, if allowed under law. In this case, the issuer must (1) submit Final Justification to CMS (which will be posted on the CMS website for three years), (2) post on the issuer's website: Parts I and II of the Preliminary Justification, the determination and explanation from the rate review conducted by the state or CMS, and the issuer's Final Justification; and (3) make this information available on the issuer's website for at least three years. The Final Justification must be consistent with the Preliminary Justification in terms of the information submitted to justify the rate increase.

CMS Impact Analysis

The final rule includes analysis conducted by CMS on the potential impact of the rule on health insurance issuers and enrollees, rate filings, and administrative costs. Those analyses are summarized below.

Given that the rate review requirements apply to all individual and small group coverage (with the exception of grandfathered health plans), CMS collected and analyzed data on the number of insurance carriers that offer products in those markets, many of which operate in both the individual and small group markets. CMS estimated that 417 issuers potentially would be impacted by the rate review requirements. By market segment, 311 issuers could be affected in the individual market; 342 issuers in the small group market. With respect to enrollees, this would translate to nearly 35 million enrollees potentially affected by rate review (approximately 11 million in the individual market and 24 million in the small group market).

CMS also estimated the number of rate filings that potentially would be subject to review and require justification, and developed low-, middle-, and high-range estimates for both the individual and small group markets.

For 2011, CMS estimated the number of rate filings in the individual health insurance market that would be subject to review and require the submission of a justification report could range from a low of 279 filings to a high of 819 filings. These estimates represent 40%-67% of all filings in the individual market for 2011. For the small group market, CMS estimated a low of 189 filings could be subject to review and require justification, and a high of 940 filings. These estimates represent 20%-32% of all filings in the small group market for 2011.

CMS also estimated the potential administrative costs to issuers related to rate review under ACA. Similar to the analysis on the number of affected rate filings, CMS developed low-, middle-, and high-range estimates of potential administrative costs, based on the 417 issuers estimated to be affected by the rate review requirements (see above). Table 7 displays the estimated costs for developing and providing justification reports, retention of records, and online notification requirements (as discussed in the final rule).

Appendix. Private Health Insurance Cost-Sharing

Other Insurance Costs Not Included in the Premium

Health insurance premiums generally represent only a part of the insured individual's or family's costs incurred under a given benefits plan for health services and prescription drugs. While enrollees and policyholders pay premiums irrespective of health service use, they typically are responsible for cost sharing in the form of deductibles, flat dollar co-payments, and/or percentage co-insurance only when services are used. Increased cost sharing has been viewed by some as a method of shifting costs to those who are utilizing the services, thus limiting the shared risk and constraining premium growth. On the other hand, increasing cost-sharing reduces the value of the coverage at the same time premiums are going up. Essentially individuals and families end up paying more for less, due to exposure to higher out-of-pocket costs.

Similar to the observed increases in premiums, cost-sharing expenses have been increasing. Thus, some individuals may be able to afford purchasing the insurance, but not be able to afford the cost of utilizing health care services despite being insured. From a consumer perspective, deductibles have the most impact because coverage does not start until the enrollee spends more than the deductible amount. As illustrated in Figure A-1 , average deductibles generally have been increasing the past few years, across plan types in both the group and non-group markets. Comprehensive data on other benefit designs such as drug co-payments and hospital co-insurance are not publicly available. However, the Milliman Medical Index estimates that for a typical family of four with private employer group coverage, out-of-pocket cost sharing has increased between 5.4% and 10.5% annually between 2006 and 2010.