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The large accumulation of reserves of the Federal Employees Health Benefits program (FEHB) has given rise to concern about the necessity of current reserve levels, the manner in which they are held, and the most appropriate way to dispose of excess funds. This study, undertaken at the request of the House Committee on Post Office and Civil Service, addresses these questions and poses several alternatives to current policy on the FEHB reserve system.

This staff working paper was prepared by R. Mark Musell of the General Government Management staff of CBO's Office of Intergovernmental Relations, under the supervision of Stanley L. Greigg and Earl A. Armbrust. Johanna Zacharias edited the manuscript, and Norma Leake typed the various drafts and prepared the paper for publication. In keeping with CBO's mandate to provide objective analysis, the paper offers no recommendations.
 

Alice M. Rivlin
Director
June 1981
 
 

SUMMARY

CHAPTER I. OVERVIEW OF THE FEHB PROGRAM AND ITS RESERVES

• How the System Operates

CHAPTER II. THE SIZE, ALLOCATION, AND USES OF FEHB RESERVES

• How Large a Reserve is Necessary?
• Who Should Hold Reserves?
• Disposal of Excess Reserves

CHAPTER III. OPTIONS FOR CHANGING THE LEVEL AND ALLOCATION OF FEHB RESERVES

• Option I. Limit Reserve Accumulations to Present 0PM Guidelines and Require Disposal of Excess Reserves in Next Contract Year
• Option II. Limit Reserve Accumulations to 0PM Guidelines, Require Disposal of Excess Reserves in the Next Contract Year, and Have the Federal Government Hold All Reserves
• Option III. Impose Lower Reserve Limits, Require Disposal of Excess Reserves in the Next Contract Year, and Have the Federal Government Hold All Reserves

APPENDIX A. SUMMARY DATA ON FEHB PLANS

APPENDIX B. OUTLAY EFFECTS OF OPTIONS
 

TABLES
1.	GROWTH OF FEHB RESERVES: CALENDAR YEARS 1971-1980
2.	COST ESTIMATES FOR GOVERNMENT-WIDE FEHB PLANS: CALENDAR YEARS 1976-1980
3.	ALLOCATION OF FEHB RESERVES: END OF CALENDAR YEARS 1971-1980
4.	ESTIMATED EFFECTS OF FEHB OPTIONS ON FEDERAL BUDGET OUTLAYS: FISCAL YEARS 1982-1986
5.	AVERAGE FEHB RESERVE LEVELS AND ALLOCATION UNDER ADMINISTRATION PROJECTION AND CBO OPTIONS: FISCAL YEARS 1982-1986
6.	FEHB PREMIUM REDUCTIONS UNDER CBO OPTIONS: FISCAL YEARS 1982-1986
A-1.	SUMMARY DATA ON FEHB PLANS: CALENDAR YEAR 1979
B-1.	OUTLAY EFFECTS OF OPTION I RELATIVE TO ADMINISTRATION ESTIMATES: BY FISCAL YEAR
B-2.	OUTLAY EFFECTS OF OPTION II RELATIVE TO ADMINISTRATION ESTIMATES: BY FISCAL YEAR
B-3.	OUTLAY IMPACT OF OPTION III ON ADMINISTRATION BUDGET ESTIMATES: BY FISCAL YEAR

 

In setting annual premium rates for the Federal Employees Health Benefits (FEHB) program, the Office of Personnel Management (0PM) and the more than 80 insurance carriers with which it does business negotiate program income that covers costs and overhead, and that usually yields some surplus. The surplus, held partly by the government in individual "contingency reserves" earmarked for each carrier and partly by each carrier in "special reserves," is intended to serve as a hedge against unforeseen adverse cost fluctuations in the contract year. Aside from how they are held, the two types of reserves differ little.

Over the past decade, the FEHB program's reserves have increased about fourfold, reaching $490 million in 1980, or 15 percent of the year's income from premiums; 0PM guidelines specify reserve levels of about 14 percent. This growth, partly resulting from overestimates of program costs used in annual rate setting, has drawn attention to three questions:

• What level of FEHB reserves is necessary?
  
  
• How should reserve holdings be allocated? and
  
  
• By what means should reserve excesses be disposed of?

