Networks are hard for insurers to build. They are easy to build when an insurer is operating in an area where it is already covering a large population base. A decent network that offers decent access at a reasonable price is very hard to build when an insurer is going into a new area. This is critical when we think about why insurers have not scrambled to go to Maine or Georgia which allow for out of state insurers to come into the state with far less local regulatory approval. Networks are tough.
The fundamental leverage dispute in a network negotiation is one of quantity versus price. Insurers have leverage against providers when the insurer can credibly promise to direct a large number of covered lives to or from a particular provider. Providers have leverage when they don’t think that the insurer is bringing a lot of members. An insurer with large market share should be able to get a better price than an insurer that has very little local membership. This is a problem when an insurer is looking to expand out of its home base. There are a couple of options. The first is to slowly blob from a central core by adding providers and members in roughly the same direction at the same time. Organic growth can work as the marginal provider who the network expansion team is talking with sees the environment slowly changing so jumping in or out is no big deal. However non-organic “jump” growth is tougher from a network perspective.
There are a couple of ways a non-core area network can be built. The cheapest way is to build a network organically. The problem is that this is a slow build and it is likely to have a fairly small network initially as a lot of providers won’t believe that there is a large enough number of covered lives to make dealing with yet another insurance company worthwhile at a given rate. The other major method is to rent a network from either another insurer or from one of the network bundlers. These networks can be fairly broad and will be widely accepted by providers but there are severe limitations. The first is that these networks tend to be expensive as they tend to pay the providers at a fairly high level and also charge a fairly high administrative fee. The second is that the contractual restrictions of a rental network means the insurer can do far less utilization and cost control slicing and dicing in the future.
Why does this all matter for the question of selling across state lines as a policy panacea?
Let’s pretend that Mayhew Insurance is based in Providence, Rhode Island with a single license to sell in Rhode Island. Let’s also pretend that the Big Idea Geniuses forgot their Dunkins this morning and decide that they want us to sell in Maine next year for the Exchange market.
The Mayhew Insurance Exchange network is centered in Rhode Island. Since the state is tiny and there is a world class medical center 45 minutes to the north of capital, the network contains a significant number of doctors and hospitals in Massachusetts as well as a decent number of docs in the Nutmeg state. However the network starts to fade to random and isolated samples north of the Charles River. A few contracted providers have offices on the South Shore and the North Shore so their North Shore office is in network but no one ever goes there from Rhode Island.
Maine may initially have half a dozen random providers in network because they are branch offices of a Boston based hospital. Everything else has to be built from scratch. If Mayhew Insurance wants to compete on Exchange in Maine, they need to have a competitively priced product which means a low cost network. The former game of designing a high cost network that appeals only to very health people so that no claims needed to be paid goes out the window due to risk adjustment. Yet Mayhew Insurance has no current membership in Maine and its Exchange market is reasonably competitive already. There is not a huge gap to jump into.
The network choices are to either build up slowly and get slaughtered in the first year as there is only a barebones network that is only attractive to very healthy people who need qualifying coverage that they don’t use and all the revenue is lost via risk adjustment or to build a decent size network by paying above current market rates to make it worth the providers’ time and effort to add yet another insurer and their paperwork/requirements to their pile of problems with an uncertainty that Mayhew Insurance will actually get anyone to sign up. From there Mayhew Insurance could either price at an actuarial fair rate and attract only sick people with the hope that risk adjustment is sufficient to get close to break even or engage in a one to two year loss leader strategy. The loss leader strategy is simple, Mayhew Insurance would commit to losing $10 to $20 per member per month in order to get a lot of members. From there the new big member pool would be used to negotiate new contracts with new providers at lower rates because there is now a credible leverage of membership and volume to get decent pricing.
This all makes sense in an isolated fashion.
However if there is a large, well capitalized insurer in the state already that has decent brand loyalty they have a strong interest in minimizing their competition because that undercuts their pricing advantage. They could afford to cut their pricing by the same margin as Mayhew’s loss leader strategy and minimize lost membership.
So there is a chicken or the egg problem with insurers expanding out of their home bases. Insurers need membership to get good pricing on their networks but they need good pricing on their networks to get membership. Dropping regulatory barriers to entry by encouraging a credit card-esque race to the bottom and enriching the state of South Dakota won’t attract new insurers into markets that are not next to home bases.