The Business of Health Insurance and “Obamacare”: What Can We Expect?

By Robert E. Prasch

Over the past couple of years there has been considerable back-and-forth over what has been accomplished by the Patient Protection and Affordable Care Act of 2010 (PPACA).  While a short post cannot survey the entirety of this multifaceted law, several elementary confusions have been repeated in public discussions and should be addressed in the interest of clarification.  The most urgent of these is to point out that, despite the Act’s (deliberately misleading?) title, it addresses neither the practice of medicine nor its cost.  At most a government-sponsored institute has been authorized to find and make suggestions.  The Act, then, is not about making health care affordable, but an effort to make health-care insurance affordable – a related but separate topic.  To understand the implications of this, we must consider the business of health insurance.

Private Health Insurance is a Business

The health insurance business is–it cannot be overemphasized–a business.  While its advertising may suggest otherwise, we would do well to remember that business differs from charity in ways that matter.  Being private for-profit businesses, health insurance companies are engaged in the pursuit of profit.  If the health insurer is a corporation, and many of them are, their profits are expected to show steady growth over time so as to satisfy “Wall Street expectations.”  This is not always easy, and firms must be vigilant if they are to achieve these targets.  As is the case for any and all businesses, revenues must be greater than expenses if health insurance companies are to show a profit.  Without profits they will soon cease to exist.  But before this occurs, senior management will be fired.  As they understand this, we should expect these managers to make every effort to avoid this outcome. None of this, it should be noted, implies that health insurers are more or less moral than other firms.  Business is business.  With that point cleared up, let us turn to specifics.

The revenues of health insurers come from customer premiums and the returns on their portfolio of earlier premiums that have been invested.  Their usual portfolio can vary, but it generally consists of government and corporate bonds (about 65%), corporate stock (about 10%), mortgages (including some mortgage-backed securities), cash and other liquid items, and other assets.  Expenses can be broken down into essentially three components.  The first includes all marketing costs, paperwork, and related overheads.  The second is wages for workers and bonuses for bosses.  The third, and by far the largest expense, is the payment of claims.

From the above list it is evident that insurance company profits can rise in one of four ways: (1) revenues from current premiums or past investments can rise (which may imply higher premiums and/or riskier investments),  (2) marketing, paperwork and overhead costs can be reduced, (3) wages and bonuses can be reduced, or (4) payments for claims can be reduced (or at least rise more slowly than revenues).

Given that the payment of claims are, by far, an insurance company’s largest single expense, it is reasonable to suppose that they will work diligently to control or even reduce them.  To this end, they hire staff to negotiate with hospitals and others over the appropriate charges for services provided.  Similarly, they employ a staff to direct customers into lower cost options, assert that the “normal and standard cost” for a given procedure is lower than the bill presented (which means that the patient must shoulder a disproportionate share of the payment even if their insurance contract suggests that they always pay a fixed percentage), or find some grounds to decline care altogether which in the past has included finding grounds for cancelling the policy.

For patients and their families, these cost-reducing decisions can be, as innumerable stories and research has shown, medically and financially devastating.  It is clear to everyone with a beating heart that these – essentially business decisions — are fraught with moral implications.  Yet, of necessity, insurance companies must think of them as part of their normal business operations.  One is reminded of the cliché line uttered by mafia movie assassins, “Sorry man, it ain’t personal, its just business.”

This difference in perspective raises a crucial observation.  Every society must decide, by some process, how goods and services are to be distributed amongst the population.  Most of us would agree that some items, such as ice cream or the vagaries of current fashions in clothing, are best left to markets.  The difficulty, and this is the largely unmentioned issue, is that most of us also believe that decisions fraught with profound moral implications – such as life and death — should not be left to the vagaries of the market.

