The Health Insurance Exchange Dilemma: To Play or Not to Play

The formation of health insurance exchanges in 2014 is fundamental to the U.S. Patient Protection and Affordable Care Act. Booz & Company has developed new fact-based perspectives on the forces shaping exchanges, and their impact on health plans. Health plans must actively engage now with state regulators to create an exchange marketplace that is sustainable over time, while developing a strategy for their participation in exchanges.

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Ashish Kaura Patricia Andriolo-Bull Robert Pottharst Gary Ahlquist

The Health Insurance Exchange Dilemma To Play or Not to Play?

This report was originally published before March 31, 2014, when Booz & Company became Strategy&, part of the PwC network of firms. For more information visit

Contact Information Atlanta Ralph Alewine Partner +1-404-519-0184 [email protected] Chicago Gary D. Ahlquist Senior Partner +1-312-578-4708 [email protected] Ashish Kaura Principal +1-312-578-4838 [email protected] New York Gil Irwin Partner +1-212-551-6548 [email protected] Joyjit Saha Choudhury Principal +1-212-551-6871 [email protected] Patricia Andriolo-Bull Senior Associate +1-212-551-6177 [email protected] Robert Pottharst Senior Associate +1-212-551-6140 [email protected] San Francisco Paolo F. Borromeo Principal +1-415-627-3387 [email protected] Sanjay B. Saxena, MD Principal +1-415-263-3729 [email protected]

The authors would like to thank Paolo F. Borromeo for his significant contribution to this Perspective.

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The formation of health insurance exchanges in 2014 is fundamental to the Patient Protection and Affordable Care Act. As envisioned, these state-based exchanges are intended to create competitive, transparent, accessible, and affordable marketplaces for health insurance. We estimate that exchanges could cover 19 million to 22 million members by 2016. Membership beyond that time frame is difficult to predict and will depend on the attractiveness of these new marketplaces, especially for small groups seeking relief from ever-increasing healthcare costs.

Through extensive interviews with health plan executives, regulators, employers, and consumers, Booz & Company has developed new fact-based perspectives on the forces shaping exchanges. We find that they will initially draw largely from subsidized populations, individuals paying their own premiums, and employers with fewer than 25 employees. However, beyond this big picture, exchanges are likely to be tumultuous and unpredictable. At the local level, state demographics, budgets, and politics will result in varying models with different levels of attractiveness to health plans. What should health plans do in this environment? First, they need to work with state regulators to

create an exchange marketplace that is sustainable over time. This will require clear rules of market conduct, consumer protection, and safeguards against stifling innovation or attracting adverse risk. If done right, exchanges can yield profitable business for health plans. Second, health plans will need a participation strategy. For some, participation in exchanges that focus on the low end of the market will be a way to maintain the volume and scale necessary to support a high-fixedcost operation. For others, exchanges may provide experience in adapting to disruptive innovations that may ultimately make their way into more traditional health plan segments.

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Key Findings • New Booz & Company research indicates that 19 million to 22 million new members will purchase health insurance through new exchanges by 2016. • Exchange design is critical to establishing a sustainable marketplace. Health plans must act swiftly and deliberately to help shape the exchange. • A sustainable exchange design preserves markets off the exchange, creates effective risk adjustment mechanisms, and maintains separate risk pools across individual and small group markets. • Health plans entering the exchange marketplace have to decide which customer segments to target and then build new capabilities to reach them. • To compete, health plans need better analytics, enhanced retail capabilities, redefined corporate functions, and a lower cost operating model to compete in a pricesensitive market. • Health plans face broad transformative change throughout the industry. New capabilities will benefit insurers no matter how, or whether, they participate on the exchange.


