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Wall Street Journal

April 9, 2002

(Editors note: reprinted with permission from Wall Street Journal)

Health Insurer's Premium Practices
Add to Profit Surge, Roil Customers

By CHAD TERHUNE
Staff Reporter of THE WALL STREET JOURNAL

Shaneen and Tom Wahl were paying $417 a month for health insurance when Mrs. Wahl was diagnosed with breast cancer in 1996. Their premiums began rising steadily, and by August 2000, the Wahls were told their new rate would be $1,881 a month.

Mrs. Wahl, whose cancer was in remission, tried to find out why. Unsatisfied with answers they got on the phone, the Port Charlotte, Fla., couple visited the Wisconsin offices of the insurer, American Medical Security Group Inc. There, Mrs. Wahl says, an executive explained why her premium was soaring: "because of your dread disease."

It's called reunderwriting. Normally, companies that sell health insurance to individuals evaluate their medical history just once, at the outset. American Medical reviews customers' health at each annual renewal. If they have developed a chronic disease in the past 12 months or filed claims that seem to foretell more claims to come, it raises their premiums.

This isn't unusual in some types of insurance, such as auto and homeowners' coverage. Drivers who have accidents or get speeding tickets can expect to see their premiums rise. But reunderwriting of individual health insurance faded away in the 1950s, in part because of regulatory pressure. Now, the practice is making a quiet comeback -- a sign of how soaring health-care costs are driving some insurers to aggressive practices that can have severe consequences for consumers.

American Medical, while minimizing price increases for healthy customers who file few claims, slaps those who are less healthy with double-digit increases year after year. To pay, some squeeze their budgets, cutting out restaurant meals and tuition savings for their children. One Florida woman took out a second mortgage. Others boost their deductible to limit the rate increase, leaving themselves on the hook for more medical expenses. The Wahls raised their deductible to $2,500 from $500, bringing the threatened $1,881 monthly rate down to $887.

Once family members become sick, their American Medical policy is often the only option, apart from finding a job that offers insurance. Other companies usually won't insure an applicant who has a serious medical condition, or will offer only a policy that excludes that condition.

'I Try to Ignore the Pains'

Policyholders who become aware of reunderwriting say they sometimes hesitate to see a doctor for fear of giving the company reason to raise its rates. Ed Bonsignore, a 58-year-old who had a heart attack four years ago, was notified of a 60% rate increase at his last renewal date. He says that although his doctor has told him to go to a hospital if he feels chest pains, he just takes a nitroglycerin tablet and tries to relax. "They make you scared to use your insurance because they just keep jacking up your rates," he says. "I try to ignore the pains. Either I drop dead or it blows over."

He and his wife, Marie, retired restaurateurs in Palm Beach Gardens, avoided their most recent increase by raising their deductibles to a steep $9,000 apiece.

American Medical's tactics have helped its performance during a tough time for the industry. Rising drug costs, advances in medical technology, an aging population and the retreat from tightly managed care are increasingly pressuring insurers' profits. But American Medical recorded a 56% earnings increase last year, which its chief executive attributed partly to "aggressive rate action." Its stock has just hit a 52-week high.

Glimpse of the Future?

Although the company, with under $1 billion in annual revenue, is far from a health-insurance giant, its moves could herald a new strategy for a beleaguered industry. A competitor, American Republic Insurance Co., recently adopted a form of reunderwriting.

"People in good health are demanding some kind of discount for not using their coverage," says Rod Turner, a vice president of the Des Moines, Iowa, company. And "if someone gets a discount for no claims, then someone has to get higher premiums for having claims. The industry is moving in that direction."

This fall, an insurance-industry work group plans to ask state regulators to be more open to individual reunderwriting. "If regulators can overcome their emotional reaction and allow it to happen, I think it could be a useful tool in managing health-care costs," says Bill Bluhm, chairman of an American Academy of Actuaries task force on rates.

Some insurers remain opposed, and others are watching to see how much resistance American Medical faces. Three states have ordered the company to stop reunderwriting. Now Florida is trying to bar American Medical from selling insurance at all in the state.

Administrative Complaint

In an administrative complaint, Florida's insurance department accuses American Medical of illegally discriminating against customers based on their health. It also says the company violates unfair-trade-practices law by not warning policyholders that getting sick may drive up their rates. In addition, a class-action suit seeks refunds and damages for nearly 12,000 American Medical customers in Florida. The company sells individual policies in 27 states and says it uses reunderwriting in more than half of them.

American Medical says there is no discrimination because customers who present the same health hazard are treated the same. As for informing them their health could affect future premiums, it says that's up to the independent agents who sell the policies. American Medical also says it isn't covered by many of Florida's rules because of the way it markets to Floridians: They buy through a nonprofit association incorporated in Ohio, a state that doesn't regulate health-insurance rates.

Individual policies account for 10% of private health insurance in the U.S., the rest being mostly employers' group plans. Nothing in federal law bars insurers from reunderwriting these individual policies each year. But a 1996 federal law prevents insurers from canceling a policyholder for getting sick. It says all the policies must be "guaranteed renewable." Some regulators take this to mean insurers have to charge the same premium increases across a particular policy type or block of business. American Medical disagrees. It says coverage is guaranteed, but rates are not.