If this supposition is correct, then the problem with privately-provided health insurance is less with the specific performance of the firms involved than with the fact that many, if not most, of us consider basic health care to be closer to a right than a commodity to be distributed according to the contingencies of price and income.  As such, we find the normal business decisions of health insurance firms, decisions that are necessary and essential to their business operations, to be at best amoral if not immoral.  That people are awarded bonuses for denying care to people they have not met, and on the basis of little more than a cursory look at a chart and some statistics based on national averages, strikes most people as wrong.  Again, if this were the market for ice cream or fashionable clothing, our response to the cost control efforts of for-profit health insurance companies would be very different.  But it is evident that firms are routinely making decisions that are fraught with the deepest moral significance.

Obamacare: What Does It Do?

As mentioned, when reading popular discussions, blogs, and more than a few newspapers, one is left with the impression that many people are confused about the distinction between health care and health insurance.  Stated simply, the PPACA does not grant anyone, anywhere, a guarantee of adequate health care.  The Patient-Centered Outcomes Research Institute that has been founded as part of the Act may, at best, fund investigations designed to uncover and publicize inefficiencies in the delivery and cost of health care.  But they cannot mandate changed practices.  At best, these revelations can be accompanied by exhortatory language.  Someone, somewhere, somehow, is then supposed to do something.

What PPACA does do is require that every American find a way to acquire health insurance.  Most likely, as in Massachusetts, this will be enforced through the tax code.  This suggests that those without health insurance will have to pay for insurance out of pocket and then await compensation in the form of a tax rebate.  If this is indeed the plan, it should raise important questions concerning the liquidity or credit-worthiness of America’s poorer households and the many well-known issues surrounding predatory lending that were not addressed in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Perhaps it is obvious, but it also needs to be stated, that on its own the health insurance mandate modifies neither the incentives nor the profit motives of private health insurers.  That said, some useful changes are embodied in the Act.  For example, in exchange for the law’s producing just under 50 million new health insurance customers through its mandate, health insurance companies will be required to spend 80-85% of the premiums they receive (depending upon the firm’s size) paying for health care and, additionally, to cease terminating contracts after the disclosure or revelation of “pre-existing conditions.”  Now, with the additional revenues anticipated from millions of new customers, the first of these requirements may or may not prove to be an imposition.  I would, however, caution everyone to be wary of the accounting rules used in calculating what is known in the industry as the Medical Loss Ratio.  It is often, and correctly, said that the devil is in the details (this is especially the case when an industry can employ legions of lobbyists).

As to the second requirement, it speaks only to the grounds by which a proposed course of care may be refused.  Let us consider the problem logically and from the perspective of a profit-seeking firm.  If there are potentially grounds, from A to Z, by which to deny or modify a proposed course of care, and grounds A are excluded, that still leaves grounds B to Z.  Perhaps none will be found applicable and the care in question will be duly authorized.  But perhaps alternative grounds can be identified, and it should be evident that the incentive to find such grounds remains.  Maybe the insurance company will find the course of care proposed by a patient’s doctor to be “overly experimental” or “unlikely to be effective” in light of statistics based on national averages that they may have on hand but whose source or author they will refuse to disclosure (believe me, I have tried).  Alternatively, they may declare that the “normal and standard cost” of the course of care proposed is one-half of what the hospital charges, thereby forcing a family to “chose” between a course of care and penury.  These problems can be expected to remain.

According to the American Journal of Medicine, 62% of all the people who declared bankruptcy in the year prior to the financial crisis, 2007, were ruined by an illness they could not afford.  Worse, the majority of those who declared bankruptcy that year were covered by heath insurance.  Stated simply, health insurance, even assuming that it actually becomes affordable to everyone, will not end of the dread of financial ruin in the event of a severe illness.