One of the main components of the Patient Protection and Affordable Care Act (PPACA) is the establishment of state-regulated health insurance exchanges in 2014. An exchange is a state-based entity through which consumers can purchase standardized health insurance plans and access federal subsidies. The goal is to expand insurance coverage and create an environment where insurers compete on cost while adhering to consumer protections, with significant flexibility left to each state to design a health insurance exchange suitable to its needs. These new marketplaces threaten to upend the traditional business-to-business model that has been the basis for health insurance delivery in the United States for decades. According to new Booz & Company research, an estimated 19 million to 22 million new members, or 6 to 7 percent of the total market, will purchase health insurance through exchanges by 2016. The majority will be individuals and small groups that are highly price-sensitive and want basic products and services. The largest segment will be 7 million

to 8 million individuals who are currently uninsured (see Exhibit 1). Another 6 million to 7 million people who already have individual coverage will switch to exchanges. The remaining 6 million to 7 million will come from small groups with fewer than 25 employees. These individuals will either be “dumped” onto the exchange by employers that drop insurance coverage altogether or “switched” into the marketplace with employers that buy coverage on the exchange as a group. Our research shows that groups with 25 to 100 employees that are eligible to buy through the exchange will largely adopt a wait-and-see approach to determine whether the exchanges are sustainable, rather than immediately dumping employees into a new, potentially volatile marketplace (see Exhibit 2). A number of factors will drive adoption beyond 2016, including the state of the economy, healthcare cost growth, and stability of the new exchange markets. Even at 6 to 7 percent of the market, the exchanges will attract the interest of health plans that rely on scale and volume to support their high-fixed-cost operations. Competitive pressure on plans to participate will be high if the exchanges lead to a larger, more encompassing retail health insurance marketplace than projected. This could happen if small groups dump significantly in response to cost pressures, or if a large number of employers opt for exchanges under a defined contribution approach.


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Exhibit 1 Inflow and Sources of Projected Exchange Membership in 2016



a Subsidized Nonsubsidized 6-7 Million 54% 5% 7-8 Million 41%
3-4 million dumped, most from low-wage microbusinesses and most subsidized, go to exchange 3 million from small groups switch to exchange

6-7 Million 68% 32%
Dissatisfied members, most of them subsidyeligible, are likely to switch to exchange

19-22 Million


Subsidized Population on Exchange (~70%)

A -


Large portion of subsidy-eligible uninsured go to exchange Minority of nonsubsidized go to exchange, while others choose to stay uninsured and pay penalty


Nonsubsidized Individuals Small Groups

L -

19% From the Uninsured



From the Small Group Market

From the Individual Market

Total Entering Exchange

Source: Kaiser Employer Health Benefits 2009; Census 2007; Congressional Budget Office; market interviews; Booz & Company analysis

N P o f T



Exhibit 2 Impact of Exchanges on Individual and Small Group Markets (2009 vs. 2016)






33 3 columns width


13 Individual on (50%) Exchange 2 columns width 4 (13%) 10 (37%)
Nonsubsidized Individual on Exchange Individual off Exchange

25 3 (11%)

Small Group on Exchange

A -

22 (89%)

Small Group off Exchange

L -

L L 2009 Post-Reform ‘16


Post-Reform ‘16

Total Individual and Small Group Market: ~40% on Exchange and ~60% off Exchange

N P o f T

Source: Kaiser Employer Health Benefits 2009; Census 2007; Congressional Budget Office; market interviews; Booz & Company analysis

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Despite significant uncertainty, health plans must soon decide whether and how to participate, given short legislative timelines and the need to prepare for major change in the marketplace Much remains unsettled in this evolving market, but health plans are not completely in the dark. Some states have already established state-run exchanges. Experience with existing exchanges, such as the Massachusetts Health Connector, yields lessons that inform the shortand long-term decisions that health plans need to make as states pass

laws governing health exchanges and as these new exchange marketplaces start up. Created in 2006 to oversee Massachusetts’s pioneering health insurance exchange, the Connector is the closest program to the concepts laid out in the PPACA. The Connector facilitates enrollment for both Commonwealth Care, the government-subsidized program for individuals earning less than 300 percent of the federal poverty level, and Commonwealth Choice, the nonsubsidized program. The Connector acts as a market

Health plans must soon decide whether and how to participate in exchanges, given short legislative timelines and the need to prepare for major change.


