The NAIC (National Association of Insurance Commissioners), a US standard setting and regulatory support organization, has imposed capital requirements on the insurance business called RBC (risk-based capital) requirements. These specify the minimum amount of capital that a health insurance company should possess in order to protect its customers and investors should it experience unexpected losses in its insurance business.
The above graph shows the risk-based capital ratios of managed care organizations such as Humana (HUM), Aetna (AET), and Cigna (CI) and the average RBC ratio of commercial health insurers such as MetLife (MET) and Lincoln National Corporation.
An RBC ratio above 200% indicates a company with a stable capital base. If the ratio falls below 200%, the insurance company has to initiate actions to increase its capital or face disciplinary actions.
Companies with higher RBC ratios generally enjoy better credit ratings. The commercial insurers generally maintain higher RBC ratios than managed care organizations, as they have higher ratings from the rating agencies. Humana has an investment-grade BBB rating and has a higher RBC ratio than prominent managed Medicaid players that don’t generally have investment-grade ratings.
Diversified companies reduces risk
The appropriate level of RBC ratio for a health insurer depends on the company’s size and the degree to which it takes different risks including investment risk, underwriting risk, credit risk, and business risk. Companies with diversified businesses generally have lower RBC requirements because diversification reduces the riskiness of their cash flows. Humana has a Medicare-concentrated business model and so requires a higher RBC ratio.
Also, the risk-sharing model between a managed care organization and contracted hospitals affects required RBC ratios. If payment to the health provider is based on a capitation or fixed-amount-per-member-per-month basis, then the financial risk resulting from excessive use of medical services is transferred from the health insurer to the health provider. Currently, 30% of Humana’s members are covered by capitation arrangements. As the health insurance industry moves toward capitation from a fee-for-service model, Humana’s RBC requirement is expected to decline.