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Services Versus Profits: What Is Really Ailing Our Health Insurance?



The cost of health insurance has been on a never-ending upward spiral in recent decades. Occasionally, such as during the mid- to late-1990s, premiums have increased only marginally over the previous year. But in most years, such as during the late 1980s and early 1990s, and each year since 2000, there have been double-digit increases, far outpacing the rate of inflation.

Health insurers routinely claim that the rise in premiums, as well as their hikes in copayments and deductibles, is due to the rising fees of hospitals, doctors, pharmaceuticals, and other elements of the health care delivery system. Surely these increases have an impact, as pressures from all sides plague the entire health care system. The squeeze in one area affects all others, as well.

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The high cost of health insurance is, in itself, another of the culprits. Many people are uninsured because they cannot afford health insurance. The shift of costs from treating those who are uninsured and are unable to pay for health care (and from treating Medicare and Medicaid patients, due to reimbursement reductions) to those with health insurance also plays a significant role in the rise.

Insurers also cite the vicissitudes of the insurance underwriting cycle, which is shrouded in accounting manipulation and obfuscation. They claim that the nature of any insurance business is cyclical, with greater losses in some years than in others, leading to variations in profit margins. Yet, health insurance utilization forecasting for a large number of people is less subject to major fluctuations than property-casualty insurance, which can be dramatically impacted by weather, natural disasters, and other events. Barring a major public health crisis, among millions of people, the incidence of certain diseases, conditions, and treatments is relatively predictable year to year. In discussing the underwriting cycle, the habitual failure of insurers to provide detailed information about the way they calculate profits and investment income is highly suspect.

There are also major impacts from the increase in insurer expenditures on administration and overhead. For example, in one study by the U.S. Government Accountability Office during the 1990s, it was estimated that $34 billion in administrative expenses would be saved if the U.S. had a health care system that does not include insurers and HMOs, due to their administrative and overhead fees. In 2008, the Center for Medicare and Medicaid Services at the US Dept. of Health and Human Services conservatively estimated that, of the over $2 trillion spending on health care in the US each year, administration and profits of health plans alone account for 7% of the total (over $14 billion annually).

In light of such large potential savings, it is mystifying that there has not been much detailed discussion about how such administrative and overhead dollars are spent. When overhead costs are questioned, insurers often switch topics to the cost of malpractice insurance and court settlements, which account for only a tiny percentage of health care and insurer costs.

Health insurer price hikes require a closer review. There is reason to believe that their profit margins have been increasing along the way. Despite the protestations of many health insurers, there are ways to identify trends in their profits and non-treatment related spending, beyond the financial metrics that the companies are most willing to publicly share.

Ideas / Solutions

American consumers and other health care stakeholders deserve a better system for monitoring the flow of health care dollars.

The first step toward accountability is a standardization of health plan terminology, to promote transparency in how health care premium dollars are spent. Currently, the lack of uniformity enables carriers and health plans to disguise their finances by creating and redefining categories of expenditures. There are frequent discrepancies over the appropriate category in which to place specific expenses. This multiplicity creates considerable confusion, defies easy analysis, and affords accountants flexibility to structure, hide, and characterize many expenses as they see fit. Effective governmental monitoring and consumer protections are therefore impeded. Ideally, the terminology should be nationally standardized, developed by Federal representatives together with the National Association of Insurance Commissioners, particularly as many carriers operate in multiple States. Since States have primary authority for insurer and health plan regulation, the States would then need to embrace these uniform definitions and categories.

Some groupings are more common, such as "general administration", which includes rents, phone, utilities and professional services such as actuaries and accountants. Another common category is for "claims processing expenses", which typically includes all activities related to the screening, denying, and paying of claims, as well as the billing for premium payments. But the costs associated with "sales" become murkier, as they include advertising, marketing, sales commissions, and even travel, conventions, and conferences.

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Perhaps the most difficult category to definitively monitor is corporate profit. Part of the problem is that there are many ways to designate revenue flows, by labeling them as profit, corporate reinvestment, shareholder dividends, risk capital, and reserves. These categories do not even include the high-dollar bonuses that are often paid to high-level executives.
The second step to promote accountability is to standardize use of specific metrics or indicators with which to monitor spending practices, again through a Federal-State partnership. The unclarity surrounding profits stems from insurers and health plans using indicators that put their finances in the best possible light.

The information is often presented as ratios that purport to indicate their corporate performance. Carriers commonly refer to "loss ratios", which are presented as the amount of claims or benefits that they paid (i.e., losses), over the amount of premiums collected. But this ratio has at least two major problems. One is that the amount of premiums stated in the denominator inconsistently varies between direct premiums, gross premiums, net premiums, earned premiums, and other premium calculations, each of which can keep the consumer or analyst scratching their head. Standardization is very necessary.

The other problem is that it erroneously creates the impression that the rest of each dollar, which is not spent on claims or benefits, is all that is left from premiums received. Loss ratios imply that health insurers only have premium dollars to work with, and no other finances.

For example, a loss ratio of 75% means that for every one dollar of premiums written (or collected), seventy-five cents worth of health care was administered. That seems to mean that only twenty-five cents of each dollar went toward administrative expenses, claims processing, sales, and profits. But that is simply not the case. One of the major income sources of insurers is investment income. During the time between the receipt of premiums and the payment of claims, insurers are making investment money off of premiums. But that reality is not reflected in a loss ratio. Agent commissions alone are often so sizeable, that insurers would not forestall bankruptcy if they only had twenty-five cents with which to pay commissions in addition to operating their core business functions. The numbers simply do not add up.

A more realistic metric of health insurer corporate performance is the "expense to premium ratio". This ratio shows how much money went toward general administration, claims processing, sales, and profits as the numerator, with the amount of premiums written (or collected) as the denominator. This ratio is much less flattering for insurers, as it shows the percentage of premium dollars that went toward the corporate infrastructure (expenses and profits) rather than toward health care for its beneficiaries. A related ratio is the "expense to claims ratio", which directly compares the amount that went toward non-health corporate activities compared to the amount that did go toward actual health care. Both of these ratios give a much more accurate snapshot of the financial health of the carrier than the carriers' preferred loss-ratio shows.

Use of these two ratios can provide a solid starting point for a real discussion of health insurer profitability, and, hence, the appropriateness of annual hikes in premiums, deductibles, and copayments. Along with a standardized approach toward categorizing health insurer expenditures and profits, consumer protection organizations, health care purchasing groups, and government regulators can begin to level the playing field between the gatekeepers of our health care and the millions of Americans who rely upon them. The additional insight which these two initiatives, in tandem, can provide would also illustrate the degree of economic efficiency between and among insurers, and would facilitate reasoned judgments about the industry's value to our health care delivery system.

A standardized approach, including use of the appropriate ratios, is a fair and meaningful way for Federal leadership, State regulators, and both Federal and State oversight, to impose a basic level of accountability on all health plans and health insurers.

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