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facilitator and a competitor to health plans because it groups customers, defines benefits, and oversees enrollment and billing for Commonwealth Choice. The exchange also acts as an active price negotiator and risk adjuster for Commonwealth Care. Our study of the Connector experience suggests three critical lessons for health plans: 1. Exchange design is crucial to long-term sustainability. Initial experience with the Connector is undoubtedly mixed. While consumers welcome the transparency, the exchange fails to control costs and reduces profitability for participating health plans. Gaps in exchange design such as the

lack of a defined enrollment period and significantly increased coverage requirements, combined with additional provider access, put cost pressure on the system. To combat rising premiums, even as health plans face rising medical costs, the state used its regulatory power to disallow rate increases . Not surprisingly, participating health plans are struggling to make money. 2. Health plans need to understand, assume, and price risk appropriately. Given changes in underwriting rules and uncertainty regarding the level of risk that plans will assume by participating in exchanges, pricing discipline and a low-cost operating model built on deep understanding of consumer behavior will be critical capabilities going forward. As in

Massachusetts, where subsidized members account for about 85 percent of individuals on the Connector, the national exchange market will be concentrated among subsidized individuals. This segment is typically the most price-sensitive, and requires low-cost, standardized products that are simple to understand, compare, and administer. Nonsubsidized individuals, accounting for about 12 percent of total lives on the exchange, are a more heterogeneous group. They represent different life stages, disparate levels of wealth, and more variable health profiles. Understanding which microsegments of this group to target and acquire, and how to serve each of them, is critical. For example, a Booz & Company

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study in Massachusetts found that even though half of newly insured, nonsubsidized individuals do not buy through the exchange, they do use the Connector as a starting point for insurance information. The exchange becomes a base for decisions on price, product design, and brand. Health plans must drive low-cost acquisition and service models tailored to the targeted microsegments. 3. Exchanges create many ways to participate and succeed. Health plans on the Connector have found different routes to success with careful choices about how to participate in submarkets, both on the exchange and in their ongoing

business off the exchange. Those participating in the subsidized market offer low-cost products and often have experience in the Medicaid market. To compete, some have adopted innovations such as steering primary care to lower-cost neighborhood clinics, and have leveraged Medicaid experience to serve consumers in an environment where price and margins are constrained. In the nonsubsidized segments, participating health plans rely more on well-developed distribution systems, products targeted to microsegments, and branding. As the exchange market develops, we expect that it will force health plans to innovate to meet the needs of a

low-cost, price-sensitive segment. Already, we are witnessing new payor–provider collaborations, new benefit designs based on network tiers, and bundled payment pilots, all aimed at creating new medical value by pushing down costs while providing better care. These findings lead to many critical questions for health plans: Can exchanges provide a source of sustainable margins? Will they attract adverse risk? How much volume will they generate? Even if health plans decide not to participate, they must ask how exchanges may alter the entire healthcare industry as providers and other players in the system react.

As the exchange market develops, it will force health plans to innovate to meet the needs of a low-cost, price-sensitive segment.


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In this environment, it is critically important for health plans to engage actively and directly with state regulators to build an exchange marketplace that will be sustainable. The legislation calls for exchanges to begin operations on or before January 1, 2014, and sets regulatory parameters that give states freedom to decide how their exchanges are designed. Local politics, prevailing economic conditions, demographics,

and the existing regulatory environment will drive state policy decisions. We believe states are likely to gravitate toward one of three health exchange models, with varying levels of regulation, product requirements, and impact on the size of the offexchange market (see Exhibit 3). The models also vary in attractiveness to health plans and other stakeholders in health insurance.

