The 40% Overhead Myth…
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So — for those of you who pay attention to my occasional musings and confessions, I apologize for the time away. I do have a day job, and I’m expected to do it. And for the past few weeks, it’s been pretty hectic. If I’m going to take a few weeks off in the future, I’ll try to post a “Gone Fishin’” sign, or something like that. Okay?
Anyway, I saw a letter to the editor in the Wall Street Journal earlier this week that prompted me to get back on my (high) horse. It was a letter from a physician taking a few shots at the health insurance industry, and among other things, it said, “The current insurance companies operate with a profit margin of 14% and other overhead expenses that total 20-40% of total premium dollars spent.”
I honestly don’t know where this stuff comes from. The non-profit health plans in Massachusetts have operating margins that vary between 1 and 3 percent of premium, and generally speaking, spend about 10 percent of premium on administering their business. Overall — including operating margins — the industry spends about 13% of premium on itself — and spends the other 87% of premium on medical care — hospitals, doctors, ancillary service providers, pharmacies and pharmaceuticals, and the like.
The for-profit plans have much higher margins than the non-profit plans, but even the most profitable ones — in their federally mandated filings — show about 80 cents on the dollar, or more, going out the door to pay for health care services. This notion that health insurance carriers keep 40% of premiums is simply unreal — and yet I’ve been hearing it for years.
Maybe that’s our fault — for doing a bad job of explaining where the money goes — but it’s incumbent on everyone who’s part of this discussion to put real numbers on the table when we debate health care costs and what we might be able to do about them. Forty percent overhead to the health insurance plans is not a real number.
A better question may be - what is the return on administrative cost growth?
If admin costs are growing with medical trend at 2+ times the rate of inflation (keeping MLR constant), where is the extra money going? Most insurers have opened their networks, dispensed with pre-authorization, increased electronic claims volumes, and (in some cases) sent call centers offshore - all of which should reduce admin cost per unit of service, not increase it.
For-profit insurers have ridden trend to produce ~15% earnings growth year over year. What have the non-profits done with these funds? HPHC is to be lauded for its quality achievements, but why haven’t these increased admin dollars yielded more cost control, for example?
Grady - most plans have reduced their administrative allocation as a percent of premium over the past ten years or so - from about 15% of premium down to the numbers mentioned above. And your characterization of how we’ve changed is interesting. You think we do less in the utilization space and have modernized/digitized some transactions. True. But overall, I think we’ve gotten more complicated - gone from just being a fully insured HMO with a defined set of benefits and services, to being a multi-product health plan with hundreds of different product offerings and funding arrangements to meet more specific market/employer/employee needs and expectations.
In addition, half of our business is now self-insured - where we administer tailored plans designed in many cases by the employer.
And our operating margins in MA have remained pretty constant - plus or minus 1-2 percent - as our medical expense trend has climbed along with our premium trend.
Finally, you sort of answered your last question (what about more cost control?) with your earlier observation about network expansion. Simply put, the broader and more accessible the provider network, the higher the price. People chose broader networks over lower prices in droves over the course of the past ten years.
Charlie - In 1992, Ken Thorpe published a paper in Health Affairs titled “Inside The Black Box of Administrative Costs” which is probably the best piece on the subject that I’ve seen. In it, he shows that administrative costs can indeed consume up to 40% of the premium dollar in the individual underwritten market. Between underwriting costs, broker commissions, advertising and marketing costs combined with very low premiums for the very healthy people who can pass the rigorous underwriting screen, you wind up with very high administrative costs as a percentage of a much lower premium than would prevail in a pure community rating state like NJ or a modified community rating state like MA. This segment, however, accounts for less than 10% of the total private health insurance market nationwide in terms of members and significantly less than 10% of premiums collected.
1992…GAK! That was kind of a long time ago. Things do/have changed a bit since then. The 10-11% number I’ve quoted here includes all the stuff you mention above. And I think your point about individual policies vis.a.vis. group policies, even in non-regulated individual market states, would still hold true. The group market is the dominant market, and the individual market is a small piece of the total picture.