This brings us to the matter of the how much assistance will be provided to help families meet the mandate.  We are told that everyone up to 400% of the poverty level will be eligible for a subsidy (based on a sliding scale).  Given the current political environment, with its bi-partisan vogue in favor of austerity, I will leave it to the reader to speculate whether or not these subsidies will remain adequate as health costs and thereby health insurance premiums continue to rise.  We can be certain, however, that the mandate will remain in place long after the subsidies become inadequate.  And, what of the days when American families had to chose between adequate care and penury?  Such dire choices will remain a part of our reality the day after the PPACA has become fully operative and every day thereafter.

9 Responses to The Business of Health Insurance and “Obamacare”: What Can We Expect?

  1. Regarding the MLR, most insurers were in the 80-85 % range BEFORE the ACA was even signed, so basically a non-issue there.

    It is not difficult to see what an absolute mess our healthcare system is, and that the model of the private health insurance monopolies has been broken for a long time. This effects both sides of the health care equation, the insurance side as well as the provider side, who are forced to employ entire departments for the handling of referrals, claims, authorizations, etc.

    Single-payer, it is the obvious answer. Let’s not pretend that this is a complicated solution. I think perhaps the only politically feasible path towards this end is on a state-by-state basis, Vermont currently appears to be the only state taking a serious initiative with this. But, once you have one state make it work, then it should spread quickly.

    • The MLR may not have much practical effect, but it’s been great political capital. The implication whenever politicians say they’ve forced insurance companies to pay 85% of premiums for care is to imply that today insurance companies are gouging consumers to pay for big bonuses to executives. However, facts and politics rarely meet.

  2. John McDonough

    There are several ways to reduce costs in health care.
    1. Single Payer, as they have in Canada. See this article referenced by Physicians for a National Health Program. Administrative costs in the US are 31% of all costs; in Canada it’s 16.7. That difference means 13.3% X $2.6 Trillion = $345.8 Billion could be saved by going to single payer.
    http://www.pnhp.org/single_payer_resources/administrative_waste_consumes_31_percent_of_health_spending.php

    2. Pharmaceutical Advertising. We are the only country that allows pharmaceutical advertising directly to consumers. That purportedly raises our drug costs by 30%. Drug costs make up 10% of our health care costs so 30% X 10% X 2.6 Trillion = 78 Billion

    3. Entrepreneurial doctors have extremely high charges compared to doctors/hospitals that agree to charge Medicare approved rates as in the Grand Junction Colorado medical district or in organization like Mayo Clinic where doctors are on salary. Savings could be as much as half of provider costs which are 21% of all medical costs. So 0.5 X 21% X 2.6 Trillion = $273 Billion. Of course provider costs also include administrative costs so there is probably some overlap there.

    And this doesn’t begin to look at savings from better practices, fraud prevention, etc.

    Total savings from just those 3 items = $696.8 Billion

    • Reductions in Administrative costs are one way to look at possible savings. But it doesn’t take into account the effects of monopsony vs. oligopoly in the market. With the Government as a single payer remunerations for providers can be driven down quickly. Canada spends about 11% of its GDP on health care. We spend about 17%. The difference $960 B per year. If we could get those savings with Medicare for All we could bring down health care costs to 1.8 T per year or so.

      This, however, would entail the Government spending about $900 B more than it spends now on Medicare, Medicaid, VA, Tricare, etc. So the question that comes up is where will the money come from. I say let the Government deficit spend it. That’s about 5.6% of GDP. Since 6% private savings and 4% trade deficit means we need to run a 10% deficit. This seems like good deficit spending to me, especially since it would save the private sector about $1.8 T per year relative to what it spends on health care. That kind of continuing stimulus should cut into unemployment quite a bit.

    • Canada does not have a single payer system. If memory serves me, it has ten payers, one for each province. Each one is essentially financially independent from each of the others. The provinces supply the majority of the funding and the quality of care, ease of access and even (in one case) the benefits can differ between provinces.

      For the record, the United Kingdom, Germany, Japan, and the Netherlands all finance their health care through systems that are NOT single payer.

      It would be helpful to the debate the in US if people would do some real research on how other countries actually finance their healthcare before using them as examples of how policy should be set here.