Exhibit 3 State Model Assessment Framework and Resulting Model Designs


1 STATE ASSESSMENT FRAMEWORK - Political profile - Historical and projected regulatory environment - Consumer wealth vs. poverty levels - Health insurance market structure STATE DESIGN OVERVIEW AND SAMPLE CHARACTERISTICS



Political Climate Local Economics

Passive Distribution Channel

- No regulations above the minimum PPACA requirements - Access and competition relatively unregulated with separate individual and small group markets - No additional qualified health plan certification, minimum product benefits, or off-exchange rules

Demographics State Readiness

Managed Market Coordinator

- Additional issuer and product rules, but no aggressive negotiations with health plans - Few additional qualified health plan rules, minimum product benefits, or product requirements - Off-exchange guidelines similar to exchange - Active regulation of the market, including negotiating with health plans - Combined individual and small group risk pools; very restrictive and limited off-exchange market - Stringent state qualified health plan certification; minimum product benefits - Additional requirements that standardize all product components

A -

L -


- Current health insurance access - Addressable population - Employer-offered rates and coverage

- Current insurance market regulations - State budgetary constraints

Active Market Regulator

N P o f T


Source: Booz & Company

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Our research suggests that most states have made little progress in exchange design and continue to grapple with several critical elements related mostly to regulation and governance. State regulators are now in the process of drafting exchange laws, and health plans must act swiftly and deliberately to have a say in exchange design. With a clear and focused strategy, health plans need to work with legislators and regulators to forge marketplaces that encourage participation by consumers, employers, and payors for the long run. We define sustainability as including these design parameters: • Off-exchange provisions: Preserve individual and small group

markets outside the exchange to provide consumer choice and encourage innovation. Establish a level playing field with the exchange in terms of rating requirements to avoid adverse risk selection both on and off the exchange. • Risk adjustment: Effective risk adjustment is vital within an exchange, especially in the early years when the potential for exchanges in many states to attract adverse risk may be high. • Health plan participation: Restrict exchange players to a reasonable number, allowing stable market share that will encourage participation. Take existing state competition dynamics into consideration.

• Product requirements: Use actuarial values, rather than strict product definitions, to preserve choice and innovation and prevent commoditization and pricing pressure that would limit health plan participation. • Risk pooling: Keep individual and small group pools separate, where possible, to limit major disruption in rates for small groups, as occurred in Massachusetts. • Governance: Encourage mechanisms allowing multiple stakeholders—including health plans, brokers, businesses, providers, and actuaries—to have input into the future direction of the exchange as market conditions change or corrective actions are made.

State regulators are now in the process of drafting exchange laws, and health plans must act swiftly and deliberately to have a say in exchange design.


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Beyond design, health plans face critical decisions about their own participation in exchanges and its potential impact on their financials and long-term competitive position. There is no clear one-sizefits-all answer. Each health plan will eventually respond to the new marketplace based on assumptions about the future that are rooted in market specifics and its own book of business. Many, particularly large regional health plans with significant market share and limited footprint, may be compelled to play on the exchange. They will seek volume to support a traditionally high-fixedcost structure, especially if the economy and cost increases provide impetus for small groups to dump coverage after 2016. On the other hand, large national health plans and smaller regional health plans may be

more selective, entering exchanges where margins would support investment in the more consumer-focused capabilities necessary to compete. Still others may choose to participate as a way to hedge their bets. These health plans would boost volume in the short term, but also learn to survive at the low end of the market in case the entire health insurance industry becomes significantly more like the retail-oriented exchange marketplace after 2016. Our conversations with health plan executives reveal that this dilemma is uppermost in their minds. To a large extent, the decision to participate will vary by state. Gauging how the rest of the market will respond, combined with a solid understanding of local demographics and market

