Individual health insurance policies don’t stay on the books with a particular carrier for long. There’s a variety of reasons for this lack of persistency, but the most common reason for a policy lapsing is that the insured has been offered coverage through their job. Since employers usually subsidize at least half the the premium, dropping one’s own policy and taking the company’s is invariably a better value. Actuaries are pretty good at anticipating the lapse rate for a particular plan.
Lapse rates are highest during the first year a policy is in-force. This reflects the loss of consumers who purchased coverage while between jobs or the like. As a result, it’s not uncommon for one-third of individual and family medical plans to terminate in their first year. It takes roughly two years, however, for the next one-third to lapse. Put another way: sell 100 individual policies on January 2011 and you can expect to have 67 still on the books come January 2012 and 33 remaining on January 1, 2014. These are estimates and averages applied over large numbers. Your results may vary.
It’s also important to note that carriers and brokers have different experiences with lapses. A broker moving a client from Carrier A to Carrier B represents a lost case to Carrier A, but not to the broker.
How does all this tie into commissions? Because persistency is an integral part of the very idiosyncratic way I compare different commission schedules. And given the changes going on with broker commissions in light of the Patient Protection and Affordable Care Act’s medical loss ratio provisions, comparing commission schedules has become, by necessity, an obsession of most brokers.
The method I use to evaluate the commissions is what I call the Three Year Approximate Commission Calculation. Here’s the “thinking” behind it:
- According to the lapse rates by actuary friends have shared over the years, a typical individual health insurance sale remains is on the books for approximately three years. Some never make it that far; others stay far longer, but three years is a good rule of thumb.
- Broker compensation is usually (but not always) based on a percentage of the premiums paid by the consumer. Which means one way to compare broker compensation resulting from any particular sale is to add up the commission percentages paid each year and apply it to the first year’s premium. This is, admittedly, just one way and would, no doubt, make my actuary buddies cringe). Using this approach, a commission schedule that pays a flat 10% commission each year over three years is paying out roughly 30% of the first year’s commission over that period. A schedule that pays commissions of 15% first year and 7.5% on renewals is also paying out roughly 30% of the first year’s commissions.
- Yes, this fails to take into account the impact of rate increases, but I’m not claiming to offer a precise way of determining commission equivalence. This is a way to approximate the value of a commission schedule on the fly – no spreadsheet software or calculators required. There’s a reason “Approximate” is in the name of this calculation.Besides, guessing at the net impact of future rate increases is just that, a guess.
The result is the Three Year Approximate Commission (or TYAC). While it was developed for comparing individual medical plan commissions it can be used on small group health insurance commissions, too, which also are likely to remain with a carrier for roughly three years on average.
The Three Year Approximate Commission Calculation is especially useful in comparing the “before and after” of commission schedules being announced by carriers seemingly on a daily basis. As I’ve written before, the math imbedded in the Patient Protection and Affordable Care Act demands broker compensation be cut (absent regulatory or legislative relief). Put simply, carriers will have 7-to-8 percent of individual and small group premium available for broker distribution after allowing for administrative costs and margins. This works out to a Three Year Approximate Commission of 21-to-24%.
Which is pretty close to what brokers are reporting in the Tracking Commission Changes post (please note: these are reported commission schedules and have not been independently verified – if anyone has corrections, please send them along).
In Arizona, Cigna is reducing individual plan commission from a Three Year Approximate Commission of 30% to one of 22% – a roughly 27% cut.
In California, Anthem Blue Cross’ 40% TYAC is dropping to 28% for the top tier – a 30% reduction. Their lowest tier pays has a TYAC of 21% – a reduction of 47.5%.
In Georgia, Humana is going from a Three Year Approximate Commission of 33% to one of 25% – a 24% drop.
Illinois BCBS’s TYAC is moving from 30% to 23% for top producers – a change of roughly 23%. For those selling less than 25 cases the TYAC is dropping from 25% to 20% – a decline of 20%.
You’ll note some carriers have tiered commission schedules paying more to larger producers at the expense of those writing just a few cases. While you may disagree with this approach, it is “broker-friendly.” A producer writes less than, say, 10 cases a year isn’t really in the business of selling individual major medical plans. Such producers earn the bulk of their income from other product lines. Selling an individual policy is often done as a convenience to an existing customer. The amount they are paid on these sales is secondary to the income they receive from clients on other lines of business.
A broker selling dozens or even hundreds of individual health insurance plans a year, however, is relying on this line of business for the bulk of their income. That carriers would want to soften the impact of commission cuts on these produces is reasonable and, for these large producers welcome.
Still, commission cuts of 20%-30% or more in one year are life changing. Name a city or state who who could withstand a 30% decrease in tax revenues in one year? A CEO announcing a 25% drop in revenue would not be CEO for long. And the resulting cutbacks in service, layoffs and closures would be a devastating on citizens and employees.
That impact – how big it is, what it means and what brokers can do about – will be the topic of upcoming posts. For today I just wanted to introduce the Three Year Approximate Commission Calculation so we’d have a common way of describing differing commission schedules.