    • Counting the savings due to moving to a “single payer” (!) system like Canada and then counting savings due to lower provider reimbursement is double counting in a massive way. The $700 billion savings John comes up with is best described as “pretend”.

  3. Might be nice of concluded with a synopsis or NET of the NET as only 1 paragraph would be fine.

  4. My biggest complaint about this article is that much of it is founded on the presumption that the best way for an insurance company to reduce expenses is to control or reduce claims payment. The author defends this argument by suggesting it is “reasonable to suppose”, but supposing is an insufficient foundation for an article on a large and complex financial system.

    In fact, the argument is incorrect because it fails to consider the pricing process. Because pricing depends on observed trend, reducing (through whatever measure) claims payments results in lower rate increases the following renewal period. In the aggregate and over time, an insurance company saves very little by putting pressure on claims payments. This does not mean they have no interest in keeping claims costs low – after all, it is a great way to lower premiums. However, the incentives don’t work the way Robert describes, since insureds may prefer higher premiums to the alternatives, such as a smaller network or reduced coverage.

    A second shortcoming of the article is that it attempts to explain and/or predict the behavior of insurance companies using only the Minimum Loss Ratio and a non-change in laws relating to policy rescissions. Robert ignores the impact that the risk corridors, reinsurance and risk adjustment, which could be substantial. The impact of plan design (given the “actuarial value” requirements) and the exchange should be considered as well. These issues go directly to his concerns about insurance company incentives, and their absence is very strange.

    While the Minimum Loss Ratio will certainly have an impact, the analysis in this article is insufficient to determine what it will be. Robert mentions premium from new members, but neglects to mention the claims as well – whether the new members increase or decrease the MLR depends on both. An important issue to consider when discussing the MLR is whether it is easier to shrink the numerator or blow up the denominator – after all, as I’ve mentioned, increased claims cost will allow for increased premiums in the future. This should have been addressed. Robert says that, when it comes to the MLR accounting, the devil is in the details, so why doesn’t he go into them? We have an interim and a final rule from the HHS. Surely he’s read them. . . right?

    The majority of this article depends on a supposition that isn’t true. The rest is incomplete. I would strongly advise against using it as a platform for better understanding the Affordable Care Act and its impact on health insurance in the US.

    (I’m having some trouble posting, if this gets double posted please feel free to delete)

  5. There are a few other points in Robert’s article that deserve mention.

    He states that the mandate will likely be “enforced through the tax code”, and he is correct. A reading of the bill and subsequent legislation shows that the IRS is the government agency responsible for handling issues related to the mandate, though it isn’t as obvious how much force they’ll actually apply.

    As another poster mentioned, Robert misunderstands how the subsidy works. An insured who wants the government subsidy will purchase the policy on the exchange. The government will pay the subsidy to the insurer directly, and the insurer only bills the policy holder for the difference, assuming there is one. Robert’s concern about the insured waiting for a tax rebate is unfounded, and it isn’t obvious why he has it.

    Robert states that there will be just under 50 million new health insurance customers. It would be helpful if he would post a reference for where he obtained this estimate, as it doesn’t agree with any I’m familiar with. I think he’s including newly Medicaid covered individuals who are not health insurance “customers”. In fact, the number of new insurance company customers is likely less than a third of this value.

    Robert states that insurance companies must “cease terminating contracts after the disclosure or revelation of ‘pre-existing conditions.’” Prior to the ACA, insurance companies could only rescind policies in the case of fraud (due to HIPAA). After the ACA, insurance companies can only rescind policies in the case of fraud. The rules haven’t changed much, but there has been additional paperwork added to the process, which may (or may not) reduce rescissions in the future. Probably a bigger factor in reducing rescissions is the political cost of incurring them.

    Robert mentions the health insurance mandate several times, but never mentions its size. This detail is critical, as it impacts incentives for both customers and insurance companies.