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structures, will help health plans determine the nature and level of demand for the exchange. They need to look inward and evaluate how participation might play to their internal strengths and capabilities. At the same time, they must examine how the exchange might impact existing business. Some health plans may choose not to participate, or will wade in only gently. Even those who choose to stay on the sidelines must account for the exchange’s impact on existing business. To accommodate new subscribers, delivery systems may expand in nontraditional ways. For example, retail clinics may proliferate. If that happens, health plans would need to reevaluate strategies

in reimbursement or branding to reach consumers seeking treatment outside the traditional channels of hospitals and physician practices. Some health plans may exit the individual and small group markets altogether as the health insurance landscape changes. In that case, health plans need to contemplate how they will manage the expectations of external stakeholders, such as politicians, regulators, and consumers, to protect the lines of business they choose to maintain. Health plans that enter the exchange marketplace will have to decide which segments to play in and what capabilities to build. As in Massachusetts, the new exchange

marketplace will have three distinct subsegments—subsidized individuals, nonsubsidized individuals, and small groups. Initially, the market will skew heavily toward the subsidized portion. These individuals will form a Medicaid-like market with a customer population that is relatively difficult to serve and a premium-constrained, fixedbudget operating environment. For the nonsubsidized market, retail segmentation will be critical to meet consumer needs and find pockets of growth and profitability. Branding and other capabilities that enhance the consumer experience in targeted microsegments will be essential within a financially viable, low-cost operating model.


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Transformative change is already under way throughout the healthcare industry. A period of even greater volatility will ensue as exchanges are established in the context of overall reform. Exchanges aside, the health insurance market will continue to become more retail-oriented. Whether or not health plans choose to operate on exchanges, they must respond to this transformation with new capabilities and innovative, highly targeted strategies. Investing now in at least a handful of these “no regret” capabilities is essential, no matter how exchanges ultimately play out, given the lead time necessary to develop them. Only those health plans that take the following steps will establish a right to win in the rapidly evolving health insurance environment: • Develop deeper capabilities in analytics: Create a robust, detailed understanding of exchange design and its effect on sustainable margins. Model potential outcomes now to shape policy through local lobbying and community influence, and to determine a framework and

criteria to guide decisions about exchange participation. • Accelerate investment in retail capabilities: Begin assembling select retail capabilities that enable microsegmentation of the market or creation of simple, low-cost products. Consider ways to enhance the customer experience, and support acquisition and retention through direct marketing, the Web, traditional bricks-and-mortar offices, and workplace marketing. • Control costs: Consider low-cost approaches to service and support. Aggressively pursue lean, automated operations and reevaluate differentiating operational capabilities and sourcing solutions. • Redefine corporate functions: Initiate thinking about stratifying risk, managing sophisticated reinsurance, and developing shared-risk contracts with provider partners. This may require adjustments to the operating model and building of core capabilities to comply with state requirements on and off the exchange.

Investing now in at least a handful of “no regret” capabilities is essential, given the lead time necessary to develop them.

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The advent of health insurance exchanges will present health plans with difficulties and new opportunities. The current market is tumultuous; this initial period of instability and volatility will create new winners and losers. In the long run, the viability and role of exchanges will be shaped by their design and uptake by health plans and consumers. Health insurers need to enmesh themselves in current exchange discussions to create the criteria and conditions that will guide

decision making. Success—perhaps survival—requires clear strategies and capabilities both on and off the exchange, shaped in large part by the assets that health plans already possess. Given the risk and capital constraints, health plans cannot simply assume that they will participate. Instead they must make informed decisions about the investment they need to make and the strategic “no regret” capabilities they need to build today to prepare for an industry that will be transformed tomorrow.


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“Health Insurance Gets Personal,” by Ashish Kaura, David S. Levy, and Minoo Javanmardian, strategy+business, Autumn 2010.

About the Authors Gary Ahlquist is a Chicagobased senior partner who leads Booz & Company’s work for healthcare clients worldwide. Ashish Kaura is a principal at Booz & Company based in Chicago, specializing in growth strategies and business models for healthcare and health services companies. Patricia Andriolo-Bull is a senior associate with Booz & Company based in New York. She specializes in helping health services clients transform their operations to reduce costs and improve performance. Robert Pottharst is a senior associate with Booz & Company based in New York, specializing in corporate and business unit strategy for healthcare and health services companies.

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