The importance of administrative cost benchmarking

In the late 1990s, online travel agencies revolutionized the airline industry by publishing fares and allowing consumers to search for and purchase tickets. No longer would consumers have to rely on an agent to filter and present options; travelers could search across all vendors and use their own criteria to evaluate their options and purchase a ticket. The individual and small group health insurance markets are poised for the same sort of dramatic change, driven by the now familiar concept of the online marketplace, known in the health insurance industry as the exchange.

Although the operation of a health insurance exchange is quite different from that of an online travel agency, these distribution channels are similar in their impact on price transparency. Under the old travel agent model, consumers would first search for tickets based on convenience factors (e.g., travel dates and times, routes, etc.) and then use price to differentiate among a few options. Likewise, in the individual and small group health insurance markets, price is often presented after the purchaser has already narrowed the options to a few that meet non-price criteria. In both of these situations, price is applied as a deciding factor after the consumer has already narrowed the universe of choices to a subset of similarly appealing options; and the consumer lacks visibility to the prices of choices that were eliminated in that process. Online markets, on the other hand, allow consumers to see the prices of all or most options at the same time, making price a primary determining factor when making a purchase decision. This new presentation format, which allows consumers to choose one product over another based on a small dollar price difference, discourages significant price variation among competitors for similar products.

For most health insurance products, price is comprised of three primary components: benefit expense, administrative expense, and risk margin. Although benefit expense makes up the lion’s share of the premium or price, administrative cost differentials among health insurers can also materially contribute to premium differences. These differences will become more pronounced and may affect consumer purchasing decisions as the benefit expense component of premium is constrained by the medical loss ratio (MLR) requirements of the Patient Protection and Affordable Care Act (PPACA). These rules effectively create a benefit expense floor, requiring that health insurers in the individual and small group markets spend no less than 80% of premium on benefits (85% in the large group market), or pay a rebate to policyholders. It is likely that MLRs for individual and small group products will eventually settle around the 80% level or higher. In this new world, the importance of managing administrative cost will increase as price competition puts pressure on overall premiums and the MLR rules force administrative cost and risk margin into a fixed share of the premium dollar.

Benchmarking is one of the most effective tools available to help health insurers manage administrative expense. For insurers working to achieve MLR targets through administrative cost reduction, a benchmarking assessment can offer a function-by-function comparison of administrative expenses and staffing levels versus competitors and peers. Such an analysis can help organizations figure out where to target their cost reduction initiatives or determine what cost level is appropriate for a given department, cost center, or function.

For insurers that have already achieved the MLR targets, administrative benchmarks combined with a dashboard view can allow for monitoring of administrative expense variation throughout the year. Optimizing administrative cost is not something that can be achieved overnight; it takes time to plan and implement cost management initiatives, and months or years before the benefits accrue to the bottom line. Thus a dashboard coupled with benchmarks can provide management the tools they need to effectively manage their price competitiveness in this new distribution paradigm.

This article first appeared at Milliman MedInsight.

One thought on “The importance of administrative cost benchmarking

Leave a Reply

Your email address will not be published. Required fields are marked *