Q & A with Douglas Sherlock of Sherlock Company

To learn more on trends in health insurers' administrative costs and how those costs may be affected by federal healthcare reform, FierceHealthPayer's contributing writer Harris Meyer talked with Douglas Sherlock, a chartered financial analyst and president of  Sherlock Company. For the past 13 years, Sherlock's Gwynedd, Penn.-based firm has surveyed mid-sized and large health insurers to produce benchmarking reports on administrative costs.

FierceHealthPayer: In your most recent survey of Blue Cross & Blue Shield plans, which costs rose and which fell?

Douglas Sherlock: Administrative cost growth was modest in 2009, though it grew faster last year than in 2008. Marketing was down. The big increase was in information systems, where costs grew near double digit rates. We've seen an evolution toward server farms, and the computing capacity on individuals' desks now is pretty powerful. That investment has led to some pretty sharp cost increases since 2008.

FHP: What about insurance broker commissions?

DS: The typical broker commission is $12-$15 per member per month. Multiplied by the average family size of 2.3, that's some serious money. Brokers play an important role in providing information to consumers. The issue is whether that information is worth the price. Some insurers now are saying they intend to pay brokers a per capita payment rather than a percentage payment, which could drive down costs a bit.

FHP: What about executive compensation?

DS: We noticed executive and governance costs went up, and we found out that was related to a lot of staff turnover, with CEOs and CFOs leaving. Plus, we saw an increase in the hiring of consultants for strategic services, such as business process improvement activities. Still, executive and governance costs, including consulting services, are about $.90 per member per month, which doesn't amount to a whole lot.

FHP: What do you make of health reform's focus on medical loss ratios?

DS: I've been puzzled by the MLR debate. What are consumers buying when they buy health insurance? Health coverage plus certain transaction services, or a package of services that supports their health care? I think it's the latter. Assuming the consumer gets high-quality healthcare, the mix of administrative and medical costs shouldn't matter. It's the overall cost the consumer is paying. Despite my puzzlement, Congress and the President have spoken, and many insurers will try to figure out ways to reduce their administrative costs accordingly.

Have you observed administrative cost differences between larger and smaller insurers?

DS: Most people are shocked to learn there aren't economies of scale in this business. The large national firms greatly resemble Blues plans and independent provider-sponsored plans. You'd figure that firms with a million members would have such strong economies of scale that costs would be lower. We don't see that. Administrative cost management is not a matter of national scale, it's a lot of blocking and tackling. That's good news for a lot of smaller health plans. While many people believe that only the large will survive, that's not at all clear to me based on administrative cost evidence.

FHP: How will the new state health insurance exchanges required by healthcare reform affect insurers and costs?

DS: The overall concept of the exchanges is a very good one. The exchanges promote an efficient market and administrative costs should fall. They should drive down transaction costs in the same way that stock exchanges have driven down transactions costs for stocks. If they work as you hope, the exchanges presumably will lead to savings of about $10 per member per month for employers and consumers.

FHP: How do health plans use your benchmarking data?

DS: Some plans give employees bonuses if administrative costs come in under the industry benchmarks. Some use the data to change strategic direction. Some target areas that are outliers. One plan said they saved $50 million annually by using our benchmarks. The idea is to create a transparent environment for plans to manage their costs as best they can.

Editor's note: Harris Meyer is a journalist based in Yakima, Wash. who has won many awards for his reporting, including the National Institute for Health Care Management Award and the Association for Health Care Journalists Award.