Would Privatization Cure the Ills of Blue Cross Blue Shield?

The following article originally appeared in the July 12, 2002 issue of the MIRS Newsletter.

Fearing a backlash in a PR war that would be tough to win, the Michigan House and Senate recently rejected the notion of privatizing Blue Cross/Blue Shield of Michigan (BCBSM). This is indeed an issue that requires much deliberate thought, is not well understood by the public, and is therefore easily demagogued, but that doesn’t mean it’s a bad idea. It may simply mean it needs to be better marketed, or dealt with in a less-politicized atmosphere. Indeed, it’s a classic lame-duck session topic and for that reason, no one should assume the Legislature’s rejection is the final verdict; if nothing else, time and growing problems will eventually force the issue.

Blue Cross/Blue Shield of Michigan (BCBSM) is not a private, investor-owned, for-profit business. It is a hybrid nonprofit health insurance firm that evinces a mix of both public and private characteristics. It sells at least 50 percent of health-insurance policies in Michigan. Michigan’s Public Act 350 of 1980 exempts it from state taxes but in return for that special privilege it insures anyone who can’t get coverage elsewhere. As a May 14 editorial in the Detroit News put it, “Blue Cross ends up with the largest share of Michigan’s sickest and most expensive patients, and fewer of the younger, healthier clients to help balance the costs.”

The state reviews and approves the rates for those high-risk clients, a factor which subjects the firm to what is sometimes a frustratingly politicized environment in which to do business. This “quasi-public” status has its advantages for the firm (tax exemption being a big one) but those advantages may be outweighed by an unhealthy reliance upon the unpredictable political process, difficulties in raising financial capital, and limited management flexibility.

Public Act 350 of 1980 regulates nonprofit health-care corporations like BCBSM to “promote an appropriate distribution of health-care services for all residents” of Michigan. The act governs how such health insurance corporations operate, i.e., how their boards are chosen, how they apply their rates, etc. 

Each health-care corporation under P.A. 350 is termed a “charitable and benevolent institution” and is exempt from taxes on revenue and property. Rather than lose the tax exemption offered by P.A. 350, BCBSM has chosen not to become a for-profit company, saving it as much as $60 million (which is offset, and perhaps completely so, by the cost of a myriad of state regulations and requirements). BCBSM has lost hundreds of millions of dollars in the “small group” area of its insurance business in recent years because P.A. 350 requires that it offer its services as an “insurer of last resort.” Furthermore, state law specific to BCBSM and no other insurer forces the firm’s insured subscribers to subsidize Medigap insurance.

Under P.A. 350, non-profit health insurers cannot raise capital by selling stock as do private companies. Frank Webster, an industry expert and former head of the Michigan Education Association’s teacher health insurance subsidiary, has argued that this is especially crippling right now because of the need for technology upgrades that may cost the firm up to $400 million over the next several years. The new technology is needed to replace hardware and software to better process enrollment, claims processing, billing, actuarial estimates and to work more efficiently with corresponding plans elsewhere. The ability to raise capital through the sale of stock would help dispose of a troubling prospect recently revealed by the Michigan Insurance Commissioner’s 2001 audit of BCBSM. That report, though affirming a relatively healthy bottom line today, warns of substantial cash flow problems over the next several years, and the politically volatile prospect of premium increases as the only possible remedy under the current non-profit regime. This is in spite of BCBSM already having raised its rates on small businesses hugely in recent years.

Michigan’s BCBS affiliate is the last state-controlled plan of its kind in the nation. Blue Cross/Blue Shield plans covering 14 states have converted to investor-owned companies. The Blues in states that surround Michigan—Ohio, Indiana, Illinois and Wisconsin—have all consolidated or become for-profit companies. Remaining a state-controlled plan for the foreseeable future means facing increased state regulation, remaining an insurer of last resort, and having a diminished ability to service regional and national businesses because it will not be sharing a common vision, values and strategies with other BCBS plans.

Oddly, opponents of privatization talk as if utter disaster would follow any form of privatization of the Blues, ignoring the fact that no such disaster has befallen neighboring states where the Blues have gone the competitive, for-profit route. High-risk people do get coverage in other states, and the discussion in Michigan should get beyond the scare talk that keeps us from looking at options seriously. 

(This “ignore the experience” perspective is painfully evident on so many other issues too. For example, during the debate over relaxing Michigan’s concealed/carry weapons permit requirements, no amount of evidence showing lower crime rates in states with such relaxed rules seemed to sway many opponents. Since Michigan made it easier for law-abiding citizens to secure such permits, crime has not only failed to explode as some predicted, but crime rates have actually fallen. Why is it that so many who put blind faith in the ability of government to fine-tune our lives ignore actual evidence time and again? In their view, not only is every flaw in the private sector a reason for more government, but even flaws in government are excuses for more of it as well).

Mark Gaffney, president of the Michigan AFL-CIO, claims that privatization is a bad idea because it would effectively do away with the cap that BCBSM now has on the “accumulation of excess reserve funds.” But other industry analysts point out that BCBSM’s surplus has historically been too low—which is itself a good argument for privatization. Private owners would undoubtedly build a more substantial reserve—a “cushion” against unanticipated future events. In genuinely private insurance markets, these reserves don’t just sit there, they are invested. The returns on those investments assure that insurance premiums are lower than would be the case without those investments.

If the Legislature repealed Public Act 350 and thereby stripped BCBSM of both its special tax exempt status and the burdensome regulations that come with it, the company could convert to for-profit, investor-owned status, giving it the same advantages that other plans have: access to capital, more flexibility, the ability to reap the benefits of economies of scale by strategically partnering with other plans. Through such “privatization,” the Blues would be converted to a stock insurance company with no special treatment, i.e., no tax breaks and no obligations or restrictions different from those of other health insurers. All insurers in the state would then be on an even playing field and the highest-risk customers would be portioned among a larger number of insurers. 

D. Joseph Olson, himself a former state insurance commissioner and currently an executive with the Amerisure Companies, points out that the problem of certain high-risk clients being unable to find affordable coverage without the current BCBSM arrangement could also be solved by the formation of high risk pools, with the administration of those pools structured to provide incentives to hold down costs, rather than just to throw them onto private carriers and their policyholders. 

The absolute worst option would be to force on every other insurer the kind of rate regulation and other political meddling BCBSM must endure. That would do little but drive other firms out of Michigan, reducing competition and raising rates as a result. Nor should BCBSM privatization bestow excessive powers of micromanagement upon the state insurance commissioner, as some in Lansing have proposed.

The chances of a really serious, thoughtful discussion about these issues in the near term, unfortunately, are just about nil. Politicians running for office this year are, with few exceptions, far more willing to obfuscate the matter and posture as defenders of the disadvantaged, even though in the long-run everybody including the disadvantaged may be better off with fundamental changes. Too many vote-seeking opportunists denigrate the very phrase, “for profit,” even though the profit motive is responsible for saving more lives, producing more goods and services, and raising our standard of living higher than any other place in the world. It takes real leaders who know more than what they can fit on a bumper sticker and who are willing to step up to the plate and work to fix a problem before it becomes a genuine crisis. Sadly, there just aren’t many of them around these days. 

So unless something surprising happens, count on no big changes from the Legislature on the BCBSM question for the foreseeable future. Problems will fester until the politicians are forced to do something, and even then there’s no guarantee they’ll do the right thing. That, unfortunately, is the nature of government.