Reserve Levels

Although holding reserves is a generally accepted way to hedge against future cost variations, no specific level of reserves for FEHB has ever been agreed on. The current practice is to tailor reserve sizes to particular plans, allowing relatively larger reserves for smaller plans, which may have less nonfederal capital to draw on and smaller pools of enrollees among whom to spread risk. Overall reserve levels for the FEHB program as a whole have averaged 19 percent of premium income throughout the past decade. Analyses by various agencies, including the Congressional Budget Office and General Accounting Office, however, suggest that an overall reserve level as low as 6 percent of premium income might well be adequate.

Allocation of Reserves

At present, some 20 percent of FEHB program reserves rests with the participating carriers, and according to the Administration's projections, the carrier-held share will decline to around 13 percent over the next five year. Allowing carriers to hold reserves, however, conflicts with governmental financial management objectives that would prevent nonfederal entities from holding federal cash balances. Indeed, there is little reason for carriers to hold any part of the FEHB reserves. All FEHB reserves could be held by the government, specifically by the U.S. Treasury.

Disposition of Excess Reserves

If overall FEHB reserve levels are to be brought down, a way must be found for disposing of the excess money. Several approaches could be considered. Under current practice, excess accumulations are used over two or three years to defray future premium rate increases. Drawing down all excesses in the next contract year instead would improve equity, because enrollees whose premiums helped create a surplus would more likely be the same enrollees to benefit from its use. Excess reserves could also be disposed of through rebates or through additional benefits. Rebates would be the most equitable approach, but they could increase program overhead and encounter administrative problems. Using excesses for additional benefits could ultimately be more costly than other methods, unless the new benefits were cancelled when the excess was exhausted.
 

OPTIONS FOR CHANGING THE LEVEL AND ALLOCATION OF RESERVES

In response to the above concerns about FEHB reserves, three options for change are outlined below. Over the next five years, each would reduce total reserve accumulations--by 30 percent under Options I and II and by 70 percent under Option III--below levels now projected by the Administration. Excess reserves would defray future FEHB premium increases by as much as $1.09 billion through 1986. Two of the alternatives, Options II and III, would also transfer all carrier-held reserves to the federal government.

Contrary to what might seem obvious, using excess reserves to defray premium rate increases would increase five-year budgetary outlays. This would occur because reduced premiums would decrease program income from enrollees and from off-budget agencies, which contribute to the program. Premiums from on-budget agencies represent internal budget transactions that do not affect total federal budget outlays. The additional outlays, however, could be partly offset if the special reserves now held by carriers were transferred to the federal government. Cumulative net outlay increases estimated for each option reflect these impacts and represent changes from the Administration's budget projections through 1986.

Option I. Limit Reserve Accumulations to Present 0PM Guidelines and Require Disposal of Excess Reserves in Next Contract Year

Option I would limit total reserve accumulations to the 14 percent of premium income specified in 0PM guidelines. Excess reserves under this plan would be used to defray rate increases during calendar year 1982, the next contract year, rather than over two or three years. The lower reserve levels would reduce premium income by some $540 million over five years, of which $230 million would benefit enrollees at an average of $12 per enrollee for each year. Five-year outlays under this approach would increase by $190 million.

Option II. Limit Reserve Accumulations to 0PM Guidelines, Require Disposal of Excess Reserves in Next Contract Year, and Have the Federal Government Hold All Reserves

Option II would impose the same reserve levels as Option I, thus achieving the same premium reduction. But in addition, it would transfer carrier-held reserves to the federal government. This transfer, phased in over three years, would bring FEHB into conformance with federal financial management objectives and would thus result in outlay increases of only $85 million.

Option III. Impose Lower Reserve Limitations, Require Disposal of Excess Reserves in Next Contract Year, and Have the Federal Government Hold All Reserves

Like Option II, this approach would transfer carrier-held reserves to the federal government. But, consistent with various analyses, it would restrict reserves to much lower levels. Cumulative reserves for all FEHB plans would average about 6 percent of premium income instead of the recent 15, with levels for particular plans still determined by plan size. The option also permits short-term Treasury borrowing by FEHB to backstop any shortfalls brought about by underfunding. The lower reserve levels would reduce premiums by $1.09 billion through 1986--about double Option I and II reductions--and increase outlays by $375 million. Of the total premium reduction, about $455 would benefit enrollees at an average annual savings of $23 per enrollee for the five years after implementation.

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