How It Works

At American Medical, shortly before a customer's annual renewal date, a computer program reviews any claims he or she has filed over the past 12 months for doctors' visits, prescriptions or medical procedures, as well as any disease diagnoses. It assigns points to various diagnoses and claims, based on their likelihood of generating future claims. A broken leg that heals normally wouldn't trigger higher premiums, explains chief actuary James Modaff. But a diagnosis of a chronic disease might, even if no claims have yet been filed.

In this annual review, the company puts each person into one of three tiers: preferred, manual or substandard. About 40% are preferred. The only rate increases they face that year are across-the-board ones based on medical inflation, unless they changed their benefits or moved to an area where medical costs are higher.

Another 40%, labeled manual, get a 5% rate increase that is due to their health and claims. The 20% or so in the substandard tier includes people with conditions such as cancer or diabetes. In addition to companywide increases, they face a 37% rise in their monthly premium that year and each year they stay in this tier.

American Medical says these tiers help it adjust, in part, for the risks of insuring the different groups. It says that for each dollar of premium from the preferred group, it pays out only 21 cents in claims. But in the substandard group, it pays out $1.71 in claims for each dollar of premium.

After Mrs. Wahl was diagnosed with cancer in September 1996, she says she and her husband paid a total of $18,180 in premiums over three years. The company paid $37,298 in claims for them in this period, she calculates, based on its paperwork. But Mrs. Wahl also estimates that in her full eight-plus years as a customer, her premiums have exceeded claims by about $10,000. The company declines to comment on her case or that of any other customer, citing privacy and the litigation.

Timothy Moore, American Medical's general counsel, says rate increases are "based on an individual's experience, just like auto or homeowners' insurance. If the risk changes, the premiums change."

Insurance regulators and researchers say health insurance is different, for several reasons. First, they say drivers and homeowners have more control over the likelihood of having a claim than people have over their health. Some state regulators also view health insurance differently because the stakes are higher. They note that reunderwriting could price people out of the market, leaving them uninsured and unable to afford medical care when they need it most.

"Their analogy between auto and health insurance is simply false, it's nonsense," says Joseph Belth, professor emeritus of insurance at Indiana University. "I am absolutely astounded they do this."

At most health insurers, buyers of individual policies are initially charged varying prices, based on medical history. Then all face roughly the same annual percentage increase, reflecting medical inflation and the claims filed by an entire policyholder group.

A key challenge in individual health insurance is keeping the healthier people enrolled. Their premiums are needed to subsidize those who get sick. The problem, under the traditional approach, is that the healthiest tend to drop out as rising medical costs gradually drive up premiums. As they drop out, the pool gets more and more concentrated with sick people and premiums go up and up, in what the industry calls a "death spiral."

Advocates of reunderwriting argue that because it gives smaller rate increases to the healthy, it keeps more of them enrolled and paying premiums, so that over the long run, it may help hold down rates. "Our tier-rating approach encourages more healthy people to remain in the system and keep rates lower for everybody," says American Medical's Mr. Modaff.

Up 60%

Arlene Shallan, a widow in Boca Raton, bought American Medical health coverage in 1994 because her job at a clothing store didn't provide any. In July 2000, she says, she broke down in tears when she opened a letter saying her premiums would soar 60% to $1,318 a month. A 37% health-related increase can reach 60% when companywide increases are added. Mrs. Shallan's new premium was more than her mortgage payment.

She called Susan Nelson, the company's underwriting chief, whose signature was on the notice. According to Mrs. Shallan, Ms. Nelson "asked, 'Do you know that you are a diabetic? Do you realize how terrible diabetes is?' I told her, 'What can I do about it? Someday we all get sick.' " The company says Ms. Nelson declines to comment.

Mrs. Shallan says she tried other insurers but none would sell her a policy because she had diabetes. Recently she turned 65, qualifying for Medicare.

Other Floridians were caught by another American Medical move that had the same effect as reunderwriting. Although insurers can't refuse to renew an individual policy, they can cancel an entire group. In 1999, American Medical canceled all of its policies held by Floridians, policies it had technically sold them through an Alabama trust. Then it offered them new policies purchased though a nonprofit group in another state. But for people whose health had worsened, the new policies were priced higher, sometimes several times as high.

Mary Rogers, who was paying $429 monthly, had just suffered a stroke. The new policy offered to her in 1999 had a premium more than triple the old one, $1,448 a month. This was more than twice the Social Security disability checks received by the former food-service worker.

Her children chipped in, but it still wasn't enough, so she took out a second mortgage on her home in Hollywood, Fla. "My mother had paid her premiums on time since 1994," says a daughter, Terry Rogers. "They can't be allowed to do what they have done." Mrs. Rogers complained to state regulators and is now a plaintiff in the class-action suit, in state court in West Palm Beach.

After negotiations between regulators and American Medical, the company agreed to cap the 1999 increases at 100%, and Mrs. Rogers's monthly premium went to $838. She has since become eligible for Medicare and dropped the policy.

Older customers like her bear the brunt of rate increases, since they are more prone to illness. But Larry and Dawn Smith, a couple in their 30s with two small children, also were snared. Mr. Smith had back surgery in 1999 and also learned he had HIV, which he says came from a transfusion. When American Medical canceled its Florida policies and offered new ones, the one he got in late 1999 doubled his premium to $217.